12/16/2006 Revision 0.1 Author: Philip Larson Bankruptcy Law: Outline Disclaimer: These notes and outlines are provided asii without any warranty as to their correctness, completeness, or quality. They are not meant to be a substitute for your own efforts. You may copy and forward this document as long as you do not alter its contents. Bankruptcy Law: Outline Philip Larson Page 2 Table of Contents 1. BANKRUPTCY LAW: OUTLINE...................................................................................... 3 1.1 INTRODUCTION........................................................................................................ 3 Bankruptcy Law: Outline Philip Larson Page 3 1. BANKRUPTCY LAW: OUTLINE 1.1 INTRODUCTION -Philosophy: For individuals, bankruptcy is designed to give the debtor relief from certain debts and provide the debtor with a fresh start financially. For entities, bankruptcy helps provide a breathing spell from certain demands so that the entity can reorganize and stay in business. Bankruptcy is intended to be fair and equitable to both debtors and creditors. Creditors benefit from the establishment of a forum in which there is either an orderly liquidation of the debtor’s estate or a judicially scrutinized plan to repay the debtors partially or fully over a period of time. While outside bankruptcy the diligent creditor that pursues consensual and judicial remedies often prevails, bankruptcy affords creditors protection. Bankruptcy prevents the creditor “race to the courthouse” and insures unsecured creditors are protected from the debtor selectively repaying certain debts (preferences) or fraudulently transferring his assets. Moreover, creditors that are secured by an interest in collateral are afforded adequate assurance in bankruptcy that their interest will be protected. -Chapters: o Chapter 7: Chapter 7 of the Bankruptcy Code provides the liquidation provisions. This defines the circumstances whereby the trustee collects the debtor’s nonexempt assets, reduces them to cash, and makes distributions to creditors. o Chapter 11: Chapter 11 provides the provisions for reorganization that typically concerns a commercial debtor that desires to continue operating a business and to repay creditors through an acceptable plan of reorganization confirmed by the court. o Chapter 13: Chapter 13 provides a method where an individual may repay all or a portion of his indebtedness over a period of time, pursuant to a plan proposed by the debtor and confirmed by the court. -Participants: o Debtor: § 101(13) – the debtor is the person filing bankruptcy. o Debtor in Possession (DIP): In Chapter 11, the debtor is called a “debtor in possession, unless a trustee has been appointed. § 1101(1). A debtor in possession has all the rights (except compensation under § 330) and must perform all the duties of a trustee serving in Chapter 11. § 1107. o Trustee: the trustee is the official representative of the estate. § 323. He obtains a judicial lien on all of the debtor’s nonexempt property, exercising his powers primarily for the benefit of unsecured creditors. He has the capacity to sue and be sued. § 323(b). A trustee is always appointed in Chapter 7 and Chapter 13, and may be, but not usually, appointed in Chapter 11. o United States Trustee – the US trustee handles a lot of the administrative responsibilities of the court, including the appointment and supervision of bankruptcy trustees. He makes sure the debtor files a monthly operating report under § 308 and also makes sure the debtor files all the appropriate schedules and financial statements. o Creditors: a creditor is an entity that has a claim against the debtor that arose at the time of or before the order for relief concerning the debtor. § 101(10). Unsecured Creditors: an unsecured creditor is an entity holding a claim against the debtor that is not secured by collateral. Secured Creditor: a secured creditor is an entity with a claim against the debtor that is secured by a lien on property of the estate or that is subject to setoff. § 506(a). o Priority Creditors – Priority creditors are “first in time” in the sense that if there is anything in the estate other than collateral used to pay off secured debt, they are first to get it. § 507(a). -WHO CAN FILE BANKRUPTCY? o General Requirements: In bankruptcy, a person is defined to include individuals, partnerships and corporations. § 101(41. A person may not file bankruptcy unless they are connected with the US. For individuals, this is based on residence and domicile. For businesses, this is based on the place of business and the location of assets. Moreover, an individual may not file bankruptcy unless they have received a briefing from an approved credit counseling agency and performed a related budget analysis within the 180 day period preceding the filing of the petition. § 109(h)(1). Entities and corporations, by contrast, do not need credit counseling prior to filing bankruptcy. While credit counseling services have become more prevalent, even being offered over the Internet, an exception to the requirement of credit counseling exists in districts that are not reasonably able to provide adequate services to the individual, § 109(h)(2)(A), or if there are exigent Bankruptcy Law: Outline Philip Larson Page 4 circumstances that merit waiver. § 109(h)(3)(A). It is also important to note that there is nothing in the code that requires a debtor to be insolvent in order to file bankruptcy. § 109. o Chapter 7: Background: The most common complaint in Chapter 7 filings is that many consumer debtors would file under Chapter 7 and discharge their debts even though they could repay a significant portion of their debts out of future income under Chapter 13. After 1984 but prior to the 2005 Amendments, a bankruptcy court could get rid of a Chapter 7 liquidation if there was “substantial abuse”, such as running up big credit card debt prior to filing bankruptcy. However, the consumer credit industry became frustrated with this test and under the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), the legislature adopted a new abuse test that includes a “Means Test” under § 707(b). The means test is basically a way of checking to see whether a debtor could actually pay off some of its debts to creditors in a Chapter 13 proceeding. Means Test: The Chapter 7 “Means Test” applies only to individuals with primarily consumer debt whose combined family income is larger than the state median. § 707(b)(1); § 707(b)(7)(A). It does not apply to individuals whose debt is primarily from business or to corporations or other entities. § 707(b)(1). If the individual does not pass the means test, there is a presumption that they are abusing the system and the trustee may dismiss the Chapter 7 case or convert the case into a Chapter 13 proceeding. § 707(b)(1); § 707(b)(2)(A). To determine if the individual’s family income is larger than the state median, you take the debtor’s current monthly income as of the petition date, multiply it by 12, and compare it to the applicable median family income under state law. If the debtor fails the test, be may try to rebut the presumption of abuse by showing that there is no reasonable alternative other than to decrease income or increase the expenses used. However, this requires the debtor to show special circumstances. Moreover, under §707(b)(4), the lawyer is on the hook. He must use due diligence in verifying that everything in the petition is correct and can be sanctioned under Rule 11 if he fails this duty. Therefore, after BAPCPA, lawyers have to do a lot more work to prepare a Chapter 7 petition and many lawyers now won’t do these cases. • Test: therefore, if you have an individual with primarily consumer debt whose family income is larger than the state median, you must apply the test under § 707(b)(2)(A). o Step 1: Compute “Current Monthly Income” under § 101(10A). This includes all income whether taxable or not, and must include income from a spouse. However, if there is a bonafide separation (not necessarily divorced) you don’t have to include their income. o Step 2: Subtract out Monthly Expenses: these include: Food and clothing expenses of up to 5% of the categories from the IRS guidelines. § 707(b)(2)(A)(ii)(I) Living expenses from IRS for area in which debtor resides. § 707(b)(2)(A)(ii)(I) Reasonable health insurance: § 707(b)(2)(A)(ii)(I) § 707(b)(2)(A)(ii)(I) Projected Secured Debts: (e.g. mortgage on your house, your car, etc. or anything you can keep under Chapter 7 that have payments.). § 707(b)(2)(A)(iii) Projected Priority debts: § 707(b)(2)(A)(iv). You can subtract out priority claims that you would have to pay out in a Chapter 13, such as child support and alimony. Other expenses: charitable contributions, and administrative charges. § 707(b)(2)(A)(ii)(II)-(V), § 707(b)(1) o Step 3: Multiple “Net Monthly Income” by 60 to see if “NET INCOME” is LESS THAN either: $6k, or $100/month (6,000/60=100) OR 25% of the debtor’s nonpriority, unsecured claims, whichever is greater. If the $6k is greater, and NET Income is less than this, the presumption is that there is not abuse and the debtor may file Chapter 7. OR, $10k or $167/month. (therefore, if you calculate a net income above $167/month the presumption of abuse will always be there. Therefore, what we are talking about is whether people between $100/month and $167/month can file for Chapter 11. Bankruptcy Law: Outline Philip Larson Page 5 o Summary: if your client has net income of > $167/month, the presumption is that he is unable to file for Chapter 7. If he has net income of < $100, he can file for Chapter 7. • Options if you fail the test: o Chapter 11: Under § 109(d), an individual, partnership or corporation that is eligible under Chapter 7 can also be a debtor in Chapter 11. Chapter 11 is designed principally for business reorganizations, although individuals may also qualify for relief. o Chapter 13: Only individuals who have “regular income” may file for Chapter 13. “Regular income” is income that is sufficiently stable and regular to enable the individual to make payments under a Chapter 13 plan. § 101(30). While regular income typically comes from wages or salary, it can also be derived from other sources of income. Moreover, to file for Chapter 13 the individual must have unsecured debts of less than $307,675 and secured debts of less than $922,975. § 109(e). -WHERE DO YOU FILE BANKRUPTCY? o Corporations may file bankruptcy in their principal place of business or the place with most of their assets. Therefore, a VA corporation with most of its assets in TX has a choice of where to file. o Voluntary Petition: Under § 301, bankruptcy can be commenced voluntarily by the debtor filing a petition. This constitutes an order for relief. Bankruptcy begins when the petition is filed. This is when the clerk actually date stamps the petition. Therefore, there is no need for a judicial proceeding for the order of relief to begin. Next, the debtor would have to file a schedule of assets and liabilities, pass the means test, etc. o Involuntary Petitions: An involuntary case can be started under Chapter 7 or 11 by filing a petition. If there are more than 12 creditors, three or more of them may file a petition only if they have undisputed unsecured claims in aggregate of at least $12,300. § 303(b)(1). If there are fewer than 12 creditors, one or more of them may file an involuntary petition if they have at least $12,300 in aggregate claims. The order of relief in involuntary petitions does not begin on filing, but rather is ordered by a judge after a hearing to ensure the bankruptcy is warranted. -WHAT IS THE EFFECT OF FILING THE BANKRUPTCY PETITION? o Bankruptcy Estate is Created: The creation of a bankruptcy estate occurs automatically upon the filing of a voluntary (§ 301) or involuntary (§ 303) petition for bankruptcy. § 541. The estate consists of all legal or equitable interests of the debtor in property as of the commencement of the case, § 541(a)(1), as well as interests of the debtor in community property, § 541(a)(2) and proceeds generated from property of the estate § 541(a)(6); Butner v. US., etc. While most of the debtor’s assets are moved to the estate bucket, salary and wages earned by the debtor after the petition date are not part of the estate in Chapter 7. §541(a)(6); Sliney v. Battley; Andrews v. Riggs National Bank. Moreover, there are a number of other items excluded from the estate bucket under § 541(b) and (c). Bankruptcy law governs whether an interest in property exists for the purpose of § 541 while state law governs the extent of the debtor’s interest in that property. Butner v. US. o Automatic Stay: At the time the petition is filed, an automatic stay is invoked enjoining all actions against the debtor from the creditors. § 362. During the stay, creditors may not commence or continue any judicial, administrative or other action against the debtor, or recover any claim against the debtor that arose prior to the commencement. § 362(a)(1). The automatic stay also prevents the enforcement of any judgments obtained against the debtor prior to the commencement of the case, § 362(a)(2), as well as any act by a creditor to obtain possession of property of the estate created under § 541. § 362(a)(3). The automatic stay even prevents acts to create, perfect or enforce a lien against the property of the estate, § 362(a)(4), and acts to collect or recover a claim against the debtor arising prior to the filing of the petition, § 362(a)(6). Regarding taxes, the automatic stay even applies to the IRS. United States v. Whiting Pools, Inc. This essentially stops the race to the courthouse. It is automatic and self-executing and takes effect whether the creditor knows about it or not. The automatic stay is a temporary injunction that lasts until the end of the case, unless the automatic stay is lifted by the court. Limitations: While the automatic stay is a powerful defense for the debtor, it has limitations. Under § 362(b), a creditor may request that the stay be lifed if the debtor has no equity in the property and the property is therefore not needed by the bankruptcy. Moreover, the automatic stay does not stop criminal proceedings, § 362(b)(1), domestic support obligations, § 362(b)(2), paying taxes, § 362(b)(9), or prevent governmental proceedings for things like traffic violations. While the automatic Bankruptcy Law: Outline Philip Larson Page 6 stay is typically effective against all property of the estate, in a case where an entity has only one asset in real estate, the stay can be lifted under § 362(d)(3); In re Victoria Limited Partnership. -WHAT CAN HAPPEN TO A SECURED CLAIM? o Secured Claims: A secured claim is one that has been allowed under § 502 and is secured by a lien on property of the estate. § 506(a). A secured creditor will be either oversecured (collateral is worth more than money owed to creditor) or undersecured (collateral is worth less than the money owed to creditor). If the creditor is undersecured, he gets a bifurcated claim. § 506(a). That is, he has a secured claim to the extent of the value of the collateral, and an unsecured claim for any amount of debt not covered by the collateral. § 506(a)(1). If the debtor is an individual in Chapter 7 or 13, the value of personal property securing a claim is based on the replacement value of the property as of the date of filing the petition, without a deduction for costs of sale or marketing. § 506(a)(2); Associates Commercial Corp. v. Rash. The replacement value is basically the value a retail merchant would charge for the property considering its age and condition. Id. Moreover, in bankruptcy a secured creditor has the right to receive adequate protection of her interest in the collateral, § 361, and failure to provide adequate protection constitutes cause for granting the creditor relief from the automatic stay under § 362(d)(1). To the extent that a secured creditor benefits directly from the preservation or disposition of the collateral, the trustee may be reimbursed from the collateral for the necessary and reasonable costs of preserving and disposing of the collateral. o Trustee can Use, Sell or Lease of Property: After the debtor’s property has been added to the estate bucket under § 541, the trustee may use, sell or lease the property of the estate. § 363(b)(1). He may do this to pay off creditors. Additionally, if the trustee is authorized under Chapter 7, 11 or 13, he may enter into transactions, including the sale or lease of property, in the ordinary course of business and may use the property of the estate in the ordinary course of business. § 363(c)(1). o Secured Creditor can try to lift the automatic stay: The secured creditor may request that the court lift the automatic stay. To lift the automatic stay for cause, the creditor can show that his interest in the property is not adequately protected, § 362(d)(1), or that the debtor has no equity in the property and therefore the property isn’t needed for an effective reorganization, § 362(d)(2). Moreover, the creditor may be able to get the stay lifted if he can show the filing of the petition was part of a scheme to delay, hinder, and defraud creditors, § 362(d)(4). The debtor can try to prevent the creditor from getting the court to lift the automatic stay by arguing a policy reason or by showing that the creditor is adequately protected. Adequate Protection: There are a number of ways the debtor can show adequate protection, including: 1) making cash payments to the extent that the value of the entity’s collateral is decreasing, 2) providing a replacement lien to the extent that the collateral is decreasing in value, or 3) by providing the equivalent of the entity’s interest in the property. § 361. For oversecured creditors, they are often adequately protected by an equity cushion if the debtor made a down payment. o Trustee can Abandon the property: After notice and a hearing, the trustee can abandon any property that is burdensome to the estate that is of inconsequential value and benefit to the estate. § 554(a). Property that is abandoned by the estate goes back to the debtor. § 554(c). At this point, the creditor can go after the property in state law. -WHAT IF THE DEBTOR WANTS TO KEEP THE PROPERTY? o Trustee or Debtor can Pay Off the creditor: As long as the creditor is paid the full value of the collateral, the debtor or estate can simply pay them off and get them out of the bankruptcy case. They might do this by getting debtor in possession financing under § 364 and use the loan to pay pre-petition creditors. Section 364 gives trustees and debtors in possession a lot of leeway to obtain financing during bankruptcy. If the trustee is authorized to operate the business of the debtor, the trustee can obtain unsecured credit in the ordinary course of business as a § 503(b)(1) administrative expense. § 364(a). If the trustee is unable to obtain unsecured credit the court may authorize obtaining credit that is secured by a lien on unencumbered property of the estate. § 364(c)(2). Additionally, the court may authorize the trustee to obtain credit secured by property already encumbered by liens if the trustee would be unable to obtain credit otherwise and there is adequate protection for the original secured interest. § 364(d)(1). Shapiro v. Saybrook (Saybrook was unable to show that the other creditor’s interests were adequately protected). o Debtor can Exempt certain property: Under § 522, individuals filing bankruptcy may exempt certain types of unsecured and secured property from the estate bucket created under § 541. § 522(b). These exemptions do not apply to corporations or other organizations. Unless the case is dismissed, property exempted by the debtor is not liable during or after the case for any pre-petition debt or any debt deemed to have arisen before Bankruptcy Law: Outline Philip Larson Page 7 bankruptcy. § 522(c). However, liens encumbering property that are not void under § 506(d) stick with the property if the debtor chooses to remove the property from the bankruptcy estate through an exemption. § 522(c). When the individual debtor files his schedule of assets and liabilities with the court, the debtor must also file a statement of his intention to exempt certain property. § 521(a)(2)(A). While there is nothing wrong with exemption planning, a debtor may not use exemptions to hinder, delay or defraud creditors. For example, you may not convert property into exempt property simply to defraud creditors. Norwest Bank Nebraska v. Tvetan (debtor’s conversion of $700k into exempt property prior to discharging debts of $19M constituted fraud and were not allowed as exemptions). Exemption Options: In bankruptcy, there is a choice between federal exemptions and state law exemptions. State law governs whether the debtor may choose. VA, for instance, has opted out of the exemptions in the bankruptcy code. • Option 1: Federal Exemptions: § 522(b)(2); § 522(d) o Residence: up to $18,450 in real or personal property that the debtor uses as a residence, § 522(d)(1). o Motor Vehicle: up to $2,950 in value in one motor vehicle, § 522(d)(2). In re Johnson (a 60-passenger bus was held to be a motor vehicle that could be exempted). o Personal items: up to $475 in one particular item or up to $9,850 in household furnishings, household goods, books, animals, and things held primarily for personal, family or household use. § 522(d)(3). o Jewelry: not to exceed $1225. § 522(d)(4). o Tools of trade: not to exceed $1850 (professional books, tools, etc.). § 522(d)(6). o Unmatured Life Insurance: owned by debtor other than a credit life insurance K. § 522(d)(7). o Social security, veterans and disability benefits: § 522(d)(10)(A)-(C). o Alimony: the debtor’s right to receive alimony, support or maintenance, to the extent that it is reasonably necessary to support the debtor is exempted. § 522(d)(10)(D). o Retirement funds: right to receive payments under an eligible pension plan is exempted. § 522(d)(10)(E) • Option 2: State Exemptions: If the debtor does not elect the federal bankruptcy exemptions, or if the debtor’s state of domicile has opted out, the exceptions available to the debtor are those allowable under applicable state law. § 522(b)(3). The exemptions allowed under state law are those in effect as of the petition date and in the state where the debtor has been domiciled for the 730 days prior to bankruptcy. § 522(b)(3)(A). In In re Laube, for instance, the debtor was allowed to exempt a truck he used as a “homestead” under the homestead exemption of Wisconsin law. However, under § 522(p) there is now a $125k cap on what state law homestead exemptions may be for any property bought in the 1215 days prior to the petition date. o Debtor can Redeem the Property: In Chapter 7 only, an individual debtor can redeem tangible personal property intended primarily for personal, family or household use, from a lien securing a dischargeable consumer debt by paying the holder of the lien the full amount of the secured claim at the time of redemption. § 722. Therefore, by paying the market value of the collateral, the individual debtor may reclaim the property free and clear of any liens. However, the debtor may only redeem the property if it is exempted under § 522 or has been abandoned under § 544. Moreover, he would have to redeem the replacement value per § 506(a). While this doesn’t typically happen, an industry of lenders has emerged that will loan to people in bankruptcy to allow the debtor to perform a redemption and charging a risk-based (high) interest rate. This “debtor financing” is allowed under § 364. o Debtor can Reaffirm the claim: A reaffirmation agreement is a voluntary contract between the debtor and the holder of a dischargeable claim whereby the debtor promises to repay all or part of the debt after bankruptcy. § 524(c). Reaffirmation requires full disclosure to the debtor of his rights by either the court or the debtor’s attorney. Moreover, the affirmation agreement must be filed with the court along with an affidavit from the debtor’s attorney stating that the debtor was fully informed and entered the agreement voluntarily and that the debtor was advised of the legal consequences of reaffirmation. Then, the reaffirmation has to be approved by the court. Sears. The creditor has a right to refuse the terms of the reaffirmation, even if the terms are the exact same as the original contract. Bankruptcy Law: Outline Philip Larson Page 8 o Debtor CANNOT Reinstate the claim: Under § 521(a)(2), the debtor must either redeem property in the estate, exempt property from the estate or reaffirm debts secured by property of the estate. He cannot simply reinstate the existing contract. If he chooses to reaffirm, the creditor can refuse. --WHAT HAPPENS WITH EXECUTORY CONTRACTS? o Definitions: Section 365 gives a lot of power to the trustee/debtor to control what happens in bankruptcy with existing executory contracts and unexpired leases. Contracts or leases that come under § 365 may be either assumed or rejected by the debtor. § 365(a). The debtor determines whether the unexpired lease or executory contract is a benefit or a burden to the estate based on what the debtor still has to perform. However, the debtor cannot pick and choose the provisions he would like to keep. He must accept or reject the entire K. Burger King Corp. v. Rovine Corp. Moreover, the debtor must get the approval of the court and when considering a request to assume or reject. The court usually applies the business judgment rule and approves the decision unless there is bad faith or gross abuse. While neither executory contracts nor unexpired leases are defined in the Bankruptcy Code, courts have construed the terms in applying § 365 regarding their assumption and rejection in bankruptcy. In determining whether a contract is executory, courts look to see if there is substantial performance left to be done by both parties. A loan, for instance, is not an executory K because the lender has done everything they need to do. Unexpired leases, on the other hand, are leases that have not expired or terminated before the petition date. The unexpired lease must be a true lease rather than one intended as a secured transaction. If the lease has terminated prior to the petition date, it does not come under § 365. Three Requirements of Assumption: If there has been default in an executory K or an unexpired lease, the trustee or debtor in possession may only assume the K or lease if three requirements are met. § 365(b)(1). First, the trustee must cure the default or provide adequate assurance that it will be promptly cured. § 365(b)(1)(A). Second, the trustee must either compensate, or provide adequate assurance of prompt redress to, the creditor for any pecuniary loss that has resulted from the default. § 365(b)(1)(B). And third, the trustee must provide adequate assurance of future performance of the K or unexpired lease. Adequate assurance of future performance of a lease in real property in a “shopping center” has some special requirements. § 365(b)(3). • Exceptions: default based on provisions relating to the insolvency or financial condition of the debtor or arising from failure by the debtor to perform nonmonetary obligations do not trigger the application of § 365. • Assignment: After assuming an executory K or unexpired lease, the trustee or debtor in possession may assign it. § 365(f)(1). However, the trustee or DIP may only assign the K or lease if 1) he first assumes it, and 2) he provides adequate assurance that the assignee will perform. § 365(f)(2). The assignment relieves the trustee and the estate from any liability resulting from a breach occurring after the assignment. § 365(k). The only party liable for the future performance is the assignee which is why the debtor must present proof of adequate assurance of how the third party will be able to perform in the future. The trustee might want to assign the K or lease if it is worth more to someone else. The proceeds can then be added to the bankruptcy estate. § 541. For the most part, anti-assignment clauses are typically invalid in bankruptcy. § 365(f)(1), (3). o Exceptions: Certain types of Ks and leases are not assignable, such as 1) personal service Ks or government Ks, w/o consent, 2) Ks to make a loan to the debtor or to issue a security of the debtor. § 365(f)(1). Rejection: The trustee is not a party to the K until the trustee makes his decision to assume. If the trustee or debtor in possession chooses to reject the K or lease, this rejection typically operates as a breach of the executory K or unexpired lease. § 365(g); Federal Realty Investment Trust v. Park (holding rejection was a breach of K but did not terminate the K). The Ks and leases do not become obligations of the estate because the trustee is not a party to the K. However, the estate no longer receives any benefits from the lease or K. The damages that result from the breach are called rejection damages and become an unsecured claim against the debtor’s estate. Damages are typically calculated based on expectation value as if the rejection took place on the petition date, even if it was actually months later. § 365(g); In Re Enron Corp. After rejection, the K is no longer executory because there is no performance left on either side. Therefore, the claims for rejection damages become § 501 and § 502 claims. Timing: The period within which the trustee or DIP may assume or reject an executory K or unexpired lease depends on the chapter under which the case is filed and the nature of the property that is the Bankruptcy Law: Outline Philip Larson Page 9 subject matter of the K or lease. § 365(d). Regardless of the time period that the trustee has to decide, the other party must continue to perform. Data-Link Systems, Inc. v. Whitcomb. • Chapter 7: In Chapter 7, the trustee has 60 days after the order for relief to assume or reject an executory K or unexpired lease in personal property or residential real property. Otherwise, the K or lease is deemed rejected. § 365(d)(4). The court may extend the period if there is cause. § 365(d)(1). • Chapter 11 & 13: In Chapter 11 and 13, assumption or rejection of an executory K or unexpired lease of personal property or residential property may occur at any time prior to the confirmation of the plan. § 365(d)(2). Although, the creditor may request that the court direct the trustee to assume or reject earlier if appropriate. • Nonresidential Real Property: If the debtor has a lease of nonresidential real property, the trustee in any chapter has 120 days from the order for relief within which to assume or reject or else the lease will be deemed rejected, and may ask for one 90 day extension. § 365(d)(4). -WHAT OTHER WAYS CAN TRUSTEE FILL UP THE ESTATE PROPERTY BUCKET? o Avoiding Powers: Under § 542, any entities other than a custodian of the estate has to deliver the property or its value to the trustee. § 542(a). In Chapter 5 of the Bankruptcy Code, the trustee has a number of avoiding powers that he may use to try to fill up the estate bucket. The trustee typically must show that 1) the transfer prior to the petition date is voidable and 2) that the property can be recovered. Sections 544, 547 and 548 all provide means by which the trustee can avoid transfers of property that occurred prior to the petition date and thereby increase the estate’s bucket. The trustee usually has 2 years from the day the petition is filed to decide whether to void any transfers using § 544, 547 or 548. § 546(a). By avoiding a transfer, the trustee is entitled to recover either the property transferred or, if ordered by the court, its value. § 550(a). o Avoidance as Hypothetical Creditor or Purchaser and as Successor for some Actual Creditors: The Bankruptcy Code gives the trustee, at the commencement of the case, the hypothetical status and the rights and powers of a judicial lien creditor, a creditor with an unsatisfied execution, and a bona fide purchaser of real property. Therefore, the trustee can avoid any transfer of the debtor’s property that any of these entities could avoid “without regard to any knowledge” of the trustee or any creditor. § 544(a). Part of the purpose of this trustee strong-arm power is to prevent the creation of secret, unperfected liens by giving the trustee a judicial lien that trumps these secret liens. Moreover, § 544 gives the trustee the power to step into the shoes of an actual creditor and exercise whatever rights that creditor would have had under state law. Under state law, for instance, the look back periods for fraudulent transfers often go back 4 years instead of the 1 year under § 548 of the federal law. Therefore, if state law allows the trustee to reach back farther and there is an actual creditor who could bring the claim, the trustee can use § 544 to reverse a fraudulent transfer as far back as the state law allows. One exception to this strong arm power is that the power does not cover charitable contributions that are not deemed to be a fraudulent transfer under § 548. § 544(b)(2). o Preferences: Under § 547, the trustee has the power to avoid pre-petition preferential transfers. This enables the bankruptcy estate to be enlarged for the benefit of creditors. It is intended to prevent the debtor from choosing which creditors he wants to repay and helping ensure all unsecured creditors are treated the same. A voidable preference occurs when there has been 1) a transfer of the debtor’s interest in property, 2) made to or for the benefit of a creditor, 3) concerning antecedent debt, 4) at a time when the debtor is insolvent, 5) within 90 days prior to the petition date (or up to one year before if the creditor is an “insider”), and 6) which results in the creditor receiving a larger share than he would have obtained under the Bankruptcy Code. § 547(b). A transfer can be any voluntary or involuntary disposition of property. Section 547(f) creates a presumption that the debtor is insolvent for the 90 days prior to the filing of the petition. The creditor can rebut this presumption by proving the debtor was in fact solvent at the time of the transfer. Moreover, to determine if the creditor would have received a greater share the court looks to see what each creditor would have gotten in Chapter 7 liquidation. Under this element of the test, payments made to a creditor whose allowed claim is completely secured do not constitute a preference because such transfers do not take anything away from the overall bankruptcy estate. Palmer Clay Products v. Brown. Exception – Contemporaneous Exchange for New Value: To the extent that a transfer was a contemporaneous exchange for new value, the transfer is not avoidable. § 547(c)(1). Exception – Ordinary Course of Business: A transfer is not voidable to the extent that it was made in the ordinary course of business according to ordinary business terms for payment of debt incurred in the ordinary course of business. Late payments generally do not count under this exception. § 547(c)(2); In re Tolona Pizza Products Corp Bankruptcy Law: Outline Philip Larson Page 10 Exception – PMSI: A purchase money security interest securing new value extended to the debtor for purpose of acquiring certain property is protected from avoidance. § 547(c)(3). Exception – Subsequent Advance of New Value: A transfer is not voidable to the extent that subsequent to the transfer, the creditor extended new pre-petition value that is not secured by an otherwise unavoidable security interest. § 547(c)(4). Exception – Security interest in Inventory & Receivables: A transfer creating a perfected security interest in the debtor’s inventory or receivables is voidable only to the extent the creditor’s position has improved. § 547(c)(5). That is, build-up of inventory is voidable. Exception – Statutory Lien: Mechanics, tax and artisan’s liens are nonvoidable as a preference if the lien could not be avoided under § 545, even if it is perfected within the 90 days before bankruptcy. § 547(c)(6). Exception – Domestic Support: Bona fied payments of alimony or child support is not avoidable by the trustee as a preference. § 547(c)(7). Exception – Consumer Debts < $600: For individual’s with primarily consumer debt, a transfer of property worth less than $600 is not avoidable by the trustee. § 547(c)(8). Exception – Nonconsumer Debts < $5000: if the case is filed by a debtor whose debts are not primarily consumer debts, the trustee may not void a transfer of property whose aggregate value is less than $5000. o Fraudulent Transfers: The trustee has the power to avoid a fraudulent transfer of the debtor’s interest in property or the fraudulent incurring of an obligation if the transfer was made by the debtor within one year prior to bankruptcy. § 548(a). A transfer may be considered fraudulent if there is 1) actual fraud, or 2) constructive fraud. Actual Fraud: Actual fraud requires the actual intent to hinder, delay or defraud a creditor. § 548(a)(1)(A). Some of the “badges of fraud” include 1) when inadequate or no consideration was received in the transfer, 2) when the transferee is a relative or close friend of the debtor, 3) when the debtor continues to enjoy the use of the property for his personal benefit, 4) when the conveyance occurs during or following the debtor’s incurrence of financial problems, and 5) when the debtor transfers assets to a company that he completely controls. Schafer v. Las Vegas Hilton. Constructive Fraud: A transfer may also be considered fraudulent, even if the debtor does not have actual intent, if the debtor receives less than the reasonably equivalent value of the exchange at a time when the debtor was insolvent or became insolvent as a result of the transaction. § 548(a)(1)(B). Reasonably equivalent value at a foreclosure is whatever value was received as long as the foreclosure followed the procedural requirements of state law. BFP v. Resolution Trust Corp. Bona fide purchaser in “Good Faith”: a good faith transferee for value is entitled to retain any property conveyed to her, to the extent of the value given to the debtor in exchange. § 548(c). Good faith requires that this be an arm’s length transaction and must take into account all surrounding circumstances. --WHO GETS PRIORITY? o What are claims? Under § 101(5), a claim is a “right to payment” or a “right to an equitable remedy for breach of performance” regardless of whether the claim is reduced to judgment, fixed, contingent, matured, unmatured, disputed, undisputed, secured or unsecured. Claims that arise after the petition date are not part of the bankruptcy. Under Grady v. A.H. Robins Co., and the Piper Test, claims that arise post-petition from conduct or relationships created pre-petition can still be valid claims if the pre-petition contact or relationship is the basis for the liability. o Filing Claims: Generally, for a claim or interest to be allowed in bankruptcy, a creditor must file a proof of claim or interest. § 501(a). In Chapter 7 and 13, a proof of claim ordinarily must be filed within 90 days after the first date set for the § 341 meeting. In Chapter 11, the court fixes a bar date which is a deadline for filing claims or interests. Any claims that are listed in the schedules filed by the debtor or the trustee are deemed to be automatically filed unless the claim or interest is scheduled as contingent, unliquidated or disputed. o Allowance of Claims: Unless a party in interest objects, a claim or interest that has been filed will be allowed by the court and will serve as the basis for distribution. § 502(a). The value of the claim is set as of the petition date. Moreover, some claims have statutory caps on them. If someone objects, the court after notice and hearing determines the amount of the claim. § 502(b). There are a number of exceptions for claims that are not generally allowed: Bankruptcy Law: Outline Philip Larson Page 11 Post petition interest: post-petition interests on an unsecured claim are generally not allowable. § 502(b)(2). Landlord – Terminated Lease: A lessor’s damages for a termination of a lease of real property is allowed, but only up to the greater of the rent under the lease for one year or 15% of the rent for the balance of the lease (up to a maximum of 3 years rent) after the earlier of the petition date or the date the property was repossessed, plus any unpaid rent that is due as of the earlier of those two dates. Claims above that amount are not allowed. § 506(b)(6). o Secured Claims: In bankruptcy, secured creditors get priority. A secured claim is one that has been allowed under § 502 and is secured by a lien on property of the estate. § 506(a). A secured creditor will be either oversecured (collateral is worth more than money owed to creditor) or undersecured (collateral is worth less than the money owed to creditor). If the creditor is undersecured, he gets a bifurcated claim. § 506(a). That is, he has a secured claim to the extent of the value of the collateral, and an unsecured claim for any amount of debt not covered by the collateral. § 506(a)(1). If the debtor is an individual in Chapter 7 or 13, the value of personal property securing a claim is based on the replacement value of the property as of the date of filing the petition, without a deduction for costs of sale or marketing. § 506(a)(2); Associates Commercial Corp. v. Rash. This means the value a retail merchant would charge for the property considering its age and condition. Id. A secured creditor has the right to receive adequate protection of her interest in the collateral, § 361, and failure to provide it constitutes cause for granting the creditor relief from the automatic stay under § 362(d)(1). Surcharge for Preservation: to the extent that a secured creditor benefits directly from the preservation or disposition of the collateral, the trustee may be reimbursed from the collateral for the necessary and reasonable costs of preserving and disposing of the collateral. o Priority Unsecured Claims: After secured creditors, priority claims are the first unsecured claims to be paid in bankruptcy. § 507. Under § 507(a), priority claims include: 1) FIRST: claims for domestic support obligations as of the date of the filing of the petition owed to a spouse, former spouse, etc., § 507(a)(1)(A), 2) SECOND: administrative expenses allowed under § 503(b). These are expenses that are necessary to preserve the estate and also include § 330 expenses for the compensation of the trustee, etc. • Administrative Expenses: After the payment of secured claims from property constituting collateral, and payment of claims for domestic support obligations, entities holding claims for administrative expenses are entitled to the next priority in the distribution of assets. § 503, § 507(a)(2). Administrative costs include: o Preserving the estate: the actual, necessary costs and expenses of preserving the estate (wages, salaries and commissioners for services rendered after the commencement of the case) § 503(b)(1)(A). o Compensation and Reimbursement: the reasonable compensation for the trustee under § 330(a). § 503(b)(2). o Attorneys’ fees & expenses: the reasonable compensation for professional services rendered by an attorney, as well as the reimbursement of actual and necessary expenses of the attorney. § 503(b)(4). 3) THIRD: involuntary gap claims, which are claims in an involuntary case that arise “in the ordinary course of the debtor’s business” after the filing of the petition but before the appointment of the trustee under § 502(f). § 507(a)(3). 4) FOURTH: wages and commissions – wages, salaries or commissions earned by an individual within 180 days of the bankruptcy or the cessation of the debtor’s business up to $10,000. This is basically repayment for services of employees that have already been performed. § 507(a)(4). 5) FIFTH: unsecured claims for contributions to an employee benefit plan that arises from services rendered w/i 180 days before the filing of the petition or the cessation of the debtor’s business. § 507(a)(5) 8) EIGHTH: income tax owed to the IRS for a taxable year ending on or before the bankruptcy within three years prior to the date of bankruptcy, § 507(a)(8)(A) and property taxes incurred prior to bankruptcy that was last payable without penalty within one year before the date of the petition, § 507(a)(8)(B). o General Unsecured Claims: these come after secured claims and priority claims. o Equity claims: these come after everyone else. -WHAT HAPPENS TO THE CLAIMS THAT REMAIN UNPAID?.....DISCHARGE. Bankruptcy Law: Outline Philip Larson Page 12 o General: A debtor is relieved of personal liability for all debts that are discharged. § 524(a)(1),(2). The main goal of bankruptcy is to give an honest debtor a fresh start and this is accomplished by relieving him from personal liability for all debts that have been discharged. This does not apply to obligations, only to debts. In Chapter 7, discharge applies to debts before the petition date. In Chapter 11, § 1141 applies to debts incurred prior to the confirmation date. Therefore, debts incurred during the bankruptcy proceeding may be discharged. In Chapter 13, discharge is only for debts included in the plan and are only discharged after the plan is completed. That is, if the debtor has made all the payments required under the 5-yr plan, he is discharged. o Nondischargeable Debts: Certain debts of an individual debtor are nondischargeable and survive bankruptcy of an individual granted discharged under Chapter 7, 11, or 13. This means creditors are enjoined permanently from attempting to collect or recover these debts from the debtor. § 524(a)(2). Some of the debts that are nondischargeable under § 523 include: Taxes: taxes under § 507(a)(8), taxes for which a return has not been filed or was filed late, § 523(a)(1)(B). Fraud: Debts for money, property, services or credit obtained by false representation or fraud are nondischargeable if the creditor justifiably relies on the fraudulent representation. § 523(a)(2)(A). Consumer debts owed to a single creditor and aggregating more than $500 for luxury goods or services incurred by an individual debtor on or within 90 days before the petition date are presumed to be nondischargeable. § 523(a)(2)(C). Debt’s Not on Schedule: if the debtor fails to list or schedule the debt as required under § 521(1), it is nondischargable in certain circumstances. § 523(a)(3). Domestic support obligations: these are nondischargeable under § 523(a)(5). Willful and malicious injury: Debts for willfully and malicious injury caused by the debtor are nondischargeable. § 523(a)(6). Fines and Penalties: a fine or penalty payable to the government cannot be discharged to the extent that it is not compensation for actual pecuniary loss. § 523(a)(7). Student loans: an educational loan guaranteed by the government or obligations to repay scholarships or stipends are nondischargeable unless there will be undue hardship on the debtor. This requires “unique or exceptional circumstances.” Drunk Driving: any debt for death or personal injury resulting from debtor’s use of a motor vehicle while intoxicated or drugged is nondischargeable. § 523(a)(9). o Liens Pass Through: Discharge does not apply to all debt. Liens, for instance, pass through bankruptcy and do not require reaffirmation. o Reaffirmed debts: Moreover, discharge does not apply to debts that have been reaffirmed in bankruptcy. This is why there are full disclosure requirements because if you reaffirm in bankruptcy, the amounts owed will not be discharged. o Discharge in Chapter 7: A debtor under Chapter 7 must be granted a discharge unless one of the 12 independent statutory grounds for denial of a Chapter 7 discharge applies. § 727(a). Most importantly, the debtor must be an individual to receive a discharge. Under § 727(a)(8), you can only file bankruptcy and get discharged under Chapter 7 if you haven’t already been granted discharge under Chapter 7 or Chapter 11 in the last 8 years. A few of the requirements ensure the debtor has not engaged in fraud and has been completely open and honest with the court. Moreover, discharge requires that the debtor complete an instructional course concerning personal financial management. § 727(a)(11). The effect of the discharge is to relieve the debtor of all debts that arose prior to the petition date as well as from debts that, under § 502, were treated as pre-petition debts. § 727(b). However, this does not apply to nondischargeable debts under § 523. § 727(b). o Discharge in Chapter 13: In Chapter 13, any unpaid debts are discharged if the debtor has adhered to the plan. Any future income cannot be forced to be used to cover pre-bankruptcy debts. -WHAT HAPPENS IN CHAPTER 11? o General: A Chapter 11 reorganization is sometimes used as a means for a troubled business to continue to operate and revitalize itself while paying creditors and keeping workers employed. In Chapter 11, the debtor can continue to manage the business as a debtor in possession unless the conduct of the current management or the interests of the creditors necessitate the appointment of a trustee. The debtor remains in possession of the property of the estate and continues the business unless the court orders otherwise. The DIP has all the rights, powers and duties of a trustee except the right to compensation and the duty to investigate the debtor. The debtor in possession has the authority to make reasonable business judgments concerning the ordinary affairs of the debtor. Bankruptcy Law: Outline Philip Larson Page 13 o Eligibility: Any person who qualifies to be a debtor under Chapter 7 (individual, corporation or partnership), except for a stockbroker or commodity broker, can file Chapter 11. § 109(d). Chapter 11 is designed primarily for business organizations. o Debtor’s Responsibilities: the debtor in Chapter 11 must do two things: 1) administer claims – minimize claims against the estate to reduce liabilities, and 2) avoidance actions. For example, the debtor can use § 502 to fight the allowance of claims and may avoid fraudulent transfers and preferences. Under § 365, you can avoid the burden of costly Ks or costly leases by rejecting the ones that are not beneficial to the debtor and assuming ones that are beneficial. Under § 363, the debtor in possession may use, lease or sell assets. However, if it is outside the ordinary course of business, you have to get the court’s approval. o Options: The DIP can get a bank to loan the debtor money and that lender may be secured with any collateral that is free of liens. Moreover, you can also get super priority liens on property already secured if the DIP shows that the original secured creditors will be paid in full. -THE CHAPTER 11 PLAN o Effect of Confirmation of Plan: Under § 1141, the provisions of a confirmed plan bind the debtor and, unless otherwise provided in the plan, vests all the property of the estate in the debtor. § 1141(a),(b). Moreover, after the confirmation the property dealt with by the plan is free and clear of all claims and interest of the creditors, except as otherwise provided in the plan. § 1141(c). Discharge in Chapter 11: Under Chapter 11, except as otherwise provided in the plan, confirmation discharges the debtor from any debt that arose before the date of confirmation, and any debt specified in § 502(g), § 502(h) or § 502(i). § 1141(d)(1). For individuals, unless the court orders otherwise, confirmation of the plan does not discharge any debt provided for in the plan until the court grants a discharge on completion of all payments under the plan. § 1141(d)(5). Moreover, for individuals, the nondischargeable debts under § 523 are not discharged under confirmation of a Chapter 11 plan. o Top Ten Things a Law Student Needs to Know About Confirmation 1) Effect – Everyone is bound by the plan whether they voted for it or not. That is what makes bankruptcy so different than negotiations and workouts outside of bankruptcy. A confirmed plan sets forth all obligations of the reorganized entity, discharges all prior obligations, and is binding on all parties, including dissenters. 2) Contents – a plan may include just about anything, as long as the parties agree. • § 1123(a) outlines the mandatory provisions of the plan. This includes things like the classes, whether or not they are impaired, that claims within a class must be treated equally. o 1) Classify all claims and interests, other than priority claims for administrative expenses, involuntary case gap claims, and priority taxes. § 1123(a)(1). o 2) Specify any class that is not impaired. § 1123(a)(2). o 3) Describe the treatment to be accorded an impaired class. § 1123(a)(3). o 4) Treat every claim or interest within a particular class identically, unless the holder consents to less favorable treatment. § 1123(a)(4). o 5) Establish adequate ways to implement the plan • § 1123(b) outlines the permissive provisions of the plan, such as liquidation under § 1123(b)(4). Most importantly, the plan may include “any other appropriate provision not inconsistent with the applicable provisions of this title”. § 1123(b)(6). Therefore, plans can get very creative. Anything the debtor and the other parties agree on can be included. 3) Who May Propose or File a Plan – the debtor has the initial exclusive right to propose a plan, but eventually other parties in interest might be allowed to propose a plan. In a voluntary case, the debtor can file a plan of reorganization with the filing of the petition or at any other time. § 1121(a). Unless a trustee is appointed in the case, the debtor has the exclusive right to file a plan for the first 120 days after the petition date. § 1121(b). He can solicit votes until 180 days after the petition date. § 1121(c)(3). This exclusivity period was liberally extended by bankruptcy courts in the past, but is now subject to an 18 month hard limit. § 1121(d)(2)(A). This hard limit goes to 20 months for confirmation of the plan. § 1121(d)(2)(B). At this point, the court has no discretion to extend. Once exclusivity expires, any party of interest can come in and propose their own plan. In the case of a small business, only the debtor may file a plan until after 180 days after the petition date and the hard limit is extended to 20 months. § 1121(e)(1); 4) “Class” structure is dominant –Bankruptcy Code requires a Chapter 11 plan to classify the claims as well as the equity interests in the case. § 1123(a)(1). Often, the division is done around secured creditors, priority unsecured creditors, general unsecured creditors, subordinated claims and equity Bankruptcy Law: Outline Philip Larson Page 14 holders. However, the manner of classification is not governed much by the Code and is left largely to the courts. For the most part, a claim or interest may be placed in a particular class only if it is substantially similar to the other claims or interests in that class. The plan must provide the same treatment for each claim or interest of a particular class, unless the creditors agree to less favorable treatment. § 1123(4). Therefore, anyone with a similar claim must be in the same class and must be treated fairly and equitably. • Impaired vs. Unimpaired: Under § 1123(a)(2), each class in the plan must be classified as being either impaired or unimpaired. A class is impaired under a plan unless the plan either 1) leaves the legal and contractual rights between the parties unaltered, or 2) cures any default that has occurred, reinstates the maturity of the claim, and compensates the holder of the claim for any damages incurred for reasonable reliance or failure to perform a nonmonetary obligation. § 1124(1),(2). Essentially, this means that an impaired class is any class that is not going to be paid everything they are owed while unimpaired classes will be paid everything they are owed. An unimpaired class does not get to vote on the plan because they are deemed to have voted in favor. • Gerrymandering: Creditors try to gerrymander the classes to create voting blocks that are conducive to their interests. Given that the debtor needs to have at least one impaired class vote for the plan to cram down the plan, the debtor may gerrymander to create an impaired class that will vote in favor. However, separate classification is denied if the purpose is to achieve confirmation by the creation of a class of impaired claims that will vote for the plan. • Therefore, 5) Voting -Creditors and interest holders get to vote on a plan, by class (unless the class is “impaired”, in which case the class is deemed to accept the plan). Acceptance requires that a majority of claims allowed to vote and representing at least 2/3rds of the amount owed. § 1126(c). You have to have at least one impaired class vote in favor of the plan to cram it down everyone’s throat. 6) Full Disclosure: Voting is preceded by full disclosure to the holders of the claims or interests whose acceptances or rejections are sought. You have to fully disclose enough information so that the creditors have enough information to make an informed, reasonable judgment about whether to accept or reject the plan. § 1125(a)(1) • Adequate information – means enough for the average Joe to know whether to vote for the plan. 7) “Best interest of Creditors test” – Each holder of a claim or interest of an impaired class must either 1) accept the plan, or 2) receive under the plan property having a present value, as of the effective date of the plan, equal to what they would receive in a Chapter 7 liquidation. § 1129(a)(7)(A). 8) Feasibility – The plan must be feasible, which means that it has a reasonable probability of being successful and that it is unlikely that following confirmation there will need to be a liquidation not proposed in the plan. § 1129(a)(11). Essentially, the judge has to be convinced that the plan has a reasonable possibility of working within a reasonable amount of time. 9) Cram Down – Under § 1129(a)(8), a plan can be confirmed if every class of claims or interests accept the plan or be unimpaired by the plan. However, on request the court will still confirm the plan, even if one or more impaired classes reject the plan, if the plan is not unfairly discriminatory and is fair and equitable. This requires that at least one impaired class vote in favor of the plan. This is a powerful tool in the reorganization process because it gives the debtor leverage to get the creditors to sit down and work with him rather than simply having something forced down their throats. 10) Absolute Priority Rule – the “cram down” requires the full payment of secured classes. Moreover, it incorporates the absolute priority rule for unsecured and equity classes. A plan will be considered fair and equitable if no holder of a claim or interest that is junior to the class receives or retains any property on account of the hunior claim. That is, the absolute priority rule requires full payment to senior classes before any distribution is made to junior classes. § 1129(b)(2)(B)(ii). The unsecured and equity classes don’t get paid anything until the priority class is paid in full. If the priority class votes against the plan and they are impaired, they can invoke the “absolute priority” rule to require that they get paid in full before the general creditors get anything. In some ways, this is in exchange for the cram down power. You can waive your right to the “absolute priority” rule.