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Law School Legal Outline Notes for Bankruptcy

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									BANKRUPTCY NOTES & OUTLINES

I.

GENERAL INFO & COLLECTING THE DEBT

A. GOALS OF COURSE: 1. 2.
Learning the technical provisions of the Bankruptcy Code Understanding how bankruptcy is used not only by Ds, but also by creditors (i.e., department stores and their creditorsuppliers) a. Have to understand both legal and economic/business standpoint (what are we going to do going forward?) Becoming professional in your use of bankruptcy law, which includes understanding how the possibility of bankruptcy impacts the non-bankruptcy actions of creditors a. Bankruptcy is a tremendous weapon for the D – allows D to turn contract law on its ear – bankruptcy is negative contract b. Worst thing is to be involved with distressed companies where one side is not knowledgeable with bankruptcy law.

3.

BANKRUPTCY – AN OVERVIEW

4. 5.

Bankruptcy is process that affects the relationship b/w Ds and creditors Generally speaking, most bankruptcy Ds are individuals who are insolvent (i.e., they do not have sufficient assets to enable them to pay their Ds in full) With the foregoing in mind, the basic bankruptcy system provides for the D’s assets to be distributed to Crs and for D to be discharged from having to pay the deficiency or shortfall. Two basic goals: a. Give deserving Ds a fresh start. b. Equal distribution to Crs.

6.

7.

1

BANKRUPTCY – SOME BASICS

8.

Debtors (hereinafter referred to as Ds) a. D are entities that have a monetary obligation to others (i.e., they have debts) b. Examples: can be individuals, corps and/or partnerships 1) Significance of type of D: indvs Ds have different rights in bankruptcy than corporate Ds (e.g., only indvs have exemptions which, along with the discharge, is another prong of the bankruptcy-provided fresh start). Creditors (hereinafter referred to as Crs) a. Creditors are entities that have a monetary claim against others (i.e., they are owed money). b. Examples: could be indvs, corps and/or partnership 1) Significance of type of creditor: irrelevant c. 2 classes of creditors – this different makes up a substantial portion of the complexity in the bankruptcy system 1) Secured Creditors a) Example = mortgage b) Senior or junior secured creditors 2) Unsecured Creditors a) Some unsecured creditors are more equal than others – priority position

9.

10. Process of creating Ds and creditors a. Factors used to determine whether credit will be extended or loan made (see list of supporting and negative loan
factors on p1). 1) Projected income of D 2) D’s necessary living or business expenses 3) Other debt’s that D owes 4) Credit scoring 5) Debtor’s credit history: to determine the likelihood that D will be able to make credit payments in future – creditor wants to do as much as he can to determine the likelihood that he will get paid tomorrow. a) What if you still want to give the loan even though credit history was poor? (1) Interest rates = reflection of risk of non-payment (2) Require some sort of collateral/security Goal of creditors is to get paid 1) When payment is not voluntarily forthcoming, creditor must take some action to collect what it is owed.

b.

2

B. COLLECTING THE DEBT 1.
The Debtor-Creditor Relationship Generally a. If A gives B a home and B pays A on the spot, there is no creditor-D relationship b. Debtor-creditor relationship occurs when one side performs and there is obligation of payment to be made some time in future. When payment is not voluntarily forthcoming, creditor must take some action to collect what it is owed. 2 Ways to Collect

2. 3.

a.

Judicial Collection Process

1)

Summary of characteristics of judicial collection process: a) Execution b) Attachment c) Garnishment d) Judicial sales and redemption rights e) Exemptions f) Fraudulent transfers g) Bulk transfers Execution: a) Execution = basic judicial collection remedy b) Generally used by unsecured Crs to obtain payment. (1) Compare to Art 9 secured Crs who may be able to grab D’s property and sell it without involving courts. c) Steps in execution process (1) File lawsuit. (2) Win lawsuit – obtain monetary judgment (3) Prepare a document aimed at clerk of court to get clerk to issue a writ of execution to sheriff (4) Writ allows sheriff to seize, get, put a levy on property of judgment D that is described in writ – this means sheriff has legal, but not necessarily physical possession of the property. (5) Sheriff holds sale (auction) of levied property (6) Cr is paid from proceeds of that sale (unless he is the one who buys the levied property) – if the proceeds do not satisfy the full debt amount, the Cr can start the execution process against another item of the D’s property. d) How does judgment creditor know what assets the judgment D has available (1) What assets are available? (2) How can the attorney discover these assets? tax forms, insurance; depose judgment D in discovery – does not work as a practical matter b/c if you do this, judgment D will move all his assets, close account, etc – THEME – watch for counter-moves (3) What factors apply to determining the assets that should be executed on? (4) How did the Goldmans’ attorneys in the OJ Simpson case ascertain what OJ owned in order to prepare the writ of execution in the required detail (read the relevant simulate c.l.e. transcript which is on the web) e) Attorney Able and Charles Creditor Example: shows difficulties unsecured creditors may face in attempting to collect on their judgments. Attachment: a) Definition: any instance in which sheriff or other officer of the court levies, seizes or attaches property or an interest that one has in property. b) Pre-judgment attachment: (1) Primarily used to attach property held by D or third parties before obtaining a judgment. (2) Good weapon for Cr. c) Post-judgment attachment:

2)

3)

3

(1) Primarily used to attach property held by the third parties (a) If property held by D, would usually be referred to as “execution” 4)
Garnishment: a) Definition: process by which property of D in the possession or control of third persons is attached or executed upon. (1) Common Scenario is with ER: Cr will serve complaint on ER, direct ER to make payment over to garnishing creditor. (2) Think about this from view of ER: have to adjust bookkeeping and accounts payable – ER will start to look at EE in negative light – result was that ER would fire EE whose wages were being garnished. b) Pre-Judgment Setting: (1) Property held by D or third party (2) ??? Not property held by D which would be referred to as “attachment” c) Post-Judgment Setting: (1) Property held by third parties (2) If property held by D, would usually be referred to as “execution” d) Wage Garnishment: (1) Limitations on amount of money that can be garnished: (a) Rationale = EE has to get something. (b) CCPA limitations – 303, 15 USC s1673 i. If creditor is owed more than monthly wages, there are laws that say that creditors can only get a certain percentage of $ due to EE/D ii. Rationale: b/c some people live from paycheck to paycheck. (c) More D-friendly state laws: 307, 15 USC 1677: D can chose lesser of the two laws. (2) Firings: (a) Reasoning: i. Creditor wants $ owed to EE/D (by ER) to be paid directly to creditor, rather than to EE/D. ii. Once ER received garnishment notice, ER would fire EE whose wages were being garnished (b) Congress came to rescue i. CCPA Limitations – s304, 15 USC s1674 ii. RULE - ER is precluded from firing someone as the result of ONE garnishment (one free bite rule) iii. Application: if there is one garnishment, there will probably be others – once one garnishment hits, EE has to prevent second garnishment from hitting and do this by filing a bankruptcy petition. (c) More D-friendly state laws – s307, 15 USC s1677 Judicial Sales & Redemption Rights: a) Case – Nussbaumer v. Superior Court of YUMA, 489 P.2d 843 (Ariz. 1971) – p16: (1) Facts: (a) General Considerations in Execution Sales: i. Attending the sale: executing creditor who does not want to buy the prop should attend the execution sale  Rationale: executing creditor has an interest in making sure the auction price is adequate and to ensure that the prop is not sold for an inappropriately small amount – executing creditor may want to try to bid the price up ii. If execution creditor becomes the execution purchaser, it does NOT have to pay the cost to consummate the sale b/c it would be a ridiculous process (creditor would have to pay sheriff who would then pay the creditor) – thus, we collapse the process – creditor only has to pay the Sheriff’s costs. iii. It is difficult to get “cash” to pay for sale. iv. Unfairness to D: third-party buyer who really wants the prop will let creditor buy prop at low price and then go to creditor and pay a little more for the prop – this will really hurt the D. v. Real estate is commonly subject to right of redemption. (b) Actual Facts of This Case – OVERBID: i. Executing creditor bid the full amount of the loan for the prop.

5)

4

ii.

(2) Held: (a) Where an overbid is made, which has in no way resulted from deceit, undue influence or any b)
Bids

Bid price applied to amount owed to execution creditor – now, there is no deficiency, eliminated possibility that creditor would be able to get any more from the D even if full amount of loan was never repaid

other form of fraudulent inducement but is, rather, the result of one’s own negligence, ignorance or inadvertence, equity should not intervene (i.e., Cr is stuck with what he did).

(1) Overbids: (a) General Rule: where an overbid is made, which has in no way resulted from deceit, undue

c)

d)

influence or any other form of fraudulent inducement but is, rather, the result of one’s own negligence, ignorance or inadvertence, equity should not intervene. (2) Underbids: (a) General Rule: mere inadequacy of price, where the parties stand on equal footing and there are no confidential relations b/w them, is not, in and of itself, sufficient to authorize vacation of the sale unless the inadequacy is so gross as to be proof of fraud or is so gross that it shocks the judgment and conscious of court. (b) Rationale: court trying to protect party that is in position of complete subjugation. (c) Deficiency Judgment Acts: real estate cases ??? Pa Deficiency Judgment Act: (1) What happens when Cr obtains $30,000 judgment against D and executes upon D’s vacation home and at sheriff’s sale, buys vacation home for $20,000 – what does he have to do to go after remaining $10,000? Distribution of the Proceeds From a Judicial Sale: (1) ??? Shortage: Cr can go after other assets. (2) Surplus (a) Under the Bankruptcy Code, D gets the surplus [726]. (b) California Statute lists priority in which proceeds of judicial sale should be distributed: i. Costs of implementing distribution ii. Preferred labor claims iii. Certain tax liens iv. Certain providers of deposits v. D for certain exemptions vi. Sheriff for non-advanced sale costs vii. Judgment Cr’s costs viii. Judgment Cr’s claim ix. Any subordinate liens that would be extinguished by the sale x. Any balance to the D.

6)

Exemptions: a) Definition: state exemption laws limit Cr’s right to seek satisfaction of what it is owed from D’s property. (1) Only available to individual Ds, not corporate Ds. (2) There is enormous variety among states as to what is exempted. (3) Examples: Bibles, sewing machines, homestead. (4) Is there a cap on how much is protectable/exempted? b) Rationale for state exemptions = fresh start policy (for other rationales, see p22) c) Influence on Bankruptcy Code: (1) Debtor has choice: D can use state exemptions or federal bankruptcy code exemptions (2) Federal law defers to a state law: b/c of Supremacy Clause, Bankruptcy Code says states could enact state legislation which would limit indvs to the state exemptions – most states have enacted such optout legislation

5

7)

Fraudulent Transfers Under State Law: a) Uniform Fraudulent Conveyance Act (UFCA) and Uniform Fraudulent Transfer Act (UFTA). (1) Influenced by the Statute of Elizabeth. (2) Generally only unsecured Crs need to use this power. (3) Both acts make actual intent to defraud actionable. (a) Look for badges of fraud. (4) What about constructive intent to defraud? (5) Remedies include: (a) Setting aside the conveyance (b) Disregarding the conveyance and attachment the property (c) Injunction (d) Appointment of receiver b) 3 Rules for Whether Foreclosure Sales = Potential Fraudulent Transfers: (1) Durrett Rule: a regularly conducted mortgage foreclosure sale can be invalidated as a fraudulent conveyance when foreclosure price is less than 70% of the property’s fmv (see Durrett v. Washington Nat’l Ins. Co., 621 F.2d 201 (5th Cir. 1980)). (2) In re Madrid Rule: a regularly conducted mortgage foreclosure cannot be invalidated as a fraudulent conveyance regardless of the foreclosure price because such a sale is not a “transfer” (see In re Madrid, 725 F.2d 1197 (9th Cir. 1984)). (3) In re Ruebeck Rule: courts should consider the following factors in determining whether a regularly conducted mortgage foreclosure sale should be invalidated as a fraudulent conveyance (see In re Ruebeck, 55 B.R. 163 (Bankr. D. Mass. 1985)): (a) Fmv of property at time of sale (b) Nature of property and its marketability (c) Number of persons appearing and bidding at sale. c) Influence on Bankruptcy Code: (1) Influenced the Trustee’s avoidance of fraudulent transfers powers [544(b) and 548]. (2) Rule for Bankruptcy Code: price paid for property at a regularly conducted, non-collusive mortgage foreclosure sale will be deemed reasonably equivalent value (see BFP v. Resolution Trust Corp., 114 S. Ct. 1757 (1994)) (a) Although 548 does not expressly immunize mortgage foreclosure sales from attack, the effect of CT’s decision immunized such sales from attack under 548 except in cases of actual fraud. (b) ??? Are they still subject to attack under 544(b). Bulk Transfers:

8) b.

Non-Judicial Means: 1) Continually calling the D and demanding payment. 2) Flooding D with barrage of collection letters. 3) Sending D notices that look as if they are court subpoenas or sheriff sale notices. 4) Threatening to blacklist D with businesses in D’s community.

6

c.

Limitations on Creditors Collection Rights in both judicial and non-judicial collection efforts. 1) State Exemptions. 2) Due Process: a) Due Process informs all the other limitations. b) Generally means advance notice. c) In Application: (1) Garnishment limitations (see Di-Chem and Finberg). (2) Replevin (see Fuentes). (3) Confessions of judgment (see Overmyer and Swarb). 3) Fair Debt Collection Practices Act (FDCPA). a) Cr cannot: (1) Harass; (2) Threaten; (3) Communicate to D’s ER; or (4) Threaten to take unintended action. b) What = “debt collector”: (1) Court said that lawyers (regularly?) engaged in litigation fall within definition of “debt collector” (see Heintz, et al. v. Jenkins, 115 S. Ct. 1489 (1995)). c) Identical state acts: states made identical acts applicable to the actual creditors.

7

II. BECOMING A SECURED CREDITOR

A. INTRODUCTION 1.
Benefits of Being a Secured Creditor

a. 2.

B/w secured creditor (one with a lien) and creditors (without a lien), secured Cr has better chance of getting paid.

Types of Secured Creditors (for more information, see sections below)

a.

b. c.

Judicial Lien Creditors 1) Judgment Lien Creditor 2) Execution Lien Creditor 3) Attachment Lien Creditor Statutory Lien Creditor Consensual Lien Creditors 1) Mortgage Lien Creditor 2) Article 9 Secured Parties

3.

Relation to Trustee’s Avoidance Powers Under 544(a) and 547(b) (for more information, see sections below)

a.

Relevance. 1) Both powers enhance the unsecured Cr’s share of the proceeds. 2) Trustee’s ability to avoid as compared to secured Cr’s ability to keep property: a) There are numerous avoidance powers in non-bankruptcy law: b) Trustee needs to find only one that will work. c) Secured Cr needs immunity from all. Trustee’s Strong Arm Power [544(a)]. 1) Text: § 544. Trustee as lien creditor and as successor to certain creditors and purchasers (a) The Trustee shall have, as of the commencement of the case, and without regard to any knowledge of the Trustee or of any creditor, the rights and powers of, or may avoid any transfer of property of the D or any obligation incurred by the D that is voidable by-(1) a creditor that extends credit to the D at the time of the commencement of the case, and that obtains, at such time and with respect to such credit, a judicial lien on all property on which a creditor on a simple contract could have obtained such a judicial lien, whether or not such a creditor exists; (2) a creditor that extends credit to the D at the time of the commencement of the case, and obtains, at such time and with respect to such credit, an execution against the D that is returned unsatisfied at such time, whether or not such a creditor exists; or (3) a bona fide purchaser of real property, other than fixtures, from the D, against whom applicable law permits such transfer to be perfected, that obtains the status of a bona fide purchaser and has perfected such transfer at the time of the commencement of the case, whether or not such a purchaser exists.

b.

8

2)

3)

4)

5)

544(a) is a status provision: a) Hypothetical: no need for actual Cr. b) 544(a) lets Trustee pretend that he is a judicial lien holder, execution lien holder or BFP. c) To figure out effect of status of Trustee under 544(a), look to non-bankruptcy law (i.e., state law, Art 9 or IRC) d) Date of bankruptcy petition is critical. Policy Underlying 544(a): a) But for the filing of the bankruptcy petition, Cr A’s interest might have become subordinate to another creditor that obtained a judicial lien on the property or to a BFP - so, why should Cr A benefit from the fortuitousness that the petition was filed before the potential even occurred? Personal Property: a) 544(a)(1) give Trustee status of judicial lien creditor b) Effect: (1) Trustee can avoid security interests that are unperfected on day of filing (2) Trustee can avoid federal tax liens that have not been filed by day of filing. Real Property: a) 544(a)(3) gives Trustee status of BFP with re: to real property. b) ??? Effect:

c.

Trustee’s Preference Power [547(b)]. 1) Text: § 547. Preferences (b) Except as provided in subsection (c) of this section, the Trustee may avoid any transfer of an interest of the D in property-(1) to or for the benefit of a creditor; (2) for or on account of an antecedent debt owed by the D before such transfer was made; (3) made while the D was insolvent; (4) made-(A) on or within 90 days before the date of the filing of the petition; or (B) 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 (5) that enables such creditor to receive more than such creditor would receive if-(A) the case were a case under chapter 7 of this title [11 USCS §§ 701 et seq.]; (B) the transfer had not been made; and (C) such creditor received payment of such debt to the extent provided by the provisions of this title [11 USCS §§ 101 et seq.].

2)

In English: 547 lets Trustee avoid 3 types of transfers. a) D makes a payment to Cr. b) Previously unsecured Cr is given a security interest or real estate mortgage interest in D’s property to secure the old debt. c) Cr waits too many days before perfecting its security interest or real estate mortgage even though Cr perfected it prior to commencement of the bankruptcy case. Policy Underlying 547(b): a) The reach-back aspect precludes and discourages a race to the court house (vis a vis obtaining judicial liens) and/or unequal treatment among legally equal creditors (by paying off one creditor before another).

3)

9

4)

5 Requirements: a) There must be a transfer of prop of D to a Cr. (1) Transfer is defined broadly (a) Transfer can be involuntary (b) Transfer can involve D paying Cr all or part of what it owes. b) Transfer must have occurred 90-days (or 1-year for insider) period to filing. (1) Effect of this provision on D’s decision as to WHEN to file the bankruptcy petition: D can try to insulate certain transfers. (2) Policy rational for insider rule: if creditor/transferee is alter-ego of D, than seems fair to lengthen vulnerable period of time – reduces potential for game-playing by creditor and D. c) Transfer must have occurred when the D was insolvent. d) Transfer has to be for or on account of an antecedent debt owed by D. e) Transfer enables Cr to receive more than such Cr would receive otherwise (3 specific situations).

d. 4.

Note theme in Bankruptcy Code: forces you to look at non-bankruptcy law (e.g., state law or other federal law).

General Priority Rule Among Secured Crs: Cr whose lien attached first gets priority.

10

B. SECURED CREDITOR - JUDICIAL LIENS 1.
SECURED CREDITOR - JUDICIAL LIENS - Judgment Lien Creditor (p49).

a. b.

Definition: Cr with a lien on D’s property arising because Cr obtained a judgment. Characteristics: 1) Obtaining and recording the judgment gives rise, without more, to a lien on the judgment D’s real estate located in the county in which the judgment is recorded. 2) Scope: a) Limited to real estate located in the county where the judgment was obtained and recorded (unless there is a statewide recording system). b) States vary on whether judgment lien extends to D’s after-acquired real property: judgment lien extends to property the D requires after the judgment is recorded. c) Judgment liens are usually limited to real property (but a few states allow the judgment lien to extend to personal property). 3) Judgment liens are governed mostly by state law. 4) Judgment lien does not arise (and, thus, is not effective) until after it is RECORDED. a) Very important to RECORD the judgment lien. b) Recording of judgment lien is effectuate when a notation is made in civil docket kept by Clerk of Court (see Brescher v. Gern, 585 A.2d 961 (NJ 1991)). ??? Priorities: what if more than one Cr obtains and records a judgment lien on D’s real estate?

c. 2.

SECURED CREDITOR - JUDICIAL LIENS - Execution Lien Creditor

a.

Definition: Cr obtains a lien on specific property (real or personal) of the D by levying on it pursuant to a money judgment 1) Compare to Judgment Lien Cr: different b/c sheriff has to be involved, and b/c applies to both personal and real property. Requirements: 1) Judgment 2) Praecipe to the Clerk of the court 3) Writ of execution to sheriff 4) Levy by sheriff 2 rules on what constitutes the “transfer date” for execution liens under 547(b). 1) Transfer date = levy date (i.e., date of the actual levy, and not the date the writ of execution is delivered to the sheriff (see In re National Quick Print, Inc., 103 B.R. 107 (Bankr. D. Md. 1989))). a) Problem: which Cr triumphs will depend on what sheriff does and when he does it. 2) Transfer date = delivery of writ of execution to the sheriff date (see Harris v. Max Kohner, Inc., 187 A.2d 97 (1963)). 3) ??? Problem 3-3 (p54): a) Facts: Cr obtains judgment and has writ of execution delivered to sheriff on May 16; sheriff levies on D’s equipment on May 30; D files bankruptcy on August 20. b) ??? Can Trustee avoid C’s Execution Lien Under 544(a)? No, because not a credit transaction and because the lien is recorded. c) Can Trustee avoid C’s execution lien under 547(b)? (1) Depends on when transfer is deemed to have been made (a) If transfer date is May 16 (writ of execution date), then not meet 90-day requirement – Trustee will not be able to avoid that lien. (b) If transfer date is May 30 (levy date) , then transfer does fall within 90-day period – Trustee will be able to avoid the lien – this is correct answer given In re National Quick Print, Inc.. ??? Priority problems 1) ??? Problem 3-4 (p59): what happens when one Cr records before second Cr delivers writ and levies first?

b.

c.

d.

11

a) b) c) d) e.

Facts: FB obtains and records $15,000 judgment against D on March 1; SB obtains and records $10,000 judgment against D on April 1; SB delivers writ of execution to sheriff on May; sheriff levies on D’s property on May 10; Judy buys property on June 20. What does FB get? What does SB get? Judy forget to check the records.

??? When should execution lien attach? 1) ??? Problem 3-5 (p60)

3.

SECURED CREDITOR - JUDICIAL LIENS - Attachment Lien Creditor

a. b.

Definition: arise as a result of the pre-judgment attachment of the D’s property. Generally, pre-judgment attachment liens arise in 3 settings: 1) Jurisdiction mechanism pursuant to foreign attachment procedures. 2) Means of precluding Ds from transferring or removing their assets in order to defraud their Crs. 3) General security mechanism which some states make available to certain Crs so that such Crs will have an available asset pool if they obtain a monetary judgment Bond requirement: to obtain pre-judgment attachment lien, plaintiff has to post a bond 1) Rationale: provides security to other side in case plaintiff loses the law suit - protect defendant against potential losses Post-judgment: 1) Same impact as execution lien.

c.

d.

12

C. SECURED CREDITOR - STATUTORY LIEN CREDITORS 1.
Generally:

a. b. c. 2.

Definition: a lien arising solely by force of a statute on specified circumstances or conditions; Cr obtains lien on specific property of the D because of some special relationship between the D, the Cr and the D’s property. Examples: mechanic, artisans, storage, attorneys, federal taxes Excludes judicial liens and consensual liens (even if such liens are provided for in statutes).

The Federal Tax Lien

a. b.

United States has a lien on “all property and rights to property” of a taxpayer who owes or has unpaid federal taxes [I.R.C. § 6321]. Federal tax liens do not automatically have priority over all other liens (see US v. McDermott, 507 U.S. 447 (1993)). 1) Federal tax lien extends to after-acquired property of D. 2) ??? If federal tax lien and state lien perfect their interest in D’s after acquired property at the same time (which is generally how it works with after-acquired property), the federal tax lien has priority. Federal tax lien is not valid against any purchaser, holder of a security interest, mechanic’s lienor or judgment lien creditor until notice . . . has been filed by the Secretary [I.R.C. § 6323(a)]. 1) Notice: a) ??? Effect of not recording: 2) Who = “Judgment lien creditor” under I.R.C. § 6323(a): this term includes bankruptcy Trustee (see US v. Speers, 382 U.S. 266 (US 1965)). a) Effect: Trustee can avoid an unrecorded federal tax lien. b)  Problem 3-6 (p72) (1) Facts: IRS demands payment from D on Feb 16 but does not file notice of federal tax lien; D acquires bulldozer on March 15; D files bankruptcy petition on Oct 1. (2) Answer (a) IRS does not have a lien on bulldozer b/c never filed notice. (b) Trustee can avoid federal tax lien b/c 544(a) gives him the status of judgment lien creditor under I.R.C. § 6323(a). c)  Problem 3-7 (p72) (1) Facts: IRS demands payment from D on Feb 16; D acquires bulldozer on March 15; IRS files tax lien notice on March 16; D files bankruptcy petition on Oct 1. (2) Answers: (a) Trustee cannot avoid federal tax lien under 544(a) because the pre-bankruptcy filing of the federal tax lien notice renders I.R.C. § 6323(a) unavailable and leaves I.R.C. § 6321 intact. (b) Trustee cannot avoid the federal tax lien under 547(b) because the transfer date of the federal tax lien (March 16) it is more than 90 days before the filing of the petition.

c.

13

D. SECURED CREDITOR - CONSENSUAL LIENS 1.
Consensual Liens Generally

a.

Crs who, by agreement with the D, obtain either an Art 9 security interest in the D’s personal property or a real estate mortgage.

2.

SECURED CREDITOR - CONSENSUAL LIENS - Real Estate Mortgage Lien Creditor.

a. 3.

 Problems 3-8 (p73) and 3-9 (p74) illustrate 544(a) and 547(b).

CONSENSUAL LIENS – Art 9 Secured Party Creditor.

a.

Overview: 1) These are not statutory liens under the Bankruptcy Code 2) Differs from secured Cr position obtained through judicial liens because it requires the consent of D. Scope of Art 9: applies to all transactions intended to create security interest in personal property or fixtures

b.

1) 2)

Does not cover real prop. Art 9 requires that you accurately identify something as equipment or inventory a) Example manu business manufactures desks and chairs – manu plant where they assembly pieces (do they make or buy the cushions) – machinery/equipment – inventory warehouse – supplier of equipment to manu to assemble chairs – this supplier also has inventory b) Principle: a specific item might carry a different label depending on how it is used by whoever happens to own it at a particular time (e.g., a sewing machine is inventory from perspective of sewing machine manufacturer but is equipment for chair manufacturer) c) Significance: will change what you want to have a security interest in. A credit sale without any else is not intended to be a secure transaction a) Suppliers typically sell on unsecured credit but this is a sales transaction, not a secure transaction - if suppliers wanted to secure it, they would have to doc that qualified it as a secured transaction b) Martha Stewart/K-Mart example: MS suppliers going to stop making shipments b/c worried that K-Mart may file for bankruptcy. Debtor Can Use Personal Prop to Secure a Transaction Debtor Can Use Accounts Receivables (Sales of Accounts) to Secure a Transaction a) Account receivable: rights that business has to be paid by its customers. b) Constantly changing c) Descending order of liquidity (closest to cash) (1) Cash (2) Accounts Receivable (3) Inventory (4) Equipment (5) Real estate d) Company may secure its loan from bank with its Accounts Receivable (1) Company still owns the Accounts Receivable, still an asset of the company

3)

4) 5)

14

e)

f) 6) 7) 8) c.

What if Company sells its Accounts Receivable? (1) This is sale transaction (2) Accounts are off the books of the Company (3) In reality, this is same as secure transaction – thus Bankruptcy Code will treat them the same with regard to protection of creditors (4) ??? Factoring This is somehow related to Chapter 11

Debtor Can Use Chattel Paper to Secure a Transaction Debtor Can Use Inventory to Secure a Transaction a) Constantly changing Debtor Can Use Equipment to Secure a Transaction

Requirements to Obtain an Enforceable Security Interest 1) Obtain a security agreement. 2) SA must contain some description of the collateral. 3) Value must be given: a) Does a creditor have an enforceable security interest when it obtains the interest to secure a pre-existing debt? See UCC s1-201(44)(b) b) Under what circumstances might a security interest be sought by a previously unsecured creditor and be granted by the D? 4) D must have rights in the collateral. 5) The obligation secured: security interest has significance only to the extent that it secures an obligation that the D owes. Perfecting the Security Interest.

d.

1)

Overview: a) Purpose is to provide notice b) If the secured party has to resort to the collateral in order to collect the amount that is owed, it is likely that the D is already in bankruptcy or about to file a bankruptcy petition or has other creditors with competing liens on the secured party’s collateral – in these situations, secured party will be no better than an unsecured creditor unless its security interest is perfected. c) Thus, secured party needs to have perfected security interest. (1) Perfection defined: status that is achieved when the requirements of R9-308(a) have been met (2) A security interest is perfected: (a) When it has attached (when all requirements for enforceability noted above have been met); AND (b) When there has been compliance with a number of Art 9 provisions. Ways to Perfect the Security Interest: nature of transaction usually determines means of perfection. a) Perfecting by filing a financing statement: (1) This is most common way to perfect. (2) Content of Financing Statement (p87): provide the names of and addresses of both the D and the secured party; indicate the collateral. (3) Filing the Financing Statement (p87): must be made in the state where the D is located. (4) Effectiveness of Financing Statement May Lapse: (a) Financing Statement is effective for 5 years. (b) If relationship continues +5 years, secured party has to file a Continuation Statement. i. Continuation Statement can be filed six months before 5-year period expires. ii. No gaps allowed: have to file before end of 5-year period. iii. As purchaser, always look back 5 years and 6 months. b) Perfecting by taking possession of collateral: (1) Applies to equipment, inventory, goods. (2) ??? Secured party may follow this route if worried about depreciation. c) Perfecting by qualifying as a transaction in which neither filing nor possession is required. d) Perfecting by complying with requirements of some other law or statute.

2)

15

3)

??? Special Case of Purchase Money Security Interests in Consumer Goods: Financing Statement need not be filed in order for a PMSI in consumer goods to be perfected. a) Example: Sears credit card – Sears has security interest in goods purchased by buyer on Sears credit card b) Only applies to consumer goods: only those goods used for personal use, not business use.

e.

Priorities.

1)

Generally: a) A security interest has significance only to the extent that the secured party can look to the value of the collateral when the D defaults on the secured obligation. (1) Art 9 planning: thus, secured party should ascertain at the outset of the transaction whether its security interest could be subordinated to the interest of some other Cr, and whether it could even be cut off by the interest of some other party. Crs/others who could subordinate or cut off the security interest of an Art 9 secured party: a) Crs holding judicial liens. b) Crs with Art 9 security interests (including lessors and consignors). c) Purchasers of collateral (including Art 6 bulk transferees). d) Bankruptcy Trustee. e) Real estate interest holders when collateral constitutes a fixture. f) Crs holding statutory liens (i.e., mechanics, artisans). g) Credit sellers of property who have Art 2 reclamation rights. Art 9 Secured Party v. Judicial Lien Creditors: a) General Rule: secured party has priority unless its security interest is unperfected when the other creditor becomes a judicial lien creditor. b) 4 Critical Questions to determine the priority b/w Art 9 secured party and judicial lien creditor: (1) Does the SP have a perfected security interest? (2) When did the SP perfect its security interest? (3) When did the judicial lien arise? (4) Does the SP have a purchase money security interest? c)  Problem 3-31 (p91): d)  Problem 3-32 (p91): e) ??? Problem 3-33 (p92): Art 9 Secured Party v. Bankruptcy Trustee: a) Code gives Trustee the status of a hypothetical judicial lien Cr: 544(a) strong arm power provides bankruptcy Trustee with power to avoid security interest that could have been avoided by a (hypothetical) Cr of the D that obtained a judicial lien on the D’s property at the time of the commencement of the bankruptcy case. (1) Trustee’s job when D has more than one Cr with an Art 9 security interest: Trustee will seek to identify those Crs who have unperfected security interests at the time of the commencement of the bankruptcy case. (2) Lessons to Crs: the only worthwhile security interest is one that is perfected as quickly as possible. b) ??? Problem 3-34 (p93): ??? Art 9 Secured Party v. Another Art 9 Secured Party: purchase money alteration

2)

3)

4)

5)

16

6)

Art 9 Secured Party v. Purchasers of the Collateral: a) Basic rule: of continuation of security interest b) Exceptions: (1) Authorized dispositions. (2) Buyers in ordinary course of business. (3) Buyers NOT in ordinary course of business. (4) Certain consumer-to-consumer transfers Art 9 Secured Party v. Real Estate Encumbrancer: a) Fixtures b) Not covered in class

7)

f.

Loss of Perfection. 1) Maintain perfection: counsel for Art 9 secured party has to ensure that perfection of the client’s security interest is maintained at all times. 2) Times when additional perfection steps may be necessary: a) Perfection status is needed for >5 years. b) Use that is made by D of the property constituting collateral changes with result that description in financing statement is misleading or inaccurate. c) Original collateral is exchanged for other property. d) D’s name is changed (especially with corporate Ds). e) Location of D changes. f) Certain changes occur in connection with collateral subject to certificate of title statutes. Inventory and Accounts Receivable.

g.

1)

Characteristics of INVENTORY as collateral for security interests: a) Inventory generally represents significant part of business’ assets. b) Using inventory as collateral: (1) Most of D’s inventory that it has at any point in time will consist of inventory that arrived recently and probably are not more than 60 days old. (2) Businesses often have to use inventory already on hand, as well as inventory they plan to acquire in the future, as collateral to secure either: (a) Supplier who sells on secured basis; or (b) Lender who provides business with funds to pay suppliers, employees and to meet working capital requirements. c) Content of inventory is continually changing: (1) Problem: (a) When collateral consists of a business D’s inventory, the normal operation of the D’s business results in the sale of goods that comprise the D’s inventory. (b) Secured party cannot assert its security interest in the inventory that is sold. (2) Solutions: (a) Art 9 allows secured party to have security interest in both existing and after-acquire inventory. i. Floating lien: Cr’s secured interest in after acquired inventory as collateral. ii. Add express clause in security agreement. (b) Joint AR and Inventory security interests: secured party with a security interest in inventory will always join it with a secured interest in accounts receivable. (c) Secured party Cr expects that collateral will consist of D’s inventory at time secured party asserts its rights thereto. d) Continuing Cr-D relationship: Art 9 secured party generally wants to continue relationship with D even if D misses a few payments. (1) Rationale: if Art 9 secured party cashes in too early, he may not get full amount of debt – may behoove him to wait it out until D has more inventory or ARs. (2) Example: Martha Stewart as K-Mart Cr.

17

e)

Working Capital Lenders (1) Definition: (a) A working capital lender needs to be an on-going relationship (b) Bank provides cash to Store to cover the always occurring shortfall b/w Store’s purchases from suppliers and Store’s sales to customers (c) Variable debt: what store owes the bank at any point in time is going to vary. (2) Bank establish a line of credit for Store: (a) Formula to determine the maximum line of credit that Bank will lend to Store i. Bank will generally advance up to 55% of eligible inventory + 85% eligible accounts receivable  Accounts Receivable  Inventory  3 categories of inventory: raw materials, work-in-process, finished goods  Eligible inventory = finished goods, maybe work-in-progress, almost never raw materials (b) This will be a floating number. (3) How is the Working Capital Lender secured? (a) Working Capital Lender is secured by inventory and accounts receivable (b) Bank wants to make sure that its security agreement covers newly arriving inventory and new accounts receivable

2)

Characteristics of ACCOUNTS RECEIVABLE (AR) as collateral for security interests a) Collateral of choice for secured lenders who provide Ds with funds for general working capital purposes. b) AR is continually changing. (1) Art 9 allows secured party to have security interest in both existing and after-acquired ARs. Priorities: a) General rule: if secured party files financing statement at time when there is not other secured party and no judicial lien Cr, secured party will have priority over any subsequent secured party in the inventory or accounts receivable and over any subsequent judicial lien Cr. b) Problem arises for secured party (with security interest in inventory or AR) when D files for bankruptcy. Influence on Bankruptcy: a) Problem: secured party’s security interest in inventory/AR is potentially avoidable under 547(b). (1) Secured party who is secured by security interest in inventory or AR almost always be faced with scenario in which all of 547(b) element are met, and the security interest, is therefore, potentially avoidable. (a) Transfer date with respect to each account or each item of inventory will be no earlier than the date when the AR arose or when D acquired an interest in the item of inventory. (2) 547(c)(5) “reduction in deficiency” solution: Bankruptcy Code protects secured party to the extent that it has not improved its position during the 90-day period preceding the bankruptcy filing [547(c)(5)]. (a) Rationale: eliminate possibility of improvement of position for working capital lenders during 90day period. (b) Computing a reduction in deficiency: i. Value of deficiency on day of filing = [how much is Cr owed on day of filing] – [value of the collateral on day of filing] ii. Value of deficiency 90 days before filing = [how much is Cr owed 90 days before filing] – [value of collateral 90 days before filing] iii. Reduction in deficiency = [value of deficiency 90 days before filing] – [value of deficiency on day of filing]; OR iv. Trustee is permitted to avoid Cr’s security interest to the extent that the deficiency was reduced.

3)

4)

18

CHAPTER 4 – STRAIGHT BANKRUPTCY (P99)

E. OVERVIEW AND HISTORY 1.
Structure

a.

Operating Chapters 1) One files a bankruptcy petition under either CH 7, 9 (we will not address), 11, 12 (we will not address) or 13 2) The sections in these chapters are applicable only to cases arising there under 3) Chapter 7: liquidation, applicable to all entities – plan can be filed by entities other than the D – D can try to convert a 7 case into a 13 or 11. 4) Chapter 11: reorganization, applicable to all entities (esp. business reorganization) – there can be involuntary (but there are few – rather, the creditor will file an involuntary 7) - plan can be filed by entities other than the D 5) Chapter 13: reorganization, available only to Ds who are individuals – plan can only be filed by the D Chapters 1, 3 and 5 contain provisions applicable to cases arising under two or more of the five operating chapters.

b. 2.

Historical Antecedents to the Bankruptcy Code

19

F.

SUMMARY OF CHAPTER 7

1. 2.

CH 7 Overview problem (p112). Goal: a. Designed to distribute D’s interest in non-exempt property to unsecured Crs on a pro rata basis Eligibility Requirements: a. Applies to both individuals and corporations b. Individual not engaged in business is still eligible to reorganize under CH 11 (see Toibb v. Radloff, 501 U.S. 157 (1991)). c. Analysis: 1) Identify relevant operating CH of the Code (CH 7, CH 11 or CH 13). 2) Examine 109 and definitions contained in 101 3) Ascertain whether additional restrictions contained in 301, 302 and/or 303 are applicable. Crs may file involuntary petition. Automatic stay [362].

3.

4. 5.

a. b. 6.

Goes into effect upon filing of petition. Automatic stay does not protect co-Ds of the D.

POE [541]. a. D’s property at commencement with a few exceptions, most post-petition prop is excluded. Disposition of estate property [524, 722]. a. Most property is liquidated and proceeds are distributed to Crs. b. Possibility of redemption [722] c. Possibility of retention of unencumbered property by reaffirmation [524] Bankruptcy will have NO impact on D’s post-petition income. Administration of Estate [701, 702, 703, 721]. a. Trustee administers the estate and conducts short-term business operations. 1) Trustee’s tasks: a) Locating D’s assets. b) Obtaining control over D’s assets. c) Reducing assets to monetary form. d) Providing for orderly distribution in accordance with Code’s priorities. b. Business is liquidated as soon as possible.

7.

8. 9.

10. Conversion [701, 706]. a. D has broad right of conversion [701] b. Crs can convert to CH 11 for cause [706].

20

11. Dismissal a. May be dismissed by D or other party in interest only for cause. b. May be dismissed by U.S. Trustee or court. 12. Likely source of funding to pay Crs’ claims [704, 726]. a. Proceeds of non-exempt POE 13. Time period for payment [704]. a. Liquidation and distribution as expeditiously as possible. 14. Minimum level of payment to Crs [506, 507, 726]. a. Crs cannot get more than total proceeds realized from estate property. b. Secured Crs are satisfied from proceeds of the collateral. c. Priority claims are paid in order of rank, followed by general unsecured claims. d. Members of each class share pro rata. e. Once the fund is exhausted, junior classes are excluded. 15. D cannot discriminate in favor of preferred Cr or class of Crs in CH 7 case. a. No discrimination is allowed. b. Crs in each category (secured, priority, general) must be treated the same as other Crs in that category. 16. D has no power to cure defaults or modify secured obligations unless secured Cr agrees to the modification in a
reaffirmation agreement [524].

17. Crs have no power to participate in formation of plan because no plan is filed in CH 7. 18. Crs consent no an issue because no plan is filed in CH 7; distribution is fixed by Code [726]. 19. Discharge in CH 7. a. For corporations: no discharge available to a corporation in CH 7. b. Breadth of discharge: all pre-petition debts are discharged except for those listed in 523 c. Denial of discharge: D may be denied a discharge for certain behavior [727]. d. When is discharge granted? during course of the case, after expiry of the period for filing objections to discharge
[Rule 4004].

20. Alimony, Maintenance & Support in CH 7 a. Exception from automatic stay: Crs of such claims may collect from non-POE (e.g., post-petition wages and b.
exempt property) [362(b)(2)(B)]. Exception from discharge: such claims are generally non-dischargeable [523(a)(5), (15)].

21

G. COMMENCEMENT OF THE CASE 1.
Voluntary Cases [301]

a.

b. 2.

How commenced 1) 301: a voluntary case under a chapter of this title is commenced by the filing with the bankruptcy court of a petition under such [operating] chapter by an entity that may be a D under such chapter. 2) 109: says who = D under one of the Code’s operating chapters. 3) 109(b): says who = D under Chapter 7. a) Generally, any person may be a D under Chapter 7 b) “Person”: includes individuals and some corporations - 101(41) c) Not every corporation can file under CH7 (1) Excluded corporations: railroads, banks, insurance companies. Filing voluntary bankruptcy petition = order for relief.

Involuntary Cases [303]

a.

Rationale for having involuntary filing (even though rarely used) 1) Prevent erosion of the asset base, halt bleeding of D’s estate. 2) Protect unfavored D: prevent D from paying favored (unsecured) creditors and not paying unfavored creditors. 3) Protect against fraudulent transfers Filing Requirements [303(a), 303(b)]

b.

1)

Against who may an involuntary petition be filed [303(a)] a) Crs can only file an involuntary petition under CH7 or CH11. b) Cannot have an involuntary against a farmer, family farmer, non-business corporation. How many creditors are required to filed petition [303(b)] a) Depends on the number of Crs with claims against the D: (1) If there is <12 Crs, only need one Cr to file (2) If there are >12 Crs, need 3 Crs to file How much must petitioning Crs be owed? a) Petitioning Crs must be owed at least $11,625 in unsecured claims [303(a)(1)]. (1) In detail: (a) An involuntary petition may be filed by holders of claims owed at least $11,625 apart from any collateral, (b) Provided that the claims are not contingent, and (c) Provided that the claims are not the subject of a bona fide dispute. b) “Apart from any collateral” requirement (1) What Cr will be able to obtain from D’s prop is affected by: (a) Amount owed (b) Value of prop (c) How value will be distributed (2) ??? Effect on CH 11 plans: in order for court to approve a reorganization plan, court places creditors in classes, each class has to, by a certain majority, approve the plan. (3) Hypo: (a) Creditor A, owed $15,000, has a non-contingent claim that is NOT subject to a bone fide dispute, and is secured by collateral worth $8,000. (b) Creditor A will NOT be able, by itself, to meet the Code’s $11,625 threshold requirement for filing an involuntary petition. (c) Although A’s claim is $15,000, only $7,000 is “more than the value” of its collateral

2)

3)

(4) Hypo: (a) Creditor B also has a non-contingent claim that is NOT subject to a bone fide dispute, and is
secured by collateral worth $8,000. Creditor B, however, is owed $20,000.

22

c) d)

for filing an involuntary pet. ??? Not contingent as to liability (defined on p152). (1) Cr has to get judgment first. (2) ??? Unmatured Claims Not the subject of bona fide dispute (1) Rule: if there is a bona fide dispute as to either the law or the facts, then the Cr does not qualify and the petition must be dismissed (see In re Lough, 57 B.R. 993 (Bankr. E.D. Mich. 1986)). (2) Problem 4-5 (p160)

(b) As a result, Creditor B will be able, by itself, to meet the Code’s $11,625 threshold requirement

4)

Contents of involuntary bankruptcy petition: a) D’s name and address. b) Name and address of each petitioning Cr. c) Nature and amount of each petitioning Crs’ claims. d) Allegation that D “is generally not paying such D’s debts as they become due, unless such debts are the subject of a bona fide dispute.” (1) General rule: If D contests the involuntary petition, court will NOT enter order for relief. (2) Exception: even if D contests the involuntary petition, if D is generally not paying such D’s debts as they become due, court will enter order for relief. (a) If D is failing to pay 80% of his debts when they become due, that will be sufficient to find D is generally not paying his debts (see In re J.B. Lovell Corp., 80 B.R. 254 (Bankr. N.D. Ga. 1987). (b) May be able to find it even lower. (3) Exception to Exception: even if D contests the involuntary petition, and even if D is generally not paying his debts as they become due, the court will NOT enter an order for relief if such debts are the subject of a bona fide dispute. (a) Effect: In determining whether D is generally paying his debts, court cannot take into account debts that are subject to bona fide dispute. e) Signed by petitioning Crs and their attorneys. ??? Problem 4-6 (p162).

5) c.

Effect of dismissal of involuntary petition. 1) If dismissed for failure to meet 303 requirements, D can recover its costs, reasonable attorney’s fees and damages. 2) If dismissed for failure to meet 305 requirements, can get reasonable attorney’s fees and what else? 3) If dismissed for bad faith, D may be able to punitive damages.

3.

Filing Bankruptcy Petition (whether Voluntary or Involuntary) Triggers Automatic Stay [362].

a.

362(a): filing operates as an automatic stay as to (1) through (8) 1) Very broad scope: most creditor remedies are covered – thus, creditor cannot use these remedies once the Debtor files. 2) Examples a) Creditor cannot file a lawsuit b) Creditor cannot send a dunning a letter c) Creditor cannot continue a lawsuit d) Creditor cannot conduct levy sale – if it does take place, it will be undone. e) Creditor, assuming he repossessed some item, cannot sell it – has to return it – it is still prop of the D or the estate f) See In re Sechuan City, Inc., 96 B.R. 37 (Bankr. E.D. Pa. 1989) Exceptions – 362(b): when filing does not operate as a stay.

b. 4.

Go through Problem 4-7 (p165).

23

H. THE AUTOMATIC STAY [362] 1.
General Characteristics

a. b. c. d. e. f. g. h.

Stay goes into effect upon filing of bankruptcy petition in both voluntary and involuntary cases. 1) In involuntary case, stay precedes entry of order for relief. Stay is binding on all entities [101(15)]. Remains in effect for duration of case. Applies in all forms of bankruptcy but impact of stay will vary depending on type of relief sought. Effectiveness of stay does not depend on Cr’s notice of filing. Stay does not preclude action in the bankruptcy court. Stay is not an end in itself. Although stay is comprehensive, it does not cover every conceivable activity.

2.

Dual Goals of Automatic Stay

a. b.

Prevents depletion of D’s assets and preserves them for surrender to Trustee or retention of DIP. Gives D sanctuary from Cr pressure so that orderly liquidation can be arranged or plan formulated.

24

3.

Activity Prohibited by the Automatic Stay [362(a)]

a.

Activity against the D [362(a)(1), (2), (6), (7) and (8)]. 1) Prohibits actions against the D by pre-petition Crs. 2) Does not prohibit actions against the D by post-petition Crs. Activity against property of the D [362(a)(5)]. 1) Prohibits actions by pre-petition Crs to create, perfect or enforce a lien against property of the D. a) ??? What = Property of the Debtor: D’s prop that D acquires after the filing of the petition. 2) Does not prohibit actions against property of the D by post-petition Crs. Activity against property of the estate [362(a)(2), (3) and (4)]. 1) Prohibits actions by pre-petition Crs and post-petition Crs against POE. a) What = Property of the Estate: D’s property that D owns at time of filing of case and that Crs can go after. 2) Examples of POE: money in D’s bank account on date of petition, rent for post-petition Examples of stayed activities, see Problem 4-8 (p178). 1) Filing lawsuit against D for alleged negligence stemming from a pre-petition car accident 362(a)(1)]. 2) Filing financing statements to perfect a security interest in inventory and ARs that D granted to secured party as security for pre-petition, working capital loan [362(a)(4)]. 3) Using self-help to repossess collateral after default pursuant to the terms of a security agreement securing a prepetition loan [362(a)(3), (4), (5)]. a) It would not make any difference if collateral was worth less than amount of debt. 4) Selling collateral that had been repossessed prior to filing of bankruptcy petition [362(a)(4), (5)]. 5) A bank’s action in setting off the funds in the D’s bank account against the D’s pre-petition debt to the bank. a) See Strumpf. 6) Landlord exercising its state law right to evict D from her apartment as holdover tenant under a lease that was entered into before tenant filed her bankruptcy petition [might fall under 362(a)(1) or (6)]. 7) Medical Clinic sends letter to CH7 D saying it would not provide medical care to her or her family because of past due, albeit dischargeable, pre-petition debt [362(a)(6)]. a) Related holdings from In re Olsen, 38 B.R. 515 (Bankr. N.D. Iowa 1984). (1) Clinic’s act of sending letter was to collect pre-petition debt and thus, voidable under 362(a)(6). (2) Clinic’s refusal to offer service was act to collect a pre-petition debt and thus, violated 362(a)(6). (3) Even if refusal occurred after the CH 7 case was closed, the refusal would be an act to collect a prepetition debt in violation of 542(a)(2). (4) Sanctions may be permitted against such Cr. 8) ??? Supplier refuses to sell goods to CH 7 D, even on cash basis, when D failed to pay past due amounts (i.e.¸ a pre-petition, dischargeable debt). a) Supplier’s refusal was coercive; if D pays supplier in advance or on delivery, supplier cannot refuse to deal with D because of D’s failure to pay past due amounts (see In re Sportfame of Ohio, Inc., 40 B.R. 47 (Bankr. N.D. Ohio 1984). 9) ??? Reaffirmation: a) Reaffirmation: D’s original debt to Creditor is dischargeable; D agrees post petition to pay Creditor X dollars – this agreement b/w D and Cr would become a binding obligation going forward – void the discharge. b) Congress’ Response: Congress is aware that consumer Ds are in disparate position with creditors – thus, in order for there to be enforceable reaffirmation agreement, the bankruptcy court has to approve it. c) Sample cases: (1) D has car and owes car loan creditor more than value of car, Congress wants D to be able to keep car but needs to get creditor to let D keep car. (2) If there is a dispute b/w D and Cr about whether deficiency is dischargeable. Automatic Stay’s Effect on Bank’s Right of Setoff: 1) A temporary administrative hold or freeze on the D’s bank account, while the bank applies for relief from the stay, does not violate the automatic stay (see Citizens Bank v. Strumpf, 116 S. Ct. 286 (1995)). a) Reason:

b.

c.

d.

e.

25

(1) State law right to set-off: Bank, under state law, has right to set off what D owes it from what it

owes D (i.e., lets Bank pay itself), [553], but once D files bankruptcy petition, Bank cannot exercise its right of set-off 362(a)(7). (2) Code wants to protect Bank: Bank is concerned that by the time it obtains court approval, D will have withdrawn or used funds.

f.

Impact of Automatic Stay on Third Parties 1) An action by a Cr to recover fraudulently transferred property from the non-bankruptcy transferee is an action to recover a claim against the D and is stayed (see In Re Colonial Realty, 980 F.2d 125 (2d Cir. 1992). a) Reason: fraudulent transfer claims are POE. 2) ??? Examples of stayed activities affecting third parties (see Problem 4-9 (p187)). a) ??? Instituting suit against the guarantor of D’s obligation to the Cr that arose out of a pre-petition contract. (1) How does this affect the co-D scenario? I thought automatic stay in CH 7 cases did not preclude claims against co-D. (2) Different from Colonial Realty in that Cr is going after co-D rather than transferee (who may have had no knowledge of security interest). b) Where a bank has a security interest in the D’s ARs arising from a pre-petition secured transaction, D defaults on this loan and then D files bankruptcy petition, bank may not notify account Ds that the amounts due to the D have been assigned to the bank and that the payment is to be made to the bank. c) ??? Where Susan is injured as result of D’s negligence (pre-petition), D files bankruptcy petition, Susan then sues D’s insurance company under direct-action statute, such action may not be stayed since Susan goes directly after insurance company. (1) ??? Different from Colonial Realty in that Cr is going directly after insurance company rather than transferee (who may have had no knowledge of security interest). Impact of Automatic Stay on Statutes of Limitations [108(c)]. 1) General rule: if the claim is subject to a limitation period and that period had not expired before the petition was filed, it will not expire until the time fixed by non-bankruptcy law or 30 days after notice of the termination or expiry of the stay whichever is later [108(c)]. ??? Impact of Automatic Stay on Post-petition Claims 1) Automatic stay’s impact on post-petition claims differs depending on whether Cr goes after the D, property of the D or POE a) Automatic stay does NOT prohibit actions against the D by post-petition Crs. b) Automatic stay does NOT prohibit actions against property of the D by post-petition Crs. c) Automatic stay does prohibit actions against POE by post-petition Crs. 2) ??? Problem 4-11 (p188): a) Facts: D owns (and has equity) in a building, D files bankruptcy petition, D injures Penny (post-petition), Penny sues (because claim arose post-petition) and obtains judgment. b) What can Penny go after to satisfy her judgment? (1) Penny cannot go after D’s building b/c it is POE. (2) Penny can go after his post-petition wages because wages are property of the D.

g.

h.

26

4.

Activity Excluded from the Automatic Stay

a. b.

Bottom Line on Scope of 362(a) and 362(b): if 362(a) covers a particular activity and it does not fall under one of the 362(b) exclusions, it is stayed. Automatic Stay Does Not Bar 3 General Types of Activities (each explained in further detail below).

1) 2) 3)

Stay does not bar certain specific activities that do not involve the collection of debt but are concerned with the enforcement by governmental units of non-commercial responsibilities of the D [362(b)(1), (4), (5)]. Stay does not bar certain specified actions taken by a Cr under non-bankruptcy law to perfect or consolidate rights against the D or the estate. Stay does not bar commencement of action or proceeding to establish paternity, to establish or modify an order for alimony maintenance or support, or to collect such debts from property that is not property of the estate (i.e., D’s own property) [362(b)(2)].

c.

Stay does not bar certain specific activities that do not involve the collection of debt but are concerned with the enforcement by governmental units of non-commercial responsibilities of D [362(b)(1), (4), (5)].

1)

Stay does not bar criminal proceedings against D [362(b)(1)] a) ??? Jail? b) ??? Restitution? Stay does not bar proceedings by govt’l units to enforce police or regulatory powers [362(b)(4), (5)] a) ??? Examples of governmental proceedings not barred by the stay (Problem 4-19 (p204)): (1) Automatic stay does not apply to on-going, non-final administrative proceedings (see Board of Governors of the Federal Reserve System v. Mcorp Financial , Inc., 502 U.S. 32 (1991)).

2)

d.

Stay does not bar certain specified actions taken by a Cr under non-bankruptcy law to perfect or consolidate rights against the D or the estate [362(b)(3), (11)].

1)

Examples: a) Cr may perform acts to maintain or continue perfection or to complete perfection procedures recognized by 546 or 547 as binding on the estate [362(b)(3)]. b) Cr may comply with procedures required by Art 3 for presentment, notice and protesting of a negotiable instrument [362(b)(11)]. Rationale: theses are merely legal procedures that Cr is entitled to take under non-bankruptcy law to validate a legitimate claim. Special Rule Benefiting Holders of Purchase Money Security Interests.

2) 3)

a)

Special Bankruptcy Code Provision for PMSI holders: Trustee may not avoid, under 547(b), a PMSI transaction that is perfected within 20 days of the D receiving possession of the property [547(c)(3)] (1) Based on state relation-back law for PMSI holders. (2) PMSI defined: a security interest in property, to the extent that it secures a loan or credit given to the D for the express purpose of acquiring the property and actually used by the D for that purpose (a) Can have PMSIs in real property or personal property (e.g., car loan).

27

b)

State Relation-bank Law for PMSI Holders in Non-Bankruptcy Context (Problem 4-16 (p202)): (1) Special Rule for PMSI holders [Art 9-317(e)]: if PMSI holder secures its interest in “a reasonably close period of time” to the transaction date, then the transaction date becomes the perfected date. (a) ??? Reasonable time = 20 days from when D obtains possession of the goods. (b) Rationale for different rule for PMSI: but for S entering into this transaction, judicial lien Cr would never have been able to obtain a lien on this stuff. (2) Facts of Problem 4-16 (p202): (a) Mar 1: S sells D goods on PMSI basis. i. The goods at the time of the K of sale could be in existence or not ii. Security interest cannot be enforceable until we know what the particular item is iii. Think about consumer goes to Sears and decides to buy refrig – points to display model – to be delivered later. (b) Apr 1: goods are selected and delivered to D; S mails Filing Statement to office where it will be filed (and thus perfected). i. Apr 1 = attachment date, transaction date, enforceability date, effective date for S’s security interest b/c D now has a right/interest in the particular goods. (c) Apr 2: Cr obtains judicial lien by cause sheriff to levy on goods. (d) Apr 4: filing officer files S’s Filing Statement (3) Answer & Reason: S has priority (a) General rule: under Art 9, the holder of the judicial lien will have priority over holder of security interest if security interest is unperfected at time that the holder of the judicial lien acquires the lien. i. Result under general rule, judicial lien creditor would have priority to the goods because the security interest is not perfected. ii. But general rule not apply in case of PMSI. (b) Result under Special Rule for PMSI holders: S has priority b/c secured within less than 20 days from day D took possession of goods. Special Rule for PMSI Holders in Bankruptcy Context (Problem 4-17 (p202)). (1) Facts: (a) Mar 1: S sells D goods on PMSI basis. (b) Apr 1: goods are selected and delivered to D; S mails Filing Statement to office where it will be filed (and thus perfected). (c) Apr 2: Cr obtains judicial lien by cause sheriff to levy on goods. (d) Apr 4: filing officer files S’s Filing Statement (e) Apr 5: D files CH 7 bankruptcy petition. (2) Answer & Reason: (a) Result under 544(a): S has priority over Trustee. i. Trustee is not able to avoid S’s interest under 544(a) b/c Trustee only has status of hypothetical judicial lien Cr and in non-bankruptcy law, S has priority over a judicial lien Cr (b/c S perfected his security interest on Apr 1 and that is before judicial lien was perfected on Apr 2 or 5). (b) Result under 547(b): S has priority over Trustee. i. Trustee can avoid S’s security interest because all 547(b) elements are met. ii. But then look at 547(c)(3): Trustee may not avoid, under 547(b), a PMSI transaction that is perfected within 20 days of the D receiving possession of the property. iii. Policy argument: ridiculous to punish PMSI holder b/c even if S did maximum that it could do (which would be to file security interest on Mar 1 but transfer date would still be Apr 1 because that would be when D got the goods), S would still lose out to Trustee - even if S pre-filed, Apr 1 would be the earliest transfer date.

c)

28

d)

??? Problem 4-18 (p203). (1) Facts: (a) Mar 1: S sells D goods on PMSI basis. (b) Apr 1: goods are selected and delivered to D; S mails Filing Statement to office where it will be filed (and thus perfected). (c) Apr 2: Cr obtains judicial lien by cause sheriff to levy on goods. (d) Apr 3: D files CH 7 bankruptcy petition. (e) Apr 4: filing officer files S’s Filing Statement (2) Answer & Reason (a) Result under 544(a): S has priority over Trustee. i. Undesirable result: if we only look at 544(a), the Trustee would be able to avoid this security interest because on Apr 3, S’s security interest was unperfected. ii. Policy argument: as a policy matter, we cannot let this occur b/c not in S’s control as to when one of its customers files a bankruptcy petition – intervening bankruptcy should not be permitted to knock this security interest out. iii. 362(b)(3) provides solution to protect PMSI holder: stay does not bar any act to perfect, or to maintain or to continue the perfection of, an interest in property to the extent that . . .  the Trustee’s rights and powers are subject to such perfection under section 546(b) of this title; OR  such act is accomplished within the period provided under 547(e)(2)(A) (irrelevant under 544(a)). (b) Result under 547(b): I. Undesirable result: if we only look at 362(a)(4), Trustee would be able to avoid this security interest. ii. Policy argument: we have to find way to protect PMSI. iii. Congress expanded 362(b)(3) to protect PMSI holders: stay does not bar any act to perfect, or to maintain or to continue the perfection of, an interest in property to the extent that . . .  the Trustee’s rights and powers are subject to such perfection under section 546(b) of this title (irrelevant under 547(b)); OR  such act is accomplished within the period provided under 547(e)(2)(A) (i.e., transfer is perfected within 10 days of date when it took effect).  Cohen says Congress put wrong reference in – only 10 days from attachment or enforceability (rather than from possession). – should have made the reference to 547(c)(3) (which includes 20 days from possession).

e.

Stay does not bar commencement of action or proceeding to establish paternity, to establish or modify an order for alimony maintenance or support, or to collect such debts from property that is not property of the estate (i.e., D’s own property).

1) 2)

Part of package of Code provisions designed to prevent D from using bankruptcy to evade support obligations. ??? Problem 4-15 (p201): a) Facts: D, who is divorced, is ordered by the court to pay $500/week in alimony, D subsequently files CH 7 petition. b) How can D’s ex-spouse enforce the court order for alimony. (1) ??? D’s ex-spouse cannot enforce a court order for alimony by garnishing D’s bank account b/c bank account is POE. (2) ??? D’s ex-spouse can enforce a court order by garnishing D’s bank account if bank account is opened after bankruptcy filing and D’s employer makes deposits directly to the account b/c the bank account is not POE. (3) D’s ex-spouse can enforce a court order for alimony by garnishing D’s bank account if bank account is opened one year prior to bankruptcy filing, account has always had a balance of at least $1,000 and D’s employer makes deposits directly to the account with respect to D’s post-petition earnings. (a) Rationale: b/c the bank account is not POE

5.

Effect of Violating the Stay

29

a. b.

Unintentional violation is treated as void or voidable. Deliberate violation may subject Cr to attorney’s fees, costs, compensatory damages, punitive damages and sanctions.

6.

Automatic Termination of the Stay [362(c)]– p218

a.

Automatic termination [362(c)]. 1) For acts against POE, the stay continues until the property is no longer POE [362(c)(1)]. 2) For all acts, except acts against POE [362(c)(1)], the stay automatically terminates when . . . a) a bankruptcy case is dismissed; b) when the case is closed; OR c) when a discharge is granted or denied. Termination by relief [362(d)]. If debt is discharged, Cr is permanently enjoined from collecting it [524].

b. c.

30

7.

Obtaining Relief from the Automatic Stay

a.

Procedure for Relief from the Stay [362(d), (e), (f), (g)]. 1) Party requesting relief must file a motion for relief. 2) Court must give notice and hearing (hearing only needed if party in interest requests it). 3) If court does not act (in some way) on motion for relief within 30 days, relief is automatically granted [362(e)]. Forms of Relief [362(d)]. 1) Termination 2) Annulment 3) Modification 4) Conditioning. Summary of 3 Grounds for Relief from Stay (further described below). 1) For cause, including lack of adequate protection [362(d)(1)] 2) When D has no equity in the prop AND the prop is not necessary for an effective reorganization [362(d)(2)] 3) Relief from stay in single asset real estate cases [362(d)(3)] Ground for Relief from Stay - for cause, including lack of adequate protection [362(d)(1)].

b.

c.

d.

1) 2) 3)

Text: court must grant relief from stay if applicant (Cr) has cause for relief, including lack of adequate protection of the applicant’s interest in property. Scope a) Applies to acts against D, property of the D or POE. Examples of generic “for cause” cases: a) Lack of adequate protection (1) If secured Cr’s collateral is depreciating, falling below secured Cr’s allowed secured claim, Cr’s interest in the collateral at the time of commencement of the bankruptcy case is not being adequately protected. (2) If secured Cr’s collateral is not being insured from fire, theft or vandalism. (3) If secured Cr’s collateral is otherwise at risk. b) Abusive behavior by D. c) More fair or efficient for another court to resolve the case. (1) If litigation is pending in another jurisdiction, parties were ready for trial at time of commencement of bankruptcy case, none of the D’s other Cr’s would be prejudiced if litigation went forward, and judicial economy would be furthered by permitting litigation to go forward. (2) Litigation is pending in another jurisdiction which would serve as a predicate to permitting the Cr to recover under the D’s liability insurance policy. d) D’s default under a plan Determining for cause a) Balancing test to determine for cause: balance harm that will be suffered by applicant if stay continues versus interests of estate and/or D that are protected by the stay. b) Applicant for relief has burden of proving cause.

4)

31

5)

Determining “lack of adequate protection.”

a)

Goal: intended to reduce secured Cr’s risk of loss from the stay by requiring Trustee (or DIP) to maintain the value of the collateral relative to the debt, so that if or when realization occurs, the secured Cr will receive as much as it would have recovered upon immediate foreclosure. Who can bring a lack of adequate protection claim? (1) Holders of interests in POE or property of the D. (a) Examples: secured Crs, lessors who have leased property to the D, co-owners of D’s property, others with valid interest in property. (2) Unsecured Crs cannot bring lack of adequate protection claim. Circumstances under which need for adequate protection arises. (1) Most common scenario is depreciating value of property. (2) Generally more of a problem in CH 11 cases b/c in CH 7 cases, property is liquidated fairly quickly. Factors in determining need for adequate protection: (1) Compare present ratio of property value to debt WITH predicted future ratio of property value to debt if the property is to be kept and used or dispose of as proposed by the estate. (a) 3 questions: i. If stay is lifted and foreclosure proceeds, what is claimant likely to receive?  Factual determination of present value of the property in relation to the debt. ii. If stay is left in effect and estate deals with property as proposed, what is likely to happen to the value of the property in relation to the debt?  Calculate the rate of increase or decrease in the debt and compare to the future value of the collateral. iii. What is likelihood of successful rehabilitation? Means of furnishing adequate protection [361]. (1) Non-exclusive means: any means by which Trustee can assure protection of claimant’s interest. (2) Express means delineated in 361: (a) Cash payment [361(1)]. (b) Additional collateral [361(2)]. (c) Grant of “indubitable equivalent” [361(3)]. (3) Trustee cannot grant a claimant an administrative expense priority as means of providing adequate protection. (4) Trustee bears burden of proving that the interest is adequately protected. When does adequate protection include interest? [506] (1) “Adequate protection” concept does not cover lost profits or loss income (due to the delay in foreclosing on collateral caused by the automatic stay) - it only covers the value of collateral at time of filing of petition (see U.S. Savings Assoc. of Texas v. Timbers, 484 U.S. 365 (1988)). Adequate protection for UNDER-secured Crs. (1) Limits on what under-secured Cr is entitled to: under-secured Cr is only entitled to protection of the present value of his interest and cannot demand an improvement in position. (2) Problem 4-21 alternative 1 (slide). (a) Facts: at time D files CH 7 petition, Bank is owed $100,000 and is secured by equipment that has a value of $75,000 but equipment is depreciating at $1,000/month. But for the stay, Bank would have sold equipment and invested at 10%. (b) Result: i. D could probably obtain relief under 362(d)(1) but only for the present value of his interest ($75,000) ii. Trustee could provide “adequate protection” up to $75,000. (3) Problem 4-21 alternative 2 (slide). (a) Facts: at time D files CH 7 petition, Bank is owed $100,000 and is secured by equipment that has a value of $75,000 but equipment is depreciating at $1,000/month. But for the stay, Bank would have sold equipment and invested at 10%.

b)

c)

d)

e)

f)

g)

32

(b) Result: Bank can obtain relief from stay under 362(d)(1) even where D pays Bank $1,000/month
(to provide adequate protection) if, in order to do so, D stops paying its casualty insurance premiums on the equipment (because this is for cause). (c) Result if D retains appropriate insurance, Cr cannot obtain relief under 362(d)(1) because not cause but can possibly obtain relief under 362(d)(2) because D has no equity in property and it is CH 7 case.

h)

Adequate protection for FULLY-secured Crs. (1) Limits on what fully-secured Cr is entitled to: secured Cr is only entitled to protection of the present value of his interest and cannot demand an improvement in position – nor can he demand interest or compensation for lost income. (2) Problem 4-20 (p220). (a) Facts: at time of filing CH 11 petition, Bank is owed $50,000 and is secured by equipment that has a value of $50,000 but equipment is depreciating at $1,000/month. (b) Result: D may be able to retain relief because can show lack of adequate protection for his collateral. (c) Trustee could provide adequate protection by: i. Making cash payments to Cr for $1000/month. ii. Giving Cr security interest in additional collateral (ideally something the D has equity in) (3) Problem 4-21 (p220). (a) Facts: at time of filing CH 11 petition, Bank is owed $50,000 and is secured by equipment that has a value of $50,000 but equipment is depreciating at $1,000/month. But for the stay, Bank would have sold equipment and invested at 10%. (b) Result: iii. Cr cannot obtain relief under 362(d)(1) by showing that it will not recover depreciation value and lost income. iv. “Adequate protection” concept does not cover lost profits or loss income (due to the delay in foreclosing on collateral caused by the automatic stay) - it only covers the value of collateral at time of filing of petition (see U.S. Savings Assoc. of Texas v. Timbers, 484 U.S. 365 (1988)). ??? Adequate protection for OVER-secured Crs. (1) Able to get interest. (2) Equity cushion. When Trustee’s Attempts at Providing Adequate Protection Fail - Superpriority [507(b)]. (1) If Trustee provided adequate protection to a claimant, and the protection turns out to be in adequate, the deficiency is treated as a priority claim that ranks at the top of the administrative expense priority category. (2) ??? It does not apply when court has refused relief from a stay on the basis that adequate protection already existed without further bolstering by the Trustee.

i)

j)

33

e.

Ground for Relief from Stay - when D has no equity in the property AND the property is not necessary for an effective reorganization [362(d)(2)].

1) 2) 3)

Text: Cr may obtain relief from the stay for an act against property of the estate or property of the D if the D has no equity in the property and the property is not necessary for an effective reorganization. Scope: applies only to acts against property of D or POE; cannot be used to obtain relief from stay for acts against the D. Examples of generic 362(d)(2) cases: (a) Cases in which secured Cr has a security interest in a CH 7 D’s property, the property’s fmv is less than the amount of the Cr’s claim. (b) Cases in which a Cr has a security interest in a CH 11 D’s property, the property’s fmv is less than the amount of the Cr’s claim, and the property is not necessary for the D’s reorganization D’s Lack of Equity in Property [362(b)(2)(A)]. a) D’s equity = value in property in excess of all encumbrances on property. b) Use 506 to value the D’s equity in the property. c) In CH7 case, if D has no equity in property, relief from stay should be granted (b/c effective reorganization is irrelevant in CH 7 case). Property is Necessary for Effective Reorganization [362(b)(2)(B)]. a) Analysis: courts evaluate 2 factors in determining necessity for effective reorganization: (1) D needs property for reorganization; AND (2) D must show there is reasonable prospect of successful reorganization within a reasonable time (see Timbers) – it is unclear to what extent courts examine this factor. b) In most CH11 cases, D will be able to demonstrate the prop is necessary for an effective reorganization – thus, Cr will be unable to obtain relief. c) Problem 4-23 (p225). (1) Facts: at time D files CH 11 petition, Bank is owed $100,000 and is secured by equipment that has fmv of $75,000. There is little hope of successful reorganization but equipment would be necessary were there to be a reorganization. (2) Result: Bank may be able to obtain relief from stay under 362(d)(2) on the ground that the property is not necessary for an effective reorganization b/c there is little hope for such reorganization. (a) It is unclear to what extent the reasonable prospect of a successful reorganization will affect this analysis.

4)

5)

f.

Ground for Relief from Stay - in single asset real estate cases [362(d)(3)].

34

I.

PROPERTY OF ESTATE [541]

1.

Scope

a.

POE is determined as of the commencement of the case 1) Examples where property = POE (see Problem 4-27 (p251)): a) Money received by D one week after D files CH 7 petition which constitutes payment for D’s pre-petition services: POE [541(a)(6)]. b) Rent money received by D post-petition for pre-petition rental period: POE [541(a)(6)]. c) Rent money received by D post-petition for post-petition rental period: POE because building for which rent is received is POE so post-petition rent is proceeds of POE [541(a)(6)]. d) Insurance proceeds payable post-petition for pre-petition fire loss: POE because proceeds constitute a substitute for value of building (which was POE). e) Tax refunds: POE 2) Examples where property is not POE (see Problem 4-27 (p251)): a) Retirement pay paid to D post-petition (as long as he performed certain minimal duties post-petition): NOT POE (see In re Haynes, 679 F.2d 718 (7th Cir. 1982)). b) Vacation pay: NOT POE c) Money received by D one week after D files CH 7 petition which constitutes payment for D’s post-petition services: NOT POE [541(a)(6)]. d) ???D’s real estate commission attributable to pre-petition sales but closed after filing of bankruptcy petition: NOT POE 3) Questionable areas (see Problem 4-27 (p251)): a) ??? D obtains judgment post-petition for a pre-petition injury (see Problem 4-26 (p250)). b) Insurance proceeds payable post-petition for post-petition fire loss = POE if the asset that was damaged was POE but not if the asset that was damaged was not POE. c) D’s real estate commission attributable to pre-petition sales and closed after the filing of the bankruptcy petition but sales agreement were signed pre-petition: courts are divided. POE includes “all legal or equitable interests of the D in property as of the commencement of the case” [541(a)(1)]. 1) Net of valid and enforceable liens (see Chicago Board of Trade v. Johnson, 264 U.S. 1 (1924)) a) Example: where D owns building with fmv of $1,000,000 and it is subject to PM mortgage with loan balance of $750,000, only $250,000 will be POE. 2) Net of funds held in trust by D for another entity (see Beiger v. IRS, 496 U.S. 53 (1990)): a) Rule: funds held in trust by D for a third party are not POE. (1) Rationale: D must have actual interest in property - property they is seemingly under the D’s control must, nonetheless, be property in which the D actually has an interest and is not considered “earmarked” for others. b) Example: Trustee cannot get federal income withholding taxes paid from D’s general accounts to IRS. 3) Determination of whether D has a legal or equitable interest in property and what the nature of that interest is, is determined by non-bankruptcy law. a) But Code invalidates any transfer restriction provisions: Code invalidates any provision of nonbankruptcy law, as well as any condition created by a K or transfer instrument, that restricts the transfer of the property rights so that they do not pass to the estate upon bankruptcy [541(c)]. 4) Common examples of “legal and equitable interests” a) For individual D: (1) House, furniture and other household goods. (2) Clothing (3) Car(s) (4) Bank account, savings & loan account, credit union account.

b.

35

b)

For corporate or partnership D: (1) Equipment (2) Inventory (3) Fixtures (4) AR (5) Real estate (6) Bank accounts

c.

Restrictions on Alienability [541(c)] 1) General rule: Code invalidates any provision of non-bankruptcy law, as well as any condition created by a K or transfer instrument, that restricts the transfer of the property rights so that they do not pass to the estate upon bankruptcy [541(c)]. 2) Exception: 541(c)(2) provides for the enforceability of restrictions on the transfer of a D’s interest in a trust a) Rule: D’s interest in an ERISA-qualified plan and/or state spendthrift trust will be excluded from POE. (1) Examples: spendthrift trusts and ERISA qualified plans (see Patterson v. Shumate, 504 U.S. 753 (1992)). b) Open question: what about D’s interest in other retirement vehicles or annuities (i.e., IRAs) Property Acquired After Filing of Bankruptcy Petition. 1) General rule in CH 7 and CH 11: all earnings and property acquired by D after the filing of the petition, from sources unrelated to pre-petition property, remain property of the D and do not become POE. a) Exceptions: proceeds and profits earned from POE and property acquired post-petition by the estate itself = POE [541(a)(6), (7)] 2) General rule in CH 12 and CH 13: POE includes not only property qualifying under 541 at time of filing of petition but also all property acquired and all remuneration for services earned by the D up to the time that the case is closed, dismissed or converted. 3) Effect of conversion from CH 13 to CH 7 [348]: provided the D converted in good faith, the CH 7 estate includes only that property of the original CH 13 estate that is still in the D’s control or possession at the time of the conversion. Trustee’s Turnover Powers [521(4), 542, 543] 1) Property within possession of D: D must surrender all property to the Trustee when the petition is filed [521(4)]. 2) Property within possession of other persons: any property of the D in the hands of other persons must be delivered to the Trustee or its value counted for [542] a) Linked to automatic stay provision. b) Exception for property of inconsequential value or benefit to estate. c) Punishment: if CR fails to turn over property recoverable by the Trustee, Trustee can disallow Cr’s entire claim [502(d)]. Abandonment of Property by Trustee [554]. 1) Examples of when Trustee would want to abandon (b/c property has no value or benefit to estate): a) Fully encumbered. b) Not needed for D’s rehabilitation. c) Fully exempt. d) Cannot be liquidated for benefit of Crs. e) Costs more to maintain that its worth. f) No economic value. 2) Permits court to authorize of order abandonment. 3) Right to abandon property is not absolute – qualified by state public health/environmental laws.

d.

e.

f.

36

g.

550 (a) Hypo 1) Problem: how to get B to be holder of allowed unsecured claim? How to let B participate in distribution of estate? a) Cr A is owned $1K; Cr B is owed $1K; D pays B $1K on 02-01-02; D files a bankruptcy petition on 02-0701. b) A is a creditor on date of filing of petition; B is not a creditor on date of filing of petition (b/c D no longer owes B anything) c) Payment to B is not POE under 541(a)(1); Trustee wants to go get that $1K paid to B – Trustee uses avoidance power (not automatic power). d) Under 550(a), the $1K comes to Trustee for benefit of estate – under 541(a)(3), the $1K now comes into the estate – distribution goes to holders of allowed unsecured claims. e) What is B now that the $1K has been brought back into estate, because on date of filing of petition B had no claim – so what do we do? 2) Solution: 502(h) brings B back in – “a claim arising from the recovery of property under . . . 550 . . . shall be determined, and shall be allowed . . . or disallowed . . . the same as if such claim had arisen before the date of the filing of the petition.” a) According to Cohen, this is cleaner way to handle statutory language than to tinker with general language of 541(a)(1).

37

2.

Exemptions – p258

a.

Text of 522(d) (d) The following property may be exempted under subsection (b)(1) of this section: (1) The D's aggregate interest, not to exceed $ 17,425 in value, in real property or personal property that the D or a dependent of the D uses as a residence, in a cooperative that owns property that the D or a dependent of the D uses as a residence, or in a burial plot for the D or a dependent of the D. (2) The D's interest, not to exceed $ 2,775 in value, in one motor vehicle. (3) The D's interest, not to exceed $ 450 in value in any particular item or $ 9,300 in aggregate value, in household furnishings, household goods, wearing apparel, appliances, books, animals, crops, or musical instruments, that are held primarily for the personal, family, or household use of the D or a dependent of the D. (4) The D's aggregate interest, not to exceed $ 1,150 in value, in jewelry held primarily for the personal, family, or household use of the D or a dependent of the D. (5) The D's aggregate interest in any property, not to exceed in value $ 925 plus up to $ 8,725 of any unused amount of the exemption provided under paragraph (1) of this subsection. (6) The D's aggregate interest, not to exceed $ 1,750 in value, in any implements, professional books, or tools, of the trade of the D or the trade of a dependent of the D. (7) Any unmatured life insurance contract owned by the D, other than a credit life insurance contract. (8) The D's aggregate interest, not to exceed in value $ 9,300 less any amount of property of the estate transferred in the manner specified in section 542(d) of this title, in any accrued dividend or interest under, or loan value of, any unmatured life insurance contract owned by the D under which the insured is the D or an individual of whom the D is a dependent. (9) Professionally prescribed health aids for the D or a dependent of the D. (10) The D's right to receive-(A) a social security benefit, unemployment compensation, or a local public assistance benefit; (B) a veterans' benefit; (C) a disability, illness, or unemployment benefit; (D) alimony, support, or separate maintenance, to the extent reasonably necessary for the support of the D and any dependent of the D; (E) a payment under a stock bonus, pension, profit-sharing, annuity, or similar plan or contract on account of illness, disability, death, age, or length of service, to the extent reasonably necessary for the support of the D and any dependent of the D, unless-(i) such plan or contract was established by or under the auspices of an insider that employed the D at the time the D's rights under such plan or contract arose; (ii) such payment is on account of age or length of service; and (iii) such plan or contract does not qualify under section 401(a), 403(a), 403(b), or 408 of the Internal Revenue Code of 1986. (11) The D's right to receive, or property that is traceable to-(A) an award under a crime victim's reparation law; (B) a payment on account of the wrongful death of an individual of whom the D was a dependent, to the extent reasonably necessary for the support of the D and any dependent of the D; (C) a payment under a life insurance contract that insured the life of an individual of whom the D was a dependent on the date of such individual's death, to the extent reasonably necessary for the support of the D and any dependent of the D; (D) a payment, not to exceed $ 17,425, on account of personal bodily injury, not including pain and suffering or compensation for actual pecuniary loss, of the D or an individual of whom the D is a dependent; or (E) a payment in compensation of loss of future earnings of the D or an individual of whom the D is or was a dependent, to the extent reasonably necessary for the support of the D and any dependent of the D.

b.

Goal of exemptions: insulate certain of D’s property from claims of Crs so that D is not rendered destitute by seizure or liquidation

38

c.

Effect of exempt status: 1) Property released to D as exempt forms part of D’s new estate, helps with fresh start. 2) Exempt property helps D because exemptions are deducted from the liquidation value of the estate 3) What D gets: a) Fully-exempt property: actual property is released to D. b) Partially-exempt property: property is sold and value of exemption is paid to D by the estate from proceeds of the sale. Exemptions are only available to individual Ds under CH 7, CH 11, CH 12 or CH 13 D has choice between non-bankruptcy (usually state) set of exemptions and Bankruptcy Code set of exemptions unless state has opted out [522(b)]. 1) The choice is conditional: a) Residency requirements: where has D been for greatest part of last 6 months – prevent “exemption state residence shopping.” b) Has the state elected “opt-out” legislation: (1) 30 states have elected “opt out” legislation. (2) Effect: states preclude their domiciliaries from electing the federal bankruptcy set of exemptions. c) Spouses who file jointly must choose same set of exemptions Bankruptcy Code Set of Exemptions (see Problem 4-28 (p261)): 1) Homestead exemption [522(d)(1)]: a) Interacts with 522(d)(5). b) D’s cause of action for violations of the Truth in Lending Act and similar statutes is “property” that may be claimed as exempt under 522(d)(1) and 522(d)(5) (see In re Smith, 640 F.2d 888 (7th Cir. 1981)). 2) Automobile exemption [522(d)(2)]. a) Limited to one car. 3) Household goods exemption [522(d)(3)]. a) 2 requirements: (1) An item cannot be fully exempted if interest of D in item exceeds $450. (2) Aggregate of all items exempted cannot exceed $9300. b) Interacts with 522(d)(5). c) Item defined: (1) Silverware: one court has said that D could apply 522(d)(3) to each individual piece of silverware rather than whole set – the aggregate requirement of 522(d)(3) is intended to protect creditors from Ds who are trying to break things down too much. 4) Jewelry exemption [522(d)(4)] 5) General exemption [522(d)(5)] 6) Tools of trade exemption [522(d)(6)]. 7) Non-credit, un-matured life insurance contracts exemption [522(d)(7)]. 8) Another life insurance contract exemption [522(d)(8)] 9) Health aids exemption [522(d)(9)]. 10) Certain benefits exemption [522(d)(10)]. 11) Certain litigation payments exemption [522(d)(11)]

d. e.

f.

39

g.

Process of declaring/claiming exemptions is not automatic [522(l)]. 1) Exemption filing requirements for D: D must file a list of exempt property and indicate whether he is choosing state or Bankruptcy Code set of exemptions. 2) Crs’ and Trustee’s right to object to D’s claimed exemptions: a) Crs and Trustee have 30 days to object. b) Effect of failure to object: if no objection is made, the D’s property is exempted as claimed, regardless of whether the exemption was technically invalid (see Taylor v. Freeland & Kronz, 503 U.S. 638 (1992)). (1) Moral: Crs must closely examine D’s exemption schedules if they want to protect their interests. Exemption Planning (p264) 1) General rule: pre-petition conversion, of non-exempt assets into exemptable assets, alone is NOT enough to violate the Code; there must be an intent to defraud creditors (badges of fraud). a) Rationale: Bankruptcy Code says D can plan for exemptions by converting non-exempt prop into exempt prop. b) Cases: (1) In re Butts, 45 B.R. 34 (Bankr. D.N.D. 1984) (holding pre-petition conversion of non-exempt assets into exemptable assets alone is NOT enough to violate the Code). (2) In re Blum, 41 B.R. 816 (Bankr. S.D.Fla. 1984) (pre-petition conversion of non-exempt assets into exemptable assets alone is NOT enough to violate the Code). (3) In re Reed, 700 F.2d 986 (5th Cir. 1983) (denying discharge when D intended to defraud his creditors). (a) Moral of the story: had Reed not acted so cavalier in his asset shifting and had he told a story that did not establish a primary intent to defraud creditors, he might have been able to have the benefit of his asset shifting. (4) In re Johnson, 80 B.R. 953 (Bankr. D. Minn. 1987) (holding that conscious effort to maximize exemptions is not per se fraudulent – look for certain factors (i.e., badges of fraud)) 2) Badges of Fraud: a) Close temporal proximity of transfer to entry of judgment against D in favor of an unsecured Cr, or presumably, to any other exercise of collection remedies against the D. b) Making of transfer after D obtained a temporary respite from Cr’s collection efforts. c) Conduct intentionally designed to materially mislead or deceive Crs about D’s position. d) Conveyance of non-exempt assets for less than fair value. e) D’s continued retention, benefit or use of non-exempt property after purported conveyance, coupled with inadequate consideration for the conveyance. 3) Punishment: D faces certain risks when he engages in exemption planning. a) Loss of discharge b) Loss of exemptions 4) Exercise 14 (p284) – see notes on our memo.

h.

40

i.

D’s Power to Avoid Certain Interests that Impair Exemptions [522(f)]

1)

Scope of D’s Avoidance Power:

a)

Type of Liens D can Avoid

(1) D’s Avoidance Power Trumps JUDICIAL LIENS: (a) Rule: D can avoid a judicial lien to the extent the judicial lien impairs D’s exemptions

[522(f)(1)(A)]. i. See impairment discussion below (b) Rationale: b/c judicial liens are acquired by the very process of seizure and judgment against which the exemptions are meant to protect the property. INTERESTS: (a) Rule: D may not avoid a valid consensual security interest in the property unless the limited exception applies. (b) Rationale: b/c by granting the security interest in the property, D waived the right to assert the exemption. (c) Limited Exception for Holders of Non-Possessory, Non-purchase Money Security Interest [522(f)(1)(B)]: i. Exception:  D may avoid a non-possessory, non-purchase-money security interest in specified household or consumer goods, tools of the trade, or professionally prescribed health aids to the extent that the security interest impairs an exemption in such property. ii. Requirements for exemption:  Secured party has no perfected the interest by taking possession of the collateral;  The loan or credit must not have been provided to enable the D to acquire the collateral;  The impaired exemption must relate to one of the three types of property specified. iii. Rationale for limited exception:  Aimed a particular type of transaction under which a Cr secures the debt by filing a security interest in household goods or other necessities already owned by the D – in many cases, the property is likely to be worth more to the D than its realization value, so that the threat of foreclosure gives the Cr great power over the D – Congress was concerned about abuses of transactions of this type, which it regarded as manipulative and unethical – it therefore subordinated them to the D’s exemptions. iv. Qualification on the limited exception [522(f)(3)]. v. See Problem 4-30 (below).

(2) D’s Avoidance Power Generally Does Not Trump Holders of CONSENSUAL SECURITY

(3) D’s Avoidance Power Generally Does Not Trump Holders of STATUTORY LIENS.

41

b)

D Can Avoid the Interest ONLY to the Extent of Impairment: (1) Limited avoidance power: 522(f) only permits avoidance to the extent necessary to preserve the exemption. (a) Said another way: if D’s equity in the property exceeds the exemption, the lien or security interest remains a valid charge on the non-exempt portion of the equity. (b) Examples: i. Collateral worth MORE than the value of exemption but less than the value of the exemption + value of debt.  If the D owns piece of equipment worth $2000 and D wants to exempt the equipment under 522(d)(6) for $1,750 and there is a judicial lien on the equipment securing a judgment for $600, the judicial lien impairs the D’s exemption to the extent of $350 – thus, D can only avoid the judicial lien to the extent of $350. The Cr will then have a secured claim for $250 (which can be paid out of collateral) and an unsecured claim for $350 (as a result of the D’s avoidance power). ii. Collateral worth LESS than value of exemption + value of debt.  If the D owns piece of equipment worth $2350 or less and D wants to exempt the equipment under 522(d)(6) for $1,750 and there is a judicial lien on the equipment securing a judgment for $600, the judicial lien impairs the D’s exemption to the extent of $600 – thus, D can avoid the entire judicial lien. iii. Collateral worth MORE than value of exemption + value of debt.  If the D owns piece of equipment worth $3000 and D wants to exempt the equipment under 522(d)(6) for $1,750 and there is a judicial lien on the equipment securing a judgment for $600, the judicial lien does not impair the D’s exemption at all – thus, the D cannot avoid the judicial lien. (2) How impairment is measured [522(f)(2)(A)]: (a) Formula: i. Determine what the value of the D’s interest (i.e., equity) in the property would be in the absence of liens ii. Add together: the lien to be avoided + other liens on the property + amount of D’s exemption iii. Compare the above two outcomes – the exemption is impaired to the extent that “ii” is greater than “i.” A State Cannot Override the Avoidance Power in Its “Opt-Out” Statute. (1) Effect: D may avoid a lien under 522(f) even though state law gives the lien precedence over the exemptions (see Owen v. Owen, 111 S. Ct. 1833 (1991)).

c)

2) 3)

Effect of D’s Avoidance Power: enhances D opportunity for fresh start. Problem 4-29 (p297): a) Facts: D’s home is subject to mortgage held by Bank; FC has judicial lien upon D’s home on February 5; D files a CH7 petition on October 20 at which time home has fmv of $80,000, Bank is owed $60,000 and FC is owed $20,000. b) Results: (1) Mortgage: D cannot avoid the mortgage because it is not a judicial lien – it is a consensual lien and it does not fit into the limited exception. (2) Judicial Lien: D can avoid judicial lien to the extent of $18,350 – thus, from sale of home, FC would only get $1,650 but FC would also have an unsecured claim for $18,350.

42

4)

Problem 4-29 Alternate (class # 11 slides): a) Facts: D’s home is subject to mortgage held by Bank; FC has judicial lien upon D’s home on February 5; D files a CH7 petition on October 20 at which time home has fmv of $80,000, Bank is owed $70,000 and FC is owed $20,000. b) Result: (1) Mortgage: D cannot avoid the mortgage because it is not a judicial lien – it is a consensual lien and it does not fit into the limited exception (2) Judicial Lien: D can avoid entire judicial lien. (a) Effect of D’s avoidance: FC will have an unsecured claim for full amount of judgment ($20,000). (b) Note that Trustee could not have avoided this judicial lien but that D can. Problem 4-30 (p298): a) Facts: (1) Tom is a mechanic. (2) Jan 2: Tom purchases a television from Appliance Store for $3,000 (he pays $1,600 down and finances the balance under an agreement that gives Appliance Store a security interest in the television). (3) Mar 1: FC lends Tom $8,000 and secures the loan by obtaining a security interest in all of Tom’s tools and household goods and perfecting that security interest. (4) Nov 10: Tom files CH 7 bankruptcy petition and elects 522(d) exemptions; all of Tom’s household goods have an aggregate value of $8,000 and none of the items is worth more than $425 with the exception of the television purchased from Appliance Store which is now worth $2,000 (note that television is only worth $2,000 even though purchased for $3,000 because a used television is worth less than a new one - this becomes important when valuing property for purposes of exemption amounts); the tools Tom owes are worth $6,000; Appliance Store is owed $1,400 and FC is owed $8,000. b) Results: (1) Appliance Store (PMSI): D cannot avoid Appliance Store’s interest because it is a PMSI. (2) FC’s security interest in tools and household goods: D can avoid because it falls under the exception to the general rule that holders of consensual security interests cannot be avoided [522(f)(1)(B)]: (a) Tools: i. Tom can avoid FC’s entire security interest in his tools using 522(d)(6) ($1,750) and 522(d)(1) and (5) ($4,250). (b) Household goods i. Tom can avoid all of FC’s security interest in his household goods using 522(d)(3) except for the television. ii. Tom can avoid the first $450 of Tom’s $600 equity in the television using 522(d)(3) and then use 522(d)(5) to pay the remaining $150. ??? Problem 4-31 – p304 a) Facts: (1) H and W own a home having a value of $150K. (2) Home is encumbered by $161,000 ($6,000 judicial lien + $10,000 judicial lien + $145,000 mortgage lien. (3) H and W file joint case under Code and elect 522(d) exemptions. (4) Trustee would not be able to avoid the judgment liens or the mortgage lien under his avoidance powers. b) Result: (1) Mortgage lien: D cannot avoid the mortgage lien (2) $6,000 judicial lien: can exempt full $6,000 (3) ??? $10,000 judicial lien: the $10,000 underwater judgment lien will not attach to any post-case appreciation in the value of the home.

5)

6)

43

j.

??? Right of Debtor to Exempt His Interest in Property Owned by the Entireties (p287). 1) Creditor with claim against single spouse a) 522(b)(2)(B) protects entireties interest when that is the case. b) If the D spouse’s creditors do not also have claims against the other spouse then the entireties prop is exempt 2) Joint creditors: a creditor or a number of creditors that have a claim against both spouses a) Execute against the entireties prop b) PA has not updated its exemption laws. c) Bankruptcy court would allow these creditors to get a judgment and then go after that prop d) Who gets the benefit of the amount owed? The estate or the joint creditors? 3) Effect of death of non-D spouse 4) Effect of divorce 5) WHERE ARE WE NOW? a) Analysis (1) Single person or H and W? (2) Are they in a juris that recognizes tenants by entireties? (3) What state law applies for 522 purposes? (4) What are exemptions available under laws of that state? (5) Has that state enacted opt-out legislation? (6) If state has enacted opt-out legislation, (7) If state has NOT enacted opt-out legislation, then D can elect bankruptcy set of exemptions OR state set of exemptions – to make this choice, look at prop? (8) Apply bankruptcy set of exemptions to prop that D now owns, ask what will D be exempt and what will D not be able to exempt (and thus will go to unsecured creditors)? (9) Can D exempt more prop if he engages in converting prop?

3.

Turnover of Property of Estate (p312)

a. b.

Rule for Property in the Possession of the D: D must surrender all property to the Trustee when the petition is filed [521(4)]. Rule for Property in the Possession of Other Persons: any property of the D in the hands of other persons must be delivered to the Trustee or its value counted for [542] 1) Whiting Pools Rule: a) In CH 11, 12 and 13 cases: even if D has no equity in the property seized by a Cr prior to the filing of the bankruptcy petition, the third party must turnover that property to the Trustee in a CH 11 or CH 13 case (see U.S. v. Whiting Pools, Inc., 462 U.S. 198 (1983)). (1) Said another way: POE, in CH 11, 12 and 13 cases, includes property that has been seized by a Cr prior to the filing of a petition. b) In CH 7 cases: it is unclear whether the Whiting Pools rule applies – there is a good argument that it should not apply when the D has no equity in the property and it is a secured Cr who will eventually get the property any way. 2) Exceptions: a) When property is of inconsequential value or benefit to estate, the D and/or third parties do not have to turn it over – monetary value is not sole consideration. Rule for Property in the Possession of a Custodian [543]. Linked to automatic stay provision. Punishment: if CR fails to turn over property recoverable by the Trustee, Trustee can disallow Cr’s entire claim [502(d)]. Examples of when D or third-party will have to turnover property. 1) ??? See Problems 4-32, 4-33, 4-34, 4-35 and 4-36 (p319-321).

c. d. e. f.

44

4.

Use, Sale or Lease of Property of the Estate [363]

a.

General rule: unless the D conducted business at the time the petition was filed and the continuation of the business is permitted under the chapter governing the petition, notice and hearing is required for any use, sale or lease of estate property, whether or not in the ordinary course of business. Goal of 363: enable Trustee to conduct affairs of the estate to the best advantage, whether that involves liquidation or the conduct of the D’s business affairs. Approval of Transaction WITHIN the Ordinary Course of Business. 1) Rule: a) Trustee may enter into ordinary course of business transactions without notice and hearing if: (1) The D had been engaged in business at the time the petition was filed; AND (2) The post-petition conduct of the business operations is generally allowed in the chapter under which the petition was filed (i.e., 721, 1108, 1304). 2) Application in CH 7 Cases a) Trustee usually has to get court approval to conduct any business in CH 7 cases: there can be no ordinary course of business activity under CH 7 without notice and hearing under 363(c)(1) unless the conduct of the business has first been authorized by the court under 721. 3) Application in CH 11 and CH 13 cases [1108, 1304] a) If D had business at time of petition, authority to continue its operation is the norm – Trustee can continue D’s business activities unless the court orders otherwise (except for cash collateral). Approval of Transactions OUTSIDE the Ordinary Course of Business [363(b)(1)]. 1) Rule: transactions outside the ordinary course of business require notice to interested parties, and, where requested, a hearing and court approval. a) Standard for Court Approval: does transaction serve the best interests of the estate and further legitimate ends of the bankruptcy. Protecting Interested Parties’ Interests in Property that Is to Be Used, Leased or Sold. 1) Limit on Trustee’s use of cash collateral is also designed to protect interested parties’ interests. 2) Trustee’s use, lease or sale of property must still ensure adequate protection for secured creditors [363(e)]. a) Secured Crs have right to seek adequate protection and challenge uses, leases or sales that deprive them of such adequate protection. 363(l) disregards contractual or statutory provisions that provide for the forfeiture or modification of the D’s property rights upon insolvency or bankruptcy. Restrictions on Trustee’s Dealings with Cash Collateral. 1) Rule: Trustee cannot deal with cash collateral, even in the ordinary course of business, unless the holder of the interest in that collateral consents or the court authorizes the transaction after notice and a hearing. 2) Cash collateral defined: cash or cash equivalent that is subject to an interest held by someone other than the estate. a) Examples: bank notes, bank accounts, commercial paper (e.g., negotiable instruments, documents, and securities that embody rights to money or property and can be transferred very easily and effectively to a purchaser). Problems 4-34 and 4-30 (p322-25).

b. c.

d.

e.

f. g.

h.

45

J.

TRUSTEE’S AVOIDANCE POWERS

1.

Generally

a.

Goal of Avoidance Provisions 1) Three main goals: a) Facilitate the Code’s goal of preservation of the estate and collective treatment of claims. b) Differentiate between legitimate and illegitimate transactions. c) Used to invalidate unpublicized rights. 2) Which ties into the key goal of the Bankruptcy Code (i.e., to foster an equitable distribution of the D’s assets among its Crs). a) Code establishes distributional priorities b) 549 prohibits certain post- petition transfers: thus, ensures that prop coming into estate remains available for distribution to creditors c) 544, 545, 547(b), 548 prohibit certain pre-petition transfers. Transfer Defined: BROAD - includes every mode of disposing of property or an interest in it [101(54)]. Summary of the Bankruptcy Code’s Avoidance Provisions. 1) The big avoidance powers: a) 544 allows Trustee to avoid transfers and obligations that could have been avoided under non-bankruptcy law by an actual unsecured Cr or by specified hypothetical claimants. b) 545 gives Trustee limited power to avoid certain kinds of statutory liens. c) 547 allows Trustee to avoid preferential transfers that occurred within 90 days (or 1 year for insiders) before filing petition. d) 548 gives Trustee the power, similar to that available to Crs under state fraudulent transfer law, to avoid fraudulent transfers and obligations that occurred within a year before the petition. e) 549 allows the Trustee to avoid certain post-petition transfers. f) 553 allows the Trustee to avoid setoffs to the extent they involved disallowed claims or arose out of certain transactions within 90 days before the petition. 2) Some quasi-avoidance powers: a) 522(f) gives D right to avoid certain liens that impair exemptions. b) 546 imposes limitations on Trustee’s avoidance powers. c) 549 permits Trustee to avoid unauthorized post-petition transfers. d) 550 and 551 govern the effect of avoidance. e) 552 has effect of partially avoiding floating liens to the extent that they would otherwise cover collateral acquired post-petition. f) 558 allows trustee to succeed to any defense that D may have against any entity. Applicability of Avoidance Provisions in Liquidation and Rehabilitation Cases. 1) Liquidation cases (CH 7): a) Trustee’s exercise of the avoidance powers directly benefits the Cr body. 2) Rehabilitation cases (CH 11 and CH 13): a) Trustee’s role is played by the D or DIP and thus, the exercise of the avoidance powers results in much of the property reverting back to the D but the exercise of the avoidance powers still benefits Crs to the extent that it increases the minimum amount that Crs in rehabilitation cases must receive under the bests interests test. Who can exercise the Avoidance Powers? Generally only a Trustee or DIP. Statute of Limitations and Reach Back Provisions [546(a) and 550(f)] Limits on the Trustee’s Avoidance Powers [546]. Preservation of Avoided Liens [551]. 1) Any avoided transfer is preserved for the benefit of the estate with respect to POE.

b. c.

d.

e. f. g. h.

46

2)

When Trustee avoids an interest in POE, the estate automatically succeeds to the avoided rights in the property – thus, allows the Trustee to assert those rights against any other interests in the property that is junior to the avoided interest.

47

2.

549 Prohibits Certain Post-Petition Transfers

a.

Text of § 549. Post-petition transaction (a) Except as provided in subsection (b) or (c) of this section, the trustee may avoid a transfer of property of the estate-(1) that occurs after the commencement of the case; and (2) (A) that is authorized only under section 303(f) or 542(c) o that is authorized only under section 303(f) or 542(c) of this title; or (B) that is not authorized under this title [11 USCS §§ 101 et seq] or by the court. (b) In an involuntary case, the trustee may not avoid under subsection (a) of this section a transfer made after the commencement of such case but before the order for relief to the extent any value, including services, but not including satisfaction or securing of a debt that arose before the commencement of the case, is given after the commencement of the case in exchange for such transfer, notwithstanding any notice or knowledge of the case that the transferee has. (c) The trustee may not avoid under subsection (a) of this section a transfer of real property to a good faith purchaser without knowledge of the commencement of the case and for present fair equivalent value unless a copy or notice of the petition was filed, where a transfer of such real property may be recorded to perfect such transfer, before such transfer is so perfected that a bona fide purchaser of such property, against whom applicable law permits such transfer to be perfected, could not acquire an interest that is superior to the interest of such good faith purchaser. A good faith purchaser without knowledge of the commencement of the case and for less than present fair equivalent value has a lien on the property transferred to the extent of any present value given, unless a copy or notice of the petition was so filed before such transfer was so perfected. (d) An action or proceeding under this section may not be commenced after the earlier of-(1) two years after the date of the transfer sought to be avoided; or (2) the time the case is closed or dismissed.

b.

Generally, the Trustee may generally avoid transfers of POE that are made after commencement of the case unless one of the exceptions applies. 1) Requirements under 549(a): a) Trustee may avoid a transfer of property of the estate (1) that occurs after the commencement of the case; AND (2) That is either (A) authorized only under section 303(f) or 542(c) of this title; OR (B) not authorized under this title or by the court. (1) 303(f): D can continue to operate during gap period. (2) 542(c): not holding banks liable for cashing D’s check when they did not know D filed for bankruptcy. Exceptions 1) 549(b): when D is contesting an involuntary CH7 petition, the Trustee cannot avoid a transfer by the D that occurred during the gap period unless the transfer was for the satisfaction or securing of a debt that arose before the petition was filed. 2) 549(c): Trustee cannot avoid a transfer of real property to a BFP without knowledge of the bankruptcy case and for fair equivalent value unless there was a notice of the bankruptcy petition in the records that the BFP would have to check before perfecting his interest. Problem 4-42 (p327) 1) Facts a) March 10: D (DEC) files voluntary CH7 case b) March 11: one of D’s vice presidents sells computer system to UNCLE for $10K – both the vice president and UNCLE were unaware of bankruptcy filing – this constitutes an “unauthorized transfer,” which can be distinguished from CH11 and CH13 case. c) Trustee seeks to overturn the sale 2) Issues & Results & Reason: a) Is the sale of the equipment avoidable? Yes – 549(a) (1) D, and not Trustee, sold the prop and such prop was POE which the D is obligated to turn over to the Trustee. b) Can the CH7 Trustee obtain the return of the computer system? Yes – 550(a)(1) c) What happens to $10K that UNCLE paid? See 502(h) (1) Text of 502(h)

c.

d.

48

(2) UNCLE will be holder of allowed unsecured claim for $10K but there is still a problem – in most

CH7 cases, there never is any distributable POE – 502(h) gets Cr back into allowed unsecured claim pool after D has paid Cr and Trustee avoids the payment.. (3) Real result: (a) Trustee keeps the $10K as POE. (b) Trustee keeps the computer system as POE. (c) UNCLE loses computer system and will not be able to satisfy claim for $10K. (4) MORAL: someone that deals with some entity in contractual relationship – you better know who you are dealing with.

e.

Problem 4-43 (p328) 1) Generally a) Key issue: when is the “entry of order for relief” (1) Voluntary case – 301: no gap between filing of petition and entry of order for relief (2) Involuntary case – 303: gap between filing of petition and entry of order for relief 2) Facts – gap case a) Involuntary CH7 filed against D (EBG). b) EBG contests the validity of the petition. c) While contesting the petition, EBG sells portion of its inventory to Drapes for $10K – transfer #1 (merchandise). d) While still contesting the petition, EBG uses the $10K that it received from Drapes to pay rent to landlord Kravitz – transfer #2 (cash). e) EBG stops contesting – thus, order for relief is entered. 3) Issues & Results & Reasons: a) May Trustee avoid, and thus, recover the merchandise sold to Luxury Drapes (transfer #1)? No (1) Reason: when there is involuntary CH7, Trustee cannot recover merchandise sold during the gap period [549(b)]. b) May Trustee recover rent (cash) paid to Ms. Kravitz (transfer #2)? Yes and No (1) Reason (a) When there is involuntary CH7 filing, Trustee may avoid and thus recover the pre-petition rent paid to a landlord – 549(b). (b) When there is involuntary CH7 filing, Trustee may not avoid the post-petition rent paid to a landlord – 549(b). 4) Policy Rationale a) What policy underlies the result? (1) Problem = transferees are at risk during gap period. (2) Solution = Code will protect somebody who, knowingly or unknowingly, deals with D during involuntary case gap period (prior to entry of order for relief) (a) Code protects them in following ways i. Transaction will not be reversed if it occurred during gap period unless it was for the satisfaction or securing of a debt that arose before the petition was filed. ii. Cr gets priority position in distribution of POE in bankruptcy case – before general creditors. iii. It gets a break on the discharge. Problem 4-44 (p329) 1) Facts a) D mails checks b) D files voluntary CH7 petition c) Bank, unaware of bankruptcy filing of D, honors D’s checks that are presented to bank for collection. 2) Issues & Results & Reasons a) May Trustee recover funds from Bank? No (1) Reason: Bank is not required to turn over funds that it innocently pays out - bank is protected by 542(c). b) May Trustee recover funds from payees of checks? Yes (1) Reason: (a) 549(a)(2)(A): “Trustee may avoid transfer of POE that occurs after commencement of case; and that is authorized only under . . . 542(c) . . .. ” i. 549(a)(2)(A) puts payee back into same position it would have been in had it not received the money – payee will still have a claim.

f.

49

(b) Banks have strong lobbies: lobbied government to change Code to protect them.

50

3.

544 (The Strong Arm Power) Prohibits Certain Pre-Petition Transfers

a.

Text of § 544. Trustee as lien creditor and as successor to certain creditors and purchasers (a) The trustee shall have, as of the commencement of the case, and without regard to any knowledge of the trustee or of any creditor, the rights and powers of, or may avoid any transfer of property of the debtor or any obligation incurred by the debtor that is voidable by-(1) a creditor that extends credit to the debtor at the time of the commencement of the case, and that obtains, at such time and with respect to such credit, a judicial lien on all property on which a creditor on a simple contract could have obtained such a judicial lien, whether or not such a creditor exists; (2) a creditor that extends credit to the debtor at the time of the commencement of the case, and obtains, at such time and with respect to such credit, an execution against the debtor that is returned unsatisfied at such time, whether or not such a creditor exists; or (3) a bona fide purchaser of real property, other than fixtures, from the debtor, against whom applicable law permits such transfer to be perfected, that obtains the status of a bona fide purchaser and has perfected such transfer at the time of the commencement of the case, whether or not such a purchaser exists. (b) (1) Except as provided in paragraph (2), the trustee may avoid any transfer of an interest of the debtor in property or any obligation incurred by the debtor that is voidable under applicable law by a creditor holding an unsecured claim that is allowable under section 502 of this title or that is not allowable only under section 502(e) of this title. (2) Paragraph (1) shall not apply to a transfer of a charitable contribution (as that term is defined in section 548(d)(3)) that is not covered under section 548(a)(1)(B), by reason of section 548(a)(2). Any claim by any person to recover a transferred contribution described in the preceding sentence under Federal or State law in a Federal or State court shall be preempted by the commencement of the case.

b.

544(a)

1)

Accords Trustee the status of either a hypothetical judicial lienholder with a lien on D’s real or personal property; a hypothetical unsatisfied execution Cr with a lien on D’s real or personal prop; and/or a hypothetical BFP of D’s real prop (but not fixtures) and permits Trustee to avoid any interests in prop that could have been avoided by such lien creditors or BFPs. Rationale: secret liens and transfers should be void b/c they unfairly prejudice the D’s other creditors. Trustee as Hypothetical Judicial Lienholder [544(a)(1)]. a) General rule: 544(a)(1) gives Trustee power to avoid any transfer of property or any obligation incurred by the D that would be avoidable in non-bankruptcy law by a Cr who both extends credit and obtains a lien on the date of the commencement of the bankruptcy case. b) Problem 4-46 (p332) (1) January: Bank obtains security interest in D’s equipment but neglects to file financing statement to perfect its security interest. (2) February: an involuntary CH7 petition is filed against D and order for relief is entered. (3) Is Bank’s security interest avoidable? YES (a) Reason: Trustee’s 544(a) status as hypo judicial lienholder enables her to trump Bank’s unperfected security interest. c) Problem 4-47 (p332) (1) January 1994: Bank agrees to finance D’s working capital requirements and secures its advances by obtaining a security interest in D’s present and future inventory and accounts receivable - Bank files appropriate financing statements but neglects to file continuation statements. (2) February 2000 (more than 6 years): D files voluntary CH11. (3) Is Bank’s security interest avoidable? YES (a) Reason: b/c Bank’s security interest lapsed after 5-year period of effectiveness – thus, it is unperfected on date of filing of bankruptcy petition/entry of order for relief. (b) Moral: make sure your security interest is perfected on date of filing of petition/entry of order for relief.

2) 3)

51

4)

Trustee as Hypothetical Unsatisfied Execution Cr [544(a)(2)]. a) General Rule: 544(a)(3) gives Trustee the status of a BFP at the time of the commencement of the case. b) Problem 4-49 (p334) (1) Facts (a) January: Bank obtains mortgage on D’s real estate but neglected to record its mortgage. (b) February: an involuntary CH7 petition is filed against D and order for relief is entered. (2) Is Bank’s mortgage avoidable? YES (a) 544(a)(3) enables Trustee to apply the rights of hypothetical BFP - non-bankruptcy law enables BFP to take property free of a mortgagee’s lien interest when the mortgage is unrecorded and when the BFP is unaware of the mortgage - thus, Trustee, as hypothetical BFP, is able to avoid the mortgage lien. 544(a) as Applied to FEDERAL TAX LIENS a) General Rule: Trustee can avoid a federal tax lien that is unrecorded as of the commencement of the bankruptcy case (1) ??? Compare to 362(b)(3): 362 seemingly prohibits the post-petition perfection of a lien but 362(b)(3) seems to allow it, b) Result: IRS’ claim is not eliminated, it is just avoided – thus, IRS goes from being secured Cr to being an unsecured Cr. c) ??? Defenses: Secured Cr has defense under 546(b) which places express limitations on the Trustee’s 544(a) power.

5)

c.

544(b). 1) General Rule: Trustee may avoid any transfer made or obligation incurred by the D that is avoidable in prevailing non-bankruptcy law by an actual creditor holding an allowable unsecured claim. a) Although an actual unsecured Cr must be in existence, the Cr need not have proved a claim in the estate – the claim merely must be allowable if proved. 2) Requirements for timely filing a 544(b) motion: a) Action must be maintainable under the state statute of limitations as of the commencement of the bankruptcy proceeding. b) Action must be brought within the earlier of two years after the Trustee is appointed or before the close of the bankruptcy proceeding. 3) When does this power arise: not on date of petition – rather, the effectiveness of the right against the transferee is determined as of its actual effective date (i.e., the date that the real life Cr became entitled to exercise it). 4) 544(b) In Application: a) Limited use: 544(b) is of little use to the Trustee because it only gives Trustee status of unsecured Cr and unsecured Crs have little power to avoid transactions entered into by the D. b) Fraudulent transfer context: 544(b) is often used if the state’s fraudulent transfer law provides broader powers of avoidance that 548 or if it allows the Trustee to reach back earlier into the pre-bankruptcy period that 548 does. 5) 544(b)(2) limits Trustee’s ability to avoid charitable transfers. Effect of 546 1) Preserves non-bankruptcy back-dating rules [546(b)]. 2) Preserves seller’s reclamation rights [546(c)].

d.

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4.

547 (The No Preferential Transfers Power) Prohibits Certain Pre-Petition Transfers

a.

Text of § 547. Preferences (a) In this section-(1) "inventory" means personal property leased or furnished, held for sale or lease, or to be furnished under a contract for service, raw materials, work in process, or materials used or consumed in a business, including farm products such as crops or livestock, held for sale or lease; (2) "new value" means money or money's worth in goods, services, or new credit, or release by a transferee of property previously transferred to such transferee in a transaction that is neither void nor voidable by the debtor or the trustee under any applicable law, including proceeds of such property, but does not include an obligation substituted for an existing obligation; (3) "receivable" means right to payment, whether or not such right has been earned by performance; and (4) a debt for a tax is incurred on the day when such tax is last payable without penalty, including any extension. (b) Except as provided in subsection (c) of this section, the trustee may avoid any transfer of an interest of the debtor in property-(1) to or for the benefit of a creditor; (2) for or on account of an antecedent debt owed by the debtor before such transfer was made; (3) made while the debtor was insolvent; (4) made-(A) on or within 90 days before the date of the filing of the petition; or (B) 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 (5) that enables such creditor to receive more than such creditor would receive if-(A) the case were a case under chapter 7 of this title [11 USCS §§ 701 et seq.]; (B) the transfer had not been made; and (C) such creditor received payment of such debt to the extent provided by the provisions of this title [11 USCS §§ 101 et seq.]. (c) The trustee may not avoid under this section a transfer-(1) to the extent that such transfer was-(A) intended by the debtor and the creditor to or for whose benefit such transfer was made to be a contemporaneous exchange for new value given to the debtor; and (B) in fact a substantially contemporaneous exchange; (2) to the extent that such transfer was-(A) in payment of a debt incurred by the debtor in the ordinary course of business or financial affairs of the debtor and the transferee; (B) made in the ordinary course of business or financial affairs of the debtor and the transferee; and (C) made according to ordinary business terms; (3) that creates a security interest in property acquired by the debtor-(A) to the extent such security interest secures new value that was-(i) given at or after the signing of a security agreement that contains a description of such property as collateral; (ii) given by or on behalf of the secured party under such agreement; (iii) given to enable the debtor to acquire such property; and (iv) in fact used by the debtor to acquire such property; and (B) that is perfected on or before 20 days after the debtor receives possession of such property; (4) to or for the benefit of a creditor, to the extent that, after such transfer, such creditor gave new value to or for the benefit of the debtor-(A) not secured by an otherwise unavoidable security interest; and (B) on account of which new value the debtor did not make an otherwise unavoidable transfer to or for the benefit of such creditor; (5) that creates a perfected security interest in inventory or a receivable or the proceeds of either, except to the extent that the aggregate of all such transfers to the transferee caused a reduction, as of the date of the filing of the petition and to the prejudice of other creditors holding unsecured claims, 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-(A) (i) with respect to a transfer to which subsection (b)(4)(A) of this section applies, 90 days before the date of the filing of the petition; or (ii) with respect to a transfer to which subsection (b)(4)(B) of this section applies, one year before the date of the filing of the petition; or (B) the date on which new value was first given under the security agreement creating such security interest; (6) that is the fixing of a statutory lien that is not avoidable under section 545 of this title;

53

(7) to the extent such transfer was a bona fide payment of a debt to a spouse, former spouse, or child of the debtor, for alimony to, maintenance for, or support of such spouse or child, in connection with a separation agreement, divorce decree or other order of a court of record, determination made in accordance with State or territorial law by a governmental unit, or property settlement agreement, but not to the extent that such debt-(A) is assigned to another entity, voluntarily, by operation of law, or otherwise; or (B) includes a liability designated as alimony, maintenance, or support, unless such liability is actually in the nature of alimony, maintenance or support; or (8) if, in a case filed by an individual debtor whose debts are primarily consumer debts, the aggregate value of all property that constitutes or is affected by such transfer is less than $ 600. (d) The trustee may avoid a transfer of an interest in property of the debtor transferred to or for the benefit of a surety to secure reimbursement of such a surety that furnished a bond or other obligation to dissolve a judicial lien that would have been avoidable by the trustee under subsection (b) of this section. The liability of such surety under such bond or obligation shall be discharged to the extent of the value of such property recovered by the trustee or the amount paid to the trustee. (e) (1) For the purposes of this section-(A) a transfer of real property other than fixtures, but including the interest of a seller or purchaser under a contract for the sale of real property, is perfected when a bona fide purchaser of such property from the debtor against whom applicable law permits such transfer to be perfected cannot acquire an interest that is superior to the interest of the transferee; and (B) a transfer of a fixture or property other than real property is perfected when a creditor on a simple contract cannot acquire a judicial lien that is superior to the interest of the transferee. (2) For the purposes of this section, except as provided in paragraph (3) of this subsection, a transfer is made-(A) at the time such transfer takes effect between the transferor and the transferee, if such transfer is perfected at, or within 10 days after, such time, except as provided in subsection (c)(3)(B); (B) at the time such transfer is perfected, if such transfer is perfected after such 10 days; or (C) immediately before the date of the filing of the petition, if such transfer is not perfected at the later of-(i) the commencement of the case; or (ii) 10 days after such transfer takes effect between the transferor and the transferee. (3) For the purposes of this section, a transfer is not made until the debtor has acquired rights in the property transferred. (f) For the purposes of this section, the debtor is presumed to have been insolvent on and during the 90 days immediately preceding the date of the filing of the petition. (g) For the purposes of this section, the trustee has the burden of proving the avoidability of a transfer under subsection (b) of this section, and the creditor or party in interest against whom recovery or avoidance is sought has the burden of proving the nonavoidability of a transfer under subsection (c) of this section.

b.

The Rule Against Preferential Transfers Generally 1) Compare to 544: 547 goes beyond the rights recognized in non-bankruptcy law and allows the avoidance of transfers that are fully effective outside of bankruptcy. 2) Rationale: a) Preferences are contrary to the goals and policies of the Bankruptcy Code. b) Discourage Crs from racing to courthouse to dismember the D during his slide into bankruptcy. c) Facilitate primary bankruptcy policy of equal distribution among Crs. 3) Summary of Preferential Transfer Provisions: a) 547(a) is definitional b) 547(b) lists the requirements for when the Trustee can avoid a transfer. (1) any transfer of prop of D to or for the benefit of a Cr (2) on account of an antecedent debt (3) made while D was insolvent (4) within 90 days before commencement of the case or within 1 year before commencement of case if Cr was “insider” (5) if effect of transfer is to permit transferee to receive more than it would have received in a CH7 proceeding if the transfer had not been made c) 547(c) lists the exceptions (i.e., when the Trustee cannot avoid a transfer even if all of the 547(b) requirements are met) d) 547(d) concerns certain transfers to sureties to secure reimbursement for a bond to dissolve an avoidable judicial lien. e) 547(e) sets out a formula for determining when a transfer takes place.

54

f) g) c.

547(f) presumes the D is insolvent in the 90 days preceding the petition. 547(g) says the transferee has the burden of proving non-avoidability if it invokes 547(c).

547(b) Requirements in Detail – Under 547(b), a Trustee may avoid 1) There must have been a transfer of an interest in property of the D to or for the benefit of a Cr [547(b)(1)]. 2) Transfer must have been for or on account of an antecedent debt [547)b)(2)]. a) If the debt arose before the transfer was made, the debt is antecedent. b) Question of when the debt arose must be determined under non-bankruptcy law. 3) The D must have been insolvent at the time of the transfer [547(b)(3)]. a) D is presumed insolvent in the 90 days preceding the filing of the petition [547(f)]. 4) The transfer must have occurred within 90 days (or one year if the Cr was an insider) before the commencement of the case. 5) The transfer must have improved the Cr’s position. a) Effect Formula = {(D’s Assets/D’s Liabilities) X amount owed to creditor [if transfer had been made]} – {(D’s Assets/D’s Liabilities) X amount owed to creditor [if transfer had NOT been made]} Cr has burden of proof under 547(c). Problems

d. e.

1)

Problem 4-51 – p337 a) Facts (1) January 2001: Bank lent D $50K (cash) on unsecured basis (2) January 1, 2002: D paid bank $10K on account of its debt (D did not make any other payments until this time). (a) Assets = $70K (b) Liabilities = $56K (to bank prior to payment) and $174K (to other Crs) (3) January 2, 2002: D filed voluntary CH7 petition. (4) Characterize this as a pre-petition cash transfer b) Issue & Result (1) May Trustee avoid the $10K payment to bank? YES c) Reason (1) 549(a) does not apply b/c this was not a post-petition transfer. (2) 544(a) does not apply b/c a hypothetical lien Cr could not have attained a lien on date of filing of petition. (3) Trustee may recover the $10K under 547(b) b/c: (a) transfer of D’s prop; (b) for benefit of Cr; (c) on account of antecedent debt; (d) made while D insolvent; (e) within 90 days; AND (f) effect of transfer will enable bank to receive more than it would have received if the $10K had not been paid. d) Analysis under 547(b)(5): compare what Cr would receive if transfer was upheld WITH what Cr would receive if transfer was not upheld (no payment had been made) (1) If transfer had not occurred, bank would receive $16,800: (a) $70K of assets (which includes $10K not paid to bank) (b) Crs owed $230K ($174K + $56K) (c) Each Cr would get 30% of what it was owed (d) 30% X 56K (amount Bank is owed) = $16,800 (e) Bank would receive $16,800 (2) If transfer is upheld, bank would receive $22,420: (a) $60K of assets (b/c $10K was paid out of assets to Bank) (b) Crs owed $220K ($174K + $46K) (c) Each Cr would get 27% (d) 27% X $46K (amount Bank is owed after $10K payment) = $12,420 (e) Bank would receive $22,420 (which is $12,420 + $10,000 paid by D) e) Rationale: when Cr gets $10K, he is getting 100% of that amount and that is not fair to other Crs. f) Any time D is insolvent 547(b)(5) will be satisfied.

55

2)

Problem 4-52 – p337 a) Facts (1) One year ago: Bank lent D $50K secured by a perfected security interest in all machinery that D owned - security interest (2) Two days ago: D paid bank $10K on account of its debt (D did not make any other payments until this time). (a) Assets = $70K [$30K (machinery) + $10K (truck) + $30K (other assets)] (b) Liabilities = $230K [$56K (to bank prior to payment) and $174K (to other Crs)] (3) One day ago: D filed voluntary CH7 petition. (4) Characterize this as a pre-petition cash transfer b) Issue & Result & Reason (1) May Trustee avoid the $10K payment to bank? YES (2) Reason (a) B/c fact that bank is under-secured ensures that 547(b)(5) requirement is met. i. If there was no payment, Bank would get $35,200 A. Bank would get machinery and have allowed unsecured claim of $26K B. $40K of assets (which includes $10K not paid to bank) C. Crs owed $200K ($174K + $26K) D. Each Cr would get 20% of what it was owed E. 20% X 26K (amount Bank is owed) = $5,200 F. Bank would receive $35,200 ($30K [from machinery] + $5,200) ii. If payment is upheld, Bank will get $42,526: A. Bank would have claim of $46K claim secured by $30K of machinery – thus, have an allowed unsecured claim of $16K. B. $30K of assets (b/c $10K of “other assets” was paid to bank) C. Crs owed $190K ($174K + $16K) D. Each Cr would get 15.7% of what it was owed E. 15.7% X 16K (amount Bank is owed) = $2,526 F. Bank would receive $42,526 ($30K [from machinery] + $10K [payment] + $2,526) (3) Conversely, 547(b)(5) will not be satisfied in case of over-secured creditor. Problem 4-53 – p338

3)

a)

Facts (1) One year ago: Bank lent D $50K secured by a perfected security interest in all machinery that D owned - security interest (2) Two days ago: D arranged for Bank to obtain a perfected security interest in a tractor that D owned. (a) Assets = $70K [$30K (machinery) + $10K (tractor) + $30K (other assets)] (b) Liabilities = $230K [$56K (to bank prior to payment) and $174K (to other Crs)] (3) One day ago: D filed voluntary CH7 petition (date of commencement of case). (a) Assume D owns same things on date of commencement of case as he did two days ago. (b) Assets = $70K [$30K (machinery) + $10K (tractor – Bank has security interest in this) + $30K (other assets)] (c) Liabilities = $230K [$56K (to bank prior to payment) and $174K (to other Crs)] (d) Note: there are 2 days of interest not accounted for in liabilities on day here (see below) (4) Characterize this as a pre-petition transfer involving a security interest on personal prop

56

b)

Issues & Results & Reasons

(1) May Trustee avoid Bank’s security interest in the machinery? NO (a) Reason: i. Strong arm power not applicable ii. Preference power not work b/c not within 90 days (2) May Trustee avoid Bank’s security interest in the tractor? YES (a) Reason:
i. ii. iii.

Meets 547(b) requirements This scenario is exactly the same as if bank received $10K cash payment. Analysis for 547(b)(5) A. If there was no transfer, Bank would get $ 35,200 1. Bank would get machinery ($30K) have allowed unsecured claim of $26K 2. $40K of assets (which includes $10K not paid to bank) 3. Crs owed $200K ($174K + $26K) 4. Each Cr would get 20% of what it was owed 5. 20% X $26K (amount Bank is owed) = $5,200 6. Bank would receive $35,200 ($30K [from machinery] + $5,200) B. If transfer is upheld, Bank will get $ 42,400: 1. Bank would get machinery ($30K) and tractor ($10K) and have allowed unsecured claim of $16K 2. $30K of assets 3. Crs owed $190K ($174K + $16K) 4. Each Cr would get % of what it was owed 5. 15% X $16K (amount Bank is owed) = $2,400 6. Bank would receive $42,400 ($30K [from machinery] + $10K [from tractor] + $2,400)

c)

Other notes

(1) Analysis (a) Are there encumbrances? How will that impact what is available for distribution to Crs. (b) On date of filing of the petition, what does D own? (c) Is Cr secured? (d) If yes, how much is allowed claim? (e) How much is allowed secure claim? (f) How much is allowed unsecured claim? (2) THEME (a) Bankruptcy is organic system (b) Whatever you do over here will have an effect over there. (3) Date of filing of petition is always relevant date. (4) ??? See 507(b) (5) Rules on Cr’s Ability to Recover Interest (a) Loan maturity not required: i. Interest is part of Cr’s claim even if loan is not matured. (b) Interest from what time period? i. Determine interest from time loan was made to date of filing of petition. (c) Interest is part of Cr’s claim i. Generally, pre-petition interest is part of Cr’s allowed claim even if loan is not matured. ii. Generally, post-petition interest is NOT part of Cr’s allowed claim – 502. A. ??? EXCEPTION for over-secured Crs:
1. Rule

a.

Over-secured Crs entitled to pre-petition interest AND post-petition interest (unless collateral value runs out) 1) See 506(a)

57

2.

3.

Post-petition interest: period from date of filing of petition to time Cr is paid 3) Example a) Cr lends D $55K b) Loan is secured with collateral worth $56K c) Amount of banks allowed claim on date of filing = $55K d) Amount of allowed secured claim = $55K e) Amount of allowed unsecured claim = $0 f) ??? Cr paid one year from now – how much is bank entitled to? g) When collateral value runs out, right to post-petition terminates 4) Over-secured Cr’s right to post-petition interest terminates when collateral value runs out. ??? Significance a. Common scenario 1) Significant in CH11 cases when you have over-secured Crs and junior lien holders and depreciable prop b. Hypo: 1) Cr loans D $55K secured by $80K collateral - D has $25K of equity to play with on date of filing – what can D do with this – get other loans from other Crs (adequate protection purposes) – BUT, collateral declines in value each day c. ??? Concept 1) Exception for over-secured Crs will affect what equity D has available to obtain additional adequate protection b/c a) Over-secured Cr’s secured claim in such prop increases WHILE D’s equity in prop declines. b) Will also reduce POE available for distribution to junior Crs. c) Because D may only be able to get money by giving priority to post-petition Crs in collateral that pre-petition Cr has interest in – thus pre-petition Cr 1 is stuck. d. Moral: want to be the senior secured Cr. Example: a. Jan 1, 2000: Bank lends D $50K (terms: 10% interest per annum and to be repaid in 2 years) – secured by prop worth $100K. b. Jan 1, 2001: D files voluntary CH7 petition - Cr’s claim will be 55K (even though D not yet required to have repaid the loan b/c in bankruptcy, claim need not be matured). c. Amount of allowed secured claim on date of filing petition = $55K d. Amount of allowed unsecured claim on date of filing petition = $0 (b/c over-secured)

2)

4)

Problem 4-53 Alternative – p338

a)

Facts (1) One year ago: Bank lent D $50K secured by a perfected security interest in all machinery that D owned - security interest (2) Two days ago: D granted Bank a mortgage in Whiteacre which Bank duly recorded (a) Assets = $70K [$30K (machinery) + $10K (tractor) + $30K (other assets)] (b) Liabilities = $230K [$56K (to bank prior to payment) and $174K (to other Crs)] (3) One day ago: D filed voluntary CH7 petition. (4) Characterize this as a pre-petition lien on real estate transfer Issues & Results & Reasons

b)

(1) May Trustee avoid Bank’s security interest in machinery? NO (a) Reason: b/c transfer date (one year ago) is not within 90 day period. (2) ??? May Trustee avoid Bank’s mortgage on White acre? (a) Reason i. Strong arm power not applicable

58

ii.

Analysis under 547 preference power A. NO – b/c Cr will get 100% no matter what happens B. Meets 547(b)(1) through (4) C. Analysis under 547(b)(5) 1. If there was no transfer of the mortgage, Bank would get $ ? a. Bank would get machinery ($30K) and have allowed unsecured claim of $26K b. Assets = $40K (tractor and other assets) + $?? (mortgage) c. Crs owed $200K ($174K + $26K) d. Each Cr would get ?% of what it was owed e. ?% X $26K (amount Bank is owed) = ?? f. Bank would receive $ ? ($30K [from machinery] + $distribution percentage) 2. If transfer of mortgage is upheld, Bank will get $30K + mortgage + distribution percentage a. Key factor: what is value of machinery on date of filing of petition – if Cr gets 100% than (b)(5) not satisfied with respect to mortgage D. Get notes from PPC from his slide !!!

5)

Problem 4-54 – p339 a) ??? Need to understand 547(e) (1) Cash (a) Transfer date = on date transferred (b) Takes effect = on date transferred (c) Perfected = on date transferred (2) Checks (a) Transfer date = honor date (date check clears (3) Personal prop (a) Transfer date i. transfer date = effect date if the transfer is perfected within 10 days of the effect date – 547(e)(2)(A). ii. transfer date = perfection date if the transfer is perfected more than 10 days after the effect date – 547(e)(2)(B) (b) Perfected = when Cr on simple contract could cannot acquire a judicial lien that is superior to the interest of the transferee - 547(e)(1)(B) i. Plain English? (c) Takes effect = ??? (4) Real estate prop (a) Transfer date i. transfer date = effect date if the transfer is perfected within 10 days of the effect date – 547(e)(2)(A). ii. transfer date = perfection date if the transfer is perfected more than 10 days after the effect date – 547(e)(2)(B) (b) Perfected = when BFP of such prop from the D against whom applicable law permits such transfer to be perfected cannot acquire an interest that is superior to that interest of the transferee - 547(e)(1)(A) i. Plain English? (c) Takes effect = ???

b)

Facts

(1) One year ago: Bank lent D $50K secured by a perfected security interest in all machinery D owned. (2) Five months ago - March 5: D arranged for Bank to obtain a perfected security interest in a tractor (3) Two months ago - June 5: Bank perfected its security interest in the tractor by filing appropriate (4) Yesterday: D filed a voluntary CH7 petition
financing statements. that D owned.

c)

Issues & Results & Reasons (1) ??? May Trustee avoid Bank’s security interest in tractor under 544(a)? (a) Reason: (2) Under 547(e), what date did Bank’s security interest in tractor take “effect”? Mar 5

59

(3) Under 547(e), what date was Bank’s security interest in tractor “perfected”? June 5 (4) Does 547(e)(2)(A) or 547(e)(2)(B) govern when Bank’s security interest will be deemed to have
been made? 547(e)(2)(B) (a) Reason: b/c transfer of tractor was perfected more than 10 days after the effect date – thus, transfer date = perfection date (5) Having determined when Bank’s security interest is deemed to have been made, are the requirements of 547(b)(2) and 547(b)(4) satisfied? YES (a) Reason: i. 547(b)(2) satisfied b/c debt arose (one year ago) antecedent/prior to tractor transfer date (June 5) ii. 547(b)(4) satisfied b/c transfer date (June 5) is within 90-day period (6) ??? Are the other requirements of 547(b) met so that the Trustee may avoid Bank’s security interest in the tractor? (a) Reason: assuming D insolvent and that effect of transfer is that Cr will receive more than had tractor transfer not taken place, all other 547(b) requirements are met.

6)

Problem 4-55 – p340

a)

Facts (1) March 1: Bank lends D $1M for working capital purposes secured by security interest (Art 9) in equipment – D signs financing statements on . . . (see alternatives below) Is Bank’s security interest avoidable if financing statements are filed on April 1, and D files CH7 petition on Sept 1? NO (1) Reason (a) B/c security interest takes effect Mar 1 (b) B/c security interest perfected on Apr 1 (c) Transfer date = Apr 1 (b/c Apr 1 not within 10 days of Mar 1) (d) Thus, not avoidable b/c Apr 1 not within 90 day period Is Bank’s security interest avoidable if financing statements are filed on April 1, and D files CH7 petition on June 3? YES (1) Reason (a) B/c security interest takes effect on Mar 1 (b) B/c security interest perfected on Apr 1 (c) Transfer date = Apr 1 (b/c Apr 1 not within 10 days of Mar 1) (d) Thus, avoidable b/c there is antecedent debt and transfer made within 90-day period Is Bank’s security interest avoidable if financing statements are filed on March 9, and D files CH7 petition on June 3? NO (1) Reason (a) B/c security interest takes effect on Mar 1 (b) B/c security interest perfected on Mar 9 (c) Transfer date = Mar 1 (b/c within 10 days of Mar 1) (d) Thus, not avoidable b/c no antecedent debt and not within 90-day period. Is Bank’s security interest avoidable if financing statements are filed on March 9, and D files CH7 petition on April 1? NO (1) Reason (a) B/c security interest takes effect on Mar 1 (b) B/c security interest perfected on Mar 9 (c) Transfer date = Mar 1 (b/c within 10 days of Mar 1) (d) Thus, not avoidable b/c no antecedent debt ??? Is Bank’s security interest avoidable if an involuntary CH7 petition is filed against D on March 5, the financing statements are filed on March 9 and an Order for Relief is entered on July 5? (1) Reason (a) B/c security interest takes effect on Mar 1 (b) B/c security interest perfected on Mar 9 (c) Transfer date = Mar 1 (b/c within 10 days)

b)

c)

d)

e)

f)

60

(d) Thus, avoidable under i. 544(a) b/c security interest is unperfected on March 5 (date petition is filed) – ii. Bank does not have a PMSI which would enable it to assert 546(b) iii. 549(a) b/c 549(b) is inapplicable where secured debt arose prior to filing of involuntary
petition.

(2) Date of the commencement = date involuntary petition was filed (a) ??? Date of Order for Relief is irrelevant 7)
Problem 4-56 – p341 a) Facts (1) Feb 1: D purchases goods on credit from Supplier – payment of $10K is due in 30 days. (2) Mar 15: Supplier inquires about the payment and D’s credit dept personnel say they do not have funds to pay (so Supplier knows D is in bad straits) (3) May 1: Supplier inquires again and is told same story (4) July 1: Supplier sues D for $10K (5) July 2: D sends Supplier check for $10K (6) July 5: Supplier receives check (delivery date) (7) July 15: D’s check clears (honor date) (8) Oct 4 (90 days after July 6) b) Issue & Result & Reason (1) May Trustee recover $10K that D paid Supplier? YES (a) Reason: b/c honor date is within 90 day period – see Barnhill (b) Barnhill says transfer date of a check for 547(b) purposes is honor date (not delivery date). i. Barnhill rule is limited to 547(b) Problem 4-58 – p348 a) Facts b) Issues c) Reason Problem 4-59 – p348 a) Facts b) Issues c) Reason

8)

9)

10) Problem 4-60 – p349 a) Facts b) Issues c) Reason

61

f.

Summary of Exceptions to 547(b) 1) 547(c) exceptions are limited to transfers avoided by the Trustee under 547(b) a) If transfer is avoided by Trustee under some other section, exceptions in 547(c) do NOT apply. 2) Cr has burden of proof under 547(c). 3) Trustee’s avoidance of the transfer is precluded ONLY to the extent that it is covered by the exception (except for 547(c)(6) and (8)). Substantially Contemporaneous Transfer Exception [547(c)(1)]

g.

1)

Requirements a) D and Cr both intended transfer to be contemporaneous exchange for new value; AND (1) “Contemporaneous” (a) Not really “contemporaneous” i. If transfer was truly contemporaneous, then it would not have satisfied 547(b) requirements. ii. Here, “contemporaneous” means close to contemporaneous. (b) Contemporaneous would NOT be satisfied in the following examples: i. Example #1 A. Apr 1: Cr sells goods to D B. Apr 5: D delivers check to D ii. Example #2 A. Apr 1: Cr sells goods to D and D delivers check B. Apr 28: Cr deposits check C. April 30: check clears iii. Example #3 A. Apr 1: Cr sells goods to D and D delivers check B. June 14: Cr deposits check C. June 16: check clears (2) “New value”: (a) Defined in 547(a)(2) (b) New debt. (c) Not an obligation substituted for an existing obligation. b) Transfer was in fact a substantially contemporaneous exchange Rationale for Exception a) From Cr’s perspective, this was not a credit transaction but a cash transaction. b) Intended to protect contemporaneous payment by check transactions – legis history clearly shows this. Problem Hypo a) Facts: (1) Apr 1: ABC buys food and pays by check. (2) Apr 14: Supplier deposits check (3) Apr 18: check clears (4) June 15: ABC files for bankruptcy b) May payment to Supplier be avoided under 547? NO – because this is classic 547(c)(1) case. Problem 4-64 (p363). a) Facts: (1) Apr 1: ABC buys food and pays by check (2) Apr 14: Supplier deposits check (3) May 3: check dishonored; ABC then wires funds to Supplier. (4) June 15: ABC files for bankruptcy b) May the wire transfer payment to Supplier be avoided by the Trustee? PROBABLY (1) If viewed as two transfers, then subsequent wire transfer (i.e., interruption in payment cycle) takes it out of 547(c)(1) (2) If viewed as one transfer, probably falls under 547(c)(1). Problem 4-65 (p364).

2)

3)

4)

5)

62

a) b) c)

Facts: Bank gives D loan and obtains security interest in D’s equipment; Bank files FS 15 days later; D files CH 7 petition 30 days later. Are all elements of 547(b) met? YES b/c the transfer date = filing of FS date and this is after the debt date [547(e)(2)(B)]. May Bank protect its security interest using 547(c)(1)? NO (1) It would eliminate effect of 10 day provision in 547(e)(2)(A) and (B) (2) Rule: courts universally hold that 547(c)(1) is not applicable to FS filing delays not protected by 547(e)(2)(B).

h.

Ordinary Course of Business Payments Exception [547(c)(2)]

1)

Requirements a) Transfer was in payment of an ordinary debt (1) Financial affairs defined: covers relationship with consumers b) Transfer was made in the ordinary course of business; AND c) Transfer was made according to ordinary business terms. Cases: a) See In Re Tolona Pizza Products Corp., 3 F.3d 1029 (7th Cir. 1993) – p366 b) See Union Bank v. Wolas, 502 U.S. 151 (1991) Rationale a) Aimed at credit transactions in the ordinary course of business – do not want to interfere with these transactions – usually not preferential. b) D is not in bankruptcy at time debt is incurred and at time debt is paid. Problem 4-67 (p370) a) Facts (1) Sept 5: D buys $5,000 of goods on credit (2) Sept 30: D receives bill; payment is due on Oct 30; D does not pay by due date. (3) Dec 15: D and Cr enter into installment payment agreement where payments will be made monthly Mar 1 to July 1. (4) July 15: D files bankruptcy petition. b) Issue & Results & Reasons: (1) Are all elements of 547(b)? (a) Trustee cannot avoid Mar 1 or Apr 1 payments b/c 547(b)(4) not met (b) Trustee can avoid May 1, Jun 1, July 1 payments (2) Is 547(c)(2) available to Cr to prevent the payment from being avoided? UNCLEAR (a) To prove that transfer was in payment of an ordinary debt, Cr has to prove that Cr ordinarily enters into installment payment relationships – if this is first time CR has done this, 547(c)(2) will probably not apply. (b) To prove that transfer was made in the ordinary course of business, Cr will have to prove that Cr ordinarily enters into installment payment relationship. (c) Transfer was made according to ordinary business terms. (3) Rule for when D fails to make payment by due date: then Cr/Supplier is out of 547(c)(2). (4) There is no specific date or # of days proscribed in the text of 547(c)(2) – there was such a specific # of days cap in earlier version but Cr lobby got 15 days out of this section.

2)

3)

4)

i.

Enabling Loan (PMSI) Exception [547(c)(3)]

1)

Rule in plain English: a) If a purchase money security interest would otherwise be avoidable because it was perfected beyond the period required by 547(e), it is saved from avoidance if the D received possession of the property after the effective date of the transfer and the Cr perfected the interest within 20 days of the date the D received possession. Rationale: a) Intended to mirror UCC § 9-301(2). b) Crs who enable D to operate his business should not be punished.

2)

63

3)

Two Requirements a) (Requirements for PMSI) Transfer created a security interest in property acquired by the D to the extent such security interest secures new value that was – (1) Given at or after the signing of a security agreement that contains a description of such prop as collateral; (2) Given by or on behalf of the secured party under such agreement; (3) Given to enable the D to acquire such prop; AND (4) In fact used by the D to acquire such prop. b) (Perfection requirements) Transfer was perfected on or before 20 days after the D receives possession of the property. Limited Scope: 547(c)(3) creates an alternative grace period for perfection (if security interest is perfected within 20 days from the date on which the D received possession of the collateral) that could save the purchase money interest from avoidance if it would otherwise be avoidable under 547(b). Illustration (p378)

4)

5)

64

j.

??? Subsequent New Value Transfer Exception [547(c)(4)]

1) 2)

Cohen did not discuss in class Rule: if, after receiving an avoidable transfer (i.e., payment from D for old obligation), the Cr gives to the D new value that is not itself secured or paid for by a new transfer, the otherwise avoidable transfer cannot be avoided to the extent of that new value. Rationale: CR who extended new credit or other value to the D after payment of an older obligation was probably motivate by that payment to deal further with the D. Problem 4-70 (p387) a) Facts: (1) Feb 1: D owes S $100,000 (2) Mar 1: D pays S $11,000 (3) Mar 5: S ships D $8,000 worth of goods (4) Mar 10: D pays S $9,000 (5) Mar 15: S ships D another $16,000 worth of goods (6) Mar 20: D pays S $7,000 (7) Apr 15: D files bankruptcy petition b) How much of the $27,000 paid by D to S during the 90-day period is recoverable? $7,000 (i.e., D’s Mar 20 payment) because all other payments were covered by subsequent new value. c) ??? Same result even if Mar 1 was when check was delivered and check not honored until Mar 6.

3) 4)

k.

Inventory and Receivables Exception [547(c)(5)]

1) 2)

Problem: secured party who is secured by security interest in inventory or AR almost always be faced with scenario in which all of 547(b) element are met, and the security interest, is therefore, potentially avoidable. Requirements: a) Reduction in Deficiency Rule: (1) Trustee cannot avoid secured Cr’s perfected security interest in inventory and AR unless there is an improvement in value – Trustee can only recover amount of improvement (aka “reduction in deficiency). (a) Bankruptcy Code protects secured party to the extent that it has not improved its position during the 90-day period (or 1-year period for an insider) preceding the bankruptcy filing [547(c)(5)] b) Analysis: (1) Determine the first date for comparison – it is either (a) 90 days before the petition was filed for a non-insider; (b) 1 year before the petition was filed for an insider; OR (c) the date of the first advance, if that occurred after the start of the applicable pre-bankruptcy period (i.e., 90 days or 1 year). (2) Calculate the value of the deficiency on the first date = [how much is Cr owed on first date] – [value of collateral on first date] (3) Calculate the value of the deficiency on the day of filing = [how much is Cr owed on day of filing] – [value of the collateral on day of filing] (4) Calculate the reduction in deficiency = [value of deficiency 90 days (or one year or first advance date) before filing] – [value of deficiency on day of filing]. Effect: Trustee is permitted to avoid Cr’s security interest to the extent that the deficiency was reduced. Rationale a) This is not a consumer transaction – this is a business transaction – there could never be a point in time when Cr could obtain a lien before security interest would be deemed perfected – only a tie and ties go to secured party – thus, have a special rule for ????. b) Improvement in value adversely effects other Crs. Problem 4-71 (p390) – did not go over in class. ??? Problem 4-72 (p391)

3) 4)

5) 6)

65

7) 8) 9) l.

Problem 4-73 – p392 Problem 4-74 – p393 ***

Statutory Lien Exception [547(c)(6)]: if statutory lien is not avoidable under 545, the Trustee cannot try to avoid it under 547(b).

m. Alimony, Maintenance and Child Support Exception [547(c)(7)]. n.
Small Value Transfers for Consumer Debts Exception [547(c)(8)]

66

5.

Statutory Liens [545]

a.

General Rule: a statutory lien that is validly obtained and perfected under non-bankruptcy law is fully effective upon the bankruptcy of the D and cannot be avoided unless it fits into one of three categories in 545 (i.e., landlords’ liens, an usurpation of the bankruptcy power or are insufficiently perfected). Three Categories When Statutory Lien Can Be Avoided: 1) Statutory lien is avoidable if it is specifically created to take effect only upon the D’s insolvency, bankruptcy or financial distress [545(1)] 2) Statutory lien is avoidable if it is NOT perfected or enforceable against a hypothetical BFP who is deemed to have purchased the (real or personal) property on the date of the commencement of the case [545(2)]. 3) Statutory lien is avoidable if it is a statutory lien for rent or of distress for rent [545(3)]. a) Reflects policy that lessors should be treated as unsecured Crs. Federal Tax Lien is not avoidable under 545 unless it is not sufficiently perfected. Interaction with 547: if a statutory lien is not avoidable under 545, the Trustee cannot try to avoid it using 547(b) [547(c)(6)].

b.

c. d.

67

6.

Fraudulent Transfers [548]

a.

Text of § 548. Fraudulent transfers and obligations (a) (1) The trustee may avoid any transfer of an interest of the debtor in property, or any obligation incurred by the debtor, that was made or incurred on or within one year before the date of the filing of the petition, if the debtor voluntarily or involuntarily-(A) made such transfer or incurred such obligation with actual intent to hinder, delay, or defraud any entity to which the debtor was or became, on or after the date that such transfer was made or such obligation was incurred, indebted; or (B) (i) received less than a reasonably equivalent value in exchange for such transfer or obligation; and (ii) (I) was insolvent on the date that such transfer was made or such obligation was incurred, or became insolvent as a result of such transfer or obligation; (II) was engaged in business or a transaction, or was about to engage in business or a transaction, for which any property remaining with the debtor was an unreasonably small capital; or (III) intended to incur, or believed that the debtor would incur, debts that would be beyond the debtor's ability to pay as such debts matured. (2) A transfer of a charitable contribution to a qualified religious or charitable entity or organization shall not be considered to be a transfer covered under paragraph (1)(B) in any case in which-(A) the amount of that contribution does not exceed 15 percent of the gross annual income of the debtor for the year in which the transfer of the contribution is made; or (B) the contribution made by a debtor exceeded the percentage amount of gross annual income specified in subparagraph (A), if the transfer was consistent with the practices of the debtor in making charitable contributions. (b) The trustee of a partnership debtor may avoid any transfer of an interest of the debtor in property, or any obligation incurred by the debtor, that was made or incurred on or within one year before the date of the filing of the petition, to a general partner in the debtor, if the debtor was insolvent on the date such transfer was made or such obligation was incurred, or became insolvent as a result of such transfer or obligation. (c) Except to the extent that a transfer or obligation voidable under this section is voidable under section 544, 545, or 547 of this title, a transferee or obligee of such a transfer or obligation that takes for value and in good faith has a lien on or may retain any interest transferred or may enforce any obligation incurred, as the case may be, to the extent that such transferee or obligee gave value to the debtor in exchange for such transfer or obligation. (d) (1) For the purposes of this section, a transfer is made when such transfer is so perfected that a bona fide purchaser from the debtor against whom applicable law permits such transfer to be perfected cannot acquire an interest in the property transferred that is superior to the interest in such property of the transferee, but if such transfer is not so perfected before the commencement of the case, such transfer is made immediately before the date of the filing of the petition. (2) In this section-(A) "value" means property, or satisfaction or securing of a present or antecedent debt of the debtor, but does not include an unperformed promise to furnish support to the debtor or to a relative of the debtor; (B) a commodity broker, forward contract merchant, stockbroker, financial institution, or securities clearing agency that receives a margin payment, as defined in section 101, 741, or 761 of this title, or settlement payment, as defined in section 101 or 741 of this title, takes for value to the extent of such payment; (C) a repo participant that receives a margin payment, as defined in section 741 or 761 of this title, or settlement payment, as defined in section 741 of this title, in connection with a repurchase agreement, takes for value to the extent of such payment; and (D) a swap participant that receives a transfer in connection with a swap agreement takes for value to the extent of such transfer. (3) In this section, the term "charitable contribution" means a charitable contribution, as that term is defined in section 170(c) of the Internal Revenue Code of 1986 [26 USCS § 170(c)], if that contribution-(A) is made by a natural person; and (B) consists of-(i) a financial instrument (as that term is defined in section 731(c)(2)(C) of the Internal Revenue Code of 1986) [26 USCS § 731(c)(2)(C)]; or (ii) cash. (4) In this section, the term "qualified religious or charitable entity or organization" means-(A) an entity described in section 170(c)(1) of the Internal Revenue Code of 1986 [26 USCS § 170(c)(1)]; or (B) an entity or organization described in section 170(c)(2) of the Internal Revenue Code of 1986 [26 USCS § 170(c)(2)].

68

b.

Two Alternative Requirements 1) Actual intent to defraud [548(a)(1)(A)]. 2) Constructive fraud [548(a)(1)(A)]. a) Two elements of constructive fraud. (1) D received less than reasonably equivalent value; AND (a) Reasonably equivalent value” in context of regularly conducted, non-collusive, foreclosure sale is the foreclosure sale price (see BFP v. Resolution Trust Corp., 114 S. Ct. 1757 (1994)). (2) D was either . . . . (a) insolvent on date that such transfer was made or such obligation was incurred, or became insolvent as a result of such transfer or obligation; (b) engaged in business or a transaction, or was about to engage in business or a transaction, for which any property remaining with the D was an unreasonably small capital; OR (c) D intended to incur, or believed that the D would incur, debts that would be beyond the D’s ability to pay as such debts matured. Based on the UFCA. The satisfaction of antecedent debt constitutes “value” but transfer might end up being avoidable under 547(b). Interaction with 544(b): Trustee may avoid fraudulent transfers in the pre-petition period either by using state fraudulent transfer law, accessible via 544(b), or by using 548. Effect: if obligation is invalidated under 548, the claim is not allowed and the holder thereof may not receive a distribution in the case. 1) Compare to effect of 547: where Cr gets unsecured claim against the estate.

c. d. e. f.

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SET-OFFS [553]

1.

General rules:

a. b.

Generally, the debts of two persons who are mutually indebted may be set off against each other. A right of set-off valid under non-bankruptcy law is generally upheld under bankruptcy law unless it falls into one of the categories in 553. 1) Rationale: Code protects the right of set-off even though the set-off right runs counter to Bankruptcy Code’s general aim of even-handed treatment of Crs.

2.

4 Circumstances in Which Set-Off is Not Appropriate Under the Bankruptcy Code.

a. b. c.

Right of set-off is NOT available if the Cr’s claim has been disallowed as a claim against the estate [553(a)(1)] Right of set-off is NOT available if the Cr’s has acquired the claim by transfer from another entity either during the 90-day period while the D was insolvent or after the commencement of the bankruptcy case [553(a)(2)]. Right of set-off is NOT available if the debt due from the Cr was incurred during the 90-day pre-bankruptcy period, while the D was insolvent, and for the purpose of obtaining a right of set-off against the claim owed to the Cr [553(a)(3)]. Right of set-off is NOT available if the set-off has enabled the Cr to improve its position in a manner forbidden by 553(b) [553(a)(4)].

d.

3.

Problems.

a.

Hypo: 1) Facts: Bank has $100,000 unsecured claim against D; involuntary petition is filed against D; order for relief is entered; D has $40,000 on deposit with Bank; D insolvent and unsecured Crs likely to receive only 10%. 2) How much will Bank receive? $40,000 from the deposit account plus a pro rata share of any other distributable assets with respect to the $60,000 deficiency. Problem 4-79 (p421) 1) Facts: a) At all times relevant, D has checking account with Bank. b) Feb 1: D borrows $100,000 from Bank (unsecured); D uses the loan proceeds to pay suppliers; Bank requires D to maintain a non-interest bearing checking account with Bank. c) Feb 15: balance in checking account is $5,000. d) Apr 1: balance in checking account is $25,000 (b/c some of D’s customers paid their bills). e) June 30: D files bankruptcy petition; balance in checking account is $40,000 (b/c more customers paid their bills). 2) If Bank had set-off the $40,000 in the account on June 28 (pre-petition), could the Trustee recover the funds? YES – Trustee could recover $15,000 3) If Bank does not set off pre-petition, will it have a recognizable set-off right to $40,000? NO.

b.

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K. EXECUTORY CONTRACTS [365] 1.
Goal of 365

a.

Empower Trustee to take the best advantage of the rights and assets of the estate while affording some protection to the countervailing interests held by other parties.

2.

Meaning of “Executory Contract” and Unexpired Lease”

a.

Executory Contract Defined: a K is executory if the obligations of both parties are so far unperformed that the failure of either to perform would be a material breach – K only qualifies as “executory,” for bankruptcy purpose, if at time of commencement of case, both parties had material obligations outstanding. Unexpired Lease Defined: is a variety of executory contract – special mention in title shows section focuses on leases.

b.

3.

Estate’s Right to Assume or Reject Executory Contracts.

a.

Trustee has option of accepting or rejecting the executory contract. 1) But this is limited – courts may refuse to approve a rejection unless it is clear that performance would place an undue burden on the estate. Procedures for Assumption or Rejection of Executory Contract: 1) Time within which Trustee must make assume/reject decision a) CH 7: Trustee in CH 7 cases must assume or reject contract within 60 days of the order for relief or in such time as court may allow [365(d)(1)] – if action is not taken by the end of this period, contract is deemed rejected. b) CH 11, CH 12 and CH 13: Trustee may make decision to assume or reject at any time up to confirmation of the plan (unless it is lease of non-residential property). c) Leases of Non-Residential Property: no matter what chapter, leases of non-residential property must be assumed or rejected within 60 days of the order for relief unless the court extends the period for cause. 2) When is court approval of Trustee’s decision required a) If Trustee makes an affirmative decision to assume or reject, the court must approve such a decision. b) If the contract is deemed rejected because the Trustee failed to act within the time period, the rejection is automatic and does not require court approval. 3) Standard for court’s approval = business judgment rule: court will not interfere with Trustee’s decision if it was based on a good faith, reasonable business judgment that appears beneficial to the estate. Factors Influencing Trustee’s Decision to Assume or Reject the Executory Contract: REJECTING the Executory Contract. 1) Effect: a) Rejecting the contract constitutes a breach – breach is treated as a pre-petition breach by the D [365(g)(1)] and thus other party’s claim becomes a general unsecured pre-petition claim [502(g)]. b) If estate first assumes a K and later rejects it, the rejection is a breach and other party’s damages are treated as administrative expense entitled to priority [365(g)(2)]. ASSUMING the Executory Contract. 1) Effect: a) Estate assumes contract b) Estate is entitled to receive the other party’s performance c) Estate is liable to perform – this performance qualifies as an administrative expense and is thus entitled to priority under 507(a)(1) 2) Assuming Contracts in Default [365(b)(1)]: to assume contract in default, Trustee must cure the default, compensating for any loss caused by it, and giving the party adequate assurance of future performance under the contract. 3) Non-assumable Contracts: under 365(c), the Trustee may not assume the following types of contracts:

b.

c. d.

e.

71

a) b) c) 4.

Contracts that are not assignable in non-bankruptcy law Loan and financing transactions Terminated leases of non-residential real property

Problems (see slides for Class #18)

72

L. CLAIMS AND DISTRIBUTIONS 1.
Allowance of Claims [502]

a. b.

Claim Defined [101(5)]: BROAD – any secured or unsecured right to payment arising in law and/or equity – can be unliquidated, contingent, unmatured or disputed. Process for filing proof of claims – p443 1) Secured Crs: a Secured claimant need not prove a claim to protect a lien but an under-secured Cr must prove a claim to receive distribution for its deficiency. 2) Unsecured Crs: a) Process for CH 7 cases: unsecured Crs must prove claims to be included in the distribution unless not included on list of Crs sent by Trustee. (1) Cr cannot be expected or obligated to file proof of claim when it does not know that D has filed for bankruptcy. (2) If D lists Cr on schedule and Cr does not file proof of claim, debt is discharged (3) Most CH 7 cases are “no asset cases” – thus, there is no distributable POE – in these cases, Trustee states on schedule that Crs do not have to file proof of claim unless and until Trustee sends another notice that says it looks like there will be something to distribute. b) Process for CH 11 cases: Cr need not prove a claim unless its claim is listed as disputed, contingent or unliquidated, or the claim is not listed and the Cr knows of the bankruptcy 3) Once a claim is proved it is allowed automatically unless a party in interest files a timely objection. Interest on Claims [502(b)(2)] 1) General rule: Crs cannot receive post-petition interest. 2) Three Qualifications: a) Over-secured Crs receive interest. b) Under secured Crs may receive interest if there are funds left over in CH 7 cases [726(a)(5)]. c) Post-petition interest should not be confused with present value payments under rehabilitation plans. 3) Lease rules a) If lease is less than one year, L gets unpaid pre-petition rent + remainder of lease amount b) If lease is more than one year, L gets unpaid pre-petition rent + greater of ([one year’s rent] OR [lesser of 15% of remaining term’s rent and 3 years of future rent]) c) You usually do not get to 3-year cap until you hit 20-year term lease Tardily-Filed Claims: whether to allow tardily-filed claims is up to court’s discretion (see Bankr Rule 9006(b)(1) (“excusable neglect” doctrine) and Dix factors). Problems Applying 502(b) (p446-48, 459)

c.

d. e.

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2.

Priorities [507]

a. b.

Distribution takes place after dischargeable claims have been discharged. Summary of Priorities. 1) Secured Claims 2) Ultra-priority claims 3) Priority Unsecured Claims 4) General Unsecured Claims CH 7’s distributional provision is slightly different [726]. Order of Distribution (see Blum chart p383) See Problem 4-91 (p464).

c. d. e. 3. 4. 5.

Subordination [510] Subrogation Other Alterations

74

M. ABANDONMENT OF PROPERTY OF THE ESTATE [554]: the Trustee can abandon property if it is a burden to the estate unless
public health and safety interest outweighs interest of the estate.

75

N. REDEMPTION [722]: lump sum requirement in CH 7 cases.

76

O.

AND REAFFIRMATION [524(c)]:

designed to encourage dispute resolution but there is plenty of room for abuse.

77

P. DISCHARGE [523(a), 524(a), 727]: two step process – (1) is D entitled to discharge?; (2) from what is D discharged?

78

Q. PROTECTION AGAINST DISCRIMINATORY TREATMENT [525]: neither governmental units nor private employers.

79

R. CONVERSION OR DISMISSAL [706, 707]: general rules and 707(b) dismissals.

80

III. CHAPTER 13 CASES

A. SUMMARY 1.
Purpose: CH 13 is designed to enable D to keep all or most of his or her property and to use part of future income over a period of time to pay Crs at least as much as – and ideally more – they would have received from the liquidation of prepetition assets. Eligibility [109(e)]: a. Because there is no Cr approval requirement in CH13, eligibility limits are very important. b. Requirements for solo indiviual filing: 1) Only an individual with regular income; a) Examples of regular income: retired indv, receiving pension benefits; monthly child support payments (even if irregularly paid); welfare payments; social security payments; 2) That owes non-contingent, liquidated, secured debt less than $871,550; and 3) That owes non-contingent, liquidated, unsecured debt less than $290,525. a) If D is sued for negligence for $300,000, that amount does not count toward unsecured debt amount because it is unliquidated c. Requirements for joint spouse filing: 1) Only an individual with regular income and his or her spouse; a) It is okay if one of the spouses has no income 2) That together owe non-contingent, liquidated, secured debt less than $871,550; and 3) That together owe non-contingent, liquidated, unsecured debt less than $290,525. d. Hypothetical sale costs should not be deducted when computing value of collateral for CH 13 purposes (see Balbus). 1) Open question as to whether same rule holds when facts result in nondeduction causing the secured debt to be in excess of limit. No involuntary petition: only D may file a voluntary CH13 petition (although Crs may still effectively force D to file). Automatic stay in CH 13

2.

3. 4.

a. b.

Automatic stay goes into effect upon filing of petition in CH 13 [362]. Expanded automatic stay protects D from both pre- and post-petition Crs. 1) Rationale: pre-petition Crs will be paid out of D’s post-petition earnings – thus, for CH 13 to work, Code has to protect D’s post-petition earnings (by labeling them as POE [1306]). 2) This creates problems for post-petition Crs: a) ??? Code provides two possible remedies for post-petition Crs. (1) 1305: (a) Provides that certain post-petition claims will be treated as pre-petition claims so that they can be dealt with in the CH 13 plan. (b) 1305(a)(2) says plan can include payment for certain taxes and goods/services that “are necessary to the D’s performance under the plan.” (2) 1328: (a) 1328 denies discharge for certain post-petition claims.

81

c.

Automatic stay extended to protect any co-D or surety of the D on consumer debt [1301]. 1) Cr can seek relief from stay to the extent that the CH 13 plan does not fully cover what Cr is owed. a) Formula for Cr in CH 13 case to obtain relief from stay to go after co-D: what Cr gets under CH 13 plan minus what Cr claim covered by co-D/guarantor. b) Application: (1) Facts: Cr lends D $5,000 guaranteed by D’s mom; ne year later, D files CH 13 petition, at which point D owes Cr $6,000 b/c of accrued interest; D’s confirmed CH 13 plan provides for Cr to receive the full $6,000 claim amount over the next 3 years. (2) ??? Outcome: theoretically, Cr may still be able to obtain relief to go after Mom b/c it will not get $6,000 in present value (a) BUT unless Cr is oversecured, Cr’s allowed claim amount is only amount plus pre-petition intererst.

5.

POE: pre-petition property as of commencement of case (like CH 7) [541], as well as some post-petition property (e.g., property acquired by D between commencement of the case and its close) [1306]. a. Rationale: pre-petition Crs are paid out of post-peition earnings and then automatic stay also operates against postpetition Crs. b. ??? Remedy for post-petition Crs of D: Disposition of estate property: revested in D on confirmation of plan [1327]. Impact on D’s post-peition income: D’s disposable income must be applied to payments under the plan [1322(a), 1325(b)]. D and Trustee split responsibility for administering estate and operating any business. a. Trustee is appointed in all CH 13 cases. b. Trustee performs investigative and supervisory duties, collects payments and distributes payments under the plan [1302]. c. Trustee has power to have D’s employer make payments directly over to Trustee. d. CH 13 does not recognize DIP concept but D continues to operate any business under Trustee’s supervision [1304]. Conversion: a. Converting to CH 13: only D can convert a case from another chapter (usually CH 7) to CH 13. b. Converting from CH 13 1) D has broad right of conversion [1307]: generally, D would convert from CH 13 to CH 7. 2) Crs have right to convert to CH 7 case for cause (e.g., dilatory, abusive or noncompliant D behavior) [1307].

6. 7.

8.

9.

10. Dismissal: a. D has broad right to dismiss [1307]. b. Other parties in interest can dismiss for cause [1307]. 11. Likely source of funding to pay Crs’ claims: generally, future income but POE may be sold for the purpose of
generating funds [1322].

12. Time period for payment: payments must be made over a period of not more than 3 years, or with court approval, 5
years [1332].

13. Minimum level of payment to Crs [1322, 1325]: a. Plan must give secured Crs the present value of the secured claim and preserve their liens. b. Priority claims must be paid in full.

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c. d.

Payments to unsecured Crs must meet the “best interests” and “disposable income” tests. Crs can consent to lesser payments.

14. Extent of D’s ability to discriminate in favor of preferred Cr or class of Crs [1322]: a. Plan may designate classes of unsecured Crs and may discriminate between them. b. Plan cannot discriminate unfairly against any class. c. Plan cannot discriminate between Crs within the same class. 15. D’s power to cure defaults or modify secured obligations: D can cure, restructure and modify the plan but D cannot
modify home mortgages[1322].

16. Crs’ power to participate in formation of plan: only D may propose a plan [1321]; Crs may not file (compare to CH 11). 17. Crs’ consent in CH 13 plan [1325, 1327] a. No Cr acceptance requirement in CH 13 plan. 1) Crs have no vote on the D’s plan, but are confined to objecting if it fails to meet confirmation standards. 2) Because Crs have no vote, there are debt ceilings in CH 13. b. Crs can consent to treatment less favorable than that to which they are entitled under the Code 18. Exemptions are still relevant in CH 13 case: exemptions are taken into account in deciding how much the D must pay
under the plan to meet minimum requirements for confirmation – best interests test.

19. Modification of CH 13 plan [1323]: a. Before CH 13 plan is confirmed, D can modify the plan without court approval [1325]. b. Before completion of payments, D, unsecured Cr or Trustee can seek to modify CH 13 plan with court approval
[1329]. 1) Possible modifications: a) Increase or reduce payments to a particular class. b) Alter the time period for such payments. c) Cange the amount of the distribution to a Cr to take account of payments outside the plan.

20. Discharge a. Available to corp? No b/c corp are not eligible for CH 13 relief. b. Breadth of discharge [1328]: 1) All debts provided for in the plan or disallowed as claims against the estate are discharged. 2) Most of the exceptions to the discharge in 523 are excluded in CH 13 case. 3) 727 is inapplicable. 4) A hardship discharge is permitted under certain circumstances where the plan is not fully consummated. c. When is discharge granted? 1) Full completition discharge: after completion of payments under the plan [1328(a)]. 2) Hardship discharge [1328(b)]: a) Excludes all claims not discharged in CH 7 case [1328(c)(2)] 3) References to 1322(b)(5) insure cpmtomied liability for any future home mortgage payment obligations. 21. Alimony, Maintenance & Support Crs in CH 13 are still protected: 507(a), 1322(a)(2), 1325(a)(1) and 1326(a)(1)
basically make such claims into priority claims and priority claims have to be paid in full.

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B. THE CHAPTER 13 PLAN 1. 2.
What are advantages of filing CH13? Timing for filing petition, plan and making payments:

a. b. c. d. 3.

D files CH 13 petition. D has 15 days to file CH 13 plan unless bankr court grants an extension for cause shown and on notice. D must begin making payments to the Trustee within 30 days of filing the CH 13 plan regardless of whether plan has been confirmed [1326(a)(1)]. Distribution begins as soon as practicable after confirmation of the plan.

Contents of the Plan

a.

Generally, 3 parts 1) States what income and assets will be used to fund the plan; 2) Proposes the treatment to be given to claims; 3) Provides for various optional matters. The Mandatory Provisions – 1322(a) - p567:

b.

1)

Plan must comply with 3 rules:

a)

Plan must bind the D to pay future earnings to the Trustee in an amount sufficient to execute the plan. (1) In application: (a) Plan must commit all of D’s “disposable income” to the plan for the three years following the date on which the first payment is due [1325(b)(1)]. i. Trustee or unsecured Cr can object and 1325(b)(1) forbids court’s approval of a CH 13 the plan unless D commits all of his “disposable income” to the plan for the three years following the date on which the first payment is due. (b) Plan must set out proposed periodic payments and length of payments. (c) Court must be satisfied that D can afford to make the payments. (2) D has other options to make payments: (a) D can also liquidate some property to supplement the monies contributed from future income [1322(b)(8)]. (b) D can surrender property to a security interest holder. Plan must provide for the full payment of all priority claims by deferred cash payments, unless claimant agrees otherwise [1322(a)(2)] (1) ??? Influence of 507: (a) If a class of priority claims would have received nothing under CH 7, the CH 13 plan need provide only for full payment of the face amount of the claims in that class. (b) If a class of priority claims would have been paid in full under CH 7, the best interests tests requires that the class receive present value of the CH 7 distribution, which includes interest on the face amount of the claims. If the plan classifies claims, it must treat claims in the same class equally.

b)

c) 2)

Plan must also comply with the confirmation criteria in 1325: see below.

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c.

Optional Provisions – 1322(b) - p568:

1)

Classification of UNSECURED claims [1322(b)(1)]:

a)

Generally: (1) 1322(b)(1) gives D discretion to place unsecured claims in separate classes. (a) Said another way, 1322(b)(1) states when a CH 13 plan may permissibly discriminate among Crs sharing the same non-bankr law legal position. (2) Three D’s rationale for allowing discrimination: (a) D wants to discriminate in 2 ways: i. D wants to pay in full his debts to Crs who hold the guarantees of family and friends. ii. D wants to pay in full those debts that will not be discharged in CH 13 case. Three Guidelines: (1) Claims in same class must be treated alike [1322(a)(3)]. (2) Claims can only be classed together if they are substantially similar [1322(b)(1) read with 1122]. (3) Plan must not discriminate unfairly against any class [1322(b)(1)] – see next bullet. Rule: if D’s CH 13 plan designates a class or classes of unsecured claims, the D may not “discriminate unfairly” against any class – D may discriminate in favor of or against certain unsecured Crs under “appropriate circumstances” (1) Factors in determining whether discrimination was “unfair”: (a) Whether discrimination has a reasonable basis; i. Examples of reasonable discrimination:  D is in apartment, L has been very understanding, D wants to pay in full.  D owes children’s pediatrician $1,000 and his children have been very sick and medical coverage does not cover and D believes if he does not make the full payment, his children may not responsive or quality care. ii. Examples of unreasonable discrimination:  D issues bad check and is concerned about criminal prosecution.  D owes doctor $1000 and would be highly embarrassed if unable to make full payment.  D wants to make full payment to business Crs.  D wants to prefer her non-businss Crs because plans to give up her business. (b) Whether D can carry out a plan without discrmination; (c) Whether the discrmination is proposed in good faith; (d) Whether degree of discrimination is directly related to the basis or rationale for the discrimination. (2) Code explicitly recognizes co-D scenario as fair discrimination: (a) Rule if individual is liable with the D on a consumer debt, that claim may be separated from other unsecured claims. i. Purpose: allow D to treat a consumer debt preferentially in order to eliminate or reduce liability of a friend or relative who is a co-D or surety ii. In Application: CH 13 plan can pay Cr of D and co-D in full and other Crs 40% (see Problem 5-10). (b) Problem 5-9 – p568 (3) Code implicitly recognizes “administrative efficiency” for small claims as fair discrimination [1322(b)(1), 1122(b)] (4) Rule for non-dischargable educational loans: a CH 13 plan that proposes to separately classify and fully repay non-discharageable student loans discriminates unfairly against other unsecured Crs who will only receive partial repayment of their dischargeable claims (see In re Groves, 39 F.3d 212 (8th Cir. 1994)). (a) This is not an absolute rule – there may be instances where it is permissible for a CH 13 D to discriminate in favor of paying off non-dischargeable debts.

b)

c)

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2)

Modification of claims [1322(b)(2)]

a) b)

Generally, this provision allows D to extend contractual installment periods that would otherwise have ended before the proposed period of the plan. D can modify the rights of holders of SECURED (Art 9) claims: (1) Rule: in certain circumstances, D can modify the rights of secured Crs (a) There is no limitation on D’s ability to modify these rights in 1322(b)(2) – instead protection for Cr is in confirmation requirements in 1325(a)(5). (b) 3 ways to satisfy 1325(a)(5): i. Secured party accepts D’s plan [1325(a)(5)(A)]; ii. D’s plan provides that Cr retains the lien + Cr receives the present value of the property (and that value is not less than the allowed amount of the claim) [1325(a)(5)(B)]; or  Wholesale value or resale value (see Associates Commercial Corp v. RASH, 520 U.S. 953 (1997) and Problem 5-12) - only applicable if going to retain the car. iii. D surrenders the prop securing the claim to the Cr [1325(a)(5)(C)] (c) ??? Before Nobelman v. American Savings Bank et al., 508 U.S. 324 (1993), courts held that no modification rule only kicked in after bifircation – impact was benefit to CH13 D – Nobelman changed all that – if D has . . . . (2) Home Mortgagee Exception: (a) Rule: D cannot modify the right of a holder of a secured claim if that claim is secured only by a security interest in real property that is the D’s principal residence. (b) In Application i. ??? Problem 5-14: (c) Exception does NOT apply to: i. D’s attempts to cure default (b/c it only applies to future payments)  Thus, default on a mortgage may be cured under 1322(b)(3) and 1322(c)(1) by providing in CH 13 plan for payment of the arrears by installments. ii. Vacation homes (b/c not a principle residence) iii. Instances where mortgagee has security other than principal residence for loan (because fails “only” part of test). iv. ??? If the final payment under the original mortgage contract falls due within the period of the CH 13 plan, the payment schedule can be amended by the plan so as to stretch out the mortgage payments over the entire length of the plan. v. ??? What happens to under-secured mortgages? (e.g., when the mortgage is only partially secured b/c the value of the home is worth less than amount owning to the mortgage) Nobleman. D can modify the rights of holders of UNSECURED claims

c) 3) 4) 5)

Plan may provide for the curing or waiver of any default [1322(b)(3)]. Concurrent payments: plan may provide for payments on any unsecured claim to be made concurrently with payments on any secured claim or any other unsecured claim [1322(b)(4)]. Long-term debt: plan may, notwithstanding 1322(b)(2), provide for the curing of any defaul within a reasonable time and maintenance of payments while the case is pending on any unsecured claim or secured claim which the last payment is due after the date on which the final payment under the plan is due [1322(b)(5)]. a) This section lets D adhere to original contractual payment schedule rather than accelerating it to bring it within the term of the CH 13 plan but requires cure of default within a reasonable time. Plan may provide for the payment of all or any part of a post-petition claim (aka, a claim allowed under 1305) [1322(b)(6)]. Plan may subject to section 365 of this title, provide for the assumption, rejection or assigment of any executory contract or unexpired lease of the D not previously rejected under such section [1322(b)(7)]. Plan may provide for the payment of all or part of a claim agains thte D from property of the estate or property of the D [1322(b)(8)].

6) 7) 8)

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9)

Plan may provide for the vesting of property of the estate, on confirmation of the plan or at a later time, in the D or any other entity [1322(b)(9)].

10) Catch-all Provision: plan may include any provision not inconsistent with the Code [1322(b)(10)]. 11) “Chapter 20” Approach: a) Scenario: (1) D has secured and unsecured debt – he would like to restructure his secured debt in CH 13 case. D’s

b)

unsecured debt uncludes non-dischargeable student loans. D’s projected income for next 3 years would be just enough to pay his secured debt ad the non-dischargeable student loan. D’s total usecured debt, however, exceeds the CH 13 eligibility limit. Court in D’s jurisdiction will not allow D’s plan to discriminate in favor of his student loan at the expense of debt owed to other general Crs. D present financial condition is such that a CH 7 case would be a no asset case. D files a CH 7 petition, obtains a discharge for his general unsecured debts but not from student loan. D then files CH 13 petition and plan which provides for payment to secured Crs and to holder of student loan. Note that there will no discrimination because the only unsecured debt is that owed to the holder of the student loan. Rule: CH 20 cases are not per se impermissible: (1) ??? Reasoning (2) Johnson v. Home State Bank, 501 U.S. 78 (1991): D wanted to be CH 13 but had too much unsecured debt so D files CH 7, gets unsecured debts discharged, then files CH 13 and now can meet CH 13 requirements. (3) Problem 5-11 – p572.

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4.

Confirmation:

a.

Confirmation Under 1325(a).

1) 2) 3)

General Rule: court must confirm a plan if it meets 6 criteria and if confirmation is not precluded by 1325(b). Court has discretion in determining whether criteria are met. 6 criteria:

a) b) c)

Plan must comply with CH 13 and all other applicable provisions of the Code [1325(a)(1)]. (1) Thus, plan must comply with 1322 requirements. All fees required to be paid before confirmation must have been paid [1325(a)(2)]. Plan must be proposed in good faith and not by any means forbidden by law [1325(a)(3)]. (1) Factors: (a) Accuracy and honesty of D’s financial disclosures; (b) Circumstances under which debt was incurred; (c) D’s pre-petition dealings with Crs (e.g., delaying tactics); (d) D’s dealing with property (e.g., fraudulent transfers, attempts to conceal); (e) Reasons for D’s financial distress; (f) Advantages sought by D in selectin CH 13 over CH 7; (g) D’s financial history; (h) Degree of effort undertaken by D to pay claims and to give CRs fair treatment. (2) Good faith is questionable when D receives a clear advantage under CH 13 without providing any more for Crs than they would have recovered under CH 7. Plan must meet the best interests test for unsecured Crs [1325(a)(4)]. (1) Distribution to be paid to each unsecured Cr under plan must be at leaset equal to what it would have received had estate been liquidated under CH 7. (2) ??? Also requires interest. Treatment of secured Crs [1325(a)(5)]. (1) General rule: unless a secured claimant accepts different treatment, plan must either provide for the collateral to be surrendered to the claimant, or it must preserve the claimant’s lien and provide for full payment of the present value of the secured claim. (2) D has 4 alternatives for treatment of secured Crs in CH 13 plan: (a) Payment of the allowed amount of the secured claim, valued as at the effective date of the plan (i.e., present value of the claim) + preservation of secured claimant’s lien until claim is paid in full [1325(a)(5)(B)]. i. Present value = amount of claim + interest (from when to when) ii. Valuing the claim:  If collateral is worth LESS than the amount of secured claim, amount that Cr will receive is fixed at collateral’s value.  If collateral is worth MORE than the amount of secured claim, amount that Cr will receive is equal to the secured claim amount.  ??? Resale or wholesale value? (b) Surrender the collateral [1325(a)(5)(C)]. i. If collateral is worth less than secured claim amount, the deficiency is provable as an unsecured claim. (c) Consensual treatment [1325(a)(5)(A)]. i. Acceptance is most clearly indicated by an affirmative act of the Cr but failure to object may also constitute acceptance. (d) Omit secured claim from plan, in which case claim survives the discharge. and

d)

e)

(3) Bottom line according to Cohen (a) D may . . . i. Cure defaults.

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(b) Cr’s protection is limited to ensuring that it will recoup the amount of its allowed secured claim
(albeit stripped down).

ii. Adjust interest rates (with exception of Nobleman situation). iii. Strip down liens. iv. Restructure payment periods

f) b.

Plan must be feasible [1325(a)(6)].

Conditional Confirmation Requirement [1325(b)]. 1) Rule: Trustee or unsecured Cr who would receive less than full payment under the plan may object to the plan if the D has not committed to the plan all of his disposable incoe for a 3-year period. 2) Determining D’s “disposable income”: a) See Jones – p608. b) “Income” is broader than “earnings.” c) Tithing expenses should be deducted from what otherwise would be the D’s disposable income. Effect of Confirmation: 1) Plan binds the D and Crs, whether or not their claims are provided for in the plan and whether they accepted or rejected it [1327(a)] 2) Confirmation of plan vests all property of estate in D, free and clear of any claim or interest in it, except as otherwise provided in the plan or the order of confirmation [1327(b), (c)]. 3) Confirmation under CH 13 does NOT operate as a discharge (unlike CH 11) – D is only discharged once plan is consummated or if he receives a hardship discharge.

c.

5.

Review Exercise 16:

89

CHAPTER 11 REORGANIZATIONS – p617

A. SUMMARY CHARACTERISTICS: 1. 2. 3. 4. 5. 6. 7. 8. 9.
SEE CHART – p444Blum. Crs may file involuntary petition. Automatic stay [362] goes into effect upon filing of petition. Automatic stay does not protect co-Ds of the D. POE: D’s property at commencement with a few exceptions, most post-petition prop is excluded pursuant to 541. Disposition of estate property: revested in D on confirmation of plan under 1141. Impact on D’s post-peition income: no set rule, it will depend on plan. DIP, Trustee or Examiner will administer estate and operate D’s business under 1104, 1108. Conversion: D has right to convert with some limitations [1112] and Crs have right to convert to CH 7 case for cause [1112].

10. ??? Dismissal: D, other party in interest or U.S. Trustee may dismiss for cause [1112]. 11. Likely source of fuding to pay Crs’ claims: D is given flexibility in devising sources for funding the payments or making
property distributions under the plan; corporate D may offer securities to Crs [1122].

12. Time period for payment: no set statutory period – period of payments set by plan. 13. Minimum level of payment to Crs: complex standards [1129]. 14. Extent of D’s ability to discriminate in favor of preferred Cr or class of Crs: plan may designate classes of Crs and
discriminate b/w them; CRs in same class must be treated equally unless they agree otherwise; D may not “discriminate unfairly” agains an “impaired” classs [1122, 1123, 1129].

15. D’s power to cure defaults or modify secured obligations: D can cure, restructure and/or modify secured obligations in
the CH 11 plan (except D cannot modify home mortgage) [1123].

16. Crs’ power to participate in formation of plan: Cr committees participate in plan formulation and, in some
circumstances, Crs may file their own plan [1103, 1121].

17. Crs’ consent:

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a. b. c.

Generally, Cr consent is necessary to validate the proposed CH 11 plan. Voting: Crs vote on CH 11 plan; voting takes place within each class and class vote is determined by majority. Cramdown: CH 11 plan can be imposed on a dissenting impaired class provided that certain conditions are met [1129].

18. Discharge a. Available to: individual and corp. b. Breadth of discharge: all debts arising prior to plan confimation c. Exceptions to discharge for individuals: see 523 d. ??? Exceptions to discharge for corps: e. Denial of discharge [727]: grounds for denying discharge apply in liquidating plans [1141]. f. When is discharge granted? At the time of confirmation of the CH 11 plan [1141].

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B. INTRODUCTION – P617: 1. 2. 3. 4.
These are the cases where the MONEY is. CH 11 designed to cover the big corporate case even though it also applies to small corps and individuals. ??? Threat to file CH 11 case is “trump card” for D or Cr. Amalgamation of Benefits of old CHs X, XI and XII of Bankr Act:

a.

Problems with old CH X: 1) Under old CH X, appointment of Trustee was mandatory (old management team replaced by new management team) – no DIP (Cr community did not think a new person – the Trustee – would be able to successfully reorganize the business, and thus Crs would decide not to deal with company [e.g., stop shipping goods, etc]) – as a result, D filed under old CH XI. Problems with old CH XI: 1) But by this time, all Crs would have become secured Crs. 2) Inefficient Problems with old CH XII: 1) Limited to real estate companies.

b.

c.

5. 6.

CH 11 is just a grown up version of CH 13. Overview of characteristics of CH 11 Plan:

a. b.

Debtor-in-possession (DIP) is the norm: 1) Possibilities = DIP or Trustee (completely displace management’s power) or Examiner. Plan is generally the D’s: 1) It does NOT have to be from the D – it could be from Crs or potential investors (especially when case has dragged on for a couple years and D has not yet put together a plan) Cr Committees: 1) Mandatory Committees: a) Statutory requirement that there be a committee of unsecured Crs. b) Rationale: (1) B/c for a CH 11 plan to be confirmed, approval of each Cr class is required (majority of those voting for each class has to confirm the plan). (2) As D you want to know that your plan has a chance of being confirmed so need some way to communicate with unsecured Crs. 2) Permissive Committees: a) Stockholders b) Secured Crs Unlimited modification rights, subject to confirmation requirements (1129). 1) Compare to CH 13 where D has right to modify – only limitations were for non-homeowners was 5-year cap, protection for secured Crs is in confirmation requirements. a) CH 11 follows same general system – protection for Crs is in confirmation requirements. Cr/stockholder acceptance. 1) Both unsecured Crs and stockholders have to approve CH 11 plan for it to be confirmed (unless cramdown).

c.

d.

e.

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f.

Cramdown [1129(b)]. 1) Cramdown = alternative if D cannot get approval of every class. 2) Compare to CH 13 3) Compare to general requirements for confirmation: a) 1129(a) includes the basic confirmation requirements. b) 1129(a)(5)(B) says that D does not need confirmation of “not impaired” class b/c they are paid in full. c) 1129(a)(5)(B) says that each class of Crs and stockholders has to confirm the plan but not everybody within class has to agree (supermajority – no veto power like there is outside of bankr. where CR can file suit, etc.) Discharge occurs at time of confirmation: 1) Rationale: business operate on credit, lets Cr have info when making decision whether to sell/deliver on Cr.

g.

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C. BEGINNINGS OF THE CHAPTER 11 CASE: 1.
Eligibility [109(d)]:

a.

Generally, who is eligible? 1) Corporations 2) Partnerships 3) Individuals (e.g., sole proprietorships and consumers) a) Sole proprietorships: whether or not eligible for CH 13 b) Consumers: whether or not eligible for CH 13 Compare to CH 13: if you were eligible for both CH 11 and CH 13, you would probably choose CH 13. Compare to CH 7: potential to retain assets, rehabilitation.

b. c. 2.

Commencement of Case – p623:

a.

Can be commenced either voluntarily or involuntarily 1) That a case is a voluntary one is somewhat misleading – it is voluntary only in the sense that the petition is filed by the D. 2) Compare to CH 13: remember that CH 13 is a voluntary proceeding only. Filing Requirements [Rule 1007] – p443Blum: Proving claims [1111(a)]: 1) Cr does not need to prove a claim unless its claim is omitted from D’s schedule or is listed as “disputed,” “contingent” or “unliquidated.”

b. c.

3.

The Automatic Stay (revisited) in Chapter 11 – p623:

a.

Once CH 11 petition is filed, automatic stay [362] goes into effect and Cr cannot repossess encumbered prop and Cr must turn over any repossessed prop (see Whiting Pools).

1)

??? What if C has a over-secured interest in D’s house? a) Critically important point - Get PPC’s notes. b) Protection for CR is in “adequate protection” notion [362(e)]. Stay operates regardless of whether D has any equity in prop: a) Instead, Cr has to seek relief from stay: (1) Cr may seek relief from stay by prove that (1) D has no equity in the prop; and (2) prop is “not necessary for effective reorg” [362(d)(1)]. (a) If D is fighting Cr’s motion to get relief from stay, then court will probably conclude prop is necessary for effective reorg. (2) Cr can always get relief if D is not providing “adequate protection” (e.g., no insurance, unsafe storage).

2)

b.

Once CH 11 petition is filed, automatic stay [362] goes into effect and Cr cannot set off deposit accounts, but Cr can freeze the account (see Strumpf ):

1)

Important distinction: a) From Crs’ standpoint, freezing the account serves a protective purpose: freezing precludes D from using the account and this is allowed by code b/c it is “cash collateral” and D cannot use “cash collateral” without court approval, and court will not grant approval unless there is adequate protection for Cr. Example: business D that becomes DIP in CH11 case, will generate an account receiveable.

2)

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3) c.

??? Interest: is any of the interest that would normally accrue on an account available to Cr or D when the account is frozen?

362(a) does not preclude actions against guarantors or co-Ds but can seek injunctions under 105(a):

1)

Under 362(a), pre-petition claimants cannot sue D but can go after co-D or third party guarantor. a) Compare to CH 13 which has a separate provision to protect co-D - 1301 expands scope of stay to protect guarantors. But see 105(a); Otero Mills case; Johns Manville case. a) 105(a) (1) Under 105(a), bankr court has equitable power to enjoin collection action against D’s co-Ds or thirdparty guarantors (a) Rationale: if not protected, then D will not be able to reorg its business. b) Case – In re Otero Mills, Inc., 25 BR 1018 (D.N.M. 1982) - p624: (1) Rule: court may enjoin Cr Bank from proceeding against non-D guarantor if guarantor provides some protection for Cr. (a) Examples of “protection”: post a bond or mortgage on house. (2) Facts: (a) Otero Mills’ president, CHarles Dugan, is guarantor of $600K of Bank loans to Otero. (b) March: Otero Mills files CH11 bankr (c) April: Bank brings suit against Dugan. (d) June: court issues injuction against Bank (e) Irreparable harm if injunction lifted. (f) Possibility of permitting action against non-relevant property c) Case – In re Johns-Manville Corp., 26 BR 405 (Bankr. S.D.N.Y. 1984) – p626: (1) Rule = bankr court most likely to grant injunction under 105(a) when (1) party seeking injunction is D, (2) there would be irreparable harm to bankr estate if injunctive relief was not granted; and (3) no more than minimal hamr will result from granting injunction. (2) Facts: (a) Tort plaintiffs file toxic state tort action against Johns-Manville and other asbestos manufacturers. (b) The effect of Johns-Manville’s CH 11 filing was that the state court actions by the tort plaintiffs were stayed against it but such suits were going forward against the co-defendants. (c) Johns-Manville’s co-defendants asked bankr court to use 105(a) to enjoin the state tort action from going forward against them until the claims of such plaintifss were resolved in JohnsManville’s CH 11 case. (3) Held: bankr court refused to grant injunction b/c Otero elements were not present. (a) No finding that there would be irreparable harm to bankr estate if injunctive relief was not granted. (b) No finding that no more than minimal hamr would result from granting injunction.

2)

d. e.

Relief from stay under 362(d)(2) will not be ordered when there is reasonable possibility of a successful reorganization within a reasonable time” for which collateral is needed (see Timbers). Adequate Protection [362(d)(1)] in CH 11 case

1)

In CH 11 case, “adequate protection” for an under-secured or fully-secured Cr does not extend to lost economic opportunity; nor can under-secured or fully-secured Crs get post-petition interest (see Timbers): a) Facts: CH 11 D owned Bank $4+ million, secured by non-depreciating prop worth less than loan balance. b) Held: CT held that Bank Cr not entitled to compensation under 362(d)(1) for delay in foreclosing on its collateral caused by automatic stay. c) Reason: for purposes of 506(a), “value of such creditor’s interest” means “value of collateral,” not collateral and interest or lost - only over-secured Crs are entitled to post-petition interest.

95

2)

??? Concept of adequate protection does not include maintenance of equity cushion for over-secured Cr (see Alyucan) a) Rule when collateral is depreciating in value: (1) ??? Problem 6-1 – p632: when CR is oversecured and property is depreciating in value and Cr can take no action due to automatic stay, what are Cr’s chances of success under 362(d)(1) to show that lack of adequate protection? (2) ??? Compare to what would happen outside bankr: Cr would foreclose and get . . .. (3) Very few court decisions on this issue. b) Rule when collateral is NOT depreciating in value: (1) If collateral does not depreciate in value, when, if at all, will relief from stay be obtainable? Bankr court may not consider the amount of junior encumbrances when determining whether adequate protection exists for a senior secured Cr (see Mellor) a) Open question: whether senior secured Cr is entitled to post-petition interest to be charge against the junior secured Cr’s position, and if so, whether the junior secured Cr is entitled to adequate protection in at least the amount of the senior’s increase.

3)

4.

Turnover of Property of Estate: a. b. c. d. Provisions: 363(b), 363(c) and 542(a). 542(a) applies to collateral repossessed by undersecured Crs (see Whiting Pools). If collateral is necessary for effective reorg, secured party must turn it over to DIP (even if D has not equity in the collateral). If secured party has repossessed, but has not yet sold the collateral, it must turn it over to DIP.

5.

Control of Chapter 11 Debtor:

a.

Decision-Making Authority: 1) Generally, only officers will have the authority to file a petition under the bankr code, and corp will generally need BOD approval (but probably not shareholder approval). 2) ??? Shareholders probably can force a meeting to displace management in bankr contexts if seek such a meeting within one year (see Lionel Corp. (allowing forced meeting) and Johns-Manville (refusing to force a meeting)). a) Better thing to do is create shareholder committee and include them in plan formulation process. DIP, Trustee or Examiner? 1) DIP [1108]: a) Most common 2) Trustee [1104(a)]: a) Appointment of Trustee will merely displace management to the extent provided for in the court’s appointment order. b) U.S. Trustee shall order appointment of a Trustee in 2 circumstances: (1) For cause: (a) Examples: fraud, dishonesty, incompetence, or gross mismanagement of the affairs of the D by current management, either before or after the commencement of the case, or similar cause, but not including the number of holders of securities of the D or the amount of assets or liabilities of the D; or (2) If such appointment is in the interests of creditors, any equity security holders, and other interests of the estate, without regard to the number of holders of securities of the D or the amount of assets or liabilities of the D

b.

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3)

Examiner [1104(c)] a) 1104(c) mandates appointment when such appointment is either: (1) in the interests of creditors, etc; or (2) D’s unsecured, non-trade debts exceed $5 million. b) Appointment of examiner will merely displace management to the extent provided for in the court’s appointment order c) When examiners are appointed to fill an investigative function, their report may result in appointment of another examiner with broad powers or even by the appointment of a Trustee.

6.

Operating the Business: a. Use, Sale or Lease of POE [363]: 1) Generally, DIP may use, sell or lease (non-cash collateral) property in the ordinary course of business without prior court approval (i.e., advance notice and hearing) [363(c)(1)]. 2) DIP must obtain advance approval to use, lease or sell cash collateral [363(c)(2)]. 3) DIP’s use, sale or lease may be conditioned on providing of adequate protection to secured Crs [363(e)]. Obtaining Credit [364]: 1) Generally, DIP obtains credit from suppliers on an unsecured basis since the obligations receive administrative priority [364(a)] a) Order of Distribution in Bankruptcy (see chart on p383Blum): (1) Secured Claims (2) Ultra-priority Claims (3) Priority Claims (4) General Unsecured Claims (5) Claims for fines, penalties, forfeiture or punitive damages which are not compensative for actual pecuniary loss. (6) Interest on Priorrity and general unsecured claims (7) Any surplue remaining goes to D. b) ??? What is Cohen mean in class # 26 slides? 2) Some post-petition Crs require more than administrative priority: a) Code requires DIP to seek post-petition financing in step-by-step staging system: (1) DIP must first try to satisfy its financing needs through unsecured, administrative priority credit. (2) To offer more, DIP has to obtain bankr court authorization: (a) Authorization will be provided only if: i. credit is not otherwise obtainable; and ii. the existing secured Cr’s interest in the property is adequately protected before the proposed senior or equal lien status is granted [364(c)(1) and 364(d)].  Inadequate protection gives rise to 507(b) super-priority. 3) Cross collaterialization: a) Example of what D can provide when Cr wants “more” to secure post-petition loan. b) Definition: Cr lends post-petition credit to the estate and collateral furnished by the estate to secure the new credit also covers an unsecured or under-secured prepetition claim of the Cr. c) Unclear whether Bankr Code allow cross-collateralization: (1) Adams says yes. (2) Saybrook says no.

b.

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D. 1.

THE CHAPTER 11 PLAN: Chapter 11 Overview Problem:

 2.

See notes on slides

Formulating and Filing the Chapter 11 Plan:

a.

When D may file plan: 1) D may file plan with petition or at any time thereafter [1121(a)]. 2) D has 120-day exclusivity period (after order for relief is entered) in which only it can file plan [1121(b), 1121(c)] but this length may be adjusted by bankr court for cause. a) After this period, any party in interest can file a plan (1) Ability to file competing plans gives Crs negotiating power. Disclosure [1125] 1) Proponent of plan (usually DIP) must submit to Cr’s committee a disclosure statement containing “adequate information.”

b.

3.

Content of the Chapter 11 Plan:

a.

Mandatory [1123(a)]: 1) Certain classes of claims and interests must be designated [1123(a)(1)]. a) Generally classify into secured, priority unsecured and general unsecured. b) Claim/interest classification is very important in CH 11 because affects voting power of Crs. c) Claims in a class must be substantially similar [1122] (1) Generally substantuially similar means claims are of same priority and quality. (2) Each secured claim is usually given a class of its own 2) Specification of unimpaired classes of claims and interests [1123(a)(2)]. a) Unimpaired: no alteration of rights [1124(1)] or no alteration of rights except for the cure of a default and deacceleration with compensation for loss [1124(2)]. 3) Specification of the treatment of impaired classes of claims and/or interests [1123(a)(3)]. 4) Equal treatment of claims or interests in a class [1123(a)(4)]. a) Each claim or interest in a particular class must receive the same treatment nunless favorable treatment is agreed to by the holder of a particular claim or interest. 5) Adquate means for the plan’s implementation [1123(a)(5)]. a) Non-exclusive list of implementation provisions: including selling assets, modifying contracts, issuing securities, merging or consolidating with other companies ,and amending the charter. 6) Voting powers for corporate Ds [1123(a)(6)]. 7) Selection of officers [1123(a)(7)]. Permissive [1123(b)]: 1) Similar to 1322(b). 2) D can choose: a) Which claims to impair or leave unimpaired. b) Whether to assume or reject executory contracts or unexpired leases. c) Whether to settle or adjust claims or interest belonging to the D or the estate. d) Whether to sell all or substantially all of the property of the estate and to distribute proceeds among holders of claims and interests. e) Whether to exercise the modification-of-rights provision [1123(b)(5)] (1) D can modify the rights of holders of unsecured claims and secured claims, except for the rights of holders of a claim secured only by a security interest in real property that is the D’s primary residence.

b.

4.

Confirmation:

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a.

Confirmation Under 1129(a) – Acceptance by all impaired classes:

1)

13 Requirements: must satisfy all requirements in 1129(a)

a) b) c)

Plan is consistent with provisions of bankr code [1129(a)(1), (2)] Plan has been proposed in good faith and noy by any unlawful means [1129(a)(3)] Payments made for services of the like in connenction eith the CH 11 case or the plan must have been approved by or subject to the approval of the court as reasonable [1129(a)(4)] (1) Rationale: protects general Crs from excessive bleeding of estate’s assets. Proponet of plan must disclose identity of certain classes of persons who will be involved with reorganized D [1129(a)(5)] Regulatory commission approval[1129(a)(6)] Treatment of impaired claims and interests [1129(a)(7)] (1) Best interests test: if class is impaired, each member of that class who did not vote to accept the plan must receive a distribution under the plan at least equal to the present value, on the effective date of the plan, of what would have been received had the D been liquidated under CH 7. (a) Rationale: protects dissenters in an impaired class that voted to accept the plan. Acceptance by all impaired classes [1129(a)(8)] (1) Each class of claims or interests must be unimpaired or must have accepted the plan. (2) Accepted = ½ in number and 2/3 in amount. (3) If one impaired class does not accept the plan, then 1129(a)(8) is not satisfied and confirmation can only be achieved via the cram down. (4) Unimpaired classes are automatically deemed to have accepted the plan and their affirmative vote is not required [1126(f), 1129(a)(8)(B)] Priority Crs are to be paid in full [1129(a)(9)] Acceptance by at least one impaired class [1129(a)(10)] (1) Majority of non-insider Crs in one impaired class has to vote in favor of plan. (2) If acceptance of impaired class was achieved only by affirmative vote of insiders in those classes, the plan cannot be confirmed. Plan must have reasonable prospect of success (a.k.a. feasibility) [1129(a)(11)]: (1) Text: plan will fail feasibility if confirmation of plan is likely to be followed by liquidation or need for futher reorganization unless such liquidation or reorganization is proposed in the plan. (2) Crs can use this to challenge plans. All fees payable under 28 U.S.C. § 1930 have been paid, etc. [1129(a)(12)]

d) e) f)

g)

h) i)

j)

k)

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b.

Confirmation Under 1129(a) - The Cram Down:

1) 2)

Purpose: give D means of confirmation even though some classes of Crs or interest holders have refused to accept the plan. Requirements: court shall confirm plan if a) All the requirements in 1129(a) are satisfied except for 1129(a)(8); (1) Most importantly, at least one class of impaired claims accepts the plan [1129(a)(10)]. b) The plan does not unfairly discriminate against any impaired class that has not accepted the plan [1129(b)(1)]; and (1) “Fair” = reasonable basis, it is not motivated by bad faith, and it is necessary to effective reorganization – if it does not have these traits, it is “unfair.” c) The plan is fair & equitable with respect to each impaired class that has not accepted the plan [1129(b)(2)] (1) 3 ways for plan to be fair & equitable for secured claim holders [1129(b)(2)(A)]: (a) D pays Cr deferred payments equal to present value (for fully-secured Crs) and Cr retains lien in prop [1129(b)(2)(A)(i)]; i. ??? What about under-secured Crs? (b) D sells property free and clear of all liens and Cr gets lien on proceeds of sale [1129(b)(2)(A)(ii)]; or (c) D provides Cr with “indubitable equivalent” of Cr’s claim [1129(b)(2)(A)(iii)]. (2) 2 ways for plan to fair & equitable for unsecured claim holders [1129(b)(2)(B)]: (a) D pays Cr allowed amount of claim (present value); or (b) Plan provides that junior claim or interest holders receive nothing. i. Said another way: no junior claim or interest receives or retains any property on account of its claim or interest ii. ??? Example: plan is not fair & equitable if D corp’s stockholders retain their stocks while an unsecured Cr is paid nothing for its claim. iii. ??? New Value Exception: LaSalle (3) 2 ways for plan to be fair & equitable for interest/share holders [1129(b)(2)(C)]: (a) D pays Cr greatest of fixed liquidation preference amount or present value; or (b) Plan provides that junior interest holders receive nothing. i. ??? Example: see LaSalle case. ii. ??? 1111(b) Election:

c.

Effect of Confirmation [1141]: 1) Plan is binding on all parties in interest (D, Crs, shareholders); general rule is subject to the exceptions for discharge. 2) Confirmation vests all estate’s property in the D free and clear of all claims and interests except to the extent that the plan provides otherwise. 3) Brings discharge into effect.

5.

Modification of CH 11 Plan [1127]

a. b.

Pre-confirmation: D can modify plan before confirmation by simply filing a modified plan. Post-confirmation: 1) D can only modify plan after confirmation with court approval. 2) ??? Can others seek to modify plan?

6.

Distribution of Plan Proceeds

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