bankruptcy outline - f09 - jjwhite (1)

Downloaded From OutlineDepot.com

I. INTRODUCTION............................................................................................................................................. 3A. STATISTICAL OVERVIEW..................................................................................................................................................3B. TRUSTEES........................................................................................................................................................................... 3C. BANKRUPTCY COURT........................................................................................................................................................4D. DEBTOR V. CREDITOR...................................................................................................................................................... 4

II. BANKRUPTCY ESTATE............................................................................................................................... 4A. COMPOSITION OF ESTATE................................................................................................................................................4B. AUTOMATIC STAY..............................................................................................................................................................6C. EXEMPTIONS FROM ESTATE............................................................................................................................................8D. CLAIMS AND DISTRIBUTIONS.......................................................................................................................................14E. DISCHARGE.......................................................................................................................................................................17

III. CHAPTER 13.............................................................................................................................................. 19A. OVERVIEW....................................................................................................................................................................... 19B. POLICY.............................................................................................................................................................................. 20C. PROCEDURE..................................................................................................................................................................... 20D. LITIGATION......................................................................................................................................................................22E. EXCEPTIONS TO CRAMDOWN........................................................................................................................................23

IV. CHAPTER 7................................................................................................................................................. 24A. BACKGROUND.................................................................................................................................................................. 24B. PROTECTION FOR LOW INCOME DEBTORS..................................................................................................................24C. MEANS TEST.................................................................................................................................................................... 25D. STATISTICS.......................................................................................................................................................................26

V. CHAPTER 11................................................................................................................................................ 26A. INTRODUCTION............................................................................................................................................................... 26B. SUCCESS OF CH. 11’S.....................................................................................................................................................27C. OBJECTIONS..................................................................................................................................................................... 27D. DIP LENDER................................................................................................................................................................... 27E. GETTING IN & OUT........................................................................................................................................................ 29F. COSTS................................................................................................................................................................................ 29G. § 1121............................................................................................................................................................................. 29H. § 1122............................................................................................................................................................................ 30I. § 1124.............................................................................................................................................................................. 31J. § 1126.............................................................................................................................................................................. 31K. § 1129............................................................................................................................................................................. 31L. ABSOLUTE PRIORITY RULE PROBLEM........................................................................................................................35

VI. AUTOMATIC STAY & ADEQUATE PROTECTION.............................................................................35A. § 362................................................................................................................................................................................35

VII. OPERATING IN CHAPTER 11............................................................................................................... 38B. CASH COLLATERAL.........................................................................................................................................................38C. SETOFF.............................................................................................................................................................................. 38D. POST-PETITION FINANCING.........................................................................................................................................40E. AVOIDANCE POWERS..................................................................................................................................................... 45F. § 365 & EXECUTORY CONTRACTS..............................................................................................................................51G. TAX CONSEQUENCES OF BANKRUPTCY.......................................................................................................................54H. STATUTORY LIENS......................................................................................................................................................... 54I. FRAUDULENT CONVEYANCE...........................................................................................................................................55

1


J. EQUITABLE SUBORDINATION.........................................................................................................................................56K. NEGOTIATION AND CONFIRMATION OF CHAPTER 11 PLAN..................................................................................57

VIII. ENVIRONMENTAL & MASS TORT CLAIMS.....................................................................................60A. INTRODUCTION............................................................................................................................................................... 60B. ASBESTOS.........................................................................................................................................................................60C. ENVIRONMENTAL CLAIMS.............................................................................................................................................61D. MASS TORT..................................................................................................................................................................... 63

IX. § 363 SALES................................................................................................................................................ 63A. OVERVIEW....................................................................................................................................................................... 63

2


I. IntroductionA. Statistical Overview

1.5 million bankruptcies this year in U.S. Out of 1.5M, only 30,000 are non-consumer

o 100 of those are the “big ones”o 1.1M consumer will be Chapter 7o 400,000 will be Chapter 13

CC companies said lots of people have income and can be in Chapter 13o 5 years of fighting: (1) existence of such people and (2) how to identify themo Forced lots of people to file in 2005 before new act became effective

Standards set to force into 13 so high that very little people fit ito White feels that CC companies probably wrong

Not a very big # that were in 7 that could be in 13o For now more Ch. 13’s than pre-2005, but equalizing again

Out of bankruptcy cases, over 70% are no-asset caseso Nothing left for creditors

B. Trustees US Trustee appointed and resides in Washington

o Appoints other trustees throughout US to be US Trusteeso They appoint trustee panel which are practicing attorneys

Judge not involved with assigning TIBo Setup by US Trusteeo Have 341 hearing where debtor answers to creditors and trustee

Nobody comes because in majority of cases there are no assets Some repeat lenders will send someone everyday to the court to ask

questions in every 341 case to try to find other assets (Sears) If you are TIB, how do you find assets?

o 341 hearing is one wayo Most TIBs are pretty passive because they know that generally won’t find

anything Chapter 13 Standing Trustee

o This person is a full-time trusteeo Sits with debtor to help him work out plan of payment and figure out, along

with debtor’s lawyer, what he can pay to creditor over 3-5 years or whatever DIP (debtor-in-possession) in Chapter 11 Cases

o Usually old managers or they’ll bring outside managers in to run it Used to appoint trustee years ago – generally a smart lawyer They make stupid business decisions Would you rather have knave or a fool? Sometimes bring in reorganization companies

o For most purposes DIP is basically a trustee DIP can control what happens to things so motivated differently

In Chapter 7, trustee just sells assets to maximize returns

3


So DIP is similar to trustee, but not identicalC. Bankruptcy Court

Judges appointed to 14 year termso Bankruptcy judges like the Chapter 11 cases because it makes their life a

little less boring Jurisdiction

o You can file almost anywhere you are incorporated, have a business location, or where subsidiary has filed

So typically have power to file, if in big case, half a dozen jurisdictionso Why go to NY or DE?

They do more cases, so less work for debtor’s lawyer and more predictable to go to NY or DE judges

Getting judge for many years, not days Predictable judges

In many places they will assign judges based by week Rigged system so you know what judge you’ll get when you file

Really this leads to massive forum shopping Jurisdiction issue is a little screwy

D. Debtor v. Creditor You would much rather be debtor’s lawyer because if a huge company like United

Airlines or GM you will staff tons of people on it because of all the creditorso Creditor attorney only staffs a few people to squeeze whatever little money

out you can Counter-intuitive, but that’s the case

II. Bankruptcy Estate In theory, you’re setting up an estate in which assets are collected to be sold off and

money distributed to creditorsA. Composition of Estate

§ 541(a) says any property wherever locatedo (a)(1) also says legal or equitable interestso (a)(3) assets that will be brought into estate by actions trustee takes after

appointedo (a)(5) any bequest you get within 180 days of filing

Proceeds of pending lawsuit where parents enter bankruptcy 150 days after plane crash that killed daughter who will get settlement from NWA for the crash?

Not in estate because the wrongful death action which they had within the 180 day window wasn’t inherited

Who owns a wrongful death action? Depends on state law But if owned by survivors, don’t get it because not bequest,

devise or inheritance

4


This could be different if in a different state the action was owned by the estate of the deceased, in which case the beneficiary of the estate (parents) receive money by bequest/inheritance

o Important to realize that bankruptcy code is built on back of state law General proposition is that stuff before filing date is in the estate and stuff after the

date is outo That’s slightly inaccurate, but in general that’s the rule

Salaryo If work a week before the date and week after, part of the salary after

petition not in estate Not like the bonus case (Sharp v. Dery) because the company is

obligated to pay the wage, unlike the bonus Bright Line Rule

o Fresh start – after the date, debtor gets fresh start instead of continuing to struggle under debt

Otherwise bankruptcy is irrelevant Problem 5.1 (130)

o Shouldn’t he have to give up the retirement account (last thing on list of 5.1)? No, even though unfair to creditors - $1M in an IRA Congress supports policy that encourages to invest for retirement So really the line isn’t all that bright when push comes to shove Product of lobbying efforts

o Suggests a virtue of state law over federal law – what’s that? In order to change uniform law, have to lobby and change all 50 states

Easier to change Federal law rather than uniform state law Uniform law is more conservative; doesn’t get changed every year

To change bankruptcy code, contribute to senator’s campaign Why federal income tax and bankruptcy statutes are hard to read

Uniform codes read like a novel compared to the Federal statutes

o All of these things are in the estate even though arose after date of filing because they are attached to and arose out of something within the state

Problem 5.3 (Post-Petition Work)o Argument to not include income from crop is that at date of filing, debtor

works for herself, not for the estate But crop belongs to estate because it’s a pre-petition asset So go to the trustee and ask to pay her to take care of the crop

o Where work has to be done afterwards there has to be a negotiation Trustee will want to pay to take care of crop because that’s where the

money will come fromo But what if assets in estate are illiquid?

The creditor will possibly want to lend the money in order to secure their pay

Could possibly get a loan, but not sure

5


362(a)(3)-(5) may give bank pause for the post-petition loan but probably meant to restrict pre-petition claims

So what does the bank do? Just get the bankruptcy court to bless the grant of the security

interest 363 gives power to trustee in bankruptcy to borrow money

and other such powers Probably want court’s approval, and with that you’re golden

o So this problem is really there to present with issue of what is the right outcome when the debtor has lost the benefit of a particular asset, but the asset still needs care

Problem 5.4o Spendthrift trust won’t be in estate under 541(c)(2), but worried she’ll die

within 180 days and trustee will step in and say money of estateo If worried about this, file immediately

Every day that goes by is a day lost, so file now and maybe send mother to Mayo clinic to get her to last longer than 6 months

If doesn’t live 6 months goes to trustee, if longer then yourso Trustee will generally negotiate over this and perhaps settle

Problem 5.6o Liquor license is property and part of estate despite Article 9 saying it’s not

property so can’t grant security interest in it State has an interest in regulating liquor licenses Licenses are for sale as practical matter, but only in limited way But probably treated as property and will be treated more and more

so Lots of recent Article 9 cases that reject old rule

o Transfer Restriction is invalid 541(c)(1)(A) says all of these restrictions struck aside in bankruptcy

o So debtor has to fall back on argument that license is not property That’s a state law issue probably But for sure if state law says it’s property, then debtor is out of luck

Problem 5.1o What about account where debtor is trustee of nephew’s trust account?o 541(d) says that if doesn’t have equitable interest, then not in estate

Only has legal interest – pay taxes, manage, etc… Nephew owns equitable interest as beneficiary

B. Automatic Stay Lawsuits stop immediately upon filing

o Collection agencies can no longer call and ask to payo Everything really just stops, with exception of the exceptions in 362(b)o Repo company can’t hold car but has to give it back

Automatic stay is unbelievably powerfulo Important benefit to the debtor

Problem 6.1

6


o Creditors must stop collection actions or they violate stay and will be subject to damages

Under § 362(k)(1) can get actual damages, fees and costs, and punitive damages if appropriate

Damages could be really big When individual bankruptcy and someone keeps coming after you,

you have a lot of power Who is most likely to mess around and who is most likely to stay

away? The nastiest creditors will be the most sophisticated But sometimes have screw-ups that will continue to harass

o Service Lien Almost all state law says if provide service on something and have

possession, you have a lien So probably a mechanics lien on car if the mechanic still has Stay may force him to give car back, but will probably continue

lien secured by the car If gave car back pre-petition, though, garage is screwed and

just becomes unsecured creditoro Secured Creditor

If have valid perfected security interest it rides through bankruptcy and can be enforced on the asset

If wants to keep the car, has to make a deal with the creditoro Can keep and pay the creditor if they agreeo Or he can redeem the caro Or he can negotiate with the creditor on a

Reaffirmation So he will have to pay for the car, one way or another Even though after bankruptcy he won’t be liable personally –

it’ll be a nonrecourse debt Problem 6.2

o § 521 Can make out schedule of assets/liabilities Schedule of income an expenditures can be made out But she doesn’t have copies of paystubs Disclosures intended to make fraud more difficult and encourage fair

revelation of assets 521(b) says must provide certificate from debt counseling agency

Can possibly have her do it online that afternoon Also needs tax returns though, but don’t need those until creditor asks

for themo § 521(i)(1)

Does it authorize you to file without the things she doesn’t have as long as file in 45 days?

Doesn’t say that so we don’t know

7


Nobody knows what that meanso What risk do you take as a lawyer if you file this?

§ 707(b)(4)(C), (D) You can make reasonable estimate of car just by looking at it and

checking KBB Just says after inquiry – do you just take her word?

We don’t really know what this means Answer probably different in every jurisdiction

Rules in every jurisdiction and they aren’t the same Must find out local rules/practices on this issue

o Petitioner’s attorney can’t be paid out of estate Must get fee and filing charge up front or you won’t get paid Must ask client how they will pay for bankruptcy after explaining cost

CC folks like that because drives some people away from bankruptcy

This is part of what came out of 2005 amendments Impossible to know how many people are deterred by this

People will come to you with sob stories but you have to get paidC. Exemptions from Estate

They operate in and out of bankruptcyo Operate out of bankruptcy in cases of seizure,

garnishment, etc…o Collection business would go find assets to seize

Usually done illegally (bribing bank workers, etc…)

Doesn’t work that way much anymoreo Generally see exemptions outside bankruptcy when

creditor gets judgment and levies asset Go into court and assert right to property as

exempt Started as exemption rules in state law litigation

o Bankruptcy law has mostly shoved if off the stage Exemption Election

o § 522(b)(2) provides election to go under § 522(d) or § 522(b)(3)(A) Reverse preemption – State law gets to preempt the federal law

It’s this way because Congress says they cano 30 days after file must make election between state law or federal law

More than majority states have opted-out 522(b)(3)(A) says take the exemption of the state

Use the state you lived in for past 2 years and if moved in that time, use place you lived at 180 days prior to the last 2 years

It’s avoiding people fleeing to generous state like FL in the face of problem

Always a big fight over these exemptions Close to putting federal cap on homestead exemption

8


Interstate movement is one of the things that will do that for the big cases in the paper

o In some cases, but not all, you get two choices Problems with exemptions

o Classification of assets The exemptions are labeled with things like “annuities” and have to

decide what annuity means to determine if certain things are exempt In some cases, may be unlimited exemptions, so very important

o Also problem with cases about proceeds Exemption for wages and money for child support

Dollar amounts don’t matter – if child support, it’s exempt But what about wages?

What you get from your employer for the work you provide is very clearly wages

But once you get paid, you no longer have wages but have money, so it’s different

o JJ doesn’t care about any of these rules for the course – he just wants us to know how important the rules are and how squirrelly the decisions can be when judge wants to favor certain party to case

Security Interests in exempt assets?o § 522(c)(2)

Can give security interest in exempt asseto Example

Car worth $12,000 wholesale, $17,000 retail, $12,500 secured debt Exemption under Federal law is $3,225 (§ 522(d)(2)) What will happen to this car in bankruptcy?

§ 506(a)(2) says to use replacement value instead of sale value for individual case under Chs. 7 or 13

So have $17,000 to split among creditor, debtor and trustee in bankruptcy

o Assuming get $17,000, creditor gets $12,500, then debtor gets $3,225 based on exemption, and then trustee gets the rest

o If doesn’t bring $17,000 but only $12,000, all goes to the creditor

More common in real estate than other places that value of collateral will exceed amount of debt and exemption

Assume $140K mortgage and $20K exemption. Trustee interested only if sells for more than $160K

Problem 8.1o Furniture is all exempto Law books

522(d)(6) says, if she’s a lawyer, her law books are in, but only get 2025 instead of 2400

Probably foolish to put down 2400

9


But how can she get the other 375?o They won’t have homestead exemption, so they can use

half of that under (5) for other thingso Cash value on insurance

She gets this under either (d)(7) or (d)(8) – what’s the difference between the two?

White not sure what fits thereo Disney Stock

Nothing generally, but maybe under homestead exemption excess (5)o Checking account

Can’t get in Texas, but can get it under unused portion hereo What about Harv’s vehicle on blocks?

Doesn’t qualify for automobile exemption because has to be operating probably

Problem is that defined by state law if state exemption so difficult to know generally

Question whether this is a motor vehicle or not But will get the moped

o Motorized wheelchair? 522(d)(9) says professionally prescribed health aid is exempt

As long as prescribed and probably will be In Texas, get § 42.001(b)(2) as well But what about Wyoming? Not exempt there, so what about there?

Wheelchair is very important to him, so will the creditors seize it if they aren’t in bankruptcy?

They have a right to seize it Could get reaffirmation. What is generally reaffirmed?

Generally caro Almost always they need it and there’s a security

interest in it What if creditor says will repossess unless pay total amount of

debt?o But you say car only worth $10K, so will reaffirm for

that because under 506 that’s the value Creditors won’t do this

o Why would you reaffirm to pay a debt for more than the asset is worth?

It’s worth more money because he knows it and its history

He probably has transaction costs built in too If doesn’t have car to get to work tomorrow, may

lose job Clearly if have security interest in wheelchair, he’ll reaffirm because

it’s very important to him Problem 8.3

10


o The Numbers $25K exemption amount, mortgage for $130K, FMV of $180K, auction

value of $129K Expected to be lowball sale

o Under what circumstances is TIB interested in house? Only if more than $155K (mortgage + exemption), plus commissions

for sale ($6K), so now have to get $161K to make it interestingo What will happen if up for sale?

Could go for $180K – on market for a few months and pay commission, etc…

Assumes whole sales process, advertising, waiting, etc…o What about foreclosure sale or auction?

Faster but lower price, about $130K TIB will abandon property because will get nothing

Bidders will be mortgagee for sure Bank will pay by debt forgiveness and will bid up to $130

o That means other buyers will have to bid above that amount and you will pay mortgagee $130K and the rest will be paid to debtor and TIB

So bidding against mortgagee who brings just debt they’ll write-off In these circumstances, mostly selling for amount of the

mortgage Mortgagee will turn around and then resell it on market

hopefully for the $180 But banks not looking to make lots of money in these cases Tough to get mortgagee to agree to reaffirmation

Problem 8.4 (variation of it)o Debtor goes into bankruptcy and has fridge bought from Sears who has

security interest ($400) Also has furniture, appliances, household goods Then has loan for $3000 with perfected security interest in the

household goodso What happens to Sears?

Interest recognized in bankruptcy because interest automatically perfected and will get the fridge

Maybe ask for reaffirmationo The other loan is not purchase money, however (generally either cost to

purchase or amount borrowed to pay someone to get good – security interest given at time of purchase to fund purchase)

Loan is non-purchase money security interest that is perfectedo So what happens with the loan?

522(f)(1)(b) - “to extent that the lien impairs an exemption” In other words, can only avoid the lien to the extent of the

exemption Assuming exemption higher than value, then avoids full lien

11


o Policy Rationale Things secured in non-purchase money interests are things of no

value to creditor but high-value to debtor Photographs, beat up furniture from kids, etc…

Collateral here is like hostage collateral High-value to debtor and low-value to market

Is it immoral to have hostage value on credit? What good is security? It’s incentive to pay and that’s what

going on here But a lot of people think that it’s immoral if there’s no resale

value to you, despite being efficacious You won’t see much of this going on anymore because of this

Problem 9.1 (216)o Need to look at § 522(b)(3)(A)

Go back 2 years and if hasn’t been in one place for 730 days, you go to place where he was 180 days prior where he was for the longest period of time

That would be Florida, but you have to determine what “domicile” means

What are the indicia of domicile? Appears to be intent of stay Getting license, changing address, etc… But only place he’s ever owned is in Chicago

If we decide domicile always in IL, then easy case On the other hand, he may argue that he was domiciled in FL

during that time and qualify for the unlimited homestead exception

The point is that the word “domicile” is there and that that’s a function of state law

o Assume domiciled in FL. Will the FL homestead law cover the property in IL? FL probably only protects FL residences He’s screwed in that case He’s probably going to lose, but he will probably try to see if IL courts

are generous to him But that’s the way the law is probably everywhere – will only protect

residence in FL Problem 9.4

o The tension is that know there are things that will help protect assets, even though might think it’s morally wrong to make him judgment proof

Problem 9.2 (216)o Fraudulent conveyance

UFTA § 4 – explains fraudulent conveyance as to creditorso Conveyance

Conveyed house to husband and wife Another conveyance – he owned the cash from the scam as the

business owner, so he also conveyed to wife as well

12


Assume they get divorced 4 months later. Does she get half the house?

o Yes – it’s entireties propertyo Characteristic is that individual creditor of one spouse

cannot take propertyo Out of reach of all creditors except for joint creditors

What is the conveyance then? Is it the purchase of property or the transfer of half the value to his wife

Effects of buying house was to change cash into the house Was cash exempt before the deal?

o Clearly noto But property owned by entireties is exempt under §

522(b)(3)(B)o So converted non-exempt property to exempt property

Mere act of converting is not, in and of itself, a fraudulent conveyanceo Have 2 cases in book from 8th Circuit

Both cases involved advice from lawyers about buying exempt property

In Tveten, denied discharge but Hanson granted (page 210) Decided same day Taken to task about it

o Tells us state of law about fraudulent conveyance is quite conflicted It’s left to judicial discretion Lawyer better be careful before saying can or cannot do something

UFTA Analysiso § 4(a)(1) - Actual intent to hinder, delay or defraud any creditor

You prove actual intent by looking at UFTA § 4(b) Obligation to an insider Debtor retains possession after transfer (here retained 50%

control) Substantially all of assets? – not sure here Sued or threatened suit prior – that happened Conceal assets – didn’t do that Value of consideration received equivalent to value of asset

transferred or amount of obligation incurredo Assume for sake of argument that property worth what

he paid; $10M But wife got 50%, so he paid $10M and got only

$5M So probably fail here

You don’t have to prove all prongs of § 4(b)o § 4(a)(2) – no adequate compensation

Insolvent or became insolvent at time of transfer UFTA § 2(a) – Balance Sheet Test – sum of debts is greater

than all assets at FMV

13


Not true balance sheet test because that test is based on book value

So FMV is deviation from balance sheet test UFTA § 2(b) – can’t pay debts as become due If fail either of these tests, then you are insolvent

o Assume you can prove intent, what does the TIB do now? § 544(b) – if eligible creditor, then trustee able to avoid transfer on

their behalf So does trustee get $10M or $5M?

One case says that as to his own $5M share, it’s permitted – just changing from non-exempt to exempt

Other issue is giving rights to wifeo So 2 transfers

Maybe successful in striking one down or both What about the argument of wife who says that doesn’t work outside

home and law shouldn’t discriminate against homemakers Not valid argument. We can for sure get the $5M that was

transferred to her If get Reed logic, then can get other $5M assuming prove other

prongs of intent under UFTA § 4 If UFTA isn’t available:

Look to § 727(a)(2) – court won’t discharge debt if transferred property with intent to hinder, delay or defraud creditor within 1 year prior to date of petition

So the money has been “transferred” to wife for at least $5M Could be we can also get him under sub (4) or (5)

o § 522(q)(1)(B) doesn’t apply either because requires exemption under 522(b)(3)(A) which homestead election

If debtor owes any debt arising from violation of Federal Securities laws, but only for exempt property from homestead exemption

o Summarize He may lose the $5M to wife May lose the whole $10M

If can convince court under UFTA that fraudulent conveyances, taken away and put in estate

Can be denied discharge under 727 523 vs. 727 Discharge

o Creditor wants 523 discharge because gets rid of all other creditors so that income goes to pay only creditors debt

o Going to be better credit risk after bankruptcy than before Problem 9.4

o Doctor who doesn’t have insurance and then gets malpractice claim? Probably evidence of fraudulent conveyance

o Hard question of when to put your views ahead of client

14


Is it ok to tell client immoral to not buy insurance while hiding assets offshore?

D. Claims and Distributions In chapter 11, the type of claim you have and type of claim you earn is important

o Oftentimes there are large payoffs in Chapter 11, unlike Chapter 7 To determine claims, you must start in § 502 before going on to § 507 502(b)(2) – what is unmatured interest?

o Post-petition interest – interest owed for any period beyond filing of periodo 506(b) provides exception for over-secured creditors

Simply overrides 502(b)(2) Creditor gets the fully secured amount of loan plus interest and fees

until value of collateral is used up Valuation Problem

Hard to prove worth of collateral GM plant has millions in environmental liabilities, for example,

before it is remotely useableo So may really have negative worth as-is

Do you value with Replacement value or Market value?o Market value will be tiny, or negative. Replacement

value will be hugeo This is a huge issue in valuation – do you apply FMV or

replacement value? What about where the asset is depreciating quickly?

o Eastern Airlines $200M worth of airplanes, then FAA passes noise control and after bankruptcy only worth $50M because can’t fly without noise limiters (expensive)

o Do you value at beginning, middle, or end, especially when over-secured at beginning and under-secured at end

o 506 doesn’t really answer this question/issue Whole lot of issues

In theory, you get interest if over-secured creditor In practice, doesn’t happen all that often People in bankruptcy generally don’t have flourishing business

and collateral is probably devaluedo Almost always collateral worth less than debt

When it’s not, going to be very hard to proveo Sometimes there is collateral that has easily determinable value

Publicly traded stock, short-term debt instruments, cash accounts, securities accounts, etc…

But of course when someone winds up in Chapter 11, that is seldom the type of asset they have

o Summary is that pre-petition interest is added, post-petition is not, unless over-secured, but that’s very rare

15


502(c)o Asbestos manufacturers

Perfectly solvent when went into bankruptcy, but had been sued by everyone under the sun

o Can’t value the claims in the aggregate But Manufacturer can’t reorganize without dealing with massive

claimso The real answer is that it’s an almost insoluble problem

JJ doesn’t know of any company with large asbestos to come out successfully from bankruptcy

One thing tried is to setup trust and put money in trust so that when people get sick they make claim against trust

Problem is that if pay people early-on, will pay people who will never get true sickness and will have no money for those left at end who end up getting sick and really need the money

o So for many companies this doesn’t matter, but for others it’s everything § 503 is allowance of administrative expenses

o The whole cost of running company in bankruptcy is an administrative expense

Once in bankruptcy, if Chapter 11, it’s expenses of running businesso What about in Chapter 7 individual bankruptcy?

Not debtor’s attorney because not part of the estate Remember that the estate is a separate entity

Trustee will have some admin expenses, but almost noneo They are huge in Chapter 11, thougho Difference between admin expenses and claims

Claim means stuff UP TO petition Admin Expense means stuff AFTER petition

o Keep these two sections distinct § 507

o Here we’re talking about both expenses or claimso Admin expenses near top because if they aren’t paid, can’t do anything

If don’t pay wages, then the company ends, obviously There are a whole bunch of people that you have to pay to keep

things goingo (a)(1)(A) is pandering to divorce lobby to make them look important, but

admin expenses will actually be paid first – (1)(C), (2)o (a)(4)

Covers wages and salaries and such up to $10K, indexed Many execs who make more than this will take money out

before filing – usually in form of cashiers’ check from the company

No fraudulent transfer because is payment for services rendered

What justifies employees being up this high?

16


Mostly just a policy issue – we feel employees need to get paid their wages

Does bankruptcy code treat all creditors equally?o No. This is one exampleo Also secured v. unsecuredo Fishermen and farmers are favoredo Just look in 523 or 522 – the exemptions and

exclusions are all policy driven We like to pretend there’s equality, but in fact there is great

inequalityo You want to be as high in list as you can in 507 so

that if assets don’t go around, you aren’t left with nothing

o Lots of variations and deviations form equalityo (a)(7)

If landlord goes into bankruptcy, you get the deposit money back before most creditors

All renters care about this in regards to landlordo For exam, at least realize set of tax rules in here that are important that

will allow Federal Government or taxing authorities to (1) have priority and (2) to be exempt from discharge to some extent

Gov’t’s interest will be protected Look at (8)(C) & (D)

Employer has to pay some types of employment taxes into trust fund and some paid directly

Imagine you invest in a restaurant that goes into bankruptcy and turns out never paid money from trust fund to the taxes

o They get priority before you get your equity investment back. Sucks

(C) has no time limit on it.E. Discharge

Secured Creditorso Nothing in code really explains what happenso If perfected security interest in automobile, trustee won’t bother to saleo There’s a section that allows trustee to abandon property

That leaves creditor and debtor to talk to each other, reaffirm debt, or could repossess car to sell for the loan

o Right is to have the asset Same is true in Chapter 7, 11, & 13

Assume debtor continues to make payments and creditor doesn’t do anythingo It just rides through the bankruptcy

If it’s secured, it cannot be discharged without creditor’s approval (which will never happen)

17


o Effect of discharge in bankruptcy on secured assets Discharge will discharge all personal liability After bankruptcy, can only go after asset

Before bankruptcy can go after the person too, seize wages, etc…

E.g. Car loan for $10K, worth $5K. After bankruptcy, can only repossess. Can’t garnish wages or anything for other $5K

In most cases, things like this will have reaffirmationo Negotiation between secured creditor and debtor, but sometimes debtor will

continue to make payments and creditor does nothing When does that, can only go after asset

o Student loans will almost always be reaffirmed because generally someone else is on the hook

Another place about what creditors can do is 1129(a)(7), (8), (b)(2) In re Sharpe (233)

o Argues under both 523(a)(2)(A) & (B)o She flunks (B) because representation of wealth wasn’t in writing

He was evidencing wealth by places they ate, fancy clothes, behaving as “rich man”

Presumably more effective representation that writing, but oh well What kind of circumstances fit exactly in this case?

In re Hill is exactly the kind of case they’re thinking about where you go get a loan and bring false statements about wealth

o Fraudulent income statement, etc…o Type of fraud been around a long time

She loses because verbal communication, not in writingo She also flunks (A)

Has exception regarding financial conditions because they’re covered by (B)

So what kind of false pretenses and misrepresentations are contemplated here?

Identity theft – claiming you’re someone you’re not In re Milbank fits well here – received loans on false pretenses

of wanting to fix marriage.o Those are false pretenses

o What about getting him under 523(a)(4)? Terrible statutory construction

Generally relate things back, not forward, so if fraud shouldn’t be modified by “while” clause, should be after it, but that’s not clear

Perhaps comma helps, so indicates that “while” clause should modify fraud

What is an example of fiduciary relationship where there could be fraud?

18


Everything in bankruptcy – no debtor owes any fiduciary duty to creditors and vice versa

But is there a fiduciary relationship when approaching bankruptcy as member of board of a company?

o Once become insolvent, creditors, in effect, become owners of company – shareholders have nothing to gain, all money to creditors

o So if you’re a lawyer and Visteon calls you in, then afraid that shareholders are out – do you owe creditors a fiduciary duty at that point?

What’s the difference between a fiduciary duty and a normal debtor-creditor relationship?

o Can withhold irrelevant information from creditors that you aren’t required by contract to disclose

o So Ms. Baker loses – as legal realist, might think she would have won In re Hill (237)

o Deed of trust is just the term for a mortgage in California Technical reason to call it that But in CA, they’re basically talking about a mortgage

o So they have a second deed of trust and first deed of trust Lender issuing line of credit has second deed of trust In April line is $190K, then in October they raise to $250 So have huge line of credit

o What do they do for a living? He works in an auto parts store and wife distributes catalogs for some

companies His actual income is $39K with overtime Hers is $26K

Basically they have combined around $60K In April, they showed they were making $145K and in October

$190K October deal not done through broker whereas April deal was

Court is suspicious as to why this is Hills afraid their buddy, who they used previous 6 times, would

notice they’re playing games and would not let them do it So she deals directly with bank

o What other datum did bank have to make this decision? CPA letter. Certified her business because she is self-employed, but

the signature doesn’t match letterhead Is judge accusing them of forgery?

She doesn’t say it, but it surely seems she’s hinting at it Implies that forgery or someone not from CPA office

o Bank says they lied about income on 2 occasions as well as the CPA letter Say that material misrepresentations that they relied on and the

debtor knows it’s false and intends to deceive

19


But the final elements are reliance and that reliance is reasonable Court says reliance wasn’t reasonable Bank really only relied on value of the home Bank finally sold for value of first trust deed

o Only $450K, and if worth $856K in that October transaction, why didn’t second deed trust holder buy?

Probably not sure of value

III. Chapter 13A. Overview

Allows individuals with steady stream of income to pay off debts with a payment plan over 3-5 years

Unless you can show undue hardship, will be pushed out of Chapter 7o Debtors now have the ability to push a debtor out of 7 and into 13o CC companies afraid of abuse that would rack up balances then wipe out

instead of pay offo Those in higher income stream will get pushed here

2005 amendmentso Presumption of abuse for debtors who failed means test in 707(b)o Waiting period between filings if filed previously

Waiting period between filings is 8 years The events are the filing dates

o Mandatory credit counselingo Limits to homestead exemptionso Allows the court to convert case from 7 to 13 if/when discover that satisfies

the requirements Eligibility

o Proceedings must be voluntary Cannot be forced into 13 Tricky policy, however, because the debtor might be forced into

bankruptcy and then only available option to remove to 13o Individuals must have some source of income

This is very broad though Doesn’t just have to be wages

Used be that way and were termed “wage-earner” plans Now just stock dividends might count

o Debt cap Must be less than prescribed in 109(e)

o Must have received credit counseling in past 180 daysB. Policy

2005 amendments began in 1997 and debates lasted until 2005 Was intended to discourage Ch. 7 filing where debtors don’t get enough returns

o In 13, there’s a payment plan worked out where all disposable income paid to creditors over period of years

20


o In 7, they sell everything in estate to payoff creditors and that often fetches sub-market returns

Over 3-5 year 13 plan, can potentially pay off a lot moreo In Ch. 7, no post-petition income is counted, but it is taken into account in

paying in Ch. 13 Often as little as 10% return in 13, but many times get 0 in 7, so it’s

better Stricter auditing requirements

o Attorneys have to “audit” filings to make sure everything complieso Attorneys can’t encourage filers to take on more debt in order to be sure they

are paid More generous discharge under Ch. 13

o Things that weren’t allowed in 7 are allowed to be discharged in 13o But discharge is only modestly better than Ch. 7, but still more than in 7

C. Procedure Similar to 7, except that plan is created to force wages into estate There is still an automatic stay once the petition is filed Trustee here is pretty much full time

o Money under plan given to trustee and the trustee then distributes to creditors according to plan

o That’s part of the 2005 amendments. Used to be that debtors made payments directly to creditors

Repayment Plan – Mandatoryo Must provide for full payment of § 507 prioritieso Must provide equal treatment for members of same class

So 2 credit card companies can’t be treated differently, but can treat CC company and mortgage company differently because mortgage may be more important

If there’s a reasonable basis for treating them differently, then probably approved

o Must include supervision for trustee in bankruptcy Repayment Plan – Optional

o Designate classes as long as no unfair discrimination Must be reasonable basis for treating classes differently

o Modify rights of secured parties with consent of creditorso Allow creditors to retain lieno Main reason people choose 13 is to save houses but most others will choose

7 One, they don’t want to give up post-petition income Two, they don’t want people looking over their shoulder for 5 years

They already aren’t doing well financially, so don’t like oversight

Only 30% who start generally even finish a 13 plan Mortgages

21


o 1322(c)(1) allows missed mortgages to be cured until foreclosure In the plan, you would say $5000 behind, so will make it up in plan So can propose a plan where for 5 years you are paying down the

arrears but the future accruing are being paid normally That’s why the plan is calculated off disposable, so it already takes

into account that you pay mortgage before calculating how much you’ll pay monthly to cure arrears

o Amount necessary to cure is same as though debtors were not in bankruptcyo Debtor must still pay current mortgageo Court needs to give permission...

Unsecured Creditorso Best interest test

Can’t pay unsecured creditor less than they would receive under 7 This is why many creditors wanted the 2005 amendments This means have to go through theoretical Ch. 7 to see what the

unsecured creditors would have gotteno Debtor must devote all disposable income to payments plan

§ 132(b)(1)(8)o Maintain good faith effort to repay their loans

Secured Creditorso Secured Creditors look to 1325(a)(5)(B)

o Cramdown is the process of reducing an undersecured claim to the value of the collateral

Can be imposed over objection of secured creditoro Also called:

Lien-stripping Strip-down

o 506(a) Bifurcation of secured claims This is essentially lien-stripping Debtor has to pay the fully secured amount under the plan, but

then the deficiency goes into the pool with other general unsecured

So if the pool is recovering 10%, only gets 10¢ on the dollar

$12,000 secured car, worth $8,000. $8,000 secured, then $4,000 unsecured So assuming 10% unsecured recovery, $8,400 keeps car

o 1322(b)(2) Says that plan may modify rights of holders Essentially lets judge change original terms of the claim

o 1325(a)(5)(B) Allows court to confirm cramdown over secured lender

objection

22


Saying that what you are going to give over the plan must be more than the value on the day of the plan

That’s in (ii)o All provisions work togethero Under 1325(a)(5)(B), courts find that repayment of the crammed

down claim must include interest paymentsD. Litigation

Value of underlying collateralo Foreclosure value, replacement value, or midpoint?o Associate Commercial Corp. v. Rash

Replacement value is appropriate standard when debtor invokes lien-stripping option because that’s the value the debtor will have if were to purchase same asset alone

This is now built into the statute in 506(a)(2) It says use replacement value, then for personal applications,

even defines replacement value as price a retail merchant would charge for property

So in case of car, what it costs to buy from lot, not cost to buy at auto auction

This issue is really important in Ch. 11 contexts right now Not sure if this will be applied in Chapter 11 This would be big issue in Chrysler sale if it got there because

how do you value the factory that is useless because of all the crap from it, but costs millions to build

What is appropriate interest rate to use?o Till v. SCS Credit Corporation

Formula rate (prime rate + risk premium) Prime rate is the rate only a select few get – the best rate a

lender can possibly get Scalia’s dissent – formula rate under-compensates creditors for risk of

default 7th Circuit said that should have used the contract rate

Presumptive rate is whatever’s written on the K That’s what the S.C. overturned

What would Liz Warren say in response to Scalia’s dissent? She’ll say the market is fixed and not competitive, so the right

number is a lower number Thomas defected from conservatives and didn’t go along with them

E. Exceptions to Cramdown 2 instances where can’t use cramdown Home Mortgage Exception

o § 1322(b)(2) says plan can modify rights of secured creditors other than claim secured only by interest in real property that is principal residence

o Because of housing bubble, many people have homes valued less than mortgages

23


Makes this pretty controversial now Negative equity-holders in residences can’t use cramdown provision

in bankruptcy, but can do it for vacation home, 2nd homes, etc… So easier to retain vacation home than primary home which is odd

o Legislation proposed to change provision but failed in senate Hope is that lenders and debtors will renegotiate on their own, but

that’s not happening Rep. Frank has attempted to reintroduce legislation

o Should it be reformed? Will reduce foreclosures and allow debtors to hold onto homes Will make lending more expensive because lenders will have to hedge

risk of losing value This would mean it would go counter to governmental interest

in promoting homeownership Hanging Paragraph Exception

o § 1325(a) paragraph about 910-day window for auto debtso Prohibits cramdown for purchase money security interest in car purchased

within 910 days (2.5 years) prior to filing of petition Purchase money security interest is just an interest created

specifically to make the purchase Secured creditors think that will drive people into 13 and out of 7, but

in 7 auto companies get reaffirmations In 13 they don’t reaffirm because they get a statutory

reaffirmation at lower price GMAC and other lenders say not going to go along with the

2005 amendments if going to drive everyone out of 7 and into 13 where they get screwed

This was the compromiseo Lots of people with outstanding debts won’t be able to

use 13 strip-down on them Purchase money security interest Issues

o Interest now where if debtor purchases car with purchase money security interest but then trades it in with negative equity. Owes $20000 but worth $17000

o If go and trade in for new car, they roll the negative-equity into the new car ($3000) and weren’t sure if that is purchase money

o Many circuits have said that the overage added into the car loan is still purchase money

Is secured creditor on the old car the same as the new one? Not necessarily Could have borrowed from Chase for 1st, then GMAC for 2nd

who pays negative equity, so not necessarily same creditor

24


IV. Chapter 7A. Background

BAPCPA (2005)o Debtors able to get discharge regardless of ability to changeo After BAPCPA, created means test under 707(b)(2)(A)(i) and if fail test, then

deemed to be abusing Chapter 7 Can then be dismissed or converted into Ch. 13

Means test created because of lobby of consumer credit industry/lobbyo Mostly this is CC industryo In 1978 could choose Ch. 7 for any reasono 1984 case could be dismissed if filing constituted “substantial abuse”

That wasn’t defined in the Code and lots of litigation over it Split among courts Not many cases were dismissed

o In 2005 means test enacted to calculate net income available to repay unsecured creditors

Calculate net income available to repay unsecured creditors This was an effort to extend 1984 rule with a more bright-line test

707(b) applies only to individual debtors whose debts are primarily consumer (b)(1)

Abuse under 707(b)(1) can be established by failure of means test or through bad faith/totality of financial circumstances test in 707(b)(3)

o Can rebut by proving special circumstances under 707(b)(4)B. Protection for low income debtors

Means test doesn’t apply to debtors whose combined income equal to or lower than state median income

o 707(b)(7)(A) Only judge or US trustee can bring 707(b) motion to dismiss for below median

debtorso 707(b)(5)o Creditors can’t do thiso Practically speaking, this means that it really doesn’t happen because US

Trustee doesn’t know and judge never looks at this stuffC. Means test

Take current monthly income (average of past 6 months income – so not looking toward future), subtract deductions allowed in Code, then multiply by 60

o Deductions allowed are living expenses, projected payments per month on actual secured debts and actual priority debts

o This is based on table by IRS (if pay more, limited on how much you can deduct)

o Multiply by 60 to get to 5 years to approximate 5 year re-payment plano You then take lesser of (1) greater of 25% of debtor’s non-priority unsecured

claims or 6575 OR (2) 10950

25


If the calculation income is greater than the other equation, deemed to have abused system

Shorthand method of applying means testo If monthly disposable income is less than 109.58, presumption of abuse

never ariseso If more than 182.50 always has presumption of abuseo In the middle ground, depends on amount of unsecured debt

Based on formula, there’s an incentive to minimize current monthly income and maximize allowable deductions

o Ch. 7 will have lower monthly income and will be more likely to rent instead of own because that’s unsecured debt which can’t be subtracted against income

o Debtor also has incentive to increase amount of unsecured debt, especially in that middle ground, because the income will be less than 25% and will discharged anyway

Under what circumstances will debtor have 3 years vs. 5 yearso 3 years if below state incomeo If above, then 5 years and means test applieso May not have to pay all of his disposable income

Problems calculating incomeo If relative helps debtor with expenses, how regular do they have to be to

count as income?o If laid off prior to bankruptcy, since current monthly income uses past 6

months records, might fail means test but will really need it Then doesn’t get into 13 either because have to be employed to be

thereo People with lots of projected future earnings (student who will have high-

paying job after graduation) Even though can pay with future earnings, current monthly income

likely 0 and won’t fail means test, but probably abusingo Incentive to keep income low

Debtor might not want to work overtime prior to filing because will increase income and be more likely to fail test

o Provision allowing subtraction of full amount of secured debt under 707(2)(A)(iii) inserted to secure automotive lenders’ approval

o Incentive to incur new secured debt before filing for bankruptcy This takes away from income Debtor rather buy car or vacation home and have asset which is

counted against income and helps them qualify So instead of paying unsecured creditors, they are able to keep assets

instead Takeaway

o Means test is way to calculate debtor’s ability to repay vs. what they would have to pay in Ch. 13

26


o Won’t be applied to most cases because most debtors below the state median anyway, to which means test doesn’t apply

D. Statistics Total petitions – 14,073 in Jan ‘06 and 34,445 in June ‘09 Only about a 3rd complete the repayment plan

o No one releases official data, though, so not certain of thiso A lot of academics argue that discharge isn’t example of success

So many things can happen so maybe not system People lose jobs, get better jobs and payoff, etc…

Ch. 13 as percentage of all bankruptcieso Huge spike after 2005 amendments, but has settled backo Averaging around 28% outside of the spike

Around Jan 2006 is when a professor started tracking with PACER data but will be off because doesn’t count reopened cases or transferred cases

o 13’s as percentage of noncommercial bankruptcies is steadily declining – from 42% to 25% between 06 and now

Ch. 13’s as percentage of all Chapter 7 and 13 caseso Around 33% or so

V. Chapter 11A. Introduction

Reasons to do Chapter 11o Selfish – preserve your salary for a bito Try to make it survive – wishful thinkingo John Connally example too – in 7 could see transfer of docs as fraudulent

conveyance and TIB would have done that In Ch. 11 he’s DIP and won’t challenge

Question whether security interest of secured creditors is valido DIP won’t raise that question because he’s in bed with the secured creditorso How does unsecured creditor raise it?

Court will allow unsecured creditor’s committee to make the claim DIP essentially run by the secured creditor But won’t go unchallenged if problem

Easy to understand why someone with small business and no great chance of reorganization will go into 11

Why don’t out-of-court workouts work more often?o Has to be unanimous out of court

All creditors have to agreeo Negotiating hand stronger in bankruptcy or under threat of bankruptcy than

would be otherwise Creditors may have small return in bankruptcy

Absolute priority rule says if people above don’t agree, can’t give anything to lower priority if shorts the higher priority at all

o Lose protection of the automatic stay as well

27


Can get judgments against you during negotiations and they will levy property and take liens on assets and tear apart the process

o Easy to see why work-outs often don’t work where Ch. 11 will But management hesitant to do Ch. 11 because will likely be replaced

B. Success of Ch. 11’s Success in sense of plan filed or business sold in 363 sale is pretty high If liquidating, however, probably very low success rate Ch. 11 is essentially a long negotiation, not litigation

o Litigation is a mischaracterizationo It’s a long negotiation with lots of hiccupso This is part of the fun of bankruptcy law

You get to negotiate a lot and litigateC. Objections

Early on will have objections to stays and such But later on, will have challenges to things like security interests

o In trustee’s personal interest to avoid security interest Representing the unsecured creditors Income is determined by how large you grow the estate for

distribution Paid on contingent fee basis If professional trustee and get right cases, can make a lot of

moneyo That interest is gone in Ch. 11 because manager is DIP who has other

interestsD. DIP Lender

Has tons of power Will require whatever they want

o Force to hire restructuring officer (probably suggest a few people)o They want to forum shop

Almost all big ones in NY or DE More experience with these large restructurings Going to live with the judge for years If no confidence in the judge, going to be difficult few years They know how the game is played

o Won’t have to argue with, and educate, the judge So they will require debtor to file in forum of their choice Most big cases have moved to S.D.N.Y.

Is that bad or good?o Probably good. Maybe some cons, but for the most part,

it’s good that these judges and lawyers are so familiar with process/rules that can do restructurings much more efficiently

28


o If in different district, have to educate judges on how to run the case and such but they already know that in S.D.N.Y. and D.D.E.

o Will also be interested in first day order Want to be in place where first day order is favorable Have to have authority to do anything in bankruptcy, so need

authority quickly to make payments, pay salary, etc… Judges usually sign first day orders to keep business going

Sometimes temporary and have hearings later for final orderso Rules in jurisdiction about paying off important suppliers

That’s important for Ford Can’t pay off pre-petition creditors in theory, but in practice there’s an

exception for particularly prized unsecured lenderso Want jurisdiction where they let us roll-up debt

If have pre-petition secured debt and will make post-petition loan, want jurisdiction where DIP can take money payments on new loan to pay old loan and leave DIP facility as only facility

Why do they want this? Will get priority status under 507 Case in book says can’t do that, but they do it all the time Not too sure how

Law firm that does these things will have a grido One column for each Circuit and then rows for these things they want and

how it is in that Circuito Then they can look at the needs for the particular bankruptcy and choose the

best forum Why does DIP Lender want to lend in Ch. 11?

o They are higher priority because they will take security Other claims are stayed as well, so full hack at the pot

o Who is most likely candidate for DIP lender? Existing secured lenders because they already have sunk costs If debtor fails and other DIP lender comes in, gets screwed So current secured lender wants it

Typically negotiation will all happen before filing, ahead of time

E. Getting In & Out Prepackaged plan

o Will work if have fixed and identifiable set of creditorso Get deal setup before hand and then go in and do it

§ 363 Saleso Section allows debtor to sell goods in ordinary course without court approvalo That’s how when K-Mart files 11, can still open doors and sell goods next day

which are technically part of the estateo But what about selling properties in a state?

Yeah. Can do that too

29


But need court approval because not ordinary course saleo GM and Chrysler are most elaborate forms of this

They both went through 363 sales Very unusual sales, but now not uncommon to sale going concern

business in 363 sale Big debate over whether that’s a good thing or bad thing

o Controversial sectiono Often are an auction

F. Costs Doesn’t cost a lot more than going through standard merger for the large guys But when a little company, costs a lot more as percentage of assets

o Apparently there’s an irreducible minimum of costs that make up larger portion in little cases

So probably pretty efficient if big case If little, though, probably not

o Probably need a way to make it more efficient SEE PAGE 404-06 IN TEXT

G. § 1121. Outlines the exclusivity period

o (d)(2) – it can be expanded by not more than 18 monthso Why do companies sit there so long

Many companies have a big problem getting money loaned to them So most ch. 11’s require DIP financing

Why don’t secured creditors that were already in there go in and propose a liquidation plan?

o Well you’d have to figure out a plan that got voteso You’d also have to go out an hire a fancy lawyer

You don’t have that kind of money, nor do you want to spend that kind of money if you’re not sure how it’ll work

So what actually happens?o You’d have to hire an accountant, a financial analyst, etc…o Then they have to go through all the books and propose a plano It is time consuming and extremely expensiveo As a practical matter, the creditors are probably like a small dog on a leash.

They bark a whole lot, but if you let them off the leash, they cowero The worst day of their lives is when someone says ok, file your plan

So it’s in here as though it were an important threat. Probably is in some cases, but not all.

The thing you could do, is file a liquidating plano Are you going to get that through the judge in Delphi?

The judge feels as though the constitution blesses chapter 11 When you go to lift the stay in the first month, you’re going to lose To the secured creditors, it might be a great deal

Unsecured creditors, though, won’t get anything

30


Secured creditors take all the assets, come out maybe ok JJ’s suspicion is that this threat doesn’t carry much credibility. 1121 has these restrictions. Query what these restrictions are going to do.

H. § 1122 What’s a claim and what’s an interest?

o Claim creditoro Interest shareholders – usually they will get nothing here.

Critical language is “substantially similar.”o Can’t put secured and unsecured creditors into the same classo Each secured creditor is in its own class

They are usually separate EXAMPLE: Taking 2 unsecured creditors

Assume Z is a group of trade creditors and Y is a group of unsecured bondholders

o How do we decide whether they are substantially similar?

What is the nature of their claim against the company?

They’re not secured. They should get the same pro-rata share These two creditors should get the same

distributiono The same priority in the bankruptcy state, the same

priority outside the bankruptcy stateo Cant discriminate if one is fat and one is skinnyo Probably the fact that you are the same level and will

share pro rata will make you similar, should be able to put in the same class

Now suppose you want to put Y in class 4 and Z in class 5o Can you put substantially similar creditors in different

classes and give them different treatment?o § 1122 doesn’t appear to restrict that.o Only a ONE way restriction, not TWO way

If in same class, must be similar. If similar, does NOT have to be same class

I. § 1124 A claim is unimpaired if claim is going to be paid in full If the payment term is extended, though, probably you are impaired In some cases, there will be questions about that

o It will easy to impair somebodyo Give them 90¢ on the dollar

Or you could change the interest rate, extend the payback periodJ. § 1126

Assuming class has more than 1 person in it, how do the numbers in 1126(c) apply?

31


Need at least 2/3 in amount. o If 1 person makes up 1/3 of the debt in a class, they have the power to block

a plan Just having one of them say no, says you don’t meet the approval process in 1129(b)

(8).o So you need to look at thiso Secured creditors can be crammed down in some cases.

K. § 1129 Most important provisions

o Referred to as creditors Bill of Rights 1129(a)(3)

o Good faith is unclearo The most likely bad faith plan is a company that has 1 mean creditor,

otherwise healthy and doing wello No one knows what good faith is until the judge tells you.

1129(a)(7)o Applies to each member of the class

Each holder of a claim Each person, not each class

o Must get as much as you would have gotten in liquidation on the filing of the plan

EXAMPLE: Assume would be liquidated for 500,000, then plan has to pay at least 500,000

Interest? Waiting 3 years and not collecting any interest so recovering

less than 500K because of TMV You don’t get any interest value. You eat that loss.

o Somewhere or another, there’s a higher value somewhere It’s very hard to figure out It would cost quite a bit of money to do the actual valuation Valuation hearings are very expensive and very unlikely to happen

1129(a)(8)o The class has to accept ito Go back to 1126, and here’s where the voting becomes importanto You’re going to negotiate with all the classes and agree, or you’re going to do

a cram down. 1129(a)(10)

o So even if you do a cram down, some classes will have to accept You’re have to have at least one impaired class accept Sometimes they’ll put accountants or layers in a class to accept

But have to be impaired. Stand still for 80%o What is the argument when this is proposed in the plan?

1122 doesn’t require similarly impaired creditors to be in same class If you’re going to attack this, would say this is BAD FAITH

32


But there are some cases that say you can’t gerrymander the class

Can’t just put accountants and lawyers into the class In the GM case, can they put Axel in there for 80% of their pay and

have them vote for the plan? Quite possible that I can find a legitimate class and have them

vote for the plan.o Example

Class 1 is a $50MM note. Secured Plan gives $10MM and a 30 year mortgage

Class 2 is a $50MM deficiency, and we’re going to give them 10%. Class 3 is $3MM of trade, and we’re going to give them 70%. No prohibition against giving 2 classes of unsecured creditors

different percentages In liquidation, they share equally But nothing in 1129 that says specifically you have to treat each

unsecured claimant the same Creditors would argue bad faith In chapter 13, there are some cases that say you can’t pay off

your doctor 100 cents on the dollar and give peanuts to everyone else

Why do you need 1129(a)(8) and (a)(10)?o Under (a)(10) need at least one class of claims accepto Under (a)(8) you need all classes, but if not, can bump to (b)(2) which isn’t

available for (a)(10) 1129(b)(2)

o (A)(i) – Secured Creditors Must receive cash payments equal to allowed claim Deferred cash payments totaling at least allowed amount of such

claim, of a value of at least the value of such holder’s interest What does that mean? If $1M claim, second clause about “value” requires that it be PV

o First part means get $1M, but “of a value equal to estate’s interest or whatever” means has to get the present value

o That’s the Code’s way of saying setup to get PV of $1M Must be careful throughout Code. Some places requires PV and

others don’t So if have collateral worth $1M, you get PV of $1M

If have collateral worth $1M and $2M claim, only the $1M is secured and so will be included in 2 classes, secured and unsecured, and only secured gets the PV cash payments

o (A)(ii) Here sell off asset and security interest attaches to whatever proceeds

they get

33


How did this happen in Chrysler? When Chrysler sold to Fiat, Fiat paid essentially nothing So they get secured interest in nothing We do NOT normally see this. Very unconventional

Normally there’s a bid on the asset or whatever and then money goes to estate

o (A)(iii) We don’t know what the language here means Indubitable equivalent is unusual language

o (B)(i) – Unsecured Creditors Must pay off in full This won’t ever happen in bankruptcy because almost by definition

don’t have money to pay unsecured creditors that amount OR

o (B)(ii) The only thing junior to unsecured debt are shareholders So this rule means that can’t give shareholders ANYTHING if not going

to pay the unsecured creditors less than full amount ABSOLUTE PRIORITY RULE

o So what is the minimum you can give to the unsecured creditors here? 0 Can give 0 and still cram-down the plan

Quite infrequent to have a plan crammed downo Especially if big bankruptcy – have to prove the requirements for all of the

creditors and stuff and it’s hard and expensive If you’re one of the $700K why can’t debtor just give nothing?

o Say not giving anything to SH so also not giving anything to unsecured creditors

o What protects them from doing that? Can’t give 0 if would have gotten more under liquidation 1129(a)(7) requires that give at least as much as would have gotten

under Ch. 7 liquidation Going to have a very long argument out of court about what

liquidation value is Probably rarely going to get from (a)(8) over to (b)(2)

o If you’re negotiating, you’re going to say “haven’t satisfied (a)(8)” and haven’t satisfied the vote

o Have to always consider other creditors while negotiating with one Particularly if creditors with big claims that can stop you If give something good to one creditor, all others will come after you

for same treatmento Involuntary creditors?

People who have a products liability claims against Chrysler, for example

34


People didn’t voluntarily lend money to debtor but it was done involuntarily

Exampleo Class 1 is $50M mortgage

Will get $10M cash, $50M mortgage 30yr + interesto Class 2 is $50M deficiency

Will get $5M (10%) over 10 years The deficiency is the amount that the loan exceeds the value of the

collateral So this is the same creditor as Class 1, but here unsecured

o Class 3 is trade 100% on the dollar payment

o Assume the mortgage votes no on this plan. Can you approve it? A class has voted no, so not satisfied under (a)(8) and will have to go

to (b)(2)(A) for secured If the interest is the PV of $40M, then can be approved because

PV of cash paid (interest and cash payment) is equivalent of value ($50M mortgage)

o So potentially could be satisfiedo Will it be indubitable equivalent?

Could argue for it, though not sure what it means exactly

But if original mortgage was 10 years and jacked up to 30 years here, arguably not indubitable equivalent

What about the $50M deficiency? That’s (b)(2)(B) for unsecured Can say 10% on dollar because not violating absolute priority

rule If they paid any money to SH’s, different matter but here they

didn’t So then trade credit. Still can’t approve. Why?

(a)(10) Class 2 certainly impaired and Class 1 possibly impaired Only class that voted yes was Class 3 and they aren’t impaired,

so no impaired class voted and can’t be approved How do you get around it?

Can you setup a 4th class with lawyers and bankers and such?o Probably not because bad faith

What about cutting trade back to 90¢o Doesn’t that make them impaired?o Quite possible that it will and trade probably wants to

do continuing business relations, so they’ll probably stay onboard for a 10% cut

o If do that, then probably ok

35


L. Absolute Priority Rule Problem In case of little businesses often, owner will say will put some personal money if can

keep company but wants to cut back creditors Question is whether that’s an exception to absolute priority rule What about a reorganization that happens through 363 that circumvents the Ch. 11

rules?o For example, for the entrepreneur that wants to protect his investment

(equity) at expense of creditors, why not setup separate company and then do 363 sale to the new company?

Not sure that would worko 363 has a true difference, namely that open risk others will bid and have to

hope you win Not sure you will win

Many people would argue that we need exceptions for these little cases

VI. Automatic Stay & Adequate ProtectionA. § 362

Problem 19.1o Secured creditors want liquidation because they can get $ and walk away

If can convince court that 140 is the correct value, they can possibly convince court to lift stay because under-secured

o What if judge says 220 is correct? Then probably adequate equity cushion because of 180 debt and 220

value Can accrue interest here

o Suppose 6 months down the road and creditor not agreeing to plan and they want to cram-down. Then what do you want to argue?

If argue 140 will get PV of 140 If convince 220, then get PV of the secured amount, or 180 This is under 1129(b)(2)(A)

o Notice when wants stay lifted, wants low value declining. When arguing for rights in cram-down, want to argue higher Tension on what you want to do

o This example is not unrealistico What do you get for adequate protection when debt is 140 and value is 220?

You really get nothing. Interest really is just a payment for waiting, so it doesn’t count

With equity cushion, you don’t get anything The cushion IS the adequate protection

o Assume now that there is creditor 2 has security interest of 100 Judge picks 220 as value He tells Creditor 1 no adequate protection because equity cushion What about Creditor 2?

Assume subordinate to Creditor 1o Creditor 1 has 40 cushion

36


o So Creditor 2 should ask for adequate protection and should get it

o Hell is a place where you’re a subordinated creditor Those who take 2nd mortgages ought to think of

themselves as unsecured Adequate Protection

o Most common form periodic payment to creditor that makes up for decline in value of collateral

Debtor is selling off inventory, for example, and not replacing with the same amount, or piece of property is depreciating, etc…

Debate about issue and must be prepared for it Often will negotiate for adequate protection under threat of motion

o Value of secured creditors collateral should be the same going out of bankruptcy as they do going in

But they don’t usually think that’s true That’s one of the reasons why creditors will look for ways to stay out

of bankruptcyo Look to § 507(b)

If this happens, he goes to the head of the list of people seeking administrative claims

Treated as HIGH priority creditor What if never asked for adequate protection or asked and never got

approval? Probably no dice here because language says “provides

adequate protection” It has to have been provided Even if ok but never ordered by court

o You want order, though cases aren’t clear whether order is required or not

o Keep 507(b) together in mind with 362 and drive hard to get a court order to try to cover yourself

Problem 19.4o 362(d)(1) – what does “for cause” mean?

Includes lack of adequate protection But besides that, not sure what it means Perhaps anything that would cause collateral to decline substantially

in value But assume can’t prove that

o 362(d)(2) She doesn’t have any equity interest

There’s a $350K PMSI and a $200K non-PMSI security interest You count both, so $550 security interest and only worth

$500K, so no equity in property So what about necessary to effective reorganization?

Operative work is “effective”

37


o Without that condition, you’d never get stay lifted The argument here is that there is no possible effective

reorganizationo Can be necessary to reorganize, but it won’t be effective,

so can’t qualify hereo Creditor will argue this – that won’t be effective

o Unsecured 2nd creditor wants to push for this immediately because Creditor 1 is over-secured, so if drag out a year, accrues interest and depreciation which will eat into Creditor 2’s recovery

Problem 19.5o Projections probably can’t be confirmed by objective market participantso This isn’t a case about bringing someone in to reorganize and make a profit

and such It’s about the real estate market on one building Just a 2-person case, not what you would design Ch. 11 for, but it has

had an impact on the law, expressed in 362(d)(3)o 362(d)(3)

Either debtor has to file plan likely to be confirmed, OR This really has no chance of being confirmed so go to test 2

Pay monthly payments generated from income of estate equal to interest at non-default rate

Has to be pay current interest If can’t do it, stay is lifted

o This is pretty harsh. What’s going on here? Forcing out of court work-outs

Problem 19.6 – Allocation of Adequate Protection Paymentso She’s made $1M in payments during bankruptcyo Do you allocate it to principal or interest?

Nothing in the Code says what should be done No right to interest payments in bankruptcy

o But what if it’s negotiated for that. 1/2 to principal 1/2 to interest

o If treat as interest it will never help the unsecured creditorso Unsecured creditor committee will want it to go to pay down principal so

that they will get some recovery Should be suspicious of any kind of agreement splitting the payment Think about alimony payment dichotomy in tax

Payor wants it to be alimony for deduction, payee wants it to be property settlement so not in GI

So they can make agreements mutually beneficial for tax reasons

Be suspect of it

38


VII. Operating in Chapter 11B. Cash Collateral

Problem 20.1 (450)o After bankruptcy, what can you do?

Most normal business functions, like buying and selling inventory Anything in ordinary course, generally

o But cash complicates it – 363(c)(2) Has to either have consent of any entity with interest in it or court

order Bank has security interest in inventory and ,under UCC § 9-315, its

proceeds as well, That of course undoubtedly happened So this is cash collateral under 363(a)

o As a practical matter, has to have court order or consent So if creditor’s lawyer, what does this mean while in negotiation a

week before filing? Want money in the bank to cover self about setoff

o What has to exist before setoff in state law? Bank has to have claim against debtor and debtor has to have claim

against bank – Equal in position So if debtor + spouse are the creditor and debtor, then won’t

work Has to be equal

If don’t have security interest, then don’t have that problemo So does it make sense to tell client to move money if bank is unsecured

creditor? It’s certainly not illegal Could even be malpractice not to tell them

Should certainly tell them They should move money If big customer, will be a signal to the bank that you’re about to

file Would only do it if unsecured

o Why will debtor go to bank to negotiate week before filing? Will be Part I in first day order Has to have permission day 1 for cash to pay employees and such Except in rare cases, there will be negotiation between secured

creditor and debtor before filing And in most cases, the secured creditor will likely be the DIP

financier, so they’ll want to work with you anywayC. Setoff

Problem 20.3 (451)o Debtor has $61K in the bank and owes bank $50K as assignee

39


§ 553(a)(2) says no setoff because claim was transferred by 3rd party to creditor within 90 days before filing petition

o If take a big loan out, bank will require that you open an account with them and maintain some sort of balance

It offers them setoff To the extent money in the account, it in effect reduces exposure on

the loan If loan of $100K and $15K in account, have exposure of only $85K, not

$100Ko (a)(3) Exception for when bank gets setoff money right before bankruptcy

Within 90 days, while insolvent, and for purposes of setoff Bank has to require compensating balance for life of loan, more than

90 days, to be ok for setoff If not, bank is jumping the absolute priority rules

They are unsecured and make themselves secured ahead of all other creditors

What’s the policy that says can’t favor one creditor over another when you can do it all day long outside of bankruptcy?

o Absolute Priority Ruleo Have a bit of skepticism about this, thougho The theory is that want to discourage creditors from

ripping debtor apart and taking things away necessary for reorganization

Probably can’t really make the case for this though, but that’s the argument

If the debtor is insolvent, if don’t do anything, what do you get? You don’t get 100% and get paid pro rata with all other

unsecured But on the setoff deposit in bank, you do get 100% of that cash So that’s the argument against the cash deposit if doing it to

subvert bankruptcyo But here, the creditor is buying a debt of the debtor while already has

obligation to debtor of $61K (a)(2) says can’t set this off What’s the policy rationale?

Congress probably had normal suspicion about people who wanted to seize bank accounts

They are immediately liquid so when seize it, the company is done the very next day

o It needs money So partly what’s behind this is being careful about not letting

bank account be seized so quickly What else might be dubious about this?

Never buys debt for 100%

40


If bought the receivable from supplier for 20¢ on dollar, he has a 50K setoff, but only cost him 10K, so they are making large profit off of this while seizing cash of company

o Need to see what’s going on in 553 Policy is quite clear in (a)(3) – it’s like a preference that the Code does

away with Policy in (a)(2) isn’t quite as clear

Perhaps its about making it risky for creditor to seize bank account because we think that’s important

o If going to bankruptcy, want to draw down cash Some people think if don’t tell them to do that, it’s malpractice No moral obligation to keep money at that bank (unless part of

agreement) If large industrial company withdraws money from account,

signal to bank that thinking about bankruptcyo How else can you signal that you’re thinking about bankruptcy during

workout? Invite a prominent bankruptcy lawyer to the workout negotiation.

Can just sit there at the table. Problem 20.4

o You’re going to want to move to appoint a trustee Sucks to represent equity in these cases. Usually get nothing

o So what’s the lever trying to get hand on when goes to § 1104? Get a trustee appointed – but what will he do? Examiner just investigates and reports to court. Trustee replaces

CEO and runs the company How will this help the equity holders?

Threatening executives who are making under-table deal with VC guys – will get distribution to management and if can get trustee, that all goes away and get level playing field

o Are they going to get trustee appointed? Not very likely Never see trustees in Chapter 11 cases When redone in 1978, drafters made conscious decision to go with

DIP instead of trustee Choice between knaves and fool Lawyer as trustee will be fool so made conscious decision to

leave guys there who are at fault in screwing up business, but that’s better than having a fool managing

Process developed outside Code is new management, but picked by, and forced on company, by creditors, not court

o Should tell client we’ll go in and make noise, but probably won’t do much Kiss investment goodbye and move on Will wind up with nothing, or very close to it

41


D. Post-Petition Financing Need money after filing petition to be able to run business Day file petition, need to know how you’re going to get money to run the company

o Need to pay employees, checks written have to clear, pay utilities, pay suppliers

o 90-day open credit Deliver on day 1 and have to pay 90 days later

Common form of credit with suppliers In effect, lending money so become unsecured creditor for

those 90 days With American Axel, may have already been cut short on this

Last few weeks probably on COD terms That eats up cash

o So need money § 364

o (a) is about accruing ordinary course, unsecured debts Wages, utilities with DTE, etc…

o (b) is slightly different End up in (b) when need unsecured credit for things not in ordinary

course Here we’re talking about some type of bigger, longer-term loan that

isn’t done every dayo (c) goes another step further

(1) allows debt to jump ahead of all administrative expenses specified in 503(b) or 507(b)

This means go to head of line This is a big deal compared with (a) or (b)

(2) allows security interest on unsecured things Won’t really help big bankruptcy like Ford where everything

already secured because outstanding debt is massive (3) allows junior lien on assets already secured

o (d) is the big one Until get here, not hurting anyone but changing priorities Here you actually jump ahead of secured creditor This is very rare Can get super-lien senior to all other liens on property of estate

But have to show that can’t get credit any other way, AND Have to provide adequate protection to holder of lien being

superseded What will creditors demand?

If have cash flow, can get periodic payments That may be all that’s left

But without adequate protection, stop 364 debto First day orders will account for most of these priority things

42


Provision to get perfected security interest, prior to so-and-so’s interest

Payment terms will be built in as wello Who is looking out for best interests of unsecureds?

Possibly DIP has fiduciary duty because once file, wipe out equity holders and unsecureds effectively the equity holders

o Need to understand that company needs money on day 1 and judge has no way to know whether what company asks for is necessary

On other hand, don’t have anyone speaking for unsecured creditors on first day motion

So what do we do? Can’t put it off for a month because company needs money on first day

Have 364(e) protected DIP lender who lends in good faith that won’t be undone and security lost

Can get unsecured money and under 503(b)(1) makes it administrative expense which bumps in front of all other unsecured creditors

Gets better for creditors the deeper you go into sectiono So where does company look for help if can’t get financing under (d)?

Person that you’re into is person with most to lose if doesn’t succeed So will go to lender and say give us money. They probably won’t want

to do that and you’ll say, we can liquidate for 20%, how would you like to take an 80% hit?

There will be a negotiation, generally, prior to the filing and will already have an agreement when they file

Person with greatest interest in success is person that lent money

o If can find someone to do this, will want security interest in everything, so how do they deal with the current secured lender?

Will offer to buy the claim at discount If pre-petition debt was $800MM, DIP lender will buy that claim for

$600MM and add to loan and then take security in pretty much everything

You’re buying out the claims ahead of you So you’re first in line and your claim is post-petition

o So this DIP business is quite profitable Can get great rates and full security

§ 552o (a) – any property acquired after filing is not subject to any lien, subject to

sub (b) Many security agreements have after-acquired security clauses If security agreement doesn’t attach, then not protected by that stuff

Becoming more and more unsecured One reason you want stay lifted or adequate protection

43


Both debtor and creditor want this taken care of in first day order to protect both interest

Security for creditor and running business for debtor § 1129(b)(2)(B)

o Can you propose a plan under which person lending money is equity owner and will wind up having share of assets?

In effect, shorting some creditors while giving SH’s who put some money in a right to assets

S.C. says can’t do that unless up for auction so that other people able to bid to make loan

Not clear how that satisfies (b)(2)(B) but they say it does § 546(c)

o Suppliers who sell on credit generally are unsecured creditor Typically suppliers and can stop shipping, assuming no extended

contract to shipo (c)(1)

Perfected security interests beat out this section, but otherwise, seller of goods has right to reclaim goods if debtor

Receives within 45 days before commencement of case But must demand in writing not later than 45 days of date of

receipt or not later than 20 days after date of filing If look at date of filing, can go back 45 days and claim assets that

haven’t been paid for Company will generally pay because need supplies for business

o Pushes them up the ladder above other claimantso Look at 503(b)(9) – administrative expenses

Besides the 546 right, this section gives pre-petition administrative claim over goods from 20 days before

Ahead of other creditorso So couple these two sections togethero Best of all, want order to pay, next best is 503(b)(9) to exercise righto Many people with 546(c) claims will not assert them because too expensive

to enforce Will generally just rely on 503(b)(9) and hope after that there’s

enough left to pay them off – probably not thougho Note that who has right to goods bought and sold daily in an operation like K-

Mart is extremely difficult to determine Critical Vendor Rule

o Violates premise of bankruptcy that all creditors treated the same You can treat critical unsecured vendors better than others

o What is justification for the rule? Maintain necessary relationships with vendors without whom can’t

surviveo How do you determine who is a critical vendor?

44


You would assume it’s vendors who, if don’t deliver, will shut you down

Lots of people will think they’re critical vendors The more you feed critical ones, the hungrier and more jealous

the others get Going to have to have some type of testimony

This might influence where you will file depending on how they see certain vendors

o Very weird rule because there are no clear rules on what a critical vendor is In most cases, lawyer running business will not be sending out list of

criticals, but will wait to see who complains a lot and sucho K-Mart case in 7th Circuit overturned use of criticals because no testimony

May as a result have less claims, but not clear yet They didn’t strike down rule, just said had to do something to help

prove that vendor is critical Shapiro v. Saybrook (462)

o $34MM pre-petition secured debt, but collateral only worth $10MM Really part secured, part unsecured

o Wants to give $3MM post-petition loan as administrative expense for priority Wanted to cross-collateralize Take collateral for post-petition assets to secure the deficiency on pre-

petition debt As it stands, deficiency is unsecured and shares pro rata with other

unsecured creditors So by cross-collateralizing and securing the deficiency, they’re

being given more favorable treatment than other unsecured creditors

o Surprisingly to the parties, court also decides issue not moot under 364(e) because that section only applies to lending under 364 and they say cross-collateralization not allowed under 364, so 364(e) doesn’t apply

o What fiction can you construct to get around Saybrook? Make a $40MM post-petition loan secured by assets, and use proceeds

to payoff pre-petition loan and left with $6MM outstanding This is really a sham, getting exactly what they wanted This is called a Roll-Up Has same effect as cross-collateralization, but just go through process

to make it fit in 364 Post-petition loan because that’s when they made the loan, but

just pay off the debt DIP Lender will probably require certain filing venues and this

issue probably has some influence over the choiceo Need to be careful how you term it, though, so no one

gets on stand saying “Chase said they wouldn’t lend if we didn’t file here”

This is mostly ok in DE and NY

45


o But not many places that have decision like Saybrook Problem 21.2 (469)

o Parties Chapter 11 Lawyer Chapter 7 Trustee and lawyer FSB Hanratty

o Have $350K that will need to be allocated Who gets first dollar?

Need to focus on 726(b)o Probably puts Ch. 7 trustee and lawyer at the top of the

list What about FSB?

Asked for adequate protection but wasn’t good enough This means goes to 507(b) which says if get adequate

protection but not good enough, goes to head of administrative expense line, so goes ahead of other two

What about Hanratty? If had lent under 364(c)(1), then would jump ahead, but lent

under 364(c)(2)o Purpose of this is how little tiny things can change priority, often for things

that make no sense For case administratively insolvent, lots of arguing over this If going to make post-petition loan, need to think about all of this

E. Avoidance Powers Mostly contained in §§ 544(a), (b), 547, 548 §544(a) – Strong-Arm Clause

o “Without regard to knowledge” means it’s a hypothetical test. Whether the trustee or creditor has knowledge or not is irrelevant

o “Whether or not creditor exists” means that it’s a hypothetical test again. There doesn’t actually have to be a creditor asserting the claim. Just that there could be a creditor asserting it

o Trustee is treated like someone with a judicial lien on property on the day of the petition

This essentially gives the trustee the power to knock off unperfected security interests

o UCC § 9-317 explains rights of a judicial lienholder under state law To perfect security interest, file UCC statement with SoS

One-page statement listing assets on lien The implication taken from 9-317 is that you rank above the

lienholder if you perfect before the lien 544(a) effectively saying that trustee gets perfected judicial

lien on date of petition, so if lienholder is unperfected, trustee beats them out

46


o This section allows trustee to recover from unperfected lieholders if any value/property was transferred via § 550(a)

Must either return the collateral or pay the valueo Lots of litigation involving 9-317 and 550(a)

Litigation is always about perfection – was it filed right, in the right place, right type of collateral asset, etc…

ISSUE: If submit UCC statement with company name with character not on QWERTY keyboard, what happens?

Unresolved issue. Lots of decisions about whether perfected or not

Also with really common name, like “Wang,” can become a problem

o NOTE: It is in the interest of the trustee to say liens are not perfected This generates lots of litigation

§ 544(b)o This section incorporates state law which will point you to UFTA for a given

state UFTA § 7 allows avoidance of transfer or attachment or other relief

o If trustee can apply UFTA, why have § 548? Language tracks pretty well except for SoL. 2 years in 548, 1 year in

UFTAo EXAMPLES: Easiest cases for application of UFTA/548 is house sale to

brother for dirt cheap or transfer of property into wife’s name Transfer to wife is not reasonably equivalent value § 4(a)(2)

o BigLaw Examples: Parent has Sub1 grant security interest in assets to bank for $100MM

loan to Corp Creditors of Sub1 not same as creditors of Parent and so

security interest on behalf of Parent puts secured creditors at $100MM disadvantage that otherwise wouldn’t have had

Structural Subordination – Where setup structure that subordinates otherwise senior creditors

How is this different than any loan? There’s always structural subordination with creditors being junior/senior to each other

o Difference here is that balance sheet not sameo Parent has $100MM asset with no liability and Sub1 has

$100MM liability with no asset In conventional loan, Borrower gets both liability

and asseto So no reasonably equivalent value to the Sub1

LBO’s Borrow $100MM from bank and grant security interest, then

use money to pay off SH’so SH’s are lower in priority that secured lenders so if

things go badly, perhaps a fraudulent conveyance

47


What is the justification?o Improve value by attracting managers to run company

well and such. That’s value to the creditors. Better chance of success

People get really nervous about LBO’so Opinion letters only go so far because firms are so

nervous they are overly-cautious when writing letters § 547(b) - Preferences

o If the transfer fits in (b) then it’s a preference. If not, then no preferenceo If it fits (b), then go to (c) to see if an exception fits

Never go to (c) before doing the (b) analysiso Only avoids transfer of interest of debtor’s property – no one else

Letters of Credit are not preferences because not debtor’s moneyo (1) – Must be to, or for the benefit of, a creditor

Most typical is just a payment to a creditor to get them to back off Payment for benefit is to a 3rd party for benefit of the creditor, such

as a guarantoro (2) – Antecedent debt

Must have some time elapsed between incurring debt and making the payment

If payment is immediate, no preference, or even if grant security interest immediately

Big question of how long a wait is necessaryo (3) – While insolvent

Much less of an issue with sub (f) which says presumed insolvent 90 days prior to bankruptcy

This is a rebuttable presumption though (In re Pysz) Can prove that they weren’t insolvent, but very tough and

expensiveo (4) – Time requirement

Common preference is within the 90-day period pre-petition Could end on a weekend, so some discrepancy on this period

Extended to 1 year for insiders Elaborate definition of insider, includes family members,

officers, board, etc… Why would you challenge transfer to wife/friend as preference

instead of fraudulent conveyance under UFTA/548? These rules are hard edged, as opposed to mushy UFTA rules If you have the data, much easier to prove preference than

fraudulent conveyanceo (5) – Creditor receives more than would in Ch. 7

Fully secured creditor getting 100¢ would not apply here because would recover anyway in liquidation

o The evil that preference provision is trying to avoid is the rearranging of priorities

48


If fully secured, you haven’t taken money out of anyone’s pocket, so fail (b)(5) and not a preference

Haven’t hurt anyoneo Law grew out of UFTA

Makes it harder for creditors to destroy business because if seizes assets, can get them back

If take preference payment, just have to return it So really no cost to taking a preference payment

o APPLICATION: If JPMorgan and have DIP that wants to pay $50MM, what do you do?

Do everything you can to help him stay out of bankruptcy for 90 days so can’t void payment

If he really owes $70MM, don’t want to demand other $20MM for 90 days so you don’t trigger bankruptcy and void your preference payment

o EXAMPLE: Debtor has creditors C1 and C2 both owed $1MM Collateral worth $1.5MM with C1 having priority over C2 If make $100K payment to each, are either of them preferences?

C1 fully secured, so probably not preference under (b)(5) C2 is secured up to $500K, so probably not preference either

o But this assumes application of payment to the secured claim

o If applies to unsecured claim, He’ll then end up with a $500K secured and $400K unsecured claim in bankruptcy, giving total payment of $600K and would be in a better position than would have been under Ch. 7 – violating (b)(5)

What if no payment to C2, but only $100K to C1 Could argue preference to C2 because payment to C1 lowers

claim to $900K, giving C2 claim on $600K. Would have gotten $500K in Ch. 7, so payment to C1 was “for the benefit of” C2 and could be voided as preference

Could imply that “for benefit” implies scienter, but not sure it’ll work

Seems NUTS to call this a preference, but rule makes it so If C1 has L/C on debt of $1MM and makes $100K payment,

preference? Appears so. By paying C1, lowers the amount that guarantor is

on the hook by $100K, conferring a benefit Seems crazy to call this a preference, but the law reads it that

way § 550 would theoretically give C2 the ability to collect from C1

Demonstrates the crazy state of preference lawo Security Interest Grants

49


Suppose on day -91 creditor takes security interest and lends money, but perfects 70 days later by filing UCC statement. Is it a preference?

547(e)(1)(B) says transfer for property other than real property is perfected when no one else can get superior claim, so that’s when the statement is filed, so this would be a preference

However, sub (2) says that if filing occurs within 30 days of transfer, perfection deemed to be the transfer date

So if filing is between -91 and -61, then deemed to have occurred on day -91 and no preference

EXAMPLE: If conveyed day -87, filed day -65, what happens? It’s all clearly within 90 days so violates (b)(3). But (b)(2)

requires the transfer be on account of antecedent debt (e)(2)(A) says if file within 30 days of conveyance, then

deemed to have all occurred on date of conveyance Because within 30 days, then the transfer and conveyance of

security interest all happened on day -87 and so not on account of antecedent debt

o NO PREFERNECE Point is to allow business to continue to operate

o If company hurting, no bank would lend because would be preferences and would lose their money

o This way they’re protected. Consequence of 30-day period in (e)(2)(A) is that it might knock the

transfer out of the 90-day period, or even within it, it might make the transfer and conveyance the same day, so doesn’t meet (b)(2) and so no conveyance

MORE EXAMPLES: Assume Debtor has L/C with Bank and Bank pays $10M to

Creditor to satisfy debt.o No preference because doesn’t involve debtor’s

propertyo No one is worse off here. All that happened is Bank

stepped in Creditor’s shoes Assume Debtor grants security interest to Bank in return for

L/Co If bank pays of creditor within the 90-day window,

cases on point say this is a preferenceo It’s no different than when a debtor gives a security

interest to a creditor Just gaming system by giving the security

interest to a 3rd partyo If within 90-days, clear preference, though JJ not sure

how you get there under statute What if Creditor draws on L/C 40-days prior to bankruptcy?

50


o Doesn’t matter to analysis when L/C drawn on. Only the transfer matters, so as long as security interest granted outside the 90-days, it’s ok to draw on L/C on day -40.

o No Preference. § 547(c) – Preference Exceptions

o (1) – Attempt to stretch antecedent debt issue (Not very important §) Most common case is check. If pay by check and doesn’t bounce, ok

under (1) because while check isn’t immediate payment, the intent is to be immediate

If check bounces and then gets cashiers check, then don’t get the exception and will be antecedent debt

This isn’t intended to cover UCC filingso (2) – Most Important Section

Have to show that debt is incurred in ordinary course (Easy) and that payment was in ordinary course or made according to ordinary business terms

(A) is about historical relationship – how things have been done in the past

(B) is about the sector/industry practices As long as can show debt was incurred in ordinary course and either A

or B, then transfer ok even if a clear preference under (b) (payment to creditor on day -40)

Available to any type of creditor Exception almost swallowing rule

Tons of litigation on this issue JJ thinks preference rule sucks and suspects judges do to, so

they use (c)(2) to circumvent preference ruleso (3) – Purchase-Money Security Interests (Not very important)o (4) – SEE PAGE 505-506 in book for analysis

Can offset new value against preference payment If make $1000 preference payment, then creditor ships $700 of

inventory to debtor on credit, can offset the $700 so the preference payment is only $300

This is only available if the offset qualifies as a preference In other words if the $700 payment was in cash, there’s no

antecedent debt so not preference and thus isn’t netted out. Full $1000 is a preference

o (5) – JJ SAYS FORGET ABOUT SECTION – ASSURED IT WON’T BE ON FINAL BECAUSE CASES DON’T COME UP

Earmarking Doctrineo Common law doctrine – No statuteo EXAMPLES:

C1 has claim against debtor and wants out. C2 comes along and says will pay debtor $100K but it’s to pay C1

51


Payment is “earmarked” for C1 If this is clearly done, then there’s no preference

If payment is clearly earmarked for C1, no other creditors ever had a claim to that money so they aren’t hurt by the payment

Assume C1 is Chase and C2 is Citi and Debtor is Sears C2 could buy C1’s loan to Sear’s and try to take his secured

position If pays money to Sears and earmarks it for C1, 2 risks

o One is that judge won’t see it as true earmark for whatever reason

o Other is that there’s no perfected interest during time that loan is paid off to C1 and deal closed with C2

To further this, C2 has new loan and might end up behind some creditors that perfected after C1, but before C2

Surest way is to purchase the loan directly from C1 to take over their position

o Avoid earmark problems and takes over C1’s perfected position instead having new position at time of loan from C2 to debtor

Just do assignmentF. § 365 & Executory Contracts

Section is a mess. Congress didn’t figure out what they were really trying to do so they keep amending for lobbies. Hard to parse the section

Executory Contract Definitiono Countrywide test: if non-performance by either side/both sides is breach of

contract Mortgage is a good example at the beginning, but can become non-

executory when one party completely performs Licenses are big problem

If 10 year license, want to know about royalties. If licensee pays up front, no executory K

If monthly royalty, then executory § 365(n)

Rejectiono If trustee rejects contract, constitutes a breach immediately prior to petition

under § 365(g) This makes it a general, unsecured claim

o What about if would have had specific performance as remedy under K? Can force to sell property if real estate But section has exceptions and doesn’t say when you get specific

performance Also only applies to real estate, not other property

o EXAMPLES: Debtor is Franchisor and rejects franchise agreement

52


Franchisee has claim for damages, but will be pre-petition, unsecured

GM is example that not all K’s treated the same Only way to help franchisor is to argue no executory

o If successful convincing Court, Debtor can just repudiate and say “so sue me”

o But puts franchisor in better position because then the claim is post-petition

In GM and Chrysler, companies settling with terminated franchisees, so they won’t ever sue on this point

o Some commentators argue that 365(g) can imply availability of specific performance

Others say that since only says breach, that’s all you geto 365 provisions (h), (i), (j), (n), (p) are exceptions

One argument out there is that subsections cover certain scenarios, so if it isn’t explicitly stated in these subsections, then it was excluded and nothing can be imputed to mean something

Assumption & Assignmento (b)(1) – If breach under lease or executory contract, have to either cure, or

provide adequate assurance that you can cure “promptly” Derives from UCC § 2-609 which says if there’s a danger of default,

other party will suspend performance until receive adequate assurances

Non-Monetary breaches If non-monetary provision is also broken, it must be cured as

well Case in book where didn’t maintain adequate insurance

o This can’t be cured because time lapseo If nonresidential lease, can cure by becoming current –

cure by performanceo Otherwise can’t cure

Untimely cure is only allowed under (b)(1)(A) for nonresidential leases

o So if non-monetary breach on, say, an airplane lease, the lessor can take airplane back

o Lease cannot be assumedo (c) – instances where can’t assume and/or assign under any circumstances

(1)(A) – applicable law excuses party other than debtor from accepting performance from an entity other than debtor AND that party doesn’t consent

Think performance K for a movie star Can possibly be used where state law says auto franchise

agreements can’t be assigned (2) – contract to make a loan or extend debt financing or other

financial accommodations, or issue a security

53


Can’t assign agreement with bank to lend $1MM because agreement to lend was based on debtor credit history

(3) – if lease of nonresidential real property and terminated pre-petition

o Ipso Facto Clauses (e) & (f) deal with clauses that say K is ipso facto CXL’d if enter

bankruptcy Harder case is where it’s not explicit

EXAMPLES:o Provision that says if assign lease, lessor gets first right

of refusal Not outright prohibition, but effectively it is

because landlord will take property back so no one will negotiate for lease

o Provision that says if assign lease, lessor gets 1/2 of increase of rent

Could argue that this is a condition on assignment prohibited by (f)(1)

Problems with these things is that it chills the ability of bidders to bid highest amount

Just more clever way of restricting ability assign – (f)(1) There’s nothing that can be done by lessor to prevent lessee from

shopping leases and keeping any upside in the assignment Short-term lease is the only way to protect against that

Most any clause that is condition will probably be seen as subterfuge under (f) and not going to be valid

Problem 26.5 (525)o Pretty hard to force acceptance/rejection. Added provision where deemed

rejected after 120 days if do nothing Gives companies time to analyze contracts

o Idea here is that most provisions are financial, so not assignable under 365(c)(2)

Lease, purchase terms, loans Lease not necessarily financial, but if you are pre-paying, say the

month ahead of time, then setup creditor/debtor situation, so possibly can argue financial term

This will be the hardest one to argue under (c)(2). Others pretty easyo Can’t divide K. Have to accept/reject as a whole

Problem 27.1 (533)o Can’t cure nonmonetary breaches of property other than commercial real

estateo So can cure real estate lease, but not equipment leases, unless they agree

Problem 28.1 (545)o Have to look at § 365(i)o If buyer has possession, they can keep the property

54


NOTE: If buyer has paid full amount but doesn’t have possession, we still aren’t helped because the K wouldn’t be executory

o Can you get specific performance? Odd argument because if you can get specific performance instead of

allowing rejection of K, then 365(i) is really unnecessary Would respond saying that can’t draw expressio unis conclusions from

365 because so full of lobbyist concessions, can’t infer that the negative of anything not enumerated isn’t true

To get specific performance, you would want to argue property right, not K right

365(g) just says there’s a breach of K. Doesn’t talk about property rights, specific performance, or anything else

Would argue all that happened is a breach, but doesn’t affect the property right expressed by specific performance

Conflicted statuteo Very unclear applications

EXAMPLE:o K-Mart comes to you to file bankruptcy and has 1,000 leases to analyze

Because not ch. 7, get 120-day rule in (d)(4)(A) Allows company to make business judgments about each lease Can get one 90-day extension “for cause” Up to 210 days (209 effectively because have to request

extension prior to 120th day) Odds are good will be able to reject what want to reject and accept

what want to acceptG. Tax Consequences of Bankruptcy

Generally debt forgiveness is taxableo Have to pay income tax on the debt that is forgiven

In bankruptcy, they don’t do that. Discharged debts are NOT taxableo But they make adjustments to other things:

Reduction of any NOL carryovers Reduction to basis in assets

All sizable bankruptcies must involve tax lawyers to handle these issuesH. Statutory Liens

De facto liens created by a statueo EXAMPLE: Mechanic’s lien – if take car and don’t pay, statute automatically

grants lien to mechanic on the automobile Date of liens go back to when work began

o If constructing building and client doesn’t pay, the lien goes all the way back to when the work began

o If project lasts 4 years and defaults in last month, the lien extends back 4 years

Usually requires some type of filing, then you are ahead of other creditors, future, etc…

§ 545

55


o Allows avoidance of statutory liens in certain instanceso (1) – Mostly just ipso facto clauses

Doesn’t do mucho (2) – If filing is required and not filed, then lien is avoided

This depends on the state lawo (3) – Not sure of the reason for this, but liens for rent payments are avoided

Problem 29.1 (553)o Lease provision is both a statutory lien and contract lien

The statutory lien is invalid under 545(3), but the contractual lien doesn’t apply to 545 so can go to court for a judgment lien

Would then have to look to 544(a)(3) and would get BFP status If BFP loses to lien, then trustee can’t avoid it

o For judgment lien, also have to look to state law to see if filed in records If BFP loses to this lien, then trustee can’t avoid it either. State law at

issueo Plumber’s statutory lien is avoided because didn’t file. 545(2)

If statutory lien, even unfiled, beats judicial lien, plumber still can’t be helped because his lien is avoided under 545

Can’t get 544(b) because that’s fraudulent conveyance lawI. Fraudulent Conveyance

Problem 30.1 (574)o Burt isn’t company, so the money isn’t his. Probably FCo No reasonably equivalent value under either UFTA or 548o Also have solvency issue to proveo Big problem here is what to tell client

Have to remember you represent company, not Burt, so would really need to tell Burt to give the $40K back, but he’ll think you’re crazy and will likely find another attorney

ISSUE: How do you effectively represent a party when you and the party have different opinions as to who the client is?

Can’t really avoid the problem and will just have to tell him it’s an FC and let the chips fall where they may

o Is the FC to Burt or to the cruise company? Cruise company will want to point to 550(b)(1) – good faith

transferee Also, (a)(1) says for whose benefit such transfer is made, and transfer

is for Burt’s benefit Company probably off the hook

o Suppose Do E/P for Burt and he calls and says bill the company. Do you do it?

Probably shouldn’t but JJ doesn’t know full reasoning why not It’s a question of do you make client happy and how you do that is

very complicated Not clear you should do this

56


o UCC Article 3 says good faith recipient of negotiable instrument takes free and clear of any upstream claims

If Burt paid by check, UCC seems to support Cruise Company’s claim that has right to money free and clear of any FC claim

Problem 30.3o 548(a)(1)(B) is at issue here – less than reasonably equivalent valueo Go to 550(e)(1) for some hope

Has $100K lien on the transfer back But can’t get the building back from Wang because he has BFT defense

under 550(b) Problem 30.4

o Estate can’t argue FC Entire real estate industry would go crazy because all foreclosure

sales happen like this The facts are rare, but could happen if there’s no mortgage

Generally mortgagee just bids what they’re owed and they take house and right off debt. No money exchanged

Entire mortgage sales industry would unravel if this was fC Answer to client is they’re screwed. Plumber gets property for $1600 Lawyer for lumber would say “Enjoy Barbados”

o S.C. case says cannot challenge these transactions as FC assuming comply with state law

Sheriff’s auction complies with state law Problem 30.5

o Could challenge dividend as FC under state law Most state corporate laws prohibit dividends by insolvent cos. Big problem here whether creditor has standing to challenge under

state corp law or UFTAo Could argue not reasonably equivalent value

Company will argue that attraction of capital, increased liquidity, etc… are all value added to co. by dividends

o Practical problem with large companies like GM How do you get dividends back from millions of shareholders?

o Under DE law, no single creditor has standing to make illegal dividend claimJ. Equitable Subordination

§ 510(c)o This is really like an avoidance powero Court can subordinate a more senior claim in the interest of “equity”

§ 510(a) – Just saying subordination agreements valid in bankruptcy § 510(b) – Claims regarding stock issuance are treated as SH, not unsecured creditor EXAMPLE:

o C1 has $100M claim, C2 has $100M claim, C3 has $40M claim. C1 subordinates to C3 to extent of C3’s claim

o $130M to divide up C2 might try to say he gets $100M, then C3 $30M, C1 nothing

57


o C1 will argue no agreement with C2, so C2 can’t be elevated above C1 Doesn’t give up first place in line

o So C1 gets $100M, then via K, gives $40M to C3. C2 gets remaining $30M C2 isn’t hurt here. Without subordination agreement, still would only

have gotten $30M. He’ll be jealous, but can’t be angryo Why sign subordination agreement?

If financial difficulty, will subordinate to allow new loan to company and increase chance of recovery to help company survive

That will lead to agreement at time C3 loan is madeo Why sign sub agreement up front when 1st loan made to C1?

Can get better interest rate because of agreement to subordinate in future

Want to be very careful about description of who will qualify for elevation so not stuck behind idiot

EXAMLE 2:o A & B going to start company and want to issue $5M stock

Can try to game system by issuing $100K stock and making a $4.9M loan

If things go badly, will then try to recover under loan because with stock, creditors get first swipe

o Equitable subordination doctrine Under 510(c) judge can say, no, effectively you’re SH’s and just gamed

system, so I’m subordinating your claims to the unsecured creditorso Almost all 510(c) cases look like this where equity investors try to look like

secured investors to get a higher claimK. Negotiation and Confirmation of Chapter 11 Plan

Problem 32.1 (627)o Go after $7.5M payment as a preference

Even though secured creditor, collateral worth only $2.5M, so got way more than would have in Ch. 7

Can recover the $7.5M for estateo Can’t approve plan now without redoing the calculations and providing more

for all the unsecured claims out of the $5M ($7.5M preference minus the $2.5 secured claim)

In re US Truck (628)o Must have at least one impaired class approve plan under 1129(a)(10)o Routinely split classes in order to get a class that will approve plano In order to justify gerrymandering of classes, have to show some good

business reason for doing so Here, teamsters were sufficiently different from other unsecured debt

because of continuing business relations, collective bargaining agreements, and so forth, so ok to put in separate class to neutralize their vote

Claims Trading

58


o Banks trade claims in an effort to improve books, especially under pressure from regulators

o Creditors involved in bankruptcy often creditors who have purchased debt, oftentimes hedge funds, but not always

o ASSUMPTION: If by $1MM debt for $300K, the claim is still $1MM Get whole claim you buy, regardless of price

o In re Figter (644) TIA purchased majority of unsecured class to oppose plan

$100M claim was bifurcated so had $34.5M unsecured claim Afraid if plan allowed, would end up with some condos, some

still apartments and titles would be difficult to enforce Court says ok to challenge plan this way

Just stepping into shoes of other creditorso Credit-Default Swaps

Essentially an insurance policy Going to be lots of traded creditors who have interests different

because of insurance Not sure how this will be viewed, but likely that judges won’t

like ito If competitor buys debts in order to block reorganization, court will clearly

see bad faith Problem 33.1 (651)

o Has $1.6M dissenting, but $5M unsecured, and 1.6/5.0 is less than 33%o What can be done?

$300K claim guaranteed by CEO. If he can knock that out of unsecured debt, then ratio is 1.6/4.7 which is 34% and that puts him in blocking position under 1126(c)

o How can you get $300K out? 1122(a) says can only put similar debts together. Argue that

guaranteed debt is different than unsecured, with different incentives Possible to knock out

o This discussion will take place in negotiation Will almost never end up before a court

Problem 34.1 (661)o Obligation to SHs is fiduciary duty because rights not protected by Ko Creditors protected by K, so duty only goes as far as K imposes

Can do lots of stuff with creditors you can’t with SHs Creditors don’t care what you do with money as long as paying

bill Don’t care if take $100K to buy car for wife unless default on

obligation But SHs can sue

o In bankruptcy, possible that SHs will get nothing and creditors will end up equity holders

Have to determine when fiduciary duty begins running to them

59


o Not sure how this will work out in public, but issue always on attorney’s mind in bankruptcy

If SHs will receive 0, what duty is owed to creditors? If can get 40¢ in liquidation, or can go for plan with 30% chance of

80¢, 20% chance of 40¢ and 50% chance of 0 Not sure how that comes out

o In DE, courts resolved that don’t owe duty to creditors because too tough to know when duty changes

Bank of America v. 203 North LaSalle Street Partnership (664)o Absolute Priority Rule at issue hereo Trade creditors paid in full, but 1124 doesn’t say paid in full isn’t impaired,

so even paid in full, any change in agreement is impairment 1124 used to have 3rd subsection “paid in full on date of

confirmation” It was removed, insinuating that payment in full doesn’t mean not

impairedo Gerrymandering issue lost in 7th Cir. And wasn’t appealed

Issue that deficiency and trade creditors split to two different classes – maybe impermissible gerrymandering

If were together, deficiency would overcome trade and wouldn’t have impaired class approving

o § 1111(b)(2) election Election means get the entire claim treated as secured claim

Don’t bifurcate in § 1111(b) By making this election, no unsecured claims to affect votes under

plan Under 1129(b)(2)(A)(i)(II) payoff in plan must be the AMOUNT of the

claim, of a VALUE of at least the value as of the effective date of plan In other words, payment must meet 2 requirements:

o Total amount of claimo Value of claim as of effective date by the time it’s paid

off So here, Total claim is $93M, so with 1111 election, gets the entire

secured amount The plan, then, must have total payments of at least $93M (the

amount) and the TMV of the payments at payoff date must be greater than $54M (the current value at petition date)

At some point, TMV kills the analysis. If 5 year payoff, probably ok. If 30 year payoff, probably not ok

Why elect 1111? Because of appreciation. If you bifurcate, your claim is stuck at

$54M If you expect value to rise over coming years, you don’t want to

take the election because you will get the full $93M secured claim so you’ll capture some of that appreciation back

60


o Plan proposes 16% on deficiency and 100% on trade credit BofA votes no and says can’t cramdown because equity holders are

going to contribute $6M over the next few years and equity interest in reorganized company, which can’t do if the deficiency isn’t paid in full

Defense is that 1129(b)(2)(B)(ii) says “on account of such claim” and they aren’t receiving equity on account of old equity – they’re receiving it on account of new value.

o Court holds not ok because of exclusivity Deal not offered to anyone else – only offered to old equity holders,

which means deal offer was on account of old equity, so impermissibleo Rule is meant to keep equity from conspiring with top of co. to screw

creditors in the middleo So Bank going to be able to be given chance to propose alternative plan

They will opt to seize asset and liquidate and payoff creditors as much as possible

Bank might be able to offer new plan, but Bank’s plan probably wins on votes.

VIII. Environmental & Mass Tort ClaimsA. Introduction

These claims are enormous, so bankruptcy is usually the forum to resolveo Most famous are Fen-Phen, asbestos, and breast implants

Environmental Claimantso CERCLA is Fed Statute from 70’s requiring cleanup of hazardous wasteo Strict liability claim

Causes billions in liabilities with no way out Clash between policies and bankruptcy

o Bankruptcy about fresh start, but environmental law about protecting public health and encouraging good business practices

o Tort law about compensating victims, etc… Conceptual Problems

o Involuntary creditors in environmental and mass tort claims. How should bankruptcy treat them?

Involuntary Creditorso Claimants don’t choose it like banks and bondholders do

But they are generally lumped in low on the totem pole – general unsecured

o Code doesn’t provide any special privileges. Maybe it shouldo However, most companies have insurance policies, so claimants not left high

and dry They at least get something, but only for medical claims generally.

Not otherwise Definition of a claim

o 101(5)(A) – Very broad definition If don’t qualify as claim, don’t have right in bankruptcy

61


o 502(c) Allows for the estimation of claims, but no guidance on how to do it Judicial determination

o When claim arises is a timing issue Asbestos claims can span lifetime of claimant, so how do you

determine when the claim “arose” pre- or post-petition?o Conflict between present and future claimants

Some claimants have been injured but won’t manifest injuries until post-petition

“Long-tail Torts”o Often times the claims force bankruptcy which will force negotiations

B. Asbestos Companies used asbestos with knowledge that it was bad for people Everyone started suing when the public learned it was bad and companies knew it

was bado Johns-Manville is most famous example

Companies went to Congress and they refused to helpo Filed bankruptcy to try to deal with it all at onceo Created trust in 1989 with life of 49 years

Paid out $2.5B to 300,000 claimants so far Payouts down to 5¢ on the dollar

Legislationo FAIR Act of 2005

Sought to create $150B trust for asbestos claimants funded by cos. Never signed into law

§ 524(g)o Channeling Injunction is most important part

Companies absolved from responsibility Anyone with claim must bring against trust Requires someone to represent future claimants’ interests Hard technical requirements often not met – insolvency

o Supermajority Requirement 75% of claims must agree to funding of trust and 524 plan

o Gives power to claimants Attorneys control the process They generate databases of potential claimants and so if debtor wants

to reorganize, firms have to approve Few key firms that are big players with massive lists of claimants Supermajority reqs. give P firms veto power

o Effectively, this means debtor and P firms work together to setup trusto Big issue that no one knows if law firms’ claimants are valid or not

Leaves insurance companies as only ones with adversary position, but don’t have standing in court to challenge plans

62


C. Environmental Claims Unique timing problems, somewhat similar to asbestos § 1141 discharges all claims that arise prepetition

o Problem with determination of when claim ariseso DICHOTOMY:

If Debtor in Ch. 7, EPA wants to have pre-petition claim so that it can recover something

If Debtor in Ch. 11, EPQ wants to have post-petition claim so that it can sue for full recovery

Main Tests for Claimso Right to Payment Test

Claim doesn’t arise unless all elements of violation exist under substantive non-bankruptcy law prior to petition

To be valid, assumes that 101(5) term “right to payment” means “right to be paid”

That’s probably not the case Note widely used

o Underlying Acts Test As long as underlying act occurs pre-petition, the claim arises pre-

petition regardless of whether there was knowledge or not Also widely criticized because leads to discharge mostly and

undermines environmental policyo Relationship Test

Pre-petition claim when act occurred pre-petition and debtor/creditor began their relationship pre-petition, regardless of knowledge

Regulatory relationship alone held to be sufficiento Fair Contemplation Test

Most widely used test Pre-petition claim only if creditor could reasonably have ascertained

that it had a claim at time of petition Not as strict as other tests one way or the other Allows claims before Right to Payment would, but not as broad

as Underlying Acts test because requires constructive notice Signature Combs, Inc. v. US (725)

o Company dumps toxic waste from 1950-1970 File Chapter 11 in 1986 1998 EPA cleans site then sues SC to force reimbursement Was CERCLA liability for cleanup discharged in Chapter 11?

o Right to Payment test Not pre-petition claim because costs hadn’t accrued Not discharged

o Underlying Acts Actual acts were pre-petition, so pre-petition debt Discharged

63


o Relationship Basically same as underlying acts EPA regulated pre-petition and acts committed, pre-petition, so pre-

petition claim Discharged

o Fair Contemplation Test Applied By Court No evidence EPA could have seen that it would have had claim in 1986 Not discharged

o Company held liable Criticism of Fair Contemplation test

o Prioritizes regulatory goals over fresh start bankruptcy policyo Debtor may have no idea there will be a claim in the future so couldn’t give

notice even if it wanted to. It can’t and the debt can never be discharged in that circumstance

Justification of Fair Contemplationo Prioritizes environmental goals

Important to protect public healtho Public is more important that Company

It’s a value judgmento Fresh start is only one of many goals of Code

Central goal is also to provide creditors with maximum recoveryD. Mass Tort

In re Fairchild Corp (738)o Plan stipulated release from liability for pre-petition airplanes

Trustee and Court confirmed 3 years later plane crash kills 4 Issue is whether confirmation extinguished liability

o Policy Concerns Bankruptcy designed to give fresh start, so should roll up debt Bankruptcy supposed to protect creditors; extinguishing everything

doesn’t help themo One idea is that bankruptcy shouldn’t extinguish any liabilities that people

don’t know exist Flip side is this will encourage rush to bankruptcy to extinguish

possible claims before they ariseo Same Tests as Signature Combs

Add State Law Approach Determine if claim exists at state law If state law says claim existed at time of manufacture, then pre-

petition claim Court doesn’t like

Court focuses on Relationship Test Planes produced pre-petition and foreseeable lawsuits

64


Trustee never took steps to establish potential tort claims as claims in bankruptcy

o Court concludes that should focus less on which test is the right test to apply in all case, and focus more on what will get the right result

IX. § 363 SalesA. Overview

Sub (b) allows sales of assets outside ordinary course, free of liens if best way to protect value

o Sub (a) allows sales in ordinary course Differences from Plan

o Very quick Chrysler 42 days start to finish

o Approval of judge only – not creditorso Plan is more comprehensive than 363 saleo Sale focuses less of valuation and feasibilityo Business justification is all that’s required

SEE Lionel for list of justification factors Requirements for Approval

o Sale terms are highest and best offero Arm’s length negotiations

Chrysler puts this in questiono Best interests of estate and creditorso Purchaser acts in good faith

§ 363(f)o (3) – Speaks in terms of value. Circuits split on what this means

Face Value Appraoch Economic Value approach (FMV) Congress insinuates should be Face Value Approach, but because of

506 bifurcation, many argue that it should come into play and mean FMV

o (5) – Only talks about “interest,” doesn’t mention “lien” like (f)(3) was amended to say

Interpretation is sketchy. Could mean that if a lien is involved, you don’t get (f)(5), only (3)

65

bankruptcy outline - f09 - jjwhite (1)

Documents

bankruptcy estate

composition of estate

bankruptcy court

statistical overview

absolute priority rule

low income debtors

dip lender

cash collateral