A “claim” against a debtor’s bankruptcy estate is creditor’s allegation that it has a bona fide legal right to payment from the debtor or the debtor-in-possession if the case is filed under chapter 11.

Because claims are used by creditors to legitimize the debts they are owed in the bankruptcy proceedings, it is commonly said that claims are made “against” a debtor’s bankruptcy estate. Chapter 5 of the US Bankruptcy Code (the “Code”) plays a critical role in identifying and processing creditors’ claims.

Processing claims is important because it determines which parties will be able to participate in the bankruptcy proceedings. To dig into the details, it’s best to begin with the basics. Section 101(5) of the Code defines a “claim” broadly to include any secured or unsecured right to payment. A particular claim need not be fixed, settled or even due at the time the bankruptcy case is filed. As a general rule, however, only debts that were incurred before the debtor filed for bankruptcy are included in the case. Debts that arise after filing for bankruptcy are unaltered by the proceedings.

Section 506 of the Code defines the rights of a creditor who has a properly-perfected security interest in the debtor’s collateral. (“Perfection” of a security interest is a technical legal term, governed by Colorado state law.) Congress created section 506 of the Code to handle two common situations that occur in bankruptcy. First, if the collateral securing a debt is worth more than the outstanding debt (i.e., the creditor is “oversecured”), the creditor is entitled to receive the amount that has yet to be paid. An oversecured creditor may also receive interest payments and reasonably-related expenses if it originally contracted for them. On the other hand, if the collateral is worth less than the amount of the debt (i.e., the creditor is “undersecured”), the claim can be bifurcated by the US Bankruptcy Court, which leaves the creditor with a secured claim that equals the collateral’s value and an unsecured claim for the difference. This process is commonly known as lien “stripping” or a “strip off.”

The remaining unsecured claims against the debtor’s bankruptcy estate are paid from the estate’s general funds. To do so, section 507 of the Code creates a categorical hierarchy of claims that are paid in descending order. Domestic support obligations, like maintenance payments owed to an ex-spouse, receive the highest priority, and unsecured creditors like credit cards and stockholders, if the debtor is a corporation, are given lowest priority. Many of the categories outlined in section 507 of the Code are capped, so any excess value is transferred to the next pool of creditors in order of priority.

A person or company’s bankruptcy “estate” is composed of all legal or equitable “interests in property” at the time of the bankruptcy filing – even if the property is owned or held by another person.

When a person or company files bankruptcy in Colorado, an estate is created to make it easier for the court to administer the case. From a legal perspective, the debtor’s estate is a completely new entity and is treated separately from the debtor. Under section 541 of the US Bankruptcy Code (or simply the “Code”), the estate contains a variety of things, including all legal or equitable interests of the debtor in property when the bankruptcy petition was filed.

If a bankruptcy petition is filed by an individual consumer (as opposed to a business), the Code imposes several important qualifications on what becomes property of the estate. For example, the debtor’s “earnings from services performed” after filing for bankruptcy are excluded from the estate. § 541(a)(6).

Individuals can also elect to keep their specific interests in property from the reach of creditors by exempting them under section 522. For debtors filing in Colorado, these exemptions are governed by Colorado state law and include assets like pensions, jewelry, motor vehicles and real property (i.e., the debtor’s residence). If the debtor is a business, however, these qualifications do not apply, and the Bankruptcy Code includes the business’s future earnings and similar assets in its bankruptcy estate.

Section 541 creates the baseline set of rules used by courts to define the bankruptcy estate. The trustee and Chapter 11 debtor-in-possession, however, have additional tools that allow them to add other assets to the estate, which increase its overall value for pre-petition creditors. These tools are called the “avoiding powers,” which are discussed in subsequent posts.

The US Bankruptcy “Code” is the informal name used by lawyers and judges to describe the sections of federal law that govern the bankruptcy process. Regardless of whether the case is a chapter 7, 9, 11, 12 or 13 bankruptcy, the entire statutory text of bankruptcy can be found in title 11 of the United States Code – specifically 11 USC §§ 101-1330.

When you “assume” a contract in bankruptcy, you are agreeing to continue performing your duties under the contract.

For example, if you currently have a monthly service contract with a cellphone provider – like AT&T, Verizon or T-Mobile – you are legally permitted to break your contract by filing bankruptcy. In some scenarios, this could be a good idea, especially if you can’t afford your monthly bill. If, however, you can afford to pay your monthly bill and you’d like to keep using your cellphone, you can choose to “assume” the cellphone contract in your bankruptcy paperwork. By doing so, there won’t be any hiccups in your service as a result of your bankruptcy filing.

In Colorado, an “adversary proceeding” is a lawsuit filed by a third party or the bankruptcy trustee to resolve a legal dispute relating to a debtor’s bankruptcy case. This term is used regardless of whether you choose to file chapter 7, 11, 12 or 13 bankruptcy.

Several examples of “adversary proceedings” are listed Federal Rule of Bankruptcy Procedure 7001, including those listed below:

When you file bankruptcy, an “automatic stay” takes effect. The “automatic stay” is like a shield that protects you from banks, credit cards and collection agencies. To be more precise, bankruptcy’s “automatic stay” is a legal injunction that stops any lawsuits, foreclosures, garnishments or collection activities against you as of the moment your bankruptcy petition was filed.

As a proud member of the National Association of Consumer Bankruptcy Attorneys (“NACBA”), we wanted to pass along breaking news about NACBA’s Principal Paydown Plan, which was featured in the New York Times.

Click here to read the NY Times article: Homeowners Need Help!

For the past year, NACBA has been urging the Obama Administration to to enact a Principal Paydown Plan to resolve the current foreclosure crisis in Colorado and elsewhere. NACBA’s plan was developed through negotiations between consumer bankruptcy attorneys, major lenders and servicers to include the PPP as one of the remedies in any settlement over foreclosure abuses. Today the PPP was featured in a NY Times editorial – pointing out once again that the nation’s economic slide will continue until major steps have been taken to address the housing mess.

Here is a summary of the Principal Paydown Plan from NACBA’s website:

SUMMARY

The Principal Paydown Plan calls for a restructuring in Chapter 13 bankruptcy of certain underwater mortgages. Under this approach, homeowners will be able to eliminate negative equity, acquire modest equity and then reamortize the mortgage into a market rate loan. The reduction of principal is not achieved by a cramdown, but rather by temporarily reducing the interest rate to 0% so that all payments made by the homeowner are applied to pay down the principal. In exchange for this benefit, the homeowner would have to agree to a general settlement of claims against the servicer, trustee and investor. The Principal Paydown Plan will achieve a significant improvement in the overencumbered status of the home; provide needed and justifiable hope for the homeowner, many of whom have a legitimate claim against the servicer; and stabilize individual communities across the country, as well as the overall housing market.

THE CONTINUING FORECLOSURE CRISIS

While there is some debate as to whether the economy is starting to rebound, the number offoreclosures continues to increase and jeopardize the fragile recovery. An estimated 6.7 million homes already have been lost to foreclosure and that number is expected to reach 13 million by the end of 2014, resulting in about $1 trillion in direct financial losses to borrowers, local governments and financial institutions. Some analysts argue that all of these foreclosures will help the market reach its bottom, at which point recovery can ensue. This viewpoint, however, does not consider that many foreclosures are unnecessary and should not occur under a system where mortgage servicers are obligated to make changes to the mortgage if the changes would return a greater value to the investor.

Unfortunately, foreclosures still outpace the negotiation of affordable and sustainable loan modifications. This is true despite the Administration’s Home Affordable Modification Program (or “HAMP”), which offers monetary incentives to servicers and borrowers in an effort to encourage such modifications. The shortcomings of HAMP, which have been well documented, are that it does not include mandated principal reduction and the modified loan capitalizes arrears into the new principal, thereby stopping the foreclosure but resulting in a loan that is even more undersecured.

We are facing historic levels of homes lost through foreclosures. Not every individual foreclosure can or should be stopped, but there is an urgent need to stop the epidemic by closing the growing chasm between prevention and losses. Without stronger policy intervention, not only will millions of families lose their homes unnecessarily, but massive foreclosures will continue to destroy communities, drag down the housing market, and keep a full economic recovery out of reach.

A SOLUTION – A PRINCIPAL PAYDOWN PLAN FOR UNDERSECURED MORTGAGES

There is no “silver bullet” strategy to fix every mortgage or repair every foreclosure-ravaged neighborhood.

Moreover, the toxic combination of negative equity and a weak economy means that many homeowners with fixedrate, prime mortgages are experiencing much higher default numbers as well. The breadth and depth of the housing crisis means that we must address it through multiple approaches and solutions. Recent research has shown a strong correlation between negative equity and mortgage delinquency. Homeowners who are underwater have no cushion to absorb financial difficulties. Furthermore, in some cases, homeowners who are unlikely to move into a positive equity position have fewer incentives to stay in the home or make the necessary ongoing investments in maintenance. For these homeowners, even the reduction of monthly payments to an affordable level does not fully solve the problem. As a result, a homeowner’s equity position has emerged as a key predictor of loan modification redefault, more so than unemployment or other factors. Bankruptcy courts are an attractive venue for addressing foreclosure problems in many cases. In particular, a Chapter 13 bankruptcy case provides the following benefits:

The stigma of filing bankruptcy and the imposition of stingy expense allowances for those in a Chapter 13 bankruptcy are more than enough to dissuade homeowners with the ability to pay from filing bankruptcy for the purpose of “gaming” the system. Furthermore, the bankruptcy court’s detailed budget review of the Chapter 13 debtor prevents the moral hazard of misuse of bankruptcy protection.

There currently are about 1.6 million active and pending Chapter 13 bankruptcy cases, of which approximately 880,000 include mortgages. An additional 22,000 new Chapter 13 cases that include mortgages are filed each month. The Principal Paydown Plan, as outlined below could apply to all of these cases. In summary, the Plan:

We applaud NACBA’s efforts to improve the current foreclosure crisis gripping Colorado and the nation! Hopefully, the Obama Administration will see the value in NACBA’s Principal Paydown Plan and begin taking proactive steps to help homeowners struggling with their underwater mortgages.

Bankruptcy releases a debtor from personal liability for certain types of debts through a process known as the bankruptcy “discharge.” Once the debtor’s discharge is granted by the bankruptcy court, he or she is no longer legally required to make payments on any debts covered by the discharge.

DISCHARGING DEBTS BY FILING BANKRUPTCY

From a legal perspective, bankruptcy’s discharge is a permanent order prohibiting a debtor’s creditors from taking any form of collection action on discharged debts – including legal action and communications with the debtor like phone calls, letters, email and other personal contact.

Although a debtor is not personally liable for discharged debts, a valid lien that has not been “avoided,” or made unenforceable in the bankruptcy case, won’t be included in the debtor’s discharge. Therefore, a secured creditor may enforce its right to repossess the collateral secured by its lien.

WHEN DOES THE DISCHARGE OCCUR?

The timing of the discharge varies, depending on the chapter under which the case is filed. In achapter 7 bankruptcy case, for example, the court usually grants the discharge promptly on expiration of the deadline for filing an objection to the debtor’s discharge and the deadline for filing a motion to dismiss the case on account of abuse, which is usually 60 days following the first date set for the 341 Creditors’ Hearing. Typically, the a chapter 7 discharge occurs about four months after the date a debtor files the petition with the clerk of Colorado’s bankruptcy court.

In non-business chapter 11 cases, chapter 12 cases involving family farmers and fishermen, and chapter 13 bankruptcies, the court generally grants the debtor’s discharge as soon as practicable after the debtor completes all of his or her payments under the plan. Because a chapter 12 or chapter 13 plan may provide for payments to be made over three to five years, the discharge typically occurs about four years after the date of filing. The court may deny an individual debtor’s discharge in a chapter 7 or 13 case if the debtor fails to complete an instructional course concerning “financial management.” The Bankruptcy Code provides limited exceptions to the financial management requirement, but it may not be required if the US Trustee or bankruptcy administrator determines there are inadequate educational programs available or if the debtor is disabled, incapacitated or on active military duty in a combat zone.

HOW DO I GET A DISCHARGE?

In Colorado, unless there is pending litigation over objections to the discharge, the debtor will almost always receive his or her bankruptcy discharge. The Federal Rules of Bankruptcy Procedure require the bankruptcy court’s clerk to mail a copy of the order of discharge to all creditors, the US Trustee, the bankruptcy administrator and the trustee’s attorney (if applicable). The debtor and the debtor’s attorney also receive copies of the discharge order.

The notice is simply a copy of the final order of discharge. It informs creditors that the debts owed to them have been discharged and that they are prohibited from attempting any further collection activities. Creditors are also cautioned in the notice that continuing collection efforts could subject them to punishment for contempt. Any inadvertent failure on the part of the clerk to send the debtor or any creditor a copy of the discharge order promptly, within the time required by the rules, does not affect the validity of the order granting the discharge.

ARE ALL OF MY DEBTS DISCHARGED OR ONLY SOME?

Not all debts are discharged. Debts that are eligible to be discharged vary under each chapter of the Bankruptcy Code. Section 523(a) of the Code specifically excepts various categories of debts from the discharge granted to individual debtors. Therefore, the debtor must still repay those debts after bankruptcy. Congress has determined that these types of debts are not dischargeable for public policy reasons – based either on the nature of the debt or the fact that the debts were incurred due to improper behavior of the debtor, such as drunken driving.

There are 19 categories of debt excepted from discharge under chapters 7, 11 and 12. A more limited list of exceptions applies to cases under chapter 13.

Generally speaking, the exceptions to discharge apply automatically. The most common types of non-dischargeable debts are listed below:

The McFarland Law Group LLC proudly announces Roy McFarland, Esq. is now a Rocket Lawyer! Click here to see his profile.

Article I, Section 8, of the US Constitution authorizes Congress to enact “uniform Laws on the subject of Bankruptcies.” Under this grant of authority, Congress created the “Bankruptcy Code” in 1978. The Bankruptcy Code, which is codified in title 11 of the US Code, has been amended several times since its enactment. Because the Constitution grants this authority to the federal government, the Bankruptcy Code is a uniform federal law governing all bankruptcy cases in Colorado and elsewhere – including US territories.

The bankruptcy process is governed by the Federal Rules of Bankruptcy Procedure (or the “Bankruptcy Rules”) and the local rules of each bankruptcy court. The Bankruptcy Rules contain a set of official forms for use in bankruptcy cases. There is a bankruptcy court for each judicial district in the country. Colorado’s bankruptcy court is located in downtown Denver in the US Customs House. For directions, click this link or check out this previous blog post: Where is Colorado’s Bankruptcy Court? by Roy McFarland, Esq. You can also visit court’s website directly by clicking here.

The court official with decision-making power over federal bankruptcy cases is the US bankruptcy judge, a judicial officer of the United States District Court. The bankruptcy judge may decide any matter connected with a bankruptcy case, such as your eligibility to file or whether to grant your discharge of debts. Much of the bankruptcy process is administrative, however, and is conducted away from the courthouse. In cases under chapters 7, 12 or 13, and sometimes in chapter 11 cases, this administrative process is carried out by a trustee, who is appointed by the court to oversee the case.

A debtor’s involvement with the bankruptcy judge is usually very limited. A typical chapter 7 debtor will not appear in court and will not see the bankruptcy judge unless an objection is raised in the case. A chapter 13 debtor may only have to appear before the bankruptcy judge at a plan confirmation hearing. Usually, the only formal proceeding at which a debtor must appear is the meeting of creditors, which is usually held at the offices of the US trustee. This meeting is informally called a “341 meeting” because section 341 of the Bankruptcy Code requires that the debtor attend this meeting so that creditors can question the debtor about debts and property.

The fundamental purpose of bankruptcy is to give debtors a financial “fresh start” from overwhelming and burdensome debts. In fact, the US Supreme Court made this point in a 1934 decision: “[Bankruptcy] gives to the honest but unfortunate debtor … a new opportunity in life and a clear field for future effort, unhampered by the pressure and discouragement of preexisting debt.” Local Loan Co. v. Hunt, 292 U.S. 234 (1934).

A bankruptcy debtor’s fresh start is accomplished through his or her bankruptcy discharge, which releases debtors from personal liability from specific debts and prohibits creditors from ever taking any action against the debtor to collect those debts. Six basic types of bankruptcy cases are allowed under the Bankruptcy Code, each of which is described below. The cases are traditionally given the names of the chapters that describe them.

CHAPTER 7

Chapter 7, entitled Liquidation, outlines an orderly, court-supervised procedure by which a trustee takes over the assets of the debtor’s estate, reduces them to cash and makes distributions to creditors, subject to the debtor’s right to retain certain exempt property and the rights of secured creditors. Because there is usually little or no nonexempt property in chapter 7 cases, there may not be an actual liquidation of the debtor’s assets. These cases are called “no-asset cases.” A creditor holding an unsecured claim will get a distribution from the bankruptcy estate only if the case is an asset case and the creditor files a proof of claim with the bankruptcy court. In most chapter 7 cases, if the debtor is an individual, he or she receives a discharge that releases him or her from personal liability for certain dischargeable debts. The debtor normally receives a discharge just a few months after the petition is filed. Amendments to the Bankruptcy Code enacted in to the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 require the application of a “means test” to determine whether individual consumer debtors qualify for relief under chapter 7. If such a debtor’s income is in excess of certain thresholds, the debtor may not be eligible to file chapter 7 bankruptcy.

For a in-depth discussion of chapter 7 bankruptcy in Colorado, check out this blog post: An Overview of Chapter 7 Bankruptcy in Colorado by Roy McFarland, Esq.

CHAPTER 9

Chapter 9, entitled Adjustment of Debts of a Municipality, provides for reorganization, much like a reorganization under chapter 11, of a “municipality” – including cities and towns, as well as villages, counties, taxing districts, municipal utilities and school districts.

CHAPTER 11

Chapter 11, entitled Reorganization, is used by companies to continue operating as a business while repaying creditors concurrently through a court-approved reorganization plan. Under a court-approved chapter 11 reorganization plan, the company can reduce its debts by repaying a portion of its obligations and discharging others. The debtor can also terminate burdensome contracts and leases, recover assets and rescale its operations in order to return to profitability. Under chapter 11, the debtor normally goes through a period of consolidation and emerges with a reduced debt load and a reorganized business structure.

CHAPTER 12

Chapter 12, entitled Adjustment of Debts of a Family Farmer or Fisherman with Regular Annual Income, provides bankruptcy protection to family farmers and fishermen. The chapter 12 process is very similar to that of chapter 13, under which the debtor proposes a plan to repay debts over a period of time – no more than 3-5 years. There is also a trustee in every chapter 12 case whose duties are very similar to those of a chapter 13 trustee. The chapter 12 trustee’s disbursement of payments to creditors under a confirmed plan parallels the procedure under chapter 13. Chapter 12 allows a family farmer or fisherman to continue to operate his or her normal business while the plan is being carried out.

CHAPTER 13

Chapter 13, entitled Adjustment of Debts of an Individual With Regular Income, is designed for an individual debtor who has a regular source of income. Chapter 13 is often preferable to chapter 7 because it enables the debtor to keep a valuable asset, such as a house and allows the debtor to propose a “plan” to repay creditors over time – usually 3-5 years. Chapter 13 is also used by consumer debtors who do not qualify for chapter 7 relief under the means test. At a confirmation hearing, the court either approves or disapproves the debtor’s repayment plan, depending on whether it meets the Bankruptcy Code’s requirements for confirmation. Chapter 13 is very different from chapter 7 since the chapter 13 debtor usually remains in possession of the property of the estate and makes payments to creditors, through the trustee, based on the debtor’s anticipated income over the life of the plan. Unlike chapter 7, the debtor does not receive an immediate discharge of debts, however. Instead, the debtor must complete his or her payments under the plan before the discharge is granted. The debtor is protected from lawsuits, garnishments and other creditor actions while the plan is in effect. The discharge is also somewhat broader (i.e., more debts are eliminated) under chapter 13 than the discharge under chapter 7.

For a more detailed discussion of chapter 13, read this previous blog post: Benefits of Filing Chapter 13 Bankruptcy in Colorado by Roy McFarland, Esq.

CHAPTER 15

The purpose of Chapter 15, entitled Ancillary and Other Cross-Border Cases, is to provide an effective mechanism for dealing with cases of cross-border insolvency. This publication discusses the applicability of Chapter 15 where a debtor or its property is subject to the laws of the United States and one or more foreign countries.

To learn more about filing bankruptcy, contact our offices today. Our experienced team canhelp you get a debt free fresh start.