BANKRUPTCY OUTLINE
Czar
Spring 2007
I.
THE NATURE, SOURCE, & POLICIES OF BANKRUPTCY LAW
A. Models of Bankruptcy
1. Liquidation (Straight Bankruptcy) a. Chapter 7
b. Bankruptcy debtor turns over all of his nonexempt assets to the
Bankruptcy Trustee (BT) who the sells them and gathers the proceeds
from the sale and then distributes it to the debtor’s creditors.
c. In exchange for the turnover of assets, debtor receives a discharge of
his debts.
2. Re-Organization a. 3-4 chapters of the Bankruptcy Code deal with this
i.
Mainly Chapter 11 and 13.
b. Debtor is permitted to keep his assets, and additionally, receives a
discharge if he complies with certain requirements.
c. Debtor must submit a plan of reorganization under which they will
operate for the next 3-10 years.
i.
Plan must provide a stream of payments to creditors such
that those creditors receive at least what they would have
received had the debtor liquidated today. (Ch. 7)
B. Federal Nature of Bankruptcy Law
1. Bankruptcy law is federal b/c Congress is given the power to establish
uniform laws for the Bankruptcy through the Constitution.
2. The Code uses the term “nonbankruptcy law” to describe the generally
prevailing law of the jurisdiction in which a bankruptcy case is filed.
3. Under the Supremacy Clause, bankruptcy law preempts state law to the extent
that they are inconsistent.
a. However, because in many respects state law is incompatible with
bankruptcy law, it is preserved in bankruptcy and forms the basis of
rights that are protected and upheld.
4. Bankruptcy courts are Article 1 courts, and therefore bankruptcy judges are
Article 1 judges as opposed to Article 3.
a. do not have life tenure
b. roughly the same status as U.S. magistrate judges
c. they are arms of U.S. District Courts
d. the order of reference is a standing order in all district courts which
automatically refers all bankruptcy cases to bankruptcy courts – i.e.
you file at the bankruptcy court clerk’s office.
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C. The Goals and Policies of Bankruptcy
1. Bankruptcy is remedial in nature.
a. Often, bankruptcy relief is sought only after the debtor’s economic
affairs have deteriorated to the point of collapse.
b. Therefore, bankruptcy’s purpose is to manage financial distress and to
do the best job possible of preserving what can be saved. Not
necessarily to give creditors their full entitlement.
2. Protection of Debtor and Creditor Interests
a. Idea of bankruptcy serves 2 purposes: creditor protection and debtor
relief.
b. Helps creditors by providing an evenhanded and controlled
environment for the settlement of the debtor’s affairs and distribution
of his assets.
c. It provides a haven for the straightened debtor, affording relief from
the pressure of financial failure.
3. Collective and Evenhanded Treatment of Creditors
a. Bankruptcy is handled by an uninterested administrator.
b. Though most creditors are not paid in full, they share equitably in the
fund. (doesn’t necessarily mean they are all paid the same)
4. Preservation of the Estate
a. BT is given substantial powers to investigate the debtor’s affairs, to
recover dispositions of ppty in fraud of creditors, to reveal hidden
assets, and to resolve the affairs of the debtor in a way that best
enhances the value of the estate.
5. The Debtor’s “Fresh Start”
a. goal of long-term rehabilitation.
b. Provided that the debtor has complied with the Code’s requirements
and has surrendered executable assets of sufficient future income for
distribution to creditors, the debtor is entitled to a new beginning,
unburdened by the unpaid balance of prebankruptcy debts.
6. Minimal Interference with Nonbankruptcy Rights
a. Generally, the treatment of such rights under the Code is intended to
affect them only as much as necessary to further the aims of
bankruptcy.
7. Efficient Administration
8. Preference for Reorganization and Debt Adjustment.
II.
ELEMENTS COMMON TO CONSUMER BANKRUPTCY
A. Deciding to File
1. Debtor must fill out a series of documents and file them with the bankruptcy
court; bankruptcy proceedings are court proceedings.
2. Most important document is the bankruptcy petition.
3. Along with the petition must be appended a number of schedules, which are
attachments to the petition.
4. Must pay a fee in order to file for bankruptcy
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5. Anyone that assists in the filing of bankruptcy petition is subject to a duty of
reasonableness.
a. This means that they have the responsibility to look into things that
they may believe are suspect.
B. The Estate (§541)
1. At the moment a bankruptcy petition is filed, and estate is created by
operation of law.
a. The bankruptcy estate is a new legal entity separate from the debtor.
2. Bankruptcy is in a sense a financial demise, which creates an estate consisting
of all the interest in ppty previously owned by the pre-bankrupt debtor.
3. §541: defines the bankruptcy estate as all ppty interests (both equitable and
legal) of the debtor as of the filing of bankruptcy.
a. §541(a) states what is included in the estate, and §§541(b) and (d)
make some specific exclusions from it.
b. ppty of the estate includes more than just tangible ppty.
i.
541(a) captures intangible ppty rights or contingent ppty
interests such as the ability to file a lawsuit that has yet to
be filed.
c. The question of whether or not the debtor has an interest in ppty and
the determination of the nature and extent of that interest must be
resolved under nonbankruptcy law.
i.
541(c), however, invalidates any provision of
nonbankruptcy law, as well as any condition created by K
or transfer instrument, that restricts the transfer of ppty
rights so that they do not pass to the estate on bankruptcy.
(intended to prevent state or individual from circumventing
541(a)).
4. Ppty Acquired After the Filing of the Petition –
a. The most important exception is for “services performed by an
individual debtor after the commencement of the case.”
i.
every penny the debtor earns after the commencement of
the case is kept by debtor.
ii.
Thus, debtor always wants to claim the earnings were postpetition and trustee, who has a fiduciary duty to the
unsecured creditors to maximize the estate, claims
everything is pre-petition.
b. For the typical consumer, this provision means that wages,
commissions, and the like earned after the petition is filed are not ppty
of the estate and do not have to be surrendered to their creditors.
c. Disputes of whether various “expectancies” have become “ppty” of the
estate fall into 3 categories:
i.
legal interests that are not enforceable at the date of
bankruptcy but may be enforceable at a future time.
(a) Sharp v. Dery – employee bonuses; where bonus
is totally discretionary and likewise contingent on
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employment for a specified time and the
employee is not employed for that time, the
employee has no legal interest in the bonus, and it
is therefore not included as ppty of the estate.
(b) must not look to the label of the expectancy but
rather (1) whether debtor has a legal right to the
expectancy and (2) what the expectancy (i.e.
bonus) is attributed to.
ii.
certain entitlements such as permits or licenses that are
nontransferable, which may or may not be ppty.
(a) most courts will hold that liquor licenses are
ppty of the estate b/c when a person buys a bar,
the only thing of “real value” is the liquor license.
(b) In re Burgess – for the purposes of the Code, a
brothel is licensed ppty of the estate. Court
analogizes the brothel license to a liquor license.
(c) Gambling License? Czar thinks that there is a lot
of doubt that the result would be the same b/c the
legislature has done everything possible to say
that theses licenses are not transferable.
(d) Sporting Tickets? Bankruptcy courts are evenly
divided on this issue.
iii.
problems of restrictions on transferability imposed by law.
(a) such restrictions are not generally favored by
bankruptcy and provisions such as §541(c)(1)
make most of them unenforceable.
NOTE: Good rule of thumb when dealing with various interest –
If the interest can be transferred to someone else (i.e. liquor
license), the interest is usually part of the estate.
(transferability usually equates to enormous value) If it
can’t be transferred, (i.e. law license) it is not part of the
estate.
d. Retirement Accounts – exceptions to unenforceability of restrictions
on transferability for retirement accounts.
i.
“Spendthrift” Trust Provision - §541(c)(2) validates
restrictions upon transfer of debtor’s beneficial interest in a
trust that are enforceable under “applicable nonbankruptcy
law” by excluding ppty from the estate.
(a) basically says that when you put money into a
trust which protects you from getting a lot of
money and spending it, if a debtor files
bankruptcy and they had a spend thrift trust, the
money does not become part of the estate.
ii.
ERISA – federal government has set up a way for
individuals to set up retirement accounts similar to a
spendthrift trust.
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“ERISA qualified” retirement plans are exempt
from the bankruptcy estate.
(b) see In re Orkin
(c) NOTE: Under a 2005 US SC case, the Court
held that most types of IRAs will be exempt from
the ppty of the estate.
5. Abandonment of Ppty by Trustee a. any property of the estate that the trustee considers of no value or no
benefit to the estate may be abandoned or given back to the debtor or
whoever has the interest in the ppty by the trustee. (ex. pets)
b. the trustee’s abandonment of burdensome ppty is intended to benefit
the estate by disposing of ppty that will drain the estate’s resources.
c. 554(c) provides that at the close of the case, ppty that was inclueed in
the debtor’s schedule but was not administered in the estate will be
abandoned to the debtor.
6. §541 makes it clear that the ppty becomes ppty of the estate and is likewise
turned over to the trustee or its value must be accounted for no matter where it
is located or who it is held by.
a. Even a creditor with an interest in ppty is obliged to relinquish
possession to the trustee. If the creditor wishes to recover the ppty so
that the interest can be enforced, application must be made for relief
from stay.
b. ex. – you have a possessory right to a car, still owe the bank money,
this interest transfers to the trustee.
(a)
C. Participants in Bankruptcy
1. Bankruptcy Court a. presided over by a bankruptcy judge
b. routinely deals as a court of first instance
c. not an independent, autonomous arm of the federal judiciary but is
statutorily described as a “unit” of the U.S. district court.
i.
its powers arise as a result of reference from the district
court, and it exercises its judicial function subject to the
ultimate control of that court.
2. The Trustee a. impartial administrator whose role encompasses not only mgt of the
estate but extensive powers to investigate the debtor’s affairs, to
enforce the rights of the estate and to participate in litigation involving
the estate’s interests.
b. Eligibility – 321 simply states the general requirement of residency
and competence, but he is normally an atty.
c. Trustee owes a fiduciary duty to maximize the value of the estate for
the benefit of all of debtor’s creditors.
d. Entitled to some % of the assets they administer. Must, however, post
a bond in an amt set by U.S. Trustee to guarantee the faithful
performance of his duties.
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3.
4.
5.
6.
e. At a minimum the trustee has to conduct a §341 meeting.
i.
meeting of creditors w/debtor present which gives creditors
the opportunity to depose the debtor.
f. Required in all bankruptcy cases except Ch. 11. Ch. 7 usually has a
panel of trustees.
U.S. Trustee –
a. appointed by US Atty General
b. there are different US trustee districts throughout the country.
c. Public official whose general responsibility is to ensure that the public
interest is being properly served in the administration of bankruptcy
cases.
d. Supervises the work of the trustee.
e. Has the right to appear in any bankruptcy case on any matter.
The Debtor –
a. Has more of a passive role in Ch. 7, and more of an active role in
Reorganization cases.
Creditors and Creditors’ Committees –
a. Creditor is defined in §101 to include any entity who has a provable
claim against the estate.
b. In order to establish a claim they must fill out a proof of claim form
that is sent by the trustee and file it with the bankruptcy court.
Attys and Other Professional Consultants –
D. The Automatic Stay
1. §362 provides an injunction that arises by operation of law upon the filing of
bankruptcy.
2. Operates as a stay to any attempt to collect a pre-petitioned debt
3. Policy –
a. essential to the accomplishment of 2 central goals:
i.
debtor’s fresh start
ii.
even handed treatment of creditors
b. allows trustee to gather assets w/o the estate disappearing
c. allows all unsecured creditors to share and share alike
gives debtor time to catch his breath and see where he stands.
4. Nature and Scope of the Stay –
a. stay is binding on all parties
b. comes into effect upon the filing of the petition
c. remains in effect for the duration of the case
d. applies in all forms of bankruptcy
e. effectiveness of the stay does not depend on creditors’ notice of filing
f. stay does not preclude action in the bankruptcy court.
g. stay is not an end in itself
h. although the stay is comprehensive, it does not cover every
conceivable activity.
5. Activity Included in the Stay (§362 (a)) –
a. Activity against the debtor
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b. Activity against the ppty of the debtor
c. Activity against the ppty of the estate
6. Automatic stay includes all “oblique” ways of trying to get debtor to pay debt.
a. Andrews Univ. v. Merchant – College not giving a student’s transcript
to an employee in order to try and recover the student loan debt after
the student filed bankruptcy. Even thought the debts were nondischargeable, they were still stayed, and any attempt to collect
violated said stay.
7. Exceptions to the Stay (§362(b)) –
a. Alimony, maintenance, or child support
b. Criminal proceedings
c. Proceedings by gov’t to enforce police or regulatory powers
d. Creditor may perform acts to perfect or maintain perfection of his
rights against the creditor if it is w/in the grace period.
e. Tax investigations or audits
f. A check to be cleared or dishonored if the check is already in the
system.
g. Accreditation process
h. Continuation statements filed to continue a lien on ppty.
8. Termination of the Stay –
a. Stay may be lifted by the court following an application for relief from
stay under §362(d).
b. §§362(c)(1) and (2) provide for the termination of the stay when ppty
is no longer ppty of the estate or until the case is closed or dismissed.
9. Any action taken in violation of the automatic stay are void ab initio (“from
the start”)
a. Debtor must go to the bankruptcy court and explain to the judge that
the creditors act in repossessing his ppty after he filed bankruptcy is
void ab initio.
b. Different rule for 5th Cir. – rather than void ab initio, actions taken in
violation of the stay w/o notice are voidable.
i.
Judge makes decision whether they will void the action.
ii.
The court will permit the secured creditor to keep the
collateral where the court would have lifted the automatic
stay had the creditor followed the proper procedures and
approached the bankruptcy court first before taking their
action.
10. The penalty for a knowing violation of the automatic stay is not just for
undoing the action or actual damages but also punitive damages.
III.
CHAPTER 7: LIQUIDATION BANKRUPTCY
A. General Info
1. Classic “straight” bankruptcy where BT is appointed to gather all the debtor’s
ppty, to sell it, and to distribute the proceeds to creditors.
2. Governed by §276.
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3. At the end of the process, the creditors have their proportional share of
whatever the debtor had, and the debtor receives a discharge of the remaining
outstanding debts.
4. As the BT prepares to sell each piece of ppty in which the debtor has an
interest, it must first determine if some other person or company has any
interest in the ppty. (i.e. co-owners or secured creditors)
5. BT must also consider any valid exemption claimed by the debtor in a
particular item of ppty.
6. General creditors are paid after secured parties and other entities with ppty
interests have been paid.
a. Divided into 3 groups:
i.
priority creditors – first in line
ii.
general unsecured creditors
iii.
subordinated creditors – paid last b/c they’ve been
“equitably subordinated” to everyone else.
B. Eligibility
1. Just about any entity is eligible to file a Ch 7 liquidation case.
a. Exception – businesses whose insolvencies are governed by another
set of nonbankruptcy laws (i.e, banks, railroads)
2. “Substantial Abuse” - §707(b) gives the bankruptcy court discretion to dismiss
a bankruptcy case for “substantial abuse.”
a. Presumption that when debtor files bankruptcy it is not a substantial
abuse.
b. In re Shaw – Court used the Green test to determine whether the
debtor had the ability to pay the debt, including consideration of the
relation of the debtor’s future income to his future necessary expenses.
See Green factors (TOC test).
i.
Where court finds that debtors are actually living beyond
their means rather than falling victim to some unforeseen
circumstances, their filing will be deemed a substantial
abuse.
c. §707(b): has been amended to give a presumption of abuse of Ch. 7
when it can be deemed to have enough disposable income to pay under
a Ch. 13 plan. For this determination 707(b) lays out called the
“threshold eligibility test.”
i.
The first component of that calculus is whether the debtor’s
income is below the medium of other debtors in that area.
(a) if it is below, then debtor can file Ch. 7 (no abuse)
ii.
If income is higher, take debtor’s income and subtract from
it some expenses (will actually be a standard number that
your get from the gov’t) then compare to a specific number
laid out in statute to tells us whether debtor will qualify to
file Ch 7.
iii.
To do the financial calculation, it is necessary to know:
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(a)
the total size of the surplus of income over
expenses over 60 mths (5 yrs)
(b) how much general unsecured nonpriorty debt that
the debtor owes.
iv.
Formula – Abuse is prusumed:
(a) if the debt is greater than $24k, and
(1) the surplus is at least
(i) $10k, or
(ii) 25% of the debt;
OR
(b) if the debt is $14k or less, and the surplus is at
least $6k.
NOTE: that if the surplus is less than $100 per month, the debtor
passes. If it is b/w $100 and $166.66, he passes if the surplus in
less than 25% of his unsecured debt divided by 60. If the surplus
is greater than $166.66, he flunks no matter how much he owes.
C. Ppty Exempt From Seizure
1. Debtor has a specified period of time to exempt certain ppty from being ppty
of the estate.
a. must do so by petitioning the court.
2. When ppty is defined as “exempt” under state law, general creditors cannot
seize it to satisfy their judgments.
a. designed to permit a judgment debtor, when he has been sued, the
ability to have at least some subsistent level of assets.
3. §522(d) provides a set of uniform federal bankruptcy exemptions.
a. §522(b) allows a state to “opt out” of these exemptions and substitute
them with their own exemptions.
i.
in doing so, state legislatures choose to have debtors who
file federal bankruptcy cases to file them in the federal
courts w/in their respecting states.
ii.
therefore most debtors choose to use state exemption law.
4. Classification of Ppty –
a. one of the primary issues that arises under exemption disputes is
whether a particular piece of ppty actually fits w/in the exemption list.
b. Debtors argue that the ppty they intend to keep fits within the statutory
classifications, while the BT and judgment creditors argue that it does
not.
b. In re Johnson – Court held that a bus w/a seating capacity of 60 was
considered a “motor vehicle” for purposes of the KY exemption
statute. Court applied plain meaning to the statute.
c. In re Pizzi – lottery winnings are not considered an “annuity K” for
purposes of FL exemption statute, but rather are nonexempt assets
which must be liquidated to pay creditors.
d. When applying exemption laws, always be alert for categorization
questions.
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5. Valuation of Exempt Ppty –
a. Most state exemption laws will allow you to exempt part of the value
of certain ppty but not the full value.
b. Exemptions work solely on the debtor’s equity in ppty (any value
of the ppty above other creditors’ security interests in the ppty).
i.
ex. – Car Note
(a) exemption = 2k; car value = 3k; secured creditor
= 1k.
(b) Result is that debtor may exempt 1k. SC gets
paid. (this is partially exempt ppty)
ii.
ex. – Homestead Exemption
(a) MS Homestead Exemption = $75k; home value =
125k; mtg = 100k
(b) Result is that debtor may exempt 25k of equity in
the house. Mtg company will more than likely get
the house.
c. Standard of Valuation – courts vary on what standard to use.
i.
Possibilities:
(a) liquidation value
(b) retail value
(c) wholesale value
(d) FMV
ii.
BT wants value to be higher; debtor wants ppty to be
valued lower so he can exempt more.
iii.
In re Walsh – held appropriate standard was liquidation
value. Favored debtor b/c a forced sale will probably result
in lower value.
iv.
In re Mitchell – Court refused to adopt liquidation value
and instead adopted FMV approach. This is the better
approach.
6. Proceeds and Tracing a. If you can trace money back to ppty that is exempt ppty, then the acct
will be exempt.
b. Have to look to state law.
c. In re Paliora - debtor has money in a checking acct that could be
traced to 1 of 2 accts: (1) wages or (2) alimony pmts made to a
previous spouse. Both are exempt ppty.
i.
Court says that the AZ exemption on wages operates only
on garnishments. AZ exemption statute said that 80% of
debtor’s wages were exempt from creditors.
ii.
However, the minute the debtor gets the cash in hand (i.e.
putting it in checking acct), wages turn into non-exempt
ppty.
iii.
With regard to alimony pmts, any ppty that is held as a
fiduciary for someone else does not become ppty of the
estate.
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7. Avoidance of Liens on Exempt Ppty - §522(f)
a. A lien that is non-possessory, non-PMSI on certain defined goods
listed in 522(f) must be avoided by the bankruptcy court.
b. Ex. – bank lends me money, and I have nothing but pots and pans,
couch, wheelchair, dialysis machine, etc to pledge. Congress has
decided that a lender who would take a security interest in such things
is in some way preying upon the debtor. This is different from a
situation where the lenders lends money to actually buy those
household items.
i.
FTC rule that makes security interest in these type goods an
unfair trade practice.
c. 522(f) also allows debtor to avoid any judicial liens on ppty that would
otherwise be to the extent of their exemption (up to the exemption amt
available to debtor).
i.
Recall: to be a judicial lien, the ppty must not have been
foreclosed upon.
D. Homesteads, Trusts, and Exemption Planning
1. Exemption truly only matter to the small minority of debtors who have assets
of substantial value.
a. Exemptions are really only important to majority debtors at the
“barrel” level – that is enough protections to cover their clothes,
household goods, cars, etc.
2. Homestead Exemptions –
a. most important type of exempt ppty for most debtors is the homestead
– allows you to exempt up to a certain amt of equity in your home.
b. different homestead amounts for different states.
i.
MS Homestead Exemption = $75k or 160 acres
ii.
20 states protect less than $20k
iii.
FL has unlimited Homestead Exemption
3. Exemption Planning a. States that protect unlimited value in a homestead, give the debtor the
opportunity to do some careful planning before filing to discharge his
debts.
b. Essentially, debtors will attempt to take non-exempt ppty and convert
it into assets that are exempt ppty.
c. Legislative history of the Code says that nothing in the Code prevents
pre-bankruptcy exempt planning, but courts have said that you must
comply with §727(b).
d. 727(b) contains a laundry list of things that you cannot do, and if you
do one of them, you will be denied a discharge of bankruptcy.
i.
one of the things you cannot do is “hinder, delay, or
defraud creditor.”
ii.
TOC test
e. In re Read – 5th Cir. reversed trial court’s decision in favor of debtor’s
pre-bankruptcy exemption planning. It held that debtor’s (whose
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company was named “Triple BS”) act of selling non-exempt ppty for
less than a 20% return and using the proceeds to payoff his mtg was
done with the intent to defraud creditors prior to filing.
f. Czar opinion is that if you do your exemption planning that is so
obvious, like naming your corp “Triple BS,” the court will probably
find an intent to defraud. If you’ve done everything professionally and
in good faith, you’re probably ok.
g. §522(o) – includes provision that you must reduce the value of the
homestead exemption by any amt that is attributable to otherwise nonexempt ppty that was disposed of with an intent to hinder, delay, or
defraud.
i.
includes a 10 yr reach back period.
h. §522(q) – absolute cap on homestead for people convicted of securities
law violations, fraud in fiduciary capacity, and a handful of other
related bad acts. Discharge can be delayed to see if the debtor is
subject to a proceeding that might give rise to this limitation.
4. Choice of Law Rules –
a. Code contains choice of law rules as to which state’s exemption laws
apply in a given case.
b. Where the debtor resided for 2 years (730 days), the applicable
exemptions of that state will apply.
c. If the debtor was moving at the time, then you go back to the 180 days
that precede the 730 days, and see where the debtor was for the
majority of the time.
E. Claims
1. Aside from the BT’s duty to maximize the estate and distribute it to unsecured
creditors, he must make sure that only valid claims of creditors are satisfied by
the estate.
2. One of the lists (schedules) the BT receives from the debtor is a list of
creditors.
a. BT will provide notice to these creditors, and on the back of the notice
will be a Proof of Claim form.
i.
will ask the creditor to list the name, address, nature of the
claim, and ask for an attachment of relevant documents to
prove claim.
ii.
filing the proof of claim presents prima facie evidence of
the validity of creditor’s claim.
(a) it will be accepted unless BT disputes the
claim
3. What is a Claim?
a. Congress has made definition extremely broad.
b. §101(5) – “means a right to pmt whether or not such right is reduced to
judgment, liquidated, unliquidated, fixed, contingent, matured,
unmatured, legal, equitable, secured, unsecured…….”
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4.
5.
6.
7.
8.
c. Czar says it is meant to include any and all potential rights to pmt
in the broadest since possible.
§503 gives bankruptcy judges the authority to estimate claims.
If BT finds that the claim is invalid, he may step into the shoes of the debtor to
dispute the claim.
Unsecured Claims –
a. Unsecured creditors are permitted to include prebankruptcy interest
into their claim, but the Code does not permit unsecured creditor to
include post-bankruptcy interest.
b. obligation is accelerated at bankruptcy
Secured Creditors –
a. Bankruptcy preserves secured creditors’ rights – no better or worse
off.
b. Secured creditors have a secured claim in bankruptcy to the extent of
the amt they are owed or the value of their collateral, which ever is
lower.
c. Entitled to prebankuptcy interest but generally not postbankruptcy
interest.
d. An oversecured creditor may keep adding interest, including post
bankruptcy interest, until their claim adds up to the amt of the
collateral.
Attorney’s fees –
a. atty’s fees incurred prior to filing are treated the same as
prebankruptcy interest – if a creditor, secured or unsecured, is entitled
to prebankruptcy atty’s fees by K or state law, then the fees are part of
the creditor’s secured or unsecured claim.
b. §506(b) - Oversecured creditors are entitled to postbankruptcy atty’s
fees up to the value of the collateral.
c. Courts differ on whether unsecured creditors are entitled to
postbankruptcy atty’s fees. See pg. 226
F. Disposition and Distribution
1. Disposition –
a. this happens first prior to paying §507 priority
b. §725 – generally speaking in a bankruptcy case, the trustee is going to
just hand over collateral to secured creditors.
i.
secured creditor essentially either receives the collateral or
its value in cash after its disposition.
ii.
secured creditor must get paid before unsecured creditor
gets anything.
2. Distribution a. all creditors must be paid in this hierarchy
b. §726(a) – ppty of the estate shall be distributed:
i.
First, to priority and secured creditors’ claims under §507
ii.
Second, to timely filed proof of claim under §501
iii.
Third, to tardily filed claims
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iv.
don’t need to worry about 4, 5, and 6
c. If there is money left after paying the priority and secured claims, it is
distributed in accordance with the hierarchy on a pro rata basis.
i.
Ex. - after paying all of §507 claims, the estate has $100
(a) timely filed claims equal $1,000
 take the $100/$1,000 = $0.10 per dollar of
claim
 get $5 for a $50 claim
ii.
recall each class of the hierarchy must be paid in full before
you move to another class.
3. Priority Claims – §507 (unsecured)
a. must satisfy all domestic support obligations (DSOs) first
i.
§101(14)(a) – debt which accrues before, on or after the
date of filing, including interest….
(a) amt owed to spouse or former spouse, child or
child’s parent or guardian.
(b) in the nature of alimony, maintenance, or support
of spouse or former spouse, child or child’s parent
(c) established before the bankruptcy case
(d) not assigned to a nongovernmental entity
(e) notice does not include division of ppty
ii.
admn expenses the trustee runs up in order to support DSOs
b. second, admn expenses, i.e. those necessary for the benefit of the
bankruptcy estate.
c. Third, don’t worry about
d. Fourth, certain claims that arise out of a debtor owning a business
which has employees
i.
(a)(4) makes claim to the extent of $10k for each individual
who has earned w/in 180 days of the filing, wages, salaries,
commissions, etc…from debtor’s business.
ii.
(a)(5) is the same thing but w/regards to any type of
employment benefit plan.
e. Fifth, allowed unsecured claims for farmer or fisherman who have
stored their products w/a facility if the storage place files bankruptcy
f. Sixth, to the extent of $2,225 for each individual, arising from a
security deposit put down for purchase, lease or rental of ppty, or the
purchase of services, for personal, family or household use that were
not delivered.
g. Eight, just about all taxes
h. Ninth, don’t worry about
i. Tenth, claims for death or personal injury resulting from the operation
of a motor vehicle or vessel while intoxicated (only monetary damage,
not ppty)
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G. Discharge
1. Enforced by an injunction issued by a federal court which is permanent – any
violation would constitute a contempt of court.
2. Debtor does not always receive discharge.
a. Governed by 2 provisions:
i.
§727 – lose right to discharge if you are in a 727 category.
ii.
§523 – contains a laundry list of debts that are not
dischargeable.
3. §727(a): the court shall grant debtor a discharge UNLESS:
a. debtor is not an individual (i.e. corporation, business assoc.)
i.
Note: if you liquidate corp., in the end there is no corp.
b. debtor w/intent to hinder, delay, or defraud…
c. debtor concealed, destroyed, of failed to keep properly recorded info
on debtor’s financial condition or business transactions.
d. debtor knowingly and fraudulently makes false statements, false
claims, bribes or withholds relevant info from BT, etc.
e. debtor fails to adequately explain any loss/deficiency of assets
f. debtor doesn’t obey court order or invokes privilege of selfincrimination
i.
bankruptcy not a right, it’s a privilege
g. debtor has previously filed within prescribed time period:
i.
Only one Ch 7 case every 8 yrs
ii.
Only one Ch 13 case every 6 years
4. §523 – Non-Dischargeable Debts:
a. (a)(1): any tax debts
i.
they are also priority claims
b. (a)(2): credit or money obtained through fraud, false representations
about debtor’s financial condition, or debt incurred (beyond $500) on
luxury goods or services within 90 days, cash advances (beyond $750)
within 70 days.
c. (a)(3): debt that debtor fails to list in his filing when it should have
been listed. (fails to give notice)
d. (a)(4): fraud while a fiduciary, embezzlement or larceny.
e. (a)(5): domestic support obligation
f. (a)(6): willful and malicious injury by the debtor to another entity or
to the ppty of another entity.
g. (a)(7): fines or penalties paid to a governmental unit
i.
could arguably include student parking tickets to a state
university.
h. (a)(8): any federally guaranteed education loan, unless it would
impose undue hardship
i. (a)(9): debt from death or personal injury caused by drunk driving,
boating, or flying, or any use of intoxicating substance.
i.
not ppty damage; some try to get it in under (a)(6)
j. (a)(13): any federal criminal order of restitution
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k. (a)(14): debt incurred to pay a tax to a gov’t unit other than the U.S. or
incurred to pay a penalty under federal election law.
i.
gets people who pay their taxes by credit card and then
seek to have the credit card debt discharged.
l. (a)(15): any debts other than DSOs that arise from divorce case
5. Bankruptcy DOES NOT discharge liens attributed to a security interest. For
the most part, liens ride through bankruptcy.
6. There is a lot of flexibility in these rules. See In re Milbank
H. Reaffirmation of Debts
1. In general if a debtor in bankruptcy wants to keep his ppty, outside of
exempting it, he has 3 options:
a. Reaffirmation
b. Redemption
c. Retention of Collateral
2. §524 allows the debtor to make a K with a creditor in which he agrees to pay a
debt, under agreed upon terms, that would otherwise be discharged.
3. Talking to a debtor about reaffirmation is not a violation of the automatic stay.
4. To be enforceable, the agreement must comply with the following conditions
under 524(c) and (d):
a. valid only to the extent that it is enforceable under nonbankruptcy law.
b. must have been made before the discharge is granted, be in writing,
and must be filed with the court.
c. debtor may rescind at any time before discharge is granted or w/in 60
days of the agreement having been filed, whichever is later.
i.
“cooling off” period must be conspicuously expressed in K.
d. creditor must provide debtor with a disclosure statement at or before
time of signing
e. if debtor is represented by atty, the atty must represent to the court
(sign affidavit) that the reaffirmation of the debt will not cause an
undue hardship to the debtor going forward.
f. debtor must attend discharge hearing.
4. Secured Debt –
a. 3 options:
i.
turn collateral over
ii.
reaffirmation of the debt under prebankruptcy terms
iii.
Redemption
b. CODE requires debtor to declare its intention with regard to collateral
that is security for a loan. If he does not, then the collateral is not ppty
of the estate and the automatic stay with regard to it is dissolved.
5. Unsecured Debt –
a. Concern is that the debtor really isn’t getting anything for
reaffirmation.
b. Beyond redemption of collateral, reaffirmation is simply voluntary at
the creditor’s discretion
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c. Reaffirmation of unsecured debt has caused much controversy fueled
by cases of widespread abuse by large providers of consumer credit
who routinely bullied bankrupt consumers into reaffirmation
agreements.
I.
Redemption
1. Recall that the debtor has an equity of redemption right “until the gavel drops”
at the foreclosure sale.
2. §722 provides a slightly more favorable remedy in bankruptcy that allows the
debtor to redeem his ppty by paying the full loan or full value of the collateral
in cash, whichever is less, to the secured creditor. (essentially buying back
from the secured creditor)
3. Permitted only in Ch. 7.
4. Only refers to redeeming the collateral subject to a lien that secures a
dischargable consumer debt.
5. Ppty must be tangible personal ppty intended primarily for personal, family,
or household use and it must have been exempted or abandoned.
J.
Retention of Collateral
1. Not specified by the Code and only permitted by some courts in Ch. 7.
2. Allows the debtor to elect to retain collateral while continuing to pay
installments to the secured party as required by the security agreement.
3. The secured transaction “rides through” the bankruptcy w/o being formally
administered and dealt with as part of the estate.
4. A majority of courts don’t like this and will say it is invalid.
K. Protection Against Discriminatory Treatment
1. §525(a) – makes it a violation of the Code for a governmental unit to
discriminate against a person who has been a debtor under the Code solely b/c
such debtor has been a debtor or someone associated with a debtor.
2. §525(b) – makes it a violation for a private company/employer to discriminate
on this basis.
3. §525(c) – private companies who distribute federally backed student loans
cannot discriminate against someone solely b/c they’ve been a debtor in
bankruptcy.
a. Usually a bank may pull your credit report and deny you a loan on that
basis.
b. However, Congress has made one exception for student loans.
IV.
CHAPTER 13: REORGANIZATION
A. Overview
1. Designed for individuals w/regular income (i.e. not too much debt).
a. no corporations may file Ch. 13, but sole proprietorships may.
b. a debtor with unpredictable or unstable income cannot be permitted to
undertake Ch 13 bankruptcy.
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2. Under Ch 13, debtors are allowed to keep their ppty as long as they present to
the court a plan that provides creditors specific payments over a period of
time.
a. Note the difference from Ch 7, where all of debtor’s non-exempt assets
immediately become property of the estate.
b. Ch. 13 focuses more on future income.
3. More flexible and cheaper than Ch. 11.
a. Court has more control.
b. Creditors have different role. If a creditor object’s to debtor’s plan,
their only recourse is to know the Ch 13 law, so they can properly
object to debtor’s plan.
4. One standing Trustee or a group of standing trustees that oversee a large
number of Ch. 13 cases.
a. Has many of the obligation of a Ch. 11 trustee:
(i)
must object to questionable claims
(ii)
receive and distribute the debtor’s plan payments to
creditors pursuant to the chapter 13 plan.
5. Must be commenced voluntarily; creditors have not right to petition for an
involuntary Ch. 13 bankruptcy.
6. Postbankruptcy ppty is included in the Ch 13 estate b/c the debtor’s
performance under the plan is dependent on it.
7. It is the general policy of bankruptcy law to favor rehabilitation under Ch. 13
over liquidation under Ch. 7, on the theory that creditors are likely to do better
in a Ch. 13 case.
8. When a debtor fails to make payments pursuant to Ch 13 plan, it can be
converted into a Ch 7 case.
B. Threshold Eligibility for Ch 13
1. §109(e) – limits access to Ch 13 to:
a. natural person
b. with limited debts
i.
non-contingent limited debts below certain levels
c. and regular income
2. Regular Income – determined on a case by case basis.
a. §101(30) – individual whose income is sufficiently stable and regular
to enable such individual to make payments under a Ch 13 plan, other
than a stockbroker or commodity broker.
b. In re Murphy – Congress intended to expand and broadly define
“individual regular income” to include funding from diverse and
nontraditional sources, such as a weekly allowance from a CL
husband.
c. Does not necessarily mean monthly pmts.
i.
most courts will accept evidence of past performance
d. Gov’t pmts (i.e., social sec, welfare, etc) do count as regular income.
e. Sales commission may not be considered regular income.
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f. Czar says probably needs to be some stable prospect of income over
the next 3 yrs.
3. Types of Claims:
a. Contingent – right to pmt that depends on a future event occurring,
which event may or may not occur
b. Liquidated – claim that has been reduced to a number or easily can be
calculated
i.
some courts will require that all litigation be at an end and a
claim be calculated before they will hold that a judgment
claim is a liquidated claim.
4. The only debts that count toward the eligibility cap are those that are
noncontingent and liquidated.
C. Chapter 13 Plans
1. Generally, the plan has 3 components:
a. states what income and assets will be used to fund the plan,
b. proposes the treatment to be given to claims,
c. provides for various optional matters, such as the election on whether
to assume or reject executory contracts.
2. In order for a plan to be acceptable, debtor must propose:
a. Creditors receive at least what they would have received in a Ch. 7
case if debtor’s assets were liquidated today.
b. Debtor must devote all his disposable income (left over after legitimate
expenses) to the plan.
3. The automatic stay is zealously enforced by the courts, but it is thin protection
for the debtor.
a. will often be lifted by the judge in Ch 13.
b. Basis for lifting the automatic stay:
i.
lack of adequate protection (secured creditors)
ii.
(1) debtor has no equity in the ppty and (2) ppty NOT
necessary for an effective reorganization.
4. Debtor’s plan must be confirmed by the court.
5. Ch. 13 plan does not preclude the debtor from liquidating certain assets.
a. debtor is permitted to surrender ppty subject to a security interest,
rather than retain it and pay off the debt.
6. The plan must specify the source of funding as well as set out the proposed
periodic payments to be made by the debtor and the length of the payment
period.
7. Length of the Plan –
a. If the combined current annual income of the debtor and spouse is less
than the median family income for a household of the debtor’s size,
the plan cannot be longer than 3 yrs w/o court’s approval for cause.
b. If the combined current annual income is higher, then it can extend to
5 yrs.
8. Good Faith Requirement - the plan must be proposed in good faith and not by
any means be forbidden by law.
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a. 3 bad faith situations claimed by creditors:
i.
Idea that the Ch 13 plan does not maximize pmts to
unsecured creditors. (most common objection)
ii.
Debtor proposes to pay off a non-dischargeable claim at a
rate greater than unsecured claims.
iii.
Ch 13 plan where the unsecured creditors receive nothing.
j. Lack of good faith by debtor is a ground for dismissing or converting
the case to Ch 7. see In re Leon
k. Congress believes that by requiring all above median income debtors
to file a Ch 13 plan, unsecured creditors will receive more than they
would otherwise.
D. Classification of Claims
1. Secured Claims a. fundamental point is that a secured creditor is entitled to protection of
its secured claim
i.
entitled to receive what they would have in a Ch 7 case,
which is either the collateral or its value in dollars.
b. Adequate Protection – how is SC protected when the collateral is
depreciating in value?
i.
SC is entitled to payments equal to the decline in value to
the collateral.
ii.
3 ways a SC can be given adequate protection:
(a) debtor pays creditor small monthly payments to
make up for the decline in value.
(b) debtor may give SC a lien on an unencumbered
ppty.
(c) equity cushion – where the collateral has a
significantly higher value than the debt.
(i)
a $1k difference probably isn’t
enough.
iii.
automatic stay must be lifted by the bankruptcy court if the
SC’s claim is not being adequately protected by providing
one of the above remedies.
c. 2 things that must be calculated to determine what SC will receive:
i.
value of the collateral (SC wants high, debtor wants low)
(a) Potential methods of valuation:
(i)
Blue Book – not really a person to
person valuation so not favored by
the Court.
(ii)
Retail / K Value – highest value
(iii)
Liquidation Value – forced sale
gives lowest value.
(b) Rash – S. Ct. says that FMV for purpose of Ch. 13
is replacement value; the amt that a willing
20
buyer would pay a willing seller for a piece of
collateral as a result of arms length bargaining.
ii.
rate of interest reflecting TVM
(a) determination of what is the mkt rate.
(b) Either party may come into court and argue that
the interest rate isn’t the mkt rate and argue for a
different rate.
(c) K Approach – 5th Cir. says the K rate of interest
agreed upon by the parties will be presumed to be
the market rate.
(i)
rebuttable presumption that has been
rejected by S. Ct.
(d) Coerced Loan Approach – ask what the interest
rate would be, if in this particular situation, the
creditor was forced to lend money to the debtor.
(i)
rejected by S. Ct. b/c we don’t want
to turn bankruptcy judges into
bankers.
(e) Formula Approach – take prime rate of interest
(rate which banks charge themselves) and add
something to represent the risk of default.
(i)
adopted by S. Ct.
d. §1322(b)(2) – gives the debtor an extraordinary right – the power to
modify the terms of secured debt in Ch. 13.
i.
creditor still must receive what it would have under Ch 7
ii.
Exception – types of Ks that cannot be modified:
(a) Home Mtgs - Ch 13 plan must provide that the
bank will continue to receive equal pmts in order
for the debtor to keep their house.
(b) secured debt entered into w/in one year of filing
(c) holder of a PMSI in a vehicle entered into 910
days before filing.
e. Important terms:
i.
“Cram Down” – despite the creditors control of a Ch. 11
case, the debtor can take a plan of reorganization and cram
it down the creditors’ throats. ( a plan that is equal to their
collateral)
ii.
“Lien Stripping” – idea that in a reorganization case, once
we reduce the creditor’s claim by the value of the collateral
(when collateral in now worth less than the outstanding
debt for which it secures), there in no longer a lien on the
ppty. The lien is stripped down to the value of the
collateral.
(a) S. Ct. rejects this idea, b/c of the fundamental
principal that liens ride through bankruptcy.
21
“Lien Strip Off” – has been referred to some bankruptcy
courts’ view that if the secured creditor becomes wholly
unsecured in the bankruptcy proceeding, then the lien goes
away.
(a) Happens in situations where there are 2 claims of
creditors against the debtor, but collateral is worth
only enough money to pay the priority claim in
bankruptcy. Creditor #2’s claim will then be
considered an unsecured creditor in the Ch. 13
plan.
(b) Note: that the logical answer is that #2 will still
have a lien even though they are now unsecured
b/c S. Ct. says there is not lien stripping.
2. Unsecured Claims –
a. 2 requirements of the Code in Ch. 13 set out by §§1325(a)(4) and (b):
b. Best Interests Test – sets a minimum level for payment for unsecured
claims.
i.
purpose is to ensure that the Ch 13 plan serves the best
interest of unsecured creditors by providing them at least
what they would have received in Ch 7 liquidation.
ii.
§1325(a)(4) requires that the amt paid on each allowed
unsecured claim have a value as of the effective date of the
plan that is no lower than what would have been paid on
the claim had the estate been liquidated under Ch 7.
iii.
also applies in Ch 11
c. Disposable Income Test (Best Efforts Test)
i.
idea that a debtor ought to be required to devote all of their
disposable income to funding their plan of reorganization.
ii.
§1325(b) forbids court approval of the plan unless the plan
commits all the debtor’s projected disposable income for
the next 3-5 years (depending on where you fall) to the
payment of unsecured claims.
iii.
Applicable “commitment period” –
(a) below median income debtor = plan only has to
be 36 months.
(b) above median income debtor = plan has to be 60
months.
iv.
What is included in disposable income:
(a) spouse’s income counts
(b) money that is set aside for a religious not
exceeding 15% of gross income is not included.
(c) does not include money for the preservation,
continuation, and operation of business.
(d) domestic support obligations that first become
payable postpetition are not included.
iii.
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(e)
bankruptcy court has complete discretion in
determining the debtor’s reasonable expenses
v.
How to calculate disposable income:
(a) Calculate debtor’s current monthly income
(b) Ascertain the median family income
(c) If debtor’s current annual income is less than the
median family income:
(i)
calculate debtor’s disposable
monthly income and multiply by 36.
(d) If debtor’s current annual income is above the
median family income:
(i)
calculate debtor’s disposable
monthly income and multiply by 60.
d. Extending the provision plan – usually can be extended from 3 -5 yrs,
but not over 5.
i.
§1322(d): to extend, the court must show for cause (all
pro-debtor):
(a) debtor will be able to pay off more of their debt in
5 yrs.
(b) to give debtor more time to meet the 70%
requirement, so that Ch 7 may be filed w/in 6 yrs §727(a)(9).
(c) debtor falls on hard times due to something out of
debtor’s control.
e. Debtor has the opportunity to place unsecured claims in separate
classes.
i.
3 guidelines for classifying claims:
(a) claims in the same class must be treated alike
(b) plan must not discriminate unfairly against any
class
(c) claims can only be classed together if they are
substantially similar.
ii.
No requirement that all similar claims be in the same class,
but all claims in a class must be similar.
3. Priority Claims –
a. all priority claims must be paid in full by deferred cash payments
unless the holder agrees to different treatment.
b. B/c priority claims have to be paid in full, the order of priority in §507
is not directly relevant in a Ch 13 case as it is in Ch 7.
d. However, the ranking has some impact on the treatment of the claims.
i.
if a class of claims would have received nothing had the
case been filed under Ch 7 (b/c the fund would have been
exhausted by senior classes), the plan need provide only for
full payment of the face amount of claims in that class.
ii.
However, if the class would have been paid in full under
Ch 7, the best interest test requires that the class receives
23
iii.
the PV of the Ch 7 distribution, which includes interest on
the face amt of the claims.
If the class would have been treated somewhere in the
middle (receiving a pro rata pmt), the amt paid under the
plan must be the greater of the face value of the claim or
PV of the Ch 7 distribution.
E. Modification and Dismissal of Claims
1. §1307(a) – debtor may convert to chapter 7 anytime.
2. §1307(c) – court can convert the case to Ch 7 for a variety of reasons.
3. §109(g) – doesn’t allow for a debtor to file a Ch 13 petition, and then file
again in the near future to take advantage of the automatic stay.
a. Can’t file Ch 13 if you’ve done it in the preceding 180 days if:
i.
debtor didn’t show up for court in the past filing
ii.
debtor voluntarily dismisses the case and then co-files, so
to avoid automatic stay (bad faith)
4. Modification After Confirmation –
a. debtor may modify in any way as long as the creditor still receives
what it was entitled to.
b. §1329(a): at any time after confirmation of the plan, but before the
contemplation of payments under such plan, the plan may be modified
upon request of the debtor, trustee, or holder of unsecured claim.
i.
modification usually occurs when unsecured creditor finds
out that debtor’s income has increased, which causes
increase in disposable income.
ii.
can ask for modification to:
(a) increase or reduce the amt of pmts on claims for a
particular class provided by the plan;
(b) extend or reduce the time of such pmts
(c) alter the amt of the distribution to a creditor
whose claim is provided for by the plan to the
extent necessary to take into acct any pmt of such
claim other than under the plan.
F. Discharge Under Ch 13
1. More debts are dischargeable under Ch 13 than Ch 7
2. Discharge only occurs after the payments are made to the creditors pursuant to
the plan.
3. Non-dischargeable Debts under Ch 13:
a. DSOs: alimony, maintenance, child support (excluding ppty
settlements)
b. student loans
c. injury from operation of vehicle while intoxicated
d. criminal restitution
4. Does not include taxes as non-dischargeable.
24
a. However, it is a priority unsecured claim, and all priority secured
claims must be paid in Ch 13 or it will be turned into Ch 7.
5. §1328(b): can get discharge even if you haven’t paid pmts if:
a. debtor’s failure to pay is due to circumstances out of his control
(usually illness), and
b. creditors have received as much as they would have received in Ch 7
liquidation, and
c. modification is not practicable
6. §1328(c): if you don’t complete your plan pmts, all the Ch 7 non-discharge
provisions apply
7. §1301 – stay of action against co-debtor
a. if you have a co-signor on a debt and you file a chapter 13, the
automatic stay applies to a co-signor (does not apply in Ch 7).
V.
CHAPTER 11: REORGANIZATION
A. Ch 11 Reorganization v. Ch 13 Reorganization
1. Model of Ch 11 is usually used by corporations and partnerships, but can be
used by individuals in certain instances.
a. available to most debtors who qualify for Ch. 7, including individuals
that exceed the debt limits for Ch 13.
2. The differences b/w Ch 13 and Ch 11:
a. in Ch 11, the creditors must approve the plan of reorganization.
b. the debt of a business debtor is often more complicated than that of an
individual.
c. Ch 11 has debtor-in-possession (DIP) instead of Trustee.
3. Some Ch 11 reorganizations are purely financial, that is the business
operations remain the same, while others involve a wholesale reshuffling of
the business operations.
a. the key point in either type is that all of some large part of the business
is preserved as a going concern rather than sold off one piece at a time.
4. Creditors must get at least what they would get in Ch 7.
5. Debtor-in-Possession (DIP) - usually an officer or director of the company
which is in bktcy.
a. debtor remains in possession of its assets of the bankruptcy estate
during bankruptcy
b. However, if debtor’s mgt is looting the company or seriously
mismanaging the company, the creditors can get together and petition
the court to appoint a trustee.
B. Mechanics of Ch 11
1. Ch 11 case can be filed voluntarily or involuntarily.
a. can be converted involuntarily only from a Ch 7 case, and can be
dismissed or converted to Ch 7 by party other than debtor for cause.
2. When the petition is filed, the automatic stay goes into effect.
25
3. The business continues to operate “in the ordinary course,” under the control
of the DIP.
a. DIP controls the estate and has all of the powers and duties of a
Trustee.
b. has avoidance powers
4. Debtor negotiates a plan of reorganization with its major creditors.
a. the Ch 11 petition is an invitation to a negotiation\
5. A creditor’s committee is appointed to scrutinize the debtor’s activities on
behalf of all the creditors and to negotiate with debtor.
6. To conclude the bankruptcy, the debtor will propose a plan of reorganization,
in which it will offer to pay each “class” of creditors a certain percentage of
their claims over a stated period of time, with pmt being in cash, ppty, or
securities.
7. If the plan is approved by the specified majorities of creditors in each class, it
will be confirmed by the court granted that every creditor who did not accept
the plan will get at least what they would have rec’d in Ch 7.
8. Upon confirmation of the plan, the debtor is discharged from all its prepetition debts except as provided in the plan.
a. Note: different from Ch 13 where debtor is not discharged until the
plan has been completed.
C. Automatic Stay and Adequate Protection
1. Chapter 11 plans take longer to put them together, often 6 months to 2 years.
Why? The creditors must approve the plan.
2. During this time, the stay is in place and the creditors are watching their
collateral decline in value. So, under chapter 11, adequate protection is more
of a problem.
3. Exceptions to the stay:
a. Filing of a criminal case and/or continuation of a criminal case filed
against you does not violate the automatic stay.
b. 362(b)(2) – a case is not stayed if it is a civil proceeding for the
establishment of paternity, custody, DSO, divorce, or any other pure
domestic relations type cases.
4. Lifting the stay §362(d):
a. for cause – lack of adequate protection
i.
collateral is greatly decreasing in value
ii.
the debtor may have to pay the decline in value, so that
creditor is adequately protected. The expert testifies to the
decline in value.
iii.
Court must lift stay if the decline in value is occurring
iv.
Also, secured creditor can require the debtor to maintain
insurance, etc… on collateral and if they don’t, the stay is
lifted – drop dead order.
v.
Market rate of interest on value of collateral isn’t included
in adequate protection.
26
vi.
**3 ways debtor may provide adequate protection so the
stay is not lifted: debtor pay creditor small monthly
payments, debtor give creditor a lien on unencumbered
property, creditor has an equity cushion.
b. secured interest equals or exceeds the value of the property – debtor
has no equity in property and property isn’t necessary for effective
reorganization.
i.
General presumption, if debtor has no equity it goes to
creditor despite the stay.
ii.
Debtor must show that property is necessary for
reorganization.
c. single asset real estate – apartment, hotel
i.
this provision lifts automatic stay if you don’t file w/in 90
days of order for relief unless debtor files reorganization
plan and it has a reasonable chance of being approved.
ii.
Also, this provision lifts automatic stay if debtor doesn’t
include lost opportunity cost (interest) in adequate
protection payments.
iii.
Only applies to one piece of real estate.
iv.
Speeds up chapter 11 process in these types of cases.
5. For the most part, secured creditors are the only ones in position to lift the
automatic stay.
a. For other creditors, any hope of an early escape in Ch 11 is by motion
to convert it to a Ch 7 case or motion to dismiss.
b. for conversion, you must show futility of a Ch 11 reorganization.
c. to dismiss, you must show bad faith.
6. § 362(e): automatic stay litigation must be decided in 30 days, or the stay is
dissolved. Czar says this is the most ignored provision in Bktcy Code.
D. Trustee’s Avoidance Powers §544
1. The basic idea behind 544 is that the Trustee should have the same avoidance
rights that would be available in nonbankruptcy law to the classes of persons
identified in the section.
2. 544(a) – The Strong Arm Clause: gives the Trustee the power to avoid or
undo certain prebankruptcy transactions.
a. 544(a)(1): BT has the status of a judicial lien creditor and
corresponding avoidance power.
i.
gives BT priority over all subsequently perfected and
unperfected security interests.
ii.
If the BT can show that the security interest was not
perfected in any way, the secured creditor becomes an
unperfected secured creditor.
(a) This effectively makes the secured creditor an
unsecured creditor in bankruptcy, b/s the BT, as a
judicial lien holder, takes priority over
unperfected security interests
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3.
4.
5.
6.
b. 544(a)(3): gives BT status as a BFP of real ppty and corresponding
avoidance power
i.
Status of a judicial lien creditor is not sufficient to defeat
all unperfected liens in real ppty. However, a BFP will
defeat such liens.
(a) Therefore, BT is given this status to give him the
same power w/regards to real ppty that he has for
personal ppty.
ii.
If under nonbankruptcy law a BFP would take precedence
over the preexisting interest in it, the BT can avoid the
transfer of that interest.
544(b)(1): BT may avoid any transfer made or obligation incurred by the
debtor that is avoidable in prevailing nonbankruptcy law by a creditor holding
an allowable unsecured claim.
Federal Tax Liens – the gov’t has super powers in connection w/collecting
taxes. The minute a tax assessment is made the gov’t obtains a security
interest in all of your ppty. Gives it an unperfected lien. Unless it takes
additional action they will not get ppty that is encumbered by pre-existing or
subsequently perfected liens.
a. Gov’t must file the tax lien. Until then, they are an unsecured creditor.
b. Filed tax lien as the powers of any other perfected lien, including
defeating the BT.
Executory Ks – K that has not been full performed on both sides.
a. When a debtor files bankruptcy, the trustee has the power to either
assume or reject the executory K when he feels it is in the interest of
the debtor.
Statutory Liens – liens that are not judgment or consensual liens and arise by
statute.
a. Ex. – mechanic’s lien, inn keeper’s lien
b. Generally liens ride through bankruptcy.
c. 2 types that are avoidable in bankruptcy:
i.
Landlord’s lien
ii.
Statutory liens that only arise upon the debtor’s insolvency.
(a) favored creditors by state legislatures will not be
permitted to opt out of bankruptcy proceedings
(b) §545 has a list of test for insolvency:
 When bankruptcy petition is filed
 When another proceeding indicating
insolvency if filed
 When a custodian is
appointed/authorized to take possession
of ppty.
 When a debtor becomes insolvent.
(c) If any of these tests are met then the statutory lien
would be deemed to arise upon debtor’s
insolvency, and will be avoided.
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E. Preferences
1. Seeks to deter debtor behavior of paying off certain creditors prior to filing
bankruptcy.
a. By receiving a pmt right before bankruptcy, the creditor will receive
more. He is a preferred creditor.
b. Ex. - debtor has three creditors and one is his brother, debtor only has
$1k total. Each creditor is owed $1k. You give the $1k to your
brother on the eve of bktcy, instead of $333 to each creditor. By doing
this, your brother has become a preferred creditor.
c. Does not necessarily mean he is being paid in full. Even partial pmts
will give them more than they would receive in bankruptcy % wise.
2. All unsecured creditors, with the exception of priority creditors, should be
treated equally.
3. Purpose of the Preference Statute is to deter debtors from preferring
creditors prior to bankruptcy that would subvert the distribution process
of bankruptcy.
4. No scienter requirement – therefore, the Trustee does not have to show intent.
5. §547(b) – trustee may avoid the transfer of any interest of the debtor in ppty.
a. transfer of interest means money, property, etc…any property being
transferred – including assignments and transfers of security interest.
b. gives the trustee the power to have the court declare a security interest
null and void.
6. Elements:
a. transfer must be to or for the benefit of a creditor.
b. for or on acct of an antecedent debt owed by the debtor before the
transfer was made.
i.
must be on acct of a pre-existing debt.
c. made while the debtor was insolvent.
i.
547(f): rebuttable presumption that 90 days prior to filing
bankruptcy, the debtor is insolvent.
ii.
If within the 90 days, debtor will have to prove solvency...if
over 90 days, trustee will have to prove insolvency.
d. made within 90 days of bankruptcy filing.
i.
this is the normal reach back period.
ii.
However, the reach back period extends b/w 90 days and 1
year.
(a) Can always avoid w/in 90 days
(b) Can avoid up to 1 yr if the creditor involved with
the transfer was an insider of the debtor.
e. Creditor received more than he would have received in Ch 7.
i.
(5) will always be met unless the transfer took place in 1
of 2 situations:
(a) debtor is solvent (can pay all creditors in full)
(b) pmts are made to an oversecured creditor.
7. Exceptions to Preference §547(c):
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a. Even if all of the elements of 547(b) are met, the transfer can still not
be made avoidable.
b. Contemporaneous Exchange - the deal was meant to be substantially
contemporaneously made. It must be intended by debtor and creditor
for a new value.
i.
Contemporaneous usually means w/in a couple of hours.
ii.
Ex. – grocery store w/cash (not check)
c. Ordinary Course Exception - debt incurred in the ordinary course of
business of debtor and transferee; payment must have been made in
ordinary course of business, and must have been paid according to
ordinary business terms. (ordinary for that particular debtor)
i.
Courts have held that start up loans can be avoided b/c they
are not ordinary. (only made once)
d. Subsequent New Value Exception – Debtor is sliding toward bktcy;
debtor pays money back and gets new items and then files bktcy.
Congress wants to encourage people to deal with debtors who are
about to file bankruptcy. This exception gives creditors incentive to
deal with these debtors, b/c they will get credit for the new value
extended to them.
i.
Ex. 1- Debtor is sliding towards bankruptcy. On Day 0
debtor pays creditor $1000 on preference antecedent debt.
On day 5 creditor extends credit to debtor for $5000. If
debtor then files bankruptcy, the debtor can off-set the pmt
by the new value that was extended. So in this case, debtor
can offset the $1000 preference pmt by the $5000.
ii.
See p 510. list in 24.4.
o First thing to determine is whether the pmt is a
preference at all.
 is it w/in the preference period?
o Only get to offset extensions of credit that occur
after the preference period.
o First preferential pmt is made on 2/10 for $2k.
Subsequent to that, new extensions of credit are
extended amting to $17k. This offsets the $2k
preferential pmt. Creditor will not have to pay the
$2k back.
o Next preferential pmt is on 3/10 for $1k. Notice you
cannot use the $17k to offset it b/c you can only use
subsequent new credit to offset. New credit was
issued on 3/17 for $6k. This can be used to offset the
$1k pmt.
o 2 more preference pmts on 3/20 and 4/1 amting to
$19k. No new credit issued subsequent to that, so
creditor will be subject to $19k in preference
exposure.
e. Earmarking Doctrine – limited and all of the elements must be met.
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i.
Situation where one creditor steps into the shoes of another
to pay off a debt in exchange for a promise by the other
creditor to repay him.
ii.
As long as there is no diminution in the debt, there is no
preference problem and Trustee can’t avoid this debt.
8. Security Interests - §547(e)(2) provides for when delayed perfection of a
security interest will constitute a preference.
a. gives creditors a 30 day grace period to perfect their security interest.
b.
Ex. – w/in preference period bank is granted a security
interest in collateral. 20 days after the granting of the
security interest the bank finally gets around to filing a
financing stmt in order to perfect.
i.
547(e) says if the creditor perfects the security interest
within 30 days of the security interest attaching, then the
perfection relates back to the date of attachment.
ii.
There will be no preference, b/c the security is deemed to
be perfected at the date of the initial transaction b/w the
parties.
-
NOTE: Whenever you see transactions made by the debtor before
bankruptcy, you must ask yourself whether the transactions led to avoidable
transfers. It will probably be a preference or fraudulent conveyance.
F. Fraudulent Conveyances
1. As a debtor slides toward bankruptcy it is simple predictable to our nature that
debtors will try to hide their assets.
2. Not only are actual fraudulent transfers before the debtor files bankruptcy are
avoidable but also constructive fraudulent transfers.
3. Reach back period is 2 years.
4. Actual Fraudulent Conveyance - §548(a)(1)
a. Transfer of interest in ppty that occurred w/in 2 yrs of filing, and the
transfer was made w/actual intent to hinder, delay, or defraud
creditors.
b. Badges of Fraud – if these are present court will impute fraud into
debtor’s transfer:
i.
transfer occurred right before bankruptcy when the debtor
was aware that he was insolvent and intended to file for
bankruptcy.
ii.
any transfer made to a close relative or insider.
iii.
Not an exhaustive list. May always claim that a transfer is
a badge of fraud.
5. Constructive Fraudulent Conveyance - §548(a)(2)
a. makes avoidable transfers by the debtor that are made:
i.
within 2 years of filing for bankruptcy,
ii.
at a time when the debtor was insolvent, and
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iii.
where debtor receives less than reasonable equivalent value
in exchange for such transfer.
b. Reasonable Equivalent Value: Debtor has a responsibility to get
reasonable value when they are insolvent b/c he has the duty to first
pay off creditors, and you can’t do so w/o receiving reasonable value.
i.
Price obtained at a properly conducted foreclosure is
deemed to be reasonable equivalent value.
c. Guaranteeing Debts – situation when one subsidiary guarantees the
debt of another subsidiary, this called a cross-stream guarantee.
i.
this will be deemed a constructive fraudulent conveyance
when it is made w/in the 2 year reach back and at a time the
debtor is insolvent, b/c a guarantee is a transfer of interest.
ii.
The type of intangible benefit in this situation can
constitute value. A by guaranteeing the debt of B made it a
more stable company which is a value to A.
iii.
Court still may be able to scrutinize the alleged value. If
they find that it is reasonable equivalent value, the act of
guaranteeing the debt will not be held to be a CFC.
6. Exception to Fraudulent Conveyances:
a. Charitable Contributions i.
Bankruptcy Courts used to hold that you did not receive
reasonable equivalent value for donating money to charity,
and was therefore a CFC.
(a) Note the arguments for both sides.
ii.
548(a)(2) – a transfer of a charitable contribution to a
qualified religious institution will not be considered a CFC,
where:
(a) The amt of contribution does not exceed 15% of
gross annual income, and
(b) Transfer was consistent with debtor’s regular
contributions.
b. Gambling –
i.
Day before debtor files bankruptcy, while he was insolvent,
he cleans out his bank account. He then goes to a casino
and blows it all. Next day he files bankruptcy.
ii.
note the arguments for both sides
iii.
Most courts will say that there is value (intrinsic
entertainment value), and refuse to inquire into the
equivalency of the value.
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