Bankruptcy Code
I.
Consumer Bankruptcy
a. Introduction to Bankruptcy
b. Elements Common to Consumer Bankruptcy
i. The Estate – All the legal or equitable property that the debtor
owns and has a right to at the time of filing (regardless of its
apparent value at the time).
1. §541 interest
2. §541(c)(1) brings into the estate property with restrictions
on transfers and does not remove those restrictions.
3. §101 – “Claim”
a. Unliquidated claim has no number assigned to it
b. Contingent claim/expectancy where creditor can’t
pursue until and unless some event occurs. These
are property of the estate only if, at the time of
filing, the debtor has some legally enforceable right
to the property.
c. Matured claim – debt that has already come due.
4. §542 – property of the estate must be returned to the estate
a. If you’re holding some guy’s car or something, you
have to give it back or else give back the money
you got for selling it.
5. §341 meeting – the trustee presides over a meeting with the
debtor. Creditors may attend but aren’t required to do so.
ii. The Automatic Stay – to prevent any interference with the debtor’s
proper enjoyment of his property, and ensures that all creditors are
paid equitably.
1. §362(a) – what is stayed
a. Actions to collect or enforce all kinds of things
2. §362(b) – what is not stayed
a. Criminal actions
b. Paternity, child support, etc.
3. §362(h) – willful violation can give damages, costs, fees,
and possibly punitive damages. Applies only to an
individual, not a corporation.
4. §362(c)(2) – the stay lasts until the case is closed,
dismissed, or discharged
5. Relief from the stay - §362(d): requires notice and a
hearing.
a. For cause, including adequate protection (see also
§361); or
i. Creditors must be protected from the
depreciation that property has over time. If
they don’t receive this amount, the stay will
be lifted.
ii. Adequate protection: (periodic) cash
payments, additional lien, other relief to
preserve the “indubitable equivalent” of the
creditors’ claim.
iii. Lack of insurance is one kind of inadequate
protection.
b. If debtor has no equity and it’s not necessary for
reorganization
i. The property cannot be necessary for an
effective reorganization.
iii. The Trustee
1. §701, §702 appointment of trustee
c. Liquidation Bankruptcy
i. Exemptions – why use FMV instead of liquidation? – Because the
debtor would have to buy a new one.
a. §522(d) – all the federal exemptions. State law may
provide its own list of exemptions under an “opt
out” provision.
i. First, the secured creditor gets paid off in
full. The exemption is subtracted from any
equity. The balance goes to the estate.
ii. The debtor gets to keep clothing and
household goods etc. sufficient to make a
fresh start, but not luxury items
1. In re Mitchell – debtor with a giant
diamond ring must declare fair
market value, not liquidation value.
2. In re Johnson – doctor put a bunch of
money in a pension plan.
iii. Homestead exemption states may protect
prebankruptcy planning
1. In re Reed
2. In re Coplan – not allowed to claim
homestead exemption to a greater
extent than they would have at home
in Florida. However, if they would
have fought it out with the creditors
in Florida state court they would still
have their house because Florida is
religious about the exemption.
3. In re Hanson – son gave parents fair
market value for some equipment but
“stored” equipment at their house.
Held: not fraudulent.
b. Rule 4003 says the trustee has 30 days to object,
and if he doesn’t, the debtor gets the claimed
exemption even if the debtor isn’t really entitled to
it.
i. Taylor v. Freeland & Kronz: TWA
discrimination claim was property of debtor,
not estate, because trustee failed to make
timely objection.
c. §542 says that if you have property of the estate you
must turn it over to the trustee. Just because the
debtor prevails in an exemption, that doesn’t mean
that the debtor doesn’t have to turn it over. It just
means that the trustee is barred from questioning the
value. The trustee still gets the car, sells it (for the
real value) and the debtor gets the amount of the
exemption.
d. Liens and Exemptions
i. Consensual liens trump exemptions. Take
these out before determining exemptions.
Wouldn’t you take out any lien before the
exemption, even involuntary? No. Only
voluntary ones. This means exemptions
come before taxes.
ii. Now, what if there is a $1000 judgment on
what would have been left after the sale of
the car and the payment of the voluntary
secured interest. Then you’ve got the
involuntary secured interest (also a lien). So
all you have left is zero, and the debtor gets
no exemption.
iii. §522(f) says a debtor can avoid a judicial
lien (but not one for child support) or a lien
for household things if it impairs an
exemption.
ii. Claims and Distributions §502 – Where is this in the code? At
filing, creditors file a proof of claim under §501. The trustee
reviews all of these documents and objects to invalid claims.
Claims against the estate (other than administrative expenses under
§503) can only be measured at the date of filing. Post petition
claims are against the debtor personally.
1. Secured claims – receive the full amount of claim up to the
value of collateral, off the top. (100 cents on the dollar).
a. Undersecured - §506(a) says that if you’re the
holder of a secured claim, you’re secured up to the
dollar amount of the collateral. If you’re
undersecured, you are only guaranteed to get the
value of the property and the rest is unsecured.
i. These are valued at the date of filing, in
dollars.
ii. If there’s no equity in the house, for
example, the estate will abandon it back to
the debtor. Then the bank will try to have
the stay lifted, and will foreclose to get their
money.
b. Fully Secured/Oversecured - §506(b) says that if the
property is worth more than the claim, the creditor
can get all the fees and costs associated with the
claim up to the amount of the value of the property,
but only as stipulated in the security agreement.
i. §506(c) - Expenses to “preserve or dispose
of the property” for the benefit of the estate,
taken before §506(b)..
c. IRS claims are entitled to post petition interest.
“Such claim” means any secured claim.
2. Unsecured claims – receive a pro-rated share of the estate
depending on the percentage of the debt owed each
creditor.
a. §502 says entitled to interest up to the date of
petition but not post-petition interest.
b. These cannot include unmatured interest on a loan,
though bankruptcy does accelerate principal.
iii. Priority of claims in Liquidation
1. Secured claims – Only secured creditors get interest, under
§506(b) (up to the value of the collateral).
2. §726(b) – burial expenses for converting to chapter 7 case.
3. Super Duper Unsecured §364(c)(1) – A loan made to the
debtor post-petition where the debtor needs extra loans.
Can only be authorized by the court. Very few Chapter 11
lenders have this.
4. Super Unsecured §507(b) – The court awarded the creditor
adequate protection, but the debtor failed to pay or
otherwise failed so the creditor is left unsecured. This is
higher than any other §507 priority.
5. “Priority” Managing the estate §507(a)/§503(b) –
administrative claims to preserve the value of the estate.
6. Post-petition unsecured claims under §507(a).
7. Pre-petition unsecured claims – these are of the lowest
priority.
iv. Discharge §523 – Creditors retain in rem remedies, but in
personam debts are discharged.
1. §524(a)(2) says you can’t try to collect on a discharged
debt.
2. §523 – Exceptions to discharge - This is for making
particular kinds of claims survive bankruptcy: child
support, student loans (except under undue hardship), loans
fraudulently procured, luxury items, etc.
a. Taxes Not dischargeable §523(a)(1) – Taxes are not
generally dischargeable in Chapter 7, but some of
them can be discharged in Chapter 13.
i. §507(a)(2) – Unsecured claims from
§502(f), which would include property tax,
etc. arising early in the case in the ordinary
course of business (between filing and either
appointment of trustee or order for relief)
ii. §507(a)(8) – Unsecured tax claims on
1. (A)(i)Business taxes for the last three
years.
2. (A)(ii) Property tax assessed within
the last 240 days etc.
3. (B) Property tax due less than a year
before filing.
4. (C) Social security withholding (no
time limit on this)
5. (D) Employment taxes in the last
three years
6. Various other things like excise tax
and customs duty.
iii. §523(a)(1)(B)(ii) Late tax return within two
years of filing petition is not dischargeable.
iv. If the debtor has made a fraudulent return
b. Taxes dischargeable
i. Discharge under 1328(b) may give a debtor
a hardship discharge.
c. “Undue hardship” is usually for a medical disability
that impedes one’s earning capacity. The question is
really whether you are living at a reasonable level,
or what the loan was for…
d. §523(a)(2) – Fraudulently getting and/or using a
credit card.
i. (a)(2)(B) – Lying to get the card
ii. (a)(2)(A) – Lying to use the card
iii. (a)(2)(C) – When you use the card for
luxury purposes within 60 days of filing,
where you’re extending credit.
3. §727 – Certain things can stop your discharge under
Chapter 7 (these do not apply to other chapters). These may
include false claims, concealing evidence of the financial
condition, not a partnership, concealing property within a
year of filing…
a. Plaintiff in a §727 case can be trustee, creditor, or
U.S. trustee. Plaintiff has burden of proof by
preponderance of evidence.
b. If a creditor prevails against a §727 discharge, none
of the debtor’s claims will be discharged. The
debtor loses all possessions except for exemptions,
but still owes everyone the same balance.
v. Reaffirmation and Redemption - §521 describes the debtor’s duties
to redeem or reaffirm property (must declare intention within 30
days of filing, and perform within 45 days thereafter).
1. Redemption – §722 Debtor pays the market value, as
determined under §722, in one lump sum (not installments).
This is for low-value property abandoned by the estate that
the creditor really isn’t interested in trying to re-sell. (I pay
$50 and get to keep my washing machine.)
a. The value is subject to “cramming down”. Often
used for cars, the collateral may have no equity and
a debt much greater than the FMV of the car. So the
car is abandoned by the estate, and the creditor is
just going to sell it anyway, so debtor gives creditor
the FMV of the car and they receive the benefit of
not having to pay to sell it.
i. Associates Commercial v. Rash
b. If debtor has already been paying on the note, the
debtor does not get credit for the previously made
payments, because these just go toward the
unsecured part of the claim.
c. Debtor may pay off the estate by giving the trustee
the equity.
2. Reaffirmation – §524(c) Debtor commits to repaying the
debt. Creditor sends debtor a letter, and after debtor signs,
creditor files it with the court.
a. In re Latanowich – Sears made a pattern of
violating the procedure, and was slapped with
punitive damages.
b. Mailing of a solicitation is not a violation of the
stay, because there’s supposed to be bargaining
about terms (amounts and dates of payments).
c. Debtor’s lawyer must sign a declaration that he’s
been informed about everything and that he knows
he has 60 days to change his mind. Lawyers often
refuse to sign if the debtor has kids, for example.
d. If debtor is pro se, there has to be a hearing to
determine whether the agreement is fair.
e. A debtor can bargain away the discharge of a debt
in exchange for new credit, but Schermer doesn’t do
it because it’s often not a good benefit for the debtor
and you can still always repay voluntarily.
f. The bank can make you reaffirm your unsecured
debt as a condition of renegotiating your mortgage.
Judges might or might not allow this, and might
suggest conversion to Chapter 13.
3. Surrender of the collateral – Once you surrender your
house, you owe the bank nothing. §524 says that after you
get a discharge, the bank can’t sue you for the deficiency
even if you owe more than the house was worth. The bank
has to proceed in rem against the house under §362 (for
cause, no equity, and not necessary for reorganization).
4. Retention/“Ride through” Continue to make payments –
This option is not found in §521, but at least 3 circuits say
if you’re current you can continue to make payments.
Estate must have abandoned the property as exempt or for
lack of equity. This lacks the consequences of
reaffirmation, because personal obligations are discharged.
However, the property can be repossessed.
vi. Non-discrimination - §525
1. §525(a) says the government can’t discriminate.
2. §525(b) says private employers can’t refuse to hire you
3. §525(c) says you can’t discriminate in student loan
guarantees.
d. Chapter 13 – Debtor keeps assets, and works out a payment plan.
i. Events of Chapter 13
1. Creation of the Estate – still as in §541, including all
property at filing.
a. §1306(a)(2) says that the estate also includes future
earnings.
b. §1306(b) Debtor retains property even for which
there are secured creditors.
c. §1327(b) After the creation of the estate and
confirmation of the plan, property vests back in
debtor, removing possibility of an Automatic Stay
violation.
i. 3 months after plan is confirmed, you
borrow $300 and fail to pay it back. The
creditor can get a judgment against you. No
violation.
ii. You have unpaid parking tickets and plan
confirmed to pay them. You get more
tickets. The city tows your car. Violation.
d. Conflict between §1327 and §1306 – A post petition
creditor can sue the debtor and execute a judgment
against any property not devoted to the plan. This
does not interfere with “vesting”.
2. Automatic Stay – §362(a)(3) Adequate protection is an
issue only from filing to confirmation of the plan, because
after plan confirmation creditors are protected by the plan.
a. The stay does not apply to postpetition earnings.
b. §1301 provides a stay against co-debtors. These
would be a family member that co-signed on a loan
but is not in bankruptcy.
c. In re Radden – Creditor had possession of the car
and wanted to lift the stay under §362(d)(2). But the
judge refused to lift the stay if the debtor made
payments and kept insurance. The court found no
equity in the car and said it was necessary for
effective reorganization.
3. Appointment of Trustee
4. Confirmation of the Plan – §1325 Only the debtor can
author a Chapter 13 plan. It must provide adequate creditor
protection.
a. §1322 says a plan can last not less than three years
but no longer than five years.
5. Broad discharge – §1328
a. A chapter 13 discharge gets rid of all nonpriority
unsecured claims. It’s broader than a chapter 7
discharge because you’ve paid for 3-5 years.
b. Anything where the last payment is due after the
plan is over you don’t get a complete discharge
from (like a mortgage).
c. You do get a discharge from §523(a) 2, 4, 6, which
is fraud and not dischargeable in chapter 7.
d. Now a Chapter 13 discharge does not exempt you
from fines imposed due to conviction of a crime.
e. If you die, you can get a hardship discharge.
ii. Plan Elements – Secured Creditors, Home Mortgage
1. Lien Retention §1325(a)(5)(B) – Not only can the bank get
its present value of the money, and also gets to keep the
lien against the property.
2. Value – the value of the property for chapter 13 is
replacement value, not wholesale value.
a. Associates Commercial Corp v. Rash – The
Supreme Court says that valuation of secured
property should be value to the debtor, so
something close to retail.
b. Cramming down -
3. Interest – Over the course of the plan, debtor must pay back
the principal plus interest, commensurate with the value of
the money as well as the risk involved in lending to an
insolvent person.
a. To compute interest, look at market rate for T-Bills,
notes, and Bonds that will mature around the same
time. This rate is for a risk-free loan, so increase
that rate by the risk.
b. ARM – Adjustable Rate Mortgage, whereby the rate
on the mortgage starts out low and changes yearly.
4. Modifications of claims – §1325(b)(2) Debtor can modify
obligations of a secured claimholder except for if the claim
is secured only by the debtor’s primary residence.
5. Home Mortgage – §1322(b)(5) While debtor can’t modify
the mortgage, the bank must let the debtor spread out the
arrearage over a reasonable time (usually the duration of
the plan). But you also have to make the payments that are
due.
a. In re Taddeo – You can de-accelerate in Chapter 13
if you continue to make payments and cure the
arrearage in a reasonable amount of time. (Here, the
lender had tried to make the whole thing due so the
debtors filed bankruptcy to get the stay to protect
them.)
b. §1322(c)(1) – Debtor can file in Chapter 13 up to
the point that the house is sold in foreclosure. Even
if there is a judgment for the sale, and it hasn’t
taken place, you can still file.
c. 1322 (c)(2), if your mortgage comes due during the
term of the plan, you can pay it off by the last day
of the plan as long as you afford it 1325 rights: lien
retention and present value (which you might do
this through refinancing).
d. Value of the house – The Supreme Court has said
you can’t bifurcate a claim for the principle
residence. So even though §506 would say that, it’s
overridden in this circumstance by §1322(b)(5).
i. In re Taddeo
e. §506 determines whether the debtor must pay
interest on the back mortgage payments
i. Oversecured - §506(b) gives interest through
confirmation, and also interest on the
arrearage and value for duration of the plan.
§1325(a)(5)(B)(ii).
ii. Undersecured
iii. Plan Elements – Unsecured Creditors, Disposable Income
1. Best Interest of Creditors Test - §1325(a)(4) The standard
for what must come out of a Chapter 13 case is what would
have been paid out in a Chapter 7 case.
a. Do a hypothetical liquidation to find out what
percentage the unsecured nonpriority claims would
get.
2. §1325(b) Unsecured Creditors receive a pro-rated share of
the debtor’s disposable income.
3. §1325(b)(1)(A) If a trustee or unsecured creditor objects to
the treatment of a claim, the court may not approve the plan
unless
a. The value of the property is not less than the
amount of the claim or the plan provides that all
disposable income will be devoted to the plan.
b. Disposable income – total income minus necessary
expenses of debtor and dependents.
c. Cushion – the lesser of $200 or 10% of the gross
income. Schermer encourages this for debtors with
kids.
4. Special cases of Disposable Income
a. Married couples - §302 permits a joint case if both
members are married at the time they file. You
count the other spouse’s disposable income in the
bankruptcy of one spouse because the income will
be distributed between them.
b. Donations to Church - §548 says you must get
value. However, §1325(b)(2)(A) now says you can
give to your church as long as it’s not more than
15% (or your pre-petition custom?).
c. Private school – private high school is not a
necessary expense. Go to public school. But you
can finance college other ways.
d. Fancy car – switch to a smaller car so you can pay
more to your unsecured creditors.
e. Extra cash sources – “reasonably” certain cash flow.
f. Retirement plan – It has to go to the “best interest”
test. If you’re less than 10 years from retirement,
Schermer lets you contribute. Otherwise, if you
aren’t paying your creditors you can’t put away
money for yourself.
5. Zero Percent Plan – Unsecured nonpriority claims get
nothing. But unsecured priority claims must be paid in full.
a. Attorneys fees are priority under §507(a)(1), as
allowed in §503(b)(1)(A). Also, court costs can be
paid in installments.
iv. Plan Elements – Taxes, Modification, Dismissal
1. Conversion from Chapter 7 to Chapter 13 –
a. §707 If filing a Chapter 7 is a “substantial abuse”
the debtor has a week to prepare a Chapter 13 case
or else the Chapter 7 case will be dismissed.
However, the Chapter 7 case will not be
involuntarily converted to Chapter 13.
b. You can keep luxury goods in Chapter 13 if you pay
100% plus interest to creditors.
c. In re Strauss – Debtor can’t clear out dischargeable
debt in Chapter 7 and then pay nondischargeable
debts in Chapter 13.
2. Taxes
a. §1325 (tests for plan confirmation) – If you haven’t
filed tax returns, you may fail on good faith or
equivalence to Chapter 7.
b. Secured Tax Claims
i. In re Baker – Debtor can’t choose to pay
secured tax claims first in order to keep
property. However, if you file Chapter 13
before the lien is filed, interest stops. You
can thus prevent interest and penalties.
ii. Voluntary? – Being in Chapter 13 is not
voluntary for tax purposes; therefore
debtor’s can’t choose to apply payments to
nondischargeable debt first. Rather, IRS
makes its own choices about plan allocation
to the oldest liability first (not necessarily
secured).
c. Priority Unsecured Tax Claims
i. §507(a)(8)(A)(i) – Taxes can be priority if
less than three years overdue.
ii. Interest on taxes
d. Nonpriority Unsecured Tax Claims
i. In re Zieg – Fraudulent or evasive failure to
pay taxes is not entitled to priority under
Chapter 13 even though it is in Chapter 7.
So you can have them discharged.
3. Good Faith – §1325(a)(3) based on a “totality of
circumstances,” not just whether a debtor is trying to avoid
the consequences of chapter 7.
a. University Professor files chapter 13. Claimant
alleged sexual harassment, and he filed 13 right
after she filed her suit.
b. Congress has made no rule to say that if something
can’t get discharged in 7 then it can’t in 13, so in
some cases, you can take advantage of 13’s broader
discharge.
4. Discrimination between classes of nonpriority claims –
1322(b)(1) You can choose to pay one nonpriority claim
over another as long as you don’t discriminate unfairly.
a. Look at §1122 for classification of claims – classes
of claims must be “substantially similar”.
i. Does the discrimination have a reasonable
basis?
ii. Can debtor carry out the plan without
discrimination?
iii. Is discrimination proposed in good faith?
iv. What kind of treatment is proposed to the
class discriminated against?
b. Nonpriority claims need not be paid in full. They
just have to get at least as much as they would have
in Chapter 7.
c. Dischargeability is an unfair criterion for purposes
of this analysis (Can’t put all your money to paying
off student loans which can’t get discharged and
then have all your other debts discharged at the
end).
d. If there’s a co-debtor, then you can discriminate on
that claim.
5. Dismissal - §1307 Trustee or “party in interest” can have
the case dismissed “for cause”.
a. Example – Debtor had filed 5 times and failed to
file a plan each time. On the day after it was due,
trustee filed for dismissal and introduced evidence
of the five filings. Debtor admitted he was just
trying to stop the city from condemning his
property. The code allows dismissal for cause.
b. §109(g) – can’t file for 180 days after dismissal if
there was a willful misuse of the system.
c. Courts can always impose costs or sanctions.
v. Threshold Eligibility - §109(e)
1. Must be a “natural person” to file Chapter 13
2. Regular income – can be a gift from a friend or some
irregular source, if it’s a sure thing.
3. Monetary limits of debt: $269,250 in unsecured and
$807,750 secured.
4. Contingent claims – Contingent debt imparts no liability to
the threshold unless the condition precedent occurs. If the
amount of a liability is readily determinable then the claim
is liquidated (or if a simple hearing is all that is necessary
to determine the amount).
II.
vi. Consumer Bankruptcy System – policy reasons for not letting
people off the hook, etc.
1. Code sections: §109(e),
2. §1325(a)(3) – Good faith requirement. If the debtor moves
to Florida with a debt not dischargeable in 7, and arranges
for creditors to get 0.01%. This could result in their plan
not getting confirmed, or a refusal to grant a discharge.
3. §1328(a), §707,§330.
Business Bankruptcy
a. Chapter 7 Liquidation
i. Involuntary business bankruptcy – Debtor is trying to defeat
security interest, or is paying creditors preferentially, or is
dissipating the assets.
1. §303(b)(1) criteria – the test to file a petition
a. If 12 or more creditors, you need at least 3 entities
and a total unsecured debt greater than $10,775.
b. If 11 or fewer creditors, you need just one special
creditor (can’t be employee or insider). Still must
owe $10,775 unsecured.
c. For counting creditors, use creditors whose claims
have not yet come due as well as those who are
already overdue.
2. §303(h) must be satisfied as well, to succeed in the claim:
a. Debtor is not paying debts as they come due.
i. Equity Insolvency – debtor can’t pay debts
as they come due.
ii. Accounting Insolvency – you owe money on
the books, but have incoming cash all the
time which you use to pay current bills.
b. A custodian other than a trustee has taken control of
the property.
c. For determining insolvency, exclude those creditors
whose debts are not yet due, including due to
dispute about the claim.
i. In re Silverman – Creditor fails to check
debtor’s credit report to find out if his credit
is good. Holder of a disputed claim dies bit
gave standing to file involuntary bankruptcy
petition.
3. §303(a) – It only takes one partner of a partnership to file
an involuntary bankruptcy petition.
4. In re Gibraltor Amusements
ii. Creditors’ rights –
1. §303(g) ask for a trustee to protect the estate (debtor can, in
the alternative, file a bond).
2. Relief from stay - §362(d)(1-3). – debtor cannot waive right
to automatic stay, because it’s a protection for the other
creditors, not really for the debtor.
a. This might be enforcible if there really were no
creditors, or if there was consideration.
iii. Debtors’ protection –
1. §303(e) Court can make the petitioner (creditor) file a bond
to protect the debtor from frivoulous cases.
2. §362(a) – The stay comes into effect at the filing of the
involuntary bankruptcy.
iv. Gap period – between filing to the date the petition is entered.
1. §502(f) – Claims arising in the gap are treated as prepetition (there’s a stay, but no trustee). But they have a high
priority under §507 because we want people to give credit
to the debtor until the court makes its findings. (they’re
second in line to administrative expenses)
2. Gap claims an also be (unsuccessfully) attempted at
§503(b).
3. §549 – payment for prepetition goods is avoidable, so
creditor has to give it back to the bankruptcy estate.
b. Chapter 11 Reorganization – rehabilitation of businesses
i. Events of Chapter 11
1. Debtor becomes Debtor in Possession (DIP) - §1107 DIP
has all obligations and powers of trustee, but without
compensation.
2. Appointment of a Trustee – §1104 A trustee is appointed
only if there has been “gross mismanagement” or if it’s “in
the interest of the creditors”.
a. Creditor must show “clear and convincing”
evidence that the trustee is necessary.
b. Debtor has the right to make the plan within the first
120 days, but if a trustee is appointed in that time
period, that right is terminated.
c. Trustee runs the company and files any avoiding
actions that need to be filed.
3. Appointment of an Examiner – third option, the guy that
“examines” the financial affairs of the debtor.
a. Examiner looks at pre-petition transactions of
debtor.
i. Sharon Steel case – prepetition asset
transfers.
b. Examiner also proposes a repayment plan.
c. Might look over a leveraged buyout.
d. Eastern Airlines – Frank Lorenzo was selling the
airplanes of Eastern Airlines to his other airline that
wasn’t in bankruptcy. An examiner would also look
at this transaction.
e. Examiner would mediate disputes between debtor
and creditor to facilitate negotiations (including
labor negotiations).
f. Examiner cannot later become a trustee.
4. Continue to operate the business – DIP continues to
manage the business, and perhaps pays a stay bonus to the
management team.
a. This might not be approved by a court on its own,
but if the creditors agree, it would be allowed.
i. Geneva Steel – Severance and bonus stay
package.
b. Stay bonus would be a priority claim because it’s
post-petition.
ii. Operating in Chapter 11 (Cash)
1. §364(a) Debtor can incur unsecured debt in the ordinary
course of business without court approval, and if debtor
doesn’t pay, the claim receives high priority under
§507(a)(1).
2. §363(b)(1) Cash collateral is frequently placed off limits
and debtor must get court approval to use cash reserves that
are outside the ordinary course of business.
a.
3. Lock Box – The merchant from whom debtor brought the
property has given a lien on its inventory and accounts
receivable.
4. §552 When a debtor acquires property post-petition, prepetition liens can’t get at it. However, if that property was
acquired with the proceeds from pre-petition property
which had liens against it, then the liens may still exist.
5. Setoff §553 (not a new right, but a preservation of a state
right)
a. To set off claims, there are two requirements:
i. Both sums of money must be pre-petition
(amount owed by debtor and amount owed
to debtor must both have been pre-petition).
ii. Mutuality – debts must be in the same right
and between the same parties (not between
someone acting as an agent for someone else
and in a personal capacity).
b. §506(d) If you have a setoff right, you’re a secured
creditor.
c. Restrictions on Setoff – Can’t setoff if within 90
days of filing, so that creditors can’t position
themselves on the eve of filing and become secured.
d. §362(a)(3) says Debtor can exercise control over
deposits. But §553 maintains the right of setoff
from non-bankruptcy state law to which the debtor
was already subject.
e. §362(a)(7) stays setoff. The bank can
“Temporarily” hold the money, which does not
violate the stay (Strumpf).
f. The bank may move immediately to lift the stay.
i. §362(d)(1), “for cause”, exercising §553
rights of setoff.
ii. Decision to setoff
iii. Action of setoff
iv. Record to verify setoff
g. In re HAL, Inc. - The government is a single entity,
so it can setoff prepetition interests (even to
different government branches).
iii. Post-Petition Financing
1. Adequate protection – §361, §362, §363(d)(1), §364.
a. §362(d) Periodic cash payments go to adequate
protection, and keep the value of collateral constant
over the life of the loan.
i. In re Earth Lite – Debtor had cash on hand,
but court refused to let the debtor spend it
without cash payments to creditor (to
maintain adequate protection).
2. §507(b) If creditor goes to court to receive adequate
protection, and debtor misses payments, these payments
have “Super Priority” above all §507(a) priorities.
3. Obtaining credit post-petition §364
a. §364(c)(1) – Super Duper Priority claim. Creditor is
unsecured, but with priority over the claim that
turned out to be inadequately protected.
b. §364(c)(2) – Debtor gives lien on unencumbered
property, so that creditor now has a secured claim.
c. §364(c)(3) – Debtor gives creditor a subordinate
lien against property that has an “equity cushion”
for an existing secured claim.
i. Before this creditor can be satisfied, debtor
must pay down the senior lien.
ii. Evidence of an “equity cushion” is
supported by an appraiser, and if it turns out
there is no equity then that’s how you get a
§507(b) claim.
d. §506(b) – Secured creditors get interest.
Postpetition lenders won’t lend unless there’s plenty
of collateral, so they will receive interest.
4. Working with the creditors
a. §549 – Debtor is not allowed to pay pre-petition
debt, but can give an interest in post-petition
property to a different creditor, or to the same
creditor in exchange for new value (avoid setoff or
preference).
b. Prepackage plan – when you tell your
reorganization to all your creditors beforehand.
c. Free fall plan – when you have no such plan.
d. Cash collateral agreement – conditions for using the
money and amount, and conditions of default.
e. Cross-collateralization – undersecured prepetition
lender gives out a loan on postpetition property. The
secured status reaches back to the prepetition claim
as well.
i. Post-petition, they’ve got a secured claim
for an amount which, prepetition, was
undersecured.
ii. Courts don’t like this because it’s inequal
for creditors.
iii. Problem 25-2.
iv. Avoiding Powers (Strong Arm Clause) §544
1. Trustee (DIP) can file an action to avoid unperfected
security interests, making such interests unsecured.
a. DIP has status of a judicial lien creditor, which
defeats unperfected security interests and all
unsecured claims, but not secured claims. (so these
get paid only after all secured claims)
2. §362(a)(5) – Creditors cannot perfect after filing because
this would violate the stay.
3. §544 enables trustee to turn unperfected secured creditor
into an unsecured creditor whereby the creditor loses
secured status but still keeps its claim.
a. (a)(1) is about personal property
b. (a)(3) is about real property.
4. Perfecting a Security Interest – With regard to a purchase
money security interest, creditor has 20 days to perfect
from the moment of debtor’s possession. Creditor can do
this whether purchaser/debtor has filed or not. If creditor
perfects within 20 days, perfection relates back to the date
of the transfer.(Is this relevant only for §547(c)(3)(B)?)
a. Perfection – no bona fide purchaser can get an
interest superior to the interest of the transferee.
v. Avoiding Powers (Preferences) §547(b)
1. Avoidance of preferential transfers preserves the equality
of distribution and the integrity of the estate.
2. Plaintiff is trustee or debtor in Possession (must be brought
post-petition).
3. Trustee recovers preferential (or otherwise avoidable)
transfers under §550
4. Elements of Preference
a. Transfer to or for the benefit of creditor
i. §101(54) describes “transfer”
b. Antecedent debt (did debt exist when the payment
was made?)
i. Prepaid goods do not belong to the buyer
until the buyer receives them. Therefore, the
transfer may occur within the 90 days but if
the goods are prepaid it won’t be on an
antecedent debt.
ii. If extension of credit, attachment, and
perfection all occur contemporaneously, no
antecedent debt.
c. Insolvency (b)(5)
i. If debtor is insolvent, creditors get less than
100 cents on the dollar.
ii. If an unsecured creditor received full
payment, he probably received more than he
would in Chapter 7. Therefore, there’s likely
an avoidable preference.
iii. This is a rebuttable presumption of
insolvency, using the debtor’s balance sheet
iv. Do not use analysis of whether debtor is
paying as debts come due.
v. You might see a solvent debtor if there are
significant assets.
d. Payment within the relevant time period:
i. 90 days before filing
1. Count day before filing to the day of
the transfer (date of filing is day
zero, date of transfer must be 90 or
lower). If the 90th day falls on a legal
holiday or weekend, it goes to the
next business day.
2. Check is paid the date it clears.
ii. One year before filing (for insider, who
debtor wants to protect).
1. §101(31) tells who the insiders can
be.
5. Determining Date of Transfer §547(e)(2)
a. Is the transfer of a security interest?
i. If no, T is the time of the physical interest.
ii. If yes, decide which part of §547(e).
b. T=A §547(e)(2)(A) Transfer relates back to the date
of attachment of the security interest, if perfection
occurs within 10 days of attachment of the security
interest.
c. T=P §547(e)(2)(b) If Perfection does not occur
within 10 days of attachment, transfer is deemed to
have occurred at the time of perfection (so it may
more easily fall within the 90 day preference
period)
d. T=C §547(e)(2)(c) If there’s no perfection by the
later of commencement of the case or 10 days after
the attachment, transfer is deemed to be at
commencement of the case.
i. If never perfection – see also §544, where
debtor is treated as unsecured. This is the
only place where §547 and §544 come
together.
ii. If perfection after the commencement of the
case, check for violation of the automatic
stay.
vi. Defenses to Preference Action
1. §547(c)(1) – Action would otherwise be a preference but it
was (substantially) a contemporaneous exchange and
parties intended it to be contemporaneous. This often also
involves (c)(3).
a. In re Alexander – Contemporaneous is purchase and
perfection within ten days, not 14 days. But it’s still
“substantially contemporaneous”.
b. If there’s contemporaneous exchange, there’s no
antecedent debt and no net depletion to the estate.
c. If not involving a security interest (as called for in
(c)(3)), it would be an exchange that was paid with
a check.
2. §547(c)(2) – Ordinary course of business defense
a. The debt on which payment was made was incurred
in the ordinary course of business (of both debtor
and transferee)
b. Transfer (payment) must have been made in the
ordinary course of business.
c. Transfer (payment) must be made according to
ordinary business terms (in the industry).
3. §547(c)(3) – Enabling Loan Defense
a. For Purchase Money Security Interests – Creditor
gives debtor money to buy stuff, and takes an
interest in the stuff. Debtor holds on to the stuff and
uses it for the benefit of the estate, but the creditor
(bank) holds the title. No net loss to the estate.
b. Timely and accurate perfection is essential under
(c)(3).
i. Must be within 20 days.
ii. Must have a title search to ensure there are
no other liens. (and get title insurance).
c. Fidelity Financial Services v. Fink – A trustee may
not displace a security interest used to acquire the
encumbered property if the security interest is
perfected on or before 20 days after the debtor
receives possession of such property.
4. §547(c)(4) – New Value Defense
a. For replenishment of the estate
i. Claims must be unsecured
ii. Not paid.
b. How it happens
i. Debtor made a payment that would
otherwise be a preference, and then creditor
supplied some new materials with no further
payment.
ii. If the delivery was accompanied by
payment, the original payment is not
protected by the new value defense.
5. The Floating Lien §547(c)(5).
a. A security interest attaches to a “mass whose
identity shifts over time” such as planting seed to
grain crops or inventory to accounts receivables.
b. §553(b) – A rough equivalent to a floating lien
applied to a right of setoff.
c. Creditor who exercises setoff before bankruptcy
may be subject to avoidance, but setoff after filing
(under §362) is OK.
6. Earmarking Doctrine (Is this a defense to preference?)
i. New lender (bank), where debtor and lender
agree to use funds to pay specific debt (such
as mechanic’s lien).
ii. Terms are actually performed (Bank pays
mechanic and debtor makes payments to
bank).
iii. Transaction as a whole does not diminish
debtor’s estate (debtor still owes same
amount, but to a different party. Also, he has
his fixed car).
vii. Limitations on Avoiding Powers §546
1. Trustee can’t avoid a preference after the case is closed or
dismissed, or the earlier of 2 years after the entry of the
order or 1 year after the appointment of the first trustee.
viii. Avoiding Fraudulent Transfers and Obligations §548
1. §548(a)(1)(A) – Trustee can avoid a transfer within one
year if debtor did it to hinder, delay, or defraud some other
creditor.
2. §548(a)(1)(B) – If you’re insolvent and you get less than a
fair amount of money for the property.
a. This is how church contributions come up, but
there’s an exception for these in §548(a)(2)
3. Prove this using circumstantial evidence. Something about
§523 and §727(a)(2).
4. Where do debtors hide their money?
a. ERISA “Spendthrift trusts”
b. Offshore Accounts – Isle of Man, Mauritius,
Cayman Islands, etc.
c. Leveraged buyout – The Company really gets
nothing, because all the assets are pledged to the
bank. Lots of people think an LBO is a fraudulent
conveyance, so sometimes an examiner is appointed
to review the transaction.
i. Management borrows money from the bank.
ii. Management uses that money to re-buy the
stock from the stockholders.
iii. The company now owns the whole
company, but the debt is secured against the
assets of the company.
iv. The assets go to the bank.
v. The money from the assets go to the
company.
vi. Management uses the money to pay off the
shareholders.
c. Various other topics
i. The Police Power §362(b)(4) – Courts aren’t stayed from
proceedings against the debtor in environmental matters (also
health and safety things). Congress values these more highly than
unsecured creditors.
d. Executory Contracts §365
i. A principal debtor’s weapon is the ability to reject executory
contracts or unexpired leases.
1. §365(d) Reject – Debtor is not bound by the terms but is
liable for breach and gives rise to a claim. It can take place
right at the beginning, or at plan confirmation (is this
because the debtor asked for an extension?)
a. Requirements to reject a contract
i. 60 days from filing, or go to court to get
additional time (which can be the duration
of the plan).
1. Debtor must keep paying the rent as
long as it occupies the premises.
2. Postpetition rent is an administrative
expense under §503(b)/§507(a)(1).
3. §365(a) Rejection is not effective
until the court approves it. So in
between the debtor vacating the store
and the hearing, debtor must pay rent
because debtor could change his
mind in that time.
ii. Good faith – Debtor is not just filing
bankruptcy to get out of a bad real estate
deal.
iii. Business judgment test – The business is
losing money and rejecting will help it
rehabilitate, etc.
iv. §502 Pay damages of breach to Landlord
1. §502(b)(6) – Debtor must pay rent
for the greater of one year, or 15% of
the rent for 3 years (or less than 3
years if the lease is up before 3
years).
2. Landlord gets a prepetition claim for
this money.
b. Debtor’s responsibilities
i. Debtor must cure post-petition rent within
60 days (Is this what can’t be extended
under (d)(3)?)
c. Landlord’s options
i. §364(d)(3) Can send letters to debtor asking
for rent and it’s not a violation of the stay.
ii. Landlord can go to court to compel
assumption or rejection of the contract.
iii. §365(h)(1)(C) Landlord can still regulate the
“use” of a shopping center, and can contract
to prohibit a “Going out of business” sale.
2. §365(b) Assume – Debtor remains bound by the terms and
contract exists even after bankruptcy.
a. Debtor’s obligations
i. §365(b)(1) Debtor must cure and provide
assurances of future performance.
1. Debtor should show projections of
future ability to pay, cash deposit,
bond, etc.
3. Assign – Debtor must assume a lease in order to assign it.
Court must approve §365(b)(3) tests in order to allow
assignment.
a. Do we really have a shopping center? (Must we
resolve the elements of (b)(3)?)
i. If there are maintenance fees directed to
common areas (sidewalks, parking lots, etc)
ii. Tenant association?
iii. Common hours?
b. Why might debtor do this?
i. Debtor will have no further obligations on
the lease.
ii. Market rent for the property is higher than
the lease rate.
iii. Debtor wants to remove itself from just one
area.
c. What do landlords get?
i. §365(b)(3)(C) and (D) – Debtor has to
preserve things required by landlord (quality
of tenant, working hours, etc).