Chapter 3 Federal Bankruptcy Proceedings

• Jurisdiction: United States

Chapter 3 Federal Bankruptcy Proceedings

This chapter introduces general concepts underlying today's U.S. bankruptcy laws and is intended for those who are new to the subject. It provides a broad overview of the key points necessary to understanding the use of liquidation and litigation trusts in a bankruptcy context. We recommend that the reader consider additional ABI resources for further information.¹

A. Origins

Early concepts of debt trace their origins back to Egyptian and Roman periods when debtors were flogged. The ancient Greeks simply sold debtors, and their wives and children, into slavery. Under Genghis Khan's regime, repeat offenders were put to death after their third bankruptcy. Although some of today's creditors may appreciate these approaches, more modern concepts emerged in Renaissance Florence, where ideas about liquidating assets to repay debts became an accepted remedy. As the story goes, when a Florentine merchant could not pay his debts, his stand was closed and a sign was placed indicating that he was a "Broken Bench," or "Banca Rupta." His assets were then sold, and the proceeds were used to repay creditors.

More modern views about rehabilitating debtors emerged from Tudor England. In 1542, King Henry VIII signed the Statute of Bankrupts, the first English bankruptcy law that equated bankruptcy with a fraud against creditors. Generally, the debtor's property was seized for distribution among creditors. In 1601, the Elizabethan Poor Act offered some protections to debtors for the first time. It is generally considered a refinement of the earlier Act for the Relief of the Poor, which became law in 1597, that essentially offered relief to people who were unable to work. By 1705, English bankruptcy laws began permitting debt discharge. The Lord Chancellor was given the power to discharge bankrupts, once disclosure of all assets had been made and various procedures had been fulfilled.

B. U.S. Laws

U.S. laws recognized bankruptcy as early as the Mayflower Compact but did not codify the treatment of debtors until 1898. The Bankruptcy Act of 1898 constituted the first set of long-standing U.S. bankruptcy laws. The Act primarily provided pro-creditor protections, but did allow corporate reorganization. The Act was later amended by the Chandler Act of 1938, which permitted voluntary petitions and included limited debtor protections.

The U.S. adopted a significantly more comprehensive approach in the Bankruptcy Reform Act of 1978, establishing what is known today as the U.S. Bankruptcy Code. Significant debtor protections were included. The Code changed the structure of the U.S. bankruptcy courts and gave them significantly expanded subject matter jurisdiction. It also created the U.S. Trustee system to oversee the operation and enforcement of the Bankruptcy Code's provisions, and to represent the voice of the U.S. government within U.S. bankruptcy courts. The Bankruptcy Code underwent its next revision in the Bankruptcy Reform Act of 1984. It was further revised in 1986, and again in 1994. The most recent significant amendments to the U.S. Bankruptcy Code were encompassed in the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), which included major revisions to consumer bankruptcy protections and significant changes to the corporate bankruptcy process.

C. Types of Bankruptcy Filings

Bankruptcy cases are generally grouped into three categories. "Free-fall" cases refer to any filings other than "prepackaged" or "pre-negotiated" cases wherein the debtor enters bankruptcy without a pre-conceived and/or pre-agreed solution with its creditors. A free-fall case is typically precipitated by a sudden event or unanticipated crisis that forces the company into an immediate bankruptcy in order to gain the protections of the automatic stay (see below). The crisis can be operational, such as a major production emergency; it can be legal, such as the filing of mass tort claims; or it can be financial, such as the inability to meet debt service. The crisis is typically urgent, frequently involving an inability to meet payroll or creditor payment obligations or the threat of imminent foreclosure by a lender. In contrast, a prepackaged or pre-negotiated case typically refers to a bankruptcy filing that is made to 'cleanse' the debtor of certain obligations as part of a resolution previously agreed upon by some (a pre-negotiated case) or all (a prepackaged case) of its major constituencies.

The U.S. Bankruptcy Code provides nine alternative types of bankruptcy proceedings, as shown below. The most common corporate types are "Chapter 7 Liquidation" and "Chapter 11 Reorganization."

Types of Federal Insolvency Matters

Chapter 7 Sub. Ill - Stockholder Liquidation

Chapter 7 Sub. IV - Commodity Broker Liquidation

Chapter 7 Sub. V - Clearing Bank Liquidation

Chapter 9 Adjustments of Debts of Municipality

Chapter 11 Reorganization (Corporate and Personal)

Chapter 11 Sub IV - Railroad Reorganization

Chapter 12 Adjustment of Debts of Family Farmer or Fisherman

Chapter 13 Adjustment of Debts of Individual With Income

Chapter 15 Ancillary and Other Cross Border Cases

Most of these types of bankruptcies are intended to apply to situations where businesses or creditors want to reorganize the debtor. The Bankruptcy Code recognizes that partial, or even significant, wind-downs or liquidations of operations and assets may nonetheless be expected.

DESCRIPTIONS OF FEDERAL INSOLVENCY CASES
BANKRUPTCY CHAPTER	TYPE	DESCRIPTION	ROI.E OF TRUSTEE
Chapter 7	Liquidation of Entities or Individuals	Orderly liquidation of all assets and distributions of proceeds to creditors. The debtor discontinues operations, or sells its operations. Proceeds are distributed to creditors based on their individual priority and standing. Chapter 7 is the most common form of bankruptcy. Subchapter III deals with stockbroker liquidations, Subchapter IV deals with commodity broker liquidations, and Subchapter V deals with clearing bank liquidations.	An independent trustee is appointed or elected. The trustee is responsible for selling/disposing of the assets, pursuing any potentially avoidable transfers, reconciling creditor claims, making distributions to administrative claimholders and other creditors, and dissolving the entity/estate.
Chapter 9	Municipalities	A municipality is a political subdivision or public agency or instrumentality of a state (as defined in § 101 of the Bankruptcy Code). In recent years, several cities and counties have used Chapter 9 — i.e., Detroit and Orange County, Calif.	The role of the U.S. Trustee is generally more limited than in chapter 11 cases. For example, there is no meeting of creditors at the commencement of the case, and the U.S. Trustee does not have the authority to move for appointment of an estate trustee or examiner or for conversion of the case. The U.S. Trustee does not supervise the administration of the case, and does not monitor the financial operations of the debtor or review the fees of professionals retained in the case.
Chapter 11	Reorganization of Entities or Individuals	Chapter 11 is typically used to reorganize a business, although individuals can file for bankruptcy protection under chapter 11. The debtor becomes the "debtor in possession," retaining possession and control of its assets without the appointment of a trustee. The debtor operates the business and performs many of the functions that a trustee performs in cases under other chapters. Subchapter IV deals with railroad reorganizations.	Chapter 11 liquidations may be performed with a chapter 11 plan administrator or the use of liquidation and litigation trusts wherein a trustee, or plan administrator, is appointed to sell/dispose of the assets, pursue any potentially avoidable transfers, reconcile creditor claims, make distributions to administrative claimholders and other creditors, and dissolve the entity/ estate.
Chapter 12	Reorganization of Farmers	Available for farmers and fishermen with total operational debts (secured and unsecured) of less than $4,031,575 (if a farming operation) or $1,868,200 (if a commercial fishing operation). Chapter 12 allows farmers to reorganize and retain all or part of their farmland. The individual, or individual and spouse, must have earned at least 50% of their gross income for the previous taxable year from farming operations.
Chapter 13	Reorganization of Individuals or Qualifying Entities	Available to individuals with a regular income, or qualifying small businesses, to adjust their debts as part of a plan approved by the court and creditors. Individual debt must be less than $383,175 unsecured and $1,149,525 secured. If debts exceed these limits, the individual, or qualifying entity, must file under another chapter.	Individual cases are administered by the U.S. Trustee through a panel of chapter 13 trustees.
Chapter 15	Mechanism for Ancillary and Other Cross-Border Cases	Mechanism for dealing with international (cross-border) insolvency.

Note: In North Carolina and Alabama, Bankruptcy Administrators...