This overview of the U.S. bankruptcy laws covers the statutory scheme, key players, and the various types of bankruptcy relief.
The federal bankruptcy laws provide a uniform framework for debtors to discharge their debts and resolve disputes with creditors. The public policies promoted by these laws include:
Bankruptcy law is governed at the federal level. However, sometimes the bankruptcy laws require courts to apply state laws, such as fraudulent conveyance statutes and state laws governing security interests in personal property. Various sources of bankruptcy law are discussed below.
Divided into chapters, the Bankruptcy Code is Title 11 of the U.S. Code and describes the six types of bankruptcy cases. Of the six, the two most important for corporate debtors are:
The four other cases are:
Chapters 1, 3, and 5 contain provisions that apply to all cases under Chapters 7, 11, 12, and 13. Some provisions of Chapters 1, 3, and 5 also apply to Chapter 9 and 15 cases:
The Bankruptcy Code was extensively changed in 2005 by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA). Generally, these amendments favor creditors, providing them additional leverage on various important restructuring issues. Also, judicial discretion on a wide range of matters was restricted or eliminated, reflecting Congress’s dissatisfaction with the way in which the bankruptcy courts formerly applied this discretion.
The Federal Rules of Bankruptcy Procedure (Federal Bankruptcy Rules) govern procedure in bankruptcy courts. Some provisions of the Federal Rules of Civil Procedure are incorporated into the Federal Bankruptcy Rules.
Bankruptcy courts also have their own local rules, which must be consistent with the Federal Bankruptcy Rules. Local rules are usually posted on the bankruptcy courts’ websites. Also, some judges have created their own rules, known as “standing orders,” governing various issues. These may not be written, but should be familiar to local counsel.
The Federal Bankruptcy Rules often require that some actions, such as the filing of a bankruptcy case or a proof of claim, be carried out on official forms. Official forms can be obtained at legal stationery stores, bought on disk for computer processing, or downloaded from the internet at www.uscourts.gov/forms/bankruptcy-forms.
The Office of the U.S. Trustee, a branch of the Justice Department, has issued a set of guidelines dealing with the employment and compensation of professionals (see Trustees, below).
These laws include:
Bankruptcy law often forms the basis to apply other substantive state, federal, or foreign nonbankruptcy laws. Usually these laws relate to debtor/creditor and commercial matters, particularly Article 9 of the Uniform Commercial Code (UCC), which governs security interests in personal property. Courts also frequently apply state laws governing mortgages, liens, and other laws allocating property rights in a bankruptcy case.
Published case law can be useful in interpreting the various provisions of the Bankruptcy Code. Bankruptcy judges are bound by the controlling decisions of any authoritative court in their particular jurisdiction. However, they may also consider judicial decisions from other jurisdictions which they find persuasive.
A debtor is any individual, corporation, partnership, limited liability company (LLC), or municipality that is the subject of a case filed under any chapter of the Bankruptcy Code.
There are eligibility requirements that must be satisfied under each chapter. For example, family farmers and family fishermen must satisfy some income and debt limitation requirements (see Chapter 12: Adjustment of Debts of a Family Farmer or Fisherman With Regular Annual Income, below). There is no requirement that a debtor be insolvent, except under Chapter 9 (see Chapter 9: Adjustment of Debts of a Municipality, below).
The debtor in a Chapter 11 reorganization case usually remains in control, or in possession, of the estate and its business affairs, subject to the restrictions of the Bankruptcy Code and the bankruptcy court. If no trustee is appointed, the old debtor becomes the new debtor-in-possession (DIP). The debtor is a distinct entity from the DIP, who acts like a trustee in Chapter 11 cases. The DIP owes fiduciary duties to the estate, its creditors, and shareholders (or other equity security holders). The DIP has the same rights, powers, and responsibilities as a trustee, with limited exceptions (for example, the DIP, unlike a trustee, is not required to investigate itself, nor is it empowered to pay itself).
Trustees are the official representatives of the estate. They owe fiduciary duties to the estate and its creditors, but their specific responsibilities differ under each chapter of the Bankruptcy Code. There are several types of trustees:
The bankruptcy judge presides over the bankruptcy court. There are about 350 bankruptcy judgeships authorized in the US. Bankruptcy judges are appointed by the U.S. Court of Appeals for each circuit and hold renewable 14-year terms.
In large Chapter 11 cases, the U.S. Trustee must appoint an official creditors’ committee to represent the interests of unsecured creditors. The committee must protect the interests of the group, rather than the individual interests of its members. The committee ordinarily consists of the seven largest unsecured creditors willing to serve. However, the U.S. Trustee has discretion to determine the size and membership of the committee.
The debtor’s estate pays for counsel and, sometimes, also pays financial advisors and other professionals to represent the committee. The committee can speak on any issue arising in the case, and can consult with the DIP or Chapter 11 trustee on various issues, including the formulation of a plan of reorganization.
Occasionally, in large Chapter 7 cases, creditors elect a committee consisting of between three and 11 unsecured creditors who may consult with the case trustee or the U.S. Trustee about the administration of the estate.
To ensure adequate representation of all creditors and interest holders, the court can order the U.S. Trustee to appoint additional official committees, such as equity committees, retiree committees, and bondholder committees. Unofficial, or ad hoc, committees can also form on their own. However, any professionals they hire can only be paid for by the estate in a Chapter 9 or Chapter 11 case if they make a substantial contribution to the case, in terms of time, nature, extent, and the value of their services.
Secured creditors include banks that have liens on large portions of the debtor’s assets, holders of mortgages, receivables lenders, equipment lenders, and holders of statutory liens. Bankruptcy litigation may occur in connection with a challenge by the trustee, as representative of the unsecured creditors, concerning the validity, extent, and priority of a secured creditor’s alleged security interest. Each secured creditor usually has its own counsel. This category also includes undersecured creditors.
Under some circumstances an examiner must be appointed by the court to investigate any charges of fraud, dishonesty, incompetence, or mismanagement by the debtor’s current or former management. Examiners are rarely appointed in Chapter 11 cases.
The trustee or the DIP may hire professionals to perform services for the estate. Professionals must be disinterested persons who do not have an interest adverse to the estate. Professionals include attorneys, accountants, auctioneers, appraisers, investment bankers, and consultants. In Chapter 11 cases, creditors’ committees can also employ professionals to perform services on behalf of the committees (see Committees, above). The court must approve both the employment and compensation of all professionals.
Other parties in interest include any party having a practical stake in the outcome of the proceedings. They include unsecured creditors, lessors, utilities, personal injury claimants, and other litigants and parties who have otherwise contracted with the debtor. These parties generally become involved in a case once a specific issue arises affecting their relationship with the debtor.
Generally, there are two types of bankruptcy relief:
The Bankruptcy Code offers relief for all six forms of bankruptcy cases.
Chapter 11 provides a procedure allowing a debtor to continue operating its business while either:
A debtor may choose to liquidate under Chapter 11 rather than Chapter 7 (see Chapter 7: Liquidation, below) because under the Chapter 11 process, the debtor can remain in control of the business, with the exclusive right to propose a plan of reorganization for the first 120 days (extendable to 18 months).
Chapter 11 relief is available to:
Chapter 11 relief is not restricted to businesses. It is a viable alternative for individual debtors who fail the Chapter 7 means test (see Chapter 7: Liquidation, below) and exceed the Chapter 13 debt limit (see Chapter 13: Adjustment of Debts of an Individual With Regular Income, below). Individual Chapter 11 cases are rare and are usually limited to individuals with complex financial affairs.
Chapter 11 relief is not available to:
Chapter 11 cases may commence by either:
There is no requirement that a debtor be insolvent. In fact, the only requirement for filing a voluntary case is that the debtor seeks relief from its creditors in good faith. Creditors filing involuntary cases must satisfy several procedural requirements.
Once a Chapter 11 petition is filed, the debtor operates under the protection of the bankruptcy laws. Some of the consequences of filing a petition include:
Under a proposed plan, creditors and shareholders (or other equity holders) are divided into different classes for the purpose of voting to accept or reject the proposed plan. A plan can only be confirmed if:
A confirmed and effective plan of reorganization:
After undertaking an in-depth three-year study, on December 8, 2014, the ABI Commission to Study the Reform of Chapter 11 (Commission) proposed significant changes to Chapter 11 of the Bankruptcy Code and issued its Final Report and Recommendations (Report).
While the Report’s proposals have not yet resulted in legislation, certain bankruptcy participants have used many of the Report’s proposals to influence courts, some of which have been receptive to these arguments. Proposed reforms that address current circuit splits may be incorporated into case law, as judges may be swayed to decide splits of authority in line with the applicable proposal. In many cases, the recommendations also reflect what is already current market practice.
Chapter 7 concerns the orderly liquidation of all of the debtor’s property. In a corporate Chapter 7 case, the proceeds are distributed to creditors without continuing the debtor’s business.
Chapter 7 relief is available to:
The BAPCPA introduced a “means test” as an eligibility requirement for individual Chapter 7 debtors. The means test works as follows:
Failure of the means test results in a presumption that the Chapter 7 filing was an abuse. The debtor may drop the bankruptcy case, convert to Chapter 13 or 11 (if it qualifies), or attempt to rebut the presumption (by demonstrating special circumstances, such as a serious medical condition or a call or order to serve in the Armed Forces). The purpose of the means test is to reduce the number of Chapter 7 filings and to push debtors into Chapter 13 (or Chapter 11), where they will pay some or all of their debt.
Chapter 7 relief is not available to railroads.
Chapter 7 cases may commence by either:
As in Chapter 11, there is no requirement that a debtor be insolvent, but in a voluntary case, the debtor must seek relief from its creditors in good faith. Creditors filing involuntary cases must satisfy several procedural requirements.
The filing of a Chapter 7 case:
In exchange for the surrender of all their nonexempt assets, individual Chapter 7 debtors normally receive a discharge for most of their debts incurred before the petition was filed. As a matter of public policy, some debts are prohibited from discharge, such as some taxes, certain consumer debts, and domestic support obligations. Partnerships, corporations, and other entities may not be released from their prepetition debts, although they operate under the protection of the Bankruptcy Code while liquidating. They are simply dissolved at the end of the case.
Chapter 9 concerns the bankruptcy of a municipality, defined broadly as a “political subdivision or public agency or instrumentality of a State.” A municipality may not file under Chapter 9 unless the state law permits filing and it is “insolvent” in the sense that it is not “generally paying its debts as they become due.”
While the scope and power of Chapter 9 is less extensive than Chapter 11 (see Chapter 11: Reorganization, above), Chapter 9 similarly provides for an automatic stay and the power of a confirmed plan to bind all parties. However, the power of the court to oversee the affairs of a Chapter 9 debtor is much more limited. It may not interfere with any of the political or governmental powers of the debtor, its property or revenues, or its use or enjoyment of any income-producing property. Furthermore, the Chapter 9 debtor maintains the exclusive right to propose a plan.
Chapter 9 also limits the state’s power to deal with municipal debt; any nonbankrupt solution is not binding on a creditor unless the creditor consents. In contrast, a confirmed Chapter 9 plan binds the debtor and all creditors. A discharge may be granted only if:
Debts are not discharged if either:
Chapter 12 is a hybrid between Chapter 11 and Chapter 13. Many Chapter 11 provisions are unworkable for family operations, and many farmers exceed the Chapter 13 debt limits (see Chapter 13: Adjustment of Debts of an Individual With Regular Income, below). A Chapter 12 case can only begin by the filing of a voluntary petition by the debtor.
The BAPCPA made Chapter 12 a permanent part of the Bankruptcy Code. Chapter 12 relief was only available to family farmers, but since the BAPCPA, it is now also available to family fishermen. An eligible Chapter 12 family farmer derives at least half of their income and debts from “farming operations.” Their total debt, excluding debt for a personal residence, must not exceed $11,097,350 (§ 101(18), Bankruptcy Code). An eligible Chapter 12 family fisherman derives at least half of their income and 80% of their debts from a “commercial fishing operation.” Their total debt, excluding debt for a personal residence, must not exceed $2,268,550 (§ 101(19A), Bankruptcy Code). Qualifying family farmers and family fishermen may be individuals and their spouses, corporations, or partnerships. In either case, they must have annual income which is “sufficiently stable and regular” to fund a Chapter 12 plan.
Chapter 13 provides relief for an individual debtor (not for partnerships or corporations) who has “regular income” (this usually, but not exclusively, means wages) and as of the petition date, owes no more than $465,275 in unsecured debts and $1,395,875 in secured debts (amounts periodically adjusted for inflation). In all cases, the debts figured into these calculations must be noncontingent and liquidated (§ 109(e), Bankruptcy Code).
Chapter 13 is intended primarily for consumer debtors who wish to devote some of their postpetition earnings to pay all or a percentage of their prepetition debts over a period of three to five years. A Chapter 13 case is always voluntary.
A standing trustee is appointed to administer the case, and to collect and distribute payments under the plan. The debtor has the exclusive right to propose a payment plan which it must file with the petition, or within 14 days after the petition date, unless the court extends this period for cause.
A Chapter 13 debtor can convert its case to Chapter 7 at any time. However, there are several reasons why a debtor may prefer Chapter 13:
However, a Chapter 7 debtor’s postpetition earnings are not part of the estate and are not distributed to repay creditors. A portion of a Chapter 13 debtor’s postpetition earnings do belong to the estate and are used to pay prepetition debts.
A discharge is granted once all payments have been made under the plan. Some debts are automatically nondischargeable as a matter of public policy. These include:
The scope of the Chapter 13 discharge has been narrowed by the BAPCPA, but it is still broader than the Chapter 7 discharge. It will only be granted if the debtor completes a personal financial management course.
The BAPCPA enacted Chapter 15, which deals with transnational bankruptcy cases. The stated purposes of Chapter 15 are to achieve:
Chapter 15 expands the scope of its predecessor, section 304 of the Bankruptcy Code. It largely incorporates the Model Law on Cross-Border Insolvency adopted by the United Nations Commission on International Trade Law (UNCITRAL) on May 30, 1997.
Chapter 15 sets guidelines for foreign representatives and creditors to access U.S. courts. Foreign creditors or other interested foreign parties may begin, or participate in, a case or proceeding under the Bankruptcy Code. Discrimination against foreign creditors is prohibited, and they must be given notice concerning a U.S. bankruptcy case. Chapter 15 also provides a mechanism to assist foreign courts concerning a case under the Bankruptcy Code. Also, Chapter 15 governs the coordination of U.S. bankruptcy cases and foreign proceedings pending concurrently regarding the same debtor.
Chapter 15 has relaxed the standards, and simplified and streamlined the process, for recognition of foreign proceedings. An application for recognition of a foreign proceeding must be approved if it complies with minimal procedural requirements and is not manifestly contrary to public policy. Ancillary filings in the U.S. are likely to increase, due to greater certainty and simplicity in the recognition process.
Generally, a Chapter 15 case is ancillary to a “foreign main proceeding,” which is a proceeding in the country where the debtor has its center of main interests (COMI). Under Chapter 15, there is a rebuttable presumption that a debtor’s COMI is based in the country of its registered office. A “foreign non-main proceeding” is a proceeding in a country where the debtor has an establishment, but not its center of main interests. If a foreign proceeding is recognized as the main proceeding, the automatic stay and some other provisions of the Bankruptcy Code apply within the US. However, once a foreign main proceeding is recognized, a foreign representative may begin a full Chapter 7 or Chapter 11 case only if the debtor has assets in the US. Only those assets located within the United States are subject to the U.S. bankruptcy court’s jurisdiction. This limits interference and promotes cooperation with the foreign main proceeding.
Click here to see a table outlining the key features of Chapter 11, Chapter 7, and Chapter 13 bankruptcies.
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