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BANKRUPTCY OUTLINE
NOTE: THIS OUTLINE, PREPARED IN THE FALL OF 2005, BUILDS ON A PREVIOUS OUTLINE
CURRENTLY AVAILABLE IN HL CENTRAL AND ADDS NEW COURSE MATERIALS PER THE
2005 AMENDMENTS TO THE BANKRUPTCY COURT AND THE 2005 CASE BOOK
SUPPLEMENT.
1) INTRODUCTION
a) Debt collection: a system characterized by bargaining and voluntary payment of
delinquencies rather than by collection through form legal processes
i) The bargaining is importantly influenced by each party’s ability to exert
leverage – usually credible threats of action that will harm the other
ii) Indirect Leverage: creditors would like to find someone else to help them
encourage the debtor to repay, especially if the cost to the creditor is
negligible; e.g. in 1998, the IRS decided to tax individuals for “debt
forgiveness” on outstanding debts reported by banks, savings and loans, and
credit unions
b) Credit Information Process: enabling creditors to make the decision to lend
based on information about the debtor
i) Fair Credit Reporting Act: giving the debtor access to credit report
information and prescribing procedures to assure the accuracy of information;
to the extent that law makes the credit records more accurate and more
credible, it may increase leverage they give a creditor
c) Usury laws: if a creditor charged more than a pre-determined rate of interest, the
loan would be deemed usurious, and the interest (and under some statutes the
principal itself) would be deemed uncollectible; some laws even provided
criminal penalties for usury lenders
i) Marquette National Bank of Minneapolis v. First Omaha Service
Corporation (1978): Supreme Court rules that under federal banking law the
state law of the customer’s location was not relevant
d) Common Law Remedies: civil and criminal protections for targets of nonjudicial
debt collection
i) George v. Jordan Marsh Company (1971): If a creditor intentionally
caused emotional distress in the overly aggressive collection of a debt, the
creditor could be liable for any resulting injuries
ii) Public Finance Corporation v. Davis (1976): Liability does not extend to
mere insults, indignities, threats, annoyances, petty oppressions, or
trivialities; liability will be found only where the conduct has been so
outrageous in character and so extreme in degree, as to go beyond all possible
bounds of decency
iii) Neb. Rev. Stat. §§20-204: a creditor who publicizes information about a
debtor might be held responsible, if the debtor can prove the information to be
false and offensive and that the collector was reckless in publicizing it
iv) Schoneweis v. Dando (1989) (where collector reveals financial difficulties of
debtor to debtor’s family): Court holds that this revelation did not constitute
adequate publicity
e) Fair Debt Collection Practices Act: fashioning remedy toward debt collection
abuses
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i) Heintz v. Jenkins (1995): court holds deciding that the term “debt collector”
in the FDCPA does apply to a lawyer who regularly, through litigation, tries
to collect consumer debts
f) Collection law: how you initiate collect on debt…
i) Unsecured Creditors: Must get a judgment and an execution writ (a.k.a. writ
of attachment) (instructing Sheriff to retrieve assets from debtor and liquidate)
(1) Writ is issued routinely by court clerk upon request of the judgment
creditor
(2) Once writ is delivered, the sheriff will take physical possession of any
properties and seize it, or tag it with a notice of seizure
(3) Process of seizure is called a levy. After sheriff levies upon the property,
he will report to the court with a document called a return, which describes
the sheriff’s effort to find property of debtor.
(4) Once sheriff levies upon a specific piece of debtor’s property, judgment
creditor=a judicial lien creditor as to that property
(5) Sheriff advertises property for public sale, sell it to highest bidder,
proceeds paid to the levying judgment creditor till he is paid in full.
Money left over goes back to judgment debtor, unless another judgment
creditor levied upon property while it was stored in courthouse. If
ii) What can sheriff take?
(1) Must be belong to debtor (cannot be rented)
(a) Live human beings are entitled to protect a certain amount of property
– exemptions; we do not want to impoverish people (note TX as
extravagant) Every state allows debtors to keep some stuff. (in DE,
gets to keep up to $5000 total things…including house). There are
state law determined things. (exemption statutes)
iii) Alternative writs for creditors:
(1) Turnover writs-allows judgment creditor to have the debtor ordered to
produce property, under threat of contempt and jail, once the JC gets the
necessary information about the assets
(2) Judgment Liens by Recordation-allows creditors to obtain lien without
going through full-blown execution; limited mostly to encumbering real
estate. (CA & ME allow creditor to put a legally effective lien on all the
debtor’s personal property available for collection anywhere in state
through a single filing)
(a) often the fastest and cheapest post-judgment collection step-creditor
ties up assets and prevents resale, since no purchaser would buy
property with title clouded by earlier lien.
(b) By recording judgment and getting lien, JC an pursue execution at
leisure, knowing that in race against other JC, the recording creditor’s
position has been assured.
2) Secured Creditors-extract voluntary liens from debtors, which allow for judicial
collection based on mortgages and security interests in debtors’ property
a) Perfection-To protect 3rd parties, consensual liens are given legal effect against
third parties only if secured party gives public notice of interest, usually be
recordation or “perfection.” Security interest must be filed to be perfected.
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b) Seizure for sale of collateral—foreclosure in real estate and repossession in case
of personalty—is governed by is governed by Part 6 of Art 9.
c) Self-help repossession: Creditor can seize the property without any help from
sheriff (“self-help repossession”) or can offer to keep the property in satisfaction
of the debt without any sale.
(a) But not allowed to breach the peace.
(b) Really only good against the ignorant
(2) Secured creditor can also sue on debt, obtain judgment, and ask sheriff to
seize/sell
3) Asset protection: allow creditors to prevent legal judgments from being enforced
against htem, often as self-settled trusts that permit assets to be placed in trusts for the
benefit of the settlor and rendering them purportedly immune from claims of
creditors.
a) Assets will not be protected if debtors are deemed to be in control of trust, even if
the assets are in a trust that removes the debtors as trustees and prevents the new
trustee from repatriating any trust assets to use if an “event of duress” such as a
law suit or a TRO occurs. Federal Trade Commission v. Affordable Media
(sentencing debtors to 6 mos. in jail for not repatriating the assets in a trust
protection plan)
4) Priorities
a) What must sheriff do to complete priority conferring levy?
i) In most jurisdictions, it is not necessary for the sheriff to remove goods in
order to complete an effective levy, as long as the property is present and
subject for the time to the control of the officer holding the writ, and he asserts
his dominion over it in express terms by virtue of writ. Credit Bureau of
Broken Bow v. Moninger (1979).
ii) Other jurisdictions require that sheriff either take possession or appoint
independent custodian
iii) In either case, if the levied-upon goods are left in the hands of debtor for an
unreasonably long period of time with consent of creditor, lien will be lost.
b) Unsecured vs. unsecured: first unsecured creditor to perfect a judgment lien
against the property by executing or levying on a judgment will win as to the
property being levied on.
i) Though levy is essential for perfection and priority, the date of levy is not
always the controlling date for determining priority
ii) Some states will backdate perfection to the date the sheriff got the writ, while
in others it is the date of the judgment or the date of sheriff’s levy that is
controlling
iii) For priority purposes, it is the recording or registration of the judgment in a
manner deemed to give notice to other parties, especially other creditors and
buyers that creates priority position
(1) If two creditors enjoy equal priority under the usual rules, a taxing
authority usually turns out to be “more equal” than other creditors. In Re
Estate of Robbins (1973)
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(2) Inactive judgments may lose their vitality and go numb. Weaver v Weaver
(a) Dormancy-If judgment creditors fail to seek enforcement of a
judgment for a long time, it is dormant (may lapse, or be subject to
collateral attack). Can be avoided by regular attempts typically yearly,
to enforce, even if unsuccessful, or by a “reviver” action
(b) Expiration expiration of the SOL to enforce judgment may be
terminal (generally 10 yrs). Can be avoided by brining a new action
on the judgment within the limitations period. Absent any valid
defense by judgment debtor, new judgment will result and new
limitations period begins.
c) Unsecured judgment creditor v. secured creditor: First to perfect wins.
i) A secured creditor or the mortgagee perfects when it records its consensual
lien according to the statutory prescription.
ii) If the judgment creditor’s lien is later it looses; if the judgment creditor’s lien
is earlier, it wins.
d) Judgment creditors and secured creditors vs. buyers: first in time, first in
right, as measured by perfection, usually through recordation. This puts a
premium on checking the certificate of title for automobiles and checking the
other perfection devices for buyers and creditors seeking an interest in other
goods.
5) NONBANKRUPTCY LAW
a) Garnishment: seizure of property from third persons; debt owed to a debtor by a
third party
i) Retrieve judgment and “writ of garnishment” used to attach debts owed to the
debtor for the benefits of the debtor’s judgment creditor
(1) A garnishment is an ancillary lawsuit against the third party garnishee
(2) E.g. W owes bookie $1000 and does not pay; Clark owes W $1000 +
interest; bookie can sue Clark directly
(a) The bookie is the garnishor and judgment creditor
(b) Clark is the garnishee
(c) W is the judgment debtor
ii) Webb v. Erickson (1982) (where the creditor serves writs of garnishment on
parties whose houses had been sold by the debtor, to garnish the commissions
the debtor earned as a real estate agent): Garnishee can be liable for entire
amount of debt if it fails to answer garnishment writ
iii) Restrictions on Wage Garnishment
(1) If a judgment creditor could seize the entire obligation owed by an
employer to a judgment debtor, then the judgment debtor’s ability to
survive might be seriously jeopardized, thus giving the creditor too much
leverage in exacting promises to pay much higher interest rates and to
adhere to new payment schedules with addt’l charges
(2) In response to those concerns, the Consumer Credit Protection Act now
restricted access of all creditors to the wages of any debtor
(3) Commonwealth Edison v. Denson (1986)(where employees had multiple
creditors, including support garnishers seeking to garnish their wages):
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Court holds that support garnishments should not be considered separate
from judgment creditor garnishments
iv) Garnishment of Bank Accounts: when a customer has a deposit account, the
bank acts as debtor (money owed to customer); when a customer has
outstanding loans from the bank, the bank acts as creditor – hence, the bank
then offers the judgment creditor only the amount left in the account after the
bank’s own setoff for the outstanding loan.
v) What can be garnished? Network Solutions, Inc. v. Umbro International,
Inc. (2000), where court holds that a contractual right to use an Internet
domain name cannot be garnished because it is the product of a contract for
services
vi) 18 U.S.C. 1674 establishes that no employer may discharge any employee by
reason of the fact that his earnings have been subjected to garnishment for
any one indebtedness; violators will be subject to a fine not more than $1000,
or imprisonment for not more than one year, or both
(1) Garnishment of an employee’s wages resulting in damage to an
employer’s reputation is not a legal excuse for firing that employee
b) Property Exempt from Seizure: exempting some items so that garnishment will
not reduce a debtor to impoverishment, allowing debtor to retain enough basic
property to make a fresh start, and to avoid becoming a charge on the community
i) Commonly defined by dollar amount and by type of property, e.g. burial plots,
homestead real property, homestead sale proceeds for six months after sale,
personal property such as alimony, home furnishings, food, tools used in
profession, clothing, car
(1) Items fitting a category but exceeding the dollar limit may be partially
exempt
ii) TX as most extravagant; DE, PA, SD as not generous (p. 105-113)
iii) What is exempt?
(1) In re Johnson (1981): Court holds that a bus can be exempt as “one motor
vehicle”
(2) In re Hall (1994): Court holds that a lawnmower is not household
furniture
(3) In re Pizzi (1993): Court holds that lottery winnings, whether received in
lump sums annually or all at once, may not be exempted as an annuity
payment
(4) In re McCollum (1993): Court holds that a damage settlement given as an
annuity contract is exempt
iv) Proceeds and Tracing: issues arise when a property not exempt is traceable to
one that is
(1) In re Williams (1994): Court holds that the amount paid for a car which
was directly traceable to worker’s compensation proceeds is exempt
(2) Holmes v. Blazer Financial Services (1979): Court cannot protect wages;
but legislature responds in 1993 with allowing six months of wages
exempt
v) What order are people paid?
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(1) State law is a “race of the diligent” – first person to get judgment takes up
to the amount he is owed; i.e. you snooze, you lose
(2) Some states only go back to the time of writ, i.e. who gets the actual writ
first
c) Fraudulent Conveyances
i) Twyne’s Case (1601) (where D was indebted to both P and Twyne and made
a secret conveyance to Twyne of all his goods and chattels, leaving D
insolvent): Court holds that this constitutes fraudulent conveyance
ii) Uniform Fraudulent Transfer Act
(1) §1(2): exempt property is an exception to fraudulent conveyance (property
subject to valid liens, generally exempt under nonbankruptcy law)
(2) §2. Insolvency: (a) A debtor is insolvent if the sum of the debtor's debts is
greater than all of the debtor's assets, at a fair valuation; (b) A debtor who
is generally not paying his debts as they become due is presumed to be
insolvent
(3) §3. Reasonably Equivalent Value
(a) At a foreclosure sale, items tend to bring a lower price (due to low
attendance, no warranty, no inspection opportunity) – code states that
foreclosure sales are not fraudulent conveyances
(4) §4. Transfers Fraudulent as to Present and Future Creditors
(a) (a) A transfer made or obligation incurred by a debtor is fraudulent as
to a creditor, whether the creditor's claim arose before or after the
transfer was made or the obligation was incurred, if the debtor made
the transfer or incurred the obligation:
(i) (1) with actual intent to hinder, delay, or defraud any creditor of
debtor; OR
(ii) (2) without receiving a reasonably equivalent value in exchange
for the transfer or obligation, AND the debtor:
1. (i) was engaged or was about to engage in a transaction for
which the remaining assets of the debtor were unreasonably
small in relation to the transaction; or
2. (ii) intended to incur, or believed or reasonably should have
believed that he would incur, debts beyond his ability to pay as
they became due
(iii)(b) In determining actual intent, consideration may be given to
whether the transfer or obligation was to an insider; the debtor
retained possession or control of the property transferred after the
transfer; the transfer or obligation was disclosed or concealed; the
debtor had been sued or threatened with suit; the transfer was of
substantially all the debtor's assets; the debtor was insolvent
1. ACLI Government Securities, Inc. v. Rhoades (1987): Court
holds that the conveyance of property to his sister, made the
day before a judgment of over $1.5 million was entered against
debtor, in exchange for $1.00, was fraudulent because: (1)
there was a close relationship among parties to the
transaction, (2) there was secrecy and haste, (3) there was
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inadequacy of consideration, and (4) transferor knew of his
duty to pay the claim and his inability to do so
(iv) Note that present creditor means creditor at time of transaction
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(5) §5. Transfers Fraudulent as to Present Creditors
(a) (a) Fraudulent if the debtor (1) made the transfer or incurred the
obligation (2) without receiving a reasonably equivalent value in
exchange for the transfer or obligation (3) and the debtor was insolvent
at that time or the debtor became insolvent as a result of the transfer or
obligation, (4) which is attacked by a pre-transaction creditor.
(b) (b) Fraudulent if the transfer was made to an insider for an antecedent
debt, the debtor was insolvent at that time, and the insider had
reasonable cause to believe that the debtor was insolvent.
(c) Note that §5 is the easier test to prove than §4, but §5 only applies to
creditors who existed at the time of the transaction
(6) §8. Defenses, Liability and Defenses of Transferee
(a) (a) A transfer or obligation is not voidable against a person who took
in good faith and for a reasonably equivalent value or against any
subsequent transferee or obligee
(b) (b) To the extent a transfer is voidable, the creditor may recover
judgment for the value of the asset transferred, or the amount
necessary to satisfy the creditor's claim, whichever is less; judgment
may be entered against:
(i) (1) the first transferee of the asset or the person for whose benefit
the transfer was made; or
(ii) (2) any subsequent transferee other than a good-faith transferee or
obligee who took for value or from any subsequent transferee or
obligee.
(7) What does a creditor get in an action for relief against a fraudulent
ctransfer? See §7
(a) Avoidance of transfer or obligation to the extent necessary to satisfy
the creditor’s claim
(b) Attachment oagainst remedy
(c) Injunction against further disposition by debtor or transferee of the
asset transfered it was in good faith, they are entitled to: (1) a lien on
or a right to retain any interest in the asset
(d) If creditor has obtained a judgment claim, he may levy execution on
asset transferred or its proceeds.
(e) Good faith buyer
(8) What is a good faith transferee entitled to, to the extent of the value
given the debtor for the transfer or obligation? See §7
(a) (1) a lien on or a right to retain any interest In asset transfer; (2)
enforcement of any obligation incurred, or (3) a reduction in the
amount of the liability
(i) Transferees/Buyers do not lose any money out-of-pocket, but they
do lose the present value of the asset purchased
iii) Leveraged Buyouts: assets of the corporation being acquired are used to
secure the purchase price paid for those assets; later targeted as fraudulent
conveyances
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(1) Not all leveraged buyouts are subject to fraudulent conveyance litigation;
two types of legitimate LBOs:
(a) The assets mortgaged by a corporation to support an LBO do not
exceed the net equity of the business (after appropriate adjustments),
the transaction will not make the corporation insolvent; open to attack
only if the margin of equity is too thin to support the corporation’s
business
(b) The cash flow is sufficient to make the debt payments; turns on two
factors: degree of risk of default undertaken in the first instance, and
the degree to which projected economic developments impacting the
business are not overly optimistic
(2) How do you show insolvency? Sum of debtor’s debts is greater than all of
the debtor’s assets
(a) Note In re Bay Plastics, Inc. (1995) (where a lot of goodwill is
pumped in to make the assets outweigh the liabilities): Court holds that
if the LBO resulted in a margin of equity too thin to support the
corporation’s business, the LBO will be deemed a fraudulent
conveyance, done only to evade debts
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CONSUMER BANKRUPTCY
6) CONSUMER BANKRUPTCY
a) Two fundamental types of proceedings
i) Liquidations: Chapter 7, debtor gives up all non-exempt assets, Trustee in
Bankruptcy sells assets, and proceeds are distributed pro rata to creditors;
debtor is discharged of all debts and begins afresh
ii) Payout plans: Chapter 11 (businesses), Chapter 13 (consumers): debtor can
propose to keep all assets in exchange for promising to pay off debts over a
period of time out of future income; can mean much higher returns for
creditors
iii) Filing a Petition-in a voluntary bankruptcy petition, the debtor is required to
file various forms called “schedules” all of which are set forth in Officials
Forms part of Bankruptcy Rules. Schedules include details list of debts assets,
income and expenses
(1) Policing Debtor Applications:
(a) Before they file, debtors must produce certification that they have
attended a debt counseling session, that they have been given
information about the other chapters of the code and about credit
counseling, and that they have been warned that false information in
files can lead to penalties and jail time. §109(h), 521(b)
(b) Debtor’s schedules must be complete, since failures to list a debt may
make the debt nondischargeable § 523(a)(3)
(c) Debtor’s schedules must be accurate, since false statements in the
petition or schedules may result in a complete denial of discharge
under §727(a)(4) (and may open the debtor to perjury prosecution).
(d) Debtors sign their petitions under penalty of perjury, must file copies
of pay stubs for 2 mos before they filed, a statement of monthly
income and an explanation of how that was calculated, and a statement
disclosing any anticipated increase income in next 12 months
§521(a)(1)(iv)-(vi)
(e) Debtors must be able to produce copy of previous year’s tax return on
request of court/creditor 521(i)
(2) Policing Debtors via Debtors’ own Counsel
(a) Attorney must sign the petition, and by signing, represents that the
attorney has performed a “reasonable investigation” and has no
knowledge that the info in the schedules is incorrect (§707(b)(4)(C))
(b) Consumer bankruptcy lawyers have been renamed “debt relief
agencies” and are specifically prohibited from making any statement
in any document filed that is “untrue or misleading, or that upon
exercise of reasonable care, should have been known to an agency to
be untrue or misleading.” §101(12A); 526(a)(2).
(c) Failure to abide by these rules might cause attorneys to lose their fees,
pay actual damages, or be forced to pay the fees of opposing counsel
§526(c)(2); 707(b)(4)(A)
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(3) First Meeting of Creditors (Section 341 meeting)
(a) Meeting held at date set by court within 40 days after petion is filed,
ordinarily at the courthouse §341, Rule 2003(a)
(b) Primary function is to permit an examination of the debtor by the
trustee and any interested creditor
(c) In most cases, creditors might elect a TIB (§702, 1104(b)) or a
creditor’s committee (§705(a), 1102(a)(1) )
iv) Property of the Estate, per §541: at the moment a bankruptcy petition is
filed, an estate is created by operation of law, consisting of all legal and
equitable interests in property previously owned by the debtor
(1) Property included, per §541(a)
(a) Exempt property is included in estate, e.g. pet
(b) §541(a)(5) includes all interests acquired within 180 days of filing by
bequest, devise, or inheritance
(c) §541(a)(6) includes proceeds, product, offspring, rents, or profits of or
from property of estate, e.g. winnings on lottery ticket purchased pre-
petition and dividends on stock owned by debtor
(2) Property excluded from estate, per §541(b)
(a) Most important exception is for services performed by an individual
debtor after the commencement of case; e.g. wages, commissions
earned post-petition
(b) Per §541(b)(1), bank account on which debtor is named trustee for the
benefit of another is not part of the estate
(c) Per §541(b)(6), if the debtor set aside in certain kinds of tax-sheltered
accounts to pay for the education of children in the family, then such
accounts are not property of the estate, even though the debtor may be
named the owner of the account, manage the account and have right of
withdrawal
(d) Per §541(b)(7), employee contributions to any ERISA-qualified
retirement plans, deferred compensation plans, tax-deferred annuities
and health insurance plans are not part of the estate. NOTE: Sup Ct
expanded protection of retirement funds in Rousey v. Jackoway,
holding that IRAs are part of the estate, but they exempt property
under 522(d) (despite not being specifically mentioned in the laundry
list of exempt retirement plans),, and therefore the debtors are entitled
to keep it.
(e) Per §541(d), secured property becomes property of the estate only to
the extent of the debtor’s legal title, but not to the extent of any
equitable interest in such property that the debtor does not hold, such
as a mortgage secured by real property.
(3) Number of expectancies at varying levels of realization or certainty that
must be allocated to the debtors’ past or future. The problem can be
articulated as the determination of the point at which an expectancy
becomes “property”
(a) In re Palmer (1986): Court holds that a post-petition year-end bonus
paid by debtor’s employer, dependent on (1) employment at the time
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that employer declared bonus, (2) satisfactory performance, (3)
employers sole discretion, is not property of the estate because such
payments were sufficiently rooted in post-petition events
(b) Sharp v. Dery (2000): Court holds that when a debtor has to work for
his employment for some time beyond the date of filing for bonus pay,
the court cannot apportion any part of that bonus dividend to the
estate. At commencement of case, neither terms of bonus plan nor
Michigan law gave debtor an enforceable part of the bonus, and thus
the trustee, who could take no greater rights in the property than debtor
had, also ha no enforceable interest in the bonus dividend at case’s
beginning.
(c) Three categories of certain expectancies
(i) Legal interests that are not enforceable at the date of bankruptcy
but may be enforceable at a future time; question of whether they
are sufficiently mature and certain; Palmer; Sharp v. Dery (E.D.
Mi. 2000)
(ii) Certain entitlements, e.g. permits or licenses, that are
nontransferable; representing a very valuable legal right that is of
no value to anyone but the debtor (like a driver’s license, versus a
license that can be bought and sold and can thus be property of est)
1. Recall Umbro re: Internet domain names
2. In re Burgess held that a brother license, like a liquor license,
is property of the estate because it is more than “a personal
privilege” or a “a state matter subject to discretionary control
of county. It was actually “property” of enormous value to the
estate, given that without the license, there would no business
left to reorganize.
(iii)Restrictions on transferability imposed by contract or by law;
Congress has permitted a few specific restrictions on alienation to
be effective to keep property out of the bankruptcy estate; e.g.
“Spendthrift” trust exception, whereby debtors are often able to
keep retirement accounts out of bankruptcy estates (§541(c)(2))
1. In re Orkin (1994): Court holds that the retirement plan is an
asset of the estate because the Plan does not contain a transfer
restriction enforceable under state or federal law. Debtor had 2
bites at the apple: if account is ERISA qualified, then it is
protected by federal law. If not ERISA qualified, can try again
under state law-if it had a valid spendthrift trust provision
preventing alienation and thus protecting it from creditors, it
will not be part of estate. Even with 2 bites, orkins can’t keep.
v) The Automatic Stay, per §362: prohibiting any creditor’s attempts to
continue to collect from debtor or debtor’s property; to prevent any property
from leaving the newly formed estate
(1) Statutory provisions
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(a) §362(a)(1): bankruptcy petition operates as a stay of all proceedings to
collect against debtors, including most judicial proceedings and even
withholding of a student-debtor’s transcript.
(b) §362(a)(2): under automatic stay, creditor cannot continue to try to
enforce a previous judgment against the debtor; also protects property
of the estate
(c) §362(b): exceptions to stay, including criminal prosecution, tax audits,
EPA investigations, collection for current alimony and child support
(2) Andrews University v. Merchant (1992): Court holds that (1) both
education loans and credit extensions are nondischargeable under §523
and (2) they are not listed within the exceptions to the automatic stay in
§362(b)
(3) Creditors who violate this stay by soliciting money, sending bills, making
phone calls, repossessions, lawsuits, etc. are subject to the court’s
imposition of excessive fines stemming from actual damages, including
cost of attorney’s fees
(a) Nissan Motor Acceptance Corp. v. Baker (1999): Court holds that a
creditor’s continued retention of estate property after notice of
bankruptcy filing constitutes an exercise of control over property of
the estate in willful violation of automatic stay and that adequate
protection need not be offered for the creditor to turn over its collateral
(b) Additionally, where the court sees appropriate, the violating creditor
may be subject to punitive damages, per Nissan, where the violation of
the provision and the disregard of the court’s notice have been so
egregious
(4) Notice to Creditors:
(a) Under § 342(e), creditors can file a “notice of address” where the
notices for in Ch 7 and Ch13 must be sent. If creditor “designates a
person or organizational subdivision” to receive bankruptcy notices
and has a reasonable procedure to deliver notices to such person or
subdivision, notice is not effective until it reaches that person. § 342(g)
(b) Creditors may request relief from the stay under §362(d) for cause,
including lack of adequate protection of an interest, or if the debtor
does not have equity in such property and such property is not
necessary to effective reorganization
b) Chapter 7 Bankruptcy: Liquidation
i) Eligibility for Chapter 7 filing
(1) Under §707(b)(1), court may dismiss a case or convert it to chapter 11 or
13 if it finds that granting relief would be an abuse of the provisions in
Chapter 7. §707(b)(2) sets forth the new provisions under which the court
may presume abuse.
(a) In re Shaw: after finding that the debtor’s proposed family budget
was excessive and unreasonable within the context of Ch. 7, court
reshapes the debtor’s budget and requires a minimum 3-year
repayment plan if the debtors want any bankruptcy relief, using a
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totality of the circumstances the test to find “substantial abuse” under
§707(b)
(b) The 2005 Amendments substitute the “totality of the circumstances”
discretionary test with a new semi-automated screen, employing a
fixed formula to determine which debtors should be deemed ineligible.
(c) Even with the revisions, there is still room for court discretion under:
(i) §707(b)(2)(B) (finding “special circumstances” that have an effect
on income or expenses that can be quantified or documented, such
as medical conditions or service in armed forces, to justify
adjustments to the calculations)
(ii) 707(b)(3) (allowing a debtor who was deemed “not abusive” under
the formula to be deemed abusive nonetheless on grounds of “bad
faith” and “totality of the cirucumstances,” a catch-all category for
any unworthy debtors not captured by payment formula)
(2) Means Test: The court shall presume abuse according to an intricate
formula of income minus expenses 707(b)(2)(A).
(a) Threshold Test of Income for Ch. 7 eligibility: formula for means
test begins with debtors’ current monthly income and a threshold test
for Ch. 7 eligibility, based on a comparison with state median income
figures compiled by the Census Bureau www.census.gov/hhes/www/
income/statemedfaminc.html. When there is no current data, courts
must adjust the census report for inflation based on the Consumer
Price Income (www.aier.org/cgi-aier/colcalculator.cgi):
(i) If income is equal to or lower than the median (as opposed to mean
income, which would be pulled up by big earners) income for
similar families in the state where the debtor filed, the debtor has
passed through the median-income screen and no presumption bars
the way to Ch. 7. §707(b)(2)(A).
(ii) “Current monthly income” is the average monthly income for
the 6 months preceding the filing, all sources included (i.e., wages,
interest on checking account, stock dividends, unemployment
compensation, tax refunds). §101(10A)
1. Code defines as “income received,” which suggests that the test
uses only post-tax income, the take-home pay of the debtor
after taxes, social security and Medicare have been deducted,
but the Census Bureau bases its date collection on pre-tax
income
2. Census Bureau income does not count capital gain, money
received from sale of property, value of income “in kind” (food
stamps, tax refund, etc.), exchange of money between relatives
that live together, and lump sum receipts such as gifts and
insurance payments. Some of these items are explicitly
included as “income received” in the Code. §101(10A)
3. Bankruptcy Code Code excludes Social Security Benefits, but
Census Bureau includes them.
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(iii)Recent data suggests that only about 6% of Ch 7 debtors would
have income above state median
(b) Expenses: For debtors fail the median-income screen because their
currently monthly income is higher than the state median, next step is
to determine what expenses the debtor may deduct, based on IRS
National Standards (www.irs.gov/individuals/article/0,,id=
96543,00.html). Like the IRS, the Bankruptcy Code permits debtors to
deduct the National Standard amounts allocated for family size and
income level, regardless of what was actually spent.
(i) Court may increase allowance for food and clothing by up to 5%,
if debtor can demonstrate that such expenditures are reasonable
and necessary §707(b)(2)(A)(ii).
(ii) Courts must include deduction for health insurance, disability
insurance, and health savings accounts (§707(b)(2)(A)(ii)(I);
expenses of caring for the elderly (§707(b)(2)(A)(ii)(I); and private
schools, up to $1500 per child per year (§707(b)(2)(A)(ii)(IV).
(iii)Through the IRS “Other Necessary Expenses” list
(www.irs.gov/irm/part5/ch14s01.html#d0e122933), the Code
permits courts to deduct actual expenses for items such as
childcare, legal fees, life insurance, union dues, taxes
(c) Secured Debts:
(i) secured loans (such as car loans) can be deducted in full, no matter
how large, along with any payments in arrearages.
§707(b)(2)(A)(iii). Gasoline, insurance, maintenances then follow
Local Standards in the IRS tables §707(b)(2)(A)(ii)(I).
(ii) Debtors can deduct the payment to a house mortgage lender in full.
§707(b)(2)(A)(iii). What to do about other costs (utilities,
maintenance, insurance, etc) is unclear, since the IRS combines all
housing costs in a single allowable amount. Currently, statute
seems to give debtor both the actual amount of the home mortgage
in §707(b)(2)(A)(ii)(I) and the Full Local Standard deduction in
§707(b)(2)(A)(ii)(I)
(iii)Though car purchasers and home buyers seem to get a break,
renters are out of luck.
(d) Income after Expenses: even if debtor has surplus after allowed
expenses are deducted, Ch. 7 might still be available. To do final
calculation, you must know (a) total size of the surplus income over
expenses over 60 months (5 yrs); and (b) how much general unsecured
nonpriority debt the debtor owes. Abuse is presumed:
1. if the debt is greater than $24k, and the surplus is at least
a. $10k OR
b. 25% of the debt; OR
2. if the debt is $24k or less, and the surplus is at least $6k
3. Another way of calculating abuse:
a. If surplus is less than $100, debtor passes
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b. If surplus is between $100-$166.66, he passes if surplus is
less than 25% of his unsecured debt divided by 60.
c. If surplus is greater than $166.66 he flunks.
(e) Policing the New Standards
(i) Abuse can be alleged against an above-median debtor by judge,
Trustee’s office or any creditor §707(b)(1)
(ii) Creditor cannot raise abuse issue against a median-or-below debtor
under either 707(b)(1) (general abuse) or 707(b)(2) (means test).
(iii)Only judge or trustee can raise claim of general abuse §707(b)(6)
(iv) Court can award costs and reasonable attorney fees to a trustee
who prevails on a motion to dismiss ch 7 filing as a violation of
707(b)(2) in violation of Rule 9011 (requiring that any petition e
made only after reasonable inquiry that the allegation have a
factual basis, and requires that legal contentions be warranted by
existing law) standard for charging for debtor’s counsel may be
high, but many attorneys will notice that if they advice debtor to
file Ch 13 instead of 7 they are less likely to end up as defendants
(v) If the debtor’s motion is challenged under 707(b)(2), the debtor
can recover (and presumably use the money to pay the attorney) if
the court finds that the creditor or trustee violated Rule 9011 or
brought motion solely to coerce the debtor to waive other rights
under Code. §707(b)(5)
ii) Exemptions – Federal (§522, only for 11 states who did not opt out) and
State
(1) 1898 Act incorporated state exemptions into the debtor’s protections in
bankruptcy; the 1978 Code provided for federal exemptions, providing
uniform exemptions, but 35 states have taken the option of opting out of
those exemptions, denying their own citizens the benefits of the federal
protection when they filed for bankruptcy.
(a) Texas, with its generous exemptions, did not opt out, leaving a Texan
to choose between an unlimited homestead and 30k value in other
property, and a federal homestead exemption of $16,150 and about
$16k or so in other property.
(b) Taylor v. Freeland & Kronz (1992) (where debtor claims as exempt
a future settlement of a pending lawsuit and the TIB fails to object to
the exemption, believing that the debtor would not get the amount she
anticipated): Court holds that objection to exemption by the TIB must
be done in a timely manner when the exemption is claimed in good
faith
(2) Classification of Property: because exemption statuts are often written to
exempt only listed types of property, disputes often arise as debtors argue
that the property they intend to keep fits within the statutory classifications
and judgment creditors, who are permitted to reach only non-exempt
property, argue the property does not.
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(a) In re Johnson(1981) (finding that a bus fit within state exemption
statute for “motor vehicles” although legislative history suggests that
motor vehicle was intended to mean “automobile”)
(b) In re Hall (1994): Court holds that a lawnmower is not household
furniture
(c) In re Pizzi (1993): Court holds that lottery winnings, whether received
in lump sums annually or all at once, may not be exempted as an
annuity payment
(3) Valuation of Exempt Property
(a) In re Walsh (1980) (where TIB seeks an appraisal of the exempt
assets at FMV, rather than liquidation value): Court assigns liquidation
value
(b) In re Mitchell (1989) (where TIB seeks FMV rather than liquidation
value on jewelry claimed as exempt): Court holds that FMV is the
proper value
(4) Security Interests in Exempt Property: valid, unavoidable consensual
security interests trump exemption claims so that a debtor may only claim
an exemption in the equity (value remaining after secured creditor has
been paid in full)
(a) §522(f) permits the avoidance of certain kinds of liens on certain
categories of exempt property listed therein, namely judicial liens and
nonpossessory, nonpurchase money consensual security interests
(i) Creditors who held these types of liens could be treated as
unsecured creditors, entitled only to a pro rata share of the debtor’s
estate along with other creditors
(5) Proceeds and Tracing
(a) In re Palidora (2004)(finding that an exception for wages ceases to
apply upon the debtor’s receipt of those wages, whether paid in cash,
by check, or by direct deposit in the debtor’s bank account, because
the wage exemption statute only limits what a creditor could obtain by
garnishment of the employer. The exemption for child support
payments does include such money received by a debtor.)
(b) In re Dasher (2002) (refusing to exempt a pick up truck purchased
entirely with money cashed from an exempt retirement account )
(c) Partially exempt property: if there is a dollar limit on a category,
property of greater value is partially exempt. It can be levied on and
sold, and the proceeds are allocated first to the debtor to the full
amount of the exemption, with the remainder going to Judg Creditor
(6) Exemption Planning
(a) Converting non-exempt property to exempt property
(i) In re Reed (1981) (where debtor, in order to convert his
homestead into an exempt asset, sold nonexempt personal property
for approximately 50% of its value and applied the proceeds
towards liquidation of improvement liens against their resident
homestead, in Texas, which has historically jealously protected the
homestead from forced sales except under very limited conditions):
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Court holds that the transactions by debtor were not fraudulent
because there is no proof that the debtors had applied the proceeds
to acquisition of exempt personal property.
(ii) However, in In re Reed II (1983): Court holds that a debtor who
converts nonexempt assets to an exempt homestead immediately
before bankruptcy, with intent to defraud his creditors, must be
denied discharge in bankruptcy under §727.
(iii)In trying to negotiate a line that provides protection for a debtor
but does not give them an undue advantage, the 2005 amendments
include a provision to reduce the dollar value of the homestead
protection by any amount that is attributable to otherwise non-
exempt property that the debtor disposed of with intent to hinder
delay and defraud a creditor §522(o)
(iv) Congress also added another provision for an absolute cap on the
homestead for people convicted of securities law violations, and
fraud in a fiduciary capacity. §522(q)
(b) Shielding assets by converting them to other types of unlimited
exemptions:
(i) Northwest Bank Nebraska v. Tveten (1988) (denying discharge
to a doctor who sold all his assets and put the money into life
insurance and annuity contracts, which where exempt without any
dollar limit, and could not be attached under state law. Dissent
argues that such exemption planning is allowed under controlling
law in Circuit and thus not unlawful, and cites House report: “as
under current law, debtor will be permitted to convert nonexempt
property into exempt property before filing.”
(ii) Hanson v. First Natl. Bank in Brookings (1988) (allowing to a
couple of farmers to discharge their debt after selling all their non-
exempt property for market value to family members, used the
money to pay down mortgage and buy exempt life insurance
policies, and then retained by agreement with purchasers, retained
possession of the goods sold)
1. case was decided on the same day as Tveten, and judge from
Tveten’s dissent noted that the same argument that justified
conversion for Hanson’s
2. noted that the only differences between the cases was the
background of the applicants and the amount of $ at stake
(iii)In re Johnson (1989): same facts and circuit as Tveten, but drew a
different judge, and obtained discharge
(c) Squirreling assets in asset protection trusts
(i) If the self-settled trust is structured correctly, including a
spendthrift provision and an automatic appointment of a third party
as a trustee if the trustee-debtor is sued, the debtor will claim that
the property in such a trust is not property of the estate §541(c)(1)
(ii) The 2005 Amendments include a 10 year reach-back for
transactions made with intent to hinder, delay or defraud creditors
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but such transferes are fraud when they are “in anticipation of any
judgment” or to escape judgments in connection with securities
fraud §548(e)
(d) moving to states with more generous exemptions
(i) In re Coplan (1993) (where the debtors incurred substantial
indebtedness in their home state of Wisconsin, moved to Florida –
for its liberal exemption laws – converted non-exempt assets into
exempt assets, and filed for bankruptcy): Court holds that the
debtors’ relocation to Florida with attendant purchase of home
was for purpose of shielding their assets from creditors
iii) Distributing the Estate under §726: TIB is appointed to gather all debtor’s
property, sell it and distribute proceeds to creditors. He must (1) determine if
some other person has any interest in that property (secured parties, liens), (2)
consider valid exemption claimed by debtor in a particular item. Once the
proceeds from the sales of all property have been obtained and the secured
parties and other entities with property interests have been paid, the TIB (3)
distributes the remaining funds among three general creditors:
(1) Priority creditors: first in line, entitled to payment in full before others are
paid
(2) General, unsecured creditors
(3) Subordinated creditors: last to be paid, likely because of some
wrongdoing
iv) Claims and Distributions
(1) A claim is anything the debtor owes or any right to payment, per §101(5)
(2) Who can file claims? See §501(a)
(a) A creditor or indenture trustee may file a proof of claim
(b) Equity security holder (i.e. shareholder) – may file a proof of interest
(i) Note that if everything is distributed to creditors, shareholders get
nothing
(c) If a creditor does not timely file a proof of claim, an entity liable to
such creditor – debtor or TIB – may file on behalf, per §501(b)
(i) Incentive to the debtor to file is that he would like to expunge all
debts; also, debtor can be held liable for a crime if he does not file
claim he knew about; creditor will be drawn in if he knew and
purposefully did not claim
(3) In Chapter 7 and 13 cases, a claim must be filed within 90 days after the
first meeting of creditors; a claim is allowed unless a party in interest
makes an objection, per §502(a) and Bankruptcy Rule 3002
(4) Once a debtor has filed for bankruptcy, his debts are discharged;
accordingly, he has very little interest in the validity of claims, so the TIB
must be very careful in reviewing the claims
(a) In re Lanza (1985): Court holds that burden of going forward for
proof is on objecting party
(5) Unsecured Claims-§501 lays out procedure for filing claim; §502
explains mechanics of calculating a claim (for both secured & unsecured)
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(a) Claim-includes any amount to which creditor is entitled by contract
(e.g., attorney fees, costs of collections).The difference between what
creditor will be allowed—the same amount as in a nonbankruptcy
lawsuit—and what it gets—a percentage of what it had coming—is to
be discharged at the conclusion of the case
(b) Interest-unsecured creditors can not collect any interest on its
unsecured claim after the filing and while the bankruptcy is pending.
§502(b)(2). By treating all unsecured creditors the same, in allowing
all to collect a pro rata share of whatever remains in the estate,
bankruptcy reinforces goal of equality among these creditors
(c) Accelerated Claims-because the debtor’s obligations are about to be
resolved in a single forum, once and forember all prebankruptcy
claims must be accelerated whether they’ve matured or not.
(6) Secured Claims, per §506: To the extent that the an allowed secured
claim is secured by property, the value of which is greater than the amount
of the claim (“fully secured”), there shall be allowed to the holder of such
claim, interest on such claim and reasonable fees, cost or charges provided
for under the agreement
(a) E.g. Sears sells to debtor lawnmower and takes security interest on it;
Sears is still owed $5000 at time of filing
(i) If TIB sells lawnmower for $6000, Sears gets $5000, $1000 goes
to general fund for unsecured creditors
(ii) If the lawnmower only brings $3000 in liquidation sale, then Sears
gets $3000 in secured claim and $2000 in unsecured claim (this is
called bifurcating the claim, with $3000 being the allowed secured
claim and $2000 being the general unsecured claim)
(b) Note that valid, unavoidable consensual security interests trump
exemption claims, so that a debtor may claim only an exemption in the
equity the value remaining after the secured creditor has been paid in
full
(7) Interest: both secured and unsecured creditors are entitled to interest
accrued prior to bankruptcy; but an unsecured creditor cannot claim any
interest for the period following bankruptcy (§502(b)(2)), unmatured
interest), while some secured creditors who are oversecured will be able to
collect post-bankruptcy interest; interest must be specified in contract
(8) Attorney’s fees: incurred prior to filing of bankruptcy, can be claimed by
secured and unsecured creditors, provided that they are specified in
contract
(a) Secured creditors who are oversecured are entitled to post-petition
attorney’s fees
(b) Unsecured creditors should not be entitled to post-petition attorney’s
fees (as indicated by §502 (b) and §506(b)), though the case law is
somewhat confused (e.g. In re United Merchants and
Manufacturers, 1982)
(9) §502(b) disallows certain unsecured claims, including unmatured interest;
unreasonable amount charged by debtor’s attorney or insider; unmatured
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alimony, child support; excessive claim by landlords who lose future
money on leases (can claim past rent due); late payments on taxes
v) Summary of Process
(1) Debtor files for bankruptcy
(2) Automatic stay for all creditors, per §362
(3) Estate is created, including all property of debtor, per §541
(4) Secured property is taken out (bifurcated, if needed), per §506
(5) Exempt property is taken out
(6) §502 claims, i.e. unsecured claims, are given priorities, per §507
(7) Unprioritized go into §502 general unsecured pot
vi) Priority Among Unsecured Creditors: after the secured creditors have been
satisfied by the sale of their collateral, unsecured creditors begin the process
of dividing the remaining assets
(1) §507(a). Priorities: claims in the following order:
(a) Administrative expenses under §503(b) and fees (lawyers’), insurance
premiums paid on items in the estate, costs of liquidation sale
§507(a)(1)(C), (1)(a)(2).
(b) Allowed unsecured claims for domestic support obligations-as owed to
or recoverable by spouse/ex-spouse, child or child’s parent
§507(a)(1)(A)
(c) Unsecured claims allowed under §502(f) – business debt arising after
filing, before appointment of TIB
(d) Allowed unsecured claims, to extent of $10k for each individual or
corp, earned within 180 days of filing, for wages, salaries, or sales
commission
(i) Note that service providers are different because there is no
security interest available (i.e. nothing available for collateral)
(ii) Providing incentives for employees to continue working
(iii)Employees are smaller players and cannot diversify
(iv) Union lobby
(v) Note that salesmen fall under §507(3)(b)
(e) Allowed unsecured claims for contributions to a employee benefit plan
arising from services within 180 days of filing to extent of number of
employees covered by plan $10k minus aggregate amount to such
employees
(f) Allowed unsecured claims of persons producing/raising grain or
engaged as a US fisherman, to the extent of $4,925 per person
(g) Allowed unsecured claims to the extent of $2255 for each individual,
arising from deposit of money in connection with the purchase, rental
of property or the purchase of services that were not delivered
(h) Allowed unsecured claims for taxes – property, income, employment,
excise
(i) Allowed unsecured claims to a Federal depository institution
regulatory agency
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(j) Allowed claims for death or personal injury resulting from operating
of motor vehicle or vessel while intoxicated with drub or alcohol
vii) Discharge: the purpose of liquidation bankruptcy is almost always to
discharge outstanding debt
(1) Debtor is not entitled to discharge as a matter of right; but it will be
granted unless challenged by the TIB or creditor
(2) Creditor can make global objection, per §727, rendering all debts
nondischargeable for, among others, lying or filing false documents in
connection with the case, failure to complete a personal finance course,
lack of financial records unless justified under the circumstances
(a) §727(a)(2): for transfer of property with intent to hinder, delay or
defraud creditors (i.e. fraudulent conveyance)
(i) In re Reed (1983): Court holds that a debtor who converts
nonexempt assets to an exempt homestead immediately before
bankruptcy, with intent to defraud his creditors, must be denied
discharge in bankruptcy
(ii) In re Robert W. McNamara (denying global discharge to a
debtor who claimed a gambling loss in a fictional attempt to hide
money that he considered to be his and not his ex-wive’s, where
the effort to transfer remove, destroy, mutilate, conceal property of
the wife occurred within one year before filing date).
(b) §727(a)(5): for failing to explain satisfactorily any loss of assets
(i) In re Robert W. McNamara (denying global discharge to a
debtor who claimed a gambling loss in a fictional attempt to hide
money that he considered to be his and not his ex-wive’s)
(3) Creditor can also object to the discharge of a specific debt, per §523
(a) §523. Exceptions to Discharge: denial to debts obtained by lying on a
credit application, debts for luxury goods worth more than $500
obtained within 90 days of filing, fraud by a fiduciary, alimony and
child support, judgments from drunk driving or boating, tax or customs
duty; willful, malicious injury; fine to government; student loans;
(i) In re Dorsey (1990): Despite the debtor’s gross mismanagement
of her credit card, court holds that as there is no evidence to
establish that the debtor submitted a materially false written
statement concerning her financial condition when she originally
applied for her first credit card, the complaint is dismissed.
(ii) In re Gerhardt (2003): Court holds that the student loans of a
professional cellist could not be discharged because it would not be
an undue hardship under §523(a)(8) for him to repay the loans.
Court suggests that the debtors should get another job in another
field. Applies the Bruner three part test for showing undue
hardship is:
1. that the debtor cannot maintain, based on his current income
and expenses, a “minimal” standard of living if forced to repay;
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2. additional circumstances exist indicating that this state of
affairs is likely to persist for a significant portion of the
repayment period
3. that debtor made a good faith effort to repay the loan
(iii)In re Miller(2004): Court may grant debtor a partial discharge of
her student loan obligations, by relying on §105(a), allowing court
to “issue any order, process, or judgment that is necessary or
appropriate to carry out the provisions of this title,” but such court
must make a finding of undue hardship. §523(a)(8) always applies
to the discharge of student loans in bankruptcy, regardless of
whether discharge is full or partial. 2005 Amendments from a
Congress fervent in protecting creditors did not attack this line of
cases.
(iv) In re Milbank (1979): Court holds that the loans made by father-
in-law and wife to debtor are nondischargeable as they were
obtained by false pretences deliberately created by the debtor
(4) Tax Priorities and Discharge
(i) The kinds of taxes in section 507(a)(8)(A)-(G) are not only given
priority in payment, but any unpaid portion of those taxes is
exempted from discharge
(ii) Pre-petition interest on a(8) shares the priority of the claims
themselves and enjoys their nondischargeable status.
(iii)Penalties on nondischargeable taxes are also nondischargeables
§523(a)(7), although such penalties do not get priority in payment
under (a)(8)
(iv) IRS can satisfy nondischeargable tax debts by seizing property that
is otherwise exempt under state law.
(5) Bankruptcy Crimes: United States v. Cluck (1998): The Court holds
that where the debtor has conveyed his property pre-petition for less than a
reasonable price and with a right to reacquire (in order to shield them from
creditors), he is guilty of bankruptcy fraud under 18 U.S.C. §152(1)&(3)
(intentional concealment of assets)
viii) Reaffirmation, per §524(c)
(1) At the moment of an individual debtor’s Chapter 7 discharge, the §362
automatic stay lifts ((c)(2)(C)), and the §524 discharge injunction slams
into its place (§524(c))
(a) Per §524(c), a debtor may have his debt become legally enforceable
again, if the debtor signs a reaffirmation agreement subject to the
procedures and terms specified.
(i) A reaffirmation agreement revives the debt and makes the debt
(and any future penalties and interest provided in the agreement)
fully enforceable in court.
(ii) §524(c): reaffirmation agreements are enforceable only if, among
others, it is stated not to be required, has been filed in court, is
fully informed and voluntary by debtor, does not impose hardship
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on the debtor, the attorney has fully advised the debtor, is in the
interest of the debtor (where unrepresented)
(2) Secured Debt
(a) Debts are discharged, but liens are not (§506(d)); a secured debt
remains attached to its collateral and be enforced against the collateral
after bankruptcy
(b) Three alternatives to avoid surrendering collateral:
(i) Redemption: requires debtor to pay the creditor the full loan or the
full value of the collateral in cash, whichever is less (§722)
(ii) Reaffirmation: requires a cooperative creditor willing to agree to
let the debtor keep so long as the debtor continues to make
satisfactory payments on the loan §524(c)
(iii)Retention or “ride through”: requires maintenance of the
contractual payments. Debtor keeps collateral by continuing to
make pre-bankruptcy payments without redeeming or reaffirming,
while discharging personal liability on debt. If collateral is
damaged/destroyed, debtor can abandon it without liability. If
debtor keeps paying, creditor is repaid in full.
1. 521(a)(2) removes collateral from the estate and lifts the stay
unless the debtor complies with the commands in section
521(a)(2) to state an intention and follow thorough on one of
three things: surrender property, reaffirm contract with secured
party, or redeem pursuant to §722.
2. 521(a)(6) is similar in overall intent, but has a savings clause
for the debtor is the creditor demands more than original terms
3. unclear whether this solves the problems—state-law collection
issues that persuaded courts that ride-through is permissible
might have survived the 2005 amendments.
(c) In re Pendlebury (1988): Court declines to intervene, at request of
debtors, in the negotiation of their respective reaffirmation agreements
for the purpose of limiting the terms of those agreements
(3) Unsecured Debt: Debtors may reaffirm unsecured debt because of (1)
gratitude, (2) protection of a codebtor, or (3) threat of objection to
discharge or offer of credit
(a) In re Paglia (2003): Debtor reaffirms debt to protect co-debtor,
agreeing to pay off the loan that mom had cosigned. Creditor did not
violate the automatic stay by undertaking an act to collect a pre-
petition claim against debtor when it threatened to take legal action
against the annuity belonging to debtors mom, and then permitted
debtor to execute a second promissory note as an alternative.
(b) In re Latanowich (1997): Court holds that in order for this
reaffirmation to have been enforceable, the agreement must have been
filed with the bankruptcy court (§524(c)(3)) and where debtor is
unrepresented in course of negotiation, the court must approve the
agreement as (i) not imposing undue hardship on the debtor and (ii) in
the best interest of the debtor (§524(c)(6)(A))
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(c) 524(c) includes elaborate series of disclosures to debtors, reminiscent
of Truth in Lending Act disclosures, but the effectiveness on this may
be undermined by the addition of this boilerplate to help consumers
understand better the requirements of the reaff, and force them to focus
on actual ability to make those payments. §521(c)(2), (k)(6)(A)
(d) 524(1)(3) gives creditors a safe harbor against any failure to abide by
the rules by requiring only a good faith attempt to do so.
(4) Debts to Sovereign States: where the creditor is a state, the federal courts
have very limited powers of enforcement, whatever the theoretical rights
of the parties might be under the Bankruptcy Code because of the
principle of sovereign immunity..
(a) Tennessee Student Assistance Corporation v. Hood (2004) (holder
of a state-administered student sought to discharge her indebtedness).
Court held that Congress had not unconstitutionally infringed state
sovereignty by making requiring debtors to file an adversary
proceeding against the state in order to discharge student loan debt,. In
adjudicating the undue hardship determination sought by the debtor
the bankruptcy court, was properly exercising its in rem jurisdiction,
and not in personam jurisdiction over the State.
(5) Nondiscrimination: §525 forbids employers or government agencies
from discriminating against discharged debtors
c) Chapter 13 Bankruptcy: Payout Plans (§301), known as Adjustment of Debt or
Wage Earners’ Plan. I
i) What is the estate? Per §1306, everything in §531 + future income (3-5 years)
ii) Debtor always has a trustee in Chapter 13; trustee recommends approval or
denial of plan confirmation (§1302(b)(2)(B)), ensures payments are
commenced wthin 30 days after filing, and that payments are properly
distributed (§1302(b(5), 1326), moves to have debtor kicked out of
bankruptcy when he stops paying, modifies plan.
iii) What is the difference between Chapter 7 and Chapter 13?
(1) Focuses on future earnings, rather than accumulated assets, to pay
creditors; debtors keep all assets and agrees to turn over a portion of all
future income for a minimum of three years
(2) Paying over time; no discharge until all payments are made, with court
supervision that lasts from the last day of filing until plan payments are
completed, as compared to Ch 7 debtor, who is under jurisdiction of the
court only from filing to discharge hearing, usually held within 6 months;
2/3 never make it to the end of Chapter 13 (either liquidate or drop out
altogether)
(3) And getting to keep all property (exempt and non-exempt) §1302(b)(1),
subject to trustee supervision
iv) How does it work?
(1) TIB takes a percentage of the debtor’s income for each pay period, applies
it to the administrative expenses, and then distributes the remainder to the
creditors according to a court-approved plan, which details the amounts to
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be repaid and the terms of repayment in accord with certain statutory
requirements
(2) When the debtor has completed the agreed payout, the debtor’s remaining
obligations are discharged
(3) TIB’s responsibilities include objecting to improper creditor claims,
asserting objections to debtor’s discharge, confirming the plan
(§1302(b)(2)(B)), and distributing payments
(4) Confirmation of the plan vests all of the property of the estate in the debtor
(§1327(b))
(5) Automatic stay provisions remain in effect, as in a Chapter 7 filing
v) Payments to Secured Creditors: one reason to choose a Chapter 13 filing is
to keep property that is subject to a valid security interest; i.e. holding
collateral over time while payments can be made
(1) Secured creditor is naturally concerned about the risk that the collateral
will lose its value, either bec of loss or neglect or depreciation
(a) Hence, a creditor can move to have the automatic stay lifted under
§362(d), claiming that its interest is not adequately protected OR that
both the debtor retains no equity in the asset AND the asset is not
necessary to effective reorganization
(b) Per §361, adequate protection may be provided by:
(i) Requiring TIB to make a cash payment or periodic cash payments
to such entity, to the extent that the stay results in a decrease in
value of such entity’s property
(ii) Providing such entity an additional lien to the extent that the stay
results in value decrease
(iii)Insurance, to be used in event of destruction or loss of collateral
1. In re Radden (1983): Court holds that if the debtor (1)
procures adequate insurance on the property at the time of
recovering possession and (2) makes monthly payments under
contract until the time that a plan is confirmed, the creditor’s
interest in the subject property will be adequately protected
(2) Modifying the Secured Creditor’s Contract through Cramdown, per
§1325 (a)(5): A debtor may modify the terms of a undersecured debt in
Chapter 13 plan, as long as the debtor paying debt off over time pays (1)
the allowed secured claim (debt or value of collateral, whichever is less)
plus (2) interest, i.e. paying present value of collateral over time.
(a) Value of Collateral: Associates Commercial Corp. v. Rash (1997):
Court holds that when a debtor seeks to retain and use the creditor’s
collateral in a Chapter 13 plan, the value of the collateral will be the
replacement standard (what the debtor would have to pay for the
comparable property). Codified in §506(a)(2).
(b) Once court determines that the security interest in asset, it has to make
two factual determinations to establish the correct amt for debtor to
pay under Ch. 13 plan:
(i) The amount of the allowed secured claim under 506(a)
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(ii) The present value of the allowed secured claim under
1325(a)(5)(B)(ii) (“value as of the effective date of the plan”
(c) Capping Interest Rates: Till v. SCS Credit Corporation (2004):
Sup Ct. finds that the adequate interest rate in computing present value
under §1325(a)(5)(B) is the formula rate, which looks to the national
prime rate, as reported in the press, adjusted for risk (does not decide
the proper scale for risk adjustment)
(d) Payments to a Home Mortgage: lienstripping is not available on a
home mortgage; the only relief in Chapter 13 is to “cure and maintain”
– to catch up on the past-due arrearage while making current payments
as they come due
(i) Problems arise involving (1) saving the home from foreclosure and
(2) proposing a plan to comply with the strict limitations imposed
by the provisions of Chapter 13 to protect the rights of mortgage
lenders
(ii) In re Taddeo (1982): Court holds that the debtor’s power to
“cure” in §1322(b)(5) contains the power to de-accelerate, despite
accelerating payment by declaring the entire balance due
immediately after default in mortgage payment
1. Congress intervenes with the 1994 amendments, giving
homeowners right to de-accelerate by statute at any time prior
to the foreclosure sale (§1322(c))
vi) Payments to Unsecured Creditors
(1) General unsecured creditors can best enhance their position by arguing
that the debtor should be required to make larger payments under the plan,
per §1325:
(a) Best Interests Test, per §1325(a)(4): requires that each creditor,
secured or unsecured, receive at east as much as that creditor would
have received if the debtor had gone into Chapter 7
(b) Debtor must devote all disposable income to make payments during
the life of plan, per §1325(b)(1)(B)
(i) Disposable Income: income minus expenses that are reasonably
necessary
1. In re Carter (1996)(where debtor’s plan did not include her
husband’s income): Court holds that the debtor has not
satisfied the burden of demonstrating that all of her projected
disposable income is being committed to the plan, given that
her husband’s income will certainly satisfy some of her
expenses
2. In the Matter of Wyant (1998)(where the Court must decide
what expenses are reasonably necessary): Court holds that the
debtor’s increased expenditures upon not having to pay
alimony and his allocated expenses for the care of his farm
animals are not reasonable, and the plan must be reconfigured
to include larger payments
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(c) Additionally, a plan must be proposed in good faith and not by any
means forbidden in law, per §1325(a)(3)
(i) Good Faith: whether the debtors acted equitably in proposing the
plan
1. In re Greer (1986)(where debtors propose a plan that would
pay approximately 1% of outstanding unsecured debt): Court
holds that the plan was entered in good faith and that a zero-
payout to unsecured creditors is not sufficient cause to extend a
payout plan beyond 3 years, per §1322(c)
2. In the Matter of Strauss (1995)(where debtors were not
permitted to file a Chapter 7 liquidation because they had filed
one fours prior): Court holds that a plan will not be confirmed
where (1) debtor received Chapter 7 within 6 years; (2) §727
would bar the debtor from obtaining a Chapter 7 liquidation;
and (3) proposed Chapter 13 plan amounts to no more than a
disguised Chapter 7 liquidation
(ii) Such factors to be considered in determining whether the debtor
files plan in good faith:
1. Amount of proposed payments
2. Debtor’s employment history and earning capacity
3. Duration of plan
4. Accuracy of information on plan
5. Whether there is preferential treatment between creditors
6. Whether plan modifies secured claims
7. Type of debt sought to be discharged
8. Whether debtor filed bankruptcy before
d) Consumer Bankruptcy System: An Overview: policies oscillate in tension
between the traditional idea of a fresh start and a pervasive fear of abuse
i) Theories
(1) Scholarly interest focuses primarily on the ex-ante problem, arguing that
the cost of credit may be greater because creditors must account for the
risk of the bankruptcy discharge at the time the credit is extended.
(2) Other scholars assert that bankruptcy is a form of social safety nest,
supplementing unemployment insurance, public medical care, etc.
(3) Reason that the focus is on the ex-ante stage is: research shoes that most
debtors who file simply can’t pay-once debt incurred, little to be done
ii) Policy debates: Is bankruptcy the result of irresponsibility or misfortune?
Some argue that credit irresponsibility, whether of the debtors who incur the
bills or the irresponsibility of the lenders who extend it, is the leading cause of
bankruptcy, while others say that bankruptcies are more often the
consequences of economic forces beyond an individual’s control (layoffs,
illness). Both theories have support in empirical data
(1) Aggressive marketing of credit and default rates of interests and penalty
fees make it impossible for debtor to catch up
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(2) Increasing economic volatility of modern America put larger share of
middle class at risk for economic collapse due to layoffs, serious medical
problems, and divorce.
iii) The Consumer Bankruptcy System Before and After the 2005 Amendments
(1) Abuses: New amendments deny a Chapter 13 discharge for a debtor who
has gotten a Ch 7 discharge within prior 4 yrs §1328(f), eliminating the
filing of so-called “Chapter 20” cases, in which debtor filed 7 & 13 in
close succession, to discharge debt under §523, and then put the
nondischargeable debts into payment plan and pay them over time in 13
(2) Recoveries for Creditors: Tries to steer debtors into Ch 13 to generate
greater recoveries for creditors. BUT lots of ch 7 reaffirm and Ch 13 don’t
complete plans, and unsecured creditors may do worse with amendments
bec of the new ch 13 rules requiring many secured debts to be paid in full,
regardless of the value of the collateral, leaving less for unsec.
(a) 524(l) gives more safe harbor
(b) provisions such as tightening of presumption of fraud and eve-of-
bankruptcy transactions in 523(2)(C) may provide creditors with more
occasions for plausible objections to discharge, to be settled with reaff
(3) Domestic Support-domestic support obligations are given top priority in
ch 7, and they must be current for debtor to confirm or maintain ch. 13
(4) Bankruptcy rates-number of bankruptcies filed might be lower bec of
cost and delay (more paper work, pre-bankruptcy debt counseling, post-
bankruptcy financial counseling), which might cause some debtors to lose
property without filing, and thus lose incentive to file
(5) Chapter choice-on ch. 7 side, the means test means applies only to 10-15
of debtors, but on ch 13 side, almost 90% of those who now file in Ch. 13
are below-median debtors who could’ve filed in 7 despite means test.
choosing which chapter to file is still a completely free choice(p. 229-230)
(a) Choice might be affected by whether courts will permit zero payment
or low-payment plans for debtors who are essentially restructuring
secured debt only
(b) Bec most potential ch 13 filers will be below-median debtors, lowering
the disposable income bar might encourage more 13 filings
(c) IRS budget for 5 years might be unattractive for above-median filers
who are not barred from 7 by means test
(d) Cost of failure in 13 has risen substantially, and anecdote and data
suggest that most ch 13 plans fail.
(6) Lawyers-must call themselves “debt relief agencies” in any bankruptcy
ads, higher sanctions that can be imposed for any mistake (professional
sanctions, court fines, damage suits by trustee or client) 527-28, 707(b),
such as failing to confirm the accuracy of debtor’s valuation of assets, and
to predict interpretation of ambiguous term such as “replacement value” of
an asset. Many lawyers, especially nonspecialist, may exit practice, and
those who remain may raise fees.
(a) Using Chapter 13 to Pay Fees: In re San Miguel (1984): Court holds
that where the only reason debtors chose a Chapter 13 plan over a
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Chapter 7 is to disseminate payment of attorney’s fees (where
requested upfront in Chapter 7) and that because the Chapter 13 plan
as presented will pay creditors $1, the purpose of the Chapter 13 plan
is frustrated
CORPORATE BANKRUPTCY
7) Corporate Liquidation, Chapter 7
a) Main differences between personal and corporate liquidation: no discharge for
corporation, which instead expires under state corporate law; no exemptions for
corporations, so that all property is available for repaying creditors.
i) Because negotiations in Ch. 11 take place wth Ch. 7 as the alternative, and bec
the analysis of the hypothetical Ch 11 position requires an analysis of the
hypothetical ch 7 position, in any workout situation (in or out of bankruptcy,
ch. 7 or 11), each of the parties in the business negotiation will do a
liquidation analysis which shows the likely result for the party in ch. 7
ii) Ch. 7 a better place to liquidate than state law proceedings, since state law
encourages a grab rule instead of an orderly sale of assets
(b) Involuntary Bankruptcy: because it always leads to a debtor’s loss of control,
partial or complete, over company, and may hurt business itself through loss of
credit and general reputational damage, combined with the natural optimism of an
entrepreneur, debtors have strong incentive to resist filing. Ideal solution is for
the debtor to initiate
iii) §303 of the Code reflects the decision in the U.S. to protect debtors by making
involuntary bankruptcy relatively difficult. Traditionally for ch 7 but also
available in ch 11.
iv) Involuntary petition can only be filed against a person, except a farmer, family
farmer, or corporate that is not a moneyed, business, or commercial
corporation, per §303(a)
v) Person, per §101(41), includes individual, partnership, and corporation, but
does not include governmental unit
vi) Corporation, per §101(9)(iv), includes unincorporated company or association
b) §303(a)(3)(A): An involuntary filing is commenced against a person if such a
person is a partnership by fewer than all of the general partners in such
partnership
c) §303(h): If it is not timely objected to by debtor, an involuntary bankruptcy will
be filed (followed by automatic stay and property of the estate), same as debtor
himself files, or, if it is contested, after trial, if (1) the debtor is generally not
paying such debts as they become due unless such debts are the subject of a bona
fide dispute, or (2) within 120 days before the date of the filing, a custodian, etc.
was appointed or took possession
i) Note varying definitions of insolvency
(1) Bankruptcy insolvency: liabilities outweigh assets
(2) Equity insolvency: debtor is unable to pay his debts as they mature
(3) Generally not paying standard, as employed in statute
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ii) In re Faberge Restaurant of Florida, Inc. (1997): Court holds that creditors
filing involuntary bankruptcy cannot be involved in bona fide dispute over
whether the debt is owed and that
d) Additionally, the court requires that, where there are at least 12 creditors, 3 of
those creditors must join in most involuntary petitions, per §303(b)(1) (only one
to file if less than 12, excluding insiders); also creditors filing must hold at least
$12,300
i) In re Gibraltor Amusements (1961): Court holds that creditor and its
subsidiaries are two distinct creditors for the purposes of §303
e) Involuntary bankruptcy can be used a bullying tactic by creditors, so §303(i)
imposes attorney’s fees and costs (and sometimes punitive damages) against
unsuccessful petitioners
i) In re Silverman (1998): Court holds that where petitioner persisted in filing
of involuntary bankruptcy against Silverman after the court adjudged that the
petitioner was a subject of a bona fide dispute, the petitioner is responsible for
paying attorney’s fees, and since he acted in bad faith, punitive damages
8) Corporate Bankruptcy: Chapter 11
a) Introduction
i) Resembles in broad conceptual outline the other rehabilitation chapter,
Chapter 13; reorganizing the debt by extending the time in which to pay it and
reducing the total amount to be paid
ii) Companies choose Chapter 11 because Chapter 7 means corporation “death”
iii) Purely financial reorganizations occur when a business is operationally sound
but has acquired loads of debt; here, old equity is wiped out, while unsecured
creditors become new stockholders; this is called a balance sheet
reorganization because it takes place on paper and does not shift the
operations
iv) Wholesale reshuffling occurs when the operations need revamping; DIB will
sell money-losing divisions, trim excess staff, cut back on number of company
car
b) Mechanics of Chapter 11
i) When a debtor files a petition, the automatic stay is imposed (§362(a)); the
business continues to operate in the ordinary course (§363(b)), under the
control of the debtor in possession (“DIP”)
ii) DIP is limited in the use of its secured assets (§363(c), (e)); also faces
prospect that secured creditors will seek court approval for lifting the
automatic stay as to their collateral, unless the DIP can provide adequate
protection of their interests (§§361, 362(d))
iii) DIP may obtain financing and other credit with court approval (§364)
iv) DIP had avoiding powers:
(1) Power to recover preferences (payments of transfer of property to favored
creditors within 90 days of bankruptcy), §547
(2) Power to assume or breach outstanding executory contracts, §365
(3) Power to void fraudulent conveyances, §§548, 544(b)
(4) Power to set aside unperfected or late-perfected security interests in
debtor’s property, §§544(a), 547
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(5) Power to require turnover of property of the debtor being held by another
entity, §§542, 543
v) Creditors’ Committee is appointed to scrutinize the debtor’s activities on
behalf of all creditors and to negotiate with the debtor, per §1102
vi) To conclude, debtor will propose Plan of Reorganization, in which it will
offer to pay each class of creditors a certain percentage of their claims over a
stated period of time. Payment can be in cash, property, or securities issued by
reorganized debtor
vii) The Plan must be accepted by the majority of creditors in each class; those
creditors that have not accepted must be paid at least as much as it would have
gotten in a liquidation (§§1126(c), 1129(a)(7), analog to “best interests” test)
viii) Upon confirmation, debtor is discharged from all pre-petition debt, except
as provided in the Plan, per §1141(d); contrast to Chapter 13, giving discharge
only after plan has been completed and Chapter 7, giving no discharge at all to
a corporate debtor
c) The Automatic Stay and Adequate Protection
i) Automatic stay is immediate, nationwide (or even worldwide) and strictly
enforced even against a large number of people who had no prior notice or
opportunity to contest it, and in action taken in innocent violation of stay by
people without notice of filing.
ii) Repossession immediately preceding bankruptcy (within 90 days) will not
improve the creditor’s position; the DIP can force return of the property to the
debtor (i.e. voidable preference)
iii) Court must act on a request to lift the stay within 30 days or it will
automatically be lifted as to the requesting creditor’s collateral (§362(e));
burden will be on DIP to show the existence of adequate protection of the
secured party’s interest in the collateral (§362(g))
(1) Farm Credit of Central Florida, ACA v. Polk (1993): Court holds that
pre-petition agreement by appellee to waive right to contest appellant’s
relief from stay is not valid because the purpose of stay is to protect all
creditors and put them on even footing with one another and therefore
cannot be waived
iv) Exceptions to the Automatic Stay: Government Claims, §105
(1) For determining when a stay for government is excepted:
(a) Pecuniary purpose test: whether the government’s proceeding relates
primarily to the protection of the government’s pecuniary interest in
the debtor’s property or to matters of public safety
(b) Public policy test: distinguishes between proceedings that adjudicate
private rights and those that effectuate public policy
(2) United States v. Seitles (1989): Court holds that where the harm caused
by defendant is neither continuing nor public health-related and where the
case is primarily an adjudication of private rights, there is no exception to
the automatic stay for governmental claims; also, though non-debtors
(even non-debtor codefendants, as Seitles) are not entitled to §362 relief,
§105 enables an exception where (1) there is irreparable harm or (2)
sufficiently serious questions and a balance of hardships
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(a) The test for non-debtors applying the stay is met when the action
against the non-debtor codefendant is so inextricably woven with the
affairs of the debtor that it would substantially hinder the debtor’s
reorganization effort
v) Lifting the Stay
(1) Lack of Adequate Protection (§362(d)(1), (2)): creditor must make a
motion to lift stay if the value is slipping below cushion; ex post complaint
will not help
(a) In re Rogers Development Corp. (1980): Court holds that plaintiffs
are adequately protected by equity cushion that exists between the
amount of debtors’ obligation and the value of property (under
§361(3)), where such property is increasing in value; further, even if
the plaintiff has no equity in the property, stay will not be lifted if such
property is essential to the debtor’s reorganization
(i) Value is determined to be the average of the FMV estimates
offered by the two competent appraisers
(ii) The lack of an equity cushion is not indicative of whether the stay
will be lifted; but the less the equity cushion, the more compelling
the argument that the decline will hurt; a fully secured creditor will
have to show a steeper decline
(iii)Note that the secured creditor can only be paid for interest to the
extent by which he is oversecured
(b) §362(d)(3) forces small single-asset cases to propose workable plans
promptly or to immediately start paying interest on value of collateral
(2) Recall §362(d)(2):
(a) Does the debtor have equity in the property?
(b) Is such property necessary to effective reorganization?
(3) Why don’t we allow secured creditors to go after their assets immediately
upon bankruptcy filing? Value-enhancing, i.e. preventing one secured
creditor from single-handedly destroying the business by taking his one,
but consequential, asset
d) The Plan
i) Creditors may file plan, per §1121(b)(2) or (3), if and only if the debtor has
not filed a plan before 120 days after the date of the filing or the debtor has
not had his plan accepted by the majority in each class of creditors within 180
days of filing, respectively; hence, if the debtor has filed but has failed for 4
months to provide a plan, the creditor may himself file a plan
(1) The court may increase or reduce the number of days (120 or 180) on
request by party in interest after notice and a hearing
ii) What do creditors get under the plan?
(1) Oversecured creditors get full amount of claims, including post-petition,
pre-confirmation interest (up to the value of the collateral) and they will
then earn interest post-confirmation on the amount that has accrued up to
confirmation
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(2) Undersecured creditors get the value of their collateral at time of filing,
plus post-confirmation interest on that amount, plus pro rata payment for
bifurcated general unsecured portion
(3) Unsecured get at least the amount they would have gotten in Chapter 7
liquidation, plus interest (present value)
e) Appointment of a Trustee or Examiner: in some circumstances, creditors
complain because the DIP is making business choices that are hostile to creditor
interest; note that estate is run for creditors, not shareholders (debt before equity,
absolute priority rule); disputes can be resolved by the appointment of a TIB to
run the business or an examiner
i) §1104: Appointment of Trustee or Examiner
(1) Trustee to run business/estate:
(a) (a)(1) for cause, including fraud, dishonesty, incompetence, or gross
mismanagement of the affairs of the debtor by current management; or
(b) (a)(2) if such appointment is in the interest of creditors, any equity
security holders, and other interests of the estate, without regard to the
number of holders of securities of the debtor or the amount of assets or
liabilities of the debtor
(2) Examiner to conduct an investigation of debtor as is appropriate, including
allegations of fraud, dishonesty, incompetence, misconduct,
mismanagement, irregularity of management:
(a) (c)(1) such appointment is in interests of creditors, any security
holders, and other interests of the estate; or
(b) (c)(2) the debtor’s fixed, liquidated, unsecured debts, other than debts
for goods, services, or taxes, or owing to an insider, exceed $5,000,000
ii) Only if estate does not have a trustee can creditors move to have an examiner
appointed
iii) In re Sharon Steel Corp. (1989): Court affirms the bankruptcy court’s use of
a totality of circumstances standard to show §1104 cause for appointment of
TIB where DIP’s actions threatened payment to creditors
iv) In re Geneva Steel Co. (1999): Court denies Geneva’s motion to implement
an employee retention plan during Chapter 11 reorganization, as an attempt to
keep the current managers from fleeing to a more successful business, which
Geneva claimed (1) would stabilize the company during reorganization and
(2) would be based on the board’s sound business judgment
(1) Note that it is ordinarily in the creditors’ best interest to have the debtor
continue to run the business
f) Cash Collateral: §363
i) Congress has placed few restraints on DIP’s use of cash that is not subject to a
lien, so long as it is used in the ordinary course of business, per §363(c)(1);
anything spent post-petition will be subject to a §507(a)(1) administrative
expense
ii) Debtor is much more constrained in its use of cash that is subject to a lien,
which is usually cash derived from the sale of inventory or collection of
accounts subject to an Article 9 proceeds claim by a lender secured by
inventory or accounts, called cash collateral
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(1) Per §363(e), cash from the sale of inventory subject to an Article 9
proceeds claim by a lender secured by inventory cannot be encumbered in
some other way without the permission of the bankruptcy court (notice
and hearing to determine whether there is adequate protection) or consent
of the creditor
(a) UCC §9-315(a)(1): A security interest continues in collateral
notwithstanding sale, lease, license, or exchange unless the secured
party authorized the disposition free of security interest; per (a)(2), a
security interest attaches to any identifiable proceeds of collateral
(i) Note that interest continues in goods, not is cash received for them
(ii) Note further that security interest in inventory acquired filing
disappears because liens do not extend post-petition to after-
acquired property, though proceeds do (because new property can
be traced back to proceeds)
iii) Lock box arrangement: instructing those who owe debtor to send their
payments to a certain P.O. Box, which is under control of the creditor or a
third party; parties have agreement as to how much of the money is in the lock
box and how much goes to the creditor
(1) In re Earth Lite (1981): Court is satisfied that Sun Bank is more than
adequately protected if the Debtor is required to cure and maintain and
that debtor may dip into lockbox
iv) Setoff: right of any creditor to offset a debt its owes the debtor against a
debtor owed to the creditor by the debtor (if I have $1k in my bank account, I
have technically made the bank a loan for that amount. If I hold a loan from
the same bank for $1k, the bank can use the $1k in the account to offset the
full loan), per §553; treated as a security interest for most purposes under the
code; subject to automatic stay to be lifted only by the court under §363(c)
(1) §553(a)(3): Setoff is permitted except to the extent that the debt owed to
the debtor by such creditor was incurred by such creditor (A) after 90 days
before filing; (B) while debtor was insolvent; AND (C) for the purpose of
obtaining a right of setoff against the debtor
(a) Bank of Maryland v. Strumpf (1995): Creditor could not set off
without violating the stay, but the creditor could protect itself with an
administrative freeze by holding the money in the checking account
pending its application to the bankruptcy court for a stay motion.
(b) In re Hal, Inc. (1996) (where government argues that it should be
entitled to setoff where the IRS owed the debtor a refund, while 4
other federal agencies were owed money by debtor): Court holds that
the 5 federal government agencies, except those acting in a distinctly
private capacity, are a single entity for purposes of setoff; and that the
court’s allowing of setoff was not an abuse of discretion
(2) Setoff may be denied at the discretion of the court if:
(a) Creditor has acted inequitably
(b) Setoff would jeopardize a debtor’s ability to reorganize
(c) In liquidation context, resulting in preference or priority over other
unsecured creditors
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(3) Note on compensating balance: banks may contrive a minimum balance so
as to allow them to setoff in the event of bankruptcy
v) Post-Petition Financing: §§ 364, 507, 726
(1) Filing for bankruptcy will not alone produce any cash, so the debtor must
find someone willing to make a new infusion; debtor’s current lenders,
who have the most at stake, are often the most likely source of new funds
(2) Options for Obtaining Financing
(a) §364(a): May obtain unsecured credit and incur unsecured debt in the
ordinary course of business allowable under §503(b)(1) as an
administrative expense
(b) §364(b): May obtain unsecured credit and incur unsecured debt not in
the ordinary course of business pursuant to notice and hearing and
allowable as an administrative expense under §503(b)(1)
(c) §364(c): If trustee is unable to obtain unsecured credit allowable as an
administrative expense, Court, after notice and hearing, may authorize
obtaining of credit:
(i) With priority over any or all administrative expenses
(ii) Secured by a lien on property of the estate that is not otherwise
subject to a lien
1. In re Garland Corp. (1980): Court permits the use of
unencumbered assets as collateral to secure post-petition
indebtedness upon compliance with §364(c)(2)
(iii)Secured by a junior lien on property of the estate subject to a lien
(d) §364(d)(1): May incur debt secured by a senior or equal lien on
property of the estate that is subject to a lien only if: (A) trustee is
unable to obtain such credit otherwise; and (B) there is adequate
protection of the interest of the original lien holder whose claim has
been subordinated to the senior lien
(3) Security interest in property
(a) Note that pre-petition security interests in after-acquired property
cease to operate immediately when bankruptcy is filed, per §552(a)
(i) Secured creditor can claim a security interest in post-petition
property by way of a proceeds argument under UCC §9-315; e.g.
if secured creditor can trace the purchase of the new, post-petition
inventory back to the sale of the old, pre-petition inventory in
which it held an interest, the secured creditor could claim a
continuing security interest
(ii) In re Hubbard Power & Light, Inc. (1996): County has a $1m
lien against debtor’s priority, to secure reimbursement of the $1m
spent fighting a fire at debtor’s real property. In Ch. 11, County
objected to having its lien subordinated to a post-petition financer
willing to lend the debtor the money for clean up and start up after
fire. Because any improvement to the debtor’s real property via
clean-up to allow operating, will greatly improve the value of the
collateral, the court granted the debtor’s post-petition senior
priority financing under §364(d)
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(4) Cross-Collateralization and Mootness
(a) Cross-collateralization: securing a pre-petition obligation with new or
additional collateral post-petition in connection with a new post-
petition loan; not specifically addressed in code; question is whether a
creditor’s pre-petition position (often under-secured) get promoted in
exchange for post-petition financing?
(i) Shapiro v. Saybrook Manufacturing Co., Inc. (1992): Court
holds that cross-collateralization is not authorized under the
bankruptcy code because (1) it is not authorized as a method of
post-petition finance per §364 and (2) it is directly contrary to the
fundamental priority scheme of the code under §507
(b) Mootness: refers to the assumption that any challenge to cross-
collateralization is moot under §364(e), to encourage the extension of
credit to debtors in bankruptcy by eliminating risk that lien securing
the loan will be modified on appeal.
(i) Several key reorganization issues are difficult for appellate review
because a stay of the bankruptcy court order will often sink the
company, but absent a stay, it is hard for the appellate court to
resolve
(ii) §364(e): Reversal or modification on appeal of an authorization to
obtain credit or incur debt, or of a grant of a priority on a lien, does
not affect the validity of any debt so incurred or priority granted
that extended the credit in good faith, unless such authorization or
priority were stayed pending appeal
(iii)Designed to encourage post-petition lenders by assuring them that
their rights will not be upset by an appeal of the order that gives
them security or a priority, leaving them with a very high-risk loan
(5) Owner Financing: some debtors turn to the old equity holders as another
source of funds in return for continued ownership of the post-bankruptcy
business
(a) Equity cannot retain value unless all the creditors have been paid in
full (“Absolute Priority Rule”); some courts allow equity to retain
value when the it provides value that cannot be obtained elsewhere
(b) Bank of America National Trust and Savings Assoc. v. 203 N.
LaSalle St. Partnership: Court holds that the partnership cannot buy
the equity in the business as part of plan confirmation without giving
others the opportunity to bid
g) Reshaping the Estate: avoiding powers allow TIB to undo pre-bankruptcy
transactions between the debtor and certain creditors, to the benefit of all
unsecured creditors; bringing an avoidance action gives the TIB or DIP much
greater leverage in negotiating with creditors, DIP is trying to save the business as
going concern on behalf of all creditors, as well as other constituencies
(employees, shareholders, community). Thus, DIP’s rights are not just rights of
old debtors, but also the collective rights of creditors to preserve business assets
i) Strong Arm Clause §544(a): power to “knock off” unperfected interests
(1) Relevant Code Provisions
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(a) §544(a) avoidable liens:
(i) (1) Creditor that extends credit to debtor at time of commencement
of case and obtains at that time a judicial lien on property
(ii) (2) Creditor that extends credit to debtor at time of commencement
of case and obtains at that time an execution against the debtor that
is returned unsatisfied at such time
(iii)(3) Bona fide purchaser of real property from the debtor against
whom applicable law permits such transfer to be perfected
(b) §362(a)(4): any act to create, perfect, or enforce any lien against
property of estate once bankruptcy has been filed is prohibited
(c) UCC §9-317(a)(2): Security interest is subordinate to the rights of a
person that becomes a lien creditor before the security interest is
perfected
(d) UCC §9-317(e): If a purchase-money security interest is perfected by
filing no later than 20 days after the debtor receives delivery of
collateral, the security interest takes priority over the rights of a buyer,
lessee, or lien creditor that arise between the time the security interest
attaches and the time of the filing
(i) What happens if filing of security interest is done right as
bankruptcy is filed?
1. §362(b): does not operate as a stay of any act to perfect an
interest in property to extent that trustee’s rights and powers
are subject to such perfection under §546(b), i.e. when Article
9 gives 20-day window, and debtor files for bankruptcy within
20 days, you still have rest of 20 days to file; still entitled to
automatic reach-back
(2) Wonder-Bowl Properties v. Hi Ja Kim d/b/a Laura’s French Baking
Co. & Laura’s Bakery (1993) (where debtor seeks to avoid lien on
grounds that initial filing was void because it lacked certain information
required by state civil procedure): Against a holder of a real property
interest, the TIB has the status of a bona fide purchaser of a real property.
The mistakes in the initial failing were such that a hypothetical bona fide
purchaser on the date of the bankruptcy would had have neither actual,
constructive, nor inquiry notice of the judgment, and thus the lien was
avoidable under §544(a)(3).
(a) Only secured parties and buyers are protected against misinformation
of certain types in a filed financing statement, while unsecured
creditors represented by the TIB are bound by a defective and
misleading filing
(3) Federal Tax Liens: before the lien is filed, the strong arm provisions
permit TIB to exercise rights of a judgment lien creditor or bona fide
purchaser of real estate on the date of filing, which gives the TIB priority
over the unfiled tax lien; after the tax lien is filed, however, the TIB must
recognize the lien in bankruptcy and treat the government as it does other
perfected secured parties
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ii) Preferences: powers of TIB include ability to dismantle transactions between
debtor and creditors that took place within 90 days immediately preceding
filing
(1) §547(b): Trustee may avoid any transfer of an interest of the debtor in
property:
(a) To or for the benefit of a creditor;
(b) For an antecedent debt owed by the debtor before such transfer was
made;
(c) Made while the debtor was insolvent;
(d) Made:
(i) on or within 90 days before the date of the filing of the petition; or
(ii) between ninety days and one year before the date of the filing of
the petition, if such creditor at the time of such transfer was an
insider; AND
(e) that enables such creditor to receive more than such creditor would
receive if –
(i) The case were a case under chapter 7 of this title;
(ii) The transfer had not been made; and
(iii)Such creditor received payment of such debt to the extent provided
by the provisions of this title
(2) Under §547(e)(2)(A), a transfer is made at the time such transfer is takes
effect, if such transfer is perfected after 10 days
(3) In re Calvert (1998) (where debtor borrows $12,000 from parents to pay
settlement secured by a mortgage note and a lien on pickup truck): Since
there was no evidence of a written security agreement and the notation on
the certificate of title did not create a presumption that one existed, Court
holds that the settlement payment was never property of the debtor’s estate
and thus was not a voidable preference under §547(b)
(4) Earmarking doctrine holds that a voidable preference must involve a
transfer of an interest of the debtor in property. It allows preference
payments, if there is:
(a) Existence of an agreement between new lender and debtor that the new
funds will be used to pay specified antecedent debt
(b) Performance of agreement according to terms
(c) Transaction viewed as a whole does not result in any diminution of the
estate
(5) Fidelity Financial Services, Inc. v. Fink (1998): Court holds that where
the security interest is perfected more than 20 days after the debtor
receives the property but within a relation-back or grace period provided
by otherwise applicable state law, the transfer is avoidable, despite the
state granted grace period
(a) A transfer of a security interest is “perfected” under §547(c)(3)(B) on
the date that the secured party has completed the steps necessary to
perfect its interest, so that a creditor may invoke the enabling loan
exception only by satisfying state law perfection requirements within
the 20-day period provided by the federal statute
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(6) General rules about preferences:
(a) Any payment made to the unsecured creditor (at moment of
bankruptcy) within 90 days will be voidable because he will still to get
pro rata distribution + previous payment
(b) For secured creditors (at moment of bankruptcy):
(i) If oversecured, no payment is voidable preference
(ii) If undersecured, all payment (or any improvement in position –) is
voidable because it makes creditor better off than he would be in
Chapter 7
(c) Any improvement in position, e.g. security interest, cash, property,
increase in value of collateral due to debtor’s transaction, can be
voidable
(d) Pulling out one voidable preference may create another that precedes it
(e.g. where a secured creditor is paid and an undersecured creditor is
secured by same piece of property as paid secured, i.e. undersecured
creditor will have higher value of collateral)
(e) If one creditor buys out another creditor, no voidable preference
(7) Recall Fraudulent Transfers: Insiders should not be paid ahead of other
creditors; UFTA §5(a) governs voidable preferences regarding such
transfers
(8) Note: when DIP does not want to void a preference, creditors’ committee
may initiate action
(9) Voidable Preferences at State Law
(a) UFTA §§ 4, 5: an insolvent debtor’s repayment of debt to an insider
can be set aside by other creditors without the need to file an
involuntary bankruptcy, i.e. in or out of bankruptcy, insiders should
not be paid ahead of other creditors.
(b) The provisions of UFTA § 5(a) are not entirely coextensive with §
547(b); the UFTA only restricts transfers to insiders
(c) The UFTA has a four-year statute of limitations, while the Code
reaches back only one year to review transfers to insiders
(10) Exceptions to Voidable Preferences: §547(c)
(a) Most common include:
(i) Contemporaneous exchange (c)(1)
1. Trustee may not avoid a transfer to the extent that such transfer
was:
a. Intended by debtor and creditor to be contemporaneous
exchange for new value given to debtor; and
b. In fact a substantially contemporaneous exchange
2. In re Alexander (1998): Court did not allow a debtor to avoid
the transfer of a mortgage. The mortgage was an enabling loan
transaction under §547(c)(3)(A), since the parties had agreed
that the mortgage was a purchase money security interest given
to secure the new mortgage funds, that such funds were given
at the time the mortgage was signed, that such funds enabled
the debtors to acquire the property, and that the mortgage was
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perfected within 20 days. §547(c)(1), concerning
contemporaneous exchanges for new value, did not apply,
because an exchange involving a security transaction could not
be substantially contemporaneous unless perfection, here
recording the mortgage, occurred within the 10-day grace
period of §547(e)(2).
(ii) Ordinary course payments (c)(2): ordinary between parties and
within industry
1. In re Roblin Industries, Inc. (1996) (where creditor contests
(1) that trustee proved the debtor was insolvent and (2) the
payments were specified in the ordinary course of business):
Court holds that §547(c)(2)(C) requires creditor to show that
the terms of payment fall within the bounds of ordinary
practice of others similarly situated; otherwise it is a voidable
preference
(iii)Purchase Money Exception (c)(3): purchase-money creditors will
receive special protection in bankruptcy (i.e. 20 days to file)
because the transactions that bring new property into the estate are
regarded as the most beneficial
(iv) New Value Exception (c)(4): only shelters preference payments
that come before a particular extension of new value, payment-by-
payment basis
1. We should not extract repayment of preferences from a helpful
creditor who, after the preferential payment, extended new,
unsecured credit to the debtor and who will suffer in
bankruptcy as an unsecured creditor to the extent of the new
credit
2. Any advance of unsecured credit after the preference will work
to trigger §547(c)(4), but the dollars of each advance can be
counted only once
3. Mechanics of (c)(4):
a. Identify payment/transfer that is preferential under 547(b)
b. See if the avoidable amount of later advances new value
qualifies under (c)(4)
i. Qualifies “to the extent that, after such transfer, such
creditor gave new value to or for the benefit of the
debtor not secured by an otherwise avoidable security
interest; and on account of which new value the debtor
did not make an otherwise unavoidable transfer to or
for the benefit of such creditor” 547(c)(4)(A)-(B)
ii. For ex, if creditor receives $1k preferential payment,
then made $700 delivery of new supplies on credit, the
$1k preference is reduced by the $700 new value)
c. Test new value for qualification under (c)(4) by
determining whether under (c)(4)(A) and (B),it was
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accompanied by a payment (or transfer or was secured)
which payment was itself unavoidable.
i. For ex: creditor receives $1k preference, and then
delivers $700 in new supplies that were paid for in cash
on delivery
ii. When the debtor files for bankruptcy, new value would
not qualify since it was accompanied by the full $700 in
time of delivery
iii. Second payment not avoidable as a preference because
it was made at the moment the debt was created and
therefore not paid on an antecedent debt under §547(b)
iv. Since payment is unavoidable, $700 of new value is
disqualified under (c)(4)(B)
(4) ALTERNATE APPROACH to (c)(4)
a. Work forward chronologically from 90th day to filing,
identifying each payment that qualifies as preferential
b. Work backwards from each grant of new value to
determine whether it is subsequent to a given preference
with the same creditor having advanced unsecured credit to
the debtor
c. Any advance of unsecured credit after the preference will
work to trigger section (c)(4), but the dollars of each
advance can only be counted ounce.
d. EX: two preferences of $1k each, followed by extention of
$1.5k will permit creditor to keep $1.5k of the two
preferences, not the full $2k
(v) Floating lien (c)(5): trustee may not avoid a transfer that creates a
perfected security interested in inventory or a receivable or the
proceeds of either, except to the extent that the aggregate of all
such transfers to the transferee cause a reduction, as of the date of
the filing, of any amount by which the debt secured by such
security interest exceeded the value of all security interests for
such debt on the later of 90 days or one year
1. Whether creditors improve their position, i.e. look at amount of
under-secured at time of bankruptcy and then look at amount
undersecured when transfer is made; difference is voidable
preference
2. In re Nivens (1982) (where TIB contends that the Bank had
benefited from an improvement in position from the increase in
the crop’s value during the 90 days before bankruptcy, so that
part of its interest in crop and support check was voidable as a
preference): Court holds that the increase in crop value that is
attributable to good fortune and sunshine does not involve a
transfer and so can be kept by the creditor with a security
interest in the crop
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(vi) Setoff Preferences (§553(b)): empowers trustee to recover from
an offsetting creditor the amount by which the creditor’s setoff
position improved during the 90 days before bankruptcy; creditor
who waits and exercises right of setoff post-bankruptcy, with
permission of court, does not have to surrender any improvement
in setoff position obtained during the 90-day period
iii) Executory Contracts, per §365: firm examines ongoing contracts, those
negotiated before the filing for which performance is continuing or is due in
the future
Debtor has not paid Debtor has paid
Creditor Executory contract – Buyer’s estate has §541
has not debtor can assume, claim against seller
delivered reject, assign
Assuming no voidable
Creditor Debtor breach with preference, delivery is
has creditor §502 claim part of the estate;
delivered bankruptcy does not
change any legal rights
(1) In determining whether there is an executory contract, most courts look to
see if there is substantial performance to be done by both the debtor and
the creditor
(2) §365(a): Subject to court’s approval (notice and hearing, alerting all
creditors), DIP may assume or reject any executory contract or unexpired
lease of the debtor
(3) Agreements Not Assignable: per §365(c), trustee may not assume or
assign any executory contract, whether or not such contract prohibits or
restricts assignment of rights or delegation of duties, if applicable law
excuses party to contract from accepting performance by an entity other
than the debtor AND such party does not consent
(a) §365(c)(1): if there is some other reason, besides the nonassignment
clause in contract, in state law, then it will not be assignable
(b) §365(c)(2): cannot assume or assign a contract for financing
(i) Part that says can lend money in future is not assumable; part that
gives credit is assumable; at common law, contracts are never
severable, but if you do not let parties sever out, parties can opt out
of bankruptcy
(c) §365(c)(3): Trustee may not assume or assign any unexpired lease if
such lease is of nonresidential real property and has been terminated
under applicable nonbankruptcy law prior to filing
(4) Bankruptcy Termination Clause: per §365(e)(1)(A), an executory
contract may not be terminated at any time after commencement of case
solely because of provision in contract conditioned on insolvency or
financial condition of debtor, commencement of filing, or appointment of
trustee, unless applicable law allows termination
(5) When may a debtor assume or reject an executory contract? §365(d)
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(a) Under §365(d)(1), in a Chapter 7, trustee has 60 days to assume or
reject contracts or get additional time for cause before court;
otherwise, contract is rejected
(b) Under §365(d)(2), trustee may assume or reject an executory contract
at any time before confirmation of plan, but the court may, on request
of any party, order trustee to determine within a specified period of
time whether to assume or reject such contract
(c) Under §365(d)(3), trustee shall perform all obligations of debtor
arising from and after the order for relief under any unexpired lease of
nonresidential property, until such lease is assumed or rejected; court
may extend for cause the time for performance of any such obligation
arising within 60 days after date of order for relief
(d) Contract MAY NOT be assumed if it was terminated prior to
bankruptcy under no-bankruptcy law. The counterparty to contract
with debtor often argues that its contract was history before debtor
filed and may therefore not be assumed.
(i) In re Krystal Cadillac-Oldsmobile-GMC Truck, Inc. (1998)
where parties had been involved in litigation to allow the
dealership to terminate the agreement, and the final determination
by the court was rendered a few weeks before petitioner filed for
bankruptcy, court held that a franchise agreement involving a
vehicle dealership was still in effect when petition was filed and
that the franchise was thus an asset of the estate.
(6) Assignment: per §365(f), except as provided in (c), trustee may assign an
executory contract of debtor, notwithstanding provision restricting
assignment, only if:
(a) Trustee assumes such contract in accordance with this section and
(b) Adequate assurance of future performance by assignee of such
contract or lease is provided
(c) Note: Where future assignment changes expectations of contract, it
will likely be disallowed
(d) In re Jamesway Corp (1996) court allowed a debtor to assign a real
estate lease and nullified a lease provision which required the lessor to
pay the landlord 50% of the profit received from an assignee or
sublessee, because §365(f) allows assignment on an unexpired lease
despite clauses in the lease prohibiting, conditioning, or restricting
assignemnt
(7) Default of Contract Pre-Petition: §365(b)(1)
(a) If there has been a default in an executory contract, the trustee may not
assume such contract or less unless at the time of assumption of such
contract, the trustee
(i) Cures, or provides adequate assurance that he will promptly cure;
(ii) Compensates, or provides adequate assurance that he will promptly
compensate for pecuniary loss; AND
(iii)Provides adequate assurance of future performance under such
contract or lease
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(8) Shopping Center Leases: §365(b)(3): adequate assurance of future
performance of a lease of real property in a shopping center includes
adequate assurance:
(a) Of the source of rent
(b) That any percentage rent due under such lease will not decline
substantially
(c) That assumption or assignment of such lease is subject to all
provisions of lease
(d) That assumption or assignment of such lease will not disrupt any
tenant mix in shopping center
(9) §365(h): If DIP rejects unexpired lease of real property under which
debtor is lessor:
(a) Under §365(h)(1)(A)(i), lessee can treat contract as terminated, giving
§502 claim against the estate, i.e. pro rata payment for expectation
damages
(b) Under §365(h)(1)(A)(ii), lessee can reject rejection, i.e. retain rights
and stay on land
(c) Under §365(h)(1)(B), lessee can offset damages against rent, though
when rent is insufficient to cover damages, he loses the amount not
covered (so it may be in best interest simply to take §502 pro rata
payment)
(i) Also note §502(b)(6): cap on amount of damages resulting from
termination of lease of real property
(10) Rejection: per §365(g), rejection of executory contract or
unexpired lease constitutes a breach of such contract or lease if such
contract is not assumed
(a) There will be a §502 claim on the damages from breach (contract
market differential)
(b) Note that there would have been no advantage to breach out of
bankruptcy, but there is an asymmetry in bankruptcy, where the debtor
pays $.30 on the dollar (but consider that if contract is assumed and
subsequently breached, it is a §507(a)(1) administrative claim)
(c) Concerns about abuse in filing petition only to reject contracts
(i) In re Watkins, Lopes, Thomas (1997): Court holds that where the
debtors are financially distressed, insolvent, and likely to
reorganize successful and there is not evidence that they filed only
to allow rejection of a contract, there is no abuse of the bankruptcy
filing
(ii) §1112: nonexclusive list for conversion or dismissal of a case;
though bad faith is not specifically mentioned; can throw out cases
on general equitable powers
(11) Summary: What happens to executory contracts after filing?
(a) If rejected, outstanding payments are §502 claims, i.e. pro rata
distribution
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(b) If assumed, then defaulted, outstanding payments become §507(a)(1)
administrative claim; if defaulted prior to bankruptcy, must cure (i.e.
paid in full)
(i) Note that where there is pre-petition breach, creditor will argue
that lease was terminated pre-bankruptcy and as such will not go
into the estate
(ii) But note §108(b): guaranteed window of 60 days to cure a default
iv) Statutory Lien: 2 disfavored liens
(1) Landlord liens: DIP can void landlords’ liens because it gives to much of
debtor’s estate to landlord to the detriment of other creditors §545(3)-(4)
(2) Bankruptcy priority liens: liens created by state law that Congress
believes to be phony in the sense that the states do not intend to creat real
liens for all purposes, but rather to use the device of liens to impose
special priority advantages for certain creditors in bankruptcy §545(1)(2)
(a) Merchant’s Grain v. Adkins: court upheld a state law which created
a lien, arising on the date of delivery of the grain, on all the
agricultural commodity assets of a failed agricultural community
handler, because it was not triggered by bankruptcy or insolvency.
Because it was not really an effort to distribute the assets of an
insolvent grain dealer to farmer creditors, it was not superseded by
federal bankruptcy law
v) Fraudulent Conveyance
(1) Recall §544(b), which gives TIB or DIP rights to set aside transfers of
assets by an insolvent debtor for less than reasonably fair equivalent value
(2) §548 provides fraudulent conveyance provisions
(a) §548(a)(1): Trustee may avoid any transfer of an interest of the debtor
in property that was made or incurred on or within one year before the
date of the filing of petition, if the debtor voluntarily or involuntarily –
(i) (A) made such transfer with actual intent to hinder or defraud
creditors; or
(ii) (B) received less than a reasonably equivalent value in exchange
for such transfer; and
1. was insolvent on date of transfer;
2. was engaged in business for which property remaining with the
debtor was unreasonably small; or
3. intended to incur debts that would be beyond debtor’s ability to
pay
(3) §550 addresses liability of transferee of avoided transfer
(a) Trustee may recover, for the benefit of the estate, the property
transferred, or, if the court so orders, the value of the property from –
(i) The initial transferee of such transfer or the entity for whose
benefit such transfer was made
(ii) Any immediate or mediate transferee of such initial transferee
(b) Trustee may not recover from (1) immediate or mediate transferee of
initial transferee that takes value in good faith, or (2) any immediate or
mediate good faith transferee of initial transferee
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(c) So creditor must argue that he is not the first transferee; if he is first,
he has no argument, per §550(a); i.e. only immediate or mediate
transferee of initial transfer may make a good faith argument
(i) In re Video Depot, Ltd. (1997): Gambler gives casino a check
made by the company of which he was president. Casino argues
that the company transferred check to gambler, and that they then
took the check in good faith. Court holds that because creditor was
determined to be initial transferee under §550(a), the transfer was
fraudulent and voidable
(4) Guarantees and Fraudulent Conveyance
(a) Types of guarantees
(i) Downstream guarantee: parent guarantees debt for subsidiary;
likely not fraudulent conveyance
(ii) Upstream guarantee: Subsidiary guarantees debt for parent;
presumptively fraudulent conveyance
(iii)Sidestream guarantee: affiliate guarantees debt
(b) Even when there has been no direct economic benefit to a guarantor,
courts performing a fraudulent transfer analysis have been increasingly
willing to look at whether a guarantor received indirect benefits from
the guarantee,
(c) In re Image Worldwide, Inc. (1998) The guarantees paid by the
debtor to an affiliate corporation were fraudulent transfers because
there was no consideration for the guarantee of debtor's loan. Both
corporations were owned by the same person, but only the affiliate
corporation received funds from the loan. Suffered consequences to
dealing in separate corporate shells: the individual companies cannot
be run entirely for benefit of common owner. Creditors of each entity
can insist that each transaction be made only for reasonably equivalent
value for that entity
h) Equitable Subordination (§510(c)): may result from finding that purported loans
should be treated as if the money had been used to purchase stock in the
company; such loans are treated as equity investments and accordingly receive
nothing until all creditors have been paid in full.
i) In re Carolee’s Combine (1980): Court finds that structure of loan between
debtor and defendant involves repayment from equity, giving rise to equitable
subordination
(1) In order for equitable subordination to be appropriate, three standards
must be met:
(a) Subordinated creditor must have engaged in some type of inequitable
conduct;
(b) Such conduct must have resulted in injury to other creditors and
conferred unfair advantage to himself; and
(c) Equitable subordination must not be inconsistent with Bankruptcy Act
ii) Grounds for equitable subordination could be that creditor is acting as an
equity holder (per Carolee’s) or that creditor is acting as an insider in ways
that hurt other creditors
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(1) Generally applied when there is an allegation of wrongdoing and
wrongdoer is in some sense an insider, such as officer or principal
stockholder; could also be applied where wrongdoer exercised control
over debtor; i.e. creditor takes advantage of debtor
iii) Per §510(c), after notice and hearing, court may:
(1) (1) under principles of equitable subordination, subordinate for purposes
of distribution all or part of an allowed claim to all or part of another
allowed claim or all or part of an allowed interest to all or part of another
allowed interest; or
(2) (2) order that any lien securing such a subordinated claim be transferred to
the estate
iv) Note on contractual subordination (§510(a)): a creditor typically makes an
agreement with another creditor that it will take payment from the debtor only
after the other creditor has been paid in full first
(1) Subordination agreements that are effective under state law are also
effective once the debtor files for bankruptcy
i) Lender Liability: lawsuits in which a debtor claims that the lender acted
improperly in the course of the loan transaction, usually during the period when
the debtor was in financial trouble and the lender was trying to protect its
position; based on allegations that a creditor has exercised control over the debtor,
ultimately to the debtor’s detriment
i) K.M.C. Co., Inc. v. Irving Trust Co. (1985): Court holds that the lender
acted in bad faith, despite engaging in conduct that was expressly permitted
by its loan agreement
j) Review: Assume creditor has a §506 claim – how can he be hurt?
i) Claim is under-secured: do not get post-petition interest or penalties
ii) Claim is just slightly undersecured: if value increases and creditor then
become oversecured after filing, it is a voidable preference
iii) Collateral value depreciates during bankruptcy
iv) If in bankruptcy with unperfected security interest, creditor now becomes an
unsecured, per strong arm clause of §544(a))
v) Post petition financing could bump creditor from first place
vi) Could be equitably subordinated
vii) Security interests stop in after-acquired property at moment of bankruptcy
k) Negotiating the Plan
i) Tax Implications of Bankruptcy
(1) Cancellation of debt (COD) by the creditors under a plan may be treated
as income to the debtor and therefore taxable
(2) In general, under IRC §§108 and 1017, income arising from the discharge
of debts in bankruptcy is excluded from gross income, but an amount
equal to the exclusion must be offset against other tax advantages, such as
net operating loss carryovers or tax credits, or it may reduce its basis in its
assets the value of which can be deducted over the years via depreciation
(a) Effect is to have debtor avoid immediate taxation on COD income at
risk of increased taxation in later years
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(b) It increases the taxes that the debtor may have to pay in future years by
reducing credits or deductions the debtor would otherwise have been
able to use to reduce taxes on its future income
l) Plan Confirmation
i) Reorganization structures
(1) Debtor may wish to issue stock to some of its creditors because it does not
foresee a cash flow large enough to allow sufficient cash payments to
them
(a) May be issuance of new stock or warrants to purchase more stock in
the future
(b) Old common shareholders may retain an interest, but their interest may
be diluted by the issuance of additional common stock to some or all
classes of creditors; such an issuance is often a “sweetener” to these
creditors, promising them not only partial payment but also some hope
of profit if the debtor eventually does well
(2) Alternatively, the best return for creditors may be found in the sale of the
debtor as an operating unit, i.e. on a going concern
(a) Can be sale of company of sale of assets, such as copyrights,
trademarks, and goodwill
(b) Can be sale of stock
(c) Can be sale of part of the debtor’s business or assets
(3) Leveraged Buyout: company or division is sold, with purchase price being
provided largely by bank loans or commercial paper secured by assets
being purchased; purchasers are often management and employees of the
business or division being sold; recall possibility of fraudulent conveyance
ii) Two ways of confirming a plan:
a. Meet all 11 requirements of §1129(a), including (a)(8), which requires all
impaired interests to accept the plan (consensual), or
b. Meet the requirements of §1129(b), which includes all requirements of
(a) except (a)(8) and imposes two additional requirements (cramdown,
see below)
iii) Consensual Plans
(1) §1129(a) requirements for consensual plan (every impaired vote in
favor)
(a) (a)(3): Proposed in good faith and not by illegal means
(b) (a)(4): No money can be leaked out without court knowing about it
(c) (a)(5): Nobody can be sneaked in without disclosure
(d) (a)(6): Governmental regulatory commission governs rates (for
regulated industry)
(e) (a)(7): Each claim holder will approve or will receive at least as much
as he would have received in Chapter 7
(f) (a)(8): Each class has accepted the plan, or such class is not impaired
under the plan
(g) (a)(9)(A): §507(a)(1) claims get 100 cents on dollar at confirmation
(h) (a)(9)(B),(C): Taxes as only priority creditors that can be strung out
over six years; all others get deferred cash payments on effective date
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(if accepted by class) or cash on effective date (if not accepted by
class)
(i) (a)(10): One class that is impaired must approve plan
(j) (a)(11): Business must be feasible, i.e. not likely to liquidate right after
confirmation
(k) (a)(12): U.S. Trustee fees must be paid
(l) (a)(13): Retiree benefits are continued
(2) §1129: two flat legal requirements to plan acceptance:
(a) (a)(7): Must be in the best interests of each individual creditor who
does not agree to it (requires finding that each creditor will receive at
least as much under the plan as that creditor would receive in
liquidation, i.e. liquidation analysis)
(b) (a)(11): Must be found feasible even if every creditor does agree to it
(how likely the plan will succeed, reflecting best business judgment of
the bankruptcy judge)
(i) In re Merrimack Valley Oil Co. (1983): as to feasibility of plan,
court should look to adequacy of capital structure, earning power
of business, economic conditions, and ability of management; see
also In re Landmark at Plaza Park (1980) (substituting the
debtors’ projections of income and expense with its own judgment
as to the real amount required to get the project back to working
condition and the potential income for the project, and finding that
the debtor cannot fulfill its plan under 1129(a)(11)
(ii) The individual creditor is protected by the best interest and
feasibility tests, but otherwise it is the will of the majority of each
class that binds all. this rule is important because it addresses a
fundamental problem of debt restructuring, eliminating the
incentive to hold out.
iv) Classification and Voting: most important check on a debtor is the
requirement that the plan be approved by a majority of the creditors, who are
divided into classes for purposes of voting and distribution, with those in a
class sharing similar legal status and pro rata distribution
(1) §1126(c) requires class approval by both a simple majority in number of
creditors in class and a 2/3 majority in amount of debt in class
(2) Code gives debtor some discretion in designating the classes, and in some
cases debtors may classify creditors in part with an eye to creating
favorable majorities in each class
(a) In re U.S. Truck Co., Inc. (1986) (where U.S. Truck is using its
classification power to segregate dissenting and assenting creditors in
order to ensure that at least one class of impaired creditors will vote
for the plan and make it eligible for cram down): Court holds that a
creditor may be classified separately, despite that it has the same legal
status, where it has a different stake in the future viability of the
reorganized company and has alternative means at its disposal for
protecting its claim
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(3) A creditor only gets a vote if its interest is impaired; a creditor is impaired
if there is any alteration of his rights, no matter how minor and even if the
creditor’s rights are improved
(a) In re Obt Partners (1997): Court holds that the disputed claim is
impaired because a portion of it is accrued pre-petition and the legal
rights of the creditor are altered
(4) Single Asset Real Estate (SARE): ability to group together small claimants
to create separate, accepting class is crucial to reorganization in this case;
if there can be an accepting class of impaired creditors, only then the plan
is eligible for cram-down
(5) Note that every secured creditor is in its own class
v) Claims Trading
(1) Outside investors may want to buy the claims (a) at a fraction of their face
value, knowing they can make substantial returns, (b) to get a seat at the
negotiating table to enhance repayment to class of claims, or (c) as a way
to buy companies
(2) The purchasing of claims by an affiliate or insider of the debtor for the
sole or principal purpose of blocking a competitor from purchasing such
claims is an obstructionist tactic done in contemplation of gaining an
unfair advantage over other creditors (1126(e);
(a) In re Figter Ltd. (1997): Court holds that (a) bad faith occurs only
when the purchaser of claims does so out of selfish purpose to obstruct
fair and feasible reorganization in the hope that someone would pay
them more than the ratable portion and (b) each creditor in entitled to
one vote for each of his unsecured claims
(b) In re Applegate Property, Ltd. (1991)(disallowing creditor votes
where the sole purpose of purchasing claim was to ensure
confirmability of their own plan, by locking in an impaired class and
by blocking acceptance of that plan, the creditor does not withstand the
“good faith hurdle imposed by 1126 (e))
(c) Bad faith does not occur when a creditor acts to preserve what he
reasonably perceives as his fair share of the debtor’s estate;
distinguishing a creditor’s self interest and a motive which is ulterior
to the purpose of protecting a creditor’s interest
(3) How can an individual shrink the amount of claims?
(a) §1122(a): organizing creditors into classes of substantially similar
claims
(b) §1122(b): permits debtor to separate big debt from trivial debt; this is
called a convenience or administrative class (de minimis level)
(4) Vote buying is forbidden, per §1126(e); could be criminal offense if
constituting fraud
vi) Solicitation and Disclosure §1125(a)(1)
(1) Required disclosures: In re Malek (1983): Court requires disclosure
statement to include description of business, history of debtor prior to
filing, financial information, description of plan, how the plan is to be
executed, liquidation analysis, management to be retained and
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compensation, projection of operations, litigation, transactions with
insiders, tax consequences
(a) Creditors are free to complain if they believe the debtor has not
provided enough information
(2) Safe Harbor Rule: §1125(e) states that no person connected with the
solicitation of plan acceptances and rejections is liable for a violation of
the securities laws, so long as that person acts in good faith and in
compliance with Title 11; i.e. bankruptcy laws displace securities laws and
provide a safe harbor for anyone relying on the accuracy of a court-
approved plan
(a) Effect is to block SEC injunctive actions, in which the SEC seeks to
enjoin a defendant from further violations of the securities laws
(b) Securities laws generally provide for absolutely liability of a person
that offers or sells securities if there was a failure to state a material
fact in connection with the offer or sale, but these rules do not extend
to good faith, though negligent, omissions or misstatements in
connection with a bankruptcy reorganization
vii) Pre-packaged Bankruptcies: debtor and key creditors work out refinancing
structure for debtor (involving forgiveness of debt, infusion of new capital,
promise of future credit, etc.) before it takes the company through Chapter 11;
when the company does go through Chapter 11, court and attorney fees as
well as time are saved in the negotiating of the plan
(1) §1126(c) deems pre-petition votes to be effective in bankruptcy
proceedings so long as pre-petition solicitation complied with applicable
disclosure laws. If there are no applicable SEC or similar laws, then
solicitations will be effective if they comply with §1125 solicitation
requirements in the Bankruptcy Code.
(2) §1125(b) can be used to get around §1125(e) safe harbor
viii) §1144. Revocation of an Order of Confirmation: at any time before 180
days after the date of the entry of order of confirmation, and after notice and a
hearing, the court may revoke such order if an only if such order was procured
by fraud; a revocation order shall (1) protect any entity acquiring rights in
good faith reliance on the order of confirmation; and (2) revoke discharge of
the debtor
(1) At instant plan is confirmed in Chapter 11, debt agreed not to be paid in
plan is discharged; if this is not paid, action can be brought in state court,
but only for the amount that is not discharged by plan (i.e. discharge
sticks)
(2) Is there a right to sue for voidable preference after confirmation? Must be
an authorization to recover preferences in the plan post confirmation;
otherwise it is res judicata as to the parties because the court has entered
an order for confirmation
ix) Cramdown: even if a plan satisfies the best interests test of §1129(a)(7) as to
every nonaccepting creditor and meets the test of feasibility, it still must be
accepted by the statutory majority of creditors in each impaired class under
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§1129(a)(8); if any class rejects the plan, then the plan can be confirmed only
if it satisfies the further tests set forth in §1129(b), i.e. cramdown
(1) To qualify for cramdown, the plan must attract at least one consenting
class of impaired creditors so that the debtor will have the opportunity to
cram down the plan against the dissenting class(es); without at least one
consenting creditor, a plan cannot be confirmed, §1129(a)(10)
(2) §1129(b)(1) permits cramdown of the rejecting class only if the plan does
not discriminate unfairly between classes and is fair and equitable, set
forth in §1129(b)(2)
(a) Liens of secured creditors must be preserved by plan and creditors
must be paid the present value of their allowed secured claims (i.e. full
value of collateral to extent to claim + market interest rate), per
§1129(b)(2)(A)
(b) If class of unsecured creditors votes against plan, it must be paid in full
or the plan must provide that any parties junior to the class will get
nothing, per §1129(b)(2)(B)
(c) Preferred stockholders must receive full value of their preferred
position or they cannot be crammed down unless the common
stockholders get nothing, per §1129(b)(2)(C)
(d) (B) and (C) are referred to as the absolute priority rule, meaning that
the higher priority takers must be paid in full before the lower priority
takers get anything, if the higher priority class has not consented to the
plan
(3) Absolute Priority Rule: secured creditor is always entitled to present
value of allowed secured claim, while unsecured creditor is entitled to full
value of claim or junior holders receive nothing (if the class has dissented)
(a) Bank of American National Trust & Savings Assn. v. 203 North
LaSalle Street Partnership (1999) (where question is whether a
debtor’s prebankruptcy equity holders may, over impaired creditors’
objection, contribute new capital and receive ownership interests in
reorganized entity, when the opportunity is given exclusively to old
equity holders under a plan adopted without alternatives): Court holds
old equity holders are disqualified from participating in such a new
value transaction per §1129(b)(2)(B)(ii)), which in such circumstances
bars a junior interest holder’s receipt of any property on account of his
prior interest
(i) I.e. plans providing junior interest holders with exclusive
opportunities free from competition and without benefit of market
valuation fall within prohibition of §1129(b)(2)(B)(ii)
(4) Small Business Reorganization: shareholders may be essential to
keeping business afloat
(a) Sweat Equity: promise of future labor as contribution to purchase
equity ownership; Supreme Court has disallowed, per In re Ahlers,
claiming that promise of future services cannot be exchanged in any
market for something of value to creditors today; Court also claims
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that there is always some value in control of an enterprise and in
possibility that enterprise will rebound
(b) Creditors often recognize that unless the manager stays on, the
business is worthless; they can vote for confirmation despite their
impairment if they believe they will do better in the reorganization
than they will do trying to liquidate or sell the business
(5) Big Business Reorganization: management may be needed for expertise,
but shareholders are not usually necessary for future operation of business
(a) Absolute priority rule is modified to permit equity participation in
reorganization if creditor consent is obtained
(b) Key to retained ownership is often §1126, which controls voting
process by which creditors approve a plan; absolute priority rule
comes into plan only if there is a cramdown
(6) Cramdown against the Secured Creditor: Election: secured creditor
receives present value of allowed secured claim, per §1129(b)(2)(A)(i)(I);
for undersecured creditors, creditor can vote its unsecured portion of its
claim and can object to cramdown on basis of absolute priority rule; or
(a) Undersecured recourse creditor can use §1111(b) election under
which an undersecured creditor can waive any deficiency or unsecured
claim that would result from creditor’s undersecurity in exchange for
debtor paying secured creditor over time the full number of dollars the
creditor is owed; but the debtor is not required to pay the present value
of the portion of the claim above the value of the collateral; i.e. debtor
can cash out creditor for just collateral value, discharging rest against
small payment to unsecureds
(i) I.e. Creditor gets unsecured portion turned into secured portion,
paid over time – catch is that he only will be paid in nominal
dollars (not present value) to extent that claim is unsecured
1. Suppose $1M claim, half secured and 10 cents on dollar for
unsecured – will be paid $500,000 +$50,000
2. If plan is 25 years long, election is not a good option because
the present value is not being paid; if plan is short, it is good
option
3. Besides length of plan, also want to know what distribution to
general unsecureds is (i.e. if it is 100%, no point in doing
election)
(b) Undersecured nonrecourse creditor will be allowed a full recourse
claim under §1111(b), saying, in effect, that if debtor wants to keep
property for a payout over time, the creditor can at least claim full
balance of loan, i.e. same treatment as undersecured creditor above
1. If property is sold under §363, creditor cannot use §1111(b)
election – an undersecured creditor cannot turn its
undersecurity into a demand for full payment at sale by using
the election
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2. Note that sometimes participation as an unsecured creditor is
more valuable than the payment over time without an
allowance for present value
3. Can do two flips, i.e. first to recourse, then to completely
secured
m) Regulatory Agencies and Bankruptcy: Nextwave
i) Facts
(1) FCC issues licenses in the public interest; decided to use an auction to
distribute these licenses, assuming that people who will pay the most are
the people who put it to best use (i.e. highest value user); FCC agrees to
sell on credit (to favor startups); at the end of the auction, winners agree to
pay in full or lose it
(2) Nextwave bids $4.74 billion, then price goes down because FCC sells
more; value of each spectrum goes down, market plummets, so FCC
allows firms to pay later; NextWave does not take option, but instead
declares bankruptcy and gives FCC secured claim
(3) Market rises again, Nextwave says that it will pay the full amount then,
and FCC says no because market price is still climbing and can reauction;
FCC re-auctions for $15.85 billion
ii) Question: Was FCC bound by §525, and not permitted to re-auction licenses?
Who really controls in debtor-creditor relationship that is deeply regulated? Is
it the Bankruptcy Code? Is it really different than non-regulated industry?
This is a clash of two federal policies
9) Attorney Ethics
a) Compensation and Disclosure
i) Requirements
(1) Counsel can only serve with court approval (§327(a)) – must not represent
an interest adverse to the estate and must be disinterested,
(2) Counsel’s fees must be approved by the court (§§328(a), 239(b), 330(a))
(3) Only disinterested persons may serve as counsel (§327(a)), and
(4) Representation and fee arrangements must be disclosed to the court and
creditors (§329(a))
ii) In re Lee (1989): Court holds that disqualification is allowable based on
failure to disclose retainer, failure to disclose parallel employment
applications to represent both debtors and their company, and attempt to
represent debtors with interests in conflict
(1) Rule 2014(a) requires the disclosure in an application for any proposed
arrangement for compensation (e.g. retainers) and all of applicant’s
connections with parties in interest
iii) Disinterested person, per §101(14), is not a creditor, an equity security holder,
or an insider; is not investment banker for outstanding security (within 3
years) or affiliated with such; and does not have interest materially adverse to
interest of estate or any class of creditors or equity holders, directly or
indirectly
(1) Adverse interest, per In re Lee:
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(a) To possess or assert any economic interest that would tend to lessen
the value of the bankrupt estate or that would create either an actual or
potential dispute in which the estate is a rival claimant; or
(b) To possess predisposition under circumstances that render such a bias
against the estate
iv) In re Filene’s Basement, Inc. (1999): Court holds that attorney firm has
failed to fully disclose its connections with parties in interest as required by
Rule 2014 and that it lacks disinterestedness in this case either because of an
actual present adverse interest or the appearance of one, citing that the firm
was also general counsel for the creditor and claiming conflict of interest. The
creditor had a state court lawsuit against the debtors at the time, for which the
firm was representing neither party. The court held that while the firm was
technically aloof from the proceedings at bar, the proceedings would have
involved related contracts on both sides. The court found that there was an
actual adverse interest in the firm's continued representation of creditor while
it sought to represent debtors; therefore, disqualification was mandatory.
(1) §327: even if there is not an actual competing interest, if there is a
reasonable perception of such an interest, the applicant should be
disqualified
v) In re Martin (1987): Court holds that fundamental objectives of Chapter 11
may be thwarted if property essential to reorganization is tied up in attorney’s
lien, or if a particular security arrangement impairs fair treatment either of
creditors or of administrative expense claimants
(1) Can attorneys waive conflict in order to maintain disinterestedness? No
(2) Can attorneys waive past attorney’s fees? Yes, but they cannot be assigned
(3) Note that Code does not prevent two attorneys at the same firm, in
different departments, from representing two different interests, per
§327(c)
b) Attorney-Client Privilege and Conflict of Interest
i) Commodity Futures Trading Commission v. Weintraub (1985): Court
holds that the trustee of a corporation in bankruptcy has power to waive the
debtor corporation’s attorney-client privilege with respect to communications
that took place before the filing of the petition
(1) In light of Code’s allocation of responsibilities, it is clear that the trustee’s
role is most analogous to that of a solvent corporation’s management (or
has the right to waive attorney-client privilege); vesting in the trustee
control of the corporation’s attorney-client privilege most closely
comports with the allocation of the waiver power to management outside
of bankruptcy without in any way obstructing careful design of the Code;
i.e. trustee in role of successor management
10) Jurisdiction
a) Domestic Jurisdiction
i) 1978 Code: Federal bankruptcy jurisdiction should be expanded to include all
disputes “related to” the bankruptcy in order to eliminate the costly, time-
consuming litigation over summary (bankruptcy jurisdiction) and plenary
(matters outside summary jurisdiction) matters
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ii) Reform Act gives big jurisdiction over plenary matters but keeping as Article
I judges
iii) 1982: Marathon (where debtor is suing someone outside bankruptcy on
contract action) holding that there is something constitutionally wrong about
jurisdictional aspects of way Congress structured bankruptcy system, i.e.
Article I judges with Article III power
(1) Burger suggests that the problem could be solved by making judges
adjuncts to district court (doing all work but still Article I) elected for 14-
year terms
iv) 1984 Amendments (in response to Bill Disco)
(1) Bankruptcy judges would become Article III judges with curtailed
jurisdiction
(2) Consumer credit amendment (easier for Chapter 13, affirmations)
(3) §1113: regarding collective bargaining agreement (rejection only upon
court approval)
(4) Required abstention by federal courts in matters involving state law claims
and limited the matters that bankruptcy judges could decide on a clearly
erroneous basis; new provision designated certain matters as core
proceedings that may be heard by bankruptcy judges, subject to unlimited
discretion of the district judges to withdraw any matter from the
bankruptcy court at any time, per §157
v) 1994 Amendments: Congress authorizes jury trials in bankruptcy court, but
only if (a) matter is otherwise within bankruptcy court’s jurisdiction; (b)
district court expressly authorizes it; and (c) the court has consent of all
parties, per §157(e)
(1) §1334(b), (c)(1) and (2): Vests very broad related to bankruptcy
jurisdiction, but limits the actual operation of jurisdiction for discretionary
or mandatory abstention in favor of state courts
(2) §157 defines matters that a bankruptcy judges may hear for review on a
clearly erroneous basis and those concerning which bankruptcy judges can
only act as masters recommending findings of fact and conclusions of law
to district judges
(a) Divides bankruptcy matters into 3 categories:
(i) Proceedings that arise under Title 11 (may be clearly erroneous
standard, depending on further categorization as a core
proceedings, per §157(b))
(ii) Proceedings that arise in Title 11 (may be clearly erroneous
standard, depending on further categorization as a core
proceedings, per §157(b))
(iii)Proceedings that are related to Title 11 cases
(3) What limits this?
(a) 1334(c): mandatory abstention (DC must abstain) and discretionary
abstention (DC can decide to abstain if it thinks it can better be treated
in state court)
(b) Personal injury and wrongful death are related to a bankruptcy case
and tried by district judge, unless parties consent to bankruptcy
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jurisdiction, or district court abstains on discretionary basis and
permits state court to try case
(c) District Court can always withdraw reference
b) Transnational Bankruptcies
i) Two theoretical approaches
(1) Territorialism: justifying “grab rule” (multinational in financial trouble,
country where assets are located seizes local assets and distributes them to
local claimants in local proceeding) on grounds that local creditors had
legitimate expectations that any financial crisis would be resolved
applying local policies and preferences
(2) Universalism: a bankruptcy resolution must be symmetric to a debtor’s
market; requiring globalizing bankruptcy regime, though not a world
government imposing same standard on everybody; one country resolves
the entire bankruptcy, i.e. “one law to all creditors”
ii) Protocols are agreements among major stakeholder groups as to how a
multinational bankruptcy will be managed
iii) Ancillary proceedings, per §304, are domestic proceedings that are designed
to assist the home court
iv) Foreign Systems: In re Treco (1999): Court holds that because petitioner is a
secured creditor does not prevent turnover, despite that the country conducting
the proceedings has a different priority of security holders (namely, after
administrative expenses) and there is no requirement that the petitioner be
given adequate protection; further, turnover may be granted regardless of
whether petitioner has valid set-off right
v) Comity: Roberts v. Picture Butte Municipal Hospital (1999): Court holds
that the matters before the court would be best dealt with by one court, and in
interest of promoting international comity the appropriate forum for this case
is the U.S. Bankruptcy Court
vi) Choice of Law: In re Maxwell Communication Corp. PLC (1996)
(1) Every international bankruptcy case requires both a choice-of-forum and
choice-of-law analysis, unlike most litigation in which only a choice-of-
law problem is presented
(2) Protocols of cooperation in administration of international case are crucial
to achievement of satisfactory result in absence of effective legal rules
11) Bankruptcy Theory
a) Exclusions from Bankruptcy
i) Banks and insurance companies have their own specialized systems
insolvency systems; a key difference is that they provide government
guarantees or complete distributional priority to one preferred class of
creditors – depositors and policyholders; other ordinary creditors and
shareholders may lose everything in the event of insolvency
ii) Brokers in securities industry is covered by Securities Investors Protection
Act; similar treatment as with banks (§§744-766)
iii) Railroads are given special treatment – forbidden from filing Chapter 7
(§109(b))
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iv) All the excluded have in common: highly regulated (at all times) financial
institution that takes deposits of money or valuables from the public
v) Consider treatment of hedge funds: not excluded technically, but effectively
excluded because liquidation would be result in nothing for distribution, as all
assets would be effectively seized by counterparties
b) Alternative Approaches to Bankruptcy
i) Automated bankruptcy (Bebchuk): debtor goes to each layer of debt to see if
it would like to purchase the debt above it and becomes the holder of the
equity
(1) Courts would enforce absolute contractual priority in both liquidation and
reorganization, and the control over the deployment of the assets of a firm
in general default would be determined by a sort of reverse bidding-in by
existing creditors or equity holders
(2) What are the benefits?
(a) Solves the delay aspect (reminiscent of pre-packaged bankruptcy)
(b) Takes away part of the negotiation; problem still exists across classes
(some will want to buy and others will not) – only a horizontal
negotiation though
(c) Switches the control from debtor to creditor
(3) What are the disadvantages?
(a) Huge liquidation possibility with small businesses – why would owner
stay?
(b) Equity is not easily transferable in small business
(c) Suppose big publicly-traded cases
(d) Lower priority creditors are very unprotected (unless they have the
sources to buy out upper layers) – uneven distributional aspects for
trade creditors
(e) How do we know where creditors are located? How are the classes
formed? Can only do automatic bankruptcy if there is a lot of certainty
about who is owed what and where each belongs
ii) Contractualism: begins with Coase theorem, proposes that eliminating or
narrowing bankruptcy law to contain an minimum of mandatory rules and
permits economic actors to construct their own rules to manage general
default (ranging from menu options to waiver proposals)
(1) Rasmussen: bankruptcy menu from which firm chooses most beneficial
bankruptcy provisions; choice made at inception of firm, and creditors can
rely upon company’s choice
(2) Alan Schwartz: proposing rolling readjustment in bankruptcy regime to
reflect changes in circumstances of debtor over time; permitting
renegotiation as you go along
(3) Tracht: parties would be free to waive the default bankruptcy rules; value
is maximized through private bargaining
(4) Steven Schwarcz: enforcement of certain kinds of waivers would promote
economic efficiency without serious prejudice to important prebankruptcy
policies
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(5) Douglas Baird/Thomas Jackson’s Common Pool Problem (also Tragedy of
the Commons): because actions by each creditor to collect tend to harm the
value of the debtor’s assets, bankruptcy law should have very few rules,
i.e. only time that federal law should supercede state law is when there is
common pool problem (e.g. automatic stay, NO distributional outcomes in
bankruptcy law)
(6) Warren: bankruptcy is about distribution; everything else learned in
substantive law has solvent parties on both sides; bankruptcy creates
something much different – question to be resolved is distribution of the
less-than-sufficient money to go around
(a) Competing goals of Chapter 11 system:
(i) Enhance value
(ii) Establish orderly distribution scheme
(iii)Internalize costs of default
(iv) Establish a privately monitored system
(b) Markets affected by bankruptcy are imperfect; many features of
bankruptcy system are intended to deal with creditors’ inadequate
information and high costs of gathering information needed to make
collective decisions
