Bankruptcy is Weird

I started my career as a corporate bankruptcy attorney (remember, don't take anything on here as legal advice). Though I don't do that anymore, there are a number of things that are unique and interesting to the bankruptcy system. I've somewhat simplified here; there are literal volumes of work dealing with the nuances of bankruptcy.

Also, I've only practiced in the US, so this doesn't apply to other countries. In addition, my experience was dealing with bankruptcies of companies or other entities; I've not really touched individual bankruptcies.

Pictured: The bankruptcy court for the Southern District of New York in downtown Manhattan.

1. The Filing of a Bankruptcy Case has Automatic Protections

Upon filing for bankruptcy, the debtor (the person/company filing for bankruptcy) automatically gets the benefit of what is called the "automatic stay". No judge approves this, it happens as soon as the case is filed (there are some exceptions for repeat filers).

In short, as long as the stay remains in place (typically through the entire course of the bankruptcy), creditors (people the debtor owes money to) cannot take any steps to collect on their debt. For example, if there is a foreclosure auction/sale on a Saturday and someone files for bankruptcy the Friday before, I hope you weren't too attached to that sale. Even if you proceed with the auction, any sale is invalid - even if you are unaware of the filing. If you are aware of the bankruptcy and proceed with enforcement of any kind, you can be subject to sanctions by the court.

2. Almost Anyone Can Show Up

Most non-bankruptcy civil cases have defined plaintiffs (the one doing the suing) and defendants (the one being sued). Though there can be way more than one plaintiff or defendant, there are typically a finite number of parties that everyone is aware of.

In bankruptcy, any "party in interest" can appear in court or file motions. This typically refers to creditors. However, this definition is extremely broad and can encompass many other parties. For instance, equity holders (if you own stock in the company) are also parties in interest, even though they typically will have no recovery. Because stock can be publicly traded, you never know whether an equity holder is going to try to throw a wrench in the whole proceeding. I remember in one of my old cases, we had an equity holder that claimed that there was massive fraud (even specifically saying that it was bigger than Enron). In addition, the individual went on to ask that the court pay for bodyguards because he believed that he would be assassinated for his findings (seriously). Obviously, this was untrue (you would have heard about something bigger than Enron) and the court denied the request for bodyguards. I understand the individual was not assassinated and has continued his crusade against other companies using the same logic.

I've also seen the press draft motions and appear in court because certain pleadings were redacted. And that motion actually went somewhere.

This variability ensures that you never know exactly what is going to happen in a bankruptcy.

3. Bankruptcy Judges can Basically do Whatever They Think is Fair

Bankruptcy courts are are governed by the Bankruptcy Code (title 11 of the US Code for the law nerds). As alluded to before, some typical rules and timelines are thrown out in favor of quicker proceedings (time is a particularly relevant factor in bankruptcies for obvious reasons) or for flexibility.

One such provision in the Bankruptcy Code exemplifies this principle. Section 105(a) of the Bankruptcy Code reads:

"The court may issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of this title. No provision of this title providing for the raising of an issue by a party in interest shall be construed to preclude the court from, sua sponte, taking any action or making any determination necessary or appropriate to enforce or implement court orders or rules, or to prevent an abuse of process." (emphasis added)

This is an incredible grant of power that has been given to bankruptcy courts. It allows courts to craft their own remedies (so long as that remedy does not conflict with other parts of the Bankruptcy Code). Further, the second part of this statute basically says that nothing can stop the court from doing what it wants ("sua sponte" just means the court is doing something on its own without any request by the parties).

4. Student Debt is Generally Non-Dischargeable

I've written on this briefly before, but the Bankruptcy Code has a special carveout for student debt. Typically, after reaching the conclusion of the bankruptcy process successfully, a debtor is given what is called a "discharge" of prior debt. Discharged debt can no longer be collected on by creditors (similar to the automatic stay, but on a permanent basis surviving the bankruptcy case), which gives the debtor a "fresh start" upon emergence from bankruptcy. Student debt, on the other hand, is only dischargeable if the court finds that "an undue hardship on the debtor and the debtor’s dependents" is present. See 523(a)(8) of the Bankruptcy Code. And this basically never happens.

5. Some Bankruptcies are Basically Over in a Single Day

Nicknamed "pre-pack" bankruptcies, many companies that are contemplating restructuring through a bankruptcy may have already negotiated what is going to happen. Typically, this takes the form of a company negotiating with its major creditors prior to filing. Those not in the negotiations typically will be treated in a way that doesn't impair their interests (like trade creditors), which means that they cannot object to the negotiated plan. This doesn't mean that they recover 100%, it just means that they couldn't do any better in a normal bankruptcy.

The day of the filing, the company will also put forward it's plan immediately and state that it has the creditor support to push things through. The court will oblige and approve the plan almost immediately.

6. Banks are Willing to Issue Loans to Bankrupt Companies

in Chapter 11 bankruptcies, the debtor remains in possession of the company's assets and still runs the company (in other chapters, property of the debtor is typically dealt with by a court-appointed trustee). This may not make sense at first, but the debtor typically is the only one with institutional knowledge of the company.

Bankrupt companies are typically cash-poor; this is one of the main causes of corporate bankruptcies. During a bankruptcy, companies need to continue paying vendors and employees if they want the business to survive. So where do they get the money to do that? To do so, they receive what are known as debtor-in-possession loans (or DIP loans).

You might think that a bank would not want to loan money to a company that has declared bankruptcy. However, there are mechanics in the Bankruptcy Code that make these loans quite appealing to banks. Among other (boring) things, DIP loans typically get to be paid out before any existing creditor. This basically ensures that the loan will be paid back, even if the company only pays a percentage of claims to other creditors. With these protections, DIP loans are extremely competitive with multiple banks looking to be a DIP lender.

7. The Docket is Open 24/7

There isn't much to elaborate on this point. Bankruptcy dockets are online and things can be filed at any time. I personally have seen (and authored) motions and other pleadings that were turned in just before midnight or the wee hours of the morning.

If you are doing docket updates (which I did as a junior), this can be particularly annoying.

8. The Entire Bankruptcy Court System was Unconstitutional for a Hot Second

There's a full explanation of how this happened here. Here's an attempt to summarize:

Bankruptcy courts are not the same as normal federal district courts. Federal district courts are given power by Article III of the Constitution while bankruptcy courts derive their power from Article I. In the early 1980s, the Supreme Court held that the (then) current system was unconstitutional because bankruptcy courts were acting too similar to district courts. This has obviously been resolved by now, but it is interesting how recent bankruptcy court history on this scale is so recent.