Documente Academic
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Documente Cultură
Paul Rodriguez
Collection Without Courts
A. Nonjudicial Collection Methods
a. Leveraging: creditors try to determine how, at the lowest cost, to make it more beneficial (or less costly) for D to
pay money owed. Creditors seek means to increase the likelihood D will pay. Constant balancing weighing and
leveraging process where D must decide which bills to pay, if any. Creditor must weigh both cost of time expended
in activities to get paid and potential loss of goodwill against any increase in likelihood of repayment.
i. Much of the leverage analysis occurs when loan is incurred.
o Why banks take collateral: Securing capital equipment provides:
a. Leverage: as long as the applicant remains in business, the assets necessary to the
business operations are important. Thus, security interests give greater incentives for
borrowers to meet their payments.
b. Collateral Control: often security agreements prevent the applicant from obtaining an
additional loan from another bank
c. Loss Reduction: when a loan is in default, security can be sold and proceeds applied
toward the loan balance
ii. Other leverage factors are entirely outside the scope of legal regulation
o Example: Loans between family members
iii. Although formal proceedings make up only a fraction of debt collections, formal debtor-creditor laws are
important because they impact negotiations.
o Creditor-debtor behavior is shaped by limits of legally permissible actions, and by what remedies
the law will grantat what costif the formal process is invoked.
a. Leverage = credible threats of action that will harm the other party.
b. Indirect Leverage in the Legal System
i. The government sometimes shifts the leverage of parties in unexpected ways. Many provisions in fed and
state laws that indirectly reallocate the leverage between debtors and creditors.
o Example: issuing a temporary restraining order closing down any company that twice in 10 years
violates duties to pay its employees. Employees can threaten to close the business down if they are
not paid immediately.
c. The Credit Information Process
i. It is the creditors ability to make negative reports to reporting agencies and influence Ds credit rating that
creates leverage in debt collections. Creditors who can make credible threats to deny access to future credit
may increase their collection leverage. If a creditor can influence other provides of goods and services to
withhold future credit from a nonpaying debtor, the unpaid creditor has far greater leverage to push or
encourage a debtor to repay. The FCRA offsets some of that leverage by providing procedures to which the
reporting agency must adhere.
ii. Most debtors deal with agencies when they are denied credit with the most frequent source being the
accuracy of the credit information supplied by the creditors-members.
o Credit report initially contains only the creditors version of any ongoing debtor-creditor dispute.
o A credit reporting agency cannot defend itself by blaming creditors for misinformation; both are
now responsible and both often find themselves as co-defendants.
iii. Fair Credit Reporting Act - provides limitations on how much leverage can be attained by placing limits on
procedures for debtors to challenge the accuracy of their credit report.
o Has two principal themes:
a. Giving the debtor access to the credit report information
b. Prescribing procedures to ensure accuracy of the information in the file.
o 1681i (pg 10)- If a customer disputes information, the credit reporting agency shall conduct a
free, reasonable investigation and modify or delete the disputed information within 30 days from
the date the agency receives notice.
o 1681m (pg 11) - If anyone takes adverse action b/c of information contained in a consumers
credit report, the actor must provide the customer with notice and inform the customer of the
rights to obtain a free copy of their consumer report for 60 days and dispute the accuracy of the
information.
o 1681 n (pg 11) - Anyone who willfully fails to comply is liable to the customer for actual
damages and potentially punitive damages and attorneys fees
1681 o (pg 12) - Negligent noncompliance creates liability for actual damages and potentially
attorneys fees.
B. Restrictions on Nonjudicial Collection
a. Usury Laws
i. Marquette National Bank of Minneapolis v. First Omaha Service Corporation: First Omaha was
soliciting credit card customers in Minnesota at an interest rate that was lawful in Nebraska, but exceeded
the Minnesota cap
o Holding: Under federal banking laws, the state law of the customers location is not relevant.
Instead, a federally chartered bank could charge whatever interest rate was legal in the banks
home state.
ii. While some states have more restrictive usury laws, FDIC analysts and other government officials now
characterize interest rates as deregulated.
b. Federal Statutory Controls on Nonjudicial Collection
i. Direct control of debt collection began at the state level with a patchwork of common law decisions and
state statutes. In the 1970s, Congress adopted the FDCPA.- The act is an effort to acknowledge debt
collection difficulties and provide a federal remedy directed specifically toward debt collection abuses. To
stop abusive, deceptive, and unfair debt collection practices
ii. Fair Debt Collection Practices Act (pg 435)
o Scope- Act applies to those who attempt to collect debts owed to others FDCPA 803(6)
a. (Does not apply to creditors, their officers, employees collecting debt for the creditor in
the creditors name) This would mean banks are excluded from FDCPA
b. Attorneys are included as debt collectors even if the activity only consists of litigation if
they often involve in such debt collection actions
o 804 (pg 16)
a. If a collector communicated with a person other than D to acquire Ds location, he shall
identify himself, not state that D owes any debts, not communicate with any such person
more than once unless requested to do so by such person or if the collector reasonably
believes the persons earlier response was erroneous or incomplete, and may not use any
language/symbol indicating the communication relates to collection.
b. Once an attorney has been retained by D, the collector shall not communicate with any
person other than the attorney, unless the attorney fails to respond within a reasonable
amount of time.
o 805 (pg 17) communications with 3rd parties
a. Without express consent, the collector cant communicate with D at any inconvenient
time/place (including place of employment if the collector knows that the debtors
employer prohibits the debtor from receiving such communication), or before 9 a.m. or
after 8 p.m.
o 806 (pg 18) Harassment or abuse
a. Collector cant harass/oppress/abuse person in connection w/ collection.
i. Cannot use or threaten to use criminal violence as a means to damage the
physical person, reputation or property of any person.
ii. Cannot use obscene or profane language.
iii. Cannot cause the telephone to ring continuously with the intent to annoy, abuse
or harass.
o 807 (pg 18)- Debt collector may not use false, deceptive or misleading representation.
o 808 (pg 19)- Collector may not use unfair or unconscionable means. Cannot collect any amount
not expressly authorized by the agreement. Cannot deposit postdated checks prior to the date they
are intended. Several issues with post-dated checks enumerated on this page.
iii. The Act provides for the recovery of actual damages, costs and $1,000 for violations.
iv. Debt Collector- collect a debt owed to another, not a debt owed to you Act covers collection agencies, not
banks
o Heintz v. Jenkins: D [appellee] defaulted on a loan she used to buy a car. P [appellant], the banks
lawyer, wrote D a letter stating she owed $4k for the insurance the bank purchased on the car b/c
D didnt. D filed suit, claiming FDCPA violations because the bank tried to collect an amount not
authorized by the debt agreement. D claimed the banks policy already insured the bank against
any loss or damage to the car.
o Holding: The term debt collector as used in the FDCPA applied to lawyers who regularly use
litigation in an attempt to collect consumer debts.
o
a.
1.
Yes. 803(6) defines it pretty broadly as any person who uses any instrumentality of interstate
commerce . Language of statute doesnt seem to except attorneys. In Heintz, law . Court says
lawyers are covered by the plain language because they are NOT exempted.
iii. Question 3- Did you the lawyer violate the FDCPA? Look at 805, 806, 807, 808- 807(5) threaten to take
any action that cannot be taken- you just wrote saying you were going to take potential action, this is
standard for a lawyer. But a debt collector is not supposed to harass or say untrue things. You also cant
settle your case for the client, he must.
1. Did you really mean to take them to court? Has your client ever taken anyone to court before?
State Law Debt Collection
A. Collection Remedies
a. Introduction to Judgment Collection- Continued recalcitrance of debtors (they wont always pay up/ race of the
diligent against the creditors (make sure YOU get paid), once you have the judgment you have to make sure that
EVERYONE knows about it, perfect your lien and security interest against everyone, not just the debtor.
i. First step is establishing that a debt is owed.
1. What is the judgment? piece of paper that represents the power of government to force them to
do what you want. But need to take that judgment and make into writ from court clerk, then you
take the writ to sheriff, who levies upon property of the debtor by telling him what YOU KNOW
the debtor has. 1) get judgment 2) get writ 3) get sheriff to levy upon the property.
ii. Execution
1. The judgment creditor remains an unsecured (general) creditor until execution is obtained on the
judgment. The only improvement in the judgment creditors position is that the claim has become
liquidated (it is indisputable by the debtor).
2. The collection process begins with a writ (execution writ, or a writ of attachment).
a. The writ orders the sheriff to look for non-exempt property of the debtor, to seize it, sell it
and pay the proceeds to the creditor until judgment is paid.
b. Issued by the court clerk upon request of the creditor and delivered to the sheriff for
execution.
c. If personal property cannot be immediately seized (b/c of size, etc), the sheriff may tag it
with a notice of seizure. Real property is always seized by posting notice of seizure and
sale or some similar method.
d. The entire process of seizure is often call a levy.
e. The whole process, from writ issuance to seizure, is often called execution.
3. Once the sheriff has levied specific property, the creditor becomes a judicial lien creditor as to
that property.
a. Sheriff will then advertise the property for sale and sell to highest bidder. Once the
creditor is paid in full, an entry is made in the judgment record noting the partial or
complete satisfaction of judgment, if incomplete, sheriff will be commanded to look for
more of the debtors property to seize and process will begin all over
b. Surplus proceeds are paid to D, unless a subsequent judgment creditor levied the property
symbolically while it was stored at the courthouse.
4. Problem 2-1-(pg 53)- we have Rollin hills appliance who is in financial trouble, and A B and C
all have judgments against its property. A got judgment November 1, B on Nov 10, and C on Nov
20. BUT judgment is not enough, need to get a writ. A didnt get a writ. B got a writ on Nov 15,
and C got one on Nov 22 (some jurisdictions have a time period limitation form when you can get
the writ after the judgment, federally its 10 days). Only C got a levy on Nov 25.
a. whos gonna get paid?- C, you have to get all 3 of them before you get paid. The
remaining 50k gets returned to the debtor until A or B satisfy the 3 requirements. B can
get the sheriff not to symbolically levy the property.
b. Can B hop over C though?- if theoretically you later get the levy, some jurisdictions say
it doesnt matter, that the writ date matters more as long as you eventually levy the
property. This encourages creditors to do it quickly, and discourages friendly sheriffs, so
you only really have control over Writs, and not when the sheriff levies property.
iii. Turnover Orders-. judgment collection deals with readily apparent property, but in modern era it deals with
intangible property, so we now have turnover statutes. They examine debtors to see if they have property,
and compels them to turn property over.
1. D is ordered to turn over property he possesses/controls. D risks imprisonment for contempt if he
does not comply. Once property is traced to D, D bears the burden of establishing that certain
iv.
v.
vi.
vii.
viii.
property is no longer in his possession. All judgment creditor needs to get is necessary info
about the asset. Generally permits examination of D under oath so assets can be found.
2. Note a low sale price generally wont invalidate the sale.
Judgment Liens by Recordation- Special recordation procedures exist to obtain a lien on a debtors property
quickly and simply, without going through the full-blown execution process.
a. Generally limited to real property. Obtained by recording a judgment in the county land
records where deeds are filed.
b. Often fastest/cheapest post-judgment collection step a creditor can take.
c. Prevents resale because no purchaser would buy property with the title clouded by a lien.
Dormancy and Limitations
1. Dormancy is a coma-like state in which the judgment still exists but is no longer enforceable
without being revived. Typically 1 year
2. Expiration of the SOL to enforce a judgment is terminal unless a new lawsuit has been brought on
the judgment. Typically 10 years.
Debt Collection by the Federal Government- Federal Debt Collection Procedures Act- Generally similar to
those procedures under state law and applies only to judgments in favor of the federal government.
Family Debts- In recognition of the importance of family support payments and the difficulty of their
enforcement, specialized rules surrounding their collection have been made.
a. Imprisonment has been retained as an enforcement tool.
b. States often exempt some or all wages from garnishment but make an exception for child
support.
Voluntary Liens - Judgment collection system is involuntary lien system, because it gives judgment creditor
rights in debtors property without any acquiescence or cooperation from the debtor. The alternative is
obtaining mortgages and security interest in debtors property. Creditors become secured creditors by
obtaining voluntary liens. Property on which the debtor grants the lien is called collateral, such as car
being collateral for car loan. Those who take security interest are mortgagees in real property and secured
creditors for all other property. Secured interests are covered by Art 9 of UCC.
1. Many creditors by obtain voluntary liens through collateral.
a. Most require a writing where D grants the lien and describes the property.
b. To protect third parties who may have dealings with the debtor, consensual liens are
given effect against third parties only if the secured party gives public notice of its
interest, usually by some form of recordation in a government office.
i. Real estate & most personal property notice is given by recordation in a
county or state filing system.
1. This filing enables other potential creditors or buyers to find out about
the earlier creditors interest in the property. Once a creditor has filed
and deemed to provide public notice, his lien is perfected
ii. Some other types of collateral notice is given when the debtor takes possession
of the item. Example: jewelry, security interest in a certificate of deposit.
iii. Other special types- Car can be perfected only when lien is entered on certificate
of title for the car.
iv. Consensual lien will give secured creditor some ability to fence off the
property covered by the lien from collection efforts of other creditors. Assures
creditor that if debt is not paid, lienholder may force sale of collateral and use
proceeds to repay outstanding loan. Consensual lien restricts Ds disposition of
property, so creditor can count on its being available at time of default.
2. Consensual liens may be purchase-money liens those liens used to furnish the credit necessary
for the purchase of the collateral (aka PMSIs). Ex: mortgages, car loans, etc.
3. Non-PMSI borrow money and gives a lien on property already owned.
a. Ex: home equity line of credit, 2nd mortgage.
4. In business, D frequently give security interests in property acquired in the future.
a. Article 9 recognizes such interests, so that D may offer a security interest in all my
equipment, current and after acquired. When D buys a new piece of equipment, the
security interest automatically attaches.
5. Sometimes more than one creditor may take a consensual lien on property.
6. Creditor with consensual lien can seize the collateral more quickly and cheaply than a judgment
creditor who has to go through all the steps of a suit and execution before sheriff sells the goods
The seizure for sale foreclosure with real estate and repossession with personal propertyis
heavily governed by a myriad of state rules that differ in detail but usually cover similar issues.
7.
b.
A creditor with a security interest in personal property has two ways to satisfy the outstanding debt
that are not available to the judicial lien creditor:
a. The Article 9 creditor can seize the property without any help from the sheriff (self-help
repossession), or
b. Can offer to keep the property in satisfaction of the debt without any sale (retain in
satisfaction). Both options have some restrictions, including a requirement that creditors
do not breach the peace (no fist-fights or breaking in).
8. Secured creditor also has all the remedies of any other creditor. Can sue, obtain a judgment and
writ of execution. Unlike unsecured creditor, secured creditor can go through formal process
secure in knowledge that his place in line is guaranteed.
9. Deficiency judgment. The collateral is sold for less than the amount of the debt.
a. Creditor becomes unsecured for deficiency.
b. D often claims the sale was conducted in violation of the complex Article 9 UCC rules
governing such sales and D isnt responsible for deficiency.
i. If D is a consumer and demonstrates proper procedures were not adhered to,
many states will stick the creditor with the deficiency.
ii. In non-consumer transactions, there is a presumption against the creditor that
can be rebutted by showing the deficiency would have been just as great even if
all of the procedures had been followed.
ix. Statutory Liens and Trust Funds- These are specifically recognized in UCC 9-333.
1. State law also creates liens by operation of law favoring certain types of creditors.
a. Ex: Artisans lien a possessory lien on personal property of the debtor.
i. Ex: garage mechanic can keep the car until the bill is paid or sell the car if
necessary to satisfy the charges
2. Trust fund statutes make the debtor a trustee and the creditor the beneficiary.
x. Property Exempt from the Collection Process (state protects home/goods from seizure)
1. FF & C Clause allows state judgments to be enforced in other jurisdictions.
a. Common law requires filing a new suit, serving a summons and so forth.
b. Judgments obtained in district court are enforceable locally in the state where the court
sits using local procedures.They can be enforced in other states by registration with other
federal district courts.
c. Judgments are often enforced in other countries.
xi. Collection in Other Jurisdictions
1. Gerdes v. Kennamer: G was a debtor of K. G owned DR, a company that was valuable because
it owned a large plot of land in Mexico. The trial court signed a turnover order, requiring G to turn
over the original stock certificates of DR. Here, evidence established Gerdeses ownership interest
in Don Rogelio. They must simply sign documents, obtain wifes signature, and deliver documents
to sheriff. Easy to comply with.
a. Holding: A court ordered turnover is an equitable remedy that may be invoked to assist a
judgment creditor to collect on his judgment. Turnover statutes permit ct to compel the
execution and surrender of documents. JC is entitled to aid form court through injunction
or other means to reach debtors property. TC has authority to compel a debtor to
execute documents that will aid in collecting a judgment debt.
The Struggle Among Creditors: Priorities - Focus of collection shifts from whether a creditor has a right to collect
from debtor over to which of several creditors gets to collect form which assets first; creditors often compete
frantically to get paid, with the rule first in time, first in right commanding
i. Background- Often, the 1st creditor to levy will have right to be paid in full from the proceeds before any
other creditor gets even a single dollar from the sale. Race of diligence
i. Generally, the first to perfect wins, but the rules vary depending on the nature of
each competitors interest.
1. Unsecured Creditor Versus Unsecured Creditor- Must first get judgment and then execute or levy
on that judgment in order to get an interest in a piece of property belonging to judgment debtor.
Levy perfects the judgment lien on that property. Between two judgment creditors, first to levy
wins property. However, the date of levy is not always the controlling date.
a. In many states, priority depends on date which judgment creditor initiated the execution
process by delivering the writ to the sheriff.
2. Unsecured Creditor Versus Secured Creditor
a. Ordinarily, the secured creditor or the mortgagee perfects when it records its consensual
lien according to statutory prescription. If judgment creditors lien is later, it loses. If
judgment creditors lien is earlier, it wins. Secured creditors must take consensual lien
AND RECORD
b. Credit Bureau of Broken Bow v. Moninger: P obtained a judgment against D. D then
took out a loan and promised his truck as security. No security agreement was entered
into at the time(unperfected security interest). P then got a writ of execution issued on the
judgment. The sheriff examined the countys records and found the bank had not
recorded the security agreement. The officer visited D, touched the truck and said I
execute on the truck for the County of Custer. The sheriff didnt take possession of the
truck at the time. The bank heard about the purported levy and got D to execute a security
agreement, which it then filed. P contends that actions of sheriff amounted to a valid levy
which bound vehicle for satisfaction of Bureaus judgment against D. The trial court
found that the Banks security interest in the truck was superior to the execution lien.
c. Holding: The trial court erred. To execute a valid levy on property, all a sheriff needs to
do is temporarily take control of the property and express his or her assertion of dominion
over the property on the basis of the writ of execution; no physical possession is
required for levy. an unperfected security interest is subordinate to the rights ofa
person who becomes a lien creditor without knowledge of the security interest and
before it is perfected
i. Was P a lien creditor on July 7? A valid levy occurred before the bank had
perfected its security interest in the truck. Cop even said sorry for doing it.
1. 9-301 defines a lien creditor as a creditor who has acquired a lien on
the property involved by attachment, levy or the like. A lien on
personal property is acquired in this state at the time it is seized in
execution, so the Bureau becomes lien creditor within meaning of
UCC 9-301 when sheriff levied vehicle.
2. **While most jurisdictions agree with this approach, there are still a
number that require the sheriff to take possession.
3. Because subsequent creditors could be misled if goods are left with the
debtor, there is a caveat in the situation where no possession is
required:
a. If the levied-upon goods are left in the hands of the debtor for
an unreasonably long period of time with the consent of the
creditor, the lien will be lost.
ii. whether the Bureau was a lien creditor without knowledge of the Banks alleged
security interest prior to the perfection of such interest by the Bank?
3. Judgment Lien Creditors/Secured Creditors Versus Buyers
a. First in time, first in rightgenerally measured by perfection.
4. Summary - When becoming a judicial lien creditor, must ask which creditor have the liens, and
have they succeeded in their levy? Is announcement enough? Is it possible SOL has expired.
When were these creditors secured and what was the order?-date is essential. You have to follow
these steps for each creditor
a. Key date, is that youre looking for date of perfection, date to secure your date in line.
Whoever perfects first, wins.
ii. Discovery- Getting information on existence/location/exemption status of levyable property.
a. FRCP and most state rules of procedure, permit the creditor to conduct discovery
concerning Ds assets and affairs.
iii. Pre-judgment Remedies
1. Two categories:
a. Traditional protection under state law by means of special requirements that a creditor
must satisfy before being able to get a pre-judgment remedy
i. Typically require:
1. A showing of need for example, the debtor is decamping with its
assets; and
2. A bond, often twice the amount of propertys value, to provide a fund
for the Ds damages in the pre-judgment remedy turns out to have been
wrongfully employed.
b. Procedural requirements in the pre-judgment process that the Supreme Court has found to
be necessary to ensure the debtor due process of law.
3.
These actions deplete the assets of an already insolvent debtor by the difference between the true
value of the property and the amount the debtor actually received, injuring the debtors creditors.
vi. Actual fraud is covered in 4(a)(1), and in 4(b) codifies the badges of fraud seen in Twyne. Burden of proof
to establish actual intent is on creditor who seeks to set aside conveyance, and must do so with clear
evidence. Intent is rarely susceptible to proof and must be established by inference from circumstances
surrounding alleged fraudulent act (badges)
4. Transfers Fraudulent to Present and Future Creditors(
(a) A transfer made/obligation incurred by D is fraudulent as to a creditor, whether the creditor's claim arose before or after the transfer
was made/obligation was incurred, if D made the transfer/incurred the obligation: INTENTIONAL FC
(1) with actual intent to hinder, delay, or defraud any creditor of D; or
(2) without receiving a reasonably equivalent value in exchange for the transfer/obligation, and D:
(i) was engaged or was about to engage in a business or a transaction for which Ds remaining assets were unreasonably
small in relation to the business or transaction; or
(ii) intended to incur, or believed or reasonably should have believed that he would incur, debts beyond his ability to pay
as they became due.
(b) In determining actual intent under (a)(1), consider these factors: CONSTRUCTIVE FC
(1) the transfer or was to an insider;
(2) the debtor retained possession or control of the property after the transfer;
(3) the transfer or obligation was disclosed or concealed;
(4) before the transfer was made/obligation was incurred, D had been sued or threatened with suit;
(5) the transfer was of substantially all the debtor's assets;
(6) the debtor absconded (fled);
(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;
(9) the debtor was insolvent or became insolvent shortly after the transfer;
(10) the transfer occurred shortly before or shortly after a substantial debt was incurred; and
(11) the debtor transferred the essential assets of the business to a lienor who transferred the assets to an insider of the debtor.
i. Note- Are badges of fraud necessary under 4(a)(2)? No - b/c badges of fraud listed on 4(b) specifically state they are for
4(a)(1) ONLY
5. Transfers Fraudulent to Present/existing Creditors (strict liability)(doesnt care about mind frame of D)(Good Faith irrelevant)
(a) A transfer is fraudulent if D made the transfer without receiving a reasonably equivalent value and D was insolvent at that time
or became insolvent as a result of the transfer or obligation.
(b) A transfer made by D is fraudulent if made to an insider for an antecedent debt, the debtor was insolvent at that time, and the
insider had reasonable cause to believe that the debtor was insolvent.
2. Insolvency (if:)
(a) The sum of D's debts is greater than all of the debtor's assets, at a fair valuation.
(b) A debtor who is generally not paying his debts as they become due is presumed to be insolvent.
(d) Assets under this section do not include property that has been transferred, concealed, or removed with intent to hinder, delay, or
defraud creditors or that has been transferred in a manner making the transfer voidable under this [Act].
7 Remedies:
(a) Creditor may obtain avoidance, an attachment, an injunction or an appointment of a receiver, subject to defenses below
Defenses
(a) Bona-fide purchaser (will be given lien equal to value paid).
(b) NOTE: 8(a): transfer is not voidable under 4(a)(1) against a transferee who took in good faith and for reasonably
equivalent value (good faith purchaser
a. 8(d): they get a lien on the purchased property for the purchase price, but lose the benefit of the bargain and any
value increase. (b) Any money put into the property: unjust enrichment claim.
(c) If a debtor conveys a security interest in all of his personal property to secure a debt, but remains in possession of the
property, its not a fraudulent conveyance under Article 9- this is b/c its not done in secret
ACLI Govt Sec v Rhoades
1. Concerns validity of conveyance of property from D to his sister, which occurred the day before a 1.5 million judgment
was entered against D in favor of P. D and sister owner 38 acres of land as tenants in common with D having 3/5 share, D then
conveyed property for 1 dollar and other consideration. Was conveyance Fraudulent? This is a present creditor so they can use
either UFTA 4 or 5.
2. P argues it was made without fair consideration by a D in suit who failed to satisfy final judgment. Burden of proof to
establish that Ds conveyance was made without fair consideration is on creditor, but where nature and value of consideration are
within transferees control, burden shifts to transferee. Heavier burden with intra-family transactions.
3. Conveyance was made without fair consideration, so must now find whether the conveyance made D insolvent within
meaning of statute. Proof of solvency is on the D, who claimed he had enough to pay his debts. Look at Sec 2. One of his properties
was grossly overvalued by expert, and was appraised at 212k, not 700k. Expert had strong friendship with 2. Other 2 properties of D
were almost valueless.
-Additionally, badges of fraud here are the close relationship, intermingling of finances, issues of the appraisal of other
properties, secrecy and haste of sale, inadequacy of consideration
- subjective element- the timing is suspicious. Cant determine whether there was adequate consideration for supposed debt,
too much secrecy.
-objective prong (goes to REV and solvency)- valuation- maybe theres no REV, and it also likely made them insolvent at the
time of the property transfer. Cash flow can also go into solvency.
Ruling- D failed to show that at the time he transferred property to sister, he had assets whose aggregate fair, salable value
was equivalent to judgment of 1.5 mill. Conveyance was fraudulent under UFTA 4(a)(2)- 5, and creditor get brothers share of
property.
Problem Set 4
vii. Problem 4.1 - A is insolvent, owing $50k to FF; he sells his piano [FMV $40k, asks $20k, sells for $15k]
for food money. Can FF successfully claim a fraudulent conveyance? Use 5(a)
1. Transfer? Yes Did arise before transfer? Yes owed FF before she sold piano, so present
creditor/not insider. Debtor insolvent? Yes. 25k less than valued, so incredibly undervalued.
2. Probably yes the debtor is insolvent and it isnt for reasonably equivalent value, so it meets
UFTA 5(a). But valuation is everything! $15k is probably the real FMV given the hurried
conditions of sale; it could also be reasonably equivalent value because its a crisis sale.
a. Note UFTA 3(b) reasonable value includes what is received at a foreclosure sale.
You could argue that this ought to be extended to mean the value that would have been
received at a foreclosure sale. Improper valuation given the context, the relevant market
for her is different.
b. Note- have to ask whether creditor would have gotten a better value. Could argue
shes only getting half the value.
3. Note that if this transaction was invalidated (if judge doesnt look at exigencies of situation and
finds no REV, so fraud), could void transfer and take piano back. The purchaser of the piano
would have a lien against the debtor for the $15k ( 8(d)(1)). However, he loses his time value of
money and his bargain.
4. There seems to be no intent by the debtor to hinder, delay, or defraud- Doesnt seem to be a sale to
insider. So UFTA4(a)(1) or (5)(b) doesnt apply
5. Is there a sec 8 defense? . Good faith matters only for transfers voidable under 4(a)(1)
(intentional fraudulent conveyances). 5 doesnt care about mind frame of anyone.
viii. Problem 4.2 - B is insolvent. He sells his coin collection (FMV $75k) to his cousin for $5k to keep it in
the family. B then buys $25k of furniture on American Express. Can AmEx use the UFTA to void the
coin collection transfer?
1. Probably not. AmEx is a future creditor the furniture debt did not arise until after the coin
collection was transferred. Thus, they cant use UFTA 5. (If there was prior debt on the card,
you could use that; you could also argue that the line of credit the card represents is the functional
equivalent of present debt).
2. They are therefore left with UFTA 4. Probably can Under (a)(1), youd have to prove actual
intent to defraud. Cant really prove she had requisite intent, but can infer it through badge of
fraud here, but thats not conclusive on the issue 4(b). There was a transfer made to an insider,
value received wasnt REV, the debtor became insolvent shortly after transaction, and the transfer
occurred before substantial debt incurred. Also, although debtor didnt retain possession she
expected to get property back
a. Under (a)(2), could argue not getting REV since theres a huge difference in value. Use
(a)(2)(ii), quasi-constructive fraud. Creditor would need to prove that D reasonably
should have believed that she was about to incur debts that they would not be able to
repay.
3. Its difficult for future creditors. You want to put some burden on both sides of the transaction. If
creditors can prevent the loan, and are diligent, then can determine financial picture and couldve
prevented this.
ix. Problem 4.3- D owns Homestead (200k),which is exempt from creditors- other assets (55k) and debt is
(75k). He conveys homestead to son as a gift. Can creditors reach homestead conveyed to son?
1. Unsure if hes insolvent (55k >75, but does home count?), it MADE him insolvent
2. Is homestead an asset? 1(2)(ii) does not include property that is exempt, so he is insolvent.
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3.
d.
Is gift a transfer? No, house is not an asset under 1(2), so there was no transfer of an asset under
1(12), so no violation of 4 or 5.
Leveraged buyouts
i. What is the fraudulent conveyance problem in LBOs?- assets of corporation being acquired are used to
secure purchase price for those assets, often through issuance of junk bonds. Key element is that
purchasers use the assets of company being bought as a security for funds borrowed to purchase
shareholders.
1. LBOs are attractive to all parties because it shifts the risk of loss to other creditors of the
corporation. Acquired corporation receives little or nothing in exchange for the debt it incurs.
2. From creditors point of view, LBO is pretty much a gift to shareholders. If value of security
interest given by the corporation does not exceed the shareholders equity, there is usually no
substantial harm to creditors. If price paid to selling shareholders is higher however, there may be
insufficient assets remaining to satisfy creditors.
3. The Vice of an LBO lies in fact that selling shareholders are paid indirectly with assets from the
corporation itself, rather than by purchasers.
ii. Application of FC law to LBOs
1. In re Plastics- Shareholders (SSH) formed debtor Bay Plastics in 1979. Financing: Debtor here is
Bay Plastics, and selling shareholders are the founders, and Millhous wants to buy them. They use
a subsidiarys subsidiary, to buy BP for 3.5 million, for the stock. They dont want to put up
money, so they use BT(bank) to make the loan of 3.9m to Bay, with BAY keeping the extra 450k,
which remaining 3.5 million getting funneled to BPI to pay shareholders. BT gets a secured
interest in all of Bays assets to secure the loan. Shintech is another creditor, though now an
unsecured creditor. They did have a secured interest and guaranty, but were induced to release
security/guaranty, without disclosure of the LBO. Milhous bought the company without using any
cash or assets.
a. Shintech, a creditor at the time of the transaction didnt learn of the LBO until 10 months
later. 3 months before the LBO, Shintech had entered into a K whereby Bay Plastics
granted Shintech a security interest in all its assets and the shareholders gave personal
guaranties, after the LBO, Milhous persuaded Shintech to release both its security interest
and the guaranties, but never disclosed LBO character of transaction. Before transaction
Bay had net equity of 1.1 million, but after it went down to 250k. Bay filed for
bankruptcy 15 months later. It owed 4 mil to BT and 3.5 to Shintech.
b. Post transaction they had 7 million in assets (+2.3 in goodwill) and 9 million in
liabilities, so difference of 250k in equity. Pre they had 6.7 mill in assets and 5.6 in
liabilities, equity of 1.1 Equity disappeared even if assets went up. Company couldnt
meet obligations because of excessive debt and ended in bankruptcy. BT gets payment in
full, BPI gets nothing (but loses nothing), SH already have money. Shintech probably get
nothing as unsecured creditors.
c. Is there fraudulent conveyance that could allow C to recover?
i. Does debtor make transfer of property interest that could be basis for
fraudulent transfer? Under 5(a) Yea, Debtor undertook 3.95 Million to BT,
transferred secured interest in assets to BT, transferred 3.5 million to selling
shareholders. Court says you must consider other relationships in the structure
because they are not isolated.
ii. Lack Of reasonably equivalent value- reality of transaction is that 3.5 million
of the funds Bay borrowed form Bt went to pay for the stock of the selling
shareholders, rather than Bay. selling shareholders had full knowledge that this
was an LBO, even discussing their exposure to fraud. Court collapses into 1
transaction, not multiple ones. In that case, the 3.5 million goes to the
shareholders and Bay gets only 450k, which is not reasonably equivalent value
in exchange for all their assets.
iii. Debtor also has to be insolvent at time, or have been rendered insolvent as a
result of transaction. Here, they were rendered insolvent by the transaction,
because the 2.3 in goodwill doesnt count because it cant be sold in liquidation.
Has no value. They were very much over leveraged. All of risk was placed on
creditors Must also look at whether they can make their debt payments, which
here they cant.
2. Legitimate LBOs, in which assets are mortgaged by a corporation to support an LBO do not
exceed the net equity of business, transaction will not make corporation insolvent. If it has
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sufficient cash flow to pay its dents as the are due, cash flow solvency test is met. This leaves an
LBO ex-post to fraud attack only if the margin of equity is too thin to support the corporations
business. Even if corporation is left insolvent, if the cash flow is sufficient to make debt payments,
transaction is unassailable.
3. For LBOs, ask whether the was a transfer, of reasonable value (can argue what goes in into
valuation), and whether this caused insolvency.
iii. Problem 4.5 - KW loans $500k to her friend PR to start a business (money lent to the company directly),
repayable in six years in exchange for interest. One years later, PR says she sold all stock of MK to RL
(who has no business know-how) for 100k by getting a loan. The sale was on credit, with the company
guaranteeing RLs payments to PR with all of the companys assets. The companys assets > its liabilities,
but its bills are piling up. KW is worried about the business failing. Can she invalidate the sale?
(i) First of all, what transaction are you trying to undo? Answer: the companys security of the loan
on the stock sale, since the company is what owes KW.
(ii) Theres no actual fraud, so UFTA 4(a)(1) doesnt apply. Thus, we are left with UFTA 4(a)(2),
which probably also doesnt apply because there is reasonably equivalent value given
(presumably the stock sale reflects the value of the company; theres no indication in the facts of
a bargain-basement sale, price that seems more than adequate for business that hasnt profited.
(iii) The company isnt balance-sheet insolvent, but it cant pay its debts as the come due so they are
presumed insolvent, UFTA 2, so UFTA 5 applies. Company is an insider, and it would have
reason to know of its insolvency. Thus, can void under UFTA 5(b). Insolvency question is at
issue here.
iv. Problem 4.6 - Tithing while legally insolvent. Can he make a 4(a) subjective intent? Seems unlikely, if
theyre legitimately Christian then their intent was legit. What about with 5(a), because they didnt receive
anything of value in return? Maybe they received emotional well-being by religious services. Maybe social
stature? Sticky questions about reasonably equivalent value. In this case, court said it was fraudulent
conveyance because they got no value, but congress then passes RFRA, which outlaws statutes that
interferes with religious expression in federal laws. The big point: by the strict statutory language, a tithe to
a church while insolvent is a fraudulent transfer under UFTA 5(a) unless value was exchanged (and
spiritual fulfillment probably does not fit in UFTA 3s definition of value).
v. State Collective remedies1. assignment for benefit of creditors wants lawyers to deal with creditors, liquidate non-exempt
property, and he distributes it. Doesnt provide discharge of remaining debt.
2. Composition and extension- restructuring. Agreement that debtor will pay less, with an extension.
It is entirely voluntary.
3. Receivership court appoints guarding that takes control od debtors financial picture and
administrates.
4. These all apply for those that cant apply to file under Title 11 federal code, like banks and places
of worship.
Introduction to Consumer Bankruptcy
A. Premised on idea of a fresh start while business bankruptcy is focused more on saving the business.
B. Federal Bankruptcy Statute Purpose
a. Creditor Perspective
i. Collection under state law is very individualistic. It is a race to Ds property and often creditors are hurt b/c
only one makes it first. Higher recovery in consolidated liquidation.
ii. Federal reach of the statute. You do not have to deal with particular state rules. The federal government
also has treaties with other countries.
iii. Finding the assets. D is required to provide extensive schedules of assets up front.
b. Debtor Perspective
i. Compassion for debtors.
ii. In the interest of the society and the state to have productive and happy individuals.
iii. Economic basis: economy depends on relatively free credit/people to taking risks. You want to balance
economic stimulation and responsible credit maintenance.
C.
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ii.
D.
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1.
2.
3.
Legal interests not enforceable at date of bankruptcy but become enforceable at later time.
a. Sharp v. Dery: P sought to include Ss post-petition employment bonus as property of
the estate. D filed for bankruptcy, then began working for Valasis and received a bonus of
11k. The bonus is form Jan 1 to Dec 31, and must have been in good standing year before
or before issuance of dividend. Timing of bonus check was at employers discretion.
Bankruptcy trustee wants it to be property of the estate, so you creditors more money.
Trustee argues that these are pre-petition wages he was entitled to based on the work he
had done the previous year, pre-petition.
i. Holding: Post-petition income (bonus) that is dependent upon the continued
services of the debtor subsequent to filing doesnt constitute property of the
estate.
1. Employer had discretion over whether to pay the bonus. Thus, S had no
property interest in the bonus. When post-petition income is
dependent upon the continued services of debtor subsequent to
petition, the amounts do not constitute property of the estate.
Because he worked more than 2 months after date of filing to be
eligible for bonus, it was dependent upon his continued services of the
debtor subsequent to the petition, and doesnt constitute property of the
estate
2. Even though its related to pre-petition wages, Bonuses dont generally
have to be paid, and there was no legal entitlement to the bonus at the
time of petition. For bonus to be issued, person had to still be employed
at workplace, which requires post-petition activity.
Certain entitlements, such as permits or licenses that are non-transferable, which may or may not
be property.
a. In re Burgess: D argued that the county couldnt revoke his license to operate a brothel
because the license was property of the estate. In this case Burgess wants it to be property
of the estate. Because its reorganization, debtor wants it to be part of estate, because its
now reorganization estate. Both trustee and debtor are working together. Property is
defined broadly. It has enormous value to estate, so how could they reorganize as a
brother without the license.
i. Holding: License is property of the estate. If a license has value (liquor license,
casino license) then it is property of the estate. Majority of cases have held that
liquor and similar licenses are property for bankruptcy purposes. But in In re
wade, 9th circuit bankruptcy panel held that license to practice law was not
property. court hold that license is property.
1. Stands for the proposition that the automatic stay prohibits attempts to
revoke certain licenses.
Restrictions on transferability imposed by contract or state law. 541(c)(1) makes most nontransferable property, restriction-free for purposes of bankruptcy, besides the spendthrift
exception in 541(c)(2) (like retirement accounts). 542(c)(2)- validates restrictions upon transfer of
debtors beneficial interest in trust by excluding property from the estate.
a. In re Orkin- has business that goes bankrupt, and he set up a retirement account during
this time. Then he goes to bankruptcy, and wants to not be part of property of the estate
(different than exempt). If his retirement account is ERISA-qualified, then fed law
protects it from his creditors and the SC has ruled that it will not be part of the estate. If it
is not qualified, the debtor can try with state law. If under Mass law, plan has a valid
spendthrift trust provision preventing alienation and thus protecting it form creditors, it
will not become part of the estate. Is his plan ERISA qualified and not part of the estate,
under 541(c)(2)?
i. What counts as ERISA-qualified? Most courts agree it must satisfy both IRC
and ERISA. Here he is not ERISA qualified because he is an employer, which
goes against definition in ERISA
ii. Does it qualify under state law? Trustee in Bankruptcy says plan doesnt
qualify under ERISA as a pension because sole shareholder gave himself
employee status, and under state sole shareholder cannot have employee status.
When debtor has power to amend or terminate the trust, the debtor has such
absolute authority over the trust that it must be included as property of the
estate. Although his plan contains a restriction on transfer, the plan is easily
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terminable on 60 days notice, with all funds reverting to him. Plan then does not
contain a restriction on the transfer of a beneficial interest of the debtor in a trust
that is enforceable under Mass spendthrift trust law and plans assets cannot be
excluded if state law exemptions were claimed.
c.
d.
The Trustee
a. The TIBs duties are to gather all the property, protect and maintain it, sell it for the highest possible price
and distribute the proceeds among creditors according to statutory priorities. 704. TIB must also
scrutinize claims and oppose those that may be invalid or overblown, challenge any improper exemption
claims by the debtor and investigate the debtors affairs to the extent necessary. 704
b. Theoretically, the trustee can be elected by the creditors in Ch7. However, he is usually appointed by the
U.S. Trustee.
c. He has a special duty (by custom) to the unsecured creditors, and thus must attack anything that harms
them (including security interests, preferences, and priority claims)
d. TIP has incentive to maximize recoveries for unsecured creditors b/c he receives a percentage of the funds
distributed and that distribution is primarily to unsecured creditors. 326, 330
Problem Set 5
a. Problem 5.1 What counts as property of the Estate?
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.
Parakeet? Yes (LOE), though not saleable probably and Pets are exempt in some jurisdictions.
07 Camry, subject to PMSI in amount exceeding value? No equity in car, though still LOE interest, so POE.
Even though he doesnt have equity interest, he has a legal interest that arose before filing
Intimate pictures? should be considered property of estate, may have value. But no one may want the picture,
may just be abandoned by TIB or may be subject to exemption.
Two U2 tickets? property of the estate, has value, may be abandoned though. Ticket may be not-transferable
though, but notwithstanding, it still becomes property of estate.
Household Furniture -clearly be property of the estate, items around the house, but may be exempt
Stock left by uncle- POE, acquired by inheritance 541(a)(5)(A)/(6) within 180 days of filing?
3/48th interest in oil well, left by uncle- Undivided interest
Baseball Cards Yes, have value
Catchers mitt- Yes, has value. Though may matter if brother left for college years ago, state of limitations
may have run and he may not have right to get back.
Bank Account named trustee for benefit of little sister? ) to extent hes named trustee, hes still named
trustee(legal title), but its still technically property of the estate. 541(d) protects the equitable interest, thus the
beneficiaries will not be affected. So the estate gets whatever rights the debtor has.
Salary month prior to petition that received hours after petition? Its pre-petition wages, so included. 541(a)(6)
because he had the right to the salary on the commencement of the case.
Retirement account he cant touch? But is it kind of trust that isnt transferable under applicable law, then it
doesnt transfer under property of estate. So, depends, we need more info. ERISA benefits are excluded.
Parakeet eggs? - belongs to property because it is the product or proceed of property of the estate, so becomes
its property. 541(a)(6):
7 months later, received dividend for stock (item 6)- Divided.
Post-petition salary/contribution to RA- these both occurred after he filed for bankruptcy, so its not part of the
estate. This occurred after the creation of the estate.
b. Problem 5.2 If the lottery ticket was purchased prior to the time he filed for bankruptcy, the proceeds
would be the property of the estate. Want to ask if lottery ticket has restriction for transferability, but in
general theyre not applicable unless its some trust or investment account situation. Here, ticket was
bought pre-filing. -what about the fact ticket is worth 0?- expected value Is still something (Probability X
value).
c. Problem 5.3 - March 1 sold; April 1 filed for bankruptcy. On March 1: $10; April 1: $15; May 1: $20;
Farmers contract is part of the estate. The trust has an equitable and legal right to enforce the contract. But
what if Frances refuses to harvest the wheat since she doesn't own the wheat? She was under contractual
obligation. But the bankruptcy estate now owns the contract. Would the trustee hire Frances to harvest it?
TIB would argue that proceeds of sale belong to estate, because property of estate was created at filing on
April 1, and property that belonged to estate was wheat itself. Anything resulting from what belonged to
estate, INCLUDING the contract. Farmer is going to say she harvested it and did a lot of the added labor to
generate 200k. Could also bring up a quantum meruit claim, to recover the labor work. Splitting it seems
contrary to Vogel. TIb could also claim they own it, and then hire someone else to harvest it.
d. 5.4- Client owes 100k, income is 1k from 200k trust from mom. Only gets income from trust until mom
dies, at which point he gets corpus of trust. Rights are not assignable. Mother is ill, may last 6months,
though not a year.
1. If restriction on trust is non-transferable under state law, if he filed bankruptcy, it wouldnt be part
of the trust as long as she doesnt die within 180 days. If she dies a week after filing it becomes
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property of estate Look at 541a(5)(a)- 541(c)(2). you could also try to amend the trust, but you
might want to look at fraudulent conveyance, if hes doing it with intent to defraud creditors, then
you might come up against subjective conveyance problem. (look at REV, was he insolvent?)
Must also look at how you define a transfer, and how active debtor has to be in active transfer?
e. 5.5 according to sharp v dery, bonus didnt have to be paid (discretionary) and he had no legal entitlement
to it at the time of the petition. He should get the award. TIB can argue it was product of pre-filing work.
depends on whether award was based on post-filing activities. Was it already a mature legal interest by time
filing? Who actually gave the award? Did the dean? Is it award given to ALL teachers (could be POE).
Was it given for alumni? (making it post-petition gift, not POE).
f. 5.6 liquor licenses issued by state and are nontransferable. Can TIB make claim for license? As a TIB,
you want liquor license to resell the store. Depending on Burgess, state-created rights dominated by state
have been treated as property for purposes of Bankruptcy law, if have value. Majority of cases have held
that liquor and similar licenses are property for bankruptcy purposes
B. The Automatic Stay
a. 362(a) prohibits collection efforts unless an exception applies once the petition has been filed. Filing petition
triggers automatic stay that prohibits any creditors attempt to continue to collect from the debtor or debtors
property. Creditors are generally precluded from taking any individual action against the debtor or debtors
bankruptcy estate, and against TIB and POE. Primarily designed to maintain the status quo while the court figures
things out; Everyone stops what theyre doing, so for both TIB and Ds benefit. Creditors can also petition the court
to lift the stay, especially if they need protection. Stay is powerful, but temporary.
a. Includes right to setoff. 362(a)(7)
b. Includes any act to create, perfect or enforce a lien 362(a)(4) - Grace period exceptions (see below).
c. Exceptions to the automatic stay:
1. Commencement of criminal proceedings 362(b)(1)
2. Actions to establish paternity or alimony/child support, or to collect alimony/child support from
non-estate property. 362(b)(2)
3. Perfection of PMSI within state law grace period (typ. 10 days) 362(b)(3)
4. Actions concerning a governments enforcement of its police or regulatory power. 362(b)(4)
5. An audit by a government agency for tax liability, notice of tax deficiency, or demand for tax
returns. 362(b)(9)
6. Act of lessor to regain property on terminated nonresidential lease. (362(b)(10))
b. Violations of the Automatic Stay
a. Willful violation ct can award attorney fees to the estate, as it is a contempt of court.
b. Nonwillful violation The action is void or voidable
c. When the Automatic Stay can be lifted
a. After notice and a hearing if there is not adequate protection for the creditors. What needs to be shown
depends on the type of creditor.
1. Protection can be shown by either making periodic cash payments to the creditor, or by giving
additional/substitute liens, or by giving other protection. 361
b. Secured Creditors can lift the stay for cause, meaning his interest in the collateral is in jeopardy. 362(d)
(1)
c. Unsecured and secured creditors can get the stay lifted if the debtor has no equity in the property [value
liens = 0], and the property is not necessary for an effective reorganization.
d. Andrews University v. Merchant: Merchant took out loan from bank in connection with loan program arranged
with Uni., had provision that gave bank full recourse against the Uni. in the event a student defaults. When merchant
defaulted, university pursuant to guaranty agreement paid the bank and took sole assignment of note, becoming sole
creditor for Merchants expenses. She filed for bankruptcy, then asked for copy of transcript and was denied, and
she filed against Uni. claiming their refusal violated automatic stay (362a). Whether refusing to provide debtor
their transcript because they are in default on prepetition debt, school violated automatic stay provision 362.
a. Holding: Withholding a transcript violates the automatic stay. Refusal to issue transcript until debtor
pays a prepetition debt is an act to collect, assess, or recover a prepetition debt and a violation of
362(a)(6)
1. Though they are not dischargeable, they are not isted within the exceptions to the automatic stay
found in 362(b). It applies to creditors of education loans and remains in effect until case is closed,
dismissed, or discharge is granted. Get several transcripts you might need before you will pay off
loan, while the automatic stay lasts.
e. Nissan Motor Corp. v. Baker: Nissan repossessed and sold a debtors car after the debtor filed CH 7. Nissan had
notice of the filing shortly after repossession but prior to sale. The sale happened while a motion for relief from stay
was pending.
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f.
g.
h.
i.
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d. they can have a preferential claim on the car because its secured 521a(2)- within 30 days or at creditor
meeting, Sydney has to say she will redeem (pay in full) or reaffirm that debt, then and only then they will
understand whats going on. If they dont perform the intention, the stay is automatically lifted under
362(h).
e. When the creditor pays back the money from the check, does Sydney get it? No. It goes into the estate and
is distributed pro rata. What would have happened if shed filed for bankruptcy before she cashed out her
retirement account? Shed have been able to keep it. (541(c)(2)/exemption). She could have used that
money to redeem the car post-petition. Now its gone!
Consumer Liquidation Bankruptcy
A. Introduction
a. At end of liquidation process, creditors get proportional share of debtors shit, and debtor is discharged from
remaining outstanding debt. Straight liquidation chapter both consumers and business. All of debts are discharged,
you hand over all your assets (liquidate), and when you leave bankruptcy you dont have further payments
b. TIB is appointed to collect estate property, sell assets that are not exempt, and distribute proceeds to creditors. The
distribution process covered later by 726. TIB must consider valid exemptions to items of property, those which are
reserved for debtors fresh start.
c. Once proceeds from sales of all property have been obtained and secured parties and other entities with property
interests paid, then the TIB distributes the remaining funds to general creditors. none of these are secured, though
some may have been partially secured, and now collecting on portion of claim not yet satisfied There are 3 types of
unsecured creditors: Priority, General (GUC) & Subordinated
i. Priority- first in line, entitled to get paid in full or up to the dollar limits of statutory priorities, before other
creditors. Among priority creditors, some get paid before others. 507a
ii. General creditors get paid in middle.
iii. Subordinated creditors- all the way at the back, equitable subordination, because of some wrongdoing.
B. Eligibility
a. A Change in Philosophy
i. In re Shaw: Ds had a $415k house and personal property totaling $56k. They earned $8k/month for the
five years preceding their ch 7 filing. They claimed $7.5k in monthly expenses, many lavish. Prior to
bankruptcy they had amassed huge debt, with first mortgage of 338k and 2nd mortgage of 60k on their
home, with their total secured debt being 469k+ and 131k+ in unsecured debt (had over 15 credit cards).
They have spent more money than they earn, and want fresh Ch. 7 start so they retain home and 3 vehicles.
TIB moved to dismiss for substantial abuse.
1. Holding: A ch 7 petition may be dismissed for substantial abuse. However, the code does not
define substantial abuse or indicate what circumstances justify dismissal, so look to totality of
the circumstances. Was dismissal appropriate for substantial abuse under 707(b)/ Green
Substantial Abuse Test.
a. Whether debtor has ability to repay the debts
b. Whether debtor filed petition because of sudden illness, calamity, disability or
employment (here, long term spending, not sudden)
c. Whether the debtors schedules and income statement and expenses accurately reflect his
financial condition (accurate)
d. Whether the debtor incurred cash advances and made consumer purchases beyond his
ability to repay (definitely made purchases in excess of their income, made purchases
assuming they would get bonuses, also, they have a huge house)
e. Whether the debtors proposed family budget is excessive or unreasonable
i. Ds expenses were excessive and unreasonable. may be dismissed for substantial
abuse under 707(b). Shaws could modify their monthly expenditures and repay
their debts. House too big for them/ obtain less expensive house. Cannot pay her
tuition at expense of creditors. Reductions can be made on Pool/phone expenses,
transportation expenses unreasonable.
f. Whether the petition was filed in good faith.( good faith met here)
1. In granting ch 7 there is a presumption of granting debtors the relief requested, even so, the
court finds that cause should be dismissed for substantial abuse. Should be dismissed under
707(b), have opportunity to convert to Ch 13. theres no presumption of abuse, but here this
is substantial abuse.
b. The Presumption of Abuse
i. 707(b)(1) exempts anyone whose debts are mostly business-related from abuse screening. Screening test is
semi-automatic, employing fixed formula with courts judgment being limited
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c.
19
20
a.
On these numbers, Michael is caught by the means test. Section 707(b)(2)(A)(i) says
there is a presumption of abuse if his monthly post-expense income multiplied by 60 is at
least $6,575 or 25 % of his outstanding unsecured debt. Because he is above median
income and he can produce $9,000 over 60 months in income above his allowed
expenses, he is caught. (income is 150/month x 60). The $9,000 is higher than the
minimum $6,575 and higher than 25 percent of his general unsecured debt (25% of
$30,000 is $7,500). Hes ineligible
2. Does that mean there is nothing to do?
a. If his general unsecured debt were $40,000, then Michael would be caught by the means
test only if he could produce $10,000 in excess income which is $166.66 a month
higher than his $150 a month. Alternatively, Michael could buy a newer car. His car
payment will come directly off his monthly income, immediately putting him below the
available income threshold. How about health insurance, disability insurance, and a nice
health savings account? If Michael doesnt have it, he should get it. The expense
deduction for health insurance alone will wipe out the extra income.
1. Can you give this kind of advice?
a. Can you tell Michael to go out and run up $10,000 in debts that he plans to discharge
(racking up $10,000 he does not intend to pay?) or to buy a new car? Section 526(a)(4)
says that a Debt Relief Agency cannot advise an assisted person . . . to incur more debt
in contemplation of filing a case. Under section 101(12A), it seems pretty clear that a
bankruptcy lawyer is a Debt Relief Agency. Congress seems to prohibit this form of
advice.
ii. Problem 7.4- has judgment against him for fraud in 1 billion. HE wants to file for chapter 7 and has 1
million in non-exempt assets. He has protected spendthrift trust that give him 2 million a year.
1. Is he eligible for ch. 7- definitely wont pass first part of test. Means test is for consumer
unsecured debts. 1 billion debt here is in business debt not consumer debt. A lot of things refer
back to 707. 707a is mostly delays/no fees/for cause, and some courts have looked at it to not
allow people like Ken here, and expanded into 707(b)(3) type of fit. Other courts say 707(a) gets
at stupid stuff, and 707b(3) gets to substantial abuse, and would let Ken file for ch 7. Depends on
how jurisdiction interprets for cause part of 707(a). Judge has discretion.
a. Why would congress do this?-this is type of stuff congress is trying to protect, even
though hes not sympathetic, this is what theyre trying to protect. You want people to
take risk, and there will only be risk if you get into debt.
Mechanical testKey questions is are you a high income individual or low income. If low income, then youre probably ok (compared to state median)
1) Compare median and annual income - median is up in dep of justice, its by household size.
i. Income is monthly income for last six months divided by 6 and multiplied by 12.
ii. If Income is Less or equal to median, then its not presumptively abusive and can file for ch
7 as long as you do in good faith. If income is greater than median than its presumptively
abusive and must go to step 2. ONLY go to step 2 if you fail step 1.
2) Compare surplus income & general unsecure non-priority debt. Surplus is monthly income
monthly expenses multiplied by 60 months.
i. Expenses- weird combo of actual expenses and expenses allowed for
bankruptcy code, which are imported by IRS local/national standards. 707 (b)
(2)(A)- determines if debtors have the means to pay back creditors.
ii. Why general unsecured non-priority debt and not all debt?- talking about credit card debt and
medical leaves, and leaves out secured car debt and mortgage, because mortgage/car payments
are included into monthly expenses no matter how expenses (prob because of lobbying).Look
at Form 22iii. If General unsecured Debt is more than 29900 and surplus is more than 12,475, then its abuse.
iv. If Gund is greater than 29900 and surplus is greater or equal to Gund x .25, then still abusive.
v. If Gund is less than 29900 but surplus is more than 7475, its still abuse
vi. Is Surplus is less then 7475, youre ok to file Ch. 7.
C. Property Exempt from Seizure- Some property is exempt to avoid draconian results that would threaten the fabric of
community. Often directed toward making sure that every debtor retains enough basic property to have a chance at a fresh
start. Another reason is that some property has little resale value. Theres difference between seizing property to satisfy a
debt and seizing property to inflict pain. Consensual agreements like mortgages, security interests on cars, or pawnshops
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possessions are not so exempt (debtor waives them as part of security interest). Compared, to CC, health care provides, and
tort victims and others who cannot get security interest
a. A State/Federal System
i. Federal vs. State Exemptions states can opt out of the federal exemption regime; if Ds state has, then D
will have to use the state regime. Otherwise, the D may choose b/w state and federal regimes, which can
lead to forum shopping to file. 522(a)
ii. Once debtor files for bankruptcy, federal law preempts state collection efforts with the automatic stay
iii. If a married couple files together, each get an exemption. 522(m) (This only applies to the federal
exemptions; state law may differ).
1. Both must choose the same exemption regime if their petition is being jointly administered.
522(b) If you can avoid being jointly administered, it may be worth filing separately to use two
separate exemption regimes.
2. A spouse is a dependent regardless of whether they actually are dependent. 522(a)(1)
iv. Calculating the Exemption
1. If creditors are all unsecured, its easy if the property is worth more than the exemption amount,
then the TIB sells the asset, gives the exemption amount to the debtor, and distributes the rest.
2. If the asset is secured, the secured party is superior to D and TIB. Ds secured interest is satisfied
first, then the exemption amount is given D, and then any leftover value is distributed by the TIB.
3. If the lien is > FMV, you can ask the TIB to abandon the property
v. Debtor gets two chances to keep his property 1) during Prop of estate and 2) With exemptions.
vi. Steps- 1) is property being exempt fall into a certain category/classfication? 2) how should it be
valued? 3) how does it look under federal and state exemption statutes. 4) planning!
2. The Federal Exemptions: ( 522(d)) The following property is exempt:
a) Ds aggregate interest (i.e., his equity) in property used as a residence up to $22,975. 522(d)(1)
(1) Recall that equity = value of asset - unpaid debt
(2) up to $11,500 can be added to the wild card of 522(d)(5)
b) Up to $3,675 in a motor vehicle. 522(d)(2)
c) Household items (used primarily for personal/family/household use). 522(d)(3)
(1) Each individual item cannot be > $575
(2) The total of the items cannot be > $12,250
d) Up to $550 in jewelry (Ds use or dependents use only). 522(d)(4)
e) The Wild Card $1,225 + whatever is left from the residential property exemption up to $11,500. 522(d)(5)
f) $2,300 of professional books or tools of the trade. 522(d)(6)
g) Unlimited amount for an unmatured life insurance contract owned by D (i.e., the death benefit on Ds life).
522(d)(7)
h) Up to $12,250 in a life insurance policys loan value, less premium payments made pursuant to 542(d). (Ds
life must be the one insured). 522(d)(8)
i)
Unlimited amount for professionally prescribed health aids (debtor or dependent). 522(d)(9)
j)
Unlimited amount for whatever debtor receives in social security, unemployment, veterans benefits, or
reasonable alimony support or pension/disability plan. 522(d)(10)
k) Receipts as a tort victim 522(d)(11)
b. Classification of Property
i. In re Johnson: P claimed bus was exempt property. The statute exempted one motor vehicle, not
exceeding $2.5k in value. TIB argued that the legislature intended motor vehicle to exclusively mean
automobile. Holding: If motor vehicle is included in an exemption statute, it means that, without more,
buses are exempt property. Bus & auto are species of the same genus, motor vehicle. Couldve been more
specific but didnt.
ii. In re Pizzi: P won the lottery, receiving a 20 year annuity. 8 years after winning, P filed ch 7. FL exempted
annuity payments from the reach of creditors(so does code under (d)(10)(E). Thus, P argued that the
remaining 12 pmnts were annuities exempt from the reach of creditors. TIB objected.
1. Holding: Lottery winnings paid over a period of years that are not specifically declared by the
lottery to be annuity payments are not subject to exemptions where the states exemption statute
exempts annuity payments. Court says Connecticut never refer to proceeds as annuity or winner as
beneficiary of annuity. (Lesson: State exemption laws are not intended to protect instant
millionaires from paying their legitimate debts). Must be liquidated.
a. The income stream flowing to P is prize winnings. The lottery never referred to the
winnings as proceeds of an annuity and the winner is never called the beneficiary or
payee of an annuity. Creditors argue that the statute is intended to protect annuity
contracts which provide life insurance and retirement benefits, should not allow lottery
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c.
d.
tickets. Would be inequitable for debtor to run up debt and then retain the lottery,
BUT it doesnt motivate the decision either way.
b. A different outcome might result if lottery winner is specifically named as beneficiary of
an annuity contract purchased to fund a states obligations.
Valuation of Exempt Property
i. The value of property is its FMV at the time of filing 522(a)(2) (or with respect to property that becomes
POE after this date, then date property becomes POE.
1. Does this mean forced sale or open market?
2. In re Walsh: The TIB objects to amount D claimed as exempt property under 522 on the grounds
that the amount is improperly valued. TIB argues the property must be appraised at FMV while D
argues that the property should be appraised at liquidation value.(it will bring in more money to
distribute to creditors, but if Liquidation is used then D gets to keep it)
a. Holding: In D.C., the court will take into account the propertys liquidation value when
determining how to value exempt property. In 522(a)(1), value is defined as FMV.
However, court must consider the interpretation of the statute as a whole, and cannot
construe a provision in a way that would be inconsistent with the statute as a whole.
1. Court must look to the usual meaning of FMV and to the liquidation
context and the overall goals of the bankruptcy code.
a. FMV = price willing seller and willing buyer will trade.
Definition varies w/ circumstances courts interpret FMV in
the context in which the valuation question arises.
b. The definition of market on the day a petition is filed is
necessarily the eventual bankruptcy sale. More fair result
2. If it was FMV here, theyre allowed to sell, give the debtor 20k
(exemption), and the rest goes to creditor and get SOME amount of
money.
3. In re Mitchell: Objection focused on Ds claim to jewelry, a 6.18 carat diamond ring worn
regularly by D worth $30k. D listed the ring exempt clothing reasonably necessary for the
family . Expert for trustee put value at 42k and FMV of 36k, while debtors expert put it at 7.8k
due to liquidation context. If its indeed worth 36k then the debtors will be forced to choose
between ring and household furnishings
a. Holding: In Texas, courts will not take the unusual circumstances of the bankruptcy sale
into account when determining the FMV of exempt personal property. Standard is thus
fmv incorporating as it does an exposure of the item to the appropriate market
for a reasonable period of time. here, 36k.
i. The court says that the reasoning in Walsh is flawed because the court focuses
on the word market and ignores the word fair. Walsh standard flouts
legislative intent. Must balance out the competing concerns of assuring a debtor
a fresh start and assuring creditors a fair recovery on their legitimate claims.
Letting the debtor have everything off the approved list without limitation
offends the sensibilities of the common man. State couldve been more explicit
ii. Continuous wear and sentimental attachment carry considerable weight
sufficient to qualify the ring as clothing reasonably necessary for the family.
iii. D gets amount up to exemption value, and doesnt keep it.
4. What if a secured creditor has a 20k interest in car that is valued at 25k (over-secured), with 10k
exemption. They give the 20k to secured creditor, the remaining 5k debtor has in equity goes to
him. TIB and other creditors get nothing.
a. what if theres 10k security interest. 10 to SC. Theres 15k left in equity and they get
exemption amount of 10k, with remaining 5 going to TIB for distribution. Secured
creditors have priority over exempted debtors, and they have priority over
unsecured creditors.
Lien Stripping
i. The debtor can avoid a lien on any otherwise exempt property that is:
1. A judicial lien not for alimony, child support, etc., under 522(f)(1)(A) or
2. A consensual lien that is not a PMSI in household goods, tools of the trade, or health aids under
522(f)(1)(B).
a. Example: creditor lends $ and takes a security interest in the household goods D already
owns. The property must be the kind specified in 522(f)(4).
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ii. The creditors are then treated as general unsecured creditors and they cannot push their claims ahead of
debtors exemptions. 522(f)(1)(B), voids certain volunteer security interest due to concern of predatory
financial practices
iii. Available in all personal bankruptcies, even if state exemptions are claimed
e. The importance of the exemptions only four types of creditors can continue to pursue exempt property ( 522(c)):
i. Creditors with tax claims exempt from discharge under 523(a)(1)
ii. Creditors with domestic claims exempt from discharge under 523(a)(5) (child support and alimony)
iii. Post-petition claims
iv. Claims not extinguished via redemption
f. ** For Exemptions, Always argue from TIB and Ds side. If term vague.
Problem 8.1- Harv and Lois Hughes live in an apartment - they are unable to pay several debts and are worried about which of their
assets may be vulnerable to creditor attachment- their largest creditor is the IRS, to which they owe about $5k in back taxes
-Texas-(168) Personal property up to 60k aggregate FMV, exclusive of lien amounts (for a family/30k single- Wages are exempt,
alimony is exempt.
They live in an apartment
42.002-home furnishings are exempt. His wheelchair will be exempt and not count towards the amount because it is a professionally
prescribed health aid.
What counts as personal property furniture (8k), clothing (2k),books-tools (2.4k), Moped (800) and Convertible (500), Wedding
ring (1k, but limited to 15k jewelry), Computer (1.2k), Friendship sloop? (6k), cat +soccer ball (202)=
No limit- Wheelchair (18k) can argue not prescribed though,Insurance (2k), shares of Disney, joint checking account,
Total of 54802, but the payments from lawsuit could potentially count as an exempt asset
-would be able to exempt virtually all of their property (except tort suit, Disney stock, checking account) so TIB need to be
aggressive with their arguments for not exempting shit.
-with potential suit, settle the suit before you file for bankruptcy. Try to get annuities, which are potentially exempt
-With wheelchair, secured party can still go after the party.
-Wyoming- pretty much fucked here.
1000 limit on clothing. Law books are exempt.
2000-limit on furniture (2 people entitled to separate exemption)
2400- motor vehicle exemption
Tools of trade (2000) -no exemption for wheelchair.
-Federal Exemptions under 522(d)522(d)(1)- aggregate interest not to exceed 22,975
(2)- motor vehicle 3675
(3)- 575 for single item or 12,250 for total value of furniture, household goods, books, apparel, animals, crops, instruments
(4)-550- in jewelry ( do you get to double up though?) also look at 4(A)(14)
(5)1,225 or 11,500 in unused amount for any item (Wild Card Exemption)
(6)2,300 in professional tools of the trade
(7) unmatured life insurance
(9) health care goods (wheelchair)- no limitations
10-E- stock bonuses
-you want to advice to file for federal bankruptcy because of the exemptions and level of protection.
D(11) - torts statute?
Problem 8.2 if D decides to declare bankruptcy can she keep 1 million dollar insurance policy from dead husband? What about the
bar? In Wyoming they exempt the entire amount for insurance purposes. In texas, all of the life insurance is exempted. Proceeds
benefitting debtor are also exempt. Theres a lot of forum shopping that can go on because of these exemptions. Federal statute
doesnt let you play games like that, unless youve been in that state for a long time.
-Federal only exempts amount she needs to support herself. 522
D. Claims and Distributions
a. 2 important questions 1) How much is allowable claim and 2) in what order do you pay claimants? (basic
order is a) secured amounts b) priority unsecured c) general unsecured non priority d) subordinate) Class ahead of
you gets paid in you before you get any.
b. The Claims Process
i. After its clear what is exempt, TIB assembles non-exempt property for sale, with proceeds distributed prorate to creditors. TO receive any distribution, each ch 7 or ch 13 creditor must submit proof of claim, which
is understandable since in ch 7 cases, few cases involve non-exempt property. This isnt the case for ch 13
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c.
d.
e.
ii. Generally, a claim must be filed within 90 days after the first creditors meeting in a consumer bankruptcy
for a creditor to receive his distribution. A creditor must submit proof of his claim. A claim is allowed
unless a party objects.
Disputed Claims
i. Disputed claims will generally require an evidentiary hearing.
ii. In re Lanza: Mr. and Mrs. Lanza (P) filed for bankruptcy. The bank asserted 3 proofs of claim against the
estate, none of which were well documented and the largest of which is for an amount that cannot be
determined because of the banks poor bookkeeping methods. Mr. Lanza died during the proceedings and
Mrs. Lanza was unable to find a single record of his transactions with the bank. The bank, due to poor
bookkeeping methods, was unable to provide much evidence to support its claim that it loaned the Lanzas
$300k. does evidence support a banks entitlement to 3 claims, notwithstanding its gross deviations from
standard banking practices.
1. Holding: A creditors proof of claim is presumptively valid and the objecting party (Debtor here)
bears the burden of overcoming that presumption. (Bank can assert virtually unsupported claim
against debtor) not the claimant, which is not satisfied by the mere filing of an objection. Here, all
parties agree that monies were lent and liabilities incurred, so application to the case before us are
bolstered. Debtors lost the case.
a. On first claim debtors claim that lack of supporting documents and mismanagement of
file should invalidate claim, but burden is not on bank to substantiate the claim, the onus
is on the debtor to overcome presumption of validity. Because of conflicting statements
by banks own employments, court will adopt banks lowest figure of 300k
iii. ALL pre-petition claims, secured or unsecured, begin with a 502 calculation.
Unsecured Claims 502
i. An unsecured claimant is not eligible for post-petition interest. 502(b)(2) (unmatured interest)
1. He is, however, eligible for pre-petition interest if his contract with the debtor provided for such
(or state law says can/cant). The same applies for pre-petition attorneys fees: if contract called
for D to pay them, the unsecured creditor can include them in his claim. Credit card companies
would be allowed to full amount of amounts accrued BEFORE bankruptcy, pre petition filing.
2. Could claim unmatured interest when a loan that provided for a lump sum of interest rather than
interest calculated over time would be reanalyzed by a bankruptcy court to determine the portion
of interest that was mature and the portion that was unmature as of the instant filing.
ii. Post-petition attorneys fees There is a split in the courts as to whether an unsecured creditor can collect
post-petition attorneys fees.
1. Some argue that since it isnt explicitly prohibited (as post-petition interest is), an unsecured party
can get fees if his contract D called for them. (2nd Cir. rule)
2. Others argue that since 502(b) is limited to pre-petition claims and 503 (governing postpetition claims) only permits post-petition attorneys fees in limited circumstances, plus the fact
that 506(b) explicitly grants such fees to oversecured parties, demonstrates Congress did not
intend to grant them.
iii. The TIB has all of the defenses of D. 501(b)(1) (ex, if D bought something that didnt work, the TIB
could assert that defense to the stores claim).
iv. If all creditors in one priority class arent paid, then they get their share pro-rata. 726.
Secured Claims 506
i. Interest and secured parties
1. Secured party can get pre-petition interest if his agreement with the debtor so provided (or state
law says can/cant). . But unsecured debtor cannot claim any interest for post-petition time.
502(b)(2). SOME secured debtors may be able to get post-bankruptcy interest under 506(b). If
secured creditor is over-secured (value of collateral exceeds pre-bankruptcy debt) then secured
creditor can receive post-bankruptcy interest until the value of the collateral is exhausted
a. Once the value of the collateral is exhausted, the secured creditor cannot get further postpetition interest.
b. If lawnmower had value of 6500, and allowed claim was 5000, then could collect post
petition interest until it reached the amount.
2. 506 grants a secured creditor an allowed secured claim up to the value of its collateral. If claim is
less than or equal to value of collateral, then the entire claim is secured. If claim is greater than
value of collateral, claim is partially secured. Remaining portion continues as unsecured claim
against the estate.
ii. Attorneys fees and secured parties
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1.
Pre-petition attorneys fees are treated like interest: if the contract called for D to pay them (or state
law says can/cant), they can be included in the claim.
2. Post-petition attorneys fees are also treated as interest: the secured party can collect them so long
as he is oversecured. 506(b)
iii. Exemptions VALID consensual security interest trump exemption claims
iv. Oversecured where a debt is secured by property that is worth more than the debt. For example, if you
owe $5,000 on a $10,000 car, your car is oversecured.
f. Post-petition Claims
i. Example: Buys paint to paint furniture for bankruptcy sale- Will be bought on credit and classified as an
administrative expense, which receives first priority in payment.
Problem 10.1- Creditor Miller claimed 3000 plus 200 in PAST DUE interest accrued PRIOR and 100 in interest accrued SINCE
bankruptcy. What is amount allowed on unsecured claim?
Unsecured claim is 3000 principal + 200 interest accrued prior to filing. 502(a) and (b). 502(b)(2) doesnt allow unmatured
post petition interest. Allow claimed amount is 3200, probably wont get it though.
Problem 10.2- C has 2 non-exempt asset claims, car worth 10k and stock worth 15k. At time of filing she owed 8k on car (valid
security interest) and claimed past due interest that accrued prior of 500, and post-filing interest of 400 + 1k for attorneys fees= 9.9k
- this is an oversecured interest, under 506(b), he gets it. = 9.9k. Because the allowed claim is LESS than the
VALUE of the car, she gets all 9.9. The value of their collateral exceeds the amount of their claim. $8,000
(principal) +$900 (past due interest) + $1,000 (attorneys fees) < $10,000 (value of the car)
- Estate receives: $10,000 -$9,900 = $100
-Attorneys Fees 506 C, TIB will take all fees out first, so C will get a bit under 9.9k.
Problem 10.3- If car only brought in 5000 when sold, then they become under-secured creditors and 506(a) applies. The 5k of the car
is the secured claim. 3k in unsecured claim. Post petition atty fees are not disallowed (1000). Will try for the rest from the stock.
Claim is 8k principal, 900 total for interest, +1000 in attorneys fees, 9.9k still less than 10k. This is ASSUMING car brings in 10k
-If car value is 5k, not 10k. Then bank is UNDERSECURED, so has to bifurcate claim. Cant include the post petition interest for
under-secured claims. They are entitled to get 5k, and 3k unsecured interest, plus pre petition fees (400).
Problem 10.4- The 5k secured goes to Bank, 15k is unsecured and must be divided pro rata.
- to figure out pro-rata distribution. Want to know what payout funds are, which here is 15k. then you want to figure
out what entire total claim owed to unsecured creditors is. 3200 to plumber, 4500 (or 3.5) left for bank, +20k for
other unsecured creditors.= 27700. Divide 15k in funds by Total owed amount of 27700 or 26.7= 54%. Or 56%.
This shows the percentage of their unsecured claim that each unsecured creditor will collect (i.e., pro rata
distribution).
- Secured get paid first, then priority unsecured (top priority first), then general unsecured, then subordinated debt.
l)
Priority Among Unsecured Creditors ( 507)
i. Once the secured creditors have been paid, unsecured creditors divide the remaining proceeds from the
liquidation.
ii. 726 determines the order of payment; 726(a)(1) tells us that first 507 determines the order (and in
some cases amount) of payment to each unsecured creditor, with 726s distribution regime picking up
after that. The order is as follows:
1. Domestic Support Obligations 507(a)(1)(A) & (B)
2. Administrative Expenses allowed under 503(b) and any fees charged against the estate
507(a)(2)
a. These include 503(b):
i. Actual and necessary costs of preserving the estate, including wages, etc., for
services rendered 503(b)(1)(A)(i)
ii. Any tax other than the kind those listed in 507(a)(8), including fines related to
those taxes 503(b)(1)(B)-(C)
iii. Compensation awarded under 330(a) (i.e., TIB and his staffs compensation)
503(b)(2)
1. 330 Reasonable compensation considering the nature, extent and
value of the services. Specific criteria listed on pg 303 of supp.
iv. In certain instances, compensation and expenses of creditors attorneys. 503(b)
(3)
1. Note there is no allowance for the debtors attorney to be paid! (A few
courts permit it under 503(b), necessary expenses of
administration)
b. Superpriority: 507(b) secured creditor who is granted adequate protection yet still
has administrative expenses gets priority over 507(a) claims.
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c.
ii.
Super-superpriority: 364(c) if the TIB cant get unsecured credit to pay for 503(b)
(1) expenses [i.e., preservation costs, listed as (a) above] that trumps all other
administrative expenses. (i.e., 503(b) priority and 507(b) superpriority).
3. Ordinary course of business claims for involuntary cases Only applies in involuntary cases.
( 507(a)(3))
4. Wages Up to $11,725 earned within 180 days of filing owed to per each individual employee or
corporation (includes sales commissions owed to independent contractors in certain cases) (507
(a)(4))
5. Employee Benefit Plans from services rendered within 180 days of filing up to $4,000 x
number of employees [less amount paid to those employees for wages above]. (507 (a)(5))
6. Farmers and fishermen ( 507(a)(6))
7. Consumers who, pre-filing, paid for goods and services not rendered, up to $2,500 each. (
507(a)(7))
8. Certain Taxes income, property, employers share of FICA, excise taxes and customs duties. (
507(a)(8))
a. The employees share of FICA is the same as wages.
b. Note specific cutoff dates for income taxes:
i. The tax year must have ended on or before filing, and
ii. The return was due after 3 years before filing (essentially, due within the 3 years
before filing).
9. Commitments to federal depositary institutions ( 507(a)(9))
10. DUI personal injury claims 507(a)(10)
11. Unsecured claims timely filed (or tardily filed if the creditor didnt know of the bankruptcy)
726(a)(2)
12. Unsecured claims tardily filed (if notice or actual knowledge of bankruptcy) 726(a)(3)
13. Fines and punitive damages owed to the creditor 726(a)(4)
14. Post-petition interest on pre-petition claims 726(a)(5)
15. The rest goes to the debtor. 726(a)(6)
iii. Also note: 506(c) costs of disposition (e.g., advertising the sale, etc.) come out before any priorities.
Problem 11.1 Harold Smith declared Chapter 7 bankruptcy in March 2006. His non-exempt assets consisted of his condo in
Kitty Hawk, which the TIB sold for $400,000 but which was subject to a $365,000 mortgage [remaining 35k into estate], and
miscellaneous personal property that sold for $25,000. All his other property was exempt. Relating to the following claims
filed in bankruptcy court, who will get what under Sections 507 and 726(a)(4), (b)? In total, amount to be distributed = 35k +
25k = 60kbut this is NOT PRO RATAMUST LOOK TO PRIORITIES!
a. Nurse- 4rth, if earned within 180 days
b. Social Sec from earlier paycheck- will go under (8)- tax required to be collected or withheld and for which the
debtor is liable in whatever capacity.
c. City property tax per year/ penalties- (8)(B)- incurred before and last payable after the date 1 year before filing.
Based on standard fee, its not for pecuniary loss, just a regular pay, so 500 dolars doesnt get priority. So only owe
3k. PENALTIES: these fall under 726(a)(4)these are not for actual pecuniary loss! Must be a pecuniary loss to
IRS, like a penalty. Actually have to look at underlying economics to see if there was a pecuniary loss.
d. George, down payment for something not yet received- $300 priority under 507(a)(7).
e. State and Fed income tax (4k, 14k)- 507(a)(8)- (8)(A)(I) means, if he files on March 1 14, go back 3 years to 2011,
so anything for which a return is due AFTER 3 years before ( 4/15/11), so the taxes for 2012 would be due on that
date. This means that taxes probably have priority, 18k, unless the been hanging around for a long time. Priority tax
claims are also non-dischargeable. How does this affect the debtors attitude toward priority? The debtor doesnt
care about priority. Its not her money anyway.The priority for non-dischargeable tax claims promotes the debtors
fresh start, by reducing the size of the non-dischargeable claim.
f. Utility. Phone bills after bankruptcy- NO PRIORITY HEREthese are AFTER BANKR, so nothing paid from
estate. These are the Dors own liabilities. If TIB had to pay these to PRESERVE ITEMS FOR SALEthen could
be expense of maintaining prop of estate (except for phone bill) and would be a priority administrative expense
under 503.
g. Attorney (1750 in fees; 500 for will, 1250 for this filing)- $500 for will = nothing to do w/ preserving estate; thus,
this is GUC. $1750 for bankr = if not for preservation of estate, the atty is a GUC b/c prof fees are only for estate
preservation (may include atty in corp bankr for reorg); - is not working for estate, is working for the debtor. A(1)Connects with 503(b) about payment of professionals with refers to 330, then 327, which talks about attorneys
filing, which only provides for attorneys working for estate.
27
h. Ex Wife/note- is this domestic support? if this is a lump sum alimony payment, it fits under 507(a)(1). but if
property settlementthis is not under 507(a) b/c its not for ongoing support. if a business deal? GUCno
priority
i. Bank, deficiency on car loan- How often are car loans not secured? Here it specifies the deficiency on the car
loan, meaning that value of car was lower than security. GUC?
j. TIB- These are post-petition administrative expenses of the estate entitled to second priority under 507(a)(2). Who
ultimately pays these administrative expenses? The lower priority claimants (if money runs out before getting to
them) or The general unsecureds (whose percentage payback is lowered pro rata). If someone is not getting paid to
run estate, no one will want to do that job and ensure property of estate. Thats why must pay those expenses first.
k. Insurance premiums on the non-exempt property prior to sale- this is post-petition. will have to argue this is
necessary expense under 507(a)(2) for preservation of estate; and this likely falls under 503(b)(1)(a)
l. Cost of sale of Harolds property- admin expense per 507(a)(2); a realtor is a professional, so make sure his
expenses are reasonable
m. GUC- no priority for gen unsec claimseverything left in the end is shared pro rata. highly unlikely theyll get
anything.
E. Discharge
a. Exceptions to Discharge
i. Discharge is not a right, but it will be granted unless challenged. 727(a) There are two principal types
of challenges to discharge: Creditors or trustee may object to discharge of particular debt under 523 or 727.
This is usually the creditors last remaining hope to receive payment on any debt. in total there are 19 nondischargeable debts including debts obtained by lying or credit app, debts for luxury goods worth over 500
obtained within 90 days of bankruptcy, fraud by fiduciary, alimony/child support, judgments resulting from
drunk driving. Grounds for total denial of discharge number 12, including that corporations dont receive
discharge. 1) What debts are non-dischargeable? 2) are there actions a creditor can take to not allow a
discharge (partial or global) 3) are there bankruptcy related actions so bad that denial is not enough that you
might have to serve jailtime.
1. 523 rifle shot an objection to the discharge of a particular debt.
a. A creditor seeking the rifle shot who fails will have to pay the debtors attorney fees for
the costs of litigating the issue. 523(d)
b. Also note rifle shot applies to all flavors of bankruptcy, not just Ch. 7
2. 727 global denial general objection to discharge of all debts.
ii. The Rifle Shot principal reasons for discharging a single debt under 523
1. Certain tax debts specified in 507(a)(8)(A)-(G) 523(a)(1)- are not only given priority during
payment, but any unpaid portion of those taxes is exempted from discharge by section 523(a)(1)
(A). debtor is obligated to pay income taxes and others notwithstanding bankruptcy.
a. Penalties on non-dischargeable taxes are also non dischargeable according to 523(a)(7),
thought they dont receive priority.
b. Non only are these tax debts NONDISCHARGEABLE, but IRS has right to satisfy claim
by seizing property that is otherwise exempt under state law. Pay taxes if nothing else.
2. Debt obtained by fraud, false pretenses or a false representation other than a statement re: Ds
financial condition (unless the stmnt was written). 523(a)(2)
3. Alimony or child support (but not for property settlements). 523(a)(5)
a. What is alimony? Two alternative tests: If the debt was for necessaries, or if the parties
intended it to be alimony, it is alimony.
b. Compare 523(a)(5) Property settlements are dischargeable only if debtor cant pay or
if the benefit of discharge to the debtor outweighs harm to ex-spouse; if not, no discharge.
4. Intentional torts. 523(a)(6)
5. Fines or penalties payable to the government (but not a tax penalty). 523(a)(7)
a. Note these must be paid to the government and it does not apply to damages paid to
anyone.
6. Student loans 523(a)(8) (exception for loans over 7 years old and for extreme hardship but
thats hard to show).
7. Injuries inflicted due to DWI. 523(a)(9)
8. Debts from previous bankruptcy that were not discharged 523(a)(10)
iii. The Global denial principal reasons for denying discharge under 727
1. Debtor not an individual. 727(a)(1)
2. Fraudulent transfer, destruction, concealment within 12 months of bankruptcy. 727(a)(2)
(actual intent to defraud required)
3. Destroyed or failed to keep reasonable records. 727(a)(3) Unless justified by the circumstances
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iv.
v.
vi.
vii.
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856k, was sold to first deed of trust holder in foreclosure sale pursuant to a credit bid on secured debt, for
450k.A bank failed to follow reasonable procedures in verifying a borrowers income for purposes of
increasing the borrowers home equity line of credit. The bank approved the credit on the basis of a letter
from a CPA firm verifying the wifes income, which was oen of the standard options available to establish
the income of self-employed borrowers. When the borrower filed bankruptcy, the bank tried to claim that
the debt was non-dischargeable because the debtor misrepresented her income.
1. Holding: A creditor seeking to establish a debt as non-dischargeable under 523(a)(2)(B) must
demonstrate by a preponderance of the evidence that (1) the debtor made a written representation
respecting the debtors financial position, (2) the representation was material ( here income was
overstated and material because otherwise loan wouldnt have been granted) (3) the debtor knew
at the time the representation was made that it was false, (they were not unsophisticated, were
familiar with loan process.)(4) the representation was made with the intent to deceive the creditor,
(5) the creditor relied on the representation, (6) the reliance was reasonable, and (7) the damage
suffered by the creditor proximately resulted from the representation.
a. The bank did not demonstrate that its reliance was reasonable (judge by objective
standard). reasonableness judged by objective standard. Lenders reliance is reasonable if
it followed its normal business practices, and may not deviate from industry standards or
if creditor ignored a red flag. The bank here clearly ignored a red flag and should have
investigated the income level, which the guidelines required. HUGE red flag based on
variation of the incomes set in both loan applications. In April income was listed at 145k
and in Oct at 190k. Many red-flags that dont meet industry standards. Exception to
discharge does not apply, and they can discharge.
i. The Guidelines in place with regard to verifying claimed income of selfemployed borrowers require an evaluation of the reasonableness of the claimed
income, which was not undertaken in this case.
1. The CPA just put the letter on his letterhead but did not sign the letter.
2. Further, the borrower claimed different income figures in seeking a
loan only one month prior.
ii. The court surmises that the bank made the loan on the (over-inflated) value of
the collateral and not the debtors ability to pay.
1. The debtor cannot be blamed for the baks loss.
viii. In re Patricia Miller, Debtor: D borrowed $90k to pursue a doctorate in philosophy, which she did not
complete. Working as an admin assistant, she filed ch 7. Bankruptcy court determined that the entire loan
was not dischargeable b/c repayment did not impose an undue hardship under 523(a)(8) because but
granted a partial discharge as equitable relief. Lender appealed.
1. Law- not dischargeable unless excepting such debt from discharge will an undue hardship on the
debtor and debtors dependents- 523(a)(8).
2. Holding: A debtor may receive a partial discharge of a student loan debt under 105(a) when,
although she cannot make a showing of undue hardship as to the entirety of the debt,
circumstances exist that warrant some bankruptcy relief.
a. Section 105(a) empowers a court to issue any order, process or judgment that is
necessary or appropriate to carry out the provisions of this title.
i. Pursuant to 105(a)s powers, the court may fashion a remedy allowing debtors to
satisfy their obligations while at the same time providing them some of the
benefits bankruptcy brings in the form of relief from oppressive financial
circumstances. Strict all-or-nothing undue hardship approach conflicts the
Codes purpose.
ii. Court must look to several factors to determine Undue Hardship: Brunner
criteria: (1) the debtor cannot maintain a minimal standard of living if required
to repay the loans, (2) additional circumstances indicate that the state of affairs
is likely to persist for a significant portion of the repayment term, (3) the debtor
has made good faith efforts to repay the loans, (4) the amount of debt and the
rate at which interest is accruing, (5) the debtors claimed expenses and current
standard of living, with a view toward whether the debtor has attempted to
minimize expenses, (6) the debtors income, earning ability, health, educational
background, dependents, age, accumulated wealth and professional degree, and
(7) whether the debtor has attempted to maximize his income by seeking or
obtaining stable employment commensurate with his educational background
and abilities.
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iii. In order to rely on 105(a) court must find undue hardship from 523(a)(8). To
discharge, you must find out it meets that provision.
1. Must look at Brunner criteria must have minimal standard of living,
good faith effort to try to pay back. Very dependent on courts
determination, lots of discretion.
2. Ultimately court holds that amount discharged must meet undue
burden, so they remand down.
ix. In re Milibank: A man obtains a loan from his wife and father-in-law by promising them that he will try to
make his marriage work. However, he was simultaneously having an affair with a neighbor. In the
bankruptcy proceedings after his divorce, his father-in-law and wife challenge the discharge of the debts.
He was aware that he could only obtain these advances under the PRETENSE that he was making an effort
to strengthen his marriage. He pretended he was making a good faith effort to stabilize marriage.
1. Where a debtor has borrowed money on the understanding that he will repair his troubled marriage
and yet continues to maintain an extra-marital relationship, he has obtained money under false
pretenses within the meaning of Section 17(a)(2) of the Bankruptcy Act.
a. Had they known of the affair, the father-in-law and wife wouldnt have lent the man
money. The man made a false pretense in order to secure money. A false pretense may be
either express or implied. The stability of the marriage was a condition upon which the
Plaintiffs relied to their detriment as a result of the bankrupts false pretenses.
b. Since loan was obtained under false pretenses, its not dischargeable under 523(a)(2)
c. 523(a)(2)- false pretenses, false representation, or actual fraud. NOT made in writing
here because its not about his financial condition. Fraudulent statements were about the
nature of his marriage NOT about his financial condition! .
b. No Discharge and Bankruptcy Crimes
i. Untied States v. Cluck: C was a tax attorney who filed ch 7. Before filing, he pawned over $30k worth of
property over which he retained a right to repurchase within 90 days. He also failed to disclose $150k in
pre-petition a/r. He returned a $50k note to its grantor and failed to disclose the transaction. He had to file
schedule of assets and statement of financial affairs, which required him to disclose accounts receivables,
asset transfers of last year. He made no mention of recently pawned assets to car dealer of his return of 50k
note or account receivable to Perfect Union. Failed to list many assets. He also failed to disclose a transfer
of real estate. HE was discharged of his debts, and thinking his plan succeeded started receiving post
petition repayments of things he had hidden, none of which was revealed to TIB.
1. Holding: A debtor can be found guilty of the criminal offenses of fraudulent concealment and
false statements if he fails to disclose all of his a/r, rights of acquisition and pre-petition asset
transfers to the TIB.
a. Under 1521(1) and (3), the prosecution must show that Ds concealment or false
statement was made knowingly or fraudulently.
i. Circumstances that would not be conclusive standing alone may be used in
combination to support a proposition as conclusive truth, especially when the
circumstances are corroborated by moral coincidences. Here, his repeated
omissions and history of questionable transfers formed the sort of
circumstances that the SC had in mind
1. A rational jury could look at the evidence of systematic concealment
and inferred an intentional plan to defraud.
Problem 12.1- Guys financial records are a disaster, does he face difficulties?-under 727(a)(2), you need intent to hinder delay or
defraud, so it wouldnt apply. Wasnt doing something affirmatively bad. Under (a)(3), theres also no intent. Problem on (a)(3) is
failing to keep records, theyre a mess, need a clear statement of affairs. Hell try to justify by just saying hes disorganized.
a. Ramification would be potentially denial of global discharge. Is this reasonable? Want people to keep records so you
can verify debts and amounts, the details.
Problem 12.2-Gordan Gram, has had money problems A while back, he gave a financial statement to his creditor, Dina to persuade
her to hold off on collecting on the debt owed to her. The statement was false in it he claimed to own 1,000 shares of AT&T stock.
Gram subsequently transferred his ski chalet to his daughter. Chapman brought an action under state fraudulent transfer law to avoid
the transfer, but before she obtained a judgment Gram filed a chapter 7 petition. Can Chapmen question Grams entitlement to a
discharge?
a. -523(a)(2)(B)(ii) she didnt loan him anything, but she held back from acting by not collecting. Could maybe
justify by saying as extension or renewal of credit.
b. 727 (a)(2)(a)- transferred, removed, destroyed, or concealed Property of the debtor within one year., with intent to
hinder or delay or defraud. transfer of the chalet to his daughter may have been an actual fraudulent transfer
c. 727- (a)(4)- debtor knowingly and fraudulently or in connection with case presented a false claim.
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d.
Chapman prefers partial denial. In global denial, she has to share smaller claims, with all creditors benefiting
form the discharge. Rifle charge means Dinas claim continues past discharge, but everyone elses may get blocked,
so only she benefits. Strategically you might want everyone else to be discharged, leaving a larger pool of assets for
you. Theres risk of 523(d)- you may pay attorneys risk if you lose. It is ethically suspect to use withdrawal of
727 complaint as leverage in settlement discussions?
Problem 12.5- Sank too much money into redoing house, resulting in remortgaging and CC debt. Have 16k in unsecured debts in CC,
sold house they put effort into, which barely covered mortgages and left small amount of exempt cash. Cash issuers want exceptions
to discharge to wallpaper, plane tickets, and mens store.
i. 523(a)(2)(C)- You want to argue these are luxury items and dont want to let people buy luxury items and run
off with them. Only those that are more than 650 owing to single creditor . term luxury goods does not include
goods or services reasonably necessary for the support or maintenance of the D or a dependent of the D. 523(a)
(2)(C)(II). you want to ask them why they purchased items. Make sure it was necessary and not luxury clothing,
necessary for job. For plane tickets, want to make sure its for job, jobs now require more traveling.
1. Also amount we want to find out how many creditors are involved here.
b. Summary- 1) Will discharge be permissible for that class of debt? 2) remember distinctions between financial
condition type statements (in writing), and whether this can turn to partial discharge. 3) check whether
debtor has acted in a way that could result in global denial of all debt.
F. The Debtors Post-Bankruptcy Petition: Reaffirmation- in code discharge is enforced by 524- remember stay is lifted after
bankruptcy is over. Discharge forbids attempts to collect dischargeable debt, which possibility of contempt if violated. Its
designed to shield Ds from collection actions of old creditors, giving D a fresh start. In post bankruptcy world, debts not
discharged are not covered in post bankruptcy world and creditors can come after them. In real world though, debtor might
want to use the same property, maintain relation to those goods, you might want to maintain relations with those creditors that
own those goods. an agreement made between a creditor and the debtor that waives discharge of a debt that would otherwise
be discharged in the pending bankruptcy proceeding. A properly executed, timely filed reaffirmation agreement modifies the
discharge such that it is rendered inoperable against the subject debt.
a. A debtor may wish to pay a debt, even though that debt would be discharged in bankruptcy. For example, a debtor
may wish to keep a vehicle. As a promise to pay that debt, a debtor must enter into a reaffirmation agreement with
the creditor. Reaffirmations are voluntary and not required by law. It is recommended that the debtor carefully
consider whether or not the agreed upon payments can be made before entering into a reaffirmation agreement.
b. Creditor must recognize that in the absence of reaffirmation, its debt will be discharged leaving recourse against its
collateral as its sole remedy. Creditor must consider reaffirmation in terms of expenses associated w/ repossession
and foreclosure; also the resale value of its collateral Foreclosing would be a creditors least desirable option
c. 524c- reaffirms debts otherwise dischargeable during bankruptcy.
i. Key elements 1) There is timing issue - Has to be made before the discharge and it has to be filed with
court. Can be rescinded anytime prior to discharge or within 60 days of filing of reaffirmation
3) Has to include a list of disclosures. If debtor is represented by attorney, need affidavit by attorney that
theres no undue hardship for debtor. If no attorney, and debtor goes forward pro se, the court has to review.
ii. 524k- restrictions- reaffirmation agreement now must contain aggressive disclosures about interest and fees
associated with reaffirmed debt and debtor must work through a mini budget to show that the debtor has
adequate income (after necessary expenses) to pay reaffirmed debt
iii. 524m- if debtor cannot manage loan on paper, court must refuse the reaffirmation. however, practice of
attorneys signing off on reaffirmation agreement that put debtor in red at signing, can continue unabated
despite reform legislation 524(C)(6)
iv. 524(m)(2)- credit union can get reaffirmation even if numbers show debtor cant pay and even if debtor is
not represented by attorney
v. Courts are hesitant about reaffirmation b/c by signing an agreement, you create 1. an enforceable right to
sue you; 2. once you get a discharge, you cant get another one for 8 years
d. Reaffirmation of Secured Debt- Debts are discharged, but liens are not. 506(d) D can negotiate a reaffirmation
agreement with the creditor in order to save the collateral. 524
i. Secured Debt: keep the collateral that was either exempt or fully encumbered (so not sold). Discharge
injunction prevents creditors from seeking repayment through a personal liability of discharged D, but
they can still repossess their asset (it is a property interest)506(d): debts are discharged, but liens are not
1. D can also redeem under 722. Must pay creditor the full value of the loan or the full value of the
collateral, whichever is less. 521(a)(2) requires debtor to issue statement in 30 days of filing as
to his intended course of action with regard to collateral
2. 3 options in secured debta. 1) redemption debt- pay allowed secured claim amount, collateral amount. Only
available for personal property, for which we have exemptions, and has to be primarily
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e.
for household things. Problem is that if you have that cash, you wouldnt be bankrupt.
requires debtor to pay creditor full loan or full value of collateral in cash (722)
i. most attractive for debtors because they force creditors to accept payment of
fair market cash value of collateral or amount of claim, whichever is less. This
alternative is better when wanting to pay off a car with not much value but with
much left to owe .Similar to Ch 13, but with installment payments.
ii. D can force it on unwilling creditor.
b. 2) ridethrough/Retention- debtors is not in default at filing and continues making
payments and keep collateral, while creditor simply does not do anything to reclaim
collateral. Debtor eventually pays it off hope you can keep it at end of bankruptcy you
still keep it, and personal obligations discharged. D is not in default at filing and
continues making payments while C doesnt reclaim, D eventually either pays loan off or
loses collateral to repossession. Not all courts permit it.
i. 362(h) removes the collateral from the estate and lifts the stay unless the
debtor complies with command in section 521(a)(2) to state an intention to 1)
surrender property 2) reaffirm contract with secured party on that collateral 3)
redeem pursuant to section 722.
ii. 521(a)(6)- has savings clause for debtor if creditor demands more than the
original terms.
c. 3) reaffirmation- requires creditor willing to agree to let debtor keep the collateral in
return for a promise to repay that survives bankruptcy. possible for secured and unsecured
debt- requires debtor to pay creditor full loan or full value of collateral in cash (722)
i. Signing a legally binding agreement waiving the discharge on debt, subjecting
themselves to losing collateral and being sued for a deficiency claim if debt is
not paid off
3. Decision to Reaffirm: Generally, good to reaffirm when the debtor has equity and can afford it.
Especially when it is something that will appreciate, like a house Generally bad to reaffirm if it
will depreciate (TV). Cars: Hard decision, depends how badly debtor needs it
ii. In re Pendlebury: (Reaffirmation) Four debtors hope to reaffirm their mortgages with the lender after
filing for bankruptcy in order to keep their homes. The debtors are not willing to agree to the lenders
insistence that any agreement contain a provision requiring the debtors to pay $250 towards the lenders
attorneys fees. Debtors want it removed to keep mobile homes (which have lower collateral value).
1. Holding: Where a debtor is represented by counsel, the court will not intervene to limit the terms
of a reaffirmation agreement he enters into with a creditor but instead will leave it to the debtors
attorney to prevent the debtor from entering into an agreement that would not be in his best
interests. Reaffirmation process involves negotiation Lender is not prohibited from included
such a provision in reaffirmation agreement. Debtors can expect creditors to want to recover
attorneys fees for expenses it has encountered in protecting its secured assets, and these are for
the most part fair and reasonable.
a. Under 524(c) a creditor can refuse any offer of reaffirmation. Thus, the court does not
intervene in the reaffirmation process except where required by 524(c)(5) and (6) and
524(d) because a debtors attorney is generally in a better position to ascertain the best
interests of his client and evaluate the effect of a reaffirmation than the court.
b. The debtor has considerable Bargaining power during reaffirmation. Debtors have
leverage, they can pay creditors or have their debt discharged and collateral repossessed.
Creditor must consider reaffirmation in terms of expenses involving repossession and
foreclosure, along with resale value of its collateral. Creditors want to continue an
uninterrupted stream of payments, and foreclosing a security interest in property is
creditors least desirable option. Leverage debtors have is that otherwise creditors
just get the market value (low) of the mobile home, with shitty resale value.
c. Reaffirmation is basically a new K, and creditors can freely negotiate for these provisions
and fees.
Reaffirmation of Unsecured Debt- (usually a bad deal) offer of future credit, threat to object to discharge. Very
infrequent that it is in the debtors best interest to reaffirm unsecured debt, so unsecured creditor is in less
advantageous position than secured. Why would they? Debtors desire to protect a co-debtor; Gratitude (to a doctor);
Offers like if you reaffirm this prepetition debt on a credit card, we will give you your credit card back for use
i. Here there is no collateral to repossess, so no redemption. If you are representing unsecured creditor (like
CC or gym), you want them to maintain a good relationship and keep using this shit. Possibility of future
continued relationship and possibility of credit use.
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ii. In re Paglia, Debtor: P borrowed $13k from a bank and his mother pledged her interest in an annuity as
security. P filed ch 7 and listed the loan as an unsecured debt. The bank demanded liquidation of the
annuity as payment. Thus, before P discharged the obligation, he took out a second promissory note to
repay the loan and his mother once again pledged her annuity as security. P then discharged all pre-petition
debts, though continued to make payments for 2nd note. P then claimed the bank violated the discharge
injunction (524(a)(2)) and automatic stay(362) by coercing him to take out/ execute the second note.
1. Holding: Permitting a debtor to voluntarily sign a new note to cover pre-petition debt is not a per
se act to collect.
a. Any other result would mean means creditor violates 524(a)(2), without regard for how
active or passive it was prior to debtors execution of another note and without regard to
whether it actively sought to collect the discharged debt, rendering the phrase vacuous.
Would make it difficult for creditor to PASSIVELY permit debtor to become liable for
discharged debt.
b. P voluntarily offered to execute a new note to spare the liquidation of his mothers
annuity. The bank did not coerce him into executing the note.
c. While the second note would be unenforceable if it were a reaffirmation agreement, the
second note created a separate agreement supported by different consideration (assurance
the bank would forego legal action against his mothers annuity).
Problem 13.1 - P wants to go back to gym but gym wont let him. If two months of dues or sauna fees are left unpaid, the membership
is revoked, and the former member is not permitted to use any of the equipment until the unpaid balance is paid in full. just filed for a
Chapter 7 bankruptcy, discharging among his other debts two months worth of MM dues. MM has revoked Peters membership, and
Peter is frantic to get back to his workouts. He has offered to pay a month in advance, but MM refuses. What would you advise
Peter?
Under 524(a)- requirements for reaffirmation,
i. After Bankruptcy, 524(a) doesnt allow action taken on those 2 months worth of dues (but you can discriminate).
ii. Reaffirmation has to be prior to the discharge. Could argue its an attempt to collect, a violation, because creditors are
not allowed to collect on a debt that has been discharged. Could tell peter to just pay those two months he got
discharged (though this could be an attempt to collect). Because theyre not actively doing anything, seems hard to
argue gym is violating 524(a)(2). Youre trying to maintain healthy relationships, think ahead to post-bankruptcy
world.
Problem 13.2 guy impulsively signs to repay something after routine Ch 7 bankruptcy.
-Its not a reaffirmation because reaffirmation can happen only before a discharge (524(C)(1)). No action can be taken on the
paper. No disclosure (524(k), no attorney (524(C)(3), no court approval of reaffirmation to check for undue hardship. EVEN if
agreement is somehow enforceable, he can rescind it within 60 days.
Problem 13.3- Chauncy Big Moon Mooneys job as dishwasher; has bike worth $20,000 because hes wrecked it twice (he owes
$28,000); he is overwhelmed with unsecured debt, and declares bankruptcy; his only asset is his small house with a 4.5% mortgage;
his equity in the home would yield about 20,000 after the sale - all which would be exempt; M wants promises to sell home & use
money redeem his bike.. Will you (his attorney) sign undue hardship for M. not going to have to sign it. No requirement with
redemption.
Problem 13.4- she worries about keeping her house and her car; the credit union holds the mortgage and the car loan, as well as to
other unsecured signature loans .The bank says that they will agree to reaffirm the home loan, but only if she also reaffirms in full all
her other debts with the credit union.
(M1), debtor basically seems to want to enter into a reaffirmation agreement that might constitute an "undue hardship"
(including car, house, credit card, etc.). This is difficult for us because remember that under 524c3 (assuming the debtor is represented
by an attny), the attorney must sign an affidavit saying the reaff agreement does not pose an "undue burden.
1. House- If she were to go along with the banks policy, it would be a horrible idea b/c she would need to pay for the
house and all of her dischargeable debts. Keeping the house is a bad deal, but she could sell the house, take the
equity to redeem the car and get a smaller house - THEN she can manage her debt. Her best bet is to NOT
reaffirm b/c selling the house and getting $ is her best bet, but by doing this, she cant reaffirm
a. Note: remember the Sears case. Is soliciting a reaffirmation a violation of the proscription on an act
to collect. Is it all a matter of who starts the reaffirmation negotiation? It does matter who initiate
the reaffirmation. If the creditor initiates the reaffirmation, it may violate the stay. The bank
technically could be violating the automatic stay but if you are trying to just re-establish a
relationship, then this may not be a violation of automatic stay
2. Car- She can redeem her car as a legal matter- she could keep the car for $5900 provided she can come up with the
cash Note: After CH 7 personal discharge, the lien on secured debt still attaches to the property.
Consumer Chapter 13 Bankruptcy
A. PlAn Overview of Chapter 13
34
b.
c.
d.
i. D repays part of debt by agreeing to turn over a portion of all future income generally over a 3-5 year
period, under the supervision of the court. TIB deducts % of admin costs and distributes remained to
creditors according to court approved plan. NO DISCHARGE UNTIL D completes payout (compared with
Ch. 7 which last about 6 months and Ch. 11 which has immediate discharge)
ii. Lets D keep his assets, opting to encumber future earnings instead. D, not a TIB, keeps and controls the
property of the estate (although a TIB is appointed). There is no involuntary Ch. 13.
iii. Role of TIB changes, no longer collecting property and selling it, instead he is now charged with objecting
to improper creditor claims and ensuring D gives up required income amount. Also has duty to assist D in
performance of Ds duties. They scrutinize everyone associated with case, to make sure they are following
rules of the code.
iv. If 707 (b) bars D form Ch. 7, he has Ch. 13 option or nothing. Difference is the prospect of payment from
present assets versus payment from future income.
v. Vs Ch. 7- Idea of Ch. 7 is to get fresh start by giving up assets and getting debts discharged and to get to
keep future stuff. Some Ds would rather keep their assets even above the exemption amounts (if theyre
above, you have to give up assets), so some find reaffirmation or redemption not workable, so might want
to think about Ch. 13 restructuring.
vi. Problems arise when dont have a steady stream of income you can promise. Less clean than Ch. 7. Secured
creditors will be unhappy about you keeping collateral and such and people dont like being monitored for
5 years. 30% dont complete plan.
Ch. 13 Petition
i. Commenced by filing of petition, 301, which only D can commence. Commencement creates an estate
(541) for all legal and equitable interests of D in property as of filing and property and earnings after
commencement but before case is closed 1306(a), all of which D remains in possession of 1306(b), with all
property vested on D once plan confirmed (1327(b).
ii. Automatic stay applies, prevent creditors from obtaining payment in preference to or detriment of other
creditors. 362. Though creditors can still apply to have stay removed (362d).
1. 1) For lack of adequate assurance or 2) no equity and not reasonably necessary for reorganization
Elements of an Acceptable Plan- Ideally you present plan and all creditors agree, but this is rarely case, youll have
creditor object to payout, valuation, valued of secured claim, interest of secured claim, adequate protection. These
questions come up a lot.
i. General Requirements of the Plan (1322-1325)
1. 1322(a) a plan must provide for the supervision of future income by the TIB, provide for full
payment in deferred cash of 507 priorities unless parties agree otherwise, and provide for
equal treatment of class members within same class.
2. 1322(b) a plan may:
a. Designate classes (but cant unfairly discriminate between them)
i. Must be a reasonable basis for treating classes differently if discrimination is
needed to implement the plan, and if the class designation is in good faith.
b. Modify the rights of secured parties (but not home mortgages) within the limits of
1325(a)(5) [creditor must accept, or creditor retains lien and property retains its PV, or
debtor surrenders property].
c. There follows a laundry list of things that can go in the plan
3. Basic rule about what is paid is in 1325 (a)(5)- SECURED claims- 2 easy options to have creditor
agree with. (a) and (c). A says secured creditor accepts plan. C says debtor gives up collateral.
a. B is the tough one. If creditor doesnt agree to plan and debtor wants to keep it.
CRAMDOWN. Secured creditor gets
i. payment itself is Allowed secured claim (includes pre petition fees) +
1. This is value of collateral + allowed pre petition interests and fees.(dif
from other interest)
ii. Interest compensation for what they are not getting NOW, to cover 3-5 loss in
value.
iii. Unsecured portion of claim- its treated like other unsecured debt (bifurcated
debt) gets 60 cents on dollar.=
Payments to Secured Creditors
i. There are two principle issues for secured creditors in a Ch. 13 plan:
1. Protection of the collateral (from damage/loss or depreciation in value),if D defaults, secured
creditor is left with collateral worth less than when bankruptcy was filed, problem is cast in terms
of providing adequate protection see 362(d), and
a. Ex.: Radden debtor must maintain the insurance on his car.
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b.
1) issue of adequate protection/lift stay issue of lifting stay to get control of collateral
you thought you could seize outside of bankruptcy. basic idea- secured party can go seize
collateral and sell it, outside of bankruptcy. Automatic stay will remain in place for a
LONG TIME in ch 13.
i. Lift stay 362(d) general provision- creditor wants to lift it, needs to
determine whether to. Can lift stay IF
1. If there is no adequate protection OR
2. If debtor has NO equity in collateral AND also collateral is not
necessary for reorganization.
3. Either one will convince court to lift stay.
2. Adequate payment to the secured party (generally, the PV of the allowed claim).
a. Ex: Radden D must periodically pay GMAC to maintain the cars value.
b. Generally, use the contract rate of interest for the PV calculation. Smith (A few courts
say use the T-bill or other neutral market rate).
c. Has to provide sufficient payment to secured creditor, has to get allowed secured claim
amount in full (collateral value + pre petition allowed amounts) + interest on that claim.
Any unsecured portion gets paid along with unsecured creditors.
ii. Recall that the plan can modify the rights of secured parties subject to certain limitations..
iii. In re Radden: (looks at First issue) R failed to make pmnts on his car. GM repoed the car and scheduled
it for sale on 8/12. R filed ch 13 on 8/10. R had to get to work by walking or getting rides w/ friends(not
much trouble getting to work) GM moved to have the stay lifted on 2 grounds: (1) pursuant to 362(d)(2),
the car was not necessary for an effective reorganization, and (2) pursuant to 362(d)(1), GM would not be
adequately protected if R regained possession. D wanted stay in place and return of car (542), turnover of
property to estate.
1. Car value was 2.7k, and Balance due 4.4k (undersecured no equity cushion). Plan proposes to
pay GMAC full value of collateral plus interest of 5 percent per year (89 dollars/month for 36
months). To extent that amount due exceeds car value, obligation to GMAC is treated as an
unsecured claim, to receive 70 cents to the dollar(better than ch. 7.)
2. C seeks relief based on lack of adequate protection 362(d)(1).
a. Under plan GMAC will retain lien on the collateral and receive amount of secured claim
with interest, so its interest will thus be adequately protected if plan is consummated.
They havent showed that debtors chances for rehab are remote. Plan also proposes he
will get insurance for car. Debtor has shown he has stable employment and is capable of
payments, so reasonable probability plan will work. Interest is adequately protected.
3. (d)(2)?On grounds that debtor does not have any equity in the property and not necessary for
reorganization (362(d)(2). D bears burden of proving property is necessary for his effective
reorganization (362(g). Court thinks car is necessary for individuals effective reorganization, and
in our society now.. Thus, not grant to GMAC for relief from the stay pursuant to 362(d)(2).
4. Holding: A ch 13 debtor may regain possession of property(turnover) which a secured creditor
has repossessed if the property is necessary for an effective reorganization and the creditors
interest in the property is adequately protected.
iv. Modifying the Secured Creditors Contract
1. Next battle for Secured C is how much it will be paid under Ch 13 plan. 1325 (a)(5) has 2
requirements.
a. 1) secured C must be paid its allowed secured claim in full and must be paid interest on
that claim and must be 2) paid interest on that claim
i. Under 1325(a)(5) D can promise to pay secured claim in full (value of
collateral) while treating unsecured portion of debt like any other unsecured
debt(bifurcating)
ii. This treatment of the under-secured debt is called cramdown because it can be
imposed over the secured debtors objection.
1. Some exceptions- Any PMSI granted within the year before bankruptcy
is exempt, If secured creditor objects, D must pay debt in FULL
2. Holder of purchase money security interest in motor vehicle, time
period to exempt security interest granted within 2 and a half years
prior to bankruptcy proceeding.
a. This is because often cars are worth less than their outstanding
debt. Usually because debtor finance 100%, debtor overpaid,
or fees and penalties caused debt to grow. Before this
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2.
amendment, people kept car and paid only its full MV, and
interest, which was really low.
b. Key question is the value of the collateral because that number determines the
amount of the allowed secured claim that must be paid in full.
Associates Commercial Corp. v. Rash: D bought a new truck for $73k, and financed it for 60
months, securing the loan with the truck(PMSI). D filed ch 13 with a balance of $41k left. With
ACC holding valid lien over truck and secured claim to extent of collateral value, with rest being
unsecured. Ds plan invoked the cram down of 1325, which provides that a debtor can keep
collateral while the creditor retains the lien securing the claim. Ds plan valued the truck at $28k,
which was the amount that would be received in a foreclosure sale. The financier objected to this
valuation, claiming it was fully secured for the cost D would incur in obtaining a similar truck
(replacement truck), 41k and wanted stay lifted. Disagreement over value.
a. Holding: When a debtor seeks to invoke the cram down power provided by 1325, the
creditors interest in the collateral is to be measured by the cost the debtor would incur in
obtaining similar property.
i. Section 506 provides that such value shall be determined in light of the purpose
of the valuation and of the proposed disposition or use of the collateral.
1. The proposed disposition or use depends on whether the debtor,
pursuant to 1325(a)(5), elects to surrender the collateral to the creditor,
or instead chooses to exercise the cram down option. Debtor decided
to use it for income stream, this elected use of collateral to generate
income stream, this is the actual use, rather than foreclosure sale.
Cost the debtor would incur to obtain a like asset for the same
proposed use.
a. When the debtor keeps and uses the property, it only seems
logical that the actual use, and not a foreclosure sale that will
never occur, should be the proper guide for valuation. Price a
willing buyer in debtors trade or business would be willing
to pay to obtain like property from a willing seller
b. Replacement value standard distinguishes retention from
surrender and renders meaningful the key words disposition
or use. Whether the replacement value is equal to wholesale,
retail or some other value will depend on the type of debtor
and the nature of the property.
c. If debtor keeps property, Creditors is exposed to double risk,
debtor may again default and property will deteriorate in
value. Adjustments for interest rate and demands for adequate
protection do not offset these risks. Must protect this risk.
d. Notes- even under amendments, would not been crammed
down because truck was bought 3 years before filing, so
vehicle exception applies
b. Under 1325(a)(5)(A) plan proposed of secured claim confirmed if one of 3 conditions
is met.
i. secured creditors accepts plan 1325(a)(5)(A). debtor surrenders property
securing claim to creditors 1325(a)(5)(c). debtor invoked cram down party
1325(a)(5)(B)
1. permitted to keep property under objection of creditor, while he retains
lien over claim. 1325(a)(5)(B)(i).debtor required to provide payments,
that will total present value of allowed secured claim (present value of
collateral) 1325(a)(5)(B)(ii).
2. Value is governed by 506(a)- congresss effort to clarify things- such
value with respect to personal property securing an allowed claim shall
be determined based on the replacement value of such property as of
the date of the filing of the petition without deduction for costs of sale
or marketing. With respect to property acquired for personal, family, or
household purposes, replacement value shall mean the price a retail
merchant would charge for property of that kind considering the age
and condition of the property at the time value is determined. 506(a)
(1)- what about improvements made pre petition.
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3.
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e.
f.
cure and maintain to catch up on past while making current payments on mortgages as they
come due 13322(b)(5).
a. Ds typically have equity because theres a DP and prices usually rise rather than decline.
As a result, adequate protection is less important than with personal property, usually
mortgages are adequately protected.
2. You can de-accelerate a mortgage that accelerates upon a default and return it back to its
original payment terms (so long as you do so before a foreclosure sale). 1322(c) If they want to
keep house, 1322c1 and 1322b4 or something, allows you if youre in Ch. 13 situation without
lien stripping available, and youre in default and theres acceleration of payment, 1322 allows
you to de-accelerate accelerate payments and cure the payments you missed. Gives it a context to
make it more likely to make payment.
3. In re Taddeo- Ds defaulted on home mortgage, and lender initiates foreclosure sale, so Taddeos
file Ch. 13, staying foreclosure action under stay and proposing to cure default and reinstate
mortgage under 1322(b)(5). Lender rejects plan and applies for relief from stay, stating that once
mortgage was accelerate, Taddeos had no way to cure the default under code but to pay full
amount. P withheld payments because of defects in property and lender in return accelerated the
mortgage after the default, declaring the entire balance due immediately, though P still deposited
money into account.
a. Court- could cure default and reinstate mortgage, denied lenders motion for relief from
state. Ds were beneficiaries of the new code. Congress intended to allow mortgagors to
de-accelerate their mortgage and reinstate its original payment schedule. Conditioning
debtors right to cure on having filed ch 13 petition prior to acceleration would prompt
race to court.
b. Concept of cure in 1322(b)(5) contains the power to de-accelerate. Ban on modification
in 1322(b)(2) does not limit Ps exercise of curative powers under 1322 (b)(3-5). So they
may first cure their default (b)(3) and then maintain their payments (b)(5).
c. 1994 amendments gave homeowners right to de-accelerate by statute at any time
prior to foreclosure sale (1322)
4. What do people do if theyre behind on mortgage?
a. If they want to keep house, 1322c1 and 1322b4 or something, allows you if youre in Ch.
13 situation without lien stripping available, and youre in default and theres acceleration
of payment, 1322 allows you to de-accelerate accelerate payments and cure the payments
you missed. Gives it a context to make it more likely to make payment.
Problem 14.1- Shes graphic artist and guaranteed loan for brother, she had problems paying and files for ch 13.
Plan provides for substantial payments, and her assets are a 5k valued mac (4.6k loan). Creditor Want to repossess it
now so it doesnt lose value when new Mac comes in.
i. Creditor would argue no adequate protection. With computers theres significant decreasing value, with
new models coming in. Computers are very fragile and lose value.
ii. Clearly (d)(2) doesnt apply because SHE HAS equity. PLUS it could be necessary to effective
reorganization for her job. Only argument is adequate protection (d)(1). And so stay should be lifted for
cause, especially once new version is released because the equity cushion will be gone.
1. She has reasonable job though. Maybe if she has insurance. She computer is still
OVERSECURED, theres still equity cushion that even if it drops in value, theres enough that
loan can be protected.
2. What can the debtor do for the adequate protection? See 361: cash payment, replacement lien,
additional insurance, and others. Problem 14.2 90k in medical bills, just got steady job working overtime. Has cabin worth 41 now, with 39k left
in principal and 12k in past due interest and attorneys fees, and 14% interest on balance and 21% on past due
payments. C is Under-secured since entire claim is 51k
i. What do they want to get in ideal world? Principal (40k) and interest and fees pre petition, which has been
running (post petition). Can they get all of that? Can likely only get principal + pre-petition. Can claim
post-petition when youre over-secured.
ii. 1325(a) says they have to bifurcate claim. Youll get allowed secured claim amount 41k (principal + prepetition) for 100 cents on dollar. They remaining amount/deficiency amount. So any plan will have to give
41k of the secured amount with interest (prime interest + 1.5 -3 % adjustment).
iii. In addition to 41k you get interest also to cover the fact youre getting payment over 3-5 years, for purposes
of ch 13. This is a dif interest.
iv. Can D keep the land and modify K with C?1322(b)(2)- although 1325 allows lien stripping, 1322(b)(2),
plan may modify rights of holders of secured claim.cant do lien stripping if this is a home mortgage
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g.
(have to pay full amount). From policy perspective- to discourage people from waiting for property value to
drop and then filing for bankruptcy.
v. Here, some indication that he may live there, his place of residence. But if its not, then it can be modified.
1. How much can it be modified? 1325(a)(5) cramdown- with respect to each allowed secured
claim provided for by the plan
Problem 14.4- Worker did well with housing boom. When he was doing well he bought a suburban to carry soccer
team. But now, hes wondering what will happen in Ch. 13 context. Suburbans lose value a lot, hes wondering
whats his payment likely to be.
i. Allowed amount to creditor will likely be: balance on note is about 34k. but car is now worth about 28k.
Can you always strip down a car? Look at 1325a 506 shall not apply if the creditor has PMSI , he cannot
lien strip a car loan less than 2.5 years old. Has to be within 910 days according to the hanging paragraph,
and here you know it was bought within a year, so cant lien strip. Allowed amount is going to be the
amount of debt, which means debt is not stripped. 34k.
ii. Interest added- you have to then calculate the interest rate to determine present value of his full payment.
Take prime rate here is 7.5 or 8 for car loan sin area. So you have to add 1-3% to compensate for additional
risk.
1. Here he will need to adequately protect for the depreciation of the car.
iii. 1326- have to pay within 30days of filing petitions, at least the estimated payments. Even before plan is
confirmed. Payments made to TIB, though any payments made for adequate protection to cover loss of
value of collateral is made directly to creditor.
iv. Oversecured/undersecured question is determined at time of filing
v. Payments to Unsecured Creditors- with secured claims, D must make payments that satisfy the statutory
requirements for the present value of the allowed secured claim. Will have to deal with both priority and
unsecured creditors. All priority claimants under 507 are entitled to payment in full (1322(a)(2) but not
entitled to interest like S.C.s In Ch. 7 a low rank priority creditor doesnt get anything until youre up, but
in CH. 13 theres no class levels, so priority gets paid in full. If you have a client that cant afford to pay
secured and priority stuff, theyre out of luck and better try Ch. 7. Unsecured claims get prorated
distribution of whatever is left. What will they want?
a. Will want to challenge priority and secured amounts ahead of you 2) get D to pay
more on a monthly basis (forcing D to make more money available to share in pie)
2. General How does code allow you to get more out of debtor in Ch. 13? (make more money
available in monthly payments)
a. There are three requirements the plan must meet regarding unsecured creditors: (1325)
i. The best interests test The plan does not give any unsecured creditor less in
restructuring than he would have gotten in a Ch. 7 liquidation. 1325(a)(4).
And 1325(a)(5)B)
ii. The debtor must devote all disposable income to the plans payments, for
the life of the plan. 1325(b)(1)(B)
1. Disposable income is income not needed for maintenance or support.
Monthly Income minus reasonably necessary amounts to be expended
(when below state median income)
2. Recent Congressional amendments have made religious and charitable
contributions (up to 15% of gross income) not disposable income (i.e.,
creditor cant stop debtor from making such contributions).
3. Another problem: what of secured debt? Is it necessary for
maintenance or support?
iii. Of course, the good faith requirement is ever-present.
3. Disposable Income ( how much DI do you have?, how long do you have to pay it?) TEST
a. Start with Median Income-Must include spouses income in determining whether above
state median. 1325(b)(4)(A)(ii). Compare your income formula with the state median.
i. If below median, they have survive the threshold test 1322(d)(1) and governed
by reasonably necessary test.
1. Are filing Ch 13 even though they would have been eligible for 7.
2. Pay over 3 years and disposable income will be current Monthly
income reasonably expenses income. 1325(b)(3)
ii. Income in excess of median:
1. Pay over 5 years. Amount they must pay is the surplus calculated by
application of the 707(b)(2) means test.
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2.
b.
c.
41
c.
3.
4.
h.
i.
Good Faith
a. In re Farrar-Johnson: Above-median income debtors took a housing allowance, even
though they lived in rent-free military housing. When the court determined that the
deduction was permissible, the ttee argued that their failure to pay more into the plan
constituted bad faith.
i. Holding: A TIBs objection to a claimed expense is limited to an argument that
the expense does not comply with 1325(b), not that it is made in bad faith.
1. The disposable income a debtor decides to commit to his plan is not a
matter of good faith but is rather a calculation of simple arithmetic.
5. Family support/taxes/ priority claims- Creditors with claims that would receive priority under
507(a) are entitled to payment in full in ch 13 (1322(a)(2).
6. Priority repayments in general
a. Admin fees ( must be paid in first 4 months)
b. Attorneys fees- some courts see them as rendered pre petition and not payable, others
disagree and say entitled to repayment in full.
c. Alimony/ child support 1322 (a)(2).
d. ALL priority debt must be paid in FULL- Its possible for someone to have an income that
is too high to qualify for ch 7 and have too many secured debts or priority debts to
confirm a plan in ch 13.
e. Tax- claims are non dischargeable. Ch 13 offers the advantage of paying what you owe in
taxes over time, with automatic stay holding off the IRS/ Also, denial of post petition
interest on unsecured claims locks the tax claim at its value as of the date of bankruptcy
filing. Change to pay off taxes over time without interest is principal motivation to
choose ch 13.These priority claims are not subject to present value or added interest
Problem 15.1- earns 23k a year, and has 240 a month left of income, if she left it all she would have nothing for
emergencies and would have no money for piano lessons. orthodontist for child. What plan do you propose?
i. Guess is she is below median (family of 4, low income). So stay in 1325(b)(2)- 3 year plan. Must look at
her reasonably necessary expenses. Piano lessons are likely not reasonable, but could argue required for
maintenance of family expenses. Orthodontics may be necessary unless cosmetic. Unclear whether code
allows you to incure future reasonably necessary expenses. In practice she probably wont sue for
malpractice. Here church donations are allowed under reasonably necessary expenses
1. Can you have emergency cushion under ch 13? doesnt say anything specific.
2. Fourth, the malpractice insurer encourages the lawyers to deduct more expenses. If the lawyer is
too conservative to calculate the expense, the client may sue the lawyer for the malpractice.
a. You can offer a plan in good faith that allows her to keep some extra money for food /
clothes / long-term expenses / savingsshe needs this, especially w/ kidseven though
no money is going to GUC.
3. Should we choose 7 or 13?
a. Ch 7 = has a certain dateand you get your future income
b. Ch 13 = live under plan for 3-5 yrs; and if she devotes 60/wk to the plan, she will have no
money for clothes / food / savings / etc.
Problem 15.2- representing Cooper, manager making over 200k has a lot of shit. Owes unsecured creditors about
195k, and all assets he has are heavily collateral (liens). because he is above median, so will have to do 5 years, and
has about 200 dollars per month for unsecured creditors, 6% of his unsecured debt (though GUC would get nothing
in Ch. 7). He has more money than woman in 15.1, shows how ridiculous this situation is.
i. Will secured/priority people, get what they need?- doesnt say what value of collateral, but any hint secures
will do okay? Seems he has the money. Says theres Heavy liens (suggest secured will be ok), maybe even
oversecured. priority claims- will be paid but dont get interest. Secured claims are deducted under
expenses in Means test.
ii. Best Interest Test does not help the creditors they get nothing under ch 7 (he has no non-exempt assets)
iii. general unsecured- have to use the 707 formula. Offers 200 a month. Unsecured creditors will say
expenses are too high, but Todd will say its part of his lifestyle. 707 is just mechanical formula. Payments
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of secured debt is already included and its ok under expenses. Secured doesnt have reasonableness
requirement. Must scrutinize his expenses (private school, homes, cars,) is his DI committed to
payments under plan?
1. Private school?-707b2a2iv- theres a cap amount you can pay for a child. 1875 per child to be
included under expenses. If more, must be included in DI.
2. What about his business expenses?-allowed if reasonably necessary. If entertainment expenses are
part of his business, could be part of expenses going forward (not just past).
3. Weaknesses- Bad faith? Looks like abuse. Means test allows you to manipulate to a limit. Here
unsecured debt is only getting 3%
j. Problem 15.2(b)- In an alternative universe, you represent two of Todds creditors, Perfection Motors, the Mercedes
dealer who holds a $35,000 pmsi on one of his cars, and Divine Cuisine, his caterer, who is owed $15,600 for a
series of business receptions Todd gave for bosses and coworkers in the fast-food chain. What position will you take
regarding Todds plan?
i. Mercedes- Plan is fine with you. You want him to keep cars and keep making payments. There is a pseudo
alliance b/w Debtor and Sec Creditor to allow the Debtor to keep as much prop as possible out of
bankruptcy at expense of Unsecured Creditor
ii. Caterer- you want Todd to sell the Mercedes to free up income to pay you and other creditors (including
Mercedes)
iii. You realistically cant represent both at same time.
k. Problem 15.5 - wants to donate money to his church. Can he? seems can be do up to 15% of gross income for the
debtor for the year in which the contributions were made. 1325(b)(2)(A)(ii).
l. Problem 15.6- if theres a change in your expenses, you are allowed to modify under 1329. Creditors cant ASK her
for more though because it would violate the automatic stay. She can offer to make additional payments, but will
have to give to notice to everyone if she just pays 1 person. She likely be above median now and will have a lot of
disposable income under Means Test.
i. Choosing between Ch. 7 and Ch. 13:
1. General considerations
a. Ch. 7 is quicker, and is thus appealing for debtors wanting to get on with our lives; its
also better for debtors with no or few nonexempt assets (so long as the debts are
dischargeable debts).Ch. 13 appeals to people who feel moral/ethical duties to pay their
debts. There is also marginally less social stigma when filing Ch. 13, since at least the
debtor can claim to be paying his debts.Of course, bankruptcy of either flavor kills your
credit rating it stays on your credit report for 10 years (and you dont get extra credit for
filing a Ch. 13).
2. Property incentives for Ch. 13
a. Under Ch. 13, the debtor retains possession of his property. He can keep his home by
paying the arrears and continuing payments. There are, of course, no property exemptions
to deal with under Ch. 13. However, 1325(a)(5) requires that the unsecured creditors
get at least as much as they would in a Ch. 7. This reduces the advantages of Ch. 13.
3. Discharge incentives for Ch. 13
a. Ch. 13 provides much broader discharge than either Ch. 7 or Ch. 13; that is, largely
ignores the discharge exceptions in 523(a).
b. 1328(a) discharges all debt upon completion of the plan except:
i. Debts not provided for in the plan. Certain long-term obligations specifically
provided for by the plan (typically home mortgages) under 1322(b)(5)
ii. The exceptions in 523(a)(5), (8), and (9), specifically:
1. Alimony and child support (5), and Student loans (8), and
2. Claims from debtors DWI (9).
iii. Restitution or criminal fine stemming from a criminal conviction.
Business Chapter 7 Liquidation
A. Introduction
a. There is no discharge for a non-individual, 727(a), which is the most attractive part of Ch. 7.
i. Usually the death of the corporation, theres no metaphorical death and resurrection; it quietly expires
under state corporation law. No exemptions for corporate debtors, all property is available for repaying
creditors. Making debtor have almost no interest in result. No exemptions, no property to redeem, no
discharge to protect, no life after bankruptcy, no need for clothes and cars. Businesses almost never seek ch
7 because of this reason. Thus, almost always involuntary.
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b.
D has an absolute right to convert to ch 7 under 1112(a) and creditors can do so on a proper showing under 1112(b).
Conversion is also required if a plan cannot be approved under 1126(c).
c. Lots of back and forth leverage to settle between Ch. 7 and Ch. 11. Each partys willingness to agree to a voluntary
reorganization outside bankruptcy will be a function of that partys analysis of the position it would occupy in Ch.
11. Analysis of Hypothetical Ch. 11 position requires analysis of hypo Ch. 7 position, since Ch. 11 plays out in
shadows of Ch. 7. Want to understand what WOULD happen in case liquidation happened so you demonstrate
outcome in Ch. 11 plan is better than liquidation, better negotiating. dont do that or Ill push you into Ch. 7
B. Involuntary Bankruptcy
a. Ch. 7 or Ch. 11. 303(b)
b. 2 policy question in thinking about involuntary bankruptcy
i. 1) should the business be liquidated at all. Is there a chance you dont want to liquidate it and business
could be revived, or is it best use of assets really liquidation for payment?
ii. 2)what protections should be given 303
1. on creditors side, theres numerosity requirement. If more than 12 creditors..
2. Debtor has not been paying debts as they come due- but if theres a bonafide dispute then thats
different.
3. 1st requirement is numerosity (in re Faberge) and 2nd is whether debtor Is paying debts or not
(silverman).
c. Creditors can force a debtor into Ch. 7 (or 11) if ( 303(b))
i. 12 or more creditors, involuntary petition requires 3 or more of those creditors have undisputed, noncontingent, not bonafide, unsecured claims totaling $15,325 in the aggregate over any lien on the debtors
property.
1. This is the most common case; most businesses have over 12 creditors, so 3 creditors must join the
petition.
2. Less than 12 creditors (not counting employees, insiders and holders of voidable transfers), if one
or more has an undisputed, non-contingent, unsecured claim totaling $15,325 in the aggregate
over any lien on the debtors property. 303(b)(1)
ii. Generally Not Paying Debts. If the company timely objects to the involuntary filing, for the company to be
placed in bankruptcy, the company also must: generally not be paying its debts as they become
due unless those debts are subject to a bona fide dispute as to liability or amount, or have had a custodian
appointed within the past 120 days to take possession or control of substantially all of its assets.
d. 303(h) provides further limits. If the debtor contests the involuntary bankruptcy petition, the court must deny the
petition if: D is generally paying his debts as they come due (unless there is a bona fide dispute regarding the debt),
and. A custodian hasnt been appointed within 120 days.
e. If a creditors petition for an involuntary bankruptcy is denied, attorneys fees and costs incurred by D can be
imposed against that creditor (and sometimes punitive damages). 303(i)
f. Also note that it doesnt have to be a corporation. 101(9) includes associations, partnerships, business trusts, etc.
(but not an individual or limited partnerships) in the definition of corporation.
g. In re Gibraltor Amusements: When a creditor and its wholly-owned subsidiary petitioned a debtor into
bankruptcy, the debtor argued both should count as 1 creditor in meeting the 3 petitioner requirement. The
subsidiary was only a debtor because it had purchased $17k of the parents notes long before the debtor experienced
financial troubles.
i. Holding: While 3 or more unpaid creditors are required to petition debtors into bankruptcy involuntarily,
creditors corporate affiliates count as separate creditors, unless they were assigned the debt to evade the
rule. Courts will pierce the corporate veil when the corporate structure is used to commit wrong, fraud or
crime, or to subvert public policy.
a. Veil piercing is inappropriate here since there was no allegation of fraud or neglect of
corporate formalities. No showing here that Wurlitzer abused distinct corporate form to
subvert bankruptcy act. No alter ego doctrine here. Must look at state law to see what is a
corporation, what is commingling.
b. Dissent- assuming it is separate form its parent to be regarded as a separate corporation,
doesnt follow that it is a creditor separate from its parent. Tough to count corporation
and subsidiary as 2 creditors when each has a claim against same debtor.
c. Note Iowa Coal Mining-because claims were interwoven and full of subrogation and
joint obligations, the court concluded that the 3 bonding companies were just 1 creditor
with one claim, not enough to sustain petition
h. Also, congress abolished requirement showing of an act of bankruptcy, instead substituting a test of the debtors
financial condition (303h1), choosing a variation of equity insolvency test (inability to pay). Failure to pay bulls is a
very visible type of test.
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i. Used to be that the generally not paying standard encompassed those that didnt want to pay as well as
those that couldnt. Congress excluded from the test debts in bona fide dispute and made the holders of
such a debt ineligible to join in an involuntary petition (303b), (303h). Congress amended statute to make it
clear that a dispute about either the fact of liability or the amount owed would be adequate to classify the
debt as disputed
i. In re Faberge Restaurant (bonafide disputes) D was involuntarily petitioned into CH 7 by 3 creditors. After the
petition was filed, D paid one of the creditors and disputed its debt to others. Additional creditors joined the petition
as a substitute for the disputed debts. The paid creditor did not withdraw its petition and D moved to dismiss,
arguing that the paid creditor had lost its standing.
i. Holding: If an involuntary bankruptcy petition is filed by 3 unpaid undisputed creditors, the petition need
not be dismissed if some creditors are repaid later.
1. Involuntary petitions are governed by 303, which provides stringent tests before debtors may be
adjudicated:
a. (1) the court must determine whether the debtor has generally not been paying its debts as
they become due, and
D admitted he lacked the money to pay numerous creditors
b. (2) If the debtor has more than 12 creditors, there must be 3 creditors not subject to a
bona fide dispute, or holders of contingent claims.
i. There were over 12 creditors and the fact that they were paid after the filing of
the petition is irrelevant.
c. court is looking at the fact that its a post-petition payment. Petition date is the key date.
Unfair to the creditors. Policy reasons?- Need a clear date.
j. In re Silverman: A rich man sued his ex-friend on a promissory note, but the court denied summary judgment,
finding the debt disputed because it was unclear whether the note was valid, so there is a dispute as to a material
fact, so a bonafide dispute.. In preparing to petition the ex-friend into bankruptcy, the man did judgment searches but
did not order a credit report. Had he ordered a credit report, he could see that the friend was paying debts as they
became due. Afterwards, when the plaintiff petitioned the ex-friend into bankruptcy, the friend countersued for costs,
attorney fees and punitive damages because a court had already determined the debt was materially disputed.
i. Holding: If an involuntary bankruptcy petition is dismissed, courts should award the debtor costs and legal
fees, and may also grant punitive damages upon a finding that creditor petitioned in bad faith under 303(i).
1. Punitive damages are predicated on a finding of bad faith under 303(i)(2)(B).
a. Filing a petition after a court had already determined the debt was materially disputed is
bad faith per se.
b. Courts should consider the totality of the circumstances when awarding punitive
damages, including all mitigating and aggravating factors. Court thinks there is bad faith
because he KNEW there was a bonafide dispute, didnt even look at his credit report, and
maybe even made a false statement.
2. 2 provisions again 1) is D generally paying debts (303h1 and 2) Here yes.
a. AND 2) 303b numerosity requirement.(court doesnt go into this, although D says he has
more than 12 creditors.)
b. State court things into second element, but the other wasnt met either
k. Problem 18.1- What information do you need to determine whether a COMPANY is paying its bills, if its paying its
debts as they come due.
i. Equivalent of looking up credit report for Company- maybe look at the liens in state records, who their
creditors are and call them, look at their assets/and liabilities. Call banks. Maybe look at trade journals.
Maybe SEC filings of their public records. You can sue them and use discovery. Hire detective
ii. What counts as generally not paying debt? if accounts payables are going through the roof. Percentage of
creditors not being paid. Percentage of debt not being paid. Want to look at which are their largest and most
serious debts and whether they are being paid.
l. Problem 18.3- If TIB is doing sale of major assets of company being liquidated, you want to consult creditor. In
general, TIB can sell in ordinary course of business. 363b1, if other than ordinary course of business, you need a
notice and an opportunity to be heard(102(1). If ordinary course 363c1
i. 75% liquidation price is not in the ordinary course of business
ii. What if bank received notice?- then tough luck
iii. Assuming there was notice and bank failed to demand a hearing, now what? 363(m) protects good
faith buyers even if there has been a reversal of an authorized sale.
m. Problem 18.7- 303(a) the concern here is whether he is a farmer that is an exception, for which involuntary
bankruptcy would not apply. But here he is not a farmer. Is it bad faith for AFF to transfer his assets to his friends?
i. 101(20-22)- person who owns a farming operation
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2.
Why cant debtors do that on their own with their creditors? Often they can. But often panic and
recalcitrant oversecured creditors get in the way. Ch. 11 is a way to bring everyone to the table in
spite of themselves.
3. Debtors have the advantage of 1) the breathing room of the stay 2) possibility of adopting a plan
that will legally bind all creditors, even if a minority rejects it 3) 6 month exclusive right to
propose such a plan 4) turnover and avoiding powers, which can augment its available assets and
provide powerful leverage over some creditors.
4. Dont have to give a business a fresh start because they dont need one, they can just go away, thus
Ch. 11 is a plan for fair distribution of assets to creditors. We allow the company to remain since it
helps pay of its debts, increasing the pie for creditors, and helping employees.
iii. Analysis of a Ch. 11 Negotiation
1. Ch. 11 negotiations always take place in the shadows of Ch. 7. This is because of three things:
a. The DIP has an absolute right to convert to a Ch. 7, 1112(a), and
b. Creditors can force a Ch. 7 conversion upon a proper showing, 1112(b), and
c. A conversion to Ch. 7 is required implicitly if the plan is rejected.
2. Thus, both sides threaten each other with Ch. 7, though no one really wants it.
3. Creditors in different positions will often fight about the validity of secured interests. Because of
problem of litigation delay, sometimes plan will provide and escrow of money or property pending
resolution of the litigation. If As security interest in vindicated, withheld money will go to it,
while the security interest is voided as unperfected, then money will provide a further dividend for
unsecured creditors.
4. Control- In ch. 11, control is exercised by DIP. Put in the existing pre-bankruptcy management of
company in charge, with flexible role. It may act on behalf of creditors, stockholders, or
employees, as well as its own interest, with experience and economic theory showing that
management will give considerable attention to protecting its own interest.
c. Large Public Companies and Nontraditional Chapter 11 Cases
i. Its common for companies in CH. 11 to resolve financial difficulties by a sale of the entire business, which
usually means there will be no meaningful recovery for shareholders.
ii. Liquidated plans are often associated with auctions and prepackaged plans.
iii. Ch. 11 provides a highly flexible approach to maximizing sale value of the debtors assets, especially in
sale of the whole business as a going concern. But Ch. 11 is a negotiated resolution of a debtors general
default permitting more flexibility in realization and distribution of value than do relatively fixed rules of
Ch. 7 supervised by the disinterested TIB.
d. Single Asser Real Estate Cases
B. The Automatic Stay and Adequate Protection
a. General Considerations the stay is one of the biggest advantages, immensely important and attractive. He mere
threat of a stay is a strong incentive for secure creditors to hold off foreclosure or repossession, Since lifting the stay
is difficult, time consuming, and expensive, and unlikely to be lifted in early days of stay. Creditors know a repo
will generally not improve their position. The automatic stay, 362(a), applies at the time of filing.
i. If a party moves to have the stay lifted, the court must act within 30 days or it is lifted automatically as to
the moving creditor. 362(e) An agreement to not contest a motion to lift the stay is void since the stay
exists to protect all the creditors. Polk.
ii. Actions taken in innocent violation of stay are void( (majority) or voidable (minority)
iii. The stay can be lifted if either: ( 362(d))- burden on DIP
1. For cause: a secured creditor does not have adequate protection, or
a. 361 defines adequate protection; the debtor can make cash payments, offer additional
liens, or other relief (such as insurance).
i. Additional relief cannot be compensation allowable under 503(b)(1).
b. The time for determining adequate protection is on the day of filing, since that is when
the creditor lost his right to pursue the asset via state remedies.
c. Remember, its adequate protection against depreciation or damage.
2. The debtor does not have equity in the property + the property is not necessary for an effective
reorganization.
iv. The burdens on a motion to lift the stay are as follows ( 362(g)):
1. The creditor has the burden of showing the debtors equity in the property
2. The debtor has the burden of showing everything else, including that he has provided adequate
protection.
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b.
v. There are exceptions to the stay in 362(b), but they are narrowly construed. (Ex.: government function
exception does not include a government civil action for money damages. Seities.) See supra for further
discussion.
vi. Prospects for Reorganization A plan that is purely speculative and unlikely to yield anything for the
creditors can result in having the stay lifted.
vii. Pendency Interest
1. There are three types of interests in Ch. 11: pre-petition (i.e., pre-bankruptcy), pendency (i.e.,
during the proceedings), and plan (i.e., after bankruptcy proceedings).
2. Recall that oversecured parties get post-petition interest until the security runs out; unsecured (and
undersecured) parties get none.
3. Also note special rules for single-asset real estate (SARE) cases in 362(d)(3) the stay can be
terminated unless:
a. Within 90 days of the order for relief the debtor presents a plan with a reasonable chance
of being confirmed within a reasonable amount of time, or
b. Within 90 days of the order for relief, the debtor makes payments to creditor securing the
real estate equal to the market interest rate.
4. SARE is defined in 101(51)
Scope of the Stay degree at which pre-petition waiver might still bind debtor, unlikely to be valid, since debtor is
now representing different range of parties.
i. Farm Credit of Central Florida, ACA v. Polk: FC agreed to extend the date of a foreclosure sale in
exchange for Polk agreeing not to contest a motion for relief from stay by FC in the event that Polk filed for
bankruptcy.
1. Holding: Pre-petition agreements providing for the lifting of the stay are not per se binding on the
debtor. Pre-petition waivers of rights are enforceable in situations where bad faith existed and the
court determined there was no prospect for a successful reorganization.
a. Stay is key in CH. 11. The stay prevents the dissipation or dimunition of assets while
rehabilitative efforts are taken and prevents certain creditors from gaining a preference on
their claim. Thus, only the court can authorize lifting of the automatic stay.
i. A debtor cannot unilaterally waive the automatic stay against the interest of his
creditors. Stay prevents certain creditors from gaining preference for their
claims against debtor, avoiding interference with orderly rehabilitation of debtor.
b. Granting relief from stay simply because debtor waived protection ignores the fact that
the stay is designed to protect all creditors and to treat them equally. Purpose of the stay
is to protect the creditors as well as Polk, who could not have unilaterally waived the
stay against the interest of the debtors. Stay is provided to preclude creditor to pursue
remedy against debtor to disadvantage of creditors, and promote the orderly
administration of bankruptcys estate.
ii. US v Seitles- Seitles convicted by US of bribing an officer. Was ordered to pay 44k in restitution to
Government in illegally obtained printing jobs. Debtors move court to stay Ps false claim against
Westbrook in light of pending bankruptcy proceedings, arguing that as to Westbrook, action is subject to
stay provision of Bankruptcy, and as to Seitles, action should be stayed in exercise of courts discretion. US
argues that the stay does not apply to claims brought by the government under False Claims ACT, and that
theres no good reason to grant a stay to a non-debtor co-defendant of Seitles.
1. LAW- 362(4) and (5) permit government to pursue actions to protect public health and safety, even
if target of action Is in bankruptcy. Congress didnt want Ds to frustrate necessary governmental
functions by seeking refuge in bankruptcy.Is present action under False Claims Act a necessary
governmental Function geared towards protection of public health and safety? Govt argues
theirs is deterrent purpose in recovering damages for fraud and bribery. D argues Govt is trying to
go around the stay to protect pecuniary interests.
a. Police and regulatory powers exception is usually narrowly construed, and FCA claims
are usually subject to stay. Public policy test distinguishes between adjudicating private
rights and those that effectuate public policy (exempted)
b. Here, there is no threat to public safety, only a money interest by government. D no
longer providing services to Govt and Seitles is already convicted in connection with
fraud. No exemption from stay for govt. Public policy not primary motivation for govt.
c. Primary considerations for determining when non-debtor co-defendant may be granted
stay under 105 are 1) irreparable harm (action interwoven with non-debtor co-defenadnt,
would substantially hinder Ds reorganization effort) and 2) either a) likelihood of
success on merits or 2) sufficiently serious questions going to the merits to make thema
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c.
fair ground for litigation and a balance of hardships tipping toward party requesting
preliminary hearing.
2. Holding- Not only did stay protect corporate debtor from prosecution under False Claims act, but
its extension through 105a protected corporate president who didnt even file for bankruptcy. 105
a can apply broadly to apply stay to non-filing party if co-defendant
Lifting the Stay 362(d) lists 3 alternative tests for lifting stay, and secured party can win invoking and of the 3.
First is adequate protection, which requires court to go to section 361 where AP is defined.
i. Stay can be lifted when
1. For cause including lack of adequate protection look at 361, specifics on AP
a. Cash payments you worry about the depreciation of collateral since it stays with the
debtor for a long time.
b. Replacement lien- if theres drop in value, maybe you can have another property to ask
for a lien as well. Easier if you unburdened property.
c. Other- Catchall- The existence of an Equity Cushion. Must look at value.
2. OR debtor has no equity in property AND it is not necessary for reorganization.
3. for d1 adequate protection analysis you only look at the specific creditor for equity. For D2,
you must look at entire debtor perspective, ALL his debt.
4. Adequate protection thus represents the maintenance of the status quo of the creditor while the
automatic stay maintains the status quo of the debtor. interest of the creditor which is protected by
362(d) is limited to an interest in the property of the debtor, and it therefore normally is
unavailable to unsecured creditors.
a. Where the creditor has been the lessor of the debtor, it has been held that the making of
regular rent payments, as required by the lease, provides the creditor with adequate
protection for his interest in the property ( 6[d], infra).Where a debtor offers to cure
arrearages owed to a debtor, the payment so offered may be considered to provide the
creditor with adequate protection, within the meaning of 362(d)
b. The mere existence of an equity cushion will not necessarily indicate that the creditor has
adequate protection, since if that cushion is relatively small it may be depleted by such
future factors as interest, depreciation, and taxes. Such a temporary cushion might be
regarded to be insufficient to comprise adequate protection. it can be said that a secured
creditor is always fully secured, and the mere fact that the value of the collateral is less
than the total debt is not sufficient in itself to show that there is a lack
of adequate protection -- there must be some indication that the value will be decreased
with respect to the size of the debt
ii. In re Rogers Development Corp: A savings and loan is seeking relief from stay after a debtor defaulted on
2 large loans and subsequently filed for bankruptcy. The total indebtedness was $548k with approximately
$63k (611k) accruing annually in interest (D accepts figures). Issue is value of property for equity purposes.
The FMV of the property was either $704k (S&Ls witness) or $800k (debtors witness). Another witness
testifying on behalf of the creditors committee claimed the property was essential to a successful
reorganization. Both expert appraisers were equally credible.
1. Holding: If a debtor provides adequate protection by an equity cushion between the amount of the
obligation and the value of the property, and if the property is necessary for an effective
reorganization, relief from stay should not be granted.
a. Section 361 provides 3 non-exclusive methods of providing adequate protection:
i. (1) periodic payments
ii. (2) additional or replacement lien
iii. (3) a catch-all, permitting other means of providing adequate protection as
will result in the realization by such an entity of the indubitable equivalent of
such entitys interest in such property. Permits using an equity cushion (for
which there is no statutory direction on calculation). Since 361 doesnt preclude
it. Must look at amount of debt and the value of property to determine whether
theres an equity cushion.
a. Standard of valuation approximating FMV should be and is
commercially reasonable standard required given the circumstances
of the case. Here must consider type of property, real estate, which is
appreciating in value.
b. Both experts used same definition, the FMV was $750k (middle ground of
both estimates), leaving an equity cushion of $130k, which provides
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d.
e.
f.
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g.
Problem 19.1 - Phoenix has a perfected security interest in Bike to secure a loan at prime plus 6% with a current
balance of 180K. Bike is in chapter 11. Phoenix equipment: one year old specialized equipment. Purchased last year
for 200k. Bike took a 20% depreciation deduction for tax purposes last year. Wholesale value of similar, new tools:
140K. Retail value: 220K. Bike thinks he can sell the equipment for 160K
i. If C doesnt think reorganization will succeed he will want the collateral sold soon with proceeds turned
over, but D will want to keep tolls to reorganize business. To do this, C will move to lift they stay
ii. C could try to lift the stay and repo tools 362(d)(2) 1) no equity 2) not necessary for effective reorg.
1. Equity? Depending on which value- If value is 160k and debt is 180, then no equity. But if value
is 220, like retail, then there might be equity
2. Necessary? Its a bike ship, will really need specialized repair tools
a. If you think reorganization will succeed, get a 180k valuation plus adequate protection by
lifting the stay and then bargaining for AP and stipulated valuation.
3. When will they want secured claim to be low?
a. If creditor wants relief from automatic stay, under 361(d)(1) , there must be lack of
adequate protection, then creditor will focus on the lower amounts, like liquidation and
whole sale amount, not retail. Phoenix will argue value is only 160k and depreciating.
4. If stay is NOT lifted, and youre secured creditor, what do you want to happen? You want to be
first and you want 180k, pre and post petition interest, and attorneys fees.
a. Secured creditor will want to ague higher valuation so theyre oversecured, which creates
a strange dilemma. Youre arguing collateral is wroth more than debt so he gets more in
fees. But when youre trying to lift stay you will argue low value.
5. Other things can you into consideration of adequate protection. What about owners unreliability?
What is feasibility of D going through reorganization? Also, bank may want money now and force
D into Ch.7
h. Problem 19.2- CWI is in Chapter 11. Atlanta (a creditor) wants to lift the stay so that it can sell CWIs corporate jet.
At the time of the bankruptcy filing, Atlanta was owed 3.8 million on a 12% note secured by the jet. Jet is appraised
at 3.1 million(no equity). The Jet has a 40 year lifespan and its not predicted to lose any value over the next several
years.
i. Seems plane will not fall in value at any time, so might want to try the catchall (361(3))
1. C will argue there is 1) no adequate protection
2. CQI- will say that the plane will not decrease in value (according to expert) of such an entitys
interest in property, so no cause for adequate protection. if youre not harming creditor you can
keep it.
3. Risk of damage- Can Atlanta argue that a plane can crash and will require property maintenance to
keep its value, so D will have to insure the plane and supply maintenance.
ii. C can only invoke 362(d)(2) for lifting stay- no equity and not needed for reorganization
1. Equity- None here. Value of collateral 3.1, is less than the value of the debt 3.8
2. Necessary? It must be NECESSARY not just important. Can go either way here. D can argue that
jet is need for business purposes, since hes in the family entertainment industry. Seems like a jet
is more of a luxury than a necessity though.
3. If you dont have equity, and you dont need the property, have to give it up.
i. Problem 19.3- Sam and R get in legal battle, and Sam wants to take him down. Eventually it gets too costly for R,
and he files for Ch 11 listing 50k for attorney and disputed debt to Sam. R said legal expenses were too much,
couldnt run his business anymore, and business was falling off because of case. What do we tell Sam about effect
for R filing and how do we get case back on track?
i. Debt to Sam is contingent and un-liquidated(no judgment yet), so he cannot ask for adequate
protection(because not secured yet) and he cannot get post-petition interests. Hard for Sam to ask to lift
stay also, since that tends to be more for secured creditors
ii. Could try to convert to Ch. 7 if Sam can establish that the conversion is not the best interest of the C and
the estate.- 1112
iii. 1129(a)(3)- the reorganization should be proposed in good faith. Here hes not insolvent, but its not
required, seems distraction is serious threat to his business and litigation will force him out of business.
HEs also unsecured, so might not work. Would suggest to hold up or to settle, bankruptcy protection is
powerful, should be enough to satisfy thirst for revenge.
j. Problem 19.4 - Wants to push video-America past tape age through Ch. 11. Only collateral is 500k piece of
recording equipment. Can heath lift stay and get the equipment, Has PMSI on it for 350, and Bank is in for
additional 200k. Secured creditor, so 362d.
i. 362d1- Under 361d1, theres equity cushion from the perspective of HM, 500 350- is there a cause for
AP? Like depreciation in value or risk of damage?
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ii. 362d2 HM can argue theres no equity on collateral and its not necessary for effective reorganization.
From TOTAL debt 550, there would be no equity in this collateral. Could try to argue that it is not
necessary for the plan either. Who knows if he needs the sound recording outfit for video tape
manufacturing, but it sounds related.
iii. If they lift is stayed, Heath will get first dibs because of his PSMI, but this might not be strategically good
for a junior lien holder because they will be 2nd in line if the stay is lifted and the item is sold.
Reorganization might represent the better opportunity to recover the entire amount.
k. Problem 19.5 - facts- youre interest in 40 million secured debt. Youre representing FDIC, which took over failing
Atlanta bank that made loan. Youre concerned because you talked to Billy, and they did basic maintenance, and
theres deferred maintenance coming up. Youre not sure if hes serious about the plan, which could potentially pay
you and others in full. What strategy do you suggest for Billy D?
i. 362(d)(1)- maybe FDIC is not adequate protected. Billy has no assets, maybe theres no equity cushion.
Debt is 40 million here and value given (20), and value when built (45) was high, but real estate has
dropped. Offered was made in good faith for 20 million earlier giveaway price though. Try to lift the stay
because of no adequate protection (will there be a depreciation/damage)?
ii. 362(d)(2)- Clearly since it failed in 362(d)(1), equity analysis is the same, no additional secured amounts,
no equity here. Is it necessary? Arguably it is because he needs an office for his company (single asset
situation).
iii. 362(d)(3)- basic idea in SARE cases (101(51)(b)- if its only substantial business of debtor tied up in this
asset, so seems to fit SARE definition.
1. Can lift stay unless files reasonable plan within 90 days of filing or start paying amount equal to
interest rate on allowed secured claim (value of collateral) or monthly payments
2. (ii) brings in valuation question to see whats the interest rate. Uses FMV
iv. A lot of lift stay litigation comes up in negotiating.
l. HYPO CS (a dry cleaning shop) has assets of 3 machines (FMV $20k each, or $60k total) and 2 presses (FMV $4k
each, or $8k total). It recently filed Ch. 11. The machines are subject to a $65k perfected security interest; the bank
(BN) wants to repossess and sell the machines and the pressers. Can CS keep the equipment?
BN will argue no adequate protection. However, CS has a slight equity cushion of $3k ($68k total assets - $65k
lien). This may or may not be enough to qualify as adequate protection (how fast do these machines depreciate?.
Recall that the burden of showing If the equity cushion isnt enough on C, then CS will have to make cash payments
to BN, or offer them additional liens, or take some other measure.
m. HYPO SAKS, in Ch. 11, owns a chandelier (FMV $25k), but doesnt want to sell it. Bank has security interest in
all fixtures, equipment and supplies for $30k. All of those items together (including chandelier) are worth $35k.
Bank wants the chandelier. Can SAKS stop them?
The bank cant make an adequate protection argument, since they are oversecured by $5k (e.g., an equity cushion
against depreciation or damage) (is this enough?).
So they go to the second test. Does debtor has no equity in the property refer to the aggregate of all assets, or to
specific pieces? Its unclear. JW says its probably in the aggregate. Its a good thing, too, since the chandelier
which is purely decorative is probably not necessary to an effective reorganization.
C. Operating in Chapter 11- 3 questions Who gets to run business? Can business use its cash freely? Given cash is likely to
not be enough, how can business get more cash?
a. Whos Running the Show?
i. The DIP has control of the business (now called the estate), though the creditors can seek to have a TIB
appointed. 1104(a). The bankruptcy court has broad discretion in making such an appointment. In Ch. 11
the DIP retains control of the business and continues to run it with debtors and creditors focusing on the
operation.
ii. Whoever runs the business does it on behalf of bankruptcy estate, which now represents multiple creditors.
iii. Amount Cs get paid depends on success of business, so D and Cs are economic partners hoping for
success of the Ds business. Sometimes one powerful C will influence business decisions at expense of
others. Sometimes creditors will look at the good will a business has to see if business will succeeds, plus
sometimes creditors want to keep Ds as a customer to offset loses.
1. Investors (stakeholders) may have opposite view to secured creditors. May only have equity or
subordinate debt, which means they get nothing unless they succeed-willing to take high risk for
high reward. Interest in keeping business going at all cost because if things fall apart in liquidation
they get almost nothing
2. If youre a secured creditor, you want to protect and maintain your assets, at least above
foreclosure and liquidation value.
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b.
3. If youre unsecured, you want to maintain relations and hope business succeeds.
4. Sometimes the community also has an interest in business success.
iv. Disagreement will focus on whos in charge. If creditors are really pressing for liquidation because they
dont think reorganization ill work, and management is resisting, they might press for TIB. If some has
personal issues, acrimony, or doesnt seem management will have success give personality issues, they
might press for TIB. Also, if theres real management issues like wasting corporate assets or not doing basic
things for restructuring business, make want TIB.
v. In re Sharon Steel Corp.: 742mill in liabilities, 478 in assets, furnaces that dont work files ch 11Sharon management remained in control, with Posner serving as chairman, president, and CEO.. Five
months after D filed for bankruptcy, the committee was dissatisfied by the progress made by Ds
management and petitioned the court for appointment of a trustee. The manager made voidable preference
payments, had not closed out the books from the year prior and failed to re-negotiate a loan that would have
saved the company $4 million a year in interest, and was spending a lot of money. Not only did Sharon not
object to get property back, but the recipients of transfers owed fiduciary duty. The court concluded such
against were indicative of gross mismanagement. The company also spent $280k in attorneys fees to fight
the appointment of a ttee.
1. Holding: The appointment of a TIB is mandated under 1104(a) when the court, in its discretion,
finds cause. 1104(a)2- creates flexile standard, instructing court to appoint trustee when doing so
addresses interests of creditors, equity, security holders, and other interest of estate- Court uses
abuse of discretion review standard giving much leeway.
a. Appointment of a TIB should be the exception, rather than the rule. Often creditors are
benefitted by the continuance of the DIP b/c the expense of a ttee is saved and the DIP
can operate the business better b/c he is more familiar with it. But management here is
VERY sophisticated, which colors interpretations of their actions, raising questions
about managements ability to fulfill its fiduciary duty as DIP to Ds creditors.
b. Whole point of keeping management is that they act in interest of everyone and
restricting, and this management is not doing that, doesnt have interest of creditors at
heart.
vi. However, the appointment of a TIB is rare. More common is the appointment of an examiner to
investigate and monitor the DIP under 1104(c). Attractive because it permits experienced management to
run business while providing comfort of a disinterested examination and monitoring of past and present
activities. You also want to avoid TIB fees.
vii. Notes- Court found large scale waste and diversion of corporate assets. In other cases, even suspected
existence of fraudulent conveyances and concealment of assets did not justify removing the DIP and
substituting a trustee
What Happens to the Cash? Restrictions on DIPs use of cash i. There are certain constraints on what the DIP can do with the businesss cash or cash equivalents.
1. If in the ordinary course of business and not subject to a lien, then there are no restrictions on use.
363(c)(1)
2. Cash subject to a lien (cash collateral) cannot be used unless either all the lienholders in the
cash agree, or the court authorizes its use 363(b).
a. Debtor is constrained in its use of cash that is subject to a lien, usually derived from sale
of inventory or collection of accounts subject to Art 9 proceeds claim by a lender secured
by inventory or accounts. This encumbered cash is called cash collateral and cant be
used by DIP without permission of court
b. Struggle over cash may be struggle over whether business is to be given a chance to
reorganize under Ch. 11 or forced to liquidate.
3. Cash exist in 3 corners/buckets
a. Unencumbered cash, not subject to a lien. Code has few restriction on use of this in
ordinary course of business. Can se used without court approval 363(c)(1).
b. Cash subject to security interest cash collateral defined in 363(a) and 553(setoff). This
includes cash that is received when you sell or liquidate physical property in which there
is a secured interest (inventory). Code limits how you can use this cash because cash is so
fungible, can you really tell the difference? 362(c)(2). Need consent of all lienholders in
the cash or court approval. In re earthlitec. Cash that is subject to a settlementii. Setoff
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1.
iii.
iv.
v.
vi.
A creditor with a setoff right (typically, a bank taking what the debtor owes it out if the debtors
account before giving the proceeds to everyone else) is treated as secured to the extent of his setoff
right. 506(a). Enables C to obtain full payment for its claim up to amount in debt to debtor.
2. However, setoff is still subject to the automatic stay. 362(a)(7). An account freeze is not a stay
violation, however.
3. An account subject to setoff is cash collateral and is subject to the 363(b) limits listed above.
4. Problem 30.3 FVL has $17k in its bank account at CB when it files Ch. 11. FVL owes $5k
unsecured to W; the bank purchased Ws FVL account. Can the bank setoff without court
permission? No. 553(a)(2) No setoff for debt transferred to a creditor either after the filing or
within 90 days of filing if the debtor was insolvent.
5. Also note 760 special rules for stock brokers
In re Earth Lite: D had a $350k loan secured by inventory and accounts receivables (AR). It filed CH 11
and was allowed to remain in possession and operate its business. Shortly after filing, D and the lender
entered a new agreement where the lender agreed to lend D an additional $75k in exchange for additional
collateral and personal guarantees of insiders. The agrmnt also called for a lock-box system for handling
the collection of a/r, to be supervised by independent firm. The value of the inventory (500k inventory 90k
a/r) was far greater than the security interest/debt on the inventory. Earthlite faced with challenge to use its
inventory and accounts receivables cash, filed motion and sought leave use cash collateral and other
pursuant 363. The creditor seeks to prevent its debtor from using its inventory and collected lockbox a/r on
an emergency basis because it believes Ds outlook of survival is hopeless. (D defaulted post-petition
agreement by not paying Feb, but had paid 137k up to that point).
1. Holding: A debtor, before it is authorized to use cash collateral, cannot rest on its equity cushion,
but must offer more to the secured party before it is entitled to use cash collateral. [If a CH 11
debtor is deprived of the use of cash, its chances to secure rehabilitation are destroyed].
a. A debtor as a general proposition must demonstrate with convincing proof that the
creditor is protected without resorting to a crutch furnished by a personal guarantee of
third parties. Personal guarantees are not adequate protection.
b. Court makes own remedy. D permitted to use CC if making payments to secured party. D
was required to resume the contractual payments and made provisions for curing the
default even without considering the value of the personal guarantee.
c. Basically, equity cushion is not enough AP for CC because its highly volatile and subject
to rapid dissipation. Must make monthly payments.
In re Hal, Inc.: The bankruptcy court allowed the government to use Ds overpayments to the IRS as a
setoff for other governmental debts owed by the debtors after filing for bankruptcy.
1. Holding: Section 553 clearly states that bankruptcy law does not affect a creditors nonbankruptcy right to setoff, however, to enforce a setoff right, a creditor must establish that it has a
right of setoff under non-bankruptcy law, and that this right should be preserved in bankruptcy
under 553. Court affirms bankruptcy courts decision.
a. There first must be a pre-bankruptcy right to setoff preserved by 553. The principal
element in setoff is mutuality, which requires that the debts are in the same right and
between the same parties, standing in the same capacity and same kind of quality.
b. Courts have consistently held that the right to setoff amongst government agencies exists
outside of bankruptcy. Court decides for single entity theory and decides agencies are like
separate department within single corporation, part of executive. Theres common pool of
money they derive money from.
c. Since bankruptcy law does not affect a creditors non-bankruptcy right to setoff,
Congress clearly recognized that 553 would allow some creditors to receive de facto
priority over others.
d. Theres disagreement within circuits
Problem 20.1- President wants to know if he can continue to operate business normally after filing
without going to court. He can continue to operate building in the ordinary course of business under 363(c)
(1), without need for approval. 1101 days DIP will have powers of TIB. Once you sell inventory, proceeds
become encumbered cash collateral, and then you must ask for permission to use, sell or lease CC. Court
order will probably be necessary to use cash once it comes in
Problem 20.2- FNB made 150k loan to Teddy and were concerned that things werent going well for
teddy. So asked him to keep at least 10% of its debt in account as compensating balance. Of 40k Teddy
has in bank account, 15k he was required to keep in there (compensating balance).
1. In Ch. 11 is all 40k free to use, or is some of it cash collateral? Remember 506a, any allowed set
off is treated like an allowed secured claim, which is basically treated like cash collateral. In order
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c.
to determine how much is CC, have to determine whats allowed set off amount here. And if setoff
right is cash collateral, how much, if any, right to a post-petition set off does bank have?
a. 553(a)(3) 40k is allowed in non-bankruptcy law. Whatever is carved out in set-off is free
to use. Are there bankruptcy limitations? Is entire 40k subject? Anything that falls in
553 wont be CC 553(a) is an exception to set-off must meet limitations of 553(a)(3).
Last point in 553, basically compensating amount (15k)
i. Compensating balance happened after 90 days before filing of petition.
Were looking at compensating balance, all of 3 requires of 553(a)(1-3), but the
25 voluntary amount doesnt meet (c) so we dont look at it.
b. Amount in account here is 40k, amount obtained to get right to set off? 15k (the
compensating balance). SO this 15, since its not allowed by 553(a)(3)(C) doesnt
count, but the remaining 25k that is voluntarily there can be set off by bank.
c. Policy- way to carve out. If youre forced to keep a deposit, limitations protect you
against right to set off. If doesnt meet all 3 elements of 553a, then its cash collateral
subject to right to set off. If youre representing Ted before filing, close out the account.
25k looks like a set off, take that shit out son.
d. Look at other requirements of 553(a)(3) right to setoff except if..
vii. Problem 20.3- she owes 50k to Winston, she has 61k in Bank. Citiwide paid 40k for her 50k owed to
Winston. Is there a right to setoff, and is any of it cash collateral (meaning you have to go to court to use)
How much can SHE use without going to court.
1. Does any of setoff fall within bankruptcy limitations? Under 552(a)(2) one of ways that set off is
not valid is if the claim was transferred by an entity other than the D (like Winston here) to such
creditor after the commencement of the case or after 90 days before the filing (will want to wait 90
days to file ) and while D was insolvent (debatable because she had payroll money)
a. All of 50k was transferred, so outside of non-bankruptcy its ok, but in bankruptcy it
would fall under 553(a) exceptions
2. She can probably use all 61. But advice her to drain the 61k just in case Bank wants to take it.
3. Setoff is like a preferential transfer- Winston was unsecured creditor on the 50k claim, and
would probably get cents on dollar. If claim is owner by the bank, now the claim is secured and
they should get all of it. Thats why advice her to take money out so they dont have setoff right.
viii. SUMMARY Key questions from the Ds perspective are Can I use the money and are there limitations?
From Creditors, Can I get money or protect it in some way, with two part analysis 1) does the set off right
exist outside of bankruptcy? 2) is that setoff right maintained within bankruptcy? If so then its treated like
an allowed secured claim. From Ds perspective its cash collateral (cant be used unless go to court). If set
off right is not maintain in bankruptcy due to some exception or limitation (553(a)(1-3), then the loan
amount will not be protected by set off right. From Ds perspective, if set off right doesnt continue with
bankruptcy, then amount is kicked outside of collateral box and become unencumbered cash.
1. EX- we have bank and D, D loans B 100 in form of deposit. B is also giving 100k loan to D.
Imagine of the 100k, 50k is compensating balance
a. First question- of 100k loan, does any of it have benefit of set off against the deposit? In
non-bankruptcy law, yes whole 100k is subject to set off. 100k is protecting the 100k
loan. Treated as secured claim 100k. From Ds perspective, entire 100k is cash collateral
and must go to court to use it.Second- in bankruptcy? Are there limitations in bankruptcy
where this no longer applies? Look at circumstances of the loan. For 50k voluntary
amount, no limitations that apply in bankruptcy. 50k of the loan amount continues to be
protected by the deposit, but other 50k was involuntary, compensating balance. In this
case, exception to this analysis applies. But from Ds perspective, you are free to use the
cash.
Post-petition Financing
i. Post-Petition Financing- even if given access to on-hand cash collateral, increase in operating capital is
essential for survival. Must find a new lender to infuse cash. Code is designed to encourage post-petition
lending by giving these creditors special protection.
1. Post-petition financing is often vital to keeping the company afloat long enough to survive
bankruptcy. Often current creditors are the best source of such financing since they already have
an interest in keeping the company alive.
a. These post-petition loans are secured by post-petition security interest. Often secured
creditor will try to trace the purchase of a new, post petition inventory back to sale of old
pre-petition inventory in which it held an interest.
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2.
The Code gives post-petition creditors special protection. must know specific requirements, and
how these requirements reshape creditor interactions (priorities among creditors 364). Perhaps
most important protection a DIP can offer to a post-petition lender is a security interest in the
property. Under 552a, a prepetition security interest does not attach to property acquired by the
DIP in bankruptcy. Also, inventory or property acquired after filing will be property of the estate
after filing, no longer subject to secure creditors after acquired property clause, instead belonging
to estate which now represents interest of all creditors collective.
a. Unsecured ordinary borrowing (supplier/relationship) are fine without court approval
b. An after-acquired property clause in a pre-petition contract ceases to be operational
after the filing. 552(a)
i. However, a creditor may still have a claim to proceeds under Uniform
Commercial Code 9-306. Thus, if a telephone retailer has a lien on its
inventory, the creditor has a right to the proceeds of each phone sale. The
proceeds are cash collateral and require the permission of the court to use.
ii. The key point is that a DIP can use assets either not encumbered before
bankruptcy or acquired after bankruptcy to secure post-petition financing.
c. Priority in Payment for Post-Petition Financing (364)
i. Priority over non-administrative expenses. 364(a) and (b)
1. The DIP can get unsecured credit in the ordinary course of business and
have it qualified as an ordinary 503(b) administrative expense (and
thus has priority). 364(a)
2. If not in the ordinary course of business, the DIP needs court approval.
364(b)
ii. Priority over administrative expenses. 364(c)
1. If being qualified as an administrative expense priority under 503(b)
(1) isnt enough to induce someone to give financing, the court can
authorize getting credit with:
a. Priority over all administrative expenses in 503(b), 507(b),
or
b. Secured by any estate property not already subject to a lien, or
c. Secured by any estate property with a lien junior to any
existing lien.
iii. Super-priority. 364(d)
1. If the 364(c) super-priority isnt enough to get financing, the court
can authorize a lien senior or equal to any existing lien. It may do so
only if:
a. The DIP cannot get financing otherwise, and
b. There is adequate protection of the existing secured creditors
of that particular property.
iv. Super-super-priority. 507(b)
1. The existing creditor has priority over the later creditor if,
notwithstanding the adequate protection provided for under the
364(d) super-priority, the existing secured party still has a 507
administrative claim arising from:
a. The automatic stay ( 362), or
b. Use, sale, or lease under 363
c. the granting of the 364(d) lien, then
2. Ex: D had loan from bank for $50k secured by a lien on inventory
when it filed Ch. 11. Ds total debt is $250k.
a. D gets a post-petition loan from FF of $25k secured by a lien
on the equipment. Bank sought adequate protection by
seeking to lift the stay. DIP offered additional lien on
accounts receivable instead, and the court approved, so the
stay wasnt lifted.
b. The inventory was mostly depleted before the bank could
force a Ch. 7 conversion, and the accounts were difficult to
collect. The bank is still owed $25k. FF got $15k from
equipment sale.
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c.
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iv. Cross-collateralization: involves securing a pre-bankruptcy loan with new or additional collateral granted
post-bankruptcy as part of new post-bankruptcy loan. Should creditors pre-petition position (often
unsecured) get promoted in exchange for post petition financing?
v. Shapiro v. Saybrook Manufacturing Co., Inc.: Debtors filed Ch 11. The debtors then filed a motion for
the use of cash collateral and for authorization to incur secured debt and the court ordered an emergency
financing order. At the time the bankruptcy petition was filed, D owed Hanover $34 million but the debts
collateral was only valued at less than $10 million. Hanover agreed to lend the debtors $3 million in
exchange for a security interest in all of the debtors current and future property. The security interest also
secured the $34 million pre-petition (and new 3 million) debt and enhanced Hanovers position relative to
other creditors, such as P, in the event of liquidation. MH was originally undersecured, and would have to
share in pro-rata distribution of Ds unencumbered assets with other unsecureds, but now all 37 million
would be paid in full before anyone else.
1. Who is unhappy? Any creditor that has an interest in the property. Certainly GUCs will be
unhappy because they were supposed to share with MH, but now MH jumped ahead. Also, priority
lenders because secured get paid infront of them
2. Holding: Cross collateralization is not explicitly authorized by section 364 of the Bankruptcy
Code, is contrary to the basic priority structure of the code, and thus is an impermissible means
of obtaining post-petition financing. 364e is not applicable and so appeal is not moot.
3. 364-authorizes CH. 11 Ds to obtain secured credit and incur secured debt as part of
reorganization, but only applies it to future, post-petition debt, extensions of credit. Doesnt
authorize granting of liens to secured pre-petition loans. Bankruptcy courts may not create their
own rules of superpriority within a single class, above those in 507.
4. 9th circuit- says cross collateralization is authorized under code for purpose of mootness analysis,
but doesnt say whether its truly authorizes.
5. What about 105 equitable powers? 11th circuit says it has that power, but its not unlimited
6. Say youre a creditor and you want CC, DIP will say his hands are tied and cant offer this level of
security. Could shift bargaining power to DIP. IF CC Is allowed, all unsecured and under-secured
creditors will WANT to provide post-petition financing.
d. Problem 21.1- TIB for go-go properties, highly overleveraged (liens on all assets), but have valuable piece of
property. New limitations though that city put on development of property in state. Go-Go was grandfathered in to
developing property, or can transfer for 100k in water and sewage treatment. Need someone to lend you money to
transfer property/advertise or to develop the property yourself. Youre a lender I want to convince. Creditor will
want this to happen because it increases assets of D. **remember some of these need court approval and/or AP.
i. What do you offer first? 364, try to convince to make it an administrative expense. IF youre a creditor,
youll see youre overleveraged and will be doubtful about what will be available. Go down list of 364
1. (c)(1)- maybe offer a lien on the actual property, and be first priority among the property
2. (c)(2)- security interest in unencumbered assets? We dont have list of creditors, but theyre highly
leveraged, so might not be many assets left over that are unencumbered.
3. (c)(3)- offers a 2nd/junior lien on an already encumbered property. Might not work here. 364(c)(3)
is not valueless, client might want to do it if the property is worth 100k and the senior lien already
on the property is protecting debt for only 50k, and your debt is only 25k, and if you have no
reason to think property will drop in value (real estate usually doesnt). In that case its good.
Someones junior lien is good given facts of case.
4. 364(d)-if ALL else fails, then they can get superpriority. Must prime the lien. You bump persons
already protected, priming lien or getting equal status. Must be unable to obtain credit otherwise,
and must give adequate protection. If theres an equity cushion, goes into D too.
5. Does creditor only get to pick one? From D/TIB perspective, youre trying to shop around and
get beast deal. Creditor can insist on many things, like junior lien, and superpriority over admin
creditor.
ii. Who will want a say on whether D gets to take out loan? Unsecured creditors because its their money D
is playing with, since secured creditor will get collateral
e. Problem 21.2- D has a loan from FSB for 500K secured by a lien on its inventory. Ds total unsecured debt is
250K. D files for chapter 11.D got a post-petition loan from HF for 250K secured by lien on its equipment. FSB
sought adequate protection and the trustee offered an additional lien on Low Prices receivables. Since then,
inventory much depleted, and there are no account receivables. Low price files for chapter 7. After the sale of
inventory, and collection of receivables, FSB is still owed 250K. HF only got 150 from the sale of equipment. There
is 350K in other unencumbered assets. The only unpaid expense from chapter 11 is the 150K fee in lawyers fees.
The chapter 7 lawyers are owed 50K( FSB left with 250k, H 100k, 11 lawyer (150), 7 (50)- 350k in unencumbered
Assets
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f.
g.
i. How much does everyone get in Ch. 11 and Ch. 7? What happens to each creditor? What is nature of
remaining debt? In general, its deficiency claimii. Answer- Of the 350k 50 goes to lawyers, then 250 to inadequate protection for FSB. Remaining 50k
split between lawyers and HF
iii. How? 507(b) says that if trustee under 362 (lift stay) provides AP of interest of holder of a claim secured
by lien of property of debtor, and if notwithstanding the AP such creditor has a claim under section 507(a)
(2) (admin priority, standard post petition debt) then such creditors claims should have priority over any
other claim.
1. The creditor here, FSB, was forced into giving a post petition loan. Any post petition loan that is
unsecured gets admin priority. If you got 364(a)(2) priority because of the lift stay motion, then
creditors claim under admin section should have priority. So you get super priority when get
forced to make loan because you didnt get to lift stay and you werent adequately protected, and
you still have a debt owed to you. You get super priority over all other admin claims.
a. Further- You tried to lift stay and you sought adequate protection, but failed, and you
still ended up being a post petition lender with administrative status. So you jump
ahead.
2. Hannerty- equipment sold not enough to cover debt, still 100k left. Made a standard post-petition
loan, so has priority status and not GUC, but didnt ask for particular security, so remaining
amount is administrative expenses.
3. DIP lawyer, not secured by anything, so have 150k debt. Post-petition loan, standard admin
expense.
4. Whoe gets paid first? 507b- super priority. FSB gets 250k. 100k left to share between Hannerty
and DIP lawyer in Ch 11 context, 250k remaining debts at same priority levels.
5. To figure prorate- 100k left, 250k in debt. Each get 40% payout, money run out with them,
so GUC gets nothing (ch 7)
Summary- basic requirements of DIP financing laid out in 364. Can continue to obtain unsecured credit if in
ordinary course of business, but will need to demonstrate that you attempted to obtain unsecured credit elsewhere. If
such priority unsecured credit is unavailable then you can offer the security of 364c (super-priority, new lien on
unencumbered assets, junior lien on already encumbered assets). 364 d(priming lien)- if nothing else is available on
364, court, after notice and a hearing, may authorize the obtaining of credit or the incurring of debt secured by a
senior or equal lien on property of the estate that is subject to a lien only if(A) the trustee is unable to obtain such
credit otherwise-want to check all requirements have been met, and how the rearrangement change the priority list.
If youre representing a creditor and might be screwed and should object.
i. With 21.2- want to keep in mind what is the initial debt. Once you have post-petition, are there additional
amounts that come in or actions that can change priorities? (lift stay). Once there is a sale of collateral, how
does that satisfy secured collaterals? What priority status do remaining amounts have? Figure out who gets
paid in what order. Remember the basic order.
ii. post petition 503(b) regular priority GUC becomes Administrative, which are outranked by adequate
protection problem (super priority) 507b, which is then outranked by 364c super super priority, post
petition out ranking 364c, and if converted to Ch. 7 726b, super super super priority, where trustee lawyers
and professionals get paid before anyone
Problem 21.3- Murphy Is owed 3 million and didnt want to lend more. Secured by 2 million facility. So its undersecured. Then filed Ch. 11. Yankee tries to loan to Vehement secured by 1.5 million in unencumbered assets. Your
client Murphy wants to offer loan at better rate but only if all money is owed is secured by all its assets.
i. Looks like CC because you want to make new loan to secure previous pre petition under-secured
loan(curing deficiency). Want to check whether your district allows CC. if they do, Court wont
automatically approve first, must look at 364 financing requirements. This is Texlon type CC.
1. 364(c) if the debtor cannot get a loan by granting the administrative expense status, it can set up a
new lien on unencumbered property
ii. Yankee is offering loan without priming anyone even at high interest rate so wont likely be kicked out in
favor of your. BUT If Yankee gets kicked out- then no financing available and court will look more
seriously at your offer.
iii. Owner Financing
1. Sometimes the old equity holders (pre-bankruptcy owners) can provide financing, and will likely
want continued ownership of post-bankruptcy business; however, they dont get the special
protections mentioned above due to the absolute priority rule (i.e., equity gets paid last;
discussed further infra).
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2.
Code generally follows rule that equity cannot retain value unless all the creditors have been paid
in full due to APR
a. Some courts make an exception when equity provides financing that cant be obtained
elsewhere, court may permit equity retain ownership if its convinced that bargain is fair
and creditors will be benefitted. If the financing provides new value, is a fair bargain,
and is for the benefit of the creditors, some courts will permit equity to retain ownership
of the company.
b. In BOA v Lasalle- Sc held that real estate partnership could not simply buy equity in the
business as part of its plan confirmation without giving others a similar opportunity to bid
iv. Financing goods and services- for some businesses, unless suppliers are willing to keep furnishing
necessary goods and services, D is done. Nothing in code forces suppliers to keep supplying, unless theres
legally enforceable K for future goods and services. Most often theres ordinary supply contracts, for a
series of orders.
1. 05 amendment improved leverage of suppliers of goods while adding burdens of financing a Ch.
11 reorganization. Suppliers were given a right of reclamation under 546c, if D receives the goods
while insolvent and within 45 days of filing bankruptcy, seller has right to get goods back if makes
a timely demand. Sellers of goods automatically gets admin priority, 100% right of payment of
those goods (503(b)(9). Reclamation doesnt work against a secured lender who claims newly
delivery property as inventory 506(c).
D. Reshaping the Estate (summary) After you realize whos in charge and whether they can use money on hands, and
whether they can get post-petition financing, then DIP/TIB will look at the pre-petition transfers and try to avoid them or
nullify them. Are there unperfected security interests out there? Are there preferential transfers you want to avoid? You want
to look at the contracts DIP may want to avoid. Any fraudulent transfers? Look at all transfers, contracts, and security interest
to challenge. Use the strong arm clause to avoid unperfected security interests, powers to avoid preferential transfers, also
have power to assume, reject, or assign executor contracts, and use fraudulent transfer laws.
a. Unperfected Security Interest- 1 creditor can beat interest of another if the other failed to record the security
interest, but must give notice that you claim on piece of property, so even though you might be good against the
debtor, you might not be good against creditor. So TIB is representing not just D but C. This is Defined in 544a
(allows DIP or TIB to bump secured to unsecured status)
i. 544a- personal property. If real property, then DIP has status of bonafide purchaser in kicking out creditors
(state law BFP position is stronger than lien).
ii. TIP or DIP- gets BFP or lien creditor status regardless of creditor of that status holding interest in estate.
To find out legal content of that power must look outside bankruptcy.
b. Avoiding powers- important in business liquidations because permits TIB to undo pre-bankruptcy transactions
between the debtor and certain creditors, to benefit of all unsecured creditors. In Ch 11, bring avoidance action
gives TIB or DIP greater leverage in negotiating with Defendant creditor, which may face the loss of its security
interest or an order requiring it to pay back amounts it received from the debtor shortly before bankruptcy.
i. **must remember DIP is not pre-petition debtor. DIP is trying to save the business as a going concern on
behalf of all the creditors, as well as other constituencies. DIP not only has rights of old debtor, but also the
collective rights of the creditors to preserve the businesss assets. DIPs may avoid transactions that old
debtor would never have been allowed to challenge.
E. Reshaping Estatei. The avoiding powers permit a TIB/DIP to undo pre-bankruptcy transactions between the debtor and certain
creditors for the benefit of all the creditors.
ii. Remember that DIP has all the powers of the TIB; whenever you read one can do something, the other can
do the same.
b. The Strong-Arm Clause Section 544(a)
1. The strong arm clause gives the TIB the position of a judicial lien creditor, execution creditor, or
bonafide purchaser (real estate). It allows him to avoid any unperfected interests on the date of the
bankruptcy filing.
2. Can knock off unperfected interests. Establishes TIBs role in state law priority scheme, also works
to establish TIBS position regarding federal tax liens.
3. Federal Tax Liens
a. If they arent filed, the lien is just another unsecured interest (and TIB can avoid it).
b. After filing, it is another security interest that must be recognized.
c. However, the Federal Tax Lien Act of 1966 adds a twist: it gives some groups superpriority over the tax lien. This creates some circular problems (A beats B, B beats C, C
beats A), which are mostly resolved by 724(b).
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4.
c.
Perfection rules and who jumps ahead in priority list must look at Art 9 or state law. Personal
property any applicable exceptions or grace periods present in bankruptcy law apply.
ii. In re Bowling: (when can you set aside unperfected mortgage )Bs mortgage was recorded, bearing Ss
notarization, which certified B executed the mortgage in her presence. Also a dispute as to whether notary
was there, even if notarized and signed. B filed CH 7 and the TIB moved to avoid the mortgage as
defectively executed because S was no present at the closing.
1. Prop in Ohio, so that law governs, court agrees mortgage not executed properly according to state
law. Pursuant to 544(a)(3), if mortgage notary not present and person did not sign as purported, if
can be show through clear and convincing evidence. A refinance is a life changing even that would
stick out in someones mind, should remember. Here, MERS showed no evidence to contrary.
2. Holding: 544(a)(3) permits the TIB to avoid a mortgage improperly executed under state law. TIB
must prove by c/c evidence. Where TIB avoided using strong arm powers, mortgage interest is
preserved and becomes part of bankruptcy estate. Perfection can be avoided. Debt doesnt
disappear, just no longer secured, becomes GUC.
3. Note- similarly, if you do not have required witness, TIb could set aside mortgage. SAC is testing
portion of BC, testing the strength of lock that secured creditor or lien creditor has put on property.
If mortgagee locked up property so it could prevail over a BFP, then lock will hold. But if property
remains unlocked, creditor will find itself just one more floater.
4. Class- some courts are less strict as long as there was actual notice. Idea with real estate is that
must pay attention to requirements.
iii. When dispute is over personal property rather than real estate, TIB has only lien creditor status of 544(a)
(1-2). Article 9 Only secured parties and buyers are protected against misinformation of certain types in a
filed financing statement, While the unsecured creditors represented by TIB are bound by a defective and
misleading filing even if they actually relied on it.
iv. Problem 22.1- Western fliers bought a plane a week before the filing. This plane was purchased from Aero
for $25K down and a promissory note for $230K (255k) secured by the. But it didnt properly file it with
the state. When Aero learned of Westerns Ch. 11, contacted you.
1. Step into position of lien creditor. DIP would try to avoid and make MA a GUC because security
wasnt perfected. Look at UCC 9-317(a)(2), which says security interest, MA, is subordinate to
lien creditor (DIP) if it wasnt perfected like it was not here. Security interest will be avoided. You
can record now but its useless, they already jumped ahead of you.
2. Your loan doesnt disappear, you just become a GUC and a GUC with a large amount at stake, you
will want to challenge everyone elses perfections too.
3. Could file malpractice suit.
v. Problem 22.2 - Western Fliers bought another plane 7 days before the filing. This plane was purchased
from Aero for $10,000 down and a promissory note for $160,000 secured by the Aero Leader being
purchased and all Western Fliers other planes, spare parts, and servicing equipment, including Westerns
ten-passenger Thunderbolt. When Aero learned of the Chapter 11, it immediately filed copies of the
financing statement in all the appropriate locations. What can Aero get in the Chapter 11?
1. Look at Art. 9, Aereo has opportunity to perfect within 20 days as long as its 20 days or less, then
its treated as perfected on sale date (language says after it receives delivery of collateral), and still
keep priority, get to keep security interest in PLAN. Other assets, this is not PMSI. Other stuff
doesnt fall under the exception UCC 9-317(e) exception because not PSMI, goes back to UCC 9317 (a)(2) and lien creditor jumps ahead.
Preferences: The General Rules 547
i. The TIB can undo certain transactions (preferences) that took place within 90 days preceding of filing;
designed to ferret out preferential treatment to the detriment of the others. Power allows TIB/DIP to review
the activities of the debtor as it neared bankruptcy and determine whether some creditors received
preferential treatment before bankruptcy was filed, facing surrender preferences received from D. Basic
idea is that if D made transfer to some creditors preferred some as things started to fall apart, then
those transfers should be voided. Assures theres no favoritism, preferential distribution to Cs
ii. Preferences are defined in 547 (b). There are seven elements:
1. A transfer of an interest - This includes a security interest or perfection of an existing debt. (Filing
a financing statement qualifies. Meritt)
2. In property of the debtor- Not someone else; a loan by a 3rd party to pay a specific debt is not
voidable if the debtor isnt involved. Sun Railings
3. To or for the benefit of a creditor
4. For or On account of antecedent debt - In other words, the debt came temporally or existed before
the transfer.
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5.
iii.
iv.
v.
vi.
Made while the debtor was insolvent - Note that there is a presumption of insolvency for the 90
days before filing for the purposes of preference analysis only. 547(f)
6. Made within 90 days before filing (or one year if the creditor was an insider)
7. That makes the creditor better off than he would have been under Ch. 7 if the transfer had not been
made. This requires a comparison of what actually happened with a hypothetical world where it
did not.
a. General rule- if you have 100k debt, if theres anything less than 100% payout. If youre
unsecured and in Ch. 7 you get 100k x 50%= 50k. Any transfer you make pre-petition
will increase this. Any time youre GUC, any transfer you receive prior to
preferential period will likely be preferential and more than Ch.7
b. Payments to Fully Secured Creditors are not preferences: Payments to undersecured
creditors w/in 90 days of bankr from an insolvent debtor ARE preferences.
Note: although in the problems there is only discussion of what element gives the problem its twist,
you should always go through each element as a checklist.
1. Also, consequences is that if transfer is cash, it gets returned, if transfer is property, it gets
returned, if its security interest, it gets undone and becomes GUC.
Also note the 547(e) deemed date rules
1. A transfer is made at the date of actual transfer if within 30 days of perfection, and at the date
of perfection if longer (or immediately before filing if not perfected after commencement of the
case, or within 30 days after transfer, whichever is later)
2. Regardless of the above, transfer is not made until the debtor gets rights in the property.
In re Pysz: P(creditor) holds judicial lien of 42k which arose form post-judgment attachment P obtained in
court through writ of attachment on logging equipment and real property, of which Debtor owns 50%
interest. Debtors files Ch. 13 and list that property as having a FMV of 300k. D offered separate appraisal
at 443k.P claimed the lien was a preference b/c he was insolvent and the lienholder received more than he
would have in CH 7.
1. Holding: A lien is a voidable preference if for an antecedent debt, for the benefit of a creditor,
filed within the 90-day preference period, the debtor was insolvent and the creditor would receive
more from the lien than from a Ch 7 liquidation. Trustee has burden of proving a voidability under
547(g). Insolvency and receive more elements of 547(b)(5) satisfied.
a. P was insolvent b/c his liabilities exceeded his non-exempt assets. A debtor is presumed
to be insolvent on and during the 90 days immediately preceding the petition. The burden
is on the lienholder/creditor to rebut the presumption, by showing evidence that D was
not insolvent at time of trasnfer. 547(b)(3) financial condition such that the sum of
such entitys debt is greater than all entitys property at fair valuation
i. D tries to allege FMV is 443 and tries to include property D failed to mention,
but leased property does not count. Here, Ds liabilities exceed his total assets,
but Defendant failed to rebut presumption.
ii. Presumption of insolvency for 90 days before anyway.
b. If the distribution to creditors is less than 100% of the debts, any payment to a creditor
during the preference period allows that creditor to receive more than he would have
received in liquidation
i. need to show judicial lien enabled creditor to receive more than if case was
brought under Ch. 7 had transfer not been made 547(b)(5). Whether 547(b)(5).
Is met turns on status of creditor to whom transfer was made.
ii. With Unsecured creditors, if distribution less than 100%, any payment on
account to an UC during preference period will enable creditor to receive more
than he would have in liquidation had payment not been made.
iii. Here, since Ds liabilities exceed his assets, he would be unable to repay GUC
100%, Ds judgment, absent attachment from judgment, is GUIC. By attachment
he converted the unsecured debt to secured one, thus lien enables D to receive
more than he would without the lien in Ch. 7 case
2. Class- 1) theres transfer (security interest receive with judgment, attachment of lien to equitment
and real property) 2) for benefit for D 3) on account of an antecedent debt 4) within 90 days.
Chase Manhattan: P had a mortgage loan w/ C that he refinanced 6 months before filing Ch.7. Later, new
mortgage on residential real estate was recorded in favor of Chase to secure Ps obligation to repay the new
loan. The mortgage was recorded 72 days after loan proceeds from refinance were disbursed. 77 days after
the refinanced NEW mortgage, P filed for bankruptcy. The TIB moved to void the lien as a preferential
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vii.
viii.
ix.
x.
transfer. C claimed it was not and used an earmarking defense, claiming the borrowed funds were used to
pay another creditor.
1. Holding: A creditor who refinances a debt owed to that creditor may not use the earmarking
defense in an action to avoid a lien created by that debt as a preferential transfer. Outcome is that
he can avoid the 2nd lien on the house, and Chase would become an unsecured creditor.
a. Is it voidable? Most requirements are met. Within 90days, insolvent, put chase in better
position.
b. Key question is it on account of antecedent debt? Was it prior to transfer?
Subsequent perfection is a transfer unless it is within grace period, which has now been
extended to 30 days. Here, they waited 72 days to record after loan proceeds were
disbursed, so transfer occurred at the time such transfer was perfected and made on
account of an antecedent debt. If they recorded within 10/30 days of 547e, would not
have been avoidable.
i. Lenders who advance loan proceeds prior to recording of mortgage transfer an
interest in subject property for purposes of 547, and such transfers are subject to
preferential transfer liability. 547e address this potential problem for lenders,
providing a 30 day grace period for perfecting sec interest, then the associated
mortgage debt will not be antecedent, but if perfection occurs later than 30 days
after transfer takes place, transfer will have occurred at time of perfection, and
debt will be antecedent. Here it was 72 days later, so transfer was on account of
antecedent debt.
ii. Chase is arguing earmarking defense- but here Chase is same creditor,
theres no new 3rd party. Also doesnt help late perfecting refinancing (court
doesnt see refinancing as unitary transaction makes sense of 543 grace
period)
iii. Chase is sophisticated, should know how its done. If you did apply
earmarking doctrine as unitary transaction, it would write out 30 day period.
In re Denochick: (concerns to and for the benefit of creditor) D owned a loan guaranteed by S. D paid $1k
on the loan and ttee claimed the pmnt was a preference b/c it indirectly reduced Ss exposure on her
guarantee. Holding: A guarantor is a creditor as defined by the Code. Guarantors also be liable for
preferential liability. Ds payment to NBOC conferred a benefit upon appellants, to detriment of other
creditors.
Problem 23.1- Mountain Lakes Fuel Oil is an unsecured creditor of Wilson Manufacturing. Wilson owes
Mountain Lakes $140,000. It makes a payment of $14,000 to Mountain Lakes 60 days before bankruptcy
while Wilson is insolvent. Wilson is liquidated in bankruptcy, and the unsecured creditors receive a 10
percent pro rata distribution. Is Wilsons payment to Mountain Lakes a voidable preference under section
547(b)?voidable.
1. Theres transfer(yes) of interest of debtor (14k), for benefit of C (yes), within 90 days (yes, 60),
for antecedent debt (yes), while insolvent (yes)
2. Which allowed them to receive more on plan than in Ch. 7? YES
a. With Transfer- 14k +(10% of 126k) 12.6- 26.6k- allowed claim here would be 126k so
add to what you already received.
b. W/O transfer in Ch 7- 140k x 10%= 14k
Problem 23.2- transferred equipment from debtor, to creditor for their benefit, on account of antecedent
debt, while he is suspected as insolvent and within 90 day presumption period, and within 90 days of filing,
which allows them to receive more than ch 7(unsecured creditor)
1. If GUC receives anything then it will likely receive more than Ch. 7. Even without knowing the
pro rata distribution, we know that the creditor will get to keep equipment PLUS any distribution
it claims in CH.7, so its better than plan. Voidable.
Problem 23.3- When gasoline was scarce and prices were high, several creditors were eager to lend money
to Raymonds Chevron Station for expansion. When the gasoline glut appeared last winter, one of those
creditors, Iowa Commerce Bank, decided it would prefer to be a secured creditor. On February 1, while
Raymonds was insolvent, the bank received a security interest for its previously unsecured debt in
Raymonds previously unencumbered equipment. The bank filed and perfected on the same day. On April
25, Raymonds filed a Chapter 11 reorganization. Is there a voidable preference? voidable
1. Transfer (yes, the lien security), from D to C, while insolvent, within 90 days, on account of
antecedent debt
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2.
Did C make more than it would in Ch. 7? Right now he secured thanks to that amount, when it
was previously unsecured. Secured creditors get paid in full up to the value of lien up to 100%. As
GUC, you get remaining.
a. If transfer if voidable, then he is just a GUC and gets whatever is liquidated.
b. Since he is now secured, creditor gets to lead ahead of unsecured creditors (like he was)
in Ch.7 distribution.
3. Relevance of perfected interest? Has to separate strong arm powers about unperfected security
interest. Here, even if perfected, if created within 90 days, youre still a GUC. Even if dealing with
perfected interest, its different of powers over and above those strong arm powers.
4. Does this mean that all security interests perfected within 90 days of a bankruptcy are invalidated?
a. No. A security interest which secures a contemporaneous advance is not a preference b/c
its not for or on account of an antecedent debt.
xi. Problem 23.4- June 1 C lends D 50k and takes security interest in Ds unencumbered equipment, which it
perfects on July 7. On Sept 15m files Ch. 11. Is there voidable preference? Loan was made more than 90
days before filing Ch. 11, but perfection of security happened within 90 days. Voidable
1. Definition of transfer- status of creditor prior to perfection, strong arm will be used and TIB will
make you a GUC. So here, as of 7/1 he was just a GUC. Perfection happening on July 6 moves
you from being a GUC to being a secured creditor, in context of bankruptcy, perfection is the
transfer of a security interest.
2. Think in Ch 7 context- you would be a GUC. If it had been perfected on 6/25, then you have the
30 day element of 547(e)(2)(A)- 30 days within getting loan then you act as perfected when loan
was MADE), then the transfer date that counts would be 6/1, and you then have perfected Sec
interest, and youre out of preference period, and you get payout.
3. IF you got sec interest and perfected on same day, then you would just have a current debt, no
antecedent debt. But since they waited a month, its a transfer on account of an antecedent debt.
4. Policy- nice cushion for creditors, 30 days, so their perfections arent voided. Strong arm polices
the late perfection by allowing trustee to go after interest that are not perfected. Preference also
polices through 90 day transfer rule.
5. What if transfer (recording) happened June 28? It would not be treated as an antecedent debt
because 547(e)(2)(b) give you 30 days to record. Must look at 1) date security interest becomes
effective between parties 2) when security interest is perfected. If it is within 30 days between 1
and 2, then perfection relates back to the attachment date.
xii. Problem 23.5- HB has 2 creditors MC and CB. MC is secured for 30k and 5k unsecured on 35k debt. CB
has 40k secured and 10k equity cushion (50k). 1 day later HB made 5k transfer to both, within preference
period. A couple months later they file bankruptcy.
1. both 1)transfer 2) from D property 3) to C 4) while insolvent 5) within 90days 6) for antecedent
debt.
2. Are they better off than in Ch. 7 liquidation?
a. MC- by getting 5k unsecured, theyre in better position. 5k + 30k= get paid in full
i. Without transfer, MC would have received 30k from collateral, plus some small
percent on its unsecured 5k debt pro rata.
ii. Payment to undersecured creditor is preference
b. CB- Oversecured- 5k did not make them better off in Ch. 7. They were oversecured and
would have gotten all 40k anyway. 5k doesnt change what wouldve have happened in
Ch.7
i. For over secured creditors, if transfer doesnt go over equity cushion they have,
then not voidable.
xiii. Problem 23.6- March 1, D owes C 250k, secured for 150/unsecured for 100k. On 4/15, debt is the sameon all current and after-acquired equipment. D added value by getting more equipment from supplier that
didnt take a security interest in goods. On may 35, D, after being insolvent for 6 months, files bankruptcy.
1. Has there been VP? Transfer? 547(e)(3) says there is no transfer until the debtor acquires right to
property. Here, new property was acquired by C because they perfected security interest in all
current and AFTER acquired equipment its called a floating lien a lien that applies not just to
property owned at the time but acquired by debtor afterwards earmarking, i.e. UCC allows it.
2. Its indirect transfer, to an for benefit of bank. They received a benefit, created/perfected a security
interest in the equipment. Within 90 days, insolvent, and did better than Ch. 7.
3. Was it on account of antecedent debt? No new debt made, same debt, addition of security interest
here fed the same debt.
4. When did transfer occur ? When was security interest created? (UCC 9-203)?
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a.
b.
c.
d.
Security agreement signed when Virginia borrowed the money from First Richmond.
The bank gave VALUE when it extended credit.
The debtor obtained RIGHTS in collateral on April 15, when it purchased the equipment
on credit from its supplier.
d. When was security interest perfected? (UCC-9-308)
i. On April 15, when D obtained rights in the collateral. Financing statement was
already on file.
5. Are other requirements for VP met? Yes, it was within 90 days, on account of an antecedent debt.
D is insolvent, received more than they would have under Ch. 7.
a. Ch 7 element- on petition date they were oversecured. But they would have been
undersecured had it not been for the extra 200k put in. Financing statement was already
on file.
xiv. Problem 23.7- Transfer here was on July 1, 20k payment. For benefit of Creditor. While insolvent? Yes,
we presume it since it says serious financial trouble. Made within 90 days. On account of antecedent
debt.
1. When they made the transfer they were over secured so they knew they would get paid
anyway. But on bankruptcy say, dhey are now unsecured and would have gotten only cents on the
dollar. Therefore 20k payment was a preference.
a. Since equipment was destroyed, under Ch. 7 they would receive nothing. Ch. 7 analysis
is made on the date of the petition.
2. Which moment should control? Courts hold that moment of petition controls, not transfer.
3. Voidable transfer.
xv. Problem 23.8- After fire, bought another used machine on unsecured credit, is there voidable preference/
what additional info would you like to know to find out if theres voidable preference?
1. If its like 23.6 with after acquired clause then would probably be a VP
2. If its specific to the equipment, not covered by old lien, then purchase payment remains a
preference, because Hillside would have been unsecured in hypo Ch. 7.
3. Assume machine covered by after acquired property clause in original agreement. Would be
avoidable because they received more as a result of the payment.
The Exceptions Puts creditors back in equal position and pay them out. Risk that preference liability might freeze
up their willingness to engage with the debtor.
1. There are 8 total exceptions, but only five are common:
a. The contemporaneous exchange exception ( 547(c)(1))
b. The ordinary course payments exception ( 547(c)(2))
c. The PMSI exception ( 547(c)(3))
d. The new value exception ( 547(c)(4)
e. The floating lien exception ( 547(c)(5))
ii. Contemporaneous Exchange 547(c)(1)
1. The TIB cannot avoid a transfer to the extent that it was intended to be a contemporaneous
exchange for new value and was in fact a contemporaneous exchange. Two elements
a. Subjective- parties intended a contemporaneous exchange (money for value)
b. Objective- and had to be substantially contemporaneous (within seconds of each other)
2. Note: some scholars think its a mistake to police delayed filings with preference rules; they say
the parties almost always intend a contemporaneous exchange, and a goof-up is what caused the
delay. The counter is the importance of protection of other creditors from lack of notice,
intentional or otherwise.
iii. Ordinary Course Exceptions 547(c)(2)
1. The TIB cannot avoid a transfer to the extent that it was for a debt in the ordinary course of
business and made in the ordinary course of business. Permits ordinary course transactions to
stand notwithstanding the fact they permitted some unsecured creditors to be paid in full. Usually
limited to short term extensions (45 days) and made according to ordinary business terms.
2. Ex: Are late payments in the ordinary course? Maj. rule is to look at the partys past practice; Min
rule is to look at both past practice and industry practice. Steel Improvement.
iv. In re Stewart: P purchased cattle from D and paid in checks that were dishonored on 1/29. On 2/12 he
gave D cashiers checks to cover the dishonored checks. On 4/11, P filed Ch 13, and in June, went to Ds
resident and was paid 15k towards debt to C. Cattle buyers are required to pay for their purchases on the
day of sale. The cashiers checks were made while P was insolvent. TIb wants to get as much property as
possible within estate, and sees cashiers check payment, and thinks it belongs to them on theory that it was
a preferential payment transfer.
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1.
Holding: A transfer within the 90 day preference pd isnt preferential if part of a contemporaneous
exchange for value, or if it paid debt incurred in the ordinary course of the Ds business and the
transfer itself was either in the ordinary course of the Ds business or was made according to
ordinary business terms.
a. The checks were given to pay antecedent debts and were not part of a contemporaneous
transfer. Buyers in actions are required to pay for purchase on date of sale, so debt was
incurred two weeks before delivery of cashiers check, so antecedent debt.
i. The checks at the time of transfer were dishonored and the transaction became a
credit transaction. Any subsequent payment would be in satisfaction of an
antecedent debt.
ii. 547(c)(1) creditor must prove that otherwise preferential transfer was
1. 1) intended by D anc C to be contemporaneous exchange for new
value given to debtor
a. new value- Money or moneys worth in goods, services, or
new credit, or release by a transferee of property previously
transferred to such transferee in transaction that is not
voidable.
b. Contemporaneous exchange cannot involve a dishonored
check. This changed nature of transaction, payment by check
is equivalent to cash unless the check is dishonored, then
payment is considered when check is delivered. When checks
were dishonored, this became a credit transaction and created
an antecedent debt, and any subsequent payment would be to
satisfy new debt- No contemporaneous exchange for value.
2. 2) In fact substantially contemporaneous transfer of cattle occurred
two weeks prior to cashiers check, court must determine whether
subsequent delivery of cashiers checks to replace insufficient funds
from check constituted contemporaneous exchanges for new value?
a. Cant involve checks that boince.
b. Checks do not qualify as transfers made in the ordinary course of business.
i. The first element was satisfied (payment of debt incurred in OCB)
1. P had an ongoing business relationship with D and the checks were
given to satisfy a debt incurred in the course of that relationship
ii. Second element the transfer must be made in the course of the debtors
business OR transfer made according to ordinary business terms.
a. P generally paid on the day of purchase. Checks were not given according
to the ordinary business terms in the industry. The usually dont bounce.
v. The Purchase-Money Exception ( 547(c)(3))
1. IF transfer was a security interest and also perfected within 30 days of D getting possession of
property, then its exception. Receive special protection because these transactions are regarded as
beneficial to the estate, but ones that bring in new property are even more so.
2. The TIB cannot avoid a transfer creating a security interest if it was (in essence) given for a
PMSI, and perfected within 30 days after debtor takes possession.
a. Problem is that states only give 20 days.
3. Policy: you want to encourage bringing assets into the estate. Perfection requirements UCC 9317
vi. The New Value Exception ( 547(c)(4))
a. Idea is when theres preferential transfer during preferential period, and creditor still
gives new value that hasnt been paid for or secured, then this subsequent new value can
shield previous preferential transfer. It incentivizes you to make continued credit. Only
shelters preference payments that come before a particular extension of new value.
Applies on payment to payment basis. The basic point is to provide some protection to a
creditor who gets a preference and then extends further unsecured credit.
b.
The TIB cannot avoid a transfer to the extent that after the transfer the creditor gave new
value to the debtor not secured by an otherwise unavoidable security interest and on
account of which the debtor did not make an otherwise unavoidable transfer to the
creditor.New Value is defined in 547(a)(2); it includes new credit as well as money,
goods, and services.
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c.
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e.
i. Here there was 2400 payment + gas delivered many times. Then we have Gas
(new value) deliver with no payment. This gas is new value, doesnt shield
anything because theres no voidable preference to shield, and any new value
must shield a past voidable preference. Then normal delivery and payment made
On top of the past due payment, then same.
ii. When next time this happens the Gas is shielding the voidable preference of the
past due payment and on and on, until the end. Which ends up meaning that the
last past due payment is the only one avoidable. Temporality matters.
d. 547(c)(9)- DO you break down per event or as total. 2400 per, 7200 as sum.
ix. Problem 24.2- John deere willing to finance 10 new pieces for security interest in it. Both want the
equipment. TIB will say it was a preferential transfer and perfection is voidable, so they become GUC.
1. Is there a preferential transfer? 1) on account of antecedent debt because it was a perfection that
was over 20 days after delivery, put john deere in better position it would have been otherwise 2)
transfer 3) from D 4) to C 5) insolvent 6) 90 days 7) would be better than in Ch 7.
2. Defensesa. 547(c)(3)- This is PMSI perfection. If its perfected within 30 days of D receiving
possession of collateral, then its OK. Since equipment was granted and delivery occurred
within 30 days, it passes.
b. What if Bank claims they had an outstanding perfected security interest in ALL of
Ds equipment? Between 2 creditors fighting out , must look at state law UCC 9-317(e)
i. Here perfection happen more than 20 after D received delivery, so original
interest holder will have property.
c. OUTCOME John Deere wins against TIB because as long as you perfect within 30 days
PMSI is good. Exception applies. BUT against OTHER creditors, must look at
State/UCC law- If you have PMSI, its only good if you perfect within 20 days, otherwise
youre junior to other creditor. Liberty wins.
d. Cab this be a voidable transfer by Liberty now? Theres transfer of Ds interest to
Liberty bank, for their benefit, which happened when D was insolvent, within 90 days,
that puts them in better position than they would have been in Ch. 7
Floating Lien Exception ( 547(c)(5))- A floating lien is when a creditor takes a security interest that covers debt
that owes right now but also property that may be acquired in the future. Its for a more ephemeral object, like
current or future inventory and accounts receivables. Identity and content of this is always changing.
i. The TIB cannot avoid a transfer that creates a perfected security interest in receivables or inventory (or
proceeds) except to the extent that it causes an increase in the value of the secured goods. (?)
1. Preferential Problem- Newly acquired property is technically a preferential transfer in 547(e)(3).
Transfer date is when the debtor acquires an interest in the property.
2. Improvement in position formula: movement of debt and value of collateral, while looking at
filing date and 90 days before. Find out insufficiency at 90 days and with subtract with petition
date. Insufficiency is debt- collateral. Then DIP/TIB can avoid those amounts of improvement.
a. For example, on the ninetieth day C is owed $10 and the inventory is worth $8. C is
unsecured for $2. On the date of filing C is owed $8 and the inventory is worth $8. C has
an improvement in position of $2. The should be TIB/DIP is entitled to avoid the amount
necessary to put the creditor in hole $2.
b. EX2- 90 days before filing, you have 100k in debt and 50k in collateral covering it.
Insufficiency here is 50k. Over the course of preference period and at filing, no debt
payments were made (so dont factor anything into 100k debt), then collateral increased
to 70k value, so insufficiency is now 30k. So here 50k -30k, is 20k improvement in
position. Youre 20k less undersecured than you used to be. So 20k is the voidable
preference
3. IF oversecured to start, will likely not have that problem.
4. Unlike new value exception, this is a snapshot, looking at beginning and end of preference
period, and ignore what happens in the middle. ALWAYS go through VP analysis first.
5. 547(e)(3) rejects the relation back approach by forbidding for preference purposes any dating
of a security interest in that property. Under that section, time of transfer of a security interest in
after-acquired property is the date the debtor acquired the property, regardless of an earlier
perfection. As a result, lenders security interest in every piece of property acquired after filing is
to be deemed transferred to lender within 90 day preferential period, because all inventory
would have been acquired and all accounts would have arisen within that period.
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a.
Because of 547(e)(3), lenders security interest in Inventory and accounts receivables will
almost always be preferential under 547(b), but security interests would be voidable but
for section 547(c)(5), which grans exception to inventory and A/Rs.
6. 545(c)(5)- code applies protection for inventory/AR lenders with an improvement in position
formula, which makes improvement in secured partys position during the preference period
potentially avoidable by trustee. Result is that Inventory/AR lenders are protected when D
acquires property preceding bankruptcy, but not permitted to enhance their position during critical
pre-bankruptcy period.
i.
QMECT: Q filed CH 11. Two creditors, C and B, had security interests in inventory and A/R. A clause
granted B an interest in after-acquired property. B was undersecured. However, when Q filed CH 11,
the value of the AR/Inventory was greater than at the beginning of the preference period. The TIB
moved to avoid the interest acquired during the preference period. However, the value of the debt was
also greater (due to accrual of interest and late fees.
7. Holding: Transfers to a secured creditor during the preference period are not avoidable if the
value of the debt in relation to the value of the collateral increases due to interest or late fees.
a. Transfers to an undersecured creditor are only voidable to the extent that the creditors
undersecured position at the beginning of the preference period is greater than its
undersecured petition when the petition is filed. This Attempts to prevent prejudicing
unsecured creditors.
b. 547(c)(5) refers only to debt not to advances or new value. This is in accord with state
law as well. Debt is defined as liability on a claim and claim would include pre-petition
interest, late fees, and attorneys fees.
c. Only post-bankruptcy interest and fees are excluded from the definition of debt.
ii.
Nivens: F & S conducted a framing business under a partnership called N&N. Each filed CH 11 in
March 1982. The bank had a security interest in their 1981 crop, which increased in value during the
90 day preference period. Ttee contended this was a voidable preference under 547(b), (c)(5)
i. Crops are inventory under 547(a)(1). With inventory If there is increase in value of
the inventory due to market fluctuations, without increase in VOLUME of inventory,
there is no avoidable preference. But crops are different because they are
continuously changing. Lien which was initially fixed against a crop in its embryonic
states continues against the crop in all its stages of development. Its same lien for
the same crop, but now its worth more, although the inventory amount didnt
increase. Nature of crop is the same, there is no substitution goods as usual with
inventory.
1. What about if a farmer uses cash to buy fertilizer or pesticides for the crop,
then the farmer executed a transfer to enhance value of crop, and if it goes
to secured interest, a preferential transfer occurred.
d. Holding: If there is only an increase in the value of the inventory due to market
fluctuations, there is no avoidable preference. Technically not a transfer.
Improvement is what matters, but must be accompanied by an actual transfer.
iii.
Setoff Preferences
8. Note that 553(b) provides similar rules for setoff preferences. Note it only applies to setoff
exercised before bankruptcy; a creditor using setoff after bankruptcy is in good shape.
a. have bank and debtor, and bank made loan to debtor, and debtor has deposit account)
treated like a security interest under the code . Imagine D putting in additional deposits,
so it looks similar to payments, puts bank in better position than it was. 553b.
b. would compare insufficiency amount pre and on bankruptcy too.
ii. Problem 25.11. Is there VP? at T-90, D is 4mil and V is 4.2 mill (.2). During filing D increases to 4.6 and
collateral to 5.2 (.6). There is a transfer (increase), but there is no real improvement in position
because they were over secured anyway. When you START oversecured, youre safe.
a. No voidable preference- C started oversecured so you cant end up in a better position.
iii. Problem 25.2- Same as above, but two payments made it between. Doesnt change anything, We only
take a snapshot of what happened on T-90 and filing date. Debtor was still oversecured 90 days before and
on filing day. Still no voidable transfer
1. Look at how oversecured creditors cant improve position much
a. With transfer 200k payment +4.4 million at 100%- 4.6m payment
b. Without transfer 4.6 million at 100%- 4.6 million
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f.
iv. Problem 25.3- - t-90 debt of 430 and collateral of 450 (20k oversecured). later 430k, and collateral drops
in value to 300k, so undersecured by 130k (insuffisicency). At bankruptcy though debt is still 430k, and
collateral now worth 500k, so 70k oversecured,
1. is there a voidable transfer? Technically no, dont care about what happens in the middle, only at t90 and P. Creditor started oversecured so no voidable transfer. DONT CARE ABOUT MIDDLE
v. Problem 25.4- Owes 1 million, and was worth 800k (200k insufficiency). Now 42% increase in value
(due to market changes) Doesnt seem to be a transfer in first place to meet 547b requirements. So even if
value increased, dont need to get floating lien exception since there is no voidable transfer in first place.
Its the same gold, no substitute item, just a rise in value. The gold price jumped 42%, so we assume that at
the date of filing, it is fully secured. It seems that the creditor was better off $200K. But the increase in
value is not a preference. No transfer here, only appreciation; so no preference. Like Nivens
vi. Problem 25.6- you represent liberty bank, and is owed 900k by Tulsa and debtor is 4 months behind. Loan
is secured by Tulsas inventory. Tulsa made purchase that increases value of inventory from 300k to 1
million.
1. You may want to wait- loan amount was 900k, 300 value (600k undersecured) at t90, later in
middle of preference period it was value went up to 1 million. You want to wait until preference
period passes. If you wait long enough, preference period will start at a period where youre
oversecured. By the time you call the loan, youre still fully secured. Strategically want to be
outside preference period so you start at a much higher amount.
Executory Contracts (contract that wasnt fully performed), ongoing contracts become a concern. Some prebankruptcy contracts may turn out to be bad bargains. Even the good bargains may be worth more to someone else.
Look at the Executory contracts and then determine which ones to assume or reject. Remember that contracts
become part of the estate, so TIB will want to maximize the value of contracts.
1. Basic Economics
a. The TIB can review the companys existing, ongoing contracts and decide if they are
good bargains, and, if they are not, to refuse performance. (The other party gets a breach
of contract claim i.e., an unsecured claim that wont be paid much anyway).
i. The business judgment rule applies to if the TIB can accept or reject basically,
the TIB has broad discretion.
2. Elementsa. 1. There has to be material performance remaining on both sides of the contract.
i. Contract has to be in force at time of bankruptcy.
ii. TIB can
1. 1) reject counterparty has a damage claim, breach of contract.
Calculate damages under applicable contract law (Cover MVP?)
2. 2) Assume and perform no damages
3. 3)Assume and Assign- sell it.
4. Limitations of 2 and 3, you must cure a default on the contract,
compensate for any pecuniary loss that resulted from default, and
provide adequate assurance that contract will be assigned in future.
5. Flexibility for TIB or DIP to decide. 356(e) ipsofacto clause, Absent
some bankruptcy law, assignment is allowed
a. 365(f)- requirements of assignment, must show adequate
assurance of assignment. Might also be required to cure
defaults that happened.
b. Basic framework What can trustee do?
i. 365(a) permits the TIB to assume or reject any executory contract.
ii. 365(b) places restrictions on assuming certain contracts that are in default
(covered infra)
iii. 365(c) says TIB cant assume or assign if excused by law or if contract is one
for financial accommodation.
iv. 365(e) kills anti-bankruptcy and anti-insolvency clauses
v. 365(f) covers assigning contracts to 3rd parties (must assume first and provide
adequate assurance of completion)
vi. 541(a), 502(g) brings contract and its burdens into the estate, respectively.
vii. 541(c)(1) kills anti-alienation and bankruptcy termination clauses to permit
those contracts containing them to become part of the estate.
c. Code- more= 365(a) trustee, subject to the courts approval, may assume or reject any
executory contract or unexpired lease of the debtor.
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ii.
iii.
iv.
v.
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vi. Problem 26.5- franchise K provides several things. Problem is that 6 months in things are going well but
store is damages and insurance doesnt cover, so shes low on capital. Bank is on her for outstanding loan
delaying with line of credit. Shes thinking of Ch 11, but worried about franchise K.
1. Generally 365(a) allows her to assume K, and shes not in default on K.
2. 365(c)(2) cant assume if such contract is a K to make a loan, or extend other debt financing or
financial accommodations to or for the benefit of the debtor, or to issue a security of the debtor:
basically saying cant assume K to get loan. Since part of K was this, cant be assume
Lease Type
Curable Defaults
Non-Curable Defaults
Personalty
365(b)(1) & (2)(d)
3.
TO what degree is the K separable? 365 doesnt say much. Could look in state law. Likely to not
be considered separable.
vii. Problem 27.2- what options do they have if Rancho rejects lease? 365h- they cant be thrown out, so
they can stay on the land.
1. 365(h)(1)(A)(ii)- If trustee rejects unexpired lease of real property under which debtor is the lessor
and if this rejections amount to breach, then lessee may treat lease as terminated by the rejection
or may retain its rights under the lease (if already commenced) that are in or appurtenant to the
real property for the balance of the term of such lease and for any renewal
a. 365(h)(1)(B) if he retains, lesse may offset against rent under lease the value of any
damage caused by the nonperformance after the date of rejection BUT lessee will not
have any other right against the estate or debtor on account of any damage occurring after
such date caused by nonperformance.
g.
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1.
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2.
b.
Prepackaged Ch. 11s a debtor can often force little creditors to go along with a plan by
rounding up the votes before filing and showing up in court with a plan already in hand.
Confirmation
i. Reorganization Structures- only a debtor can propose a plan for 120 days, afterwards anyone can
ii. Best Interests of the Creditors and Feasibility- in general the acceptance of financial plan by majorities
in each class of creditors is at the heart of Ch. 11 process, with most requirements in Sec 1129 relating back
to this acceptance process.
iii. Best Interests and Feasibility
1. In order for a plan to be confirmed, it must be in the best interests of each creditor (not just
creditors generally) and be feasible.
2. Note that the words dont appear in the Code; its just jargon for the requirements in
1129(a)(7) and (11).
iv. Best Interests Test ( 1129(a)(7) plan has to be in best interest of each individual claim holder that
objects- SO unless each creditor accepted the plan, best interest test requires finding that objecting creditor
will receive at least as much as he would in Ch. 7. Must do liquidation analysis which turns on valuation
of assets in potential Ch. 7 liquidation. Must perform this analysis on each creditor that objects.
1. Plan proponents will say liquidation value is LOW because ch. 7 wont generate as much as Sh.
11 would in comparison. Plan opponents will say valuation is high in liquidation, more than DIP
admits, so that in Ch. 7 theyd get getting 75% payout instead of 45% in 11.
v. The Feasibility Test ( 1129(a)(11)) even if every creditor doesnt agree, plan must be found feasible. the
plan is likely to succeed (a case-by-case judgment based on the bankruptcy judges business judgment). Are
Creditors not likely to be paid. Will business prosper long enough to make scheduled payments? Are results
expected in light of operational capacity of DIP, look at past evidence of this. Look at the degree to which
the plan is conditional.
1. Requirement is undesirable because one dissenting creditor can object in the face of a majority
that agree (seeing it as protection form naivete). Test must be satisfied EVEN IF all creditors
approve the plan. Requires court to join in creditors judgment about prospects of business
survival. REQUIRES JUDICIAL business judgment- (policy)
vi. Voting requirements- requires each class of claims or interest to accept plan, or to be unimpaired under
plan. Insures every class has some say. If a class of claims is impaired under plan, at least one class of
claims that is impaired under the plan has accepted the plan.
1. Malkus: (feasibility) M proposed a CH 11 plan that projected financial gains, despite historically
exceeding its operating budget monthly. Holding: Ct should not confirm a CH 11 plan if there is
no reasonable likelihood the plan will succeed. Cant guarantee success, but also dont want some
visionary scheme, there must be evidence of some success that plan is feasible. Evidence here is
dismal track record in past performance
a. Stopped making tax and insurance payments, stopped paying loan, barely passed quality
test. D repeatedly failed to comply with agreements even when court mandated it.
b. Ds expenses during post-petition period exceeded Ds own budget every month
c. Even if revenues rose slightly, he has dismal track record spanning through case that
shows his projections relied upon are unreasonable and unachievable.
2. Made in Detroit(feasibility) Ds only significant asset is property for purpose of development.
Became delinquent to primary secured creditor, who then started a foreclosure action, so D files
for bankruptcy protection under Ch 11. D proposed a CH 11 plan whereby creditors would be paid
pursuant to a contingent loan. Plan provides for funding through loan contingent on a fee and a
minimum valuation of property.
a. Holding: Conditional plans are not feasible and therefore ineligible for confirmation.
Plan doesnt need to guarantee success, just a reasonable assurance of it, by providing a
realistic and workable framework for reorganization. Plan here is based on wishful
thinking and promises, contingent on financing, without assurance loan will close or
property appraised at amount. Not likely Ds plan will be funded. Court still checked
whether contingencies are likely to happen or not.
3. S-K Palladin Partners(best interest): D was in CH 11. They had a music catalogue they claim is
worth $15 million. P, an unsecured creditor of D, claims the catalogue is worth $60 million. Thus,
P objects to the plan containing the $15 million appraisal, claiming it is not in the best interest of
creditors.
a. Holding: The value of a debtors assets must be properly supported by admissible
evidence.
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a.
i. P knew of the proposed liquidation for a month and failed to diligently conduct
necessary discovery in a timely manner (had one month). It also failed to
designate a witness to lay the foundation of the appraisal, labeling it hearsay.
ii. After you figure out valuation you have to figure out debt. Here, there was
another lender in front of them(33mill) in line that can receive value of
catalogue. This claim and admin claims would be paid be paid before Ps claim,
so CH. 11 is actually in their best interest.
b. Notes- once there was an objecting creditor, burden was on proponent of proposed plan
(debtor) to show liquidation value of the company in order to determine how much the
creditor would get.
vii. Problem 32.1- D files Ch. 11, Owes your client 1 million on unsecured basis, proposing 50cents on dollar
unsecured creditors. . Afraid to losing them as customer if they liquidate. Other unsecureds owed 4
million, so plan could be adopted even if he dissents(no numerosity, amount). Theres also secured loan in
all of Cs equipment, undersecured by about 7.5 million.
1. VP- Payment of 7.5 raises flag. Could threaten voidable transfer to push bank towards your
position, to back it. Is there enough info to do voidable transfer analysis?
a. Theres transfer to creditor, in his benefit, on account of antecedent debt, during
preference period, and we presume insolvency. Last element is that creditor is better off
than in Ch. 7. To determine this, 10 million dollar loan is secured in Ds equipment, and
assuming 2.5mill liquidation value(we are given that amount).
i. w/transfer- get 7.5 million transfer in full and 2.5 million secured (100cents).
First aid gets 10 million.
ii. Without transfer- Since bank is undersecured, their claim is only 2.5 million +
7.5 deficiency paid in bankruptcy dollars. Payout will be (take unencumbered
assets and divide by GUC).
1. So 7.5 in money/assets they keep
2. Debt is 4 million owed to GUC + 7.5 owed to other unsecureds, plus 1
million to pany. = 12.5
3. Payout is 7.5million X7.5/12million (60%)
4. 2.5 x 7.5 at 60% (4.5) = 7 million. So they get 7 million as compared
to 10 million w/transfer.
iii. Theyre unfairly getting full payment, so voidable transfer. Could direct the DIP
to bring this up. Also, were getting lower payout here, so its not in our best
interest
Feasibility- problem doesnt go into too much details of plan, but could try.
2. Best interest. Raise its not in your best interest, threaten the bank to bring it up. Look at hypo Ch.
7 liquidation. Have valuation questions like whats real estate and the equipment worth in trying to
figure out liquidation value. Figure out companys position in payout to see how much they would
receive in Ch. 7.
3. Could try saying First Bank is acting in an inequitable way, and subordinate their claim
Classification and Voting- Every holder of a claim is allowed to vote.
a. The creditors must approve the Ch. 11 plan. Approval is done by class. A class is deemed to have
approved the plan if both of the following criteria are met: ( 1126(c))
i. Numerosity- > 50% or Majority of the number of creditors within the class approves. AND
ii. Value- 2/3 of the amount of debt (i.e., holders of 2/3 of the dollar amount of the debt) within the
class approves.
iii. Creditors accept by classes, not individually. Individual creditor is accepted by feasibility and
best interest test, but otherwise its in will of majority of each class that binds all. Eliminates
incentive to hold out.
b. The debtor has a great deal of flexibility in setting classes. This permits financial gerrymandering (
1122). Can create favorable majorities in each class.
i. Each creditor need only be substantially similar to other creditors within the class. 1122(a)
1. Cannot combine differently situated creditors in same class. Need to look sufficiently
alike.
2. Q- can you put similarly situated creditors into different classes? What makes them
similarly situated? 1129(b)(1)- for cramdown purposes.
a. There is no requirement that all similar claims be classed together. US Truck.
ii. A plan can (with court approval) create a de minimis class for holders of insignificant amounts of
unsecured debt for administrative convenience. 1122(b)
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iii. Any creditor doesnt count for either of the above tests if he did not accept/reject in good faith or
was solicited in bad faith. 1126(e).
iv. Can you classify class as unimpaired to neutralize objections? Are there limitations on claims
trading?
v. Each class has to approve the plan or not be impaired, 1129(a)(8), (unless there is a
cramdown, see infra).
c. In re US Truck: Local union P claims D is liable for rejecting a collective bargaining agreement between
them. After filing CH 11, D rejected the agrmnt w/ the approval of the judge, who found the rejection
absolutely necessary to save the debtor from collapse. New agreements have been negotiated to the
satisfaction of the other local union creditors, over the lone dissent of P. P claims the plan does not meet the
reqts of 1129(a)(10) in that at least one class of impaired claims accept the plan because D impermissibly
gerrymandered the classes in order to neutralize Ps dissenting vote. D created 2 classes, 1 composed of
remainder of labor units and other unsecure creditors (broader) and put P in UC. D wants at least one class
of impaired creditors to vote for the plan, making it eligible for cram down consideration by the court.
1. 2 ways to have plan confirmed-, need all event requirements of 1129(a) met, including
(a)8), which requires all impaired classes of claims or interest to accept plan.
a. Teamsters argue (a)(10) not met because of impermissible gerrymandering to
neutralize their vote.
2. OR Meet ALL the requirements of (a) except (a)(8), and meet the requirements of (b), the
cramdown. Permits reorganization plan to go into effect over objections of one or more
impaired classes.
4. Holding: When does code permit separation of claims that are similar in nature - Code
permits a debtor to keep a creditor out of a class of impaired claims which are of a similar legal
nature and are against the same property when the interests of the isolated creditor are
substantially dissimilar from those of the other creditors. Now you have impaired class that is
wiling to vote yes. And possibility of cramdown with Teamsters class who are voting no.
a. To allow P to vote with the other unimpaired creditors would be to allow it to prevent a
court from considering confirmation of a plan that a significant group of creditors with
similar interests have accepted. P is still protected by the prohibition on unfair
discrimination and the requirement that the plan be fair and equitable.
viii. In re Bernhard Steiner Pianos: In order to restore its reputation with consignment creditors (and improve
plans chance of success), the debtors CH 11 plan proposed to classify those creditors separately from other
unsecured creditors and repay them sooner, but 100% basis. Separated into consignment and standard
creditors. Plan approved by all impaired classes except 1 class.
1. Holding: Substantially similar claims should be put in same class, except when good business
reasons exist, the ct may allow separate classification of substantially similar creditors.
a. Consignment sales were integral to future success. Consigned pianos have been important
to D in past because of its local market. Needed to accelerate their payment to regain
trust, repair their image, and succeed in plan.
ix. Classification and Single Asset Case
x. Impairment- refers to whether a creditor class will be completely protected under the plan.
1. If a class is not impaired, there is no need to get the approval of that class. 1129(a)(8)(B).
a. Members of non-impaired classes are deemed to have accepted the plan. 1126(f)
2. If a class on claims is impaired under plan, at least one class of claims that is impaired under plan
has to accept plan. 1129(a)(10)
3. What is meant by impairment? Legal impairment? Economic impairment? Both? The issue is
fuzzy.
a. 1124(1)- provides that class is impaired unless the plan leaves unaltered the legal,
equitable, and contractual rights to which such claim entitles the holder of such claim.
b. Code desires to avoid valuation and favors focusing solely on legal impairment
c. TIGHTROPE- must offer favorable enough terms to attract a yet vote, but must impair
claims of the class in order for the class to have any voting rights.
4. Each member of an impaired class must either approve the plan or get the same amount as they
would in Ch. 7. 1129(a)(7)(A)(i).
a. Note code words: on the effective date of the plan means they must get the same
amount in present value terms as they would in Ch. 7.
5. PPI Enterprises: S, an unsecured creditor, tried to disapprove of Ps CH 11 plan. P had defaulted
on lease payments to S and 502(b)(6) limits damages in such a circumstance to unpaid rent. S
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tried to block the CH 11 plan but the ct ruled S was an unimpaired creditor b/c Ss claim was not
impaired under the claim.
a. plan here divided into 4 classes, which PPIE contended approval of was necessary
because none was impaired.
b. Holding: Under the Code, a claim is impaired unless the plan leaves unaltered the legal,
equitable and contractual rights to which the claim holder is entitled. Impairment results
from what the plan does, not the statute. A plan which leaves unaltered the legal rights of
a claimant is one which does not impair the creditor. HE was only entitled to what he is
now receiving.
i. Ss claim was limited by the 502(b)(6) and not the CH 11 plan. 502(b)(6) is
independent from the plan. 502(b)(6) limits recovery of a lessor.
c. Under 1124(1)- claim is impaired unless plan leaves unaltered the legal, equitable, and
contractual rights to which such claim entitles holder of such claim. S argued that broad
definition of claim required finding that impairment from statute or plan is impairment.
d. Other cases (Windsor) turned out differently.
b.
c.
Claims Trading
xi. Figter: A creditor bought 21 shares out of 34 unsecured class 3 claim (100 cents on dollar) so that there
would not be an impaired, consenting class of claims, thus preventing confirmation of the plan.
1. Holding: The Code provides that on request of a party in interest, and after notice and hearing, the
ct may designate any entity whose acceptance or rejection of a plan was not in good faith, or was
not solicited or procured in good faith or in accordance with the provisions of this Title. 1126e.
Because of this purchase, the plan became unconfirmable because plan couldnt meet
1129(a)(10) (no more impaired consenting class) and thus couldnt meet cramdown (and force
them to accept)
a. Here- C proposed alternate plan when it purchased class 3 claims, not for purpose of
blocking Ds plan while injuring others. They offered to purchase ALL class 3 claims.
Moreover, C was a lender, not a competitor to D, acted to protect its own interests as Ds
major creditor. Acted to protect its own selfish interest, and not with ulterior motive.
Didnt attempt to obtain some benefit to which it was not entitled.
i. C didnt like the plan because D wanted to convert to condos.
2. Voting- 1126 speaks in terms of number of claims, not number of creditors. Each claim arising out
of a different transaction, requiring different proof and evidence, is entitled to one vote for each.
xii. Northwest Airlines: A committee of equity security holders did not disclose the claims and interests of
each individual committee member, and NW said the disclosure was insufficient.
1. Holding: The claims the interest of individuals of a group/committee of equity security holders
must be disclosed, b/c the group represents the interests of
2. Bankruptcy rule 2019 mandates disclosure of amounts of claims of interest owned by members of
committee, the times when acquired, the amount paid therefore, and any sales or other disposition
thereof.
xiii. Problem 33.1
1. Feasbility probably not available, though in facts he claims its not likely to succeed. Best
interest might be an argument you can make, He thinks he gets in Ch. 7
2. Hes unable to block the plan on his own (no 2/3 debt or of creditors)
3. Could try to engage in claims trading buy all the small claims worth 300k total, but this still
wouldnt amount to 2/3 debt total debt of class.
a. Could try to argue or suggest that the small claims should be put in their own class.
4. Could try to argue that the claims of the two unsecured creditors are substantially similar, so may
not work if there is a good business reason to separate them, like here might be.
xiv. Summary- all claims within a class are supposed to be substantially similar and small creditors can be put
in their own class. Can put substantially similar creditors in different classes, If they have different interest,
or theres good business reason then its allowed. A class has to be impaired to vote. Issues 1) whether
claimant has been impaired by plan or by operation of other provision of code (PPIP), impaired by plan is
what matters. Third strategic element is claims trading, under 1126e, court can disregard vote made in bad
faith. Courts tend to allow purchase claims for reasonable self-interest, not malicious intent. Solicitation
disclosure, 1125, generally not problematic, but can be potentially powerful. Can revoke confirmation.
Have to show bad faith under safe harbor rule
Solicitation and Disclosure
a. 1125(b) says acceptance of a plan cannot be solicited unless adequate information is disclosed.
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b.
xv.
xvi.
xvii.
xviii.
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d.
after preferred. If the statement is silent about going after further actions, some
jurisdictions will say this is estoppel
2. Backlog- could argue backlog means there was not adequate information to confirm the plan
adequately. (1125(a)(1), that D didnt sufficiently give information. 250k not in disclosure
statement and we agreed to plan we wouldnt have otherwise. Check for bad faith/ good faithyou can try to prove D deliberately lied though, Court can revoke a plan procured by fraud. Check
if they KNEW order plan wasnt in the claim. Even if client relies, as long as its good faith its ok.
3. You could sue the company. Maybe try sec violation (if good faith safe harbor applies)
4. REVOKE CONFIRMATION UNDER 1144
Cramdown 1129(b)- Even if plan satisfied best interest test of 1129(a)(7) as to every nonaccepting creditor and
meets the test of feasibility, it must also be accepted by statutory majority of creditors in each impaired class under
1129(a)(8). IF any class rejects plan, then plan cannot be confirmed as consensual under 1129(a). BUT if plan
satisfied tests in 1129(b), it may be confirmed. Since creditors vote by class, and because a plan is consensual if all
classes accept the plan, sometimes a plan proponent will try to create multiple classes of creditors where dissenters
can be outvoted. To qualify for cramdown, plan must attract at least one consenting class of impaired creditors.
Without that consenting class, plan cannot be confirmed even by cramdown (1129(a)(10). But with it if debtor can
meet other requirements of 1129(b), D may confirm plan even over vigorous objects
a. If an impaired class rejects the plan, the debtors only hope of approval lies in the cramdown rules (which
permit avoiding the (a)(8) acceptance requirements). Still required to meet feasibility and BI tests
i. You need at least one approving, impaired creditor for a plan to be approved. 1129(a)(10).
Thus, a debtor will strive to create at least one consenting class.
ii. 1129b1- permits cramdown of rejecting class only if the plan does not discriminate unfairly
against rejecting class/ or among classes AND is fair and equitable.
1. 1129b2- sets minimum requirements for a plan to be found fair and equitable
iii. Generally: strategic work is done in fair and equitable req.
1. The secured creditors liens must be preserved by the plan, and the secured parties must
be paid the present value of their secured claims. ( 1129(b)(2)(A) must receive payment
of the full value of the collateral plus market interest rate.
2. Unsecured parties and other interest holders in addition to the best interest test of 1129(a)
(7). (i.e., equity) are subject to the Absolute Priority Rule; the objecting class gets
either: ( 1129(b)(2)(B)) If class votes against the plan it must be paid
a. The full value of its claim (in present value terms), or
b. Plan provide that No parties junior to it get any compensation at all.
i. Cannot be crammed down unless equity owners get nothing
c. Absolute priority rule- unless creditors waived their rights by voting for the
plan, the higher priority takers (unsecured creditors) must be paid in full before
lower priority takers (owners) get anything.
3. EX- imagine Sec votes yes, Priority Unsec says yes at 70%, GUCS get 3% and they
reject. As long as equity after them gets nothing, its still fair and equitable.
iv. The controversy: old owners often end up as new owners by putting up new capital postbankruptcy as new value. Sometimes they want to invest in company, maybe because they can
make idea work or get assets at a discount, nothing to lose. Is holding that interest violative of the
absolute priority rule? Problem is that they are now getting something, theirs violative of the
absolute priority rule. Is there a new value exception in cramdown?
1. Probably not for new monetary contributions. Bonner Mall Partnership.
2. No sweat equity is allowed. Ahlers.
b. Note that cramdown typically operates as leverage for the debtor.
c. Cramdown and secured parties
i. See supra, a secured creditor must get the present value of his secured claims one of the most
litigated issues is what interest rate to use when computing this.
ii. Another consideration: 1111(b) elections. An undersecured creditor can waive his unsecured
debt in exchange for full payment of the secured portion over time.
1. Oddly enough, the election is in 1111(b), but the requirement that the creditor be paid the
value of his claim is in 1129(b)(2)(A)(i)(II)
2. There are two tests in 1129(b)(2)(A): it must get the full amount of nominal dollars
owed it, and it must get the present value of its secured position. (Ex.: $100k loan
secured by $50k property; election means you must be paid $100k nominally at the end
of the plan and $50k in PV terms).
3. There are exceptions as to when the election can be used.
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d.
e.
Bank of America v 203 North Lasalle Street- 203 North LaSalle was a single-asset real estate case.
During the debtor's exclusive period to propose a plan of reorganization (known as the "exclusivity
period"), the debtor sought to confirm a Chapter 11 plan over the objection of dissenting junior creditors.
Under that plan, the old equity holders would have retained their interests in the real estate project
by contributing $20 million in tax liabilities that would otherwise have been due if the lender
foreclosed. The plan did not provide a mechanism for non-insiders to bid on the equity. Seemingly, this
case perfectly framed the issue of whether the new value exception was still valid.
i. - Pre-bankruptcy equity holders may not, over the objection of a senior class of
impaired creditors in a Chapter 11 plan, contribute new capital and receive ownership interests
in a reorganized entity, when the opportunity is given only to the old equity holders under a
plan adopted without consideration of alternatives. Rather, in order not to violate the absolute
priority rule, a plan conferring an interest to old equity must extend an opportunity to others who
may compete for the equity (e.g. at auction) or who may propose a competing reorganization plan.
ii. Cram down is barred if a junior interest (old equity) holder under a proposed Chapter 11 plan
receives or retains property on account of such junior interest. 11 U.S.C. 1129(b)(2)(B).
Therefore, the absolute priority rule is triggered by a causal relationship between holding the prior
claim or interest and receiving or retaining property. The Court neither decided whether the statute
included a new value exception, nor decided whether the exception exists at all.
iii. Decision is not very broad. Basically new value exception doesnt apply when offer was made
exclusively to old equity.
e. What happens to old equity in case of publicly held company, when company goes to ch 11, old stock
certificates are cancelled. Sometimes certificates get sent back. Sometimes its not certificates. Stock is
right to receive profits/ vote, no longer receiving dividends, no longer get voting rights and value of stock
drops to zero.
f. Problem 35.1- - Is there an impaired accepting class if unsecureds are not longer accepting. Is Bank
impaired if they are getting paid in full, no. No Impaired class here. NEED an impaired class to force
cramdown. If bank agrees to less than full payment?
g. We filed for ch 11, dealt with auto stay and lift stay litigation. Figured out financing (cash collateral issues)
deal with management, negotiated and confirmed the plan. Theres potential twist in ch 11, like dealing
with special claimants and ethics in Ch 11
Special Claimant- most creditors are individuals that engaged voluntarily with debtor. In interaction had some
element of control, had some sense of parameters of potential loss. Special claimants like tort claimants or
environmental agencies, interact with debtor in different way. Congress hasnt granted them any priority payment in
code. One key question is whether claimants should be prepetition or post petition creditor. Pre petition claims will
be dealt with and discharged. Bankruptcy code estimates any contingent or liquidated claims to deal with them. Post
petition claims continue and can be brought against a more solvent debtor. Dynamic here is that there will be a fight
as to characterize the claim. Debtor will say its pre petition so discharge, Creditor will say its post petition
a. Questions- They special types usually didnt have the opportunity to negotiate. Code doesnt have priority
payment for them. How do courts deal with and balance ongoing claims and are their claims labeled post or
pre petition?
i.
Judge can estimate liabilities under 502(c)
ii.
Environmental Claims- depending on test of circuit, these dates will mattera. When contamination happened, when cleanup obligation emerged, how long obligation
continued?
b. Theres issue of principally responsible parties that arises owners will share obligations under
federal law. PRPS will be asked to pay claims PRP will says not pre- petition, its post, so
agency go after debtor.
5. Remediation costs incurred post-petition are generally priority admin expenses.
6. Signature Combs: SC sought to recover CERCLA claims from MD but MD claims the debt was
discharged in bankruptcy.
a. Key Bankruptcy issue- was it discharged in bankruptcy and did that contingent cercla
claim arise prior to MDL bankruptcy? MDL will say yes SC will say it arose After
bankruptcy
b. Holding: A CERCLE claim may be discharged if it is based on pre-petition conduct that
could fairly be contemplated at the time of the bankruptcy.
i. Cts have developed 4 tests to determine dischargeability:
1. Right to payment approach: for pre petition claim to arise. Latest
possible for time. Ds liability discharged only if all 4 cercla elements
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exist prior to bankruptcy. This gives creditor lots of power, they can
just wait and wait.
2. Underlying Act approach- pre bankruptcy claim subject to Codes
discharge provisions exists so long as underlying polluting act occurred
prior to Ds bankruptcy earliest. D will press for this. Unfair to
Creditors because D will go bankruptcy proceedings and be discharged
before creditor even knows of Ds involvement.
3. Debtor-Creditor Standard- Cercla liability if C and D began
relationship before D filed for bankruptcy. defined too broadly, can be
manipulated
4. Fair Contemplation approach: When potential Cercla claimant at
time of Bankruptcy could have ascertained through exercise of
reasonable diligence that it had a claim against D. Its a nice balance
between accommodating fresh start goal of bankruptcy and speedy
cleanup and polluter accountability
ii. Here- nothing in complain or MDLs bankruptcy reorganization order suggest
that EPA contemplated or had reason to foresee MDLs potential liability to the
EPA for the sites. Court cannot conclude that EPA had a contingent claim against
MDL at time MDL discharged its claims in bankruptcy reorganization
iii. Therefore, SC is happy because MDL is liable.
xix. Problem 38.1- - if file ch 11, are you likely to have confirmable plan. EPA will be happy. You will have
one unhappy class voting no so you might have to have cramdown.
1. Reqs -Best interest- payout is at least as good as ch 7.
a. Here ch 7 payout is- whenever you hear overleveraged, means assets not sufficient to
sustain liabilities. Prob means ch 7 pay out will not be great because even secured
claimants wont get paid as much.
b. Feasibilityc. Cramdown- equity owner here is kim. Possible EPA might say if im not getting anything
you cant keep the farm either. (new value)
2. What can you do to make sure will be dischargeable in bankruptcy?
a. Maybe you dont want to file bankruptcy now. Let EPA clean up and send bill, and then
you can find out whether its pre or post. Make sure no pollutants happens now though,
any post petition thing where you make things worse.
b. Kim can also be presented with PRP bill as well.
3. 38.2 working as congressional aid and theres proposal for bill that creates lien for cleanup cost.
This kind of lien will give priority over all kinds of lien even mortgage liens.
a. Whats proper policy and who should bear burden. Whos best positioned to bear burden?
b. If youre against bill EPA, taxpayers will pay the bill. Maybe mortgage lenders.
c. Key questions with environmental is it pre or post petition?
iii.
Mass Torts- Difficult to deal with mass torts claims because not everyone has been harmed yet, dont
know who the future claimants will be.
4. The use of bankruptcy for mass tort cases can help solve the problem of later claimants i.e.,
prevent early claimants from killing company before later claimants can collect. Court will have to
think about how to balance debtors need for certainty (if reorganized debtor ever wants to find
future financing) against future claimants need for compensation; and also the deterrent effect that
a tort is supposed to have. This is case when present claimant is getting pay out, so who will
represent future claimants.
5. Kane v John-Mansville- lawfulness of Manville (D) reorganization. Kane represents 765
claimants with asbestos related diseases who filed suits before Ch 11. No standing to fight for
future claimants, not inextricably woven to his claim.
a. Plan- Creates trust for future claimants. They try to reach out to everyone by media
campaigns.Here their standing is the issue. Injunction issue must test injunction now
because he said it affects his ability to get paid, but court denies this.
b. Outcome 524g is asbestos specific.
6. What if company is falling apart and new investors only want to deal with company, not with past
litigation
a. Fairchild aircraft- going to ch 7 and selling off company to pay off debtors. Another
group said they would help reorganize and pay off planes but didnt want any liability as
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7.
to the planes made before. TIB was ok with it because it would give all parties involved a
much better result (everyone keeps their job due to reorganization).
b. Did that ch 11 cleanse company or are these present suits still potentially bankruptcy
claims? Court goes into definition of a claim
i. Conduct test- claim had to arise based on claim before. Debtor would want this
because its broad. More likely that its something that should have been
discharged
ii. Relationship test had to be an identifiable relationship with D pre petition
Court adopts this.
iii. Process- court says a claim must not violate due process. There has to be some
relationship and some fair process that would make it dischargeable. Court
suggest some elements of process that might be acceptable.
Problem 38.3 can you guarantee there wont be any liability? Look at Fairchild, you gotta
have a future claims representative. Get all info and where everythin was sold. Set up a
reasonable trust fund to deal with future compensation.
a. Now can you guarantee there wont be any successor liability? No guarantee, look at
cases, look at where you can be potentially sued. Try to gauge possibility that you will be
sued.
b. Some courts say you cant have DP for people that dont exist, others say they do exist .
c. Outside bankruptcy, get insurance.
d. 363 sales- you can sometimes sell assets free and clear of liability. But If you by enough
then theres still likely to be liability (more about individual asset sales and not entire
company
i.
G. Ethical Issues
a. 327(a) TIBs counsel must be a disinterested person and be approved by the court.
b. 328(a), 329(b), 330(a) fees must be approved by the court for the TIB, the debtors counsel, and other
professionals employed by the TIB.
c. The Trojan Horse
i. If you represent a single-shareholder company, there is a potential conflict waiting to happen. If you
represent the company, then you have a possible conflict with the owner, and vice-versa.
ii. This is because there is a possible monetary conflict, at least in theory. The company wants to survive
bankruptcy; the owner (theoretically) wants to get paid as much as possible under the plan.
iii. This is also because the TIB controls attorney-client privilege, see infra.
d. Important points on conflicts
i. Disclosure is vital even if a possible conflict seems unimportant, you must disclose it to the court. You
may still be removed later, but you wont be subject to sanction.
ii. All compensation must be approved for the debtors attorney.
iii. When talking to employees, etc. you need to make it explicitly clear that you dont represent them, and that
they may need their own lawyers. This is doubly true for conversations with directors and officers.
e. Privileges
i. The TIB controls the attorney-client privilege.
ii. JW thinks this is wrong, because bankruptcy is about property, not people (including corporations).
1. Counter: a corporation is nothing but property.
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