Ten Bankruptcy Terms
by
Frank J. Kokoszka, Esq.
Kokoszka & Janczur
Almost every attorney,
whether he/she be a litigator, corporate attorney or real estate practitioner,
will be confronted with bankruptcy issues.
The following are ten (very
simple) bankruptcy definitions or "terms of art," that every
attorney should master, to know just enough about bankruptcy to be considered
"dangerous."
1. Adversary
Proceedings: An adversary
proceeding or "adversary" is a lawsuit filed in or within a
bankruptcy case (think of it as a "battle" within the
"war"). Adversary proceedings
are governed generally by Part VII of the Bankruptcy Rules (Rules 7001- 7087),
which incorporate most of the Federal Rules of Civil Procedure. Bankruptcy Rule 7001 lists what type of
matters or disputes must be "fought" as an adversary; i.e., commenced by the filing of a
complaint. Most issues in a bankruptcy
case are not adversary proceedings, but are "contested matters"
(defined below).
2. Applicable Law: Bankruptcy is governed by the Bankruptcy Code
which is Title 11 of the United States Code, the Federal Rules of Bankruptcy
Procedure (the "Bankruptcy Rules"), Local Rules, and to a great,
great, extent, case law. As one
of my bankruptcy mentors, a prominent bankruptcy attorney, once taught me,
"some bankruptcy judges feel compelled to publish every decision they
enter." Bankruptcy law is
constantly being shaped by new case law and the skilled bankruptcy practitioner
must keep abreast of recent decisions.
Please note that state law does come into play in some instances, such
as determining whether something is a valid security interest.
3. Automatic
Stay: Generally, the automatic stay
commences immediately with the filing of a voluntary bankruptcy petition and
the entering of an order of relief in an involuntary case.
There are exceptions where an entity has filed for bankruptcy within certain
time periods. The automatic stay operates as an injunction prohibiting any
collection action against a debtor outside of the bankruptcy court. See Bankruptcy Code Section 362. This includes collection letters, telephone
calls, repossessions or lawsuits against the debtor. There are exceptions to the automatic stay,
and situations in which a party can seek to have the automatic stay modified or
"lifted." The purpose of the
automatic stay is to allow the bankruptcy to go forward in an orderly
fashion. Willful violations of the
automatic stay can subject the violator to punitive damages. Even innocent violations of the automatic
stay (such as a repossession by a creditor who did not know of the bankruptcy)
are void, and must be corrected (for example, by returning the repossessed
collateral).
4. Contested Matters: When the resolution of a disputed matter in a
bankruptcy case does not have to be brought as an adversary proceeding, then it
is a "contested matter."
Contested matters are usually resolved by filing a motion and the
opportunity for a hearing. See
Bankruptcy Rules 7001 (to determine whether something is an adversary
proceeding), 9014, and 2002 (dealing with notice requirements). For example, a creditor seeking relief from
the automatic stay would file a motion, since such is considered a contested
matter.
5. Discharge: A discharge is a permanent injunction against any action
to collect a debt incurred before the bankruptcy filing, unless the debt was
either (1) reaffirmed; or (2) excepted from discharge. A bankruptcy discharge frees the debtor from
the legal obligation to pay the debts which existed prior to the bankruptcy and
provides the debtor with a "fresh start." See Bankruptcy Code Sections 523 and 524.
There are exceptions
to discharge. Corporations and other
legal entities (non-individuals) do not get a discharge when they are
liquidated in a chapter 7 case. There are
time limits to how often a Debtor can obtain another discharge. Debtors who have committed illegal acts in
connection with the bankruptcy or business debtors who cannot (or will not)
explain their financial affairs and produce supporting records are also denied
a discharge (See, pervious K & J Law blog entry: “Business Debtors Beware!”). The Denial of Discharge requires the
commencement of an adversary proceeding objecting to discharge.
Second, some debts may
not be included in a general discharge.
Some type of claims automatically are deemed
"non-dischargeable." For
example, in general, most (but not all ) taxes, child support obligations and
student loans are not discharged. Additionally,
the Bankruptcy Code and Bankruptcy Rules (and of course, case law) provide
grounds for objecting to the dischargeability of a particular debt. In order to do this, a creditor must commence
an adversary proceeding. Thus, a debtor may receive a general
discharge but, an individual creditor may object to the specific
dischargeability of the creditor's claim.
6. Disposable
Income: In a chapter 13 case, which
is a repayment plan for individuals with "regular
income," the debtor and the chapter 13 trustee negotiate a budget in
order to determine how much the debtor can afford to set aside each month to
pay creditors. The amount of the debtor's income above necessary expenses is
known as "disposable income."
The trustee receives the debtor's disposable income (often through
payroll withholding), and distributes it to creditors per a chapter 13 plan
approved by the bankruptcy court. See
Bankruptcy Code Section 1322.
7. Exempt Property: Just as certain property is "exempt" from judgment and
collection by garnishment or citation, certain property of the debtor is "exempt" from turnover to the
trustee in a chapter 7 case. While the Bankruptcy Code lists certain
exemptions, the Code allows each state to choose whether its debtors will use
the federal exemptions or state exemptions.
See Bankruptcy Code Section 522.
In Illinois, a debtor must use the state exemptions. These exemptions are set forth in the
Illinois Code of Civil Procedure at 735 ILCS 5/12-1001 et seq. (exemptions of
personal property) and 735 ILCS 5/12-901
(homestead exemption), and include the following: necessary wearing apparel, up
to $15,000 in value in a homestead property, up to $2,400 in value in one car,
and $4,000 worth of other personal property (sometimes referred to as the
"wild-card" exemption). Only
an individual and not a corporation can claim exemptions.
8. Preference: A preference is a payment (or other
"interest") made for an antecedent debt to a creditor while the
debtor is insolvent. See Bankruptcy Code
Section 547. An insolvent debtor is one
who cannot pay all of its creditors, so if it pays some creditors, it is
"preferring" them to the other creditors. Every preference reduces the amount of assets
available to pay the other, non-preferred, creditors. The Bankruptcy Code presumes that most
payments made by a debtor within 90 days of a bankruptcy filing are preferences
which may be avoided (recovered by the bankruptcy estate), although there are
defenses. For payments benefiting
"insiders," (relatives, partners, stockholders, officers, etc.) the
90 day period is extended to one year.
Preference law is also
aimed to discourage extremely aggressive collection methods (such as
repossessions, levys and garnishments) against debtors who are on the verge of
bankruptcy. This consideration sometimes
restrains non-trade creditors, such as banks and mortgagees, and makes it
easier to work out many situations.
9. Proof of Claim: A proof of claim is an official form (Official Form #10)
which creditors must file to share in any payments the trustee makes to
creditors. There are deadlines for
filing proofs of claims, which are usually stated in the bankruptcy notices
sent by the clerk of the bankruptcy court, (known as the "bar date.")
Most
consumer chapter 7 cases are "no asset" cases. A creditor may get a notice stating that
"at this time there appear to be no assets available from which payment
may be made to unsecured creditors."
If so, unless the creditor receives a follow-up notice, there will be no
payments to unsecured creditors by the bankruptcy trustee, and there is no need
to file a proof of claim.
10. Reaffirmation: A reaffirmation is a promise by the
debtor to pay a debt despite the discharge. There are two usual reasons why a
debtor would enter into a reaffirmation: (i) there is collateral for the debt
which the debtor wants to keep; or (ii) the debt may not be dischargeable and
by saving the creditor the expense of an adversary proceeding, a debtor can
usually get a compromise as to the amount of the debt, and/or a structured
repayment plan, and also avoid the embarrassment of an adversary proceeding on
the public record. A reaffirmation
agreement cannot place an undue hardship upon the debtor.
Some big consumer
creditors, like credit card issuers and department stores, routinely ask for
reaffirmations of the entire pre-petition debt, even though there is no reason
in the world why the debtors should agree.
They usually talk about maintaining "good credit" -- a foolish
notion, considering that people with a recent bankruptcy don't have "good
credit."