Bankruptcy 1/12/05 We will be focusing on chapter 11 of the bankruptcy code. Problem 1-1: What losses would be caused by closing the business? Loss of jobs, waste of the training (some of it may be useful in the future), $12,000 in remodeling specific to the company, the post office boxes will not be totally lost but the value is pretty much gone, the time spent negotiating the lease is wasted, also be losing an integrated enterprise that is generating cash, When chapter 11 is filed all the assets go into an estate but the debtor is left in possession, called debtor in possession or DIP. A bank will usually have a UCC Article 9 Security Interest: 1. These are voluntary 2. They create a lien, a property interest (this will be respected by the bankruptcy laws)
Chapter is about recognizing which businesses have a higher value in going concern as a present value than if the business was liquidated. Remember the terms Accounts Receivable and Accounts Payable. Chapter 11 provides 2 things: 1. A way to bind dissenters (an appropriate majority of creditors can approve the plan, and once the court approves it then all creditors are bound). 2. Gives you time to negotiation (sets up an automatic stay). Read up though the end of chapter 1, try to get up through part 4 of the problem on page 45. 1/14/2005 Out of court workout saves everyone money, Chapter 11 will cost a lot that is paid to the attorneys. In a Chapter 11, new borrowings will have priority over all the other debts. Bankruptcy is a creature of equity. Equality among similarly situated creditors is a main concern. The bankruptcy process places some burdens on the creditors: 1. Recognize that you lost money
2. Delay List on Page 16 Page 19, problem 1-4 1. §362(a) creates a stay against all entities (includes all people and business and aliens). (a)(3) specifically refers to property, and no eviction allowed. 2. UCC article 9 says the bank can reposes it, but Bankruptcy law says no (§362(a)(5) or (6)). UCC article 9 is state law and Bankruptcy law is federal law so Bankruptcy trumps it. 3. No go, under (a)(1) or (2) or (3) or (4) or (6) Problem 1-5 The $250 is cash collateral and §363(c)(2) says that the debtor in possession or trustee can not use, sell, or lease the cash collateral unless the entity with a lien consents or unless the court authorizes it. The court can not allow the use of cash collateral unless the court finds there is adequate protection of the creditor. Can’t use it to pay wages, but possibly can use it to buy new inventory. Problem 1-6 If they are not incorporated then the yogurt creditors can seize her Post-Haste assets. Either improve the yogurt shop real quick or close it down.
1. 2. 3. 4.
Keep people from taking further acts to destroy the debtor (automatic stay) Give the business an infusion (cash collateral and borrowing more money) Drop dead weight and get the business to make positive cash flow Find out what is owed and what is owned
3 ways to give creditor value: 1. Cash (give them some part of their claim in cash) 2. Debt (give them some part of their claim in debt in the reorganized business) 3. Equity (give them some stock or ownership) 1/19/05 The basic rule is that creditors get paid before owners. So stockholders are on the bottom. § 1129 – Confirmation of plan. (a)(8) – Each class must except the plan or be unimpaired by the plan. Must be more than half of the creditors voting in a class, and more than 2/3 of the amount of credit voted in the class. If you can’t satisfy (a)(8) then you need to go to § 1129 (b). Then you need two other requirements, 1. fair and equitable standard and 2. no discrimination.
(a)(11) – Must not be likely for the company to fall back into financial trouble. Take the amount of the return and divide it by the interest rate you demand. 1/24/05 1129(a)(10) – at least one impaired class of claims (not interests) has to have accepted the plan not counting insiders (officers, directors, stockholders, etc.) If a class is unimpaired it is conclusively deemed to have accepted the plan. If someone is an insider, then for the purposes of 1129(a)(10) we basically treat them as if they did not vote. If a class does not accept the plan then they get the extra protection that the plan can not unfairly discriminate against them and must be fair and equitable. 1/26/05 Balance Sheet Assets – Liabilities = Stockholders Equity Assets = Liabilities + Stockholders Equity A lot of things on the balance sheet are based on historical cost, not present market value, especially real estate. 1/28/05 The financial statements are usually accrual statements. Try to match up costs of making a batch of foam and the revenues from selling that foam. In the accrual system if someone is entitled to be paid then it is taken into account, doesn’t matter if they have been actually been paid. A current assets is either already cash, or will be cash within a year. All we need to know is straight line depreciation. LIFO – Last in First out. The oldest stuff that is made is sold. FIFO – First in First out. The newest stuff that is made is sold. With LIFO the income looks higher and the value of assets looks higher. How can a workout agreement be enforceable? There is a pre-existing duty to pay the full amount, how can they agree to pay less? Where is the consideration? The company agrees to refrain from paying the other creditors the full amount. Also all the other trade creditors are agreeing that they will accept less money, that is consideration as well (consideration doesn’t have to come from the party itself).
1/31/05 Who can file? §109 (a) Says only a person can be a debtor. But person includes a lot of things (business, etc.) Only a person that resides, or had a place of business or property or domicile in the United States. So Foam Corp. can file. Its domicile is in the US. Usually those who qualify for Chapter 7 also qualify for Chapter 11, exceptions are Railroads and Stockbrokers or Commodity Broker. Railroads can only file for Ch. 11, no Chapter 7. If you are a small business (only sole proprietorship) then may be able to do Chapter 13. The definition of person is in § 101. Bankruptcy Judges are Article I judges, they are not life tenured and they do not have protection of having their salary reduced. p.67 problem 2-2 U-Foam is domiciled in North Carolina (where it is incorporated). Principle place of business is in Eastern North Carolina, this is where the corporate offices are (nerve center test). Most of the assets are also in Eastern District of NC, so it looks as if the most appropriate place for venue is the E.D. of NC. Foam corp and U-foam are affiliates because if you own 20% stock of another company or another company owns 20% of your stock then the two of you are affiliates. If Foam corp filed in California appropriately then U-Foam could also file there. p.77 Problem 2-3 The problem is that the law firm is not disinterested. 1/2/05 Problem 2-3 § 1107(b) – When we are dealing with a debtor in possession obtaining counsel, the lawyer is not disqualified simply because they were employed prior to the case. If the lawyer is owed money from before the case, then he is not considered disinterested. The lawyer would have to waive the debt to be dis-interested. Can’t pay the lawyer just before filing BK. § 527.
There is an exception for ordinary course payments of ordinary course debts. If it is paid with a cashier’s check, then it is probably not ordinary course. Problem 2-3 – You must disclose it or you can be dismissed without payment. Problem 2-4 – Can you have dual representation of debtors If there is an actual conflict, then you can not represent both parties. If there is a potential conflict then dual representation is disfavored but if there is a good enough reason it will be allowed. In this case, if a conflict arises, then at that point the law firm needs to pick a client, or sometimes won’t be allowed to represent either. § 327(c) – A person is not disqualified solely if they represent one of the creditors. This is because the creditor is supposed to work with the DIP in bankruptcy. If someone objects then there needs to be a showing of conflict. Gruff’s interest as a guarantor puts him at conflict with the estate. Problem 2-5
Can you represent a creditor and a creditor committee at the same time? Generally yes. But sometimes no. 2/4/05 § 1103(b) loosens the standards for attorneys that are hired for the creditor’s committee. The committee is supposed to look out for all the general unsecured creditors as an entity. If you represent one of the creditors in the committee, that does not mean that you are adverse to the committee. The question is, if the creditor and the committee have adverse interests does it mean that the attorney for the committee can not represent the creditor in connection with this case, or can not represent the creditor on any matters (whether it has anything to do with the case or not). We think it means that only not represent the creditor in connection with this case. Chapter 3 The automatic stay will terminate. At that point, if a discharge has been granted, then a discharge injunction will come into play. § 362(c) – Stay exists until: Property is no loner property of the estate. Case is closed or dismissed or discharged is granted.
All debts will be discharged when the plan is confirmed, they will be replaced with the obligations in the plan. § 524 – Any willful violation of the stay may result in sanctions. The stay takes effect with no notice given. An automatic stay by a parent does not protect the sub in any way. All guarantors have the right of reimbursement from those that they guarantee. 2/7/05 If a company in bankruptcy owes money, and that money is guaranteed by another. The person who is owed the money can go after the guarantor only if the debt is undisputed (liquidated). Because it does not effect the company whether the debtee has a claim or the guarantor has a claim, it is the same thing because the debt is undisputed. If the debt is disputed then can not go after the guarantor because that could change the game. This is because a guarantor automatically has a right of reimbursement from those that they guarantee. § 105 – This will extend the stay. When there is a disputed claim the debtor in possession must come forward and make a § 105 motion. The automatic stay does not protect the debtor and guarantor. 2/9/05 2/25/05 Assume that Foam is worth 9 mil as going concern and 5 mil as liquidated. Kick credit is owed 6 mil that is fully secured. Should we allow Foam to use the cash collateral. If during the bankruptcy Foam can get Tina Chemical to sell it chemicals on credit. Tina Chem will get an administrative expense priority. Those new chemicals will not be acquired from anything that was collateral of Kick Credit, so the new chemicals are not subject to lien by Kick Credit. This will put Kick’s security interest in jeopardy. Foam Corp needs money so they sell their U-Foam Stock
If you want to sell an asset, the smaller the asset the more likely the courts will let you do it under 363(b). If the asset is large then courts will say do it through the plan. Also, the stock is under lien by Kick Credit. If Foam sells something in the ordinary course of business then it is free of the lien to the buyer (f)(1). Under (f)(3) cal also sell free of lien to buyer if the sale is for more than the value of the lien. Must have equity in the property. 2/28/05 Selling stock § 363 will possibly allow you to sell the stock. The problem is that there is a lien on the stock. §363 (f) allows for the sale to be free and clear of the lien. (f)(3) – Must sell for more than the value of the lien. (f)(4) – (f)(5) – Two approaches: 1. It applies to exotic interest that you rarely see, 2. If you can cash out an interest then you can sell free and clear but only if you actually pay the money. If all of the collateral is worth more than the amount of the debt then there is equity on the whole but not on each item because each item is subject to the total lien. So you should be able to sell the whole thing, but what about selling a part of it? What protection does the purchaser of the stock have if a court of appeals says the stock should not have been sold, it should have been part of a plan? § 363(a) protects the purchaser. Getting credit – § 364 If a company extends credit to a company in bankruptcy then they get an administrative expense claim. 3/2/05 If a trade creditor extends credit to a company in bankruptcy that trade creditor will get an administrative expense claim. The administrative expense claim may not be enough, so they may ask for a carve out of the collateral “Ordinary course of business” – What is usual for this particular business (have they done it in the past) and What is usual for other similar companies? Ordinary course of business transactions do not require court authorization because they happen on a regular basis.
What if you are representing Foam Corporation? If it is determined to not be an ordinary course transaction then the DIP is violating the bankruptcy laws by engaging in the transaction. § 363(b) deals with non ordinary course business. §364 (a) – incurring unsecured debt in the ordinary course of business is ok, it becomes an administrative expense priority (b) – if not in the ordinary course of business, need notice and hearing, and court authorization, and then it becomes an administrative expenses priority Remember, administrative expense status does not guarantee repayment. Lien holders are paid first. (c) You have to attempt to obtain regular course of business unsecured credit and if you can not get it then you can move the court for permission to get credit on one of the following basis: 1. Super-priority administrative expense (Judge can order it to be above or below § 507(b) super priority) 2. Secured Credit (give a lien on the estate on property that is free and clear 3. Secured Credit (give a subordinate lien on already secured property) Most court say you can give any one you want, or even combine them and give more than one (d) The court may authorize credit or debt to be incurred secured by a senior or equal lien on property that is subject to a lien, but only if (1) the DIP can not get credit using (a)-(c) and (2) there is adequate protection for the senior lien holder (of the existing value of the lien, not of the whole debt) who is getting pushed down in priority. This is called a priming lien. The other possibility is 506(c) – Allows the estate to recover, out of the value of collateral (even if there is a lien) a surcharge for compensation for a benefit that the DIP has incurred for improving the value. The courts say that the only people with standing to assert the claim are the DIP or trustee, technically the new creditor does not have standing, so no one uses this option. “Taking the dive” – if the debtor in possession may have some basis for challenging the pre-petition lender, the lender may ask that the DIP give up any right to object to the prepetition debt in exchange for the lender lending extra money. This is not an unreasonable thing for the lender to ask, but the court should not give in to this too quickly, should allow other parties to object. Some courts would allow the lender to get paid his post-petition interest on his prepetition debt in the current time, rather than the regular rule that it gets paid out at the end.
Saybrook case deals with cross-collateralization. 3/4/05 Saybrook case: Dealing with giving additional collateral for a pre-petition debt. Now the lender has a lien worth 15 million and they say, if you give us 3 million more dollars, we will give you a lien on all of our stuff (24 million total) The lien on all the property securing the 3 million is ok, but the lien on all the property securing the original 15 million is not ok. § 364(e) – What is protected is the grant under this section (§364). Does not allow the court to authorize the grant of a lien to secure pre-petition debt. New liens for old debt as part of the deal for getting new debt. Generally this is not allowed, some courts say that if this the only way to get the new credit, then the bankruptcy court can allow it. This is a rare view. If bankruptcy court grants cross-collateralization and it goes up to appeals, can it be reviewed on appeal? Some courts say it is so far out of the bounds of what is allowed that it can not be appealed, other courts like the 9th circuit say that it is not appealable. There is no way the court will grant cross-collateralization if the DIP can live off of cash collateral. Creditors better off under 364 because it is post petition debt and it accrues interest. The degree of adequate protection needed for a priming lien is very high. EDC holding case: Workers are owed pre-petition wages and they are on strike because they have not been paid, they have a picket line. This keeps the bank from getting at their inventory to repo and sell. The workers have a 3rd priority claim (look at § 7). The bank lends money to the estate to pay the workers so the picket lines go down. They say they won’t go away until they are paid and the union lawyers are paid. The problem is that the bill for the union lawyers is not a priority claim, it may not even be an obligation. If the bank lends them more money it becomes an administrative expense claim. Judge says it was improper for the estate to take this claim that has no standing, and turn it into an administrative expense claim. Chapter 5 – How to turn around the business. The first thing you need to know is why is the business failing in the first place. 1. Economic conditions 2. Inside underlying causes
a. Overextension of credit – and you may be paying commission to people on sales made, not money collected b. Inefficient Management i. Inadequate sales ii. Improper pricing iii. Inadequate handling and receivable of payables iv. Excessive operating costs v. Overinvestment in fixed assets vi. Insufficient working capital 3/7/05 c. Insufficient Capital 3. Outside influences 4. Fraud and Dishonesty The earlier you take corrective action, the easier to solve the problem. p.200 Part B X1=.717 x 2/10 X2=.547 x 0/10 3/9/05 Difference between solvency v. viability. Solvency looks at assets v. liabilities. Viability looks at future cash flow, can you generate enough cash to cover operating expenses? What is ordinary course of business? If I go and buy one refrigerator from an appliance store, that is an ordinary course transaction so I will get it free and clear of any lien that the appliance store financer may have. What about making a collective bargaining agreement? Occurs every 3 years maybe for a company. There is some authority that the entering into a collective bargaining agreement is an ordinary course transaction. Scarberry thinks that is flat wrong. Horizontal test: what similar companies do? Vertical test: what has this company done in the past? Most courts say it must meet both tests to be ordinary course. Better approach: Is it a day to day activity of the company? 3/21/05 Note 4 on page 218. What is the effect of finding that the transaction was entered by the DIP in ordinary course of business? If the DIP enters into a contract and later breaches, the result ought to be that the DIP has entered into an obligation that is now the estate’s obligation. It should be considered an administrative expense.
Another view says that it is only an obligation of the estate to the extent that the DIP has benefited. Other than that becomes just like a pre-petition debt. You would think that non-ordinary course transactions would be governed by 363(b). If the transaction is not one where you are using or leasing and it is outside of the ordinary course, then it falls under 364. Severance pay agreements: Raising pay of managers while in chapter 11. Trustee requires notice and hearing before doing so. Generally not allowed, court will not apply business judgment rule because very conflicted transaction. DIP must show that there is need to do so, good to get a 3rd party assessment. APPOINTING A TRUSTEE When to do it? § 1104 There are levels of dishonesty and incompetence. In deciding what that level is in taking into account if it amounts to cause, you should look at the costs of appointing a trustee (bring new management up to speed, etc.). What are the important qualities of a trustee? Somebody with experience in that business. The court orders appointment of the trustee, but the U.S. trustee actually chooses the trustee. The court must approve the choice. The bankruptcy court can move sue esponte for the appointment of a trustee. Makeup session for 2/23/05 Sovereign immunity: dealing with recovery of monetary award against states. This immunity applies to instrumentalities, not municipalities. Concern is the money coming out of state treasuries. Problem 3-9. Look at §362(h) What is a willful violation? Is an individual a flesh and blood human being, or can it also be a corporation? Split in circuits. A willful violation of the stay is when you know a stay exists and you willfully do an act and the act violates the stay. Part 7 – avoiding powers. The code allows for a reversal of a transfer or a debt incurred. When someone has failed to record a mortgage, or failed to give public notice of a security filing. § 544(a) will allow those to be avoided. Under §548 we avoid transfers that are fraudulently done. Like giving money to your niece the day before you file bankruptcy. § 549 deals with transfers that occur after the bankruptcy petition is filed. Ask, did the transfer occur after the commencement of the case? If yes then it falls under § 549.
§303(f) deals with involuntary bankruptcy cases. We are not responsible for involuntary bankruptcy cases. §542(c) deals with banks that don’t know a bankruptcy petition has been filed. If a check comes in, the bank should dishonor the case. If the bank does not know about it and they pay the check then they are ok. If the bank knew about it and paid the check, then the bank is responsible for reimbursing the company in bankruptcy. Part 8 – If the bank ignores the garnishment because the company is in bankruptcy, then can the state court hold the bank in violation of adhering to a garnishment petition? They can not because federal law trumps state law.
Then he did a basic introduction to Chapter 4 – The need for cash. §363(c) authorizes the DIP to use, sell or lease property in the ordinary course of business, so they are not avoidable under §549. Under 28 USC 959(b) says the DIP is obligated to obey the law in operating the business. The automatic stay does not effect criminal actions. The U.S. Trustee has authority to investigate and ask for reports and put guidelines on the operation of the business. 3/23/05 If the major secured creditor is also a major unsecured creditor then should they be on the unsecured creditors committee? The court will usually say no, because the secured creditor may want to trash the reorg so they can get at their collateral. If the U.S. trustee finds that a pre-petition unofficial unsecured creditors committee adequately represents the interest of the unsecured creditors, then the US trustee can simply keep the same committee and they will become official, then all their attorneys get paid out of the estate. What about committees for shareholders? Look at § 1102. It only makes sense if there are a lot of small stockholders, and it will be tough for them to afford to represent themselves in the case. 2 views 1. The code says equity security holders get to vote, they get to be put in a class and they are entitled to a voice by way of a committee. Especially if it is a large publicly held company where the board of directors is usually not acting in the interest of shareholders. 2. Stockholders should be represented well. EXECUTORY CONTRACTS – These are both an asset and a liability. If I have a contract to purchase Greenacre but it has not been conveyed yet then that contract represents both an asset and a liability.
We know how to deal with assets and liabilities, but what about these things that are both. The Countryman Test – If either party has substantially performed then you can not have an executory contract. MISSED CLASS 4/4/05 1111(a) 1112(b) – Non recourse loans are treated as recourse loans unless . . . 1129(b)(2) 4/6/05 You can not make the election if your interest is of inconsequential value (like if you have a second lien and there is not even enough value to cover the first lien). If somebody provides a benefit that increases the value of the collateral, there can be a surcharge placed on the collateral. Only the estate has standing to enforce this surcharge and they get the money which will be distributed equally to the claimants. 4/8/05 Exclusivity has to do with who can file a plan and when can they file it. Classification how to divide up the claims in to voting classes. Impairment: who gets to vote. It s only impaired classes that get to vote. Who can file a plan and when can they file it? § 1121 4/111/05 If you allow exclusivity to expire and then ask the court to re-impose it, there is a split in jurisdiction as to whether they can. 4/13/05 Votes must be cast in good faith, otherwise they will be set aside. If you cast your vote out of malice then that will not qualify. But voting in your economic interest is not bad faith. And if a secured claim holder also has an unsecured claim, they can vote their unsecured claim against the plan simply for the purpose of trying to liquidate the company to get at their security. § 1129(a)(1) 4/18/05 p.779 15-1 (a) Without the election, Galactic bank’s claim is 100,000. Global bank’s claim is 45,000.
4/20/05 When determining present value, what interest rate do we use. 3 views. Risk free rate, Market value rate, or a risk free rate + a little. The rate used is at the time of the plan, not when the petition was filed. 4/22/05 Treating dissenting classes of unsecured claims fairly and equitably. § 1129(b) One part is the absolute priority rule, must pay debts before owners. 4/27/05