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					Bankruptcy Chapter 11 Reorganization Spring 2004 with Scarberry Introduction  Why Chapter 11? o Objectives:  Preserve jobs  Assets are worth more as a going concern business than on auction block  Ex: goodwill, Accounts Receivable: harder to collect if customers know that business is liquidating.  Creditors and Liens o Consensual Liens: giving a loan on an asset purchased with credit (mortgage)  UCC Art. 9: gives sellers a lien on personal property sold on credit  Outside bankruptcy, UCC-9 lien holder can use self-help as long as they do not breach the peace o Judicial Liens  Attachment: lien before judgment  Execution: lien on a specific piece of property  Judgment: general lien pursuant to a judgment  BUT: judicial lien obtained 90 days before filing BKR petition is wiped out unless recorded § 547 o Statutory  Liens granted by statute (tax liens) o How Liens are acted upon: Sheriff seizes personal property or disables it. Rea property has a levy recorded against it and is usually sold.  Priority o General Rule: first in time fist in right (1st mortgages have priority over 2nd) o Requirement: To have priority, lien holder must record the lien before  File a financing statement with the Secretary of State  Automatic Stay o Policy: we want to allow the business to continue so we stop enforcement of these liens. Creditors are individually better off with acting quickly, but the group is better off if everyone waits. BKR accomplishes this with the automatic stay. This prevents creditors from destroying the business and thus eliminating the going concern.  Only binds creditors in the profitable future (if business is not going to make money, the stay will be inappropriate).  National service of process  Violation of the stay: to try and collect ANY debt.  Losing Business: 3 Categories o Business cannot cover their going concern expenses and cannot be changed  Opportunity cost in using money (% return)  depreciation o Business can/cannot cover their ongoing expenses and worth more if assets are liquidated.  Creditors are entitled to get at least as much value in Chap. 11 as they would get in Chap. 7 liquidation (must be calculated at present value) o Business cannot cover ongoing expenses, but worth more as going concern than in liquidation.  Reorganization Value: calculated at what amount an investor would pay for the business. o the amount of money business will generate compared with the liquidation value (value of the assets)  3 Major Obstacles to Reorganization Outside Chapter 11 o Premium on diligent collection

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First in time, first in right gives incentive for creditors to act quickly (payment in full for some, no payment for others) o State law collection seizes assets and make them unavailable to business o Individual creditors may not act in collective best interest Bankruptcy is good leverage outside BKR. Benefits v. Burdens of BKR o Risk of further loss o Still operated by old managers. However, many times the managers are changed before the filing (don‟t‟ want to change surgeons mid-operation). o Losing money is not grounds for dismissal if reasonable likelihood of rehabilitation o Unanimity is not needed for confirmation o Binds dissenters. Dissenting creditor generally gets as much value as it would receive in Chap. 7 o Stops collection activities (better for the whole). o Risk of business having to liquidate after even more loss. o Out of court workout cheaper (quicker) o Administrative Expenses: BKR may allow the business to get credit, ensuring that the new claims will be administrative expenses (have priority and paid in full). Decision of BKR v. Out of Court Workout o Advantages o Not depending on self-discipline of creditors o Automatic stay o Access to new credit o Bind creditors w/o consent (leverage) o Reverse certain actions o Special treatment of executory contracts and unexpired leases  Can cure breaches and get contracts back. o Disadvantages o Forces recognition of existing loss  BKR does not cause loss, but make people accept that money has been lost o Risk of further loss to creditors o Expensive o Often a long process o Damages reputation Voting o In Chap. 11 you need 2/3 of the amount of $ of a class claim and ½ of voting members in the class to approve. § 1126(c) o This DOES NOT count the acceptance of insiders Reversal of Pre-petition actions o Can wipe out judicial liens obtained 90 days before filing and get money back that was paid before filing. o Avoiding powers allows business to get back property transferred before BKR was filed (90 days). Executory Contracts and Leases o Can assign a lease of commercial property o Opportunity to cure the breach and get the K back in good standing (not available outside of BK). o Have to pay for the benefit you receive under lease Adequate Protection o Entitled to value of liens o Over-secured creditors get post-petition interest. Regular secured, and under-secured creditors do not.

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o Must protect assets (but we don‟t give preset value on the lien during BKR. Classes o Drafter of the plan creates the classes: 120-180 days exclusivity period. o Can only put two claims together if substantially similar o A lien holder is always in its own class b/c never substantially similar o § 506(a) if the value of the property securing the debt is less than value of line, divide into secured and unsecured parts (two claims)  Property 40K  Loan on property 100K  40 secured and 60 unsecured o Cramdown: If you can find at least one class of claims to accept, you cram it down on everyone else (special rules)  No rule in code that says you have to put substantially similar claims together  Never say “gerrymandering” give a reason  Don‟t count acceptances by insiders for cramdown  Have to have enough support (see voting rules) from non-insider creditor

Best Interest of Creditors Test: § 1129(a)(7)(A)  If you impair the interest of a class, each holder has to: o 1) Accept the plan or o 2) receive or retain under the plan value that is not less than the amount that such holder would receive or retrain if the debtor liquidated. o Dissenters have to get as much as in Chap. 7  Courts usually accept the plan if it does not discriminate unfairly and it is fair and equitable with the class that doesn’t accept.  Discriminate Unfairly: same % of value for the class as compared to another class.  Fair and Equitable: If a class rejects a plan, you have to give them 1) 100% of payment or 2) wipeout everyone jurion to them.

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Four Ingredients for a Successful Chapter 11 Reorganization o Keep Ship Afloat  Needs cash to prevent disruption in business o Turning Business Around  Restructuring the operation to generate more cash than consumes o Determining Claims by and Against the Estate  Use avoiding power to get back various transfers of property that occurred before BKR o Restructuring Debts and Dividing the Enterprises Value  What is the value of the enterprise?  How will the value be divided.  Look at how much cash the assets can generate beyond cash used. Treat as a box that spits out money every year.  Each class treated differently but the same within each class. Financial Statements o Balance Sheets: Assets and liabilities must balance  Doesn‟t usually represent FMV, rather what was initially paid.  Assets – Liabilities = SH equity  Assets = Liabilities + SH equity

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Value Gained with Bankruptcy  Interest stops accruing on unsecured debt in bankruptcy  Accounts receivable get paid for two months o Current Assets: used for determining liquidity  Cash  Accounts Receivable  Hard to recover if business liquidates  Property, Plants and Equipment  Market Transactions to determine worth  Only put cost of units sold o It could take awhile to sell product and we don‟t want to misrepresent on balance sheet  Use an at-cost, can‟t inflate the value of property o Unless the market is easily accessible (like stock) o Depreciation and Amortization. Spread the cost over the life of the property. Keep the original cost and have a negative depreciation (slowly reducing assets).  Match expense with the periods that the assets are of value. (good for a period of time)  Land doesn‟t typically depreciate  Amortization used for tangible assets (life of patent)  Can even amortize patents you buy.  Inventory  LIFO: last in first out o Increases income (because of inflation) and increases taxes (appears that you made more)  FIFO: first in first out o Decreases income and decreases taxes o May not reflect true value in years down the road  Tax Receivables: can get back taxes with a losing business  carry forward 20 years  Prepaid Expenses: asset  Current Ratio: liquidity indicator, if less than 1.0 sign of a problem o Current Liabilities  Debt is an asset. Liabilities plus stockholder equity has to equal other side (assets). Take away some debt in company, makes it worth more.  Debt which must be repaid within 1 year  Ex: accounts payable, short term notes, portions of term loans  Taxes are negative expense o Statement of Cash Flows  Shows people what you paid  See what the company is bleeding Workout Attempt o Cannot “promise” to NOT file BKR o Process: informal committee of creditors o Problem  Creditors not consenting to the workout are NOT bound by the workout AND no creditor wants to be bound if all other creditors are not bound.  Consideration is required to discharge debt (pre-existing duty rule: not consideration to do something already obligated to do)  Give out a promissory note to unsecured creditor in a workout attempt:

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Pre-existing duty, no consideration Promissory note is easier to sue on, this is not consideration

Filing for Chapter 11  Eligibility o § 109(d) To be eligible for Chapter 11, must be:  1) Person residing or with domicile, place of business, property in the U.S. or a municipality  includes: human beings, corps, partnerships, LLC  Not: government agencies  AND  2A) Eligible as a debtor under Chap. 7 other than a stockbroker or commodity broker  Not: RR‟s, insurance companies, S&L associations  OR  2B) Railroad o Debtor Must Be  Insolvent, or  Serious need in dealing with financial difficulty  Ex: Texaco after 10 billion judgment in Penzoil case  Not able to get a bond may be a debt problem  Policy: insolvency is not absolutely required b/c want debtors to us Chap. 11 while there is still chance for a turnaround. o Good Faith Requirement  Cannot use bankruptcy to deter litigation  no serious debt problem  Authorization o Corporation: authorization depends on state corporation laws  Generally: Board must make major business decisions : Chap. 11 is major  Usually doesn‟t need SH approval o Partnership: all general partners must agree, or its an “involuntary petition) o LLC: depends on operating agreement, parties who make key decisions o Special Purpose Vehicles  Governing documents provide for a provision that one of the members owes a primary fiduciary duty to the creditors and that bankruptcy cannot be filed with the concurrence of that person. Usually never consents to bankruptcy.  Jurisdiction and Venue o Courts have to look at core matters of the other cases that affect BKR case. If it is not a core matter, court can only enter proposed findings.  Debts, rights, reorganization plan  Not core: contract interpretation o Bankruptcy Judges  Appointed for 14 year terms  Magistrates: not Art. III judges o Jurisdiction  Filing  Fed. Dist. courts have original and exclusive jurisdiction of all Chap. 11 cases (28 USC § 1334(a)).  Dist. courts can refer any/all cases under BKR code to bankruptcy judges for the district. (28 USC § 157).  Thus: BKR cases are commenced by filing petition with a BKR court. (28 USC § 157(d)).

Judgment  BKR judges cannot enter a judgment  Judgments must be entered by a Dist. Ct. jude  Usually rubber stamp  If there is an objection, Dist. Ct. can review de novo. o Venue § 1408  Venue is proper for Chapter 11 Bankruptcy where: (has been located for the longest for the 180 days immediately preceding filing) 91 days key  Domiciled: of debtor for past 180 days  State of incorporation  Residence: of debtor for past 180 days  Arg: by analogy to § 1391(c): residency could be any district where subject to personal jurisdiction  No, corporations do not have residence  Principle Place of Business: of debtor for past 180 days  Factors, etc.  Affiliate: pending Chap. 11 case o § 101(2) Affiliate: Debtor owns 20% of Affiliate or Affiliate owns 20% of the debtor o Forum Shopping: create subsidiary in desired district with local assets. After subsidiary files there, Parent company can too. o Issue: if one affiliate files in a district, can another affiliate file there?  Unclear: So, have affiliate 1 file, then parent file, then affiliate 2 files. Professional and Ethical Issues Powers of Committee § 1103  Hire professionals Professionals o Attorney for Corporation and not for Managers  We sometimes accept that managers are going to keep their own interests.  Atty‟s responsibility to call DIP to their fiduciary duty.  If DIP is doing “bad things” then the court will appoint a debtor trustee who can waive the attorney-client privilege see Weintraub o § 327 (a) Trustee/DIP with court‟s approval may employ one or more attorneys, accountants, appraisers, auctioneers, and other professionals  must file application for retention quickly (only courts may not apply retention retroactively (not pay)). o Requirements  § 327(a) Professionals cannot hold or represent an interest adverse to the estate.  Shareholder: too risk prone  Officers: salary  Landlord: rent/lease  Gurantor: incentive to have debt paid to detriment of estate (unless it was a fraudulent guarantee, ie no consideration, then likely wiped out)  § 327(a) Professionals must be disinterested  § 101(14) Creditor, equity holder, insider  § 101(14) Investment banker for an outstanding security of the debtor  § 101(14) Investment banker for any issuance of securities for 3 years before filing  § 101(14) A director, officer, or employee of debtor, for two years before filing

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§ 101(14) Indirect materially adverse interest to any creditor, equity holder by relationship with above parties.  Exception  § 327(b) In House o Professionals regularly employed and receiving salary (in house) may be retained (or replaced) o Cannot be used as general BKR counsel but can assist  § 327 (c) Representation of Creditors o Employment by representing a creditor, alone, does not disqualify from representation of the debtor. o Unless: objection by another creditor or trustee: court determines if actual conflict of interest exists o But: NOT generally permitted  § 327(e) Special Interest Counsel o No conflict because dealing with a particular issue (anti-trust, IP, etc.) o Not interested w/ respect to issue employed, so can defend w/ personal injury claim but not represented w/ BKR.  Representing Parent and Subsidiary Can Cause Conflict o See White Glove o § 1107(b) Professional is Not Qualified Solely b/c of Past Employment by Debtor o Small Minority: § 1107(b) also implies that debts arising from pay employment by debtor o Majority: § 1107(b) does not waive disinterested requirement. Small Debt o Still interested o Only: makes it easier for creditor to waive debt Services Rendered in Workout Attempt o Professionals not disqualified for services rendered for filing of BKR (administrative expense). But court must still approve the representation of counsel…if not then no compensation for counsel. o BKR starts only after petition filed, so service provided in workout are technically not part of the BKR and are “claims” o BUT: argument that the workout should be included as “cost of filing” but most courts reject this. Filing Costs o Money paid for services provided to Debtor to enter BKR cannot disqualify professional Failure to Disclose Existence of Debt (even if would have been approved) o There is harm and judge has discretion to disqualify o Rule #1: always disclose everything Issue o Debtor‟s debt to a professional is guaranteed by another o White Glove: still interested, professional must waive debt  Mere appearance of conflict is not enough to deny choice of counsel. If there is a potential conflict we would normally deny the right to specific counsel and def. if there is an actual conflict. Firm would need to withdraw when conflict occurs.

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Creditor’s Professionals  Creditors/Equity Holders Committee can hire professionals o Limits: § 1103(b) o Professionals hired by a Committee may not represent any other entity having an interest in connection with the case.

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Representation of one or more creditors represented within the committee is not a per se adverse interest  Critical Issue: Potential for Litigation between Creditors and Committee  Walnut Equipment, Court found no adverse interest even though law firm agreed to not act adversely to the client. Potential conflict? Yes, but did not disqualify b/c no actual conflict.  Questionable b/c counsel less likely to be as zealous in representing committee. Compensation o § 330 Court can award reasonable compensation to professionals under § 327 or § 1103 o § 328(c) Court can deny compensation if professional was not disinterested or had an adverse interest o Retainer: counsel may demand a retainer to draw upon

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The Automatic Stay § 362  § 362(a) Once a petition has been filed, it operates as an automatic stay.  Policy: gives DIP breathing room to get reorganization in place.  Prevents free for all frenzy under state law  Different than a court of equity which doesn‟t bind individuals without notice. Here, the automatic stay essentially deprives people of action‟s validity w/o notice.  Doesn‟t eliminate debts, but rather makes this a collective rather than an individual proceeding. Equal treatment of creditors.  Presumes proof of claim unless disputed  Goal: protect value of estate for protection of creditors o No entity can:  1. Commence suit to recover a claim arising before filing  stays: processes, subpoenas, depositions, writs of execution, status conferences, dismissals void  2. Enforce judgment obtained before filing  Ex: creditors of DIP trying to garnish money from debtor (Accounts Receivable is property of the estate).  Ex: creditor cancels contract with the DIP once DIP enters bankruptcy (Contract is property of the estate). o Most courts, the creditor cannot suspend performance.  3. Act to obtain or exercise control over property of the estate  4. Create or enforce liens against the property of the estate obtained before filing.  Ex: seeking Writ of Attachment (creates a lien)  6. Any act to collect debt arising before the filing  Issue: creditor refuses to do further business with DIP who declares bankruptcy o Courts: refusal to deal with DIP is not an act to collect o BUT: say refusal to deal, unless you pay us pre-bankruptcy debt…will be a violation of the automatic stay; but what is the remedy? Usually require the require to deal with them at the ordinary price (COD OK). o Creditors as DIP to use “doctrine of necessity” will also violate the automatic stay. o Creditor must simply be “silent” and refuse to deal.  7. Setoff for any debt arising before the filing  8. Commence proceeding before U.S. tax court  Duration o § 362(c) Automatic stay continues until earliest of:  Bankruptcy case closed, or

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Bankruptcy case dismissed, or § 524 Stay is replaced by a “discharge injunction”  § 524 creates permanent injunction which renders void any judgment at any time as to DIP‟s claims discharged by a bankruptcy court

Exceptions o Police and Regulatory Actions  § 362(b)(4) General Rule:  Police and Regulatory Actions can be taken to judgment (whether monetary or injunctive)  Judgments from Police and Regulatory Actions can be enforced (except for monetary judgments)  Injunctions require DIP to take steps which cost money is NOT considered a „money judgment‟ Penn Terra o Some question if the injunction is to only remedy past harm. If it is to prevent future harm then clearly not a money judgment. More important to look to see if it is subterfuge. If there is subterfuge going on, then the injunction will not be enforceable.  Criminal contempt fines are NOT money judgments  Civil contempt fines MAY be money judgments.  If DIP fails to comply with environmental laws and the state or agency must do so, the money expended by the state or agency is considered reorganization Administrative Expenses and get priority in payment.  DIP must comply with valid law o Issue: Insertion of Chemical Weapons language  Plain meaning: only chemical weapon regulatory actions are exempted from the automatic stay  But read and applied: government entities can exercise police/regulatory actions in spite of automatic stay § 362(b)(3) §362(b)(6) o Tax Liens  § 362(b)(18) Automatic stay does not prevent property taxes becoming due post petition from becoming liens on estate.  Supplemental Injunctions o § 105(a) “Courts may issue any order necessary or appropriate to carry out the provisions of the bankruptcy code.” o Discretion to protect o Can be used to protect a third party not protected by the stay, but has 1) special knowledge or 2) are needed for reorganization. Protect reorganizing corporation by protecting them.  Appeals o Stay applies to all lawsuits brought against the DIP (includes appeals)  Guarantor’s of DIP’s debt o General Rule: Guarantors of DIP‟s debts are NOT protected by automatic stay  Even if guarantor is a subsidiary of DIP (unless harm will occur to the value of the assets of the estate)  Example: suing subsidiary for stock of DIP to satisfy claim will be OK. Unless the attempt to seize stock is part of a plan to gain control and get to the assets of the DIP. (stock = votes = new board = liquidate)  Exceptions o Courts may apply §105 injunction if there is an Identity of Interest

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Example: Debtor has Indemnity Agreement (will pay if G‟s loses) with Guarantor. A.H. Robbins  If not allowed to proceed: Creditor: disputed PI claim; Guarantor: contingent disputed claim  If allowed to proceed: Guarantor: undisputed contract claim of indemnity o If Guranator is officer or critical to business of DIP, court may give stay under §105(a)  Reasons: distractions, takes money away that could be put towards reorganization (money defending),  Critics: allows Guarantor to through good money after bad instead of giving to creditors.  Also: IF no consideration, guarantee is fraudulently obtained o Issue: preliminary injunction vv. Permanent injunction of limited duration  Preliminary injunction is usually only granted where demonstration of success on the merits is likely.  Here, Court grants based on reorganziation‟s chance of success.  Use of PI is inapplicable. Violations of Automatic Stay o § 362(a) The automatic stay applies to all entities  includes governmental entities  U.S. Sovereign Immunity  § 106 waives federal government immunity, including liability for monetary damages  State Sovereign Immunity  Split: 6th Circuit overcomes sovereign immunity  Sup.Ct: Likely to find bankruptcy code does not overcome sovereign immunity (intent to abrogate). So, State court not obligated to follow federal law and hold state liable for violating the stay.  Injunctions  Not actually issued against the State  Issued against persons who are state officials violating  Thus, courts can enjoin but not obtain money damages from state o Issue: IRS tells Bank to garnish DIP’s bank accounts  IRS liable for violation of the automatic stay  Bank: arguably acting in concert to violate the say  Also, may violate § 542(b) debtors of the DIP must turn over property to the estate  § 542(c) Exceptions: entities are not liable if NO ACTUAL NOTICE or knowledge of the filed bankruptcy petition. Violations are VOID o Acts violation the automatic stay are VOID (not voidable), and subject to retroactive annulment of the Stay o No action necessary to set aside lien obtained in violation of the stay (it‟s void) o BUT: if court grants retroactive annulment of the Stay, this will give legal effect to actions taken in violation of the Stay (acts like Stay never existed) Recovery by DIP o Individual‟s injured by any willful violation of a stay shall recover actual damages, including costs and attorneys‟ feels, and may recover punitive damages o Are Corporations individuals?  Courts are split…some say yes, others no.  So, court can issue contempt sanctions in favor of the DIP o Willful?  Knew of bankruptcy  Intent to do the act which violated the stay

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Relief from Automatic Stay o Courts may grant relief from stay: o § 362(d)(1) For Cause  Lack of Adequate Protection  Adequate protection does not include the opportunity to get money out and invest it. No claim for unmatured interest.  Policy: Senior creditors NEVER have to give anything to junior creditors. This comes into play with subsequent mortgages on property. First gets FULLY paid, first.  Unsecured Creditor o Protection of unsecured creditors in collecting debts out of DIP‟s assets o Unsecured claim does not rise to level of property interest (must have a lien) o Not entitled to adequate protection o Only entitled to dismissal of case and conversion to Chapter 7 liquidation (§1112) o But: mere continuation of losses is insufficient grounds for relief o Requires: continuing losses + no reasonable likelihood of successful reorganization o Contrast: secured creditors can get relief from stay if property interest being injured in value.  Under-Secured Creditor o Under-secured creditors are entitled to protection against any further drop in value of their collateral. o Not entitled to NPV (potential value?) of collateral or interest on debt for delay of foreclosure.  No interest because where would it come from? If you don‟t have a right to any excess, then some other property would have to be used to give you interest and you don‟t have an interest in that other property. o ONLY: amount of property value at the filing of the petition.  Over Secured Creditor o § 506 over-secured creditor is entitled to post-petition interest for delay on foreclosure to the extent the creditor is oversecured  Four theories of Adequate Protection o Extreme Anti-Secured Creditor View  Adequately protected so long as end with size of claim that existed at filing. (Timbers: no requirement for maintaining present value) Basically this view says we pay you out at the end of the case, so then we will look at the situation, and there is no protection above the amount of the original claim (may not get any interest). o Moderate Anti-Secured Creditor View (intersection point)  Only necessary to protect the value of collateral immediately necessary to fully secure claim (at a given point in time)  Creditor only receives interest until depreciating equity cushion equals creditor‟s increasing claim, then that value is maintained o Moderate Pro-Secured Creditor View  Adequate protection requires maintenance of the initial value of collateral at the time of filing  Creditor only receives interest up to amount of initial equity cushion

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 Most courts apply (Orix) o Extreme Pro-Secured Creditor View  Adequate protection requires that equity cushion be maintained above amount of claim, even as interest accrues and size of claim increases  Ex: If 10% over-secured at petition, DIP must maintain at 10% equity cushion o Issue: Real Estate  Courts often grant relief from automatic stay if equity cushion is 5% or less in real estate situation because large market fluctuations make protection of value of collateral inadequate.  Ways to Harm Creditor  General wear and tear  Failure to maintain insurance  Failure to pay property taxes o If not paid, tax claims are superior claims (even to secured creditors)  Failure to make interest payments to senior mortgage holders o If not paid, principle of senior lien increases, thereby reducing the secured amount of the junior lien  Ways to Protect Creditor  Cash payments equal to amount of collateral  Replacement lien on other property of equal value  Lien on funds in an account o Lack of Good Faith in Filing  Some Courts  Filing in advance of litigation (defensive choice) o § 362(d)(2) No Equity and Not Necessary  DIP has no equity in the property AND  Property is not necessary for effective reorganization o § 362(d)(3) Single Asset Real Estate Project  4 million dollar ceiling (may be repealed)  Court shall grant secured creditor relief from Stay UNLESS DIP w/in 90 days of filing (or court extension)  A: Files a plan of reorganization that has a reasonable possibility of confirmation within a reasonable time. o Problem: DIP does not know what has a reasonable chance. o Issue: What if plan could be passed with slight amendments? OR  B: DIP has commenced monthly payments to each secured creditor equal to interest at FMV rate on the value of the creditor’s interest in real estate o Issue: what if interest paid on day 88 is $5.00 short? o Probably allowed to pay the extra amount. Modifications by Other Courts o Automatic Stay is a Court Order and no other court can modify another court‟s order Contractual Consent o Pre-Bankruptcy Contractual Consent  Unsecured: court would never enforce  Secured: split  Some: against bankruptcy policy  Other: promote negotiations and workouts o Post-Bankruptcy Contractual Consent

Most courts would enforce Rationale: denies other creditors Due Process because substantially their rights should be give notice do can object  Elevating Pre-Petition Debt Priority o General Rule: DIP cannot elevate a creditor above any other or pay a creditor before any other o Exception: Doctrine of Necessity  If DIP must be able to deal with creditor who refuses to deal with DIP, DIP can pay claim outside of bankruptcy  Example: wages for workers (consequences: lose good employees, pay themselves with stuff, vandalism)  Also high priority, would get paid anyway  Rule:  9th Circuit: does not recognize anything outside of RR reorganizations  Other: will allow where there is only one supplier  Turnover of Property to the Estate o § 542(a) requires 3rd parties to turn over property (or the value of the property) to the DIP o § 542(b) requires 3rd parties to repay debts owed to DIP  Except to extent that such a debt may be set off against a claim against DIP  § 506 right of setoff is treated as collateral for secured interst  Example: creditor bank can freeze DIP‟s bank accounts (Strumpf)  Rationale: checking account is not debt, but a K, refusal to pay is not a setoff but a breach of K.  Limit: only up to amount owed to the bank  Requirement: bank must immediately ask bankruptcy court for relief from stay.  Exceptions: Leasehold Interests o § 541(b)(2) A DIP‟s lease of nonresidential real property ceases to be part of the estate upon termination of the lease, whether it terminates before the filing or even during the bankruptcy case.  Q: is this only with relation to the date of the lease or can it terminate for other reasons? Avoiding Powers Strong Arm Avoidance Powers § 544(a)  Hypothetical Judicial Lien Creditor Test § 544(a)(1)  Rule: DIP can avoid lien if a hypothetical judicial lien creditor could have defeated the lien at filing . . . Eliminates the security interest (secured claim becomes unsecured claim) o Lien holders must give sufficient notice to maintain lien  File financing statement  Possession (if tangible asset . . not, eg, AR)  Statement filed with DMV (noted on cert. of title) (where Lien on Motor Vehicles)  Bona Fide Purchaser of Real Estate Power § 544(a)(3)  Rule: DIP can avoid unrecorded mortgages if hypothetical Bona Fide Purchaser would defeat mortgage at filing . . . Eliminates the security interest (secured claim becomes unsecured)  Defense: cannot avoid if Mortgagee has already taken possession Preference Law  Rule: § 547(b) DIP may avoid Debtor‟s previous transfer of interest of Debtor in property if constitutes a preference o Requirements: § 547(b)  Transfer of Property  Ex: Paying 100K debt to creditor for 100K debt  To or for the benefit of a creditor  Ex: Benefit of receiving money

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For or on account of antecedent debt  Debt must be owed before payment is made Made while the Debtor was insolvent  If payment was within 90 days of bankruptcy, typically a dispositive presumption of insolvency. (Hard for creditor to find evidence otherwise) Made within 90 days of the bankruptcy filing OR within 1 year of filing if the transferee is an Insider For MORE than would have received in bankruptcy  Generally violated ANYTIME the creditor receives full payment  Transfer to undersecured creditor . . . More o Whole transfer is avoidable if received more than would have received in bankruptcy (if get full value)  Small transfer to undersecured creditor o Ex: 1K payment on 100K debt with $75 collateral o General Rule: “MORE” Any payment to an undersecured creditor gives undersecured creditor more than would receive in BKR. Rationale: any payments made to undersecured creditor generally only reduce amount of unsecured claim (75K secured +25 unsecured = 75 secured + 24 unsecured) o Exception: “not more” Not avoidable if payment reduces amount of secured claim. Ex: payment from sale of part of collateral; Agreement with creditor to reduce lien for payment  Debtor gives fully secured creditor additional collateral . . . not more o Courts: because already oversecured, cannot get more than full value. Even though allows creditor to get more post-petition interest.  Debtor gives unsecured creditor collateral . . . more o Unsecured creditor gets more than would receive in BKR b/c collateral allows unsecured creditor to get full value for a portion of his claim.

Defenses: § 547(c)  If recipient of preference can establish defense, can retain the property o No Defense = Transfer is avoidable preference o Defense = Transfer is non-avoidable preference  Contemporaneous Exchange Defense §547(c)(1) o To the extent the transfer was INTENDED to be a contemporaneous exchange of new value, then not avoidable. o Ex: Forget to sign mortgage at closing, do so 2 days later (Not: decide 2 hours later that need mortgage) o Ex: Check when buys groceries (money transfers later, but intent is for contemporaneous exchange)  New Value Defense §547(c)(4) o To the extent the creditor extends additional credit after receiving transfer, creditor can keep transfer  § 547(c)(3) o cannot avoid if creditor files financing statement within 20 days of receiving transfer  Ordinary Course §547(c)(2) o Cannot avoid if debt incurred in ordinary course, payment made in ordinary course (not from pressure of creditor) and not too strange o Rationale: encourage creditors to refrain from pressuring debtor to pay (very large exception)  Security Interest in Inventory or AR §547(c)(5)  Test o If Creditor is oversecured 90 days before petition: Preference cannot be avoided

 DIP cannot avoid the preference o If Creditor is undersecured 90 days before petition: Preference CAPPED  DIP can avoid preference to the extent the Creditor‟s secured position improved over the 90 days before filing.  Rationale o If creditors would not lend to Debtor (based on lien on Inventory/AR) if creditors through that might lose liens if bankruptcy occurs  New liens in AR/Inventory are continuously being created (revolving door) Finding Cash to Continue Operations  Ways to Get Cash in BKR o Asset sales, using cash collateral, borrowing, trade credit  Asset Sale §363 v. Debt § 364 o Asset Sale §363: interest on claim limited by the value of the collateral o Debt §364 (cross-collateralization): no limitation on post-petition interest based on the value of the collateral  Use, Sale, or Lease of Estate Property §363 o Advantages: avoids creditor vote to approve and disclosure requirements  Ordinary Course Transactions o DIP may enter into transactions in the ordinary course of business without notice or hearing §363(c)(1) o “Ordinary Course of Business”  Horizontal Test: Industry standards (what similar companies do)  Vertical Test: Creditors‟ particular expectations (what this company has done in the past) o Exception: Cash Collateral o Rule: DIP may not use, sell, or lease cash collateral unless CREDITOR CONSENTS or CREDITOR NOTICE and COURT AUTHORIZATION §363(c)(2)  Creditor Consent: Debtor must obtain consent of creditor with lien on property §363(c)(2)(A)  Creditor Notice and Court Authorization: Debtor must provide notice and obtain court authorization AND adequate protection. §363(c)(2)(B) o Cash Collateral: Includes cash and cash equivalents in which the estate and another entity both have an interest (whenever acquired) §363(a)  Ex: Deposit accounts; proceeds from sale property subject to a lien; fees or other payments from use of lodging property subject to lien.  Non-Ordinary Course Transactions o Rule: DIP must give notice and opportunity for a hearing before use, sale, or lease of property of the estate in ordinary transactions. §363(b)(1) o If objection: Court requires Sound Business Reason  Majority: DIP must have an articulated sound business reason for sale of assets  If sound, court will not evaluate that decision  Generally, can almost always find a reason (ex. needed cash)  But: creditor pressure is not a sound business reason  Limitation: Interested transaction. Court will insist that transaction is “completely fair” (much less deference) o Issue: Can use to circumvent § 363(c)(2)?  Yes, if no one objects, but would likely incur wrath of the judge later  Technically: could use to circumvent cash collateral requirements Sale of Property Free and Clear of Liens §363(f)  DIP can sell encumbered property of estate free and clear of liens if: o Nonbankruptcy law permits sale of such property free and clear

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Ex. Buyers in ordinary course paying value in good faith take free and clear of any security interest. UCC Art. 9 o Creditor consents o Property is sold for price greater than the total value of all liens on the property  Issue: value of liens cannot exceed the value of the property  AND: if amount of liens exceeds the value of the property, value of liens = value of property  BUT: Price must EXCEED (not equal) the value of all liens  SO: Must sell for an amount greater than the AMOUNT of total of all the liens  Some Courts: (minority) Becker Industries  Read § 363(f) as “greater than or equal to” which allows DIP to sell free and clear  But wrong b/c would allow to always sell free and clear  Rationale:  If there is some value beyond the liens allow the DIP to recover that value o The validity of the interest is in bona fide dispute  Rationale: May be value for the estate b/c the lien may be invalid o The creditor could be compelled to accept money satisfaction of its security interest  Unknown meaning: seems to make other exceptions superfluous  Some: this means that Debtor must be able to pay off lien  Others: this applies to weird interests Good Faith Requirement/Reversal on Appeal §363(m) o Reversal on Appeal of authorization of sale or lease of property does NOT affect the validity of sale or lease if:  Purchaser purchased or leased in good faith (regardless of knowledge of appeal) and  Not collusive bidding for assets: grounds for setting aside sale  Authorization and sale was not stayed pending appeal  If no good faith, buyer can be liable for any discount from FMV or to return the property Sales as Part of Reorganization Plan o All Debtor‟s debts are discharged and replace by permanent injunction o 3rd parties: cases are all over  9th Cir: No basis in statute for discharge of debt of anyone other than debtor  Other Courts: can discharge if creditors consent  For Certain: if creditor does not want 3rd party release to bind it, must:  Object in BKR court, and File timely appeal Sale of ALL or Substantial Portion of Assets Outside of a Plan o SPLIT:  Some courts: Require that creditors receive disclosure statement and vote on transaction  Other: allow such sales under §363 b/c nothing expressly precludes such sales Sale as Sub Rosa Plan o Many courts: If a sale determines the course of the reorganization in the future, then sale cannot be authorized outside a Reorganization Plan. Property not sold free and clear may be lost through foreclosure by secured party

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Obtaining Credit § 364  Ordinary Course Credit o DIP may incur unsecured debt in ordinary course of business as an administrative expense without a hearing or court approval §364(a) o Administrative expense priority makes post-petition debt easier to obtain than pre-petition debt o “Ordinary Course of Business”  Horizontal Test: Industry standards (what similar companies do)

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 Vertical Test: creditor‟s particular expectations (what this company has done in the past) Non-Ordinary Course Credit o DIP must obtain court authorization after notice (opportunity to object) and a hearing in order to incur unsecured debt not in the ordinary course of business as Administrative Expense §364(b)  If there is any doubt about ordinary course, DIP should obtain court order  However: might not need authorization if debt does not have Administrative Expense priority. Roth American Super Administrative Priority Debt o DIP is unable to otherwise obtain unsecured debt on an Administrative Expense priority basis, court may authorize debt with Super-Administrative Expense Priority after notice and hearing. §364(c)(1)  Paid off before all other Administrative Expenses (unless converts to Chap. 7) Debt Secured by a New Lien on Unencumbered Property o DIP is unable to otherwise obtain unsecured debt on an Administrative Expense priority basis, court may authorize debt secured by a lien on property not already subject to a lien after notice and hearing. § 364(c)(2) Debt Secured by Junior Lien on Encumbered Property o DIP is unable to otherwise obtain unsecured debt on an Administrative Expense priority basis, court may authorize debt secured by junior lien on a property already subject to a lien after notice and hearing § 364(c)(2) Debt Secured by Priming Lien o DIP is unable to otherwise obtain unsecured debt on an Administrative Expense priority basis, court may authorize debt secured by senior lien on property already subject to a prior lien §364(d)(a)  More often threatened than used  Courts almost never do this (if not one would willingly take a second lien position, then first lien holder probably is not adequately protected if forced into second lien position) o Two circumstances where using this is likely:  Unfinished building is ¾ finished (20M value and 30M mortgage)  Need additional 4M to complete and increase value by 6M  New lien actually increases value of old lien b/c building is worth so much more when complete  Building needs renovation (20M value and 30M mortgage)  Need 200K to do renovations  No creditor wants a small lien junior to a very large senior lien  But large lien that is junior to only a very small senior lien is not harmed much Good Faith Requirement/Reversal on Appeal o Reversal on appeal of authorization to incur debt does not affect the validity of any such debt incurred IF: §364(e)  Lender extended credit in good faith (regardless of knowledge of appeal) AND  Authorization and incurring of such debt was not stayed pending appeal o Issue: Buying a higher priority pre-petition claim from another creditor (in order to further organization) and trying to claim more value than in original claim  Ex: extra value for attorney fees for transaction  Court may find Bad Faith (Ex. EDC Holding Co.)  Counter argument: this same amount would constitute a reasonable loan origination fee o Installment Loans: On appeal, court can reverse order authorizing loan installment, but not alter the rights of the lender as to installments already lent in good faith (Swedeland) o Possible Exception: Building being constructed with installments  If future installments are stopped, puts installments already lent by lender at sever risk.

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SO: court can affect rights as to installments already lent in good faith by denying later installments Cross-Collateralization o Ex. One item of property serves as collateral for two different debts o Good Form: Collateral for creditor‟s pre-petition debt also used for same creditor‟s post-petition debt o Bad Form: Requiring collateral for creditor‟s post-petition debt also provide additional collateral for same creditor‟s pre-petition debt (only permitted for adequate protection)  Not included under §364: collateral can be taken away  6th and 9th Cir: Admamson Not-Reversible  If BKR court order provides CC and money has been lent, and appeal is dismissed as non-reviewable  11th Cir: Shaprio Reversible  Can review on appeal b/c protection §364(e) requires that it must be a “grant under this section” since nothing in §364 allows the grant of additional collateral for pre-petition debts o Bankruptcy Courts: Have allowed cross-collateralization in emergency situations. Priority: CANNOT give Administrative Expense priority to pre-petition debts.

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Controlling and Supervising the Reorganization  DIP o Ordinary Course Transactions  Two Tests  Horizontal: what similar companies do  Vertical: 1) Most: would creditors expect that debtor would normally engage in this transaction 2) Some: would creditors expect to hear about transaction it is carried out. o Issue: Collective Bargaining Agreements  Probably not ordinary course b/c: 1) can greatly prejudice other creditors 2) can make reorganization impossible if breached 3) not the kind of transaction that would make DIP go to court to get approval all the time.  Some authority: ordinary course o Issue: Severance Pay Agreement with Management  Purpose: incentive to say with company during BKR  Not ordinary course of business  Even if normally done by companies in BKR, BKR not an ordinary occurrence  Some courts: anything done specifically in response to BKR is NOT ordinary course  Also: can act like a poison pill which discourages Trustee or Chap. 7 b/c huge administration expense. o Interested Transactions  Courts are not as deferential to DIP‟s business judgment (will look at decision more closely)  Less inclined to give super-priority or priming lien if interested transaction  Definitely not if would make an oversecured creditor undersecured  Anytime there is an interested transaction, creditors should have noticed to evaluate fairness  Trustee  Appointed in two scenarios §1104  For Cause o Fraud and Dishonesty: DIP violates fiduciary duty to creditors (need someone who will not defraud them) Issue: conflict of interest (DIP also owns half of customer) = insufficient

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o Incompetence: Inability to manage appropriately, or Gross mismanagement of the affairs of the debtor (able to manage but other problems . . . example . . .too busy) In the interests of ALL the constituents in the estate o NOT:  Conflict b/w interests of SH‟s and creditors = insufficient  Help creditors more, instead of SH‟s = insufficient  Big, important company = insufficent o Standard: clear and convincing evidence o Court’s Discretion  Though not clear from Code, courts often claim broad discretion in determining whether “cause” exists (AH Robbins 10th cir)  However, no discretion once “cause” has been found . . . the Code states “shall” o Courts reluctant to appoint Trustees  Trustee must get up to speed, exclusivity period only lasts for a limited time, and creates bad incentive for managers to tile for Chap. 11 before too late (fear of losing jobs) Selection of Trustee: o US Trustee selects the Trustee for the BKR case o But: BKR judge can veto the selection o But: Creditors can elect a new trustee if more that 20% of the amount of claims are vetoed  §1104(b) and §702 Compensation: by moving for Trustee, creditors may be agreeing to have Trustee paid out of their collateral Corporate Governance o General Rule: State corporate law still determines corporate governance in Chap. 11 (SH‟s elect directors, who hire managers) o But: subject to overruling by court IF clear abuse:  “clear abuse” Real threat to a successful reorganization  Ex: using threat of replacing Board: not clear abuse  Ex: replacing board with one more sympathetic to SH‟s: not clear abuse  Ex: electing new board with no knowledge of debtor‟s business: clear abuse Committees: o Equity Committee: 1) not automatic (unlike creditor committee) 2) multiple committees  Wang Laboratories court said no b/c the cost of the committee outweighed the need o Creditor Committee  Purposes: 1) keep an eye on the DIP (ex. hire lawyer/acct to keep eye on things; ask DIP to bring avoidance actions) 2) Negotiate a play with Debtor‟s management (recommendations given weight by creditors when voting on plan) 3) Resoluation of inter-creditor conflict o Multiple Committees: Court said no b/c creditors have adequate voice through representation on 1 committee (Hills Store Co.). If individual creditors want professionals, must pay for them on own. o Grounds for Removal  Improper Relationships: Yes  Ex: father of DIP is on creditor committee  Gruff is the principle shareholder  Disputed Claim: No o Risks: although committee members receive qualified immunity, can still be sued (costly).

Executory Contracts § 365  What is an executory contract? o Contryman Test: If either party has substantially performed, then NOT an executory contract

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o However: some legislative history suggests that contract is executory if ANY duty remains unperformed. o Ex: If DIP has fully performed and all that remains is non-debtor‟s performance, DIP interest is purely an asset. So, no election to assume is necessary. Rationale: do no want risk that DIP might discard right to performance which might be valuable o Ex: If non-debtor performed and all that remains is DIP‟s performance, non-debtor hold a general unsecured claim (not an administrative expense) Interim Period o Majority: Non-debtor must continue performing while DIP decides to assume or reject, even if DIP is in material breach.  Witken and Keller, Court can force non-debtor to keep performing with §105(a) injunction o But: Conflicts with Doctrine of Constructive Conditions underlying theme of §365  If one party is not willing to undertake the burden, then should not enjoy the benefit  Indicates that DIP should not enjoy benefit until decides to undertake the corresponding burden o Exception: non-residential real property  If DIP neither assumes nor rejects lease in non-residential real property interest within 60 days of filing, lease is deemed rejected (DIP must vacate premises). §365(d)(4) Accepting/Rejecting: DIP may assume or reject any executory contract or unexpired lease of the debtor, subject to court approval §365(a) Rejection of executory contract? o General Rule: Damages for breach of executory contract are general unsecured claims §365 and 502 o Exception: to the extent that performance was rendered to DIP during BKR, creditor will be given and administrative expense. o Effect of Rejection by DIP  Rejection IS NOT an avoiding power  Not recission and does not require non-debtor to give DIP back anything previously received under the contract. (Ex. DIP cannot get lad back after already transferred title) Assumption of executory contract: o Requirement: If DIP has breach the executory contract, it may NOT assume until the DIP cures or provides adequate assurance of prompt cure, of the default. §365(b)(1)  If CURABLE at filing, right to cure is not subject to contractual time limitations (Moody v. Amoco Oil) Limit: curing in BKR does not eliminate all effects of breach (ex. rebate – 2 net 10)  If NOT CURABLE at the time of filing, then DIIP cannot cure breach during BKR to assume (Moody v. Amoco Oil)  Exception: Breaches as to financial condition of DIP, filing petition, satisfaction of penalty rate for breach  Assumption by Implication: DIP cannot assume contract by implication (court order forcing non-debtor to perform), court approval is required before any assumption. Unenforceable Clauses o Non-Assignment Clauses: Court will invalidate contractual provisions prohibiting assignment/delegation of contract §365(f)(1), (c) o Ipso Factor Clauses: ex: we can cancel if you file BKR, will invalidate §365(b)(2), (e)(1) o Penalty Rates: for breach are unenforceable in BKR §365(b) o Release from Liability Clauses: Provisions not releasing debtor if assigning or delegating duties to another will not be enforceable. §365(k) o Restrictions on Use of Leased Premises Clause: Clauses restricting use of leased are not enforceable. §365(f)(1)

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Some Courts: unless LL shows that lack of enforcement would jeopardize LL‟s economic position or other tenants. o Cross-Default Clauses: “a breach with respect to one lease is a breach as to all leases”  Courts: 1) Cross default clauses are unenforceable to extent that they deny DIP flexibility necessary within BKR. Prevent creditor from keeping things together which should be treated separately. Limit: DIP cannot make lease of store in half and only use half. Issue: Lien v. Lease o Ex. 30K debt; Value of property/collateral 20K o If a lien: 20K secured claim + 10k unsecured claim (get very little on the dollar)  SO: DIP must only pay 20K + interest to keep the property o If a lease: DIP must assume executory contract (all payments) in order to keep property  SO: DIP must pay 30K + interest to keep the property o Courts: will allow parties use to trump economic reality  SO: if a “lease” DIP may convince court that “lease” is really a “sale with a security interest” Issue: collective bargaining agreements §1113 o Not governed by normal executory contract law o Rejection Requirement o Before filing motion to reject Collective Bargaining Agreement:  Debtor must make a proposal to union which provides “modifications in employee benefits and protections that are necessary to permit reorganization of the Debtor and assures that all creditors, Debtor, and all affected parties are treated fairly and equitably.” §1113(b)(1)(A)  Most Courts: Modifications can be “necessary” even if it goes beyond absolute minimum needed to avoid liquidation.  “Fairly and Equitably” if creditors give up too much, then workers must also give up much  Debtor must provide union with information to evaluate and confer with union §1113(b)(1)(B), (2)  Courts shall approve rejection only if: § 1113(c) o Debtor has made proposal o Union reasonably refuses to accept o Balance of equities clearly favors rejection o Interim Period o DIP may obtain interim relief with court approval §1113(e)  DIP must show that short term survival of the debtor is threatened unless immediate changes authorized  NOT: long term survival is jeopardized  SPLIT:  Some courts require that motion to reject agreement be pending  Other courts do not require that motion to reject Agreement be pending o Pre-petition Collective Bargaining Agreement obligations  SPLIT:  Some courts: administrative expense  Other: Not an administrative expense Non-Assumable Executory Contracts o Contracts non-delagable by non-bankruptcy law §365(c), (e) (West Electronics)  Ex: personal service contracts, government contracts, IP licenses (patent law) o Financial Accommodation Contracts  Majority: If primary purpose of contract is to provide funding, DIP cannot assume it  Exception: some courts allow if other party consents

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Some Courts: If contract provides substantial amount of credit, it is a financial accommodation contract (Coal Bros.)  Ex: selling large amounts of goods on credit (would fail in majority)

Determining Claims Against the Estate  Amount of the Claim o The amount of a claim is determined as of the date the petition was filed §502 o “Claim” includes rights to payment whether or not pursuant to a judgment, liquidated, matured §101(5) SO: includes “un”matured claims o Exception: Unmatured Interest  Unmatured interest is not recognized as part of a claim §502(b)(2)  Limited Exception to Exception: Oversecured creditors can receive unmatured interest §502(b)  Limitation: Can only receive interest to the extent oversecured creditors collateral has value  To Recognize a Claim o Must File Proof of a Claim §501(a)  Simply a written statement setting forth a creditor‟s claim §3001(a)  Should conform to Official Form 10 and provide documentation §3001(a),(c) o Listed in Debtor’s Schedule of Liabilities  Proof of claim is deemed filed if claim is listed on Debtor‟s schedule of liabilities  Risky: may not actually be listed and if case converts to Chapter 7, MUST actually file proof of claim.  Objecting to Claims o DIP or Creditor Committee will object if they think the claim is invalid o Courts will determine merits by estimation of the amount of the claim (avoid undue delay/cost)  Contingent Right o Ex: gurantors o Contingent right to payment is a recognized claim (right can be discharged pursuant to plan)  Secured Claims o Includes only amount of value of collateral (rest is then an unsecured claim) o Interest: Yes, only if OVERSECURED o Attorney Fees: Yes, if provided for in the contract §506 o Reduced By: Debtor actions taken at estate expense to protect collateral may be recoverable out of the amount of the lien (surcharge on collateral) o Note: Creditors cannot add to claim if they pay to protect collateral  Secured Claim which is not Adequately Protected o If “adequate protection” fails to be adequate, unsatisfied secured claim is given SuperAdministrative priority §507(b) o Some courts: to get Super priority, must also show some benefit to estate for denial of relief from stay  Administrative Expenses o Some courts: look at expenses incurred by estate o Other courts: only recognize claims to extent estate benefited from expense (probably wrong)  Tax Claims o Interest: yes o Attorneys fees: no  Post Petition Contract Breach by Debtor o Benefit of post-petition contract by Debtor creates an administrative expense only to extent Debtor received a benefit (Dant & Russell 9th Cir.)

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o But b/c leaves other party with only restitution remedy, can have chilling effect on post-petition contracts Mass Tort Claims (Ex: Asbestos Claims) o Determining Amount of the Claim o Personal injury tort and wrongful death claims can only be tried in Dist. Ct. jury trial §157(b)(5)  If Dist.Ct. abstains, state jury trial may be allowed  Thus: BKR court can determine amounts of claims for purpose of distribution UNR Indu.  However: BKR court can estimate amounts of claims for purposes other than distribution  Ex: BKR court can estimate for purpose of voting and setting up trust Manville o Future Claims  Property: If court waits to resolve future claims then BKR will go on for years  Solution: Set up trust to settle future claims (reorganized business is free of such future claims). Court can estimate validity and amount of claims for purpose of estimating amount of funds Debtor must place in trust Manville  Issue: When does a claim arise?  Important when: o Confirmation of plan discharges any debt arising before confirmation of the plan §1114(d) o Court actions commenced or could have been commenced before the filing are stayed §362(a) (court applies conduct test) o Claims arising before the filing cannot receive administrative expense priority  Test: o Conduct: claim arouse at the time of the Debtor‟s conduct which gave rise to the claim. o Conduct and Sufficient Relationship: Piper Aircraft  Most reasonable. Two Requirements for a claim to exists: 1) Debtor‟s action giving rise to the claim has occurred 2) Must be some relationship b/w pre-BKR conduct and the ultimate claimant for claim to exist. The relationship must be sufficient to know that should get involved in BKR case. o Can claimant sue? Frenville 3rd Cir  Claim does not exist until state law would allow claimant to actually sue. (More restrictive) o Channeling Injunction  Even if claim did not exist before confirmation of a plan, prohibits Plaintiff‟s from suing the reorganized business – only allowing claims against the trust. §524(g)-(h)  Potential Problems: Due process clause requires that P‟s be given notice, but channeling injunctions have been upheld in court.

Proposing a Plan of Reorganization  Debtor o Can file at any time §1121(a) \ o during the first 120 days ONLY the Debtor can file a plan §1121(b)  Other Parties of Interest o Any party of interest can file a plan IF: 1121(c)  Trustee is appointed or  Debtor does not file plan within 120 days, or  Debtor‟s plan has not been accepted by ALL impaired classes w/in 180 days o However: Court will often extend Debtor‟s exclusivity period if:  Large or complex case, or

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 Many peripheral issues at beginning, or  Creditors are obstructive (recalcitrant, not just unreasonable) Small Business Election §1121(e) o If Debtor elects to be treated as a small business (not real estate company and no more that 2 million in claims):  ONLY Debtor can file a plan for first 100 days  All plans must be filed within 160 days Selective Termination of Exclusivity o Ex: Court allows Creditor Committee to file a plan, but no other parties of interest o Some Courts: Yes, §105(a) allows court to do anything to further the Code. o CA (prof): No, exclusivity is all or nothing.

Voting On and Confirming the Plan  Disclosure Statement  General Rule: Approval by Court: Plan must disclose information that would enable a hypothetical reasonable investor to make an informed judgment about the plan. §1125(a)(1)  Adequate disclosure depends on creditors‟ sophistication and ability to fend for themselves. §1125(a)(2) o Info of other plans: Disclosure statement need not include info about other plans §1125(a)(1) o Going Concern Variation: Courts MAY approve a disclosure statement that does not include a going concern valuation. §1125(b). But: many courts require going concern valuation so creditors know value of stock they will receive. o Liquidation Valuation:  Courts will require that disclosure state include liquidation value  Issue: low ball liquidation valuation  If disclosure statement underestimates liquidation value, but plan still passes Best Interest test, plan must be amended and voted on again (McCall Pattern)  Rationale: still affected vote b/c different forms of value. o Post-Petition Operations  Courts will require information regarding post-petition operations if creditors receive promissory notes or stock. (important to determine value of notes or stock)  If creditors receive ONLY cash, operations do not affect value of property received, but if Debtor will do well, creditors may want more cash.  Basis for Denying Approval o Courts should limit its decision to approve to whether there is adequate information, not whether thinks is a good plan. Ex: Interest rate below market rate = creditors should evaluate the attractiveness of a plan.  Appeal: If claimant voted against the plan, can still appeal on claim that inadequate disclosure. o Rationale: Though not misled, claimant bound by other misled claimants in his class who voted for plan.  Issue: Additional Information o Proponent may supplement Disclosure Statement with additional information (DS: floor) Century Glove 3rd Cir. o Limit: court may disqualify votes if based on FALS additional information o SO: creditors can include added information to try and persuade other creditors. Soliciting of Acceptances and Rejections  General Rule §1125(b): cannot solicit acceptance or rejection after filing of petition UNLESS first transmitted: 1) Summary of the plan, and 2) disclosure statement approved by the court o Issue: what is a solicitation? A formal request for a vote at a time when valid can be made (Century Glove 3rd cir)

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o Test: Does the recipient think that they are being asked to make a PRESENT vote (Century Glove 3rd cir). SO: cannot be a solicitation if before plan is filed (Unless ask creditor to complete actual ballot)  Creditor shows another creditor a unified plan: court says NOT a solicitation  “I urge you not to support Debtor‟s plan”  3rd Cir: Century Glove not a solicitation  Other courts: may be a solicitation of a “rejection” o Exception: Small business election §1125(f). Allows conditional approval of disclosure statement at hearing with final approval after confirmation of plan. Penalty for Violation §1135(b) o If make a prohibited solicitation: Liable for attorneys fees and disqualification of recipient‟s vote Voting Purchased Claims o Purchaser of claims can vote each claim purchased (Figter) o UNLESS: purchased claims with ulterior motives b/c violates good faith requirement of §1126(e) Figter  Ex: Destroy competition or if Debtor has cause of action against Creditor and blocking reorganization eliminates cause of action.  Not: voting just because do not way (no requirement to negotiate in good faith) o Issue: Undersecured mortgagee vote unsecured claim to block plan to force liquidation and foreclose on secured claim. (Selfish motives do not disqualify vote . . . self interest does not equal ulterior motive) o Also: did purchaser treat other creditor fairly? (offered to buy all/paid full value) Bribery: Featherworks, cannot pay/bribe creditors to vote for/against plan. This includes when a Debtor may dismiss a suit against a Creditor if they vote for plan. Good Faith Requirement: §1126(e). Court may designate/disqualify votes cast, solicited, or procured not in good faith Changing Vote: Court may permit creditor/SH to change vote for cause §3018(a) Modification of Plan: No new vote is necessary unless the modification adversely changes the treatment of the claim. § 3018(a). Most Courts hold that this must be a “material” adverse change. o Even if change value of separate class, can adversely change treatment of other classes b/c: 1) Can affect success of plan and 2) can affects relative pain born by different classes Shareholders: class is conclusively deemed to reject plan if claimants receive NO VALUE o SH only get to vote if Plan provides some value for SH‟s o Does not require Cramdown if do not approve: not a class of claimants Conflict of Interest: Plan meets both Best Interest test and gives value to SH‟s o Majority SH who also holds unsecured debt, by voting for plan gives value to SH‟s stock. o Rule: conflict of interest is not basis for disqualifying votes  Rationale: Insiders votes generally count and Congress deleted provision which would have expressly permitted court to disqualify votes made in conflict of interest.  Limited by Bad Faith §1126(e)

Classification  Substantially Similar: Cannot place claims in the same class unless substantially similar §1122(a) o Relates to the claim‟s RELATIONSHIP to the Debtor o Ex: Private deal b/w creditors to subordinate one‟s clam to the other = not impact on substantial similarity o Ex: private deal b/w two creditors and the Debtor = impacts substantial similarity  No requirement that ALL substantially similar claims be placed in same class (US Truck) o Existence of No Unfair Discrimination Requirement (requires that separate classes with equal rights receive equal Present Value) suggests that claims of equal rights can be placed in separate classes.

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However, there must be SOME limit on ability to separate substantially similar claims or could always create a class to accept and satisfy §1129(a) US Truck  Rule: Can only create separate class to satisfy (a)(10) if the class represents a substantial group of creditors with real stake in case (a few creditors might be ok if have big claims) US Truck  Issue: Can Non-recourse mortgagee‟s unsecured claim be placed in separate class from other unsecured claims?  Argue: mortgagee‟s unsecured claim would not exist in Chap. 7 liquidation  Majority: cannot do this to meet 1129(a)(10)  Some courts: will allow this Limit: Gerrymandering: express gerrymandering is NOT allowed.

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Confirmation of the Plan  Standing to Object o Creditors: Most courts limit objections to those harmed by what objected to (SO: if not impaired, cannot object) o DIP: DIP can object to harm against any creditor o Court: Court just looks for big problems, does not go into details.  General Confirmation Requirements o Plan § 1129(a)(1)  Plan must comply with the provisions of the BKR code. Ex: must set up classes of claims §1123; Claims in different classes unless substantially similar §1122. o Proponents §1129(a)(2)  Must comply with the BKR code. Ex: Disclosure, Solicitation of Votes, DIP‟s misuse of cash collateral (if considered a serious violation) under §363 o Good Faith §1129(a)(3)  Plan is proposed in good faith (do not need declaration of good faith) but Bribery will cause failure of confirmation. o Debtor’s Payments to Proponent §1129(a)(4)  Plan must disclose ANY payments made or to be made to proponent by DIP for expenses in connection with the case. o Officers and Directors §1129(a)(5)  Plan must disclose who officers and directors are going to be upon confirmation. o Principal Purpose: Avoid Taxes §1129(d)  Court cannot confirm a plan if principle purpose is to avoid taxes. o Feasibility Requirement §1129(a)(11)  Rule: Plan must not make DIP likely to face financial distress again soon  Test: Proponent must show reasonable probability of Debtor‟s success. Ex: 86 year old will pay for 30 years. Remember, this is not a requirement that plan WILL succeed.  Purpose: Prevent financial cripple from reentering economy and do not want to confirm visionary schemes.  Issue: Plan call for liquidation of assets.  Courts: conditional provision for liquidation of assets does not violate (a)(11) as shown in Nite Lite Inns  Requirement: If conditional provision for liquidation of assets, Plan must ensure that value to be given to creditors will be sufficient upon sale or (back in BKR).  Courts should NOT find plan has reasonable probability for success based upon conditional liquidation. o Priority Claims

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Rule: 1129(a)(9)(A) Dissenting priority claims MUST receive CASH EQUAL to full amount of claims on effective date of the plan. NOT: stock, notes, deferred payments  Unless the class accepts the plan and agrees to get paid overtime. Priority Claim:  Prepetition unpaid wages w/in 90 days of petition, but capped at 4k, §507(a)(3)  Employee benefit claims for services w/in 180 days of petition, also capped at 4K, §507(a)(4)  Consumer deposits, capped at 1800, 507(a)(6)  Alimony/child support, §507(a)(7)  Unsecured governmental claims (esp. taxes), § 507(a)(8) Effect: If priority class accepts, then can impair class to fulfill §1129(a)(10)  But still must meet Best Interest of Creditors Test o In Chap. 7 would get paid immediately after secured claims o If would get full value in Chap. 7 must get full value in Chap. 11 o Even if must pay full value, can defer payments to impair class and meet the BIOC test. o If priority class rejects: must pay cash in FULL at plan‟s effective date.

Consensual Confirmation Requirements § 1129(a)  Designation of Classes §1129(a)(1) o Plan must designate classes of claims and interests.  Equal Treatment of Claims in Same Class §1129(a)(4) o Each claim or interest is treated equally with other claims or interests in the same class. o Unless: claimant is AGREEING to less favorable treatment than the rest of the class.  Acceptance by Impaired Classes §1129(a)(8) o All impaired classes must accept the plan  Acceptance without Insider Votes §1129(a)(10) o If there is at least one impaired class, at least one impaired class must accept the plan WITHOUT INSIDER‟S votes  Impaired Classes  Class is impaired unless § 1124(1) o No change in the legal or equitable interests of claimant o Interests unaltered except curing default and reinstate original maturity  And must also compensate for expenditures on foreclosure right (ex. attorneys fees)  Issue: post-petition interest o Majority: Any alteration of the rights of the claimholders makes the class impaired.  SO: even denial of post-petition interest (or portion of) can make class impaired  ALSO: Congress deleted §1124(3), which made unimpaired if only paid amount of claim  ALSO: DIP could deny post-petition interest even where more than enough money was there to pay it. o Minority: (Best approach)  9th Cir. Impaired if rights are altered in ANY way, including interest.  Limit: manipulation of class can be evidenced of bad faith.  Unimpaired Classes

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Unimpaired classes are conclusively presumed to have accepted the plan (no acceptance required) §1126(f)  Creditors who accept the plan CANNOT claim protection of Best Interest of Creditors Test §1129(a)(7) BEST INTEREST TEST §1129(a)(7) o Dissenting claimants must receive at least as much value as would have received in Chap. 7 liquidation. (EVEN: dissenting claims in an accepting class) o BUT: does not protect creditors individually  Ex: plan has less tax advantage than liquidation; Plan puts other creditor in BKR. o Issue: Partnership in Chapter 11 (w/ solvent partners)  Problem: creditors can fully recover in chap. 7 liquidation but not in chap. 11  SO: Best Interest Test entitles creditors full value in chap. 11 case  Solution: Some courts will give creditors SOME value under the plan and leave creditors their cause of action to sue partners. Criticism: makes cost of suing more difficult and harder for smaller claim holders to recover their value this way. o Issue: Punitive Damages  Subordinated in Chap.7: Paid after other claims (merely a penalty, no compensatory) §726(a)(4)  No provision in Chap. 11: Punitive damages appear equally right to be paid  Best Interest Test: If creditors would get .63 on the dollar in liquidation (punitive gets nothing), then must get this amount in plan for plan to meet §1129(a)(7)  Most Courts: Equitably subordinate punitive damage claim o Rationale: Cannot create per se rule that all punitive damages are subordinated, but BKR judge can equitably subordinate on a case by case basis. o Fact: Punitive damage claimant rejects reasonable compromise and rejection prevents reorganization (cannot meet BIT). o Issue: Unsecured Non-Recourse Mortgage  Ex: 1.5 million unsecured debt. 30M non-recourse mortgage; 20M real property; 1M assets  In Chap. 7: Secured creditor would only recover on secured claim. Unsecured creditor would receive all the non-collateral assets  In Chap. 11: NON-RECOURSE loans are treated as RECOURSE loans (general unsecured debts) §1111(b)  Unless: o Class votes by 2/3 for §1111(b)(2) election OR o Collateral is solder under Plan or §363 (Rationale: get protection you bargained for)  Problem: Violates BIT: Unsecured creditor must split value of non-collateral assets with secured creditor in Chap. 11 and receive less value than would receive in Chap. 7  Solution: CRAMDOWN  Equitable solution: never done in this situation  Give no value to secured creditors unsecured claim: if no value, class is conclusively deemed to reject, §1126(g) so MUST CRAMDOWN  Give any value to secured creditors: violates BIT

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CRAMDOWN REQUIRMENTS §1129(b)  Rule: If the only reason §1129(a) is not met if the failure of 1129(a)(8), can still confirm the plan if it is fair and equitable and is not unfairly discriminatory to dissenting classes §1129(b) o Requirements:  One impaired class must accept the plan

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 Plan is fair and equitable to dissenting classes  Plan does not unfairly discriminate against dissenting class FAIR AND EQUITABLE o ALL: unsecured claimants and other interests o Absolute Priority Rule: (uncodified requirement of Fair and Equitable standard). Senior claimants cannot receive more that full value if junior claimants do not receive full value. Ex: Stockholder can object if debt claimants receive 1.02 on the 1.00. o Exceptions:  New Value Exception (possibly)  Claim Loses Priority over Junior Claims  Rule: Senior debt claimants can receive more than full value to compensate for senior debt claimant losing senior priority (even if junior claimants lose value). Ex: Senior and Junior claimants both given notes with the same priority. Secured Claim: 3 ways to satisfy o Provide Creditor with “indubitable equivalent” of secured claim §1129(b)(2)(A)(iii)  Vague: courts are tough  Give Creditor the collateral: this clearly satisfies  Substitution of Collateral: court may allow if the new collateral has no increased level of risk, otherwise it is not the “indubitable equivalent”  Partial Transfer of Collateral: subject to very close scrutiny. Ex: collateral of 150 acres; transfers 100 acres to fully satisfy the lien. Many courts will not allow unless includes option to transfer additional collateral if sale of the partial collateral is insufficient to satisfy the lien. o Sell Collateral and attach lien to proceeds of sale, then treat lien as under (i) or (iii); §1129(b)(2)(A)(ii) o Holders of secured claim §1129(b)(2)(A)(i)  Retain the lien to the extent of the allowed secured claim  General Rule: Allowed secured = value of lien = value of collateral. Collateral valued at DIP‟s replacement cost; NOT liquidation Rash  Exception: §1111(b)(2) Election. o If creditor makes election, treated as having a SECURED claim for entire amount of the lien §1111(b)(2). o Amount of lien is NOT reduced to value of lien (value of collateral) o SO: plan must leave creditor the entire amount of lien.  Receive cash payments with PRESENT VALUE equal to value of the lien (value of collateral)  Issue: Interest Rate  Present Value: of cash payments depend on interest rate  Courts: o Say: PV based on Fair Market Interest Rate for type of collateral o However: Often use Risk Free Rate + Risk Premium (risk premium is arbitrary by judges) o Other courts use blended rate based on breaking mortgage into several mortgages  Receive total cash payments equal to amount of lien (whether principle or interest)  General Rule: amount of lien reduced to value of collateral  Exception: §1111(b)(2) election o If Creditor makes election, treated as having a secured claim for entire amount of the lien. Amount of lien is NOT reduced to value of lien (value of collateral)

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o SO: plan must give Creditor total cash payments equal to entire amount of lien. o Solution: To increase total cash payment but not increase Present Value: stretch payment over longer period of time. LIMIT: If life of assets does not permit sufficient lengthening of payment period: Debtor must either increase size of payments (giving more PV than necessary) OR just let Creditor have the collateral. o Issue: Creditors Decision to make §111(b)(2) Election  Advantages: Debtor cannot sell the property without paying the full amount of the original lien.  Without it, Debtor could sell collateral 2 months later for substantial profit and pay off the reduced lien, while creditor still takes loss.  With it, Debtor cannot sell free and clear until pays off entire amount of original lien  Disadvantages:  Creditor gives up distributions on substantial unsecured claim.  Creditor gives up voting rights in unsecured claim class (ie, cannot block plan, forcing DIP to perform Cramdown)  Limitation:  Cannot make election if SECURED interest of inconsequential value §1111(b)(2)(B)(i)  Cannot make election if Recourse Creditor and collateral sold under 363 of Plan  Issue: Due on Sale Provision  Though not provided for in Code, some courts hold that “due on sale provision” is included in §1111(b)(2) election b/c otherwise the Election is worthless b/c the Debtor could just sell the collateral SUBJECT to the lien (buyer takes over payments) Unsecured Claims: 2 ways to satisfy o Plan Provides claimant property with Present Value equal to entire amount of claim §1129(b)(2)(B)  “property” can be: stock, notes, cash, etc.  Issue: If claimant receives stock, must determine value of enterprise (cap or DCF less debt) o Plan Provies that junior claimants receive NO value of any kind §1129(b)(2)(B)  Ex: stockholders must receive NOTHING if creditors are not fully paid  Issue: multiple hats: parties with both debt claims and stock claims may still receive value for debt claims. Preferred Stockholders o Dissenting Preferred SH‟s are entitled to greatest of §1129(b)(2)(C) o Liquidation preference, Redemption preference, or Value of Interest (market value) Common Stockholders o NO §1129(b) Protections o Ex: dissenting class must receive full value or no junior claimant receives any value o BUT: NO JUNIOR CLASS to receive any value, so no requirement that dissent SH‟s receive full value. o ABSOLUTE PRIORITY RULE: Uncondified requirement of Fair and Equitable Standard

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Senior Claimants cannot receive more that full value if junior claimants do not receive full value. Ex: stockholder can object if debt claimants receive 1.02 on the 1

NO UNFAIR DISCRIMINATION  General Rule: o Dissenting classes should receive about same Present Value as other classes with equal rights against the Debtor o Ex: dissent class received 35%, another equal class receives 75% then Unfair  Some Courts o Use FOUR FACTOR test: drawing upon Chap. 13 (bad b/c of different policies)  Reasonable basis for discrimination  Can debtor confirm plan without discrimination  Is discrimination in bad faith  How bad is the treatment of the dissenting class  Effect: Plan has much more room to discriminate o Examples  Trade Creditors: pay more b/c need them to continue business  Institutional Creditors: pay less b/c don‟t need them, can find others  SHOULD NOT NORMALLY BE ABLE TO DO THIS  Issue: Negative Amoritzation o Ex: make payments that are less than the accruing interest for initial periods o Key Factors: as to whether violates Fair and Equitable Standard o Drop Dead Provision: can foreclose if collateral not maintained  Giving Old Shareholders Value: CRAMDOWN o B/cone class will not accept plan that allows SH value o SO: Fair and Equitable Standard applies  Unless dissenting class receives full value, no junior claimant can receive any value ON ACCOUNT OF THAT JUNIOR CLAIM §1129(b)(2)(B) o SO: New Value Exception  SH‟s may be able to receive ownership interest for new contribution of money  Requirements:  Present Money or money’s worth: Not Services  Substantial amount: o Compared to “unsecured debt” Doesn‟t count if so small to be token. This may be the value that keeps it from being insolvent.  Necessary: “very helpful” to the organization  Must pay good value: Reasonably equivalent to new ownership o Cannot be a sweetheart deal b/c could only get sweetheart deal as a result of old ownership interest (sweethear: would someone have paid more) o SO courts require an auction or other exposure to market o Problem: Bank can always outbid b/c it ends up owning money it pays to bid for ownership.  Unsecured Priority Tax Claims o Unsecured priority tax claims must receive payments over no more than 6 years with present value equal to amount of such claims §1129(a)(9).  Sldfjsljdfs  lsjdflksjdfl


				
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