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ESSAY TEST spring 1995 bus reorg

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ESSAY TEST spring 1995 bus reorg Powered By Docstoc
					PEPPERDINE UNIVERSITY SCHOOL OF LAW

FINAL EXAM:

Business Reorganizations in Bankruptcy-Essay Portion

TOTAL NO. OF QUESTIONS:

2

SPRING 1995

TOTAL NO. OF PAGES:

5

Two (2) Hours and twenty (20) minutes ____________________________________________________________________________ INSTRUCTIONS 1. This portion of the exam consists of two essay questions designed to be answered in one hour each. However, the questions are a little long, and thus I have given you an extra 20 minutes for the exam in case you need it. Each question will count as onethird of your final examination grade. (The multiple choice section will also count onethird.) You are permitted to use a calculator, the statutory supplement (annotated as you wish), and nothing else on this exam. Please use blue or black pen only, and start each question in a separate bluebook. Good luck! Have a great summer. (If you will be taking the bar this summer, work very hard and very smart, and then go into the bar exam with confidence.) Early in the summer I will get back the "page proofs" of the book from the co-author who is putting it in camera ready form. Drop me a note if you are interested in being part of a team that will go over the page proofs with a fine tooth comb; I hope to be able to find some money to pay people on the team for their work.

PROFESSOR

Scarberry

TIME:

2.

3. 4.

Essay 1--One Hour HalfPint Co. manufactures and sells electronic processor chips (called "RISKY" chips) that are the "brains" of a kind of very powerful small computer called a "workstation." A few years ago there were six manufacturers of workstations. Due to competition from manufacturers of less expensive personal computers that use Unintel Corp. processor chips, there are now only three manufacturers of workstations. Unintel Corp. has announced that it will soon start selling a new, more powerful microprocessor, the Hexium. Some computer industry analysts predict that if and when Unintel does so, the remaining workstation manufacturers may be unable to compete and may all stop manufacturing workstations. If they all stop, workstations may decline dramatically in value. DeeCo is one of the three workstation manufacturers. On April 15 DeeCo filed a chapter 11 petition. The main reasons for DeeCo's difficulties are (1) competition from Unintel processor-based personal computer manufacturers, and (2) a series of very bad decisions by its credit manager, Crumm. In January, Crumm approved sales of eighty workstations on unsecured credit--$480,000 of credit--to four financially troubled companies. All four ended up filing bankruptcy petitions. DeeCo has not been paid for the workstations and likely never will be. Crumm promised to be more careful in the future in approving credit sales, and DeeCo's president allowed Crumm to stay on as credit manager. FinCo has a security interest in DeeCo's accounts and inventory. Eighteen months ago, FinCo lent DeeCo $1 million; in connection with that loan DeeCo signed a security agreement granting FinCo a security interest in "all of DeeCo's inventory and accounts, including afteracquired and after-arising property." As of April 15, DeeCo owed FinCo $900,000. DeeCo's inventory (workstation computers and computer parts) was worth $500,000 valued at wholesale as of April 15. Its accounts (valued at the amount that would likely be collected) were worth about $210,000 as of April 15. On April 20 DeeCo purchased $200,000 of computer parts (not including processor chips) from SelCo on 90 day unsecured credit; that was enough parts (other than processor chips) to make 60 workstations. On April 22 DeeCo purchased 80 Risky chips ($80,000 worth) from HalfPint, also on 90 day unsecured credit. Using these parts, and other parts DeeCo had as of April 15, DeeCo is now assembling 135 workstations. Sixty of those workstations (Group "A") will contain only parts purchased on April 20 and April 22. Twenty others (Group "B") will contain a Risky chip purchased on April 22 but otherwise will be made from parts on hand as of April 15. The remaining 55 (Group "C") will be made solely from parts, including 55 Risky chips, which DeeCo had on hand as of April 15. Labor costs for putting the workstations together are about $600 per workstation. On April 23, DeeCo sold 25 workstations--from the inventory of finished computers which it had as of April 15--to BuyCo for $150,000 cash. (The wholesale value of the workstations was $125,000.) On April 25 Crumm authorized sale of five additional workstations--from the inventory of finished computers which DeeCo had as of April 15--to NewCo (a very young small company that operates out of its founder's garage) on unsecured credit. Today, April 28, DeeCo is in court seeking authorization to use cash collateral to pay wages, to buy additional parts so that it can make even more workstations, and to pay other expenses of operating the business. Also today, FinCo is in court on a motion for relief from

stay, seeking permission to foreclose on its collateral.

Briefly discuss the following questions: (1) Does FinCo have a lien on the $150,000 cash received from BuyCo? When the sixty Group "A" workstations are completed in a month and a half, will FinCo have a lien on them? (2) What kind of claims will SelCo and HalfPint have for the credit extended on April 20 and April 22? Are they likely to be adversely affected by the fact that DeeCo did not seek court authorization to make the purchases? (3) FinCo has a lien on the Group "B" workstations, but does the lien cover the entire value of them? If at some point FinCo obtains relief from the automatic stay and sells the Group "B" workstations in a foreclosure sale, would HalfPint be entitled to recover $20,000 of the foreclosure sale proceeds from FinCo under section 506(c)? (4) Should the court give FinCo relief from the stay under section 362(d)(2)? under section 362(d)(1)? (5) Should the court authorize DeeCo to use cash collateral? What might DeeCo offer in order to help convince the court to grant its motion?

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Essay 2--One Hour Engine Rebuild Corp. ("ERC") filed a chapter 11 petition on January 3, 1994. ERC's business is to rebuild old, worn out automobile engines so that they are nearly as good as new. ERC's place of business--its machine shop--is located on land owned by ERC and known as 123 Oak Street. First Bank holds a $2 million first mortgage on the land and building at 123 Oak Street; Second Bank holds a $1.5 million second mortgage on the land and building. Both mortgages are nonrecourse. There are no other secured creditors. All the parties agree that the going concern value of the property of the estate (including 123 Oak Street) is $5 million and that the value of the land and building at 123 Oak Street is $2.5 million out of the $5 million total. ERC owes 37 different trade creditors (each of whom holds one claim) a total of $1 million. ERC owes its president and sole stockholder, Block, $700,000 for money lent to ERC in a legitimate loan transaction several years ago. Fourteen residents of a condominium located next to 123 Oak Street sued ERC in mid-1993 claiming that their health was ruined due to fumes emanating from ERC's facility. (ERC uses various solvents to clean engine parts; the fourteen health claimants claimed that they developed chemical sensitivities due to exposure to the solvents.) ERC improved its air filtration system in late 1993; no fumes have escaped the machine shop since then. Nevertheless, the fourteen health claimants would prefer to have the machine shop closed down, since they fear that the air filtration system may not be maintained properly in the future. Costs of defending the suit, costs of improving the air filtration system, and a slowdown in sales of rebuilt engines all combined to force ERC into chapter 11. In late 1994 ERC filed a proposed plan which created four classes: 1. The plan leaves Class 1--consisting only of First Bank's secured claim--unimpaired. 2. The plan places Second Bank's secured claim by itself in Class 2 and provides that Second Bank will receive, on account of its secured claim, a $500,000 promissory note secured by a second mortgage on 123 Oak Street. The $500,000 promissory note will carry an interest rate of 10% per year (which you should assume is a fair market rate), but for the first two years no payment at all of principal or interest will be made; the accrued interest will be added to the principal amount of the note, so that after two years the principal amount will be $605,000. On the third through tenth anniversaries of the effective date, ERC will pay 10% interest, which will be $60,500 each year. On the tenth anniversary of the effective date ERC will also pay the entire amount of the principal, $605,000. The plan commits ERC to spending at least $30,000 per year on building maintenance and improvements, and it provides that the interest rate on the note will go up to 12% for any year in which ERC does not meet that commitment. 3. The plan places all unsecured claims together in Class 3. Holders of claims in Class 3 will receive five year promissory notes at a market rate of interest in an amount equal to 25% of their allowed claims. They will also receive one share of stock in the reorganized ERC for each $1,000 of claim. (Interest on the notes and dividends payable on the stock will be calculated from the effective date of the plan, even if the notes and stock are not given out until later. Thus, if it takes a year or two to determine the amount of the claims owed to the health claimants so that the amount of the notes and stock to be given to them can be determined, they will not lose out on the interest and dividends due them for the period from the effective date up until the time they get their notes and stock.) 7

4.The plan places the interests of ERC's stockholder (Block) in Class 4. Block's existing shares in ERC will be cancelled, but, on account of his old stock, Block will receive 1,000 shares of stock in the reorganized ERC. The disclosure statement correctly stated that holders of general unsecured claims would receive payment equal to approximately 30% of the amount of their claims if ERC were liquidated in a chapter 7 case. ERC objected to the large claims filed by the health claimants, who then sought allowance of their claims for voting purposes. The bankruptcy judge ruled that "the health claimants likely suffered serious injury for which ERC is liable, and I will try their cases in a few months. For purposes of voting, each health claimant's claim will be temporarily allowed in the amount of $1 each, which will give each the same voting power. That is appropriate because their injuries seem to be similar in severity." The 37 trade creditors and Block all voted to accept the plan. Second Bank and all 14 of the health claimants voted to reject the plan. Briefly discuss the following questions: (1) Does the plan treat Class 2 fairly and equitably? How is your analysis affected by whether Second Bank made the section 1111(b)(2) election? (2) Did Class 3 accept the plan? Is your analysis affected by whether Second Bank made the section 1111(b)(2) election? (3) Assume the total amount of allowed claims in Class 3 turns out to be $5 million after the claims of the health claimants are finally determined. Is the plan fair and equitable with respect to Class 3? Is the best interests of creditors test (section 1129(a)(7)(A)) satisfied with respect to the health claimants? (4) Did the bankruptcy judge err in assigning a $1 value to each health claimant's claim for purposes of voting on the plan proposed by ERC? Did the bankruptcy judge err in stating that "I will try their cases"?

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