Chapter 19: Creditors’ Rights and Bankruptcy

1. Chapter 19: Creditors’ Rightsand Bankruptcy

2. Learning Objectives • What is a prejudgment attachment? What is a writ of execution? How does a creditor use these remedies? • What is garnishment? When might a creditor undertake a garnishment proceeding? • In a bankruptcy proceeding, what constitutes the debtor’s estate in property? What property is exempt from the estate under federal bankruptcy law?

3. Learning Objectives • What is the difference between an exception to discharge and an objection to discharge? • In a chapter 11 reorganization, what is the role of the debtor in possession?

4. Introduction • Liens. • Garnishment. • Creditors’ Composition Agreements. • Suretyship. • Guaranty.

5. Laws Assisting Creditors • Liens. • Encumbrance on property to satisfy a debt or protect a claim for the payment of debt.

6. Laws Assisting Creditors • Liens. • Mechanic’s Liens: security for labor, materials, or service on real estate. CASE 19.1 BHP Land Services, Inc. v. Seymour (2011). What should Jean do next: settle with BHP, go through foreclosure, or appeal the case?

7. Laws Assisting Creditors • Liens. • Artisan’s Lien. labor and materials on personal property. • Judicial Liens: arises out of a court decision. • Writ of Attachment: court orders sheriff to seize non-exempt property. Writ of Execution: court order to seize and sell debtor’s non-exempt real and personal property to satisfy debt.

8. Laws Assisting Creditors • Garnishment: permits a creditor to collect a debt by seizing property of the debtor held by a third party (garnishee). • Typically the garnishee is the debtor’s employer. • Garnishment Proceedings governed by state law.

9. Laws Assisting Creditors • Garnishment (cont’d). • Laws Limiting the Amount of Wages Subject to Garnishment. • Both federal and state laws limit the amount that can be taken out of a debtor’s take home pay.

10. Laws Assisting Creditors • Creditors’ Composition Agreement. • Creditors take less than owed on a liquidated debt. • Binding on those who agree because consideration given by each depending on one another.

11. Laws Assisting Creditors • Suretyship: promise by a third person to be primarily liable for the debtor’s obligation to the creditor. • Express contract between surety and the creditor. • Creditor can demand payment from surety at any time after debt is due.

12. Laws Assisting Creditors • Suretyship: (cont’d). • Creditor need not exhaust all legal remedies against the debtor before holding the surety responsible.

13. Ex. 19-1 Suretyship and Guaranty Parties

14. Laws Assisting Creditors • Guaranty: third person making the guaranty is secondarily liable. • Guarantor is liable only after the principal debtor defaults. • Statute of Frauds requires guaranty to be in writing, unless main purpose exception applies.

15. Laws Assisting Creditors • Suretyship and Guaranty. • Actions Releasing Surety and Guarantor: same as those that will discharge the guarantor. • Defenses: Surety can use any of the principal debtor’s defenses EXCEPT incapacity, bankruptcy, or statute of limitations. 

16. Laws Assisting Creditors • Suretyship and Guaranty. • Defenses. • Surety can use his own defenses, EXCEPT fraud between debtor and surety that is unknown by creditor. • Material contract modification between debtor and creditor will release a gratuitous surety and a compensated surety to the extent he suffers a loss. 

17. Laws Assisting Creditors • Suretyship and Guaranty. • Rights of the Surety and Guarantor. • Right of Subrogation. • Right of Reimbursement. • Right of Contribution. • Sureties in equal amounts. • Sureties in equal amounts, one or more co-sureties missing or insolvent.

18. Protection for Debtors • Exempted Real Property. • Homestead: state laws permit entirely or up to a certain dollar amount. • Exempted Personal Property. • Household furniture up to certain limit. • Clothing and personal possessions. • Vehicle for transportation. 

19. Protection for Debtors • Exempted Personal Property (cont’d). • Certain classified animals. • Equipment debtor uses in a trade or business, up to certain dollar amount.

20. Bankruptcy Law • Bankruptcy Courts. • Types of Bankruptcy Relief. • Special Requirements for Consumer Debtors.

21. Bankruptcy Law • Chapter 7 – liquidation. • Chapter 11 – reorganizations. • Chapter 12 - adjustment of debts of family farmers and fishermen with regular incomes. • Chapter 13 - adjustment of debts of individuals with regular incomes.

22. Chapter 7-Liquidation • Chapter 7: referred to as ordinary or straight bankruptcy. • Debtor turns all assets over to the bankruptcy trustee. • Trustee sells nonexempt property and distributes the proceeds to the creditors. Remaining debts are discharged.

23. Chapter 7-Liquidation • Available for any person, individual, corporation, partnership. • Railroads, insurance companies, banks, savings and loan and investment companies licensed by the SBA, and credit unions cannot be debtors.

24. Chapter 7-Liquidation • Straight bankruptcy is commenced by the filing of a voluntary or involuntary petition in bankruptcy with the bankruptcy court. • If a debtor files the petition, it is voluntary.  • If creditors file a petition, it is involuntary. 

25. Chapter 7-Liquidation • Voluntary Bankruptcy. • Prior to filing, debtor(s) must receive credit counseling within 180 days of filing, and submit certificate. • Debtor must confirm accuracy of contents; attorney must file affidavit informing debtor about other chapters.

26. Chapter 7-Liquidation • Voluntary Bankruptcy. • Chapter 7 Schedules. • A list of both secured and unsecured creditors, their addresses, and the amount of debt owed to each. • A statement of the financial affairs of the debtor.

27. Chapter 7-Liquidation • Voluntary Bankruptcy. • Chapter 7 Schedules. • A list of both secured and unsecured creditors, their addresses, and the amount of debt owed to each. • A statement of the financial affairs of the debtor. • A list of all property owned by the debtor, including property claimed by the debtor to be exempt. 

28. Chapter 7-Liquidation • Voluntary Bankruptcy. • Chapter 7 Schedules. • A listing of current income and expenses • A list of all property owned by the debtor, including property claimed by the debtor to be exempt. • A certificate of credit counseling (as discussed previously). 

29. Chapter 7-Liquidation • Voluntary Bankruptcy. • Chapter 7 Schedules. • A statement of the amount of monthly income, itemized to show how the amount is calculated. • A copy of the debtor’s federal income tax return for the most recent year ending immediately before the filing of the petition.

30. Chapter 7-Liquidation • Voluntary Bankruptcy. • Tax Returns During Bankruptcy. • Substantial Abuse—Means Test: to determine whether debtor’s petition will be dismissed under Chapter 7. • Basic Formula: debtor’s average monthly income is compared to median income in area where he lives. If below median income, no presumption of abuse. 

31. Chapter 7-Liquidation • Voluntary Bankruptcy. • Substantial Abuse—Means Test (cont’d) • Applying the Means Test to Future Disposable Income: if debtor’s income is above the median income, then further calculations are necessary, including calculations of disposable income. 

32. Chapter 7-Liquidation • Voluntary Bankruptcy. • Additional Grounds for Dismissal. • Conviction of violent crime or drug-trafficking. • Debtor fails to pay post-petition domestic-support obligations. • Order for Relief. • If filing is proper, filing itself is an order for relief

33. Chapter 7-Liquidation • Involuntary Bankruptcy. • Creditors force debtor into bankruptcy. • If there are 12 or more creditors, need three or more with unsecured claims totaling at least $14,425 to join in petition. If less than 3 creditors, one or more creditors with $14,425 debt may file.

34. Chapter 7-Liquidation • Involuntary Bankruptcy. • Debtor can challenge involuntary bankruptcy but court will enter an order for relief if: • Debtor is not paying debts as they come due, OR • The debtor was in receivership for the 120 days before filing the petition.

35. Chapter 7-Liquidation • Automatic Stay. • The moment a petition is properly filed, an automatic stay is granted protecting debtor from all creditors. • Creditors cannot commence or continue most legal actions. • Damages for knowing violation of stay. 

36. Chapter 7-Liquidation • Automatic Stay. • Adequate Protection Doctrine: protects secured creditors from losing their security interest due to the automatic stay. 

37. Chapter 7-Liquidation • Automatic Stay. • Exceptions to the Automatic Stay. • Domestic Support Obligations. • Proceedings against Debtor related to divorce, support, custody, and maintenance. • Investigations by securities regulatory agency. • Limitations on the Automatic Stay. • Secured party can petition bankruptcy court for relief from automatic stay.

38. Chapter 7-Liquidation • Bankruptcy Estate. • Debtor’s Estate includes: • All Debtor’s legal and equitable interests in property presently held, including community property; • Property transferred in a “voidable” transaction; and • Property which Debtor becomes entitled within 180 days after filing. 

39. Chapter 7-Liquidation • Bankruptcy Estate. • Debtor’s Estate includes: • Proceeds and profits from the property of the estate. • After-acquired property such as inheritances, property settlements, and life insurance death proceeds.

40. Chapter 7-Liquidation • Bankruptcy Estate. • Debtor’s Estate includes: • Proceeds and profits from the property of the estate. • After-acquired property such as inheritances, property settlements, and life insurance death proceeds.

41. Chapter 7-Liquidation • Bankruptcy Trustee. • Appointed by Court: duties include collecting assets and paying creditors in order of priority. • Duties for Means Testing: to determine whether there is substantial abuse. Must file statement within 10 days after 1st meeting with creditors.

42. Chapter 7-Liquidation • Bankruptcy Trustee. • Trustee’s Powers: has right to ‘strong arm’ creditors return debtor’s property to trustee. • Has “Avoidance Powers” to set aside certain transfers: • Voidable Rights.  • Preferences.  • Fraudulent Transfers. 

43. Chapter 7-Liquidation • Bankruptcy Trustee. • Trustee’s Powers. • Voidable Rights: Trustee can stand in shoes of debtor and assert any lack of capacity or lack of assent. 

44. Chapter 7-Liquidation • Bankruptcy Trustee. • Trustee’s Powers. • Preferences. • Debtor is not permitted to transfer property or make a payment that favors—or gives a preference to—one creditor over another. • For a Trustee to recover payment, debtor must be insolvent and transferred property for preexisting debt within previous 90 days.

45. Chapter 7-Liquidation • Bankruptcy Trustee. • Trustee’s Powers. • Preferences. • Preferences to Insiders: avoidance power of Trustee extends to transfers made within ONE YEAR before filing. • Transfers That Do NOT Constitute Preferences: payments for services within 15 days, payments made in ordinary course of business, and generally debts that are not preexisting.

46. Chapter 7-Liquidation • Bankruptcy Trustee. • Trustee’s Powers. • Fraudulent Transfers. Trustee may avoid fraudulent transfers if made: (1) within two years of filing of petition, or (2) with actual intent to hinder, delay or defraud a creditor.

47. Chapter 7 - Exemptions(See Pages 376-377) • Up to $21,625 in equity in the debtor’s residence and burial plot (the homestead exemption). • Interest in a motor vehicle up to $3,450. • Interest, up to $550 for a particular item, in household goods and personal effects (up to $11,525). 

48. Chapter 7 - Exemptions(See Pages 376-377) • Interest in jewelry up to $1,450. • Interest in any other property up to $1,150, plus any unused part of the $21,625 homestead exemption up to $10,825. • Interest in any tools up to $2,175. • A life insurance contract owned by the debtor. 

49. Chapter 7 - Exemptions(See Pages 376-377) • Certain interests in accrued dividends and interest not to exceed $11,525. • Professionally prescribed health aids. • Social Security and other benefits. • The right to receive certain personal-injury and other awards up to $21,625.

50. Chapter 7-Liquidation • Homestead Exemption. • Places limits on the amounts of home equity debtors can shield from creditors. • Debtor must have lived in state two years prior to filing. • Maximum equity: $146,450, if within previous 3.5 years of filing.