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Bankruptcy – Overview

What is Bankruptcy?

The Bankruptcy Power is Granted to the Congress of the United States in the Constitution of the United States.

Bankruptcy is a complex area of the law within the federal legal system. Congress is vested with the power in the United States Constitution to create uniform laws on the subject of bankruptcy. Article I, Section 8, Clause 4 of the Constitution provides in pertinent part that: “Congress shall have the power . . . to establish . . . uniform Laws on the subject of Bankruptcies throughout the United States. . .. ” While access to bankruptcy is not technically a constitutional right, the framers of the Constitution of 1787 thought it was important enough to put in the emerging nation’s foundational document.

Congress Has Enacted Bankruptcy Legislation Various Times Since the 1800’s. The Most Recent Changes in the Bankruptcy Law Were Made Effective In 2019.

Congress first exercised that power briefly in 1800. The next bankruptcy laws were the Bankruptcy Acts of 1898 and 1938, the latter known as the Chandler Act. A thorough-going revision to the nation’s bankruptcy laws in 1978, called the United States Bankruptcy Code, modernized the bankruptcy process. This restructuring led to challenges to the jurisdiction of bankruptcy courts and bankruptcy judges. (Bankruptcy judges are appointed for 14-year terms, unlike United States District Court judges who are appointed for life, ostensibly to be free from outside influence.) Those jurisdictional challenges in turn led to further revisions to the nation’s bankruptcy laws, notably the Bankruptcy Amendments and Federal Judgeship Act of 1984 (“BAFJA”). A number of further revisions followed, with the most comprehensive being the Bankruptcy Abuse and Consumer Protection Act of 2005 (“BACPA”).

BAPCA created a number of new requirements for individuals seeking bankruptcy protection. The statute had the (intended) effect of making obtaining bankruptcy relief for individuals more complex and somewhat more time-consuming.

The most recent changes to the Bankruptcy Code were made effective in February 2020. They are the Small Business Reorganization Act (the “SBRA”, or subchapter V of chapter 11) and the Honoring American Veterans in Extreme Need Act (the HAVEN Act).

What Kind of Court is the Bankruptcy Court?

The Bankruptcy Court Is Unlike Most Other Courts You May Be Familiar With.

The United States Bankruptcy Court is a unit of the United States District Court. Bankruptcy cases are “referred” from the District Court to the Bankruptcy Court by standing order. That reference may be withdrawn in a particular case by the District Court if the Bankruptcy Court is determined to be outside of its jurisdictional limits. Decisions in the Bankruptcy Court are made by a Bankruptcy Judge, and not by a jury. That is, when there are disputes, the Bankruptcy Judge resolves them at the trial level. In most chapter 7 bankruptcy cases, there are no disputes and the client never appears before the Bankruptcy Judge. In chapter 13 cases, you will meet the Bankruptcy Judge at least once, in a typically non-threatening hearing on confirmation of your chapter 13 plan of reorganization.

Bankruptcy is like an aircraft carrier: you can fly a lot off of it. You can operate a business (except in chapter 7), discharge debts, sue and be sued (although pre-filing collection cases, foreclosures, etc. are stayed), challenge your taxes, reject certain contracts and leases, bifurcate (split) claims secured by a lien into their secured and unsecured components, strip off entirely unsecured liens, in certain cases recover repossessed or foreclosed property, and more.

What is the Bankruptcy Estate?

When a case is filed under one of the chapters of the United States Bankruptcy Code, a bankruptcy estate is created. That estate (with certain exceptions) consists of everything that the filer (called the “debtor”) owns or has a vested right to receive on the date the case is filed, now or in the future. Examples of vested future rights are personal injury cases or claims, and inheritances or marital property settlements received within 180 days of the date of filing. Generally speaking, in reorganization cases under chapters 11, 12 and 13, the bankruptcy estate expands to include property and rights received during the pendency of the case.

In a case under chapter 7 of the Bankruptcy Code, the bankruptcy estate is administered by a fiduciary appointed by the Office of the United States Trustee, a division of the United States Department of Justice. Those fiduciaries are called chapter 7 trustees. They are private persons (usually lawyers), reviewed and approved by the Office of the U.S. Trustee, bonded and insured for their role and serving on a panel. Panel trustees randomly assigned cases as cases are filed by bankruptcy lawyers and sometimes by individuals filing for relief without a lawyer.

A chapter 7 trustee is incentivized to more or less aggressively represent the interests of unsecured creditors (credit card companies, doctors, hospitals, creditors extending personal loans, etc.) by how their compensation is structured. Trustees are paid a small fee (from your court filing fee) if no assets are collected, liquidated and distributed in a case. But the trustee is rewarded by a commission on a sliding scale paid from any assets the trustee recovers, liquidates and distributes to unsecured creditors.

Chapter 12 and chapter 13 trustees are paid a commission on the funds paid into and disbursed from a chapter 12 or 13 plans of reorganization. However, unlike chapter 7 trustees, chapter 12 and 13 trustees have no power to collect or liquidate any assets. Power over the use of estate property remains with the chapter 12 and/or chapter 13 debtor.

In chapter 11 bankruptcy, a debtor in the usual case remains in possession of estate property and continues to operate its business. That right may be forfeited as the result of gross mismanagement, serious conflicts of interest, or other conduct determined by the Bankruptcy Court to be inconsistent with the debtor in possession’s duties as a fiduciary for the benefit of its creditors.

What are the Bankruptcy Court’s Core Functions?

Two basic functions are at the core of the Bankruptcy Court’s responsibilities: (i) the allowance of claims and distribution of assets on those claims; and (ii) the issuance of the bankruptcy discharge.

Chapter 7 is Titled “Liquidation”. Will My Property Be Liquidated If I File a Chapter 7 Case?

In the ordinary chapter 7 case filed by persons residing in Orange, Sullivan, Ulster, Dutchess, Putnam, Greene and Colombia counties, no unprotected assets of sufficient value are, as a practical matter, subject to seizure or sale by a chapter 7 trustee. In a typical case, the trustee conducts a meeting with the debtor on the record and files a document on the docket of the case stating that, after examination, the trustee has determined that there are no assets of the bankruptcy estate to be liquidated (administered), and that the debtor should receive a discharge. Such a case is referred to as a “no asset” chapter 7. That is not because the debtor doesn’t own any assets, but rather because any assets that the debtor owns or has a right to receive are protected in some fashion from seizure by the chapter 7 trustee. In a no-asset chapter 7 case, creditors are not requested to file claims, and the claims allowance process is not conducted. Absent objection, the second core bankruptcy function of issuing the chapter 7 discharge takes place, and the debtor gets a fresh start, free from personal liability for most or all of his or her debts.

What is the Bankruptcy Discharge?

The discharge is a court order that makes debts that arose before the commencement of the case uncollectible as a matter of the debtor’s personal liability. In other words, a creditor may not attempt to collect a debt from a debtor after issuance of the discharge, except to the extent that the creditor’s claim was reduced to judgment before the commencement of the bankruptcy case, and that judgment became a lien on the debtor’s property before the commencement of the case. Alternatively, a creditor may proceed to collect a debt after issuance of the debtor’s discharge if the creditor’s claim against the debtor is not dischargeable (see Personal Bankruptcy Litigation).

What is the Automatic Stay & How Does it Work?

Common to bankruptcy cases under all chapters, the automatic stay of Bankruptcy Code section 362(a) is a statute that functions as a court order. The automatic stay arises without need for any action by the Bankruptcy Judge as soon as a voluntary bankruptcy case is filed. It is in the nature of an automatic prohibitory injunction against collection activity, and it applies to nearly all kinds of collection actions, whether they be demands for payment, harassment, repossession, foreclosure, the commencement or continuation of litigation, judgment enforcement, the perfection or enforcement of a non-judicial lien, etc. Certain exceptions to the stay exist, such as the exercise of the police power of the state, and domestic relation actions to establish child support, alimony (separate maintenance) and paternity.

The automatic stay is of central importance to the proper functioning of the bankruptcy process, proving as it does a much-needed breathing spell to the debtor, free from the pressures of debt collection and litigation.

The automatic stay remains in effect until it is lifted by Bankruptcy Court order, or by the closure of the case. The stay applies to property of the bankruptcy estate, and under certain circumstances to property of the debtor even if that property is no longer considered property of the bankruptcy estate.

Knowing and willful violation of the stay exposes creditors to sanctions by the Bankruptcy Court, If a debtor suffers actual damages as the result of the knowing and willful violation of the stay, the creditor is required to pay the debtor’s reasonable attorneys fees incurred in responding to the stay violation. Intentional violations of the stay expose the offending creditor to possible punitive damages.

Contact a Hudson Valley bankruptcy attorney for a free consultation

Michael D. Pinsky, P.C. represents clients throughout New York’s Hudson Valley in a full range of bankruptcy matters. Please call 845-394-2616 or contact me online for a free initial consultation at my office in Newburgh.

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