No one-size-fits-all approach in bankruptcy filings

By many metrics, Hawaii’s economy is doing fine. According to the Department of Business, Economic Development and Tourism, unemployment is at a record low, the real estate market continues to perform well, and visitor expenditures and inflation-adjusted gross domestic product (the total value of goods and services) are projected to grow through 2019.

Beneath the surface, however, there are indications that the pendulum COULD start swinging the other way. Rising costs of living in Hawaii, combined with sluggish wage growth, have many people leaving the state. Homelessness has reached crisis levels. Additionally, 2018 has seen an uptick in bankruptcy filings.

Overall bankruptcy rates in Hawaii remain low compared WITH the rest of the United States, and filings have decreased every year since 2010. More recently, however, bankruptcy filings in Hawaii for the first five months of 2018 have increased, year over year, with double-digit percentage increases in March, April and May.

While this is a small sample and not necessarily indicative of long-term trends, it raises concerns as bankruptcy filings are generally countercyclical. When the economy is good, bankruptcy filings are down; when there is a market downturn, bankruptcy filings increase. An uptick in bankruptcies could indicate current or future weaknesses in the economy.

The primary reason an individual or entity files for bankruptcy is to get immediate relief from creditors. Upon filing a petition in Bankruptcy Court, collection activities against the debtor are automatically stayed, pending further actions in the bankruptcy case.

There are two bankruptcy types: Reorganization (Chapter 11 or 13) and liquidation (Chapter 7).

How the case proceeds largely depends on the type of bankruptcy filed. Whether a debtor can file for bankruptcy under a particular chapter depends on various factors, including the debtor’s legal status and income.

Generally, when reorganizing under either Chapter 11 or 13, the debtor’s debts are consolidated, and the debtor and creditors agree to a future payment plan to pay off some percentage of those debts. In a Chapter 7 case, the debtor’s nonexempt assets are sold to pay off debts, which are forgiven at the completion of the bankruptcy case.

Bankruptcy is a powerful tool. For a debtor with multiple creditors, it usually has the effect of providing a single forum to address creditors’ claims and discharging all unsecured debt. However, bankruptcy is not a cure-all. Many debts — including most tax liabilities, child-support obligations and student loans — cannot be negated or discharged in bankruptcy proceedings. Similarly, certain types of civil claims, particularly those with elements of fraud, are nondischargeable, and claimants may be allowed to pursue such claims despite the bankruptcy filing.

Creditors faced with a bankrupt debtor are not necessarily without options. In general, secured creditors, such as a bank holding a mortgage on real property, are in a much better position than unsecured creditors, such as a bank holding credit card debt. That is because the bankruptcy filing generally does not affect the security interest.

Both secured and unsecured creditors, however, have many tools under the Bankruptcy Code to thoroughly examine a debtor’s finances, including general business operations. This can provide a creditor with broader insight into the debtor’s finances, potential transfers of assets not directly related to the creditor’s claims, and, ultimately, likelihood of recovery. Also, all creditors must timely file with the Bankruptcy Court a proof of claim, which sets forth the basis for the amount the debtor owes them. Otherwise, their claims may be barred and they will recover nothing.

Despite the economy’s apparent health, it might be a good time for both potential debtors and creditors to assess the possibility of bankruptcy affecting businesses or transactions. Bankruptcy is a complicated area of law and can be potentially expensive and fraught with pitfalls for both debtors and the creditors. Counsel should be sought in either case as there is no one-size-fits-all approach.

William Harstad is a partner in the litigation and alternative dispute resolution practice group at Carlsmith Ball LLP. He can be reached at wharstad@carlsmith.com.