It shouldn’t come as a surprise that, compared to prior years, 2009 has seen substantially more Northern Nevada businesses and individuals filing bankruptcy.  According to the United States Bankruptcy Court for the District of Nevada website, 1,770 bankruptcy cases were filed in Northern Nevada during 2007, while a total of 2,602 bankruptcies were filed in 2008.  In comparison, through October, 2009, a total 3,892 cases had been filed, putting Northern Nevada on pace for 4,670 bankruptcy filings for 2009, nearly twice the number filed in 2008 and approaching three times the cases filed in 2007. 
   The increase in bankruptcy filings in Nevada means it is more likely a business may, in one way or another, become involved the bankruptcy process.  With that in mind, it is wise for any business or individual to understand certain fundamentals of bankruptcy.  
       
The Bankruptcy Chapters
   The three primary forms of bankruptcy cases, commonly known as the bankruptcy chapters, are Chapter 7 (liquidation), Chapter 11 (business reorganization), and Chapter 13 (wage-earner reorganization). Chapter 7 of the Bankruptcy Code is available to both individual and business debtors, with the purpose of achieving a fair liquidation and distribution of the debtor’s non-exempt property to creditors.  A Chapter 7 trustee is appointed to collect, liquidate and distribute the debtor’s assets to creditors.  With some exceptions, unsecured debts are completely discharged, providing the debtor a fresh financial start.
   Chapter 11 of the Bankruptcy Code is also available for both business and consumer debtors.  A Chapter 11 debtor is a debtor-in-possession, which means no trustee is appointed and the debtor controls its assets during the case.  The purpose of Chapter 11 is to rehabilitate and reorganize a debtor’s finances through a court-approved reorganization plan, which creditors have the opportunity to vote on and approve. 
   Chapter 13, known as the wage-earner’s reorganization, is only available for individuals with regular income.  Similar to a Chapter 11 case, a Chapter 13 also involves a plan for the reorganization of the individual’s debt.  The Chapter 13 plan is used to budget the debtor's future earnings and to commit a portion of the debtor’s income to the repayment of creditors, in whole or in part, over a period of time.

The Bankruptcy Players
   Bankruptcy involves four types of key players: (1) the Court; (2) the debtor; (3) the creditors; and (4) the trustee or trustees. 
   Bankruptcy is a matter of Federal Law and is played out in the Federal Court System.  Bankruptcy Court’s are a sub-set of the United States District Courts.  Bankruptcy judges are specialized federal judges handing only bankruptcy cases and closely related matters.
   The debtor is the person or entity filing a bankruptcy case, while the creditors are those that are owed money from the debtor. 
   There are two types of trustees that are involved in bankruptcy cases.  First, there are chapter trustees, such as a Chapter 7 trustee or a Chapter 13.  A chapter 7 trustee steps into the shoes of the debtor and takes control of a debtor’s non-exempt assets and takes responsibility for the debtor’s debts.  In a Chapter 11 or 13, the debtor remains in possession and control of its assets, while a Chapter 13 trustee acts as an intermediary between debtor and creditors, while also looking out for the interest of unsecured creditors.
   The second trustee involved in bankruptcy cases is the Office of the United States Trustee, a division of the United States Department of Justice.  The U.S. Trustee operates as a watchdog over the bankruptcy system.  As part of its duties, the U.S. Trustee identifies potential bankruptcy fraud and refers such matters to the Federal Bureau of Investigation and United States Attorney’s Office for further investigation and prosecution.

The Bankruptcy Automatic Stay
   Immediately upon the filing of a bankruptcy petition, the debtor gains the protection of the automatic stay, which halts virtually all actions against the debtor and property of the bankruptcy estate.  The automatic stay stops all collection efforts, including phone calls, lawsuits, repossessions, foreclosures and garnishments.  Under certain circumstances, the automatic stay may be lifted by the bankruptcy court.  However, absent a court order lifting the stay, the automatic stay is strictly enforced and a violation of the stay may result in sanctions against the violating party, including punitive damages. 
   Beyond providing a debtor breathing space, the automatic stay also benefits creditors by playing an important role in maintaining the status quo after the bankruptcy has been filed.  This is important to ensure creditors claims are treated orderly and equitably.

The Powers Of The U.S. Bankruptcy Code

   While many think of bankruptcy as a mechanism to discharge debt, much of the Bankruptcy Code is focused on modifying, restructuring or terminating various aspects of financial relationships.  For example, under certain circumstances, the Bankruptcy Code empowers debtors to modify secured debt, terminate leases and contracts, sell assets over the objection of lien holders and pursue claims.
   The powers to modify secured debt are some of the most substantial and unique powers of the Code.  While there are various limitations to modifying secured debt, a bankruptcy court has the power to: (1) reduce secured debt down to the value of collateral, often called a cram down; (2) strip second or third liens off collateral and reclassify the debt as general unsecured debt; (3) reduce interest rates; (4) extend or reduce the term of repayment; and (5) provide for the cure of defaults and the repayment of arrears. 

Bankruptcy’s Priority Scheme
   The Bankruptcy Code establishes a priority scheme for repayment of creditors.  Generally speaking, administrative claims (including professional claims and actual, necessary costs and expenses of administering and preserving the estate) and secured claims (to the extent there is security) share the highest priority.  Second priority generally falls to secured creditors, followed by priority unsecured claims, such as taxes.  General unsecured claims, such as credit cards, unsecured lines of credit, trade debt and medical bills hold lowest priority.
   While a general understanding of the bankruptcy process is certainly beneficial, bankruptcy is a highly specialized area of the law.  Bankruptcy can be full of pitfalls for the unwary, particularly those who engage the process without the advice and guidance of qualified legal counsel. 

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(Tricia M. Darby, Esq. is the managing attorney at Darby Law Practice, Ltd., a financial solutions law firm focusing on representing small businesses and individuals in bankruptcy, out-of-court debt workouts and general business and corporate matters.  Prior to joining her husband and law partner, Kevin A. Darby, Esq., at Darby Law Practice in the Spring of 2009, Tricia spent eight years representing banks and other large institutional lenders in a variety of legal matters. Tricia now puts her knowledge and experience as a bank attorney to work for small businesses and individuals.  Tricia can be reached at 775.322.1237 or tricia@darbylawpractice.com)