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Bankruptcy and its Types

Manisha Thapa

Westcliff University 

BUS 602 Business Law  

Mr. Bhola Nath Dhungana 

November 26, 2020

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Bankruptcy and its Types

Bankruptcy is a legal lawsuit concerning an individual or corporation incapable of

repaying their outstanding debts. The phase of bankruptcy starts with a petition lodged by the

claimant, or on account of lenders. All of the assets of the debtor are calculated and weighed,

and the assets will be used to settle a part of the debt outstanding (Tuovilla, 2020 May15).

Chapter 7: Liquidation

This is also known as liquidation bankruptcy. A chapter 7 is most common types of

bankruptcy for individuals. When a company went bankrupt then a court appoint a trustee to

liquidate the tangible assets to pay off the loan of creditors. While any other unsecured debt is

deleted. However, in this type of debt student loan and taxes is not included. Eligibility

criteria for the filing of Chapter 7 is set out here because the debtor must not have a Chapter 7

bankruptcy released in the previous eight years and the claimant must complete a means test.

This method is also known as bankruptcy "straight” (Jimenez, 2009).

Under this law, unsecured debt is classified into groups or categories, with preference

being given to each category for repayment. In order to minimize the risk involved with

lending, such as a mortgage, secured debt is debt backed or secured by collateral (White,

2011).

Depend on the state one sheltering, court make leverage on few things such as most

people only possess basic necessities like house, car, and retirement fund, so court wont force

to sell. One can only file the chapter 7 bankruptcy if court agrees that party doesn’t have

sufficient fund to pay off its debt (Jimenez, 2009). The decision of the court is taken based on

the mean test where incomes is compared with state leverage and oversee the finances to see

the disposable income to pay back the amount back to creditors. But if the income is too low

then one is qualified for chapter 7.

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To file a chapter 7 bankruptcy, one must pass the means test. This test is created to

prohibit the people with substantial incomes from filing a chapter 7 bankruptcy if they have

appropriate mode to pay off their debts. The means test evaluates the income of individual is

more than median income of state so in case if we don’t earn more than median, then one can

case for chapter 7 bankruptcy. But if earning is more than median, in this case total

disposable income is calculated after deducting the basic expenses to pay the debts. However,

one cannot seek for chapter 7 bankruptcy discharge even if passing the means test in case

applied for chapter 7 within 8 years previous to second filing (Welch, Bris & Zhu, 2006).

Basic Purpose and Procedure of Bankruptcy are:

The main purpose of chapter 7 bankruptcy is to get the opportunity for a fresh start

while getting safe from creditor abuse, the threat of litigation, and crippling debt to those

debtors who are facing extreme hardship.

While the procedure of chapter 7 bankruptcy are as follows:

1. Counselling and forms

Within 6 months of filing, filers must first have credit counseling before they file

the bankruptcy of Chapter 7. They cannot move ahead if there is no authorized

counseling agency in the district. However, based on the debtor's situations, other

exceptions may apply. While on the other hand, applicants must compete the

multiple forms. All the details such as finances of debtors, creditors, properties,

total income and expense and soon should be detailed out in the forms. The

applicant must also file the petition in the court which prohibit the creditors to

collect their debt.

2. Appointment of Trustee and credit conference

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An impartial trustee will be assigned by the bankruptcy court to manage phase of

bankruptcy. In order to compensate creditors, they will evaluate the total assets

and decide which assets can be liquidated. The trustee then holds meetings with

the creditors, where it checks the legitimacy of the petition and finances. The

conference of creditors enables them, as the name implies, to meet with the trustee

and the debtor to ask questions (Kenton, 2020 July 21).

3. Reimbursement of Debt

The trustee investigates the debtor's personal properties and accounts whereas

debtors exempt and non-exempt property will be properly verified and analyzed

whether debtors maintains exempt property-or property required to sustain basic

living standards. In case of non-exempt properties which will be confiscated and

liquidated in order to compensate creditors. The exemption of the property differs

from state to state. In certain situations, debtors are allowed to retain their basic

necessities like house, car and other personal belonging while trustee manage

other property being liquidated (United States Court, 2020).

4. Discharge of remaining debt

In a Chapter 7 bankruptcy, most debts are discharged. The debtor would be

discharged from any personal obligation for payment through the discharge of

debt. The borrower can no longer demand potential compensation from the

creditor once a deficit is discharged under Chapter 7. Release after bankruptcy is

not permissible for commitments relating to alimony, child care, certain

government debts, income taxes, and federal student loans.

5. Severe Consequences

Insolvency undoubtedly has negative implications, which is why debtors should

be confident that it is right for them. After bankruptcy, creditors can seek to
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restore debt even though they have no right to it so maintaining bankruptcy

records is crucial, as duplicates can be costly. For ten years from the date of filing,

the case of bankruptcy will appear on credit records, severely affecting the

debtor's ability to get loans.

Chapter 11 Bankruptcy: Reorganization

Chapter 11 is a type of bankruptcy requiring a restructuring of the corporate relations,

debts, and properties of a debtor, and is also known as bankruptcy reorganization. Usually,

companies file chapter 11 bankruptcy if they need time to reorganize the debt. This type of

bankruptcy gives a chance to debtor to start fresh however, conditions are subject to debtor’s

fulfillment of his obligations under reorganization agreement. Businesses typically maintain

ownership and control of their properties under the jurisdiction of a bankruptcy court during a

Chapter 11 bankruptcy.

Filing for Chapter 11 permanently disables against the filing undertaking all

decisions, collection operations, mortgages, and foreclosures of land. This allows it time for

its lenders to bargain. The lenders of the corporation are also not authorized to resolve debts

or allegations that emerged until the petition for bankruptcy was filed (Warren & Westbrook,

2009).

Purpose and process

The main objective of filing the chapter 13 bankruptcy is to assure that any entities or

individuals will be able to continue the business operations and balance the income and

expenses. Hence, this bankruptcy aims to give time for business to reorganize the operations

without any interference from the lenders.

The procedure of filing the chapter 11 bankruptcy are:

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 The first process is to submit the petition on the court. This can be non-voluntary or

voluntary. A voluntary petition is filed by the debtor’s subject to the requirements that

no bankruptcy petition is refused due to the debtor's deliberate failure to present in the

court or obey the court orders.

 A debtor must also request a schedule of current income and expenditure, assets and

liabilities, executory contracts and unexpired leases, as well as a declaration of

financial affairs, when filing the petition. While in non-voluntary petitions is filed by

creditors who meet the criteria of court.

 The completion of petition submission ensures that debtors in role of possession so

now debtors can take control over the operations and assets during the reorganizations

except the investigation and trustee role while trustee will monitor the debtor’s

possessions. In case debtors failed to meet the requirement of reporting then trustee

will resolve the case or convert to another chapter of bankruptcy (Warren &

Westbrook, 2009).

 The staying against creditors remains in effect immediately when the petition is filed.

In an effort to overcome the financial uncertainty, it allows the debtor a chance of

holding discussions. In certain cases, secured creditors can in order to withdraw on

assets and allocate the proceeds from the sale to the debt incurred, request relief from

the automatic stay.

 Within 120 days from the date of submitting the bankruptcy petition, the bankruptcy

court allows the debtor to present a proposal. If within the specified time, the debtor

presents a restructuring plan, the court grants additional 180 days to enable the debtor

to receive approval of the plan

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 Each type of creditors must accept the reorganization plan for further processing. If

plan is not accepted court either convert the case into chapter 7 bankruptcy or cancel

the case (Warren & Westbrook, 2009).

Chapter 13 Bankruptcy: Repayment Plan

Chapter 13 applies to a U.S. bankruptcy case in which, under the oversight and

acceptance of the courts, debtors conduct a reorganization of their assets. Individuals and

married couples are entitled to file for Chapter 13 bankruptcy, even if they are self-employed

or are running an unincorporated company. Debtors must apply and proceed through with a

proposal to repay unpaid creditors within three to five years as part of the financial

restructuring of Chapter 13, which is also known as a "wage earner's plan." The repayment

scheme must provide creditors with a reasonable payback in certain cases at least equivalent

to what they'd obtain in other forms of bankruptcy, and must use 100% of the debtor's

earnings for payment if appropriate (Neil. 2020).

For a bankruptcy under Chapter 13, debtors should create a list of all lenders

including the amount of capital owned whereas a list of any property owned, data on income

amounts and sources, and comprehensive monthly expenses information. A debtor then pays

to a designated, independent bankruptcy trustee an agreed-upon monthly sum, essentially

trying to consolidate debts into one monthly amount (Armstrong, 2020).

The objective of chapter 13 of bankruptcy is to make sure that the entity or person

(including family farmers and fishermen) continues to function and to balance their income

and expenses. It was intended to alleviate the debts of wage earners and give them chance to

recover. This insolvency is less expensive than chapter 11 as it considers individuals in the

low-income community.

Process of Chapter 13
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 Within the period of 6 months before filing for Chapter 13 bankruptcy, credit

counseling course must be taken from the agency approved by the U.S. Trustee’s

office.

 A chapter 13 bankruptcy starts with filing a petition in the court serving the area

where debtors has residence. The debtors must also disclose all the property, income,

debts, property transfers, and more. Likewise, draft of proposed repayment plan must

be submitted.

 The debtor must file a certificate of credit counseling and a copy of any debt

repayment plan developed through credit counseling, evidence of payment from

employers and statement of monthly net income and any anticipated increment in

income or expenses after filing.

 The proposed payment plan must be submitted within 14 days of filing the petition.

 After reviewing the repayment plan, court assigned the trustee and now trustee will

monitor the repayment plan, monthly income and other expenses.

 Once file is submitted, automatic stay come in order and this will restrict the creditors

to collect from operations.

 The bankruptcy trustee will conduct the meeting with the creditors where questions

will be asked to creditors while creditors could object the plan. And finally based on

objection made by creditors or trustee, plan will be approved or rejected.

 Usually, the payment period might need 3 -4 years to complete the repayment plan.

 In between the payment period, debtors must submit the documents like income and

expenses and must complete debtor education class. After repayment plan is

completed, court will order discharged.

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Debtor's assets and liabilities during bankruptcy

Individuals and corporations can both go bankrupt. Throughout a bankruptcy, an

investigation will be carried out into the financial state of the debtors. Bankruptcy specifies

the assets and liabilities of the debtor. All the debtor’s properties are recognized during

bankruptcy. Some properties, including clothing, house, vehicles and other personal items,

are excluded from this law. The prime object of this investigation is to evaluate total cash to

compensate those who have a debtor's claim so all the personal expenses is deducted from

total disposable income to pay back the debt. A full settlement does not happen very often.

Under chapter 7 bankruptcy; once, the chapter 7 bankruptcy is filed in the court, trustee

will be assigned in order to take monitor the actions of individuals or companies. Now,

trustee hold all the authority to take charge on assets and liabilities of the debtors. In chapter

7 case, debtors can hold the property if he/she can claim the exempt property. The debtors

can claim their personal belongingness, property, car, retirement plan etc. while trustee has

right to sold out debtor’s other assets such as second house, second car, other assets such as

bank deposits to pay off the debt of the creditors. While, the non-exempt properties will be

confiscated and liquidated by trustee in order to compensate creditors (Jimenez, 2009).

Under Chapter 11: The debtors are entitled as the debtor in possession after they file the

request to charge the asset and liabilities. The person and the corporation are permitted to

continue the company's activities in order to repay their debt. They are authorized to use the

properties, i.e., equipment, machinery, vehicles and construction, to work. However, in order

to leverage the properties with borrowing, debtors must have permission from the court.

Likewise, trustees may be appointed as debtor’s possession in some situations.

Under Chapter 13: Under this, when reorganizing their finances, the person self-employed

or running an incorporated company may retain control of their properties. However, the

debtors are working with the bankruptcy trustee, but the trustee's role will be limited to
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evaluating the proposed. The repayment schedule, the meeting of creditors and the control of

debtors. As alluded to in the plan, the trustee would collect the sum from the debtor and

allocate it to the creditors.

Recommendations to Creditors

Attend the creditors meeting: Attending a meeting of creditors would help creditors to

acknowledge what contributed to the filing of the debtor's bankruptcy, and more important,

the debtor's proper financial position and the status of the allegations of other creditors. Bear

in mind that filing a bankruptcy does not necessarily mean the debtor is completely insolvent.

Debtors also have remaining assets that can be liquidated to meet debts, or the debtor can also

be able to restructure or reorganize its activities and continue to do so (Davis, 2018).

File Notice of Presence: the court will inform all the debtor's actions and appearances when

creditors file a Notice of Presence with the bankruptcy court. Thus, creditors should file

notice of presence in the court.

Evidence of claim: Creditors have right to file proof of claim to ensure that you will present

in the allocation of any non-exempt funds. For instance, this might entail creditors to share in

any repayment plans formed by the debtor.

Review the reports: the creditors have right to review the report under the chapter 11 when

the petition filed sent to trustee after filing in the court.

Debt discharge objection: the creditors have the right to object the debt owned. The

creditors can file non-dischargeable complaint if any debts were occurred through fraudulent

or false act in financial statement. This must be filed within 60 days after creditors meetings.
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Non-dischargeable debts

Some of the debts are not dischargeable by bankruptcy processing. Any extra debts can be

non-dischargeable, but only when the discharge is objected to by the creditor.

 According to Bankruptcy code section 523(a) (2), income and property gained from

false representation or fraud act are not dischargeable.

 The consumer debt for luxurious goods owned by single creditors of amount more

than $550 is non-dischargeable if the petition is filed with 90 days of debt occurrence.

 The cash advance of more than $825 obtained by debtors are assumed to be non-

dischargeable if received within 70 days earlier bankruptcy petition.

 The student loan is non-dischargeable as mentioned in the section (523) (8) of

bankruptcy. But it is possible to get the discharged if the debtors able to prove the

undue hardship.

 With the exception of credit card debts exempted from discharge under section 523(a)

(2)(B) (for significantly false written statements concerning the financial condition of

the debtor) and section 523(a) (14) (debts incurred to pay non-dischargeable taxes to

the United States), debts accrued on a credit card granted to the debtor not exceeding

the credit card limit of the debtor should be dischargeable unless the credit card issued

to the debtor reaches its credit limit.

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Consequence of the bankruptcy

 The consequences of filing the bankruptcy depend on the debtor’s financial conditions

and reason for filing the bankruptcy. Bankruptcy filing is no free of cost, so fee is

charged differ from state to state (Lopez, Olalla & Olmo, 2006).

 Loss of property: bankruptcy process is never ending process so there is no deny that

one has to bear the loss of property. If one file chapter 7 bankruptcy then court

appointed trustee dispose all the properties to pay off the creditors. One is permitted

to retain the property if they can claim exempt property such as home, car, personal

items and soon.

 Not all debts are dischargeable: filing a bankruptcy doesn’t assure the return of your

debt. Debts such as tax, students’ loan are not dischargeable (Lopez, Olalla & Olmo,

2006).

 Likewise, within 14 days of filing the bankruptcy petition, statement of debtor’s assets

and liabilities must be presented in the court and if any case failed to submit the

statement will dismiss the bankruptcy file and prohibit the debtors to file again until 6

months.

 Similarly, if chapter 7 bankruptcy is entered by the court than debtors is restricted to

get another discharge in a later file chapter 7 case filed within 8 years of filing the

first case.

 After filing the chapter 7, the bankruptcy will be recorded in your credit report for 10

years while in chapter 13, it is reflected for 7 years. This might make impossible to

get loan or regular credit card and also affect the ability to get a job or even rental

apartment (Ghitti, 2018).

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Example

Under Chapter 7 (Liquidation)

Shopko was a retail stores chain based in Green Bay, Wisconsin which was closed

after bankruptcy filing in the court. A federal bankruptcy court denied Shopko's plan to

liquidate in bankruptcy and distribute the proceeds among creditors.

Under chapter 11 (Reorganization)

The 2009 General Motors Chapter 11 sale of the assets of the vehicle maker General

Motors and some of its subsidiaries was carried out in the U.S. bankruptcy court for the

Southern District of New York under Chapter 11, Title 11, United States Code. The sale

endorsed by the government of the United States allowed NGMCO Inc. to buy the old GM's

continuing operating properties. During the bankruptcy proceedings, regular activities,

including employee benefits, guarantees, and other customer support, were uninterrupted.

Operations outside the United States were not part of court filings. To complete the process,

the corporation obtained $33 billion in debtor-in-possession funding. The date to provide the

U.S. with an appropriate feasibility plan was June 1, 2009 (Wikipedia, 2020 October 4).
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Reference

Armstrong, C. (2020). Introduction to Chapter 13 Bankruptcy. Retrieved from The

Balance: https://www.thebalance.com/introduction-to-chapter-13-bankruptcy-

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Adler, B., Capkun, V., & Weiss, L. (2005). Theory and Evidence on the Bankruptcy

Initiation Problem.

Davis, N. (2018). Ghitti, M. (2018). Courts meet the Law: consequences of

Bankruptcy Law Enforcement on Bank Credit for SMEs. Retrieved from

lawblog: https://lawblog.vilaw.com/2018/08/articles/business/how-creditors-

can-protect-themselves-during-bankruptcy-proceedings/

Jimenez, D. (2009). The Distribution of Assets in Consumer Chapter 7 Bankruptcy

Cases. American Bankruptcy Law J. 83.

Kenton, (2020, July 21). What Is Chapter 7? Retrieved from Investopedia:

https://www.investopedia.com/terms/c/chapter7.asp

Lopez, G, C., Olalla, M. & Olmo, B. (2006). Financial Consequences of the

Bankruptcy Law: European Comparison. Revista de Contabilidad - Spanish

Accounting Review. 9. 111-143.

Neil, C. (2020). An Overview of Chapter 13 Bankruptcy. Retrieved from Nolo:

https://www.nolo.com/legal-encyclopedia/chapter-13-bankruptcy-overview-

30099.html

Tuovilla, A. (2020, May 15). Bankruptcy. Retrieved from Investopedia:

https://www.investopedia.com/terms/b/bankruptcy.asp

United States Courts (2020, September 16). Chapter 7 - Bankruptcy Basics.

Retrieved from US court: https://www.uscourts.gov/services-

forms/bankruptcy/bankruptcy-basics/chapter-7-bankruptcy-basics
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Warren, E. & Westbrook, J. (2009). The Success of Chapter 11: A Challenge to the

Critics. 107 Mich. L. Rev. 603.

Welch, I., Bris, A., & Zhu, N. (2006). The Costs of Bankruptcy: Chapter 7

Liquidation versus Chapter 11 Reorganization. The Journal of Finance, 61(3),

1253-1303.

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White, M. J. (2011). Corporate and Personal Bankruptcy Law. Annual Review of Law

and Social Science, 7(1), 32-51.

Wikipedia. (2020, October 4). General Motors Bankruptcy. Retrieved from:

https://en.wikipedia.org/wiki/General_Motors_Chapter_11_reorganization