There are many common words and phrases that are used in bankruptcy cases - terms that aren’t commonly used in our everyday life, but that have specific meaning in bankruptcy cases. Knowing what these words and phrases mean eliminate some of the mystery that a person considering bankruptcy might experience in making a decision as to whether a bankruptcy case is in his/her best interest. Let’s look at some of these words and phrases below:
A chapter 11 bankruptcy is (in most cases) a business reorganization bankruptcy. The theory of chapter 11 is to allow businesses to regain profitability by allowing the business to restructure its debt. Chapter 11 bankruptcy cases, more than other chapters, require creditors to take an active role in making the bankruptcy work. Creditors are given an opportunity to vote on chapter 11 debtor’s reorganization plans, and if an insufficient number of creditors (or an insufficient percentage of debt holders) don’t approve the reorganization plan, the chapter 11 plan is in trouble.
Individuals can also file chapter 11 cases to reorganize their finances, but because of the cost involved, the time and attention needed, and the involvement of creditors, almost all chapter 11 cases filed are filed by businesses. The chapter 11 debtor is in most cases allowed to continue to operate the business - it is uncommon for trustees to be appointed in chapter 11 cases.
There is sometimes confusion caused by the fact the bankruptcy code is found in Title 11 of the United States Code. But don’t be confused - chapter 11 refers to a chapter of the bankruptcy code, not the bankruptcy code itself.
One of the features of bankruptcy law is the ability of a bankruptcy debtor currently in one chapter, to convert her case to a different chapter. For instance, a chapter 13 debtor who is having difficulty making her monthly plan payments can choose to change the bankruptcy case from a chapter 13 case to a chapter 7 case. The requirements for conversion are that the debtor is eligible for a discharge in the chapter to which the case is being converted, and that the conversion is being done in good faith.
Since there are time restrictions with respect to receiving a discharge for an individual with a previous bankruptcy discharge (the longest operative time period is eight years from the date a chapter 7 case was filed with the bankruptcy court to the date a second chapter 7 case is filed; there are time restrictions for all combinations of filing chapter 7 and chapter 13 cases), a bankruptcy debtor seeking to convert a case must be aware of whether a discharge in the desired chapter is available.
Good faith means that the debtor is converting the case for the right reasons, and not simply to avoid the payment of income or liquidation of assets to the trustee in the original chapter. For instance, in most chapter 13 cases, when a chapter 13 debtor receives a large income tax refund, a portion of the refund must be paid over to the chapter 13 trustee, or the debtor runs the risk of having his case dismissed. The chapter 13 debtor who wants to retain 100% of a large refund, who decides to accomplish this by converting his case to a chapter 7 runs the risk of having the chapter 7 trustee seek the dismissal of the case, and the denial of the debtor’s discharge for bad faith.
One reason that an individual should convert a case from a chapter 13 to a chapter 7 is that conversion allows an individual in a chapter 13 to include debt that has been accrued after the chapter 13 case was filed (and thus, not eligible to be included in the chapter 13 discharge) in the chapter 7, and thus receive a discharge of that debt, too.
A preferential payment is a payment or payments, in excess of $600 to one individual creditor, made less than 90 days (if the creditor is an unrelated third party) or one year (if the creditor is a relative or a business partner) before a person files a bankruptcy case. If there has been a preferential payment made prior to a chapter 7 case, the chapter 7 trustee can “avoid” the payment by recovering the amount paid from the person or the company that received the payment.
In Chapter 13 cases, the trustee does not recover the payment from the creditor. Rather, the chapter 13 debtor has to propose a plan that pays unsecured creditors at least as much as they would have received in a chapter 7 case where the preferential payment was recovered.
There are defenses to preferential payment actions - most notably the “regular course of business” defense - where the payment(s) made were consistent with the normal billing and payment practices of the creditor and the debtor, as well as the “new value” defense - where the creditor, after receiving payment extends new credit to the debtor.
A fraudulent transfer is the transfer made less than two years prior to a bankruptcy case being filed by the debtor of money or property to a third party, relative or friend in which the party receiving the transferred property does not give the debtor equivalent value in return. Just as is the case with preferential payments, the chapter 7 trustee can recover the transfer from the party who receives the property. Just as is the case with preferential payments, the chapter 13 trustee cannot recover the transfer, but the chapter 13 plan has to provide for payment to unsecured creditors in an amount at least as much as the value of the transfer.
The two-year fraudulent transfer action has defenses to it, also. Most notable is the defense that the debtor was not insolvent at the time of the transfer and that the transfer was made without intent to deceive or defraud creditors. The fraudulent transfer rule allows trustees to avoid almost all transfers that fall within the two-year time period, so it is important for people thinking about filing bankruptcy to let their attorneys know about any transfers.