Bankruptcy Law for Accountants

By Hanson, Randall K.; Smith, James K. | The National Public Accountant, February-March 2003 | Go to article overview

Bankruptcy Law for Accountants


Hanson, Randall K., Smith, James K., The National Public Accountant


Bankruptcy filings are once again increasing at an alarming pace: 1.5 million bankruptcy filings are expected this year and an estimated $40 billion in debt is expected to be discharged by financially troubled debtors. With the alarming number of filings, it is clear that accountants need to be keenly aware of bankruptcy law. While no accountant needs to be a bankruptcy expert, it is important to be current on developments in this area of the law so that a referral can be made when necessary. Clients may be considering bankruptcy protection, or customers of clients may well be seeking bankruptcy relief.

New bankruptcy legislation has been seriously considered for more than five years, and the credit card and banking industries have aggressively lobbied for reform throughout this time frame. A reform package was nearly in place when the terrorist attacks occurred and halted the legislation. With the passage of time, bankruptcy reform has returned to the forefront.

A bill appeared imminent during the summer of 2002, but right before the summer recess, the bill was pulled from consideration because of a dispute over whether or not certain judgments involving antiabortion protest activities at abortion clinics would be dischargeable in bankruptcy. This political issue polarized the legislative body, precluding the passage of the reform package. Bankruptcy reform is not dead--it is just being delayed once again.

Even with the legislation setback, the hazy picture of bankruptcy reform is becoming much clearer. Several issues still need to be resolved, but the Senate and the House have basically reached an agreement on what the Bankruptcy Reform Legislation will look like. President Bush has frequently indicated that he would sign reform legislation when presented to him.

OVERVIEW OF THE PRESENT BANKRUPTCY SYSTEM

There are three primary chapters of bankruptcy law: Chapters 7, 11 and 13. Chapter 7 provides for a discharge of debts and a fresh start for debtors who feel they cannot turn around their financial situation. Chapter it provides for a business reorganization, to allow business debtors in financial trouble to develop a viable plan for recovery without discharging debts. Chapter 13 allows wage earners to develop a plan for recovery without discharging all debts.

Chapter 7

Chapter 7 bankruptcy proceedings are the most alarming to businesses because these proceedings result in the complete discharge of valid obligations. The distressed debtor is given a fresh start through the discharge of debt process.

Briefly, the way Chapter 7 works is that a financially troubled debtor retains an attorney; the attorney prepares a bankruptcy petition and files it with the Bankruptcy Court. The debtor is permitted to keep exempt assets, but is forced to turn all nonexempt assets over to the trustee in bankruptcy. In return for turning nonexempt assets over to the trustee, the debtor is discharged from all dischargeable debts (which are most of the debtor's debts). The Bankruptcy Court will appoint the trustee who represents the creditors and a bankruptcy judge will oversee the action. The debtor is permitted to go through Chapter 7 again after six full years have elapsed.

If the debtor does not file for bankruptcy relief, creditors are permitted to force a debtor into bankruptcy by filing an involuntary petition under Chapter 7. Some creditors, who are not being paid despite aggressive collection activities, may prefer to force the appointment of a trustee who may be more cooperative than the debtor. This may also minimize losses by a creditor if the debtor is squandering away any remaining assets.

Once a petition under Chapter 7 is filed, creditors are precluded from attempting to collect from the debtor on any claims. The creditors listed in the bankruptcy petition are notified that the debtor has filed for bankruptcy and the creditors then must file a proof of their claim with the bankruptcy court. …

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