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Bankruptcy
Proceedings

Understand the types, effects, and legal protections of bankruptcy under the U.S. Bankruptcy Code: from the automatic stay to discharge of debts.

CPA Regulation (REG)

What Is Bankruptcy?

Bankruptcy is a federal legal process governed by Title 11 of the United States Code. It provides debtors with a fresh start by either liquidating assets to pay creditors or reorganizing debts under a court-approved plan.

For the CPA exam, you must identify which chapter applies, who may file, and what effects follow: the automatic stay, the bankruptcy estate, and the discharge of debts.

Essential Terminology

Debtor
The person or entity that owes debts and files for (or is subject to) bankruptcy.
Creditor
Any party to whom the debtor owes a debt, whether secured or unsecured.
Trustee
A court-appointed official who administers the bankruptcy estate and distributes assets.
Automatic Stay
An immediate injunction halting all collection actions, lawsuits, and foreclosures against the debtor.
Discharge
A court order releasing the debtor from personal liability on specified debts.
Estate
All legal and equitable interests of the debtor in property at the time of filing.

Why It Matters for the CPA Exam

Bankruptcy intersects with taxation, business law, and ethics. CPA candidates must understand how proceedings affect creditor rights, tax obligations, and the debtor's legal status.

1
Voluntary vs. involuntary filing: Know who can initiate proceedings and under which chapter.
2
Priority of claims: Understand secured, priority, and general unsecured creditor rankings.
3
Non-dischargeable debts: Identify debts that survive bankruptcy, such as taxes, fraud, and student loans.
4
Tax consequences: Recognize how cancellation of debt income and estate taxation work.

The Three Core Chapters

Chapter 7 Liquidation Trustee sells non-exempt assets Individuals + Businesses Voluntary or Involuntary Chapter 11 Reorganization Debtor proposes plan to restructure Businesses + Individuals Voluntary or Involuntary Chapter 13 Wage Earner Individual repays over 3-5 years Individuals Only Voluntary Only

Chapter 7: Liquidation

Chapter 7 is the most common form of bankruptcy. A trustee is appointed to collect and sell the debtor's non-exempt property, distribute the proceeds to creditors in order of priority, and then the debtor receives a discharge of remaining eligible debts.

1
Who may file: Individuals, partnerships, and corporations. Individuals must pass a means test.
2
Exempt property: Debtors may keep certain assets (homestead, personal property) as defined by federal or state exemptions.
3
No discharge for corporations: Only individuals receive a Chapter 7 discharge. Corporations are simply dissolved.

Chapter 11: Reorganization

Chapter 11 allows a business (or individual with substantial debts) to continue operations while restructuring debts. The debtor typically remains in possession as a "debtor in possession" (DIP) and proposes a plan of reorganization.

Debtor in Possession
The debtor continues to manage the business unless cause exists to appoint a trustee.
Plan of Reorganization
Must be accepted by creditors and confirmed by the court. Creditors vote by class.

Chapter 13: Wage Earner Plan

Chapter 13 is available only to individuals with regular income whose debts fall below statutory limits. The debtor proposes a repayment plan lasting 3 to 5 years, paying all or a portion of debts from future earnings.

1
Debt limits: Unsecured debts must be below a set threshold (currently adjusted periodically). Secured debts also have a ceiling.
2
Voluntary only: Creditors cannot force a debtor into Chapter 13.
3
Broader discharge: Chapter 13 discharges more types of debts than Chapter 7, sometimes called a "super discharge."
4
Property retained: The debtor keeps all property while making plan payments.

Voluntary vs. Involuntary Filing

Voluntary Involuntary
Who files? The debtor Creditors
Available chapters 7, 11, 13 7 and 11 only
Creditor requirement N/A ≥ 3 creditors (if 12+ total) or 1 creditor (if < 12 total)
Debt requirement None stated Claims must total at least a statutory minimum above any lien value
Entities excluded Banks, insurers, railroads (special rules) Same + farmers, nonprofits, and individuals under Ch. 13

The Automatic Stay

Automatic Stay Filed = Activated BLOCKED Lawsuits Foreclosures Repossessions Wage Garnish EXCEPTIONS Criminal cases Tax audits Domestic support Eviction (some)

The automatic stay takes effect immediately upon filing. Creditors who violate it may face contempt sanctions and liability for damages. However, secured creditors may petition for relief from the stay if the debtor lacks equity in the collateral.

Priority of Claims

1
Secured creditors: Paid first from the collateral securing their claims (outside priority).
2
Domestic support obligations: Alimony and child support claims have the highest unsecured priority.
3
Administrative expenses: Costs of preserving the estate, trustee fees, and professional fees.
4
Employee wages: Earned within 180 days before filing, up to a statutory cap per employee.
5
Tax claims: Certain tax debts owed to governmental units.
6
General unsecured creditors: Paid last; often receive only a fraction of amounts owed.

Non-Dischargeable Debts

Not all debts are eliminated in bankruptcy. Certain debts are deemed non-dischargeable as a matter of public policy. Memorize these for the CPA exam:

Taxes
Recent income taxes (generally within 3 years of filing) and fraudulent tax returns.
Student Loans
Unless the debtor proves "undue hardship" (a very high standard).
Fraud
Debts obtained through fraud, false pretenses, or false financial statements.
Alimony / Support
Domestic support obligations are never dischargeable.
Willful Injury
Debts for willful and malicious injury to another person or property.
DUI Damages
Debts for death or personal injury caused by intoxicated driving.

Analyzing a Bankruptcy Scenario

1
Identify the debtor type: Is the debtor an individual, partnership, or corporation? This limits available chapters.
2
Determine filing type: Was the filing voluntary (by debtor) or involuntary (by creditors)? Apply creditor count and debt thresholds.
3
Apply the automatic stay: Check whether the collection action at issue is stayed or falls within an exception.
4
Classify the creditor's claim: Is it secured, priority unsecured, or general unsecured? Rank accordingly.
5
Check dischargeability: Is the specific debt on the non-dischargeable list? If so, the debtor remains liable.

Example 1: Individual Ch. 7 Filing

1
Automatic stay: All creditor collection actions are immediately halted.
2
Trustee liquidation: Non-exempt assets are sold and proceeds distributed to creditors by priority.
3
Discharge analysis: The $40,000 credit card debt is dischargeable. The $25,000 student loan and $8,000 tax debt are non-dischargeable.

Example 2: Involuntary Petition

1
Creditor threshold: Since TechCorp has 20 creditors (≥ 12), at least 3 petitioning creditors are required. ✓ Met.
2
Debt threshold: Combined claims must meet the statutory minimum (above any lien value). ✓ Met at $50,000.
3
Not paying debts: The debtor must be generally not paying debts as they become due. ✓ Satisfied.

Example 3: Chapter 13 Repayment

Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Filing Min. plan Max. plan Monthly plan payments from disposable income Home is protected: mortgage continues as scheduled

Result: Maria keeps her home, makes plan payments for 3-5 years, and remaining unsecured debt is discharged upon completion.

Common Mistakes

✕ Ch. 13 for Corporations
Chapter 13 is only for individuals with regular income. Corporations and partnerships must use Chapter 7 or 11.
✕ All Debts Discharged
Student loans, recent taxes, alimony, fraud debts, and DUI injuries are non-dischargeable in most cases.
✕ Involuntary Ch. 13
Chapter 13 is voluntary only. Involuntary petitions are permitted only under Chapters 7 and 11.
✕ Stay Blocks Everything
The automatic stay has exceptions: criminal proceedings, certain tax actions, and domestic support enforcement continue.
✕ Wrong Creditor Count
For involuntary filing: if the debtor has fewer than 12 creditors, only 1 petitioning creditor is needed (not 3).
✕ Corp. Ch. 7 Discharge
Corporations do not receive a discharge in Chapter 7. They are simply liquidated and dissolved.

Chapter Comparison Summary

Chapter 7 Chapter 11 Chapter 13
Purpose Liquidation Reorganization Repayment plan
Who may file Individuals, corps, partnerships Individuals, corps, partnerships Individuals only
Filing type Voluntary / Involuntary Voluntary / Involuntary Voluntary only
Trustee Always appointed DIP (unless cause) Standing trustee
Discharge Individuals only Upon plan completion Upon plan completion
Property Non-exempt sold Retained by debtor Retained by debtor

Question 1 of 5

Which of the following types of bankruptcy may be filed involuntarily by creditors?

Question 2 of 5

When a debtor files a bankruptcy petition, which of the following immediately occurs?

Question 3 of 5

A debtor has 15 creditors. How many creditors must join to file an involuntary petition?

Question 4 of 5

Which of the following debts is generally dischargeable in a Chapter 7 bankruptcy?

Question 5 of 5

In a Chapter 11 bankruptcy, who typically manages the debtor's business during reorganization?