Bankruptcy Terms to Know

Bankruptcy: General bankruptcy is a legal process that provides relief to those who can no longer pay all of their debts. The goal of the bankruptcy laws is to give debtors a “fresh start” by releasing debtors from specific debts and prohibiting creditors from taking action against the debtor to collect those specific debts. The release of the debtor is accomplished through the bankruptcy discharge, which is a release of a debtor from personal liability for certain debts set forth in the Bankruptcy Code.

Bankruptcy – Authority: Title 11 of the United States Code (11 U.S.C. §§ 101-1330) is the federal bankruptcy law and is generally known as the Bankruptcy Code. Bankruptcy is federal law and not state law, although some state law (such as what property may be exempt from bankruptcy) is considered in the process. The bankruptcy process is governed by the Federal Rules of Bankruptcy Procedure, or “Bankruptcy Rules.” The court official with decision-making power over federal bankruptcy cases is the United States bankruptcy judge, a judicial officer of the U.S. District Court. The Bankruptcy Code and Bankruptcy Rules comprise the formal legal procedure for dealing with debt problems of persons and businesses.

Automatic Stay: The filing of bankruptcy results in an “automatic stay,” which is an injunction that automatically stops lawsuits, foreclosures, garnishments and all collection activity against the debtor the moment a bankruptcy petition is filed. However, debts incurred after the bankruptcy filing are not subject to the automatic stay. Post-petition debts are called administrative expenses of the bankruptcy and must be fully satisfied before the bankruptcy case is closed.

Bankruptcy – Chapter 11: Generally know as “Reorganization,” Chapter 11 under Title 11 allows businesses to continue to operate and repay creditors while operating through a court-approved plan of reorganization. The Chapter 11 debtor is required to provide creditors with a disclosure statement that provides enough information so the creditors may evaluate the reorganization plan. The bankruptcy court either approves or disapproves the debtor’s plan of reorganization. Under the approved plan, the debtor can reduce its debts by repaying a portion of its obligations and discharging others. By this process, the debtor may be able to terminate certain contracts and leases, recover assets, and rescale its operations to try and return to profitability. It is common for Chapter 11 debtors to go through a period of consolidation, with the objective of reducing debt and reorganizing its business to emerge from bankruptcy.

Bankruptcy – Chapter 7: This Chapter of Title 11 is called “Liquidation” and is intended as an orderly court-supervised procedure in which a trustee takes over the debtor’s assets, reduces the assets to cash, and makes distribution to creditors. Distributions of assets are subject to the rights of secured creditors as well as the debtor’s rights to retain certain exempt property. Exempt property varies by state, but may include the debtor’s primary residence or “tools of the trade” used by the debtor to make a living. However, many Chapter 7 cases are “no-asset” cases, which mean the debtor has little or no property that is not exempt and thus the creditors will not receive any distribution from the trustee.

Your Client as ‘Debtor in Possession’: Upon filing a petition under Chapter 11, the debtor automatically assumes an additional identity as the “debtor in possession.” The term refers to a debtor that keeps possession and control of its assets while undergoing reorganization under Chapter 11, without the appointment of a trustee. A debtor remains a debtor in possession until their plan of reorganization is confirmed, their case is dismissed or converted to Chapter 7, or a Chapter 11 trustee is appointed. The appointment or election of a trustee occurs only in a small number of cases. Generally, the debtor, as “debtor in possession,” operates the business and performs many of the functions that a trustee performs in cases under other chapters.

The Bankruptcy Code places the debtor in possession in the position of a fiduciary, with the rights and powers of a Chapter 11 trustee.

Sources: U.S. Bankruptcy Courts (www.uscourts.gov); American Bankruptcy Institute (www.abiworld.org)

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