Bankruptcy Law: Five Things Every Lawyer Should Know

Tue, 03/29/2011

by Lisa Yonka Stevens, Esquire
The Advocate, Young Lawyers Section-Maryland State Bar Association, Volume 26, Number 2, Winter 2010

With the downturn in the nation's economy and a full recovery on the distant horizon, many businesses, as well as individuals, are facing difficult financial situations. Bankruptcy is a system under which persons, individuals, and companies can deal with their financial distress. The basic purpose of bankruptcy is to provide honest debtors with a fresh start from insurmountable financial problems while devoting the value of the debtor's nonexempt assets to creditors and distributing such assets fairly among similarly situated creditors. Before you advise your client to pursue such relief, there are five things every lawyer should know about bankruptcy.

1. When is Bankruptcy Appropriate?

Whether your client is a business or an individual, the decision to file bankruptcy should not be taken lightly. It will likely affect the ability of an individual to obtain credit in the future, as he or she will be considered a higher risk. The bankruptcy may be reviewed when applying for a new job, lease, or insurance. For businesses, a bankruptcy may be seen as a sign of weakness, causing vendors and customers to stop doing business with that entity. In fact, some business contracts have an anti-bankruptcy provision making the contract voidable if a party to the agreement files for bankruptcy. As such, all contracts should be vetted thoroughly before filing. Yet, in the end, bankruptcy may be your client's best and perhaps only option.

Bankruptcy is appropriate when your client is so burdened by debt that he or she is no longer able to pay creditors. While bankruptcy may help alleviate much of your client's financial stress and give him or the breathing room needed to get back on his or her feet, as discussed below, not all debts can be discharged. Depending on the nature of your client's debt, bankruptcy may not be a viable option.

2. Different Chapters Available for Relief

The three most common types of bankruptcy are Chapters 7, 11, and 13, based on their applicable chapter in Title 11 of the U.S. Code (the Bankruptcy Code).

Chapter 7 can be filed by individuals or entities. It is a liquidation of the debtor's nonexempt assets by a court-appointed trustee. Put simply, the debtor surrenders his nonexempt assets, if any, and usually gets a discharge. The trustee converts the assets into cash and distributes them among creditors in accordance with the types of claims that the creditors have against the debtor or the assets.

Exempt property includes assets a debtor may choose to keep through and after the bankruptcy. In Maryland, which has opted out of the federal statutory exemption scheme, exemptions include $5,000 in real and personal property, $6,000 as a "wild card" exemption, and $1,000 for household goods and furnishings. Md. Ann. Code, Cts. & Jud. Proc. § 11-504. Additional exemptions in Maryland include a debtor's interest in qualified pensions and in property held in tenancy by the entireties. As of October 1, 2010, Maryland's new homestead exemption equals the federal homestead exemption, which is currently $21,625.

Chapter 7 can be quick and fairly inexpensive. However, as a result of significant changes in 2005 to the Code under the Bankruptcy Abuse Prevention and Consumer Protection Act ("BAPCPA"), personal debtors are required to complete pre- and post-petition debt counseling and must undergo means testing to see if they meet minimum requirements for filing. In Chapter 7, the debtor receives a discharge — the legal proof that dischargeable pre-petition debts are no longer owed as a matter of law.

Chapter 11 likewise can be filed by individuals or entities. It requires debtors to propose a plan of reorganization or liquidation that will provide creditors with a higher percentage of payment than they would receive in Chapter 7. Chapter 11 plan creation, negotiation, litigation, and solicitation can be time-consuming and expensive. The discharge usually comes upon the bankruptcy court's confirmation of the debtor's plan of reorganization. The debtor has an initial exclusive period where only he or she can file a plan. If the exclusive period lapses, any party in interest may propose and solicit acceptances to a plan.

Chapter 13 can only be filed by individuals with noncontingent liquidated unsecured debts not exceeding $360,475 and noncontingent liquidated secured claims not exceeding $1,081,400 as of April 1, 2010. In a Chapter 13 case, the debtor generally keeps all of his property and in exchange, must devote all of his "disposable income" over a period of time — no less than 36 months and no more than 60 months — to the repayment of unsecured claims. Secured claims must continue to be paid in full during the bankruptcy case. The debtor does not receive a discharge until completion of the payment plan proposed to and confirmed by the bankruptcy court. Changes implemented under BAPCPA were designed to steer debtors who formerly filed Chapter 7 into filing Chapter 13 cases, thus ensuring that creditors would receive at least some payments on their claims, rather than none. If a debtor cannot maintain his or her plan payments, his or her bankruptcy case can be dismissed by the court or converted to a Chapter 7.

3. Dischargeability and Discharge

Although bankruptcy is meant to give debtors a fresh start, not all debts can be erased with bankruptcy. Dischargeability is a process or finding of whether an individual debt is eligible for discharge. A discharge, on the other hand, is an order of the bankruptcy court establishing that the debtor no longer owes the dischargeable legal obligations he or she owed to creditors prior to filing bankruptcy. It is important to understand that, while many debts can be discharged by bankruptcy, some debts cannot be wiped out. Examples of common nondischargeable debts include claims for:

  • Money, property, or services or an extension or renewal of credit obtained by use of a false written statement
  • Fraud or defalcation while acting as a fiduciary, embezzlement, or larceny
  • Alimony or child support
  • Willful and malicious injury caused by the debtor
  • Student loans
  • Most (but not all) taxes
  • Drug or drunk driving-caused injuries
  • Criminal restitution

If your client faces any of these types of claims, he or she will need to develop a repayment plan to satisfy these debts. That said, a trustee or creditor must alert the bankruptcy court of the nondischargeable status of these claims, or the debts may under certain circumstances be discharged despite their nondischargeable status. For example, in a Chapter 7 case, claims of nondischargeability must generally be raised in the first 60 days of the case.

4. The Automatic Stay

One of the key protections afforded to a debtor under the Code is the automatic stay under § 362. The automatic stay enjoins most actions taken by creditors against the debtor or property of the debtor's bankruptcy estate for debts incurred prior to the bankruptcy filing. The stay applies in any bankruptcy, regardless of the Chapter and whether the bankruptcy is voluntarily or involuntarily filed. The stay is effective immediately upon the filing of a bankruptcy petition, whether creditors have notice of the bankruptcy petition or not.

The legislative history of the statute makes clear that the stay is intended to give the debtor adequate time to attempt a repayment or reorganization plan or to simply temporarily relieve him or her of the financial pressures that drove the debtor into bankruptcy. Various acts that are halted by the automatic stay are:

  • Judicial proceedings brought against a debtor for claims that were or could have been brought prior to the commencement of the bankruptcy case
  • Enforcement of judgments against the debtor or against property of the debtor's estate that were obtained prior to the filing of the bankruptcy case
  • Acts to obtain possession of property of the estate or to exercise control over property of the bankruptcy estate
  • Acts to create, perfect, or enforce liens encumbering property of the estate

However, certain acts are not enjoined by the automatic stay, including:

  • Criminal prosecutions
  • Actions to determine alimony and child support and paternity actions
  • The exercise of governmental, police, and regulatory powers
  • Determination and assessment of taxes

The automatic stay only applies to the debtor and not to actions against subsidiaries, affiliates, shareholders, directors, guarantors, or other nondebtor parties liable for the debts of the debtor. The stay also is inapplicable to nonbankruptcy co-defendants. However, under certain limited circumstances, a debtor can seek to have the stay extended to certain third parties.

The automatic stay lasts until a bankruptcy case is closed or dismissed, when a discharge is granted or denied, or when the bankruptcy court grants a motion to lift the stay. Generally, the length of the automatic stay depends on which Chapter the bankruptcy was filed under.

Acts taken in violation of the automatic stay are void ab initio. In re Miller, 10 B.R. 778 (Bankr. Md. 1988). A creditor need not knowingly and intentionally intend to violate the automatic stay in order to be liable for damages for a "willful" stay violation. It is enough that a creditor commits an intentional act with knowledge of the existence of the stay, without necessarily knowing a stay's applicability to the act in question. In re Mountaineer Coal Co., Inc., 247 B.R. 633 (Bankr. W.V. 2000). A party injured by any willful violation of the stay shall recover actual damages, including costs and attorneys' fees and, in appropriate circumstances, may recover punitive damages. 11 U.S.C. § 362(h).

5. Consult Qualified Bankruptcy Counsel

The number one thing that every lawyer should know about bankruptcy is when to seek the assistance of a qualified bankruptcy attorney who understands the Bankruptcy Code, as well as state and local laws, who can best assist your client in exploring all options available for alleviating his financial distress. Due to the complexities in the Code and significant changes under BAPCPA, most people filing bankruptcy have found that they save more time, money, and assets by using a qualified attorney than what they pay out in legal fees.