#6 - Automatic Stay in Bankruptcy Flashcards
Federal Bankruptcy System
Bankruptcy does 2 things:
1) for debtor, it’s a fresh start
2) consolidates resolution of debt problems
Why it matters = Bankruptcy matters because creditors’ rights operate in the shadow of bankruptcy. Secured transactions matters to bankruptcy because secured creditors generally have prio over unsecured creditors as expected.
The Automatic Stay
Upon filing bankruptcy, all creditors are AUTOMATICALLY STAYED (enjoined) from collecting debts. The court then liquidates the assets or lets the debtor keep using them.
Chapters of Bankruptcy
Consumers: Choose 7 for liquidation or 13 for plan. A sole proprietor could choose 11 for a plan also.
Businesses: Choose 7 for liquidation or 11 for plan.
Chapter 7 = (individual consumers or businesses) Surrender assets for liquidation; get discharge. This one is all about liquidation.
Chapter 11 = (for individuals and businesses, but almost entirely businesses) Retain assets; create plan that will be approved by (or “crammed down” on) creditors to repay out of future revenue; discharge when plan approved. Fundamentally Chp 11 is about reorganization, not liquidation. It’s all about building a PLAN, where the debtor is gonna pay some or all of what is owed. Many creditors will get less, but still overall the debtor ends up paying more than if everything went belly up in complete liquidation.
Chapter 13 = (individuals only): Retain assets, create plan that pays creditors disposable income over 3 to 5 years; discharge upon plan completion.
Bankruptcy’s Illusion of Choice
In reality, if you make too much money you have to go into 13 as a consumer and enter a plan to pay creditors over time. If you make too little, you’re gonna be driven toward 7. There’s a “means test” driving these pathways.
Bankruptcy Terminology
Petition = document that commences bankruptcy litigation case. This creates the automatic stay as soon as it’s filed through PACER down to the exact minute.
Schedule = list of assets and debts filed with petition
Proof of Claim = creditor’s statement of debt owing (501); claim calculation according to 502, 506. Claims of the same priority share pro rata in available money.
Pro Rata = same percentage of each claim is paid to unsecured creditors from whatever is left over after paying secured creditors. That solves the collective action problem because outside of bankruptcy it’s just a race to sue first as between unsecured creditors. Bankruptcy doesn’t reward first come first serve.
Property of the Estate = all legal or equitable interests of the debtor in property as of the commencement of the case except exempt property
Discharge = injunction against future efforts to collect the debt from the debtor (but not debtor’s property)
Lifting the Automatic Stay
Secured creditors ONLY can file a motion to lift the automatic stay. They must show:
1) Lack of Adequate Protection (362(d)(1)) OR
2) Debtor has no equity in property (aka the collateral is underwater) AND the collateral is not necessary for an effective reorganization
What is Adequate Protection? = protection against decline in the value of the secured creditor’s collateral (361, 362). This is a fact-intensive inquiry.
if individual debtor, stay is automatically lifted after 60 days following the motion to lift unless the court makes a determination otherwise.
Otherwise, 30 days post-motion to lift.
4-Step Analysis for Automatic Stay Problems
1) Is the stay in effect?
Usually easy to find out
2) Does anything in 362a prohibit the act that the creditor wants to take?
Automatic stay is very broad, so likely yes
3) If so, is there an exception in 362(b) (20+ of these)?
If exception found, could pursue an action in line with the exception
4) If not, are there grounds for lifting the stay under 362(d)?
This will require court action analyzing the adequate protection and equity issues
Bankruptcy Claims Terminology
Nonrecourse Debt = discharged secured debt is essentially a nonrecourse claim against the asset; secured creditors cannot pursue debtor for unpaid portion. Debts become nonrecourse in bankruptcy.
Proof of Claim = form filed by creditor describing the debt and the outstanding amount owed.
Claim = what the creditor is owed. But the claim will be split between secured and unsecured portion
Discharged vs. undischarged debt = creditors can pursue undischarged debt post-bankruptcy
Three options if debtor wants to keep the collateral
(1) reaffirm debt via written agreement w/ secured creditor. must be disclosed to bankruptcy court and highly regulated.
(2) if collateral is tangible personal property, debtor can redeem the collateral by paying its fair market value in cash.
(3) debtor can continue making payments w/o a reaffirming agreement in hope creditor does not foreclose after bankruptcy.
Cushion of Equity
Cushion = Collateral exceeds the value of debt such that depreciation will not likely injure the value of the lien and satisfies need for adequate protection.
Amount of cushion depends on (1) nature of the collateral, (2) volatility of the market, (3) rate of increase in the secured debt.
Should creditors try to lift the stay?
Yes! it either allows them to collect on the collateral or force the debtor to put adequate protection.
Strategy - threatening to lift the stay may serve as effective leverage to renegotiate the terms of payment.
