Bankruptcy Law Part 1

What are the two objectives of Bankruptcy Law

1. To allow honest , insolvent debtors to surrender their assets and obtain a release from their debts, a “Fresh Start”

2. Give all creditors a fair opportunity to share in debtor’s limited assets.

Only who can give debtors a DISCHARGE

Federal Bankruptcy Courts

Voluntary Petition

Filed by the debtor → They want to be in bankruptcy

Involuntary Petition

Filed by creditors

What are the two requirements individuals must meet to file a Voluntary Petition for bankruptcy

Must pass the Means Test, and complete Credit Counseling.

Means Test Requirements for Chapter 7 Bankruptcy?

A. Debtor’s income is less than the state median income or

B. Looking at Debtor’s projected income over the next 5 years, and after deducting expenses, Debtor is unable to pay creditors a certain minimum amount.

Individuals must receive credit counseling before what?

Before they can file a voluntary petition and complete a personal financial management course before getting a discharge.

Why do we have credit counseling?

To make sure debtors actually belong in bankruptcy.

Why is a financial management course required?

To make sure debtors don’t come back filing bankruptcy every few years.

Within 45 days after filing a petition a Debtor must do what?

They must disclose its assets and liabilities and provide a list of creditors. → they must give addresses, amounts owed, and provide tax returns.

In listing creditors, why is there a tendency to be over-inclusive?

You would rather be over-inclusive because if you forget a creditor and they have a debt on you then they can come after you.

What are the two immediate effects after filing a voluntary petition?

An Automatic Stay, and the court appoints a Trustee In Bankruptcy

An Automatic Stay?

Stops all lawsuits, foreclosures, creditors from trying to collects debts from you after filing petition. → Doesn’t apply to criminal matters or support allocations like child support.

Trustee in Bankruptcy?

Instantly get a lien on all assets and can distribute that on all creditors.

If there are 12 or more creditors for a involuntary petition, how many must sign?

At least 3 creditors must sign. If fewer than 12, any creditor may sign.

In all cases, creditors who sign a involuntary bankruptcy petition must be owed what?

They must be owed in the aggregate at least 21,050 in unsecured debt → the number changes every three years

What happens if a debtor challenges the involuntary petition?

The court holds a hearing. If the petition doesn’t meet legal requirements , it is dismissed. Petitioning creditors may owe costs, attorney’s fees, and possibly punitive damages for bad faith.

Why should you not use involuntary petitions as a routine means of debt collection

Courts will dismiss the case and may enforce penalties on creditors who file frivolous or bad faith involuntary petitions.

What does filing an involuntary petition do?

It creates a GAP PERIOD

Gap creditors and what do they do?

Creditors who only arise during involuntary petitions → They help offer finances during the gap period and get high priority for repayment.

Why should Gap Creditors get high priority over other creditors?

Because if they didn’t get high priority than we would have a problem that would mean it be almost impossible for the debtor to get financing → It would be unfair if debtor get no financing during gap period

The trustee collects the debtors assets. What can they recover?

Only the assets owned by the debtor when the petition was filed.

What are the three exceptions for property received by the debtor within 180 days after filing the petition?

1. An inheritance

2. Property acquired by the debtor as result of divorce

3. Proceeds from a life insurance

Exempt Property

Assets that a debtor is allowed to keep during bankruptcy proceedings, often including necessary items for living and working.

What are the typical exemptions?

1. A certain dollar amount of equity in a residence, car, and other personal property

2. Prescribed health aids

3. Tax empt retirement accounts

What happens if the debtor has equity in property?

The trustee will take the property and pay the debtor its equity, up to the maximum allowed under the state’s HOMESTEAD EXEMPTION. (the value of the property minus the debt secured by the property)

Assume the state homestead exemption lists $50,000 of equity in the debtor's principal residence and the debtor's home is worth $200,000 but is subject to Bank's mortgage which has a $130,000 balance.

A. What is Debtor's equity in the house?

A. 70,000 → (200,000 - 130,000)

Assume the state homestead exemption lists $50,000 of equity in the debtor's principal residence and the debtor's home is worth $200,000 but is subject to Bank's mortgage which has a $130,000 balance.

B. How much, if anything, do each of the following receive: 1.Debtor, 2. Bank, 3. Other Creditors

1. Debtor →50,000

2. Bank → 130,000

3. Other Creditors → 20,000

Virginia’s Homestead Exemption allowed a debtor to exempt several types of property, including “One horse.” Shortly before declaring bankruptcy, Debtor sold all his non-exempt property and bought a $640,000 thoroughbred horse. He claimed an exemption for the horse and declared he had no non-exempt property. The trustee in bankruptcy challenged the exemption.

issue Is there a right to convert non-exempt assets to exempt assets before filing the petition?

Yes, debts have the right to do that

Debtor won because the courts can disallow the exemptions if it was used in a fradulent manner.

When can courts take away an exemption in bankruptcy?

If it was Fraudulent

Federal Rule?

In order to elect a states list of exemptions, the debtors must have lived in the state for the two years before filing the petition.

What other three broad powers does the trustee have?

1. Trustee steps into the debtors shoes to enforce creditors claims

2. The trustee can set aside PREFERENCES

3. The trustee can set aside (clawback) fraudulent conveyances

PREFERENCES?

Pre-petition payments preferring one creditor over others

Why would a debtor set aside preferences?

If creditors are family friends and prefer them → non dischargeable debt that will have to be paid anyway

What are the two ways to recognize a voidable preference?

A. Applies only to antecedent debts, not to “Substantially contemporaneous exchanges (Does not include paying a months bill)

B. Made within 90 days before filing the petition, or 1 year if the preferred creditor is an insider → family member business associate

Rich carelessly injured his brother, Poor. As a result, Poor has big medical bills he cannot pay. Poor could sue Rich, but instead Poor goes to court, not to sue his brother but to file a petition in bankruptcy and get a discharge of his medical bills. What could go wrong with this strategy?

Bankruptcy may discharge the debts, but it won't give Poor money to cover his medical bills—only suing Rich could do that

Skipper needs to declare bankruptcy soon but doesn’t want his $80,000 boat to be taken to pay creditors. So, Skipper sells the boat to his friend, Ginger, for $200 with an understanding that Skipper can use the boat anytime he wants. A few weeks later, Skipper files a petition in bankruptcy. Can Ginger keep the boat?

No, the transaction took place less than two years before filing the petition of bankruptcy and may be considered a fraudulent conveyance, allowing the trustee to recover the asset.

Time element to identify (Clawback) fraudulent conveyances?

Transfer was made within 2 years before filing the bankruptcy petition.

Indicators that identify (Clawback) fraudulent conveyances?

A. Made with an intent to delay or defraud a creditor (subjective) or

B. Debtor received less than reasonably equivalent value while debtor (objective) was insolvent or became so as a result.

A parent paid all their child’s tuition to an expensive university, and then within a year, the parent declared bankruptcy. The Trustee in Bankruptcy demanded the tuition payments from the university. What argument can the Trustee make?

The trustee can argue that its hard to prove that your tuition payments are fraudulent and it would be preference. Debtor has to show when they paid and the that the trustee was insolvent.

Disbursement of creditors payment

1. Perfected secured creditors (to the extent of collateral)

2. Priority claims

   1. Each level must be paid in full before the next level receives anything; then, prorate at the level where there is not enough to satisfy all the claims. (Child support, wages, taxes, gap creditors)

3. General unsecured creditors

4. Excess money goes back to debtor

Objections to discharge vs. Exceptions to discharge — when does a debtor not receive a full discharge?

Objection to discharge: Debtor gets no discharge at all.

Exception to discharge: Debtor gets a discharge, but some debts remain.

Unless there is what, a debtor is discharged?

A objection to discharge or exceptions to discharge, creditors are ordered to leave debtor alone.

What two situations can lead to an objection to discharge?

1. Fraud or refusal to obey a bankruptcy court order

2. Failure to explain loss or deficiency of assets

Beth has many debts and no assets. She files a petition in bankruptcy and during the proceedings is asked to explain how she came to be in this situation. Beth truthfully tells the bankruptcy court she took all her money and bet it on a dog at the racetrack. The dog lost.

Will Beth be entitled to a discharge in bankruptcy?

Yes, as she explained to the bank truthfully why she lost money. It doesn’t have to be a good explanation just a truthful one.

What are 4 examples of exceptions to discharge?

1. Student loans, unless “substantial hardship”

2. Liability for intentional torts, not negligence → negligence liability is dischargeable

3. Taxes

4. Amounts above 900 (Until April of 2025) for luxury goods or services charged to a credit card within 90 days before filing.

Would you advise a client to borrow money to pay their taxes before filing for bankruptcy?

No, as the IRS and Congress have laws that stop this loophole.

Any debt incurred to pay off non dischargeable debt has to be what?

Also has to be paid off.

Why are some creditors quite willing to lend to someone who just came out of bankruptcy?

Creditors would see this as a opportunity to charge a higher rate of interest and a debtor would be expected to pay a higher rate.

What happens if a debtor has already gotten a discharge?

The debtor can no longer get another one. Creditor than has 8 years to go after the debtor.

What is an objection to discharge in bankruptcy?

A challenge that, if successful, denies the debtor a discharge of any debts—common reasons include fraud, concealing assets, or lying under oath.

What is an exception to discharge in bankruptcy?

A rule that prevents specific debts from being discharged—examples include student loans, child support, and certain taxes.

What is the means test in bankruptcy?

A calculation used to determine if a debtor qualifies for Chapter 7 bankruptcy by comparing their income to the median income and assessing their ability to pay debts.

What is a voidable preference in bankruptcy?

A payment/transfer made by the debtor to a creditor within 90 days before filing for bankruptcy (or up to 1 year for insiders) that favors one creditor over others and can be reversed by the court.