Risk Management Manual of Examination Policies - FDIC

LOANS Section 3.2
Trustees are selected by the borrower's creditors and are
responsible for administering the affairs of the bankrupt
debtor's estate. The bankrupt's property may be viewed as
a trust for the benefit of the creditors, consequently it
follows the latter should, through their elected
representatives, exercise substantial control over this
property.
Voluntary and Involuntary Bankruptcy
When a debtor files a bankruptcy petition with the court,
the case is described as a voluntary one. It is not necessary
the individual or organization be insolvent in order to file a
voluntary case. Creditors may also file a petition, in which
case the proceeding is know as an involuntary bankruptcy.
However, this alternative applies only to Chapter 7 cases
and the debtor generally must be insolvent, i.e., unable to
pay debts as they mature, in order for an involuntary
bankruptcy to be filed.
Automatic Stay
Filing of the bankruptcy petition requires (with limited
exceptions) creditors to stop or "stay" further action to
collect their claims or enforce their liens or judgements.
Actions to accelerate, set off or otherwise collect the debt
are prohibited once the petition is filed, as are post-
bankruptcy contacts with the obligor. The stay remains in
effect until the debtor's property is released from the estate,
the bankruptcy case is dismissed, the debtor obtains or is
denied a discharge, or the bankruptcy court approves a
creditor's request for termination of the stay. Two of the
more important grounds applicable to secured creditors
under which they may request termination are as follows:
(1) The debtor has no equity in the encumbered property,
and the property is not necessary to an effective
rehabilitation plan; or (2) The creditor's interest in the
secured property is not adequately protected. In the latter
case, the law provides three methods by which the
creditor's interests may be adequately protected: the
creditor may receive periodic payments equal to the
decrease in value of the creditor's interest in the collateral;
an additional or substitute lien on other property may be
obtained; or some other protection is arranged (e.g., a
guarantee by a third party) to adequately safeguard the
creditor's interests. If these alternatives result in the
secured creditor being adequately protected, relief from the
automatic stay will not be granted. If relief from the stay is
obtained, creditors may continue to press their claims upon
the bankrupt's property free from interference by the debtor
or the bankruptcy court.
Property of the Estate
When a borrower files a bankruptcy petition, an "estate" is
created and, under Chapter 7 of the law, the property of the
estate is passed to the trustee for distribution to the
creditors. Certain of the debtor's property is exempt from
distribution under all provisions of the law (not just
Chapter 7), as follows: homeowner's equity up to $7,500;
automobile equity and household items up to $1,200;
jewelry up to $500; cash surrender value of life insurance
up to $4,000; Social Security benefits (unlimited); and
miscellaneous items up to $400 plus any unused portion of
the homeowner's equity. The bankruptcy code recognizes
a greater amount of exemptions may be available under
State law and, if State law is silent or unless it provides to
the contrary, the debtor is given the option of electing
either the Federal or State exemptions. Examiners should
note that some liens on exempt property which would
otherwise be enforceable are rendered unenforceable by
the bankruptcy. A secured lender may thus become
unsecured with respect to the exempt property. The basic
rule in these situations is that the debtor can render
unenforceable judicial liens on any exempt property and
security interests that are both nonpurchase money and
nonpossessory on certain household goods, tools of the
trade and health aids.
Discharge and Objections to Discharge
The discharge, as mentioned previously, protects the
debtor from further liability on the debts discharged.
Sometimes, however, a debtor is not discharged at all (i.e.,
the creditor has successfully obtained an "objection to
discharge") or is discharged only as regards to a specific
creditor(s) and a specific debt(s) (an action known as
"exception to discharge"). The borrower obviously
remains liable for all obligations not discharged, and
creditors may pursue customary collection procedures with
respect thereto. Grounds for an "objection to discharge"
include the following actions or inactions by the bankrupt
debtor (this is not an all-inclusive list): fraudulent
conveyance within 12 months of filing the petition;
unjustifiable failure to keep or preserve financial records;
false oath or account or presentation of a false claim in the
bankruptcy case and estate, respectively; withholding of
books or records from the trustee; failure to satisfactorily
explain any loss or deficiency of assets; refusal to testify
when legally required to do so; and receiving a discharge
in bankruptcy within the last six full years. Some of the
bases upon which creditors may file "exceptions to
discharge" are: nonpayment of income taxes for the three
years preceding the bankruptcy; money, property or
services obtained through fraud, false pretenses or false
representation; debts not scheduled on the bankruptcy
petition and which the creditor had no notice; alimony or
child support payments (this exception may be asserted
DSC Risk Management Manual of Examination Policies 3.2-59 Loans (12-04)
Federal Deposit Insurance Corporation