Bankruptcy: An Option of Last Resort lLegal

The prolonged recession continues to push people into bankruptcy at an alarming rate. Bankruptcy filings in the United States increased 13.8 percent to 1,596,355 in fiscal year 2010, according to the Administrative Office of U.S. Courts, which compiles statistics from October 1 to September 30.

While business bankruptcy filings actually decreased 0.7 percent to 58,322, non-business filings increased 14.4 percent to 1,538,033, the highest number of non-business filings since 2005.

The Middle District of Florida fared worse than the national average, with total filings increasing more than 15 percent to 66,881 in fiscal year 2010. The Florida Middle District (which covers Jacksonville, Orlando, Tampa, Ft. Myers and Naples) was second only to the Central Division of California, which had an astonishing 42 percent increase in filings in fiscal year 2010!

While bankruptcy can be an important economic tool to help struggling businesses and individuals, it is often misunderstood. Bankruptcy should be a planned, thought-out strategy used as an option of last resort.

Bankruptcy is broken into nine chapters, all odd-numbered except Chapter 12. Chapters 1, 3 and 5 are administrative in nature. Chapters 7 through 15 describe the different forms of relief available: Chapter 7 (Liquidation), Chapter 9 (Municipalities), Chapter 11 (Reorganization), Chapter 12 (Family Farmers), Chapter 13 (Individual Reorganization) and Chapter 15 (Cross-Border Insolvency). The three most commonly used Chapters are 7, 13 and 11.

Under Chapter 7, the debtor can discharge all debt, with some exceptions, but may sacrifice non-exempt assets and secured assets which are delinquent in payments. Any person or entity is eligible to file Chapter 7, except a railroad, insurance company, bank or homestead association.

Chapter 13 allows the debtor to (1) retain secured assets even if the secured debt is behind in payments, (2) change payment terms on some secured debts, (3) turn some secured debt into unsecured debt, (4) pay delinquent taxes, and (5) pay unsecured creditors a percentage of what is owed them. Individuals who file Chapter 13 must have regular income with less than $336,900 of unsecured debt and less than $1,010,650 of secured debt.

Since businesses cannot file under Chapter 13, Chapter 11 is used to reorganize business entities.

States are allowed to opt out of the federal exemptions provided by the Code. Florida is an opt-out state and provides specific exemptions to be used by debtors who file in Florida. It is significant to note that corporations and limited liability companies are not entitled to exemptions under the Code. Knowledge of allowed exemptions also is important because any non-exempt assets are property of the bankruptcy estate and may be liquidated for distribution to creditors.

The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) added the “means test,” which was intended to make it more difficult for some consumers to file bankruptcy under Chapter 7. Under the means test, the debtor’s current monthly income (CMI) is reduced by allowable expenses. If the debtor’s CMI is below the median IRS income, then the debtor will have a presumption that the case was filed in good faith. If, however, the CMI is above the median IRS income, then the debtor will have a presumption that the case was filed in bad faith – meaning the Chapter 7 will be disallowed and the debtor will have to file Chapter 13.

CMI is defined as the monthly average of the debtor’s income over the previous six months as determined by the debtor’s income, non-separated spousal income, and any regular third party contributions to the household (for example, from a roommate). CMI excludes social security payments and victim’s compensation payments.

Under a strict reading of the Code, the debtor’s future income is irrelevant to the means test calculation. However, the trustee and creditors may also bring a motion to dismiss or a motion to convert the case if the debtor’s future potential income will allow monthly disposable income to be paid to creditors under a “totality of the circumstances” approach to the filing. Additionally, the means test applies only to individuals whose debts are primarily consumer debts. Individuals who have primarily non-consumer or business debts (such as investment properties or deficiencies under corporate guarantees) may qualify for Chapter 7 without consideration of the means test.

Under Chapter 11, the debtor automatically becomes a “debtor in possession” and generally operates the business and performs many of the functions that a trustee performs in cases under other chapters. For businesses, the reorganization plan must include a classification of claims and must specify how those claims will be treated. Creditors whose claims are affected vote on the plan by ballot. After the ballots are collected and tallied, the court will conduct a confirmation hearing to determine whether to confirm (approve) the plan.

Creditors’ committees play a major role in Chapter 11 cases. The committee is appointed by the U.S. trustee and consists of unsecured creditors who hold the seven largest unsecured claims against the debtor. The committee can be a great ally in the reorganization of the business, as well as an important safeguard to the proper management of the business by the debtor in possession.

The two biggest advantages of bankruptcy are the automatic stay and the discharge. The automatic stay immediately stops the commencement, continuation or enforcement of any debt collection activities against the debtor. Most lawsuits are halted by the automatic stay except criminal, paternity, and alimony actions.

The discharge, for all practical purposes, means the debt is “wiped out.”

When used correctly, bankruptcy is a fantastic tool to help struggling individuals or companies get back on their feet. Or it can be a great tool to help business owners or individuals with an orderly wind-down of their operation and personal affairs.

Companies That Have Filed for Chapter 11 Protection Within the Last 10 Years:
Enron (December 2001)
US Airways (August 2002 & September 2004)
Trump Entertainment Resorts (November 2004 & February 2009)
Delta Airlines (September 2005)
Northwest Airlines (September 2005)
IndyMac Bancorp Inc. (July 2008)
Lehman Brothers (September 2008)
Washington Mutual (September 2008)
Chrysler (April 2009)

Individuals Who Have Filed for Bankruptcy:
Phineas Taylor Barnum
Mark Twain aka Samuel Langhorne Clemens
Henry John Heinz
Oscar Wilde
Milton Snavely Hershey
Henry Ford
Mickey Rooney
Johnny Unitas
Jerry Lee Lewis
Burt Reynolds
Wayne Newton
Kim Basinger
MC Hammer a/k/a Stanley Burrell
Walt Disney
Larry King
Donald Trump
Mike Tyson
Jose Conseco

This article is for general educational purposes only and does not constitute legal advice.

About the Author
Shawn M. Yesner is founder of the Yesner & Boss law firm. He represents clients in residential and commercial foreclosures, bankruptcies, residential and commercial closings, debt collection negotiation, and general corporate matters. Find us on the web at www.yesnerboss.com.