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Bankruptcy Law School Legends Professor David Epstein I. Introduction to Bankruptcy A. What is Bankruptcy?

Bankruptcy Law School Legends

Professor David Epstein

I. Introduction to Bankruptcy

A. What is Bankruptcy?

1. Federal Law – Article I of the Constitution empowers Congress to enact uniform laws of bankruptcy.

2. Statutory Law – Title 11 of the United States Code

a. 2005 Changes – Bankruptcy Abuse Prevention Consumer Protection Act

3. Differences between Bankruptcy Code and State Debtor-Creditor Code

a. State Debtor-Creditor law focuses on individual actions by a particular creditor. By contrast, the Bankruptcy Code is a collective process. The focus is on what happens to creditors generally.

b. The prospects for meaningful relief for the debtor are much greater in bankruptcy.

c. Different vocabulary.

i. “Debtor” – In the Bankruptcy Code, the “debtor” is the person who is in bankruptcy.

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4. Types of Bankruptcy

a. Chapter 7 – Liquidation Bankruptcy – The assets of the debtor as of the time she files for bankruptcy are taken by a court- appointed trustee and sold, and the proceeds used to pay creditors.

b. Chapter 11 – Court approved plan of payment in the future from future earnings.

c. Chapter 13 – Business entities cannot use Chapter 13.

5. Building Blocks

a. Policies

i. Equality of Distribution – People who have the same status outside of bankruptcy are treated the same in bankruptcy.

ii. Fresh Start – Debtors can earn a fresh economic start.

iii. Adequate protection of an interest in property – If a person other than the debtor has not only a contract law right but a property interest, primarily a lien, we will see bankruptcy law recognizes that property right.

b. Concepts

i. Discharge

(a)

Discharge is protection from any further personal liability after bankruptcy.

(b)

Not every person who files for bankruptcy receives a discharge.

(c)

When a discharge is given depends on the type of bankruptcy case.

ii. Property of the estate – Determined as of a fixed point of time.

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iv. Secured Claim – Must be secured by a lien on property in which there is an interest, or that is subject to a set-off under Section 553.

(a)

A lien is an interest in property.

(b)

While bankruptcy can change contract obligations, bankruptcy generally respects other parties’ rights in property, such as a lien.

v. Automatic Stay

(a)

Applies in every bankruptcy case.

(b)

An automatic stay is like a statutorily imposed injunction.

(c)

A stay lasts as long as the bankruptcy case lasts.

(d)

If a stay is disregarded, actions taken in violation of the automatic stay will have no force or effect.

(e)

Grounds for relief from automatic stay

(1) “For Cause” – A creditor can obtain a relief from stay for cause.

(2) “Lack of adequate protection of an interest in property of such party in interest” – Focused on what is happening to the collateral

B. People Concerned With the Bankruptcy Process

1. Debtor – Person against whom the bankruptcy is filed

2. Debtor in Possession – Debtor in a Chapter 11 bankruptcy case

3. Creditor – The holder of the claim

4. Trustee – In every Chapter 7 case there is a trustee. The trustee is charged with gaining control of the property of the estate, selling it, and distributing the proceeds.

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C. Where do Lawyers do Bankruptcy Law?

1. Allocation of judicial power over bankruptcy

a. Historically, bankruptcy courts were courts of limited jurisdiction.

b. Bankruptcy Reform Act of 1978 – The policy decision was made that the bankruptcy court should be one of pervasive jurisdiction.

2. Grant of jurisdiction to district courts

II. The Beginning of a Bankruptcy Case

A. How an Individual Bankruptcy Case Begins

1. Filing of a petition

a. Debtor – Voluntary petition

b. Creditors – Involuntary petition

2. Petitions

a. Voluntary Petitions – Filing of a petition constitutes an order for relief

b. Involuntary Petitions – Opportunity for the debtor to contest whether the debtor belongs in bankruptcy. It is only after the debtor has had this opportunity that the court shall order relief.

3. What an individual debtor has to do before filing a bankruptcy case

a. Credit Counseling

b. Bankruptcy Education

c. Schedules that the debtor must file in addition to the petition.

4. Means Test

a. Important terms

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i. Debtor’s current monthly income – Subjective as to this particular debtor.

ii. Median Family Income – Standard figure

b. If twelve times the current monthly income is greater than the median family income, then continue with the Means Test.

III. During the Bankruptcy Case

A. Chapter 7 Case

1. Trustee has an obligation to collect and sell the property of the estate.

a. Exemption Issues

i. What law applies – State law typically applies to determine whether or not property is exempt

(a)

Each state has the opportunity to opt out – An individual debtor in a state that has opted out cannot use the bankruptcy exemptions.

(b)

Which state’s law is applicable?

(1) If there is a debtor who has been in the same state as she is in now, for the past 730 days preceding bankruptcy, then that state’s exemption laws control.

(2) If there is a debtor who sometime in the past two years has lived in more than one state, go back to 180 days before the 730 days to determine which state’s law governs.

ii. Which property is exempt?

(a)

Most retirement funds

(b)

Insolvency Planning – Homestead

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(1) Looks back on the ten-year period prior to bankruptcy – If there has been a build-up in the homestead over the ten year period prior to the bankruptcy with the intent to hinder, delay, or defraud creditors, that build-up will be lost.

(2) Look back on the last 1,215 days – If over the last 1,215 days, the value of the homestead has increased by more than $125,000, regardless of whether there is any fraudulent intent or not, the increase beyond $125,000 is lost.

iii. Which creditors are affected by exempt property?

(a) Two groups not affected by exempt property:

(1) Creditors having domestic support claims

(2) Creditors who have liens on exempt property

2. Trustee’s distribution of proceeds pursuant to statutory guidelines

a. Section 726 – Distribution of the Property of the Estate

i. Property of the Estate – Debtor’s interest in property

ii. Secured creditors get paid first for their property interests

iii. Priority claims get paid next – Often not enough left to pay the priority claims

3. Chapter 7 Discharge

a. Discharge – Protects the debtor from any further personal liability of a debt.

b. Availability of a discharge depends on Section 727 – Objections to discharge

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ii. Some objections to discharge are based on what the debtor did before going into bankruptcy.

(a)

Debtor’s bankruptcy past

(b)

Debtor may have done bad things before bankruptcy, such as a transfer with the intent to hinder, delay, or defraud.

(c)

What a debtor does in the bankruptcy case, such as making a false oath.

c. Which debts are affected by the discharge – Debts that are not covered by a bankruptcy discharge – Exceptions to discharge

i. Nature of the debt – Taxes, domestic support obligations

ii. Debtor’s conduct in incurring the obligation

d. Discharge and Secured Debts

i. Secured Claim – The holder of the claim has a lien on property of the debtor

ii. Redemption – Only available to individual debtors.

(a)

The individual debtor can redeem tangible personal property that is primarily used for family or household use.

(b)

Tangible personal property may be redeemed by paying the allowed amount of the allowed secured claim.

(c)

Cash

iii. Reaffirmation – An agreement entered into by the debtor and the creditor after the bankruptcy case which says that the debtor is going to repay a particular amount.

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(a)

Before the debtor enters into a reaffirmation agreement, there are certain pre-agreement disclosures that must be made to the debtor.

(b)

The reaffirmation agreement must be filed with the court.

(c)

If the debtor was represented by an attorney in the reaffirmation process, the attorney must submit an affidavit saying that the attorney was involved in the process and the attorney believes the agreement is not an undue hardship on the debtor.

B. Chapter 13 Bankruptcy Case

1. “Plan”

a. The debtor’s attorney files a “plan” proposing who is going to be paid and how they are going to be paid.

b. Plan must be approved by the court.

i. Priority claims must be paid in full.

ii. With respect to secured claims, Chapter 13 distinguishes between secured claims that are secured by the house which is the debtor’s principal residence, claims that are secured by automobiles, and claims secured by other collateral.

(a)

House – Chapter 13 plan cannot modify or alter the payment obligations.

(b)

Cars – Chapter 13 plan cannot modify or alter the payment obligations.

(c)

Other – It is possible for a Chapter 13 plan to force down changes on these other obligations.

2. Obtaining Court Approval – A court will look to the following things:

a. Priority claims are paid in full.

b. Home mortgages are unimpaired.

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c. Car loans are unimpaired.

d. Other unsecured claims – Must get as much as they would be getting in a Chapter 7 case, and the debtor must be committing all disposable income.

3. Chapter 13 Discharge

a. Contemplates that the debtor will get a discharge after completion of the payments under a claim.

b. Hardship Discharge – Can be granted by the court if the debtor has already paid as much as the creditor would have received in a Chapter 7 case, and the debtor’s failure to complete the payments is due to circumstances for which the debtor is not accountable.

C. Business Chapter 11 Case

1. Business continues to operate

a. Getting funding for Chapter 11 Case

i. Section 364a – Ordinary Course – To encourage creditors to continue extending ordinary credit, they get an administrative expense. No notice and hearing are required.

ii. Section 364b – Requires a notice and a hearing.

iii. Section 364c – Obtaining new secured credit

iv. Section 364d – Obtaining new secured credit with a super-priority

2. Selling assets – Section 363

a. Compare Section 363b(1) with Section363c(1)

i. Section 363b(1) – Property is used or sold other than in the ordinary course of business and requires bankruptcy court approval.

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b. Cash collateral – Property that is encumbered that is cash.

c. Adequate protection of the creditor’s interest in property

D. Developing a plan of restructuring

1. Who may file a plan?

a. A debtor has an initial exclusive period of 120 days in which only the debtor can file a claim. If the debtor files a plan, then the debtor has 180 days from the time of the filing of the petition to gain creditor approval of the plan.

2. Disclosure Statement – Supposed to explain the following:

a. How the debtor got into bankruptcy in the first place

b. What the plan provides

c. How the debtor will be able to meet his obligations under the plan

3. Creditor Approval – “Acceptance”

a. Creditors have the opportunity to vote on the plan.

i. Creditors vote the amount of their claim.

ii. Votes are counted according to classes of claims.

4. Court Approval – “Confirmation”

a. Feasibility – Confirmation of the plan is not likely to be followed by the need for further financial reorganization.

b. Cram-down – Is the plan fair and equitable?

i. Absolute priority rule

(a) Secured Claims – Holder of the secured claim must be paid an amount that has a present value equal to the value of its collateral.

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(b)

Unsecured Claims – Must be paid in full before equity gets anything.

(c)

Classes of interest in stock – Classes of stock must be paid before inferior, subordinated classes of stock get paid.

IV. Three Most Frequently Tested Areas

A. Fraudulent Transfers and Obligations

1. Section 548 – A debtor, before filing for bankruptcy, has somehow sold or transferred what would ordinarily be property of the estate.

a. Key time period –Within two years of the date of the petition.

b. “Actual Intent” – Typically established by indirect surrounding circumstances called “badges of fraud.”

c. “Less than reasonably equivalent value” – The amount of consideration matters here.

B. Preference Law – Did one creditor get more than other creditors?

1. Section 547

a. Elements of a preference

i. There must be a transfer of an interest of the debtor in property.

ii. It must be for the benefit of a creditor.

iii. It must be for or on account of an antecedent debt.

(a) Antecedent Debt – Amount that was owed before the transfer.

iv. It must be made while the debtor was insolvent.

v. By and large, preferences are limited to what has happened ninety days before bankruptcy, unless the creditor was an insider.

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b. Preferential Effect

i. If the creditor was at all times fully secured, then the payment to that creditor was not a preference.

ii. Even if the creditor was only partly secured, if the creditor only received its collateral, that is not a preferential effect.

iii. If the creditor was totally unsecured, then the transfer will always be a preference unless creditors would have been paid in full.

c. Exceptions

i. Ordinary Course

(a)

The debt must be ordinary course.

(b)

The payment must be ordinary course.

ii. Look at what happened after the preference

C. Leases and Executory Contracts

1. The debtor has three choices:

a. Rejection – The debtor who rejects the lease is breaching the lease and is giving up his rights to the leasehold.

b. Assumption – The debtor continues to keep the lease property and must continue to keep up the payments.

c. Assignment – The debtor sells the rights of the leasehold to someone else.

2. Effect of rejection, assumption, and assignment

a. Rejection

i. Debtor loses the property of the estate.

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b. Assumption

i. Debtor gets to keep the property of the estate.

ii. The other debtor party has an administrative expense priority for the remaining lease payments.

c. Assignment

i. The debtor who assigns the lease has no further liability under the lease.

3. Role of the court

a. Most courts use a business judgment standard.

b. Courts are more careful in approving assumption decisions than rejection decisions.

4. Time period for making the decision whether to reject, assume, or assign

a. Commercial Leases – Initial period of 120 days. Time period can only be extended for another 90 days.

b. Chapter 7 Case with anything other than a commercial lease – Initial 60 day time period.

c. Chapter 11 and Chapter 13 Cases, and it is something other than commercial real estate – No time period. Any time up to the time the plan is confirmed by the court.

5. Performance obligations during the gap period

a. Commercial Real Estate Leases – Debtor has to timely perform all obligations.

b. Equipment Lease – Statutorily imposed obligation to perform, but there is a 60 day delay.

6. Limitations on the effect of rejection

a. Debtor is a landlord – Landlord cannot use bankruptcy to evict its tenants.

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b. Debtor is the licensor under an intellectual property license – If there is a situation where a patent owner has licensed its patent to another party, and the patent owner files for bankruptcy, the patent owner cannot use the bankruptcy as a way of ending the rights of the licensee to use the intellectual property.

7. Contract limitations on assumption and assignment

a. Bankruptcy termination clauses have no cause or effect.

b. Anti-assignment provisions are not affective in bankruptcy.

8. Requirements for assumption and assignment

a. Assumption

i. If there has not been a default, look at Section 365b.

ii. If there has been no default, then there are no requirements for assumption.

b. Assignment – Always have to look at Section 365b.

c. Requirements of 365b

i. Must be cured.

ii. Must pay for any economic loss caused by the default.

iii. Provide adequate assurance of the assignee’s future performance.

9. Leases and executory contracts that cannot be assumed or assigned

a. Contract to make a loan or extend other debt financing – It cannot draw on the line of credit.

b. If the law outside of bankruptcy is that the debtor cannot sell the contract, then in bankruptcy, not only can the debtor not sell the contract, he cannot even keep it.

10. Scope of “Executory Contracts”