Chapter 11 for Individuals: Three Key Differences from Business Reorganizations

Chapter 11 is primarily a vehicle for businesses to reorganize, but can also be utilized by individuals.

Brandon P. Johansson

Chapter 11 is primarily a vehicle for businesses to reorganize, but can also be utilized by individuals.

Tracy M. O’Steen

Chapter 11 is primarily a vehicle for businesses to reorganize, but can also be utilized by individuals (i) who have debts that exceed the limits for “wage earner” repayment plans under Chapter 13; and/or (ii) earn too much to be eligible for a Chapter 7 liquidation. For example, Chapter 13 is only available to debtors with less than $383,175 in unsecured debt (debts that are not secured by property, such as credit card debt and medical bills) and less than $1,149,525 in secured debt (debts in which a creditor can take the property securing the debt if it is not paid). On the other hand, Chapter 7 filers in Nevada must not exceed the median income level set for this state. [1]  Creditors who have experienced Chapter 11 in a business setting should be aware that the process in individual cases differs in at least three ways.

The goal of any Chapter 11 case is for the debtor to obtain a discharge of pre-petition debts.  In a business case, that occurs when a bankruptcy court “confirms” a plan of reorganization that provides for payments to creditors.  In an individual case, that happens when a debtor completes all required plan payments. Subject to certain exceptions, the duration of the plan in a business case will be based on the time necessary to pay creditors in accordance with the plan terms and could vary in duration and amount.  An individual, however, is simply required to commit his projected “disposable income” for a period of five years. Disposable income is typically determined by looking at the debtor’s current monthly income less his “reasonable” expenses.  If and when an individual completes five years’ worth of payments, he receives a discharge.   An individual can shorten this period by providing for payment in full to all creditors before the expiration of the five-year term.  Upon completion of the proposed payments, the debtor will receive a discharge and the case will be closed thus foreclosing a creditor’s opportunity to move to modify the plan in the event an individual debtor’s income starts to rise. Creditors in individual cases should review budgets carefully and consider filing an objection with the bankruptcy court where expenses appear overstated.

A second difference between individual and business reorganizations involves the “absolute priority rule.”[2]   In the typical business reorganization, the “absolute priority rule” prevents shareholders from retaining their equity in the company without first paying unsecured creditors in full.   However, there are conflicting court decisions as to whether the “absolute priority rule” should apply in Individual Chapter 11 cases.  The most recent cases decided in Nevada have held that the “absolute priority rule” should not apply in the Individual Chapter 11 case, but other circuits have reached the opposite conclusion, such as the Fifth Circuit Court of Appeals in May of this year. Creditors should thus be especially vigilant in an individual case since the absolute priority rule may not apply and ensure full payment.

Finally, in community property states such as Nevada, all marital property, including post-petition marital property, becomes property of the estate even if the debtor’s spouse does not jointly file bankruptcy.  Therefore, when the debtor receives a discharge, the discharge prevents any creditor from attaching community property in which the non-debtor spouse has an interest.  Thus, a non-debtor spouse is protected by a “Community Property Discharge Injunction.”[3]   A creditor’s only recourse against the non-debtor spouse would be to execute on the non-debtor spouse’s separate property.

In conclusion, haste does not necessarily make waste when it comes to the Individual Chapter case. The most successful debtors seem to be proactive verses reactive, not even entering a Chapter 11 proceeding until an exit strategy is formulated. Conversely, creditors who delay and fail to become involved in the reorganization process early on may have their rights negatively affected.

About the Authors

Tracy M. O’Steen is an Of Counsel attorney with Armstrong Teasdale. She has experience with bankruptcy matters, distressed loans, commercial loan transactions, receiverships and other related commercial litigation. Brandon P. Johansson is an Associate with Armstrong Teasdale. He has experience in areas of commercial litigation, creditor’s rights and insolvency, receiverships and real estate law. Both authors are members of Armstrong Teasdale’s Financial and Real Estate Services practice group and are based in Las Vegas, Nevada. They may be reached at www.armstrongteasdale.com or 702.678.5070.

[1] Section 707(b)(2) of the Bankruptcy Code applies a “means test” to determine whether an individual debtor’s chapter 7 filing is presumed to be an abuse of the Bankruptcy Code requiring dismissal or conversion of the case (generally to chapter 13). Nevada bankruptcy filers must compare their income to the median income for a household of the same size in Nevada. If the income is below the Nevada median, then the individual is presumed eligible to file under Chapter 7. For Nevada, the state median income is $44,924 for the individual earner, $55,674 for families of two or three people, and $66,562 for families of four. For cases filed after April 1, 2013, add $8,100 for each person in excess of four.
[2] See 11 U.S.C. §1129(b)(2)(B)(ii).
[3] See 11 U.S.C. § 524(a)(3).

Armstrong Teasdale, www.armstrongteasdale.com