Chapter 1 Bankruptcy and Banking Basics
| Jurisdiction | United States |
In order to understand how cash-management systems and bank products are affected by bankruptcy, it is important to know some basic legal and banking concepts. The following summary is not an exposition of bankruptcy practice and law or banking in general; countless volumes and articles have been written on each subject. Instead, the following is intended to explain basic principles and introduce some vocabulary and jargon that is necessary to use this book.
A. Bankruptcy Basics
The heart of the Bankruptcy Code (a Federal statute) is to provide a mechanism for individuals or organizations who are insolvent or unable to currently pay their debts to receive a "fresh start." The many Code provisions, interpretations and case law are all pointed toward that end goal.
1. Types of Cases
Bankruptcy cases can be divided into two categories: liquidation and reorganization. Bankruptcy cases are further organized by chapter.
A chapter 7 case is always a liquidation case, and the debtor can be either an individual (i.e., a living, breathing person) or a legal entity.
A chapter 9 case is a reorganization filed by a municipality or other governmental entity. Chapter 9 cases are relatively rare.
A chapter 11 case may be a reorganization case or a liquidation case, depending on the circumstances. If a business cannot be reorganized, it can be liquidated in chapter 11, or the debtor can use chapter 11 to effectuate a sale of its assets. Chapter 11 debtors can be individuals, businesses or legal entities. The debtor generally runs these cases without assistance of a trustee.
A chapter 12 case is a reorganization case filed by a family farmer or fisherman with regular income. These cases are more common in agricultural areas.
A chapter 13 case is always a reorganization case, and the debtor is always an individual. In order to qualify for chapter 13, the debtor must have regular income and cannot have debt above a statutory threshold (which changes from time to time).2 Debtors failing to meet the ceiling thresholds will file a chapter 11 case instead.
2. Roster of Players
Bankruptcy has its own jargon, and it is first necessary to know who the parties are. The person or entity filing for bankruptcy is the debtor. In chapter 7 cases, the bankruptcy court appoints a trustee automatically, and that person is charged with liquidating the debtor's assets and distributing them to creditors. In a chapter 13 case, a trustee will also be appointed to make sure that a chapter 13 debtor proposes and follows a chapter 13 plan to pay creditors, and the chapter 13 trustee makes distributions to creditors under the chapter 13 plan.
In contrast, in chapter 11 cases there are no trustees unless the court specially appoints one. The appointment of a trustee is considered to be a drastic remedy and generally occurs after some wrongdoing has happened or the bankruptcy case is hopelessly stalled. In a chapter 11 case, the debtor, operating its business itself, is sometimes referred to as the debtor-in-possession.
Parenthetically, Congress uses the term "trustee" throughout the Bankruptcy Code, even when referring to debtors-in-possession. The designation is somewhat interchangeable, as § 1107 of the Code specifies that a debtor-in-possession generally has all of the rights and powers of a trustee.
Sometimes, a specific issue arises in a bankruptcy case not warranting the appointment of a trustee but that requires third-party involvement. Debtor conflicts of interest or financial reporting snafus fall into this category. In those circumstances, the court can appoint an examiner to perform investigations and file a report as to its findings. Examiners may be appointed to do more than investigations, as the circumstances require.
A larger chapter 11 case often has an official committee of unsecured creditors, usually just referred to as the creditors' committee. The creditors' committee is made up of unsecured creditors and is formed by the Office of the U.S. Trustee (discussed below) to work for the benefit of all unsecured creditors. A creditors' committee can — at the debtor's expense — hire its own counsel and other professionals. A creditors' committee can also be provided with information not generally available to other creditors, and it can influence the bankruptcy case both positively and negatively. The court can appoint additional committees where the circumstances warrant, such as committees that represent equityholders or retirees.
The Office of the U.S. Trustee, usually referred to as the U.S. Trustee or UST, is a part of the Department of Justice and has general oversight over bankruptcy cases and trustees in most districts. The U.S. Trustee has no financial interest in the case but is a party in interest, with standing to file objections and to participate in any bankruptcy proceeding. The UST is present in all jurisdictions except the judicial districts of Alabama and North Carolina.
Finally, a patient care ombudsman may be appointed in health care bankruptcies to monitor the quality of patient care and represent the interests of the patients, and a consumer privacy ombudsman may be appointed when a debtor wants to sell or lease the personally identifiable information of individuals and consumers. Ombudsmen are relatively rare.
B. Banking Basics
Debtors often file for bankruptcy when they run out of cash or are unable to pay their debts as they become due. In order for a debtor to continue to pay operating or living expenses while in bankruptcy, the debtor must use available cash from somewhere. Often, that cash comes from their banking relationship (from existing deposit accounts or from loans). Loans can be made available, with court permission, from any formal or informal source. Money in deposit accounts can also be made available on certain specified terms and conditions, and only from a regulated depository who is authorized to serve as a bankruptcy depository in that judicial district.3
1. Account Types
Deposit accounts can take many shapes and sizes, depending on the products offered by the depository bank. In large measure, accounts fit into two categories: demand accounts, meaning that the bank must pay the depositor all available amounts in the deposit account on the demand of the customer (which includes basic checking, savings and money market accounts), or timed accounts (such as certificates of deposit), where the depositor agrees to keep the monies at the bank for a specified period of time and would suffer a penalty for early withdrawal. Brokerage accounts, which hold investments that would need to be liquidated before being disbursed out as cash, are held at an SIPC-regulated brokerage company. Potential debtors should be aware that a deposit bank may place a temporary administrative hold on deposit accounts when a petition is filed, pending an order of the court directing disposition or use of these accounts.4
There are other types of accounts that hold monies or assets in some fashion that look a little different or where ownership is not fully vested in the debtor, such as escrow accounts ...
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