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Fundamentals of Bankruptcy Law and Procedure in Illinois

What You Should Know About Bankruptcy Procedure and Litigation

Adversary Proceedings vs. Contested Matters

Issues are brought before the Court as either a contested matter or a adversary proceeding.

Adversary Proceedings
Handled like regular civil lawsuit under FRCP

Rule 7001 10 kinds of disputes that must be brought as adversary proceedings

Recover money or property subject to exception
Determining validity, priority, or extent of a lien
Obtain approval pursuant to §3636(h) for sale of an interest of both the Estate and of a co-owner of property
Object to or revoke a discharge
Revoke Plan confirmation under Chapter, 11, 12 or 13
Determine dischargeability of a debt
Obtain and injunction or other equitable relief

More disputes that must be brought as Adversary:

Subordinate allowed claim or interest, except when subordination provided in Chapter 9,11,12 or 13 Plan
Obtain declaratory judgment relating to the foregoing
Determine a claim or cause of action removed pursuant to 28 U.S.C §1452

NB: Must bring adversary to determine dischargeability of fraudulent payments and divorce payments.

NB: In Chapter 7 the Creditor must file adversary not more than 60 days after first meeting of creditors.

Contested Matters
Includes all disputes not set forth by Rule 7001 Governed by FRBP not FRCP Deadlines, discovery, witnesses et al. determined by Court

Summary

Discovery in Bankruptcy Proceedings

Governed by FRBP 7026-7037 and FRCP 26-37
Rule 2004 allows for examination of the debtor to determine dischargeability – subject to permission of the Court and limited to: (1) finances of the debtor or the Estate (2) matters affecting administration of the Estate (3) the right to receive a discharge

DIS: Unlike Federal District Courts, the Bankruptcy Court may issue rulings concerning the practical application of discovery to fit the circumstances of Bankruptcy litigation

Preference Actions

Preferential Transfers

Payment to debtor or creditor within specific time period or under certain conditions prior to debtor’s filing.
Creditor receives a “preference” over others
§547(e) defines the date of the transfer and mirrors the Illinois UCC rules such as perfection, etc.
Even if avoided, interest is allowed on the transfer from the first time demanded by the creditor

Avoiding Preferential Transfers
§547 of the Code grants Trustees the ability to recover preferential transfers on behalf of the Estate, which gives the Trustee the power to avoid the preferential transfer Limits and Characteristics of Adversary
§550 of the Code: Trustee must file an action to recover the preferential transfer on the earlier of the following:

(1) within 1 year after the transfer; or (2) by the end of the case.

Burden of Proof: Trustee must prove voidability, Creditor must prove non-voidability

Prima facie elements §547(b): 5 conditions

Transfer of;

Property of the Estate;
On account of an “antecedent debt”;
Within 90 days of filing (or 1 year for an Insider);
That allows the creditor to receive more than they would have in a Chapter 7 distribution

§547(e) determines when transfer is made: (1) When debtor acquires rights in the property; (2) When transferred if perfected within 10 days Definition: Preference is a transfer made

To or for the benefit of a creditor;
On account of an “antecedent” debt
While the Debtor was insolvent (rebuttable presumption)
Within 90-days prior to filing or 1 year if an “insider” DIS: Insider must have had reasonable cause to know debtor was insolvent at time of transfer
That enables the recipient to receive more than if the transfer had not been made and Debtor were liquidated

Defenses to the “Preference” Rule
§547(c) provides 8 exceptions or defenses to the Trustee’s ability to avoid a preferential transfer

(1) Substantially Contemporaneous Exchange Example: Say debtor takes delivery of widgets and remits cash (C.O.D.). This exception presumes Estate is no worse off because it received what it paid for at the time.

Note: Even if debt were created on day 1 and repaid on day 7 it may qualify for this defense if the parties intended for the transaction to be contemporaneous

(2) “New” Value Example: Say the Debtor owes $1000. 25 days before Bankruptcy and pays Creditor in full. 2 days later Creditor ships another $1,000 in goods to the debtor. Debtor never pays for that shipment. Then, debtor’s original payment technically constitutes a preference, however this section excepts that payment because of the “new value” extended to the Debtor.

Note: There is a split among Federal Circuits as to how “new value” should be calculated (7th Circuit requires that the new value remain unpaid)

(3) Ordinary Course of Business Transfers made

to pay obligations incurred in ordinary course of business;
actually made in the ordinary course of business;
on ordinary business terms

will not be recaptured

While Courts vary in their articulation of the standards, generally payments are protected if consistent with:

Industry-wide terms; Terms within that area (course of dealing); Parties’ actual dealings (course of performance)

When analyzing “industry standards,” Courts compare the practices of firms similar to the Creditor.

Note: extraordinary or idiosyncratic dealings are usually outside the scope of this section and hence recoverable.

End Result of a Successful Preference Action

If Trustee prevails, debtor’s interest in property transferred must be returned to the Estate and the Creditor receives an unsecured claim for the same amount
Court will grant the Creditor interest on the transferred amount as of the date of the transfer, unless there no sound reason to do so

Fraudulent Transfer Issues

Fraudulent Transfers
DIS: whereas a preference is strictly mechanical, a fraudulent transfer involves the transfer of property of the Estate for inadequate value (“constructive fraud”) or actual fraud.

Key Inquiry: effect the transfer has on the Estate

e.g. Conditions for a fraudulent transfer mirror the Uniform Fraudulent Transfer Act 740 ILCS 160/1

A gift or transfer of debtor’s property
for little or no value
while debtor was or became insolvent as a result
Debtor knew he could not pay his debts or obligations
With intent to hinder, delay or defraud creditors

Avoiding Fraudulent Transfers
§548 of the Code grants Trustee the ability to recover fraudulent transfers on behalf of the Estate.

Time Limitations

According to §548 the Trustee may avoid a fraudulent transfer that occurred within one year of the filing of the subject case, unless State law provides a longer statute of limitations.
The Illinois Fraudulent Transfer Act (UFTA) can extends the 1 year limitation to 4 years. Establishing a case for recovery
2 out of the following must be proven before the Court can find a fraudulent transfer:

Actual fraud: intent to hinder delay or defraud;
Constructive fraud: inability to repay debts;
Less than equivalent value for the transfer.

Discharge and Dischargeability: Who is entitled to a discharge?

§727(a) Court shall grant a discharge unless debtor:

Is not an individual; or
Transferred or destroyed property of the Estate within a year before filing or any time after filing with intent to hinder, delay or defraud; or
Concealed, destroyed or falsified info re financial condition; or
Knowingly:
made false oath or account;
presented or used false claim;
gave, offered or received money;
withheld information re property et al.
Fails to explain loss of assets or inability to meet liabilities;
Fails to obey an order of the Court;
Received a discharge in a case started 6 years before filing of current Petition.

Basic Discharge Exceptions: Discharge does not absolve the Debtor of debts …

For taxes or customs duties;
For property or credit obtained by fraud;
That are not listed or scheduled;
Arising from breach of fiduciary duty.
For alimony, maintenance or support;
For willful, malicious injury;
Is a government fine;
For educational loans guaranteed by the government or not-for-profit organization;
From a DUI fatality caused by Debtor;
That could have been listed in prior case;
Arising from fraud in a fiduciary capacity;
For failure to pay Federal institution;
Taxes to the United States;
Others: See §523.

In order to contest dischargeability of a particular debt the Creditor must usually file an Adversary
Upon obtaining a discharge, §524 extinguishes the debtor’s personal liability and prevents creditors from all forms of collection efforts (the “Discharge Injunction”).
Violation of the Discharge Injunction by creditors will subject them to contempt of Court damages.

Reaffirmation Agreements

An opportunity for the Debtor to continue payments on an otherwise dischargeable debt.
An opportunity for the Creditor to lock the Debtor into the terms originally agreed to.
§524(c): strict compliance is required including:

(1) Agreement must be made before the Discharge;

(2) Agreement contains clear and conspicuous language advising the Debtor that (a) it may be rescinded any time prior to Discharge or within 60-days after it is filed; and (b) that it is not required by law;

(3) Agreement must be filed with the Court and accompanied by the Affidavit of Attorney representing the Debtor stating that debtor-client was: (a) fully informed; (b) voluntarily entered into the agreement; (3) will not suffer undue hardship

Bankruptcy Appeals

Bankruptcy Courts are part of the Federal Court system.
To appeal a decision one must appeal to Bankruptcy Appellate Panel (BAP) of the Federal Circuit. From there appeals go to the Circuit Court of Appeals.
Basis for appeal is similar to State and Federal appeals: legal error on the part of the Bankruptcy Court.
Appeal is based on lower Court’s record and Appellate Court will not entertain additional evidence or hear witnesses

Fundamentals of Bankruptcy Law and Procedure in Illinois Chapter 13 Issues

“Should I stay or should I go…” Chapter 13 or Chapter 7?

Chapter 7: Debtor’s non-exempt property liquidated to pay debts of the Estate
Orders creditors not to attempt collection of debts in future
Chapter 13: portion of Debtor’s future income is used to pay Estate obligations, as feasible
Broader release of several types of debts not dischargeable in Chapter 7
More expensive for the Debtor
Takes longer

So you’ve decided to file Chapter 13 … now what?

Words of wisdom for the indecisive Debtor:

Income
Dischargeability of debts
Retaining Secured Property
Retaining non-exempt property
Protecting co-signors
Time and Expense

Getting the Monkey off the Debtor’s Back: The Plan and Schedules

Plan
Unless otherwise ordered, Debtor must file Plan in 15 days of filing Petition and commence payments within 30.
Code requires that Plan be completed and paid within 3 years (or 5 years for cause shown)
Schedules
Creditors must be able to anticipate their recovery in the event of a Chapter 7
Debtors must disclose expected earnings allow creditors to determine whether Plan is feasible

Those who fail to Plan … Plan to fail

Determining feasibility of a Plan
Secured Creditors;
Percentage unsecured
Percentage over secured
Arrearage
Assets
Necessity of asset
Amount of equity in non-exempt property
Any co-signors Debtor seeks to protect
Whether payments can be made inside/outside Plan
Costs/fees
Trustee
Attorney
Income
Steady or is it likely to change during life of Plan

Plan Confirmation and other Goals

Plan shall be confirmed according to §1325 if:

Fees and charges are paid;
Plan is proposed in good faith;
Holders of secured claims accept the Plan;
Debtor will be able to comply with the Plan.

Property of the Estate

Chapter 13 Estate consists of:

Interest of the Debtor in property as of commencement
Interest of the Debtor in “community property”
Interests that Trustee recovers on behalf of Estate
Interests in property that would have been property of the Estate if acquired within 180 days
Proceeds from property of the Estate
Interests of the Debtor in property that Estate acquires after commencement of the case

Regular Income/Retaining Property

Regular income
To qualify for Chapter 13 Debtor must have regular income as defined by §101(30)
Employment with sufficient, regular income to make payments under a Plan
Retaining Secured Property
Curing default for automobile or mortgage
Debtor needs to, and can, cure arrearages
Retaining Non-exempt Property
If Debtor has too much property or equity, Chapter 13 is the way to go Protecting Co-signors/Time & Expense
Unlike in Chapter 7, §1301 of the Code provides for co-signor stay that prevents creditors from moving against co-signers as long as the Debtor pays.
Time is Money:
Chapter 13 - longer and more expensive usually lasting 3-5 years with discharge only at the end.
Fees and expenses are also higher

Fundamentals of Bankruptcy Law and Procedure in Illinois The Creditor’s Perspective

The Importance of Pre-Bankruptcy Collection: 90 Days Plus

Bankruptcy Code makes it extremely important to collect more than 90 days prior to the filing of a Petition.
§547(b): payments made within 90-days prior to filing are presumptively preferential and therefore fraudulent.
Both State and Federal law provide that any transfer by an insolvent Debtor on account of an antecedent debt is presumptively fraudulent.
Once Debtor has filed an Automatic Stay goes into effect and the Creditor is virtually powerless.

Creditors’ Meetings: What to Do? What to Avoid?

§341: within a “reasonable period” after the Debtor files (usually 20-40 days), a Meeting of Creditors is held outside the presence of the Judge.
Meeting permits the Trustee to review the Petition and Schedules with the Debtor face-to-face.
Debtor is required to answer questions under oath as to conduct, property, liabilities, financial condition and any matter affecting administration of the Bankruptcy Estate or the right to a discharge.
Creditors may ask questions, but the Trustee will keep them on a short leash, permitting only limited questions bearing on a particular debt, etc.

Rule 2004 Exams: What are They & How to Use Them

In re Samuelson, 174 F. 911 (W.D.N.Y. 1909): Any person who has a provable debt and can show that he is an actual creditor is entitled to an order for examination even though he has not formally proved his claim.
If the Creditor is careful in questioning the Debtor, this is a good opportunity to learn about the Debtor’s banking activities and available funds disbursed, including the Debtor’s knowledge of invalid or NSF checks.

Proofs of Claim: When in Doubt, File

Rule 3001(a): Proof of Claim = a written statement setting forth the Creditor’s claim.
Rule 3002(a): Creditor must file a Proof of Claim for the claim to be allowed (secured, unsecured, disputed, whatever).
While a Secured Creditor under Chapter 7 and 13 is not required to file a Proof of Claim, they should because: Rule 3001(f) makes a Proof of Claim prima facie evidence of the amount and validity of a claim and Rule 3003(4) provides that the Proof of Claim supersedes the sum scheduled by the Debtor.
§726(a)(2): Proof of Claim is a prerequisite to making distributions to Unsecured Creditors in the event money later comes into the Estate.
§506(b): Should the Trustee sell the collateral free and clear of the Creditor’s lien, the Creditor may bid the amount of its claim only if and to the extent that the Proof of Claim has been filed.
§506(b): Creditor should be aggressive in filing its Proof of Claim, seeking the maximum amount for which the Debtor may be liable: including pre-and post-petition Attorneys’ Fees and interest.

Rule 3002(c): Creditor in Chapters 7 or 13 must file not more 90 days after the first date set for Meeting of Creditors unless:

(1) Creditor = a governmental unit; (2) Creditor = infant, incompetent or their representative; (3) Claim arises from a judgment; (4) Claim arises from rejection of an executory contract; (5) Notice of insufficient assets to pay a dividend.

The form for Proof of Claim can be found online at Court Website: http://www.ilnb.uscourts.gov/index.html

Relief from Stay: Tricky but Possible

§362(a): Once a Petition is filed an Automatic Stay goes into effect immediately -- all collection activity must cease until further order of the Court.
Laguna Assoc. Limited Partnership v. Aetna Casualty and Surety Co., 30 F.3d 734, 737 (6th App. Cir. 1994): Automatic Stay gives the honest Debtor the opportunity to protect assets so that resources can be marshaled and distributed equitably.
In other words: seek grounds for relief from the Stay.
§362(d): Court will only grant relief from the Stay if (1) there is cause; or (2) Debtor his no equity in the property and it is not necessary for reorganization.

Laguna Associates: Debtor’s lack of good faith in filing Bankruptcy may be grounds for lifting the Stay. In assessing “good faith” Courts look at a multitude of factors:

Debtor only has one asset;
Debtor’s pre-petition conduct is improper:
Few unsecured creditors;
Property posted for foreclosure and Debtor has been unsuccessful;
Debtor and Creditor in litigation and Debtor required to post bond;
Filing the Petition allows the Debtor to evade Court Orders;
Debtor has no ongoing business or employees;
No possibility of reorganization.

Dismissal of the Case: The Zen Moment

But beware: Chapter 13 is practically fraud proof.
Unsecured Creditors: dismissal levels the playing field.
Secured Creditors are less enthusiastic because they are more likely to be able to modify the Automatic Stay.

Fundamentals of Bankruptcy Law and Procedure in Illinois

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