Get documents about "Bankruptcy Outline Warren Westbrook
Description
Bankruptcy Outline Warren Westbrook document sample
Document Sample
Debtor and Creditor Rights Outline
Spring 2003-Prof. Trujillo
I. Introduction
A. The text for this course is ELIZABETH WARREN & JAY WESTBROOK, THE LAW OF
DEBTORS AND CREDITORS. All problems are from this text.
B. Abbreviations used
1. JW – Jay Westbrook
2. UFTA – Uniform Fraudulent Transfers Act
3. TIB – Trustee in Bankruptcy; DIP – Debtor in Possession
4. FMV – Fair Market Value; TVM – Time Value of Money; PV – Present
Value; FV – Future Value
5. PMSI – Purchase Money Security Interest
C. Definitions:
1. Liquidation – debts are paid out of current assets (i.e., by selling them)
2. Payout – debts are paid out of future earnings; the debtor keeps the assets
3. “Code” – The bankruptcy code
D. In all instances, code citations are to the bankruptcy code unless otherwise
indicated.
E. A brief overview of the bankruptcy code (Title 11 of the US Code):
1. Chapters of General Application
a) Ch. 1 – definitions, types of eligibility
b) Ch. 3 – administration of the bankruptcy estate
c) Ch. 5 – creditor’s claims, debtor’s duties, and the definition of the
estate
2. Operating Chapters
a) Ch. 7 – “straight” liquidation
b) Ch. 9 – municipal bankruptcies
c) Ch. 11 – business reorganizations (some individuals use, also)
d) Ch. 12 – family farms
e) Ch. 13 – individual reorganizations (“payouts” for natural persons)
F. Classic bankruptcy dichotomies
of 54 1
1. Individual vs. Creditors – under state law, it’s all a race to the courthouse
(the law of the jungle); bankruptcy is different – it is based on collective
action, preventing one creditor from getting ahead of another.
2. Liquidation vs. Payout – Bankruptcy is divided into liquidations (Ch. 7) and
payouts/reorganizations (Ch. 11 and 13.)
3. Purpose: Business vs. Consumer Bankruptcy – consumer bankruptcy is
premised on the idea of a “fresh start” for an overwhelmed debtor; business
bankruptcy is focused more on saving the business (not killing the goose
that lays golden eggs).
G. Historical tidbits on bankruptcy
1. The first US bankruptcy law was enacted in 1800 and lasted 1½ years;
another was passed in 1841 (lasted about 2 years) and another right after the
Civil War. Finally, in 1898 a bankruptcy code was passed and the US has
had one ever since.
2. Congress is expressly given the power to create a bankruptcy law in Art. I,
§ 8, cl. 4 of the U.S. Constitution.
3. This is mostly to deal with the problem of the north-south division between
pro-creditor and pro-debtor states by creating a uniform law. It’s also
important to note that bankruptcy represents a serious interference with
private economic arrangements.
II. Debt Collection Outside of Bankruptcy
A. The concept of leverage and collection outside of court
1. Leverage is an extremely important concept. It basically means using your
legal position to gain a better bargaining position in negotiations.
2. For instance there is “hostage value” – debtors pay high-priority items like
their house or their car first because the consequences of losing them are so
great. Thus, the threat of collection is a more powerful tool than collection
itself.
3. Perhaps the biggest source of leverage is the adverse impact collection
proceedings have on a person’s credit ratings. Since that rating is important
for access to future credit, the threat of damaging it is an extremely
powerful tool.
a) The Fair Credit Reporting Act (FCRA), 15 USCA 1681 et. seq.,
provides limitations on how much leverage can be attained by placing
limits on the procedures for debtors to challenge the accuracy of their
credit report.
(1) However, the FCRA doesn’t provide nearly as much protection as
it appears because it doesn’t cover in-house debt collection.
of 54 2
(2) Heintz – A lawyer is a “debt collector” for FCRA purposes (so be
careful!)
B. State-law debt collection
1. Judgment collection
a) Execution (by a lien creditor) – being a judgment creditor alone gives
no interest in the debtor’s property or income; you have to go get a writ
of execution and have the sheriff levy (or execute) on a specific piece of
the debtor’s property.
(1) Note that in most states, judicial sales are governed by antiquated
statutes – returns on the sales are typically quite low. A low price
alone won’t invalidate the sale, but it might increase judicial
scrutiny for other problems.
(2) A lien can apply to after-acquired real property (Estate of Robbins)
(min. rule), but you have to take steps to keep the judgment alive
(Weaver).
b) Garnishment – going after an asset of the debtor held by a 3rd party. It
creates a “temporal net” that “catches” money placed in an account.
(1) Collection typically requires a writ of garnishment, especially if
it’s an intangible, like money in an account (be it bank or payroll).
(2) Courts are generally more lenient with a garnishee who defaults
than they are with a defaulting debtor, especially if the garnishee is
a natural person. (Webb).
(3) Garnishment of a bank account – the key is that banks have the
right to setoff, i.e., to offset any amount owed to them by the debtor
before they pay the garnishor (that is, the creditor).
(a) The setoff language must be in the bank’s agreement with the
debtor (it’s boilerplate, so every bank has it).
(b) Setoff is in essence a security interest held by the bank; the
bankruptcy code explicitly treats it as such.
(c) Problem 5.1: FF gets garnishment writ on WS’s bank account
for $3k; he has a ($10) balance. On 2/5, he deposits $5k; on
2/7, SF gets $3.5k judgment and does same; on 2/9 both writs
are served.
(i) Bank gets $10 setoff, leaving $4,990 balance. Who gets
what depends on the state; either FF wins (if writ date
relates back); otherwise, they split pro-rata.
(4) Wage Garnishment
of 54 3
(a) The basic problem with wage garnishment is that the debtor
still has to provide food and shelter, etc. for himself – you
obviously can’t take every dollar of his paycheck.
(b) 15 USCA § 1671, et seq. sets federal limits (lesser of 25% of
disposable income or 30x minimum wage).
(i) This acts as a floor – state law can provide additional
protections to the debtor. (Commonwealth Edison)
(ii) Texas doesn’t permit garnishment at all (except for child
support).
c) Judgment liens by recordation – some states have a “short-cut” process,
typically for real estate only, that permits a creditor to get a lien via a
simple filing process.
d) Family debts (alimony, child support) – in many states, the debtor can
be imprisoned for failure to pay, and property exemptions often don’t
apply.
e) Voluntary liens – secured creditors get a voluntary lien on collateral
that permits them to collect via self-help (i.e., repossession).
f) Collection by the federal government – When the federal government is
a creditor, it follows the Federal Debt Collection Procedures Act, 28
USCA § 3001 et. seq.
g) Statutory liens/trust funds – state law often provides special rules for
certain types of creditors, such as landlords and mechanics.
h) Pre-judgment remedies – there’s a basic tension between due process
rights and insuring a remedy. In most states there is a bond
requirement, and you have to allege the debtor is a flight risk (or will
damage property, etc.). Not important for this course, but very
important for real life.
2. State law priorities (covered in more detail in the course on secured credit)
a) General Rule: 1st in time wins (“the race of the diligent”)
b) Unsecured vs. Unsecured – 1st to levy wins; levy date may be deemed
to be the date the sheriff is given the writ, depending on the state.
c) Unsecured vs. Secured – 1st to perfect wins. Unsecured perfects by
levy; secured perfects by filing.
d) Judgment Lien Creditor/Secured Creditor vs. Buyers – Typically 1st
to perfect, but buyers of inventory almost always win regardless of
timing.
3. State law exemptions
of 54 4
a) Each state has its own set of exemptions, or property that cannot be
reached by a creditor (ex: a homestead exemption prevents seizure of
the homestead except for failing to pay the mortgage or taxes)
(1) For example, Texas has very generous exemptions, while Alabama
does not.
(2) Most states impose dollar limits to prevent calling all assets as
exempt.
b) Note there is a separate exemption regime for federal taxes that actually
trumps the state exemptions; you should always pay the IRS!
C. Fraudulent conveyances
1. In order to prevent a debtor from frustrating collection attempts by giving
away property, every state has a rule permitting the court to invalidate the
improper transfer.
a) “A man must be just before he is generous.”
b) Ex.: a “badge of fraud” is the debtor selling ownership of an asset while
retaining possession. Twyne’s Case
2. Most states (39) have adopted the Uniform Fraudulent Transfers Act
(UFTA), which governs the invalidation of fraudulent transfers.
a) The UFTA defines “asset” as property of the debtor,” but it doesn’t
include exempt property or property encumbered by a lien.
b) A “present” creditor is one whose claim arose before the transfer was
made.
c) Transfers fraudulent to present and future creditors (UFTA § 4)
(1) Transfers made with actual fraud (i.e., intent to defraud)
(UFTA § 4(a)(1))
(a) UFTA § 4(b) lists “badges of fraud” to consider in
determining intent, including if the transferee was an insider,
the debtor retaining possession, concealment of either the
transfer or the asset, timing, etc., etc.
(2) Transfers made with constructive fraud (i.e., no intent)
(UFTA § 4(a)(2))
(a) Elements:
(i) The debtor did not receive reasonably equivalent value,
and
(ii) Either the remaining assets of the debtor are
unreasonably small, or the debtor reasonably should have
believed he was incurring debts beyond his ability to pay.
d) Transfers fraudulent to present creditors only (UFTA § 5)
of 54 5
(1) Test #1 (UFTA § 5(a))
(a) A transfer is fraudulent to a present creditor if it was not for
reasonably equivalent value, and
(b) The debtor was insolvent
(i) “Insolvent” is defined by UFTA § 2 as either balance
sheet insolvency (debts > assets) or debtor can’t pay debts
as they come due (latter creates a presumption of
insolvency)
(2) Test #2 (UFTA § 5(b))
(a) A transfer is fraudulent to a present creditor if it made to an
insider for an antecedent debt (i.e., debt existing prior to the
transfer), and the insider had reasonable cause to believe the
debtor was insolvent.
e) See also Remedies, UFTA § 7 (generally, avoiding the transfer), and
Defenses, UFTA § 8.
3. Problem 9.1 – A is insolvent, owing $10k to FF; he sells his piano [FMV
$3k, asks $2k, sells for $1.5k] for food money. Is this a fraudulent
conveyance?
a) Probably yes – the debtor is insolvent and it isn’t for reasonably
equivalent value, so it meets UFTA § 5(a). But valuation is everything!
$1,500 is probably the “real” FMV given the hurried conditions of sale;
it could also be reasonably equivalent value because it’s a crisis sale.
(1) Note UFTA § 3(b) – “reasonable value” includes what is received
at a foreclosure sale. You could argue that this ought to be
extended to mean the value that would have be received at a
foreclosure sale.
b) Note that if this transaction was invalidated, the purchaser of the piano
would have a lien against the debtor for the $1,500. Of course, he loses
his TVM and his bargain.
4. Problem 9.2 – B is insolvent. He sells his coin collection (FMV $15k) to
his cousin for $1k to “keep it in the family.” B then buys $5k of furniture
on American Express. Can AmEx use the UFTA to void the coin collection
transfer?
a) Probably not. AmEx is a future creditor – the furniture debt did not
arise until after the coin collection was transferred. Thus, they can’t use
UFTA § 5. (If there was prior debt on the card, you could use that; you
could also argue that the line of credit the card represents is the
functional equivalent of present debt).
b) They are therefore left with UFTA § 4. Under (a), you’d have to prove
actual intent to defraud. There is a “badge of fraud” here, but that’s not
of 54 6
conclusive on the issue. Under (b) you’d have to prove B’s cousin had
reason to believe B was insolvent.
5. Problem 9.5 – KW loans $100k to her friend PR to start a business (money
lent to the company directly), repayable in six years. Six years later, PR
says she sold all stock to RL (who has no business know-how). The sale
was on credit, with the company guaranteeing RL’s payments to PR with all
of the company’s assets. The company’s assets > its liabilities, but its bills
are piling up. KW is worried about the business failing. Can she invalidate
the sale?
a) First of all, what transaction are you trying to undo? Answer: the
company’s security of the loan on the stock sale, since the company is
what owes KW.
b) There’s no actual fraud, so UFTA § 4(a)(1) doesn’t apply. Thus, we are
left with UFTA § 4(a)(2), which probably also doesn’t apply because
there is reasonably equivalent value given (presumably the stock sale
reflects the value of the company; there’s no indication in the facts of a
bargain-basement sale).
c) The company isn’t balance-sheet insolvent, but it can’t pay its debts as
the come due so they are presumed insolvent, UFTA § 2, so UFTA § 5
applies. Company is an insider, and it would have reason to know of its
insolvency. Thus, can void under UFTA §5(b).
6. Problem 9.6 – The big point: by the strict statutory language, a tithe to a
church while insolvent is a fraudulent transfer under UFTA § 5(a) unless
value was exchanged (and spiritual fulfillment probably does not fit in
UFTA § 3’s definition of “value).
D. Assignments for the Benefit of Creditors (ABC’s) and other remedies
1. A debtor can assign all his nonexempt property to a 3rd party and have his
creditors go deal with him; it gets all the creditors off his back.
a) Property is in the custody of the court; trustee acts in much the same
way as a bankruptcy TIB.
2. Composition – Creditors all agree to a partial payment in full satisfaction of
the debt.
a) This is used in bankruptcy as well, but with important differences –
such as the inability in bankruptcy for a creditor to “revive” the debt
once the composition has been accepted.
3. Extension – Creditors give debtor more time to pay.
4. Receivership – Similar to how a guardian takes over the property of a minor
or incompetent; it is commonly used when the debtor is exempt from
bankruptcy protection (such as churches, non-profits, certain insurance
companies)
of 54 7
a) There are two types of receivership: regulatory (ex.: SEC takes over a
financial institution for breaking regulations) and financial (to protect
creditors.)
5. Why use a state alternative to bankruptcy? Procedures can be faster and less
expensive; some options are less public (like compositions); full bankruptcy
protections aren’t always necessary.
III. Consumer Bankruptcy – Common Elements
A. Deciding what type of bankruptcy to file
1. The first thing a lawyer should do is to determine if there are any conflicts
of interests he might have by representing one of the parties to a bankruptcy
proceeding.
a) § 327(a) – an attorney must be “disinterested” – meaning no interest at
all in the outcome of the case. This is a tough standard to meet.
2. Next, a lawyer should see if a non-bankruptcy proceeding would be better.
3. Finally, a lawyer should consider whether a liquidation (Ch. 7) or a payout
(Ch. 13) would be better. Some individuals with large debts not qualifying
for Ch. 13 may want to use Ch. 11.
4. Converting to other Chapters
a) You can convert your case from a Ch. 7 to another chapter once. § 706
b) You can convert a Ch. 13 to a Ch. 7 any time. § 1307.
c) You can convert a voluntary Ch. 11 only under certain conditions.
§ 1112.
5. Involuntary consumer bankruptcies
a) Creditors can force a debtor into Ch. 7 (or 11) if… (§ 303(b))
(1) 12 or more creditors, and 3 or more of those creditors have
undisputed, non-contingent, unsecured claims totaling $10k in the
aggregate over any lien on the debtor’s property.
(2) Less than 12 creditors, if one or more has an undisputed, non-
contingent, unsecured claim totaling $10k in the aggregate over
any lien on the debtor’s property.
b) You cannot force an involuntary Ch. 13.
c) For more on involuntary bankruptcies, see Ch. 7 business bankruptcies,
infra.
B. The Bankruptcy Estate (§ 541)
1. Things included in the estate
a) Income from rents, profits, etc. of estate property (even if post-petition).
§541(a)(6)
of 54 8
(1) Important Exception – not for income from services performed
by the debtor after the bankruptcy filing. § 541(a)(6), last phrase.
b) Property Interests – All of the debtor’s “legal and equitable interests” in
property unless an exception applies. §541(a)(1).
(1) Ex.: Power the debtor exercises wholly for the benefit of another is
not part of the estate. § 541(b)(1). Also, nontransferable
beneficial interest in a trust (enforceable under state law) is not part
of the estate. § 541(c)(2).
c) Inheritance, divorce decree, or life insurance payout the debtor acquires
within 180 days of filing are estate property.
2. All property of the estate is turned over to the TIB/DIP. § 542.
3. Setoff
a) A bank has the right to setoff if the creditor 1) has a state law right to
setoff, and 2) both the debt and the claim are mutual and arose pre-
petition. § 553
b) However, setoff is part of the estate if the claim is disallowed, or if the
debt was incurred within 90 days of filing.
4. The Trustee – the trustee is ostensibly elected by the creditors, though
practicalities mean he is usually appointed by the U.S. Trustee. He has a
special duty (by custom) to the unsecured creditors, and thus must attack
anything that harms them (including security interests, preferences, and
priority claims)
5. Problem 12.1 – it’s all property of the estate save for the wages earned post-
petition.
C. The Automatic Stay (§ 362)
1. The automatic stay (§ 362(a)) prohibits all debt collection efforts unless an
exception applies once the petition has been filed.
a) This includes the right to setoff. (§362(a)(7))
b) Exceptions to the automatic stay:
(1) Commencement of criminal proceedings (§362(b)(1))
(2) Actions to establish paternity or alimony/child support, or to
collect alimony/child support from non-estate property.
(§362(b)(2))
(3) Perfection of PMSI within state law grace period (typ. 10 days)
(§362(b)(3))
(4) Actions concerning a government’s enforcement of its police or
regulatory power. (§362(b)(4))
of 54 9
(5) An audit by a government agency for tax liability, notice of tax
deficiency, or demand for tax returns. (§362(b)(9))
(6) Act of lessor to regain property on terminated nonresidential lease.
(§362(b)(10))
2. Violations of the Automatic Stay
a) Willful violation – the court can award attorney fees to the estate, as it
is a contempt of court. Knaus.
b) Nonwillful violation – The action is void or voidable
3. When the Automatic Stay can be lifted
a) The stay can be lifted after notice and a hearing if there is not
“adequate protection” for the creditors. What needs to be shown
depends on the type of creditor.
b) Secured Creditors can lift the stay “for cause,” meaning his interest in
the collateral is in jeopardy. § 362(d)(1)
(1) Protection can be shown by either making periodic cash payments
to the creditor, or by giving additional/substitute liens, or by giving
“other protection.” §361
c) Unsecured creditors (and secured creditors as well) can get the stay
lifted if the debtor has no equity in the property [value – liens = 0],
and the property is not necessary for an effective reorganization.
D. Problem 13.1 – Joe files bankruptcy. He makes $19k/yr. as a meat cutter, but
hurt his arm last year and missed 8 months of work. His current wages have a
$50 garnishment against them. Joe has $58k in unsecured debt (including
alimony/child support and utility bills) and $4,850 secured [$4,500 car loan,
$350 to garage]. D.A. is considering a bad check prosecution. Landlord is
threatening eviction. Joe has insignificant assets (car, clothes, misc. household
goods). He will be paid tomorrow for the two-week period ending yesterday. If
Joe files Ch. 7, what results?
1. Will he get his full paycheck? The automatic stay will kill the garnishment.
Joe will have to institute a turnover proceeding to get the current check
because it becomes part of the estate (it’s not from services performed after
the filing), but his remaining checks are safe.
a) Joe could spend the check on exempt assets (like food) and then file,
though he should beware of the appearance of fraud.
2. All of the phone calls, etc., from Joe’s creditors must cease. § 362(a)(6)
3. The utility company cannot cut of Joe’s utilities. § 366(a) [Utility Service]
4. The D.A. can continue to pursue his charges. § 362(b)(1). However, you
can argue this is a de facto collection attempt, since bad check charges are
routinely dismissed if the defendant makes restitution quickly. Also, § 105
of 54 10
is a “wild card” that lets a court issue any order to carry out the Bankruptcy
Code’s provisions; you can argue that this is an appropriate place to use that
power.
5. The landlord will have to stop trying to evict, since the § 362(b)(10)
exception only applies to nonresidential leases.
6. Joe will have to pay the alimony. §362(b)(2)(B) provides that the stay does
not apply to such collections from non-estate property (and his later income
is not part of the estate).
IV. Consumer Bankruptcy – Ch. 7 Liquidation
A. A ch. 7 bankruptcy is the classic “straight” bankruptcy. A TIB is appointed to
collect estate property, to sell those assets that are not exempt, and distribute the
proceeds to the creditors. The distribution process is covered by § 726.
1. There are three types of unsecured creditors in bankruptcy:
a) Priority creditors
b) General creditors
c) Subordinated creditors
B. Exemptions (§ 522)
1. Federal vs. State Exemptions – the Code permits the states to “opt out” of
the federal exemption regime; if the debtor’s state has done so (and 39
have), then the debtor will have to use the state regime. Otherwise, the
debtor may choose between the state and federal regimes. § 522(a)
a) This is an all or nothing choice. You can’t cherry-pick between the
two regimes; you must choose to go all-state or all-federal.
2. If a married couple files together, they each get an exemption, effectively
doubling the amount of exemptions. § 522(m) (This only applies to the
federal exemptions; state law may differ).
a) Both must choose the same exemption regime if their petition is being
jointly administered. § 522(b) If you can avoid being jointly
administered, it may be worth filing separately to use two separate
exemption regimes.
b) A spouse is a dependent regardless of whether they actually are
dependent. § 522(a)(1)
3. Calculating the Exemption
a) If the only creditors are unsecured, it’s easy – if the property is worth
more than the exemption amount, then the TIB sells the asset, gives the
exemption amount to the debtor, and distributes the rest.
of 54 11
(1) Ex.: Car (FMV $3,000), where exemption amount is $2,400;
Debtor keeps $2,400, the rest goes to creditors. If the car is only
worth $1,000, debtor keeps car.
b) If the asset is secured, the secured party is superior to the debtor and
the TIB. In that case, the debtor’s secured interest is satisfied first, then
the exemption amount is given to the debtor, and then any leftover
value is distributed by the TIB.
(1) Ex.: In example above, if car secured a $1,200 loan, the secured
creditor gets $1,200, and the debtor gets $1,800. In the latter
example, the TIB just gives the secured party the car since its
interests is greater than the car’s value. Note in both cases the
unsecured creditors get nothing.
c) If the lien is > FMV, you can ask the TIB to abandon the property
4. Valuation
a) Of course, valuation is the heart of these exemptions. The Code says
that the value of property is it’s FMV at the time of filing (§522(a)(2));
the question is, does this mean it’s value in a forced sale or its value on
the open market?
b) In Re. Mitchell – says value means value on the open market. A
recent Supreme Court case, In Re Rash, seems to agree (Rash involved
Ch. 11 cramdowns, but it is analogous to valuation here as well).
c) In Re Walsh – says value means value in the debtor’s hands, i.e., value
in a distressed sale context. (Stevens dissent in Rash agrees)
5. The Federal Exemptions (§ 522(d)) – The following property is exempt
(check for current amounts):
a) The debtor’s aggregate interest (i.e., his equity) in property used as a
residence up to $15k. § 522(d)(1)
(1) Recall that equity = value of asset - unpaid debt
(2) If there is any of the $15k remaining, up to $7,500 can be added to
the “wild card” of § 522(d)(5)
b) Up to $2,400 in a motor vehicle. § 522(d)(2)
c) Household items (used primarily for personal/family/household use).
§ 522(d)(3)
(1) Each individual item cannot be > $400
(2) The total of the items cannot be > $8,000
d) Up to $1,000 in jewelry (debtor’s use or dependent’s use only).
§ 522(d)(4)
of 54 12
e) The “Wild Card” $800 + whatever is left from the residential
property exemption. § 522(d)(5)
f) $1,500 of professional books or tools of the trade. § 522(d)(6)
g) Unlimited amount for an unmatured life insurance contract owned by
the debtor (i.e., the death benefit on the debtor’s life). § 522(d)(7)
h) Up to $8,000 in a life insurance policy’s loan value, less premium
payments made pursuant to §542(d). (debtor’s life must be the one
insured). § 522(d)(8)
i) Unlimited amount for professionally prescribed health aids (debtor or
dependent). § 522(d)(9)
j) Unlimited amount for whatever debtor receives in social security,
unemployment, veteran’s benefits, or “reasonable” alimony support or
pension/disability plan. § 522(d)(10)
k) Unlimited amount for payment on tort claims to debtor (but only $15k
for the portion allocated to pain and suffering). § 522(d)(11)
6. Lien Stripping (§ 522(f))
a) The debtor can avoid a lien on any property that is:
(1) A judicial lien not for alimony, child support, etc., or
(2) A consensual lien that is not a PMSI in household goods, tools of
the trade, or health aids.
b) Lien stripping is available in all personal bankruptcies, even if state
exemptions are claimed.
7. The importance of the exemptions (exceptions)– only four types of
creditors can continue to pursue exempt property (§ 522(c)):
a) Creditors with tax claims exempt from discharge under § 523(a)(1)
b) Creditors with domestic claims exempt from discharge under
§ 523(a)(5) (child support and alimony)
c) Post-petition claims
d) Claims not extinguished via redemption
8. Problem 14.2 – HK is a trucker who has just declared bankruptcy. Figure
his exemptions.
a) Property: mobile home ($11k); VW Rabbit ($5.2k); household items,
each worth <$400 each except for a $5k freezer ($13.6k, $8.6k without
freezer); cow ($1,600); calf ($800); grandfather’s watch ($4k);
Peterbuilt truck w/ rebuilt engine ($20.6k, subject to $30.1k PMSI);
cash in checking account ($150); Life insurance ($1k cash value, $5k
death benefit). All debt but truck are unsecured.
of 54 13
b) He gets the full $11k for the mobile home, which leaves $4k over of the
$15k cap for the “wild card.” (Recall that you can only use $7.5k of
surplus for the “wild card.”)
c) He only gets $2.4k in the VW Rabbit; so he loses $2.8k of value there
(unless he applies the “wild card” to the remainder)
d) He loses the freezer (it’s over $400) and he loses $600 of the other
household goods ($8.6k goods without freezer - $8k limit) unless he
uses the “wild card.”
e) He could try to call the cow/calf household goods (are they for
“personal use”?) Either way, the cow is over the $400, unless he uses
the “wild card.”
f) He loses the watch unless he uses the “wild card.”
g) The life insurance is OK (no limit on death benefit, and cash value is
under the $8k limit).
h) He keeps the truck because his aggregate interest is under the limit for
tools of the trade. (Here, the lien > FMV, so his interest is zero, so it’s
clearly below the cap).
i) He has a $4.8k “wild card” to use however he wishes. ($800 + $4k
spillover from mobile home).
C. Claims and Distributions
1. Generally, a claim must be filed within 90 days after the first creditor’s
meeting in a consumer bankruptcy for a creditor to receive his distribution.
A creditor must submit proof of his claim. A claim is allowed unless a
party objects.
2. Disputed Claims
a) Resolving a disputed claim will generally require an evidentiary hearing
like a trial.
b) In Re Lanza – The burden of proof rests on the party arguing the claim
is invalid.
3. Unsecured Claims
a) An unsecured claimant is not eligible for post-petition interest.
§ 502(b)(2) (“unmatured interest)
(1) He is, however, eligible for pre-petition interest if his contract with
the debtor provided for such (or state law says can/can’t).
(a) The same rule applies for pre-petition attorneys’ fees: if the
contract called for the debtor to pay them, the unsecured
creditor can include them in his claim.
of 54 14
b) Post-petition attorney’s fees – There is a split in the courts as to
whether an unsecured creditor can collect post-petition attorney’s fees.
(1) Some argue that since it isn’t explicitly prohibited (as post-petition
interest is), an unsecured party can get fees if his contract with the
debtor called for them. (2nd Cir. rule)
(2) Others argue that since § 502(b) is limited to pre-petition claims
and § 503 (governing post-petition claims) only permits post-
petition attorneys’ fees in limited circumstances, plus the fact that
§ 506(b) explicitly grants such fees to oversecured parties, all
demonstrates that Congress did not intend to grant them to
unsecured parties. (This is JW’s position)
c) The TIB has all of the defenses of the debtor. § 501(b)(1) (thus, for
example, if the debtor had bought something that didn’t work, the TIB
could assert that defense to the store’s claim).
d) If all the creditors in one priority class aren’t paid, then they get their
share pro-rata. § 726.
e) Priority Among Unsecured Creditors (§ 507)
(1) Once the secured creditors have been paid (see infra), the
unsecured creditors divide the remaining proceeds from the
liquidation.
(2) §726 determines the order of payment; §726(a)(1) tells us that
first § 507 determines the order (and in some cases amount) of
payment to each unsecured creditor, with § 726’s distribution
regime picking up after that. The order is as follows:
(a) Administrative Expenses allowed under § 503(b) –
(§ 507(a)(1))
(i) These include (§ 503(b)):
(a) Actual and necessary costs of preserving the estate,
including wages, etc., for services rendered
(b) Any tax other than the kind those listed in
§ 507(a)(8), including fines related to those taxes
(c) Compensation awarded under § 330(a) (i.e., TIB and
his staff’s compensation)
(d) In certain instances, compensation and expenses of
creditor’s attorneys.
(i) Note there is no allowance for the debtor’s
attorney to be paid! (A few courts permit it
under § 503(b), “necessary expenses of
administration”)
of 54 15
(ii) The moral: get paid up front!
(ii) Superpriority: § 507(b) – secured creditor who is granted
adequate protection yet still has administrative expenses
gets priority over § 507(a) [read: § 503(b)] claims.
(iii) Super-superpriority: § 364(c) – if the TIB can’t get
unsecured credit to pay for § 503(b)(1) expenses [i.e.,
preservation costs, listed as (a) above] that trumps all
other administrative expenses. (i.e., § 503(b) priority and
§ 507(b) superpriority).
(b) Ordinary course of business claims for involuntary cases –
Only applies in involuntary cases. – (§ 507(a)(2))
(c) Wages – Up to $4,000 earned within 90 days of filing owed to
the debtor’s employees (includes sales commissions owed to
independent contractors in certain cases) – (§507 (a)(3))
(d) Employee Benefit Plans – from services rendered within 180
days of filing up to $4,000 x number of employees [less
amount paid to those employees for wages above].
(§507 (a)(4))
(e) Farmers and fishermen – (§ 507(a)(5))
(f) Consumers – who, pre-filing, paid for goods and services not
rendered, up to $1,800 each. (§ 507(a)(6))
(g) Alimony and child support – but not property settlements.
(§ 507(a)(7)
(h) Certain Taxes – income, property, employer’s share of FICA,
excise taxes and customs duties. (§ 507(a)(8))
(i) The employee’s share of FICA is the same as wages.
(ii) Note specific cutoff dates for income taxes:
(a) The tax year must have ended on or before filing, and
(b) The return was due after 3 years before filing
(essentially, due within the 3 years before filing).
(i) Commitments to federal depositary institutions – (§ 507(a)(9))
(j) Unsecured claims timely filed (or tardily filed if the creditor
didn’t know of the bankruptcy) – § 726(a)(2)
(k) Unsecured claims tardily filed (if notice or actual knowledge
of bankruptcy) – § 726(a)(3)
(l) Fines and punitive damages owed to the creditor – § 726(a)(4)
(m) Post-petition interest on pre-petition claims – § 726(a)(5)
of 54 16
(n) The rest goes to the debtor. § 726(a)(6)
(3) Also note: § 506(c) – costs of disposition (e.g., advertising the sale,
etc.) come out before any priorities.
(4) Problem 16 – HS declares bankruptcy in March ’95; he has non-
exempt assets consisting of a beach home (sold for $200k, but
subject to $175k mortgage, so net is $25k) and miscellaneous
personal property sold for $25k. Sort out the priorities (listed
p.273).
(a) Administrative expenses include the $3k in back property
taxes (maintaining the estate), the TIB’s fees, prorated
property taxes on sale, the insurance, and maybe the $500 fee
for HS’s lawyer.
(b) Next is the wages owed his cleaning lady (assuming within 90
days) up to $4,000 (she’s owed $4,500). The remaining $500
is general unsecured debt.
(c) Next is the payment to his wife if it’s for support. If it’s a
property settlement, she’s just a general unsecured creditor.
(d) Next is the down payment by the neighbor on the undelivered
lawn mower HS was going to sell him.
(e) Next are the income and the employer’s share of FICA
withholding (recall the employee’s share is included in her
wages). Also, have to note the timing of the return.
(f) The post-filing utility bills aren’t even part of the estate
because they are post-petition debts.
(g) Everything else is a general unsecured debt.
4. Secured Claims
a) § 506 governs claims of secured parties.
b) Classification of secured party’s interest
(1) A secured parties’ claim may be bifurcated (split in two) if he is
undersecured, that is, if the value of the collateral is less than the
loan amount. If that is the case, the creditor has a secured interest
to the extent of the value of the collateral and an unsecured interest
for the remaining value of the loan. § 506(a)
(2) If the secured party is oversecured, that is, if the value of the
collateral is greater than the underlying debt, then the creditor’s
claim is limited to the amount of the loan; the surplus goes for the
use of the unsecured creditors.
(3) In a nutshell: the secured claim is the lesser of the loan amount or
value of collateral.
of 54 17
c) Interest and secured parties
(1) A secured party can get pre-petition interest if his agreement with
the debtor so provided (or state law says can/can’t)
(2) A secured party can get post-petition interest to the extent he is
oversecured. § 506(b)
(a) Once the value of the collateral is exhausted, the secured
creditor cannot get further post-petition interest.
d) Attorney’s fees and secured parties
(1) Pre-petition attorneys fees are treated like interest: if the contract
called for the debtor to pay them (or state law says can/can’t), they
can be included in the secured party’s claim.
(2) Post-petition attorneys fees are also treated as interest: the secured
party can collect them so long as he is oversecured. §506(b)
e) Exemptions – recall that a valid, unavoidable consensual security
interest trumps all exemption claims (i.e., a debtor can only claim an
exemption in his equity – the value after the secured party has been
paid in full).
D. Discharge
1. The principal reason for filing Ch. 7 is the discharge of indebtedness. Once
the creditor’s claims have been paid from the liquidation, the debt is no
more.
2. The discharge is not a right, but it will be granted unless challenged.
§727(a) There are two principal types of challenges to discharge:
a) § 523 “rifle shot” – an objection to the discharge of a particular debt, a
successful challenge means that all the debts save for the one
challenged are discharged.
(1) A creditor seeking the “rifle shot” who fails will have to pay the
debtor’s attorney fees for the costs of litigating the issue. § 523(d)
(2) Also note the “rifle shot” applies to all flavors of bankruptcy, not
just Ch. 7
b) § 727 “atomic bomb” – a general objection to discharge of all of the
debtor’s debts.
3. The “Rifle Shot” – principal reasons for discharging a single debt under
§523
a) Certain tax debts. § 523(a)(1)
b) Debt obtained by fraud (Dorsey), but you must show actual intent to
defraud (Reed). § 523(a)(2)
of 54 18
c) Alimony or child support (but not for property settlements).
§ 523(a)(5)
(1) What is alimony? Two alternative tests: If the debt was “for
necessaries,” or if the parties intended it to be alimony, it is
alimony.
(2) Compare §523(a)(5) – Property settlements are dischargeable only
if debtor can’t pay or if the benefit of discharge to the debtor
outweighs harm to ex-spouse; if not, no discharge.
d) Intentional torts. § 523(a)(6)
e) Fines or penalties payable to the government (but not a tax penalty).
§ 523(a)(7)
(1) Note these must be paid to the government and it does not apply to
damages paid to anyone.
f) Student loans § 523(a)(8) (exception for loans over 7 years old and for
extreme hardship – but that’s hard to show).
g) Injuries inflicted due to DWI. § 523(a)(9)
h) Debts from previous bankruptcy that were not discharged § 523(a)(10)
4. The “Atomic Bomb” – principal reasons for denying discharge under §727
a) Debtor not an individual. § 727(a)(1)
b) Fraudulent transfer within 12 months of bankruptcy. § 727(a)(2)
(actual intent to defraud required)
c) Failing to keep reasonable records. § 727(a)(3) (Harron)
(1) Unless “justified” by the circumstances
d) Failing to explain loss of assets. § 727(a)(5)
e) Refusal to obey court order or answer questions (including taking the
5th). § 727(a)(6)
5. Other Discharge Issues
a) Recall that § 507(a)(8) exempts certain taxes; § 523(a)(1)(A) exempts
the unpaid portion of those taxes from discharge.
b) Be aware that there are myriad other non-discharge provisions scattered
all over the US Code.
c) 18 USCA §151 et. seq. covers crimes in bankruptcy.
6. Effect of Discharge
a) Discharge protects the debtor from future personal liability on the debt,
limits the enforceability of a reaffirmation agreement (an agreement
where a debtor waives discharged of a debt), see § 524(c) and (d), and
of 54 19
grants limited protections against discrimination on the basis of his
filing.
b) Discharge does not get rid of the debt; it only removes personal
liability. Co-debtors are still liable. Also, liens are still valid post-
bankruptcy (unless lien-stripped, see supra); a secured creditor can still
repossess – he just can’t sue for any deficiency.
(1) Thus, many debtors will do a redemption (paying the loan in full)
or a reaffirmation (formal waiver of discharge subjecting debtor to
deficiency action if he doesn’t repay) with the secured creditor in
exchange for keeping their secured property.
7. Problems
a) Problem 17.2 – bankrupt person had held many jobs, and kept no
records. Discharge? Even though he failed to keep records, JW says as
a practical matter a court will still grant him the discharge so long as he
“looks honest.”
b) Problem 17.3 – bankrupt makes pre-bankruptcy false statement of
ownership and fraudulent conveyance of his chalet. What result?
(1) Can’t use §727 “nuclear bomb” because (a)(2) requires the fraud
be “in connection with this case.”
(2) Can use §523 “rifle shot” because it imposes no such requirement.
c) Law student has 123 parking tickets, files bankruptcy. Can he get them
discharged? Not if it’s a government unit issuing the tickets. But if he
goes to a private school and it’s the school’s police issuing the tickets,
he can probably get a discharge.
E. Dismissal § 707 – see infra, “The Consumer Bankruptcy System”
V. Consumer Bankruptcy – Ch. 13 Workouts
A. Ch. 13 Generally
1. Ch. 13 differs from Ch. 7 in that the debtor repays part of his debt,
generally over a three or five year period, under the supervision of the court.
2. It has the advantage of letting the debtor keep his assets, opting to
encumber future earnings instead. The debtor, not a TIB, controls the
property of the estate (although a TIB is appointed)
3. The co-debtor stay
a) § 1301(a) prevents collection attempts from co-debtors if:
(1) the debt is a consumer debt and
(2) the co-debtor didn’t give the loan in the ordinary course of business
(i.e., he’s not in the credit business).
of 54 20
b) A creditor can get relief from the stay if the co-debtor received
consideration for the debt, the plan proposes not to pay the debt, or the
creditor can show “irreparable harm” to his interest by continuing the
stay.
4. There is no “involuntary” Ch. 13; only a debtor can elect to file it. A debtor
in Ch. 13 is presenting an acceptable plan and having it approved by the
court.
B. Elements of an Acceptable Plan
1. General Requirements of the Plan
a) §1322(a) – a plan must provide for the supervision of future income by
the TIB, provide for full payment in deferred cash of § 507 priorities
unless parties agree otherwise, and provide for equal treatment of class
members within the same class.
b) §1322(b) – a plan may:
(1) Designate classes (but can’t unfairly discriminate between them)
(a) What is unfair discrimination? Must ask if there is a
reasonable basis for treating classes differently, if the
discrimination is needed to implement the plan, and if the
class designation is in good faith.
(b) Minority (Sutherland) view: if a creditor isn’t legally entitled
to anything, he cannot be discriminated against.
(2) Modify the rights of secured parties (but not home mortgages)
within the limits of §1325(a)(5) [creditor must accept, or creditor
retains lien and property retains its PV, or debtor surrenders
property].
(3) There follows a laundry list of things that can go in the plan…
2. Payments to secured creditors
a) There are two principle issues for secured creditors in a Ch. 13 plan:
(1) Protection of the secured party’s collateral (from damage or
depreciation), see §362(d), and
(a) Ex.: Raddon – debtor must maintain the insurance on his car.
(2) Adequate payment to the secured party (generally, the PV of the
allowed claim).
(a) Ex: Raddon – debtor must make periodic payments to GMAC
to maintain the car’s value.
(b) Generally, use the contract rate of interest for the PV
calculation. Smith (A few courts say use the T-bill or other
“neutral” market rate).
of 54 21
b) Recall that the plan can modify the rights of secured parties subject to
certain limitations, see supra.
c) Recall that an undersecured creditor has his interest split into secured
and unsecured debt.
d) Problem 20.1 – A nurse with $20k/yr. income files Ch. 13; her only
asset is an Apple computer (FMV $3,300) subject to a $2,800 PMSI.
You represent the secured creditor.
(1) You have to prove no adequate protection to lift the stay. Here, the
debtor has a $500 “equity cushion,” so she will say the creditor is
shielded from loss from depreciation. However, it’s a computer
(and a lousy one at that) – the danger of depreciation might be
significantly higher than just $500.
(2) She will also want an assurance of getting the PV of the claim
(possibly via periodic payments).
e) Problem 20.2 – Debtor has hunting cabin [not a home mortgage!]
(FMV $21k, subject to a $20k, 5-year note, with $19,980 in principal +
$6,300 in interest, late penalties, and attorney’s fees as provided in the
contract). Contract interest rate is 14% on principal, 21% on all else.
(1) The plan can modify the rights of secured parties, but this is
limited. Two of the limits – that the creditor must accept the plan,
or the debtor must turn over the property – are both unsatisfactory.
Thus, the we are left with the requirement that the creditor retains
the lien and property retains its PV.
(2) What interest rate to use? Courts are split among contract or
market rates. Probably use the 14% rate.
3. Payments on home mortgages
a) §1322(b) does not allow the terms of a home mortgage (defined as debt
on a primary residence) to be tinkered with in the plan.
b) Some courts used to work around this via a § 506 valuation, writing
down the value of the home (and thus the secured portion). The
Supreme Court killed this practice in Nobelman.
c) You can “de-accelerate” a mortgage that accelerates upon a default and
return it back to it’s original payment terms (so long as you do so
before a foreclosure sale). § 1322(c)
4. Problem 20.4 – Debtor buys house ($55k FMV, $32k remaining on 30-yr.
mortgage; debtor thus has $23k equity). Debtor has missed 6 straight
monthly payments of $250, so she is $1,500 in arrears. What must her plan
provide?
a) Can’t restructure because it’s a home mortgage. However, under
§ 1322(b)(5), you can cure a default and maintain payments while the
of 54 22
case is pending. Thus, she will have to cure her arrears and continue
making payments (plus post-petition interest and attorneys fees up to
her equity stake)
5. Payments to unsecured creditors
a) There are three requirements the plan must meet regarding unsecured
creditors: (§1325)
(1) The “best interests” test – The plan does not give any unsecured
creditor less than he would have gotten in a Ch. 7 liquidation.
§ 1325(a)(4).
(2) The debtor must devote all “disposable income” to the plan’s
payments. § 1325(b)(1)(B)
(a) “Disposable income” is income not needed for maintenance or
support.
(b) Recent Congressional amendments have made religious and
charitable contributions (up to 15% of gross income) not
disposable income (i.e., creditor can’t stop debtor from making
such contributions).
(c) Another problem: what of secured debt? Is it “necessary for
maintenance or support?”
(3) Of course, the good faith requirement is ever-present.
b) Problem 21.1 – You represent a single nurse with three kids files Ch.
13. She has $60/wk. left over after rent, food, etc. and her $10 tithe to
her church; her proposed plan would yield 50% to creditors over 3
years or 80% to creditors over 5 years. However, it also kills her kids’
piano lessons and orthodontics.
(1) Everything is OK. In fact, you could try to file a plan with 0%
payment if you want to claim the orthodontics (it’s a close call).
JW says you should file the most pro-debtor plan possible (without
doing so in bad faith, and with an eye towards your reputation with
he judge) or risk malpractice.
C. Threshold Eligibility for Ch. 13
1. Unlike Ch. 7 and Ch. 11, there are certain requirements a debtor must meet
in order to be eligible for Ch. 13.
2. Debt Ceilings
a) A debtor can only file Ch. 13 if he (or aggregating, he and his spouse)
has noncontingent, liquidated debts of less than: (§109(e))
(1) $250,000 unsecured (recently increased to $269,250), and
(2) $750,000 secured (recently increased to $807,750)
of 54 23
(3) Use original amounts for the test.
b) A “noncontingent” debt means that the fact that the debtor owes the
claim is undisputed.
c) A “liquidated” debt means that the amount the debtor owes is not in
dispute.
d) Of course, this again brings up difficult valuation problems. Rash
seems to make it clear that “true” market value should be used instead
of foreclosure value. (But this isn’t clear from the text regardless of the
Court’s claim of “plain meaning.” Compare the 1st and 2nd sentences of
§ 506(a))
3. Regular Income requirement – § 109(e) also requires the debtor have
“regular income.” § 101(30) defines this as “stable and regular income,” but
courts have construed it broadly – it need not be traditional wages nor need
it be precisely regular. McMonagle
4. Problem 24.1 – Oil well firefighter has wildly varying income (ranging from
$0 to $160k/yr., average is $80k). He has a $250k judgment against him for
punching a plumber. He wants to appeal, but can’t afford to post an appeal
bond. Is he eligible for Ch. 13?
a) He can get the debt discharged – an intentional tort is dischargeable,
under Ch. 13 (see infra)
b) He’s probably OK under the “regular income” requirement, since he
apparently at least has a stable average.
c) The problem is the size of the judgment: if it was one dollar less, he’d
be within the limit. He can avoid this problem by paying $1 to the
plumber and then filing.
d) Also note: because of the automatic stay, bankruptcy is the “poor man’s
appeal bond” – he can use bankruptcy to halt collection efforts while
his appeal is pending.
5. Problem 24.2 – Your client, MT, a lawyer ($75k/yr. income), has $90k in
unsecured debt, a $180k home mortgage, and is the guarantor of a $600k
mortgage on an office building held by her former partner (FMV $500k,
future FMV $700k). Office mortgage is held by former partner’s ex-wife,
who hates them both (i.e., she’ll hurt them even if it’s economically
unwise).
a) Note right away that Ch. 7 is bad for her. There’s a lot of property at
stake, plus it would hurt her career (so would Ch. 13, but it hurts less).
b) If the former partner has not yet defaulted, then no problem – the office
mortgage is a contingent debt because MT isn’t liable on any of it
unless her former partner defaults.
of 54 24
c) If the former partner has defaulted, she’s over the limit on secured debt
by $30k (i.e., $180k + $600k = $780k total secured debt). However,
you could argue that the property should be valued at it’s current value
of $500, so that’s the only amount that is secured. But § 109(e) says
“amount owed at date of filing.” It’s an arguable point.
d) She could also argue that the guarantee is not the same as a security
interest (it’s not her office building at risk), but this would put her over
the limit on unsecured debt.
D. The Consumer Bankruptcy System
1. A brief word on Ch. 12 (Family farms) – it is much like Ch. 13, but the debt
limit is higher and it gives the power to modify mortgages.
2. Choosing between Ch. 7 and Ch. 13:
a) General considerations
(1) Ch. 7 is quicker, and is thus appealing for debtors wanting to “get
on with our lives”; it’s also better for debtors with no or few
nonexempt assets (so long as the debts are dischargeable debts).
(2) Ch. 13 can appeal to people who feel moral and ethical duties to
pay their debts.
(3) There is also marginally less social stigma when filing Ch. 13,
since at least the debtor can claim to be paying his debts.
(4) Of course, bankruptcy of either flavor kills your credit rating – it
stays on your credit report for 10 years (and you don’t get extra
credit for filing a Ch. 13).
(5) JW’s research – shows that local legal culture influences the choice
as well; many attorneys specialize in one form or the other, and
that’s what they recommend to pretty much everyone.
(6) Congress (or, rather, the consumer credit lobby) tends to want to
move people toward Ch. 13, which is why the incentives discussed
supra exists.
b) Property incentives for Ch. 13
(1) Under Ch. 13, the debtor retains possession of his property. He
can keep his home by paying the arrears and continuing payments.
There are, of course, no property exemptions to deal with under
Ch. 13.
(2) However, § 1325(a)(5) requires that the unsecured creditors get at
least as much as they would in a Ch. 7. This reduces the
advantages of Ch. 13.
c) Discharge incentives for Ch. 13
of 54 25
(1) Ch. 13 provides much broader discharge than either Ch. 7 or Ch.
13; that is, largely ignores the discharge exceptions in § 523(a).
(2) §1328(a) discharges all debt upon completion of the plan except:
(a) Debts not provided for in the plan
(b) Certain long-term obligations specifically provided for by the
plan (typically home mortgages) under § 1322(b)(5)
(c) The exceptions in §523(a)(5), (8), and (9), specifically:
(i) Alimony and child support (5), and
(ii) Student loans (8), and
(iii) Claims from debtors’ DWI (9).
(d) Restitution or criminal fine stemming from a criminal
conviction.
(3) Do not confuse § 1328(a) and (b); subsection (b) lets a court
discharge before completion of the plan, but it is subject to all the
discharge exceptions of § 523.
d) Access limitations on Ch. 7
(1) An individual can only get a discharge under Ch. 7 once every 7
years, § 727(a)(9); there is no such limit on Ch. 13.
(2) “Substantial Abuse” of Ch. 7 under § 707(b).
(a) A court can, either sua sponte or on motion of the U.S. Trustee
(not the TIB or any of the creditors) dismiss a Ch. 7
proceeding if it is a “substantial abuse” of the bankruptcy
system.
(i) There is, however, a presumption in favor of granting
relief.
(b) Some courts say that if the debtor can pay a significant portion
of his debts, then he is committing substantial abuse. Walton
(but over a strong dissent).
(c) Recent Congressional amendments to § 707(b) make it clear
that past or ongoing donations to religious or charitable
organizations (within certain limits) are not abusive.
(d) Problem 25.5 – Debtor has $35k in unsecured debt, and makes
$45k/yr (with $1k/mo. of disposable income). He is
unconcerned about giving up assets; he wants to go to back to
school (no income for two years) and become an elementary
school teacher (income of $18k/yr.). Would his filing be a
substantial abuse?
of 54 26
(i) This really just depends on the court. He will have to
disclose these intentions (the official forms requires as
much). On the one hand, you don’t want to stop the guy
from doing what he wants; on the other hand, there’s
nothing compelling him into bankruptcy, either. You may
end up saying you have make a choice between school
and bankruptcy.
e) The use of “Ch. 20” bankruptcy.
(1) Some practitioners have developed a “Ch. 20” bankruptcy – the
debtor files Ch. 7 first and gets the discharge, then uses Ch. 13 to
pay out on any debts not discharged under Ch. 7 (7+13=20, get it?)
(2) Saylors – “Ch. 20” is permissible so long as it’s in good faith.
VI. Business Bankruptcy – Ch. 7 Liquidation and Involuntary Bankruptcy
A. Business Liquidation
1. Ch. 7 is available for businesses as well as for individuals; however, there is
no discharge for a non-individual, § 727(a), which is the most attractive part
of Ch. 7.
a) Indeed, Ch. 7 usually means the death of the corporation; it quietly
expires under state corporation law.
2. Thus, a business Ch. 7 is almost always involuntary.
B. Involuntary Bankruptcy
1. Under certain circumstances, the creditors can force a company into either
Ch. 7 or Ch. 11. (They can also force a consumer into bankruptcy, but that
is rare; see supra). § 303(b)
2. Creditors can force a debtor into Ch. 7 (or 11) if… (§ 303(b))
a) 12 or more creditors, and 3 or more of those creditors have undisputed,
non-contingent, unsecured claims totaling $10k in the aggregate over
any lien on the debtor’s property.
(1) This is the most common case; most businesses have over 12
creditors, so 3 creditors must join the petition.
b) Less than 12 creditors (not counting employees, insiders and holders of
voidable transfers), if one or more has an undisputed, non-contingent,
unsecured claim totaling $10k in the aggregate over any lien on the
debtor’s property.
3. § 303(h) provides further limits. If the debtor contests the involuntary
bankruptcy petition, the court must deny the petition if:
a) The debtor is generally paying his debts as they come due (unless there
is a bona fide dispute regarding the debt), and
of 54 27
b) A custodian hasn’t been appointed within 120 days.
4. If a creditor’s petition for an involuntary bankruptcy is denied, attorney’s
fees and costs incurred by the debtor to challenge the petition can be
imposed against that creditor (and sometimes punitive damages). § 303(i)
5. Problem 27.2: Debtor, a successful personal injury lawyer, makes real estate
investments; the latest one has gone downhill. He’s solvent, but has short-
term cash flow problems. He seeks a workout from his creditors; all but one
(SSB) agrees (SSB was involved in a lawsuit where the debtor represented
the other side). SSB wants to bring an involuntary bankruptcy. Can they?
a) No. The debtor is (probably) generally paying his debts as they come
due (do extension agreements count as not paying?), and no custodian
has been appointed. The debtor can also get costs against SSB.
6. Also note that it doesn’t have to be a corporation. § 101(9) includes
associations, partnerships, business trusts, etc. (but not an individual or
limited partnerships) in the definition of “corporation.”
VII. Business Bankruptcy – Ch. 11 Reorganization
A. Overview of Ch. 11 Reorganizations
1. Ch. 11 Generally
a) Ch. 11 is much like Ch. 13; the creditors are paid from the future
earnings of the company rather than by liquidating the company’s
assets.
b) This is beneficial because it means the company still exists – and the
company is usually worth more alive than dead.
c) Business reorganizations used to be handled differently depending on
the size of the entity involved; today it’s all done under Ch. 11. Many
commentators say that doesn’t make sense – big businesses are
fundamentally different from small businesses, and should be treated as
such.
2. The Mechanics of Ch. 11
a) Filing imposes the automatic stay, just like in other Chapters. § 362(a)
(1) Of course, secured creditors can move to remove the stay if there
isn’t “adequate protection.” §362(d)
b) The business continues to operate “in the ordinary course”; under
§ 363(b), the company is controlled by the debtor in possession (DIP),
who takes the place of a TIB. §1107. The DIP is typically current
management.
(1) The DIP has the same duties as the TIB – i.e., to act on the behalf
of the creditors (note that this creates a natural tension between
of 54 28
management’s ordinary duty to the stockholders). He also has the
same powers.
(2) There is no court approval needed for routine transactions,
§ 363(c)(1), but there are limits on things that can be done with
property subject to a security interest, § 363(e). (The court can
restrain use, sale, or lease if there isn’t “adequate protection” of the
secured creditors.)
(3) The DIP/TIB has many “avoiding powers” which permit him to
recover preferences, assume or breach executory contracts, void
fraudulent conveyances, and set aside unperfected or late-perfected
security interests. These are covered in greater detail infra.
c) A creditor’s committee is appointed to oversee the DIP. §§ 1102, 1103.
d) The debtor must propose a reorganization plan. To be approved, it
must be (all of this is covered in greater detail infra):
(1) Approved by a specific majority of creditors (with certain
exceptions), § 1126(c), and
(2) Conform to the requirements of § 1129
e) Discharge occurs when the plan is confirmed. § 1141(d) (Cf. Ch. 13,
where discharge doesn’t occur until plan is complete)
3. The Logic of Ch. 11
a) The basic idea behind Ch. 11 is “an invitation to negotiation;” that is, to
get all the parties to slow down and come to the negotiating table.
b) Why can’t debtors do that on their own with their creditors? Often they
can. But often panic and recalcitrant oversecured creditors get in the
way. Ch. 11 is a way to bring everyone to the table in spite of
themselves.
4. Analysis of a Ch. 11 Negotiation
a) Ch. 11 negotiations always take place in the shadows of Ch. 7. This
is because of three things:
(1) The DIP has an absolute right to convert to a Ch. 7, § 1112(a), and
(2) Creditors can force a Ch. 7 conversion upon a proper showing,
§1112(b), and
(3) A conversion to Ch. 7 is required implicitly if the plan is rejected.
b) Thus, both sides threaten each other with Ch. 7, though no one really
wants it.
B. The Automatic Stay and Adequate Protection in Ch. 11
1. The automatic stay, § 362(a), applies at the time of filing, just as it does for
all other flavors of bankruptcy.
of 54 29
2. If a party moves to have the stay lifted, the court must act within 30 days or
it is lifted automatically as to the moving creditor. §362(e)
a) An agreement to not contest a motion to lift the stay is void since the
stay exists to protect all the creditors. Polk.
3. The stay can be lifted if either: (§ 362(d))
a) “For cause”: a secured creditor does not have adequate protection, or
(1) § 361 defines adequate protection; the debtor can make cash
payments, offer additional liens, or “other relief” (such as
insurance). §362(d)(1)
(2) The time for determining adequate protection is on the day of
filing, since that is when the creditor lost his right to pursue the
asset via state remedies.
(3) Remember, it’s adequate protection against depreciation or
damage. OR
b) The debtor does not have equity in the property + the property is not
necessary for an effective reorganization. §362(d)(2)(A); §362(d)(2)(B)
4. The burdens on a motion to lift the stay are as follows (§ 362(i)):
a) The creditor has the burden of showing the debtor’s equity in the
property (§362(d)(2)(a)).
b) The debtor has the burden of showing everything else, including that he
has provided adequate protection. (§362(d)(1);§362(d)(2)(b)).
5. There are exceptions to the stay in § 362(b), but they are narrowly
construed. (Ex.: “government function” exception does not include a
government civil action for money damages. Seities.) See supra for further
discussion.
6. Problem 28.1 – CS (a dry cleaning shop) has assets of 3 machines (FMV
$20k each, or $60k total) and 2 presses (FMV $4k each, or $8k total). It
recently filed Ch. 11. The machines are subject to a $65k perfected security
interest; the bank (BN) wants to repossess and sell the machines and the
pressers. Can CS keep the equipment?
a) BN will argue no adequate protection. However, CS has a slight equity
cushion of $3k ($68k total assets - $65k lien). This may or may not be
enough to qualify as adequate protection (how fast do these machines
depreciate?. Recall that the burden of showing
b) If the equity cushion isn’t enough, then CS will have to make cash
payments to BN, or offer them additional liens, or take some other
measure.
7. Problem 28.2 – SAKS, in Ch. 11, owns a chandelier (FMV $25k), but
doesn’t want to sell it. Bank has security interest in all fixtures, equipment
of 54 30
and supplies for $30k. All of those items together (including chandelier) are
worth $35k. Bank wants the chandelier. Can SAKS stop them?
a) The bank can’t make an adequate protection argument, since they are
oversecured by $5k (e.g., an equity cushion against depreciation or
damage) (is this enough?).
b) So they go to the second test. Does “debtor has no equity in the
property” refer to the aggregate of all assets, or to specific pieces? It’s
unclear. JW says it’s probably in the aggregate. It’s a good thing, too,
since the chandelier – which is purely decorative – is probably “not
necessary to an effective reorganization.”
8. Problem 28.3 – ASI (a slide rule maker in Ch. 11) owns a drill press (FMV
$50k). HM has valid PMSI in the press for $35k; CB has another security
interest in the press for $20k. Can HM get the press?
a) HM can’t claim no adequate protection of it’s interest, since it is first in
priority (it has a PMSI), so it is oversecured by $15k. (CB, on the other
hand, could claim no adequate protection, since it comes after HM and
therefore has no equity cushion.
b) ASI has no equity in the press since the security interests are larger than
value of the collateral. However, ASI could argue that the press is
necessary to a reorganization. On the other hand, HM could argue that
the business isn’t viable and therefore it isn’t necessary because there
won’t be a successful reorganization either way. (JW: As a practical
matter, HM probably will have to wait at least a little while before
making this argument – most judges give the debtor the benefit of the
doubt.)
9. Prospects for Reorganization – A plan that is purely speculative and
unlikely to yield anything for the creditors can result in having the stay
lifted. Cartwright (or, the revenge of the Girl Scouts…)
10. Pendency Interest
a) There are three types of interests in Ch. 11: pre-petition (i.e., pre-
bankruptcy), pendency (i.e., during the proceedings), and plan (i.e.,
after bankruptcy proceedings).
b) Recall that oversecured parties get post-petition interest until the
security runs out; unsecured (and undersecured) parties get none.
c) Also note special rules for single-asset real estate (SARE) cases in
§ 362(d)(3) – the stay can be terminated unless:
(1) Within 90 days of the order for relief the debtor presents a plan
with a reasonable chance of being confirmed within a reasonable
amount of time, or
of 54 31
(2) Within 90 days of the order for relief, the debtor makes payments
to creditor securing the real estate equal to the market interest rate.
d) SARE is defined in § 101(51)
C. Operating in Ch. 11
1. Who’s running the show?
a) The DIP has control of the business (now called the estate), though the
creditors can seek to have a TIB appointed. § 1104(a). The bankruptcy
court has broad discretion in making such an appointment. Sharon
Steel.
b) However, the appointment of a TIB is rare. More common is the
appointment of an examiner to investigate the DIP under § 1104(c)
2. What happens to the cash?
a) There are certain constraints on what the DIP can do with the
business’s cash or cash equivalents.
(1) If in the ordinary course of business and not subject to a lien, then
there are no restrictions on use. § 363(c)(1)
(2) Cash subject to a lien (“cash collateral”) cannot be used unless
either all the lienholders in the cash agree, or the court authorizes
its use § 363(b).
b) Setoff
(1) A creditor with a setoff right (typically, a bank taking what the
debtor owes it out if the debtor’s account before giving the
proceeds to everyone else) is treated as secured to the extent of his
setoff right. 506(a)
(2) However, setoff is still subject to the automatic stay. § 362(a)(7)
(a) An account freeze is not a stay violation, however. Hoffman,
Strumpf.
(3) An account subject to setoff is “cash collateral” and is subject to
the § 363(b) limits listed above.
(4) Problem 30.3 – FVL has $17k in its bank account at CB when it
files Ch. 11. FVL owes $5k unsecured to W; the bank purchased
W’s FVL account. Can the bank setoff without court permission?
(a) No. §553(a)(2) – No setoff for debt transferred to a creditor
either after the filing or within 90 days of filing if the debtor
was insolvent.
(5) Also note §760 – special rules for stock brokers
3. Post-Petition Financing
of 54 32
a) Post-petition financing is often vital to keeping the company afloat long
enough to survive bankruptcy. Often current creditors are the best
source of such financing since they already have an interest in keeping
the company alive.
b) The Code gives post-petition creditors special protection.
(1) An after-acquired property clause in a pre-petition contract ceases
to be operational after the filing. § 552(a)
(a) However, a creditor may still have a claim to proceeds under
Uniform Commercial Code § 9-306.
(i) Thus, if a telephone retailer has a lien on its inventory, the
creditor has a right to the proceeds of each phone sale.
The proceeds are cash collateral and require the
permission of the court to use.
(b) The key point is that a DIP can use assets either not
encumbered before bankruptcy or acquired after bankruptcy to
secure post-petition financing.
(2) Priority in Payment for Post-Petition Financing (§364)
(a) Priority over non-administrative expenses. § 364(a) and (b)
(i) The DIP can get unsecured credit in the ordinary course of
business and have it qualified as an ordinary § 503(b)
administrative expense (and thus has priority). § 364(a)
(ii) If not in the ordinary course of business, the DIP needs
court approval. §364(b)
(b) Priority over administrative expenses. § 364(c)
(i) If being qualified as an administrative expense priority
under § 503(b)(1) isn’t enough to induce someone to give
financing, the court can authorize getting credit with:
(a) Priority over all administrative expenses in
§§ 503(b), 507(b), or
(b) Secured by any estate property not already subject to
a lien, or
(c) Secured by any estate property with a lien junior to
any existing lien.
(c) Super-priority. § 364(d)
(i) If the § 364(c) super-priority isn’t enough to get financing,
the court can authorize a lien senior or equal to any
existing lien. It may do so only if:
(a) The DIP cannot get financing otherwise, and
of 54 33
(b) There is adequate protection of the existing secured
creditors of that particular property.
(d) Super-super-priority. § 507(b)
(i) The existing creditor has priority over the later creditor if,
notwithstanding the adequate protection provided for
under the § 364(d) super-priority, the existing secured
party still has a §507 administrative claim arising from:
(a) The automatic stay (§ 362), or
(b) Use, sale, or lease under § 363
(c) the granting of the § 364(d) lien, then
(ii) Ex: D had loan from bank for $50k secured by a lien on
inventory when it filed Ch. 11. D’s total debt is $250k.
(a) D gets a post-petition loan from FF of $25k secured
by a lien on the equipment. Bank sought adequate
protection by seeking to lift the stay. DIP offered
additional lien on accounts receivable instead, and the
court approved, so the stay wasn’t lifted.
(b) The inventory was mostly depleted before the bank
could force a Ch. 7 conversion, and the accounts were
difficult to collect. The bank is still owed $25k. FF
got $15k from equipment sale.
(c) Thus, the bank gets a 507(b) super-super priority
because the adequate protection failed. They get paid
first.
(e) Super-super-super-priority. § 726(b)
(i) If a case is converted to Ch. 7, then any § 507(b) super-
super-priorities arising under the Ch. 7 have priority over
any § 507(b) super-super-priorities arising before the
conversion.
c) Cross-collateralization – securing pre-petition obligations with new
collateral obtained with new, post-petition loans.
(1) This is not allowed. A creditor can’t bootstrap his pre-petition
position (typically undersecured) with post-petition financing.
Shapiro. Why? Because it messes up the statutory priority
scheme.
d) Owner Financing
(1) Sometimes the old equity holders can provide financing; however,
they don’t get the special protections mentioned above due to the
of 54 34
“absolute priority rule” (i.e., equity gets paid last; discussed further
infra).
(2) Some courts make an exception when equity provides financing
that can’t be obtained elsewhere. If the financing provides new
value, is a fair bargain, and is for the benefit of the creditors, some
courts will permit equity to retain ownership of the company.
D. Avoiding Powers
1. Generally
a) The avoiding powers available in consumer bankruptcies, but are more
common in business bankruptcies. They permit a TIB/DIP to undo
pre-bankruptcy transactions between the debtor and certain creditors
for the benefit of all the creditors.
b) Remember that DIP has all the powers of the TIB; whenever you read
one can do something, the other can do the same.
2. The Strong Arm Clause (§544(a))
a) The strong arm clause gives the TIB the position of a judicial lien
creditor. It allows him to avoid any unperfected interests on the date
of the bankruptcy filing.
b) The strong arm clause is covered in-depth in the course on secured
credit.
c) Federal Tax Liens
(1) If they aren’t filed, the lien is just another unsecured interest (and
TIB can avoid it).
(2) After filing, it is another security interest that must be recognized.
(3) However, the Federal Tax Lien Act of 1966 adds a twist: it gives
some groups super-priority over the tax lien. This creates some
circular problems (A beats B, B beats C, C beats A), which are
mostly resolved by § 724(b).
3. Preferences: The General Rules § 547
a) The TIB can undo certain transactions (“preferences”) that took place
within 90 days of filing; this is principally designed to ferret out
preferential treatment of one creditor to the detriment of the others.
b) Preferences are defined in § 547 (b). There are seven elements:
(1) A transfer of an interest
(a) This includes a security interest or perfection of an existing
debt. (Filing a financing statement qualifies. Meritt)
(2) In property of the debtor.
of 54 35
(a) Not someone else; a loan by a 3rd party to pay a specific debt is
not voidable if the debtor isn’t involved. Sun Railings
(3) To or for the benefit of a creditor
(4) On account of antecedent debt
(a) In other words, the debt came temporally before the transfer.
(5) Made while the debtor was insolvent
(a) Note that there is a presumption of insolvency for the 90 days
before filing for the purposes of preference analysis only.
§ 547(f)
(6) Made within 90 days before filing (or one year if the creditor was
an insider)
(7) That makes the creditor better off than he would have been under
Ch. 7 if the transfer had not been made.
(a) This requires a comparison of what actually happened with a
“hypothetical world” where it did not.
c) Note: although in the problems there is only discussion of what element
gives the problem it’s “twist,” you should always go through each
element as a checklist.
d) Also note the § 547(e) deemed date rules
(1) A transfer is made at the date of actual transfer if within 10 days of
perfection, and at the date of perfection if longer (or immediately
before filing if not perfected after commencement of the case, or
within 10 days after transfer, whichever is later)
(2) Regardless of the above, transfer is not made until the debtor gets
rights in the property.
e) Problem 33.1 – MLFO is an unsecured creditor of WM (WM owes
$4,000). WM pays $400 to MLFO while WM is insolvent. In the
liquidation, the unsecured creditors get 10% of their claims. Is it
voidable as a preference? Yes. MLFO is better off, since they get $760
(the $400 preference + 10% of their remaining claim, or $360) rather
than just $400 (10% of the original claim). The key is to ask if they
better off than if the transfer had not been made.
f) Problem 33.2 – U, a wildcat driller, may be insolvent. OS calls asking
about the unsecured debt U owes them. U gives OS spare equipment,
then files. Preference? Yes. U is presumed insolvent.
g) Problem 33.3 – RC has several unsecured creditors. One of them gets a
perfected security interest securing the previously unsecured debt while
RC was insolvent on 2/1. RC files on 4/25. Preference? Yes. It is
within 90 days; the security interest is an interest in property
of 54 36
h) Problem 33.4 – NWI, an insolvent logging company, gets a $50k loan
from VC secured by NWI’s unencumbered equipment on 6/1; however,
VC doesn’t perfect until 6/20. On 9/15, NWI files Ch. 11. Preference?
Yes. The key is § 547(e)(2), which deems the transfer occurred at the
date of perfection.
(1) This is a classic case of “delayed filing” as a preference – the moral
is to file early.
i) Problem 33.6 – VAC owes $25k to FRB (perfected and secured by all
after-acquired property); on 3/1 the FMV of VAC’s equipment is $15k;
on 4/20 VAC buys more equipment on unsecured terms. VAC files on
5/25. Preference? Yes. The key is § 547(e)(3), which says that a
transfer isn’t made until the debtor has acquired rights in the property
(unlike the UCC). Thus, the after-acquired property clause gives FRB
increased security, and thus a preference.
j) Problem 33.7 – CSBC owes HB $80k secured by a machine (FMV
$100k). On 7/1 CSBC makes a $10k payment. On 7/15 a fire wipes
out the factory. CSBC failed to maintain insurance in violation of the
security agreement. On 8/1 CSBC files Ch. 11. Preference? Yes,
because HB got $10k more than they would have in the real world.
However, you could argue that the collateral existed on the date of
payment – but the precedent is against you.
k) Problem 33.8 – Same facts, but on 7/16 they buy a new machine for
$100k on unsecured credit, and HB had an after-acquired property
clause. Preference? No, because there’s no difference in what they
would get. They received a $10k payment, reducing their extended
debt to $70k; they’d get that from the sale of the machine because they
have a perfected interest in it (for a total of $80k). In the “hypothetical
world” where the transfer never happened, they’d get $80k off of the
sale of the machine, so they’re no better off.
4. Preferences: Exceptions (§ 547(c))
a) There are 8 total exceptions, but only five are common:
(1) The “contemporaneous exchange” exception (§ 547(c)(1))
(2) The “ordinary course payments” exception (§ 547(c)(2))
(3) The PMSI exception (§ 547(c)(3))
(4) The “new value” exception (§ 547(c)(4)
(5) The “floating lien” exception (§ 547(c)(5))
b) The “contemporaneous exchange” exception. (§ 547(c)(1))
(1) The TIB cannot avoid a transfer to the extent that it was intended
to be a contemporaneous exchange for new value and was in
fact a contemporaneous exchange.
of 54 37
(2) Problem 34.1 – FC is insolvent; it’s gas supplier (E) would only
make deliveries for cash. They made two deliveries per week for
$400/ea. in the 90 days pre-bankruptcy. Twice FC didn’t have
cash on hand, so the driver picked up the payment on the next
delivery. Can the trustee recover?
(a) Most of the payments aren’t preferences, because the debt
isn’t antecedent. The problem is are the delayed presents – do
they fit under the “contemporaneous exchange” exception?
No. The delay means it wasn’t contemporaneous in fact.
Courts read this requirement narrowly.
(3) Note: some scholars think it’s a mistake to police delayed filings
with preference rules; they say the parties almost always intend a
contemporaneous exchange, and a goof-up is what caused the
delay. The counter is the importance of protection of other
creditors from lack of notice, intentional or otherwise.
c) The “ordinary course payments” exception. (§ 547(c)(2))
(1) The TIB cannot avoid a transfer to the extent that it was for a debt
in the ordinary course of business and made in the ordinary
course of business.
(2) Ex: Are late payments in the ordinary course? Maj. rule is to look
at the party’s past practice; Min rule is to look at both past practice
and industry practice. Steel Improvement.
d) The PMSI exception. (§ 547(c)(3))
(1) The TIB cannot avoid a transfer creating a security interest if it was
(in essence) given for a PMSI, and perfected within 20 days after
debtor takes possession.
(2) Policy: you want to encourage bringing assets into the estate.
e) The “new value” exception. (§ 547(c)(4))
(1) The TIB cannot avoid a transfer to the extent that after the transfer
the creditor gave new value to the debtor not secured by an
otherwise unavoidable security interest and on account of which
the debtor did not make an otherwise unavoidable transfer to the
creditor.
(a) New Value is defined in § 547(a)(2); it includes new credit as
well as money, goods, and services.
(2) The basic point is to provide some protection to a creditor who gets
a preference and then extends further unsecured credit.
(3) The mechanics of the exception:
(a) Identify the preferential payment
of 54 38
(b) See if the preference can be reduced by later “new value”
given (the new value must be unsecured and go unpaid)
(c) See if the new value was accompanied by a
payment/transfer/security interest which was unavoidable as a
preference.
(4) Hint: Work forward chronologically from 90th day to the day of
filing, identifying each payment that qualifies as preferential under
§547(b). After preferential transfers located, work backward from
each payment to determine if it's subsequent to a given preference,
same creditor having advanced unsecured credit to debtor. Any
advance of unsecured credit after preference triggers (c)(4), but
dollars of each advance can be counted only once.
(5) Problem 34.4 – ON is insolvent, but is operating on an unsecured
line of credit from DMPB to meet payroll and pay bills. (See
payment schedule on p. 573). ON files on 4/10. How much of the
payments can DMPB keep?
(a) All of the payments outside of 90 days are, of course, not
preferences so DMPB can keep those (here, only the 1/3
payment)
(b) You can’t just net the payments, though. The language in
(c)(4) says “after such transfer” the creditor gave new value.
Thus, the payments without following extensions of credit
don’t count.
(c) At the end of the day, DMPB only gets to keep the 1/3
payment (because it’s not a preference) and the 2/10 and 3/10
preferences under the exception.
f) The “floating lien” exception. (§ 547(c)(5))
(1) The TIB cannot avoid a transfer that creates a perfected security
interest in receivables or inventory (or proceeds) except to the
extent that it causes an increase in the value of the secured goods.
(?)
g) Note that § 553(b) provides similar rules for setoff “preferences.” Note
it only applies to setoff exercised before bankruptcy; a creditor using
setoff after bankruptcy is in good shape.
5. Executory Contracts (§ 365)
a) Basic Economics
(1) The TIB can review the company’s existing, ongoing contracts and
decide if they are good bargains, and, if they are not, to refuse
performance. (The other party gets a breach of contract claim –
i.e., an unsecured claim that won’t be paid much anyway).
of 54 39
(a) The business judgment rule applies to if the TIB can accept or
reject – basically, the TIB has broad discretion.
(2) Basic framework
(a) § 365(a) permits the TIB to assume or reject any executory
contract.
(b) § 365(b) places restrictions on assuming certain contracts that
are in default (covered infra)
(c) § 365(c) says TIB can’t assume or assign if excused by law or
if contract is one for financial accommodation.
(d) § 365(e) kills anti-bankruptcy and anti-insolvency clauses
(e) § 365(f) covers assigning contracts to 3rd parties (must assume
first and provide adequate assurance of completion)
(f) §§ 541(a), 502(g) brings contract and its burdens into the
estate, respectively.
(g) § 541(c)(1) – kills anti-alienation and bankruptcy termination
clauses to permit those contracts containing them to become
part of the estate.
(3) Problem 36.1 – PCI (an oil refinery) has filed Ch. 11 It has a
contract to provide 100,000 barrels at $15/barrel. In the current
market, it could sell the oil for $25/barrel. Assume unsecured
creditors get 30%.
(a) The DIP should reject under § 365(a). It can sell the oil at the
higher price, and the other party’s breach claim will only get
30¢ on the dollar as an unsecured creditor.
(4) Problem 36.3 – FM makes canvas canteen slings for the Army.
FM has suffered two strikes and a fire, and thus has filed Ch. 11.
Gov’t contract has a “no assignment clause” and a “bankruptcy
termination clause.” Can the government bail? No. § 541(c)
makes this contract part of the estate regardless of the anti-
alienation clause, and §365(e) prevents the anti-bankruptcy clause
from voiding the contract.
(5) Problem 36.4 – Z is in Ch. 11. It has a $100k line of credit, of
which $62k has been used on the date of filing. The TIB wants to
use the remaining $38k to finance the reorganization. Can the TIB
assume the line of credit? No. It is a contract for debt, and the TIB
can’t assume a contract that extends debt. § 365(c)(2).
(6) Problem 36.5 – AMM is in Ch. 11. It has several lucrative
contracts, but does not have the manpower or equipment to service
them. What should the DIP do? This is a two step process. The
of 54 40
DIP must first assume, then assign the contract to another
company.
(a) Assume under § 365(a), then assign under § 365(f)(1).
§ 362(f)(2)(A) makes it clear that the DIP must assume the
contract first; (B) makes it clear that he must provide adequate
assurance to the contracting party that it will be fulfilled by
the party the contract is assigned to.
b) Statutory Constraints on Executory Contracts
(1) While the DIP has broad powers to assume a contract, there are
limits on the exercise of those powers.
(2) If a landlord evicts pre-bankruptcy (for a breach other than an anti-
insolvency clause), does the automatic stay operate to reverse the
eviction? No. Mimi’s of Atlanta. However, some courts disagree.
Mulkey.
(3) Problem 37.1 – Strip center landlord wants to evict JP. He is two
months behind on the rent ($800 total) due to a fire. JP violated
lease term requiring insurance (he reinstated the policy, though).
Today is the last day of the 5 day “notice and cure” period on the
lease. Is bankruptcy an option?
(a) § 365(b)(1) – the trustee can’t assume unless he cures (or gives
adequate assurance of cure), compensates for any loss, and
provides adequate assurance of future performance.
(b) § 365(b)(3) – defines adequate assurance for a shopping mall
tenant (source of rent, rent won’t decline, won’t disturb mix of
tenants, etc.)
(c) § 365(c)(3) – TIB can’t assume or assign a nonresidential
lease terminated under nonbankruptcy law.
(d) Answer: File immediately, because otherwise the lease is
terminated due to the 5-day provision. This way, the stay
saves you. The trustee can assume the lease, but must cure,
provide assurance [such as proof of insurance], etc.).
(4) Problem 37.3 – NI leases facility for a 20-year term at $20k/yr.
Lease has anti-alienation clause, bankruptcy termination clause,
requires landlord’s approval to assign, and can be terminated by the
landlord if NI’s debt is ever 2x equity (with 10 days notice).
Landlord seeks to terminate on the equity rule; today is the last day
of the 10-day provision. NI wants to get out of the business
anyway, so he doesn’t need the facility. What advice?
(a) § 365(e)(1) zaps the debt-to-equity provision (it’s premised on
insolvency). Bankruptcy termination clause is also zapped.
of 54 41
Filing today stays eviction (don’t wait!). TIB can assume and
assign.
(5) Problem 37.4 – Same facts, but lease has a free assignment clause
so long as landlord gets ½ of any rent increase. Does this change
anything? No. § 365(f)(3) kills any provision that modifies the
contract terms due to an assignment.
(6) Problem 37.5 – Same facts. Lease also has term where landlord
agreed to make a $10k loan at below-market rate to NI. Can we
enforce this provision? No. You can’t cherry-pick provisions.
(a) This provision screws NI. § 365(c)(2) prevents assuming
contracts for financial accommodations. Since you can’t
cherry-pick, you can’t assume this contract, so you can’t
assign it. You may argue that no cherry-picking is designed to
prevent taking benefits while leaving burdens, and that here
you’re trying to leave a benefit – but that’s unlikely (it’s really
a burden after all, right?)
(7) Problem 37.6 – SF filed Ch. 7 on 3/1; He has a contract to buy
wheat at $2.35/bushel in May. On 4/25, the seller asks you to
consult with the TIB about this. Price of wheat is rising due to
Canadian drought; it is currently at $3.25/bushel and going up.
What to do? Don’t call. If TIB does nothing within 60 days, the
contract is deemed rejected. § 365(d)(1).
c) Advanced Problems
(1) Procedural problems
(a) A non-debtor cannot use the bankruptcy code to evade a
contract with a bankrupt party. Feyline Presents
(b) The better option is to use § 365(d)(2) to request the court to
force the TIB to make a decision on a specific contract.
(2) Extra-statutory restraints on assumption/rejection
(a) Review: § 541(a) makes an executory contract part of the
estate; § 541(c)(1) kills anti-assignment clauses from
preventing them from becoming part of the estate.
(b) The big question: What is “executory”?
(i) The most common solution to this query is the
Countryman Test. It provides that a contract is
executory if:
(a) There is a material breach, and
(b) Both sides still have obligations to perform.
of 54 42
(ii) Some scholars have criticized this approach as being too
easy to manipulates. Alternatives include:
(a) The Andrews Test – says contracts never become part
of the estate until they are assumed. Problem: what
to do with rejected contracts, since they’re outside of
the estate?
(b) The Westbrook Approach – Disregard executoriness
as irrelevant. Any contract not fully performed can
be accepted/rejected. See 72 Minn. L. Rev. 227 for
further details.
(c) What consequence if the contract isn’t executory?
(i) Then the contract can neither be rejected nor assumed.
The consequences are fuzzy. Some courts kill ancillary
obligations (like, in the sale of real property, a warranty of
no easement) but enforce the basic conveyance.
(3) Real Estate (§ 365(i))
(a) § 365(i)(1) – If the trustee rejects a contract for the sale of real
estate (or timeshare) the buyer already in possession can either
treat the contract as terminated or remain in possession.
(i) § 365(i)(2) – If the buyer remains in possession he must
make all payments but may offset payments by damages
suffered due to debtor’s nonperformance, but he has
no rights against the estate for damages. TIB’s only
obligation is to deliver title.
(ii) Thus, in a nutshell, the buyer can:
(a) Accept the rejection (getting a breach claim for pre-
petition damages, paid out of teeny bankruptcy
dollars), or
(b) Reject the rejection, getting offset against purchase
price but not damages.
(b) Problem 38.1 – You represent the TIB. She found contract
for sale of office building to J-M for $175k (FMV is $250k).
60 days is almost up. What can she do?
(i) She wants to reject the contract, so she can re-sell the
building at the higher market rate.
(ii) If J-M is not in possession, then TIB can absolutely reject
the contract; J-M has a lien for the recovery of anything it
has paid to date. § 365(j)
of 54 43
(iii) If J-M is in possession of the building, then they have the
right to reject the rejection, paying the purchase price
reduced by any damage claim they have against the estate
(such as a warranty of no easement).
(iv) Further examples
(a) J-M has paid in full ($175k); they have two claims:
the $175k under § 365(j) and the state-law loss of
bargain damages ($250k-$175k=$75k). If TIB is
paying 10%, they will get $182.5 ($175k+$7.5k).
Thus, it makes sense for the TIB to reject.
(i) However, is this executory? Probably not.
Recall the Countryman test. Here, there is no
further performance due from one party (the
buyer)
(ii) Note that if there was still performance due, J-M
could not get damages from the estate on the
state-law claim (but could setoff).
(iii) Some courts say a mere obligation to make
mortgage payments isn’t performance sufficient
to be a material breach (and thus not sufficient to
make the contract executory). It’s stupid, but
that’s what they say!
(b) The important distinction is between damages from
the estate and offset. The latter is better since you get
paid in pre-bankruptcy dollars (with the former,
you’re just an unsecured creditor).
(4) Intellectual Property Licenses (§ 365(n))
(a) § 365(n) – If the TIB rejects a contract where the debtor is a
licensor of intellectual property, the licensee may:
(i) Accept the rejection, taking breach damages paid in teeny
bankruptcy dollars, or
(ii) Reject the rejection, retaining its rights, including any
right to exclusivity (but no other type of specific
performance).
(a) Licensee must make all royalty payments with no
setoff and gets no § 503(b) administrative claims
arising from the performance of the contract.
(iii) Thus, in a nutshell: This is something of the opposite of
the real estate rules; the licensee can retain its rights
of 54 44
(including exclusivity, but no other specific performance),
loses setoff, but keeps his right to damages.
(a) JW: That’s nonsensical!
(iv) Note that trademarks are not included under the Code’s
definition of “intellectual property” in § 101(35A).
(b) Problem 35.2 – CL holds patent on “Death Spray” bug killer
and its trademark. 18 months ago he licenses both to FVT for
20 years (exclusive for one). He was tough in negotiations,
and has no further obligations under the contract. He then
becomes insolvent. GO offers a lucrative contract if it can
license both exclusively. Under state law, no consequential
damages, but specific performance for licenses is common.
What advice?
(i) CL shouldn’t have been so tough in negotiations. Under
the Countryman Test, this contract isn’t executory, so
the TIB can’t reject it. CL should renegotiate the contract
pre-bankruptcy to add some additional obligations
(hoping FVT’s lawyers aren’t bankruptcy experts!) so he
can reject.
(ii) The exclusivity period is up on the FV contract. The
problem then becomes the fact that GO wants exclusivity.
CL is probably screwed here, since FV can continue to
exercise its rights under the license if it rejects the
rejection.
(a) Alternative: accept the contract, and fail to perform.
This gives FV a post-petition damage claim (i.e., not
paid in teeny bankruptcy dollars), but since
consequential damages aren’t allowed this may not be
so bad. However, state law may force specific
performance anyway.
(iii) Recall that trademarks aren’t defined as intellectual
property for Code purposes so, we’re left with the
§ 365(a) – the TIB can reject and the licensee can’t do
anything about it.
6. Fraudulent Conveyances (§ 548)
a) The TIB has the right to void the transfer of assets for less than their
FMV if that transfer amounts to a fraudulent conveyance. Most of the
fraudulent conveyance material is covered supra.
b) Note that § 548 provides a baseline for fraudulent conveyances; state
law can provide more. § 544(b) (part of the “strong-arm” clause) lets
the TIB opt to use state law provisions.
of 54 45
c) Federal fraudulent conveyance law (§ 548).
(1) The TIB can avoid a transfer within one year of filing if the debtor:
(a) Had actual intent to defraud, or
(b) Received less than reasonably equivalent value and was
insolvent, had unreasonably low capital, or intended to incur
debts beyond his ability to pay.
(i) Recent Congressional amendments remove religious and
charitable contributions (up to 15% of gross income or
consistent with debtor’s prior practice) from this
provision.
(ii) Also note that there is no presumption of insolvency for
this section (unlike preferences).
(iii) Note the test for insolvency in § 101(32) is balance sheet
insolvency.
(2) Unless voidable under another section, a transferee taking a
fraudulent transfer in good faith and for value has a lien on the
interest transferred to the extent of value given.
(3) Also: § 550 – TIB can get value from initial transferee; good faith
transferee also has lien to the extent of the lesser of any
improvements and increase in value related to such improvements.
d) An interesting point: fraudulent conveyance provisions permit a debtor
to attack a transfer he made, something he can’t normally do, because
the “debtor” isn’t the “debtor” – he’s the DIP, taking the place of the
TIB, who can void such transfers.
(1) However, there can’t be a fraudulent conveyance in a foreclosure
sale, because such a sale is automatically deemed to be equal to
reasonably equivalent value. Resolution Trust (a 5-4 Supreme
Court decision).
e) Problem 40.1 – BD’s company files Ch. 11; 6 months ago, he withdrew
$25k for a family vacation. Advice? The “no equivalent value” part is
met, since the company got nothing. There’s probably no actual fraud.
The thin-capital and debt-beyond-ability-to-pay options are probably
not useful. Thus, we’re left with the insolvency requirement. The TIB
will have to prove this since there’s no presumption.
f) Problem 40.2 – You represent the TIB for AAI in Ch. 7. They traded
an office building for stock in SFI. The SFI stock was worth only $9k,
but both AAI and SFI thought it was worth $90k. SFI spent $30k
renovating the building, but only sold it for $100k to LW. What should
TIB do?
of 54 46
(1) There is a lack of reasonably equivalent value given on the deal, so
it is a fraudulent transfer if the debtor is insolvent.
(2) LW is a bona fide purchaser, so you can’t recover the property
from her; instead, you must look to SFI as the initial transferee
(liable under §550)
(3) § 550 tells us that SFI has a lien for the improvements and any
profit related to the improvements. Thus, it depends on what date
you use. If you use date of transfer, then you get $81k from SFI
(there were no improvements made on that date, and the “lien” is
basically a setoff). If you use the date of sale to LW, then SFI gets
a lien for $9k plus the lesser of cost or value of the improvements
(requires an appraisal).
g) Also note – if TIB can avoid even $1, he can avoid the whole
transaction, even if greater than all the claims of the creditors in whose
shoes he is standing. Moore v. Bay.
7. Equitable Subordination
a) Equitable subordination is a common-law doctrine incorporated by
reference into §510(c); it permits the “subordination” of payments to
one creditor until the rest are paid.
(1) The typical effect of this is to convert loans into “stock” so those
loans are paid last (with the equity holders).
(2) It is typically used with insiders who are creditors, or creditors who
use their position for improper leverage against the debtor.
b) Contractual subordination – § 510(a) permits creditors to voluntarily
agree to subordination by contract. Thus usually occurs on the demand
of a new creditor, who won’t offer new financing unless the old
creditors take a subordinated position.
c) Lender liability – creditors can be sued for inequitable conduct; this is a
state-law action. The debtor’s claim against the creditor becomes part
of the bankruptcy estate.
d) Problem 42.1 – LL has a loan from HSB secured by LL’s accounts.
The economy slumps; HSB demands and gets a second interest in
inventory and equipment. They send a “workout man” who demands
personal guarantees from LL’s owners, forces them to overbuy
equipment, and takes over payment of creditors (only paying where
such payment enhances the odds of an account being collected – he
ignores all other obligations, including sales taxes). After most
accounts have been collected and inventory is swelled, workout man
pushes for foreclosure. LL doesn’t want to stiff any of its creditors; can
bankruptcy help them?
of 54 47
(1) The automatic stay stops the workout man from pushing
foreclosure.
(2) The TIB can’t void the excessive inventory purchases as a
preference because § 547(c)(5) provides an exception for floating
liens.
(3) They might be able to use common-law equitable subordination
under § 510(a) to push HSB to the back of the line.
E. Negotiating the Plan
1. General Principles
a) Ch. 11 is a process. The rules only provide a framework for that
process.
(1) All negotiations take place in the shadow of Ch. 7; thus, you
always have to do a liquidation analysis to see how strong your
bargaining position is.
(2) The debtor is in the drivers seat (though involuntary bankruptcy or
foreclosure can force the debtor’s hand).
(3) Tax planning is really important – especially for the principle of
debt forgiveness as income.
b) “Prepackaged” Ch. 11’s – a debtor can often force little creditors to go
along with a plan by rounding up the votes before filing and showing
up in court with a plan already in hand.
2. Best Interests and Feasibility
a) In order for a plan to be confirmed, it must be in the best interests of
each creditor (not just creditors generally) and be feasible.
(1) Note that the words don’t appear in the Code; it’s just jargon for
the requirements in § 1129(a)(7) and (11).
b) Best Interests Test (§ 1129(a)(7) – each creditor must either accept the
plan, or get as much as he would in Ch. 7.
c) The Feasibility Test (§ 1129(a)(11)) – the plan is likely to succeed (a
case-by-case judgment based on the bankruptcy judge’s business
judgment).
d) Problem 43 – Ch. 11 plan offers 50% to unsecured creditors ($50k
total, your client has $10k). There was a $75k payment made to bank
on a $100k secured loan for equipment (FMV$25k) within 90 days of
bankruptcy (note this makes the bank fully secured).
(1) Do a hypothetical Ch. 7:
(a) The Ch. 11 proposal means there is $25k cash (50% of $50k)
available to the unsecured creditors
of 54 48
(b) Recover the preference. The bank retains it’s $25k security
interest (it’s undersecured, remember!); the recovery generates
$50k more cash to distribute ($75k preference - $25k secured
interest).
(c) Add the cash already available to the cash made available via
the preference recovery: there is $75k to distribute ($25k +
$50k)
(d) There is now $125k of unsecured debt to reach in a
liquidation: the original $50k of unsecured credit and the $75k
that the bank is undersecured.
(2) The Ch. 11 plan provides for 50% payment to unsecured creditors;
in a Ch. 7, the unsecured creditors would have $75k/$125k, or a
60% payout, thus it’s not in their best interests.
(3) Note a creditor has no standing to bring a preference action by
himself, but can petition the court to appoint an examiner for the
DIP. § 1104.
3. Classification and Voting
a) The creditors must approve the Ch. 11 plan. Approval is done by class.
A class is deemed to have approved the plan if both of the following
criteria are met: (§ 1126(c))
(1) > 50% of the number of creditors within the class approves.
(2) 2/3 of the amount of debt (i.e., holders of 2/3 of the dollar
amount of the debt) within the class approves.
b) The debtor has a great deal of flexibility in setting classes. This permits
“financial gerrymandering” (§ 1122).
(1) Each creditor need only be “substantially similar” to other
creditors within the class. § 1122(a)
(2) A plan can (with court approval) create a de minimis class for
holders of insignificant amounts of unsecured debt for
administrative convenience. § 1122(b)
(3) Any creditor doesn’t count for either of the above tests if he did
not accept/reject in good faith or was solicited in bad faith. §
1126(e).
c) There is no requirement that all similar claims be classed together. US
Truck.
d) Each class has to approve the plan or not be impaired, § 1129(a)(8),
(unless there is a “cramdown,” see infra).
e) Problem 44 – same facts as 43 (assume you won). The debtor now
proposes a 60% plan. Your client is still hacked off. Recall he has
of 54 49
$10k of $50k total unsecured debt. Joining him in dissent is a holder of
$6k of unsecured debt ($16k total held by the dissenters). $3k of the
unsecured debt is held by multiple claimants of insignificant size. Can
he prevent this plan from passing?
(1) The key here is that if you can edge the $3k holders out, you will
have over 2/3 of the debt dissenting (16/47); if you can’t, you don’t
(16/50).
(2) You could argue that creation of a de minimis class would be
appropriate here for administrative convenience. You might argue
that the little creditors weren’t solicited in good faith.
4. Impairment
a) If a class is not impaired, there is no need to get the approval of that
class. § 1129(a)(8)(B).
(1) Members of non-impaired classes are deemed to have accepted the
plan. § 1126(f)
b) What is meant by “impairment”? Legal impairment? Economic
impairment? Both? The issue is fuzzy.
c) Each member of an impaired class must either approve the plan or get
the same amount as they would in Ch. 7. §1129(a)(7)(A)(i).
(1) Note code words: “on the effective date of the plan” means they
must get the same amount in present value terms as they would in
Ch. 7.
5. Solicitation and Disclosure
a) § 1125(b) says acceptance of a plan cannot be solicited unless
“adequate information” is disclosed.
(1) “Adequate information” (defined not-too-usefully in § 1125(a)(1))
includes information a reasonable investor would need to make an
informed judgment about the plan.
(2) This includes things like a description of the business, a pre-filing
history, financial information, a description of the plan, a
liquidation analysis, management to be retained, pending litigation,
insiders, and tax consequences. Malek.
b) Also note the “Safe Harbor Rule” that displaces SEC regulations.
§ 1125(e). So long as the plan is in good faith and complies with the
bankruptcy laws, the solicitor can avoid those rules (including liability
for fraud).
c) Problem 45 – same facts as 44. Plan is up to 70%. Debtor sues for a
$2,500 preference paid to your client (which makes your client even
of 54 50
madder). Also, the odds of the plan being successful are slim due to a
backlog of orders is smaller than claimed. What to do?
(1) You could argue that the backlog claim means that there was not
“adequate information” to confirm the plan. However, there is no
liability for a bad faith failure to disclose (§ 1125(e)). So can you
prove the debtor deliberately lied? If so, the court can revoke a
plan procured by fraud. (§ 1144). (If you can’t, you could sue the
company – but that’s useless. Can you sue the president
personally?)
(2) It is unlikely that you could void the preference in a similar way.
Your client knew about it from day one, even if he didn’t realize it
was a preference. You could (weakly) argue that estoppel
principles should govern.
6. Cramdown (§ 1129(b))
a) If an impaired class rejects the plan, the debtor’s only hope of approval
lies in the cramdown rules (which permit avoiding the (a)(8) acceptance
requirements).
(1) You need at least one approving, impaired creditor for a plan to be
approved. § 1129(a)(10). Thus, a debtor will strive to create at
least one consenting class.
(2) A cramdown must be “fair and equitable” §1129(b)(1)
(3) Generally:
(a) The secured creditor’s liens must be preserved, and the
secured parties get the present value of their secured claims.
(§ 1129(b)(2)(A)).
(b) Unsecured parties and other interest holders (i.e., equity) are
subject to the Absolute Priority Rule; the objecting class gets
either: (§ 1129(b)(2)(B))
(i) The full value of its claim (in present value terms), or
(ii) No parties junior to it get any compensation at all.
(4) The controversy: old owners often end up as new owners by
putting up new capital post-bankruptcy as “new value.” Is holding
that interest violative of the absolute priority rule?
(a) Probably not for new monetary contributions. Bonner Mall
Partnership.
(b) No “sweat equity” is allowed. Ahlers.
b) Note that cramdown typically operates as leverage for the debtor.
c) Cramdown and secured parties
of 54 51
(1) See supra, a secured creditor must get the present value of his
secured claims – one of the most litigated issues is what interest
rate to use when computing this.
(2) Another consideration: § 1111(b) elections. An undersecured
creditor can waive his unsecured debt in exchange for full payment
of the secured portion over time.
(a) Oddly enough, the election is in 1111(b), but the requirement
that the creditor be paid the value of his claim is in
§ 1129(b)(2)(A)(i)(II)
(b) There are two tests in § 1129(b)(2)(A): it must get the full
amount of nominal dollars owed it, and it must get the present
value of its secured position. (Ex.: $100k loan secured by
$50k property; election means you must be paid $100k
nominally at the end of the plan and $50k in PV terms).
(c) There are exceptions as to when the election can be used.
d) Problem 46 – same facts as 45. Plan is revoked. Two weeks later, the
debtor gets a huge contract; it still pushes the 70% plan, and your client
still opposes it. Can the debtor cramdown on our client?
(1) While it depends on the facts, it’s probably doubtful that
cramdown is an option since there will probably be something left
over for the equity holders (i.e., no absolute priority here).
7. Reorganization Structures
VIII.Additional Issues
A. Creative Uses of Bankruptcy
1. Mass Torts
a) The use of bankruptcy for mass tort cases can help solve the problem of
later claimants – i.e., prevent early claimants from killing company
before later claimants can collect.
2. Labor-Management Relations
a) Can the use of the executory contract avoiding power be used to avoid
union contracts when a company gets into financial trouble? Should it?
(1) § 1113 – specifically deals with collective bargaining agreements;
court can approve rejection of the contract if certain prerequisites
are met.
b) Remember, a union always has its power to go on strike.
c) What of union pensions? Can a DIP avoid those in bankruptcy?
(1) § 1114 sets out guidelines for handling pensions
3. Municipal Bankruptcies
of 54 52
a) Ch. 9 is specially reserved for municipalities.
b) The court can’t interfere with the political or governmental powers of
the debtor. § 904.
c) Confirmation is basically the same as Ch. 11.
B. Theories of Bankruptcy
1. Three principal schools of thought:
a) “Creditor’s bargain” – don’t kill the golden goose (bankruptcy as a
means of creditor’s protection.
b) Contractarian – bankruptcy should be governed by free contract (or a
menu of choices), letting parties stipulate in advance what will happen
in bankruptcy.
c) Complex indeterminate – bankruptcy is a big, complex group of
competing social and financial policies, so there is no coherent theory.
2. JW’s (admittedly incomplete) theory: “Depoliticizing” – bankruptcy
removes the need for a political solution (such as Chrysler, Long-Term
Capital Management bailouts) by providing a legal one.
C. Conflicts of Interest and Lawyering Fees
1. Beware
2. § 327(a) – TIB’s counsel must be a disinterested person and be approved by
the court.
3. §§ 328(a), 329(b), 330(a) – fees must be approved by the court for the TIB,
the debtor’s counsel, and other professionals employed by the TIB.
4. The “Trojan Horse”
a) If you represent a single-shareholder company, there is a potential
conflict waiting to happen. If you represent the company, then you
have a possible conflict with the owner, and vice-versa. In Re Lee.
b) This is because there is a possible monetary conflict, at least in theory.
The company wants to survive bankruptcy; the owner (theoretically)
wants to get paid as much as possible under the plan.
c) This is also because the TIB controls attorney-client privilege, see infra.
5. Important points on conflicts
a) Disclosure is vital – even if a possible conflict seems unimportant, you
must disclose it to the court. You may still be removed later, but you
won’t be subject to sanction.
b) All compensation must be approved for the debtor’s attorney.
of 54 53
c) When talking to employees, etc. you need to make it explicitly clear that
you don’t represent them, and that they may need their own lawyers.
This is doubly true for conversations with directors and officers.
6. Privileges
a) The TIB controls the attorney-client privilege. Weintraub.
b) JW thinks this is wrong, because bankruptcy is about property, not
people (including corporations).
(1) Counter: a corporation is nothing but property.
D. Bankruptcy jurisdiction
of 54 54
