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Chapter 6 Module 5: Bankruptcy
Bankruptcy:
Bankruptcy is an often-tested component of the business law section of the CPA
exam. You
will be required to have a general understanding of the six types of bankruptcy
cases. These
consist of the following:
a) (know for the exom)
1) Chapter 7 (liquidation)
y Shit, Primary Bankruptcy Cases
2) Chapter 1 (reorganization)
3) Chapter 13 (reorganization)
Miscellaneous Bankruptcy Cases
(be familiar with)
4) Chapter 9 (municipal debt adjustment)
5) Chapter 12 (family farmers with regular income)
6) Chapter 15 (cross-border insolvency cases)
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Breakout of
Primary Bankruptcy Cases
(know for the exam)
1) Chapter 7 (Liquidation):
In a Chapter 7 bankruptcy is also referred to as liquidation and permits both
voluntary
and involuntary petitions. In some cases, debtors are seeking bankruptcy (voluntary
bankruptcy) as it would be more advantageous for them to be free of their debt by
liquidating their assets and paying it off (i.e. the debt might be enormous, and
the
assets are relatively small). In order to file for bankruptcy, the debtor must
first establish
that they have no means to pay off their debt.
Trustee Requirement:
Under Chapter 7 liquidations, a trustee will generally be appointed to act of
behalf of
the debtor and when the time comes, will be the fiduciary that is responsible for
collecting,
and liquidating their assets. The proceeds from the sale of these assets will be
applied to
pay off the debt owed to creditors.
Key Characteristics:
1) Trustee will be appointed
2) Debtor can be an individual, partnership, or corporation
collection efforts and the debtor must provide:
°
Automatic Stay
Once automatic stay has been ordered by the court, the creditor must stop all
1) A list of all of the creditors and all of their addresses
2) Breakout a schedule of all of the debtor's assets and liabilities (at FMV)
3) Schedule of current income and expenditures
4) A statement of all of the debtor's financial affairs and a copy of all of their
paystubs within the last 60 days prior to filing
5) May also provide federal tax returns for the prior year
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[+ Included property will consist of:
(from the bankruptcy estate)
* All of the debtor's real and personal property (including all property that has
been obtained or acquired within 180 days after the bankruptey filing).
* Income generated from the estate (e.g. interest and dividend income) that has
been received within 180 days after the filing.
* Property that the debtor received from divorce, inheritances or from insurance
proceeds within 180 days after the petition has been filed.
Excluded property will include:
(from the bankruptcy estate)
+ Post-petition earnings of the principal debtor (individuals), contributions
to educational retirement plans (529 savings plans), spendthrift trusts, and
qualified state tuition programs that have been made at least 365 days prior
to the petition being filed as well as contributions that have been made by
employees to qualified employee benefit plans (e.g. pension plans).
nmin
Str)
* Any and all property that the principal debtor will require in order to continue
to live unless that property has a specified lien on it (e.g. shelter, clothing
etc.)
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Requirements for Voluntary Bankruptcy fr map
Debtor wants “If debtor wants to file for bankruptcy, they must prove
bankruptcy that they don't make enough money to pay back their debt.”
step) Median test py
Creditor does If an individual (married or single) has a monthly income
not want bankruptcy
«5%
in an amount that is greater than the state medion income
step 2) Means test
If 60 times the debtor's average monthly
income (less allowable expenses)
[1 Less that $8,175 Between Greater that $13,650 X
Discharge from bankruptcy Discharge from bankruptcy if amount is No discharge from
bankruptcy
at least 25% of the debtor's unsecured
claims after priority cloiments are paid
Payment Priorities:
1) Secured claimants
2) Priority claimants
(3 Unsecured claimants J
Means Test - The means test is the test that is a formulaic approach to identify
the debtors
monthly income (less allowable expenses provided under bankruptcy law). The
debtor's
monthly income will generally be considered the average income in the six months
prior to
the petition.
Sixty Times Test:
In addition, the means test will generally apply the “sixty times test”, which will
be used to
rationalize the debtor's election to choose Chapter 7 liquidation as opposed to a
Chapter 13
election. This test will be applied as:
60 x Debtors Monthly Income
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This computed amount will be subtracted by allowable expenses and then compared to
dollar value thresholds. This will essentially be used to “ballpark” if the
debtor's income
levels are appropriate. The general rule is that if the debtor's average income is
less than
$7,700, the debtor should be entitled to Chapter 7 liquidation.
Summary of Chapter 7 Liquidations:
e In a Chapter 7 liquidation bankruptcy filing, a trustee is responsible for
collecting the
debtor's assets, and subsequently liquidates them to pay off the debtor's debt.
Chapter 7 liquidations can be used for individuals, partnerships, and corporations
and must be a United States resident.
Certain debtors are prohibited from filing for Chapter 7 bankruptcy. These types of
debtors include:
o Insurance companies
o Railroads
o United States banks or other credit institutions
o Governmental units
Prevention of Chapter 7 Discharge:
As mentioned, debtors will often seek discharge from their debt to creditors. When
attempting to do so, the creditors can either first seek (1) objections to the
discharge or, (2)
assert that certain debts aren't dischargeable all together.
2) Chapter 11 (Reorganization)
Often considered the preferred method of bankruptcies, Chapter 11 reorganizations,
unlike Chapter 7 liquidations are not liquidating the debtor's assets and offering
proceeds
to the creditor. Chapter 11 reorganizations rather, enable the debtor to reorganize
and
restructure their debt in a more realistic way for them to pay back the amount
owed. Like
Chapter 7, Chapter 11 of fers both voluntary and involuntary petitions.
Key Characteristics
1) Trustee will not be appointed
2) Debtor can be an individual, partnership, or corporation
3) No liquidation (company still exists)
Involuntary Petitions:
For cases related to both Chapter 7 and chapter 11, an involuntary petition can be
filed by
creditors if:
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Sligo, Pye
Rr . Mental map
Z a Requirements for Involuntary Bankruptcy
=
step 1) If less than 12 creditors
1) One or more creditor must have outstanding debt of
$16,750 in order to petition
2) Outstanding debt must be unsecured
~~ Step 2) If 12 or more creditors
- . 1) Three or more creditors must have outstanding debt of
Le $16,750 (in the aggregate) in order to petition
gan
2) Outstanding debt must be unsecured and undisputed
Example
Connor owes Morgan, Cassandra and Fred $21,000, $10,000 and $17,000, respectively.
Either Morgan or Fred qualify to petition Connor into filing for Chapter 7
bankruptcy as
they meet the criteria for outstanding debt owed to less than 12 creditors.
Fred Morgan
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Example 2
Connor owes Morgan, Cassandra and Fred $21,000, $10,000 and $17,000, respectively.
Fred's $17,000 owed amount is secured by Connor's inventory. Only Morgan would
qualify
to petition Connor into filing for Chapter 7 bankruptcy as she is the only one that
meets the
criteria for outstanding debt owed to less than 12 creditors. Please note, that
because Fred's
owed amount is secured, he will not qualify.
Morgan
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Example 3
Connor owes 18 creditors a grand total of $90,000. Of the $90,000 Morgan, Cassandra
and Fred are each owed $11,000, $5,000 and $3,000, respectively. Morgan, Cassandra,
and Fred want to petition Connor into involuntary bankruptcy.
Solution:
Morgan, Cassandra, and Fred would meet the criteria to petition Connor into
involuntary
bankruptcy because in the aggregate, they are collectively owed over $16,750 in
unsecured,
undisputed debt.
18 total Morgan Cassandra
$11,000 $5,000
$19,000 (311,000 + $5,000 + $3,000)
£19,000 > $16,750
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Prohibited From Filing Prohibited From Filing
Chapter 7: Chapter II:
1) Savings institutions 1) Savings institutions
2) Insurance companies 2) Insurance companies
3) Banks ¢ small business investment companies 3) Banks ¢ small business investment
companies
4) Railroads 4) Stock brokers ¢ commodity brokers
Limitations to Bankruptcy Filings:
Certain groups or institutions will be prohibited from filing for either Chapter 7
or Chapter 11
bankruptcy. Generally, the same parties that are prohibited from filing for Chapter
7 are the
same parties that are prohibited from filing for Chapter 11, with the exception of
railroads.
Additionally, only domestic residents will be able to file for bankruptcy per the
Bankruptcy
Code.
3) Chapter 13 (Reorganization)
In a Chapter 13 case, the debtor is responsible for repaying most of their debts
over a three to five-year period. A trustee is responsible for handling all of
Chapter 13
cases. Chapter 13 cases will be availoble to individuals only.
Key Characteristics
1) Trustee will be appointed
2) Debtor con be an individual only
3) No liquidation (company still exists)
4) Debtor must pay off debts within a 3-5 year period
Miscellaneous Bankruptcy Cases (understand at a very high level):
o Chapter 15 - Cross border insolvency cases. Basically, this allows for the United
States courts and foreign courts to cooperate.
Chapter 9 - Municipal debt cases. The purpose of chapter 9 is to provide a
financially
distressed municipality protection from its creditors while it develops and
negotiates
a plan for adjusting its debts. Reorganization of the debts of a municipality is
typically
accomplished either by extending debt maturities, reducing the amount of principal
or interest, or refinancing the debt by obtaining a new loan.
Chapter 12- Family farmer with regular income. Chapter 12 is designed for "family
farmers" or "family fishermen" with "regular annual income." It enables financially
distressed family farmers and fishermen to propose and carry out a plan to repay
all
or part of their debts. Under chapter 12, debtors propose a repayment plan to make
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installments to creditors over three to five years. Generally, the plan must
provide for
payments over three years unless the court approves a longer period "for cause.”
Distribution of Debtors Estate:
After the assets of the debtor have been collected and subsequently liquidated, it
will be
critical to understand who receives priority when it comes to distributions of
bankruptcy
estate. You will also be required to have a general understanding of what
individuals will be
prioritized during the distribution of payments.
The three basic payments will be paid out to (1) Secured claimants, (2) Priority
claimants,
and (3) General creditors. The priority list is as follows:
Mental map
. . . — ae
Bankruptcy Distribution Order n=
Ist Distribution: Secured Claimants
Bankruptcy distributions will be first paid out to secured claimants, to the extent
of the overall value of the collateral that “secures” their claims on the debtor.
2nd Distribution: Priority Claimants
Subsequent to secured claimants receiving the bankruptcy distribution that they
are entitled to, priority claimants will be paid next based on their priority
order.
= 3rd Distribution: General Creditors
¢ Subsequent to secured claimants, and priority claimants receiving the bankruptcy
distribution that they are entitled to, all general creditors will be paid any
excess
amount.
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Bankruptcy Distribution Order Na of
Ist Distribution: 2A
. ] » or
end Distribution: Priority Claimants > HRN
Priority 1) Child support and alimony
Debts owed for domestic support obligations such as child support, alimony etc.
Priority 2) Administrative expenses (trustee fees, attorney fees)
Administrative expenses, fees related to attending court, legal fees, filing and
trustee
fees etc.
Priority 3) In between claims
These claims are also referred to as involuntary gop claims ond are claims thot
appear
in between the filing of involuntary suits, and order for relief and trustee
appointments.
These claims will typically arise during the ordinary course of business of the
debtor.
Priority 4) Wage claims up to $13,650
Any wages, salaries, or commissions that are earned within 180 days of the
petitions’
filing, up to $13,650 for each individual.
Priority 5) Employee benefit plans up to $13,650
Contributions that have been made to employee benefit plans (i.e. pension plan) for
services that have been performed within 180 days of the filing. This amount will
be
prioritized up to $13,650 and cannot exceed $13,650 times the number of employees.
Priority 6) Grain farmers and fisherman up to $6,725
Unsecured claims of people engaged in the production of grains or engaged in the
production of grains or engaged as U.S, fisherman to the extent of £6,725.
Priority 7) Deposits up to $3,025
Deposits made of monies by individuals with the debtor for purchase or rental or
property
or other personal services for personal or household use up to $3,025 each,
Priority 8) Tax claims
Most tax claims (e.g. federal, state, local, income, property, or withholding)
taxes will all
be subject to the next level of priority.
Priority 9) In jury claims arising from intoxicated driving
Claims for death or personal injury cases made that have resulted from operating a
motor
vehicle due to the intoxication of the driver.
3rd Distribution:
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Creditors Objections:
If creditors successfully object to the discharge of a debtor's debt, they may do
so if any of
the following occur:
Debtor Creditor
Creditors Objections:
Commission of a bankruptcy crime
Certain bankruptcy crimes will be susceptible to objections for the creditor to
discharge
debt of principal debtor. If certain acts have been committed fraudulently such as
presenting false claims, bribing bankruptcy officials, or refusing to distribute
information
or documents an objection to the discharge can be made.
8 years) Prior discharge within eight years
AND, If the debtor has been discharged in the previous eight years, they will not
be able to
be discharged in the present yeor os debtor's ability discharge from debt once
every
eight yeors.
Un justifiably failed to keep books and records
If if the debtor has failed to provide appropriate bookkeeping, or has
unjustifiably created
false records, the debtor will not be subject to discharge.
Hiding of property
If the principal debtor hos fraudulently transferred property to other creditors,
or has
hidden property, they will not be subject to discharge.
Failure to justify loss of assets
If the debtor is unable to justify the loss of assets in the bankruptcy estate,
they wil
not be sub ject to discharge.
Refusal to answer questions
Certain bankruptcy crimes willbe susceptible to objections for the creditor to
discharge
debt of principal debtor. If certain acts have been committed fraudulently such as
presenting false claims, bribing bankruptcy officials, or refusing to distribute
information
or documents an objection to the discharge can be made.
WERE | Attempt to set up an artificial entity
HIRING!
If the debtor attempts to set up an artificial entity, they will not be subject to
discharge.
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