1 B.R. 1
November 6, 1978
by Howard A. Patrick[†] and Michael L. Meyer[††]
On November 6, 1978, President Carter signed P.L. 95-598, thereby enacting into law the Bankruptcy Reform Act of 1978. The Act is the first major revision of bankruptcy law in 40 years and the first entirely new Act since 1898. Significant also is that the new law is the first bankruptcy act not enacted as the result of a national recession or depression.
The Act is divided into four titles. Title I, which contains the substance of the new bankruptcy law, codifies and enacts a new Title 11 of the U.S.Code. Title II consists of amendments to Title 28 of the U.S. Code and to the Federal Rules of Evidence and enacts a new Chapter 6 relating primarily to creation and structure of the new bankruptcy courts, a new Chapter 39 relating to the establishment of a United States Trustee pilot program, a new Chapter 50 relating to the staff and other employees of the new bankruptcy court, and a new Chapter 90 relating to establishment of jurisdiction, venue, appeals and other powers of the new bankruptcy court.
Title III consists of amendments to other federal acts in order to conform or amend such acts to be consistent with the Bankruptcy Reform Act of 1978. Title IV is the repealer and contains the transition provisions relating to the new bankruptcy law.
Title I (11 U.S.C.A. §) consists of Chapter 1 (General Provisions); Chapter 3 (Case Administration); Chapter 5 (Creditors, the Debtor and the Estate); Chapter 7 (Liquidation); Chapter 9 (Adjustment of Debts of Municipalities); Chapter 11 (Reorganization); Chapter 13 (Adjustment of Debts of an Individual with Regular Income); and Chapter 15 (United States Trustees), and will hereafter be referred to as the Bankruptcy Code or simply the Code.
This article is not designed or intended to be an analysis or comparison between the former law of bankruptcy and the Bankruptcy Reform Act of 1978. However, where deemed appropriate to explain or clarify
certain aspects of the Code or to emphasize the significance of certain changes from the former Bankruptcy Act, reference will, from time to time, be made to the former law. Also, because of the substantial changes effected by the Code, this article must of necessity devote itself to those areas deemed most significant or informative and, accordingly, no attempt is made to discuss all aspects or details of the Code.
The Bankruptcy Code and related changes in the law generally took effect October 1, 1979. Any bankruptcy case or proceeding in a bankruptcy case filed prior to that date continues to be conducted and administered to the same effect as if the Bankruptcy Code had not been enacted. The new bankruptcy court structure, however, will not become effective until April 1, 1984.
Between October 1, 1979 and March 30, 1984, the existing bankruptcy courts will continue to be the courts of bankruptcy under the Code. In addition, the method of administration, including the role of the bankruptcy judge, will be affected depending upon the applicability in particular districts of the United States Trustee system.
GENERAL PROVISIONS. COURTS AND PROCEDURE Court Structure
The new bankruptcy court will be an adjunct of the United States District Court in each judicial district. The court will be a court of record known as the “United States Bankruptcy Court (for the district)” with all powers of a court of equity, law and admiralty (28 U.S.C.A. § 1481). The bankruptcy court existing prior to October 1, 1979 and continuing through April 1, 1984 will continue to be the court of bankruptcy under the Bankruptcy Code, subject to the expanded jurisdiction, the changes in venue, and the administration of the case and application of substantive law under the Code.
Bankruptcy Judges and Staff
Each bankruptcy court shall consist of one or more bankruptcy judges for the district (28 U.S.C.A. § 151). Bankruptcy judges will be appointed for a term of 14 years by the President with the advice and consent of the Senate. Although the Judicial Council for each circuit may recommend nominees, such nominations will not be binding upon the President (28 U.S.C.A. § 152). The present sitting bankruptcy judges will continue to serve until March 31, 1984 or until the end of each presently sitting judge’s appointed term. A Merit Screening Committee will be formed in each state to determine the qualifications of presently sitting bankruptcy judges whose terms expire prior to March 31, 1984 to continue to serve in that capacity until April 1, 1984.
The Code provides for appointment of a bankruptcy court clerk for each district. The clerk, in turn, may appoint with approval of the court necessary deputies, clerical assistants and employees as may be approved by the Director of the Administrative Office of the United States Courts.
Bankruptcy judges may also appoint such other employees including law clerks, secretaries and court reporters as may be deemed necessary. All proceedings before the bankruptcy court held in open court shall be recorded whenever practicable.
The United States District Court is granted original and exclusive jurisdiction of all cases under Title 11, and original, but not exclusive, jurisdiction of all civil proceedings arising in or related to cases under Title 11 (28 U.S.C.A. § 1471).
The new bankruptcy court in turn is delegated all of the jurisdiction so granted to the district courts with the exception of the powers to imprison for contempt and to enjoin other courts (28 U.S.C.A. § 1481). The new bankruptcy court shall have jurisdiction over all property of the debtor wherever located. The grant of jurisdiction results in the bankruptcy court having pervasive jurisdiction of all proceedings arising in or relating to bankruptcy cases, and the distinction between summary and plenary jurisdiction is abolished.
Virtually everything occurring within a bankruptcy case will be encompassed by the term “proceedings”, thereby eliminating the necessity of distinguishing between summary and plenary proceedings and between contested and so-called “administrative matters”. Although it has jurisdiction over all bankruptcy cases and all proceedings arising in or relating to such cases, the bankruptcy court is not required to exercise jurisdiction over all proceedings which might arise in or be related to such bankruptcy cases. The court may, in the interests of justice, abstain from hearing a particular proceeding and permit another court to hear and determine issues involved (28 U.S.C.A. § 1471(d)).
Venue of a bankruptcy case will be the district wherein the debtor has been domiciled, resided, had his or its principal place of business or principal assets in the United States, for the 180 days immediately preceding commencement of the bankruptcy case or for a longer portion of such 180 days than in any other district (28 U.S.C.A. § 1472); or in the district where a bankruptcy case is pending involving the debtor’s affiliate,
general partner or partnership (28 U.S.C.A. § 1472(2)).
Proper venue for proceedings arising in or related to a bankruptcy case is in the bankruptcy court where the case is pending except:
1. An action by the trustee (or debtor-in-possession) to recover a money judgment of, or property worth, less than $1,000 or a consumer debt less than $5,000 may be commenced only in the bankruptcy court for the district where the defendant resides.
2. An action by the trustee (or debtor-in-possession) based on a claim arising after commencement of the bankruptcy case from the operations of the business of the debtor may be commence only in the bankruptcy court for the district in which an action on such claim might have been brought under applicable non-bankruptcy venue provisions.
3. An action by the trustee (or debtor-in-possession) based upon a claim arising by virtue of the trustee’s succession to the property rights of the debtor (11 U.S.C.A. § 541) and rights, claims or causes of action in connection therewith or arising under the trustee’s avoiding powers as a lien creditor or successor to certain creditors and purchasers (11 U.S.C.A. § 544(b)), may be brought in the bankruptcy court in the district in which under applicable non-bankruptcy law the debtor or creditor might have commenced the case had the bankruptcy case not been commenced.
4. A proceeding based on a claim arising after the commencement of the bankruptcy case from the operation of the business of the debtor may be commenced against the trustee or debtor-in-possession in the bankruptcy court for the district in which the party commencing such case would under applicable non-bankruptcy venue provisions have brought the action if no bankruptcy case was pending. However, such claim or action may be brought in the bankruptcy court in which the bankruptcy case is pending (28 U.S.C.A. § 1473).
A bankruptcy court may, notwithstanding proper venue, transfer a bankruptcy case or a proceeding arising in or related to such case to another bankruptcy court if in the interests of justice or for the convenience of the parties (28 U.S.C.A. § 1475). The court may also retain a case or proceeding laid in the wrong venue if in the interests of justice or for the convenience of the parties (28 U.S.C.A. § 1477). Absent timely objection, a party waives the right to object to improper venue.
The Code also makes provision for institution of a bankruptcy case by a foreign representative of an entity subject to a foreign proceeding. Relief sought by the foreign representative will normally be the enjoining of enforcement of a lien against, or turnover of property located in, the United States, or the enjoining of commencement or continuation of an action or proceeding in a United States court for enforcement of a judgment. A foreign representative may also seek the bankruptcy court’s jurisdiction for the purpose of administering the “foreign” debtor’s assets located in the United States.
Venue for enjoining enforcement of a lien against property or for turnover of property is only in the bankruptcy court for the district where the property is found; venue for the enjoining of commencement or continuation of an action or proceeding in a United States court for enforcement of a judgment is in the bankruptcy court for the district in which the action or proceeding is pending; and venue to administer the
foreign debtor’s assets is in the bankruptcy court for the district in which are located the principal assets of the foreign estate in the United States. The bankruptcy court has broad discretion in granting relief to a foreign representative (11 U.S.C.A. § 304).
A civil cause of action subject to the jurisdiction of the bankruptcy court may be removed by a party to the bankruptcy court for the district where such civil case is pending (28 U.S.C.A. § 1478). Excepted from this right of removal are United States Tax Court proceedings and civil actions by a governmental unit to enforce police or regulatory power.
Although a cause of action may be removed to the bankruptcy court, that court will have the power to remand the case on any equitable grounds, with neither a remand nor denial of a remand being appealable. If a civil case is removed to a bankruptcy court, the case is left essentially undisturbed as of the time of removal including aspects such as rights or liabilities under bonds, injunctions, orders or other proceedings previously determined or issued by the court from which the action is removed, including any judicial liens created in or by the action. The bankruptcy court may, however, dissolve or modify such injunctions or orders if appropriate (28 U.S.C.A. § 1479).
The Code provides for three methods of appeal. (28 U.S.C.A. §§ 1334(a), 1408). The first is for appeal from all final judgments, orders and decrees of the bankruptcy court directly to the district court for the district in which the bankruptcy court is located. The second is to an appellate panel consisting of three bankruptcy judges. These panels may be established for any district within a circuit by order of the Circuit Council, in which event the chief judge for the circuit shall designate panels of three bankruptcy judges to hear appeals from final judgments, orders and decrees of the bankruptcy court for that district.
Members of an appellate panel shall consist of bankruptcy judges serving in districts located within the circuit in which the panel sits. An appeal may not be heard by a panel whose members include the bankruptcy judge whose judgment, order or decree is being appealed (28 U.S.C.A. § 160(b)). Where appellate panels are established, appeals must be taken to the panel and not the district court. Interlocutory judgments, orders and decrees of a bankruptcy court may be heard only by leave of the district court or appellate panel.
The third method of appeal from final judgments, orders or decrees of a bankruptcy court is directly to the Circuit Court of Appeals if the parties to the appeal so agree. The Circuit Court of Appeals shall also hear appeals from decisions of the district court and the appellate panels.
UNITED STATES TRUSTEE
The dichotomous role or function of the bankruptcy judge as an administrator and judicial officer of the bankruptcy court under prior law has concerned various groups or interests involved in bankruptcy matters.
This concern has ranged from the increasingly heavy administrative burden being placed upon the judge because of the dramatically increased number of cases being filed in the bankruptcy court to the appearance of impropriety or unfairness caused by a judge adjudicating contested matters between a litigant and a trustee appointed by the judge and further caused by the fact that his decision or judgment may be affected or influenced by facts learned during other hearings (such as from the bankrupt’s testimony at the first meeting of creditors) extraneous to the matter in controversy. Congress’ proposed solution under the Code is establishment of a “United States Trustee” system.
This system is presently structured as a five year pilot program covering ten districts or groups of districts, wherein a United States Trustee shall be appointed for each of the ten pilot districts. The United States Trustee will be appointed and supervised by the United States Attorney General and will not be an arm or adjunct of the bankruptcy court. The United States Trustee will establish and maintain separate quarters and staff totally apart from the bankruptcy court.
The bankruptcy court will have no power to remove a United States Trustee from office. Such removal will be under the jurisdiction of the Attorney General’s office. In addition to appointment of a United States Trustee for each pilot district, the Attorney General may also appoint deputy United States Trustees as may be necessary to properly administer and carry out the assigned duties and responsibilities of the United States Trustee.
The primary purpose of the United States Trustee system is to remove the administrative functions and duties from the bankruptcy judge to the United States Trustee. Principal duties of the United States Trustee include the establishment and supervision of panels of private trustees and the appointment therefrom of trustees to act in Chapter 7 cases.
The Attorney General will, by rule, establish qualifications of private trustees to serve on the panels. The United States Trustee will supervise the private trustees and the administration of cases under Chapters 7, 11 and 13. The United States Trustee will not have authority to appoint an interim trustee in involuntary cases unless so ordered by the court.
The United States Trustee may object to the grant of discharges. In connection therewith, the court may, upon request of a party in interest, order the United States Trustee to investigate and examine acts and conduct of the debtor to determine if there exists grounds for denial of the discharge. The United States Trustee is also empowered to appear and examine the debtor at any meeting of creditors in a Chapter 7, 11 or 13 case.
In a Chapter 11 case, the United States Trustee shall appoint the committee of creditors holding unsecured claims and, in addition, if so ordered by the court, appoint additional committees of creditors or equity security holders. The United States Trustee shall have standing in a Chapter 11 case to request the appointment of a trustee or an examiner. The United States Trustee may not serve as a trustee in a Chapter 11 case or appoint the Chapter 11 trustee from the panel of private trustees, although the United States Trustee will appoint the Chapter 11 trustee if so ordered by the court. Termination of a Chapter 11 trustee’s appointment may be requested by the United States Trustee under appropriate circumstances.
Special rules govern appointment of a trustee in railroad reorganization cases under Chapter 11. In a railroad reorganization, the Secretary of Transportation shall submit a list of five disinterested persons qualified and willing to serve as trustee, and the United States Trustee shall appoint one of such persons to serve as trustee in the case.
In Chapter 7 cases or in Chapter 13 cases not involving a standing trustee where no private trustee is willing to serve, the United States Trustee shall serve as such trustee. The United States Trustee shall receive no compensation for so serving, and any compensation which would otherwise have been paid to the trustee is to be paid to the clerk of the bankruptcy court and by the clerk into the United States Treasury.
The United States Trustee system has an automatic sunset provision, and unless Congress determines to continue the system, the program will automatically terminate upon expiration of the five year period. It is anticipated that if the United States Trustee system terminates, all appointments made thereunder will also terminate.
COMMENCEMENT OF THE CASE AND ITS EFFECTS Who May Be a Debtor
Only a person residing in the United States or having a domicile, place of business, or property in the United States or a municipality may
become a debtor under the Bankruptcy Code (11 U.S.C.A. § 109). A domestic insurance company, bank, savings bank, cooperative bank, savings and loan association, building and loan association, homestead association, or credit union, or a foreign entity engaged in such activities or business in the United States may not become a debtor under the Code. A railroad may become a debtor under Chapter 11 but not Chapter 7, whereas a stock broker or a commodity broker may be a debtor under Chapter 7 but not Chapter 11.
A voluntary case may be filed by a qualified debtor in the bankruptcy court of proper venue (11 U.S.C.A. § 301). Commencement of a voluntary case constitutes an order for relief in the particular chapter under which the case is filed.
A joint case may be filed by an individual and such individual’s spouse (11 U.S.C.A. § 302). After commencement of a joint case the extent, if any, to which the estates of the spouses shall be consolidated shall be determined by the court.
The Code makes extensive changes in the law of involuntary bankruptcy (11 U.S.C.A. § 303). In addition to expanding the scope of involuntary proceedings to Chapter 11 reorganization cases (see general discussion under the Chapter 11 section of this article), the grounds upon which an involuntary petition may be filed have been liberalized by replacing the former rather structured statutory “acts of bankruptcy” with the grounds that the debtor “is generally not paying his debts as they become due, “ or that a “custodian” has been appointed to, or did take possession of, substantially all of the debtor’s property within 120 days before the date of the filing of the petition.
Although these relaxed bases for initiating an involuntary bankruptcy case have been questioned by some who see the procedure as possibly subject to use as a “creditor’s collection tool” for specific debts or as a weapon by a debtor’s competitors, certain safeguards have been enacted which should alleviate much of the apprehension of potential abuse.
First, the requirement that an involuntary petition must be filed by three or more holders of non-contingent unsecured claims aggregating
$5,000 is consistent with prior law. Second, the Bankruptcy Code specifically provides that the debtor may continue to operate its business with the right to use, acquire, or dispose of property as if the case had not been commenced.
This right, however, is subject to such limitations as may be imposed by the court, including, upon request of a party in interest and after notice and hearing, the appointment of an interim trustee to take possession of the debtor’s property and operate the business.
In the event of appointment of an interim trustee, the Code permits the debtor to reacquire possession of his property and business upon posting of a bond as the court may require conditioned on the debtor’s accounting for and delivering to the trustee such property so reacquired if the petition is granted.
The Code further provides that after notice and hearing and for cause, the court may require the petitioning creditors to file a bond to indemnify the debtor for costs, expenses or damages incurred in the event the petition is ultimately dismissed.
Upon motion of a petitioning claimant or upon consent of all petitioning claimants and the debtor, or for want of prosecution, the court may, after notice to all creditors, dismiss an involuntary petition. If the court does dismiss a petition other than on consent of the debtor and all petitioners, and the debtor does not waive a right to judgment, the court may grant judgment against the petitioners in favor of the debtor for costs, reasonable attorneys fees, or damages proximately caused by the taking of possession of the debtor’s property by a trustee or against any petitioner for damages proximately caused by the filing of the involuntary, and punitive damages if the petition was filed in bad faith.
An involuntary petition may be filed against any person who could become a voluntary bankrupt with the exception of a farmer or an eleemosynary institution. In addition, an involuntary petition may be filed against a foreign bank if that bank is not engaged in the banking business in the United States and if a foreign proceeding concerning such bank is pending.
A debtor subject to an involuntary petition at any time either before or after entry of order for relief may, if otherwise qualified, convert the case to a Chapter 11 or 13 if the case has not previously been converted from Chapter 11 or Chapter 13. A debtor may not waive such right to conversion (11 U.S.C.A. § 706(a)).
The filing of a petition, either voluntary or involuntary, under any of the operative chapters (Chapters 7, 9, 11 and 13) operates as an automatic stay against the commencement or continuation of virtually all acts or proceedings against the debtor or the debtor’s property relating to a claim or transaction arising prior to the filing of the bankruptcy case (11 U.S.C.A. § 362).
Exceptions to the automatic stay involve criminal action or proceeding against the debtor; enforcement, including enforcement of a non-money judgment, of a governmental unit’s police or regulatory power; collection of alimony, maintenance or support out of property other than the debtor estate’s property; preservation of certain non-voidable liens or interests which, under generally applicable non-bankruptcy law, requires perfection within certain specified times; foreclosure of real estate mortgages or deeds of trust by the Secretary of Housing and Urban Development insured or formerly insured under the National Housing Act covering property or combinations of property consisting of five or more living units; issuance to the debtor by a governmental unit of a notice of tax deficiency; and certain rights of setoff involving commodity futures contracts and transactions relating to commodities or securities.
The automatic stay is effective against property of the bankrupt estate so long as the property remains property of the estate. As to any other act or proceeding, the automatic stay remains effective until the case is closed or dismissed and, in the case of an individual, a discharge is granted or denied.
A party requesting relief from the stay may, after notice and hearing and upon cause shown, including a lack of adequate protection of the moving party’s interest in property subject to the stay or that the debtor has no equity in the property and that such property is not necessary to an effective reorganization, obtain such relief from the stay, including its termination, annulment, or modification or imposition of specific condition, as is appropriate under the circumstances.
The hearing on the party in interest’s request must be held within 30 days of the request or the stay will automatically terminate as to the requesting party’s interest.
The hearing may either be a final or preliminary hearing. If it is a preliminary hearing, the stay will continue in force if there is a reasonable likelihood that the party opposing the requested relief from the stay will prevail at the final hearing in establishing that the party requesting relief from the stay is adequately protected or that the debtor has equity in the property subject to the requesting party’s interest and the property is necessary for an effective reorganization.
“Adequate protection” may be provided by requiring periodic cash payments to the extent the stay results in a decrease in the value of the property involved; providing additional or replacement liens to the extent that the stay results in decrease in the value of the property involved; or granting of such other relief as will result in the realization by the requesting party of the “indubitable equivalent” of such person’s interest in the property (11 U.S.C.A. § 361).
The party requesting relief from the automatic stay has the burden of proving that the debtor has no equity in the property, whereas the party opposing relief from stay has the burden of proof on all other issues, most critically the issue of adequate protection.
The court may grant necessary relief from the automatic stay without notice or hearing if such relief is necessary to prevent irreparable damage to the requesting party’s interest in property, providing that such damage will occur before there is an opportunity for notice and hearing.
Property of the Estate
Upon the commencement of a case under Title 11, an estate of property is created (11 U.S.C.A. § 541). The make up of that estate has undergone only minor changes from that created under the Bankruptcy Act. The estate under the Bankruptcy Code consists of all the debtor’s legal and equitable interests in property wherever located, together with community property, property transferred in a transaction voidable by the trustee, proceeds and profits from the property of the estate, and certain after acquired property.
The rights of the trustee to property acquired by the debtor after filing have been expanded to include interests in property which the debtor acquires or becomes entitled to acquire within 180 days after filing and which are received as a result of a property settlement with the debtor’s spouse or under an interlocutory divorce decree or as a beneficiary of a life insurance policy or death benefit plan.
The Bankruptcy Code makes prior law more certain by codifying the rights and obligations of a third person in possession of the property of the estate. Such third persons, other than “custodians”, are required to deliver to the trustee, and account for, any property of the estate in their possession or its value, unless that value is inconsequential (11 U.S.C.A. § 542).
If the third person owes a debt to the estate which is due and payable, then that debt is to be paid to the trustee. However, if the third person has no actual notice or knowledge of the proceeding, he may transfer estate property or pay a debt owing to the estate to a person other than the trustee without liability provided that he does so in good faith.
This provision codifies Bank of Marin v. England, 385 U.S. 99, 87 S.Ct. 274, 17 L.Ed.2d 197 (1966), but not to the extent that that case permitted a bank setoff which would now violate the automatic stay under section 362(a)(7) of the Code.
Where a life insurance premium is paid on an automatic loan provision in the policy, that transfer is also protected from attack by the trustee. In addition, after notice and a hearing, and subject to applicable privilege, the court may order an attorney, accountant or other person holding recorded information regarding the debtor’s affairs to disclose that information. Thus, the effect of a possessory lien on the debtor’s records in the hands of an attorney or accountant provided by state law can be avoided by the trustee.
A custodian who has knowledge of the commencement of the case cannot transfer or take any action to administer property of the estate in his possession except as is necessary to preserve that property (11 U.S. C.A. § 543). He has the further duty to deliver such property to the trustee and file an accounting of all the debtor’s property and its proceeds which were in his possession at any time.
When property has been delivered to a trustee by a custodian, the court is required, after notice and a hearing, to protect the creditors of the custodian whose claims arose in connection with the estate’s property and to provide for the compensation of the custodian. These claims are accorded treatment as an administrative expense in the bankruptcy proceeding. In addition, the court may surcharge the custodian for any improper or excessive disbursement from the debtor’s property. Under appropriate circumstances, and after notice and a hearing, the court may leave a custodian in possession, custody and control of the property.
After notice and a hearing, the trustee may abandon any property of the estate that is burdensome or of inconsequential value (11 U.S.C.A. § 554). However, contrary to prior law, if the trustee neglects to abandon property which is part of the estate but which he does not administer in the case, that property remains property of the estate until the case is closed and is not deemed abandoned in the interim.
If the trustee does not affirmatively abandon property of the estate during the pendency of the case, in order to require abandonment a party
in interest must request the court to order the trustee to abandon the property, and the court may do so after notice and a hearing if the property is burdensome or of inconsequential value.
The trustee is authorized, after notice and a hearing, to use, sell, or lease property of the estate other than in the ordinary course of business (11 U.S.C.A. § 363(b)). Any such sale of the property of the estate will be free and clear of any interest in the property of an entity other than the estate only if applicable non-bankruptcy law permits sale of the property free and clear of the interest, the entity holding the interest consents, the interest is a lien and the price at which the property is to be sold is greater than the amount of that interest, the interest is in dispute, or the entity could be compelled to accept a money satisfaction of the interest.
The trustee is further granted the power to sell property in which the estate has only a part interest by way of a tenancy in common, joint tenancy or tenancy by the entirety, but only if a partition is impracticable, the sale of the estate’s interest in the property would yield significantly less than the sale of the undivided interest free of the interests of the co-owner, the benefit of sale of the whole to the estate outweighs the detriment to the co-owners, and the property is not used in the production, transmission or distribution for sale of certain energy related products.
If such property will be sold by the trustee to a third party, the co-owner has the right to purchase the property at the price at which the sale will be consummated. If the sale is consummated by the trustee to a third party, the trustee must then distribute to the co-owner his proportionate share of the proceeds of sale less his proportionate share of the costs.
Executory Contracts and Unexpired Leases
Although the new law fails to enlighten the shadows surrounding the question of “what is an `executory contract’,” it does substantially expand the statutory treatment of executory contracts.
With certain exceptions, an executory contract in existence on the date of entry of the order for relief may, subject to court approval, be rejected or assumed (11 U.S.C.A. § 365). In a Chapter 7 case the trustee must either assume or reject an executory contract within 60 days after the order for relief or within such additional time granted within such 60 day period as the court for cause fixes or the contract is deemed rejected.
In Chapters 9, 11, and 13 the 60 day period does not apply and the contract may be assumed or rejected at any time before confirmation of a plan. However, any party to the contract may request that the court order a determination by the trustee or debtor to either assume or reject the contract within a specified time.
If an executory contract is assumed, any existing defaults (with some exceptions noted herein) must be satisfactorily dealt with or resolved by
the curing of that default or providing of adequate assurance that the default will be promptly cured; by compensating the other party to the contract for any actual pecuniary loss resulting from the default, or giving adequate assurance that such compensation will be promptly given; and by giving adequate assurance for future performance under the contract.
In cases involving shopping center leases, adequate assurance of future performance includes adequate assurance of the source of rent and other consideration under the lease; that there will be no substantial decline in percentage rental; and that assumption or assignment of the lease will not substantially breach any provision such as a radius, location, use or exclusivity provision in any other lease, financing agreement or master agreement relating to the shopping center and will not substantially disrupt any tenant mix or balance in the shopping center.
Unless the other party to the contract consents, the contract cannot be assumed or assigned if such other party is excused by applicable law from accepting performance from or rendering performance to the trustee or assignee of the contract, nor may a contract be assumed if it is one to make a loan or extend other debt financing or financial accommodations to or for the debtor or issue a security of the debtor.
A lessor may not, prior to assumption of the lease, be required to provide any services or supplies incident to the lease unless compensated for such in accordance with the terms of the lease.
Where the default or breach of the contract is by reason of so-called “ipso facto” bankruptcy clauses (e. g., the insolvency or financial condition of the debtor, the commencement of a bankruptcy case by or against the debtor, the appointment of a trustee in the bankruptcy case, or appointment of a custodian or receiver before commencement of the bankruptcy case, pursuant to non-bankruptcy law) the Code does not require the curing of defaults or assurance of future performance as a condition to assumption of an executory contract, nor does it give the other party to the contract the right to terminate or modify the executory contract after commencement of the bankruptcy case unless applicable non-bankruptcy law excuses the party (other than the debtor) from accepting from or rendering performance to the trustee or an assignee of the contract or the contract is a contract to make a loan, extend other debt financing or financial accommodations to or for the benefit of the debtor or to issue a security of the debtor.
Notwithstanding a provision to the contrary in the contract or in applicable non-bankruptcy law, a trustee may assign a contract, but only if the trustee first assumes such contract and adequate assurance of future performance by the assignee is provided. These requirements for assignment are applicable whether or not there is an existing default in the contract.
Assignment by the trustee of a contract or lease relieves the trustee and the debtor’s estate of any liability for any breach occurring after the assignment.
With the exception of real estate leases where the debtor is the lessor and contracts for the sale of real property where the debtor is the seller, the rejection of an executory contract and the resulting effect upon the claim of the other party to the contract depends to a great extent upon the timing of the rejection as well as upon the treatment accorded the contract prior to its rejection and the nature of the proceeding in which the particular executory contract may be involved.
Rejection of an executory contract or unexpired lease of the debtor constitutes a breach of the contract or lease. If the contract or lease is not assumed, rejection constitutes breach as of the date immediately prior to the filing of the petition initiating the bankruptcy case. If a contract or lease has bee assumed under § 365 or under a confirmed plan in Chapter 9, 11 or 13 and rejection takes place before conversion of the Chapter 11 or Chapter 13 to Chapter 7, breach is as of the time of rejection.
If the contract has been assumed under § 365 or under a plan in Chapter 9, 11, or 13 and rejection takes place after conversion of the Chapter 11 or Chapter 13, the breach is as of the date immediately prior to conversion. If assumption of the contract and rejection of the contract take place after conversion of a Chapter 11 or Chapter 13, the breach of the contract or lease is as of the date of the rejection.
The different dates or times of determining breach of an executory contract or unexpired lease are relevant in determining the treatment to be accorded the claim of the party whose contract or lease has been rejected. Where a contract has not been assumed, the rejection relates back to the date immediately prior to filing of the petition and the claim will be allowed and treated as a pre-petition claim.
If, on the other hand, a contract is assumed under § 365 by a trustee in a Chapter 7 case, whether or not such assumption follows conversion of a Chapter 11 or Chapter 13 to a Chapter 7 case, the claim is entitled to be treated as an administrative expense claim in the Chapter 7 liquidation case. If a contract is assumed in a Chapter 11 or Chapter 13 case, the claim will be treated as an administrative expense claim with the only distinction being the date of the breach. If the assumed contract is rejected prior to conversion, then the breach is as of the date of rejection. If the rejection occurs after conversion of the Chapter 11 or Chapter 13, the breach is deemed to have occurred immediately prior to the date of conversion.
Even though a contract is not assumed at any time during the bankruptcy case and the claim for damages will be treated as a pre-petition claim, the claimant may be entitled to an administrative expense claim under § 503(b)(1)(A) for the reasonable value of the use and occupancy of any real estate involved, services or supplies rendered, and the like, if such contributed to, and are actual costs and expenses of, preserving the estate.
Although the Code is silent on the specific question of treatment of the party’s claim where the contract is affirmatively assumed during the course of the bankruptcy case, prior law, if applicable, should result in the claim for damages being an administrative expense for all allowed damages. Where assumption and rejection occurs during a Chapter 11 or Chapter 13 case which is subsequently converted to a Chapter 7 case, the claim, albeit an administrative expense, will be subject to prior payment of administrative expenses allowed in the Chapter 7 case.
Distinguishing between rejection of a contract assumed in a Chapter 11 or Chapter 13 case prior to conversion and rejection of that contract after conversion simply establishes the date of the breach which, in turn, may affect the quantitative measure of damages. On the other hand, where the contract is both assumed and rejected after conversion of a Chapter 11 or Chapter 13 case to a Chapter 7 case, the claim for damages would be entitled to be treated as an administrative expense in the Chapter 7 case.
In cases where the debtor is a lessor of real property or a seller under a contract for sale of real property under which the purchaser is in possession and such contract or lease is rejected, the lessee or purchaser in possession may treat the lease or contract as terminated or may remain in possession of such real property (11 U.S.C.A. § 365(h)(1)). If the lessee or the purchaser remains in possession, rent or contract payments must continue to be made subject, however, to the right of offset by the lessee or purchaser in possession against any damages occurring after and by reason of rejection of the lease or contract.
The estate of the debtor shall have no liability or obligation to the lessee or purchaser in possession on account of any damages arising by reason of such rejection after date of rejection other than the right of offset. The trustee is, however, obligated under a contract for purchase to deliver title.
A purchaser who elects to treat an executory contract for the purchase of real property as terminated, or where the contract is rejected, or a purchaser who is not in possession, has a lien on the interest of the debtor in the property for the recovery of any portion of the purchase price that has been paid.
Meeting of Creditors
Despite strong opinion and pressure to the contrary, the prior practice of a meeting of creditors is retained in the Code (11 U.S.C.A. § 341). In addition, the court may order a meeting of “equity security holders” if it is deemed necessary. In accord with the policy of the Code to remove the bankruptcy judge from administrative duties, the judge does not preside over, nor does he attend, the meeting of creditors.
In cases under all chapters, the debtor is required to appear and be examined at the meeting of creditors, and creditors, any indenture trustee, or any trustee, or examiner may examine him (11 U.S.C.A. § 343). In connection with this examination, the rules regarding self-incrimination and immunity have been substantially modified.
Under prior law, a debtor was required to testify with no claim of privilege or be denied a discharge. The testimony given could not then be used against him in any criminal proceeding except to the extent the testimony was given in a hearing on objections to discharge. The Code introduces Part V of Title 18 of the United States Code, governing immunity of witnesses before other federal tribunals, into bankruptcy practice. Under those provisions, immunity is not automatic as under prior law, but instead is dependent upon the debtor’s invocation of the privilege against self-incrimination.
Invoking the privilege causes the United States attorney to request immunity for the debtor from the district court. If the request is granted, the debtor must then testify or face denial of his discharge (11 U.S.C.A. § 727(a)(6)). If the request is denied, the debtor may continue to claim the privilege without jeopardy to his discharge. The immunity granted by Part V is use immunity, not transactional immunity.
In Chapter 7 cases, the first meeting of creditors serves the further purpose of providing creditors the opportunity to elect a trustee.
Dismissal or Suspension of Proceedings
A bankruptcy court may, after notice and hearing, either dismiss a bankruptcy case or suspend all proceedings at any time if the interests of creditors and the debtor will be better served by such dismissal or suspension (11 U.S.C.A. § 305). Unless otherwise ordered, such dismissal will be without prejudice.
If a bankruptcy case is dismissed, any transfers or liens which may have been avoided prior to dismissal will be reinstated. Orders, judgments, or transfers entered or ordered by the bankruptcy court as a result of such avoidance will be vacated and property formerly vested in an entity will be revested in that entity (11 U.S.C.A. § 349(b)). The bankruptcy court will have the power to preserve transfers or sales of property to good faith purchasers or other transactions involving good faith reliance.
Generally, however, dismissal of a bankruptcy case will, to the extent possible, without imposing unjust or inequitable results upon innocent parties, restore all property and rights as they existed on the date of commencement of the bankruptcy case.
LIQUIDATIONS ELECTION AND DUTIES OF A TRUSTEE
Although the eligibility, qualification and duties of trustees remain basically unchanged, the Code eliminates the period of uncertainty regarding the bankrupt’s property now existing between the date of filing of the petition and the election or appointment of the trustee at the first meeting of creditors and furthermore somewhat changes that election process.
The Bankruptcy Code provides that the court, or the United States Trustee when in office, shall appoint an interim trustee from the panel of private trustees promptly after the entry of an order for relief under Chapter 7 (11 U.S.C.A. § 701). If a trustee is serving under another chapter at the time of the entry of the Chapter 7 order for relief, then that person shall serve as interim trustee.
The interim trustee takes the place of a receiver who can be appointed under present law, and accordingly under the Code the court no longer has the power to appoint a receiver (11 U.S.C.A. § 105(b)). The duties of the interim trustee are the same as those of the trustee set forth in Section 704, but the service of the interim trustee terminates as soon as a trustee is elected or appointed.
An election of a trustee by qualified creditors is held at the meeting of creditors if an election is requested by such creditors who hold at least 20 percent in amount of the allowable, undisputed, affixed, liquidated, unsecured claims against the debtor held by those eligible to vote (11 U.S.C.A. § 702). The requirement that an election be requested is new,
but eligibility to vote apparently remains dependent upon the filing of a claim.
In order for a trustee to be elected, at least 20 percent of creditors entitled to vote must vote and one person must receive the votes of creditors holding a majority in amount of claims of creditors who do vote. The majority by amount rule and the 20 percent participation requirement represent changes from current law which measures majority by amount and number and contains no participation requirement. If no trustee is elected, the interim trustee will continue to serve.
Under present law, a vacancy in the trustee’s office is filled by appointment of the court. The Code grants creditors the right to fill such vacancies by election although the court retains the power to appoint, or order appointment by a United States Trustee of, an interim trustee under appropriate circumstances (11 U.S.C.A. § 703).
TRUSTEES AVOIDING POWERS Trustee as Lien Creditor
The Code provides the trustee with the rights and powers of a creditor who extends credit to the debtor at the commencement of the case and who obtains a judicial lien on the debtor’s property or obtains an execution against the debtor which is returned unsatisfied (11 U.S.C.A. § 544). Moreover, the trustee is granted similar rights and powers of a bona fide purchaser of real property against whom a transfer of property by the debtor can be perfected and who has obtained the status of a bona fide purchaser at the time of the commencement of the case.
These powers are roughly equivalent to those provided by the “strong arm clause” under present law, and are not dependent on the existence of an actual creditor possessing the rights. Although the lien creditor provision is not new, the bona fide purchaser provision provides a new avoiding power to the trustee in states where the real estate recording law protects only bona fide purchasers and encumbrancers.
The trustee is further provided with the avoiding power of a creditor holding an unsecured claim under applicable non-bankruptcy law. This subsection does not employ the concept of the hypothetical creditor as does § 544(a), but instead the trustee’s power is reliant upon the existence of at least one creditor having rights under applicable law. If that creditor exists, the trustee may act on behalf of all creditors.
However, the creditor upon whom the trustee relies must hold an unsecured claim, whereas under prior law, the creditor was required to hold only a provable claim, thus including secured as well as unsecured creditors among those who trigger the trustee’s avoiding power.
Statutory Lien Avoiding Power
A trustee may avoid the fixing of a statutory lien on the property of the debtor provided that the lien is triggered by one of a variety of circumstances relating to the debtor’s financial condition, such as the commencement of a bankruptcy case or the insolvency of the debtor (11 U.S.C.A. § 545).
In addition, statutory liens which are not perfected as against bona fide purchasers from the debtor or are landlords’ liens for rent are voidable. The trustee may also avoid statutory liens that secure any penalty or fine which is not compensation for actual pecuniary loss (11 U.S.C.A. § 724(a)). This section codifies and extends current case law regarding the avoidability of liens securing tax penalties to cover all statutory liens.
The rules regarding voidable preferences are substantially changed under the Bankruptcy Code (11 U.S.C.A. § 547). In certain respects the definition of a preference is unchanged in that a preference remains a transfer of the property of the debtor to or for the benefit of a creditor for or on account of antecedent debt which is made while the debtor is insolvent.
However, the relevant time period has been reduced from four months to 90 days before the date of the filing of the petition and with regard to a transfer during that time period, the trustee no longer is required to prove that the transferee had reason to believe the debtor insolvent. In addition, insolvency during the 90-day period is presumed and no longer falls as a matter of proof upon the trustee.
If the transfer occurs between 90 days and one year before filing, the trustee has the power to avoid the preference but only if the transferee was an “insider” who had reason to believe the debtor “insolvent”.
Moreover, a preference is avoidable only if it enables the transferee to receive more than he would receive if the case were one under Chapter 7 (a liquidation), the transfer had not been made, and the transferee received payment of his debt to the extent provided by Title 11. This element clarifies the “greater percentage” test under current law in that it requires an examination not only of how the creditor is treated compared to creditors within his class, but also of the relative distribution between classes. This examination would include an inquiry into the allowability of the claim. Thus, if by the transfer the creditor received no more than he would in a liquidation, the transfer could still be avoided if his claim would not be allowable in a Chapter 7 liquidation.
In addition to the restrictions inherent in the definition of a preference, there are certain transactions which are specifically excepted from the trustee’s avoiding power:
(1) an exchange for new value given (as defined in § 547(a)(2)) which was intended by the debtor and creditor to be contemporaneous and was substantially so;
(2) payment in the ordinary course of business of a debt incurred in the ordinary course of business within 45 days after the debt was incurred provided that payment is made under ordinary business terms;
(3) a security interest in property acquired by the debtor where the security interest secured new value given at or after the signing of the security agreement covering the acquired property for the purpose of acquiring that property, provided that the security interest is perfected within ten days after it attaches;
(4) a transfer where new value is given by a creditor after the transfer to the extent that that new value was not secured and was not transferred by the debtor to or for the benefit of the creditor, but only to the extent of the new value; and
(5) a statutory lien not avoidable under § 545.
The final exception to the trustee’s power to avoid preferential transfers relates to the enforceability of a security interest in inventory or accounts receivable which predates the 90-day or one-year preference period, whichever is applicable, but which contains an after acquired property clause.
The exception protects the creditor’s security interest, but only to the extent that his position has not been improved during the preference period by after acquired collateral. If the creditor has given new value during the preference period, his interest is vulnerable only to the extent his position improved from the date of the new value to the date of the filing of the petition.
The trustee is also empowered to avoid a transfer to secure reimbursement of a surety who furnished a bond to dissolve a judicial lien avoidable as a preference. The surety is then discharged to the extent of the value of the property recovered by, or the amount paid to, the trustee.
A transfer for purposes of the preference section is deemed to be made at the time the transfer takes effect between the transferor and the transferee if the transfer is perfected at or within ten days of such time, and at the time of perfection if perfection takes place after that ten-day period. A transfer of real estate is perfected when a bona fide purchaser from the debtor cannot acquire an interest superior to that of the transferee, and a transfer of personal property or fixtures is perfected when a contract creditor cannot acquire a judicial lien superior to that of the transferee.
The transfer is deemed to be made immediately before the date of filing of the petition if perfection has not occurred at the later of the commencement of the case and ten days after the transfer takes effect between the transferor and the transferee. Under no circumstances, however, can a transfer take place before the debtor acquires rights in the property.
Fraudulent Transfers and Obligations
Consistent with prior law, the trustee is empowered to avoid transfers which are in fraud of creditors on basically the same grounds provided a creditor under the Uniform Fraudulent Conveyance Act (11 U.S.C.A. § 548).
However, the rule of Dean v. Davis, 242 U.S. 438, 37 S.Ct. 130, 61 L.Ed. 419 (1917) has been omitted from the Bankruptcy Code. That rule gave the trustee the power to avoid certain pre-petition transfers or obligations of a bankrupt where the consideration obtained was used to prefer a creditor. It has been omitted from the Code because it had a negative impact on out of court workouts and arrangements and was seen as duplicating other avoiding powers of the trustee. Furthermore, the concept of “fair consideration” under the Bankruptcy Act has become “reasonably equivalent value” under the Code, and the requirement of good faith in the definition of “fair consideration” is not present in the definition of “value” under the Code. Thus, if full value is given a transfer will not be fraudulent in the absence of good faith unless made with actual intent to hinder, delay or defraud creditors.
Post Petition Transfers
Post petition transfers of property are generally avoidable by the trustee if they were not authorized by the court or under Title 11 (11 U.S.C.A. § 549). Exceptions include transfers of property while a debtor operates his business after the filing of an involuntary petition against him but only to the extent the transfer is for fair value given after the filing of the petition, and transfers by the debtor to a good faith purchaser for fair value of real estate located in a county other than that in which the case is commenced when a copy of the petition has not been filed with the county recorder or register of deeds of the county in which the real estate is located.
A creditor retains the right to setoff mutual, prepetition debts between the debtor and the creditor (11 U.S.C.A. § 553). However, setoff is not permitted where the creditor’s claim is not allowable, where the claim was transferred to the creditor after commencement of the case or within 90 days before commencement while the debtor was insolvent, or where the debt to the creditor was incurred within days of commencement while the debtor was insolvent for purposes of obtaining the right to setoff. Contrary to prior law, for purposes of this section the debtor is presumed to be insolvent on or within the 90 days preceding the filing of the petition.
The trustee is further granted a new power to avoid, with minor exceptions, otherwise valid prepetition setoffs on or within 90 days before filing where the creditor improved his position between the date of setoff and the beginning of the 90 day period. As a result, if the difference between the debtor’s claim and the creditor’s claim, where the creditor’s claim is greater, is lessened by a certain amount between the date of filing of the petition and 90 days prior thereto, the trustee can recover that amount.
Limitations on the Trustee’s Avoiding Powers
The trustee’s avoiding powers are limited in a number of ways (11 U.S.C.A. § 546). An interest which under applicable law can be perfected so as to be prior to that of an entity which acquired rights in the property before that date of perfection is enforceable against the trustee where his rights are those of the intervening entity.
If perfection under this section must be by seizure of the property or commencement of an action, then perfection can be accomplished after filing by notice, provided that that notice is within the time fixed by law for the seizure of commencement of the action. The trustee is additionally restricted in commencing actions to avoid liens, preferences, fraudulent conveyances or setoffs to the period ending two years after the date of his appointment under Chapters 7, 11 or 13 or ending the date the case is closed or dismissed, whichever is earlier.
The Code also resolves the question, frequently litigated in recent years, of a creditor’s right to reclaim goods sold to the debtor. The trustee’s powers of avoidance are subject to the reclamation right under statutory or common law if the debtor received the goods while insolvent and in the ordinary course of the seller’s business and the seller demands reclamation in writing before ten days after receipt of the goods by the debtor. Even if the reclaiming creditor qualifies for reclamation under this section, however, the court may deny reclamation, but only if the court grants the seller’s claim priority as an administrative expense or secures the claim by a lien.
Liability of Transferees of Avoided Transfers
Under the Code, the concept of avoidability is distinguished from the concept of recovering from the transferee. If the trustee is entitled to avoid a lien, a preference, a fraudulent conveyance, or a post petition transfer, the trustee may recover the property transferred, or its value if the court so orders, from the initial transferee or the entity for whose benefit the transfer was made or from a secondary transferee, immediate or not, of that transferee (11 U.S.C.A. § 550).
However, a trustee may not recover from a secondary transferee who has taken for present or antecedent value, in good faith, and without knowledge of the avoidability of the transfer, or from a good faith transferee from such a secondary transferee. This latter good faith requirement prevents “laundering” the transfer through an innocent third party. Even though the trustee may be able to recover from more than one person under this section, he is limited to one recovery.
If a trustee recovers from a good faith transferee, the transferee has a lien on the property recovered to secure the “improvement” to the property. “Improvement” is defined to include physical changes or repairs, payment of taxes on the property, payment of a debt secured by a lien on the property, discharge of any lien, superior or equal to the rights of the trustee, and the preservation of the property. The amount of the improvement to be secured is limited to the lesser of the cost of the improvement less any profit realized from the property and the increase in the value of the property caused by the improvement.
An action by the trustee to recover property or its value where he has avoided the transfer of that property must be brought within one year after avoidance or before the case is closed or dismissed, whichever is earlier.
Any transfer avoided by the powers of the trustee discussed above or under the exemption provision of the Code (11 U.S.C.A. § 522) or any lien avoided because the underlying claim is not allowed, is preserved for the benefit of the estate (11 U.S.C.A. § 551). This rule represents a change from prior law in that the preservation is automatic and not dependent on an order of the court. If a lien not beneficial to the estate is preserved, the trustee must then abandon that interest in order to avoid its application.
CLAIMS AND DISTRIBUTION Claims
The Bankruptcy Code does little to alter the present scheme of proof, allowance and payment of claims. The procedure of filing a proof of claim is retained as the method of presenting a claim for payment out of estate property (11 U.S.C.A. § 501). In an expansion of prior law which permitted a debtor to file a claim only on behalf of tax and wage creditors, he may now file a claim on behalf of any creditor who does not do so.
The concept of provability under the Bankruptcy Act has been eliminated leaving allowability as the only test whether a claim will be entitled to share. The concept of allowability has been changed and more specifically defined (11 U.S.C.A. § 502). Claims which are not allowable include: Those unenforceable against the debtor; those for unmatured interest; those subject to set off; property taxes in excess of the value of the property; those for services to the debtor by an “insider” or attorney to the extent the claim exceeds the reasonable value of the services; and alimony or child support obligations arising after the date of filing.
A claim for damages resulting from the termination of a lease of real property is allowed only to the extent the claim does not exceed the rent under the lease without acceleration for the greater of one year or 15% of the remaining term of the lease (not to exceed three years) following the earlier of the date of filing of the petition and the date on which the lessor retook possession of the property, plus any unpaid rent due under the lease on that date.
As a result of a similar method of computation, allowability of a claim for damages resulting from termination of an employment contract is
limited to the compensation under the contract without acceleration for one year following the date of filing or the date of termination, whichever is earlier, plus unpaid compensation due on that date.
Moreover, the exception to allowability existing under current law and based on the unliquidated or contingent nature of the claim if such claim is found not capable of estimation is eliminated. The court is required under the Code to estimate or have estimated not only contingent or unliquidated claims, the fixing or liquidation of which would unduly delay closing the estate, but also any right to an equitable remedy for a breach of performance if the breach gives rise to a right to payment. As a result, virtually all claims, unless subject to disallowance on other grounds, must be reduced to a dollar amount during the proceeding.
The priorities of claims and expenses have been somewhat modified by the Code (11 US.C.A. § 507). Allowed administrative expenses are accorded first priority: The only exception to this rule is that in the event a trustee provides “adequate protection” to a lien creditor under Section 362, or 364 in connection with denial of relief from the stay, sale or use of estate property in extension of credit to the trustee, and that creditor nevertheless has an allowable administrative expense arising from the action taken by the trustee, that claim will be entitled to payment prior even to administrative expenses.
Unsecured claims arising in the “involuntary gap” between the date of filing of the petition and the order for relief or the appointment of a trustee are entitled to second priority.
Wages and related claims have been dropped from second to third priority. However, the $600 limitation per person on such claims has been increased to $2,000 and the claims may now include vacation, severance and sick leave pay. In addition, employees are protected by a new fourth priority for unsecured claims for contributions to employee benefit plans, if the claim arose within 180 days of filing or cessation of the debtor’s business, whichever occurs first.
Such claims, however, are limited to $2,000 times the number of employees covered by the plan less the aggregate amount paid to those employees under the third priority and the aggregate amount paid by the estate to any other employee benefit plan on behalf of those employees.
This priority overrules United States v. Embassy Restaurant, 359 U.S. 29, 79 S.Ct. 554, 3 L.Ed.2d 601 (1958), which denied priority status to fringe benefit claims, thus recognizing the fact that wages and fringe benefits are many times considered together in labor negotiations.
A new fifth priority is accorded consumer claims of individuals arising from a deposit of money with the debtor before filing in connection with the purchase, rental or lease of property or purchase of services that were not delivered or provided. The priority for taxes has been reduced from
fourth to sixth, with essentially the same taxes being given priority as under former law. The third priority under the Bankruptcy Act which covers certain costs to creditors who aid in setting aside, refusing or revoking a discharge or a plan under Chapters XI or XIII and the fifth priority for debts to governmental units other than taxes, have been deleted.
The Bankruptcy Code codifies preexisting case law by rendering subordination agreements enforceable to the same extent as under applicable local law and by recognizing the court’s power to subordinate claims on equitable grounds when appropriate (11 U.S.C.A. § 510). With regard to the latter power, it is contemplated that existing case law, which normally provides for subordination if inequitable conduct on the part of the claimant is found or if the claim is of a class which merits subordination as a whole, will be followed.
Furthermore, any claim for rescission or damages arising out of a purchase or sale of a security of the debtor or an “affiliate” of the debtor is subordinated to all claims senior or equal to that security.
After payment of priority claims under Section 507, timely filed unsecured claims and those tardily filed where the creditor had no notice or actual knowledge of the case in time to file within the deadline but who did file in time for payment, are to be paid (11 U.S.C.A. § 726). This rule represents a change from prior law where the time limitation for filing a proof of claim was strictly enforced.
If all such unsecured claims are paid in full, then claims which are filed after the deadline but not falling into the above class, claims for penalties or fines which are not compensation for actual damages, and interest on all claims at the legal rate are paid in that order. If any property then remains, it is paid over to the debtor.
In addition, the Code apparently permits early payment of a class of claims provided all prior classes are assured of full payment. For example, if adequate funds exist, all wage claims can be paid on an expedited basis in order to avoid hardship to those claimants.
A significant change in distribution involves the treatment of a partnership, its creditors, and the creditors of the partners. Under prior law, the “jingle rule” provided that payment of claims of partnership creditors against the estates of individual partners was delayed until the claims of the individual’s nonpartnership creditors had been paid in full.
This rule has been eliminated by the Code which provides that if the partnership estate is not sufficient to pay partnership claims and if a partnership’s trustee is not able to recover the deficiency from nonbankrupt partners, he may assert a claim in the bankruptcy proceeding of each individual partner which will be accorded equal status with those of the individual’s personal creditors (11 U.S.C.A. § 723).
In the event the partnership trustee pursues a nonbankrupt partner, or files a claim in an individual partner’s proceeding, the partnership creditors are prohibited from doing so. This change in the law eliminating the jingle rule makes the applicable rule in bankruptcy more in accord with the rights of partnership creditors under nonbankruptcy law.
FEES AND COMPENSATION
The general rule in awarding compensation for services rendered in a bankruptcy proceeding was, if not one of parsimony, one of conservatism and on the lower end of the scale of reasonableness. The Code provides that:
[R]easonable compensation for actual, necessary services rendered by [the] trustee, examiner, professional person, or attorney, as the case may be, and by any paraprofessional persons employed by such trustee, professional person, or attorney, as the case may be, [shall be] based on the time, the nature, the extent, and the value of such services, and the cost of comparable services other than in a case under this Title; (emphasis added) (11 U.S.C.A. § 330(a)(1).
A trustee’s compensation in a Chapter 7 or Chapter 11 case is governed by statute which dictates the maximum allowable based upon all monies dispersed or turned over in the case by the trustee to parties in interest, with the test being “reasonable” compensation (11 U.S.C.A. § 326). The same statutory maximums apply in a Chapter 11 reorganization case as in a Chapter 7 liquidation case. It can be, however, anticipated that by reason of funds paid out during the course of operating the debtor’s business, a trustee in a Chapter 11 case will, notwithstanding the statutory maximum, receive compensation commensurate with the enlarged duties and responsibilities of operating the debtor’s business.
In the event more than one person serves as trustee, the aggregate compensation may not exceed the maximum statutory compensation prescribed for a single trustee. This rule will apply in cases where a trustee is appointed and subsequently replaced by an elected trustee, or where a trustee is replaced during the course of the case for any reason.
A trustee may, with court approval, act as his own attorney or accountant. However, “separate” compensation to the trustee will be awarded based upon those services normally and regularly performed by a trustee and those services normally performed by an attorney or an accountant.
Compensation may be denied a trustee for failure to make diligent inquiry into facts that would permit denial of allowance of compensation of attorneys, accountants, or other professional persons, or where the trustee with knowledge of such facts employed such professional person.
In a Chapter 13 case, a standing trustee is entitled to no Court awarded compensation in addition to his statutorily determined salary under § 1302(e). However, where a person other than the standing trustee is appointed, the trustee will be allowed reasonable compensation subject to the maximum allowances prescribed in § 326(a), but, in any event, in an amount not to exceed 5% of all payments made under the plan.
With certain exceptions, the court may authorize the trustee to employ one or more attorneys, accountants, appraisers, auctioneers, or other professional persons. Such individuals must not hold or represent any interest adverse to the estate and must qualify as “disinterested persons” (11 U.S.C.A. § 327(a)).
However, where the trustee or debtor-in-possession is authorized to operate the business of the debtor in Chapter 7 or 11 individuals regularly employed by the debtor as attorneys, accountants, or other professional persons on salary may be retained if necessary for the operation of the business. A person is not disqualified for employment under Chapter 7 or 11 solely because such person was employed by or represented a creditor.
However, such employment or representation may not continue while the person is employed by the trustee or debtor-in-possession in connection with the case. An attorney that has represented the debtor may, with court approval, be employed by the trustee for specific purposes if such employment is in the best interests of the estate and the attorney does not represent or hold any interest adverse to the debtor or the estate in connection with the matter upon which the attorney is employed.
In addition, an attorney, accountant, or other professional person who has regularly represented the debtor may continue to be employed by the debtor-in-possession under a Chapter 11 if the person has no adverse interest to the debtor or the estate (11 U.S.C.A. § 1107(b)). If an examiner has been appointed, that person may not be employed by the trustee or debtor-in-possession.
The Code provides that the trustee, debtor-in-possession, or a creditors’ committee in Chapter 11 may, with the court’s approval, employ or authorize employment of a professional person including an attorney on any reasonable terms and conditions including a retainer, an hourly basis, or a contingent fee basis (11 U.S.C.A. § 328).
However, the court may, after conclusion of the employment, modify or alter such terms and conditions, including the amount of compensation allowed, if the prior compensation agreement proves to be improvident in light of developments unanticipated at the time of entering into the employment agreement.
If a professional person at any time during such employment is deemed to be or becomes not disinterested or represents or holds an interest adverse to the estate with respect to the matter on which such person was employed, the court may deny allowance of compensation for services rendered and reimbursement of expenses.
Compensation may be awarded to a trustee, examiner, professional person, or the debtor’s attorney only after notice to parties in interest and the United States Trustee and upon hearing. Interim compensation, upon notice and hearing, may be allowed not more than once every 120 days, or if the court permits, on more frequent intervals, for services rendered or expenses incurred prior to the date of the application for compensation (11 U.S.C.A. § 331).
Any attorney representing a debtor in a bankruptcy case or in connection with such case, whether or not applying for compensation, must file with the court a statement of compensation paid or agreed to be paid, including the source of such compensation, for services rendered or to be rendered in contemplation of and in connection with the case if such payment or agreement was made within one year before the date of the filing of the bankruptcy petition (11 U.S.C.A. § 329). If the court finds that the compensation paid or agreed to be paid exceeds the reasonable value of such services, the court may cancel the agreement or order return of any excess payment.
RIGHTS AND DUTIES OF THE DEBTOR Duties
Although the debtor has certain duties which are set forth in provisions of the Code dealing primarily with other matters, the Code sets forth certain specific duties which the debtor is required to perform (11 U.S.C.A. § 521). Those duties include filing a list of creditors, and unless the court orders otherwise, a schedule of assets and liabilities together with a statement of affairs, cooperating with a trustee as is necessary to enable him to perform his duties, surrendering to the trustee all property of the estate and any records relating to that property, and appearing at the discharge hearing required under § 524(d).
The Code departs significantly from prior law by providing a comprehensive scheme of exemptions (11 U.S.C.A. § 522). The debtor is accorded an option to choose the Code exemptions or those provided under applicable state law, whereas under present practice state law applies in all cases. However, state legislatures may enact legislation prohibiting use of the federal exemption. In any event, the federal exemption does not
bar liability of exempted property for alimony, child support or maintenance or for a lien not avoided by the trustee or debtor under the Code.
A waiver of the exemption is unenforceable in a case under Title 11. Moreover, the debtor is accorded the right to avoid a lien on exempt property if that lien is a judicial lien or a non-possessory non-purchase money security interest in personal household goods, tools of the trade, or health aids.
The debtor may also declare exempt property which is recovered by the trustee by way of his avoiding powers if the debtor could have exempted that property initially, or he may actually avoid those transfers if the trustee does not attempt to do so. If the trustee does recover property later claimed exempt by the debtor, the property will be subject to payment of the costs and expenses incurred by the trustee in making the recovery.
A debtor or his dependent must file a list of exempt property, and if no party in interest objects, the exemptions listed thereon shall be allowed. The exemption section applies separately to each spouse in a joint case.
Redemption of Personal Property
The Code accords an individual debtor under Chapter 7 the right to redeem personal property intended for personal, family or household use from a lien securing a dischargeable consumer debt if the property is exempt under § 522 or if it is abandoned (11 U.S.C.A. § 722). A waiver of this right is unenforceable. Redemption is accomplished by the debtor paying the secured creditor the amount of the allowed claim secured by the lien. The right to redeem exempt property extends to the whole property and not simply to the debtor’s exempt interest in it. This right of redemption represents a substantial expansion of that available under the U.C.C. which provides that the entire debt plus expenses must be paid to redeem the collateral.
The Code provides that a utility is prohibited from refusing service to a trustee or debtor solely on the ground that a debt for service rendered before the order for relief was not paid when due (11 U.S.C.A. § 366).
That prohibition continues only twenty (20) days after the order for relief, however, unless during that time the debtor or trustee furnishes adequate assurance of payment, by deposit or other security, for service after commencement of the case. The court may modify that security upon re-request of a party in interest, but only after notice and a hearing.
DISCHARGE The Discharge
The discharge in a Chapter 7 liquidation, providing the fresh start the debtor seeks in commencing the case, is governed by § 727 of the Code. The discharge excuses the debtor from payment of all debts arising before the date of the order for relief under Chapter 7 and from liability
on any claim that is determined under § 502 (allowance) to have arisen before the commencement of the case.
It is critical that the cut off time is the entry of the order for relief under Chapter 7 because in a case converted from Chapter 11 or Chapter 13, this feature serves to discharge debts incurred after the commencement of the case but before conversion. In addition, the discharge has been extended to cover liabilities, such as those on a rejected contract, which actually arise after the commencement of the case but are determined by § 502 to arise before that date.
Furthermore, whether a debt is covered by the discharge is not affected by whether a proof of claim is filed or whether the claim is allowed.
The circumstances in which an entity will not be granted a Chapter 7 discharge have been somewhat modified. Contrary to prior law, only an individual, and not a corporation, partnership or other entity, is entitled to a discharge. Although discharges were not normally granted to non-individuals under the Bankruptcy Act, the change is apparently designed to discourage the use or transfer of shell entities whose debts have been discharged.
A new ground for denial of discharge under the Code is the commission of an act by the debtor in connection with a bankruptcy case concerning an “insider” on or within one year prior to, or any time after, the commencement of the debtor’s case. The relevant acts in this regard include wrongdoing concerning property of the insider or his estate, the financial records of the insider, or the administration of the insider’s estate.
The rule prohibiting a second discharge within six years of the first has been generally preserved. However, if the prior discharge was under former Chapter XIII or under new Chapter 13, the six year ban does not apply if; (1) 100% of the allowed unsecured claims were paid under the prior plan, or (2) 70% or more of such claims were paid and the plan was proposed by the debtor in good faith and was his best effort. The second exception involves subjective judgment and would require a hearing, probably at the request of the debtor.
As under prior law, a debtor may waive his discharge in writing. However, the waiver becomes effective under the Code only upon approval by the court.
The remaining grounds for denying discharge are derived without significant change from present law. Discharge will be denied if the debtor commits wrongdoing with regard to his property or that of the estate, commits wrongdoing with regard to his records, commits a “bankruptcy crime”, fails to explain lost assets, or refuses to obey a court order or to testify. The last ground is subject to the debtor’s right to invoke the privilege against self-incrimination treated elsewhere in this article.
A trustee or creditor may object to discharge, and the court may also order the trustee to examine the acts and conduct of the debtor to determine whether grounds exist for denying discharge if such investigation is requested by a party in interest. In addition, as under prior law the court retains the power to revoke discharge on the request of a creditor or the trustee and under appropriate circumstances.
Exceptions to Discharge
While the above discussion on discharge relates only to discharge under Chapter 7, the Code provision excepting certain debts and liabilities from discharge relates to discharge under any of the operative chapters of Title 11 except Chapter 9 (11 U.S.C.A. § 523). The exceptions to discharge are essentially those set forth in prior law with some changes and additions.
Any debts incurred by false pretenses, false misrepresentation, or by a fraudulent financial statement remain nondischargeable, and “actual fraud” has been added as a further basis by the Code (§ 523(a)(2)).
However, the Code causes uncertainty as to the applicability of the “fresh cash” requirement developed in case law under the Bankruptcy Act. Those cases have interpreted “obtaining money or property” under Bankruptcy Act § 17(a)(2) as rendering only the portion of the debt represented by fresh cash received in a refinancing nondischargeable when the fraud by the debtor was in connection with that refinancing. If the refinancing was simply a renewal without fresh cash, the debt was dischargeable.
The Code provides, however, that nondischargeability applies to “obtaining money, property, services or an extension, renewal or refinance of credit” by a fraudulent act (11 U.S.C.A. § 523(a)(2)). This language, although not entirely dispositive of the question, seems to spell doom for the fresh cash requirement.
As under prior law an unscheduled debt where the creditor did not have sufficient notice or knowledge of the proceeding to timely file a claim is not dischargeable. The Code further expands this rule to provide that if the debt is one which would require the filing of a complaint in order to determine dischargeability, the creditor must have notice or knowledge of the proceeding to enable him to timely file that complaint.
The nondischargeability of alimony, support and maintenance is also retained; however, the debt will be dischargeable if it has been assigned to another entity. This rule will likely have substantial impact on the practice of public welfare agencies which have the alimony, support and maintenance rights of recipients assigned to them. The Code further makes it clear that substance will prevail over form in determining whether this exclusion applies to payments designated as alimony, support or maintenance in a decree or other document.
In retaining the nondischargeability of priority and other taxes, the Code specifically states that tax penalties are nondischargeable if the underlying tax is nondischargeable under § 523(a)(1), thus confirming the United States Supreme Court’s recent decision in United States v. Sotelo, 436 U.S. 268, 98 S.Ct. 1795, 56 L.Ed.2d 275. Educational loans also remain nondischargeable within five years after the loan first becomes due and if repayment would not impose undue hardship. However, the ban on discharge of educational loans now encompasses all loans by, or guaranteed by, any governmental unit instead of only federally insured loans as under prior law.
The Code retains the requirement that the creditor institute an action to determine dischargeability of any claim under the sections involving fraud and misrepresentation, fraud or defalcation by a fiduciary, and willful and malicious injury to person or property or suffer discharge of those claims. A new protection against such actions instituted under the fraud and misrepresentation provision is provided to the debtor, however, in that the court is required, instead of simply authorized, to grant judgment for the debtor and against the creditor for costs and attorneys fees if the debt is discharged, unless that grant would be clearly inequitable.
Effects of Discharge
The primary effect of a discharge is to void any judgment on a discharged debt and to enjoin any action to collect a discharged debt from the debtor or his property, whether or not discharge of that particular debt has been waived (11 U.S.C.A. § 524(a)). The discharge does not effect the liability of a co-debtor.
The Code imposes extensive restrictions on reaffirmation of a discharged debt. The agreement to reaffirm must be made before the granting of the discharge. The debtor may rescind that agreement within 30 days after the agreement becomes enforceable, and, if the debtor is an individual, the court must inform the debtor at his discharge hearing that he is not required to reaffirm and of the legal consequences of the agreement.
Furthermore, if the debtor is an individual and the debt is a consumer debt not secured by the debtor’s real estate, the court must approve the agreement as: (1) not imposing undue hardship on the debtor and as being in the best interests of the debtor, or (2) entered into in good faith and in settlement of nondischargeability litigation or a redemption of personal property under the Code.
As mentioned above, the Code further requires in a case concerning an individual that the court hold a hearing at which the debtor shall appear in order to inform him that a discharge has been granted or why one has not been granted (11 U.S.C.A. § 524(d)). In addition, if applicable, the court must deal with the reaffirmation issues discussed above.
CHAPTER 11: REORGANIZATIONS
Chapter 11 consolidates Chapters VIII (Railroad Reorganizations), Chapter X (Corporate Reorganizations), Chapter XI (Business Arrangements) and Chapter XII (Non-Corporate Real Property Arrangements) of the Bankruptcy Act. Chapter 11 covers all business reorganizations and essentially adopts the flexibility of Chapter XI while retaining various aspects of Chapter X’s public protection features and ability to deal with secured creditors and equity security or shareholders’ interests. Chapter 11 permits both voluntary commencement by the debtor or involuntary commencement by creditors (11 U.S.C.A. §§ 301, 303). Exceptions from involuntary Chapter 11 are farmers and eleemosynary institutions.
All persons, with certain noted exceptions, who can proceed under Chapter 7 (Liquidation) can become debtors under Chapter 11 (11 U.S. C.A. § 109(d)). Persons not eligible for Chapter 7 are railroads, insurance companies and certain lending institutions. Railroads can proceed under Chapter 11 but not Chapter 7 and stock brokers and commodity brokers can proceed under Chapter 7 but not under Chapter 11.
Chapter 11 contains a compromise between Chapter X and Chapter XI as it pertains to the choice of continuing the debtor-in-possession or appointing an independent trustee. Unless otherwise ordered, the debtor remains in possession to continue the operation of the business. However, upon request of any party in interest, and after notice and hearing, the Court may appoint a trustee to operate the debtor’s business (11 U.S.C.A. § 1104(a)).
Grounds for appointment of a trustee are flexible and give substantial discretion to the Court. A trustee may be appointed for reasons including fraud, dishonesty, incompetence or gross mismanagement by or involving the debtor, or if such appointment is in the best interests of creditors, including equity security holders or any other party having an interest in the estate.
A trustee’s appointment may be terminated by the Court at any time during the pendency of the case prior to confirmation of a plan, and the debtor restored to possession and management upon a satisfactory showing that the grounds or reasons for the original appointment no longer require the existence of a trustee (11 U.S.C.A. § 1105).
A trustee’s duties in addition to operating the business include filing with the Court the list of the debtor’s creditors’ schedules of assets and liabilities, and statements as required under applicable provisions of chapter unless previously filed by the debtor.
The trustee shall, unless otherwise ordered by the Court, conduct an investigation of the acts and conduct of the debtor, the debtor’s financial affairs and condition and operation, as well as determine the desirability of continuing operation of the business and investigate any other matters which might be relevant to the case or formulation of a plan.
The trustee shall as soon as practicable file a plan of reorganization or a report of why such a plan will not be filed, or recommend either conversion of the case to Chapter 7 or 13 or dismissal of the case (11 U.S.C.A. § 1106).
Essentially a debtor-in-possession has all of the rights, powers and duties of a trustee authorized to operate the business under Chapter 11 except that provisions under the Code relating to the trustee’s compensation are not applicable nor is the debtor-in-possession obligated to conduct the investigation pertaining to possible fraud, dishonesty, etc., which is the responsibility of the trustee (11 U.S.C.A. § 1107).
The Bankruptcy Code provides a “middle ground” between retaining a debtor-in-possession or appointing a trustee by permitting, upon request of any party in interest and after notice and hearing, the appointment of an “examiner” at any time during the pendency of the case prior to confirmation of a plan (11 U.S.C.A. § 1104).
The Court shall appoint such examiner if it determines that such appointment will be in the best interests of creditors, including equity security holders, or if the debtor’s fixed, liquidated, unsecured debts (excluding debts for goods, services or taxes, or an obligation to an insider) are in excess of $5,000,000.
The examiner is required to investigate all acts, conduct, assets, liabilities and the financial condition of the debtor, including the operation of the debtor’s business, desirability of continuing the business, and any other matter relevant to the case or formulation of a plan (11 U.S.C.A. § 1106).
As soon as practicable after the order for relief, a creditors’ committee is appointed by the Court (11 U.S.C.A. § 1102) or, where in office, the United States Trustee (11 U.S.C.A. § 151102). The committee will consist of unsecured creditors and ordinarily its members will be the holders of the seven largest claims if such creditors are willing to serve.
However, if a committee has previously been selected before the case is commenced, that committee may be continued if it fairly represents the various claims to be represented. Additional committees of creditors or of equity security holders may, upon request of a party in interest, be appointed if such appointment is necessary to provide adequate representation of such additional classes of creditors or equity security holders. Membership of the committee of equity security holders normally will consist of those persons holding the seven largest amounts of equity securities willing to serve on the committee.
The Court may, upon request of a party in interest and after notice and hearing, change the membership or the size of any committee if it appears that the membership is not representative of the claims or interests being represented by that particular committee.
The committee may consult with the trustee or debtor-in-possession concerning administration of the case, investigate acts, conduct and the financial condition of the debtor, the debtor’s business operations, the desirability of continuing the business or any other matter relevant to the case or formulation of a plan.
The committee may participate in the formulation of a plan, make recommendation to those creditors or persons represented by the committee regarding any plan so formulated, and collect and file with the Court acceptances to the plan. The committee may request that a trustee or examiner be appointed and may, with Court approval, employ attorneys, accountants or other agents to represent or perform services for the committee.
Any person employed to represent a committee is precluded from representing any other person or entity in connection with the case during such employment with the committee (11 U.S.C.A. § 1103).
THE SECURITIES EXCHANGE COMMISSION
Consistent with the objectives under prior Chapter X, Chapter 11 permits the Securities Exchange Commission to appear, raise and be heard on any issue; however, the Commission is not given the status of a “party in interest” and may not appeal from any judgment, order or decree entered in the case (11 U.S.C.A. § 1109).
OPERATION OF THE DEBTOR’S BUSINESS
Upon entry of the order for relief, continued operation of the debtor’s business is automatic unless otherwise ordered by the Court (11 U.S.C.A. § 1108). The debtor-in-possession or trustee may operate the debtor’s business in the ordinary course, including use, sale or lease of property in the ordinary course of business, without notice or hearing except as to specific kinds of property designated as “cash collateral” (11 U.S.C.A. § 363).
Cash collateral is defined as “cash, negotiable instruments, documents of title, securities, deposit accounts, or other cash equivalents in which the estate and an entity other than the estate have an interest.” (11 U.S.C.A. § 363(a)). Cash collateral cannot be used unless the entity having an interest (usually a secured creditor) in the collateral consents or, after notice and hearing, the Court authorizes such use.
The hearing may be either a final or preliminary hearing. In most cases the hearing will probably be in the nature of a preliminary hearing, in which event the use, sale or lease of cash collateral may be authorized if there is a reasonable likelihood that the debtor-in-possession or trustee will prevail at the final hearing. In order to prevail at the final hearing, the debtor-in-possession or trustee has the burden of proof to show that the entity having an interest in the cash collateral can be provided “adequate protection” of such interest.
Adequate protection can be provided by requiring periodic cash payments to the extent that the use, sale or lease of cash collateral results in a decrease in the value of the other entity’s interest in the collateral; granting an additional or replacement lien to the extent that there is a decrease in the value of the other entity’s interest in the collateral; or granting such other relief (except allowing any claim as an administrative expense) as will result in the realization of such other entity of “indubitable equivalent” of the other entity’s interest in the collateral (11 U.S.C.A. § 361).
The debtor-in-possession or trustee may, in connection with the operation of the debtor’s business, obtain unsecured credit and incur indebtedness if done in the ordinary course of business, and such credit or indebtedness is entitled to a priority as an administrative expense (11 U.S.C.A. § 364). In addition, the debtor-in-possession or trustee may obtain or incur unsecured credit or debt other than in the ordinary course of business but only upon notice and hearing and Court authorization.
In the event the debtor-in-possession or trustee cannot obtain unsecured credit, the Court, after notice and hearing, may authorize obtaining of credit or incurring of indebtedness having priority over any or all other administrative expenses, secured by a lien on property of the estate not otherwise secured or subject to a lien, or grant a junior lien on property of the estate already subject to a lien.
The Court may also grant a lien senior or equal to liens already against property of the estate, but only if it is not possible for the debtor-in-possession or trustee to obtain credit otherwise, and if the interest of the existing lien-holder is afforded adequate protection, with the debtor-inpossession or trustee having the burden of proof regarding the adequacy of protection.
CONVERSION OR DISMISSAL
The Court may, upon request of a party in interest, after notice and hearing and upon cause, either convert the Chapter 11 case to Chapter 7 or Chapter 13 or dismiss the case, whichever is in the best interests of creditors and the estate (11 U.S.C.A. § 1112).
Cause may include continuing loss to or diminution of the estate and absence of a reasonable likelihood of rehabilitation; inability to effect a plan; unreasonable delay by the debtor that is prejudicial to creditors; failure to propose a plan within the time prescribed; denial of confirmation of a plan; revocation of confirmation of a plan; failure to effectuate “substantial consummation” of a confirmed plan; a material default by the debtor with respect to a confirmed plan; or termination of a plan by reason of the occurrence of a specified condition in the plan.
A case can be converted only to a chapter under which the debtor is eligible to be a debtor. A case cannot be converted to Chapter 7 if the debtor is a farmer or eleemosynary institution unless the debtor consents, nor can a case be converted to Chapter 13 unless the individual debtor so requests and the debtor has not received a discharge under Chapter 11.
The provisions of § 365 apply to Chapter 11 except that the 60-day assumption requirement is not applicable to Chapter 11. However, the other party to the contract may request the Court to order the trustee or debtor-in-possession to assume or reject the contract within a specified time (11 U.S.C.A. § 365(d)(2)).
The automatic stay provisions in § 362 are generally applicable to Chapter 11 cases. However, an exception to its application is where the property is necessary to an effective reorganization even though the debtor has no equity in the property (11 U.S.C.A. § 363(d)(2)).
Claims scheduled by the debtor as undisputed, liquidated and non-contingent are deemed filed, thus eliminating the need for every holder of a claim or interest and every equity security holder to file a claim in a Chapter 11 case to participate under the plan (11 U.S.C.A. § 1111). Secured claims will be allowed as having recourse against the debtor whether or not there is such recourse unless two-thirds in amount and more than half in number of the class of which such claim is a part elect to have the claim deemed a secured claim to the extent it is allowed.
Exceptions are claims not having recourse where the property is sold under § 363 and where the interest of the holder of the claim in the property is of inconsequential value.
THE PLAN Who May File
If no trustee has been appointed, only the debtor may file a plan until after 120 days after the order for relief (11 U.S.C.A. § 1121). The plan may be filed with the petition in a voluntary case. If the debtor files a plan within the 120 days, an additional period of 180 days from date of the order for relief is granted to obtain requisite acceptances.
If a trustee is appointed or the debtor fails to file a plan within the 120-day period, or if so filed but requisite acceptances are not obtained within the 180-day period, then any party in interest, including the debtor, the trustee, creditors’ committee, equity security holders committee, a creditor, equity security holder or any indenture trustee, may file a plan.
The 120 or 180-day period may, upon request of a party in interest after notice and hearing, be reduced or increased.
Under § 1123, a plan SHALL:
(1) Designate classes of claims and interests. A claim or interest must be placed in a class with other claims or interests which are substantially similar to the other claims or interests of such class, except that a separate class of unsecured claims less than (or as reduced to) a certain amount as approved by the Court as reasonable and necessary for administrative convenience may be designated (11 U.S.C.A. § 1122).
(2) Specify any class of claims or interest not impaired under the plan. The concept of “impairment” is a departure from the “materially and adversely affected” concept under prior law. If a claim or interest is unimpaired (as that term is defined), objection or dissent of a class of holders of claims or interests deemed “unimpaired” will not prevent confirmation of a plan (11 U.S.C.A. § 1124).
A plan does not impair a claim or interest (or classes thereof) if:
(a) The plan leaves unaltered the legal, equitable, and contractual rights to which the claim or interest entitles the holder of such claim or interest;
(b) Any default that entitles the holder of the claim or interest to accelerated payment is cured by the plan, the plan reinstates the maturity of the claim or interest, the plan compensates the holder of such claim or interest for damages resulting from reasonable reliance by the holder of the claim or interest on contractual provisions or applicable law, the plan does not alter the legal, equitable or contractual rights to which the holder of the claim or interest is entitled; or
(c) The plan provides for payment in cash of an amount equal to the allowed amount of the claim, or the greater of any fixed liquidation preference to which any security representing such interest entitles the holder of such interest or any fixed price at which the debtor, under the terms of such security, may redeem such security from the holder.
(3) Specify the treatment of any class of claims or interests that is impaired under the plan;
(4) Provide the same treatment for each claim or interest of a particular class, unless the holder of a particular claim or interest agrees to a less favorable treatment;
(5) Provide adequate means for the plan’s execution such as: retention by the debtor of all or any part of the property of the estate, transfer of all or any part of the debtor’s property to one or more entities whether organized before or after confirmation of the plan, merger or consolidation of the debtor with one or more persons, sale of all or any part of the property of the estate either subject to or free of any lien, or the distribution of all or any part of the property of the estate either subject to or free of any lien, or the distribution of all or any part of the property of the estate among those having an interest in such property, satisfaction
or modification of any lien, cancellation or modification of any indenture or similar instrument, curing or waiving any default, extension of maturity date or a change in an interest rate or other term of outstanding securities, amendment of the debtor’s charter, or issuance of securities of the debtor or of any entity to which all or any property of the estate had been transferred or into which the debtor had been merged or consolidated for cash, property, existing securities or an exchange for claims or interests or any other appropriate interest;
(6) Provide for the inclusion in the charter of the debtor, if the debtor is a corporation, or of any corporation to which all or any part of the property of the estate has been transferred or into which the debtor has been merged or consolidated, of a provision prohibiting issuance of nonvoting equity securities, and provide as to the several classes of securities possessing voting power an appropriate distribution of such power among such classes, including in the case of any class of equity securities having a preference over another class of equity securities with respect to dividends, adequate provisions for the election of directors representing such preferred class in the event of default in payment of such dividends;
(7) Contain only provisions consistent with interests of creditors and equity security holders and with public policy respecting the manner of selection of any officer, director or trustee under the plan and any successors thereto.
A plan MAY:
(1) Impair or leave unimpaired any class of claims or interests;
(2) Provide for assumption or rejection of any executory contract;
(3) Provide for the settlement or adjustment of any claim or interest belonging to the debtor or the estate, and retention and enforcement by the debtor, by the trustee or by a representative of the estate appointed for such purpose of any such claim or interest;
(4) Provide for sale of all or substantially all property of the estate and distribution of the proceeds among holders of claims or interests, and
(5) Provide for any other appropriate provision not inconsistent with applicable provisions of chapter 11.
If the debtor is an individual, a plan proposed by anyone other than the debtor cannot provide for use, sale or lease of exempt property unless the debtor consents thereto.
Disclosure and Solicitation of the Plan
Prior to or at the time of solicitation of creditors or holders of interests for either acceptance or rejection of a plan, there must be transmitted to each holder of a claim or interest a copy of the plan or a summary of the plan and a written disclosure statement (11 U.S.C.A. § 1125).
The written disclosure statement must, after notice and hearing thereon, be approved by the Court. The disclosure statement must contain “adequate information” upon which those being solicited can make an informed judgment about the plan. “Adequate information” is defined in
the Code as information of a kind and in sufficient detail as far as is reasonably practicable in light of the nature and history of the debtor and condition of the debtor’s books and records that would enable a hypothetically reasonable investor typical of holders of claims or interests of the relevant class receiving the disclosure statement to make an informed judgment about the plan.
An “investor typical of holders of claims or interests of the relevant class” means an investor having a claim or interest of the relevant class, such a relationship with the debtor as the holders of other claims or interests of such class generally have, and such ability to obtain such information from sources other than the disclosure statement as holders of claims or interests in such class generally have. The same disclosure statement need not be transmitted to all classes of holders of claims or interests.
Different disclosure statements containing different details or kinds of information may be transmitted depending upon the nature of the class to which the disclosure statement is being transmitted.
The holder of claim or interest whose claim has been allowed under § 502 and who is otherwise entitled to vote may accept or reject a plan (11 U.S.C.A. § 1126(a)). In the event a holder of a claim or interest has accepted or rejected a plan prior to the commencement of a case, such acceptance or rejection shall be counted if the solicitation thereof complied with any applicable non-bankruptcy law, rule or regulation governing adequacy of disclosure in connection with such solicitation or, if there is no such applicable law, rule or regulation, the solicitation of such acceptance or rejection was with disclosure of such adequate information as required under Chapter 11.
The plan will be deemed to have been accepted by a class o claims if the holders of at least two-thirds in amount and more than one-half in number of the allowed claims of such class so voting accept the plan. The plan will be deemed to have been accepted by a class of interest holders if at least two-thirds in amount of the allowed interests of such class voted for acceptance of the plan.
A class that is deemed to be unimpaired under the plan does not require an affirmative vote of acceptance, and the plan will be deemed to have been accepted by such class. A class not entitled to receive any payment or compensation under a plan will be deemed not to have accepted the plan.
The proponent of a plan may modify the plan at any time prior to or after confirmation but before “substantial consummation”
of the plan, providing such modified plan meets the requirements regarding classification of claims or interests and the mandatory contents of the plan (11 U.S.C.A. § 1127). Such plan shall become the plan only if, after notice
and hearing, the Court confirms the plan as modified. All relevant requirements of disclosure and solicitation are applicable to any modified plans.
In addition, acceptances or rejections of the plan being modified shall be deemed to be acceptances or rejections of the modified plan unless the holder of the claim or interest changes the acceptance or rejection within a time fixed by the Court.
Hearing on confirmation shall be by the Court after notice (11 U.S.C.A. § 1128). Any party in interest may object to confirmation.
The Court shall confirm a plan ONLY if:
(1) The plan complies with applicable provisions of Chapter 11;
(2) The proponent of the plan complies with applicable provisions of Chapter 11;
(3) The plan has been proposed in good faith and not by any means forbidden by law;
(4) The proponent, the debtor or any person issuing securities or acquiring property under the plan discloses to the Court any payment made or promised for services or costs and expenses in connection with the case or with the plan and incident to the case, and if any such payment has been made before confirmation of the plan, such payment is reasonable or if such payment is to be fixed after confirmation of the plan, such payment is subject to approval of the Court as reasonable;
(5) The identity and affiliations of any individual proposed to serve after confirmation as a director, officer or voting trustee of the debtor, an affiliate of the debtor participating in a joint plan with the debtor or a successor to the debtor under the plan, have been disclosed by the proponent of the plan, and the appointment or continuance in such office of such individual is consistent with the interests of creditors and equity security holders and with public policy, and the identity of any insider that may be employed or retained by the debtor and the compensation therefor are disclosed by the proponent of the plan;
(6) Any regulatory commission having jurisdiction over the rates of the debtor after confirmation of the plan has approved any rate change provided for in the plan or such rate change is expressly conditioned on such approval;
(7) If each holder of a claim or interest of each class has accepted the plan or will receive or retain under the plan property having a value as of the effective date of the plan of not less than the amount that such holder would receive or retain if the debtor were liquidated under Chapter 7; or as to those creditors who have elected to have their claims allowed only as secured claims, each holder of such claim will receive or retain property having a value as of the effective date of the plan of not less than the value of each creditor’s interest in the estate’s interest in the property securing such claim;
(8) Each class has accepted the plan or such class is not impaired under the plan.
(9) Priority claims have either accepted the plan and will receive deferred cash payments in the amount equal to the allowed amount of the claim, or if such priority class has not accepted the plan, cash on the effective date of the plan equal to the allowed amount of such claim, and tax claimants entitled to the sixth priority whether or not accepting the plan will receive deferred cash payments over a period not exceeding six years after date of assessment in an amount equal to the allowed amount of such claim plus interest;
(10) At least one class of claims has accepted the plan, excluding acceptance by any insider within such class;
(11) Confirmation is not likely to be followed by liquidation or a need for further financial reorganization unless such liquidation and reorganization is proposed in the plan (11 U.S.C.A. § 1129.)
If all of the foregoing requirements for confirmation are me except subparagraph (8) regarding acceptance of the plan by each class whose claims are impaired under the plan, the Court may nevertheless, upon request of the proponent of the plan, confirm the plan if each class of impaired claims or interests not accepting the plan is accorded fair and equitable treatment under the plan.
As defined under the Code, a plan is fair and equitable with respect to a class if the plan includes the following:
(1) As to secured claims, the holders of such claims retain the lien securing such claims whether the property subject to such lien is retained by the debtor or transferred to another entity to the extent of the allowed amount of such claim, and each holder of such claim receives on account of such claim deferred cash payments totaling at least the allowed amount of such claim of a value as of the effective date of the plan of at least the value of such holder’s interest in the estate’s interest in such property; or, if property subject to the lien securing such claims is sold free and clear of such liens, the liens attach to the proceeds of such sale; or, for the realization by such holders of the “indubitable equivalent” of such claims.
(2) As to unsecured claims, each holder of such claim receives or retains on account of such claim property of a value as of the effective date of the plan equal to the allowed amount of such claim; or the holder of any claim or interest junior to the claim of such class will not receive or retain on account of such junior claim or interest any property.
(3) As to a class of interests, each holder of such interest receives or retains property of a value as of the effective date of the plan equal to the greatest of the allowed amount of any fixed liquidation preference to which such holder is entitled, any fixed retention price to which such holder is entitled, and the value of such interest, or the holder of any interest that is junior to the interests of such claim will not receive or retain under the plan on account of such junior interest any property.
Except in the case of modification of a plan or the setting aside of an order of confirmation, only one plan may be confirmed by the court irrespective of the number of plans which may be proposed.
The provisions of a confirmed plan are binding upon the debtor, any entity issuing securities under the plan, any entity acquiring property under the plan, and any creditor or equity security holder of, or general partner in the debtor, whether or not the claim or interest of such creditor, equity security holder or general partner is impaired under the plan, and whether or not such creditor, equity security holder or general partner has accepted the plan (11 U.S.C.A. § 1141).
Except as might otherwise be provided in the plan or the confirmation order, confirmation of a plan revests all of the property of the estate in the debtor, and the property dealt with by the plan is free and clear of all claims and interests of creditors, equity security holders and general partners in the debtor except as otherwise provided in the plan or confirmation order.
Except as otherwise provided in the plan or the order confirming the plan, confirmation of a plan discharges the debtor from all dischargeable debts unless the debtor is an individual and a debt is excepted from discharge; or the plan provides for liquidation of all or substantially all of the property of the estate, the debtor does not engage in business after consummation of the plan, and the debtor would be denied a discharge if the case were a case under Chapter 7.
With this latter exception, a corporate or non-individual debtor will be discharged of all debts by confirmation of its plan of arrangement.
EXEMPTION FROM SECURITIES LAWS
Section 5 of the Securities Act of 1933 and any state or local law requiring registration for offer or sale of a security does not apply to an offer or sale of a security under a plan of the debtor or of an affiliate participating in a joint plan with a debtor or of a successor to the debtor under the plan if the offer or sale is in exchange for a claim or an interest in the case, or if such offer or sale is principally for exchange an partly for cash or property (11 U.S.C.A. § 1145).
The exemption from the securities laws also applies to the offer of a security through any warrant, option, right to subscribe or conversion privilege if sold as provided above. In addition, chapter 11 provides limited exemptions regarding the offer or sale, other than under a plan, of a security of an issuer other than the debtor or an affiliate of the debtor, providing certain requirements are met.
Limited exceptions are also provided to certain stockholder transactions in securities of the debtor offered or sold under a plan. Chapter 11 further defines who is and who is not deemed an underwriter under Section 2(11) of the Securities Act of 1933. An entity is not considered an underwriter under Section 2(11) of the Securities Act of 1933 with respect
to an agreement that provides only for matching, purchasing or selling fractional interests in securities offered or sold under a plan for conversion into whole interests.
Perhaps the greatest conflict with the fundamental objectives of bankruptcy to afford an honest debtor the right to a “fresh start” and at the same time accord to the extent possible equal to treatment to the debtor’s creditors and maximize recovery to creditors out of property of the bankrupt estate is the treatment to be accorded tax claims, particularly federal tax claims.
Although the Code grants tax claims enlarged priorities and attempts to answer or clarify formerly troublesome or ambiguous tax problems under the Bankruptcy Act, it also reduces some of the powers or rights regarding collection or enforceability of tax claims. Perhaps most significant is the absence of any substantive guidance relating to treatment of the effect of bankruptcy upon income tax matters at the federal level.
The basic problem, although admittedly oversimplified, is that Congress has jurisdiction over enactment of both bankruptcy and federal income tax law, and the objectives of the two, if not inherently incompatible, often clash. Accordingly, the Bankruptcy Code, while dealing generally with treatment of taxes in bankruptcy, leaves the bulk of substantive law to further study and legislation by the appropriate Congressional committees responsible for tax legislation.
However, treatment of taxes is covered in a number of categories or sections under the Code, and one dealing with the Bankruptcy Code must be aware of these various provisions.
Under prior “chapter cases” the general rule was to the effect that forgiveness of indebtedness as part of the plan did not result in taxable income. The major exception (apart from a finding that if the filing of the proceeding and the plan had for one of its principal purposes the evasion of any income tax the exception would be disallowed) was a reduction in the basis of the debtor’s property equal to the amount of such forgiveness where the property was transferred to another party required to use the debtor’s basis.
This basis was not, however, reduced to less than the fair market value of the property as of the date of confirmation of the plan. This limitation of reduction of basis of property contained in the Bankruptcy Act has been eliminated by the Code.
The principal sections under the Code dealing with income tax effects of a bankruptcy proceeding are §§ 346, 728 and 1146 which cover income tax return filing requirements, determination of taxable years or periods of the debtor’s estate, right and extent of use of certain tax attributes such as net operating loss carryovers, and tax treatment for income purposes by reason of discharge or forgiveness of indebtedness. Essentially these provisions, however, apply only to state and local taxes.
Because of the relative dearth of treatment of debt forgiveness in Chapter 11 for income tax purposes, it will be necessary to await further Congressional action or guidance before the full impact of Chapter 11 on federal income tax treatment can be determined.
Certain specific provisions under Chapter 11, however, do relate to payment or satisfaction of tax claims. One of the most significant is elimination of the prior power of the Treasury to effectively block confirmation of a plan unless all taxes entitled to priority were paid in full upon confirmation of the plan.
Although Chapter 11 requires that the plan of reorganization contain provision for payment of taxes entitled to priority (11 U.S.C.A. § 1141(d)(1)), and § 1129 requires payment upon confirmation of plan in cash of tax liability incurred during the administration period of the estate, prepetition priority tax claims may be paid in installments over a period not to exceed six years after the date of assessment of the tax, plus interest. The plan may be confirmed if such installment plan is part of the plan even though the taxing authority does not accept the plan (11 U.S.C.A. § 1129(a)(9)(C)).
In summary, extensive further Congressional action and/or development of case law appear necessary before there will be definitive answers in many areas involving the impact of income tax treatment in Chapter 11 as well as other operative chapters of the Bankruptcy Code.
CHAPTER 13 — ADJUSTMENT OF DEBTS OF AN INDIVIDUAL WITH REGULAR INCOME
Chapter 13 expands the application of, and makes more flexible, Chapter XIII of the Bankruptcy Act. While prior Chapter XIII was available only to a “wage earner” who had regular income by way of wages, salary or commission, Bankruptcy Code Chapter 13 relief is available to any individual with regular income. This availability compliments the expanded application of Chapter 11 to provide an alternative to the sole proprietor of a business for whom the simpler Chapter 13 procedure may be more appropriate.
Eligibility to file under Chapter 13 is limited, however, to those individuals (or in a joint case, to the individual and his or her spouse) with unsecured debt of less than $100,000 and secured debt of less than $350,000 (11 U.S.C.A. § 109(c)).
A Chapter 13 proceeding may only be commenced by the filing of a voluntary petition or by conversion from a Chapter 7 or Chapter 11 proceeding, but then only at the request of the debtor (11 U.S.C.A. §§ 706, 1112). Since Chapter 13 requires the debtor to file a plan for the repayment of creditors out of income over time, an involuntary petition is prohibited as violative of public policy because it would require a debtor to work for his creditors against his will.
EFFECT OF FILING THE PETITION
In addition to the automatic stay of actions against the debtor and his property under § 362, Chapter 13 provides the debtor with additional protection by staying actions against codebtors on claims against the debtor (11 U.S.C.A. § 1301). The purpose of this new provision is to prevent indirect pressure from being brought to bear on the debtor through the codebtor. Thus, although the section provides incidental protection to the codebtor, the primary goal is to further the protection afforded the debtor by Chapter 13.
After notice and a hearing, the court may grant relief from this stay only to the extent that (1) the codebtor and not the debtor receive the benefit from the claim, (2) the debtor’s plan proposes not to pay the claim, or (3) the stay will cause irreparable harm to the creditor.
The commencement of a case also causes the appointment of a trustee by the court or a United States Trustee where appropriate (11 U.S.C.A. § 1302). Where a standing Chapter trustee has been appointed, the stranding trustee will serve; otherwise, a trustee will be appointed from the panel of private trustees. The creditors do not have the right to elect the trustee at the meeting of creditors as under Chapter 7.
The trustee plays a major role in a Chapter 13 case. In addition to making the periodic disbursements to creditors under the plan, the trustee is charged with all duties of a trustee under Chapter 7, except liquidation of the debtor’s property and the filing of certain tax reports and returns, and, if the debtor is in business, with certain further duties delineated under Chapter 11. In addition, the trustee is to appear and be heard at certain hearings in the case and is to advise the debtor regarding his performance under the plan on all but legal matters.
A debtor who is in business may continue to operate his business after filing unless the court orders otherwise (11 U.S.C.A. § 1304). Despite the fact that the filing of the petition creates an estate consisting of the debtor’s property under § 541 together with all like property acquired by the debtor or earnings earned by the debtor during the pendency of the case, the debtor remains in possession of that estate property unless the court orders otherwise (11 U.S.C.A. § 1306). The debtor has the right to deal with the estate property in the same fashion as the trustee under § 363.
A creditor must file a proof of claim in order to participate under the plan. A proof of claim may only be filed on a post petition debt if it is for taxes which become payable while the case is pending or for a consumer debt arising after the order for relief for property or services necessary for the debtor’s performance under the plan (11 U.S.C.A. § 1305).
That post petition claim, although determined as of the date it arose, will then be allowed or disallowed as though it arose prior to filing. However, the consumer debt post petition claims will not be allowed if the creditor knew or should have known that prior approval by the trustee of the incurrence of the debt was practicable and that approval was not obtained.
A Chapter 13 case may under appropriate circumstances be converted to a case under Chapter 7 or Chapter 11 (U.S.C.A. § 1307). Notwithstanding any waiver of the right, a debtor may convert the case to one under Chapter 7 at any time.
Upon request of a party in interest, the court may convert the case to a liquidation, if after notice and a hearing it finds cause to do so. Cause includes unreasonable delay, nonpayment of fees or charges, failure to timely file a plan, denial of confirmation and of an extension of time to file another plan, material default by the debtor under a confirmed plan, revocation of confirmation, or termination of a confirmed plan by occurrence of a condition specified in the plan. The same grounds are applicable to the court’s consideration of dismissal of the case.
The court may also convert the case to one under Chapter 11 upon request of a party in interest and after notice and a hearing. If a case has not been converted, the court must dismiss a case under Chapter 13 if the debtor so requests. This right cannot be waived.
Only the debtor may file a plan, and he is required to do so (11 U.S.C.A. § 1321). At any time before confirmation, the debtor may modify the plan as a matter of right (11 U.S.C.A. § 1323). A secured creditor who has accepted or rejected the plan at the time of filing of the modified plan may change his vote only if the modified plan treats the creditor differently than had the original plan.
The plan MUST:
(1) Provide for the turnover of all or such portion of future earnings or other future income of the debtor to the supervision and control of the trustee as is necessary for the execution of the plan;
(2) Provide for the full payment in deferred cash payments of all claims entitled to priority under § 507 unless the holder of a priority claim agrees to different treatment; and
(3) If the plan classifies claims, provide the same treatment for each claim within a particular class (11 U.S.C.A. § 1322).
The first feature represents a change from prior law where the future earnings and income were turned over to the supervision and control of the court, not the trustee.
There are also a number of optional, permissive features of the plan (11 U.S.C.A. § 1322).
The plan MAY:
(1) Classify claims;
(2) Modify the rights of unsecured and secured creditors other than those secured only by a mortgage on the debtor’s homestead;
(3) Provide for the curing or waiving of any default;
(4) Provide for the payment of unsecured creditors concurrently with secured and priority creditors;
(5) Provide for curing a default within a reasonable time and maintenance of payments while the case is pending of any claim where the last payment is due after payment under the plan is completed;
(6) Provide for payment of the post petition claims discussed above;
(7) Assume or reject any unexpired lease or executory contract not previously rejected;
(8) Provide for payment from the property of the estate or the debtor;
(9) Provide for the vesting of property of the estate in the debtor or other entity at or after confirmation; or
(10) Include any other provision consistent with the Code.
Item 8 is a significant change from prior law in that it permits the plan to be funded by property of the debtor or the estate in addition to the future income or earnings of the debtor, thus providing more flexibility to the debtor in formulating the plan.
An additional restriction placed on the debtor is that the time for payment under the plan may not exceed three years, except upon approval of the court in which case such time cannot be longer than five years.
After the filing of the plan, the court will hold a confirmation hearing at which any party in interest may object to the plan (11 U.S.C.A. § 1324). The most significant change made by the Code regarding confirmation is that acceptance by unsecured creditors, by majority vote or otherwise, is no longer required (11 U.S.C.A. § 1325).
Aside from their right to object to confirmation, unsecured creditors are protected only by the requirements that the court find that the plan is in good faith and that payment under the plan will result in payment to unsecured creditors of at least as much as they would receive in a Chapter 7 liquidation.
The court will confirm the plan with regard to each secured creditor (1) if he has accepted the plan, (2) if the plan provides that he retain his lien and the value of the property to be distributed to him under the plan is
not less than the secured portion of his claim, or (3) if the debtor surrenders the property securing the claim to the creditor. In addition to these findings regarding creditors, the court will confirm the plan only if it finds that the plan complies with Title 11, that applicable fees and charges are paid, and that the debtor will be able to perform under the plan.
Confirmation of the plan serves to vest the property of the estate in the debtor free and clear of all interests of creditors provided for in the plan except as otherwise provided in the plan or in the order of confirmation (11 U.S.C.A. § 1327). The debtor and all creditors, whether objecting, accepting or rejecting the plan, are bound by its terms.
A plan may be modified after confirmation to increase or decrease payments to a class, to extend or reduce time to pay, or to alter the payment to a creditor to the extent he receives payment on his claim other than under the plan (11 U.S.C.A. § 1329). The requirements regarding the contents of a plan and the rights of a secured creditor to change his vote discussed above still apply, however, and the standards of confirmation remain the same, including that the court must again determine that the payments under the plan will pay more to the unsecured creditors than liquidation. The modified plan will become operative unless the modification is disapproved after notice and a hearing.
On request of a party in interest and after notice and a hearing, the court may revoke an order of confirmation procured by fraud (11 U.S.C.A. § 1330). Upon revocation, the court must dismiss the case or convert it to another chapter unless the debtor proposes a modified plan which is confirmed within the time set by the court.
The court must grant the debtor a discharge after performance under the plan is complete (11 U.S.C.A. § 1328). All debts provided for by the plan or disallowed under § 502 are discharged except those which were not fully payable during the term of the plan under § 1322(b)(5), or were for alimony, support or maintenance.
The discharge is more expansive than those under Chapters 7 and 11 and that under Bankruptcy Act § 660 in that, other than alimony, support and maintenance, the discharge is not limited by § 523(a) which delineates the standard exceptions to discharge. The Code also continues the option of the “hardship discharge” under prior law.
If payments have not been completed under the plan, the court may grant a discharge if:
(1) The debtor’s failure to complete payments was due to circumstances for which he should not be held justly accountable;
(2) The value, as of the effective date of the plan, of property actually distributed under the plan to unsecured creditors is not less than the amount which would have been paid on their claims if the estate had been liquidated under Chapter 7; and
(3) Modification of the plan is not practicable.
However, a discharge granted in this fashion is more limited than that granted if the plan is fully performed. In addition to the long term debt under § 1322(b)(5), all debts described in § 523(a), that is, those normally not discharged in a Chapter 7 or an individual’s Chapter 11 case such as taxes, fraud related debts, and educational loans, are excepted from discharge.
Despite the comprehensive nature of the Bankruptcy Reform Act of 1978, a number of questions remain unanswered. The new Bankruptcy Code provides what appears to be workable substantive law but no detail regarding the procedure to be employed to comply with that law.
The present Rules of Bankruptcy Procedure remain in force except to the extent they are inconsistent with the Bankruptcy Code. To that extent, and to the extent the Code contemplates or necessitates procedures unprecedented under prior law, new or additional rules of bankruptcy procedure are necessary. The Committee on Rules and Practice for the Judicial Conference of the United States has promulgated suggested interim bankruptcy rules and local districts have now adopted local rules for application in the bankruptcy courts. Permanent Bankruptcy Rules will be promulgated.
It is the consensus that after years of deliberation and hesitation Congress has passed a comprehensive Bankruptcy Code which responds to the needs and rights of today’s consumers and business persons.
Although the transition to practice under the Code may not at times be easy, that ultimate goal will be worth the effort.
At any other time before an involuntary case is dismissed or the relief sought is ordered, other unsecured claimants may join in the involuntary case to the same effect as if they had been original petitioning claimants. This provision covers principally a situation where one or more of the original petitioning creditors may be disqualified to act as a petitioning creditor. Without right of intervention of other qualified creditors, the involuntary petition would be dismissed even though otherwise appropriate.
Special rules may be applicable in partnership cases whereby an involuntary petition may be filed by fewer than all of the general partners, or if relief has been ordered with respect to all general partners it may be filed by a general partner, the trustee of a general partner or the holder of a claim against the partnership.