Introduction to Business Bankruptcy

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					                                       BANKRUPTCY MASTER NOTES

Introduction to Business Bankruptcy .............................................................................................. 3
   Introduction ................................................................................................................................. 3
   Early Bankruptcy Law ................................................................................................................ 3
   The Butner Doctrine ................................................................................................................... 4
The Automatic Stay: Its Scope and Effect ...................................................................................... 6
   The Applicable Provisions .......................................................................................................... 6
   The Scope of the Automatic Stay ............................................................................................... 8
   Effect of Violating the Stay [362(k)] .......................................................................................... 9
   The Automatic Stay and Secured Claims ................................................................................. 10
   The Affect of the Stay on 3rd Parties [362(a)]........................................................................... 11
       Co-Defendants to a Lawsuit.................................................................................................. 11
       Third Parties Liable to Pay the Debtor’s Obligations [362(a)] ............................................. 12
   Relief from the Automatic Stay for Cause [362(d)] ................................................................. 13
   Prepetition Waiver of Stay ........................................................................................................ 14
Property of the Estate .................................................................................................................... 15
   What is Included ....................................................................................................................... 15
   Consequences of Exclusion and Inclusion ................................................................................ 15
   Turnover .................................................................................................................................... 16
Claims Against the Estate ............................................................................................................. 17
   Overview (Baird) ...................................................................................................................... 17
   Introduction ............................................................................................................................... 17
       Terminology.......................................................................................................................... 17
       Procedure .............................................................................................................................. 18
   Rights to Payment ..................................................................................................................... 18
       Legal Rights .......................................................................................................................... 18
       Equitable Rights .................................................................................................................... 21
   Determining the Amount of a Claim ........................................................................................ 22
   Secured Claims ......................................................................................................................... 23
       Valuing a Secured Claim ...................................................................................................... 24
       Avoiding Liens under § 506(d) ............................................................................................. 25
       Postfiling Interest on Secured Claims ................................................................................... 26
       Adequate Protection for Undersecured Creditors ................................................................. 26
       Single Asset Real Estate ....................................................................................................... 28
Executory Contracts ...................................................................................................................... 30
   Introduction ............................................................................................................................... 30
   Rejection and Intellectual Property........................................................................................... 31
   Non-Assignable Contracts ........................................................................................................ 32
       Assumption ........................................................................................................................... 32
       Assignment ........................................................................................................................... 34
   Period Before Assumption or Rejection ................................................................................... 35

                         Introduction to Business Bankruptcy

      Approaches to bankruptcy
          o Proceduralist – sole purpose of bankruptcy is to provide procedures for debt
          o Traditionalist – recognizes procedures, but the purpose of bankruptcy is to
              vindicate a set of values (e.g. distributive values); this definition is disfavored
              because it is unclear what those values are
      Purposes of the bankruptcy code
          o Avoid the costs of race to a bankruptor’s assets
          o Alter capital structure of financially distressed debtors
          o Relieve individuals overburdened with debt – provide debtors with a fresh start
      Debt collection outside of bankruptcy – creates an uncoordinated race among creditors
       because the first party to obtain a lien gets priority (grab law)
          o Debtor owes creditor
          o Creditor obtains a judgment from the court
          o Creditor gets a writ from the court
                   Execution writ (tangible property)
                   Attachment writ (intangible property)
                   Judgment docketed (real property)
          o Writ filed and passed to sheriff and sheriff levies on property
          o Individual obtains an execution lien
      Consensual creditors (taking by consent) also leads to race/grab law
      Problems with uncoordinated debt collection (race)
          o Likely will be in every creditor’s interest to try to collect, but collection requires
              an expenditure of resources that may prevent the parties from reaching the best
              possible outcome
      Benefits of coordinated debt collection
          o Synergistic value – assets may be more valuable when sold together (not always
          o Collection costs – usually higher collection costs if creditors move to recover
          o The S Ct recognizes that part of the value of bankruptcy is the value of collective
              debt collection

Early Bankruptcy Law
      Aims of bankruptcy – 1) secure an equitable division of insolvent debtor’s property, 2)
       prevent conduct detrimental to interests of creditors by insolvent debtor
      Bankruptcy is now a protection for debtor so there are incentives to declaring bankruptcy
       (fresh-start policy)

           o As a result the majority of bankruptcies occur by voluntary acts of debtors
               seeking relief from creditors – there is little relief for debtors outside of
      In each federal judicial district there is a bankruptcy court; trustees supervise
       administration of bankruptcy cases
      Types of bankruptcy
           o Chapter 7 – liquidation of all of the property owned at the date of bankruptcy
               becomes party of bankruptcy estate; some property may be exempted
                     An individual debtor will usually be discharged of all personal liability
                     Only individuals can be discharged of debts under Chapter 7 (because a
                        corporation can just be dissolved)
                     Individuals with sufficient means are required to file under Chapter 13
                        (which sets out a plan for paying all debts)
           o Reorganization/rehabilitation – Chapter 11, 12, 13
                     Chapter 13
                             Debtor can get benefit of discharge without losing non-exempt
                             Court helps debtor to create a plan for paying off debts; creditors
                                 can object to plan
                     Chapter 11
                             Debtor retains assets as debtor in possession, but unlike Chapter 13
                                 is considered only after voted on by creditors and stockholder
      Eligibility for bankruptcy
           o Under § 301 a voluntary case can be commenced by any entity that may be a
               debtor, but only a person or a municipality may be a debtor
                     A person includes individuals, partnerships, and corporations, but not
                        government units (e.g. states)
                     “Corporation” includes LLCs, unincorporated associations and business
                     Excludes government units (except municipalities), and estates and trusts
                        (except business trust); insurance companies, banks, and financial
                        institutions may not be debtors and thus are also excluded
      What happens when someone files
           o Filing of the petition in bankruptcy results in an automatic stay against acts that
               might be taken against the debtor:
                     Starting or continuing judicial proceedings against the debtor, the
                        enforcement of any pre-bankruptcy judgment, any act to obtain possession
                        of property of the estate or against property of the estate, etc.

The Butner Doctrine

Butner v. United States – Substantive rights (at least property rights) of the parties in a
bankruptcy are ordinarily governed by non-bankruptcy law (i.e. state law) unless an articulated
bankruptcy rule or principle alters those rights

   Golden Enterprises, Inc. borrowed money from Butner; it filed for an initial Chapter 11
    bankruptcy (restructure debts), during that bankruptcy, Butner requested, and the court
    granted, that a trustee to collect rents from Golden properties (to be paid to Butner)
        o Under this scheme, Butner collected because it was deemed to be in constructive
            possession of Golden’s property
   Golden goes bust and declares bankruptcy again – this time, Butner does not request that
    the court appoint a trustee to collect rents; this bankruptcy is declared in April 1974, but
    the property is not sold until Febuary 1975
   When Golden’s property was sold, all proceeds went to Butner, but were insufficient to
    permit Butner to recover fully
   Golden collected rents between the time it declared bankruptcy and the time its property
    was foreclosed; Butner seeks these rents, but under NC law it is not entitled to them
    because it did not request that the court appoint a trustee to collect the rents, and thus was
    not in constructive possession of the property (as it had in the first bankruptcy)
   The lower court applied federal law, and on the grounds of equity granted the rents to
    Butner; the Supreme Court finds that state law governs substantive rights, and thus
    reverses the decision; money is paid to the federal government (for unpaid taxes)
   The problem with the ruling is that the NC Law maybe just describes a procedural
    requirement (what is required for an individual to collect), not a property right—raises
    issue of how to define a property right
   Limitations on the Butner rule
        o Procedural rights of the parties are still necessarily determined by federal
            bankruptcy law
        o Butner is a default rule – there are many federal bankruptcy rules that specifically
            alter substantive rights between parties in bankruptcy
                 Eventually, in response to Butner, Congress created a rule stating that real
                    property rents are treated as “cash collateral” and thus belong to the
                    creditor in a Butler-like situation

                         The Automatic Stay: Its Scope and Effect

The Applicable Provisions
       Stay and injunctions arise under 2 provisions
           o 105 – The court’s discretionary stay
           o 362 – The Auto-Stay
       Purposes of the automatic stay
           o Protects creditors - Allowing creditors to take action during bankruptcy
               proceeding would undermine bankruptcy’s pro rata sharing rule and would keep
               bankruptcy from effectively preventing a race to a debtor’s assets
                    This rationale does not apply to secured creditors, but secured creditors are
                       subject to the automatic stay because allowing secured creditor to exercise
                       rights is likely to interfere with attempts at reorganization (nevertheless,
                       court may lift the stay if the property is not needed for reorganization)
           o Protects debtors – gives debtor a breathing spell, stops collection efforts and

§ 105 – Discretionary Stays and Injunctions
     (a) Allows the court to “issue any order, process, or judgment that is necessary or appropriate to
        carry out the provisions of this title.” The court can sua sponte take any action or make any
        determination necessary to enforce or implement court orders to prevent an abuse of the
        bankruptcy process.
            o This is thought to be a broad equitable right for the courts to take whatever action is
                necessary to enforce the bankruptcy code
     (b) This section does not permit a court to appoint a receiver
     (c) Judges executing this responsibility are still subject to general provisions relating to carrying
        out responsibilities identified in title 28
     (d) The court can, on its own motion or at the request of a RPI
            o (1) hold status conferences
            o (2) prescribe limits at the status conference that the court deems appropriate to ensure that
                the case is handled expeditious and economically
                      Specifies type of orders that can be set
                      Still must comply with applicable provision of rest of title and the Federal Rules
                         of Bankruptcy Procedure

§ 362 – The Automatic Stay
     (a) – prevents a prepetition general creditor from enforcing a claim
           o (1) – commencement or continuation of judicial or administration proceedings against
               the debtor that was or could have been brought before bankruptcy was declared, or to
               recover a claim against the debtor that arose before the commencement of this case
           o (2) – enforcement of a judgment obtained before the commencement of bankruptcy
           o (3) ANY act to obtain possession or exercise control over property of the estate
           o (4) – any act to create, perfect, or enforce any lien against property of the estate
                    Ensures attempts to enforce liens violate auto stay

            o (5) – any act to create, perfect, or enforce a lien that relates to that secures a pre-petition
              loan (claim) that arose before the commencement of the case
         o (6) – any act to collect, assess, or recover a claim against the debtor that arose before the
              commencement of the case
         o (8) – commencement or continuation of proceedings before the US Tax Court
                    concerning a corporate debtor’s liability for a taxable period that can be
                       determined by the court
                    concerning an individual debtor for a taxable period ending before order for relief
                       (don’t know when that is)
    (b) – Exceptions to the stay
         o (b)(4) – government action NOT stayed when undertaken to enforce police or regulatory
              power, (not stayed from use of governmental unit’s police and regulatory power,
              including the enforcement of a judgment other than a money judgment)
                    government can clearly pursue a judgment through exercise of regulatory power
                       (e.g. judgment that debtor violated a government policy), but it cannot enforce
                       that judgment (attempt to collect on it) if it is a money judgment
                    means can pursue judgment forcing corp to pay for an environmental cleanup
    (c) – Termination of the stay
         o 362(c)(3)(A) – if individual debtor has had a prior case dismissed within prior one-year
              period, the automatic stay in second case terminates within 30 days, unless debtor can
              meet a heavy burden for showing it was a good faith filing
         o 362(c)(4) – if two or more bankruptcies have been pending in prior year, there is no stay
              in the second case unless the presumption of bad faith is rebutted
    (d) – Lifting the stay or granting other relief from the stay –
         o Court has ability to terminate, annul, modify, or place conditions on the stay
                    Ability to annul gives court ability to retroactively eliminate the stay and
                       provides grounds for finding violations of the stay are invalid (stay can be
                       retroactively lifted and actions can be made valid), but not void
         o 362(d)(4)If court finds transfers of property are part of an attempt to defraud creditors,
              court can record an in rem judgment; in that case the automatic stay does not apply to
              actions to enforce a lien or security interest for the next two years
    (h) – stay terminated if debtor who has kept property subject to a security interest with a right to
     redemption loses right to redemption by virtue of failure to redeem within statutory limits
    (k) – Willful Violation of the Stay–
         o (1) individual injured by a willful violation shall recover actual damages, attorneys fees,
              and sometimes punitive damages
         o Violations of the stay or void, voidable, or invalid (subject to judicial dispute)
    362(a) – Creating the automatic stay
         o Ensures rights of prepetition creditors are frozen in place, giving debtor’s assets a safe
         o Does not stay ALL debt collection – pursuit of post-petition claims is not stayed, but
              enforcing those claims against pre-petition assets is stayed
         o Does not stay action against pre-petition third parties (guarantors / co-debtors)
                    May stay actions against third parties when real party in interest is the bankrupt
                       debtor (e.g. where bankrupt company has indemnification clause with directors))
         o The auto stay is only a presumption – can always move to have it lifted, or move under
              105 to have the court stay an action that is not automatically stayed
    362(b)(4)
         o Embraces notion that debtor’s should not be discharged of duty to comply with

              applicable laws (doing so would effectively give the company a subsidy – value of
              company would increase because costs would assumedly drop, and would be able to
              obtain more money from a liquidation to pay creditors; thus spending money to comply
              with environmental standards is not something an organization can avoid in bankruptcy
          o   *L Requires courts to draw line between action undertaken in exercise of regulatory
              power (not stayed) and government in the role of a prepetition creditor (stayed) –

The Scope of the Automatic Stay
      To whom does the automatic stay apply: in the short term everybody, even when seems
       like it shouldn’t apply
           o Bailors (i.e. those who lend property, e.g. someone who takes close to dry
                cleaner) – typically only subject to stay for as long as it takes to identify true
                owner of property, except where leant items are necessary to a re-org
                     Plastech Engineered Products – Court would not allow bailor to retrieve
                        loaned machinery after lendee declared bankruptcy, even though lendor
                        had called back property before bankruptcy because machinery was
                        necessary to re-org
           o Third parties with right to cancel contract – when 3rd party has a general right to
                cancel a contract (e.g. an insurance policy), courts hesitant to allow businesses to
                exercises that right BECAUSE OF the signaling effects of a bankruptcy; will
                usually be allowed to terminate if can show that would have terminated absent the
      Rules of stay:
           o all proceedings to collect prepetition claims are stayed if the claims are if they are
                claims against the debtor or the property of the debtor or the estate
           o the stay is automatic; no injunction need be sought and it is immediately binding
      What is stayed (362(a)):
           o (1) – commencement or continuation of judicial or administration proceedings
                against the debtor that was or could have been brought before bankruptcy was
                declared, or to recover a claim against the debtor that arose before the
                commencement of this case
           o (2) – enforcement of a judgment obtained before the commencement of
           o (3) ANY act to obtain possession or exercise control over property of the estate
                     Appears that this provision stays cancellation of a bankrupt’s insurance
           o (4) – any act to create, perfect, or enforce any lien against property of the estate
           o (5) – any act to create, perfect, or enforce a lien that relates to that secures a pre-
                petition loan (claim) that arose before the commencement of the case
           o (6) – any act to collect, assess, or recover a claim against the debtor that arose
                before the commencement of the case
           o (8) – commencement or continuation of proceedings before the US Tax Court
                     concerning a corporate debtor’s liability for a taxable period that can be
                        determined by the court

                      concerning an individual debtor for a taxable period ending before order
                       for relief (don’t know when that is)
      Exceptions to the stay (362(b)) – most exceptions are result of special interest groups that
       have sought and obtained exceptions – most are very specific and need not be memorized
          o Most major exception is police and regulatory exception
          o Specifies that can obtain a judgment “other than a money judgment” – this means
              that in the exercise of the police or regulatory power the government can execute
              and obtain a judgment, but cannot enforce it if it is a monetary judgment
                   What qualifies as a monetary judgment is subject to dispute
                            Penn Terra Ltd. v. DOE – Requiring cleanup for environmental
                                violations is not a monetary judgment, and thus is nto stayed
                            US v. Nicolet – EPA pursuing suit for reimbursement for
                                environmental cleanup not barred (though collection would be)
      Limitations on stay – used to deal with abuse of repeated filings
          o 362(c)(3)(A) – if individual debtor has had a prior case dismissed within prior
              one-year period, the automatic stay in second case terminates within 30 days,
              unless debtor can meet a heavy burden for showing it was a good faith filing
          o 362(c)(4) – if two or more bankruptcies have been pending in prior year, there is
              no stay in the second case unless the presumption of bad faith is rebutted
          o 362(d)(4)If court finds transfers of property are part of an attempt to defraud
              creditors, court can record an in rem judgment; in that case the automatic stay
              does not apply to actions to enforce a lien or security interest for the next two
          o 362(h) – stay terminated when individual has security interest in property subject
              to a right to redemption and redemption period expires
      Termination of the Stay – governed by 362(c)

Effect of Violating the Stay [362(k)]
      Willful violations of automatic stay shall recover damages, costs and attorneys fees, and
       sometimes punitive damages
           o Creditors can protect selves by filing notice of address with court specifying
              where court should contact them to inform them of automatic stay; no punishment
              given for acts violating the stay committed before the creditor was given an
              effective notice
           o Circuits are divided on whether these damages permit for damages for emotional
           o Most courts hold that to demonstrate a willful violation, the debtor must show that
              creditor knew of the stay and intended the action that violated it
           o Circuits are split on whether k(1) applies only to natural persons, and not
              corporations, but all agree that corporations are free to petition for damages under
      Acts violating the automatic stay are invalid (Easley v. Pettibone) – these actions have
       no legal affect
           o The actions may also be considered to be void or voidable (void actions can never
              be made valid)

           o Acts violating the automatic stay can be made valid by retroactively lifting the
             stay, however this will only be done “sparingly and in compelling circumstances”
             (though some courts would apply a lower standard)

In Re Soares
The debtor fell behind on mortgage payments. The lender commenced foreclosure proceedings
and petitioned for a default order. The debtor then filed for bankruptcy, but no one notified the
state court (even though the lender knew about the bankruptcy filing and the automatic stay).
The default foreclosure judgment was entered, and the lender filed a motion seeking relief from
the automatic stay, without telling the court that it had obtained a judgment in violation of the
stay. The Debtor then sought relief in the state court on the grounds that judgment had been
granted in violation of the stay, but the court denied the motion by claiming its postpetition
foreclosure judgment was “ministerial” and thus was not subject to the stay. The bankruptcy
court then vacated the automatic stay retroactively.

H1 – The court’s action in granting the default foreclosure judgment was not ministerial. Thus
the action as only proper if it was proper for the court to retroactively lift the automatic stay.
H2 – Though courts possess some limited discretion to grant retroactive relief (implying that
violations of the automatic stay or voidable, rather than void), this should be exercised “only
sparingly and in compelling circumstances.” This was not such a circumstance.
     Basis for the holding was 362(d) – grants courts discretionary power to terminate, annul,
        modify, or place conditions on the automatic stay. The court reasoned that in order for
        termination and annulment to be given different meaning (as the court must have
        intended), annulment must grant the court the capacity to retroactively lift the stay.

The Automatic Stay and Secured Claims
      In liquidation bankruptcy – stay gives the trustee to sell the collateral and turn the
       proceeds over to the secured creditor
            o If the trustee sees no likelihood of there being equity in the collateral, it can
               abandon the property to the debtor (under 554(a)), subject to the secured
               creditor’s security interest
      Bankruptcy petition impact on secure claims under the UCC (fungible goods)
            o If creditor has not retaken possession - 362(a) stays act of secured creditors to
               enforce security interest in property, even when that right stems from UCC 9-609
               (which grants right to repossess by self-help or judicial process)
            o If creditor has retaken possession before the petition, it cannot realize on
               collateral by sale under the UCC after the petition
            o If the creditor has retaken possession and sold the collateral, the debtor has no
               right to redeem under the UCC and thus the stay is inapplicable because the
               property is no longer property of the estate
      Bankruptcy petition impact on secure claims on mortgages (not under UCC)
            o If creditor has not yet taken possession – stayed from foreclosing its mortgage
            o If creditor has retaken, but has not sold, must stop its action at any stage of the
               foreclosure process
            o If foreclosure sale completed before petition

                      If petitioner has no right to redeem (period has run) – sale completed, and
                       no action stayed
                      If petitioner has a right to redeem (redemption period not yet completely
                       run) – there is litigation about whether 362 stays the running of the
                       redemption period; appears that courts cannot stay tolling of redemption

Johnson v. First National Bank – Courts cannot toll (extend) statutory redemption periods for
real estate pursuant to their authority under § 105 after an individual declares bankruptcy.
First National had a mortgage on property owned by Johnson. The bank foreclosed on that
property and then Johnson declared bankruptcy. The Court considers whether the court can toll
(stop) the running of the redemption period.

The court held that courts cannot extend the statutory tolling period. Under the Butner
principal, property interests are defined by state law. The Court argued that since this
property interest had not been specifically altered by Congress, Congress must have meant
to maintain the state law. Accordingly a court’s general equitable power (evident in 105)
would not permit it to create a property right (right to extended tolling) for Johnson.
In reaching its conclusion that the code does not explicitly provide for extension of tolling
the court considered § 108(b) which explicitly grants a trustee additional time to perform
certain acts in certain situations. The court argued that if 362 was intended to give the
court the broad authority to extend tolling periods wherever it wanted, 108(b) would then
be superfluous (and thus 362 must not be interpreted to have this meaning).

The Affect of the Stay on 3rd Parties [362(a)]

Co-Defendants to a Lawsuit
    While 362 applies only to actions against debtors, § 105(a) gives the bankruptcy court
      broad authority to issue any order, process, or judgment that is necessary or appropriate
      “to carry out the provisions of this title”—raises questions of whether 105 can be used to
      provide relief to anyone besides the debtor
          o Lynch v. Johns-Mansville Sales Corp. – Action brought against manufacturers of
              asbestos. Two of those asbestos manufacturers declared bankruptcy, and thus
              actions against them were automatically stayed. Co-defendants (other asbestos
              manufacturers) claimed action should be stayed against them too
                   The court denied the co-defendants relief from the stay arguing that any
                      benefits to the co-defendants from the stay were outweighed by
                      countervailing interests of the plaintiffs (destruction of evidence, dying
                      plaintiffs); this is especially problematic given potentially lengthy duration
                      of the stay
          o Courts have determined that 105 can be used to stay action against non-debtors,
              but courts only apply this right in narrowly prescribed instances

A.H. Robins Co. v. Piccinin – Court can enjoin a suit against a third party pursuant to its
authority under § 105 when circumstances exist such that the action could endanger the bankrupt
estate, or would be tantamount to a judgment against the bankrupt. This will usually happen

where defendants are employees of same bankrupt corporation (and have right to reimbursement
from company), or share a common insurance policy.
A.H. Robins and key executives were sued for product liability stemming from a harmful
contraceptive device. A.H. Robins filed for bankruptcy so suit against the company was
automatically stayed. The directors moved to have the action stayed against them too, arguing
that a verdict against them would endanger the bankruptcy estate because they had a right to
indemnification from the company.

Though 362 does not stay pending against a bankrupt’s codefendants, the broad equitable
discretion afforded under 105 permits the court to stay actions against codefendants when
there is a showing that there is such an alignment of interests between the bankrupt and
the co-defendant that a finding against the co-defendant would be tantamount to a
judgment against the bankrupt. The court found that the non-bankrupt defendants’
interests were so aligned with Robins that any judgment against the co-defendants would
have come out of the same pot of funds (because the co-defendants were entitled to
indemnification and were personally listed on the insurance policy). Since depleting those
funds would have an adverse impact on the bankruptcy estate, the district court enjoined
action against the co-defendants

      Suits against a debtor where debtor is covered by insurance will only be enjoined if the
       debtor is entitled to the insurance payments, and thus insurance policy is property of the
       estate; if, under the insurance policy, only the victim is entitled to insurance payments,
       then the insurance policy is not property of the estate
           o This may be treated differently in instances where insurance proceeds would be
                exhausted by many plaintiffs, were they not first marshaled into bankruptcy

Third Parties Liable to Pay the Debtor’s Obligations [362(a)]

Credit Alliance Corp. v. Williams – Even though a debtor files for bankruptcy, action to collect
on a loan to that debtor is not stayed against a (third-party) guarantor of that loan. This usually
arises when companies take out loans guaranteed by principals of the company
Credit Alliance loaned money to a company and Williams guaranteed that loan. When the
company defaulted on the loan, Credit Alliance sued both the company and Williams and
obtained a judgment. The company then filed for bankruptcy, and credit alliance executed the
judgment against Williams so he brought a case.

The court held that Williams, as a guarantor, was not protected by the automatic stay. The
plain language of § 362 provides for the automatic stay only “against the debtor or
property of the estate,” not against guarantors, and nothing else in that section implies that
Congress intended to strip creditors of the protection they received by obtaining a

      In re Otero Mills, Inc. Exception – The court may exercise its § 105 equitable authority to
       grant a stay against obtaining property of a guarantor when that a judgment against the
       guarantor might endanger the re-organization plan of the debtor
           o In the Otero mills case, the guarantor was the principal of the company; the bank
               obtained a judgment against him; the bankruptcy court issued an injunction and
               the decision was appealed; the district court held that an injunction could issue
               only if the action would cause irreparable harm to the bankruptcy estate; on
               remand the bankruptcy court found that the action would cause irreparable harm
               because Otero would rely on Dugan’s assets in its re-organization
           o Since a personal guarantor of a corporation will often be its principal stockholder
               – guarantors should always raise the Otero Mills argument to stay actions against
               them (action will cause irreparable harm to bankruptcy estate)
           o This ruling on personal guarantees aligns with the rule for debt secured by a lien
               on property – creditor does not have an unqualified right to the property, but
               rather can be stayed from enforcing the lien if the property is necessary to a
               Chapter 11 reorganization (as long as the creditor is adequately protected)
           o Courts still disagree on the showing necessary to show that a claim against a
               debtor will harm the bankruptcy estate
                    Matter of Supermercado Gamboa, Inc. rejected the relatively lax Otero
                       approach and required a clear showing that making guarantor pay would
                       have a detrimental impact on the re-org before it would stay action against
                       the debtor

   Consensual security devices that can assure payment of debt
        o Security interest in property of the debtor (lien)
        o Third-party guarantee (guarantor)
        o Standby letter of credit from a bank – bank enters into an agreement in which it is
            essentially the guarantor of a loan
                 Usually debtor grants a security interest in property to the issuing bank
   In re Page – Even when a debtor files in bankruptcy, the creditor is not stayed from
    seeking payment on a standby letter of credit because that line of credit is not property of
    the estate and cashing the letter of credit does not “create or enforce a lien” as barred
    under 362(a)(4); though the claim will give rise to a claim by the bank against the debtor,
    that claim will not divest the debtors of any property because the bank’s claim against the
    debtor is clearly subject to the stay

Relief from the Automatic Stay for Cause [362(d)]

In Re Holtkamp – The stay can be lifted, even against unsecured creditors; the court does so at its
discretion, it considers primarily whether doing so would jeopardize the bankruptcy estate, and
then considers additional factors.
P filed a personal injury action against D, and D later filed for bankruptcy. P filed a petition to
have the stay lifted. The bankruptcy court lifted the stay as to prosecution of the suit, but not
collection. It reasoned that doing so was appropriate because the defense was being paid for by

D’s insurer, and so had no impact on D’s estate. D appealed claiming the court could not grant
relief from the automatic stay to an unsecured creditor.

The court held that it was appropriate to grant relief from the automatic stay (the lower
court did not abuse its discretion). The court reasoned that under the circumstances, the
stay did not further code policy because the litigation did not jeopardize the bankruptcy
estate-- collection was still barred by the stay and the insurance company assumed
financial responsibility for the defense. Further other considerations suggested that the
stay should be lifted—it would remove a major area of uncertainty regarding the
obligations of the estate, and it would serve judicial economy (since some of the trial had
already been organized).

      The stay is commonly lifted when it is unlikely that a judgment will endanger estate
       assets; this can be shown by:
           o Stipulating that the plaintiff will use the nonbankruptcy forum only to liquidate a
               claim and not satisfy a judgment
           o a party seeking to get a stay lifted can demonstrate an action will not endanger
               estate assets by stipulating that it will seek recourse only against an insurance
      Factors court considers in deciding whether to lift a stay:
           o Whether the issue in the pending litigation involve only state law (so bankruptcy
               expertise not needed)
           o Whether modifying the stay will promote judicial economy, and potential adverse
               impact on bankruptcy court if issue had to be litigated in bankruptcy court
           o Whether estate can be protected by requirement that creditors seek enforcement
               through bankruptcy court

Prepetition Waiver of Stay
      Though it was long the law that debtors could not waive their right to an automatic stay
       in a bankruptcy filing, an increasing number of courts are enforcing pre-petition waivers
           o Courts that have permitted waivers have generally held that they are not self-
               executing and the court considers several factors in determining whether waiver
               should be granted:
                   Sophistication of party making waiver
                   The consideration for the waiver
                   Whether other parties are affected by the stay
                   The feasibility of the debtor’s plan
                   Whether the debtor has equity in the property
      Some courts and bankruptcy authorities have taken a strong position against pre-petition

                                       Property of the Estate
§ 541 – Defines what is included in property of the estate
     (a)(1) – Estate comprised of “all legal or equitable interests of the debtor in property as of the
        commencement of the case” (except as provided in (b) & (c)(2)

§ 542(a) – Turnover of Property of the Estate
     Except as provided in other subsections, an entity in possession of property that the trustee may
        use, sell, or lease under § 363 or that the debtor may exempt under § 522 shall deliver to the
        trustee, and account for, such property of the value of such property unless it is of inconsequential

§ 363(b) & (c) – Use, Sale, or lease of Property
     (b) – After notice and a hearing a trustee may use, sell, or lease property of the estate, except for
       certain personally identifiable information
     (c) – In certain circumstances the trustee can engage in transaction, including the lease or sale of
       property without notice or a hearing and may use property of the estate in the ordinary course of
       business without a notice or hearing—this occurs if the business of the debtor is authorized to be
       operated under §§ 721, 1108, 1203, 1204, 1304
           o (2) – limitations on use, sale, and lease of cash collateral

What is Included
       Includes “all legal or equitable interests of the debtor in property as of the
        commencement of the case
            o For an individual who has filed in Chapter 7, any legal or equitable interests in
               property acquired after the commencement of the bankruptcy is not part of the
               estate, and thus is not available to pay pre-bankruptcy claims
            o Including all of the debtor’s interests in assets and excluding post-petition
               interests for Chapter 7ers further the “fresh start” policy

Consequences of Exclusion and Inclusion
       Property of the estate is the pool of assets available to satisfy a creditors’ claim
            o Property in the possession of the debtor at the time of filing that is not property of
                the estate is not subject to the claims of prepetition creditors
       Under Chapter 11 and 13
            o Debtor may retain assets during re-org (11) or rehabilitation (13), but the debtor’s
                plans must give debtors as much as they would have received under Chapter 7
       If property does not enter the estate, that property goes to another party (either the debtor
        or other creditors)—thus by excluding postpetition earnings in Chapter 7, debtor
        benefitted at expense of creditors

           o Conversely, Congress has redefined property of the estate in Chapter 11 & 13 to
             include postpetition earnings

     When debtor files in bankruptcy, trustee must gain possession of property of the debtor’s
      estate that is in possession of third parties (unless it is of inconsequential value); debtor
      achieves this through a turnover order under 542(a)
          o 363(b)&(c) empower the trustee to use, sell, or lease “property of the estate”
              (including turned over property)
     United States v. Whiting Pools – Party may be entitled to a turnover order, even though
      they no longer have a property interest in the possessed property
          o In Whiting Pools, the IRS seized the equipment of the company in lieu of back
              taxes; the bankruptcy trustee claimed for turnover; the property was worth 35K if
              liquidated, but 162K in the debtors hands; the court found turnover appropriate
              because the court determined that 541(a)(1) is inclusive, not exclusive (not a
              limitation on what is property of the estate)
                    This creates tension with the Butner doctrine, because under applicable
                       non-bankruptcy law (Internal Revenue Code), the IRS had right to obtain
                       the property as it did; this right was supplanted by bankruptcy procedures
     Issues Whiting Pools declined to decide:
          o How ruling applies to a chapter 7 case (WP was Chapter 11)
                    The trustee is entitled to a turnover in a Chapter 7 liquidation when the
                       debtor has equity in the asset; the trustee should then sell the asset and pay
                       out the amount of the secured creditor’s claim and the remainder to
                       unsecured creditors
                    Should only be done when trustee has right under 363 to liquidate the
                    Should not be done if debtor has no equity in the property
          o Pledge Situation in Chapter 7
                    Where debtor holds a promissory note that the debtor turns over to the
                       bank as security for a loan, can the trustee claim the note in bankruptcy
                       (assuming debtor has equity in it because pledge is for more than the loan)
                       – at least one court has found that turnover can be obtained

                                    Claims Against the Estate
§ 101(5) – Defining a claim
     (5) – “any right to payment, whether or not such right is reduced to judgment, liquidated,
        unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal, equitable,
        secured, or unsecured” OR
        “right to an equitable remedy for breach of performance if such breach gives rise to a right to
     (10)

§ 502(b) & (c)

Overview (Baird)
       Examines “who” gets a claim against the bankruptcy estate
            o As always, the Butner principal guides this inquiry—who has a claim is governed
               by substantive rights determined by applicable non-bankruptcy law
       How to distribute proceeds of estate – pro rata distribution (proportional), though no
        dividend of less than $5 is paid
            o Justification: approximates rights of each party, though under applicable non-
               bankruptcy law some would have recovered in full and other not at all
       Order of payments:
            o Secured creditors
            o Fees for the trustee and lawyers
            o Pro rata distribution to unsecured creditors
       Valuing disputed and unliquidated claims:
            o After the holder of the claim files a proof of claim and the debtor files an
               objection, the bankruptcy judge may conduct a streamlined trial under 502(b) and
               rule on the emrits of the case
            o Bankruptcy judge can, but is not required to fix a value on the claim, but rather
               can estimate value for the purposes of the bankruptcy, but the creditor can re-
               appear if it gets a judgment for a different amount
            o Usually disputed claims given estimate akin to present value of claim – may be
               unfair because is likely to over or under value claim; thus courts will sometimes
               estimate the value of a claim as zero—most likely to occur when the claim is
               large and the probability of success is low
       Stopped at 83

    The term “claim” describes both the obligations that will receive distros in bankruptcy,
      and the kinds of obligations that will be discharged
    Claim is defined broadly to discharge almost essentially all obligations of the debtor
    Types of claims

           o Secured – debtor’s obligation secured by a lien on the debtor’s property that
               allows creditors to proceed against the property to satisfy debts
           o Priority claims – certain unsecured claims that are granted priority over others
           o Unsecured claims – residual claims; claims that would race outside bankruptcy
      Creditor is defined as an entity holding a claim that arose “before the filing of the
       petition,” thus rights to payment that arise after bankruptcy are not “claims”

    Process
          o Debtor files for bankruptcy and fills out schedules that lists all liabilities with
            names and addresses of creditors
          o Creditors sent notice of bankruptcy
          o Creditors file a proof of claim
          o Once filed, the claim is “allowed” unless there is an objection to it
                 Only claims that are “allowed” are entitled to distribution (726(a))
    What happens if you don’t file a proof of claim:
          o In Chapter 7:
                 Individual debtor – must file a proof of claim, otherwise claim will not be
                    allowed (§ 502) and will still be discharged under 727(b); if however the
                    individual debtor fails to list your claim and you do not know about the
                    bankruptcy your claim cannot be discharged
                 Corporate Debtor – must file a proof of claim, regardless of whether your
                    claim is listed or you learn of bankruptcy because even though debt won’t
                    be discharged, corporation will dissolve and can’t collect against anyone
          o In Chapter 11:
                 Creditor must file a poof of claim ONLY IF its claim is not listed in the
                    scheduled or is disputed/contingent/unliquidated; all corporate debts are
                    discharged in Chapter 11, even if they are not scheduled, thus anyone not
                    listed or with a d/c/u claim is left out if they don’t file
    Time Limits for filing Proof of Claim
          o Chapters 7, 12, 13 – Creditors whose claims are scheduled by the debtor should
            receive notice of commencement of bankruptcy case, notice of the first meeting of
            the creditors, and a deadline to file a proof of claim (the bar date)—this date
            cannot be more than 90 days after the first meeting for the creditors [§ 341(a)]
          o Chapter 11 – 90-day rule does not apply, but rather the time within which proofs
            of claim must be filed is fixed by the court; can file after the (bar date) when
            make a motion to do so and failure to timely file was due to excusable neglect

Rights to Payment
Legal Rights
    A “claim” in bankruptcy includes future rights to payment, and uncertain rights to
       payment (“contingent” claims) (e.g. rights to payment for breaches of performance that
       have not yet occurred)
          o Thus, under bankruptcy law the value of these claims must be estimated and the
              claims are subject to discharge

      Considering contingent rights to payment to be claims creates issues; not every possible
       future right to payment is contingent and thus included in the estate and subject to
       discharge; a collection of tests have arisen to determine if a possible future right to
       payment is a contingent and thus a 101(5) claim:
           o Accrued state law claim test -
           o Conduct test – right to payment arises when conduct giving rise to the alleged
               liability occurred
           o Prepetition Relationship test – See In Re Piper Aircraft; claim exists if debtor and
               third party has a pre-petition relationship, such as contact, exposure, impact, or
               privity, between the debtor’s prepetition conduct and the claimant that gave rise to
               the right to payment
           o Piper test (modified pre-petition relationship test) – an individual has a 101(5)
               claim if
                    Events occur before confirmation that create a relationship such as
                        contact, exposure, impact, or privity, between the claimant and the
                        debtor’s product AND
                    The basis for liability is the debtor’s prepetition conduct in designing,
                        manufacturing, and selling the allegedly defective or dangerous product

In Re Piper Aircraft – Individuals with future rights to payment from a debtor have a claim
under 101(5) only if the parties have a pre-confirmation relationship, such as contact exposure,
impact, or privity that gives rise to the right to payment.
Piper was an airplane manufacturer that made defective parts and thus was subject to significant
tort liability. Piper filed for voluntary Chapter 11 bankruptcy protection and a trustee was
appointed. The trustee filed a claim for $100 Million on behalf of future claimants (claiming
they had contingent claims) based on statistical assumptions regarding the number of persons
likely to fit the definition of Future Claimants. The unsecured creditors and Piper objected to
the claim on the grounds that the rights to payment asserted for the future claimants did not
amount to claims under § 101(5) and thus could not participate in the Chapter 11 distribution
under § 101(10). Court considers whether individuals with no pre-petition relationship with
debtor have a claim under 101(5).

Court adopts the pre-petition relationship tests and holds that parties do not have a claim
under 101(5) where the party has no prepetition exposure to a product of the debtor or any
pre-confirmation relationship with the debtor that might give rise to the claim. The court
recognizes that Congress intended to define the term “claim” broadly so that all legal
obligations of the debtor would be dealt with under the bankruptcy case. On this basis the
trustee asserts that the court should adopt the conduct test—under that test the future
claimants would have claims because Piper’s prepetition manufacture, design, sale, and
distribution of defective products gives rise to their rights to payment. The Court rejects
this argument because it would stretch 101(5) too far and adopts the prepetition
relationships test. The court clarifies, however, that this test does not require that claims
are restricted to parties who can be identified prior to the filing of the petition, but extends
to those who can be identified prior to confirmation of the bankruptcy plan.

      Fogel v. Zell – Expressed doubt about prepetition relationship because seems unduly
       harsh to hold that tort victims who were unidentifiable prepetion, nevertheless had their
       claims discharged in a bankruptcy
           o Debtor sold defective piping to the city of Denver; by the time of the debtor’s
               bankruptcy a lot of the piping had burst; Denver’s piping didn’t burst until several
               years later; Posner expressed doubt that claims were discharged. He distinguished
               cases in which the potential claimants are a small, easily identifiable group of
               people—in these cases he recognized that value of claims might be estimated.
      A pre-petition relationship requires real pre-petition, contact, privity, or other
       relationship, that permits the debtor to identify, during the course of the bankruptcy
       proceeding, potential victims and thereby permit notice to these potential victims
       (Lemelle v. Universal Mfg. Corp.) – Always litigate this issue
           o Those injured in post-petition wrongful death did not have a discharged claim

Mass Future Claims in Bankruptcy (The Asbestos Cases)
   Asbestos cases have provided forum for exploring how to treat mass future claims
          o Faced with prospect of tremendous liability two major asbestos manufacturers
              filed for Chapter 11; this raised questions about the impact this would have on
              those who had no symptoms at the time of the Chapter 11 filing
          o Impact of recognizing / not recognizing a claims
                   Under Chapter 7 – non-recognition means no compensation for any injury
                      that manifests after bankruptcy; individuals unquestionably better off if
                      have a claim
                   Chapter 11 – non-recognition means claim is not discharged; so can
                      recover after bankruptcy – individuals may be better off if don’t have a
          o Because an unrecognized claim is not discharged in Chapter 11, having many
              unrecognized claims might make a re-organization impossible; so asbestos
              manufacturers wanted to stretch definition of claim (though still probably won’t
              include those who had not yet been exposed to asbestos)
   Under the Manville reorganization; Manville established a trust from which claimants
      might collect damages through litigation, arbitration, or mediation
          o Trust used to permit Manville to maximize going concern value to have maximum
              amount to pay out
          o As part of agreement, Bankruptcy Court issued an injunction channeling all
              asbestos-related personal injury claims to the trust; even future claimants are
              subject to the injunction (as long as had pre-petition exposure to asbestos)
          o In Manville, trust had to be given much more money, even though started with 2
              Billion in assets and 20% of all profits
          o Trust device has been used in other cases, including the Dalkon shield cases
   Channeling injunctions like the one employed in the asbestos cases is of questionable
          o The point of channeling injunctions is to prevent Chapter 11 re-org from being
              inhibited by lawsuits
          o In the bankruptcy code, Congress added a provision that permits channeling
              injunctions, but only in the asbestos context

       Asbestos litigation has been someone of a mess
       Due process issues with future claimants
           o In order to comply with due process, an individual must be given notice and an
               opportunity for a hearing
           o Future claims raise due process concerns because they may discharged without
               either—e.g. in the Dalkon Shield action, women were initially barred from
               recovery if they did not submit a claim by the bar date; this was later altered such
               that if they were unaware of the bar date, and didn’t know they were using a
               dalkon shield, they could still bring a claim
           o Appointing fidiuciaries for future claimants (Resolution) – to address due
               process issues, some courts dealing with mass torts appoint a representative to act
               as a fiduciary for future claimants

Equitable Rights
§101(5) – A claim includes “a right to an equitable remedy for breach of performance if such breach gives
rise to a right to payment”

§ 502(c)(2)

       When an equitable remedy constitutes a “claim” is subject to dispute
          o The apparent meaning of this language appears to be that the equitable remedy
              itself need not give rise to a right to payment, but the right to the remedy must be
              based on an obligation on which a right to payment could be based
          o Ordinarily the claimant to lose an equitable remedy because it is a “claim” can
              have it valued under §502(c)(2) as a right to payment

In Re Ward – An equitable remedy is a “claim” if a court could award damages, rather than
equitable relief under non-bankruptcy law.
The wards signed a franchise agreement with maids in which they agreed not to compete for a
period of years after cancelling their franchise agreement. When the franchise agreement
ended, the Wards began operating another cleaning service. Maids obtained a judgment against
the Wards, and then the Wards filed for bankruptcy. Maids contended that the Wards
bankruptcy filing did not affect their right to an injunction against the Wards’ competition, but
the Wards argued that Maid’s injunctive rights were a claim subject to discharge in bankruptcy.
This raised the question of when a right to equitable relief is a “claim” subject to discharge in

The Court holds that Maids’ right to equitable relief is a claim subject to discharge. The
Court held that a right to equitable relief is a claim if a court could award damages, rather
than equitable relief under non-bankruptcy law. The Court indicated that a right to
damages, rather than an injunction, is generally recognized for a breach of a covenant not
to compete, and thus Maids’ claim could be discharged in bankruptcy. The Court also
recognized that courts increasingly recognize a right to grant damages, rather than
equitable relief, where equitable relief might be due, and thus rights to equitable relief are
generally claims in bankruptcy. The Court noted that this furthers the fresh-start policy of
the bankruptcy code and the policy of favoring equality among holders of similar rights.
The Court rejects the 7th circuit’s interpretation of when a right to equitable relief
constitutes a claim: the 7th circuit concluded a right to equitable relief was a claim where a
right to payment arises from the exercise of the right to equitable relief OR any right to
payment is an alternative to an equitable remedy.

       Tests for determining if a right to equitable relief is a “claim” in bankruptcy
           o Udell Test – Construed 101(5) to mean that a right to equitable relief is a claim if
                     exercise of the right itself gives rise to a right to payment OR all right to
                        payment is an alternative to an equitable remedy
                     Appears to be the more common view
                     (under this test a right to relief is not a claim if money damages would be
           o In Re Ward Test – A right to equitable relief is a claim if a court could award
                damages, rather than an injunction to satisfy that right
                     Appears to be a minority view
           o Walt Test – A right to equitable relief is a claim if a court would award damages,
                rather than injunctive relief, even if it had the option to grant injunctive relief?
       Right to an equitable remedy for a breach of a contract to convey real estate
           o Prototypic case where right to equitable remedy found to be a claim

Determining the Amount of a Claim
§ 502
       (a) – a claim is deemed allowed unless a party in interest, including a creditor, objects
       (b) – with some exceptions, if an objection is made, the court shall determine the amount of the
        claim, and allow only that determined amount (with a few exceptions)
       (c)(1) – directs bankruptcy court to estimate the amount of a contingent or un-liquidated claim

       Bankruptcy essentially accelerates due date of all debts – so all future debts must be
        estimated so they can be included
       A claim is deemed allowed unless the debtor objects to it
       Many claims may be unliquidated or uncertain; the court must determine the amount of
        each of these claims in dollars under 502(b) (contested claims) and 502(c)(1) (contingent
        and unliquidated claims)
            o Justification – keeps some creditors from enjoying a windfall while others are
               denied recovery based on the financial status of the debtor post-bankruptcy
            o Court Options non-Chapter 11
                    Court can estimate amounts of unliquidated claims itself under 502(b)
                    Court can lift stay and permit parties to litigate claims in state court which
                       gives creditor a liquidated claim in bankruptcy
                    A personal injury tort or wrongful death claim must be tried in a federal
                       district court, rather than a bankruptcy court – apart from this, tort
                       creditors enjoy no special priority in bankruptcy (because enjoy none
                       outside of bankruptcy)
            o Court Options in Chapter 11

                      Court must determine that re-org is feasible; and in making the feasibility
                       finding, the court can make a preliminary estimation of the amount of
                       claims, but reserve final determination of value for later
           o By filing proof of claims in bankruptcy court, the creditor brings itself within the
               equitable jurisdiction of the bankruptcy court and relinquishes any right to trial by
           o 502(c) gives no hint of how court should go about estimating value of contingent
               or unliquidated claims – Collier’s suggests using “whatever method is best suited
               to the particular circumstances”
       After determine who is owed what, must determine if any party has priority for recovery

Secured Claims
§ 362(d) – lifting the stay
     (1) – the court can grant relief from the stay by terminating, modifying, or condition it “for cause,
       including lack of adequate protection of an interest in property of such party in interest”

    The amount of a claim shall be determined by the court “as of the date of the filing of the petition,
        and shall allow such claim in such amount”

§ 506(a) – Specifies that a creditor’s claim is secured to the extent of the bankruptcy estate’s
interest in the property
     An allowed claim of a creditor secured by a lien on property is a secured claim to the extent of the
        value of the creditor’s interest in the estate’s interest in the property and is unsecured to the extent
        that the value of the creditor’s interest is less than the amount of the allowed claim
     (a)(2) – If the debtor is an individual under Chapter 7 or 13, the value of the secured claim shall
        be determined based on replacement value of the property as of the date of filing without
        deduction for costs of sale or marketing. W/r/t such property acquired for personal, family, or
        household purposes, replacement value means the price a retail merchant would charge for the
        property given the age or condition at the time of valuation.

§554(a) – After notice and a hearing, the trustee can abandon property of the estate that is
burdensome to the estate or is of inconsequential value and benefit to the estate

§ 1324(a) – plan confirmation
     With some exception, the court shall hold a hearing on confirmation of the plan, and a party in
       interest can object to confirmation (e.g. because they feel they aren’t adequately protected)

       A secured claim is a right to specific property – holders have top priority in hierarchy of
       Reasons parties may not be secured:
            o Lack bargaining power to obtain secured interests
            o Deal with such high reputation debtors that security unnecessary
       Why do we allow some creditors to subordinate other creditors? This harms tort victims
        (involuntary creditors) in particular
       Entitlement of secured creditors:
            o What is secured

                      Party has a secured claim to the extent of the value of its collateral
                       [506(a)]; thus a party has unsecured claim for everything loaned above
                       value of collateral
           o Over/under securitization
                    If a secured creditor is oversecured, the trustee will sell the collateral, pay
                       the secured claim, and distribute the surplus to the undersecured
                    If secured creditor is undersecured the trustee can save expenses by
                       abandoning the property under 554(a) or agreeing to lift the stay 362(d)
           o Secured claims under Chapter 11, 12, 13 – If security kept for use in a re-
               organization; secured creditor entitled to adequate protection of rights and
               compensation for present value of secured claim
      Effect of a discharge on a secured claim
           o If property abandoned or stay lifted, it discharges the debtor from liability,
               however it does not affect the debt itself, and thus third parties who were liable
               for the debt remain liable
           o If discharged debt is secured by a lien, the lien continues to exist after the
               bankruptcy, even though the debtor may have been discharged from liability for
               the debt (Long v. Bullard); thus individual can still seize land

Valuing a Secured Claim


Associates Commercial Corporation v. Rash – When a party exercises the cramdown option in
a Chapter 13 proceeding and elects to keep secured collateral, it that collateral is valued at
replacement value—the cost the debtor would incur in obtaining similar property for a
comparable use.
Rash purchased a tractor-truck for his freight hauling business and pledged the truck as security
for the loan. Rash fell behind on payments and ultimately filed for Chapter 13 bankruptcy
reorganization. In order for the Rashs’ plan to be confirmed, it had to satisfy the requirements
of § 1324(a)—the plan could only be confirmed if1) the secured creditors approved the plan, or
2) the debtors surrender the secured property to the creditor, or 3) the debtor selects the
cramdown option. Under the cramdown option, the debtor maintains possession of the secured
property and the debtor makes payment to the creditor equal to the present value of the secured
interest in the collateral. The Rashes selected the cramdown option and generated a plan to pay
the present value of the truck’s liquidation value to the secured creditor. The creditor brought
the case seeking the replacement value of the collateral (cost to the debtor to purchase a similar

The court held that when a debtor exercises the cramdown option under a Chapter 13 plan,
the value of the collateral should be determined based on a replacement-value standard. §
506(a) provides that a creditor’s claim is secured the extent of the creditor’s interest in the
property, and “shall be determined in light of the purpose of the valuation and of the
proposed disposition or use of the property.” For cramdown this value of a secured claim
is measured by the cost the debtor would incur in obtaining similar property for a
comparable use. The Court rejected the Rash’s argument that the proper valuation was

the value to the creditor; the Rash’s argument was based on 506(a), which says that a claim
is secured to the extent of the creditor’s interest. The Court relied on the second sentence
arguing that reference to valuing based on “the disposition and use” of the property shifted
the valuation focus to how the property was being used, and use of the property by the
debtor suggests a replacement value standard. The Court argued further that holding
replacement value to be the proper measure protects the creditor’s secured interest from
decline in value of the secured property. The Court leaves to bankruptcy courts the best
way to ascertain replacement value.

       506(a)(2) has been altered since rash:
            o For individuals under Chapter 7 or 13, value of personal property securing an
               allowed claim shall be determined based on replacement value of the property
               without deductions for costs of sale or marketing
            o w/r/t property acquired for personal, family, or household purpose, replacement
               value means the price a retail merchant would charge of the property of that kind
               considering the age and condition
       506(a)(2) applies only to individuals, thus Rash is still good law for commercial cases
       § 1325(a) makes valuation irrelevant in cramdown on motor vehicles—if an individual
        has taken out a secured loan to purchase a vehicle within the last 910 days, and the
        vehicle as used as collateral, 506(a) does not apply and individual must pay the full
        amount of the claim

    Redemption permits individuals to obtain secured property that has ben seized from them
     “by paying the holder of the lien the amount of the allowed secured claim”
    Valuation for redemption (amount that must be paid to redeem) is unclear
         o Before 506(a)(2) most had embraced wholesale value, but 506(a)(2) may require
            replacement value

Avoiding Liens under § 506(d)
§ 506(d) – Voiding certain claims
     (d) – to the extent that a lien secures a claim against the debtor that is not an allowed secured
       claim, such lien is void, unless (exceptions)

       506(d) intended to preserve the Long v. Bullard rule under which liens pass through
        bankruptcy unaffected, but the wording of 506(d) has raised issues
           o On the plain language, would seem to void the unsecured portions of liens in
               bankruptcy—the unsecured portions are not allowed secured claims, and thus the
               liens should be void
           o Problems with this interpretation—allocates all risk to creditor:
                    Strip-down – creditor owes 100K on property worth 75K, but thinks it will
                       appreciate; he files for bankruptcy; if can borrow enough to redeem the
                       land at 75K, then he gets value of subsequent increase in price
                    Strip off – creditor owes 100K first lien, and 25K second lien on same
                       land; if land worth 100K, when declares for bankruptcy second lien is not

                      an allowed secured claim and thus under literal interpretation seems to be
                      stripped off; debtor thus benefits by redeeming for 100K
            o S Ct rejected lien strip-down and strip-off in Dewsnup and In Re Talbert – held
              that 506(d) just function to void liens that were not allowed (executing substantive
              decisions made elsewhere)
                   Scalia was indignant – argued that plain language warranted different
                      finding—said court was reading 506(d) to be a lien is void if it is an
                      allowed claim

Postfiling Interest on Secured Claims

    The amount of a claim shall be determined by the court “as of the date of the filing of the petition,
        and shall allow such claim in such amount”

    506(b) – allows oversecured creditor, to the extent of the value of collateral, to recover interest
        on the claim, and any reasonable fees, costs, or charges, provided for under the agreement under
        which the claim arose

       Secured Creditor
           o 506(b) – allows oversecured creditor, to the extent of the value of collateral, to
               recover interest on the claim, and any reasonable fees, costs, or charges, provided
               for under the agreement under which the claim arose
           o S Ct has held that no agreement is necessary for the recovery of interest, just for
               recover of fees, costs, etc.
           o 506(b) is silent on the rate at which interest should be paid – courts usually
               employ the contract rate for consensual security interests, but the statutory rate for
               judicial or statutory liens – doing so, however, raises some tension because it may
               challenge what would ordinarily happen under applicable non-bankruptcy law
       Unsecured Creditor
           o In Chapter 7 – postfiling interest on unsecured claims is allowed in rare case
               where debtor is solvent and all claims are paid in full
           o In Chapter 11 (see below)

Adequate Protection for Undersecured Creditors
§ 1129 – Confirmation of a Plan
     (b) – If all of the applicable subtitle of the section are met, the court shall confirm the plan when
        asked to do so if the plan does not discriminate unfairly and is fair and equitable with respect to
        each of the class of claims that is impaired under the plan and has not accepted it.

§ 361 – Defining Adequate Protection
     (1) periodic cash payments to the creditor to the extent that the stay results in a decrease in the
        value of the entity’s interest in the property
     (2) providing creditor an additional or replacement lien to the extent that the stay results in a
        decrease in the value of the creditor’s interest in the property
     (3) granting other relief, (other than administrative expense relief) that will result in the creditor

       receiving the indubitable equivalent of its interest in the property

§ 507(b)

§ 503(b)

      In a chapter 11 proceeding, the creditor is barred from seizing property by the automatic
       stay (because the property is to be used in the re-org), but the creditor is entitled to relief
       from the stay unless offered adequate protection
           o Raises question of what constitutes adequate protection—specifically, must a
               creditor be compensated for the loss resulting from delay in realizing on collateral
               (time value of an immediate liquidation)
           o This question has is subject to great debate; those who argues that individuals
               should get protection argue that creditors do not benefit from a re-org (only get
               value of security) and thus should not bear the costs of postponed realization of
               his security interest (essentially an interest-free loan to the debtor)

United Savings Association of Texas v. Timbers of Inwood – An undersecured creditor is not
entitled to receive compensation (e.g. interest) for the delay caused by the automatic stay in
foreclosing on the collateral in which it has a secured interest.
Timbers owned an apartment project on which it had taken out a loan secured by the property.
The value of the apartments was depreciating slightly and was less than the amount of the debt,
and thus United Savings was an undersecured creditor. Timbers agreed to pay United Savings
the post-petition rents from the project; though it is unclear, we can assume that this represented
the full value of the property. United Savings moved for relief on the grounds that the plan did
not adequately protect its interest in property (362(d)(1)); it sought compensation for the delay it
would face in realizing on the present value of the apartment project—specifically, it sought
interest on the present value of apartment project (the equivalent of the value if United Savings
seized the property now, as it had a right to under non-bankruptcy law, and invested it).

The court held that undersecured creditors are not entitled to receive compensation for the
delay caused by the automatic stay in Chapter 11 re-org plans. An examination of the code
reveals that the “interest in property” that must be “adequately protected” in order for the
stay to be preserved does not include the creditor’s right to immediate possession of the
collateral on the debtor’s default. Specifically, the Court considers 506(b), which permits
interest on collateral to oversecure claims, but does not mention under secured claims; this
Court interprets this to be an indication that no such protection exists. The Court
recognizes that 1129(b), which sets for the standards for confirming a reorganization plan,
grants a secured claimant the right to the “indubitable equivalent” of his collateral, but
holds that the creditor is entitled to his only upon completion of the re-org, not
immediately, and “indubitable equivalent” does not include use value of collateral.
Notably, dicta in this case specifies that an undersecured creditor should not be considered
to be adequately protected unless the Chapter 11 plan is reasonably likely to succeed within
a reasonable time; so as not to cause inordinate and extortionate delay to the creditor in
realizing on her collateral.

       In Timbers, the court declared that under 362(d)(2) that the debtor has the burden of
        showing that the collateral is essential for an effective re-org that is in prospect. This
        means that there must be “a reasonable possibility of a successful re-org within a
        reasonable time.” –
            o Before Timbers courts employed two tests under 362(d)(2)
                     Feasibility test – debtor had to show that property was necessary for a reo-
                       org and that re-org was reasonably likely
                     Necessity test – did not require a showing of reasonable likelihood of
            o Timbers seen as endorsement of feasibility test
       Adequate protection under 361:
            o Periodic cash payments (of the value of the property)
            o Additional or replacement liens (for the value of the property)
            o Other relief amounting to the indubitable equivalent of an entity’s property (of the
                present value of the property; does not include interest for undersecured creditors)
            o NOT administrative expense priority, though administrative expense priority has
                been endorsed as a back-up protection to a secured creditor who had been given
                an approved method of adequate protection that turned out to be inadequate
       Tension between 507(b) which promises “adequate protection,” and 503(b) which limits
        creditor’s recovery to benefits conferred on the debtor’s estate
       Majority view is that 507(b) permits administrative expense priority even for private
        adequate protection agreements (that turn out to be inadequate) for which no court
        approval has been obtained

Single Asset Real Estate
§ 101 – Excludes real estate projects on which debtor operates a “real” business from SARE rules

§ 362(d)(3)
     w/r/t SARE, a court shall grant relief from the stay unless within 90 days of entering Chapter 11
       the debtor can show that it has filed a re-org plan that has a reasonable possibility of being
       confirmed within a reasonable time or that it has started monthly payments equivalent to interest
       payments on the SARE; while initially this was capped, it no longer is
     (B) – payments may come from pledged rents

       Timbers rule has been limited for single-asset real estate – one large secured lender with
        an unsecured claim in real estate
            o Under 363(d)(3) – court must grant relief in a SARE case unless within 90 days of
               entering Chapter 11 the debtor can show that it has filed a re-org plan that has a
               reasonable possibility of being confirmed within a reasonable time or that it has
               started monthly payments equivalent to interest payments on the SARE; while
               initially this was capped, it no longer is
                     Interest rates based on non-default rate of interest in the mortgage and
                        current value of creditor’s interest in the collateral

        Under Timbers payments equivalent to interest should be counted against
         principal, rather than interest for undersecured creditors (but may be
         counted against interest for over-secured)
o § 101 – excludes real estate projects on which the debtor operates a “real”
  business from SARE rule

                                    Executory Contracts

§ 365

       Meaning of “Executory Contract”
            o Though term not defined; courts are very influenced by Countrman definition:
                    A contract
                    Under which the obligation of both the bankrupt and the other party to the
                    Are so far unperformed
                    That the failure of either to complete performance would constitute a
                       material breach
                    Excusing performance of the other
            o Under this definition, a contract cannot be executory if either the debtor or the
               other party has fully performed its obligations
            o The Countryman Definition of executory contract leads to some strange results:
                    If a non-debtor has fully performed, and a debtor has not performed, the
                       contract would not be considered executory; thus the debtor could not
                       assume the contract, even if it was in the debtor’s best interest (e.g.
                       because they are re-orging and need to maintain relationships with
            o Growing case law and academic writing suggests eliminating executoriness as a
               requirement for assumption / rejection, and always permitting a party to breach or
               perform as would benefit the estate
                    Thus requirements for finding a contract executory are applied
                       increasingly flexibly where such a finding would help the debtor’s estate
       § 365(a)allows a trustee in bankruptcy to assume or reject any executor contract or
        unexpired lease of the debtor
            o An executor contract is a contract with mutual unperformed obligations
            o Contracts must be assumed or rejected in their entirety—trustee cannot reject
               debtor’s performance and assume non-debtor’s performance (e.g. expect buyer to
               pay for goods, but reject shipment of goods)
       Assumption – converts the obligations of the debtor into obligations of the bankruptcy
            o If the debtor in possession/bankruptcy estate fails to perform in compliance with
               the contract, the non-debtor has right to administrative expense priority for breach
               of contract – breach treated as a post-petition breach
       Rejection – trustee decides not to perform
            o Treated as a pre-petition breach of contract; non-debtor entitled to claim for
               breach of contract and is released from obligation to perform, but claim for breach
               is as an unsecured creditor

          o Because claims are treated as pre-petition claims, estate benefits from
              economically from rejection because it will be able to pay out less than value
              obtained by estate (pay out ratably as to other unsecured creditors)
      Court’s analytical process in assessing assumption/rejection decisions
          o Determine if contract is executory as of date of filing bankruptcy petition –
              definition applied increasingly flexibly.
          o If contract is executory, court considers whether assumption/rejection was
              undertaken in bad faith in gross abuse of discretion [Trustee must obtain court’s
              approval in order to assume or reject (365(a))]
                   No statutory standards governing when court grants approval, but
                      prevailing view is that trustee’s decision to assume or reject because of a
                      belief that there is a business advantage is subject to deference akin to the
                      business judgment rule
                   Courts might reject trustee’s judgment if the contract is not burdensome or
                      if the cost of rejection to non-debtor is disproportional to benefit to the
                      estate (especially if rejection might cause destruction of non-debtor’s

Rejection and Intellectual Property
Lubrizol v. Richmond Metal Finishers – Case reaches wrong result by misinterpreting
Determining if a contract is executory – A contract is executory if there are mutual unperformed
obligations on both sides, unless the promise on one side is merely a promise to pay money.
This standard is applied flexibly—a promise to pay money and provide accounting of revenue to
the other wide is sufficient to find a contract executory.
Impact of Rejection on IP – Rejection of a licensing agreement permits the debtor to revoke the
non-debtor’s license to use the good. The debtor then has a right to sue for breach. This leads to
a questionable result (and one counter to rule around real property) because ordinarily rejection
allows the debtor not to perform future obligations, but does not allow the debtor to take back
part of the contract that have already been performed—e.g. in a contract to sell widgets, the
debtor could not take back already delivered widgets – the contract would not even be
considered executory!
Richmond licensed a metal coating process to Lubrizol. Under their licensing agreement,
Richmond was obligated to defend any patent infringement suits and notify Lubrizol of any other
licenses it issued, and Lubrizol was obligated to account for its profits and pay royalties.
Richmond then filed in bankruptcy and sought to reject the licensing agreement.

H1 – The licensing agreement was an executory contract. An unfulfilled agreement to pay
money is ordinarily not sufficient to make a contract executory. Nevertheless because
Lubrizol also agreed to account for profits, this contract was found to be executory.
H2 – The decision to reject was not an abuse of discretion. The Court determined that
rejection permitted Richmond to revoke the license it issued to Lubrizol, and there was
sufficient indication that this would be beneficial to Richmond.

      Lubrizol results for IP have been explicitly overturned in bankruptcy code—

          o 365(n) – permits licensees to retain rights in IP conveyed to them before
              licensor’s bankruptcy
          o This rule assures treatment 1 or 2 below
      Conflict in Lubrizol
          o Treatment 1: Transfers of intellectual property are often treated as exclusive
              licenses, rather than sales because the price is not fixed at the beginning of the
              transaction – thus transfers of IP may be more like actual sale than a lease
                    This would suggest permitting no rejection
          o Treatment 2: Lower court judge saw licensing agreement as a grant of a property
              right – if grantor goes into bankruptcy after conveying a property right, the grant
              might reject the executory contract, but no court would permit the grantor to
              rescind conveyance of the property
                    Thus a lessor could reject a contract in which she agreed to pay for
                      utilities, but could not evict the tenants
                    In prior similar cases, court with a similar view permitted a debtor to
                      convert an exclusive license into a non-exclusive license – this result is
                      akin to lease treatment (debtor let out of obligation not to license further
                      like let out of obligation to heat and cool)
          o Treatment 3: Appellate judge treated this not like a sale, and not like a lease, but
              further down the spectrum as an un-performed contract
                    Lubrizol goes further by treating rejection as some form of contract
                      recision – not what rejection is supposed to be!
                            National Bankruptcy Review Commission recommended
                               amending 365 to clarify that rejection does not permit debtor to
                               vaporize or nullify contract, merely to breach it

Non-Assignable Contracts

    365(c)(1)(A) – if applicable law excuses the non-debtor from accepting or rendering
     performance to an entity other than the debtor or debtor in possession; the trustee cannot
     assume or assign the contract
         o Courts have developed competing interpretations of this provision:
                 If applicable law excuses the non-debtor from accepting or rendering
                   performance to an entity other than the debtor or debtor in possession, the
                   debtor / debtor in possession / trustee cannot assume a contract over the
                   non-debtor’s objection if:
                         Hypothetical test - if the non-debtor debtor / debtor in possession
                            might hypothetically attempt to assign the contract, even if the
                            debtor / debtor in possession has no intention to do so
                         Actual test – if assumption itself would entail an assignment of the

In re Catapult Entertainment, Inc. – A debtor / debtor-in-possession cannot assume an
executory contract or lease, regardless of any contrary provisions in the contract, if applicable
law excuses the non-debtor from accepting performance from an entity other than the debtor or

debtor-in-possession, the non-debtor does not consent to such an assumption, and the debtor / d-
i-p might hypothetically assign the contract.
Catapult filed for a Chapter 11 re-org that left it as a wholly owned subsidiary of Mpath. At the
time that Catapult filed, it had 140 executory contracts and leases. Perlman objected to
Catapult assuming the executory contracts it had with him, and applicable law excused him from
accepting performance from anyone other than the debtor / d-i-p. The Court considered whether
a Chapter 11 debtor could assume the licenses over the licensor’s objections.

A debtor / d-i-p cannot assume a contract over the non-debtor’s objection (regardless of
any contrary provisisions in the contract) if applicable law excuses the non-debtor from
rendering performance to an entity other than the debtor / d-i-p and the debtor / d-i-p
might hypothetically assign the contract, even if it has no intention of doing so. The court
reaches this conclusion based on the plain language of the statute (which establishes a
hypothetical test). Under this reading, the law must be carefully crafted excuse the non-
debtor from rendering performance to an entity other than the debtor / d-i-p, rather than
generally ban assignment (otherwise, c1 would render f1 superfluous).

      Policy commentary – (c)(1) equates assumption and assignment, but assignment in an
       expansion of rights outside of bankruptcy and assumption is a mere continuation of such
       rights. Nevertheless, 365 seems to limit assumption and expand assignment.
       Hypothetical test runs afoul of bankruptcy policy:
           o Pro-reorganization policy
           o Policy that bankruptcy entitlements should mirror non-bankruptcy entitlements
           o Principles favoring equal treatment of creditors with similar non-bankruptcy
           o Additional problems with hypothetical test:
                     Often non-bankruptcy law does not outright prohibit assignment, but
                        prohibits assignment under certain circumstances – hypothetical test
                        cannot be neatly applied in this situation because whether law would
                        prohibit assignment depends on context that has not yet developed
      Actual test – courts recognizing this policy issue resolve it by applying an actual test –
       the actual test preserves assumption rights in bankruptcy
           o Under actual test, a nonassignable contract is nonassumably only where the
               assumption would amount to a forbidden assignment under otherwise applicable
      Ipso Facto Clauses – contract clauses that provide that contract is terminated on
       bankruptcy of one of the parties
           o Ipso-facto clauses are presumed invalid, except in certain instances; proponents of
               these clauses argue that the ipso-facto exception provides for a hypothetical-like
                     This argument has been rejected by at least one court, which held that both
                        the ipso-facto language and (c)(1) impose an actual test
      Assignor Liability
           o In ordinary contract law, the assignor is liable for default by the assignee

          o Bankruptcy code 365K releases the trustee-assignor from liability for assignee
             default, but 365(f)(2) provides for no assignment unless the assignee provides
             adequate assurance of performance
      Assuming contracts in default
          o Debtor cannot assume a contract in default until it has cured the default or
             provided adequate assurance it will do so promptly (365(b)(1))
                  Exceptions – Debtor need not declare defaults that result from contractual
                     terms that declare debtor to be in default on filing of a bankruptcy
          o Application to personal property leases and other executory contracts
                  Debtor is excused from having to pay penalties for default (365(b)(1)(A)
                  Debtor is not excused from any other performance related to default; thus
                     if the default cannot be cured (e.g. because it is for past non-performance),
                     the contract cannot be assumed or assigned
          o Application to real property leases
                  Debtor excused from paying penalties for default, but if a lessor of
                     nonresidential real property suffers any pecuniary losses as a result of the
                     debtor’s default, these losses must be compensated as part of the cure
                  The trustee need not cure defaults if it is impossible to do so in order to
                     assume contract

    Though (c)(1) limits the trustee’s ability to assume a contract that could not be assigned
      under non-bankruptcy law, 365(f)(1) seems to embody a pro-assignment policy
         o (f)(1) – Except as provided in other subsections, regardless of a provision in an
             executory contract or unexpired lease of the debtor, and regardless of applicable
             law prohibiting or restricting the assignment of the contract or lease, the trustee
             can assign the contract
         o Raises of issue of how to read (f)(1) & (c)(1) to be compatible

In re Pioneer Ford Sales, Inc. – 365(c)(1) prohibits assignment where applicable state law
unequivocally [prohibits assignment regardless of what the contract says]; 365(f)(1) permits the
trustee to assign a contract where a state law operates to say that a contract is not assignable as
long as the contract prohibits assignment (where state law functions to enforce the contract) [see
p. 263 #3]
Pioneer operated a Ford franchise. After Pioneer’s bankruptcy, it sought to transfer the
franchise to another car dealer. Ford objected, largely because the dealer did not maintain the
working capital that Ford required its dealers to maintain. The bankruptcy court nevertheless
permitted the assignment and Ford appealed.

The Court held that (c)(1) applied to this case, rather than f(1). The court rejected the
lower court’s interpretation that (c)(1) applies only to personal services contracts and held
that (c)(1) applies wherever applicable state law prohibits assignment in all circumstances
(regardless of contractual terms), whereas (f)(1) applies where state law prohibits
assignment only if the contract prohibits assignment. On these terms, the court considered
state law and found that it functioned as a universal prohibitor, rather than an enforcer of

contractual terms, as long as the non-debtor’s rejection was reasonable. Here the rejection
was reasonable because it was traceable to the non-debtor’s working capital requirements.

      Irony of this case is that the relevant Rhode Island statute was enacted to protect auto
       dealers from anti-assignment provisions (by requiring that they be reasonable), but
       because the legislature acted, the franchise was rendered non-assignable in bankruptcy
      Criticisms of Pioneer Ford:
           o Invites state legislatures to override bankruptcy’s pro-assignment policy to protect
               favored constituencies by writing laws that prohibit assignment regardless of what
               the contract says
           o From the policy perspective, there is no apparent justification for favoriting
               statutory restrictions on assignment over bargained-for restrictions on assignment
      Alternate interpretations of (c)(1) & (f)(1):
           o Some still hold that (c)(1) is limited to contracts for personal services and (f)(1)
               applies to everything else:
                    Magness – held a Chapter 7 debtor’s golf membership in a country club to
                       be non-assignable as a personal contract (on grounds that it was a personal
           o Bussel theory –
                    There are four categories of assignment rights
                            Contract rights are conclusively presumed assignable
                            Contract rights are presumed assignable unless contractual
                               restrictions on assignment apply
                            Contract rights are presumed assignable unless statutory or
                               common law restrictions on assignment apply
                            Contract rights are presumed nonassignable without consent of the
                               non-assigning party
                    Argues that (c)(1) prevents assignment only in the 4th category and 1st-3rd
                       are assignable under (f)(1)
                    Absence of statutory support for theory
      Juxtaposition of above law (state-law controls w/r/t anti-assignment statutes), with policy
       on ipso facto clauses (state contract laws do not apply w/r/t ipso facto clauses) raises
       question of whether there is a justification of distinguishing between the two

Period Before Assumption or Rejection
      365(d)(2) provides that in a Chapter 11, the debtor can decide whether to reject or assume
       at any time before the confirmation of the plan, but the non-debtor can request that the
       court fix an earlier time within which the debtor must decide
           o Court’s may be hesitant to set an earlier date because the trustee may not know
               whether the contract is beneficial to the estate until it knows the terms of the
      In Chapter 11 re-orgs a debtor in possession may be allowed a considerable period of
       time in which to decide whether to reject or assume. This raises many questions:
           o Is the non-debtor required to perform according to the contract during this time
           o If the debtor accepts performs, does that equate to assumption of the contract?

Matter of Whitcomb & Keller Mortgage Co. – A contractor of a bankrupt may be compelled
to continue performance of an executory contract while the debtor decides whether to assume or
reject the contract. Accepting performance does not equate to assumption.
Whitcomb had a contract with Data-Link for D-L to provide computer services to maintain
Whitcomb’s customer accounts. When Whitcomb filed for bankruptcy, and D-L realized that it
would be considered a general unsecured creditor, it discontinued service to Whitcomb. This
discontinuation paralyzed Whitcomb’s operation, and thus Whitcomb went to court to force D-L
to continue its service. Whitcomb later sought to reject the contract, and D-L sued claiming that
Whitcomb’s actions functioned as an assumption of the contract.

The court held first that D-L was required to provide services pursuant to the executory
contract after the petition was filed, but before Whitcomb had decided whether to assume
or reject the contract. The Court held next that it is not an abuse of discretion to deny a
non-debtor’s request to set a date by which the debtor must assume or reject if the non-
debtor is adequately protected for its post-petition performance (e.g. b/c it is being paid, or
because it is granted a lien/security interest in property). The Court held next that
Whitcomb’s accepting D-L’s performance did not operate as an assumption of the
contract. Finally, the court held that D-L was not entitled to administrative expense
priority from its pre-petition claim. In this case D-L was paid in full for its post-petition
services; it is unclear whether it would have been entitled to administrative expense
priority for post-petition, pre-rejection services if they went unpaid.

      If a debtor assumes an executory contract, the contract becomes a post-petition obligation
       of the estate and the non-debtor is entitled to administrative expense priority for its
       performance according to the terms of the contract, but this does not dictate that a non-
       debtor is entitled to administrative expense priority for performance post-petition, but
       pre-rejection (because acceptance of such performance is not assumption)
            o 503(b)(1)(A) dictates that administrative expense priority is allowed for “the
               actual, necessary costs and expenses of preserving the estate”
            o Obviously this standard sucks
      Alternative – the National Bankruptcy Review Commission suggest that administrative
       expense priority should be allowed to the extent that compensation would be awarded to
       the nondebtor party (for breach?) under similar nonbankruptcy circumstances
            o This would abandon the crappy benefit to the estate standard
      There are severe consequences to non-debtor parties to executory contracts who take
       unilateral actions to cease performance prior to rejection
            o Even if a contract term permits termination (e.g. because the contract contains an
               ipso facto clause, and the contract was a nonassignable agreement that could not
               be assumed), unilateral action may still violate the automatic stay and warrant
               heavy punitive fines (Computer communications, Inc. v. Codex Corp)

                    Preferences & the Trustee’s Avoidance Power

Introduction to Preferences
      Since an insolvent debtor cannot pay all debts in full, transfer of property to pay/secure
       obligations of some creditors “prefers” those creditors at the expense of others
           o This includes payment in cash, in kind, or grant of a security interest
      These payments undermine bankruptcy laws that establish rules on which creditors
       should be preferred over others:
           o Secured claims are satisfied first
           o Unsecured claims paid according to a system of priorities set in 507, and this
               scheme cannot be altered by the parties after the bankruptcy commences
      Policy considerations – Preference law balances the interest of creditor equality against
       the cost of upsetting normal transactions
      Bankruptcy law addresses these problems by voiding preferences which satisfy the
       following elements [547(b)]:
           o Transfer to or for the benefit of a creditor
           o On account of antecedent debt
           o While the debtor was insolvent
                    547(f) creates assumption that debtor was insolvent in 90 days before
                        bankruptcy – if recipient doesn’t rebut presumption, element satisfied
           o Within 90 days of the bankruptcy filing (one year for “insiders”)
           o Enable preferred creditor to receive more than it otherwise would in a Chapter 7
      Exceptions [547(c)] – burden of proof is on the recipient of the preference
      Impact of avoiding preferences – property transferred to the creditor can be recovered for
       the benefit of the estate [550(a)]
           o If the preference is a lien (either judicial lien or security interest), impact of
               avoidance means lien is nullified; this increases value of estate by amount of
               nullified lien
           o Avoidance takes place “for the benefit of the estate” – thus if a property is
               encumbered by two liens, and one is avoided that would have provided a
               monetary benefit to the non-debtor, value of that lien goes to the estate, not to
               the other lien-holder, even if the other lien-holder was not receiving the full value
               of his lien because of the competing lien

Elements of Preferences Law
      Qualifying property - Preference law applies only to the transfer of property that
       diminished or depleted the debtor’s estate [547(b)]
          o Earmarking doctrine – If debtor obtains a loan to pay creditors, and that loan is
              disbursed to the debtor (rather than directly to the creditors), the transferred

            money is not qualifying property because it never entered the debtor’s estate
            (because since the funds were earmarked for payment to creditors, they were
            never really the debtor’s funds)
                 In order to satisfy doctrine, the new creditor and debtor must agree that
                    loan proceeds are for a particular creditor
                 The earmarking doctrine is controversial and is approved by only some
   Preference Period – If the transferee is an “insider” as defined by 101(31), the preference
    period is one year; if transferee is an outsider, the preference period is 90 days
        o Some question of how to calculate the preference period: definitely don’t count
            the date of filing, if 90 day period lands on a weekend/holiday, go back to the next
   Antecedent Debt Requirement – Voidable transfers must be made “for or on account of
    an antecedent debt” [547(b)(2)]; contemporaneous exchanges for new value are not
        o Thus if insolvent debtor buys goods and pays for them at the time, there is no
        o Raises question of how much of a delay in payment makes the payment for an
            antecedent debt –
                 if the parties intend a transfer to be a contemporaneous exchange for new
                    value and it is in fact a substantially contemporaneous exchange, the
                    transfer is not a voidable preference [547(c)(1)]
   Payment Made in Ordinary Course of Business are NOT Voidable [547(c)(2)]
        o Policy Justification – preference law reflects the policy in favor of equal treatment
            of creditors;
                 reflects a concern that creditors with insider knowledge or particularly
                    great bargaining power might obtain an advantage over those without
                    similar knowledge and this may reflect a sort of fraud or unconscionable
                    benefit to the creditor over other creditors
        o In reality, most creditors paid shortly before bankruptcy are not taking advantage
            of special status, and likely do not even know debtor is distressed
                 Old Bankruptcy Act required non-debtor to have “reasonable cause to
                    believe” the debtor was insolvent for a preference to be voidable, but this
                    requirement was removed because it placed to big a burden on the trustee
                 Removing this requirement undermined the general commercial law goal
                    of certainty and finality in business transactions
                         In order to address this aim, Congress prohibits avoidance of
                             transfers “made in the ordinary course of business or financial
                             affairs of the debtor and the transferee” and “made according to
                             ordinary business terms”
                                 o Originally debtor payment had to be made within 45 days
                                     of exchange; this requirement dropped because certain
                                     industries (commercial paper) had ordinary business
                                     practice of holding accounts payable for more than 45 days

Union Bank v. Wolas – Payments made on long-term debt can satisfy the “ordinary course of
business requirement,” and thus be non-avoidable transfers under preference law, even though
the ordinary course of business requirement was developed to address the needs of short-term
creditors (those who sell on credit).
The debtor borrowed 7 million dollars from the non-debtor and later declared Chapter 7
bankruptcy. During the 90 days before filing, the debtor made two interest payments to the non-
debtor for a total of 100K. The trustee filed to recover the payments as avoidable preferences
under 547(b) on the grounds that the payments did not satisfy the ordinary course requirement
because they were made on long-term debt.

The court held that payments on long-term debt can qualify for preference exception as
“ordinary course of business” payments. The court relied on the plain text of the statute
and argued that the plain text does not distinguish between long-term debt and short-term
debt. The court also argued that the legislative history of 547 also does not support the
view that long-term debt should be treated differently from short-term debt; Congress
eliminated the requirement that payment be in exchange for a transfer within last 45 days.
The court also argued that on the policy side, 547 is designed to prevent creditors from a
race to the debtor’s assets (post-petition). The ordinary-course requirement promotes this
aim in this instance by enabling the struggling debtor to continue operating the business
pre-petition (increasingly the likelihood that creditors will be paid). (Should be noted that
policy argument is dubious because the ordinary course exception arguably encourages
creditors to seek payment from insolvent debtors)

      The ordinary course exception [547(c)(2)] can be repugnant to creditor equality in some
       cases because it may deplete the debtor’s estate
           o At least one court has said that the point of the ordinary course exception is that
              the payment does not diminish the estate because it is not for antecedent debt –
              this would suggest limiting ordinary course requirement to short-term debt
           o Wolas was a S Ct case, however

Meaning of Ordinary Course of Business
547(c)(2) prevents avoidance of transfers to the extent that they are in payment of a debt incurred
in the ordinary course of business; AND were executed in the ordinary course of business OR
made according to ordinary business terms

In Re National Gas Distributors, LLC – In order to satisfy the “ordinary business terms”
requirement, a transfer must have been made according to ordinary business terms for receipt of
a transfer in the transferee’s industry, and according to ordinary business terms for transferring
something in the transferor’s industry. The industry standards cannot characterize the industry at
too high a level of generality because that would render the subsection meaningless. Also, this
analysis should involve a consideration of standards of business in general (the substance, rather
than the form of the transaction) to see if parties are attempting to accomplish something that
would ordinarily be prohibited.
National was a purchaser and distributor of energy commodities that filed for Chapter 11.
National had several debt obligations to BB&T that were unsecured, but guaranteed by the
company owners. Before the filing National transferred 755 K to pay BB&T to pay the

outstanding balance on the line of credit, and shortly thereafter it paid 2.5 M to BB&T to pay off
a working capital note; National also transferred additional money to BB&T to collateralize
obligations related to two standby letters of credit for which the owners’ property was being held
as collateral. The trustee seeks to avoid these transfers on the grounds that they were not made
according to ordinary business terms because the owners were the true beneficiaries of these
transfer because they functioned to release the owners from obligations to pay out on

The court held first that in order to meet the ordinary business terms requirement, a
transfer must be made in the ordinary business terms of both the transferor and the
transferee. The court first holds that the transfer was not made in the ordinary business
terms of BB&T (the transferee) because BB&T stated the industry terms too broadly,
stating “it is normal for promissory notes to be paid on or a few weeks before the date of
maturity.” The court held that accepting a standard this broad would undermine the rule.
The court next held that the transfer was not made according to ordinary business terms of
the transferor because the transfer was made in order to benefit the company owner and
was made based on the owner’s end-of-the-year personal financial planning. The court
argued that corporations ordinarily do not decide to pay off loans based on the financial
planning of its owners, or in order to relieve owners of liability.

Insider Preferences
     Preferences in which an insider creditor receives payment/security from an insolvent
       corporation sinking into bankruptcy
          o Insider broadly defined; w/r/t corporations it includes affiliates, officers, directors,
              and persons in control (persons who may have superior information and may have
              the power to cause the corporation to pay them more than 90 days before the
          o If an insider guarantees a bank loan, and the bank is paid back (and thus the
              insider benefits because she is released from her obligation), the preference can be
              avoided, even though the bank is not an insider:
                   Within 90 days, the trustee can recover from either the bank or the CEO
                   After 90 days, but within a year:
                          The trustee can recover from the CEO under insider preference
                              rules (547(4)(B))
                          The trustee cannot recover against the Bank – transfers made
                              between 90 days and 1 year are avoided “only with respect to the
                              creditor that is an insider) [547(i)]

Safe-Harbors (Make Sure Have the Categorized as Such in Main)
      Subsequent Advance Rule – Preferences cannot be recovered if the creditor subsequently
       “gave new value” to the debtor that was not otherwise secured by a security interest AND
       the debtor did not make some other unavoidable transfer for the “new value”
           o This provision is designed to protect running accounts—where creditor would not
              have provided additional items to the debtor had the debtor not paid off part of her

        o When the debtor is considered to have paid/transferred to the creditor is important
            because it determines whether a creditor “subsequently” advanced something to
            the debtor; in particular, issues arise when debtor gave creditor a check and then
            creditor advanced new value
                 Date-of-delivery-view – transfer occurs when check is delivered to the
                    creditor, as long as the check is paid by the bank within a reasonable time
                         Prevailing view among circuit courts, BUT
                 Date-of-honor view – transfer occurs when the check is paid by the
                    drawee bank
                         The S Ct held that for the purposes of 574(b)(4), transfer occurs on
                            date bank honors the check (declined to decide on 574(c))
   Liens against inventory or receivables (floating liens) – Floating liens (liens on
    inventory/receivables/property that moves) cannot be avoided to the extent that the
    creditor was secured on the later of 90 days before the bankruptcy (1 year for insiders)or
    the date on which new value was exchanged and the security interest was created
        o The trustee cannot avoid a transfer that creates a perfected security interest in
            inventory, receivables, or the proceeds, except to the extent that these security
            interests are greater than the security interest on the later of:
                 90 days before the date of filing (1 year for insiders)
                 The date on which new value was given to create the security interest
        o Under this rule, it is not necessary that the items making up inventory or
            receivables be identical to the items making up the items as the prior date; only
            the volume is important –Grain Merchants
   Delayed Perfection of Liens (False Preferences) – Secret liens generally can be avoided
    as being for antecedent debt
        o Liens are treated as having been received whenever they are perfected [547(e)(2)]
        o If liens are granted as part of a mutual transfer and are perfected immediately,
            then they are contemporaneous exchanges for new value
        o however if they are not perfected immediately, then they are considered transfers
            for antecedent debt (and thus are avoidable)
                 The code worries about secret (unperfected) liens because they could be
                    used to deceive creditors into thinking that the debtor is not distressed
        o Because of concern that unsuspecting creditors might not perfect immediately
            (and thus might be caught unaware), the code permits relation back to the date of
            transfer for liens perfected within 30 days of the transfer 547(e)(2)(A), and thus
            these transactions are protected as “contemporaneous exchanges for value”
                 If 30 days has passed once perfection occurs, liens considered transferred
                    as of date of perfection
                 If liens not perfected as of the later of date of petition or 30 days after the
                    transfer, they are considered perfected immediately before the bankruptcy
   Other Protected Transfers; cannot avoid:
        o Payments made in the nature of alimony, maintenance or support [547(c)(7)] –
            this includes debts owed to governmental units that have acquired the rights to
            these payments by providing for families

           o Payments made on debts that are “primarily consumer debts” if the aggregate
               value of these debts is less than $600 [547(c)(8)]
           o Payments made on debts that are not primarily consumer debts if aggregate value
               is less than $5,475 [547(c)(9)]
      Letters of Credit – Sometimes are avoidable as preferences
           o Bankruptcy does not affect the creditor’s ability to proceed against the issuer of a
               standby letter of credit, but under preference law letters of credit sometimes may
               be avoidable when given for antecedent consideration
                     Letters of credit given as part of contemporaneous exchanges for new
                        value are not preferences
                     The buyer/debtor grants the bank a security interest in its property in
                        exchange for a standby letter of credit
                     Buyer/debtor then grants the seller/creditor a standby letter of credit in
                        exchange for seller’s goods
                     Even though the security interest granted to the bank is a transfer of
                        property for the benefit of the seller (and even if seller exercises standby
                        letter of credit), it is not a preference on account of antecedent debt, but
                        rather a contemporaneous exchange, and thus unavoidable
           o If a standby letter of credit is granted to a creditor for antecedent consideration, it
               is an avoidable preference; this rule holds even if the debtor does not transfer any
               property to the creditor, as long as the debtor transfer property “to or for the
               benefit of” the creditor [547(b)(1)]
                     Seller/creditor presses buyer/debtor for payment of antecedent debt, and
                        buyer/debtor obtains a standby letter of credit from bank, offering property
                        as security
                     If buyer/debtor does not pay and seller/creditor claims on the letter of
                        credit, the seller/creditor has obtained a preference and it is avoidable
                        (even though the buyer/debtor did not transfer any property to the creditor)
                              Even though the bank engaged in a contemporaneous exchange
                                 with the debtor, the seller/creditor did not
           o Determining who benefitted from a voidable preference is sometimes difficult:

In re Powerine Oil Co. – In determining whether a payment was a preference, the court
considers whether the creditor received more than it would have received from the estate in a
Chapter 7 liquidation—whether the creditor would have recovered from the estate a lesser
percentage than it received. A transfer in which a debtor pays a creditor and the creditor releases
a claim to a standby letter of credit does not qualify as a contemporaneous exchange for new
value if the value of the claim released by the creditor represents less than the value transferred
to the creditor by the debtor. The release of a claim against a standby letter of credit represents
less than the value transferred by the debtor when the holder of the standby letter of credit is less
than fully secured, and thus those who can claim against the letter will only receive a ratable
portion of their claims.
The debtor, Powerine, obtained a 250 M line of credit from lenders. Koch Oil agreed to sell oil
to powerine and to secure the obligation, Powerine designated Koch as the beneficiary of two
standby letters of credit. Later, Powerine paid Koch 3.2 M for the oil, but then filed for
bankruptcy. The trustee sought to reclaim the money paid to Koch.

The court first held that Koch received a preference. The court recognized that Koch did
not receive more than it would have under a Chapter 7 (because under a Chapter 7 it
would have recovered from the bank against the letter of credit), but the proper inquiry is
into whether it received more than it would have under a Chapter 7 from the estate. Since
Koch would have recovered from the bank under a Chapter 7, the 3.2 M it received from
Powerine were more than it would have recovered under a Chapter 7 from the estate. The
Court next held that only a portion of the preference was exempt from avoidance as a
contemporaneous exchange for value. The court recognized that ordinarily, the 3.2M
payment would have been a contemporaneous exchange—in exchange for the 3.2M, Koch
released a secured claim for that amount (against the standby letters of credit) and
Powerine would have received new value equal to that amount. The bank, however, was
only partially secured on the letters of credit, and thus Koch did not release claims
equivalent to the 3.2M they received. The contemporaneous exchange provision thus
protected the payment to Koch from avoidance only to the extent that the bank’s claim for
reimbursement was secured.

      Koch, Powerine, and Bank entered into a triangular standby letter of credit relationship –
       the point of the relationship was to shift the credit risk of Powerine’s insolvency from
       Koch to the bank; thus the true beneficiary of payments to Koch was the bank
           o This case results in a particularly inequitable result – the bank gets to retain the
               benefitted of the preference it received (because the letters of credit expired so
               Koch cannot claim against it), and as one of the secured lenders, also gets a pro
               rata portion of the money obtained from Koch
      After Powerine, the safest way to structure this deal for Koch is using a commercial letter
       of credit—under this arrangement the bank would have to pay up as soon as Koch
       provided evidence that it shipped the product
           o Raises question of why bankruptcy code requires would incentivize parties to use
               commercial letters of credit—there is no apparent advantage to these types of
               letters over the standby letter that would ordinarily be used because they are
               easier to administer

Citizens Bank of Maryland v. Strumpf - A creditor with a right to setoff (a creditor who is also
a debtor) is permitted to temporarily refuse to pay a debt that is subject to setoff against a debt
owed by the bankrupt without violating the automatic stay.
Setoff allows entities that owe each other money to apply their mutual debts against each other to
cancel each other out). The right to setoff is preserved in bankruptcy by 553(a), but is restricted
by the automatic stay under 362(a)(7). Effectuating a setoff requires three steps: i) a decision to
effectuate a setoff, ii) some condition accomplishing the setoff, and iii) a recording of the setoff;
thus a setoff requires that the creditor intend to permanently reduce the debtor’s property to the
creditor’s possession. Accordingly, placing an administrative hold on the debtor’s property does
not accomplish a setoff as long as it is merely a temporary refusal turn over the debtor’s property
(while the creditor seeks relief from the automatic stay), and thus does not violate the automatic

The debtor had a checking account with the petitioner and was also in default on a loan when he
declared bankruptcy. The petitioner placed a hold on the respondent’s account while it
petitioned for relief from the automatic stay. The bankruptcy court determined that the
administrative hold constituted a setoff and required the petitioner to lift the hold. The debtor
then drew down the account, and subsequently the stay was lifted, but by then there was no
money with which to accomplish a setoff. The court considers whether the hold was a setoff.

The court holds that the hold was not a setoff, and accordingly was not affected by the
automatic stay. The court reasons that the petitioner did not permanently and absolutely
refuse to pay its debt to the debtor, but only temporarily, while it sought relief from the
automatic stay. The court argues further that 542(b) of the code, concerning turnover of
property of the estate, requires debtors of the Debtor to pay to the trustee any debt that is
property of the estate except to the extent that such debt can be offset under 553 (as a
setoff). Reading 542(b) and 362(a)(7) [automatic stay] together, the court argues that
362(a)(7) cannot have been intended to accomplish something that is directly contradictory
to 542(b). Accordingly, the court finds that 362(a)(7) refers to when a setoff can be
accomplished (not during the automatic stay), but does not imply that a party cannot put a
hold on a debtor’s property.

      The court states that three steps are required to accomplish a setoff: 1) the decision to
       exercise the right, 2) some action that accomplishes the setoff, 3) some record
       evidencing the right of setoff has been exercised
           o The action that accomplishes setoff is a bookkeeping transaction that reduces the
               debtor’s accounts and credits the debtor’s loan account
           o If, however, the bank simply places a hold on an account, it continues to
               recognizes its debt to the debtor, but refuses to pay that debt. Setoff is also
               distinct from a hold in that an account with a freeze will continue to bear interest
               (to both sides the loan account and the deposit account)
      The bankruptcy code does not create a right of setoff, but brings the doctrine of setoff
       into bankruptcy; in bankruptcy this policy flies in the face of the equality of distribution
       rule—the holder of the right benefits at the expense of other creditors
           o A setoff is accorded the same favorable treatment as a security interest; 553
               recognizes a claim to setoff is a secured claim to the extent of the setoff right
      Courts distinguish between setoff and recoupment
           o Recoupment – involves netting of debts and credits to determine net liability on a
               single transaction
           o Recoupment does not require relief from the automatic stay and is not subject to
               other limitations under 553
      Triangular Setoffs
           o 553 contains a mutuality requirement – right to offset “mutual” debt
           o Explanation of triangular setoff – a triangular setoff occurs when 1) a creditor
               claiming setoff owes money to an affiliate of the debtor, rather than the debtor;
               OR 2) a creditor tries to claim setoff against the bankrupt’s affiliate, but the
               bankrupt owes money to the creditor, the affiliate does not
                    Example 1: Bankrupt owes Bank; Bank owes Party B; Party B owes
                       bankruptcy – Bank tries to claim offset against bankruptcy

                   Example 2: Bank owes Bank’s affiliate; Bankrupt owes Bank; bank tries
                    to offset against affiliates
           o Ordinarily triangular setoffs are not allowed
                 Caveat: for the purposes of setoff, all branches of the US government are
                    treated as a single entity:
                         Debtor owed SBA; Navy owed Debtor; Navy was allowed to claim
                             a setoff because Navy and SBA deemed to be the same entity
                         This erodes equality of distribution

In Re B&L Oil Company – Recoupment permits the bankrupt’s debtor to offset money it owes
to the bankrupt against money the bankrupt owes it that arise from the same transaction. A
creditor invoking recoupment can receive preferred treatment, even where setoff would not be
permitted because of concerns of equity and fairness. Because recoupment is a doctrine of
equity, courts apply the concept of the “same transaction” flexibly in order to reach an equitable
result—where disallowing setoff would permit a debtor to assume the favorable aspects of a
contract without assuming the unfavorable aspects, courts are more likely to find debts arose
from the same transaction and thus recoupment is appropriate.
B&L Oil Company had an oil purchase agreement with Ashland. Ashland overpaid B&L by
90K, and then B&L declared bankruptcy. Ashland later claimed recoupment for later oil
deliveries made post-petition. The oil deliveries were executed under the same purchase
agreement, but were not part of a larger contract. The trustee / debtor in possession asserts that
they were thus not part of the same transaction, and thus recoupment was not appropriate.

The court holds that the purchase agreement was a single contract, and thus recoupment
was appropriate. The court recognizes that since the agreement was for month-to-month
purchases, the purchases were not closely intertwined, and ordinarily a bankruptcy acts as
a cleavage in time that separates transactions. Here, however, it argues that by continuing
to deliver oil it took on the favorable aspects of the contract, and thus should be required to
take on the unfavorable aspects as well. In this case the unfavorable aspects include its
liability to repay the prior overpayment. Accordingly, recoupment is appropriate in order
to prevent giving B&L a windfall.

Fraudulent Conveyances

Actual Fraud
    State Law
           o Uniform Fraudulent Transfer Act – under state law in most states, outside of
               bankruptcy, any transfer made with actual intent to hinder, delay, or defraud any
               creditor can be avoided to the extent necessary to satisfy the creditor’s claim; if
               the creditor has already obtained a judgment, the creditor can move immediately
               to level on the assets transferred or its proceeds; functions to invalidate the
               fraudulent transfer
    Federal Law – If after a fraudulent transfer, debtor files for a Chapter 7 bankruptcy,
       federal law will apply:
              §548 – The trustee may avoid any transfer of the debtor’s interest in property that is:

               o Incurred on or within 2 years before the date of the filing of the petition
               o Made with the actual intent to hinder, delay, or defraud any entity
          §550 – To the extent that a transfer is avoided under 548, the trustee can recover the
           property transferred or, of the court prefers, the value of the property from:
               o The initial transferee
               o Any immediate or mediate transferee of the immediate transferee
               o In a chapter 11, the debtor in possession exercises the trustee’s rights to avoid
                   fraudulent transfers under §1107(a)
          §541(a)(3) – property recovered under 550 becomes property of the debtor’s estate
           available for distribution to claimants
        o Two year provisions extended to 10 years for transfers to trusts
   Defining “actual intent to hinder, delay, or defraud” – because of practical difficult of
    obtaining evidence of the debtor’s intent, courts have identified indicia that indicate
    fraudulent intent:
        o 1) insider relationships between parties, 2) retention of possession, benefit, or use
           of the property, 3) the lack or inadequacy of consideration for the transfer, 4) the
           financial condition of the party sought to be charged before and after the
           transaction, 5) the existence or cumulative effect of the pattern or series of
           transactions or course of conduct after the incurring of the debt, 6) the general
           chronology of events under inquiry, 7) an attempt by the debtor to keep the
           transfer a secret , 8) shifting of assets by the debtor to a corporation owned by him
   Differences between state law under UFTA and Federal Law under the bankruptcy code
    (fraudulent transfer law & use of UFTA):
        o In bankruptcy, the victim of a fraudulent transfer loses the right to satisfy
           judgment out of the fraudulently transferred property (rather it goes back into the
           estate), and the victim’s judgment is discharged
        o In bankruptcy, 548(a) allows trustees to avoid fraudulent transferred only within
           the two years prior to filing, but the SOL for UFTA is four years
                 The trustee can utilize the UFTA four year provisions under 544(b)(1),
                    which grants the trustee derivative rights of creditors under UFTA
           §544 – The trustee may avoid any transfer of an interest of the debtor in property that is
           voidable under applicable law by a creditor holding an unsecured claim that is allowable
                 The trustee can fall back on UFTA because there will always be at least
                  one unpaid creditor at the time of bankruptcy
               The action of a trustee in avoiding a transfer under UFTA is not just for
                  the benefit of creditors who would have been able to set aside the transfer
                  under state law, nor is the avoidance power limited to the amount of these
                  creditor’s claims, but rather the entire transfer is set aside for the benefit of
                  the estate Moore v. Bay
   Who can sue to set aside the transfer:
      o On plain language, on the trustee or debtor in possession can sue to avoid a
          fraudulent transfer
      o Because of lack of incentive for debtor-in-possession to act to avoid transfer,
          courts have permitted creditors’ committees to pursue recovery for the benefit of
          the estate

          o This was declared by the Third Circuit to violate the plain meaning of 544; on
            rehearing, the Third Circuit reversed after insistent urging because fraudulent
            transfer law is useless without a means of enforcement

Constructive Fraud
    Introduction
          o Constructive fraud is a basis for avoidance under both UFTA 4(a)(2) and
             548(a)(1)(B) – UFTA requirements are roughly the same
              §548(a)(1)(B) – UFTA requirements are roughly the same
                  Bankruptcy Code Constructive Fraud Requirements – a trustee can avoid a
                     transfer or obligation by proving:
                         o The debtor received less than reasonably equivalent value in exchange
                              for the transfer or obligation, AND
                         o That on the date the transfer was made the debtor was (choose 1):
                                    Insolvent or rendered insolvent by the transfer
                                    Engaged in or was about to engage in business or a transaction
                                       for which any property remaining with the debtor was
                                       unreasonably small capital
                                    Intended to incur debts beyond the debtor’s ability to pay as the
                                       debs matured
                                    Was made for the benefit of an insider under an employment
                                       contract that is not in the ordinary course of business
                         o Constructive fraud applies without regard to intent
                     Constructive fraud provisions have had a significant impact on common
                      business transactions necessitating a determination in every case of
                      whether transferor is receiving reasonably equivalent value and will be
                      rendered insolvent
                   The rationale behind the provision is that if a sale is made at a bargain
                      price, the debtor may intend to confer a benefit on the buyer
                   If debtor is not trying to favor the buyer, the interests of the debtor and its
                      creditors coincide so deals reached in arm’s length transactions should be
                      for reasonably equivalent value (suggests that if court determines that
                      parties negotiated at arms length, then price received is reasonably
                      equivalent value)
      Religious and Charitable Contributions
          o In re Young – permitted the trustee in a Chapter 7 case to avoid charitable
              contributions made to the bankrupt’s church
          o In response Congress passed the Religious Liberty and Charitable Donation
              Protection Act – added
              §548(a)(2) – A contribution to a religious or charitable entities cannot be avoided as long
                   The contribution does not exceed 15%of the debtor’s gross annual income for the
                     year in which the transfer was made (there is no statutory limit on the number of
                     these transfers), OR
                   Even if it does exceed that amount, the contribution is consistent with the
                     debtor’s past practices with respect to making charitable contributions
          o The absence of the number of 15% gifts guts avoidance for contributions to
            charities with some exceptions:

                     Obligations to make charitable gifts in the future
                     Since actual fraud language is unchanged, presumably donations by a
                      debtor who attempted to gut estate through donations could be avoided as
                      actual fraud
                   Law makes no reference to preference law, so presumably if transfer made
                      within 90 days and can be characterized as being on account of antecedent
                      debt, it is arguably avoidable
      Insider Transfers or Obligations under Employment Contracts
               548(a)(1) permits the trustee to recover payments made to insider under employment
                contracts by showing:
                    o Services rendered by the employee were not reasonably equivalent value of the
                        transfers or obligations, AND
                    o That the transfers or obligations were not made in the ordinary course of
           o Under this provision, the trustee can prove constructive fraud without proof of the
             insolvency of the debtor
           o Unclear what impact this will have on bankruptcy law – trustee has difficult task
             of proving that contract was so excessive that at the time it could not have
             amounted to reasonably equivalent value
           o Unclear how to establish that transfers are not in the debtor’s ordinary course of

BFP v. Resolution Trust Co. – By definition, the amount received through a foreclosure sale is
“reasonably equivalent value” for the purposes of the fraudulent transfer provision, as long as the
sale has been conducted in accordance with state foreclosures laws; accordingly such a transfer
cannot be avoided., as long as all requirements of state law have been complied with.
Conversely, any irregularity in the conduct of the sale permits the transfer to be avoided if the
price received was not reasonably equivalent value—the price that would have been received if
the foreclosure sale had proceeded according to law.
The petitioner owned a home subject to a deed of trust. When the petitioner went into default,
the creditor scheduled a properly noticed foreclosure sale. The home was purchased, but the
petitioner alleges the home was purchase for grossly inadequate consideration (well below fair
market value).

The court recognizes that 548 sets forth the powers of the trustee to avoid constructively
fraudulent transfers. In order to avoid a transfer, one must show that the debtor 1) had an
interest in property, 2) that she transferred within one year of filing, 3) that the debtor was
insolvent or because insolvent as a result, and 4) received less than reasonably equivalent
value. In assessing reasonably equivalent value, the court recognizes that though the code
refers to fmv elsewhere in the code, the plain language does not require fmv. Moreover,
the court argues that fmv is not applicable in a forced-sale context because fmv presumes
certain selling conditions, and a forced sale alters those conditions. Property that must be
sold within a certain time frame is worth less than property sold in an ordinary market.
The court recognizes that it might instead require a fair forced sale price, but argues that
there is no justification for that in the code. Accordingly, the court holds that as a matter

of law the amount received a foreclosure sale is reasonably equivalent value unless the
price is so low as to shock the conscience.

549(c) allows the trustee to avoid post-petition transfers of property of the estate unless the transfer was
     Exception – transfers to good faith purchasers of real property without knowledge of the
        commencement of the case and for fair equivalent value cannot be avoided
       Lower courts dispute the extent of the holding in BFP; the holding has been found to
           o Courts have generally limited BFP to situations where the transfer involved the
               forced sale at public auction pursuant to statutes requiring opportunity for
               competitive bidding
           o To foreclosure sales of personal property collateral under the UCC
           o Local government tax sales
           o The UFTA adopts the irrebuttable presumption rule and applies to both real and
               personal property foreclosures

Corporate Distributions as Fraudulent Transfers
    There is sometimes overlap between fraudulent transfer law and corporate law limiting
      the extent to which distribution can be made to equity holders
          o A distribution by a corporation might violate both corporations and fraudulent
              transfer law, or just one of them—when it applies to both, remedies may be
                   Corp Law Rules (in most states)—in order to recover illegal payments
                      (payments that impair capital) from a stockholder, ordinarily, the s/h must
                      be charged with notice of the illegal payments
                   Bankruptcy Law—If the payments not only impair capital, but are paid by
                      an insolvent corporation, corporate assets have become a trust fund, and
                      recipient of those assets takes them with whatever trust they were subject
                      to in the hands of the donor; accordingly they can be recovered from s/hs
                           There is some state- by-state variation over whether payouts to s/hs
                              that impair capital, but are made by a solvent corporation may be
                              avoidable under the UFTA
                           Judge Hand implied that even payments that impair capital may
                              fall under the UFTA; the UFTA does not recognize innocent
                              receipt of a gratuitous fraudulent transfer as a defense (as most
                              corporate law does); thus recovery may be permitted under UFTA,
                              but not under state corporate law
                           At least California resolves this issue in favor of UFTA

Robinson v. Wangemann – Repurchases of a corporation’s stock are equivalent to paying out
dividends to s/hs. Corporate distributions are assessed under ordinary fraudulent transfer
provisions (548- reasonably equivalent value, made when debtor insolvent). In assessing
corporate fraudulent transfers, the relevant point of time is when cash is actually paid out for the
shares, not when the shares are purchased for a note (subject to dispute amongst states). Thus if
the corporation becomes insolvent while the debtor holds a note, the s/h does not have an

allowed claim (or presumably if the corporation paid out while it was insolvent, the transfer
would be avoidable pursuant to fraudulent transfer laws).
S/h sold shares to corporation. At the time the corporation was solvent, but instead of paying the
s/h, the corporation issued a note to him. Periodically the note was renewed, but was not cashed
in and eventually the corporation became insolvent. The trustee then claims that the s/h’s claim
should be disallowed.

The court holds that the s/h claim must be disallowed. It holds first that a stock re-
purchase is akin to a dividend (because the corporation does not receive anything, but
merely pays out s/h equity). Accordingly, share repurchases are reviewed under ordinary
transfer avoidance laws. While under corporate law, the court would consider whether the
s/h acted in good faith (was aware of the insolvency of the corporation), the bankruptcy
code does not require that the s/h be aware of the insolvency of the corporation. Moreover,
the court recognizes that when the corporation transferred the note to the debtor, it was
solvent, it holds that the corporation must have sufficient surplus to protect creditors when
the payment is actually made.

      The purchase of a corporation’s own shares is economically indistinguishable from a
      There is never “fair consideration” in the sense of the UFCA when a corporation
       distributes to s/hs because the corporation receives nothing that debtor’s could levy on
           o Same rule has been extended to partnerships in Buncher Co v. Official Committee
               of Unsecured Creditors
      Statutory response to Robinson has varied – it seems counterintuitive that the
       enforceability of the note should depend on the financial condition of the time the note is
       paid, rather than the time the note is given
           o California – the time of any distribution by purchase or redemption of shares shall
               be the date cash or property is transferred (encourages s/h to demand cash), except
               where corporation repurchases shares by issuing the s/h a debt obligation that is
               an investment security of a type commonly traded in securities markets
           o Model Act – validity of a distribution by purchase, redemption, or other
               acquisition of a corporation’s shares shall be measured as of the earlier of:
                    The date money or other property is transferred or debt incurred by the
                        corporation OR
                    The date the s/h ceases to be a s/h with respect to the shares

Reasonably Equivalent Value in Corporate Transactions
In re Northern Merchandise, Inc. – Presents the indirect benefit rule—in order for an entity to
be considered to have received “reasonably equivalent value,” the benefit to the debtor can come
from a party other than the party to which the debtor transfers value. Thus, a corporation
receives reasonably equivalent value when it transfers a security interest to a creditor in
exchange for a loan to the corporation’s s/h who then transfer the money directly to the
corporation (because the creditor will not loan to the corporation. In assessing whether a
bankrupt corporation has received reasonably equivalent value, the courts look to the substance
of the transaction, not merely the form of the transaction.

The debtor corporation attempted to procure a loan from Frontier for $150K. Frontier
determined that the corporation’s performance did not support an additional loan, but agreed to
loan the money to the corporation’s shareholders. In exchange, the corporation granted
Frontier a security interest in its assets and Frontier transferred the money directly to the
corporation. The trustee sought to avoid the transfer of the security interest on the grounds that
the corporation did not receive reasonably equivalent value. It reasoned that the 150K was
loaned to the s/h, and they gave it to the corporation, so it was a capital contribution and the s/h
received nothing for the transfer.

The court holds that the corporation received reasonably equivalent value. It recognizes
the indirect benefit rule which specifies that “reasonably equivalent value can come from
one other than the recipient of the payments.” In other words, a debtor may receive fair
consideration, even though the consideration for his property goes initially to a third party.
The court rejected the argument that the 150K was a capital contribution on the grounds
that such an interpretation would be an overly formalistic interpretation of the transaction.

      In several cases courts have recognizes that subsidiaries of a debtor/corporation may
       receive reasonably equivalent value for their guarantees, even if the benefit derived from
       the guaranties was indirect (but there must be a real benefit to subsidiaries)
           o In some instances, this requires that the benefits must be quantifiable and
              compared to the amount of obligations incurred or the property transferred under
              the guaranty
           o One court has held that the synergistic business relationship between the parent
              and the subsidiary was a substantial indirect benefit to the subsidiary
           o This economic benefit is assessed as of the time the investment is made, not later
              when the deal turns sour (essentially if it appeared ex ante as though the affiliate-
              guarantor received a benefit)
           o Example – bank loaned money to parent company / debtor who secured it with
              cross-corporate guarantees in the assets of subsidiaries; parent invested money in
              something of significant benefit to the subsidiaries so court found that there
              subsidiary received reasonably equivalent value

Leveraged Buyouts
    General Rule – Assess LBOs under fraudulent transfer law like you would assess
      anything else under fraudulent transfer law – look to the substance of the transaction , not
      the form, to determine if the Target received reasonably equivalent value, and if one of
      other conditions is met; if fraudulent transfer law unavailable, consider try under UFTA
          o In assessing the substance of the transaction, whether the lender and target s/hs
              were aware financing arrangement may be relevant to determining if substance of
              transaction was an unequal exchange
    When a company purchases another company in an LBO, and the target company
      subsequently files for bankruptcy, it raises fraudulent transfer questions because the
      target company receives no reasonably equivalent value (benefit goes to acquirer) and
      target probably insolvent or made insolvent by the transaction; examples:

           o Bootstrap financing – Target s/h sells to acquirer and takes a security interest in
             Target’s assets; potential constructive fraud because Target does not receive
             reasonably equivalent value (must still meet one of other conditions)
           o Acquirer borrows from bank and gives Target assets as security interest for the
             loan; potential constructive fraud because Target does not receive reasonably
             equivalent value (must still meet one of other conditions)
           o Target borrows from bank; bank gives money to Target in exchange for security
             interest in Target assets; Target then loans the money to acquirer to pay out Target
             s/hs in exchange for a security interest in acquirer property – courts look to
             substance of transaction, rather than form: in United States v. Tabor Court Realty
             Corp. court permitted avoidance under fraudulent transfer law because the Bank
             knew when it was loaning the money that it was really loaning it to the acquirer

Bay Plastics v. BT Commercial Corp. - In assessing LBOs, apply the ordinary fraudulent
transfer provisions, or if unavailable apply the UFTA. In order to state a claim in bankruptcy
under the UFTA one must allege: 1) the debtor made a transfer, 2) without receiving reasonably
equivalent value, 3) while in financial distress (insolvent, unreasonably small capital, debt
beyond ability to pay), 4) that the transfer (could be) attacked by a pre-transaction creditor (pre-
petition creditor exists, within SOL). In assessing reasonably equivalent value, look first to the
form of the transaction; transactions should be collapsed (look to the form of the transaction) if
the case is brought on behalf of a pre-petition creditor or is brought by a post-petition creditor
and it appears from the evidence that the s/h knew or should have known that the buyout was an
LBO. In assessing whether a transaction rendered a debtor insolvent (financial distress
component), the bankruptcy code adopts the balance sheet approach—a debtor is rendered
insolvent if liabilities exceed assets when based on a fair valuation (not historic cost, get rid of
intangibles like good will). The good faith defense under the UFTA is not available for
constructively fraudulent conveyances.
Acquirer agreed to purchase Bay Plastics. In order to finance the transaction, the acquirer took
out a loan secured by the assets of Bay Plastics and paid the proceeds to the shareholders. The
selling shareholders (closely held corporation) were aware of the financing arrangement and
agreed to sell the company anyway. Subsequently the corporation declared bankruptcy. By
taking out the loan the corporation became insolvent (though on its balance sheet it appeared to
remain solvent because it recognized the purchase of good will to offset its liability. There is at
least one creditor who would be able to bring a claim under the UFTA. Bay Plastics’ owes
Shintech 3.5M in new debt, which was secured until Shintech was convinced to release the
security interest because of the good credit of the acquirer, but shintech was unaware that the
Target was purchased with an LBO.

The court recognizes that in order to state a claim for a violation of the UFTA, one must
state a claim that 1) the debtor made a transfer or incurred an obligation, 2) without
receiving reasonably equivalent value, 3) while the debtor was in financial distress (debtor
is insolvent or rendered insolvent, the transfer leaves the debtor undercapitalized, or
debtor intends to incur debt beyond ability to pay), 4) which is attacked by a pre-
transaction creditor. In assessing whether the debtor received reasonably equivalent value,
look first to the form of the transaction. Even if it appears in form that the debtor received
reasonably equivalent value (like here, debtor received a loan in exchange for a security

interest), the court will collapse the transaction (look to the substance) if the case is brought
by pre-petition creditors or there is evidence that the s/h knew or should have known the
transaction would deplete the assets of the company (knew the buyout was an LBO). The
court then concludes that Bay Plastics did not receive reasonably equivalent value because
it gave a security interest worth 4M and 3.5M of the loan went to s/hs. The court next
holds that the transaction rendered the debtor insolvent (the debtor was in financial
distress) because its liabilities exceeded its assets after the transaction. The court
recognizes that bankruptcy applies the balance sheet approach to determining insolvency,
but requires adjustment to a fair valuation of assets (not historic cost). The court holds
finally that the action is attacked by a pre-transaction creditor. The courts holding
amounts to a holding that the s/h effectively defrauded creditors by sucking money out of
the corporation and transferring risk of LBO leverage to creditors. The court recognizes
that the UFTA imposes a good faith defense, but the good faith defense is not available for
a constructive fraudulent conveyance.

      LBOs that escape fraudulent transfer attack under court reasoning?
           o Legitimate LBO where debt incurred does not exceed equity
           o LBOs where cash flow is sufficient to make debt payments (either because of
              sufficient capitalization or good luck)
      Insolvency – no matter how sophisticated the structure of the LBO, one must assume that
       a bankruptcy court may look through the form of the transaction and conclude there was
       no reasonably equivalent value
           o Lenders and s/hs are never safe in an LBO unless the target corporation can pass
              all tests of solvency:
                    Bankruptcy Code insolvency test 548(B)(ii)(I) – Balance sheet test
                    UFTA/ state law insolvency test (applicable in bankruptcy when trustee
                       exercising powers under UFTA) – Equity test: debtor insolvent when
                       unable to pay debts as they become due (short term liabilities greater than
                       short-term assets)
                    Bankruptcy Code Unreasonably Small Capital 548(B)(ii)(II) – debtor left
                       with unreasonably small capital because lacks capital to pay for short-term
                       outlays or projected cash flow in future insufficient to meet future
      The innocent shareholder defense – 548(c) protects transferees or obliges who take for
       value and in good faith against avoidance
           o This should not protect s/hs in an LBO because they did not give value to the
              debtor corporation, but rather gave value to the acquirer (in the form of stock)
           o Some courts have imposed an innocent s/h defense if s/hs can distance themselves
              from LBO transactions
                    546(e) provides that the trustee cannot avoid transfer made as a settlement
                       payment to a financial institution –courts disagree on whether this blocks
                       avoidance where s/hs have sold stock in LBO through a financial
                            The purpose of 546(e) is probably to protect securities markets
                               from disruptions caused by major bankruptcies- this purpose is not
                               served by application to private LBO transactions

     Special Defenses for Counterparties to Swaps, Derivatives, Repurchase Agreements, and
      Other Financial Contracts
         o There has been tremendous pressure on wall street to protect financial engineering
             products from bankruptcy, especially from the automatic stay and avoidance
         o Application: even if the face of a constructively fraudulent conveyance, the
             trustee cannot avoid a transfer that occurred through the securities market? Get
         o 546(e) was the initial means by which this was accomplishes, but many
             provisions have emerged that accomplish the same thing—the gist is that those
             who deal in complex financial instruments are entitled to enforce the terms of
             their contracts in accordinace with otherwise applicable nonbankruptcy law,
             without regard to the auto stay, avoidance powers, etc.
              546(e) – The trustee may not avoid a transfer that is a margin payment or settlement
              payment made by or to a commodity broker, forward contract merchant, stockbroker,
              financial institution, financial participant, or securities clearance agency
          o While initially these special provisions were relegated only to complex financial
            instruments, they have expanded in ways that have caused issues—
          o 546(g) protects swap agreements – the 2005 code updates expanded the definition
            of a “swap agreement” and thus expanded the area protected from bankruptcy
                 Fourth Circuit found no statutory requirement that swap agreement be a
                    contract of a type that is traded in financial markets or that it must not
                    involve physical delivery of a commodity—the court did not, however,
                    provide any further elucidation on what DOES qualify as a swap
                 this opens up the possibility that all commercial contracts could be
                    protected from bankruptcy as swap agreements

Strong-Arm Powers
      §544(a)(1) – The trustee shall have the rights and powers of, or may avoid any transfer of the
      property of the debtor or any obligation incurred by the debtor that is voidable by a creditor that
      extends credit to the debtor at the time of commencement of the case and obtains a judicial lien
      on all property on which a creditor on a simple contract could have obtained a judicial lien,
      whether or not such a creditor exists
     544(a)(1) – the trustee acquires the status of a hypothetical judicial lien creditor under
      state law; trustee can avoid encumbrance on property that would be voidable by a judicial
      lien creditor under state law (unperfected security interests in personal property)
          o Exception: 546(b) & 362(b)(3) allow perfection after bankruptcy to defeat the
              rights of the trustee in cases where applicable bankruptcy law allows relation back
              for perfection
          o Article 9 permits creditors to take security interests that a debtor owns or will
              acquire in the future; 544(a)(1) can be used to attack and invalidate such security
              interests when they are unperfected – the effect of avoiding a security interest in
              bankruptcy is to relegate the secured creditor to the status of an unsecured creditor
                    Perfection under article 9 is usually done by filing an appropriate
                      financing statement
     544(a)(3) – gives trustee the powers of a bona fide purchaser of real estate

           o Ordinarily, under state law, judicial lien creditors defeat unperfected security
              interests in personal property, but not in real property—an unrecorded mortgage
              on real property has priority over a subsequent judicial lien; conversely an
              unrecorded mortgage may not be enforceable against a bona fide purchaser for
              value (depends on notice state or race state)
           o 544(a)(3) permits trustee to invalidate unrecorded mortgages if under non-
              bankruptcy law they would invalidated by a bona fide purchaser for value
      Strong-arm powers are directed at invalidating secret liens

Knowledge of the Trustee in Bankruptcy
McCannon v. Marston – 544(a)(3) specifies that the trustee takes the rights of a bona fide
purchaser for value “without regard to any knowledge of the trustee or creditor.” This phrase
does not remove a notice requirement in state law—state law determining that a bona fide
purchaser does not take title if she had notice of the previous sale is preserved in bankruptcy.
Under constructive notice, a bona fide purchaser (and thus the trustee) does not take property
from a prior purchaser who is in clear and open possession of the real property (was living in it).
A woman entered into an agreement in which she purchased a condominium complex, but never
recorded her title to the property. The seller later went into bankruptcy and pursuant to its
rights as a bona fide purchaser, attempted to reclaim the property from the woman. Under
pertinent state law a bona fide purchaser takes possession only if she did not have notice of the
prior purchase. The court considers if 544(a)(3) eliminates this notice qualification.

The court holds first that, even though the security interest was not perfected, the woman
provided constructive notice by exercising full and open possession of the property. The
court next holds that 544(a) does not invalidate the relevant state-law notice qualification.
Rather, the 544(a) language was intended to address concerns that a trustee with actual
knowledge of unperfected security interests in personal property would not be able to avoid
those security interest, but there seemed to be no relevant reason for avoidability of
unperfected security interest to turn on the trustee’s knowledge.
           o The reason congress was concerned about the trustee’s inability to avoid transfers
               if she had knowledge of them is that in Chapter 11 cases, as a debtor in
               possession, the trustee will always have knowledge of these security interests

      Summary of current law from 544(a) a debtor in possession (Chapter 11) or a trustee
       (Chapter 7) can avoid an unrecorded mortgage if a bona fide purchaser could take free of
       the unrecorded mortgage
      544(a)(3) provides that the trustee takes the position of a bona fide purchaser of value
       who has perfected the transfer – this permits the trustee to take possession of the property
       in race states

Property Held by Debtor as Nominee or Trustee
    Impact of 544(a)(1) on property over which the debtor has nominal ownership, but no
      beneficial interest (e.g. where debtor holding property to invest for somebody else):
          o Property in which debtor holds legal title, but not an equitable interest becomes
             property of the estate only to the extent of the debtor’s legal interest 544(d)
          o There is some conflict between 544(a)(1) and the intention expressed by 544(d):

                      Option 1 – Avoidance depends entirely on 544(a)(1) – if a judicial lien
                       would defeat the claim of the beneficial owners, then trustee can avoid any
                       claims of the beneficial owners;
                            Option adopted in Belisle v. Plunkett – investors left with only
                              unsecured claims against the insolvent debtor
                            Variation on Option 1 – property in which legal interest is held by
                              debtor but beneficial interest is held by someone else is a
                              constructive trust; a constructive trust is a judicial remedy, and
                              thus cannot apply as of the commencement of a bankruptcy case;
                              thus beneficial owners cannot claim an equitable interest in the
                              property as of the commencement of the case, and 541(d) does not
                              limit the trustee’s ability to avoid their interest in the property
                              under 544(a)
                      Option 2 – other courts have relied on 541(d) to limit the scope of the
                       strong-arm power

Begier v. Internal Revenue Service – The trustee cannot avoid payments of funds held in trust
for an entity, even if those payments otherwise qualify as avoidable preferences. Money
collected in taxes creates a trust at the moment of those payments, not when put into a special
account for payment. There is no statutory guidance on tracing those funds; thus a debtor’s act
of paying its obligation is sufficient to establish that any money paid to satisfy those obligations
was satisfied by the funds held in trust. Reveals a two-step analysis process; in order to prevent
avoidance it must be established: 1) that was there a trust, 2) that the funds paid out were paid
from the funds held in trust.
American International Airways was a commercial airline. As an airline it was required to
collect excise taxes from its customers. When the airline fell behind on its obligations, the
service required it to establish a separate bank account to keep those funds separate. The airline
paid its obligations for the next few months, but eventually went into Chapter 7. The trustee
sought to avoid payments made in the 90 days preceding the bankruptcy.

The court holds first that money collected by the airline for taxes is held in trust—tax
money is held in trust from the moment collected, not the moment paid or segregated into a
special account.. The IRC specifically provides that whenever an entity is required to
collect a tax, the amount collected is held in trust for the United States. On the basis of this
language the court determines that it is irrelevant whether those funds are segregated into
a special account. The court proceeds to consider whether the funds paid were those held
in trust. The court recognizes that statutory language offers no guidance in how to trace
those funds (in order to determine if money paid to satisfy tax obligations was the money
held in trust). Accordingly, the debtor’s voluntarily paying its trust-fund obligation is
sufficient to establish the requisite nexus between the funds held in trust and the funds paid
to assume that the funds paid were from the trust fund. Thus the trustee cannot avoid
voluntary payments to satisfy the debtor’s tax obligations.

Equitable Subordination and Substantive Consolidation

Equitable Subordination

Claims of Insiders
    The bankruptcy code authorizes courts to subordinate claims and interests “under
      principles of equitable subordination,” but does not fully explain equitable subordination
    Case on overview of where equitable subordination applies; equitable subordination
      appropriate where:
          o The creditor has engaged in inequitable conduct; including, but not limited to:
                   Fraud, illegality, and breach of fiduciary duty
                   Undercapitalization
                   Claimant’s use of debtor corp as a mere instrumentality or alter ego
          o The misconduct has resulted in injury to the creditors of the bankrupt or conferred
              unfair advantage on the claimant, and
          o The subordination is not inconsistent with the bankruptcy act
          o Who can bring a claim:
                   Some cases have held that creditors can prosecute equitable subordination
                      actions against other creditors without bankruptcy court permission
          o Most equitable subordination cases concern activities of fiduciaries or insiders
              (officers, directors, or controlling stockholders) – their dealings are closely
    Recharacterization – Creditor is deemed not to have a legitimate claim, but rather to have
      only an ownership interest in the corporation. Accordingly, the investor’s debt is re-
      characterized as equity (and thus functionally that investor’s claims are relegated to
      residual claims on property behind all unsecured creditors)
          o Factors for determining when debt should be re-characterized as equity:
                   The absence of notes or other instruments of indebtedness with stated
                      payment schedules and interest rates
                   Expectation of payment depends solely on the success of the borrower’s
                   Inadequacy of capitalization is evidence that advances intended as equity
                   Stockholders make advances in proportion to their respective stock
                   Absence of security
                   Debtor’s inability to obtain outside financing
                   Use of advances as working capital to meet daily operational needs
          o conceptually different from equitable subordination, but also occasionally relied
              on to subordinate or disallow insider claims – some courts disclaim power to
              recharacterize absent inequitable conduct
    Parties will often seek both equitable subordination and re-characterization
    Where equitable subordination / re-characterization might be appropriate:
          o Insider loan money to a corporation and take a security interest in the
              corporation’s assets – depends on the court, some would fine this to be a
              contemporaneous exchange; others would see the unavailability of other financing
              as sign that insider behaving inequitably
          o Equitable subordination particularly likely where insider loan money to
              corporation and take a security interest, but don’t perfect interest until after have

               secured additional loans from other parties unaware of security interest – this seen
               as inequitable conduct
    Undercapitalization: defined by Posner as “excessive leverage”
           o At least one case has determined that undercapitalization alone is not sufficient to
               justify equitable subordination, but rather equitable subordination requires
                    Debtor finds itself unable to make payments
                    In order to allow debtor to stay in business until economy improves,
                       insider makes periodic cash advances to debtor
                    When insider gives up on debtor and puts it into Chapter 11, unsecured
                       creditors try to subordinate insider’s claims on the grounds that the
                       business was under-capitalized
                    Rejects undercapitalization as grounds for equitable subordination on
                       grounds that creditors are aware of risk and are free not to lend when a
                       loan seems too risky; rather creditors lend money because return justifies
                       risk posed – thus should not be able to claim equitable subordination to
                       mitigate because have already been compensated for risk
Claims of Noninsiders
    Claims arising between debtor and insider are closely scrutinized, but if creditor is not an
       insider, the evidence must be much more egregious in order for equitable subordination
       to be permitted
    Where a creditor exercises sufficient control over decision-making of a debtor, the
       creditor may be held accountable under a fiduciary standard, and thus may have claims
       subject to equitable subordination
    In order to obtain equitable subordination for a non-insider, must show:
           o The creditor so dominated the will of the debtor to the detriment of other creditors
               that his claim should be relegated to an inferior status. Indicia of control (In re
               American Lumber):
                    Bank has right to a controlling interest in debtor’s stock in the event of
                       default of certain loan obligations
                    The bank placed debtor within its coercive powers by refusing to honor its
                       payroll checks and by foreclosing on its security interest in the debtor’s
                       only source of cash
                    The bank forced compliance with its wishes by imposing such harsh
                       measures as: forcing termination of employees, drastically reducing
                       salaries, coercing security agreements on remaining assets, and
                       determining which of debtor’s creditors would be paid
           o Cases suggest that a non-insider creditor will be held to a fiduciary standard only
               where ability to command debtor’s obedience is so overwhelming that there has
               been to some extent a merger of identity (alter-ego)—creditor’s allowed to exert
               significant control over financial decisions as a condition of lending money
                    Court permitted equitable subordination where creditor required debtor to
                       change attorneys and accountants, and participated in board meeting of
Matter of Clark Pipe & Supply Co. – Equitable subordination for insiders is assessed under the
same three-prong standard as for insiders. A lender is permitted to exercise some level of control

over creditors without incurring equitable subordination. The court attempts to distinguish
proper levels of control from control in which the lender acts inequitably to his own benefit or
exercises so much control as to have essentially replaced the decision-making authority of the
lender. The lender’s exercise of control in accordance with a contract negotiated at arm’s length,
is an indication that the creditor does not exercise the requisite level of control, even if the
creditor uses that contract to put a tight leash on the debtor in an attempt to maximize the
creditor’s payout.
The debtor negotiated an agreement with the creditor under which the creditor would make
revolving loans secured by an assignment of accounts receivable and inventory. Under the
agreement, the debtor was required to deposit all accounts in the creditor bank. The amount
that the lender would supply was determined by a percentage formula, but the creditor was
permitted to reduce the percentage advance rate at will. When the debtor’s business declined,
the creditor begin reducing the advances to just enough that the creditor could keep his doors
open, sell inventory, and increase the creditor’s security interest, but not enough to pay
suppliers. When the debtor’s Chapter 11 was converted to a Chapter 7, the trustee attempted to
obtain equitable subordination.

The court overturns the lower court’s award of equitable subordination. The court
recognizes that the creditor acted entirely in accordance with the its loan agreement and
the agreement was negotiated at arm’s length. Moreover, it recognizes that the creditor
exercised much less control over the operations than in cases where equitable
subordination has been allowed. Notably, the creditor did not mislead other creditors into
continuing to supply the debtor, and did not coerce the debtor into giving it a security
interest after it became insolvent. The court distinguishes between the leverage given to the
creditor here, and the total control necessary for equitable subordination.

      Role of contract in equitable subordination for outsider – in above case, court relied on
       the fact that control exerted in accordance with a contract entered into at arm’s length
           o In another case, court reaffirmed this rule, and argued that equitable subordination
               requires breaking of a promise (in accordance with a contract) PLUS some effort
               to take advantage of that (e.g. by using it as leverage to negotiate for a better
           o This rule holds even if court finds creditor would have been secured in extending
               loan to debtor (because assessments of security must be made ex ante)
      Equitable subordination can be granted with respect to only one creditor (e.g. because
       only one of many creditors was misled by subordination –creditor)

Substantive Consolidation
    Overview
          o Under this doctrine, assets of several affiliated corporations are pooled in
             bankruptcy and claims against each of the corporations are treated as claims
             against the consolidated assets
                 Creditors of a debtor-corporation with a higher asset-to liability than the
                     affiliated entity will lose (and visa-versa); thus the doctrine is invoked
          o No code provisions specifically authorize substantive consolidation

      In re Owens relevance: provides restrictive view of substantive consolidation; binding in
       Delaware (where most corporations based)

In re Owens Corning – In considering whether to permit substantive consolidation courts
should consider the motivating principles behind it: 1) courts should respect separateness absent
compelling circumstances (because creditors rely on it), 2) the harms addressed by substantive
consolidation are those caused by debtors who disregard separentess, 3) mere benefit to
administration of the case is not a harm necessitating substantive consolidation, 4) because
substantive consolidation is extreme and imprecise, the remedy should be rare, 5) substantive
consolidation may not be used offensively (as a tactic employed by a creditor to alter / improve
its rights). In order to prove substantive consolidation, the proponents of it must show either that
i) prepetition the debtors disregarded separateness so completely that their creditors relied on the
breakdown of entity boarders and treated them as one legal entity, or ii) postpetition their assets
and liabilities are so scrambled that separating them is prohibitive and hurts all creditors. A
prima facie case for substantive consolidation exists when a proponent proves i) disregard
creating contractual expectations that they were dealing with debtors as one indistinguishable
entity, AND 2) that proponents actually and reasonably relied on debtors’ supposed unity.
Opponents of consolidation can defeat the prima facie case if they can prove they are adversely
affected by consolidation and relied on debtors’ separate existence. Seeking a deemed
consolidation may be evidence that consolidation is not warranted (because if financial structure
was such a shame before the file, then doesn’t make sense that structure stays undisturbed after

      Alternate standard for substantive consolidation (applied in other courts):
           o 1) there is substantial identity between the debtors, AND
           o 2) consolidation is necessary to avoid some harm or realize some benefit
      The most common use of substantive consolidation is when it is consensual among the
       parties, in which parties agree on the distribution of value among the parties
           o Deemed consolidation – affiliates are considered as consolidated for the purposes
               of valuing creditor claims, but it does not result in the merger of affiliates or
               comingling of their assets; typically used in consensual consolidation cases
      Since Owens Corning another court has found that substantive consolidation is not
       limited to cases where no objecting creditor is prejudiced, but rather restricted its inquiry
       to whether prepetition debtors disregarded separateness…(In re Lisanti Foods)
           o Unclear then how courts will come out; should still do full analysis, but note that
               part of it may not be necessary
      In spite of court’s emphasis that substantive consolidation should be rare, it is used with
       quite a bit of frequency, often in Chapter 11 cases in which consolidation is merely
       deemed (so affiliate structure preserved post-bankruptcy) – contradicts reasoning in
       Owens Corning
      Substantive consolidation may provide a basis for attacking bankruptcy remote
       vehicles—Subsidiaries to which principles transfer assets in order to obtain low-rate
       secured loans (or issue low-rate bonds)
           o In In re LTV Steel – court considered transfer of assets to bankruptcy remote
               vehicle as not a true sale – so creditors of principal could get at assets
           o Debtors could also attack under substantive consolidation

        Certainly if principal hides the existence of such a vehicle in order to
         obtain loans, it seems like the court might permit consolidation.
o Also, bankruptcy remove vehicle might itself be forced into a bankruptcy


Managing the Estate—Obtaining Credit, Using Collateral and Selling Assets

Administrative Expenses

In re Jartran, Inc. – A claim will be afforded administrative expense priority under 503 if: 1)
the debt “arises from a transaction with the debtor in possession,” and 2) “is beneficial to the
debtor-in-possession in operation of the business.” Services provided post-bankruptcy pursuant
to obligations incurred pre-bankruptcy (in a pre-bankruptcy contract) do not “arise from a
transaction with the DIP,” and thus do not qualify for administrative expense priority. In
determining whether an obligation arises pre-petition, consider the closing date for the contract.
Administrative expense priority is intended to provide incentive for creditors to do business with
the debtor-in-possession; those who are contractually obligated to do business with the debtor-in-
possession need so such encouragement.
Jartran entered into a contract with an advertising agency to place advertisements about
Jartran’s company in telephone directories. The agreement provided that Jartran would be
billed for the ads only after they were published. Before the ads were published, Jartran
declared bankruptcy; the advertising agency sought administrative expense priority for its post-
bankruptcy services. Jartran argues that it satisfies the language of 503(b)(1)(A) which permits
administrative expenses for “the actual, necessary costs and expenses of preserving the estate,
including . . . for services rendered after the commencement of the case.”

The court denies the creditors administrative expense priority to the creditors. It
recognizes that the policy underlying 503 is that if a reorganization is to succeed, creditors
must be given priority as an incentive to furnish the needed credit. Moreover, finding that
the creditors do not get administrative expense priority is not unfair to the pre-petition
creditors because it is for their benefit that the re-organization is attempted.
The court applies a two-part test in determining if administrative expense priority is
appropriate. It concedes that the agreement is “beneficial to the DIP in operation of its
business.” It holds, however, that the debt does not arise from a transaction with the
DIP—the DIP did not induce performance because the closing date for the contract that
settled the agency’s obligation occurred pre-petition.

Operating the Business from Petition to Confirmation
      Introduction:
           o In a re-organization, needs of the debtor to use its assets collide with the rights of
              secured creditors to collateral
           o 363(c) permits the debtor to use all property of the estate (except cash collateral),
              as long as it is acting in the ordinary course of business

           o Interests of secured creditor are safeguarded by 363(e) which instructs court to
               “prohibit or condition use, sale, or lease of the property of the estate as is
               necessary to provide adequate protection of “ the secured creditors’ interest in
           o The rights of unsecured creditors protected by court’s ability to convert a chapter
               11 to a Chapter 7 if there are “substantial and continuing” losses or bad
      Use of Deposit Accounts and Other Cash Collateral
           o Whether DIP can continue to use collateral in which creditors have a security
               interest is usually decided under 362 (not 363) when creditors move for relief
               from automatic stay
                    Judicial inquiry probably the same under either provision—whether the
                       secured creditor has “adequate protection [362(d)(1)]
           o W/r/t cash collateral, the burden is on the debtor to obtain court authority to use
               the property, rather than on debtor to seek to limit its use [363(c)(2)]
                    Court can condition use on adequate protection
           o Since business can operate only a few days without cash; application for use of
               cash usually one of DIP’s first steps
                    Options: a) can get consents from creditors with security interests in bank
                       accounts, b) can present court with request to use cash collateral
                    Courts have attempted to regulate relief available through disclosure
                       requirements of controversial provisions in cash collateral agreements
      Sale or Lease of Property in Ordinary Course
           o Under 363(c)(1) a DIP can sell or lease property of the estate without court
               approval if done in the ordinary course of the debtor’s business, but ordinary
               course is not defined in Bankruptcy Code; Court commentary on term:
                    “ordinariness” is the interested parties’ reasonable expectations of what
                       transactions the DIP is likely to enter in the course of business
                             As long as transactions so limited, creditor has no right to notice
                               and hearing because there is no right to notice and hearing where
                               DIP merely exercising Chapter 11 privilege to operate the business
                             If creditors want relief, must petition for relief from stay
                               [362(d)(1)] or dismissal of Chapter 11 petition [1112(b)]
           o Thus “ordinary course” language allows debtor to continue to operate with no
               notice to creditors and no court authorization

Obtaining Credit
   Critical Vendors
          o Obtaining cash collateral may not be sufficient to keep a Chapter 11 debtor going,
             debtor may need credit; often their suppliers will refuse to continue extending
             supplies to them without receiving some cash payment
          o Accordingly, first day motions seeking relief often include motion for
             authorization to obtain “debtor-in-possession financing” from a lender institution
             under 364, and motion to pay certain prepetition debts to “critical vendors”
                  “critical vendor claims to employees and customers often go
                    unchallenged, by payments for ordinary prepetition trade claims are

                       questionable – Next case considers legality of critical vendor payments
                       and how to determine vendors are critical:

Matter of Kmart Corporation – Critical vendor payments are not permissible where there is no
evidence in the record and no possibility that the class of disfavored creditors will benefit. In
order for critical vendor payments to be approved, the petitioner must prove, and not just allege,
that 1) but for the immediate full payment, vendors would cease dealing, and 2) that the business
will gain enough from continued transactions with the favored vendors to provide some residual
benefit to the remaining, disfavored creditors, or at least will leave them no worse off.
Kmart received permission on the first day of its bankruptcy to pay in full all “critical vendors.”
Kmart used this authority to pay in full prepetition debts to a bunchy of creditors from DIP
financing. The claim is brought by the disfavored creditors who received 10Cents on the dollar
in the re-organization (mostly in Kmart stock).

The court recognizes that section 105(a) allows a bankruptcy court to “issue any order,
process, or judgment that is necessary or appropriate to carry out the” code. This right
does not, however, give a judge the right to redistribute rights in accordance with a
personal view of fairness. Accordingly, the critical vendor payments are permissible only if
necessary to carry out some other provision of the code. On this point the court considers
363(b)(1) which permits the DIP use, sell, or lease, property of the state other than in the
ordinary course.” Reading this statute to do as little damage as possible to the rest of the
code, it does not authorize a judge to re-shuffle priorities among creditors.
The court then applies the criteria mentioned in the rule. On the vendors will cease dealing
point it points out that some critical vendors will continue to do business with the debtor
out of obligation (e.g. because of long-term contracts). The court also recognizes that
payment in full to creditors was not the only way to protect creditors’ to support continued
dealings with the debtor. Kmart could have put part if its credit behind a standby letter of
credit on which unpaid vendors could draw for future purchases.

      Reorganizing debtors typically seek special treatment for three types of creditors at the
       beginning of a Chapter 11: employees, customers, and suppliers
          o Employees – bankruptcy courts routinely allow ordinary course payments to
               employees, at least to the extent of the wage and benefit priority under
               507(a)(4)&(5) (assuming reorganization impossible if essential employees not
          o Customers – unsecured claims of customers who have paid in advance, have
               returns or allowances coming to them are generally permitted
      After this case, critical vendor payments are more narrowly drawn, but practice has
      Reclamation
          o BAPCA sharply improved the position of trade vendors, regardless of whether
               they qualify as “critical vendors” by:
                    creating an administrative priority in favor of vendors for the value of all
                       goods shipped to a debtor within 20 days of the bankruptcy filing (whether
                       or not have reclamation right) 503(b)(9)

                      reclamation rights preserved from state law (available for goods shipped
                       within 45 days of filing under UCC, subject to claims of secured creditors
                       and good faith purchasers for value); this expansion of reclamation rights
                       could effectively undermine limitations on critical vendor status
Rights of Administrative Claimants
    In order to operate business between petition and confirmation, the DIP may need to
       borrow money or buy things on unsecured credit
    If the credit is obtained in the ordinary course, no approval required under 364(a),
       otherwise court approval required under 364(b)
    If credit obtained in ordinary course or pursuant to court approval, the authorized credit is
       an administrative expense under 503(b)(1)
    I) If admin expense priority won’t induce creditor to grant credit to DIP, II) 364(c) allows
       court to authorize:
           o 1) super priority – priority over all administrative expenses
           o 2) A lien on any unencumbered property of the estate
           o 3) A junior lien on property already encumbered
           o If still no one willing to grant credit, 364(d) permits courts to authorize a lien
               senior or equal to an existing lien on property of the estate, so long as adequate
               protection given to holder of existing lien
    Rights on overturning lower court decision – if bankruptcy court issues order authorizing
       DIP to incur debt, and during an appeal the DIP incurs that debt, the reversal or
       modification of the order (from the appeal) does not affect the validity of the debt or
       priority lien unless incurring of the debt/granting priority or lien was stayed pending
       appeal under 364(e)
    364 creates opportunities and risks:
           o Any creditor who receives less than a security lien is taking risk that it may not be
               paid back; but even a post-petition secured lender may find its position changed
               by cts

General Electric Credit Corp v. Levin & Weintraub – Ordinarily, expenses incurred for the
preservation of disposition of property obtain administrative expense priority and thus do not
achieve priority over secured creditors. Under 506(c), expenses incurred in preserving or
disposing of a secured creditor’s collateral can be recovered from the secured creditor.
Accordingly, if and only if expenses are incurred for the preservation or disposition of
property primarily for the benefit of a secured creditor, the expenses can be charged
against the secured creditor. The claiming creditor has the burden of proving that their fees
were incurred for the benefit of the secured creditor.
Flagstaff filed a petition for reorganization, and as permitted continued to operate as DIP.
GECC had been financing Flagstaff’s operation for years. Under the Chapter 11, Flagstaff was
authorized to borrow more money from GECC, secured by a super-priority interest in present
and future property of the estate. GECC extended additional credit to Flagstaff, but the
reorganization ultimately failed. The bankruptcy court awarded attorneys fees from the
encumbered collateral worth 70% of the amount claimed.

The court holds first that on plain language, GECC has priority over L&W. GECC was
granted a super-administrative priority, and L&W’s services had ordinary administrative

priority (pursuant to section 330 permitting administrative expense priority for services
provided by attorneys). Accordingly, the court holds that any fees payable from GECC’s
collateral must be for services which were for the benefit of GECC, rather than the debtor
or other creditors; the court makes this conclusion based on 506(c) which permits the DIP
to recover expenses from secured parties when it expends money to preserve or dispose of a
secured creditor’s collateral. The court holds here that the benefits provided by the
attorneys did not benefit GECC. The court also rejects the argument that GECC impliedly
consenting to bearing L&W’s costs.

      Under current practice financing orders commonly approve negotiated “carve outs” that
       grant priority to a limited amount of professional fees for the debtors’ and creditors’
       committee’s professionals; the size and terms of carve outs are often among most
       contentious issues in negotiations
      Confirmation of re-org plan requires payment in full of all administrative expenses under
       1129(a)(9) so as long as lenders prefer to exist through a re-org, rather than a chapter 7,
       admin claimants retain significant leverage
      The berth of 506(c) and the GECC rule is still subject to interpretation:
          o Narrow reading – “the DIP must show that its funds were expended primarily for
               the benefit of the creditor and that creditor directly benefited from expenditure”
               (later GECC case)
          o Broad reading – preservation of going concern value can constitute a benefit to a
               secured creditor under 506(c) (In re McKeesport)

Hartford Underwriters Ins. Co.v. Union Planters – Only a trustee can bring a claim under
506(c) to recover from the secured creditor for services that benefitted the secured creditor. On
the plan language of the provision a creditor cannot independently initiate such an action.
Hen House entered a Chapter 11 and its primary creditor agreed to loan it an additional 300K
to help finance its reorganization. During the reorganization it obtained workers comp
insurance from Hartford. Hen House repeatedly failed to make payments, but Hartford
continued to provide insurance anyway. Hartford then attempted to charge the premiums to the
secured creditor pursuant to 506(c) (providing “the trustee may recover from property securing
an allowed secured claim the reasonable, necessary costs and expenses of preserving or
disposing of . . . the secured creditors’s property.”

The court recognizes first that since the plain language of 506(c) permits only the trustee to
bring a claim, the petitioner bares a particularly high burden for demonstrating that it is
appropriate for a third party creditor to bring a claim under 506(c). Its reference to pre-
code practice is not sufficient to overcome this burden. Moreover, the court rejects the
suggestion that public policy necessitates that third parties creditors be allowed to pursue
compensation under 506(c) because the trustees might lack the motivation to pursue this
payment. First, the court notes, that the trustees have certain fiduciary duties which
protect 3rd party creditors. Further, 3rd-party creditors who provide services that benefit
the secured party have other protections—they can insist on cash payment or contract
directly with the secured creditor.

      The court declines to decide whether other interested parties (e.g. creditors committees)
       can pursue recovery under 506(c), subsequent cases raised issue:
          o Third circuit – code provides bankruptcy courts authority to designate official
              committees as estate representatives for purpose of prosecuting lawsuits

Rights of Prepetition Creditors
    The debtor’s choice of a Chapter 11 plan dictates that prepetion creditors will receive no
       payment on claims until the debtor’s reorg plan is confirmed—often years or months
       later; moreover amount they receive may be much less than would have been under Chap
           o One of reasons for decreased value of prepetition claims is ballooning
               administrative expenses – creditors have no voice in determining what admin
               expenses are approved
           o Limitations on admin expenses: Plan cannot be confirmed unless all admin
               expenses can be paid in cash as of day of confirmation; before admin expenses
               get so high that it seems unlikely that debtor will be able to pay in full; prepetion
               creditors should request conversion to Chapter 7
    Prepetition secured lenders are in better position, but under 364(d) may find lien
       subordinated and protected only by “adequate protection” requirement
           o Example – In Re Swedeland; debtor received approval for borrowing 4M more
               dollars secured by liens senior to the liens of an undersecured creditor; court
               granted order on the basis that they had adequate protection because the land was
               likely to increase in value with the 4M expense; though court of appeals reversed,
               credit already granted had the senior lien pursuant to 364(e)

    Cross-collateralization – creditor with a pre-petition claim grants postpetition credit as
      long as he is given a lien on assets of the estate that secure not only the postpetition
      credit, but also the prepetion credit

Matter of Saybrook Manufacturing Co. – Cross-collateralization is not a permissible means of
obtaining post-petition financing. 364(e) precludes overturning debts incurred only when those
debts are authorized under 364.
Saybrook filed a motion for use of cash collateral. The bankruptcy court entered an emergency
financing order under which a pre-petition creditor would lend an additional 3 million in
exchange for a security interest for its pre-petition and post-petition claims. The creditor’s
previously unsecured 24M of prepetition claims became fully secured. Prepetition unsecured
creditors appealed, but their appeal was denied as moot under 364(e) because they failed to
obtain a stay. They then appealed again.

First, the court rejects the argument that the appeal is moot under 364(e). Under 364(e)
reversal on appeal of an authorization does not affect the validity of any debt incurred
pursuant to the authorization unless such authorization was stayed pending appeal. The
court holds that 364(e) precludes taking away a security interest granted under 364(c) / (d)
only if the challenged lien or priority was authorized under 364. Accordingly, it must
determine whether cross-collateralization is authorized. The court holds that cross-

collateralization is not authorized under 364. It notes first that cross-collateralization is not
specifically authorized. Moreover, it is also beyond the scope of the bankruptcy court’s
equitable power because it is directly contrary to the fundamental priority scheme of the
bankruptcy code.

      Judicial resistance to cross-collateralization has resulted in increasing reliance on “roll-
       ups” which attempt to achieve same thing; original roll-ups (the creeping roll):
          o Senior secured creditor that had extended working capital loans pursuant to a
               revolving credit agreement
          o If creditor willing to advance fresh working capital on same basis post petition
          o Parties can agree (subject to court approval) that repayments are credited to
               prepetition claims while new advances are post-petition loans
          o This improves the secured creditor’s position: creditor ends up with postpetition
               loans that are immune from avoidance and restructuring as admin expenses
      New, more aggressive, roll-ups:
          o Secured creditors have sought advantage of roll-ups by offering postpetition
               financing on condition that prepetition secured term loans be refinanced into
               unavoidable postpetition loans
          o Courts sometimes permit these , but otherwise limit the ability of the debtor to
               restructure indebtedness under a re-org plan

Sales Not in Ordinary Course: Partial Liquidation
    If a DIP wants to sell or lease property other than in the ordinary course, it can do so after
       a notice and a hearing [363(b)(1)]
    Under 1123(b)(4), a Chapter 11 plan may provide for liquidation of all or part of the
       estate, but the plan is subject to acceptance by holders of claims and interests
    Is there a potential conflict between these provisions

In re Lionel Corp. – The court holds that there must be “some articulated business justification,
other than appeasement of major creditors, for using, selling or leasing property out of the
ordinary course” before the bankruptcy code can order such disposition under 363(b). This
requires that a judge determining a 363(b) application expressly find from the evidence presented
before him at the hearing a good business reason to grant such an application. In making this
determination, the judge should consider “all salient factors” pertaining to the proceeding and act
to further the interest of the debtor, creditors and equity holders alike. He might consider (a non-
exhaustive list): 1) the proportionate value of the asset to the estate as a whole, 2) the amount of
time elapsed since the filing, 3) the likelihood that a plan of reorganization will be proposed and
confirmed in the near future, 4) the effect of the proposed disposition on future plans of
reorganization, 5) the proceeds to be obtained from the disposition vis-à-vis any appraisals of the
property, 6) which of the alternatives of use, sale or lease the proposal envisions, and 7) whether
the asset is increasing or decreasing in value. The burden is on the debtor of demonstrating that
use, sale or lease will aid the reorganization, but an objector bears some burden for producing
evidence to support its objections.
Lionel Corp and its subsidiaries filed joint Chapter 11 petitions. Lionel’s most important asset
was an 82% ownership of common stock in Dale. Under 363(b) it applied to sell this stock
“other than in the ordinary course,” and soon after filed a plan of reorganization conditioned on

the sale of the stock. Following objections the bankruptcy court approved the sale without
making any formal findings. It noted simply that the Creditor’s committee’s insistence on selling
provided sufficient cause to sell. Public shareholders appealed claiming that sale prior to
approval of the reorganization deprived equity holders of the Bankruptcy Code’s safeguards.

Here the court offered no business justification for approving the use of the asset.
Moreover, the appellant met its burden of supporting its objections by showing that the
sale was premature because the stock was not a wasting asset, that there was no emergency.

      Section 1123(b)(4) states that a plan may “provide for the sale of all or substantially all of
       the property of the estate and the distribution of proceeds “
           o Raises question of why a debtor would prefer liquidating under Chapter 11 then
               under Chapter 7:
           o By liquidating under a plan, the equity interest holders of an insolvent debtor are
               likely to do better in retaining some property than under 363 sales – though after
               property is reduced to cash, distribution must generally follow Chapter 7 priorities
           o 363 sales may primarily benefit secured creditors; in recognition of this some
               bankruptcy courts condition 363 sales in Chapter 11 on approval of unsecured
               creditors committee – allows unsecured creditors to take some money out, though
               if they try to take too much, will just liquidate through Chapter 7
      In re Braniff – debtor and certain secured and unsecured creditors agreed to a sale of a
       major part of Braniff’s airline assets under 363(b) conditioned on several provisions.
           o Court rejected the transaction as an attempt to force a re-organization through an
               asset sale, and thereby eliminate Chapter 11 approval requirements:
           o The debtor and Bankruptcy Court should not be able to undermine the
               requirements of Chapter 11 for confirmation of a reorganization plan by
               establishing the terms of the plan in connection with an asset sale
           o Appellate court rejected on the grounds that the transaction exceeded the scope of
               363(b) because portions of the agreement exceeded the scope of 363(b):
                     Example – agreement called for release of claim against Braniff officers –
                        clearly not contemplated under “use, sale, or lease of assets”

Proposing the Plan
      Introduction
           o Considering the process under which a plan of reorganization is proposed by the
              debtor, negotiated amongst the parties in interest and accepted by holders of
              claims and interests
                   Under 1121 for the first 120 days after filing, only the debtor can file a
                   If the debtor files within 120 days, the debtor is given an additional period
                      ending 180 days after the initial filing to obtain acceptance by holders of
                      claims and equity interests
                           The courts can increase or decrease periods, but 1121(d)(2)
                             provides that the periods cannot be extended past 18 months and
                             20 months, respectively
                   Debtor’s exclusive right to file ends if a trustee is appointed

         o In drafting plan, debtors can classify claims and interests into classes under 1122
                  Classes are important because they are the voting units for accepting the
                  A class of creditors accepts if 2/3 in amount and ½ in number of claims
                     vote for accepting the plan
                  A class of equity interests accepts if 2/3 of shares voted cast ballots
                     accepting the plan 1126(d)
         o If any class impaired by the plan rejects it, the court cannot confirm the plan
             under 1129(a)
                  On request of proponent of plan, the court can confirm the plan anyway if
                     the plan complies with all other requirements of 1129(a) and “does not
                     discriminate unfairly and is fair and equitable” with respect to each
                     impaired non-consenting class
         o If debtor unable to confirm a plan, case may be converted to Chapter 7 or
    Exclusivity
         o The limited exclusivity requirement (120days, 180 days) is thought to advance the
             reorganization goal of Chapter 11 because debtor is usually most pro-reorg
         o Early terminations of exclusivity are rare, but extensions are common; factors:
                  Size and complexity of case, progress debtor is making towards a re-org,
                     the extent to which exclusivity is being used to hold off other plans,
                     otherwise maintain balance between debtor and creditors
         o As long as exclusivity intact, debtors have significant bargaining chip – unsecured
             and under-secured creditors receive no postpetition interest so delay is costly to
             them; in face of length delays, creditors may feel compelled to accept an
             unfavorable plan
         o On flip side, courts discretion to terminate exclusivity can be employed to
             motivate the debtor to make concessions
         o Before 2005 courts repeatedly extended exclusivity if persuaded debtor was
             making progress towards a plan so debtor had incentive to quickly file anything
                  Congress responded with BAPCA, limiting extensions to 18 and 20 mos.
                          In large cases a non-extendable deadline might actually slow down
                             cases because creditors have incentive to wait out exclusive period
                             before making concessions
Acceptance of the Plan

     Once a plan is filed with the court, impaired classes of claims or interest vote to accept or
        reject it; before these votes can be solicited, a court-approved disclosure statement must
        fist be given to holders of the claims or interests 1125(b)
             o Statement must contain “adequate information”—information that “allows the
                 holder to make an informed judgment about the plan”
     Plan of reorg is usually a production of negotiation between the debtor and creditors who
        negotiate individually or through a creditor’s comm.; if debtor has many s/hs, a s/h
        committee may also participate in negotiations

           o Negotiation process often results in non-binding de facto acceptance of the plan
           o When this happens, solicitation may amount to little more than formality
      If plan involves offering of securities, plan raises issues of disclosure and protection
       normally dealt with by securities laws; the adequacy of disclosures is governed by
       Bankruptcy Code, rather than securities laws that would otherwise be applicable

Century Glove, Inc. v. First American Bank of NY – Section 1125 solicitation requirements
do not require that all communications between creditors be approved by the court, even if those
discussions include a draft plan proposed by a creditor during the exclusivity. Moreover, it also
does not bar discussion or negotiations over a plan among creditors leading up to its presentation.
Accordingly a creditor may solicit rejections of the debtor’s plan during the exclusivity period,
but may not solicit votes for its plan during the exclusivity period; courts adopt a formalist
approach in determining if a creditor has solicited votes for its plan. Accordingly a creditor may
negotiate with other creditors regarding its plan, as long as it does not solicit votes.
Century filed a petition under Chapter 11, and thereafter filed a re-org plan. FAB questioned
whether the unsecured creditors’ comm. should endorse the plan, arguing that some of the assets
claimed by Century were too speculative. FAB then sought to convince other creditors to vote
against the plan. It disclosed to other creditors that it had drafted a plan and tried to file it. It
then shared the copy of the plan it had tried to file; the copies of it were marked draft and
accompanied by cover letters saying they were submitted to the creditors for comments. After
receiving several rejections CG petitioned the court to invalidate the votes of FAB and two other
creditors on the basis that FAB violated the spirit of exclusivity by seeking approval for its
unfiled plan.

The court holds that section 1125 does not require that all communications between
creditors relating to the debtor’s solicitation be approved by the court. The court
recognizes that the Code places limits on solicitation, it never limits the facts that a creditor
can receive, but rather guarantees a minimum amount of information (through the
disclosure statement) and defines when a creditor may be solicited. Accordingly, a creditor
may receive information from sources other than the disclosure statement. Thus, the court
holds that FAB did not violate exclusivity by soliciting other creditors to reject CG’s
proposed plan. 1125 did, however, prevent FAB from soliciting official votes for
acceptances of its own plan during the exclusivity period. Since it did not do so, the case
against it is dismissed.

      CG’s narrow reading of the solicitation requirement is majority rule
           o In re Clamp-All Corp. – criticized CG for failing to recognize Congress’ intention
              to allow the debtor a reasonable time to obtain confirmation of a plan without the
              threat of a competing plan
                   Court hoeld that non-debtor parties are prohibited from circulating
                      solicitation materials before a disclosure statement has been approved
                   For violators, faced subordination of their claims to all other non-insider
                      claims, and had to pay attorneys fees for debtor
      Pre-packaged bankruptcies
           o Pre-packs are Chapter 11 cases that are filed solely to implement an already full
              negotiated restructuring that requires confirmation of a reorg plan

             o Debtor will solicit acceptance pre-bankruptcy using a prospectus that complies
                 with securities laws, rather than a court-approved disclosure statement
             o Section 1126(b) specifically authorizes court to rely on pre-bankruptcy
                 acceptances solicited in accordance with applicable nonbankruptcy law
             o 1125(g) makes clear acceptances are valid if solicited before bankruptcy, but
                 received after
     Small Business Cases
             o Under BAPCA small business provisions are no longer optional—all business
                 debtors with less than 2.19M in debt must comply with special provisions:
             o 1121(e) – extends small business debtor’s exclusivity period to 180 days and
                 absolute plan-filing deadline to 300 days after date of order of relief
             o Court not permitted to extend those periods unless:
                      1) it is demonstrated by preponderance of evidence that it is more likely
                         than not that the court will confirm the plan within a reasonable time
                      2) a new deadline is imposed at the time the extension is granted,
                      3) an order is signed before existing deadline expires
             o These provisions make it more difficult for small business debtors to extend
                 exclusivity period – small business must act quickly to ensure order signed before
                 deadline expires
             o Small business debtors have significant additional reporting and record-keeping
             o Serial small business case filing discouraged by limiting auto stay in subsequent
Trading Claims
In Re Figter Limited – On request of a party in interest, and after notice and a hearing, the court
can disqualify from voting any entity whose acceptance or rejection of a plan was not in good
faith. The good faith requirement does not prevent entities from acting in their own best
interests, but from attempting to obtain some benefit to which they were not entitled.
In a single-asset bankruptcy, claim purchasing activities (to prevent confirmation of the plan) are
not, as a matter of law, considered to be in bad faith.
A creditor with “multiple claims, has a voting right on each claim it holds,” regardless of who’s
hands the claims are in (e.g. regardless of whether they have been transferred to a single party),
though a creditor cannot get away with splitting one claim into many to obtain extra votes.
Figter proposed a reorg plan that contemplated full payment of a promissory note, but at a
disputed rate of interest. Under the plan, the claim of Teachers, a secured creditor was not
impaired and unsecured creditors were impaired to only 80% of their face value. Teachers then
purchased 21 of 34 unsecured claims and filed proper notices of transfer of the claims. Since
Teachers would not support the plan, Figter’s plan was unconfirmable because it eliminated the
possibility of obtaining consenting impaired class of claims (and thus precluded cramdown).
Figter appealed the approval of the transfer of the claims. It argued that Teachers acted in bad
faith, or alternatively could not vote claims separately, but was limited to one total vote.

 The court holds that Teachers claims were not made in bad faith. It declines to adopt the
rule suggested by Figter that claim purchasing in single asset bankruptcies is made in bad
faith as a matter of law. It holds further that whether a party has acted in good faith
depends on whether it has attempted to gain access to a benefit to which it is not entitled.

In this case Teachers acted in good faith because it acted out of a rational concern that it
would wind up with separate fractured liens on various parts of property that would
impair its interests. The court also rejects the assertion that Teachers should be limited to
a single vote. It adopts a bright-line rule that a creditor with “multiple claims, has a voting
right or each claim it holds.”

     The debtors and their insiders cannot use the Figter claim-buying strategy to confirm
      their plans
          o If insiders attempt to do so using their own funds, the one-consenting-class
              requirement must be determined “without including any acceptance of the plan by
              an insider”
          o One-consenting class requirement – cramdown requires plan approval by at least
              one class of impaired claims
    Case suggests that a claim buyer may not only be able to block opposing plans, but also
      affirmatively cause creditor classes to accept its own plan if it acquires required votes
    In re Allegheny – Court found vote buyer acted in bad faith:
          o Japonica launched a hostile takeover bid for corporation and thereafter began
              aggressively buying claims
          o Court recognized that an outsider who chose to become a creditor of the bankrupt
              should not have control over the re-org process
    Bankruptcy’s reliance on consent of “similarly situated” class members to bind an entire
      class has become increasingly problematic in light of modern financial engineering that
      increasingly has divorced consent rights from economic rights
          o Ability to engage in undisclosed and nontransparent hedging transactions has
              created opportunities for manipulation because bondholders may profit when their
              bonds lose value because the hold offsetting positions
          o Through options, swaps, and participations, security holders often acquire or
              dispose of substantially of the underlying economic interests without transferring
              the correlative right to vote on a reorg plan
Impairment of Claims or Interests
    Only impaired classes vote; unimpaired classes are deemed to have accepted the plan
          o Impairment defined in 1124 – “impairment is present unless plan leaves unaltered
              the rights of the holder of the claim or interest”
                   Thus, s/h who are given nothing in reorg of an insolvent corporation have
                      been impaired because rights as s/hs are taken away by the plan, and thus
                      can effectively demand a valuation of the reorganizing firm before their
                      interests can be eliminated without their consent
          o Since 1124 impairment test is so broad, virtually all claims and interests are
              impaired in a Chapter 11 unless there is a cure under 1124(2):
                   Cure – plan may effectively reinstate prepetion obligation on prepetition
                   In re Southeast – considered scope of cure necessary: cure sufficient if
                      only returns parties to pre-default interest rates
                           Plan provided for getting mortgage up to date and paying interest
                              on unpaid payments, but returning future interst payments to pre-
                              default rate

                      In re Southland – critical of Southeast; determined that reinstatement
                       returned parties to pre-bankruptcy status, not pre-defaault status, thus
                       debtor remained responsible for paying default rate of interest
           o 1123(d) added to address cure requirements – “the amount necessary to cure the
               default shall be determined in accordance with underlying agreement and
               applicable nonbankruptcy law”
                    Can be read as requiring cure amount include default rate of interest if
                       applicable nonbankruptcy law would allow default rate
    Cashing Out
           o Used to be that if plan called for payment in cash of a claim on the effective date
               equal to “the allowed amount of the claim,” the claim was not impaired
           o This language has been removed out of concern that cashed out claims that it
               prevented cashed-out claims from receiving postpetition interest from a solvent
           o Ramifications may be bad as it may no longer be possible to cash out
               “convenience classes” and thereby leave them unimpaired—classes with small
               claims paid off to relieve debtor of having to obtain assent of host of small claim
Classification of Claims
    Since voting on acceptance or rejection of plan is done by classes, composition of classes
       may have great strategic importance
           o If a class accepts the plan, no member of the class may assert rights under
               1129(b), including the absolute priority rule
           o Proponents often known in advance which creditors are likely to oppose the plan
               and thus may tailor plans so these claims are not impaired or may place these
               claims in a class in which it anticipates sufficient favorable votes to assure
               approval by that class
    Questions:
           o Must proponent place all similar claims and interests in the same class?
                    1122(a) – a claim or interest may be placed in a class “only if such claim
                       or interest is substantially similar to other claims and interests of such
                       class” (so dissimilar claims cannot be together), BUT
                    Nothing in codes expressly authorizes or prhobits placing similar claims or
                       interests in different classes
           o If proponent can separate similar claims or interests into different classes, can the
               plan discriminate in treatment accorded to different classes?
                    1123(a)(4) – requires plan provide same treatment for each claim or
                       interest within the class
                    1129(b)(1) mandates that plan not discriminate unfairly against rejecting
                       classes, but there is no requirement of equal treatment for similar claims in
                       different classes and there is little case law establishing the limits 1120b1
                       puts on differential treatment of similar claims in different classes
    Though 1122a requires claims and interests classified together be “substantially similar,”
       it does not define “substantially similar”:
           o Claims or interests of unequal priority rank in liquidation are not similar
           o Secure claims cannot be put into same class if secured by different collateral

                    If more than one claim secured by same collateral, separate classification
                     necessary if claims have unequal priority, but a single class is apt if have
                     same priority
           o Unsecured debt of equal rank might be dissimilar because of transaction of which
             it grew or identity of creditor

In re US Truck Co. – There is some limit on a debtor’s power to classify creditors so as to
segregate those who assent to the plan from those who do not (and thereby force confirmation
through cramdown). The extent of that limit is not evident in the code, but may merely require
that the debtor have some factual justification that supports distinguishing creditors among
classes (based on fact that pre-code cases suggest that courts were given broad discretion to
determine proper classification according to factual circumstances).
Options for approving a plan:
Option 1: Plan approved by all classes of impaired claims & 10 other reqs
Option2: Plan approved by at least one class of impaired creditors and is fair and equitable, with
respect to each class of claims or interests that is impaired, and has not accepted
US Truck Co sought to reject a collective bargaining agreement it had previously entered with
the Teamsters Committee. The bankruptcy court approved the rejection and held that it was
essential to effect the reorg plan. The reorg plan contained twelve classes of claims, and only
the Teamsters Comm opposed the plan. The district court confirmed the plan and the Teamsters
appealed on the grounds that US Truck impermissibly gerrymandered the classes to neutralize
the Teamster’s dissenting vote.

Here the court finds sufficient factual justification for distinguishing the Teamsters from
other classes: their claim is connected to the collective bargaining process, and thus is in a
different posture from other claims because it has a noncreditor interest related to benefits
to its membeers who are in an ongoing employment relationship with the debtor.
Moreover, the court notes that Teamsters are still protected by the requirement that the
plan not discriminate unfairly and be fair and equitable to its claim.

      Apparently what was going on here was that union thought its opposition to plan give it
       leverage in collective bargaining process


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