Bankruptcy Outline

** REMEMBER LEVERAGE**
Notions that Drive Bankruptcy Proceedings:
(1) We want to Give the Debtor a Fresh Start
(2) Equal Treatment of Creditors
I.

Individual Debt Collection State Law

A. Non-Judicial Debt Collection
Vast majority of debt collection occurs without formal court help
o Although no formal process is used, the law affects the bargaining and
negotiations that happen outside of court
All bargaining occurs in the shadow of the law
Creditors reasons for pursuing debtors without the aid of the court
o Creditors may lose on the merits
o It is expensive
o Debtor may be judgment proof
Leverage Matters
o Debtors chose what debt to pay and when
o Creditors decide what kind of effort to expend to get this debtor to pay
The game is to influence the other party to do what you want
o Creditors use scare devices and annoy the debtor
o Debtors evade
Credit Reporting
o It is a tool creditors can use to determine which applicants to approve or deny
and it also a tool that creditors can use- threaten future credit to exact payment
Heintz v. Jenkins
The Issue here was whether the attorney was a debt collector under the terms of the Fair Debt
Collection Practices Act such that the damages could be access. Court HELD that the lawyer was a
debt collector b/c he regularly collected or attempted to collect directly or indirectly consumer debts
owed or due or asserted to be due.
Problem 1.2: You work for a major firm in a large city. One of the clients is Security Bank who is
having trouble collecting on an unsecured loan from local physician. What is the wisest course of
action. The debtor takes home 12,500 a month. She owes1200 a month to the client. She spend 1800
on food, utilities and other day to day expenses. She has no other late payments except to the client.
Each month she owes 10,650 to creditors. Thus once she pays off creditors she has 1800 to spare, and
she spends 1800 living expense
-First Step: Determine why she is paying everyone else but us Home Mortgage- The one thing debtors will hold on to
Car Loan- Need the car to drive to work
Health Insurance- Probably already set up, as a physician she knows what happens if you dont
have it, if she has children then it is even riskier although usually this is an item debtor will let
go
Vet Bill- Cannot return to a vet that she stiffed
Robbie Reich- co-workder- Thus there is social pressure- see every day and it is person you
know
Country Club- Social pressure
MasterCard/Visa/Gas Card- need to get to work, plus there is a higher rate of interest if default
and creditor card companies and gas card will notify credit reporting
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Clothing store- same as above

Alimony- May be arrested if dont pay
o Thus generally the debtors reasons are for not paying are not about the law- they result
from social pressure
-What are some solutions available?
Take security in some of her assets, particularly her house
o This makes it less complicated- dont have to have the sheriff execute a lien on the
property if you are secure- have some measure of self help
o Plus security give you leverage, thus debtor will be more inclined to pay
o To induce the debtor to give a security interest we can threaten to turn her over to the
credit reports
Restructure the Debt
o Reduce the interest rate
o Reduce the monthly payments
Problem 1.3: MW has difficulties with credit charges on his account at Highland Department store.
They billed him for 4,000 in goods that MW did not purchase. He notified Highland of the mistake but
they kept billing. He then decided to apply for a mortgage but he was turned down by the ME. Under
the Credit Protection Act, the mortgage company sent a letter explaining that he was not within the
range of applicants they lend to. What are MW options if he finds out that the dispute with Highland is
the root of his problems? What is your advice if the disputed amount was $40 instead of $4000.
-First, how does MW find out that he has had the erroneous credit report to determine if this is the
problem?
Under the Fair Credit Reporting Act says that if a creditor looks at the credit report you have to
tell them your decision NOT to extend credit was based on the adverse credit report.
o Thus there is a notice requirement in the Fair Credit Reporting Act
The purpose of the notice requirement so to ensure accuracy
If the issue ultimately cannot be solved the individual can submit a written
statement explaining the issue
o If the creditor fails to give notice, the creditor has to pay damages
Thus here if the bank had forgot to give him notice and they relied on the credit
report in denying him credit, they will be liable for damages but not a lot
If the dispute amount was 40 instead of 4000- tell the debtor to just pay it off
Problem 1.4: The senior partner of a big firm explains that one of the pension funds that the firm
advises is considering a sizable investment in a payday loan company. Before investing the firm wants
an opinion on the practices of the company to determine if they are in accordance with the law
- First how does payday lending work
o Debtor writes a post-dated check for the amount of money borrowed plus interest, the
lender gives you the cash now and then cashes the check on the day the check is dated
The effective interest rate is higher for larger amounts and for longer post dates
- Second we need to know what the rules are on interest rates
o Usury laws regulate interest rates of states
o Supreme Court in Marquette decision determined that the states usury law of the home
state of the banks PPB is the laws that govern interest rate
In response, race to bottom- states are deregulating to attract business
o Thus probably not an issues here
- Third we want to know this the loan company can be held liable under the Fair Debt Collection
Practices Act
o First question under this act is if they are debt collectors
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Statue only affects third party debt collections those that collect debt for other
people
So if you are collecting your own debt then you are not covered
- Finally we want to know if there are any substantive violations
o The debt collector cannot say that the debtor is going to be arrested unless it really is a
possibility
Problem 1.5: Fiddle Collections is a debt collector for K-Mart that charges a fee to the debtor on top of
the fee collected from K-mart for its debt collection actions. They come to you to determine they are
working within the parameters of the law.
-Problem: Fair Debt Collection Protection Act 808(a) says that- debtor collector cannot just charge a
fee
- Solution: May be able to put in the agreement that the borrower agrees to pay all fees associated with
the collection but that probably wont work here
- Should you tell Fiddle to stop
o Maybe- as a practical matter, enforcement here is sketch b/c it requires the average
person bouncing a check to know their rights
Problem 1.6 Mrs Cs law student that left her with 2,000 worth of damage in her apartment wants to
know what she can do. You as a new attorney send the tenant a letter saying that the outlining damages
are claimed and that you are demanding a quick resolution and will commence legal action if the
debtor does not pay. The tenant writes back charging you with violations of the FDCPA and agrees not
to prosecute if you agree to drop the charges.
- Step 1: Are you a debt collector under the statute?
o Lawyers are not categorically exempted if the business has a principal purpose of
collecting debt for others or does so frequently, the it counts as a debt collector
- Step 2: Are you really going to sue if the tenant does not pay
o Must have the requisite amount
- Step 3: Was the Amount of the Debt Correct
o Did we do any diligence to make sure that this is the amount that is actually owing
o If not then the statue could cause problems

B. State Law Debt Collection

i. Collection Remedies
Involuntary Lien- Judgment Lien
Step 1: When a creditor pursues collection through court system, the first step is
to establish in court that the debt is owed and the amount owing
We assume this has been done
Step 2: Execution of the Judgment
Receiving the judgment does not put money in the creditors pocket
The judgment creditor remains unsecured until the execution is obtained
on the judgment
After you receive a judgment, a writ is issued
After the writ is issues, the writ is given to the sheriff with order to look
for non-exempt property of the judgment creditor
o Exempt property = home or household goods
The sheriff will then seize any personal property it finds and levy it
o The sheriff is required take control of the property
In some jurisdictions the sheriff must take physical
possession or appoint a custodian
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In other jurisdictions it is not necessary that the sheriff

remove the goods
NOTE: See Credit Bureau of Broken Bow- sheriff
effect a valid levy when executed the lien on the
property but did not take possession
o NOTE: Notice to the sheriff of a prior lien
does not impure knowledge to the
subsequent judgment creditors
o When real property is levied, a recording is required with the
county clerk of the levy
o NOTE: There is no general levy- it applies on the assets in
question
Step Three: Judgment Lien Creditor Status
Upon successful levy the judgment creditor becomes a judgment lien
creditor
Step 4: Sale occurs
Typically an auction The proceeds are used to pay off the judgment creditor
NOTE: Turnover Orders
The judgment debt may be order to turn over the property he possess as
well as the property no matter who possess it subject to his control
o These statues have been used to get to intangible assets that
cannot be levied by the sheriff
Voluntary Lien
In a voluntary lien, the debtor agrees to give the creditor a lien on certain assets
in return of a loan or for goods
If the debtor does not repay the debt, the creditor is entitled to seize the assets
and sell them to repay the debt
Thus the debtor is giving the creditor a future self-help method
The process is heavily regulated in every state to protect the debtor
Step 1: Creation of the debt
o NOTE: not every debt is secured
Simply having a Promissory Note does not make a loan
secured
Step 2: Creation of the Lien
o For the debt to be secured, accompanying the Promissory note
must be another set of documents
In real estate those documents will be a deed of trust or a
mortgage
In Personal Property it will be a security agreement
o These documents identify the debt obligation as secured, the
property referred to is used to secure the debt
Step 3: Perfection of the Lien
o A party with an interest in the property must make their interest
known in the public record
For real property this is done by recording the interest
with the county clerk

For personal property the party that has the interest must
record the financing statement whit the secretary of states
office
This is the requirement under the UCC Article 9
which specifies different methods of perfection for
different types of property
NOTE: If more then one party has a lien on the property and priority is
not an issue- one will have a first lien and one will have a second lien
o The party with the first lien will get the proceeds from the sale up
to the amount of the debt and any surplus left over will go to the
party with the second lien
Issues of Priority
The rule is first in time = fist in right
Thus the first creditor to levy on a particular piece of property will have
the right to be paid in full from the sale proceeds of the property before
nay other creditor gets even a single dollar
However this may be difficult to determine
In a judgment lien- the lien attaches to property that the debtor acquires
even after the lien is recorded
As between two unsecured creditors
The first party to get a judgment and levy the judgment is the first party
to have priority on the property- assuming no other liens were before it
If the levy occurs on the same day to determine priority may
o Use the date of the writ to determine which party prevails
o Use the levy down to the nanosecond
o Call the levy simultaneous and prorate the proceeds
As between an unsecured creditor and a secured creditor
First perfection wins
To perfect, the secured creditor must only record
The unsecured must get the judgment and then get it levied
As between judgment creditors and secured creditor against the buyer
When a party buys a piece of property, if that property is encumbered the
encumbrance stays on the property
However, if the purchaser buys the property and records before the
judgment creditor or the secured creditors perfect, the purchaser will win
o Thus if A busy a car on Monday and records her ownership on
the certificate of tile, and B executes judgment and levies on
Tuesday, A wins
As between an unsecured judgment creditor or a secured party and the trustee in
bankruptcy
The TIB is the most dangerous foe of judgment creditors who have
levied or secured party with a consensual security interest
Judgment liens are routinely avoided in the bankruptcy, nullifying all the
diligence and expense in the execution process
Remember: A judgment creditor can record in the county records, and any
interest will attach to the debtors property as the debtor acquires the property
subsequent to the recording
In re Estate of Robbins

If two creditors enjoy equal priority under the usual rules, a taxing authority usually turns out to be
more equal then the other creditor and therefore takes priority
As between an executed judgment lien or secured creditor and a Purchase
Money Security Interest
o Under the UCC, Purchase money security interest secures an
obligation for the money borrowed to effect the sale as long as the
grantor of the PMM perfects within 20 day of effecting the sale the
seller takes priority
o Thus:
o M&P Bank a Security Interest in After Acquired Property and Bank
give M&P a loan
o M&P buy a drill press form HE- pays cash
Here, Bank would have a lien on the drill press b/c of the after
acquired property clause
o What if M&P bought it on credit and gave HE a Security Interest in the
drill press
Under the normal rule, whoever perfects first has priority
With an after acquired property clause you dont have to
perfect again if you did it when the loan was issued thus
the Bank would have priority
o HEs Security Interest would be worthless and
should not have sold on Credit
o Thus the UCC rule kicks in and the Seller on a
PMSI gets priority
This is a good result b/c:
HE gets the sale
ME gets a drill press
And Bank gets a second lien on
the drill press
Whereas if the sale did not happen the
bank would not have any lien b/c the
drill press would not have been bought
The Aging Judgment
o A judgment that has not been subject of enforcement efforts for a long
period faces disability in two ways- Dormancy and Limitations
o Dormancy- if the creditor fails to seek enforcement of a judgment for a
period of time, often a year, the judgment becomes dormant
The dormant judgment can be revived or avoided by regular
attempts to enforce the judgments even if unsuccessful
Limitations- After a longer period of time, usually ten years, the
judgment expires and cannot be revived
Weaver v. Weaver
Here the court held that since the Drs lien had sat for five years without any attempts to execute, the
lien expired and cannot be revived.
Problem 2.1: A, B and C all have judgment for 10k. A received his judgment on November 1st. B
received his judgment on Nov 10th, and delivered the writ of execution on November 15th. C received
his judgment on Nov 20th, had the writ delivered to the sheriff on November 22nd and on November
25th. The sale of all the appliance will only bring in 15k. What can you do? You represent B.
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C is the only party with a lien on the property. C will get full 10k and 5k will be left to the
debtor b/c no one else perfected.
o NOTE: In some states, once you levy the date of perfection may be backdated to the
date of the delivery of the writ or the date of the judgment
But since here no one else has perfected, no one else is even in line
NOTE CAREFULLY: Delivering a writ to the sheriff is not the same as
perfecting, you have to drag the sheriff to get the assets
Can you change the judgment?
o If the state allows relation back to the date of judgment or the date of delivery of the
writ then you can drag the sheriff to levy the assets (ceremonious act). Then A and B
would be better the C.
How could you change the outcome
o Since the sale has not happened you can perfect your lien and get a second lien on the
property if there is no relation back
o In addition, if you really want you can push the debtor into bankruptcy b/c in
bankruptcy none of the creditors get anything
Problem 2.2: There are five creditors to which SBC owes 5k to each. Our client, HK executed a writ
against the shoes in the store, but before the sheriff seized the shoes, HK agreed to enter into
negotiations in which each creditor would get monthly payments. The Debtor granted a lien to a bank,
perfected on 12/5 for 20k. HK predicts the sale of the shoes will yield 20k. HK want to know how the
proceeds will get distributed
All of the proceeds from the shoes will go to the bank UNLESS sheriffs announcing seizure
created good levy against the inventory
This may not work however
o The bank will argue that they had now way of knowing about the sheriffs execution
and levy thus they had no way to protect themselves
o Another way HK might lose is if HK allowed the inventory to stay with the debtor for
an unreasonable period, the creditor will lose their lien
How can the we protect HK
o Rather then participating in negotiations, negotiate a voluntary lien for your client when
the sheriff is there to seize the shoes
o HK should not have to give up that position of leverage
NOTE: B/c we are dealing with inventory here, the creditor will have an after
acquired security interest in the agreement with the debtor- every lien on
inventory has to have one
ii.
Fraudulent Conveyance
Two types of Fraudulent Conveyance Actions under the Uniform Fraudulent
Transfer Act (UFTA- page 238 in Code)
Actual Fraud
o A creditor can avoid a transfer made by the debtor with actual
intent to hinder delay or defraud the creditors
Constructive Fraud
o Fraud is construed as a matter of law with out any evidence as to
intent
o If fact constitute constructive fraud are shown, a presumption of
fraud is created but it is a rebuttal presumption
Actual Fraud- UFTA 4(a) and (b)
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Any transfer that is made with the actual intent to hinder the collection
by creditors
o 4(b) give you factors to consider when determining if actual
fraud was present- called badges of fraud
A claim of actual fraud is available to creditors who existed at the time of
the transfer and to those whose claims arose after
4(b)- Badges of Fraud
o These are just inferences to help the court determine if actual
fraud was evident
o 4(b) States- In determining actual intent under subsection (a)
(1), consideration may be given amount other factors, to whether
(1) The transfer or obligation was to an insider
(2) The debtor retained possession or control of the
property transferred after the transfer
(3) The transfer or obligation was disclosed or concealed
(4) Before the transfer was made or obligation was
incurred, the debtor had been sued or threatened with suit
(5)The transfer was of substantially all of the debtors
assets
(6)The debtor absconded
(7)The debtor removed or concealed assets
(8)The value of the consideration received by the debtor
was reasonably equivalent to the value of the asset
transferred or the amount of the obligation incurred
(9) The debtor was insolvent or became insolvent shortly
after the transfer was made or the obligation incurred
(10) The transfer occurred shortly before or shortly after a
substantial debt was incurred; and
(11) The debtor transferred the essential asset of the
business to the lienor who transferred the assets to an
insider in the business
ACLI Government Securities Inc v. Rhoades
Here the court found that the had engaged in a fraudulent transfer when the transferred property
held as tenants in common with his sister to his sister entirely days after a verdict was rendered against
him and days before a large judgment was rendered against him. The court looked at the close
relationship among the parties, the secrecy of the sale, the inadequacy of consideration, and the
transferors knowledge of the creditors claim and his own ability to pay it.
Constructive Fraud: UFTA 4(a)(2) and 5(a)
No showing of intent on the party of the transferor is required
o Relieve the borrower from proving actual fraud
It is available to both pre-transfer creditors and post-transfer creditors
o However, the pre-creditors ability to show Financial Shakiness
are broader then the post-creditors ability to show financially
shakiness
Two elements are required when showing constructive fraud
o (1) The transfer was for less the REV (debtor did not receive
REV)
o (2) The Debtor is Financially Shaky
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Determining REV
o The UFTA itself does not provide a formula for determining
whether value is reasonably equivalent
o The court will usually take into account the relationship of the
parties, the market environments, and the apparent motive for the
transfer
Determining Financially Shakiness Three ways ASK FIRST IF
THE CREDITOR IS A PRE-PETITION CREDITOR OR A POSTPETITION CREDITOR
o The debtor was involved in or was about to engage in a business
venture, and the transfer left the debtor with insufficient capital
for the project
Unreasonably small assets at the time of the transfer or
after
o The debtor incurred debt beyond her ability to pay either before
the transfer or after the transfer
o The debtor was insolvent at the time of the transfer or as a result
of the transfer
NOTE: The ability to prove financial shakiness through
proving insolvency is only available to pre-transfer
creditors
IT IS NOT AVAILABLE TO POST-TRANSFER
CREDITORS
o B/c they are bound to the debtor as they
found them
o Measuring Insolvency- 2 Ways
Balance Sheet Test Liabilities exceed assets at fair
value
Assets Property to the extent of exemption or
encumbrance
Cash Flow or Equity Test The debtor cannot pay debts
as they become due
REMEMBER: This option is only available to pretransfer creditors
o Undercapitalization or Intent to Incur Debts that Will not be Paid
Any creditor can rely on one of two other forms of
financial shakiness
The tests focus more on the relationship of the debtors
financial condition and intended future business activity
then on the traditional measure of financial precariousness
In broad terms, they allow the creditor to impugn a
transfer for inadequate value if it was reckless or
irresponsible in light of the debtors prospective
commercial dealings or if it would likely doom the
debtors planned venture to fairly certain failure.
NOTE: SOL for fraudulent transfers are usually tolled at the time of the
transfer and are usually 4-6 years
What Can a Creditor recover from the Transferee of a Fraudulent Transfer
o 8 provides the Defenses, Liabilities, and Protection of a Trasnferee
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To the extent that transfer is not voidable, the creditor cannot recover
NOTE: Under 8(a) a transfer is not voidable even if the transferor had an
actual intent to defraud if the transferee paid REV
To the extent that the transfer is voidable the creditor may recover
The judgment for the value of the assets transferred as adjusted by
subsection (c) or the amount necessary to satisfy the creditors claim
whichever is less
Under subsection (c)- The value of the asset transferred- The judgment must be
for an amount equal to the value of the assets at the time of the transfers, subject
to adjustment as the equities may require
However, under subsection (d)- even though a transfer is voidable, a good faith
transferee is entitled to the extent of any valued given to the debtor for the
transfer to a:
Lien on or a right to retain any interest in the asset transferred
Enforcement of any obligation incurred
Reduction in the amount of liability on the judgment
o NOTE: A transfer is not voidable under 4(a)(2) or 5 if the transfer results from
Termination of a lease upon default by the debtor when the termination is
pursuant to the lease and applicable law; or
Enforcement of the security interest in compliance with Article 9 of the UCC
o NOTE: A transfer is not voidable under 5(b)
To the extent that the insider gave new value to or for the benefit of the debtor
after the transfer was made, unless the new value was secured by a valid lien
(2) If it was made in the ordinary course of business or financial affairs of the
debtor
(3) If it was made pursuant to a good faith effort to rehabilitate the debtor and
the transfer secured present value given for that purpose as well as an antecedent
debt of the debtor
Under 5(b) transfer is fraudulent as to a creditor who arose before the transfer was made if
the transfer was made:
o To an insider
o For antecedent debt
o The debtor was insolvent at the time
o And the Insider had reasonable cause to believe that the debtor was insolvent

Leverage Buy Out- LBO

o LBO- is a transaction in which the purchase of shares or the purchase price of the
business is financed by the corporation itself or secured by the by the assets of the
corporation.
The expectation is that reimbursement of the corporation will come from the
future profits that the buyer that the buyer will make from the operation of the
corporations business
o One way to structure an LBO is for the corporation to allow the buyer to use its
unencumbered assets to secure the purchase price of the shares
o Ways this can be accomplished:
Seller may give the buyer creditor for the price of the shares and secures this
credit by having the corporation grant a security interest in its assets; or
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The corporation may borrow money secured by its assts, and then it may lend
this money to the buyer as an unsecured loan
The buyer may borrow money from a financial institution and the corporation
guarantees this debt using its assets to secure its guarantee
o Thus the risk of failure is on both the corporation and its unsecured creditors who have
lost the protection of the recourse on unencumbered assets
o LBO and Fraudulent Transfer Law
LBOs are not per se fraudulent but THEY ALL HAVE A CONSTRUCTIVE
FRUAD PROBLEM
The standard response to this argument is that the company is not getting
anything
The converse is that the company is getting new management and better
prospects for the future
o However, the creditors are harmed when the company gets
nothing b/c now the seller is secured by the assets of the
corporation that would have been used to pay the unsecured
However, if the corporation fails to pay the debts after an LBO, creditors may
look to fraudulent transfer law to avoid the transfer made by the corporation in
connection with the LBO
Thus the transfer to be avoided is the grant of the security interest.
To avoid the transfer, the creditor can use either actual or constructive fraud
When using constructive fraud- NOTE: it is not relevant that the owner
may have received REV for the transfer, the corporation- which is the
debtor- did not
In re Bay Plastics
Court held that LBO have two essential features: (1) The purchaser acquires the funds necessary for
the acquisition through borrowings secured directly or indirectly by the assets of the company being
acquired. (2) The lender provides funds is looking primarily to the future operating earnings of the
acquired company and/or the proceeds from future sales of the company rather then any assets of the
purchasers, to repay the borrowings used to effect the acquisition. Here the court HELD that it was
appropriate to apply fraudulent transfer law to the LBO b/c the corporation did not receive REV and
the company was insolvent (NOTE: This is a pre-transfer creditor so can use insolvency test)
Problem 4.1 AL is insovlent. She owes 50k to FF. However to make her rent payments and to buy
food AL decides to sell her grand piano. Piano is valued at 15k, AL runs ads for 10k, and it is
ultimately sold for 7.5k. Can FF successfully claim a fraudulent conveyance?
First we are dealing with constructive fraudulent transfer- 5 not actual fraudulent transfer b/c
on the facts there appears no intent to defraud FF by AL- none of the badges of fraud are
evident
To prove constructive fraud, FF would have to show that
o (1) AL did not receive REV for the transfer; and
o (2) That AL was financially shaky at the time of the transfer
Hereo The facts show that AL was financially shaky at the time b/c they specify that AL was
insolvent
Since FF is a pre-transfer creditor, it can use ALs insolvency to establish
financial shakiness- although if FF was a post-transfer creditor it would not be
able to prove financial shakiness by insolvency but would have to do it through
the other two means available- i.e. (1) That the debtor was undercapitalized
either before the transfer or as a result of the transfer or (2) that the debtor
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incurred debt beyond its ability to pay either before the transfer or as a result of
the transfer
o Thus the only remaining issue is if the transfer was for REV- what are the arguments
Here can say that we are dealing with an arms length purchaser, the facts do not
reveal a close connection between the transferor and the transferee
By allowing the fraudulent conveyance actions, we are allowing the creditor to
muck up the transaction
Here there is no bad intent- AL needed food
Problem 4.2: B is insolvent and fees like creditors are closing in. She sells her $75,000 coin collection
for 5,000 to her cousin b/c she wants to keep it in the family and she knows her cousin will sell it back
to her. After the transfer, she buys $25,000 in new furnishings on her AMEX card. Can MEX claim
fraudulent transfer?
Step 1: Will AMEX use actual fraud or constructive fraud.
o Actual Fraud:
Was this transaction made to hinder or delay creditors?
Possibly- look at the badges of fraud, do any exist
o Here- there was low consideration
o Transferred to an insider-family
o Knowledge that it will be sold back
o Incurred enormous amount of debt after the transfer
Maybe able to argue actual fraud
o Constructive Fraud:
First, Did B received REV?
No- the coin collection was worth 75,000 and she only received 5,000
Second, Was B Financially Shaky at the time?
Is AMEX a pre-transfer creditor or a post transfer creditor
AMEX is a pre-transfer creditor therefore he cannot use insolvency to
prove financial shakiness. Must use one of the other two forms
Was B undercapitalized
o We dont know, not enough information
Did B incur debt that she would be unable to pay either before the
transfer or as a result of the transfer
o Arguably yes, said that felt like creditors were closing in so
transferred coin collection then incurred a debt for 75k to AMEX
although it is not clear that B will not be able to pay it
Problem 4.3: This problem has to do with exemptions, when the UFTA does not consider something
an asset- thus it is exempted, the it is not subject to the Fraudulent Transfer law-A house is exempt and
therefore is not subject to the UFTA.
Problem 4.4: W is insolvent and owes 100,000 to L. He sells 60,000 mobile homes to S for 30,000. S
cleans it up, places 5,000 of repairs into it, and enhances its value by 20%. Can L win on fraudulent
transfer action and if so what can he recover from S?
Step One: Is it actual or constructive Fraudulent Transfer
o Not actual b/c there does not appear to be any intent by W to hinder his creditors- none
of the badges of fraud exist based on the facts
o Constructive Fraud: L must establish
W did not get REV; and
W was financially shaky
Step 2: REV
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o Here W arguably did not get REV. Sold the mobile home for half of what it was worth.
Sold it to his neighbor which is arguably evidence that was not for REV. If can prove
did not receive REV then go to step 3, if cannot then no fraudulent transfer action
Step 3: Was W financially shaky at the time of the transfer?
o Is L a pre-transfer or a post transfer creditor- Here L is a pre-transfer creditor so he can
use all three tests for establishing financially shakiness- insolvency, undercapitalization,
and incurred debts beyond his ability to pay
Here we know from the facts that W is insolvent and since L is a pre-transfer
creditor L can prove financial shakiness from this fact
o Thus L will be successful in a Fraudulent Transfer Action
Step 4: What can L recover from S
o Look at 8(d) of the UFTA
o Under (d)(1) S has a valid lien on the mobile home to the extent of the value he gave
for the transfer
Thus S has a valid lien on 30,000
o However, 8(d) does not cover the 5,000 in repairs the S put in to the mobile home b/c
that value was not given to the debtor
Under 8(c) there may be an argument that the equities require the S receive the
5,000
o However, is there any recourse for S for the appreciation of the mobile home by 20%
Again can argue that the equities require an adjustment under 8(c) but that is a
stretch
Problem 4.5: K lent money to PR to start a dry cleaning business. PR then sold the dry cleaning
business in a stock sale to RL. RL bought on a credit sale in which RL guaranteed payments to PR
secured by all of the companys assets.
Is this a leveraged buyout?
o Yes b/c the purchaser is borrowing on the equity of the corporation
Is there a fraudulent transfer problem with this deal
o There is a security interest on the corporation, and PR is the secured beneficiary of the
assets
Thus, RL is promising to PR that if he defaults on his payment in the credit sale,
all of the assets of the business are PRs
Thus it is the corporation that is promising to answer for the debts of the
buyer- PR will foreclose on the assets of the business if RL cannot pay
on his personal loan
o Is there constructive fraud Must be able to show:
A purchase was for less the REV; and
Debtor is financially shaky
Did the Company receive REV
Before the LBO, K is a creditor of the 100,000 and PR is the owner of
equity
After the LBO- PR leap frogs K but the company has not gotten anything
in return from the creditor and now has the equity of RL
o Thus the previous creditors are worse off b/c K lent her money to
the company and would look to the company for repayment
Was the company financially shaky?
13

Business is not insolvent but they are having problems paying debts as
they become due which is a presumption of insolvency
o Since the creditor here K, is a pre-transfer creditor, she can use
this to prove financial shakiness
o NOTE HERE: If Ks loan is not in default, does that affect her ability to get UFTA
relief?
NO- b/c a creditor is just a party that has a claim right to payment whether or
not it is in default
However, if she is getting paid she is unlikely to bring a claim
Problem 4.6: Are donations to charities subject to fraudulent transfer voids
If you are a church and you are being sued to cough up donation made by insolvent
practitioners, what would you argue
o Argue the practitioners get REV- Practitioners have received all the benefits of being
party of the church such as services of the pastor and bible study
NOTE: If the contributions were voluntary in terms of amount and time, it is
difficult to argue REV b/c there the person that does not give donations at all
still gets the same benefits.
II.
Consumer Bankruptcy
A. Introduction
o Puts a federal overlay on the entire state collection process
In the state collection process it is about the race to the assets for creditors
But in Bankruptcy that problem is solved by acting as a groups which results in
a higher return for all creditors then when the act individually
o Also provides for a work out for debtors
Under a workout creditors will do better
In state law there is not coordinated effort to try to help the business
work
o Bankruptcy Courts
Division of the federal district court- have 14 year terms
o Bankruptcy court has jurisdiction over all the assets of the debtor, no matter where they
are and impose disclosure requirements that state laws do no
o Bankruptcy discharges all the debts and give the debtor a fresh start
o Objectives of Bankruptcy:
Giving the debtor a fresh start
Equal Treatment of Creditors
o Organizing the Business World:
Consumer Bankruptcy v. Business Bankruptcy
Consumer bankruptcy primarily focuses on the debtor and the fresh start
o It is a high value form business
o Usually no asset bankruptcies
Business Bankruptcy there is more focus on the debtors rights and the
creditors rights
o Its is more of an ongoing multi-layered negotiations between the
debtor and its creditors
Sell Out v. Pay Out
Chapter 7: Sell Out
o This is called balance sheet bankruptcy
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o The trustee gathers all of the debtors assets that are owned on the
day of petition is filed, sells them, and uses the proceeds to pay
the creditors
o All debts are discharged after bankruptcy get a fresh start
o Creditors are paid from the proceeds of the sale of assets on a
pro-rate basis
Chap 11, 12, 13: Pay out
o Also called income statement bankruptcy
o Generally the individuals and businesses debtors get to keep the
assets but have to come up with a payment plan to pay the
creditors
Business comes up with a plan of reorganization
Not every creditor will be paid 100 cents on the dollar, but
each will get some payments
o Chap 11 is for business
o Chap 12 is payout scheme for family farmers
o Chap 13 is consumer
B. Elements Common to Consumer Bankruptcy The Bankruptcy Estate
To begin bankruptcy the debtor files a petition
o No matter what kind of bankruptcy you file- the following things will happen
when you file the petition
An estate is created 541
Automatic stay is put in place- 362
o Debtor must fill out a schedule which lists important financial information and
discloses property that is owned
o Petition is filed with the bankruptcy clerks office who takes the fee- $220 and
date stamps the petition by minute, hour and day
The Creation of the Estate 541
o The estate consists of all legal and equitable interest in the property previously
owned by the pre-bankrupt debtor
At the instant of the bankruptcy petition all property owned by the debtor
becomes property of the estate
o What is considered part of the estate is found in 541 and is deliberately
expansive with exceptions set out in the Code
541(b) contains the exceptions
o Under 541(a)(6) the proceeds, product, offspring, rents and profits of or from
the property of the estate except such as are earnings from services performed
by an individual debtor after the commencement of the case
This is one of the most important exceptions b/c it requires the court to
determine what is considered part of the activities of the debtor prior to
filing and what monies are earned after the filing and therefore part of
the fresh start
Any wages, commission, and the like earned after the petition is
filed are not property of the estate and do not have to be
surrendered to the creditors but instead become part of the fresh
start
NOTE: Under 541(c)(1)- Property of the debtor becomes property of
the estate notwithstanding any provision
15

That restricts the condition of transfer or such interest of the

debtor
Is conditioned by insolvency or the financial condition of the
debtor or the commencement of bankruptcy
However Under 541(c)(2) Any property with an enforceable
spendthrift provision is enforceable at bankruptcy
o Conceptually, disputes about the inclusion of certain expectances in property of
the estate under 541 can be divided into three main categories
(1) Legal interests that are not enforceable as of the date of petition but
may become enforceable at some future time- Sharp
Ask, whether they sufficiently matured and are certain- then
included in estate
Ask, whether some value of the payments might arise from
personal services performed by the debtor after bankruptcy
(2)Certain entitlements such as permits or licenses that are nontransferable- In re Burgress
Drivers license legal right of no value to anyone but the debtornot property; license to practice law
Taxicab license, liquor license, license to operate a brotheltechnically non-transferable but sold all the time-maybe property
of estate
(3)The problem of restrictions on transferability imposed by contract law
In re Orkin
Debtor clearly owns valuable property but the debtor may have
no legal right to transfer the property or can only transfer in
restricted circumstances
Congress allow few specific restrictions on alienation to be
effective to keep property out of the bankruptcy estate
o One is spendthrift trusts 541(c)(2)- allows debtors to
keep ERISA approved retirement accounts out of
bankruptcy estate
o Another is money set aside for children or grandchildren
for their education
Sharp v. Dery
ISSUE: Should the post-petition bonus be considered property of the estate for the purpose of the
bankruptcy proceedings. Court HELD that the post-petition bonus should not be considered part of the
property of the estate but should be allocated to the fresh start. Court came to this holding by rejecting
the argument that just b/c it is a bonus for some work pre-filing (sufficiently rooted in pre-petition
activities). Instead held that b/c the debtor had to be working for the company the date of the bonus,
the debtor had to be in good standing (i.e. satisfactorily performed job) and the payment of the bonus
was at the employers discretion, the debtor should be able to keep the bonus as part of their fresh start.
In re Burgress
Issues: Is the license to operate the brother property for the purpose of the estate of the debtor. Court
HELD that the license to operate a legal brothel in Nevada is a license that has value and should be
considered part of the estate- it is like a liquor license not like a license to practice law.
In re Orkin
Issue: is the debtors pension plan exempt from inclusion in his estate through federal law or state law.
The pension plan is not exempt through state law b/c it is not an ERISA qualified plan b/c cannot be
ERISA qualified plan when the employer is functioning as the employee under the plan. Does not
16

qualify under state spendthrift law b/c the debtor has absolute authority over the trust and can terminate
it and revert the funds back to him anytime he wants. Thus it is part of the estate.
Appointment of the Trustee
o Usually a local lawyer
o Charged with the responsibility of
Gathering the debtors property
Protect and maintain it
Sell the property for the highest possible price
Distribute proceeds to creditors according to statutory priorities
Scrutinize claims challenge any that are overblown
Challenge any improper exemption claims
o NOTE: The TIB has special obligation to unsecured general creditors thus most
police the debtors activities
o NOTE: Do not TIB with the US Trustee (UST) who monitors the bankruptcy
courts
Problems 5.1: We are trying to determine which assets are part of the estate- must determine which of
the assets are part of the pre-bankruptcy life and which are part of the post-bankruptcy life and are
therefore part of the fresh start.
Step 1: Which items are not part of the estate
o Retirement Account- There are two aspects of the retirement account:
o (1) The Account Itself
This covers all the money sitting in the account right now
The restriction on alienability are not enforceable in bankruptcy
we know this from 541(c)
However, under 541(c)(2) if there is restriction on alienation for
the trust- a spendthrift provision- under (c)(2) this provision is
enforceable in bankruptcy as well
So we protect the account based on its (c)(2)
NOTE: The rationale for protection the retirement fund
o Go to the idea of the fresh start
o Estate cannot get interest that the debtor cannot get at the
time of the filing
o (2) The Contribution
Contribution is not part of the estate through 541(b)(7)
o Ford Taurus
Under the definition of property, the car will belong to the estate
However, b/c the debt on the car exceeds the value of the car leaving
the car with no value- the trustee will leave it out of the estate ultimately
NOTE: Before the TIB lets it go the TIB will want to make sure
that the car does not have some equity that the debtor is not
claiming
o Parakeet The parakeet will be part of the propertyo The offspring of the parakeet
(a)(6) says they too will be property of the estate- says that offspring of
pets owned before the petition are part of the estate
If the mother is part of the estate then the offspring are part of the
estate
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o Monumental Inc
The dividends are pat of the estate under 541(a)(6) b/c the proceeds of
property already in the estate are part of the estate
Like the eggs of the parakeet
o Salary
Wages from work done before filing would be part of the estate but the
work done after the petition would not be part of the estate
NOTE: The timing of the payment is irrelevant, it is dependent
on the work done
o All the other worthless items
All become part of the estate b/c 541 gives a broad reach of what is
counted
NOTE: Anything that is valueless to the estate will be abandoned,
but the trustee must have the opportunity to eyeball everything
Problem 5.2: The debtor buys a lottery ticket on 1/5. On 1/20 he files bankruptcy and on 2/1. Who
gets the proceeds of the lottery?
The fact that the lottery is only a contingent expectation does not change the fact that it is
property of the estate
The ticket is part of the estate and anything that comes out of it will go to the estate
Problem 5.3: On March 1st local farmer, FA contracted to seller her wheat crop of 10,000 bushels to a
local grain warehouse at the prevailing price on May 1. FA files bankruptcy on April 1st at which time
the wheat is immature and has no value. Price of wheat on March first was $10 bushel. B/c of draught
the price rose to $15 on April 1st and to $20 on May 1st when it was harvested. Buyer pays $200,000who gets it?
Step 1: Is the wheat part of the estate?
o Yes the wheat is part of the estate
Step 2: Is the contract part of the estate
o Yes the contract is part of the estate
Step 3: Who should get what from the appreciation in value?
o One suggestion is to apportion the wheat b/c the debtor worked post-petition to bring
the wheat to market- could have stopped and the wheat would have had no value
o But if FA stopped the trustee would just hire someone else to do the work and then
would pay for the laborer for the time she cultivated the land- the value of her
contribution as fungible labor can be calculated and paid
o So the same should apply to the debtor- All of the 200k should go to the estate and the
trustee must pay the debtor for cultivating the wheat after the petition
The wages received by FA will go to the fresh start b/c they were for work done
post-filing
NOTE: Even if the wheat declined in value, FA would still get paid the price of labor as she did
when price went up
o Her wages are an administrative priority
Problem 5.4: Here we have an unconventional debtor, he has a trust fund but he is currently broke. He
is receiving $1000 a month in income from the trust but will not get the $250,000 trust until his mother
dies. What should he do?
Step One: Identify the parts of the trust
o Corpus
o Right to Future Income
o Income already received
18

Step 2: Is the corpus part of the estate

o It is part of the estate b/c it is an interest that the debtor owns
o Do any exceptions apply to the corpus?
Under 541(c)(2) there is a spendthrift provision thus it is not transferable
under state law thus it does not become part of the estate
Step 3: Is the future income part of the estate
o It is part of the estate like the corpus
o But like the corpus it is exempted by (c)(2) thus stays out of the estate
Step 4: Income Received
o This is part of the estate
o There are no restrictions on it relating to the trust b/c already outside the trust so it is in
Step 5: What do we recommend:
o If the debtor waits and his mother dies, the money will become part of the estate
o Thus we probably would recommend that he file before she dies so the money will be
used as part of the fresh start
However, under 541(a)(5) anything the debtor receives 180 days after from
inheritance or as a beneficiary that would have been part of the estate at the date
of filing becomes part of the estate
Thus- both the corpus and the future income could be part of the estate if the
debtor files today and his mother dies within 180 days.
Advice is to file today and hope that mother does not die until outside the 180
day window.
Problem 5.5 Here the debtor owns and operates a liquor store, thus having a liquor license. He files
bankruptcy and we want to know if debtors TIB can make a claim for the liquor license even though it
is nontransferable. However, even though expressly non-transferable the state will usually issue a new
license to the purchaser of an already existing liquor store, however without purchasing the liquor
store, it is very difficult to get a new license since the state wants to limit the number of liquor stores.
Step 1: Is the License part of the estate
o Yes the liquor license is part of the estate. The case distinguishes between license like a
license to practice law and liquor license. This is the type of license is type that is
transferable to the estate
Step 2: Why would the TIB want the license
o The TIB wants to maximize the value of the estate and selling a liquor store without a
license is not going to be very profitable
NOTE: In the case of Drivers license and liquor license the answer of whether the license is
part of the estate is easy- No in the former yes in the latter
o But things such as Airport landing spots, FCC license are trickier b/c there the party that
granted the license may care more about the identify of the licensee
C. Liquidation Bankruptcy
i. The Automatic Stay
Found in 362
o 362(a) Details the prohibitions of the stay
o 362(b) Provides Exceptions that permit certain types of action
against the debtor to continue
It is triggered at the moment of filing a petition for bankruptcy and applies in
both Chap 11 and Chap 7
19

o It prohibits any creditors attempt to continue to collect from the debtor

or the debtors property
o Allows the court to gather the assets and precludes any individual
action against the debtors estate
The power of the automatic stay is very broado See Andrews University
The creditors can requires relief from stay which will be granted by the
bankruptcy court if the creditor can prove that it deserves adequate protection
Under the 2005 Amendments, 342(e) and (g) were added to respond to
creditors claim that they did not have notice of the automatic stay
o Under 342(e) creditors are authorized to file a notice of address
with the court where all notices of Chap 7 and Chap 13 cases must be
sent
o In addition, under 342(g)(1) notice sent somewhere other then the
address specified will be ineffective until the notice has been brought
to the attention of the creditor
Automatic Stay does a couple of things
o Give the debtor breathing room
o Facilitates equal treatment
It puts a stop to all state law collection efforts
Any action taken after the stay gets unwound as a result
of the stay
Enables the trustee to get a handle on what the assets of the
estate are
Andrews University v. Merchant
Issue: Were the actions of the University in refusing to issue a transcript to the a violation of the
automatic stay when the student loans are not dischargeable? Court HELD that the actions by the
violate the automatic stay. Court HELD that even though the loan is not dischargeable, the student
loan is not exempted from the things in which the automatic stay applies to. Thus the is liable for a
violation of the automatic stay
Nissan Motor Acceptance v. Baker
The is liable for a violation for the automatic stay when they repossessed the truck, and upon
finding out about the bankruptcy filings refusing to give the truck back to the debtor. Even though the
court eventually lifted the stay as to the , the had already sold the truck and thus were still liable
for its earlier violation.
Preliminary Procedures
o Before a debtor can file for bankruptcy the debtor must file various
detailed forms called schedules
Must list their debts, income, expenses, list their creditors
with addresses and identify any property they expect to
exempt
Must also produce a certification that they have attended
credit counseling
In addition they must include pay stubs for the past two
weeks, a statement of monthly income, tax returns
o The attorney must sing the debtors petition representing that the
attorney has performed reasonable investigation and has no
knowledge that the information on the schedules is incorrect
20

Problem 6.1: JW makes about 34k in income and has about 68k in debt. Currently his wages are being
garnished by an action of the finance company. He has been trying to make small payments to each
creditor to try to appease them but he wrote the car loan lender a bad check for the balance due on the
loan and now has a criminal charge pending. His landlord is threatening to evict him and the utility
company is threatening to turn off his utilities. JW comes with the paper work for filing Chap7. He
wants to know what he can expect in the next couple weeks. What is the effect of the Automatic Stay?
What will the effect of the Automatic Stay be on his paycheck?
o The garnishment will cease immediately, so his paycheck tomorrow will be cut for the
full amount 362(a)
Automatic stay dictates that garnishment ends b/c all collection efforts of the
individual creditors is stopped
o Although the check will be cut for the full amount, the entire pay check will go to the
estate b/cit it is for work that he did pre-bankruptcy filing.
Future Pay Checks
o His future pay checks will be for the full amount- no garnishment and they will go to
him b/c they will be fore work done after the bankruptcy filing.
What about the collection efforts against Joe?
o Most will have to stop but a few can continue
o The Stay is not Applicable to:
Alimony or Support Obligations- 362(b)(2)(C)
Criminal Prosecution- 362(b)(1)
NOTE: Some courts have held that the automatic stay will prohibit the
debtor from testifying b/c this is just another way for the creditor to get a
check
Landlord may be able to evict
A landlord that has a judgment for eviction already can carry out his
eviction- 362(b)(22)
A landlord that can certify endangerment or using of illegal substances
have the ability to evict under 362(b)(23)
o Utility Company=
Under 366, the utility company cannot do anything for 20 days
They have a partial exception to the stay b/c the utility company can
demand a deposit or an assurance of payment
Problem 6.2: PS has found out that tomorrow her house is going to be foreclosed on. She wants to
know what she can do to stop it. She fills out the schedules in your conference room but did not bring
her pay check stubs, tax returns, or any other paper work required. She lives an hour away and does
not know where all the paper work is. What can we do for her today.
2005 Amendments come into play here
She needs the automatic stay from the foreclosure so wants to file today
However after the amendments it is risky
o There are now a laundry list of things that the debtor must file with the petition.
Pay stubs, tax returns, and notice (notice that the debtor received credit
counseling)
o If the debtor cannot get the back up documents right now, there is more risk for the
lawyer
Under 526 the law is on the hook for any false statements in the debtors
filings
21

There is now a standard of reasonable care on the part of the debt relief
agency (includes lawyers)
Lawyers must make some amount of investigation to make sure that
there where no untrue statements in eth debtors filings
As for the value of the car- you may want to go out and look at it
Balances all of this with the fact that if we dont file she will lose her house
o There is a little leeway to work with
Have 45 days after filing to provide the schedules
Not a much leeway for the credit counseling- but could argue that you provided
credit counseling
Definition of credit counseling is debatable
Problem 6.3: Neighbor asks you for some advice. He sold his car to RR, taking back a PN secured by
car and properly perfected. Also had an agreement covering things like maintenance of insurance until
full price is paid. RR occasional let payment slip and once let insurance lapse. Neighbor kept keys
and repossessed the car at that time. When RR reinstated insurance, neighbor gave it back. But RR let
insurance slip again, and neighbor reposed. Just received notice that RR is in bankruptcy and TIB
demanded that neighbor return the car. Neighbor wants to politely tell him for payment and
reinstatement of the insurance but does not want legal problems.
The fact that the creditor reposed does not mean that the debtor does not own it- the property is
still part of the estate.
o Once the automatic stay kicks in the creditor must give the property back
How do we tell that have to give it back?
o When secured creditor on personal or real property repossess in the face of a voluntary
security agreement given at the time of the loan self-help is afforded to the creditor
o However, even with this self-held remedy, the process is heavily regulated
Mere repossession transfer of ownership
Must have transfer of title
o When does the debtors ownership interest expire?
Question of state law
There are a number of hurdles that the creditor must get through before the
property is the creditors.
Until these things have been done the property is still the debtors.
Problem 6.4: CA was having financial difficulty, filed Chap 13 but had formed a good plan. However,
last night the bank came in to the debtors chiropractic practice and took all of her equipment. You
contact the loan officer and they say that they knew about the plan and did not like it. You go back at
him with violations of the automatic stay and he simply says that the banks official place and person
of notice did not hear anything from you.
Under 342(e) the creditor is permitted to specify certain people or department for notice
o This requirement puts the burden on the debtor to deliver this notice that there has been
a bankruptcy filing
o The provision protects the creditor if they did not get notice and are acting despite the
stay
Under 342(g) notice sent anyplace else will not be effect therefore monetary penalties of state
violations are not available
o On the one hand this makes sense- should not impute notice to CitiBank simply b/c a
branch office in Cheektowaga received notice
o On the other hand the creditors are being insulated from monetary sanctions just b/c
notice hasnt been delivered to the right person
22

This is a bold move by the creditor however you PROBABLY dont want to go in front of the
judge to explain this
o There is still some ambiguity in the statute
342(g)(2) suggests that knowledge is not necessarily enough- must have notice
ii.
Claims and Disbursements
Introduction:
State law collection can take two years
But bankruptcy makes it simpler
o The debtor files schedules of assets and liabilities
o Creditors must file a proof of claim 501
Proof of claim = one sheet form
As long as it is filed the claim is allowed unless someone
objects
NOTE: In chap 7- no objection process, claims are
just allowed
Claim Allowance v. Claim Distribution
Claim Allowance = the legal recognition of the dollar amount of the
claim
o This is almost never the amount that the creditor gets paid
Claim Distribution = the amount of the claim that gets distributed
o May be just cents on the dollar
Once proof of claim is filed, the claim then must be calculated
For all pre-petition claims- secured and unsecured- you begin with 502
for calculation
Unsecured Claims
Unsecured creditors can receive pre-petition interest however Under 502(b)(2) an unsecured creditor is denied the opportunity to
collect any interest on its unsecured claim after the filing and while the
bankruptcy is pending
o The interest is unmatured
NOTE: If the interest is lump sum, the court must
determine which part is matured and which part is
unmatured
Under 506 attorneys fees incurred prior to filing of the bankruptcy
petition are treated the same as pre-petition interest
o Thus unsecured creditors are entitled to pre-petition attorneys
fees
The case law is unclear on whether the unsecured creditors are permitted
to received post-petition fees
o The argument is supported by the fact that there is not express
prohibition by the drafters of the code for unsecured creditors to
post-petition fees as there are for post-petition interest
However this argument can be countered by the argument
that the prohibition of 502(b) covers attorneys fees and
by the fact that Congress knew how to grant post-petition
attorneys fees as it did so for oversecured creditors and
thus did not intend to give them to unsecured creditors

23

o Courts have been reluctant to grant post-petition attorneys fees

to unsecured creditors- stating that the right of the unsecured
creditor to post-petition attorneys fees are allowed to the extent
applicable under state law and generally post-petition attorneys
fees are generally not so allowed
Secured Claims
Even when a creditor has a secured claim, the first part of the calculation
remains the same- the creditor can show it is owed pre-bankruptcy
through calculation of 502 claim and the TIB can raise any contract
defenses
o Thus first do the secured creditors claim calculation as if it was
unsecured
However, a different treatment is afforded to creditors with valid security
interest then what is given to unsecured creditors
o 502(b) governs the permissible nature and extent of an allowed
pre-petition claim
o 506 sets fort the special post-petition and collection rights of
secured creditors
506 grants a secured creditor an allowed secured claim up to the value
of its collateral
o A creditor is fully secured when the value of its claim is equal to
or less then the value of the collateral
o If the claim is greater then the value of the collateral, the claim is
partially secured and the remaining portion of the initial claim
continues as an unsecured claim
Secured creditor is entitled to pre-petition interest just like the unsecured
creditor, however, the secured creditor may be able to get post-petition
interest under 506(b)
o NOTE: The only time a creditor can receive post-petition interest
is when the creditor is OVER SECURED- that is the collateral
exceeds the pre-bankruptcy debt (including the pre-bankruptcy
interest)
The creditor can receive post-petition interest at the
contract rate, until the value of the collateral is exhausted
506(b)
Secured creditor can also receive attorneys fees that they are entitled to
(either by state law or contract law) for pre-petition work
o Over secured creditors can also collect fees incurred post-petition
Exemptions:
Unavoidable consensual security interests trump exemption claims
o The debtor may claim only an exemption in the equity- the value
remaining after the secured creditor has been paid in full
Post-Petition Claims
Example- Suppose the TIB decides to paint some of the furniture before
selling it and bought the paint at Sears on credit
o Sears would have a claim, but it would be post-petition claim
o Sears claim would be made under 503- expenses of the
administration
Not under 502
24

o The reason Sears claim is made under 503 is b/c these are
administrative claims with a first priority in payment- 507(a)
(1)-(2)
Problem 10.1: CZ lost her job a month ago and filed Chap 7. One creditor claimed $3,000 plus (a)
$200 in past due interest accrued prior to bankruptcy; and (b) another $100 in interest accrued since
the bankruptcy began. Creditor has no security interest in any of CZs property. What is the amount
the creditor is owed?
Creditor is an unsecured creditor- so only entitled to the amount of his claim plus any prepetition interest accrued
o He is not entitled to any post-petition interest
So he has a claim for 3,000 + 200 in accrued interest.
o He does not have a claim for the 3,000 + 200 + 100
Problem 10.2: CX only has 2 non-exempt assets- Car worth $10,000 and 1,000 shares of MircoStock
for $15,000. At the time of the filing she owned the bank $8,000 principal, the bank had a valid and
enforceable security interest in the care. The bank claimed (a) past-due interest that accrued prior to
bankruptcy worth $500, (b) interest since bankruptcy was filed of $400, and (c) attorneys fees of
$1000 expended trying to collect. What is the amount of the banks secured claim in bankruptcy
Start by assuming the bank had no collateral (was unsecured) the banks claim would look like
this- $8,000 in principal + $500 in pre-petition interest + $1000 in attorneys fees trying to
collect (pre-petition)= $9,500.
o Under 502(b) if the creditor is without collateral, no post-petition fees and interest
Bank is secured for the amount of the car b/c that is what they had a security interest in- thus it
is secured by collateral worth $10,000.
Thus the Bank is oversecuredo 506(b) says the bank can collect for the amount of the debt up to the amount they are
secured
o Thus here, they can collect the full amount they show owing - $8,000 in principal +
$400 in pre-petition interest + $1000 in pre-petition attorneys fees + $500 in postpetition interest
The post petition fees are accruable against the collateral, thus if they accrue
another $100 in fees they can probably get that too
Problem 10.3: What if the car turns out to be only worth $5000- what then?
Again, start by calculating the creditors claim as if they did not have a security interest
o Thus bank claim would look like this $8,000 in principal + $500 in pre-petition interest
+ $1000 in attorneys fees trying to collect (pre-petition)= $9,500.
Then go to the amount of the security interest- which is now $5000
o So now the bank is unsecured so we will have to bifurcate the claim into a secured and a
secured portion 506(a)
The secured portion is $5000
Thus the benefits of 506(b) disappear no post-petition interest or
attorneys fees 502(b)(2)
The amount of the unsecured claim or the deficiency is $3,500 + any other prepetition fees
Problem 10.4: Ten other creditors of CZ are owed a total of $20,000, but none of them are claiming
any interest. If you were appointed TIB in CZs bankruptcy and collected $5,000 for the car and
$15,000 for the stock how should you distribute the money?
First have to pay the secured creditor the amount of their secured claim
o Here, the bank is secured only by the $5000 in the car.
25

o The remaining claim by the bank- the deficiency or unsecured portion is $4,500 and
must be added to the other General Unsecured Creditors
NOTE: The Bank loses on the $100 in post-petition interest
o The total GUC is $27,700 (the $20,000 of this problem + $4500 from the bank + 3,200)
o The remaining assets we have collected reap $15,000o Divided 15,000/27,700 = 54.2% payout (this is the pro-rata payout)
iii.
Priorities Among Unsecured Creditors
After the secured creditors have been satisfied by the sale of their collateral, the
unsecured creditors begin the process of dividing the remaining assets
The undersecured creditors, to the extent that the sale of the collateral did not
satisfy their allowed claims also join in the process
507 determines the order and the amount of the payout to unsecured creditors
The unsecured creditors find that equity is equality is not strictly the
rule
NOTE CAREFULLY: Non-dischargeable debt that is not given priority or given
payment will still be due after the bankruptcy
Thus anything that is non-dischargeable the debtor will argue is a priority
and should get paid
o Why would the debtor do this?
B/c all non-dischargeable debt that is not paid (usually if
it is not a priority it is not paid) will be allocated to money
that he still has to pay in his fresh start
He wants to limit the money coming out of his fresh start
so he will argue they are priority
523 covers what is non-dischargeable
o Specifically- taxes are non-dischargeable
o Domestic support obligation and all obligations coming out of
divorce settlements are non-dischargable
NOTE: The debtor therefore has an incentive to argue that
any payment made to a spouse is a support obligation b/c
that is given priority in 507
Divorce Settlements such as property settlement or
division of debt are not included in domestic support
obligation and thus are not given priority
o Claims of death or personal injury resulting from the operation of
a motor vehicle or vessel if such operation was unlawful b/c the
debtor was intoxicated from using alcohol, a drug, or another
substances are non-dischargeable
**REMEMBER: The more generous you are with one group the more another group is
giving up**
Problem 11: Remember where we are: (1) All credits claims are stayed, (2) secured creditors have
clams to their collateral (3)as to the remaining debt that may still remain after the collateral is taken
they are lumped in with the general unsecured creditors (4) go to 507 which describes who get paid
first. The problem- who the creditors, what are the claims worth, and in what order will they be paid
Who are the creditors and what are their claims worth and where do they fall in 507
John Harry Nurse claiming $11,000- If the filing is within 180 days of when these wages
become due it has a priority claim of $10,000- - 507(a)(4)
o The excess $1000 becomes a general creditor claim
o Rational for Make Wages a Priority
26

The normal trade creditor is in a position to be able to diversify their risk

However, employees are not in such a position- they are relying on the
employer for the wages and this priority status is a recognition of that for the
employee
But why the cap?
Code is trying to distinguish between those people that need the money
and those that do not- reduce the amount of priority for employees paid
more
Why the 6 mth limit?
If you are an employee and you dont get paid your wages in a short
time you will find another job.
If you have stuck around for that long you have agreed to take the
creditor positions and may not need the money as much as a person that
cannot get paid for 5-6 months
o NOTE: There is a change that JH will be seen as an independent contractor in which
case his priority would be lost
Social Security Administration- $534- 507(a)(8)(C)
o Social Security taxes are two types- employees an employers Here HS was acting as an employer and he neglected to withhold from the
employee JH what the employee was suppose to pay
(a)(8)(C) v. (a)(8)(D)
o (a)(8)(C): Covers the employer contribution- HS was the one
that was suppose to hold this back, if you fail to withhold and
paid it to the employee- you as the employer are still liable
o (a)(8)(D): Covers the employer independent liability to make
contribution which is an employment tax- it is paid out of the
employers own pocket
The employer is not failing to withhold what the
employee was suppose to pay
Why are Social Security Taxes given a priority?
o In the aggregate, to the extent that government tax collections
are getting short changed the effect can be staggering
o In addition, the social security tax is being used to pay existing
beneficiaries now and if there is a huge hit every year it would
be a tremendous impact to the people on it
NOTE: In most bankruptcy cases are non-asset cases so by and large
even if you are a priority claim you are not getting anything
City of Eden property taxes, $3000 per year for the last three years, plus $500 per year
penalties for each of the three years
o Property taxes are under (a)(8)(B)- Two separate requirements
o Property taxes are a priority if:
(1) It was incurred before the petition date; and
(2) Last payable without penalty after one year before petition
If the bank filed on 1/1/06, the property tax to have priority must be
payable without penalty on 1/1/05
o Hypo- make this in a time line it is easier to see
2004
5/04- Tax 1 is accessed

27

2005

2006

9/31/05: Tax 1: Last Payable without Penalty -LPWOP

3/1/05- One year before the petition date
5/05- Tax 2 is accessed
9/31/05- Tax 2- LPWOP

3/1/06: Petition Date

5/06: Tax 3 is accessed
9/31/06: Tax 3 LPWOP
o **The highlighted portion is the period in which falls in the
second requirement for (a)(8)(C)
Step 1: Are there any taxes that are cut off by requirement one:
Yes- Tax 3 b/c it was incurred after the petition date
No others
Step 2: Are there any taxes that are cut off by requirement two
Yes- Tax 1 b/c it became LPWOP outside the one year window
No others
Result
Tax 2 will keep its priority status
Tax 1 and Tax 3 will both lose priority status and go with the General
Unsecured Creditor claim
Step 3: How do we deal with the penalty
(a)(8)(G)- A penalty will only receive priority if it represents a
compensation for actual loss
o City here would have to prove that the penalty was an actual
pecuniary loss so the chances are pretty good that the fees will
not be priorities
NOTE: When subsection refers to a paragraph (such as
(a)(8)(G) it is referring to all of the section
So in our hype if there were penalties on these
taxes, the only one that would get a penalty
accessed would be Tax 2 b/c it is the one that falls
in the section to be payable in this section
o If it is found to be a pecuniary loss then it
will be paid
o But if it is not a pecuniary loss then it
comes under 726(a)(4) so that it gets
subordinated so that it gets paid after the
general unsecured creditors
George Nartowski, down payment against a tractor lawnmower HS agreed to sell to George:
$300
o Generic priority for consumer deposits 507(a)(7)
Covers things like security deposits for landlord- if landlord goes into
bankruptcy you get it back up to $2,225
It protects the little people priorities
Also covers lay away payments for department stores
State Department of Revenue and IRS, income taxes: State $4000 and federal $14,000
28

o Again under (a)(8)(A)- A tax measured by income or gross receipts for a taxable year
ending on or before the date of the filing of the petition- (then have three ways to make
determination: NOTE (i), (ii) and (iii) are disjunctive
o Here we are concerned with (a)(8)(i)- for which a return, if required is required, is last
due, including extensions, after three years before the date of filing of the petition
Again we have two requirements for (a)(8)(A) priority
Tax year has to end before the filing of the petition date; and
Return must be last due after 3 years before P
o Hypo: We have three taxes and the party being taxed filed bankruptcy- which if the
taxes survive? NOTE Do as a timeline- easier to see
o 2002:
12/02: Tax year 1: End of tax year (ETY)
o 2003
3/1/03- P- 3 years
4/15/03: Tax 1- Return last due (RLD)
o 2004
12//04: Tax 2: ETY
o 2005
4/15/05- Tax 2: RLD
12/05- Tax 3: EYT
o 2006
3/106: P date
4/15/06: Tax 3: RLD
**Highlighted part represents the time period of the three years before filing P
in which the return must last be due to qualify for the priority
o Under requirement 1 do any of the taxes lose their priority?
No- All the tax years ended before the filing of the petition
o Under requirement 2 do any of the taxes lose their priority
No- All the taxes return must be due after the date three years prior to filing
(3/1/03)
o Rationale for the for the back end requirement- that it must be for a tax year ended
before P?
B/c if the tax year ended after the petition date- it should have been paid with
the fresh start
o Rationale for the front end requirement i.e. that the return must be last due after three
years before P?
If the tax collectors are sitting on their rights we should not let them get priority
if they did not take action before
There is a desire to cut stale claims-they sat for too long so cannot go back too
far in history
o NOTE CAREFULLY: If we are dealing with non-dischargeable debt (like taxes (see
523) the debtor wants to make sure they are a priority b/c that will decrease the amount
you owe when you start your fresh start.
Telephone, utility and other regular bills following bankruptcy of $5,000
o These are part of the fresh start b/c they are post-petition
Get no priority in bankruptcy payout and in fact do not get paid out at all in
bankruptcy
29

Sara Fleet, HSs attorney: $1250 in fees ($500 for a will; $750 for preparing the bankruptcy
filing)
o Entire claim goes into the pot of general unsecured claims
o Why doesnt Sara get anything for filing?
This is not part of the estate
The trustee gets paid out of the estate but the debtors lawyer is not
rendering services to the estate b/c the estate does not exit at the time the
filing was rendered
The services were personal to HS
o NOTE: Lawyers will require they get paid the cash up front
NOTE: Attorneys fees do not come under (a)(4)(A) b/c that applies only to
employees and attorneys are NOT the debtors employees
Distinction from employees- the typical attorney does not work for one
client- thus they are independent contractors and not an employee of the
client
Do not come under (a)(4)(B) b/c that applies only to sales commission
which is a hybrid between employees and independent contractors but
still does not cover attorneys
Suzan Smith, HSs ex-wife, negotiable note for $25,000
o It depends how this is read If it is a domestic support obligation then it falls under (a)(1)(A)
Under 101 of domestic support obligation- property settlement or
division of debt not included as domestic support obligation and thus in
not given priority
If it is not a domestic support obligation then it falls to the general unsecured
claim
o What will the parties be arguing?
Suzan will argue for the priority as will the debtor
Why will the debtor argue priority- b/c these are non-dischargeable debt
(both domestic support and all obligations coming out of divorce
settlements are non-dischargeable)
o B/c the are non-dischargeable the debtor will want them to be
paid with the pre-petition claims to leave more for the fresh starto If they are left to the fresh start, he will have less in the fresh
start
TIB as trustee and as trustees counsel: $4000
o The costs of the trustee and the acting as trustees counsel fall under (a)(1)(C) and (a)
(2)
Under (a)(1)(C) we are paying the trustee for paying domestic support
obligations
The trustee gets an equal priority as those that receive domestic support
for the trustees expenses of paying the domestic support obligation
Under (a)(2) cover all expenses of the trustee other then paying the domestic
support
Insurance premium for insurance on non-exempt personal property prior to its sale by the TIB:
$750
o It depends- it is either (a)(1)(C) or (a)(2)
30

To the extent that the insurance covered property is used to satisfy the debtors
domestic support obligation it may be a (a)(1)(C) priority
To the extent that the trustee is spending money or paying auctioneer to sell an
item or inspect property it is an expense of the administration of the estate and
falls under (a)(2) priority
Cost of sale of Harolds non-exempt real estate and personal property, including advertising:
$2,800
o This is an (a)(2) priority claim b/c it is an expense of the estate
Other unsecured, general claims of $17,000
o No priority for general unsecured claims
What is the order of payment?
It will depend on whether Suzan is considered an (a)(1)(A) priority or is a general unsecured
claim
If Suzan is an (a)(1)(A) priority then the following is the break down of payment:
o Trustees claim of $4000
o Suzans claim of $25,000
o Insurance- $750
o Cost of the Sale- $2800
o Nurse - $11,000
o Georges deposit- $300
o Group of Tax Priorities total $21,534
Social Security Tax- $534
Property Tax- $3000
Income Tax- $18,000
o NOTE: After George is paid there is only $17,150 left to pay out to claims
Thus, the taxes will each share a pro-rata share of that $17,150 to satisfy their
$21,534 debt NOTE: The reason we share is b/c all claimants in a subsection (so all
claimants under subsection (1) under subsection (2), under subsection (3)
and so on will each get treated alike- therefore if each will not be paid in
whole, the total amount to be paid is lumped together and the claimants
in the section share pro-rata
o So we have Taxes claiming of $21,534 and only $17,150 to pay 80% of each claimants
claim ($17,150/$21,534 almost 80%)
Social Security Tax of $534 will get paid $425.29
Property Tax of 3000 will get 2389.24
Income Tax of 18,000 will get 14,335.47
o No other claims will be paid out of the estate
If Suzans claim is unsecured then the following will be the priority
o Trustees claim of $4000
o Insurance of $750
o Cost of Sale of $2800
o Nurse of $11,000
o Georges deposit of $300
o All of the taxes- $21,534
Social security tax of $534
Property tax of $3000
Income Tax of $18,000
31

o This leaves $19,616 for the General Unsecured Claim

The General Unsecured claims total 43,250
Represents: Suzans claim for $25,000, Sara Fleets Claim for $1,250, and
Other Unsecured General Claims of $17,000
GUC will get paid about 45% of their claim
Suzan will get $11,338
Sara will get -$566.94
Other GUC will get - $7,710.34
o NOTE: The utility company still does not get paid b/c that is post-bankruptcy claim
III.

Business Bankruptcy
A. Introduction to Business Bankruptcy: Liquidation
Consumer v. Business Bankruptcy
o Consumer cases
Smaller and must be handled in mass otherwise it would be too costly
Discharge of debts
Some assets are exempted
Offers a fresh start to the individual
o Business
No discharge for Chap 7 debtors
No exemption for the corporate debtors- all the property is available for
repaying the creditors
No fresh start- business ceases to exist- must start anew
Two Conceptual Points and Two Practical Points of Liquidation
o Conceptual Point 1: Chap 7 represents the most basic purposes and devices of
bankruptcy as a legal response to the circumstances of general default
o Conceptual Point 2: Many Small and Medium Enterprises that file Chap 11
collapse into Chap 7
Thus all Chap 11 negotiations are held the shadow of Chap 7
Under 1112(a) a debtor usually has an absolute right to convert
the case into Chap 7
Under 1112(b) the creditor can do the same on proper showing
Each side wants to avoid Chap 7 however each side will threaten it
What each party will get or not get in Chap 7 will affect the
leverage position they have in Chap 11
NOTE: Non-bankruptcy workouts take place in the shadow of Chap 11
o Practice Point 1: Bankruptcy is collective in nature and national in scope there if
it is a much better place to liquidated a business then state law proceedings
In state law- creditor just grab what they can
Chap 7 offers the automatic stay, the ability to negotiate, the ability of
the TIV to reverse certain kinds of pre-bankruptcy transactions, and to
permit orderly distribution based on legal rights
It also saves the creditors money by allowing them to pool their
resources
o Practice Point 2: Chap 7 is most often chapter when involuntary bankruptcy
petition is filed- EVEN THAT HOWEVER IS RARE
Involuntary Chap 7 Bankruptcy 303
32

o Does not happen that often

Voluntary Chap 7 does not happen that often either- usually starts as a
Chap 11 case and is converted to Chap 7 case
NOTE: Only Chap 7 and Chap 11 can be involuntary
But it represents a leveraging device- creditors will threaten debtors that
it will file involuntary bankruptcy
o Rationale for a Creditor Putting a Debtor into Involuntary Chap 7
Automatic Stay Keeps other creditors from grabbing the assets,
keeping the creditors with higher priority from getting the assets
Levels out the race
Preference Avoidance- Any payment made to an unsecured creditor
during the 90 day period before bankruptcy can be avoided
Dont want the debtor to pay off their friends first
Information Debtors are required to file schedules of assets and
liabilities as part of the proceedings
o 303 provides the requirements for a creditor filing an involuntary bankruptcy
action The petition is like a mini-lawsuit: The creditor must ensure that the
requirements of 303 have been met
Who Can bring an involuntary petition
Have to be unsecured (or undersecured), have a non-contingent
and undisputed claim See In re Fabege
o 303(c)
Numerosity Requirement 303(b)- See In re Gibraltor
If there are twelve creditors or more creditors there then there
must be three creditors that meet the monetary requirement that
file the involuntary bankruptcy petition ( 303(b)(1))
If there less then twelve creditors then one creditor is sufficient of
that one creditor meets the monetary requirement 303(b)(2)
Monetary Requirement
All claims must aggregate at least $12,300
o It may be 12,300 more then the value of any lien on the
property of a secure debtor holding
Insolvency Requirement 303(h)(1)
Applies ONLY if this case is NOT being converted
Must establish insolvency by showing that the debtor is generally
not paying such debtors debts as such debts become due
UNLESS such debts are subject to a bona fide dispute as to
liability or amount
Damages- 303(i)
If the court dismisses an involuntary petition other then on the
consent by all parties without the debtor waiving their rights
under this section the court may give the debtor
o (i)(1) actual damages Consisting of costs and reasonable attorneys fees
o (i)(2) punitive damages if the involuntary petition was
filed in bad faith.
o See In re Silverman
In re Gibraltor Amusement
33

The Court had to determine if the creditor filing an involuntary petition against the debtors had met the
numerosity requirement. Here the debtor had twelve creditors and thus must be joined by at least two
others in order to satisfy the requirements of 303(b). The Court HELD that the wholly owned
subsidiary that had claims against the debtor counted as separate creditor b/c the wholly owned
subsidiary was not merely a front for the principal and Congress had not, as it had in other places,
manifested an intent for subsidiaries to be treated as one with the parent.
NOTE: There was a dissent that held that the subsidiary should not be permitted to be counted in the
number of creditors required in bankruptcy.
In re Faberge Restaurant of Florida, Inc
Here the Court had to determine if there were sufficient number of creditors that had non-disputed,
non-contingent claims. The Court HELD that post-petition payments to creditors will not deprive the
court of jurisdiction or require the dismissal of the petition- they can count as creditors with nondisputed, non-contingent claims.
In re Silverman
The Court held that the debtor was permitted to receive punitive damages from the creditor that
attempted to invoke involuntary bankruptcy. The court HELD that bad faith must be determined in the
totality of the circumstances, and here creditor was suing the bankruptcy court as a tool for collection
in disregard of the 303 requirements.
Problem 18.1: Our client R is being hit hard by a recession and is not receiving payments from certain
clients. One client is G and it is considering filing of involuntary bankruptcy. It believes it can get 2
other creditors to join and it meets the requisite amount of debt required, however they need to
determine if they have satisfied 303(h) proof of insolvency. What is your suggestion?
Generally, 303(h)(1) is shown by the debtor not paying their debts as they come due
What kind of information do you need to determine if they are not paying their debts as they
come due?
o Are they paying anyone?
o How much are they paying, are they paying enough?
o How long have they been stiffing their creditors?
o How many creditors are they paying and how much?
o Some percentage of dollars of total debt
o What is the largest debt?
o What is the critical debt?
o When was payment last due?
How do you get this info?
o Private investigator
Give detailed info but it will be expensive
o Call a mutual acquaintance
o Buy a brad street report
o Discovery Sue in state court and depose anyone you need to
What are the repercussions if you are wrong? If you file and the generally not paying their
debts requirement is met?
o The losing creditor could be assessed costs and fees
o If can prove bad faith, punitive damages are an option
Problem 18.2: Our client GB is a lawyer and a real estate developer that b/c of a bad project is having
a problem meeting some of his bills. He has worked out a plan with most of his creditors, but one is
not budging. He fears an involuntary bankruptcy action. What do we advise.
We know he does is not insolvent according to balance sheet insolvency however he is having
cash flow problems.
We want a general profile of his debt34

o How many creditors does he have- if he has more then 12 then Solid would need three
creditors to join him
o Who are his creditors and what are their relationship to Solid
If they are customers of Solids bank then we may be worried solid will put
pressure on them to join the petition
o Does the bank need the protection of involuntary filing?
If the bank does file, what can we do?
o We can argue for a dismissal and can argue that the petition was done in bad faith.
Problem 18.5: Our client UT is having trouble collecting its debts from W. W does business in a small
town and UT will not be able to meet the numerosity requirements for filing involuntary bankruptcy.
UT has proposed opening two subsidiaries and filing as the principal and the two subsidiaries. What is
your advice?
After Gibraltar I would tell UT that they cannot create the numerosity requirement by forming
two subsidiaries b/c the court would see this as intending to subvert the bankruptcy laws
May be able to argue that the debtor just incurred the debts to have more then 12 creditors to
create the numerosity problem for the creditor- but I dont know how far that will take you
However does the creditor really need the protections of involuntary bankruptcy or is state law
sufficient?
B. Business Reorganization in Chapter 11
Stages of Bankruptcy
Petition Phase
Claims Allowance Phase
Confirmation
Estate is Created
Avoidance
Best Interest
Automatic Stay
Preference Avoidance
Feasibility
DIP Created
Strong Arm
Classification
Creditors Committee
Fraudulent Transfer
Disclosure
Cash Collateral
Executory Contract
Solicitation
Adequate Protection
Voting
Post-Petition
Cramdown
The Objective of Chap 11 is Confirmation
o In the plan you are telling creditors what they are going to get postconfirmation for their pre-bankruptcy claims
To get to the plan a variety of negotiations must take place
The Mechanics of Chap 11
o Petition is filed
o The estate is created
DIP is created as is the creditors committee ( 1102)
Includes the debtors 7 largest unsecured creditors who
are willing to serve
The administrative and professional fees of creditors
committee are paid from the estate
Most smaller cases do not have a creditors committee
b/c no one will volunteer
In larger case also have discretion to form other
committees that will represent other creditors that have
different sakes in the company then the typical creditors
o May even have equity committees
o Automatic Stay is imposed- 362(a)
35

o The business continues to operate in ordinary course- 363 under the

control of the DIP- 1107
DIP has the rights, duties and power of the TIB
Business is however limited in the use of its assets, if those
assets are subject to a security agreement- 363(c) and (e)
o The Debtor will face objections by secured creditors on the automatic
stay with arguments on adequate protection 361, 362
o The DIP may obtain financing and other credit on courts approval-
364
o The DIP also has a number of avoiding powers:
Power to recover preferences 547
The power to assume or reject executory contracts- 365
The power to void fraudulent conveyances- 548, 544
The power to set aside unperfected or later perfected security
interests- 544(a) and 547
o Negotiations will ensue and the endgame is a plan of reorganization
Plan must be approved specified majorities in each class-
1126(c)
Must also be blessed by the court that it conforms to
requirements of 1129
Upon confirmation, the debtor is discharged from all prepetition debts as provided in the plan
o Once a plan is confirmed, everyone is back operating under state law Thus if a default occurs, the creditors recourse is to go under
state law
There are some nontraditional Chap 11 Mechanisms
o Auctions - where the company resolves its financial difficulties
through sale of the entire business
o Prepackaged plan - the deal has been negotiated before the petition was
filed but now they need the help of the bankruptcy law to close the deal
o Single Asset Real Estate Cases (SARE)
o Liquidation in Chap 11- always been permitted
i. Operating In Chap 11
Three Issues held determine how much cash the company will have to run the
business throughout the course of the bankruptcy proceedings
o The Automatic Stay and Adequate Protection
o Cash Collateral
o Post-Petition Financing
1. The Automatic Stay and Adequate Protection
o Automatic Stay
o One of the biggest advantages to debtors filing bankruptcy is the relief
granted through the automatic stay
Remember the stay applies automatically except to those things
specifically exempted in (b) and is nationwide and strictly
enforced- See United States v. Seitles
o The protections afforded from the automatic stay can be waived in
certain scenarios however courts are reluctant to enforce such waiversSee Farm Credit of Central Florida
36

o Action taken in innocent violation of the stay, without notice of

bankruptcy filing are void or voidable
o The automatic stay may be applied to actions against a non-debtor
through the power of the court according to 105 if it can be shown
that allowing the claim to continue against the non-debtor that is so
inextricably interwoved with the affairs of the debtor if it would cause:
Irreparable harm, and
Substantially hinder the debtors reorganizational efforts
Farm Credit of Central Florida v. Polk
Here, the and the debtor had entered into an agreement by which the would extend the date of
foreclosure sale in exchange for the agreeing not to contest to a motion for relief from the stay by the
creditors. The Court HELD that although a wavier of relief from the stay is permissible in single asset
cases that do not involve a number of creditors, here, where the automatic stay is designed to protect
all creditors and to treat them all equally, the stay cannot be waived in a bilateral agreement with the
creditor and debtor.
United States v. Seitles
Under the standard exception of 362(b), the United States under (4) may continue a proceeding
against the debtor even after filing of bankruptcy. However, the court HELD here that the United
States action was a violation of the stay b/c the US was not acting in a way that aiding the public
safety or stopping a continuing harm; instead their actions were not in the interest of public policy.
o Lifting the Stay
o However, debtors must know that the stay lifting litigation will be filed
by creditors early in the case
Creditors have the right to request relief from the automatic
stay under 362(d)
o Relief from the stay can be granted through the creditor establishing
any of the three tests under 362(d) or the stay will automatically be
lifted as to the requesting party thirty days after the request is made
unless the court after notice and hearing, orders the stay continued
362(e)
o Under 362(g) the BURDEN is on the DIP to prove why the stay
should not be lifted - including that the creditor has adequate
protection Exception: the DIP does not have to establish that the debtor
has equity in the property at issue
o Only secured creditors can request that the stay be lifted
o Bases for Relief from Stay 362(d)
362(d)(1)- For cause, including the lack of adequate
protection of an interest in property of such party in interest
Adequate protection = A secured creditors protection
throughout the case should be no worse then their
position on the first day
Rational for making sure the creditors is adequately
protected: The debtor should not be able to keep the
collateral unless they can assure that the secured
creditors interest in its collateral is not impaired
If the value of the creditors collateral goes down b/c of its use
the creditor is entitled to adequate protection
37

The means for providing adequate protection are found

in 361
Adequate protection may be provided by:
1. Requiring the trustee to make cash payments or
periodic payments to the creditor to the extent the
extent of the decrease in value of such creditors
interest;
2. Providing such entity an additional or replacement
lien to the extent that such stay, use, sale, lease, or
grant results in a decrease in the value of such
entitys interest in such property;
3. Granting such other relief, other than entitling the
creditor to compensation allowable under 503(b)
(1) of this title as an administrative expense, will
result in the realization by such entity of the
indubitable equivalent of such entitys interest in
such property.
a. NOTE CAREFULLY: This is not an
exclusive list - other ways of providing
adequate protection may be possible
ii.
If adequate protection cannot be given then the
relief from stay will be granted
362(d)(2)- Two requirements
The debtor has no equity in the property; AND
The property is not necessary for effective
reorganization
o Rogers- If there is no reasonable likelihood of
reorganization then this requirement is met
If both requirements are met then relief from stay will
be granted and the party can grab the property
363 (d)(3)- Relief from Stay In SARE in payments
Under 362(d)(3) if a creditors is oversecured, and the
debtor is a SARE, the debtor has to pay interest to the
secured creditor at the contract rate if the debtor cannot
file a credible plan within 90 days
If the payments cannot be made or the plan is not made
then the stay will be lifted
NOTE: DISMISSAL OF CASE:
o A case can be dismissed under 1112(b) if the debtor did not file the
petition at an appropriate time and the petition was not made in good
faith
In re SGL Carbon Corp. The company was a healthy
company (solvent) but was facing liability in the amount of
$240 for a class action anti-trust case. The Court held that the
case should be dismissed b/c the evidence showed that the
debtor filed the action too earlier and the petition was made
only to change the amount that the anti-trust creditors would
receive.
38

NOTE: This case is weird b/c the court just relied on the
debtors statement that the company was healthy but
companies always say that
Problem 19.1 PA has a security interest in BC to secure a loan with a current balance of $180,000 at
prime plus 6%. BC is currently in Chap 11. The loan is secured by a security interest in all of BCs
equipment which is mostly standardized repair tools bought a year ago for $200,000 with a life
expectancy of 10 years with no salvage value. They took a depreciation deduction of 20% on the tools
last year ($40,000). The wholesale value is $140,000 for such tools and the retail value today is
$220,000. Found a purchaser that would buy these tools for $160,000 but we dont know anyone else.
What should we tell PA?
This case is about VALUATION
Step 1: When dealing with a case of Valuation- we need to decided what the secured creditors
position is going to be:
o If the Secured Creditor believes that the Debtor is going to go into liquidation, then we
want to argue a high valuation of the assets to make sure we are fully secured
When fully secured under 506(b), an oversecured creditor gets to accrue
interest and fees pursuant to contract terms up to the value of the collateral.
o If the Secured Creditor does not believe that the Debtor is going into liquidation, then
the creditor wants to argue low valuation.
o Want to argue that the debtor does not have an equity cushion- 362(d)(1)
Equity cushion = Excess value of the collateral over the amount of the
debt- the secured creditor is oversecured
If it is found that the tools are worth $220 this year and the debt owed is
$180, the creditor is over secured by $40, there is an equity cushion of
$40, so it is going to be tougher for the creditor to argue that the value is
going to be depreciating
If there is NO equity cushion, the secured creditor is not entitled to relief from
stay under
Debtor do one of three things to give adequate protection to the debtor
under 361 otherwise the stay will be lifted
o Cash payments are one way to give adequate protection
Through the cash payments you reduce the dollar amount
of the secured creditors claim to preserve the secured
creditors status (thus creating an equity cushion by
paying down the debt)
o Can also argue 362(d)(2)
Once again you are arguing low valuation b/c have to show the debtors have no
equity in the property
Remember this burden is on the party request relief from stay
Must show that the tools are not necessary for reorganization
Here have to make the Rogers argument, i.e. there is no reasonable
likelihood of reorganization to satisfy this requirement b/c obviously the
tools would be necessary if the business was to reorganize
Problem 19.2: We represent CWI who has just entered Chap 11. CWI has a loan from AF for 1.8
million on a 12 percent note, secured only by the corporate jet. CWI wants to keep the jet. You had
the jet appraised and it is worth about 1.1 million with a life span of 40 years and with regular
maintenance and upkeep the value is not likely to change in the next 40 years. What is your argument
to keep the jet?
First you are going to argue adequate protection exists
39

o Told that the value of the jet is stable as long as it is properly maintained
CWI can offer a small cash payment from time to time to keep the creditor
adequately protected
Also could offer insurance and assignment of proceeds
There is probably already insurance- but creditor will want to see that
Proceeds are assigned to the creditor to the extent of their debt from this
insurance policy
Second can argue (d)(2)
o Although we will lose on the no equity b/c there is no equity
o We can argue that there is beneficial uses of the plane for the company
Although this probably will not work
NOTE: Theories behind (d)(1) and (d)(2)
o Under (d)(1) the idea is to preserve the creditors position that they had at the beginning
o Under (d)(2) protect the creditor if the assets is not necessary for the reorganization b/c
there is no need for the debtor to keep it
But where the debtor has equity in the property it makes it a kind of co-owned
situation where the debtor and the creditor own a piece of the asset.
Problem 19.3: We represent Sam who was in a feud with Roy over some lamps for Sams house that he
purchased from Roys store. Sam has told you to go and pursue him to the full extent, which you have
done. Roy has not filed bankruptcy. What is your litigation strategy?
Litigation on the dispute is over as long as the company is still in Chap 11.
o Under the stream lined claim allowance process, the disputed claim will go before the
judge therefore you will not be able to bleed the client dry
What are Sams options?
o 1112- Can try to Change the Chap 11 to a Chap 7.
Under 1112 have to establish cause
Have to argue that there is no hope for the company
But this is a weak argument
o Could make a good faith argument- that Roy did not file this petition in good faith, just
done to jigger his creditors like Sam
Compare to SGL- the debtor is filing this petition as a litigation strategy- there is
nothing to reorganize here
Debtor is just using bankruptcy as leverage
This really does not look like SGL
Problem 19.4: We represent HM a creditor of ASI which is in Chap 11. HM has a valid PMSI on a
stamping machine that is worth $50,000. HSs security interest is for $35,000. CB has a non-PMSI on
the press of $20,000. Can HS get his machine?
Step 1: Can he get relief from stay through 362(d)(1)o NO- HS is oversecured
HSs collateral rights are senior to the CBs rights, so the fact that there is a
second lienholder does not affect the seniors equity cushion
The senior is going to get interest, both pre-petition and post-petition and fees
pursuant to 506
NOTE CAFREULLY: Purchase Money is ALWAYS senior
o Is this fair to the Junior- no but who cares
Step 2: Can he get relief under 362(d)(2)
o Maybe Remember for relief under (d)(2) the creditor must show
40

 That the debtor has no equity in the property

And that the property is not necessary for reorganization
We know ASI has no equity in the property
All the equity has been leveraged out to HS and CB
Thus the first element is met
But what about the second
CEO has some good showings, but a mere statement is not enough
o If mere statements were enough it would make the second
requirement superfluous everyone could make such statements
Even though it has value in the business, that is not a reason to hold on to
ito Rogers cannot just hold on to something to hold on to it
What if you represented the second creditor- what are your arguments then?
o Have to decide what you want to doo Can either take your $15,000 after liquidation or you can take the gamble and wait it out
If you wait it out you may get your $20,000 if the company is successful in
reorganizing but you will not get more then that
Problem 19.5:Here we are dealing with a single asset case. BW is just trying to park the estate in Chap
11 and wait for the value to go up. If we represent the FDIC, what do we do?
Here we are dealing with a single asset case, so 362(d)(3) is available in addition to the other
ways to receive adequate protection
Issue 1: If the FDIC has adequate protection all depends on valuation
o We want to make an argument for adequate protection so we peg the value for the
building
Typically we will have an expert appraisal done
o What if the FIDC is oversecured
If they are oversecured they are then adequately protected
Depending on the size of the equity cushion, it may be itself enough for
the debtor to defeat relief of stay
However there are benefits of being oversecuredo Get post-petition interest and fees
o If the FDIC is oversecured by they still want to go after adequate protection- can always
try and use 362(d)(2)
Here however, if the creditor is oversecured and is the only lien on the property
then the creditor will fail to show that the debtor has no equity in the property Thus will not get adequate protection
Plus it will be hard to show that the building is not necessary for reorganization
o If the FDIC is undersecured there is better argument for a adequate protection
o This is also a Single Asset Real Estate
The debtor is just waiting for the value of the building to go up- parked it in
Chap 11 to ward of foreclosure as long as possible and usually would not pay
interest
If you are oversecured 362(d)(3) offers one more relief from stay offers one
more relief form stay
Debtor has to pay interest to the secured creditor at the contract rate if
the debtor cannot file a credible reorganization plain within 90 days
41

With a building there is low managerial skills involved and the

knowledge of the debtor is not necessary so it would be a good
investment then bank can enjoy the uptake from the market
ii.
Cash Collateral
When a business enters Chapter 11, one of the first critical steps to survival is to keep the
business going until a plan can be confirmed- this will require cash.
The use of cash collateral is governed by 363
o Congress has placed few constraints on the DIPs use of cash that is not subject tot a
lien, so long as the cash is used in the ordinary course of business (c)(1).
o Congress has placed more constrains on cash that is subject to a lien, which is usually
cash derived from the sale of inventory or the collection of accounts subject to Article
9.
This cash is encumbered (cash collateral) and cannot be used by the DIP
without the permission of:
1. The bankruptcy court; or
2. The creditor that has the interest in the cash collateral.
o NOTE: All other assets that creditors have liens on are allowed to be used by the DIP
in the ordinary course of business.
However cash is different b/c it disappears easily and it is hard for creditors to
keep track off.
When the debtor uses cash collateral, the creditor must get adequate protection like any other
secured creditor.
o So the typical fight over cash collateral is how does the bank get adequate
protection? what can the debtor give the secured creditor for adequate protection.
Earth Lite
Here the debtor/creditor structure is similar to a line of credit. Earthlite uses credit to buy inventory,
they use what they need, and the pay the money when it is outstanding. Do not have to take out a lump
sum. The Bank and the borrower sign a credit agreement and the borrower gives the bank a security
interest on the inventory, accounts receivables, and cash. The idea is, as the borrower sells its
inventory, it can pay down the amount it borrowed from the line of credit.
B/c the bank has a security interest on the cash it is cash collateral. The Court HOLDS however that
with the equity cushion in combination with the personal guarantees by the executives of the company,
the company should be able to use the cash collateral.
Lock-box arrangement- An arrangement that involves giving direction to
those who owe money to the debtor to send their payments to a certain
post office box
o The debtor and creditor then agree on how much of the money in
the lock box will be distributed to the debtor and how much goes
to the creditor
Setoff Payments
o The bankruptcy code through 553 recognizes the right of any
creditors to offset a debt it owes to the debtor against a debt owed
to the creditor by the debtor
Although not technically a security interest it operate with
the much of the same effect under the Bankruptcy Code
In particular a creditor with a right of setoff is
treated as secured for the amount of its setoff
right- 506(a)
42

o
o
o

In addition, the account subject to setoff is cash

collateral and governed by the rules set forth in
363(c)
o BUT NOTE: Creditors with the right of
setoff are also subject to the automatic stay
just like secured creditors and cannot
exercise the setoff without permission of
the court- 362(a)(7)
Set off is not a bankruptcy right, it is right that is given outside of
bankruptcy that the bankruptcy courts recognize
553(a)(2) deal with the issue of when the setoff amount is
purchased to satisfy the debt- see problem 20.3
Example:
Lisa sells watches to Macys - $100 worth of watch
Macys is a debtor in Chap 11
Lisa makes purchases on Macys credit worth $100
When Macys goes into bankruptcy it does not
impair its ability to collect on the claims owed to
it- such as purchasers made on credit
Rationale for setoff right: if bankruptcy did not
respect setoff rights, then Macys would get paid
100 cents on the dollar from Lisa but Lisa would
get paid pennies on the dollar from Macys
Thus Bankruptcy on equitable principals says that
if setoff right is recognized in state law, then it is
permitted to continue in bankruptcy
However we then have (a)(3) so that creditors
cannot make themselves a higher priority and
preference
How (a)(3) works- (a)(3) prohibits the setoff when it is
done on the eve of bankruptcy
Thus if Lisa read that Macys was in trouble, could
not pay debts, and may go into Chap 11recognizing that she would only get pennies on the
dollar for her sale to Macys, and knowing about
setoff, she runs to Macys and purchases socks for
$100 b/c that is the debt she is owed then (a)(3)
would kick in
o (a)(3) would treat these like they were
separate transactions and Macys could
collect $100 from Lisa, but Lisa could not
demand $100 for the watch
NOTE: The most important part about 553(a)(3)(C) is a
deposit account
NOTE CAREFULLY: 553 has the presumption of
insolvency 90 days before filing
NOTE: A setoff obligation increase a persons interest rate
(effectively)
43

B/c now you are actually borrowing less (b/c you have
provided the deposited amount that can be setoff) but you
are required to pay the same interest payments for the full
amount- See Problem 20.2
o NOTE: Setoff may be misleading to other creditors would see
that the debtor has money in the bank so it artificially enhances
the health of the debtor
In re Hal
The Court HELD that the US government has a set off right to pay itself for taxes that are owed from
the debtor with moneys paid that exceeded the amount owed for a different tax. The court HELD that
the mutuality requirement was met between the different government departments, similar to different
departments in a corporation that satisfy the mutuality requirement and distinguished it from
corporations subsidiaries that were not permitted to use set off rights.
Problem 20.1: The Bank has a security interest in the debtors inventory. Can F operate the business as
usual?
363 authorizes the debtor to run the business in the ordinary course, to use or sell, except for
cash
o The debtor can sell the inventory but once he gets the cash he cannot use the cash
without the consent of the creditor or an order from the court
Problem 20.2:On 6/1 T owes the bank 150k on an unsecured basis. On 7/1 the bank demands a 10%
compensating balance (deposit in a bank account to get a setoff). On 9/10 the debtor files Chap 11- He
has 40k in the checking account. What is the setoff right
Under 553, when there is a mutual debt between two parties the party not in financial distress
can cancel out the debt owed to the party in financial distress against the debt owed to it
Is the compensating balance cash collateral?
o To the extent that there is a setoff right in the account, it is cash collateral
This may seem odd to call it cash collateral b/c there is no security interest but to
the extent that there is a setoff right that creditor is treated as a secured creditors
So here, what is the extent of the setoff right
o Although they do have a setoff right, it is not for the full 40k.
o 553(a)(3) is drafted to prohibit creditors from manipulating the system on the eve of
bankruptcy
o Thus if T would put the money in voluntarily then the entire $40k would have been
covered
o But 553(a)(3) says that if you create the obligation to put money in for the purpose of
obtaining a setoff right then the bank only gets the amount that is held in the account
voluntarily- not the amount that is required by the bank
This principal is applicable here- The bank demanded that T keep a
compensating balance only after T was in trouble
Thus all three of the requirements were met- the demand came 90 days
before filing the petition, it was made while the debtor was insolvent and
it was made for the purpose of creating the obligation
Thus the bank here does not get the full $40k, but they do get something
o The bank required the debtor to keep a compensating balance of
$15k (10% of debt), the remaining 25K was kept in the account
voluntarily thus the bank can set off against it
o The other 15k the debtor can use b/c there is no setoff right
NOTE: T could have drained the full amount b/c once the debtor is in bankruptcy that is just
one more claim (breach of contract) against the debtor

44

Problem 20.3: FTV has an account with CB for 61k. W is a creditor of FTV and has a claim against
FTV for $50k. Last month W sold the claim for 50k on FTV to the bank for 40k
Question 1: Why would W sell its claim for $10k less then it is worth and why would CB buy
the claim?
o W wants to sell the claim b/c they dont they are going to get paid so they figure out a
better way to get something rather then nothing
o CB will be willing to buy the claim but they have a setoff right for the full 50k against
the debtor b/c the CB has 61k in the debtors deposit account
So the bank can set off for the full 50k
It owes the debtor the remaining 11k and it made 10k from the deal with
W.
Question 2: Who much can FTV use without the courts permission, how much of this bank
account is not cash collateral, how much of the bank account is not subject to the setoff
amount?
o This issues comes under 553(a)(2)- Under (a)(2) the bank does not have a setoff b/c
the debt was transferred
Under (a)(2) there are two requirements
(1) That the transfer be made within 90 days of bankruptcy; and
(2) When the debtor is insolvent (which there is presumption of in the 90
days preceding bankruptcy)
NOTE: Under (a)(2) there is no requirement that this transfer be done for the
purpose of creating the obligation
o Result: The bank is still an unsecured creditor so they may get pennies on the dollar
NOTE: To get to this result you may also be able to argue that this was a special
account so there is no setoff right b/c it was used for payroll
NOTE: Banks use to be caught in this odd scenario in which they had deposit accounts and
loans for the debtor that they wanted to keep in order to obtain the setoff
o Typically if they gave up the money they knew they had no chance of setoff
o So the Supreme Court held that the bank could freeze the accounts and wait until they
received a court order to give up the money
Problem 20.4: This question implicates how to deal with management that you dont like when you
represent the equity holders of the Chap 11 debtor and a plan has been proposed that threatens to wipe
out all the old equity (your clients) and the creditor approval is likely
Here the equity holders want to gamble and would be even willing to put in more money
So what are some possible arguments?
o Make a claim to for a trustee- to replace the DIP
Could argue mis-management
However it is rare that a trustee will be put in place in Chap 11 b/c it is gamble
to put in new management that does not know what is going on
The Sharon case is a good example of what needs to be shown to get the
trustee appointed
o There is another issue that might give us some fighting room-that is 5% equity of the
management
In 2005 Amendments, Congress put limits on what you can give managers in
reorganization
Retention payments are prohibited unless the manager can show a bona
fide other job opportunity under 503(c)
o But this might give some more grounds for mismanagement
45

However it still is probably not enough to get the trustee

replaced but it may be enough to get the payments
rescinded.
1. Post-Petition Financing
A debtors ability to obtain post-petition financing is governed by 364
The Mechanics of 364 are as follows
o (a) The debtor is authorized to incur ordinary course unsecured
debt with an administrative priority without court approval
o (b) The debtor must obtain court approval for no-ordinary course
unsecured debt
o (c) IF the trustee is unable to obtain unsecured credit as an
administrative expense, the court may authorize the obtaining of
credit or debt
With priority overall other administrative expenses
(superprioirty) for unsecured
Thus the debt sits on top of the heap on
administrative property
A lien on unencumbered assets or possibly even a junior
lien
Junior lien on assets that are already secured
o (d) The Court can authorize a priming (senior) lien or equal liens
on existing secured assets Two things must be show to get a
priming loan
(1) That the debtor could not induce lending through other
means, and
(2) The debtor can give the previously (pre-petition)
secured creditors adequate protection
The adequate protection required here is the same
kind of adequate protection required to keep the
automatic stay intact
An equity cushion may be adequate protection if
there is enough equity in the collateral to satisfy
the existing lien and the priming lien when we are
done
o Overview of 364- If cannot get unsecured credit then you start
giving liens, if all the assets are encumbered then you try giving
priming liens and equal loans
Hypo using 364
o Our client is SAP. It is going to file Chap 11 and wants to
minimize the fall out so calls all of its major suppliers to let them
know what is going on. The biggest supplier is ACD
o When ACD hears about the filing it gets nervous and rethinks its
agreement that it has had with SAP in the past that affords SAP
60 day credit giving SAP 60 days to pay off ACD for the
supplies it shipped
o Considering cash terms, SAP has asked you to talk to ACD about
the cash terms. What can you offer your biggest supplier to
entice him not to insist on cash up front?

46

You can offer unsecured debt with an administrative

priority
Thus the supplier can keep on extending credit in
bankruptcy and to ensure they keep getting paid
we give them an administrative priority
Will we need court approval to make this offer?
It depends on whether this is considered in the
ordinary course of business
Under (a)- we do not need to get court approval if
the credit is extended in the ordinary course of
business the creditor can continue to do as they
always have
Under (b)- we will need court approval if this is
not in the ordinary course of business
Who give post-petition financing
Usually the pre-petition creditors are the most common to offer funds
post-petition
o This is often seen b/c the pre-petition creditors know the business
the best and therefore they an beat outside lenders on pricing that
dont know as much
o In addition, the pre-petition lender has a lot of incentive to lend to
the DIP, particularly to avoid a priming loan
In re Garland Corp
This case dealt with the debtors ability to receive post-petition financing. The Court had granted the
right to take out post-petition loans that were given priority costs of administration and a first
encumbrance on all the assets of the debtor. The court HELD that the borrowing was authorized under
362(c)(2) b/c after notice and hearing, the debtor was able to make a sufficient showing that it was
unable to obtain unsecured credit. The Court HELD that the unsecured creditor do not receive
adequate protection.
Post-Petition Priming Liens
o The court under (d) can offer post-petition priming liens that pus prepetition creditors out of the way
In re Hubbard Power and Lighting
The court held that the Debtor tried to obtain unsecured financing, however the only options available
were to use 364(c) and (d). The Court held that specifically to the Countys objections to the priming
loan given for the clean up costs, that adequate protection for the creditor for the purposes of the
provision entitled the debtor to obtain financing secured by liens senior to all other interests means to
safeguard the creditor from any diminution in the value of the property. The Court held that b/c the
value of the property will only improve due to the clean up, and therefore increase in value, the
Creditors are not hurt.
Cross-Collateralization
o Cross collateralization is secured pre-bankrupt loans with new or additional
collateral granted post-bankruptcy as part of the new bankruptcy loan
It is made at the cost of unsecured creditors
o Although it is okay for pre-petition lenders to get SI on pre-petition assets
and post-petition creditors to get SI on post-petition assets- when a prepetition creditor gets SI on post-petition assets which gives the lender
coverage for deficiency from pre-petition loan it changes the priority

47

Now what would have been unsecured loan (the deficiency) that
would have been lumped together with all other unsecured creditors
but would have given a chance for unsecured creditors to get
something will allow the pre-petition creditors to get a better deal
(get paid 100 cents) and cuts out what other unsecured creditors
would have received.

Mootnesso The problem with key reorganization issues notably post-petition financing
is that they are difficult for appellate courts to review
A creditor lending new money to a business in bankruptcy would be
reluctant to turn lose the cash if the bankruptcy decision approving
the priority repayment could be overturned on appeal
Thus 364(e) is designed to encourage post-petition lenders by
assuring them that their rights will not be upset by an appeal order
Shapiro v. Saybrook
The Court HELD the financial agreement between the debtor and the lender, which had the lender
giving an additional $3 million in financing in return for a security interest on their previously
undersecured pre-petition loan as well as their post-petition loan was not permitted. The court held
that such an arrangement changes the priority and is outside the scope permitted by the bankruptcy
code.
Pre-petition after-acquired property clauses and their effect in bankruptcy
o Pre-petition security interests with after-acquired property clause cease
to operate at the instant bankruptcy is filed
The security interest locks up all the property the debtor owns
at the moment of filing but it does not attach to any property
acquired by the DIP after the petition
o NOTE: Sometimes the secured creditor will claim that the secured
creditor can trace the purchase of the new post-petition inventory back
to the sale of the old pre-petition inventory in which it held an interestthus the secured creditor still has a continuing interest
Financing Good and Services
o Nothing in the bankruptcy code requires suppliers to continue to deal
with the debtor except in cases where the debtor has a legally
enforceable contract for future goods and services
o Many suppliers and servicers will require that they be paid in cash
o HOWEVER: If suppliers want to ship to a debtor after bankruptcy they
get administrative priority
o Since the 2005 Amendments, suppliers and services have been given
additional leverage
Previously everywhere the rule was that trade creditors had to
wait to be paid any part of what they were owed as part of the
unsecured class of creditors
This was true for all creditors except critical vendorsvendors that delivered suppliers that were absolutely
crucial to the success of the Chap 11 case
This exception for critical vendors has been expanded
over time in some circuits to include non-critical
vendors
48

In addition, under 546(c) Congress greatly expanded the

suppliers of goods right of reclamation
Under 546 if the debtor receives goods while
insolvent and within 45 days of filing bankruptcy, the
seller may have the right to get the goods back if it
makes a timely written demand
o If those 45 days end after the petition is made,
the supplier is given 20 days from the date of
petition to get the goods back
NOTE If the 45 days run and then
petition is filed, the supplier does not get
another 20 days
In addition, a seller of goods received by the debtor
within the last 20 days before bankruptcy gets an
automatic administrative priority
Problem 21.1 We represent the debtor who owns a very valuable piece of land that cannot be
developed by any other entity by virtue of the no growth clause which the debtor is grandfathered out
of, unless the transfer of the land occurs after water and sewage are already put on the land at the time
the negotiations for the sale begin (thus a potential purchaser cannot agree to put them on). What do
you do?
NOTE: This is like Hubbard- thus the only way to reap the benefits of the valuable property is
to put water and sewage on the property, and the only way to put water and sewage on the
property is to receive financing.
How do you give a priming loan on the property?
o Ask the court- Give Notice- Give adequate protection
But here the argument is really over who should bear the risk of financing Here the land is not exactly like Hubbard b/c it presumably has some
value without the water and sewage where the land in Hubbard was
valueless to the County b/c no matter where it was transferred the clean
up costs followed it
Here if the post-petition creditor believes that the improvements will
increase the value of the property, then that should be the party that bears
the risk
o A predicted post-improvement valuation that that the pre-petition
creditor has to rely on is not adequate protection
o If the post-petition creditors is right about the improvement and
post-improvement valuations, then they should be willing to go
through with the financing with just a junior lien
NOTE: When the trustee gathers up the property, does the property remain in the name of the
debtor or is it transferred to the estate?
o Bankruptcy does not view it as a transfer but state law may (Tung does not think it
would)
Problem 21.2 Debtor files for Chap 11. At the petition date the debtor has GUC of 250k and a loan of
500k from FSB secured by inventory. After the petition happens, HF gave Debtor 250k in postpetition financing secured by a lien on all equipment. FSB moved for relief form the stay but was
given adequate protection by lien on the accounts receivable. Then the Case is coverted to Chap 7.
The inventory is depleted and the accounts are difficult to collect. After the sale, FSB is still owed
$250k, HF got $150k from the sale so is down to 100k owing, the debtors from chap 11 is owed

49

$150,000 in fees, and the debtors chap 7 attorney is owed 50k. The debtor has assets of $350k- who
gets paid if If they did not go into Chap 7 who gets paid out of the three claims
o To determine priority you go to 507
o Under 507(b) if the creditor is given adequate protection that turns out not to be
adequate, that protection turns into a superpriority administrative expense
The deficiency is the only part that becomes the superpriority- that is the extent
that their adequate protection is inadequate thus the shortfall of the adequate
protection is the pat that is given superpriority in (a)(2)
o HFs priority is just generic administrative priority
o Therefore as between FSB and HF
FSB will be at the top b/c of 507(b) of putting inadequately protected creditor
at the top
HF is probably just an administrative expense priority thus below FSB b/c not
a superprioirty
o So as between FSB, HF and the attorneys
FSB with 507(b)
HF and Chap 11 lawyers with 507(a)(1)(C)
NOTE: Chap 11 lawyers are also administrative expense but they
initially carve out a certain amount of collateral that will cover their
unpaid fees- these unpaid fees are kept low b/c every 3 months the
lawyers ask the court to authorize fees for the last 3 months and only at
the end will the lawyers go to this carved out collateral
When we add in the Chap 7 attorneys the result changes
o Under 726, the post conversion administrative expenses get priority over pre-petition
administrative expenses
Have to allow this b/c we need to given the Chap 7 trustee an incentive to work
o Thus the outcome is
Chap 7 trustee paid 50k b/c of 726(b)
FSB gets 250k from deficiency 507(b)
HF 100k deficiency and Chap 11 lawyers 150k are split pro-rate 503(b) Here Each will receive 20k and 30k respectively
o NOTE: IF you were HF if you are an attorney you should have originally asked for
priority under 364(c)(1)
Then they get surper-priority over and above all the other administrative
expenses BUT HF had to request it to get it
When you compare 507(b) and 364(c)(1) you can see that 364(c)
(1) will be given priority over 507(b)- thus super-super priority
But when you compare 364(c)(1) and 726(b) although there is an
argument that 364 should trump, it is unlikely that it will
Problem 21.3 This is a cross-collateralization case. Our client is ME is undersecured. He has a
$3million dollar loan secured by $2 million of collateral. The debtor has $1.5 million in
unencumbered assts and YSB is willing to lend $750k post-petition with a lien on all the
unencumbered assts. M changes his mind and is willing to offer post-petition financing at a lower rate
if the debtor will give him a security interest on all the debtors assets for both pre-petition and postpetition loans.
This is Saybrook but with different numbers- The issue really comes down to what desperate
the company is (although some courts wont allow it at all)
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o If YSB decides not to give its loan, this will improve Ms chances b/c it is the debtors
only chance So even though changing priority it is excused b/c it is the only way to save the
business
Thus the court will probably approve the cross collateralization or its changes
will at least be improved
o If you are an unsecured creditor would you fight it ?
If you are an unsecured creditor and you think the business will fail you will
argue against the cross collateralization
You will say that it is not authorized and it if no one else is willing to
lend that it is a sign that the business will fold
We should save the money
May also argue that M is just trying to improve his position for what is
inevitable- liquidation
If you are an unsecured creditor and you think the business will succeed
Then you should not fight it b/c it is the best way for the company to
continue.

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iii.

Reshaping the Estate

1. Strong Arm Clause
Governed by 544
o Allows liens that are unperfected as of the petition date to be
voided and they liens to go back into the estate (thus as
unencumbered property)
STRONG ARM POWER RELATES TO STATE LAW!
This is done by the DIPs strong arm power which is afforded through
544
o (a)(1)-(2) allows the DIP to take the position of lien creditor
that came into existence the day of petition
Whatever liens could have been avoided by state law by
the hypothetical lien creditor that came into existence on
the date of petition can be avoided by the DIP
o (a)(3) allows the DIP to take the status of a BFP in real property
Thus the DIP is given that position of BFP as of the
petition date and can avoid mortgages on real property
that a BFP could have avoided
In re Bowling
The DIP can avoid the mortgage pursuant to 544(a)(3) b/c the mortgage was defective b/c of the
absence of a notary at the time the debtor executed the mortgage.
Strong Arm Power and Federal Tax lines
o DIP may also be able to avoid tax liens until the lien is filed
Until the lien is filed it is treated like an unfilled security
interest good against the debtor but not good against most
other interested parties including the TIB
Before the lien is filed, the strong arm provisions
permits the TIB to exercise the rights of a
judgment creditor of a BFP of the real estate on
the date of filing, which gives the DIP priority
over the unfilled tax lien
After the tax lien is filed, the TIB must recognize
the lien in bankruptcy and treat the government as
it does other perfected security interest
Strong Arm Powers and 546(b) and State Law (UCC 9-317)
o 546(b) relates to strong arm powers b/c it allow perfection to
relate back to the date the property was received
The ability to relate back comes from state law
Thus is state law is the UCC 9-317(e) then you have 20
days to perfect your interest in it is a PMSI
If you perfect your interest in those 20 days it
relates back to the date the property was received
o Thus 544(a) give the DIP the right of the judicial lien creditor
546(b)(1)(A) give us a limitation on the strong arm
power but it is a limitation based on STATE LAW
Saying that any STATE law that allows postpetition perfection is honored in bankruptcy
52

o NOTE: The perfection of a security interest after the petition date

does NOT violate the automatic stay
362(b)(3) creates an exemption to the stay that allows
the secured creditor to continue perfecting after the
petition when they are ALLOWED UNDER STATE
LAW-even after the stay has kicked in
o NOTE ON UCC 9-317(e)
A PMSI is a lien that is created when the goods are sold
The Bankruptcy allows the seller the ability to
relate back by perfecting within 20 days, even if it
means perfecting post-petition to encourage sellers
to give creditor
Perfection relates back to the date of deliveryProblem 21.1WF bought a plane from our client MA. WF gave down payment of 25k and signed a PN
for 230k secured by the aircraft. The security agreement and financing statement are not filed and WF
files of Chap 11. MA realized that they did not file their financing statement and security interest, what
do they do?
MA is not a secured creditor- they have an unperfected interest on the date of petition.
o NOTE: It is not that they are an unsecured creditor- as between the two parties they are
still secured by the plane
Perfection is not required to make a security interest between the creditor and
debtor
Perfection is required only if the creditor wants the security interest to be good
against third parties.
o But they are an unperfected lien creditor- which can be avoided by a lien creditor
Thus the DIP can avoid the security interest b/c it was not perfected under 544(a) powers as a
hypothetical lien creditor that perfected on the date of petition
Problem 21.2: WF had bought a plane a week before petition from Aero, putting a $10,000 down
payment and a PN for $160k secured by a plane being purchased and all of WF;s other planes, spare
parts, servicing equipment, including the plane from MA. When Aero learns of the Chap 11 they file
copies of the financing statement immediately in the appropriate locations- what is the result.
Step 1: Can the DIP avoid the security interest given by WF?
o There is a security interest given on two different things: Security interest is given on
the plane that the credit was extended to allow the debtor to buy and a security interest
was given on all other equipment. MUST TAKE THEM APART
Step 2: Can the DIP avoid the security interest given by WF for the plane that Aero sold them
on credit- (NO)
o 544 give the DIP the power to avoid liens on property the are not valid against a
hypothetical lien creditor as of the date of filing
Thus it appears that DIP could avoid this
o However 546 limits that power based on state law
o Assuming State law is UCC 9-317(e) when dealing with a PMSI, the lien is created
when the goods are sold as long as the seller perfects the interest within 20 days of
when the purchaser takes possession
o HERE- There is a valid lien on the plane b/c AERO perfected its interest within 20 days
and thus the DIPs avoidance power is limited by the State law that permits the security
interest to relate back
Step 3: Can the DIP avoid the security interest given by WF for all the other equipmento Yes- The plane is different from all of these materials b/c it was a PMSI
53

o All of these are things are general unsecured- although the relation back can be used for
the plane- it only permits relation back for the collateral given by the seller
o On the other collateral, AERO does not enjoy a Purchase Money Creditor status so no
exception to the strong arm b/c does not fall within UCC 9-317(e)
Step 4: Did AERO violate the stay when it perfected the security interest after the debtor filed
their petition
o Under 362(b)(3) an exemption to the stay is created
The exemption allows the secured creditor to continue perfecting after petition
when they are allowed under state law
o HERE- AERO was permitted to continue perfecting under state law based on UCC 9317(e) after the date of petition b/c it was a Puchase money creditor
BUT NOTE: This only applies to the perfection of the security interest on the
Purchase Money Collateral
o The exemption from the stay created by 362(b)(3) DOES NOT extend to the
perfection after the date of petition on the other property b/c that perfection was not
allowable under state law
Thus there is a possibility that AERO will get hit for a breach of the stay
Problem 21.3: Investors are your client. They gave money to a developer for building a house and
took back a mortgage on the house as security. The developer went into bankruptcy as did the
homeowners. The Investors want to know they are secured and will get their investment back through
the proceeds of the house (security interest). You look at the recording and find the mortgage was
recorded by it was missing the witnesss signature as required by state law. What is the situation of the
investors?
Under 544(a)(3) the DIP takes the status of a BFP that perfected on the date of petition
To the extent that the mortgage is defective under state law, it is defective under bankruptcy and
the DIP can take it as a BFP
o State law here says you lose without the mortgage being signed by witness, DIP takes
the status of BFP that perfected on the date of petition, and beats the mortgage.

2. Avoiding Powers: Preferences

Preference avoidance is about vindicating the equal treatment of creditors
o It is not available anywhere else but in bankruptcy
It is different from strong arm b/c it does not vindicate a state
law right of hypothetical creditors
It is different from Fraudulent transfer b/c there is no
argument that the debt being repaid is fraudulent or that the
debtor does not owe the money
547 is designed to allow eve of bankruptcy payments to be brought back
into the estate
o NOTE: 547 has a deterrent effect in engaging in pre-bankruptcy
preferential payments and gives the debtor leverage
Deters the creditor from putting pressure on the debtor to
make payments b/c debtor may use the leverage to say that it
will just be brought back in if it files
If you are a creditor- you want to grab the payment and hope
that the debtor wont file for 90 days
NOTE: If you are an insider it gets trickier b/c the
reach back period for an insider is 1 year
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547(b) sets out the laundry list of requirements to get preferential payment
back- Ask
o (1) Is there a transfer?
o (2) Is it a transfer of property interest of the debtor?
o (3) Was the transfer for the benefit of the creditor?
o (4) Was the transfer made on account of antecedent debt?
o (5) Was the transfer made while the debtor was insolvent?
o (6) Was the transfer made within 90 days of the petition or if we
are dealing with a transfer to an insider, within one year?
o (7) Does it enable the creditor to recover more then under Chap 7
(1) Was there a transfer? (Found in (b))
o Have to worry only about transfers out of the estate- only the
transfers that take property out of the estate
Transfers into the estate are NOT AN ISSUE
o The transfer can be a transfer of cash (i.e. a payment) or it can be a
transfer of a security interest to a creditor that was an unsecured
creditor or it can be a transfer of property
The transfer of the security interest often happens when the
creditor is threatening not to ship- Debtor will give security
interest to appease the creditor
Problem 23.2: U is a wildcat driller that has hit hard times. Fears insolvency, and one of his principle
suppliers- OKCS calls him to discuss a payment on his unsecured account. U wants to help OKCS b/c
been good to him so tells OKCSS to take some of the equipment of U. One month and fifteen days
later U files for bankruptcy. Can DIP for U get the equipment back?
Here all the other requirements have been met- only question that may be is was there a
transfer Yes- it was a transfer of property equipment- that counts
(2) Was it a transfer of property interest of the debtor?
o Have to worry about an argument from the Earmarking Doctrine that
this was not a transfer of a property interest of the debtor.
o Earmarking Doctrine is a Judicially Created interpretation of this
requirement and to satisfy the earmarking doctrine three
requirements must be met (1) The existence of an agreement between a new lender and
the debtor that the new funds will be used to pay a specified
antecedent debt
(2) The performance of the agreement according to its terms;
and
(3) The transaction when viewed as a whole does not result in
the diminution of the estate
o Argument of the Earmarking Doctrine is that just substituting one
creditor for another creditor- the old and the new creditor are both
enjoying the same priority
NOTE: There is some argument that still unfair arguably if
the money from the loan is not given to the debtor (i.e. the
new lender cuts a check to the old creditors directly) then
there is no argument about earmarking

55

However, if the new creditor deposits money in the debtors

account and the debtor cuts the check to the old creditors then
there is an argument of control.
o EXCEPTION TO THE EARMARKING DOCTRINE:
The security interest exception applies when it looks like the
earmarking doctrine applies, however the new creditor has a
better position then the old creditor (do not share the same
priority)
Thus earmarking doctrine applies when a security interest is
given for funds used to pay a SECURED creditor
BUT the earmarking doctrine does not apply b/c of the
security interest exception when a security interest is given
fro funds used to pay an unsecured debt
If the security exception applies, the transfer is not earmarked
and it therefore is avoidable to the extent the transfer depleted
the debtors estate or the extent of the value of the collateral
given up by the estate to secure the loan
In re Calvert
The debtor paid off a judgment creditor with a loan he received from his parent. The loan proceeds
were earmarked to pay off an unsecured judgment creditor, thus there was no transfer of the debtors
estate for preference avoidance to be triggered. However, in return of the loan the debtor gave his
parents a security interest in his truck. His parents recorded the security interest by making a
notation on the title. Thus it appeared that the debtor was substituting an unsecured creditor for a
secured creditor, therefore triggering preference avoidance b/c there was a transfer out of the estate.
However, the court held that the security interest was not valid under state law, b/c under state law for
a security interest to be enforceable the collateral must either be in possession of the secured party of
the debtor must have signed a security agreement which he did not here, therefore the security
agreement was not enforceable and therefore there was no transfer and no preference avoidance.
(3) Was the transfer for the benefit of the creditor?
o This also implicates the earmarking doctrine and the problem of
antecedent debt.
o When a new lender is brought in and given a security interest for a
new loan, the antecedent debt requirement is not met (see below)
However, when that new loan is used to pay off the old
creditors antecedent debt is in the game-the transfer is given
for the benefit of the creditor
o When this arises we use 550 which tells you there is liability for the
transfer
Problem 23.9: C owned hardware store that hit on hard times and he is now insolvent. C wants to pay
back some of his creditors, including GC for $20k and FOCB for $30k. He does not care about this
other creditors. So on the eve of bankruptcy, he goes to a new lender for a new loan to pay off these
two creditors. He gives the new lender a security interest in his equipment in return of the loan.
- First- it appears that there is an argument here that there is a preference avoidance issue b/c an
unsecured creditor is being paid by a giving a security interest to a new creditoro This implicates the earmarking doctrine- But the transfer to the bank is not voidable b/c it is not on account of antecedent debt.
o Here the bank took out the loan when it gave the security interest- it was
contemporaneous
- However, here the security interest benefit not just the bank but it also benefits the old
creditors, GC and FOCB. To get the preference back, go to 550 which tell you where there is
56

liability for a transfer- under (a)(1) you can recover from the initial transferee or the entity
whose benefit such a transfer was made
o Here there is a good argument that the transfer was made for the benefit of the
antecedent debt of GC and FOCB- so that satisfies the antecedent debt requirement and
can get the transfer back to them (the payments that were made)
o Also can get the transfer back from Bank even though it is not preferential b/c it is the
initial transferee
550(a) tells us that
However, if the bank has to cough up the security interest they could through the
state law of subrogation rights get the money back from GC and FOB
- NOTE HERE: There is also a claim fro UFTA 5(b)
o 5(b) allows for voidance of the transfer when the transfer is made to an insider who
knew at the time of the transfer that the debtor was insolvent
Remember: This is state law- HOWEVER: The DIP can use state law avoidance
under another section
o For 5(b) transfers, the SOL is typically four years thus the reach back is longer
In addition, the reach back starts from the date of transfer, where in 547 it is
from the petition
So the reach back will be more powerful
o Have to show that the two favored creditors were insiders
For GC this probably would not be a problem b/c she is family
For the FOCB it is harder but there is at least an argument b/c the CEO of the
bank is a gold buddy
o We would also have to show the debtor is insolvent Dont get the presumption like in preference avoidance but have an easier testcash flow insolvency instead of balance sheet insolvency.
(4) Was the made on the account of antecedent?
o All the trustee needs to establish is that the debt arose at some time
before the transfer was made
Under 547(e)(3) a transfer is not made until the debtor ahs
acquired rights in the property transferred
o Under 547(e)(2)(A) there is a 30 day grace period to perfect the
security interest, it is 30 days from when the transfer between the
parties took effect (NOTE: Different from PMSI exception which is
30 days from when the debtor took the property)
If the security interest is perfected within those 30 days it
relates back to the date of the loan
o Under 547(e)(2)(B) there is no relation back if it is perfected
outside the 30 days- then transfer is said to occur on the date of
perfection
o If the transfer of the security interest is given at the same time as the
loan- then the transfer is not on account of antecedent debt
Problem 23.4: Debtor and the creditor agree on loan on 6/1. On 7/1 the creditor perfects and on 9/15
the debtor goes into bankruptcy. Can we avoid the preference given on 7/1?
- Here there was a transfer made of the debtors property (security interest), for the benefit of the
creditor, while the debtor was insolvent and would improve the creditors position as compared
to Chap 7.
- However, this is not account of antecedent debt b/c of the relation back of 547(e)(2)(A) and
was not within the 90 day reach back
57

o Here under the 30 day relation back, the security interest was perfected in the 30 days
after the debtor obtained a legal interest in the property therefore it is deemed to have
been perfected on the same day the debtor go the loan
o B/c it is deemed to have occurred on 6/1, it is also not within the 90 day reach back
period
- Suppose perfection occurred on 7/5 does this change the analysis?
o Yes b/c 547(e)(2)(b) would kick in so that it would be on account of antecedent debt
b/c the perfection would not relate back b/c not within 30 days of the debtor receiving
an interest, and it was transfer was given 90 days before the petition date
o However, if the perfection occurred on 7/5 but the loan agreement and the security
agreement were also executed on 7/5 then it is no longer on account of antecedent debt
and therefore no longer a preference
(5) The transfer was made while the debtor was insolvent?
o Under 547(e) there is a presumption of insolvency for a debtor 90
days before petition
o If we are doing preference avoidance for a transfer to an insider
outside of the 90 days (b/c the reach back is 1 year) then we must
prove insolvency through the balance sheet insolvency test
However we may be able to create a presumption of
insolvency by showing the debtor was not paying debts as
they became due
(6) The transfer was made 90 days before the petition or one year before
petition if the transferee was an insider
o Easy- but must count the actual days (it is not a presumption of 3
months when say 90 days)
o However, under 547(e)(3) any security interest in a piece of
property dated before the debtors acquisition of the property is flatly
forbidded for preferences purposes
The time of the transfer of a security interest in after acquired
property is the date that the debtor acquired the property
regardless of any earlier perfection
As a result every piece of property acquired after the filing is
deemed to be transferred within the 90 day preference period
Problem 23.6: VAC owed FRB $250k. The loan is perfected on all VACs current equipment and all
after acquired equipment which on 3/1 is worth 150k. On 4/15, VAC acquires another $200k in
equipment by a supplier who does not take a security interest, and on 5/25 files for bankruptcy.
- Is there a voidable preference? YES
o A transfer of the debtors property was made for the benefit of the creditor, on account
of antecedent debt (the debt was incurred prior to the transfer of the security interest on
the after acquired property), while the debtor was insolvent, within the 90 day reach
back period, and it allowed the creditor to have a better position then it would in chap 7.
Here, we know the transfer was made within 90 days b/c 547(e)(3) says that
the transfer does not occur until the debtor has acquired rights to the property
The debtor only acquired rights to new equipment on 4/15
- NOTE: It is still a preference even though the transfer is made in accordance with a previous
security agreement allowing security interest on after acquired property.
o NOTE: That if the equipment on 4/1 had been bought with funds from another lender
with a purchase money security then that would not have a security interest by the bank
58

through the after acquired property and if done properly would not be on account of
antecedent debt.
(7) It enables the creditor to recover more then under Chap 7
o The comparison here is how the creditor will do if it gets to keep the
transfer and the pro rata share that it will receive as compared to
what it would just get in liquidation.
o Thus if you are an oversecured creditor, and you receive a payment
in the 90 days preceding bankruptcy it will not be considered a
preference.
o If the creditor is undersecured, then anything the creditor receives in
the 90 days leading up to bankruptcy will be considered a preference
o NOTE CAREFULLY: The test to determine if a creditor is
oversecured or underscored is NOT the date of the payment but it the
date of the petition
On the date of the petition would the creditor do better in
Chap 7 NOT on the date of the payment would the creditor
do better then in Chap 7
Problem 23.1: MILFO is owed $140,000 and it is unsecured. It receives $14,000 payment 60 days
before petition. All the GUC receive 10% distribution in liquidation. Can the payment be avoided?
- Yes, there is a transfer from the debtor for the benefit of the creditor on account of antecedent
debt, while the debtor is insolvent within the 90 day reach back period, and the creditor would
do better then it would in liquidation.
o How does this payment improve the position in comparison to Chap 7?- 10% of 140k is
14,000 which is what the creditor got
NO- B/c not only would they be able to keep the $14,000 payment but then they
would also receive 10% of the rest of the GUC claim
After the payment form the debtor, MILFO has the $14,000 from the
payment and still has GUC for 126,000. Thus it then gets 10% of that
claim as well- thus it get another 12,600.
So in total they are getting $26,600 which is 19% and in liquidation they
would have only received 10%
Problem 23.5: Debtor has two secured creditors, MC which as a debt of $35k secured by $30 collateral
and C which as a debt of 40k and is secured by $50k of collateral. On 2/2 debtor makes a payment to
both creditors of 5k then files for bankruptcy on 4/2. Are either in trouble of having the payments
avoided through preference litigation?
- Yes- Each element is met for both except element 7 is not met for C b/c it is oversecured but it
is met for MC b/c it is undersecured- therefore MC runs the risk of being avoided.
Problem 23.7: On 6/1 the creditor is oversecured- the balance on their debt is $280k and it is secured
by collateral of 300k. On 7/1 the debtor makes a payment to the creditor of $20k. On 7/15 a fire
destroys the banks collateral and on 8/1 the debtor files Chap 11. Can the payment of $20k on 7/1 be
avoided?
- Yes b/c all the elements are met, and the creditor is improved b/c at the time the petition was
filed, the bank had no collateral
o REMEMBER, determine whether the creditor is oversecured on the date of petition.
- Here the bank is just one more unsecured creditor
Problem 23.8: Suppose that after the fire destroys the machine, the company goes and buys another
machine on unsecured credit from the manufacturer and the machine is worth $300k, would there be a
voidable preference? NOTE: The presumption is that the debtor gives a new security interest on the
machine.
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Now we have two transfers that may be avoided. Again all the elements are met, just
determining if there are improvements to the creditor from the Chap 7 position.
o NOTE: The creditor is not fully secured now, but the security interest is a transfer to an
unsecured creditor (bank become unsecured when the machine caught on fire)
Once we avoid the security interest, we also have to avoid the payment b/c the
creditor is still unsecured
o NOTE: IF this had been done right, the collateral would have been insured and the bank
would have been named beneficiary in the insurance proceeds
Then if the bank allowed the proceeds to be used to buy a new machine they
would have a security interest in the proceeds
Then a security interest in the new machine would have been allowable
b/c the security interest just continues with it
Even if the insurance proceeds did not cover the full amount of the new machine
and the bank covers the difference, then the bank will be secured to the full
extent of the machine
Say there was $200,000 of insurance proceeds, the bank is still secured
on the $200,000 of the machine b/c the bank remains a secured creditor
on the $300,000 machine
There is $100,000 in the machine and a $100,000 loan at issue
o If the bank gave the $100,000 loan and took a security interest in
the machine for the remaining amount it is not a preference b/c
the new security interest is not given on account of antecedent
debt- it is for a new loan
o The bank is however still undersecured b/c the $100,000 of old
debt is undersecured
Voidable Preference and State law Fraudulent Transfer Law as an Option
o When a creditor is looking at pushing a debtor into involuntary
bankruptcy to avoid preferential payments made- always ask if the
same ends could be met through State law Fraudulent Transfer
Problem 23.10: Here a group of GUC want to push the debtor into either making payments or into
bankruptcy. They have found out that he just repaid himself for a $22,000 loan he made to himself,
depleting the business of all of its liquid assets. What should you advise your clients?
- If we decide to use 547, we would be able to get the payment back even though we are
coming up on 3 months which is the reach back period for generic preference avoidance b/c the
creditor that received the payment is an insider.
o 547 allows for 1 year reach back for insiders
o However, if we wait past the 90 days we will lose the presumption of insolvency
The burden will be on the GUC to show insolvency which can be very tricky
o So what else can be suggested other then Involuntary bankruptcy?
- Instead of putting the company into involuntary bankruptcy we could try to use state law 5(b)
of the UFT.
o Here we will have to show insolvency as well BUT under the UFT, insolvency is shown
by the cash flow test- 2(b) gives you a presumption of insolvency when the debtor is
not paying their debts when they come due
This is not available in 547 after the 90 day pre-petition presumption of
insolvency expires. Then have to show balance sheet insolvency which is very
difficult
o The other advantage of going under state law is you dont have to pay the trustee or
share with other creditors and you have a longer reach back period (2 years)
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3. Preference Exception
ASK FIRST- IS THERE A PREFERNCE
o If there is a preference, then determine if the preference should be
avoided
547(c) describes the exceptions to preference avoidance
Each of the most commonly used subsection of (c) are an exception
o (c)(1)- Contemporaneous Exchange
o (c)(2)- Ordinary course payments
o (c)(3)- Purchase Money
o (c)(4) New Value Rule
o (c)(5) Floating Lien
Contemporaneous Exchange
o 547(c)(1)
o It permits debtor to pay off creditors within 2-3 days without
incurring preferential avoidance
o Two requirements for contemporaneous exchange exception:
Intended by the parties to be a contemporaneous exchange
Was in fact substantially contemporaneous
o The exception is intended to protect parties that pay by check b/c
usually a check is cleared 2-3 days later- so really there is an
argument that the check was payment for antecedent debt
NOTE CAREFULLY: The exception for checks only if the
check is accepted on the first presentation Thus if the check bounces then the contemporaneous
exchange exception is lost and any payment used after
that will be a payment for antecedent debt
Problem 24.1: Here, the debtor is having some financial difficulty and the chief supplier told them they
would only make delivery for cash payments. The Creditor completed about two deliveries per week
for about $2400 each during the 90 days preceding bankruptcy. Three times during that period the
debtor did not have the cash on hand so the creditor agreed to collect the payment the next delivery,
which was accomplished each time. When the debtor files bankruptcy can the DIP recover any of these
payments made 90 days before bankruptcy?
- Step 1: Is there a preference here?- Yes, there was payments made from the debtor for the
benefit of the creditor, for antecedent debt, while the debtor was insolvent, within 90 days prior
to bankruptcy (not dealing with an insider) and it would permit the creditor to do better than in
just Chap 7 b/c unsecured.
- Step 2: Is there an exception to the preference avoidance- Possible Contemporaneous Exchange
o Contemporaneous exchange says the debtor can pay the creditor back in 2-3 and it will
count as substantially contemporaneous. However, must who two requirements.
o Although this may in fact have been substantially contemporaneous the parties may not
have intended it to be substantially contemporaneous
Ordinary Course Exceptions
547(c)(2) covers the ordinary course exception- it allows for an
exception to violation of the preferences when the transaction is in
accordance with the ordinary course of business, notwithstanding the fact
that they permitted some unsecured creditors to be paid in full

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There is a two part process to determine if ordinary course exception

applies
o First must determine if the debt is incurred in the ordinary course
of business
o Second must determine if the payment of the debt (the
preference) is in the ordinary course of the business
To determine if the ordinary course exception applies under step 2 the
court looks at:
o The way the parties actually conducted business, looking at the
consistency of the transactions as compared to other transaction
between the parties
Court will consider alterations from any of the as
evidence that the transaction is outside the ordinary
course of business
The length of time the parties were engaged in the
transaction at issue- did the debtor always wait a
few months to make a payment
Whether the amount or form of tender differed
from past practices did the debtor always pay
late
Whether the debtor or the creditor engaged in any
unusual collection or payment activities
Whether the creditor took advantage of the
debtors deteriorating financial condition
o If cannot show that this is ordinary course of the parties, we may
be able to use the ordinary business terms test to prove ordinary
course
Under ordinary business terms an objective test is
applied- look not to how the parties behaved but how
parties in general interact in such circumstances
NOTE: We are not talking about the ordinary
business terms for a company in financial distress
Problem 24.3: GV nursing home filed for bankruptcy in September. The Trustee found the following
entries of transactions: (1) $14,200 in utility bills paid 4 weeks before filing. GV had been behind on
utility payment, power company threatened to shut them off, GV paid them in full. (2) June, July,
August mortgage each due on the first but paid between the 20th and 25th with $50 late fee. Mortgage
is undersecured. (3) $10,000 to Solid State Bank for undersecured 6 month loan. Payment made on
7/15 the day it was due. (4) Payment of 6,000 to JM the principal s/h for repayment on 30 day loan
made on its due date.
- Step 1: Are these payments preference payments?
- Step 2: If they are does an exception apply?
- Utility Billso This is a preference- all the elements are met.
o Does the ordinary course exception apply?
o Step 1:
Utilities are incurred in the ordinary course of business
o Step 2:
Is this how payments were done in the past between the creditor and the debtor?
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May be able to make an argument but the threat from the utility company
that it would shut off the power makes it a much more difficult argument
Does this fall under the ordinary business terms objective test?
This will be even harder to meet b/c the threats of the utility company are
not routine for the normal course of business
o They are routine for customers that dont pay bills but this is not
the test
The June/July Mortgage Payments
o Step 1: These are preferential payments b/c made within 90 days (assuming June was
made within 90 days) and the mortgage is undersecured
NOTE: Under the preference- the entire payment not just the late fee must be
returned.
o Step 2: Does an exception apply- Ordinary Course Exception
o Step 2(a):
Mortgage are incurred in the ordinary course but are late fees incurred in the
ordinary course- probably not but look at it from both tests
o Step 2(b)
Is the payment how it was done in the past between the debtor and the creditor?
If the nursing home ordinarily pays on time and the pays late in
June/July then this cuts against the ordinary course argument b/c it is not
the standard practice of the parties
But if the debtor for some reason always paid late, then there would be a
better argument that this is how the parties always did it
Does this fall under the ordinary business terms objective test?
Maybe able to make an argument that people make later payments all the
time and the mortgage holders have this policy on how to handle it
o This is at least a viable argument
Loan payments to Solid State
o Step 1: Is this a preference- Yes all the elements are met
o Step 2: Does an exception apply- Does the Ordinary Course Exception Apply?
o Step 2a:
Loans are incurred in the ordinary course of business
o Step 2b
This is ordinary under both test- both the practices of the parties and the
objective test
Loan Payment to the S/H
o Step 1: Is this a preference- Yes all the elements are met
o Step 2: Does an exception apply- Ordinary Course Exception
o Step 2a:
A loan from a s/h is normally not in the ordinary course
However there is an argument that it is incurred in the ordinary course in terms
of 547(c)
However this loan is probably considered not in the ordinary course b/c it looks
like a desperation loan
Have to look at the background is this the way the parties always did it
o Step 2b
Repayment on time would again depend on the facts according to the parties but
under the objective test re-payment on time is normal.
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The Payment to the S/h for the loan may be dealt with under UFTA 5(b) b/c it is repayment to
an insider while the debtor is insolvent and the insider probably has reason to believe the debtor
is insolvent
o Remember, under 544(b) the DIP can use state law
Thus the DIP can use state fraudulent transfer law to avoid the preferential
payment
o UFTA 8(f)(a) may apply to this however this really only covers when an insider
makes a good faith effort to rehabilitate the debtor and gets back a security interest for
the new value and for securing the antecedent debt- then it will not be avoidable under
5(b)
Purchase Money Exceptions
o 547(c)(3)
o Similar to the exception from UCC Title 9
o A PMSI creditor that files within 30 days of the transfer receives
full protection against voidable preferences
Rationale: PM are regarded as beneficial to the estate b/c
they bring new property in and therefore they deserve
protection
Problem 24.2: On 7/1 the debtor places an order for $300,000 worth of equipment with a
corresponding note and security interest. On 7/28 the equipment is delivered. On 8/21 the security
instrument is perfected. On 9/30 the debtor files for bankruptcy.
- Step 1: Is there is preference?
o A transfer was made, but from 547(e)(2) we know the transfer did not occur until the
debtor acquired the rights to the property which did not occur until 7/28. From (e)(2)
(A) and (B) we know that b/c the transfer took place on the 7/28 and perfection was
within 30 days the transfer relates back to the date the debtor took possession so there
is an argument that this is no on account of antecedent debt
o However, there is still probably a preference b/c there is still probably antecedent debt
b/c the debt starts on the date the loan was taken
- Step 2: Do one of the exceptions apply?
o The Purchase money exception applies- exception (c)(3)
o This is the EASIEST exemption to prove
May be contemporaneous exchange but dont really need to argue all that when
PM exception applies
o NOTE: Even if there had been another lender who had perfected a security interest
including after acquired equipment that would not affect the creditors rights to the
equipment b/c Purchase Money is given priority over such security interests
New Value Exception
547(c)(4)
o This exception is difficult by the exception only shelters
preference payments that come before a particular extension of
new value
Rationale- entice creditors to give credit to companies in
financial distress
This exception will normally apply when dealing with a line of credit
Mechanics of (c)(4)
o Identify a payment or transfer that is preferential under 547(b)
o See if the avoidable amount of the preference can be reduced by
the amount of the later advanced new value
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o Start by working chronologically form the 90th day of Bankruptcy

Identify each payment or other transfer that qualifies as a
preferential payment under 547(b)
After the preferential transfers are located, work
backward from each grant of new value to determine
whether there it is subsequent to a given preference with
the same creditor having advanced unsecured credit to the
debtor
o Any advance of unsecured creditor after the preference will work
to trigger (c)(4) but the dollars of each can only be counted once
Thus two preference of $1000 each followed by an
extension of $1500 unsecured credit will permit the
creditor to keep $1500, not the full preference.
Problem 24.4: Where does the new value exception apply in the list?
Date
Transaction
Amount
Balance owed to
Creditor
1/1
Beginning balance
$80,000
1/3
Payment from Debtor
5,000
75,000
1/15
New credit from creditor
4,000
79,000
2/10
Payment from Debtor
2,000
77,000
2/28
New Credit from creditor 8,000
85,000

New credit from creditor

9,000
94,000
3/10
Payment from debtor
1,000
93,000
3/17
New credit from creditor
6,000
99,000
3/20
Payment from debtor
10,000
89,000
4/1
Payment from debtor
9,000
80,000
4/10
Debtor files bankruptcy
- Step 1: Which ones are preferenceso The only issue we will be looking at here is if they are outside the preference periodItalicized means outside the preference period
- Step 2: Does an exception apply- Does the new value exception apply
o Look at the payments going out- Gray
o Determine if they are preferences- we did that in step one
o Then determine if there is a new value exception
2/10 payment of $2,000
New value extended on the 28th and 4th in the amount of 17,000 so the
new value covers the payments and it is not a preference
o NOTE If the payment from the debtor had been $12,000 it would
still have been covered b/c the every dollar of new value can be
counted once
However if the 2/10 payment was $18,000, then $17,000
of the 2/28 and 3/4 extensions would have been coveredi.e. not preference
But $1000 would have still been a preference and could
be avoided
The 3/10 payment of $1000 is a preference
But new value of $6000 is extended so it is not a voidable preference
o NOTE:T that under the second hypo- if the 2/10 payment had
been 18,000 and there was $1000 of the payment that was still a
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preference, the 6,000 extension would cover the extra $1000 so it

would not be a preference
Both the 3/20 and the 4/1 payments are preferences b/c they are not followed by
any new value and the excess of new value given before the payment cannot be
counted for subsequent payments
Diminimus preferential payments
o (c)(9) excuses diminimus preferential payments If the payment is so small not going to fight it
If the preferential payment is less then 5,000 in the
aggregate then we are not going to pay to fight it

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4. The Floating Lien

A floating lien is a lien that goes on the inventory and accounts
receivable of the debtor- 547(c)(5)
o Called a floating lien b/c the value of the goods is always
changing
Floating Lien v. After Acquired Property
o The security interest given by virtue of an after-acquired property
clause during the preference period is considered a preference
even thought the security interest was signed before possession
o Likewise a floating lien applies to the new inventory and
accounts receivables as they come into the estate, thus they
would be deemed a preference and wiped out b/c the inventory is
acquired by the debtor during the 90 days pre-petition and they
allow the creditor to do better in liquidation
The Code decided to make an exception
o Did not want a blanket exception b/c then creditors could strong
arm the debtor to keep enough inventory to make sure the
secured creditor is always secured
o (c)(5) curbs such abuse by saying that during the preference
period, if the creditor is more secured then it was before the
preference period then the extra preference is a preference that
can be avoided
A creditors collateral position is improved when its insufficiency is
smaller on the petition date then on the day 90 days before the petition
date
o Take two snap shots One on the creditors collateral position on the date of the
position
The other of the creditors collateral position on the first
day of the preferential period (90 days before the petition
is filed)
Under the floating lien, the creditors cannot improve their position on the
collateral liens
IF The LOAN IS GIVEN DURING THE PREFERENCE PERIOD
o 547(c)(5)(B) covers the scenario when the loan is given during
the preference period
o Still concerned about the floating lien but cannot use P-90 b/c the
loan was not executed at that point
Thus two snap shots are of the date the loan is given and
the Petition date.
Problem 25.1: On 2/14 (P-90) the debtor has 4.2 million of inventory secured by the creditor, and the
creditor is owed a loan balance of 4.0 million. Thus as of 2/15 the creditor is oversecured. On 5/14(P)
the debtor has an inventory of $5.2 million which the creditors have a lien on and a loan balance of 4.6
million. Is there a preference and does an exception apply?
- Step 1: Is there a preference?
o All the security interest on the inventory bought during the preference period is a
preference.
- Step 2: Does an exception apply?
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o 547(c) says that there is an exception: As long as the deficiency of the creditor does
not get smaller between P -90 and P there is no preference avoidance for the liens given
on the collatearl- the deficiency of the creditor cannot get smaller
If the deficiency of the creditor does not get smaller based on P-90 and P then
there is no preference avoidance
o On 2/14 there was a deficiency of zero, thus there is no where for the creditors
deficiency to go-they are oversecured
Since the creditor cannot improve its position the creditor is going to be able to
keep whatever security interest they have on the petition date
Problem 25.2: Even if the debtor made two payments to the creditor of $100,000 during the preference
period- would there be a preference avoidance?
- Now at P the loan is paid down to $4.4 million
o But remember basic preference- since the creditor is oversecured at P, there is no
preference b/c there is no Chap 7 improvement
Problem 25.3: On 9/10 there is 405k in collateral on the inventory and 430k in the loan balance. Thus
the creditor is oversecured. Then sometime in September the collateral goes down to 300k with the
loan balance remaining the same. Threats by the creditor were made, so the debtor pumps the
inventory up. Debtor files for bankruptcy on 12/10 with collateral in the amount of 500k and with a
loan balance still of $430k. Is there a preference avoidance?
- Step 1: Was there a preference
o Yes there is a preference given based on the liens that are given when the inventory
changes
- Step 2: Is there an exception that applies- yes- The Floating lieno Under the floating lien only to two snap shots- on P-90 and on P
These are the only two days that are looked and it does not matter if the
collateral when down during the in between
o Here there is no preference b/c the Creditor is oversecured on 9/10 and on 12/10 they
are still oversecured.
Problem 25.4: SV has a lien on all of MTs inventory (gold). On 4/1 the inventory is worth 800k and
the loan is worth $1 million. The government freezes MTs assets, including gold and during that time
the price of the gold jumps up 42%. On 6/1 the MT files for bankruptcy. Can the DIP sue SV for a
preference
- There is no preference here b/c there was not a transfer during the preference period. Thus
there is no preference avoidance, just b/c SV is in a better position b/c market price went up
does not mean that there is a preference
o There must be a preference to be an avoidance and there must be a transfer for there to
be a preference
- NOTE: What happens if the collateral is something like crops- where the value gets higher the
closer to harvest but there are no transfers
o Here it is different in that there have probably been estate transfers in labor, fertilizer,
etc
o So how are those transfers dealt with
Have a tri-lateral preference agreement
Can probably say that there is a transfer to satisfy 547(b)
How do you get some of the floating lien for the benefit of the unsecured
creditors
o How do you divide the value of the crop?
Unclear from the statute- Tung thinks the unsecured
creditors should at least be made whole
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5. Setoff Preferences
Governed by 553- specifically 553(b)
A setoff right is much of the same effect as a security interest
o Thus like the floating lien, the Code is designed to deter an
improvement in a lenders set off position
The formula in 553(b) is similar to the concept that 547(c)(5)
espouses but not identical
o NOTE WELL: The avoidance power of the DIP applies only to a
creditor that offsets prior to bankruptcy
A creditor who waits and exercise its right to setoff after
bankruptcy with the permission of the court under 362
will not be required to surrender any improvements in the
set off position obtained during the 90 day period
The court takes two snap shotso One on the day the set off is taken; and
o One 90 days before petition.
Court is looking for a decrease in the deficiency between what it is owed
and what it owes on those two days
o Thus the best the bank can do is on P-90
Exampleo On P-90 there is $10,000 in an account with a $200k loan balance
o On the set off date there is $20,000 in an account with the same
loan balance
Thus the deficiency on P-90 is 190k and the deficiency on
the setoff date is 180k
o 553 operates to make the $10,000 amount received by the bank
from the improved position to be a preference
The bank will have to give it back
6. Executory Contracts
Executory contracts if both parties have material obligations outstanding
o If either have fully or substantially performed then the contract is
no longer executory and should not be dealt with by 365
o Similarly if the contract had been terminated prior to bankruptcy,
either b/c it its term had ended or b/c one of the parties rightfully
canceled it, it is not executory.
A contract may provide grounds for termination other
then bankruptcy or financial condition of the debtor
If valid in non-bankruptcy law, termination rights not
based on an ipso facto clause are effective against the
estate
365 gives the estate the right to assume or reject executory contracts
o NOTE: Executory contracts are an asset of the estate and are
brought into the estate through 541
Assuming or rejecting an executory contract
o Under 365(a) the trustee can either assume the contract or reject
it with court approval
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NOTE: If the trustee assumes the contract then the

performance is due by the estate and qualifies as an
administrative expense and is thus entitled to priority
under 507(a)(1)
NOTE: That if the estate assumes the contract and
then later rejects it, the rejection is an estates
breach and the damages are treated as an
administrative expense under 365(g)(2)
o If the trustee rejects it, the breach is treated by 365(g)(1) as a
pre-petition breach by the debtor
The other party to the contract becomes a creditor and its
claim for damages for breach of contract is classed by
502(g) as a general unsecured pre-petition claim
When will a trustee assume and when will a trustee reject?
o If a contract is advantageous and profitable or if it advances the
debtors plan for economic recovery in Chap 11 cases, then the
trustee should assume it
o If the contract is not on favorable terms the estate could do better
by using it resources elsewhere or if the contract imposes an
unacceptable burden or risk, the trustee should reject it
When the price in the market compared to the contract
price is rising, the debtor should breach
o NOTE: What a non-debtor gets if either the contract is breached
and then the breaching party enters bankruptcy or the debtor
breaches first and then enters bankruptcy is the same
Damages upon termination
o P is the debtor seller that has contracted with C the buyer for C to
pay $30 per barrel of oil. P has promised to provide 100k barrels
at that price. The value of oil jumps to $50 per barrel two weeks
before this contract is suppose to occur. P is in bankruptcy, so he
will reject the contract b/c he can sell it at $50 per barrel.
C is out $2 million ($20 lost per barrel for the contract of
100k barrels)
C will have a claim for that amount in bankruptcy as a
pre-petition unsecured creditor
If the GUC get paid $.30 on the dollar, C will get
$600,000 and P will profit $1.4 million (Revenue went up
to $5 million on breach from $3 million- thus $2 million
in profits minus the damages owed to C)
But note: That it is the unsecured creditors that are
benefiting from the $1.4 million
o Damages for lease that is rejected- 502(b)(6)
(b)(6) Puts a cap on rejection damages for a landlord
First the landlords damages are determined like regular
breach
Then (b)(6) puts a cap on the cap is
(A) sets the damages for the future
- (i) and (ii) determine when you start
calculating

70

 (B) gives you back rent

Under (a) it is a ceiling of The greater of one years rent or 15% of the
remaining lease not to exceed three years
- Thus one year is the minimum
- Three years is the maximum
The easy way to think if the breach occurs
Anywhere from 0 years to 6 2/3 years is one years
rent
Anywhere between 6 2/3 years and 20 years you
have to calculate 15% of the remaining lease
If the remaining lease is 20 years or more then
three years
- NOTE: That if the rent is increased as the
lease goes on you only use the earlier rents
NOTE: The landlord still has a duty to mitigate-try to relet immediately so there are no damages
When must the decision to accept or reject be made by
o Under 365(d)(1) the trustee in Chap 7 case has 60 days after the
order of relief to assume or reject a contract
The period may be extended b the court for cause
o Under Chap 11, unless the contract is non-residential real estate,
the trustee may make the decision to assume or reject any time up
to confirmation of the plan
o Upon application of the other party to the contract, the court can
require the trustee to make an earlier decision but this is rare
that a court would make such an order
o Assumption and rejection must be given approval by the court
unless the trustee does nothing and the 60 days pass- in which
case the rejection is automatic.
Assumption of Contracts in Default:
o 365(b)(1) governs assumption of a contract that is in default
o A trustee is it wishes to assume a contract that is in default must:
(A) Cure the default
(B) Compensate for any loss caused by the default; and
(C) Give the party adequate assurances of future
performance under the contract
o Under 365(b)(2) there are two types of default that need not be
cured:
(1) If the default is simply a violation of the ipso facto
clause the default really cannot be cured be cured
therefore it is not required
(2) If the default consists of failure to pay a penalty rate or
its consists of some non-monetary default (like keeping a
business open for certain hours in a day) the cure is not
need to assume
Adequate assurance is provided by showing that
resources are likely to be available for the

71

discharge of the contractual obligations and

performance appears to be commercially feasible
Problem 26.5: Here the debtor is a franchisee and wants to keep the franchise agreement she currently
has with D, but she is afraid D will cancel for any reasons. We need to worry whether this contract can
be assumed.
- Look at the parts of the contract- break it down- here there are four components to the contracto Installment Real Estate Purchase
o Credit supply contract (90 day term)
o Option for $100k loan
o 1 years Real estate lease
- Of these sub-agreements which can be assumed?
o The loan standing alone could not be assumed under (c)(2)
o In addition, the installment real estate purchase has some aspects of the debtor owing
money to the franchisor and bankruptcy courts have said that cannot be assumed
o The Credit supply contract courts have said can be assumed
o The lease of real estate can be assumed
- So overall can it be assumedo Probably not without severing the pieces of the contract b/c at least the loan portion
cannot be assumed
o If you can assume the two pieces that are clearly assumable there are two problems with
this
The debtor may not want it then b/c not as valuable
Run the risk of having a contract enforced that represents neither parties
intentions when the signed the contract
Problem 27.1: A lease exists between J and LL. J experiences a fire and goes into bankruptcy. J wants
to assume what must he do and what are the arguments that he cannot?
- To assume J will have to bring the contract up to date which requires
o Provide adequate assurances
o Cure default
o Pay for any damages from his default
- LL will argue that J cannot assume under two theorieso (1) LL can argue that lease was terminated by the eviction
If LL is right, the contract was terminated before the petition then J cannot
assume
Argue that notice was given to terminate immediately
But J may argue that had 5 days to cured, filed before that period expired.
o (2) LL could argue that J breached the contract by not having insurance and that there is
no way not for J to cure that breach
This relates to (b)(1)(A)
Under the lease there was always required to be insurance on the
property, and the debtor let the insurance lapse
There was a period on the lease that it was uninsured and the debtor
cannot go back and cure the default now
J will argue that brining the insurance current will cure the breach
Some courts will allow it others will not
J may also be able to argue under (b)(1)(A) it is impossible to cure

72

However, if it is impossible to cure but its non-residential real property,

then you can cure at the time of assumption- which means you can get
insurance
o The break down of 365 on this issue is as follows- the Code
draws a distinction between real property and non-real property
and commercial and residential
o We have the cure requirements exceptions to the cure
requirements under (2)(D)
o However under (1)(A) cure is also not required if
Non-monetary default on real property lease if it is
impossible to cure EXCEPT for non-residential RP lease
In non-residential RP lease, they must cure by
complying with the lease going forward
Thus a tenant in a non-residential RP lease has a
greater obligation then a debtor on residential RP
Thus under this analysis- J would win b/c he brought the insurance up
he has complied with the lease
Contracts that are Not Assumable
o 365(c) denotes three types of executory contracts that may not
be assumed
o Under 365(c)(1) in the absent of consent of the other party, a
trustee may not assume a contract if the applicable law excuses
the other party from accepting performance from or rendering
performance to someone other then the debtor or the debtor in
possession
Here the non-transferability under non-bankruptcy law
enables the other party to resist assumption by the estate if
the transfer of the contract could have been prevented
outside of bankruptcy
This usually applies to personal services contracts
(like the actress case from Contracts) and to
contracts with the government.
o 365(c)(2) forbids the trustee from assuming a contract to make
a loan, to extend other debt financing or financial
accommodations to the debtor, or to issue a security of the debtor
It is confined to loan and financing contracts
It has been strictly construed and courts refuse to extend it
to contracts whose primary purpose is not the provision of
loan or financing
o 365(c)(3) talks about contracts that are terminated before
bankruptcy
Bankruptcy Termination or Ipso Facto Clauses
o An ipso facto clause is a clause in a contract that allows a nondebtor to declare default or to terminate the contract on the
grounds of the insolvency, financial condition, or bankruptcy of
the debtor
It is ineffective in bankruptcy
o Ipso facto clause is referred to in 365 in
73

(b)(2)- which does not require cure of a breach of an ipso

facto clause in the contract
(c)(1) makes such contract terms ineffective in deciding
whether contract rights are transferable under nonbankruptcy law
(e)(1)- prevent termination or modification of an
executory contract after the petition on grounds of ipso
fact clause in the contract or in non-bankruptcy law
(f)(3) prevents termination or modification under such a
clause or provision of non-bankruptcy law when the
trustee assigns an executory contract after assuming it
Debtor Lessor and Debtor Lessee
o If the debtor is the lessor of real property, 365(h) allows the
lessee to elect either to treat the rejection of the lease as either
termination of the lease, or to remain in possession of the
property until the end of the lease term
If the lessee non-debtor continues in occupation (h)(1)(A)
(ii) preserves all the lessees rights under the lease, such
as those relating to the due dates for rent and other
payments, the right to occupy and the right to sublet
However, the lessor is relieved form performing
any of is future obligations such as the provision
of services and maintenance of the premises
The lessee may still pay rent, which is offset against any
damages suffered as a result of the non-performance of
the lessors duties
o NOTE: A tenant non-debtor does better then the owner nondebtor in bankruptcy
The owner non-debtor who is leasing to debtor tenant just
becomes an unsecred creditor in the face of rejection
o But a tenant non-debtor under (h) although he has to still pay
rent, can offset the payment of rent
NOTE: We see the same thing with leases in intellectual property under
365(n)
Assignment
o A trustee can assume a contract and then sell it out to someone
else
If the contract is the kind that would be assignable by the
debtor outside of bankruptcy, there is no reason why the
trustee should be able to do the same
o 365(f) governs the trustees ability to assign assumed contracts
on the condition that the assignee provides adequate assurances
of future performance
NOTE CAREFULLY: That the trustee must first assume
the contract before he assigns it therefore he must go
through the process outlined in (b) before he can even
assume
(f) invalidates contractual anti-assignment clauses and
also overrides non-bankruptcy laws that generally uphold

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anti-assignment clauses in contracts or prohibit

assignment of contract rights
o Upon assignment, 365(k) relieves the estate of all liability for
post-assignment breaches
7. Federal Fraudulent Transfer Law
Under the Bankruptcy Code 548 the DIP has fraudulent transfer rights
similar to that in state law under the UFTA
Under 548, the DIP can avoid a transfer if either
o (a) The transfer was down with the actual intent to defraud; or
o If the debtor received less the REV and was financially shaky at
the time of the transfer
Financial shakiness can be established trough one of four
ways
The debtor was insolvent or the transfer made
them insolvent
The debtor is left with unreasonably small capital
(undercapitalization)
It was intended or believed that the transfer would
cause the debtor to incur debts beyond their ability
to pay
It was a non-ordinary course transfer to an insider
under an employment contract
548 v. UFTA
o Under 548 the reach back period is 2 years from the date of
petition
Under the UFTA, the reach back period is varied
o Under 548 the DIP is the one avoiding the transfer, do not have
the requirements that there be an actual creditor
Under UFTA, there must be an actual creditor
548 v. 544(b)
o 544(b) allows the DIP to use UFTA as well as the Strong Arm
provision
Under 544(b) however there has to be an actual creditor
that could have relied on state law to avoid the transfer
The DIP can then use the law that that creditor
could have relied on, including state law
o There are subtle differences between 548 and 544 and the
UFTA, but there may be times the latter is more advantageous
Usually the UFTAs reach back provision is longer
There may also be other scenarios when the TIB or DIP
wants to use state law transfer avoidance instead of 548
The question remains that if the TIB steps in the
shoes of an actual creditor with $100 claim is the
TIB limited to avoiding only $100 b/c that is what
the creditor could avoid
The Supreme Court said NO- TIBs avoidance
power is not limited to the avoidance power of the
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creditors claim that the TIB is relying on for the

TIBs status.
Down stream, upstream and cross stream transfers
All of these transfers involve a parent and its subsidiary or two
subsidiaries
o A downstream transfer is where the parent transfers something to
the subsidiary (whether it is payment, or a security interest, or
usually a guarantee on their assets)
o An upstream transfer is where the subsidiary guarantees the
parent
o A cross stream transfer is where one subsidiary guarantees
another subsidiary
Downstream transactions are usually not vulnerable to fraudulent
transfer b/c any value the subsidiary gets from the financing, the parent
enjoy b/c they own the subsidiary
But upstream and cross stream transfers are vulnerable to fraudulent
transfer b/c there is a claim that one party is not getting REV.
Hypo based of Image Worldwide
Sister 1 owns Sister 1, Inc
Sister 2, owns Sister 2 Inc
Sister 1, Inc Sister 2, Inc (a gift of land to help out)
o b/c of the transfer, Sister 1, Inc is insolvent and 6 months later
files bankruptcy
This is s fraudulent transfer b/c there is no REV to Sister 1 and it renders
her insolvent
o NOTE: This result should not change b/c they have common
ownership
o Thus if Sister 1, Inc and Sister 2, Inc are both owned by Sister 1
and Sister 2 and the same conveyance is made, the CREDITORS
of Sister 1 are harmed by the give away
o NOTE: The harm to Sister 1 Inc, does not change if Sister 1, Inc
gives an asset or if they incur a liability on behalf of Sister 2, Inc
If Sister 1, Inc is the guaranty and gives a security interest
in Sister 1s assets and Sister 2, Inc gets the loan, then
Sister 1, Inc gives the security interest without getting
anything back
Creditors are still hurt the same way as if land was
given away.
REMEMBER: IT IS THE CREDITORS WE ARE PROTECTING
Who is liable for a Fraudulent Transfer
550 (a) determines who is liable for the fraudulent transfer
o Under 550(a)(1) if the transfer is void b/c of fraudulent transfer,
the initial transferee of such transfer is liable
Thus the DIP can go after the initial transferee to have the
fraudulent transfer unwound
o Under 550(a)(2) if the transfer is void b/c of fraudulent transfer,
the subsequent transferee may be liable unless the subsequent
76

transferee takes in good faith and without knowledge of the

voidable of the transfer
o Thus in a fraudulent transfer, the initial transferee is always on
the hook and the subsequent transferee is only on the hook when
it can be established that they did not take in good faith and
without knowledge of the voidability of the transfer.
Problem 30.1: B owns a company and 6 mths ago when company was in trouble, went a spent $40,000
on a family vacation.
- If the company gave B the loan and did not get REV in return, then there may be a fraudulent
transfer assuming financially shakiness
- Thus if the requirements of 548 are met we want to know whether the cruise company is the
initial transferee or the subsequent transferee
o If they are the initial transferee- i.e the check went right from the company to the cruise
company then cruise company- then they are on the hook and must give the money back
But if the check was deposited in Bs account first then the cruise company is a
subsequent transferee
The cruise company can then argue that they acted in good faith and
without knowledge of the voidability fo the transfer- in which case they
can get out of the voidability of the transfer
o NOTE: If this is the case the B is the initial transferee and the
TIB can go against him for the return of the transfer
- If B is the initial transferee and we are representing B and the company we cannot proceed b/c
their interests are now opposed to one anothero You as the companys lawyer may have to sue Burt- need to tell B to get own attorney
Problem 30.3: This is classic fraudulent transfer case. Advant is a Chap 7 debtor the sold a building to
SF. The building was worth $900k and SF paid for the building in stock that was told to be valued at
$900k but really had a value of $90k at the time of the transfer (NOTE: It does not matter if the value
goes up in value after the transfer, we look at the value of the stock at the time of the transfer). SF then
puts in $300k worth of renovations and sells the building to EW for $1 million
- Can the Chap 7 TIB get back the transfer
o Chap 7 TIB can argue the transfer was fraudulent- Advent did not receive REV
Argue Constructive Fraud b/c the debtor only go 90k
- From whom can the TIB recover
o If EW did not know about the fraudulent transfer then A cannot recover from EW b/c he
is not an initial transfer (who is always on the hook) but instead is a subsequent
transferee that took in good faith and without knowledge of the voidability of the
transfer.
o So SF would be on the hook b/c SF is the initial transferee
What can A recover from SF?
A can get $810k to make the transfer for REV but we cannot unwind the
transfer in the traditional sense b/c SF does not have the building and
cannot get the building back from EW
o But A can recover the value given
And remember that at the day that the stock was
transferred it was only worth $90k which is what we look
at- even if it went up in value to REV since then
- Suppose that when the TIB sues for fraudulent conveyance to get the building back and SF has
not sold the building but has put improvements in the building, what does SF get and what does
A get?
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o When SF gives the building back A will also give the stock back
Therefore, A has a building that is now worth $1 million and SF has their stock
back
However, SF will also get a lien on the building- 550(e)(1)
o 550(e)(1) says that SF will get a lien in the amount of the value
given or in the amount of the improvements- whatever is less
Here the value give is $100k and the improvements were
$300k so SF would get a lien on the building for $100k
So net to the TIB is even
o He has a building that is worth $1 million and a lien on that
building for $100k so total of $900k
SF is still out $200k but that is okay b/c it was just a bad
investment deal.

78

iv.
Negotiating and Confirming a Plan
When looking at a plan- review two things to determine is value
Business issues- how do you get cash
o Cash to fund reorganization
Short term cash may come from
- Lien avoidance that can then be given for postpetition financing
- Preference avoidance of payments
o Cash to pay the priority claims on the effective date of the plan
(wages)
o Cash after bankruptcy
Legal issues- how do you formulate a plan that is feasible given the cash
1. Negotiating
After the petition is filed, the debtor begins negotiations with creditors to
determine how much the creditors will get
o No creditor expects to get paid in full on time However the creditors are negotiating with the debtors to
determine how much they will get
o Debtor is trying to negotiate with creditors to take less then they
would outside of bankruptcy and to convince creditors that they are
taking as much pain as everyone else
o However, one of the most important statutory requirements is that a
statutory majority of each class of creditors vote in favor of the plan
for the plan to be confirmed- 1126, 1129(a)(8)
Thus the debtor and creditor must be negotiating a plan that is
favorable
Under 1121(b), the debtor has an exclusive period (120 days after petition)
to submit a plan and have 180 days to get plan accepted
o During that time a creditor cannot submit a plan (although rare that
they would)
o The exclusive period can be extended under 1121(d) for cause
(court is generous in doing so) but there is a hard cap on exclusivity
of 18 months
o Under 1121(c)(3) however, the creditors may submit a plan if the
debtor has not filed the plan and it has not been accepted
Mechanics of Plan Confirmation:
o Debtor files a plan
Must include disclosure statement that is sent to creditors
when soliciting votes
Included in the disclosure statement is the history,
operating condition, disposition of the business, who
will run the management outside of bankruptcy,
earnings projects, and a liquidation analysis
Before the disclosure statement can be sent, the court must
bless it
Standard the court judges the disclosure statement by
is reasonable information for creditors to vote
79

Disclosure statement is blessed at a hearing which is

heard on 25 days notice to the court
o NOTE: This hearing is really a drafting effort
o After the court blesses the disclosure statement it can be sent to the
creditors
o Once the ballots are received back and the debtor gets the requisite
number of votes they have a confirmation hearing on 25 days notice
At the confirmation hearing the court will go through every
step of 1129to make sure it is met
2. Tax Implications
Every plan negotiation implicates many areas of law but a constant is the US
income tax law
After the 2005 amendments, the tax laws are less favorable to a reorganizing
company then they were in the past
The principal respect in which a plans success may be threatened by tax
consequences is the forgiveness of the debt by the creditors under a plan may be
treated as income to the debtor
This income is called Cancellation of Debt Income
o B/c the canceled debt constitute income economically, it follows
that the debtor risks having to pay income tax on the value it
realized from the cancellations
3. Plan Confirmation
A plan may take different forms as to the debtors future
The debtor may decided to continue on as it was
The debt may want to issue stock to some of its creditors- thereby wiping
out the old equity
The debtor may do an asset sale
The debtor may do a stock sale
The debtor may decide some of its assets or one of its divisions
The ground rules for Plan Confirmation
First it must be established that the plan satisfies all the requirements of
1129
o Most are acceptance requirements
o But the Best Interest and Feasibility requirements found in
1129(a)(7) and (11) are legal requirement that can not be
crammed down
o Under 1129, priority claims must get paid on the effective date
of the plan
The plan classifies claims groups them into classes- 1123(a)(1)
o Only substantially similar claims may be classified together
o HOWEVER- There is no requirements that all substantially
similar claims be classed together- 1122(a)
- This wiggle room is important for 2 reasons:
Treatment- Under 1123(a)(4) all claims in a
class must receive the same treatment
Voting by class- Under 1129(a)(8) each impaired
class must accept the plan for it to be confirmed
(except cram down)
80

Thus this wiggle room gives debtors an incentive to

gerrymander classes to get favorable result- to either
Separately classify opposing creditors so you can
cram them down; or
Put opposing creditors in large class to dilute their
vote
When voting- there are two majorities fairly thick approval is required
o (1) 2/3 in dollar amount must approve
o (2) Simple majority in number of claims that actually vote
a. Best Interests
o Governed by 1129(a)(7) Each opposing creditor must receive
as much under the plan on a present value basis, as if the
company liquidated on the effective day of the plan
o Best interest argument is only available to creditors who vote
against the plan but done on an individual basis (not a class basis)
However if you vote for the plan you cannot argue best
interest
o Cannot cramdown over a best interest argument
THUS IT GIVE A LOT OF LEVERAGE
o Thus for every Chap 11 confirmation a liquidation analysis is
done
It is done as part of the disclosure statement debtor is
arguing that they satisfy best interest by the comparison
o Then when a company objects to best interest, the court must go
through a valuation process to determine what the company
would get in liquidation
This is usually done by expert testimony and it is all about
valuation
If you are the debtor you argue low valuation to
say that the creditor would not do well in
liquidation thus the plan is better
But if you are the objecting creditor you argue
high valuation to say that you would do better in
liquidation
o Example- If a creditor has a claim of $100 and the plan in
liquidation would give the creditor $.10 on the dollar on the
effective day of the plan, then the plan must be at least as good as
$.10 on the dollar on a present value basis
Problem 32.1: Our client is a trade creditor that is owed $1 million from the debtor. The debtors main
creditor is the bank who was owed $10 million but was paid $7.5 million and is secured by the debtors
equipment which is worth $2.5 million. The debtor has $4 million in other GUC, for a total of $5
million and in his plan is offering a 50% payout. Our client is furious- what do we do?
- Step 1: Can we do preference avoidance to get the $7.5 million payment back
o Assuming that all the elements are made there is one small hang up to that- that usually
it is the DIP that gets the preference back
However in some cases in which the debtor refuses to go after the preference,
and the creditor committee petitions the court, the court will permit it to do so
after careful determination that there is a clear conflict
81

However if the decision by the DIP is a good business decision the court
will not
NOTE: It is like Business Judgment Rule
Step 2: After we have done all the avoidance, we can then argue best interest and feasibility
o I dont know what the feasibility argument would turn out since we dont really know
enough facts
o But under best interest- if we can bring the preference back in then our client will have
a lot of leverage b/c under the plan he is not doing as well as if a liquidation occurred on
that day- we come to this conclusion through the following
If bring back the $7.5 million it has two effects
First it increases the number of dollars to be paid out in liquidation (so
have 7.5 million)
But it also increases the amount of unsecured claims b/c now include the
banks deficiency (claims are now 12.5 million)
But when do the may, liquidation would give a 60% payout (7.5million/
12.5million) which is better then the 50% payout under the plan
b. Feasibility
o Feasibility is governed by 1129(a)(11) and it cannot be out
voted
o Feasibility is a determination of if the plan will work
Can the debtor coming out of bankruptcy make all the
promises that they are making in the plan
It is a determination of the likelihood that the plan will
succeed
o NOTE: Feasibility does not require a guarantee that the debtor
will be successful
It just must be determined that the plan offers a
reasonable prospect of success and is workable
The plan in the face of a feasibility argument should only
be confirmed if the court determines that confirmation of
the plan is not likely to be followed by liquidation or need
for future financial reorganization unless either of those
are part of the plan
o Typically the fight over feasibility is whether the debtor coming
out of bankruptcy can make the promises that they are making
Usually the plan promises not cash payments to creditor
but a pay out of future earnings
Thus the cash flow post-reorganization must be
enough to make payments Thus the fight is over the earnings projections
When a debtor throws up pie in the sky projections that
the debtor is not even making in bankruptcy you know
they cannot make those kind of earnings out side of
bankruptcy
Remember- During Chap 11 the debtor is just
paying operating costs
o Thus if the debtor is not doing well even in
bankruptcy, the feasibility is a good
argument
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c. Classification and Voting

o Under 1122, the debtor must classify the creditor and put each
creditor into a class
Creditor are divided into class for purposes of voting and
distribution
Every party in a class share similar legal status and
receive the same pro-rata distribution
o Debtors have some flexibility in how to construe each class to get
favorable majorities- it is a type of gerrymandering
o Under 1122, dissimilar claims cannot be included in the same
class- classes must be homogeneous
o In addition, under 1122, smaller creditors can be separated into
a class for convenience
But there is no express requirement that all similar claims
must be grouped together
Although the rule is technically that a debtor may
not gerrymander
Practically they are able to as long as they show a
good business purpose for doing soo Which is easy to do
In re US Trucking Co
Here the debtor separated the teamsters from other unsecured creditors. The debtor objective was to
quarantine the teamsters so they did not swamp the other unsecred claims, providing at least one
impariedcclass that would accept the plan and achieve cram down over the Teamsters dissenting vote.
Court held that debtors were allowed to separately classify the Teamsters b/c their interest in the estate
was different
o Impairment
Only impaired creditor classes get to vote If you are not impaired by the plan you are
deemed to have accepted the place
1124 defines impairment
NOTE: that if there is an impairment the debtor
can cure that impairment by the time of
confirmation. Thus the creditor is reinstated and
there is no impairment so no vote
However impairment is fuzzy b/c there are a number of
ways to change their rights without changing the
creditors legal entitlements
Economic impairment is when a the business
coming out of bankruptcy will be the size that
you originally decided to do business with
o Here there is probably economic
impairment b/c the likelihood of
repayment is not as secure but usually such
arguments are rejected
o Voting
o Under 1126(c) classes vote for confirmation and plan is
approved only when a two-party majority is achieved
First a majority in dollars must be achieved
83

Second a simple majority of claims must approve the plan

However for purpose of determining the majority
of claims, we look only to the claims that votednot the total number of claim
o Thus out of the claims that voted a
majority must have voted yes
o Claim Trading
Creditors or outside investors may want to buy claims
thereby allowing the purchaser to vote for the newly
acquired claim in plan confirmation
Problem 33.1: Our client is still not happy (see 32.1) and the debtor has amended the plan but our
client is still not happy. The claims have been classified, have a secured creditor (mortgage holder) for
$2.5 million. Then there are unsecured claims of $5 million in total. Included in that $5 million is
$300,000 of small claims that are personally guaranteed to be paid in full by the debtor.
- Our clients wants to vote the plan down what are his arguments.
- First, argue that the small claims should be classified differently b/c the are getting different
treatment- being paid in full
o If that does not work to get the $300,000 of small claims out of the GUC, could also
argue that this attempt by the debtor is bad faith b/c the insider is trying to buy small
votes so their votes will not count
o If this argument still does not work, then creditor could just buy the votes
- If the small claims are separated, this would reduce the amount of unsecured claims to $4.7
million
o Under this amount can our client vote down the plan- for confirmation need two
majorities
First need 2/3 of the amount dollar claims
Here the debtor holds a claim for $1 million and another $600,000 of
claims would vote to reject this plan
With those numbers there is enough to stop the confirmation of the plan
b/c those represent 34% of the votes and the debtor would need to get
67% to get it approvedo Thus the debtor cannot get the first majority
The second majority is based on a majority of claims approving the plan
If the small claims cannot be separate there is still hope: here, the
creditor can hope that not everyone votes
o If not every party votes the denominator is smaller b/c the
majority must be a majority of the claims actually voted
NOTE ON SARE: Here there is often an issue of classification
o Usually there is only one creditor a bank that holds both a
secured claim and an unsecured claim.
The two parts of the banks claim will need to be split up
The bank can then halt confirmation by rejecting the plan
as an unsecured, impaired creditor
However, debtor will often create another class of
creditors in trade creditors and separate them from
the unsecured claim of the bank
o The trade creditors will vote to approve the
plan b/c they will do better if the debtor
continues
84

o This will allow the debtor to cram down

the banks objections
d. Solicitation and Disclosure
o A debtor cannot begin to solicit votes without a court approved
plan and disclosure statements
o 1125 provides that a disclosure statement must provided
adequate information for a reasonable investor to know how to
vote on the plan
The Court has flushed this standard out by providing that
a disclosure statement must contain the following:
Description of the Business Including: information
on the nature of the business, the competitive
conditions of the industry, the debtors role in the
industry, whether debtor is dependent on one or
more customers of clients, whether the debtor is a
licensed professional that bills an hourly rate and
if so what are the number of his clients, the
anticipated services, the hourly rate, and the
anticipated annual billing, a description of the
services to be rendered, location of the principal or
branch offices, employee payroll, salary of officers
and directors, and any special party interests
History of the Debtor Prior to Filing including:
detail of his activities before filing including his
reasons for filing in an objective statement
Financial Information including: assets and
liabilities with a profit or loss analysis, financial
information sufficient to inform the creditors of all
liens, encumbrances, security interests, loans, or
other financial obligations which impair assets
Description of the Plan in sufficient detail
How the Plan is to be Executed
Liquidation Analysis
Management to be retained and the compensation
of the personnel retained
Projections of Operation including sufficient
financial information, the basis for any assumption
of an increase in income, the risk of loss from any
future operations or any anticipated financial
instability
Litigation: including all pending or completed
litigation, any known trial dates, any appeals that
are filed, and a professional evaluation of any
pending or completed litigation
Transactions with Insiders must be described fully
Tax Consequences
1125(e) offers the debtor a safe harbor from SEC
regulations governing liability for statements made
85

Under this section of the Code no person

connected with the solicitation of the plans
acceptances or rejections is liable for a violation of
the securities law, so long as the person acts in
good faith and in compliance with Chap 11
However under 1144, a plan that is confirmed by fraud
can be revoked within 180 days
o Pre-Packs
In a pre-pack all the negotiations occur before the petition
is filed and the debtor has all the plan acceptances
Pre-petition disclosures are fine as long as the disclosures
conform to any non-bankruptcy law that applies
Typically securities laws
Do a pre-pack to:
Limit the fallout
Limit the amount of time you spend in bankruptcy
Problem 34.1: Our client is still not happy, but the disclosures have been made. Then after the
disclosures are made, the debtor comes after our client for a preferential payment of $75k. What can
we argue?
- Since the disclosure statements were already sent out there is a plausible argument that the
disclosure statements were inadequate.
e. Cram Down
o When a plan is not confirmed b/c it does not satisfy the
requirements of 1129(a)(8) it can still be confirmed through
Cram Down
(a)(8) requirement is that all class of creditors confirm the
plan
o To qualify for cram down you MUST under 1129(b)
Meet all the other requirements of 1129(a) besides (a)
(8);
Have at least one consenting class of impaired creditors;
AND
The plan is fair and equitable
o To determine if a plan is fair and equitable you first determine
what kind of creditor you are dealing with and then apply from
the subsection governing that creditor (b)(2)
Secured Creditors fall under 1129(b)(2)(A)
As a general rule secured creditors must be
preserved by the plan and the creditor must be
paid the present value of allowable secured claims
When a secured creditor is impaired under the
plan and the debtor wants to cram down, there is
going to be two fights
- (1) Fight over the value of the collateral
b/c that will determine the amount of the
secured claim
- (2) Fight about the interest rate that will
pay to future payments to ensure that
present value is paid back
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Unsecured Creditors fall under (b)(2)(B)

Equity Holders fall under (b)(2)(C)
Both GUC and Equity holders you apply the
Absolute Priority Rule
- Under this rule any creditor that votes no
but are crammed down must either be paid
in full or if there is not enough to pay them
in full they should get what is left over
- Thus they either get paid in full or all
classes junior to the rejecting class get
nothing
Thus if the rejecting class is the unsecured
creditors, the equity holders get nothing
If the rejecting class is the preferred s/h then the
common s/h can get nothing
o If this is possible, why doesnt the GUC always refuse and the
equity holders always get nothing The debtor management has some leverage to negotiate
some equity for the s/h (especially in small companies
where the equity holder is the owner with whom which
the company would be lost)
Legal Leverage the DIP has
Possibility of a New Value Exception
- See -LaSalle- the old equity can still retain
some value by putting in new value
- However the new value must be:
Necessary (no one else offered it)
Substantial (sufficient); and
It has to be money (no promise to
work hard)
The DIP also has agenda control which can be used as
leverage
If the debtor cannot get agreement, it will not file
a plan which will cost the creditors money
DIP can use time delay to get concession
o NOTE CAREFUL: Contested cramdowns are rare
Most creditors are consensual
Really only seen in SARE
o But if contested cramdowns are rare, then application of the
absolute priority rule is rare- so why do we care about it
REMEMBER: All negotiations are structured by legal
rules- you negotiate in the shadow of the law
So it is important b/c it can be used in
negotiations- NOTE: Equity will have a tougher time
negotiating new value in the shadow of
LaSalle
- However to the extent that the value of the
company is in the owner, the equity
87

holders have some leverage which can get

them goodies
LaSalle
The issue is whether the old equity holders can give new equity and gain control of the new company.
The dispute is over what on account of in the statute means. The old equity holders cannot get new
equity on account of the fact that they were old equity holders. Giving old equity holders the exclusive
right to put money in is not good enough, does not satisfy 1129(b)(2)(B). The company needs to
have an open bidding or show that the open bidding is futile (no one else would bid to rebut the
argument that they got goodies b/c they were old equity holders)
Problem 35.1: Our client is still rejecting the plan. A new plan has been submitted that would give
GUC 70% and our client still opposes. Can they be crammed down?
- Step 1: What are the Classes?
o Secured Creditors mortgage holder
o GUC- $5 million
o Convenience Class- $300,000
o Equity- Debtor
- Step 2: Under the statute can our client be crammed down?
o Yes
However b/c the debtor is getting equity in the new company and the GUC vote
no, then the debtors equity will violate the unsecureds absolute priority rule
o Is there a way that the debtor could get around the no vote so that the debtor can take
some equity
The debtor could buy off all the claims
The debtor could threaten to walk
The debtor could argue new value- hold an auction to auction off the equity and
take only cash bids
Then the debtor would win and he would satisfy LaSalle b/c the new
value is necessary, substantial, and he did not receive it simply b/c he is
old equity he won the cash bid
o NOTE: Here the debtor is going to win b/c he is the only one that knows the most about
the business
C. Reorganization of Public Companies
o The affects of a large company in Chap 11 on the whole are different then the effect of a
small company on the whole- thus there are major differences between them
o Public Company v. Closed Company
The payment of fees and expenses
In a Closed company the fee and expenses will be smaller b/c there are
not so many people involved
But in a Public Company, there are a ton of professionals working and
the judge has the discretion to appoint different committees other then
creditors committee (such as a committee to represent tort victims for
equity holders)
o Thus b/c of the larger number of people and committees (which
expenses getting paid by the estate) there will be a vastly larger
amount of expenses
The relationship between the ownership and the management
In a closed company the hierarchy is Secured Creditors GUC
Equity holders who are usually the owner/manager/DIP
88

o So in a small business b/c much of the value of the business is in

the equity holder, the creditors are trying to keep that owner
happy
But in a public corporation the equity is not as important b/c equity is
held by s/h
o The management is divorced from the s/h thus the negotiations
between the management and the creditors will be very different
In the end, much of the lions share of the stock in the
new company will be owned by GUC and the old equity
will be wiped out
The Role of the CEO
In a closed corporation the role of the CEO is to save the ownership and
the company
o Here the CEO is less likely to lose his job b/c the value of the
company is dependent on the CEO
But in a public owned company the CEO will be looking out for
themselves to save their jobs
o Their job security will be shaky b/c they are not a central figurethey can be replaced.
What is the DIP/Managements fiduciary obligation to the equity and the
creditors
In a public corporation the interests of the equity and the interest of the
creditors will be opposed
o The creditors will want to management to take only conservative
risks that are sufficient to pay the debt owed to them b/c their
recover is capped at the debt owed, but they stand to lose that
amount
o The equity will want the management to take large risks b/c the
their value is already gone and they will benefit more the more
money the company makes
o Thus if your fiduciary obligation runs to the creditors then you
should take conservative risks and if the your fiduciary duty runs
to equity you should take large risks
BUT NOTE: The BJR will probably protection you in the
decision you make so long as there is not fraud or conflict
The CEOs Concern for his job and his compensation
When making a decision on how to proceed with a company, the CEO
will make decisions based on what is good for him
When a company goes in the Chap 11, the CEOs job is on the line
CEO may have to worry that about both 503 and 548 kicking in and
affecting the compensation he will receive or has received
503(c) puts limits on KERPS for insiders
o KERPS are Key executive retention programs
o In Chap 11 KERPS are always given as part of the new
employment arrangement
o Under 503(c) retention payment will be scrutinized
o The Court will not allow the payments to insider unless the court
finds:
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The Payments is essential b/c the insider has a competing

job offer and higher pay; AND
Insiders services are essential to the survival of the
business
o In addition, any payment the executives do receive will be less
then 10 times the mean paid to non-management employees
o USUAL RESULT IN BANKRUPTCY- Since it is unusual that a
CEO in a company approaching bankruptcy will have a
competing offer, the practical effect is that if the creditor can
convince the court that this provision applies, there will not be
KERP payments
In addition, insider severance payments are limited
o They must be part of generally available program for full time
employees; and
o Less then 10 times the mean paid to non-management employees
CEOs will also have to worry bout Fraudulent Transfer 548(a)(1)(B)(ii)
(IV)
o This section of 548 states that transfers to insiders pursuant to
employment contracts are avoidable if
Not in the ordinary course; and
No REV
o NOTE: These transfers are avoidable regardless of the debtors
financial condition at the time of the transfer
o There is a 2 year look back for this
NOTE: It would depend on the dollars given to the
executive if it was considered in the ordinary course
These three things will place constraints on the compensation packages
that are available insider Chap 11 and also the negotiations for
compensation outside of bankruptcy will be done in the shadow of this
law
o Thus a CEO will probably want to stay out of Chap 11 as much
as possible to avoid the risk of fraudulent transfer and KERP
payments
o If there is an offer on the table form another company to sell the
bankrupt company and go work for the new company- the CEO
is likely to take it
D. Post- Confirmation: Life After Chapter 11
- Effects of Confirmation for Claims Against the Debtor
o Liability depends on the time period to which a claim is assigned: Preconfirmation or Post-Confirmation
o Claims that arise after the discharge of the debtor the debtor is still liable for
o However, claims that arise post-confirmation that have roots in the preconfirmation past can create problems- Called Future Claims
o Future Claims:
The usual scenario is that a big company may have manufactured
products or done other stuff pre-bankruptcy and the liabilities dont show
up until post-bankruptcy
Two issues need to deal with in such scenarios The amount of the pay
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o This can be solved by setting up a litigation trust

Was notice properly given to discharge the claim
o When we give discharge for all actions pre-confirmation
we wipe the slate clean
We set a Claim Bar Date that says you have to file
this claim by this date
If you do not make a claim by that date
you do not exist
NOTE: A claim can be a contingent claim
Thus if notice is adequate and you have not filed a
claim you can be discharged
o To determine if notice is proper must first determine if the
claimants are known or unknown claimants
o Known Claimants must be given actual notice in order to
discharge the debtor for its obligations post-confirmation
o Unknown Claimants publication or constructive notice is
sufficient
How do you determine if a party is a known or an unknown
claimant? It is about reasonableness
o A claimant is known if their identity is known or
reasonably ascertainable
Thus if a debtor knows about the defect in the
product then the claimants are known claimants
o But if the debtor does not know about the defects the
question of reasonableness changes
It would be unreasonable to say that a debtor
should give notice to every consumer that a
product may be defective
Constructive notice would be sufficient
Effects of Confirmation on Claims by Debtor
o Debtors who contemplate bring lawsuits after bankruptcy have one important
point to bear in mind: Making sure that the cause of action survives court order
granting confirmation of a plan
o While claims by the debtor or not discharged under 1141, other legal doctrines
may bar them
Discharge of Non-Debtor
o Here it is common- the dominant party pre-bankruptcy will induce financing by
giving personal guarantee
Then once the company goes into bankruptcy the dominant party wants
releases from such personal guarantees in order to give more money and
the creditor that enjoys the benefit of those personal guarantees is
rejecting the plan
o In generally, non-debtor discharge is not permissible
A non-debtor can only get released with the consent of the creditors
524(e) says discharge does not effect anybodys else liability so no
release
o What else may you do for a party that gave personal guarantees?
May be able to argue Bernard Test
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If the individual looking for release and the corporate debtor have
identical interest that suing the individual and suing the debtor
would hurt the reorganziational process the court can order a
temporary injunction
o NOTE CAREFULLY: That this is not a permanent
injunction- it is not a release
o It is just relief until and unless the debtor defaults under
the payments on the plan
As long as the debtor makes all of its promised
payments the injunction prohibits suit against the
individual
o Another option is to just start a new company- have both the individual and the
corporation go into liquidation
This will work if the individuals assets are mostly exempt
But may have to worry about fraudulent transfer issues by the non-debtor
that may be unwound in the bankruptcy proceedings

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