Articles Posted in Chapter 11

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Vladimir Makovsky [Public domain], via Wikimedia CommonsThe Bankruptcy Code provides individuals and families with several options when they need to file a bankruptcy petition, and it allows them to convert a case from one chapter to another in certain circumstances. A federal appellate panel in California recently considered an interesting question:  if a debtor converts a case from Chapter 11 or 13 to Chapter 7, what happens to income earned after the petition but before conversion? It would belong to the bankruptcy estate under Chapters 11 or 13, but to the debtor under Chapter 7. The court ruled that it reverts to the debtor once the case is converted from Chapter 11 back to Chapter 7. In re Markosian, 506 B.R. 273 (B.A.P. 9th Cir. 2014) (PDF file).

By filing a bankruptcy petition, a debtor creates a legally distinct “bankruptcy estate.” A court-appointed trustee has the right to make certain decisions about estate property and the duty to manage the estate responsibly. In general, any property that a debtor owns when he or she files a bankruptcy petition becomes part of the estate. 11 U.S.C. § 541. In Chapter 11 or 13 cases, property acquired and earnings received for services rendered by the debtor, including salary or wages, also become part of the bankruptcy estate until the case is dismissed, converted, or closed. 11 U.S.C. §§ 1115, 1306.

The debtors in Markosian, a married couple, filed a Chapter 7 bankruptcy petition in February 2009. The trustee moved to dismiss the case for abuse under 11 U.S.C. § 707(b), claiming that the debtors had enough income to pay their debts. In response, the debtors converted the case to Chapter 11. While Chapter 13 is much more common among individuals and families, the Bankruptcy Code sets upper limits on the amount of debt a Chapter 13 debtor can have. Currently, Chapter 13 is not available to debtors whose secured and unsecured debts exceed $1,149,525 and $383,175, respectively. 11 U.S.C. § 109(e), “Revision of Certain Dollar Amounts in the Bankruptcy Code Prescribed Under Section 104(a) of the Code”, 78 F.R. 12089 (Feb. 20, 2013). Continue reading

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Tyler [CC BY-SA 2.0 (], via FlickrA bankruptcy judge recently denied a debtor’s request to convert his case from Chapter 11 to Chapter 7, finding that he had not acted in accordance with his fiduciary duties throughout the case. Most individual debtors do not find Chapter 11 to be helpful. It is much more common for business bankruptcies and individuals with very large estates. In this case, the debtor is a professional hockey player. In re Johnson, No. 2:14-bk-57104, petition (S.D. Oh., Oct. 7, 2014). When he moved for conversion to Chapter 7, the court reviewed the course of the case and issued a 150-page order denying the motion and criticizing the debtor’s conduct. Johnson, op. and order (Feb. 26, 2016). The judge’s reasoning offers an idea of the concerns that courts address in Chapter 7 cases.

A key difference between the Johnson case and a Chapter 7 or Chapter 13 case is that the bankruptcy estate had no independent trustee. The debtor was acting as trustee when he moved for conversion to Chapter 7. In Chapter 11 cases, a trustee is only appointed if requested by a party in interest or the U.S. Trustee’s Office. 11 U.S.C. § 1104. If no trustee is appointed, the debtor serves in the capacity of trustee, with all the same fiduciary duties towards creditors and others. Under Chapters 7 and 13, the Bankruptcy Code states unconditionally that a trustee “shall” be appointed. 11 U.S.C. §§ 701, 1302.

Debtors are typically allowed to convert their case from one chapter to another if they meet various criteria established in the Bankruptcy Code. A Chapter 11 debtor can convert their case to Chapter 7, with several exceptions. A bankruptcy court may not convert a case to Chapter 7 if it finds that appointment of a Chapter 11 trustee would be in the estate’s and the creditors’ best interest, or if it “identifies unusual circumstances” indicating that conversion would not be in their best interest. 11 U.S.C. § 1112(b). A Chapter 7 debtor can convert their case to Chapter 11 or Chapter 13 with the court’s permission, after establishing cause. 11 U.S.C. § 707. A Chapter 13 debtor is far less constrained in converting a case to Chapter 7. 11 U.S.C. § 1307.
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By tinyfroglet (originally posted to Flickr as Roadrunner) [CC-BY-2.0 (], via Wikimedia CommonsDesert Hot Springs, a small resort town of about 26,000 people in Riverside County, California, is reportedly considering filing for bankruptcy protection. Two other California cities, Stockton and San Bernardino, have filed for bankruptcy since 2012. The most well-known current municipal bankruptcy is that of Detroit, Michigan, the largest American city to seek protection under Chapter 9 of the U.S. Bankruptcy Code. A municipal bankruptcy shares some similarities with Chapter 13 personal bankruptcy cases, but it is more like a corporate bankruptcy filed under Chapter 11. Both types involve a reorganization of debt payments, but some debts that are nondischargeable for an individual might be more flexible for a city government. A key issue emerging in many current municipal bankruptcies involves payments owed to pension funds, which could affect thousands of individuals and play a role in personal bankruptcy filings.

The state of California is reportedly doing well, with an estimated $2.4 billion budget surplus for the upcoming fiscal year. Some California cities are not doing as well. A new finance director in Desert Hot Springs found that the city’s $13.5 million budget is short by $3 million. She placed the blame on “higher-than-expected pension and salary costs.” The city is also still paying bond debt incurred to get out of a 2001 Chapter 9 bankruptcy filing. Nearly seventy percent of the city’s budget, Reuters reported, went toward salaries and payments to the California Public Employees’ Retirement System (Calpers). Pension payments to Calpers have been a prominent issue in California’s other two recent municipal bankruptcies.

Pension plans are generally part of an agreement a city makes with its employees, similar to retirement plans for employees of private businesses. The closest analogy in a personal bankruptcy, in terms of legally-required payments and aside from any other duty to support children and other dependents, might be child support, spousal maintenance, or alimony. Bankruptcy law expressly prohibits the discharge of domestic support obligations, 11 U.S.C. § 523(a)(5), but both governments and corporations have considerable leeway to modify their obligations to their employees, including payments to pension funds. A California federal district court, for example, gave the City of Vallejo the ability to reject collective bargaining agreements with its own employees in a Chapter 9 case. In re City of Vallejo, 403 B.R. 72 (Bankr. E.D. Cal. 2009), affirmed 432 B.R. 262 (E.D. Cal. 2010). Continue reading

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Backstreet_Boys_Concert_2The trustee has filed a proposed Chapter 11 bankruptcy plan in the case of Lou Pearlman, a music mogul currently serving a prison sentence for various fraud offenses. In re Pearlman, No. 6:07-bk-00761, Chapter 11 trustee’s plan (Bankr. M.D. Fla., Jun. 12, 2013). Investors and creditors, whose allowed claims exceed a quarter of a billion dollars, have already voiced objections to the plan. One of the musical groups Pearlman created, the Backstreet Boys, says that the plan does not adequately compensate them for losses they suffered due to alleged criminal activities by Pearlman. The trustee has stated that Pearlman often mixed his fraudulent activities with his other business affairs, making the bankruptcy estate particularly difficult to manage.

Pearlman is primarily known as the creator of “boy bands” like the Backstreet Boys in the 1990s He also created the group N’Sync and several others. His legal troubles began in 2007, when state officials in Florida seized two businesses that he operated under the name “TransContinental” in Orlando. They alleged that the companies existed only on paper, and that Pearlman was operating a Ponzi scheme to cheat investors by selling stock in those companies. The scheme included a fake accounting firm that generated fake financial statements to show to investors, and ultimately cost investors, over $300 million. He fled the country in January 2007, and was arrested in Bali, Indonesia that June. He pleaded guilty to charges including conspiracy and money laundering in March 2009, and is currently serving a twenty-five-year prison sentence. Continue reading

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RonaldreaganstatebuildingIn certain circumstances, creditors may file a bankruptcy petition against a debtor, essentially forcing the debtor into a repayment plan. This process, known as involuntary bankruptcy, is mostly used against businesses with substantial debts and sufficient assets to pay those debts. Involuntary bankruptcy proceedings against individuals are very rare. For most consumers, an involuntary bankruptcy would put creditors in a worse position, because they would be unable to attempt direct collection from the debtor. A recent Ninth Circuit case reviewed an involuntary bankruptcy claim brought by several individuals against another individual, addressing the question of what sort of claims meet the statutory requirements for an involuntary case. In re Marciano, No. 11-60070, slip op. (9th Cir., Feb. 27, 2013).

The case originated with a lawsuit filed by the debtor, Georges Marciano, against five employees for alleged theft. Three of those employees filed cross-complaints, which resulted in judgments in the three employees’ favor totalling $105.3 million. Marciano appealed the judgments in state court, but did not post a bond to stay enforcement. Marciano, slip op. at 4. During the pendency of the appeal, the three employees, identified in the Ninth Circuit’s opinion as the “Petitioning Creditors,” id., filed an involuntary bankruptcy petition under 11 U.S.C. § 303(b)(1) in the Central District of California. Continue reading

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2businessbayIn a bankruptcy proceeding, a trustee may avoid transfers made, or obligations incurred, by the debtor during the two years prior to the filing date, if the transfer or obligation was actually or constructively fraudulent. 11 U.S.C. § 548(a). The Ninth Circuit recently considered whether a transfer made to pay a purported debt was constructively fraudulent, finding that the Bankruptcy Code requires courts to apply state law. In re Fitness Holdings International, Inc., No. 11-56677, slip op. (9th Cir., Apr. 30, 2013). The court articulated a procedure for evaluating a purported debt, and it held that courts have the authority to recharacterize a debt under certain circumstances.

The debtor, Fitness Holdings International (FHI), signed multiple promissory notes to its sole shareholder, Hancock Park (HP), in exchange for over $24 million in funding from 2003 to 2006. The company also received about $12 million in loans from Pacific Western Bank (PWB) in 2004, secured by FHI’s assets and guaranteed by HP. In June 2007, FHI refinanced its loans with PWB, which included favorable repayment terms and a release of HP from its guarantee. From the funds received in the refinance, FHI made a $12 million payment to HP to pay off its unsecured promissory notes. Despite these efforts, FHI filed for Chapter 11 bankruptcy in October 2008. Continue reading

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797px-Trump_Taj_Mahal_and_Chairman_TowerAmong famous and wealthy businesspeople in the United States, Donald Trump stands out for having had particularly great influence on American culture. With a series of real estate ventures, several television series, numerous books, and no small amount of public controversy, Trump is often considered a major success story. He has also sought bankruptcy protection for his businesses four times. While his experience with bankruptcy is far from typical for most Americans, it offers some examples of how others may be able to protect their interests through a bankruptcy filing.

Corporate, Not Personal, Chapter 11

The key to understanding Trump’s bankruptcy experience is that he filed for Chapter 11 bankruptcy protection for his business interests. While he had considerable personal debt tied up in his first bankruptcy, he was generally able to protect his personal assets by keeping them separate from his business activities. Chapter 11 bankruptcy allows an individual or business to reorganize debts. It is most commonly used by corporations seeking to restructure debts without going out of business, as they might have to do in a Chapter 7 liquidation if their business has significant assets beyond that which the law allows one to protect and keep in a Chapter 7. Trump has stated that he prefers not to use the word “bankruptcy,” describing his Chapter 11 filings as prudent business decisions. Continue reading