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| A New Playing Field: Whatever your perspective, it’s apparent
that the new bankruptcy rules have altered the playing field and pose
challenges that deserve the attention of debtors and creditors alike. Consumer Bankruptcy The provisions in the new legislation
addressing consumer bankruptcies have fundamentally changed the dynamic
of the debtor-creditor relationship.
The changes will likely curtail the number of bankruptcy filings
and significantly impact prebankruptcy negotiations
and recoveries, the relief available, and the ability of many individual
debtors to obtain bankruptcy protection under Chapter 7.
Now, there are many more hurdles.
Creditors’ rights are strengthened.
In short, consumers will find it more difficult under the new
law to avail themselves of bankruptcy protection
and rid themselves of debt. Debtor Education Required. The new legislation requires individual
debtors in Chapter 7 and 13 cases to complete “an instructional course
concerning personal financial management.” [ Exclusions.
The following types of property are added to the list of items
that never become property of the bankruptcy estate: (1) certain funds
placed in an education individual retirement account; (2) certain
funds used to purchase a tuition credit under a qualified state tuition
program; (3) amounts withheld from wages by an employer or received
from an employee for payment of a contribution to an erisa-qualified
plan, deferred compensation plan, tax-deferred annuity, or health
insurance plan regulated by state law; and (4) an interest of the
debtor in tangible personal property that is pawned. [11
U.S.C. §541(b)(5), (7), (8)] Residency Requirements.
The Bankruptcy Code defines which state’s exemptions are available
to a debtor by delineating certain domiciliary requirements. The amendments change these requirements and
impose new residency rules with respect to applicable exemption schemes. Under the new legislation, the applicable state
exemption law is governed by the state where the debtor has resided
for 730 days (i.e., two
years) preceding the filing (up from 180 days).
If a debtor did not reside in any one state for 730 days, then
the governing exemption law is that of the state where the debtor
resided for 180 days immediately preceding the 730-day period (i.e.,
2 1/2 years before filing) or for the longest portion of that 180-day
period. If a debtor does not
satisfy any of the above, then the debtor may elect the federal exemptions. [ Retirement Plans. The list of exemptions is expanded to include
retirement funds covered by various provisions of the Internal Revenue
Code. Significantly, this exemption
is available to debtors irrespective of which exemption scheme (state
or federal) is elected. iras
and seps are capped at $1 million (without
regard to rollover amounts).
[ Lien Avoidance. Significant exemption restrictions have also
been imposed. The Bankruptcy
Code permits a debtor to avoid a nonpossessory,
nonpurchase-money security interest on certain items of personal
property, including “household goods,” to the extent that such lien
interest impairs an exemption to which the debtor would otherwise
be entitled. The definition
of “household goods” has been narrowed significantly to minimize such
lien avoidance. [ State Domestic
Support Obligations. The new law bestows enhanced priority
status upon certain domestic support obligations that were outstanding
at the time of the filing. Debt
obligations owed to a spouse, forme Family Law Property Settlements.
The law is amended to render nondischargeable
in Chapter 7 cases all property settlement obligations (i.e.,
those not actually in the nature of support) arising in connection
with a separation agreement, divorce decree, order of a court, or
other obligations resulting from a determination made by a governmental
unit in accordance with state law.
[11 U.S.C. §523(a)(15), (c)] Student Loans. The student loan exception from
discharge is amended to extend nondischargeability
to student loans issued by profit and nongovernmental organizations. In the absence of “undue hardship,” student
loans are now essentially nondischargeable,
without regard to the nature of the lender.
[ Credit Card Fraud Debts.
The Bankruptcy Code currently renders certain consumer purchases
of “luxury goods and services” on credit and “cash advances” incurred
shortly before a debtor’s bankruptcy filing presumptively fraudulent
and nondischargeable. This
presumption of nondischargeability for credit
card charges is now expanded. Under
the new law, the threshold triggering the presumption is reduced from
$1,225 to $50 for “luxury goods” and from $1,225 to $750 for cash
advances. The prepetition
look-back period for which such threshold-meeting charges or cash
advances are deemed to be presumptively fraudulent has also been extended
in order to capture more debt.
[ DUI Obligations.
The provision rendering nondischargeable
debts for personal injury or death arising from the debtor’s operation
of a “motor vehicle” while intoxicated has been expanded to include
the operation of a “vessel” and “aircraft” while under the influence. [ Pension Plan Loans. The new law renders loan balances
owed on certain qualified pension, profit sharing, stock bonus o “Superdischarge”
Limited. The generous discharge available under current
Chapter 13 (the “superdischarge”) has been
narrowed to exclude debts for (a) certain types of taxes; (b) fraud,
including credit card abuse; (c) failure to schedule debts to permit
the timely assertion of claims; (d) embezzlement, larceny and breach
of fiduciary duty; and (e) restitution or damages awarded in a civil action as a result
of a willful or malicious injury causing death or personal injury. Domestic support payments, student loans, dui injuries, and criminal restitution
still remain excepted from the scope of the discharge as under former
law. The few obligations still covered by the Chapter
13 superdischarge include debts for “willful
and malicious injury” not referenced above, and debts arising from
property settlements awarded in connection with a divorce o Repeat Filings. A debtor will also be denied a Chapter 7 discharge
if the debtor received a prior discharge under that chapter within
the last eight years (up from six under prior law). A discharge will be denied in Chapter 13 if
the debtor obtained a discharge in Chapter 7, 11 or 12 within four
years, or in a Chapter 13 within the last two years.
[ Chapter
13 Changes. The rules for Chapter 13 have likewise
changed. As summarized above,
the superdischarge is significantly minimized. Most Chapter 13 plans will be five-year commitments
(rather than three years as under former law). Chapter 13 debtors will also be faced with new
obstacles with respect to secured debt.
An individual debtor will not be able to strip down secured
debt (1) of any kind if the obligation was incurred
during the one-year period preceding the bankruptcy filing, or (2)
if the collateral consists of a purchase-money security interest in
a motor vehicle that was purchased within
“910 days” of the bankruptcy filing (i.e.,
two days less than 2 1/2 years) and acquired for “personal use.” [ Business Reorganizations The new legislation makes significant
changes to the dynamics of business reorganizations under Chapter
11 of the Bankruptcy Code. Though
these changes have received little media attention, their importance
and impact on the direction of many business bankruptcy cases are
no less significant. Exclusivity Limited. Under the current
Bankruptcy Code, the debtor has the “exclusive” right to file a plan
of reorganization for the first 120 days of a bankruptcy case, and
the exclusive right to solicit votes in favor of the plan for the
first 180 days. Since no other party can propose a plan during
this period of exclusivity, the debtor has significant leverage in
plan negotiations. Courts in
a number of jurisdictions have routinely granted extensions to the
debtor’s exclusivity periods. Under
the new law, the court will not be permitted to extend the debtor’s
exclusivity periods for filing a plan and obtaining acceptances beyond
18 months and 20 months after the filing, respectively. (Somewhat
different rules apply for a “small business” debtor). [ Small
Business Bankruptcies. Congress has departed from the “one-size-fits-all”
approach to business reorganizations. The new legislation creates a special set of
rules for “small business” cases, defined as those involving a business
with debts of $2 million or less, not including debts owed to affiliates
and insiders. [See,
e.g., id. §§101(51C), 51(D), 1121(e),
1125(f); 28 U.S.C. §546(a)(7), (8)] The amendments attempt to reduce cost and delay
and increase debtor accountability in small business reorganizations.
The changes streamline the time frames and process for plan
preparation, filing and confirmation. Additional reporting requirements and other
duties are now imposed on qualifying debtors so that cases in which
a successful reorganization is improbable can be more quickly identified. [11 U.S.C. §1116] Dismissal or Conversion Required. Congress
recognized that many Chapter 11 cases have no meaningful prospect
of reorganization. The new
legislation therefore contains a number of provisions that operate
to significantly expand the grounds under which a Chapter 11 case
can be (and will required to be) dismissed or converted to a Chapter
7 proceeding. [ Key
Employee Retention Plans.
The amendments significantly restrict the ability of Chapter 11
business debtors to implement arrangements, typically known as Key
Employee Retention Programs (“kerps”),
under which a select group of executives and other personnel deemed
valuable to the business are paid bonuses as an incentive to remain
with the company. Under the new law, there must be a showing that,
among other things, the particular employee is “essential to the survival
of the business.” The amendments
also limit the amount of payments that can be made for the purpose
of “inducing” an insider to remain with the business and impose additional
restrictions on the debtor’s ability to utilize incentive, severance,
bonus and other retention programs. [ Preferential
Transfer Rules. A number of the recent amendments
affect a trustee’s ability to recover preferential transfers, including
changes that will (1) make it potentially easier for creditors to
establish the “ordinary course of business” defense; (2) allow creditors
“30 days” to perfect their purchase-money security interests (rather
than 20 days); (3) preclude lawsuits seeking to recover relatively
small sums (less than $5,000) from creditors; and (4) require lawsuits
seeking to collect a consumer debt of less than $15,000, or any other
non-insider debt less than $10,000, to be brought in the district
where the defendant is located (rather than in a foreign venue where
the bankruptcy is pending).
[ Fraudulent
Transfer Rules. In an attempt to thwart excessive
prebankruptcy compensation arrangements, the new law modifies
the fraudulent transfer rules to expressly provide for the recovery
of certain payments made to or for the benefit of insiders under an
employment contract prior to the bankruptcy filing.
[ Sellers of Goods Protected. The new
legislation enhances reclamation rights by lengthening from ten days
to 45 days the deadline within which sellers of goods can demand to
reclaim goods delivered to buyers.
Furthermore, if the 45-day period extends beyond the petition
date, then the new deadline for receipt of the reclamation demand
is 20 days following the bankruptcy filing. [11 U.S.C. §546(c)] A creditor will also have a priority claim for
the value of all goods shipped on credit in the ordinary course and
that were received within 20 days of a buyer’s bankruptcy filing. This new priority will be given without regard
to whether the creditor made a timely reclamation demand. [ Real
Estate Leases. Chapter 11 debtors now have new limits
placed on their ability to determine whether to assume or reject their
obligations under unexpired leases of commercial property. Courts, recognizing the magnitude of liability
associated with assumption, routinely allowed debtors to postpone
their decisions with respect to real estate leases for an extended
period of time. The new legislation
deems all commercial real estate leases rejected (with immediate surrender
of the premises required) if not specifically assumed within 210 days
of the case, absent the consent of the landlord.
[ Chapter
12 Bankruptcies. The new law makes Chapter 12 of the
Bankruptcy Code, which now applies to “family fishermen” as well as
“family farmers,” permanent. The
debt limits and other tests for determining eligibility have been
liberalized under the new legislation to allow more farmers (and fishermen)
to obtain relief under this chapter.
[ Conclusion In myriad ways, only some of
which could be covered in this article, this legislation will change
the ability of consumer and business debtors to leverage the bankruptcy
system in an effort to escape or minimize their obligations.
While consumer debtors have been granted additional protections
for certain types of property in the form of new exemptions and exclusions,
they will also be faced with many new obstacles.
The “fresh start” is no longer what it used to be. For businesses, a streamlined process and enhanced
creditors’ rights will operate to deny many companies rights formerly
available in a reorganization case.
For creditors, the legislation provides increased protections
and fashions new rights. The
new rules of bankruptcy have changed the field for all players and
should be given careful attention. o Notes 2
The debtor may have up to “45 days” from the meeting of creditors
to perform if the loan is a purchase-money obligation.
See 11 U.S.C. §521(i). How will the new bankruptcy bill affect your practice? Watch upcoming editions of Legal News Digest, MSBA’s members-only email newsletter,
for related news and
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