May 02, 2012 Articles

Bankruptcy 101: Are You Smarter than a 1L?

Test your bankruptcy knowledge by answering these questions and finding out if you’re smarter than a first-year law student.

By Aubrey Colvard

Bankruptcy issues can often be confusing to those who do not practice bankruptcy law. With its own courts, code, and lingo, bankruptcy is truly a horse of a different color. Though bankruptcy issues can sometimes be daunting, there are certain bankruptcy basics every 1L knows. Test your bankruptcy knowledge by answering the questions below and finding out if you’re smarter than a 1L.

Questions:

1. What are the three most common types of bankruptcy, and what are the differences between them?

2. What is the governing body of law for bankruptcy?

3. Who the debtor is and who the creditors are is clear enough, but who or what is the “trustee”?

4. What is an “automatic stay” and how does it affect creditors?

5.What is a 341 meeting?

Extra Credit: What is a “DIP”?

Answers:

1. The three most common types of bankruptcies are Chapter 7, Chapter 11, and Chapter 13.

In a Chapter 7 bankruptcy, also known as liquidation, a trustee takes over assets of the debtor’s estate, reduces them to cash, and makes distributions to creditors. A debtor does get to retain certain exempt property, if it possesses any. A Chapter 7 debtor may be an individual or a business.

A Chapter 11 bankruptcy, also known as reorganization, is typically utilized by commercial organizations that want to continue operating a business while repaying creditors through an agreed-to plan of reorganization. Though Chapter 11 is typically entered into by businesses, some wealthy individuals take advantage of this chapter as well.

A Chapter 13 bankruptcy, which is entitled “Adjustment of Debts of an Individual with Regular Income,” is designed for individuals who have a regular source of income. Unlike a Chapter 7 bankruptcy, a Chapter 13 bankruptcy allows debtors to retain valuable assets because it allows the debtor to propose a plan to repay creditors over time—typically three to five years. Chapter 13 is also used by consumer debtors who do not meet the qualifications for Chapter 7 relief under a provision called the “means test.”

2. Title 11 of the United States Code is the uniform federal law that governs all bankruptcy cases. Referred to as the Bankruptcy Code, Congress enacted Title 11 in 1978 pursuant to Article I, Section 8 of the Constitution, which authorizes Congress to enact “uniform Laws on the subject of Bankruptcies.” The procedural aspects of bankruptcy are governed by the Federal Rules of Bankruptcy Procedure (commonly referred to as the Bankruptcy Rules), as well as each bankruptcy court’s own local rules.

3. A trustee is a representative of the bankruptcy estate who exercises statutory powers, principally for the benefit of the unsecured creditors, under the general supervision of the court and the direct supervision of the U.S. trustee or bankruptcy administrator. The trustee is a private individual or corporation appointed in all Chapter 7, Chapter 12, and Chapter 13 cases and some Chapter 11 cases. The trustee’s responsibilities include reviewing the debtor’s petition and schedules and bringing actions against creditors or the debtor to recover property of the bankruptcy estate. In Chapter 7, the trustee liquidates property of the estate and makes distributions to creditors. Trustees in Chapter 12 and 13 have similar duties to a Chapter 7 trustee and the additional responsibilities of overseeing the debtor’s plan, receiving payment from debtors, and disbursing plan payments to creditors.

4. An automatic stay is an injunction that automatically stops lawsuits, foreclosures, garnishments, and all collection activity against the debtor the moment a bankruptcy petition is filed. During the duration of the automatic stay, creditors may not initiate or continue collection proceedings against the debtor without permission from the Bankruptcy Court.

5. A 341 meeting is the meeting of creditors required by Section 341 of the Bankruptcy Code at which the debtor is questioned under oath by all creditors, a trustee, an examiner, or the U.S. trustee about his or her financial affairs.


Extra Credit: “DIP” stands for “debtor in possession.” In a Chapter 11, the debtor automatically assumes an additional identity as the DIP. 11 U.S.C. § 1101. As the DIP, the debtor retains possession and control of its assets while undergoing a reorganization under Chapter 11 without the appointment of a case trustee. A debtor will remain a DIP until the debtor’s plan of reorganization is confirmed, the debtor’s case is dismissed or converted to Chapter 7, or a Chapter 11 trustee is appointed, which occurs in only a small number of cases. Generally, the debtor, as the DIP, operates the business and performs many of the functions that a trustee performs in cases under other chapters. 11 U.S.C. § 1107(a).

Keywords: litigation, business torts, bankruptcy, young lawyers

Aubrey Colvard – May 2, 2012