As discussed in a previous post, on Friday, the Small Business Reorganization Act was signed into law and will take effect in 180 days. The new law, which FactorLaw will further summarize in future blog posts, adds a new subchapter to the Bankruptcy Code that is designed to make the process less expensive and more feasible for small businesses (defined as persons engaged in a commercial or business activity with aggregate and noncontingent debts of less than $2,725,625). The American Bankruptcy Institute indicates that some have estimated that about half the chapter 11 cases filed today could qualify for treatment under this new law.
Stay tuned as we continue to monitor these changes.
If you would like to speak to one of our experienced attorneys regarding your business, please call (312) 878-6976 or fill out a contact form here.
Members of ABI’s Commission on Consumer Bankruptcy discuss the recommendations in the Final Report focused on the Code’s credit counseling and financial management course requirements, and asks the question: do the new provisions make a financial clean-slate more challenging for debtors?
The round-table discussion podcast features FactorLaw’s Consumer Bankruptcy expert Ariane Holtschlag, and can be accessed below, or you can click here to go to the ABI article directly.
In addition, click here to download a copy of the Final Report of the ABI Commission on Consumer Bankruptcy.
Every now and then, a debtor will appear in bankruptcy court on a case that is set to be dismissed. The nervous debtor will stand at the podium, and the judge will ask the debtor why he or she has not filed certain required papers within the time prescribed by the Bankruptcy Code. The debtor will likely appear flustered, “I don’t know, Judge.” The judge will ask some more questions, and the debtor will often reveal that he or she does not have an attorney, but rather has paid a non-attorney bankruptcy petition preparer (BPP) a non-trivial sum of money to help them file for bankruptcy.
Unfortunately, in many of these cases, the judge will have no choice but to dismiss the debtor’s case because various statutory requirements have not been satisfied. The debtor will inevitably be very disappointed, as he or she will not receive a discharge of their debts or a refund of their filing fee.
Needing to file for bankruptcy can be an overwhelming experience. Hiring a BPP instead of a bankruptcy lawyer in order to save money may seem like a good idea. While it is not illegal to hire a BPP, it is not always wise. Section 110 of the Bankruptcy Code explicitly allows for debtors to hire non-attorney BPPs to type their petition and schedules. 11 U.S.C. § 110. There are some very specific limitations and disclosure requirements for BPPs. 11 U.S.C. § 110(b)-(h).
For example, BPPs “may not offer a potential debtor legal advice” 11 U.S.C. § 110(e)(2), they may not use the word “legal” or similar terms in their advertisements, 11 U.S.C. § 110(f), and they are required to fill out Official Form 119 every time they help prepare documents that are filed in a case. 11 U.S.C. § 110(b)(2). Some bankruptcy courts have imposed even stricter regulations for BPPs. For example, in the Eastern District of Michigan, a BPP may charge no more than $100 for their services. Bankr. E.D. Mich. Admin. Order 10-21.
If a BPP does not comply with all the requirements of Section 110 of the Bankruptcy Code, he or she may face some very steep penalties. A debtor, trustee, or U.S. Trustee may file a motion against the BPP pursuant to Sections 110(i) or 110(l) of the Bankruptcy Code. The penalties awarded under this statute may include a refund of the fee the debtor paid to the BPP and the greater of $2,000 or twice the amount of the BPP’s fee. 11 U.S.C. § 110(i). Additionally, a BPP may be required to pay up to $1500 in fines to the U.S. Trustee for each violation of Section 110 of the Bankruptcy Code if certain conditions are met. 11 U.S.C. § 110(l). The court may also enjoin (or forbid) the offending BPP from providing their services to other debtors. 11 U.S.C. § 110(j). Some BPPs have even ended up in jail for providing “services” in violation of Section 110 (see links here, here and here).
While it is good that debtors who have been ripped off by unscrupulous or incompetent BPPs have some recourse, the relief offered by Section 110 of the Bankruptcy Code does nothing to help these debtors get any closer to receiving a discharge of their debts.
Overall, if you are considering filing for bankruptcy, please consider hiring an experienced bankruptcy attorney who be able to competently represent you. If you cannot afford an attorney, contact the clerk’s office at your local court to see if they can refer you to a legal aid clinic. In the Chicago area, the Bankruptcy Assistance Desk or a legal aid organization such as Chicago Volunteer Legal Services may be able to help you.
If you have been a
victim of a BPP, reach out to your local U.S. Trustee’s office for assistance.
By cooperating with the U.S. Trustee, you may be able to recover your losses and you might be able to help prevent that BPP from harming another person like you.
I. Explanation of absolute priority rule
Consumer debtors that do not qualify for protection under Chapter 7 or Chapter 13 of the Bankruptcy Code, are left with filing under Chapter 11, where they will come face-to-face with the absolute priority rule (the “APR”). The APR is a cornerstone of bankruptcy law. It was first developed by the Supreme Court in the late nineteenth-century to deal with widespread collusion in railroad reorganizations. To prevent unfair deals between senior creditors and equity holders, the Court held that “stockholders are not entitled to any share of the capital stock nor to any dividend of the profits until all the debts of the corporation are paid.”
Simply stated, the APR establishes a hierarchy of rights in bankruptcy proceedings, commencing with secured creditors at the top of the heap and ending with equity holders (or the debtor when the case involves an individual) at the bottom. This rule recognizes that equity holders, or debtors, have less rights and entitlement to recovery of a bankrupt enterprise’s assets because they stood to reap the most if the entity succeeded. It also recognizes that equity-holders generally control the allocation of value and absent limitations, they would unfairly allocate a disproportionate share to themselves. “This rule assured those who did business with the corporation that if the business were dissolved the creditors would be paid before the insiders would recover their investments. In case of collapse, the creditors could count on payment in full before equity collected anything from the business assets.”
Individuals debtors may find problematic their efforts to satisfy the APR because a Chapter 11 plan cannot be confirmed over the objection of a dissenting class of creditors if value is being allocated to the debtor, unless secured creditors and unsecured creditors are paid in full (see below discussion on the requirements for full payment), or the Plan meets the stringent “new value” test. On a practical level, an individual debtor cannot retain any property in a Chapter 11, unless all senior creditors are paid in full, including over an extended time period; all impaired classes accept the plan; or the debtor contributes what is known as “new value” in exchange for retaining its equity interests. 
II. How the rule applies in chapter 11
The APR evolved beyond a judicially created doctrine when Congress codified it as part of the Bankruptcy Code in 1978. To confirm a Chapter 11 plan, all impaired classes must accept the plan. However, a court may still confirm the plan (i.e., through a “cramdown”) if an impaired class rejects it, but only if the plan is otherwise “fair and equitable” within the meaning of the Bankruptcy Code, or, in some cases, the debtor contributes “new value” in accordance with that exception to the APR, and satisfies certain other criteria enumerated in §§1129(a)(1) through (a)(14).
To be fair and equitable, a plan must provide property of a value, as of the effective date of the plan, equal to the allowed amount of a creditor’s claim or it must satisfy the APR. A plan can satisfy the APR if value is allocated in accordance with the APR – e.g., if unsecured creditors are not paid in full, the debtor receives no property.
Full payment to senior classes does not necessarily require a single payment of the full amount owed and does not have to be immediate or in accordance with existing debt instruments (except for loans on an individual’s principal residence, which cannot be modified), so long as the payment stream is accompanied with an appropriate interest rate and is otherwise “fair and equitable.” Thus, the deferred cash payments can be structured in many ways, so long as the restructured terms are “fair and equitable” in the view of the Court.
This makes the cramdown of a Chapter 11 plan difficult for individual debtors that have a lot of debt and limited means to repay that debt.
III. After BAPCPA a minority of lower courts have held that the APR no longer applies in individual chapter 11 cases.
In 1988, the Supreme Court unanimously held the APR applied in individual Chapter 11 cases. However, the Bankruptcy Abuse Prevention and Consumer Protection Act (“BAPCPA”) that was enacted in 2005, led some courts to question whether the APR was still applicable in individual Chapter 11 cases.
BAPCPA modified §1129(b)(2)(B)(ii) and added §1115. The interaction between these two provisions has generated some decisions holding that the APR no longer applies when the debtor is an individual, although the majority view, which is followed by five Circuit Courts, holds otherwise – i.e., the APR still applies and was not abrogated by BAPCPA.
Section 1129(b)(2)(B)(ii) provides that, “in a case in which the debtor is an individual, the debtor may retain property inclu…