Chapter 23:

Creditors’ Rights and Bankruptcy

WHAT THIS CHAPTER IS ABOUT

This chapter sets out the rights and remedies available to a creditor, when a debtor defaults, under laws other
than federal bankruptcy law. This chapter also covers bankruptcy law. Congressional authority to regulate
bankruptcies comes from Article I, Section 8, of the U.S. Constitution. Bankruptcy law (1) protects a debtor by giving
him or her a fresh start and (2) ensures equitable treatment to creditors competing for a debtor’s assets.

CHAPTER OUTLINE
I. LAWS ASSISTING CREDITORS
A. LIENS
A lien is a claim against property to satisfy a debt or to protect a claim for payment of a debt.

1. Mechanic’s Lien
A creditor can file this lien on real property when a person contracts for labor, services, or materials
to improve the property but does not pay.

a. When Must a Creditor File the Lien?

A creditor must file the lien within a specific period, measured from the last date on which
materials or labor were provided (usually within 60 to 120 days).

b. What If the Owner Does Not Pay?

The property can be sold to satisfy the debt. Notice of the foreclosure and sale must be given to
the debtor in advance.

2. Artisan’s Lien
This is a security device by which a creditor can recover from a debtor for labor and materials fur -
nished in the repair of personal property.

a. The Creditor Must Possess the Property

The lien terminates if possession is voluntarily surrendered, unless the lienholder records notice
of the lien in accord with state statutes.

b. What If the Owner Does Not Pay?

The property can be sold to satisfy the debt. Notice of the foreclosure and sale must be given to
the debtor in advance.

3. Judicial Liens

a. Writ of Attachment

1
2 UNIT FIVE: DEBTOR-CREDITOR RELATIONSHIPS

Attachment is a court-ordered seizure and taking into custody of property before the securing of
a judgment for a past-due debt. A sheriff or other officer seizes nonexempt property. If the
creditor prevails at trial, the property can be sold to satisfy the judgment.

b. Writ of Execution
A writ of execution is an order, usually issued by the clerk of court, directing the sheriff to seize
and sell any of the debtor’s nonexempt property within the court’s geographical jurisdiction.
Proceeds of the sale pay the debt.
 CHAPTER 23: CREDITORS’ RIGHTS AND BANKRUPTCY 3

B. GARNISHMENT
Garnishment occurs when a creditor collects a debt by seizing property of the debtor (such as wages or
money in a bank account) that a third party (such as an employer or a bank) holds. The creditor ob tains a
judgment against the debtor and serves it on the third party (known as the garnishee). There are limits on
amounts that can be garnished and on the discharge of an employee for a garnishment order.

C. CREDITORS’ COMPOSITION AGREEMENTS

A creditors’ composition agreement is a contract between a debtor and his or her creditors for discharge
of the debtor’s liquidated debts on payment of a sum less than that owed.

D. MORTGAGE FORECLOSURE
A mortgagor (creditor) can foreclose on mortgaged property if the mortgagee (debtor) defaults. Usual
method is a judicial sale. Proceeds are applied to the debt. If proceeds do not cover the costs and the debt,
the mortgagee can recover the difference from the mortgagor with a deficiency judgment.

E. SURETYSHIP AND GUARANTY

1. Suretyship
A promise by a third person to be responsible for a debtor’s obligation. Does not have to be in writ -
ing. A surety is primarily liable—a creditor can demand payment from the surety the moment the
debt is due.

2. Guaranty
A promise to be secondarily liable for the debt or default of another. A guarantor pays only after the
debtor defaults and the creditor has made an attempt to collect from the debtor. A guaranty must be
in writing unless the main-purpose exception applies (see Chapter 11).

3. Defenses of the Surety and the Guarantor

To avoid payment, a surety (guarantor) may use the following defenses.

a. Material Change to the Contract between Debtor and Creditor

Without obtaining the consent of the surety (guarantor), a surety is discharged completely or to
the extent the surety suffers a loss.

b. Principal Obligation Is Paid or Valid Tender Is Made

The surety (guarantor) is discharged from the obligation.

c. Most of the Principal Debtor’s Defenses

Defenses that cannot be used: debtor’s incapacity, bankruptcy, and statute of limitations.

d. Surety or Guarantor’s Own Defenses

e. Surrender or Impairment of Collateral

Without the surety’s (guarantor’s) consent, this action on the part of the creditor releases the
surety to the extent of any loss suffered.

4. Rights of the Surety and the Guarantor

If the surety (guarantor) pays the debt—

a. Right of Subrogation
4 UNIT FIVE: DEBTOR-CREDITOR RELATIONSHIPS

The surety (guarantor) has available any remedies that were available to the creditor against the
debtor.

b. Right of Reimbursement
The surety (guarantor) is entitled to receive from the debtor all outlays made on behalf of the
suretyship arrangement.
 CHAPTER 23: CREDITORS’ RIGHTS AND BANKRUPTCY 5

c. Right of Contribution
A surety who pays more than his or her proportionate share on a debtor’s default is entitled to
recover from co-sureties.

II. LAWS ASSISTING DEBTORS

A. EXEMPTED REAL PROPERTY
Each state allows a debtor to keep the family home (in some states only if the debtor has a family) in its
entirety or up to a specified amount.

B. EXEMPTED PERSONAL PROPERTY

This includes household furniture up to a specified dollar amount; clothing and other possessions; a ve-
hicle (or vehicles); certain animals; and equipment that the debtor uses in a business or trade.

III. BANKRUPTCY PROCEEDINGS

A. THE GOALS OF BANKRUPTCY LAW
Federal bankruptcy law has two goals: to protect a debtor by freeing him or her from creditors’ claims to
make a fresh start and to insure fair treatment to creditors competing for the debtor’s assets.

B. BANKRUPTCY PROCEEDINGS
Proceedings are held in federal bankruptcy courts. Current law is based on the Bankruptcy Reform Act of 1978 and
the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (the Bankruptcy Code, or the Code). Relief
can be granted under the Code’s Chapter 7, Chapter 11, Chapter 12, or Chapter 13.

IV. CHAPTER 7—LIQUIDATION

This is the most familiar type of bankruptcy proceeding. A debtor declares his or her debts and gives all as-
sets to a trustee, who sells the nonexempt assets and distributes the proceeds to creditors.

A. WHO CAN FILE FOR A LIQUIDATION

Any “person”—individuals, partnerships, and corporations (spouses can file jointly)—except railroads,
insurance companies, banks, savings and loan associations, and credit unions.

B. VOLUNTARY BANKRUPTCY

1. The Debtor Receives Credit Counseling

A debtor must receive credit counseling from an approved nonprofit agency within 180 days (six
months) before filing a petition.

2. The Debtor Files a Petition with the Court

A husband and wife may file jointly.

3. The Debtor Files Schedules (Lists) with the Court

Within 45 days, a debtor must file schedules of (1) creditors and the debt to each, (2) the debtor’s fi-
nancial affairs, (3) the debtor’s property, (4) current income and expenses, (5) payments from em-
ployers within the previous 60 days, (6) a certificate proving the receipt of credit counseling, (7) an
itemized calculation of monthly income, and (8) the debtor’s most recent federal tax return.

4. The Debtor’s Attorney Files an Affidavit

6 UNIT FIVE: DEBTOR-CREDITOR RELATIONSHIPS

The debtor’s attorney, if there is one, must attest to a reasonable attempt to verify the accuracy of the
debtor’s petition and schedules.

5. The Court or Other Party “of Interest” Asks for More Information
Copies of later federal tax returns may be required. A debtor may need to verify his or her identity.

6. The Court May Dismiss a Petition for Substantial Abuse

a. If the Debtor’s Family Income Exceeds the Median Family Income in the Filing State
Abuse will be presumed, and a creditor can file a motion to dismiss the petition, if the excess is
$6,000 or more, under this “means test.” A debtor can rebut the presumption by showing “special
circumstances.”

b. If the Debtor’s Family Income Does Not Exceed the Median Family Income in the Filing State
A court can dismiss a petition on determining that the debtor seeks only an advantage over
creditors and his or her financial situation does not warrant a discharge of debts.

7. Other Grounds on which the Court May Dismiss a Petition

If the debtor has been convicted of a crime of violence or drug trafficking, a victim can file a motion
to dismiss. Failing to pay post-petition domestic support may also result in a dismissal.

8. Filing of the Petition Constitutes an Order for Relief

The clerk of the court must give the trustee and creditors notice within twenty days.

C. INVOLUNTARY BANKRUPTCY
A debtor’s creditors can force the debtor into bankruptcy proceedings.

1. Who Can Be Forced into Involuntary Proceedings

A debtor with twelve or more creditors, three or more of whom (with unsecured claims of at least
$13,475) file a petition. A debtor with fewer than twelve creditors, one or more of whom (with a claim
of $13,475) files. Not a farmer or a charitable institution.

2. When an Order for Relief Will Be Entered

If the debtor does not challenge the petition, the debtor is generally not paying debts as they come
due, or a receiver, assignee, or custodian took possession of the debtor’s property within 120 days be-
fore the petition was filed.

D. AUTOMATIC STAY
When a petition is filed, an automatic stay suspends all action by creditors against the debtor.

1. Exceptions
These include domestic support obligations (owed to a spouse, former spouse, debtor’s child, child’s
parent or guardian, or the government), related proceedings, securities regulation investigations,
property tax liens, prior eviction actions, and withholding to repay retirement account loans.

2. Limitations

a. Request for Relief

A creditor or other party “in interest” can ask for relief from the automatic stay, which then expires in 60
days, unless the court extends it.

b. Secured Debts—Adequate Protection Doctrine

 CHAPTER 23: CREDITORS’ RIGHTS AND BANKRUPTCY 7

This doctrine protects secured creditors by requiring payments, or other collateral or relief, to the
extent that the stay may cause the value of their collateral to decrease.

c. Secured Debts—Other Protection

The stay on secured debts may expire within 30 days of a petition if the debtor had a petition dismissed
within the prior year. Two dismissed petitions require a finding of good faith in the current filing before the
stay takes effect. A stay on secured property terminates 45 days after the creditors’ meeting if the debtor
does not redeem the property or reaffirm the debt.

E. PROPERTY OF THE ESTATE

1. What Property Is Included in the Debtor’s Estate

Interests in property presently held; community property; property transferred in a transaction
voidable by the trustee; proceeds and profits; certain after-acquired property; interests in gifts, inheri-
tances, property settlements, and life insurance death proceeds to which the debtor becomes entitled
within 180 days after filing.

2. What Property Is Not Included

Property acquired after the filing of the petition except as noted above. Also, withholdings for em -
ployee benefit plan contributions are excluded.

F. CREDITORS’ MEETING AND CLAIMS

Within “not less than twenty days or more than forty days,” the court calls a meeting of creditors, at
which the debtor answers questions. Within ninety days of the meeting, a creditor must file a proof of
claim if its amount is disputed. If the debtor’s schedules list a claim as liquidated, proof is not needed.

G. EXEMPTIONS

1. Federal Law
Federal law exempts such property as interests in a residence to $20,200, a motor vehicle to $3,225,
certain household goods to $10,775, tools of a trade to $2,025, and retirement and education savings
accounts, and the rights to receive Social Security, domestic support, and other benefits.

2. State Law
Most states preclude the use of federal exemptions; others allow a debtor to choose between state and
federal. State exemptions may include different value limits and exempt different property.

3. Limits on a State’s Homestead Exemption

To use this exemption, a debtor must have lived in the state for two years before filing a petition. If
the home was acquired within the previous three and a half years, the exemption is limited to
$136,875 (except for rolled-over equity). In certain cases of substantial abuse, no amount is exempt.

H. THE TRUSTEE
After the order for relief, an interim trustee is appointed to preside over the debtor’s property until the
first meeting of creditors, when a permanent trustee is elected. A trustee’s duty is to collect and reduce to
money the property of the estate and distribute the proceeds.

1. Initial Duties
A trustee must state whether a filing constitutes substantial abuse under the “means test” (see above)
within ten days of the creditors’ meeting, notify creditors within five days, and file a motion to
dismiss or convert a filing to Chapter 11 (or explain why not) within forty days.
8 UNIT FIVE: DEBTOR-CREDITOR RELATIONSHIPS

2. Duty with Respect to Domestic Support Obligations

A trustee must provide a party to whom this support is owed with certain information.

3. General Powers
A trustee has the same rights as (1) a lien creditor with priority over an unperfected secured party
and (2) a bona fide purchaser of real property from the debtor.

4. Specific Avoidance Powers—Voidable Rights

To obtain the return of property, a trustee can use any reason (fraud, duress, etc.) that a debtor can.

5. Specific Avoidance Powers—Preferences

A trustee can recover payments made or property transferred (or the value of the property if a pre -
ferred creditor has sold it to an innocent third party) by a debtor (1) within ninety days before the
petition and (2) for a preexisting debt.

a. Insiders or Fraud
If a creditor is an insider (partner, corporate officer, relative) or a transfer is fraudulent, a trustee
may recover transfers made within one year before filing.
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b. Transfers That Are Not Preferences

Payment for services rendered within the previous 10 to 15 days; payment received in the ordi-
nary course of business (such as payment of a phone bill); transfers of property up to $5,000;
payment of domestic support debts; and transfers under a credit counselor’s negotiated schedule.

6. Liens on Debtor’s Property

A trustee can avoid most statutory liens that first took effect on a petition’s filing or a debtor’s in -
solvency, and any lien against a bona fide purchaser not enforceable on the date of the filing.

7. Fraudulent Transfers
A trustee can avoid fraudulent transfers made within two years of a petition’s filing or if they were
made with intent to delay, defraud, or hinder a creditor. Transfers for less than reasonably equivalent
consideration may also be avoided if, by making them, a debtor became insolvent or was left in
business with little capital.

I. DISTRIBUTION OF PROPERTY
Any amount remaining after the property is distributed to creditors is turned over to the debtor.

1. Secured Creditors
Within 30 days of a petition or before the creditors’ meeting (whichever is first), a debtor must state
an intent to redeem secured collateral (or not). A trustee must enforce the statement within 45 days. If
collateral does not cover a debt, a secured creditor is an unsecured creditor for the rest.

2. Unsecured Creditors
Paid in the order of priority. Each class is paid before the next class is entitled to anything. The order
of priority is—

a. Claims for domestic support obligations.

b. Administrative expenses (court costs, trustee and attorney fees).
c. In an involuntary bankruptcy, expenses incurred by a debtor in the ordinary course of business.
d. Unpaid wages, salaries, and commissions earned within ninety days of a petition.
e. Unsecured claims for contributions to employee benefit plans.
f. Claims by farmers and fishermen.
g. Consumer deposits.
h. Taxes due to the government.
i. Claims of general creditors.

J. DISCHARGE
A discharge voids any judgment on a discharged debt and prohibits any action to collect a discharged
debt. A co-debtor’s liability is not affected.

1. Exceptions—Debts That May Not Be Discharged

Claims for back taxes, amounts borrowed to pay back taxes, goods obtained by fraud, debts that were
not listed in a petition, domestic support, student loans, certain cash advances, and others.

2. Objections—Debtors Who May Not Receive a Discharge

Those who conceal property with intent to hinder, delay, or defraud creditors; who fail to explain a
loss of assets; who have been granted a discharge within eight years prior to filing a petition; or who
fail to attend a debt management class (unless no class is available).

3. Revocation of Discharge
10 UNIT FIVE: DEBTOR-CREDITOR RELATIONSHIPS

A discharge may be revoked within one year if the debtor was fraudulent or dishonest during the
bankruptcy proceedings.

K. REAFFIRMATION OF DEBT
A debtor’s agreement to pay a dischargeable debt can be made only after certain disclosures and before a
discharge is granted, usually requires court approval, and will be denied if it will cause undue hardship.
Can be rescinded within sixty days or before a discharge is granted, whichever is later.
 CHAPTER 23: CREDITORS’ RIGHTS AND BANKRUPTCY 11

V. CHAPTER 11—REORGANIZATION
The creditors and debtor formulate a plan under which the debtor pays a portion of the debts, is discharged
of the rest, and continues in business.

A. WHO IS ELIGIBLE FOR RELIEF UNDER CHAPTER 11

Any debtor (except a stockbroker or a commodities broker) who is eligible for Chapter 7 relief is eligible
under Chapter 11. With some exceptions, the same principles apply that govern liquidation proceedings
(automatic stay, etc.).

B. WHY A CASE MAY BE DISMISSED

A case may be dismissed if this is in the creditors’ best interest, there is no reasonable likelihood of re -
habilitation, a debtor is unable to affect a plan, or there is an unreasonable delay. Creditors may prefer a
workout (a privately negotiated settlement) to bankruptcy.

C. DEBTOR IN POSSESSION
On entry of an order for relief, a debtor continues in business as a debtor in possession (DIP).

1. If Gross Mismanagement Is Shown

The court may appoint a trustee (or receiver) to operate the business. This may also be done if it is in
the best interests of the estate.

2. The DIP’s Role Is Similar to That of a Trustee in a Liquidation

The DIP can avoid pre-petition preferential payments and fraudulent transfers and decide whether to
cancel pre-petition executory contracts.

3. Strong-Arm Clause
A DIP can avoid any obligation or transfer that could be avoided by (1) a creditor who extended
credit at the time of bankruptcy and who consequently obtained (a) a lien or (b) a writ of execution
that was returned unsatisfied; and (2) a bona fide purchaser of real property, if the transfer was
perfected at the time of the bankruptcy.

D. CREDITORS’ COMMITTEES
A committee of unsecured creditors is appointed to consult with the trustee or DIP. Other committees
may represent special-interest creditors. Some small businesses can avoid creditors’ committees.

E. THE REORGANIZATION PLAN

1. Who Can File a Plan

Only a debtor can file within the first 120 days (180 days in some cases) after the date of an order for
relief. Any other party can file if a debtor does not meet the deadline or fails to obtain creditor
consent within 180 days. A court may extend these time periods.

2. What the Plan Must Do

Be fair and equitable (“in the best interests of the creditors”); designate classes of claims and interests;
specify the treatment to be afforded the classes; and provide an adequate means for execution; and
provide for the payment of tax claims over a fine-year period.

3. The Plan Is Submitted to Creditors for Acceptance

12 UNIT FIVE: DEBTOR-CREDITOR RELATIONSHIPS

Each class adversely affected by a plan must accept it (two-thirds of the total claims must approve). If
only one class accepts, the court may confirm it under the Code’s cram-down provision if the plan
does not discriminate unfairly against any creditors.

4. Discharge
The plan is binding on confirmation, but an individual debtor must complete the plan to obtain a
discharge. A debtor is discharged from all claims not within the plan (except those that would be
denied in a liquidation).

VI. BANKRUPTCY RELIEF UNDER CHAPTER 13 AND CHAPTER 12

A. INDIVIDUALS’ REPAYMENT PLAN—CHAPTER 13

1. Who Is Eligible
Individuals (not partnerships or corporations) with regular income and unsecured debts of less than
$336,900 or secured debts of less than $1,010,650 are eligible.

2. Filing the Petition

A Chapter 13 case can be initiated by voluntary filing of a petition or by conversion of a Chapter 7
case. A trustee is appointed.

3. Automatic Stay
On a petition’s filing, a stay takes effect, but applies only to consumer debt, not business debt.

4. The Repayment Plan

The plan must provide for (1) turnover to the trustee of the debtor’s future income, (2) full payment
of all claims entitled to priority, and (3) the same treatment of each claim within a particular class.

a. Filing and Confirming the Plan

Only a debtor can file a plan, which a court will confirm if (1) the secured creditors accept it, (2) it
provides that secured creditors retain their liens until full payment or discharge, or (3) a debtor
surrenders property securing claims to the creditors. Also, a creditor with a purchase-money
security interest in a car bought within 910 days before a filing must be paid in full.

b. Payments under the Plan

The time for payment is five years if a debtor’s income exceeds the state’s median under the
“means test” (see above) and three years if it does not. Payments must be timely, or the court can
convert the case to a liquidation or dismiss the petition. Before completion of payments, the plan
may be modified at the request of the debtor, the trustee, or an unsecured creditor.

c. Objection to the Plan

Over the objection of the trustee or an unsecured creditor, the court may approve a plan only if
(1) the value of the property to be distributed is equal to the amount of the claims, or (2) all the
debtor’s disposable income (with some exceptions) during the plan will be used to make
payments.

5. Discharge
After completion of all payments, all debts provided for by the plan are discharged. Many debts (tax
claims, domestic support obligations, student loans, and others) are not dischargeable. A hardship
 CHAPTER 23: CREDITORS’ RIGHTS AND BANKRUPTCY 13

discharge may be granted even if a plan is not completed. A discharge obtained by fraud can be
revoked within one year.

B. FAMILY FARMERS AND FISHERMEN—CHAPTER 12

The procedures and requirements under Chapter 12 are nearly identical to those under Chapter 13.
Eligible debtors include family farmers and fishermen.

1. Family Farmers
A family farmer is one whose gross income is at least 50 percent farm dependent and whose debts are
at least 80 percent farm related (total debt must not exceed $3.237 million), and a partnership or
closely held corporation (at least 50 percent owned by a farm family).

2. Family Fishermen
A family fisherman is one whose gross income is at least 50 percent dependent on commercial fishing
and whose debts are at least 80 percent related to commercial fishing (total debt must not exceed $1.5
million), and a partnership or closely held corporation (at least 50 percent owned by a fishing family).

TRUE-FALSE QUESTIONS
(Answers at the Back of the Book)

1. A mechanic’s lien involves personal property.

2. An employer can dismiss an employee due to garnishment.

3. A writ of attachment is a court order to seize a debtor’s property before the entry of a final judgment in a
creditor’s lawsuit against the debtor.

4. A surety or guarantor is discharged from his or her obligation when the principal debtor pays the debt.

5. A surety cannot use defenses available to the debtor to avoid liability on an obligation to a creditor.

6. A debtor must be insolvent to file a voluntary petition under Chapter 7.

7. With some exceptions, the same principles cover liquidations and reorganizations.

8. Under Chapter 13, the automatic stay applies only to consumer debt, not business debt.

9. When a business debtor files for Chapter 11 protection, the debtor is not allowed to continue in business.

10. No small business can avoid creditors’ committees under Chapter 11.

FILL-IN QUESTIONS
(Answers at the Back of the Book)
14 UNIT FIVE: DEBTOR-CREDITOR RELATIONSHIPS

A ___________________________________ (contract of suretyship/guaranty contract) is a promise to a creditor

made by a third person to be responsible for a debtor’s obligation. A ______________________ (guarantor/surety) is
primarily liable: the creditor can hold the ________________________ (guarantor/surety) responsible for payment of
the debt when the debt is due, without first exhausting all remedies against the debtor. A
________________________________________ (contract of suretyship/guaranty contract) also includes a promise to
answer for a principal’s obligation, but a _____________________ (guarantor/surety) is secondarily liable—that is, the
principal must first default, and ordinarily, a creditor must have attempted to collect from the principal, because
ordinarily a debtor would not otherwise be declared in default.

MULTIPLE-CHOICE QUESTIONS
(Answers at the Back of the Book)

1. Ann borrows money from Best Credit, Inc. Ann defaults. To use attachment as a remedy Best must first

a. be unable to collect the amount of a judgment against Ann.

b. file a suit against Ann.
c. lose a suit against Ann.
d. succeed in a suit against Ann.
 CHAPTER 23: CREDITORS’ RIGHTS AND BANKRUPTCY 15

2. Ed’s $2,500 debt to Owen is past due. To collect money from Ed’s wages to pay the debt, Owen can use

a. an order of receivership.
b. a writ of attachment.
c. a writ of execution.
d. garnishment.

3. Eve owes Fred $200,000. A court awards Fred a judgment in this amount. To satisfy the judgment, Eve’s
home is sold at public auction for $150,000. The state homestead exemption is $50,000. Fred gets

a. $0.
b. $50,000.
c. $100,000.
d. $150,000.

4. Eagle Company wants to borrow money from First State Bank. The bank insists that Holly, Eagle’s
president, agree to be personally liable for payment if Eagle defaults. Holly agrees. She is

a. a guarantor and a surety.

b. a guarantor only.
c. a surety only.
d. neither a guarantor nor a surety.

5. Ira and Jill agree to act as guarantors on a loan made by Ken. Ken defaults on the payments and Jill re -
fuses to pay. If Ira pays the debt, he can recover from

a. Ken and Jill under the right of reimbursement.

b. Ken and Jill under the right of proportionate liability.
c. Ken under the right of subrogation and Jill under the right of contribution.
d. neither Ken nor Jill.

6. Bob files a bankruptcy petition under Chapter 7 to have his debts discharged. Assuming Bob passes the
appropriate test, the debts most likely to be discharged include claims for

a. back taxes accruing within three years before the petition was filed.
b. certain fines and penalties payable to the government.
c. domestic support.
d. student loans, if the payment would impose undue hardship on Bob.

7. Carol is the sole proprietor of Diners Cafe, which owes debts in an amount more than Carol believes she
and the cafe can repay. The creditors agree that liquidating the business would not be in their best in-
terests. To stay in business, Lora could file for bankruptcy under

a. Chapter 7 only.
b. Chapter 11 only.
c. Chapter 13 only.
d. Chapter 11 or Chapter 13.
16 UNIT FIVE: DEBTOR-CREDITOR RELATIONSHIPS

8. Pat files a Chapter 7 petition for a discharge in bankruptcy. Pat may be denied a discharge if Pat

a. fails to explain a loss of assets.

b. fails to list a debt.
c. owes back taxes.
d. owes domestic support payments.
 CHAPTER 23: CREDITORS’ RIGHTS AND BANKRUPTCY 17

9. Dora and Ed make down payments on goods to be received from Fine Furniture Store. Before the goods
are delivered, Fine files for bankruptcy. Besides consumers like Dora and Ed, Fine owes wages to its
employees and taxes to the government. The order in which these debts will be paid is

a. consumer deposits, unpaid wages, and taxes.

b. taxes, consumer deposits, and unpaid wages.
c. unpaid wages, consumer deposits, and taxes.
d. unpaid wages, taxes, and consumer deposits.

10. Regional Stores, Inc., files for bankruptcy. A corporation can file a petition for bankruptcy under

a. Chapter 7 only.
b. Chapter 11 only.
c. Chapter 13 only.
d. Chapter 7 or Chapter 11.

SHORT ESSAY QUESTIONS

1. What is a lien? What are the ways in which a lien can arise? What is a lienholder’s priority compared to other
creditors?

2. What are the differences between contracts of suretyship and guaranty contracts?

ISSUE SPOTTERS
(Answers at the Back of the Book)
1. Joe contracts with Larry of Midwest Roofing to fix Joe’s roof. Joe pays half of the contract price in advance.
Larry and Midwest complete the job, but Joe refuses to pay the rest of the price. What can Larry and Midwest do?

2. Pat wants to borrow $10,000 from Quality Loan Company to buy a new car, but Quality refuses to lend the
money unless Ron cosigns the note. Ron cosigns and makes three of the payments when Pat fails to do so. Can Ron
get this money from Pat?

3. Ada is a vice president for Beta, Inc. On May 1, Ada loans Beta $10,000. On June 1, the firm repays the loan. On
July 1, Beta files for bankruptcy. Cole is appointed trustee. Can Cole recover the $10,000 paid to Ada on June 1?

CUMULATIVE HYPOTHETICAL PROBLEM

FOR UNIT FIVE—INCLUDING CHAPTERS 22–23
(Answers at the Back of the Book)

Omega Computers, Inc., sells computers to consumers.

18 UNIT FIVE: DEBTOR-CREDITOR RELATIONSHIPS

1. Alan fixes the roof of Omega’s office building, but Omega does not pay. Bob fixes one of Omega’s trucks,
but Omega does not pay. Bob does not return the truck to Omega. Alan and Bob place a mechanic’s lien
and an artisan’s lien on Omega’s property. Before foreclosure, notice must be given to Omega by

a. Alan and Bob.

b. Alan only.
c. Bob only.
d. neither Alan nor Bob.
 CHAPTER 23: CREDITORS’ RIGHTS AND BANKRUPTCY 19

2. In the course of business, Omega borrows money from First National Bank. Gail co-signs the loan as a
surety. Omega defaults on the loan, and Gail pays the entire amount. To collect from Omega, Gail has the
right of

a. contribution.
b. exemption.
c. exoneration.
d. subrogation.

3. Omega buys inventory from Gamma Products. Gamma finances the purchase, accepts the inventory as
security, and perfects its interest. Under UCC Article 9, the perfection of a security interest will not affect
the rights of

a. a buyer in the ordinary course of business.

b. a debtor.
c. a subsequent secured creditor.
d. a trustee in a debtor’s bankruptcy.

4. Omega files a voluntary petition in bankruptcy under Chapter 11. A reorganization plan is filed with the
court. Normally, the court will confirm a Chapter 11 plan if it is accepted by

a. Omega.
b. Omega’s secured creditors.
c. Omega’s shareholders.
d. Omega’s unsecured creditors.

5. Omega’s Chapter 11 plan is confirmed, and a final decree is entered. Omega will be

a. discharged from all debts except as otherwise provided by the law.

b. liquidated.
c. operated in business by the bankruptcy trustee.
d. required to change its business purpose.

QUESTIONS ON THE EXTENDED CASE STUDY FOR UNIT FIVE—

CENTRAL VIRGINIA COMMUNITY COLLEGE V. KATZ
(Answers at the Back of the Book)

1. Alpha, Inc., files for bankruptcy. Ben, Alpha’s bankruptcy trustee, wants to recover a transfer that Alpha
made to Colorado State University (CSU) less than ninety days earlier. CSU asserts its sovereign
immunity. Under the majority’s holding in Central Virginia Community College v. Katz, the party most
likely to prevail in this situation is

a. Ben.
b. CSU.
c. both Ben and CSU in equal measure.
d. neither Ben nor CSU.
20 UNIT FIVE: DEBTOR-CREDITOR RELATIONSHIPS

2. According to the opinion of the dissent in the Central case, the prevailing party in the previous set of facts
would be

a. Ben.
b. CSU.
c. both Ben and CSU in equal measure.
d. neither Ben nor CSU.
 CHAPTER 23: CREDITORS’ RIGHTS AND BANKRUPTCY 21

3. According to the majority in the Central case, a party that would prefer a different result should seek
relief from

a. Congress.
b. the courts.
c. the president.
d. the students of CSU and other state schools.