US Insolvency Law

Overview of US Insolvency Law

US insolvency law is governed principally by the Bankruptcy Code, codified at Title 11 of the United States Code (11 USC). Enacted in 1978 and substantially amended by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), the Code establishes a comprehensive federal framework for the adjustment of debts of individuals, corporations, and other entities. Bankruptcy jurisdiction vests exclusively in the United States district courts, though core proceedings are typically referred to the bankruptcy courts as units of the district courts.

Chapter 7 Liquidation

Chapter 7 — the liquidation regime — constitutes the most familiar form of bankruptcy relief. Upon the filing of a voluntary petition (or, in limited circumstances, an involuntary petition), an automatic stay under 11 USC § 362 immediately enjoins all collection efforts, litigation, and enforcement actions against the debtor or the debtor’s property. A trustee is appointed promptly thereafter, charged with collecting and liquidating the debtor’s non-exempt assets for distribution to creditors in accordance with the priority scheme set forth in 11 USC § 507.

The trustee exercises formidable powers. Under the strong-arm clause of 11 USC § 544(a), the trustee assumes the status of a hypothetical lien creditor as of the petition date, thereby avoiding unperfected security interests and certain other interests that would be subordinate to such a creditor. The trustee may also pursue avoidance actions under 11 USC §§ 547–548, recovering preferential transfers made within ninety days before the petition (or one year for insiders) and fraudulent transfers made within two years (or longer under applicable state law via § 544(b)). The 341 meeting of creditors provides an opportunity for creditors to examine the debtor under oath about assets, liabilities, and the administration of the estate.

Individual debtors receive a discharge of most pre-petition debts, subject to extensive exceptions enumerated in 11 USC § 523 (including taxes, fraud-based debts, and student loans absent undue hardship). BAPCPA introduced a means test (11 USC § 707(b)) that presumptively bars debtors with above-median income from accessing Chapter 7 relief, channeling them instead into Chapter 13.

Chapter 11 Reorganization

Chapter 11 is the premier reorganization tool for business debtors. The debtor typically remains in possession as a debtor in possession (DIP), exercising most powers of a trustee. The exclusive period under 11 USC § 1121 grants the debtor 120 days to file a plan of reorganization and 180 days to solicit acceptances, though courts routinely extend these periods in large cases.

The absolute priority rule (11 USC § 1129(b)(2)) dictates that a plan may be confirmed on a non-consensual (“cram down”) basis only if no class of claims junior to an impaired dissenting class receives any distribution under the plan unless all members of that dissenting class are paid in full. This rule ensures that equity holders retain nothing unless all objecting creditors are satisfied in full.

Confirmation requires, inter alia, that the plan be proposed in good faith (11 USC § 1129(a)(3)), that it comply with the Code, and that — for each impaired class that has not accepted the plan — the plan does not unfairly discriminate and is fair and equitable.

Chapter 13 Individual Adjustment

Chapter 13 provides a repayment-based alternative for individuals with regular income. The debtor proposes a plan – typically lasting three to five years — to devote disposable income to creditors. Chapter 13 offers advantages unavailable under Chapter 7: the ability to cure mortgage arrears, strip certain junior liens, and discharge debts that would be non-dischargeable under Chapter 7 (such as willful injury claims).

The Automatic Stay and Relief therefrom

The automatic stay is the cornerstone of bankruptcy relief. It operates immediately upon filing, without judicial order, and halts virtually all creditor activity. Creditors may seek relief from stay under 11 USC § 362(d) for cause, including lack of adequate protection or absence of equity in property necessary for reorganization. BAPCPA narrowed the stay for serial filers and expanded the grounds for its termination in residential eviction cases.

BAPCPA 2005 and Subsequent Developments

BAPCPA represented the most significant revision to the Bankruptcy Code since 1978. Key changes included the means test for Chapter 7 eligibility, enhanced credit counseling requirements, caps on the homestead exemption (11 USC § 522(o)–(p)), and stricter discharge limitations. The Small Business Reorganization Act of 2019 added Subchapter V to Chapter 11, streamlining reorganization for small business debtors. More recently, the Pandemic-era procedural adjustments under the CARES Act modified certain Chapter 13 provisions and eligibility thresholds.

Conclusion

US insolvency law reflects a policy balance between affording honest debtors a fresh start and protecting creditor expectations. The automatic stay, the trustee’s avoidance powers, and the strict prioritization of claims structure a system that, while complex, provides a well-established forum for the resolution of financial distress across all categories of debtors. The prominence of Chapter 11 has made US restructuring practice a global benchmark, and the American approach to debtor-in-possession reorganization continues to influence restructuring regimes worldwide.