JangerFall 2011Debtor and Creditor RightsBrooklyn Law SchoolText Book: Elizabeth Warren and Jay Westbrook, The Law of Debtors and Creditors

Week 1 Non-Judicial and State Law Debt CollectionRead pages 3-31 in the Casebook. Do problems 1.1-1.6Read Casebook pages 33-54 and NYCPLR '' 5202, 5232, and 5234 (in handout). Do problems 2.1-2.3. Do problem 2.1using NYCPLR '' 5202 and 5234. Do problem 2.2 using NYCPLR ' 5232.

(1) Leveragea. A troubled debtor must pick and choose which creditors to pay. The decision turns on

creditor leverage, which can be legal, reputational or transactional.b. Three Types of Leverage

i. Legal Leverage 1. Security interests; Judgments

ii. Reputational Leverage 1. Friends, social clubs

iii. Commercial Transaction Leverage 1. Debtors might want to participate in future activities w/ that creditor

c. Security Interestsi. A secured loan has 2 parts:

1. Contract (promise to repay)2. Property (right of the creditor to seize property if debtor fails to pay)

ii. Secured lender doesn’t want to seize property, they get less money that way, but the security interest gets them leverage.

iii. Ties up the asset so the debtor can’t use it as collateral w/ another lenderd. Indirect Leverage in the Legal System:

i. Creditors can sue for unpaid debts: Expensive, riskye. Credit Information Process

i. Reputational Leverage: ruin a debtor’s credit report(2) Credit Leverage Solution for the disgruntled

a. Erroneously credit reporting agencies i. Dispute the claim under Fair Credit Reporting Act – (FCRA) §611

1. What if decides information inaccurate?a. FCRA §1681(B) allows consumer to file a brief statement setting

forth the nature of the dispute. Max – 100 words.ii. Non-cooperation by credit agency

1. Willfullya. §1681n – actual, statutory and punitive damages, attorney fees

2. Negligentlya. §1681(o) – actual damages and attorney fees

iii. Leverage1. Transactional?

a. No – it won’t shut down business and won’t stop existing business. But it can hurt new business.

2. Reputational?a. Changes reputation going forward. b. Won’t be able to get credit

3. Answera. So it’s a little bit of both.

(3) Restrictions on non-judicial collectionsa. Usury Laws: A law that prohibits moneylenders from charging illegally high interest

rates.i. State regulated by the location of the creditor (most pay-day loan companies are

in DE or SD)b. Fair Debt Collection Practices Act (FDCPA)

i. Act fashions a federal remedy for abuses1. To stop “abusive, deceptive, and unfair debt collection practices”

ii. Scope1. Act applies to those who attempt to collect debts owed to others FDCPA

803(6)a. (Does not apply to creditors, their officers, employees collecting

debt for the creditor in the creditor’s name)b. This would mean banks are excluded from FDCPA

2. Attorneys are included as debt collectors even if the activity only consists of litigation if they often involve in such debt collection actions.

iii. 805: Communications w/ third partiesiv. 806: Harassment or abusev. 807: False or misleading representations: i.e., can’t threaten to sue if no intention

to do sovi. 808: Unfair Practices: ie, can’t collect more than you were owed

vii. Post Dated Checks: 1. Solicitation of a post-dated check violated the FDCPA if an agency plans

to use it as the basis for a bad-check prosecution FDCPA 808(3)2. If a check is post-dated by more than 5 days and they want to cash it, the

creditor has to give notice in writing before cashing it 3. Can’t threaten to deposit the check before the date on it (as a method of

collection?)4. Is a bad-check collector a “debt” collector within the meaning of

FDCPA?a. Writing a check includes a contractual promise to pay (Snow v.

Riddle) so it is debt! (4) Debt Collectors:

a. Collecting a debt owed to another; not collecting a debt owed to youb. Covers collection agencies, not banks (unless the bank uses a different name to collect)

i. Heintz v. Jenkins: The Fair Debt Collection Practices Act applies to a lawyer who regularly tries to collect consumer debts through litigation.

(5) Limits on Banks not covered by FDCPA (still must follow tort and contract law!)a. Tort Law

i. Intentional Infliction of Emotional Distress, Davis v. Public Finance1. Conduct must be outrageous (beyond bounds of decency), emotional

distress must be severe, & high probability of mental distress2. False Lights, Shoneweiss v. Dando

b. Contract Lawi. Implied duty of good faith and fair dealing

(6) Problemsa. 1.1 – SKIPb. 1.2

i. Question – Who is Talis most likely to pay?1. After calculating all the expenses, it seems like she only has 875 to pay

to the bank per month (even though she is supposed to pay 1800 a month.) The other debts are a lot more important to her – like her house, car, mastercard/visa (need to keep credit lines open), etc.

2. All of these creditors have something that the bank does not have and that is leverage!

ii. Question – How can Security try to improve its relative position?1. By increasing leverage. How would you do that? Try and make a deal,

like get a security interest. Or, go to court and get a judgment, etc. c. 1.3

i. Question – What can he do to dispute the claim?1. He should use the Fair Credit Reporting Act – (FCRA) §6112. FRCA §1681(B) allows consumer to file a brief statement setting forth

the nature of the dispute. Max – 100 words.ii. Question – What if the credit agency does not comply?

1. If its willful go to 1681n and the credit agency can be liable for actual damages, statutory damages, punitive damages and costs and attorney fees.

a. Janger – this is rare!2. If its negligent go to 1681(o) – and the credit agency can be liable for

actual damages, cost and attorney fees. d. 1.4

i. Question - Is the interest rate a problem?1. 924% seems like a crazy high number which is sure to be illegal in most

states. I think you would have to look at the states’ statute.2. See FDCA §803-808:

a. Cannot use unfair or abusive means to collect a debt3. Sec. 808: (3)

a. The solicitation by a debt collector of any postdated check or other postdated payment instrument for the purpose of threatening or instituting criminal prosecution.

b. One could argue that Kesha was not forced to write a second check.

ii. Question – Is Payday covered under FCPA?1. It seems like it go either way. But in the end of the day, it seems like

Janger believes it is covered. iii. Question – Assuming they’re covered, what has Payday done wrong?

1. Communication with third parties (805)2. Harassment or abuse (806)3. False or misleading representations (807)

4. Unfair practices (808)iv. Question – Assuming they’re covered, has Payday violated the FDCPA by taking

a post-dated check?1. Under § 808 of the FDCPA, if the check is postdated by more than 5

days, the creditor has to give notice in writing before cashing the check.a. (2) The acceptance by a debt collector from any person of a

check or other payment instrument postdated by more than five days unless such person is notified in writing of the debt collector's intent to deposit such check or instrument not more than ten nor less than three business days prior to such deposit.

2. The solicitation of a post-dated check violates the FDCPA if Integrity plans to use it as the basis for a bad-check prosecution

a. (3) The solicitation by a debt collector of any postdated check or other postdated payment instrument for the purpose of threatening or instituting criminal prosecution.

3. Can’t deposit it before the date of the check.a. (4) Depositing or threatening to deposit any postdated check or

other postdated payment instrument prior to the date on such check or instrument.

e. 1.5i. Question - Is a check a “debt” within the meaning of the FDCPA?

1. Debt collectors have argued that a check is not a debt for FDCPA purposes. However, some courts have ruled that it is. Writing a check includes a contractual promise to pay something.

ii. Question – What section of the FDCPA is likely to be applicable to these collectors?

1. Communication with third parties (805)2. Harassment or abuse (806)3. False or misleading representations (807)4. Unfair practices (808)

a. Under unfair practices, it states, that the only amount you can collect is the amount that is expressly authorized by the agreement. So it depends on Fiddle is convincing debtors to pay more than they owe. They can be violating this statute. They could probably get away with it, if there was a sign next to the cash register: “Bounced checks subject to $100 fee.”

f. 1.6i. Question 1

1. Is Ms. Chalmers’ claim for damages a “debt”?a. Yes. § 803(5) – debt is defined as basically anything owed

arising out of transaction. So I guess – yes. ii. Question 2

1. Are you the lawyer a debt collector?a. Yes. §803(6) – defines it pretty broadly – as any person who

uses any instrumentality of interstate commerce iii. Question 3

1. Did you the lawyer violate the FDCPA?a. Look at 805, 806, 807, 808

2. 807(5) – threat to take any action that cannot be takena. Did you really mean to take them to court?b. Has your client ever taken anyone to court before?c. Etc.

(7) Recapa. Most debts are paid in the ordinary course of business without judicial intervention.b. A troubled debtor must pick and choose which creditors to pay.c. The decision turns on creditor leverage.

i. Leverage can be legal, reputational or transactionald. There are limits upon the creditor’s right to put pressure on the debtor.e. Some limits are imposed by the FDCPA.

i. Only covers “debt collectors” not creditors collecting in their own name.ii. Lawyers may be “debt collectors” so you need to understand the FDCPA limits.

f. Even if you are not covered by the FDCPA, you must not run afoul ofi. Tort law:

1. Intentional infliction of emotional distress2. False lights3. Disclosure of confidential information (if you have a duty)

ii. Contract law:1. Implied duty of good faith and fair dealing

State Law Debt Collection

(1) Collection Remediesa. Intro to Judgment Collection

i. Judicial Enforcement1. Sometimes, even after a judgment, debtors still don’t pay the creditor 2. Debts are not enforcement against the debtor, but against his assets.

ii. Three Steps to Compel Payment of a Debt:1. Get a judgment

a. Get a writ (court order)2. Become a lien creditor (levy or record)

a. Deliver writ to sheriff and have them execute the writ3. Sell the property in satisfaction of the debt

iii. Liquidating the Collateral1. Once a creditor has a perfected judicial or consensual lien on the debtor’s

property, they get certain rights:a. Judgment Lien Creditor:

i. Judicial Saleb. Real Property Mortgagee

i. Judicial Foreclosureii. Non-judicial foreclosure (power of sale)

c. Art. 9 Secured Creditori. Self Help Repossession: § 9-503

1. Repossess the property upon default w/o judicial intervention (as long as it can be done w/ no breach of the peace)

ii. Strict Foreclosure: § 9-505(2)1. Retain the collateral in satisfaction of the debt

iii. Public or Private Sale: § 9-5041. Sell the property in satisfaction of the debt, then

pursue debtor for any deficiency(2) Priorities

a. Basic Priority Rule: FIRST IN TIME IS FIRST IN RIGHTi. Becoming first in time:

1. Unsecured Creditors: Needs to execute or “levy on” a judgment lien, or record on real property

a. Most states: no general levy, must be item-by-item2. Secured Creditors: needs to perfect security interest3. Buyers: Needs to record certificate of title4. Statutory Liens and Trust Funds: certain liens created by statute have

priority as a matter of law over other creditorsb. EXECUTING A JUDGMENT LIEN

i. NYCPLR 5201: $ judgment can be enforced against any property that could be moved or assigned….unless exempt

ii. Execution1. Moninger: (NE) no need for sheriff to remove the goods in order to

complete effective levy; just lay hands and pronouncea. Problem w/ “hugging rule”

i. Collateral stays w/ debtorii. Leads to secret liens: lets debtors give security in things

they don’t own

2. NYCPLR 5232: a. (a) if prop is not capable of being delivered, sheriff must deliver

garnishee w/ a copy of executionb. (b) if deliverable, sheriff has to take it

iii. Race to Execute1. If delivered to the same sheriff, the date that matters is the date delivered

to the sheriff, not the judgment date or the execution datea. NYCPLR 5202: When a creditor delivers a writ to a sheriff,

they have an “inchoate lien” on everything that could be seized.b. NYCPLR 5234(b): When 2 or more orders of execution are

delivered to a sheriff, they are satisfied in the order they were delivered to the sheriff

2. If different sheriffs, first to execute wins.3. NOTE: if creditors are racing to execute liens, another creditor w/o a

judgment could file an involuntary bankruptcy petition against debtoriv. Turnover Orders

1. Sheriff can take stuff, but can’t make people do stuff2. If debtor needs to do something (ie, sign over a letter of credit), Judge

can issue a turnover order forcing the debtor to do it3. Gerdes: Judge ordered stock docs be created and signed over

v. Dormancy: Courts can declare judgments dormant if creditor fails to seek enforcement (usually 1 year); judgments can’t be held as security

1. Judgment still exists, but is unenforceable unless “revived”2. Subject to collateral attack3. Can be avoided by a yearly attempt to collect, even if unsuccessful4. Webster v. Webster

(3) Problemsa. 2.1

i. Concept of priority- ‘first in time is first in right’1. First at what? First to obtain a property interest that cannot be defeated

by an intervening third party- perfection is a statutory term that refers to this

ii. Facts

Name Date of Judgment Delivery of Writ Execution of Writ Ace November 1

Blake November 10 November 15Cratchett November 20 November 22 November 25

1. (Three of Rollins suppliers have recovered judgments against Rollins, each in the amount of 100k. The appliances are expected to bring 150k at the sheriff’s sale.)

iii. Are the appliances lienable in New York state? 1. Yes- NYCPLR 5201- any property that could be assigned or transferred,

unless exempt2. Basically anything the debtor can give away or sell can be taken by the

creditor to satisfy its judgment3. (Real property may be exempt - NY homestead exemption, for example)

iv. Priority 1. So who comes first, Blake or Cratchett?

a. If Blake and Cratchett delivered to the same sheriff? i. NYCPLR 5234(b)

1. If 2 writs are delivered to the same sheriff and the sheriff executes on the stuff, the priority is dated not according when the sheriff executes but when the writs were delivered to the sheriff - so in this problem, Blake is served first b/c he delivered his writ to the sheriff first

b. If Blake and Cratchett delivered to different sheriffs? i. NYCPLR 5234(B)

1. The proceeds would first go to the creditor whose sheriff actually levied and then distributed according to the order in which the other creditors place a demand on the levying sheriff -so not withstanding 5202, in this situation, Cratchett would win first even though he delivered his writ second

2. What can Blake do to make sure Ace doesn’t jump in front of him? a. Blake has to make his sheriff give notice to Cratchett’s sheriff to

give him notice of Blake’s judgment before the proceeds are completely disbursed

b. If different sheriffs, the one that executes wins first then to ASSURE your priority, have you sheriff notify the executing sheriff

3. Does bankruptcy change any of these alternative approaches? a. Bankruptcy Code 541(a)(1) says in bankruptcy an estate is

created of all legal and equitable interest in property- 544(a)(1)(c) the key to priority is to become a lien creditor

b. 2.2i. Point: a perfected security interest TRUMPS judgment liens

ii. Facts1. Your client had a judgment lien, served the writ to the sheriff, and then

the sheriff went to levy but decided not to b/c shoes below cost said they will work out a deal - in the interim, shoes below cost gave the bank a security interest who perfected it by recording

iii. Holding1. Therefore, the bank wins b/c they are a perfected security interest

iv. Note: 1. Nebraska

a. In Nebraska there was a case called Broken Row v. Monenger that said a sheriff could go out and say ‘I seize’ w/o taking and therefore, the judgment lien became perfected and so this case would say your creditor perfected when he went to shoes below cost

2. New Yorka. In NY- 5232(b) to COMPLETE a levy, the sheriff has to take all

the property according to the judgment lien that is capable of DELIVERY- if the property is not ‘leviable’ then look at 5232(c)

i. So according to NY- the sheriff did not complete the levy b/c instead of taking shoes (5232(b)), he just went home

3. Professora. Professor likes NY rule better than Nebraska rule - b/c more

definite and it truly gives the other creditors notice that the property is encumbered

v. Moral of the story1. To BETTER protect your client, you should have either levied OR taken

a perfected security interest in the shoes before the bank didc. 2.3

i. (I think this is a garnishment question, so disregard for the time being)

Garnishment and Fraudulent ConveyancesRead Casebook pages 54-77. Do problems 3.1-3.2. Use NYCPLR ' 5232Read Casebook pages 78-92. Do problems 4.1-4.4, 4.6. Use UFTA §§ 1-8. Read Bay Plastics carefully. We willdiscuss it in class.

(1) Garnishmenta. Designed to allow a judgment creditor to seize either:

i. Tangible property being held by a 3 rd partyii. Debts owed to the debtor by a 3rd party

1. ie, A owes B $500. B owes C $500. B refuses to pay. C can bring suit against A to tell him to pay C instead of B.

b. Terminologyi. Garnishor – Judgment Creditor

ii. Garnishee – Third Party Debtor1. The Garnishor uses the Garnishment to assert the rights of the Judgment

Debtor against the Garnisheec. Webb v. Erickson :

i. Rule: 1. More liberality should be shown in setting aside a judgment against a

defaulting garnishee than in setting aside a judgment against a defaulting D.

d. Set-offi. Banks can “set-off” debts owed to it from deposits before the deposits are

garnished (debtor didn’t have right to that moneye. Leases

i. If the judgment debtor leased something to someone else already, the creditor cannot take it from the lessee (neither could the debtor under the lease)

1. Should be given to the creditor at the termination of the lease2. If the garnishment writ was executed before the lease was signed, should

be given to creditor immediatelyf. Answering a Writ:

i. NYCPLR 5232: bank has 90 days to answer, but if on date of service, bank says there is no money in the account, the writ of garnishment can close. If the bank says nothing, the writ stays open for 90 days

1. Stupid rule; Requires re-service of writs.g. Mistaken Payments:

i. If a bank is garnished and accidentally provides funds for a check from the debtor, the bank is liable. They violated a judicial order

ii. See NYCPLR 5232, 4-401, 4-303h. Firing for Garnishment

i. 304 of CCPA says can’t fire on the basis of “garnishment for any one indebtedness”

ii. Purpose: 1st garnishment is usually child support, you’d hurt the kidsiii. You can fire on the basis of more than one garnishment!!!

i. RESTRICTIONS ON WAGE GARNISHMENTi. Income Execution: garnishing the money owed to the debtor from their

employer1. Could impose severe hardship on earners w/ families to support

ii. Limits on Income Garnishments:1. Federal restrictions (Consumer Credit Protection Act) limit creditor to

25% of the debtor’s income, and in no event will the debtor be left w/ less than 30 times the min wage.

2. Limit is 50-60% when judgment is to enforce a support judgment3. States can give more protection (IL in Denson), but not less.

j. GARNISHING NEW PROPERTYi. Network Solutions v. Umbro

1. Court said you can’t garnish a domain name, deeming it a service contract and not property.

k. Problems

Priority of Competing Garnishments and Setoff rights:

(1) Priority of competing garnishment and setoff rights Creditor date of judgment delivery to sheriff service of writ amt first bank feb 1 feb 1 feb 9 3500second bank feb7 feb7 feb 9 3500

date deposit balance feb 1 -10feb 5 5000 4990

(2) (3.1A) a. How much money is subject to garnishment?

i. Any debt he or she owes to the debtor on the date the writ was delivered.b. In this situation

i. The bank is the garnishee / 3rd party debtorii. First AND second banks are the judgment creditor/garnishor

iii. Smettle is the judgment debtorc. How much is subject to garnishment?

i. Any property of the debtor in its possession on the date the writ was deliveredii. Any debt he or she owes to the debtor on the date the writ was delivered

iii. Any property or debt acquired or accrued up to the date of the garnishee’s answer

d. However, i. ‘Set offs’ trumps garnishment regardless of the timing

1. This means that the bank can deduct (i.e. set off) the overdraft before accounting to the garnishee

2. The bank is ‘setting off’ the $10 they are owed by the 5k deposit- and so the amount available to garnishment is 4990

3. If the bank charged an overdrawn fee, then this is also a ‘set off’e. When did each creditor perfect their judgment lien?

i. Note: 1. Consensual liens is the one that requires race/notice 2. Judgment liens requires service of writ - Depends on jurisdiction

ii. If perfection is obtained by service of writ, then First and Second perfected their interest simultaneously

1. Under this scenario, distribution would be 2495 eachiii. If perfection is obtained by delivery of writ, First perfected on 2/1 (2/5 for the

deposit) and Second perfected on 2/71. Under this scenario, distribution would be 3k to first and 1990 to second

iv. Rule: Perfection goes back to delivery of writ date IF the service of writ date the same

v. Distribution1. Under (II), First would get 30/65 and Second would get 35/652. Under (III), First would get 3000 and Second would get remained – 19903. Ruling – priority relates to the date the writ is delivered to the sheriff

a. (2 / III) is how we would distribute it

f. What’s the result in NY?i. Can the account be garnished?

1. NY 5201 – YESii. When does the creditor become a ‘lien creditor’?

1. NY5202- when the writ is delivered to the sheriffiii. How is priority determined?

1. NY 5234(b) - same sheriff? a. Date of delivery to the sheriff. First gets the first 3k and second

gets 19902. NY 5234(b) – diff sheriffs?

a. Date of service – first and second split 50/50g. Powerpoint

i. Can account be garnished?1. Yes. § 5201

ii. When does the creditor become a “lien creditor”?1. § 5202 when the writ is delivered to the sheriff.

iii. How is priority determined?1. §5234(b) Same sheriff?2. date of delivery to the sheriff. First gets the first 3000 and Second gets

1990.iv. §5234(b) Different sheriffs?

1. Date of service. First and Second split 46/54.(3) (3.1B)

a. What happens in situation where garnishment writ is served to bank but debtor writes check out to someone:

b. Factsi. It seems the debtor didn’t know about garnishment and wrote a check for $500 to

the phone company- the bank paid the check on Feb 10 and the question then is who gets $500 paid on the 9th?

c. Phone Company i. The phone company doesn’t have to give the money back b/c it was entitled to

the check ii. But the bank knew of the garnishment and screwed up—it was NOT allowed to

cash the check b/c the writ of garnishment means the bank can’t give the money to anyone BUT the creditors

iii. So the bank will have to pay back the $500 b/c it was their own faultd. What happens if on Feb 11, the debtor deposited $200 into the bank?

i. (This was a dumb move b/c anything going into the bank account goes into the NET - anything the 3rd party gets after the writ of garnishment, it goes into the net and gets paid to the garnishing creditor)

ii. Who gets the $200? 1. This would reduce second bank’s short falls

e. What if First had a judgment for 5990 (this means that after they took the 4990, they were still owed 1000) and 2 nd would have a judgment of 3500; THEN the $200 check is deposited, who gets it?

i. Assume that the writs were sent to the same sheriff and first delivered his writ to sheriff first - what happens to the money that falls into the garnishment debt AFTER the acount was first emptied?

1. Minority rule – NY a. According to in re Robbins which dealt with property coming

into the net after writ delivered: b. first and second would share ‘pari pasu’ - 10/45 ($44.44) would

go to First and 35/45 ($155.56) would go to Second- ie get their percentages

2. Majority rule a. priority from delivery to sheriff- First would get all

f. What happens after bank files an answer to the garnishment writ? i. The day after the bank’s answer, the debtor’s employer deposited $300-

1. Is the garnishment net still open? a. Majority

i. NO - the net closes when the creditor answers- so if you want this $300, you need to get another writ of garnishment

1. Always remember that in majority juris, non NY, the net CLOSES when the writ is answered!!!!

b. NY rule - minority rule – i. NYCPLR 52.32 - the garnishment net closes when the

garnishee turns over the property to sheriff or after 90 days, whichever is sooner—the answer doesn’t matter at all and

ii. Basically, in NY answering means NOTHING and so the $200 would fall into the net b/c it hasn’t been 90 days yet

(4) 3.2a. Powerpoint Answer:

i. How would a valid lease effect the garnishment?1. The garnishment only attaches to the debtor’s interest in the property. If

the debtor has conveyed a valid leasehold interest then the garnishment would attach to the property subject to the leasehold interest.

a. In the meantime, JCI can garnish the lease paymentsi. What happens if the lease was executed on October 20 and backdated?

1. If no lease was in effect at the time of the garnishment, the garnishment would attach to the property free of the leasehold interest.

l. 3D Outline Answeri. How would a valid lease affect the garnishment?

1. The garnishment only attaches to the debtor’s interest in the property. If the debtor has conveyed a valid leasehold interest then the garnishment would attach to the property subject to the leasehold interest

ii. Is judgment net open in NY? 1. Yes b/c writ was served and he had property- he has now answered, has

the net closed? No b/c you have to wait 90 daysiii. The garnishment only attaches to the debtor’s interest in the property. If the

debtor has conveyed a valid leasehold interest then the garnishment would attach to the property subject to the leasehold interest.

iv. Under the lease, Baker could not reclaim the equipment for a year, so long as Nicholson paid the rent- so baker couldn’t get the equipment from Nicholson till end of lease and therefore creditor couldn’t get the equipment from Nicholson

v. So you can get a writ of garnishment and have the monthly lease payments to the judgment creditor

1. You could also turn over the equipment for the duration of the year, but then its prob better to just get the payment

vi. If the equipment wasn’t leased after the garnishment, then the equipment would have to go back to the garnishor

vii. If no lease was in effect at the time of the garnishment, the garnishment would attach to the property free of the leasehold interest

viii. How will the court deal with a factual dispute over the date the lease became in effect?

1. Trial - just like any other issue

(1) Overview and Origins of Fraudulent Conveyance Lawa. When debtors try to protect themselves against creditors by transferring title in their

assets to other peopleb. Twyne’s Case : “Badges of fraud” that imply a transaction has the “intent” to “hinder,

delay, or defraud”:i. Transfer was a general gift of all property, w/o exceptions for personal property

1. if you are truly giving someone your stuff, you’re careful to reserve certain things for yourself

ii. Donor continued in possession, and was thereby able to defraud or deceive others

1. Possession is a strong indication of ownership, debtor was able to continue borrowing against property that wasn’t his own

a. Modern Solution: UCC filing systemiii. Transfer was done secretly

1. Goes along w/ number 2iv. Transfer was made “pending the writ”

1. Timing: It was done while the sheriff was coming to levy. Raises the inference that the transfer only took place b/c the creditors were coming

a. It could be that the debtor is in debt trouble and knows the creditors will be coming

v. There was a trust between the parties, the donor possessed and used all goods as his own: “fraud is always appareled and clad w/ a trust and a trust is the cover of fraud”

1. has to do w/ what is apparent to creditors and what is truevi. The deed says the deal was “bona fide”

1. If a K needs to say it is bona fide, it probably isn’t.(2) Uniform Fraudulent Transfers Act

a. ACLI Gov’t Securities v. Rhoades : NYi. Factors from which fraudulent intent can be inferred include:

1. A close relationship btwn the parties to the transaction2. Secrecy and haste of sale3. Inadequacy of consideration; and4. Transferor’s knowledge of the creditor’s claim and his own inability to

pay itb. 40 states adopted Uniform Fraudulent Transfers Actc. Insolvency

i. § 2(a): if the sum of the debtor’s debts are greater than all of the debtor’s assets at a fair valuation

d. Assets:i. § 1(2): not: (i) encumbered property; (ii) exempt property; (iii) interest in

property held in tenancy by the entireties to the extent it is not subject to process by a creditor holding a claim against only one tenant

e. Transferring Exempt Property: 1(12): you can do so b/c creditors couldn’t get itf. Present and Future Creditors

i. 4(a)(1): INTENTIONAL Fraudulent Conveyances1. 4(b) Determining Intent: Smell Test, consider:

a. the transfer was to an insiderb. debtor retained possession or controlc. transfer was concealedd. before the transfer, debtor was sued or threatened w/ suite. transfer was substantially all debtor’s assetsf. debtor abscondedg. debtor removed or concealed assetsh. value of consideration compared to transferred valuei. debtor was insolvent or became insolvent shortly after transferj. transfer occurred shortly before a substantial debt was incurredk. debtor transferred the essential assets of the business to a lienor

who transferred the assets to an insider of the debtor2. NOTE: § 8(a): transfer is not voidable under 4(a)(1) against a transferee

who took in good faith and for reasonably equivalent valueii. 4(a)(2): CONSTRUCTIVE Fraudulent Conveyances (no intent necessary)

1. Debtor made the transfer w/o receiving reasonable equivalent value and the debtor:

a. (a)(2)(i) was about to engage or just engaged in a transaction where the debtor’s assets were unreasonably small compared to the transaction

b. (a)(2)(ii) intended to incur, or believed or should have reasonably believed, that he would incur debts beyond his ability to pay as they became due

(3) Fraudulent Conveyances as to Existing Creditors (Strict liability)a. § 5(a): fraudulent conveyance if the debtor was

i. Insolvent at the time of the transfer or the transfer renders him insolvent; andii. Did not receive equivalent consideration

b. § 5(b): fraudulent conveyance if the transfer:

i. Was to an insider;ii. The debtor was insolvent at the time of transfer; and

iii. The insider had reason to know the debtor was insolventc. (Same as 4(a)(2)

(4) Good Faith Purchaser:a. § 8(a): They keep the property if it was fraudulent under 4(a)(1) and gave reasonable

considerationb. § 8(d): they get a lien on the purchased property for the purchase price, but lose the

benefit of the bargain and any value increasei. Any money put into the property: unjust enrichment claim

(5) Leveraged Buyouts as Fraudulent Conveyancesa. When one is insolvent, giving gifts to people other than creditors is a fraudulent

conveyanceb. So, in corporations, look for insolvent corporations “giving stuff away”

i. If a corp has 1.5M in assets and debt of 500K. They can give their shareholders up to 1M w/o rendering themselves insolvent. If they give more, it is a fraudulent conveyance

c. LBO’s deplete the company’s unencumbered assets, so the selling shareholders are paid indirectly w/ assets of the corporation itself

i. Enables shareholders to liquidate their equity interests w/o first paying general unsecured creditors as required

d. Legitimate LBOs:i. When the net equity exceeds the mortgaged assets

ii. Or even when the deal leaves the corp insolvent, but the cash flow is sufficient to pay the debts

iii. Example:1. Not a Fraudulent Conveyance

a. Old Corp has:i. Assets: 100,001

ii. Debt: 1iii. Equity: 100,000

b. Purchasers buy OC for 100K. i. Purchasers pay 10K

ii. Bank pays: 90K (secured by the corp)c. Now OC has:

i. Assets: 100,001ii. Debt: 90,001

iii. Equity: 10Ke. Application of FC law to LBO’s—In re Bay Plastics

i. Facts:1. Shareholders (SSH) formed debtor Bay Plastics in 19792. In Oct. 1998, SSH sold their Bay Plastics stock to Milhous for $3.5

million in cash plus $1.8 million in deferred payments3. Milhous caused its subsidiary Nicole Plastics to form its own

subsidiary, BPI, to take ownership of the stock4. Financing: Milhous didn’t pay for the stock but instead caused

Bay Plastics to borrow $3.95 million from BT Bank and then

caused Bay Plastics to direct $3.5 million of the loan to be disbursed to BPI BPI directed the $3.5 million to be paid directly to the SSH; as security for its $3.95 million loan, BT received a first priority security interest in all of the assets of Bay Plastics

5. Basically BT Bank received all of the proceeds of the debtor’s assets in this bankruptcy case and nothing was left for unsecured creditors

6. Knowledge of SSH: they knew about the LBO and they received a projected post-transaction balance sheet, which showed a balance of $250K in equity only b/c of the addition to the asset side of the ledger the sum of $2.26 million in “goodwill”

7. Shintech, a creditor at the time of the transaction didn’t learn of the LBO until 10 months later

a. 3 months before the LBO, Shintech had entered into a K whereby Bay Plastics granted Shintech a security interest in all its assets and the shareholders gave personal guaranties

b. after the LBO, Milhous persuaded Shintech to release both its security interest and the guaranties

(6) State Collective Remediesa. State debt collection law creates a race to diligence/race to the courthouse

i. Pro:1. Simple, easy to administer

ii. Con:1. Ignores greatest use of value; is debtor worth more alive?2. Unfair to help mean people at the expense of cooperative people

(7) Problemsa. 4.1

i. Powerpoint Answer 1. Did she intend to defraud her creditors?

a. Not as far as we can tell. Therefore no §4(a)(1) violation2. Did the conveyance nonetheless violate the UFTA?

a. Seems like it (look at the three points of §5)b. As a result, the purchaser has to give back the piano

3. Can the purchaser defend herself under 8(a) by asserting that he/she acted in good faith?

a. Not voidable. Good faith matters only for transfers voidable under §4(a)(1) (intentional fraudulent conveyances)

ii. 3d Answer iii. UFTA4(a)(1)

1. There was no intent by the debtor to hinder, delay, or defraud- so UFTA4(a)(1) doesn’t apply

iv. UFTA5(a)1. So Family Finance would turn to UFTA 5(a)- 2. The elements of 5(A)

a. Transfer? i. Yes

b. Claim arose before transfer arose? i. Yes - already owed Family Finance before she sold the

pianoc. Reasonably equivalent value?

i. This is a hard one - Prof thinks not reasonable b/c she only got half the value – have to ask whether ‘creditor would have gotten a better value’

d. Debtor insolvent? i. Yes

ii. §5 requires insolvency but §4(a)(1) doesn’t require insolvency, the main point of 4(a)(1) is intent

iii. §2 defines insolvencye. Remember 5(a) doesn’t care about the mind frame of any one- so

it doesn’t matter if debtor did it in good faith3. What happens to the purchaser?

a. The purchaser has to give back the piano - but he/she retains a lien on the piano for the purchase price, but he loses the benefit of the bargain

4. 8(a)a. Can the purchaser defend under 8(a) that he/she acted in good

faith? i. No, b/c good faith exception under 8(a) only applies to

intentional fraudulent conveyances of 4(a)(1) - remember the creditors have to go to §5 to get relief in this hypo

b. 4.2 i. PowerPoint Answer

ii. Is this transaction voidable under §4(a)(1)?1. What type of transaction violates this section?

a. A transfer made or obligation incurred by a debtor is fraudulent as to a creditor, whether the creditor’s claim arose before or after the transfer was made or the obligation incurred.

2. Was this transaction made “with actual intent to hinder, delay or defraud any creditor of the debtor?”

a. Sure it was. 3. Can we prove actual intent?

a. Probably not, but we can bring in the badges of fraudi. Transfer made to an insider

ii. Value received not reasonably equivalentiii. Debtor became insolvent shortly after the transactioniv. Transfer occurred short before substantial debt incurred.

iii. Can we also use (a)(2)(ii)?1. Yes – quasi constructive fraud

a. Creditor needs to prove unreasonably small capital or the debtor reasonably should have believed that she was about to incur debts that they would not be able to repay.

iv. Is this transaction also voidable under §5 (constructive fraud)?1. No. Amex was not a creditor at the time of the transfer. §5 applies only

to present, and not to future creditors. v. 3D Answer

1. Can AMEX successfully claim a fraudulent conveyance under 4(a)(1)?

a. Probably yes:i. Was this transaction made ‘with actual intent to hinder,

delay or defraud any creditor of the debtor?” 1. Yes b/c debtor was simply trying to hide an

assetii. Can’t really prove that she had the requisite intent but

you always prove intent through inferencesb. The transaction bears the badges of fraud under UFTA 4(b)

i. the transfer or obligation was made to an insider (the cousin)

ii. while the debtor did not retain possession of the property, she still expected to get the property back

iii. the value of the consideration received by the debtor was not reasonably equivalent to the value of the asset transferred or the amount of the obligation incurred- she sold something worth 15k for 1k

iv. the debtor was insolvent after the transfer was made v. the transfer occurred shortly before or shortly after a

substantial debt was incurred - remember the 5k amex charge

c. (you don’t need ALL badges, just a good number)d. The badges of fraud apply only to ‘actual intent to defraud under

4(a)(1), not to the mental states to be inferred in 4(A)(2)(i) and (ii)

i. 4(a)(2)(ii) works in this case:1. 4(a)(2)(ii) deals with ‘quasi constructive fraud’-

creditor needs to prove ‘unreasonably small capital,’ or the debtor ‘reasonably should have believed’ that he/she was about to incur debts that they would not be able to repay

ii. Are badges of fraud necessary under 4(a)(2)? 1. No - b/c badges of fraud listed on 4(b)

specifically state they are for 4(a)(1) ONLYe. If a debtor conveys a security interest in all of his personal

property to secure a debt, but remains in possession of the property, its not a fraudulent conveyance under Article 9- this is b/c its not done in secret

2. Is this transaction voidable under 5(A) (which is constructive fraud)? a. The debtor has to be 1. insolvent and 2. the transfer has to be

made for not reasonably equivalent value- here both are satisfied3. Could amex sue under section 5?

a. No b/c Amex’s claim arose AFTER the fraudulent transaction- 5(a) says the claim needs to be made BEFORE the transfer was made - we would only be worried if bonnie lied to amex but they didn’t- so amex has to jump through the hoops of 4(a)(1) or 4(a)(2)

4. Point- §5 applies ONLY to present, and not to future creditors- therefore, amex can’t use the easy §5 but has to do 4(a)(1) or (2)

c. 4.3 i. PowerPoint

ii. Was Jeremiah insolvent?

1. §2(a) – if debt is greater than all assets at a fair valuation.2. So he’s not insolvent (155 > 75)3. Is the homestead an asset?

a. §1(2) does not include property that is exempt. Thus his assets are actually only 55 and 55 < 75

4. so he is insolvent!iii. Is the gift a transfer?

1. No, since the house is not an asset, there was no transfer of an asset2. Since no transfer, no violation of §4 or §5 of the UFTA

iv. 3D 1. Is he applicable to §5?

a. Was he insolvent?i. §2(a) defines insolvency as the sum of the debtor’s debt

being greater than all of the debtor’s asset at fair valuation

ii. §1(2) defines assets as NOT including exempt property (such as the value of the homestead)

iii. So he is insolvent- b/c his assets minus his homestead is 3k and his debts are 5k

b. While he is insolvent- the gift was nonetheless NOT a transfer- §1(12)

i. Defines transfer as disposing of or parting with an asset or an interest in an asset- however, remember that in §1(12) the homestead was not an asset - so the transferring of an exempt property is not considered a transfer under UFTA

c. So §5 doesn’t apply- fails transfer2. Is he applicable to §4?

a. Nope b/c this also fails to have a ‘transfer’d. 4.4

i. PowerPoint ii. Does § 8(a) give Sam a defense?

1. Noa. §8(a) gives a defense to an action under §4(a)(1) to a good faith

transferee for REVb. This defense doesn’t apply here unless the action was brought

under §4(a)(1). More likely it was brough under 4(a)(2) or 5(a)c. Even if it was, the transfer was not for REV (even if it was in

good faith)iii. What about §8(d)?

1. If sam is a “good faith transferee” this gives sam a lien on the trailer for the purchase price and the value of the improvements to the extent that they are a “given to the debtor.”

iv. Assuming Sam acted in “good faith”, what happens?1. Sam can keep the home until he is compensated for the value “given the

debtor” a. What does that cover?

i. 3k cash1. Yes it was paid to the debtor

ii. 5k repairs1. No. not given to the debtor

iii. 12k increase in value1. In the statute covers this.

e. 4.6 i. Can the creditor attack the church contributions as being fraudulent transfers?

1. If the creditor was a present creditor then look to 006, which requires insolvency and reasonably equivalent value.

2. Under 4(a) there must be a transfer of property. a. They want to argue that they got a value in return. Not only does

it have to be reasonably equivalent value, but it has to be in an exchange.  If they could have gotten the services without the paying of the tithe then there’s no exchange, then there would be no reasonably equivalent value. If they gave 13k last year, but how far back can we go?

b. 24.010, p. 14—there’s a 4 year statute of limitations.  So, the creditor could go back 4 years and avoid those transfers.

Week 3 Introduction to Bankruptcy, Property of the Estate and the Automatic StayRead Casebook pages 99-131. Do problems 5.1(a)-(f), (k). Use. 11 U.S.C. §541.Read Casebook pages 131-138. Do problems 6.1-6.3. Use 11 U.S.C. §362

1. Introduction to Bankruptcya. Principle

i. Similarly situated creditors share equally (opposed to “1st in time, 1st in right” of state bankruptcy law)

1. At bankruptcy, the clock stops and everyone similarly situated is treated equally

2. Three big things happen to effectuate this equality of distribution:

a. An Estate in Bankruptcy is createdi. all the debtor’s stuff

b. An Automatic Stay goes into effecti. Injunction telling all creditors to stop collection

effortsc. Trustee in Bankruptcy takes over

i. Sometimes a person, in many business cases, the powers of trustee are given to the incumbent management of the corporation.

b. General outline of stepsi. Debtor files petition, pays fees (unless exempt)

ii. Automatic Stay 362 is automatically put into placeiii. TIB take over and Bankruptcy Estate is created 541iv. Debtor must file schedules; detailed lists of assets, debts, expenses

1. Documents needed, 521

2. Failure to list a debt could render it non-dischargeable 523(a)(3)3. False statements could lead to complete denial as to all debts

727(a)(4)v. Debtor provides complete list of creditors and addresses and what

exemptions they’re claimingvi. Debtor must provide certification of debt counseling attendance 109(h),

521(b)vii. Trustee Gathers assets

1. Divides exempt and non-exempt assets 5222. Divides encumbered and non-encumbered assets 544(a)3. Brings avoidance actions to bring things back into the estate 547,

544(a)viii. To monitor debtors:

1. Debtor must file copies of pay stubs, statement of monthly income, possible increase in income, etc

2. Failure to do so could result in dismissal 521(i)3. AG can perform random audits4. Debtor’s attorney is responsible for a “reasonable investigation” of

the schedules 707(b)(4)a. Attorney can lose fees, pay damages, pay fees to opposing

counselix. First Meeting of Creditors

1. 341 Meetinga. W/in 40 days after petition is filedb. Presiding officer from US Trustee’s Officec. Permits an examination of debtor by trustee and interested

creditorsx. Trustee Gathers Assets

1. § 522: Exempt and non-exempt assets gathered2. § 544(a): Encumbered and unencumbered assets 3. §§ 547, 544(b): Avoidance actions brought

xi. Validity and priority of creditors’ claims determinedxii. Dischargeability/non-dischargeability of claims determined

xiii. Assets sold; proceeds distributed according to priorityxiv. § 524: Discharge

2. Property of the Estate §541

a. When a debtor files bankruptcy, an estate is created, “such estate is comprised of all the [debtor’s] property, wherever located and by whomever held”

i. (b) Except as provided in subsections (b) and (c)(2) of this section all legal or equitable interests of the debtor in property as of the commencement of the case. . . .

a. Extent of Property of the Estate :ii. Security Interest: comes in “with its burdens”

1. Over-or Completely-Secured: 506(a)2. Under-secured:506(b)

iii. Exemptions: comes in, debtor keeps money up to limit, creditors get the rest

iv. Valueless: comes in, but gets kicked back out to the debtorv. Legal Title: (541(d)): If debtor only has legal title to something (ie,

trustee for niece’s trust account), only the legal title comes in, money is untouched

vi. Proceeds: 541(a)(6): “proceeds, product, offspring, rents, or profit” that come from something that is property of the estate.

1. Includes the paycheck for work done before filinga. Sharp v Dery : Discretionary bonuses are NOT proceeds

from work done2. Winnings from a lotto ticket purchased pre-filing (it is a contingent

right to any winnings)3. Does not include a mere expectancy: a bet you’re going to get

something, as opposed to an enforceable contingent right.a. Another example: I am engaged to marry invana trump. Is

my right to her assets, upon marriage, property of my bankruptcy estate reachable by my creditors? Of course not! The right must be an enforceable right (ie tort claim or contract right) not a mere expectancy.

4. How does the statue bring the proceeds of a contingent contract right into the estate?

a. The lottery ticket is property of the estate under 541(a)(1)b. The winning are “proceeds” of the ticket (a)(6)c. The winnings are also property of the estate under 541(a)

(7)i. Any interest in property that the estate acquires after

the commencement of the casevii. Inheritance, Divorce: 541(a)(5)(A), (B): Any property interest that

becomes the debtor’s w/in 180 days of filing from inheritance or divorce comes into the estate

1. What happens if Mom dies one week after Moss files for bankruptcy?

a. Take a look at 541(a)(5)i. “Any interest that would have been property of the

estate if such interest had been an interest of the debtor on the date of the filing of the petition and that the debtor acquires or becomes entitled to acquire within 180 days after such date – (a) by bequest, devise or inheritance.”

b. This language raises a further question – Is the termination of the trust a “bequest, devise or inheritance?

i. The problem here, for you future interest mavens, is that this is a “Contingent remainder.”– Moss could still predecease Mom, and then the gift would fail.

c. Is a contingent remainder a “bequest, devise or inheritance”?

i. –If it is not, then Moss is okay.ii. However, if it is treated as an inheritance, then the

corpus will come into the estate.2. If a “contingent remainder” is an inheritance, when should you

file?a. File now and hope that she lasts 181 days.b. Don’t let the doctor take her off life support.

viii. Non-Assignment Clauses: 541(c)(1): invalid in bankruptcy, K still goes into estate

i. Licenses: Courts go both ways, 1) interest in alienability 2) public interest in id of licensee

b. Exceptions to Property of the Estate ii. 541(a)(1): no interest in them at the commencement of the case

1. Post-filing wages: Backbone of the fresh-startiii. 541(c)(2): Spendthrift Trusts: if there is a restriction on alienation

respected outside bankruptcy, it is respected inside bankruptcy.a. i.e., if the debtor couldn’t legally transfer the money to

creditors pre-bankruptcy, they can’t take it post-bankruptcy.

2. Need to look to state law to see if it is unassignable3. In re Orkin: debtor could terminate the trust, so not Spendthrift4. In re Yates: even though debtor owned the company, he couldn’t

touch his account, so yes Spendthriftc. Why is Property of Estate so Broad?

iv. Court Supervision

5. We don’t trust debtors and want to bring everything under court supervision

v. Price of Discharge6. It’s the exchange for discharge from BK for the debtor - court gets

to sort everything out and give it to creditorsvi. Efficiency

7. Handle all legal and equitable disputes in one actionvii. Uniformity

8. Eliminates forum shopping that might be created if certain disputes were handled outside the bankruptcy courts

3. Problemsa. 5.1

a. You have just been appointed TIB for the estate of Donald Lapman. Which of the following items are property of the estate?

i. Parakeet 1. Does the debtor have a “legal or equitable” interest in them

“as of the commencement of the case”?a. Yes

2. Could a judgment creditor have seized these assets and sold them in satisfaction of his or her debt?

a. Probably not. Pets, family bibles and furniture are exempt in most jurisdictions.

3. Does exempt property become property of the estate?a. Yes, initially.b. The exemption is respected by the trustee under

§522(c):i. “property exempted under this section is not

liable during or after the case for any debt of the debtor that arose . . . before the commencement of the case. . .

ii. Pinto 1. Does the debtor have any “equity” in the Pinto?

a. No. The bank’s security interest exceeds the value of the car.

2. Is the Pinto worth anything to the unsecured creditors?a. No.

3. Does the debtor have a “legal or equitable” interest in the Pinto?

a. Yes. Until the bank forecloses, he has a right to possess the Pinto.

b. That’s worth something to the debtor, if not the creditors.

4. It’s property of the estate.iii. Snapshots

1. Yes is “property” of the estate.  They may be subject to exemptions, or the TIB may decide they are of no value and abandon them, but they are property of the estate.

iv. Concert tickets 1. Yes

v. Household furnishings1. Yes

vi. Stock 1. Yes, acquired by inheritance §541(a)(5)(A)

vii. Baseball cards1. Yes

viii. Catcher’s mitt in his brother’s possession.  1. Yes, §541(c)(1)(A) “it doesn’t matter where the property is

located.2. Are the rights of the estate limited by Donald’s brother’s

rights in the mitt under the original agreement, whatever they may be?

a. Yes.3. Does it matter if Donald left for college more than 20 years

ago?a. Yes. The statute of limitations may have run. He

may not have an enforceable right to get it back.ix. Trustee for which debtor is trustee

1. §541(d) yes, to the extent that the trust capacity and the ownership of legal title, it is property of the estate, but 541(d) protects the equitable interest, thus the beneficiaries will not be affected. So the estate gets whatever rights the debtor has.

2. §541(d) makes it clear that the account “becomes property of the estate . . . Only to the extent of the debtor’s legal title.”

x. Salary for services performed before the petition.  1. Assume he files a petition today. Tomorrow he received his

salary which represents the past two weeks’ salary.  a. Under the estate

i. 541(a)(6) because he had the right to the salary on the commencement of the case.

xi. Retirement acct which he cannot touch until after he retires.  1. No.  restriction on alienation are fairly common, and (c)(1)

says that all these restrictions are overridden by the

bankruptcy code, but (c)(2) says that if there is beneficial interest, the restriction on alienation is enforceable. “applicable nonbankruptcy law “ under §541(c)(2) includes both state spendthrift law and federal law including ERISA. Thus, ERISA benefits are excluded from the debtor’s bankruptcy estate. 

2. In Shumate, the court was looking at a retirement acct under ERISA.  Does ERISA constitute applicable non-bankruptcy law?  This also applies to spendthrift trusts, but it says applicable non-bankruptcy law which will include federal nonbankruptcy law.  There are several ways the debtor can prevent it from becoming property of the estate.  First is (c)(2), the second is the exemptions under state law.

xii. Are the baby parakeets (hatched from eggs laid one month after the petition) property of the estate?

1. Do they fit within the definition of §541(a)(1)?a. No. The debtor did not have a “legal or equitable

interest” in the not yet conceived parakeets “as of the commencement of the case.”

2. Are they nonetheless property of the estate?a. Yes, under 541(a)(6): “Proceeds, product, offspring,

rents, or profits of or from property of the estate.”3. Same rule would apply to the Monumental dividend check.

xiii. What about Donald’s salary for the month prior to the filing of the petition?

1. This is clearly property of the estate.2. Does it matter that he received the check after the petition

was filed?a. No. His claim against his employer for wages arose

when he did the work. This occurred before the petition was filed.

xiv. Are Donald’s wages for work done after the petition was filed property of the estate?

1. No.2. Post-petition wages are excluded by §541(a)(6).

a. “Proceeds, product, offspring, rents, or profits of or from property of the estate, except such as are earnings from services performed by an individual debtor after the commencement of the case.”

xv. What about his retirement account which he cannot touch until he retires?

1. The answer depends upon whether the fund would be treated as a spendthrift trust under nonbankruptcy law.

2. §541(c)(2): “A restriction on the transfer of a beneficial interest of the debtor in a trust that is enforceable under

applicable nonbankruptcy law is enforceable in a case under this title.”

3. You would need to do some more research on this one.b. 5.5

i. On Mar. 1, Robert filed for bankruptcy; On Apr. 1, he won the $1000 Teaching award for the school year; who gets the $1000?

1. Palmer case—court held that a bonus was not property of the estate where the president retained discretion as to whether to award it

ii. When post-petition income is dependent upon the CONTINUED services of the debtor subsequent to the petition, the amounts do not constitute property of the estate

iii. If there was no discretion whether to give the award, one could argue the award is part of the estate

iv. If there were some years where the award was skipped, then Palmer would control and for sure it would constitute post-petition earnings.

1. If on the other hand, the award is awarded to someone every year and is based on prepetition of work, one could argue that it’s part of the estate.

c. 5.6i. Happy Harrison runs a liquor store. He has a liquor license and he

files for bankruptcy. The license is non-transferable. The liquor control board always issues licenses to purchasers of existing stores unless the purchaser is a felon. However they won’t grant new licenses easily, b/c they want to limit the no. of liquor stores is the license property of the estate?

ii. Courts go both ways—they consider 2 factors:1. 1. interest in alienability2. 2. the public interest in the identity of the license holder

d. Hypoi. Your client EndRun wants to raise capital. EndRun has several

million dollars worth of receivables. These receivables will produce income slowly - over the course of the next few years. End Run needs cash now. They could borrow money secured by the receivables, but, as it turns out, they can get a lower interest rate if, instead of borrowing against the asset, they sell it to another company called a special purpose vehicle (or "SPV") that exists for the sole purpose of buying End Run's receivables. The SPV can then raise money by issuing debt securities that will be paid off as End Run collects its receivables. A precondition of the deal is an

opinion, from you, that if End Run files for bankruptcy, the assets held by the SPV will not be found to be assets of End Run's bankruptcy estate. Can you give that opinion?

1. First thing is to realize that is not a true sale. In a true sale, when you sell an asset, your cash will increase, but your debt will not increase by that same amount.

2. The success of the Delaware statute, and fallout from Enron has led to a response:

a. Section 102 of the Employee Abuse Prevention Act of 2002 (Durbin-Delahunt)

3. Not sure what the answer is.

4. The Automatic Stay, §362a. Definition

i. An injunction issued by the bankruptcy court that stays (stops/prohibits) any action by a creditor to collect on a pre-petition debt

ii. Intended to:1. Stop the race of diligence (which leads to dismemberment of the

debtor)2. Give the debtor some breathing space to arrange his/her affairs3. Force creditors to determine if a collective solution will yield a

greater distribution to all creditors4. Give the debtor some leverage

iii. Debtor’s can’t contract away their automatic stay protection (Farm Credit v. Polk)

1. Because the automatic stay protects both the debtor and creditors!b. Scope of Stay is Broad:

i. Scope of the automatic stay is broad. ii. Turnover

1. Applies to property of the debtor in the hands of 3rd parties2. Creates an obligation to turnover ‘property of the debtor’ to the

estate3. Willful refusal to turnover the property to the estate gives rise to

punitive damages under § 362(h).i. § 362

4. (a)(1): can’t sue debtor

a. 362(b) provides exceptions that permit certain types of actions against the debtor to continue

i. 362(b)(1) criminal action: like bad check prosecutions. Usually dropped when check is paid for. Dirty way to use threat of criminal charges to avoid the stay. Judges often say if the creditor testifies, it violates the stay, so the case gets dropped

5. (a)(2): can’t execute on property of the estate6. (a)(3): Can’t obtain possession of the property7. (a)(4): no one can create, perfect or enforce any new liens against

property of estatea. this protects existing creditors

8. (a)(5): Can’t create, perfect or enforce liens that arose pre-petitiona. This protects debtor’s fresh-start

9. (a)(6): General injunction10. (a)(7): can’t set-off any debt owing to the debtor11. (a)(8): Tax proceedings

ii. § 366 (Utilities)12. Can’t cut off service unless w/in 20 days, neither the trustee nor

the debtor give adequate assurance of payment 13. Debtor will have to pay for any utilities used post-filing date

c. Violation of the Stay i. §362(h) provides: “(h) An individual injured by any willful violation of a

stay provided by this section shall recover actual damages, including costs and attorneys' fees, and, in appropriate circumstances, may recover punitive damages.”

ii. Punitive Damages: Are your clients’ violations willful?iii. Actual Damages: When are there likely to be actual damages?iv. Are there any other sanctions for violating the automatic stay?

1. §105 provides: “(a) the court may issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of this title.”

a. The court may invoke a judge’s full panoply of equitable remedies, including civil and criminal contempt.

i. Damages2. 362(h): For actual damages, the violation has to be willful, but

then there can also be punitive damages.ii. Judge’s Power

3. 105(a): sort of a necessary and proper power for judge to carry out Bankruptcy provisions

a. Court may invoke judge’s full range of equitable sanctions, including civil and criminal contempt

iii. Cases4. Andrews University v. Merchant :

a. Refusal to give bankruptcy debtor a copy of his transcript was a violation of the automatic stay, an attempt to collect on a pre-petition debt

b. The court held that this violated §362(a)(6) as an attempt to collect on a pre-petition debt.

c. The University argued that the debt was non-dischargeable, and therefore not subject to the automatic stay.

d. The court responded that, even though the student loan was non-dischargeable under §523(a)(8), it was not excepted fromthe automatic stay under §362(b).

a. No damages awarded, b/c University didn’t act willfullyb. Does she get her transcript? Yes. Will she be able to get it

transcript after the case is over? No. At that point, the automatic stay will have terminated, and the discharge injunction will not cover the student loan.

5. Nissan v. Baker :a. Nissan should have returned the post-filing, repossessed car

when they heard of the filing. 363(e): no self helpb. They acted willfully, paid actual and punitive damages.

d. Notice of Filing i. § 342 :

1. Big creditors can file a “notice of address” where all its debtors must notify them of chapter 7 or 13 filings.

2. Automatic Stay does not affect that creditor until they receive notice.

3. Policy:a. It protects big creditors who auto-bill from stay violation

litigatione. Criminal Proceedings

i. 362(b)(1) allows criminal lawsuits to proceed to protect the public health and safety.

ii. Court needs to ask if the trial was protecting health and safety or merely pecuniary:

1. Is there a continuing threat?2. Is there a person to be punished or just a company?3. Is there a public policy served? (deterrence)

4. Is this case merely pecuniary?iii. US v. Seitles

1. TESTS:a. Pecuniary Purpose Test: does the proceeding relate

primarily to protection of gov’t’s pecuniary interest or to matters of public safety?

b. Public Policy Test: Is the gov’t engaging in this purpose for private rights or public good? Does the action affect immediate parties, or a wider group?

2. 105 Supplemental Stay. Suit against Seitles was stayed, even though he was not the debtor, nor bankruptcy (he was the debtor’s president). Gov’t’s actions against him are “inextricably interwoven” w/ the claims against the debtor. Needs four showings:

a. suit will cause irreparable harm to the debtor’s reorgb. likelihood of success of reorgc. balancing of equities: benefit of staying the injunction is

greater than the harm of issuing the injunctiond. public interest is served

f. Lifting the Stay i. 362(d) 2 alternative tests for lifting the stay. A secured party can win by

successfully invoking either of them1. (d)(1) When there is a lack of adequate protection

OR2. (d)(2) When:

a. (A) the debtor has no equity in the property; and b. (B) the property is not necessary for an effective

reorganizationi. (or that the reorg will fail w/ or w/o the property)

ii. Adequate Protection § 361 1. Adequate Protection may be provided by –

a. Requiring the trustee to make a cash payment or periodic payments to the secured creditor, to the extent that the stay results in a decrease in value of the property

b. Giving the secured creditor an additional or replacement lien to the extent that the stay results in a decrease in value of the property

c. Granting such other relief as will result in the realization by the secured creditor of the indubitable equivalent of such entity’s interest in the property

iii. Opposite Valuations:

1. (d)(1): creditors argue the value of the property is high, so they get a higher payment/security interest/get the property

2. (d)(1): creditors argue the value of the property is low, to show the debtor has no equity

5. Problemsa. 6.1b. Does Joe have any realistic chance of avoiding bankruptcy?

i. Assuming he’s eligible, no; he seems to have nothing to lose and everything to gain by filing. The stay would bring immediate relief from most creditors’ collection efforts. He would be able to keep virtually everything he owns. And he would free himself from a crushing load of debt.

c. Which of the collection efforts would be stayed by § 362?i. Dunning letters and phone calls?

1. Must stop under § 362(a)(6).2. (a) . . . a petition filed under section 301, 302, or 303 of this title, . .

. operates as a stay, applicable to all entities, of -. . .a. (6) any act to collect, assess, or recover a claim against the

debtor that arose before the commencement of the case under this title;

d. Can his doctor’s collection agency file suit tomorrow?i. No.

1. §362(a)(1)2. (1) the commencement or continuation, including the issuance or

employment of process, of a judicial, administrative, or other action or proceeding against the debtor that was or could have been commenced before the commencement of the case under this title, or to recover a claim against the debtor that arose before the commencement of the case under this title; – The automatic stay prevents commencement or continuation of suits against the debtor.

e. Isn’t this an action to collect a pre-petition claim?i. Yes, so it’s also prohibited by §362(a)(6).

f. Can the car lender or garage repossess the care?i. No.

1. This violates §362(a)(6), which stays “acts to . . . recover on a claim that arose before the commencement of the case.”

2. It also violates §362(a)(3), which prohibits “any act to obtain possession of property of the estate or of property from the estate or to exercise control over property of the estate”

g. Can the utility company discontinue electric service at midnight?i. What if they say “pay or we cut you off?”

1. This is pretty clearly an attempt to collect on a pre-petition debt, and it violates § 362(a)(6).

2. Furthermore, § 366 says:

a. – a utility may not alter, refuse, or discontinue service to, or discriminate against, the trustee or the debtor solely on the basis of the commencement of a case under this title or that a debt owed by the debtor to such utility for service rendered before the order for relief was not paid when due.

ii. Does this mean that the utility company can never cut joe off?1. § 366 (a) says “solely” on the basis of a pre-petition debt.

a. Can they turn Joe off for not paying his post-petition bill?

i. – Probably2. What if Joe is in really bad financial shape, even after filing. Does

the utility have to keep extending credit until he misses a payment?a. § 366(b) says, “Such utility may alter, refuse, or

discontinue service if neither the trustee nor the debtor, within 20 days after the date of the order for relief, furnishes adequate assurance of payment, in the form of a deposit or other security, for service after such date.” . . .

b. They’re probably stuck for 20 days.iii. Does the Automatic stay stop bad check prosecution?

1. Does the automatic stay stop a criminal prosecution?a. § 362(b) provides that “the filing of a petition under

section 301, 302, or 303 . . . does not operate as a stay:i. (1) under subsection (a) of this section, of the

commencement or continuation of a criminal action or proceeding against the debtor;”

2. Would your answer change if the prosecutor always dropped the prosecution upon payment?

a. Then it looks more like a collection device.b. Principles of comity preclude a federal court from

enjoining a state criminal proceeding, absent a showing of prosecutorial bad faith or harassment, or a patently invalid state statute.

3. See, e.g. Younger v. Harris, 401 U.S. 37 (1971).iv. What about eviction?

1. To what extent is the landlord seeking payment of a prepetition debt?

a. Rent is owed in advance.b. Can the landlord evict Joe if he keeps his post-petition rent

current, but does not pay pre-petition rent?i. This appears unfair. Some limitations on this are

imposed by § 365, which we will discuss later.ii. Joe gets some time to decide whether to assume or

reject.

iii. The landlord can bring an action to compel assumption or rejection.

iv. If Joe assumes, he will have to cure any pre-petition default.

v. Can Joe keep his paycheck?1. How much does he earn per week?

a. $34,000/52=$654b. Right now its subject to a $100/week garnishment.

2. If Joe files this afternoon and gets paid tomorrow, are his wages property of the estate?

a. Yes. He did the work pre-petition.i. Therefore, the check is proceeds of a prepetition

asset. §§541(a)(1), (6)vi. Will the attaching creditor be able to garnish the paycheck?

1. No.a. §§362(a)(2) and (3) prohibit:

i. (2) the enforcement, against the debtor or against property of the estate, of a judgment obtained before the commencement of the case under this title;

ii. (3) any act to obtain possession of property of the estate or of property from the estate or to exercise control over property of the estate;

b. The trustee will get the wages free of the garnishment.i. Does the garnishing creditor have a secured claim?

vii. If Joe files this afternoon, is the paychecks that he will receive in two week property of the estate?

1. No § 541(a)(6).2. It’s post-petition wages

a. What about the garnishment now?i. – It’s off!!

viii. Should Joe wait until tomorrow to file for bankruptcy?1. If he waits, he will receive his paycheck, reduced by garnishment.2. When he files for bankruptcy tomorrow, will the paycheck be

property of the estate?a. – Yes, if it’s still around.

3. What can Joe do with the paycheck once he receives it?a. Anything he wants.b. He could pay a creditor of his choice (probably a

preference).c. He could buy groceries.d. He could buy dinner at the Palm.e. He could tithe.

ix. Are there any risks associated with this strategy?1. Joe might run into denial of discharge problems if he is too cute

2. But it wouldn’t be considered “cute” to feed his family, pay rent, etc.

3. Paying some creditors and not others might be an avoidable preference, though.

h. 6.2 i. 11 U.S.C. §521(a)(1)

ii. (a) The debtor shall –1. (1) file

a. (A) a list of creditors; andb. (B) unless the court orders otherwise

i. (i) a schedule of assets and liabilities;ii. (ii) a schedule of current income and current

expenditures;iii. (iii) a statement of the debtor’s financial affairs and,

[if applicable, a section 342(b) certificate];iv. (iv) copies of all payment advices...within 60 days

before the date of the filing of the petition....;v. (v) a statement of the amount of monthly net

income....;vi. (vi) a statement disclosing any reasonably

anticipated increase in income....;c. (e)(2)(A) the debtor shall provide –

i. (i) not later than 7 days before the date first set for the first meeting of creditors, to the trustee a copy of the Federal income tax return required under applicable law...for the most recent tax year...;

2. Provide a certificate that you have received pre-filing credit counseling.

iii. Timeline1. By when must Puja get all this paper together?

a. Look at § 521(i)(1):i. (i)(1) Subject to paragraphs (2) and (4) and

notwithstanding section 707(a), if an individual debtor in a voluntary case under chapter 7 or 13 fails to file all of the information required under subsection (a)(1) within 45 days after the date of the filing of the petition, the case shall be automatically dismissed effective on the 46th day after the date of the filing of the petition.

iv. Checking over work1. Your paralegal points silently to the value Puja listed on her

schedule of assets for the car ($250). Is it enough to ask Puja if she’s sure of this valuation? What should you do?

2. Look at § 707(b)(4)(B):a. (B) If the court finds that the attorney for the debtor

violated rule 9011 of the Federal Rules of Bankruptcy

Procedure, the court, on its own initiative or on the motion of a party in interest, in accordance with such procedures, may order –

i. (i) the assessment of an appropriate civil penalty...3. Look at §707(b)(4)(C):

a. The signature of an attorney on a petition, pleading, or written motion shall constitute a certification that the attorney has—

i. performed a reasonable investigation into the circumstances that gave rise to the petition, pleading, or written motion; and

ii. determined that the petition, pleading, or written motion [is well grounded in fact and warranted by existing law];

4. Look at §707(b)(4)(D):a. The signature of an attorney on the petition shall constitute

a certification that the attorney has no knowledge after an inquiry that the information in the schedules filed with such petition is incorrect.

i. 6.3i. Was it OK to cash the check?

1. Take a look at 362(a)(6)a. Is it an act to collect on a prepetition debt?

i. Sure it is.2. Take a look at 362(a)(3)

a. Is it an act to take possession of property of the estate?i. The money in the bank account was property of the

estate.3. Does 362(b)(11) help?

a. It was not a violation to present the checki. But the bank shouldn’t have paid it

ii. Creditor shouldn’t have taken the money.1. What’s the point of presenting then?2. Allows you (necessary) to go against co-

signers, indorsers and guarantors. ii. Does the creditor have to give back the money?

1. Yes.2. Take a look at 542(a)

a. What happened in Nissani. The creditor was supposed to have given back the

car.3. The money is property of the estate.

a. Creditor has to give it back.iii. Does the creditor have to give back the car?

1. Is the car property of the estate?a. Nissan!!

b. The car is property of the estate.c. – The creditor has to give it back too!!

iv. So Sidney gets her car back. Can she keep it?1. 521(a)(2)

a. She must state her intention to reaffirm or redeem, so within 30 days, they’ll know where they stand

b. If they don’t perform the intention, the stay is automatically lifted under 362(h).

j. When the creditor pays back the money from the check, does Sydney get it?i. No. It goes into the estate and is distributed pro rata.

1. What would have happened if she’d filed for bankruptcy before she cashed out her retirement account?

a. She’d have been able to keep iti. (541(c)(2)/exemption).

1. She could have used that money to redeem the car post-petition. Now it’s gone!

Week 4 Eligibility for Chapter 7 and ExemptionsRead Casebook pages 141-166. Do problems 7.1-7.2. Use 11 U.S.C. §707(b)Read Casebook pages 169-196. Do problems 8.1-8.3. Use NYCPLR ''5205 and 5206, in lieu of the Wyoming exemption statute

1. Introduction to Liquidation Bankruptcya. A change in philosophy

i. Before 2005, debtors could choose between chapter 7 and chapter 13.ii. The decision was solely for debtors and their advisers to make.

iii. But filings had increased since 1978, and the consumer credit industry lobbied for change.

iv. A 1984 amendment to 11 U.S.C. § 707 permitted courts to dismiss a chapter 7 petition as “a substantial abuse” of the Bankruptcy Code.

a. Basic Liquidation Bankruptcy Case v. Debtor files, automatic stay kicks in to protect estate from creditor

interference 362vi. Estate is created w/ all the debtor’s stuff (subject to what debtor actually

has) 541vii. TIB then looks at what property is exempt 522(d)

1. Abandons fully exempt propertyviii. TIB then looks at what property in encumbered 544

1. Abandons property that is fully encumberedix. What’s left over:

1. Partially exempt property2. Partially encumbered property3. Unencumbered property

x. TIB sells the property, then distributes the assets, keeping in mind existing encumbrances and exemptions

xi. After secured parties and other parties w/ property interests have been paid, TIB distributes remaining money to the General creditors

xii. Three types of general creditors1. Priority Creditors: entitled to get paid, in full or up to the dollar

limits of their statutory priorities before other creditors get anything

a. Trustee himselfb. Then go through 507 priorities

2. General, Unsecured Creditors3. Subordinated Creditors: paid last b/c they have been “equitably

subordinated,” usually b/c of some wrongdoing2. Eligibility

a. Congress wants people to file chapter 13, better if debtors pay off debtsi. Chapter 13: Debtor keeps their stuff, but has to pay the creditors the

value they would have gotten in a chapter 7, through wage garnishmentii. Incentives: Debtor’s keep their assets, broader discharge than 7

b. 1984 Amendmentsi. 707: Judicial scrutiny of debtors to see which debtors should be denied

access to Chapter 7 liquidation b/c of substantial abuse of the system1. In re Shaw: Court looked at “totality of the circumstances” and

decided Shaw’s were abusing the system (had big house, nice stuff)

c. 2005 Amendment: follows the idea of 1984, but took the power away from the judges

i. Created a complex test to determine which debtors are ineligible for chapter 7

ii. 7071. (b)(1)

a. instructs courts to dismiss or convert a 7 into 13 if there’s an abuse

2. (b)(2)(A) a. creates a presumption of abuse based upon an intricate

formula of income minus expenses, calling for extensive documentation

3. (b)(2)(B) a. special circumstances may justify adjustments to the

calculations to determine which debtors are presumed to have abused the system (i.e., serious medical conditions, military service)

i. The presumption of abuse may only be rebutted if the additional expenses or adjustments to income referred in clause (i) cause the product of the debtor’s current monthly income reduced by the amounts determined by clauses (ii), (iii) and (iv) of subparagraph (A) when multiplied by 60 to be less than the lesser of

ii. (I) 25 percent of the debtor’s nonpriority unsecured claims, or $6,000, whichever is greater; or

iii. (II) $10,000.4. (b)(3)

a. gives the court discretion to find a filer who has passed the formula to still be an abuser if they acted in bad faith; or the totality of the circumstances (catch-all for unworthy debtors) shows they shouldn’t qualify

iii. NOTE: 707 ONLY APPLIES TO CONSUMERS, NOT BUSINESSES

3. THE FORMULA: INCOME & EXPENSESa. MEANS TEST definition:

i. Mechanical formula to determine who can and cannot (as a matter of law) repay some debt. (NOT APPLICABLE TO BUSINESSES)

ii. Basic question = does the ∆ have enough disposable income to repay his debts? (so that he should file a 13 instead of a7)

b. Formulai. FIRST threshold: Is ∆ CMI (Current Monthly Income) above or

below median?1. If Income < median income for similar families in ∆’s filing state,

no presumption of abuse (and they PASS exempt from the means test and thus eligible for chapter 7)

2. Figuring income:a. Defined in 101(10A)

i. (A) Total income for 6 months divided by 6ii. (B) all income, which includes wages, dividends,

etc. b. Add all income from the past 6 months, divide by 6,

multiplied by 12 3. If income is higher than state median, go to 707(b)(2)(A)4. Policy: What percent of filers earn income above the State

median?

a. Warren & Westbrook found only 6 percent above their State median

b. Culhane & White found only 3-4 percent above the national median.

c. Does this mean the “means test” won’t be a problem for 94 percent of all debtors?

ii. SECOND threshold if First failed: Expenses/presumption of abuse?1. No matter what ∆s actually spend, they can only deduct National

Standards used by the IRS for family size and income level 2. If court finds it reasonable and necessary, § 707(b)(2)(A)(ii) allows

an additional < 5% of national standards to be deducted for clothing and food.

3. Courts alsoa. Instructed to include certain other deductions in addition to

National Standards starting with § 707(b)(2)(A)(ii)(I)b. Allowed to include ACTUAL expenses for certain things

like:i. Childcare

ii. Taxesiii. Life insuranceiv. Union duesv. Taxes

vi. Arrearanges on personal debts which are listed in §507(a)

vii. Mortgage payment, no matter the cost. c. Other expenses:

i. Health insuranceii. Private school (up to 1.5k per child)

iii. If after Second calculation, ∆ has net income (above-median income minus specified expenses is positive number – the surplus income), then see

iv. Abuse is presumed:1. If the debt is greater than $26,300, and the monthly surplus X 60 is

at least $10,950 or 25% of the debt OR

2. If the debt is $26,300 or less, and the monthly surplus is at least $7,025

v. Abuse is presumed:1. If you have 110/month in surplus and the debt is less than $26,300,

abuse is presumed.

2. If you have between 110/month and 183/month in surplus, then abuse is presumed if the monthly surplus*60 is greater than 25% of the debt

3. If you have more than 183/month in surplus income abuse is presumed.

vi. Rules of thumb:1. If the monthly surplus is less than $110, the debtor is eligible for

Ch. 72. If surplus is btwn 110 and 183 she is eligible if the surplus is

less than 25% of her unsecured debt divided by 603. If surplus is > 183 she isn’t eligible

vii. THIRD If after all calculations, under (b)(3) court can dismiss1. If it finds ∆ filed in bad faith or2. Totality of circumstances of ∆’s financial circumstances

demonstrates abusec. Policing

i. ∆ must first do means test herself on form given in § 521ii. US Trustee must also check and has certain other related duties (§ 707(b)

(1))iii. Raising of question of abuse

1. Any party can raise abuse question for above-median debtors. (b)(1) Though such parties cannot “abuse” this right or they may have to pay fees under (b)(5)

a. A party bringing a wrongful motion to dismiss is liable only if the court finds that the creditor or trustee violated Rule 9011 or brought its motion “solely to coerce the debtor to waive” other rights guaranteed under the Bankruptcy Code.

2. Only court or US Trustee can raise abuse question for below-median ∆s. (b)(2)(A)(i)

iv. Attorneys for ∆ must certify as to their reasonable investigation about circumstances giving rise to case and truth of filing (b)(4)(C) / (D)

1. Sufficient Inquiry? If debtor files 7, and court later determines they are ineligible, lawyer is liable for the amount owed to the creditor.

2. Pushes attorney’s to push borderline debtors toward 13v. Raising the Inquiry: Who can allege abuse?

1. Above-median debtor: a. (b)(1) General Abuse (ie, bad faith filing, totality of the

circumstances)i. Judge, UST 707(b)(3)

b. (b)(2) Means Test Abuse

i. Judge, the UST, or any creditor 707(b)(1)2. Median-and-below Debtor:

a. (b)(1) General Abuse (ie, bad faith filing, totality of the circumstances)

i. Judge, UST 707(b)(6)b. (b)(2) Means Test Abuse

3. No one 707(b)(2)(A)(i)d. NOTES

i. If the Debtor FAILs the means test, but he can rebut the presumption of abuse?

1. 707(b)(2)(B): If debtor failed due to “special circumstances” (serious medical condition or call to active military service) there can be a reasonable adjustment to income or expenses to the extent that the special circumstances so justify

ii. Can the Debtor PASS the means test, but in some way cheat the system?

1. 707(b)(3) allows judge to deny Chpt 7 for:a. Bad Faithb. Totality of the circumstances shows abuse of the system

iii. Problems w/ using the Census Bureau’s Medians w/ the Bankruptcy Code

1. Tax: Census is found pre-tax, Bankruptcy Code is unclear, but says “income received,” so probably post-tax

2. Other Income: Census Bureau does not include other income (sale of prop, gifts, etc) and the Bankr Code does

3. Social Security: Census Bureau includes SS benefits, Bankr Code excludes them

e. Beating the Systemi. To reduce surplus income, debtors can:

1. Buy better health insurance2. Buy a car3. Increase his unsecured debt

ii. 707(b)(3) can kick you out of chapter 7 for manipulating the system, acting in bad faith

iii. 526(a)(4) says a Debt Relief Agency can’t “advise an assisted person…to incur more debt in contemplation of a case”

1. 101(12A) categorizes a bankruptcy lawyer as a “Debt Relief Agency”

2. This provision has been found to be a violation of lawyer’s 1st A rights in TX

f. Conflict:

i. Statute says everyone needs to complete the means test, even if below the median. Lawyer needs to fully investigate.

ii. Form says if you’re below the median, skip the rest of the form…

4. Problemsa. 7.1

i. Facts1. 600 per month in unemployment, then she got a job and 6.1k per

month income. 1k per month in child support but doesn’t get it. Instead he pays 6K per year in tuition.

ii. Is she eligible for chapter 7?1. The BK code doesn’t define household. Census Bureau says that

household includes all the people who occupy a housing unit. Don’t need to be blood related.

2. US Trustee’s office website says that the median income for a two person household is 53K.

3. What is the debtor’s current income?a. “Current monthly income” is defined in section 101(10A).

i. It takes all the debtor’s income for the preceding six months and divides by 6.

ii. Although Social Security benefits don’t count, unemployment benefits are part of the calculation.

iii. So that means Marissa received $1300 unemployment for the first three months and earned $16,400 salary and $8000 overtime for the last three months (for a total of $24,000 overall for the last three months), for a total of $25,700.

b. In order to determine how she fits under the means test, her current monthly income must be multiplied by 12, for an annual income of $51,400.

c. That’s above the median for 1-person Michigan household and below the income for a 2-person household.

4. Child supporta. She doesn’t collect it, so it seems that she doesn’t have to

count it. Section 101(10A) speaks in terms of “received” income, not income due.

b. But her ex-husband has been picking up expenses for Jamal. He feeds the boy, buys him clothes, and pays for school tuition. Is the tuition, for example, $500 a month income to her? Or are the clothes, tuition, and the like gifts to Jamal?

i. Section 101(10A)(A) talks about income to the debtor—not to her son. But Section 101(10A)(B) includes any amount paid by someone other than the debtor for “household expenses of the debtor or the debtor’s dependents.”

iii. What advice do you give?1. Marissa has a chance to file for Chapter 7 right now, but that if she

waits, she will lose the chance (unless she has high expenses). The period of unemployment creates a distortion in her income that will disappear over time.

2. What if Marissa doesn’t want to file now? Should she quit working overtime so there will be less income to work with?

3. If Marissa says she wants to try a little longer without filing bankruptcy, should we tell Marissa that if she decides later to file, she could quit her job for a month or two to make herself eligible for Chapter 7 again before she comes back to see the lawyer?

4. What are the ethics of helping Marissa file for Chapter 7 when it is clear that her “real” annual income will be above the state median?

iv. How aggressive are you willing to be?1. If she litigates and loses on family size, the attorney may end up in

a second litigation over whether the advice to Marissa to file a Chapter 7 violated Rule 9011.

2. Point: Isn’t the easiest thing for us to do is advise Marissa to file a Chapter 13, even if she pays far more over the long run and runs a substantial risk of failure?

b. 7.2i. Facts

1. Couple earns 6.6FK and 5.2K per month2. Three children. One with a heart condition 100k in debt. 3. Last year 5.2K parent took 7 months off to tend to kid. 4. Small three bedroom house. Mortgage payments are high b/c they

financed 100% of the cost. ii. Where do we look to see if Jason and Evie’s expenses can all be deducted

from their income?1. IRS National and Local Standards

iii. Do the analysis using form 22a. c. 7.3

i. Facts1. 30k in unsecured debt. Income puts him in above the median

bracket. After deducting allowable expenses, Michael seems to have $150.00 month available payment for creditors.

2. Rents a modest apartment and owns a junker of a car.3. Income is erratic so he is unwilling to commit to a chapter 13

bankruptcy. ii. Is he eligible for chapter 7? Do you have any suggestions about how mike

might become eligible?1. On these numbers, Michael is caught by the means test.2. Section 707(b)(2)(A)(i) says there is a presumption of abuse if his

monthly post-expense income multiplied by 60 is at least $6,575 or 25 % of his outstanding unsecured debt.

3. Because he is above median income and he can produce $9,000 over 60 months in income above his allowed expenses, he is caught.

4. The $9,000 is higher than the minimum $6,575 and higher than 25 percent of his general unsecured debt (25% of $30,000 is $7,500).

5. He’s ineligibleiii. Does that mean there is nothing to do?

1. If his general unsecured debt were $40,000, then Michael would be caught by the means test only if he could produce $10,000 in excess income which is $166.66 a month—higher than his $150 a month.

2. Alternatively, Michael could buy a newer car. His car payment will come directly off his monthly income, immediately putting him below the available income threshold.

3. How about health insurance, disability insurance, and a nice health savings account? If Michael doesn’t have it, he should get it. The expense deduction for health insurance alone will wipe out the extra income.

iv. Can you give this kind of advice?1. Can you tell Michael to go out and run up $10,000 in debts that he

plans to discharge (racking up $10,000 he does not intend to pay?) or to buy a new car?

2. Section 526(a)(4) says that a Debt Relief Agency cannot “advise an assisted person . . . to incur more debt in contemplation of filing a case.”

3. Under section 101(12A), it seems pretty clear that a bankruptcy lawyer is a “Debt Relief Agency.”

4. Congress seems to prohibit this form of advice.d. 7.4

i. Guy has one big debt which is in connection with a business. ii. Section 7 is limited to consumers with primarily consumer debts.

e. 7.5

i. Facts1. You and your three partners run a large practice in Tulsa, OK.

2. More than 95% of the people you see have incomes below the state median, adjusted for family size.

3. That makes the means test easy, right?

4. What does it do to your reporting requirements, though?

ii. 707(a)(3)

1. An argument can be made that the Code requires that the information must be provided no matter what, and that a no-harm-no-foul on not filing useless information just won’t work.

2. Section 707(a)(3) suggests that failing to fill out the expense sheets would be separate grounds for dismissal.

3. Look at section 521(a)(1).

a. It says that this information must be provided – no exceptions.

1. Property Exempt From Seizurea. Definition

i. Property designated by statute which creditors can’t reach; the sheriff can’t grab it in order to pay a debt

ii. Idea is that some property can’t be levied on and sold to pay off debtb. Policy

i. Fresh Start - we want people to get out of the hole so that they’re not a burden on the state

c. State v. Fedi. Exemptions represent a compromise between the state and federal system

1. Federal bankruptcy Code established uniform federal exemptions (§ 522)

2. Federal law preempts state law when it comes to the automatic stay, but state has priority in exemptions.

3. But states would be permitted to opt out of those exemptions, denying their own citizens the benefits of federal protection when they filed for bankruptcy

4. 35 states have opted out including NY—it only allows NY exemptions

5. Debtor can use state law exemptions under 522b2ii. There is wide variation among the states:

1. TX and FL are very liberal2. DE leaves the debtor very little

d. Basic structure of exemption statutes:i. Type of property (category approach)

ii. Maximum value (dollar amount approach)e. Which comes first? Mortgage or Exemption?

i. Mortgages and other secured loans come first1. Exemption provides protection only against involuntary liens

and forced sales2. This is b/c banks wouldn’t give purchase money mortgages if

secured creditors couldn’t get their moneyii. What is the order of distribution?

1. expenses of sale2. mortgage3. exemption amount4. 1st judgment creditor5. any subsequent judgment creditors6. surplus to debtor

2. Problemsa. 8.1b. Harv and Lois Hughes live in an apartment - they are unable to pay several debts

and are worried about which of their assets may be vulnerable to creditor attachment- their largest creditor is the IRS, to which they owe about $5k in back taxes- what result if they lived in NY? In Texas?

3. Texas:4.

5.

Texas conclusion:a. They have no homesteadb. There is a $60,000 aggregate limit on personal property exemptions. They do not

have 60,000 in personal property.c. Under Texas law they will be able to exempt virtually all of their property.

i. Except the tort suit.ii. The Disney Stock

iii. The Checking Account

Item Value NYHousehold furniture and appliances

8k Fed- 5205(A)(1) and (a)(5)- just requires reasonably necessary for the debtor- the aggregate limit is stated in NY Debt Cred Law 283(2) which has 5k limit—NOTE: NYDCL 283(2) limits you to 5205(a) exemptions which means only when debtor applies for bankruptcy – sum: exempt under 5205(A)(5) and limited to 5k under NYDCL283(2)

Clothing 2k 5205(a)(5)- 5k limitLois’s law books 2.4k 5205(a)(6)- tools of trade limit up to 600Lois’s moped 800 NYDCL 282(1)- up to 2.4k- this stat says 2 car limit and

only when filing for bankruptcy- maybe since 2 people filing, 2 car stacking allowed

Item Value Texas Law Amount Comments

Household furniture and appliances 800042.002(a)(1) home furnishings

Up to $60,00042.001(1)

Clothing 200042.002(a)(5) wearing apparel Up to $60,000

Lois's Law Books 240042.002(a)(4) tools of Up to $60,000

Lois's Moped 800 42.002(a)(9) motor vehicle

Up to $60,000 One for each adult

Harv's 1971 MGA (on blocks) 50042.002(a)(9) motor Up to $60,000

Cash Value on Lois's insurance 2000Texas Insurance

No Limit

Lois's wedding ring 100042.002(a)(6) (jewelery)

Up to $15,000

Lois's computer 120042.002(a)(4) tools oftrade

Up to $60,000

100 shares of Disney Co. (Dad knew Walt) 5000 No. Heirloom?

Joint checking account 200 No

Harv's Computer 7500 42.002(a)(4) tools of trade

Up to $60,000

25 foot Friendship Sloop 6000 Athletic Equipment? Homestead?

Harv's wheelchair 1800042.001(b)(2) prescribed health aids

No limit

Fluffy (cat) 200 42.002(a)(11) pets Up to $60,000

Soccer Ball 2 42.002(a)(8) athletic equipment

Up to $60,000

Tort suit 250000 Legislature forgot

Total (excluding lawsuit) 54802

Total (including lawsuit) 304802

Harv’s 1971 MGA on blocks

500 NYDCL 282(1) up to 2.4k- maybe stacking? See above

Cash value of lois’s insurance

2k 5205(1)

Lois’s wedding ring 1k 5205(a)(6) with 5k limitLois’s computer 1.2k 5205(A)(7)-with 5k limit100 shares of Disney 5k No- note: in NY you can exempt cash as long as under

5k limitJoint checking acct 200 NYDCL 283(2)- 5k limit if no homesteadHarv’s computer 7.5k 5205(a)(7) – 5k limit25 foot friendship sloop 6k There is no exemption for athletic equip or household

stuff- but you could live on a boat..so maybe NYCPLR 5206 homestead?

Harv’s wheelchair 18k 5205(h)(1)- no limitFluffy –cat 200 5205(A)(4)- 5k limitSoccer ball 2 NoTort suit 50k 282(3)- pecuniary less than 7.5k plus lost earnings-if

bankruptcy on the horizon, then characterize it as lost earnings- if taxes are on the horizon, then characterize them as pecuniary damages

Total excluding lawsuit 54,802 20,800 (500 + moped + wheelchair)- note, it would be a lot more if we could get the sloop in

Total including lawsuit 104,802 70,800 (if 100% lost earnings)

6. 8.27. 8.3 - Partially exempt property and the problem of valuation

a. Facts:i. Kim owns a home in a state that permits an individual debtor to exempt

$25K in value of the debtor’s homestead from a creditor attachment; Kim bought house in 1995; Kim paid $15K down and signed a mortgage obligation for $135K, which she’s paid down to $130K; Similar houses are now selling for about $180K when they are put on the retail mkt for 2-3 mos and listed w/ a real estate broker, who charges a 6% commission;

ii. A similar house sold in a sheriff’s auction for $129,428; Kim owes a judgment creditor $25K will she be able to keep the house?

b. The question is ‘will a judge force Kim to sell the house to give the proceeds to a judgment creditor’

c. How much equity does Kim have in the house?i. What is equity? The value of the house in excess of any debt secured by

the house. 1. EQUITY = FMV OF HOUSE – DEBT

ii. When she bought the house, she paid 150K for the house; took out a $135K mortgage Kim’s equity = $15K

iii. How much equity does she have if the house now that it’s worth $180K?1. Amt of secured debt = $130K2. Value of house = $180K3. Costs of sale (from 6% commission) = $10,8004. Equity = FMV (180) – costs of sale (10,800) – mortgage (130,000)

= $39,2005. Kim’s house will be treated as partially exempt.

iv. What if Kim doesn’t pay his mortgage during the three months the house is on the market?

1. Additional carrying costs for three months: 1,500 (assume 500 per month mortgage)

a. If Kim is not making his mortgage payments, then the missed payments would be rolled into the secured debt.

b. If Kim skips his mortgage payments, secured debt = $41,200 and equity = 29,300.

v. How much equity does Kim have if the house is worth $129,428?1. Equity = Value ($129,428)-Secured Debt ($130,000)=-$572

d. Which valuation should the court use?i. Most statutes say “fair market value,”

1. private sale value? (180,000 minus 6%)2. forced sale amount (129,428)

ii. What will the judgment creditor get if the court orders a sale? < $0 (even if private sale value is $180,000)

iii. Should courts order sales that will not yield any proceeds for the judgment creditor?

1. Read the Supreme Court’s decision in Rash2. Does 522(f) change the answer?

a. (f)(1) . . . the debtor may avoid the fixing of a lien on an interest of the debtor in property to the extent that such lien impairs an exemption to which the debtor would have been entitled under subsection (b) of this section, if such lien is –

i. (B) a nonpossessory, nonpurchase-money security interest in any –

1. (i) household furnishings, household goods, wearing apparel, appliances, books, animals, crops, musical instruments, or jewelry that are held primarily for the personal, family, or household use of the debtor or a dependent of the debtor;

2. (ii) implements, professional books, or tools, of the trade of the debtor or the trade of a dependent of the debtor; or

3. (iii) professionally prescribed health aids for the debtor or a dependent of the debtor.

b. LOOK AT PAGES 17 – 18 OF SLIDEe. If based on mkt value of $180K, Kim’s interest in the house exceeds the max

exemption amount house will be sold Kim will then receive the proceeds of the sale up to the max exemption amount judgment creditor will receive whatever is left over

f. if based on sheriff’s value of $129,428; in the event of a sale, the mortgagee would receive all of the proceeds of the sale (less costs). Kim and judgment creditor would receive nothing

i. Judgment creditor can’t force a saleg. Note: when a state’s homestead exemption is less than the debtor’s equity in the

house, then the unsecured creditor can force the sale of the house- if an unsecured creditor can do this, then the bankruptcy trustee will force the sale

i. if an unsecured creditor couldn’t force a sale then a bankruptcy trustee can’t either

ii. the value of the exemption ONLY APPLIES to the equity- a purchased money mortgage (or consensual lien) beats an exemption

iii. exemptions only protect property from judicial lien, they don’t protect property from liens you put on the property yourself (consensual liens)- this is the law in all 50 states

iv. So- if the house is worth 129,428 Kim gets to keep the house b/c its fully exempt since there is negative equity- basically, a judgment creditor can’t force the sale and a bankruptcy trustee can’t force the sale, but the mortgagee can force the sale if he doesn’t pay them

v. irony- if you borrow against your property more than its valued, then you get to keep it

vi. note: mortgage came first, can’t just ahead of his secured interest

Week 5 Exemption Planning and Claims in BankruptcyRead Casebook pages 196-217. Do problems 9.1-9.3Read Casebook pages 218-228. Do Problems 10.1-10.4 and Problem 11. Use 11 U.S.C. §§ 502, 506

Homesteads, trusts and exemption planning1. States vs. Fed

a. 522(b) - debtor can use exemption options available to them under state law, or use the provisions under 522(d)

b. BUT, States may choose to forbid their citizens from using the federal exemptionsi. States that didn’t opt out have high exemptions

1. TX, in; NY, out; DE, outii. 522(b) “imports” the state’s exemptions into bankruptcy when the debtor

is using them2. § 522(d): Federal exemptions

a. (3) is homestead exemption and protects ~$20K in equity in the house, if any.3. Homestead

a. Most important exemption, 60% of people’s wealthb. In re Reed :

i. Debtor who converted nonexempt assets to an exempt homestead immediately before filing w/ intent to defraud: denied discharge

ii. discharge will be denied under 707(b) for really bad cases of obvious planning because it is federal law that governs discharge, even if state exemption would allow someone to keep a home.

iii. Pretty clear intent by ∆ to deceive creditors will not do any favors to casec. State Flight

i. 522(b)(3)(A) prevents people from flight to a better exemption state before filing

1. Exemptions apply for where you have lived for the last 730 days (2 yrs)

2. If you lived in more than one place in the 730 days, the place you were domiciled for the majority of the 180 days preceding the 730 days

a. For longest period OF that 180 days 4. Unlimited Exemptions and Asset Trusts

a. Judgment Proofing: moving money around to protect it from creditors, i.e., using corporate structures to isolate assets from certain liabilities

i. Putting activities into LLCs and keeping assets personally, so you are not accessible through lawsuits against the corp

ii. Asset Protection Trusts1. Some in the US (DE, Alaska, SD), some off shore (Cook and

Cayman Islands)2. Trusts w/ a clause allowing the beneficiary and the settler to make

withdrawalsa. SLIMEY: when you put $ in trusts, you shouldn’t be able

to get to it

3. If someone else tries to get the money, it is frozen and no one has access to it. After the proceeding, it becomes available to the debtor again

4. Risks:a. Fraudulent Conveyance (Twyne’s Case)

i. If in US, banks might still be able to get itb. Loss of Bankruptcy Discharge (Reed)c. If overseas, judge could hold debtor in contempt and lock

him up until he gets the moneyd. If the trust works, this won’t help courts get the money, but

it will prevent the debtor from getting itiii. Convey property to wife and friends

1. Could be fraudulent conveyance2. Can safely give money, but good idea to retain enough to cover

reasonably anticipated liability. That way, the conveyance doesn’t make you insolvent and is not fraudulent

5. Secured Loans v. exemptionsa. 522(f)(1) grants debtors the power to avoid certain nonpossessory, non-

purchase money security interests to the extent that the liens encumber the debtor’s interest in assets otherwise exempt from creditors’ claims.

i. Problem: Charley purchased and completely paid for a pickup truck; when the construction industry entered another slump, Charley used the pickup as collateral for a $7500 loan from his credit union. After 3 months of no work, Charley decided to go into business for himself. Charley filed for bankruptcy 2 months after opening although he’s still trying to make the business go the credit union filed to lift the stay on the pickup; should the stay be lifted?

1. Is this a purchased money loan? NO b/c a purchased money loan is when you take out the loan to buy the property- here he already paid for the truck and is using the truck as collateral for ANOTHER loan

2. Is it a possessory security interest? NO b/c he is still using it- when we are talking about a possessory security interest, its when the creditor has control of the property- usually, the item is a nonpossessory interest

3. Is this exempt? 522(d) has the federal exemptions and says can’t exceed a certain dollar amount…but he may be able to get this under tools of the trade exemption up to 2,175

4. so- does 522(f)(1)(b) beat the exemption? Yes up to a certain amount-

5. How much can he avoid?

a. He can avoid 2,175 under 522(d)(6) as tools of tradeb. He could possibly avoid another 3,450 under 522(d)(2) as

motor vehiclec. If he exempts both tools of trade and motor vehicle of

4925 (slide has diff value of 522(d)(2) and (6)) and the truck is worth 10k, then the impairment/avoidance is 5075 (the exemption minus equity)

6. Point of all this- if the equity is less than the full exemption amount AND 522(f)(1) applies then the lien is AVOIDED up to the point the debtor is allowed to take their full exemption- in this limited category of cases, the debtor’s exemption beats the security interest only up to the exemption

a. Let’s say the debtor’s equity is 2500 and the exemption equals 5000 and lets say the property is worth 10k

b. the avoidance equals EXEMPTION minus EQUITYc. 5k minus 2.5k = 2.5k (which is the avoidance)d. that means the value of the lien to the creditor will be

reduced by 2.5k and the value of the exemption is increased by 2.5k

e. just moving the extra money from the creditors to the debtors

f. Why do this? the creditors should have known that they were securing against a partially exempt property b/c then they wouldn’t have done this

g. what we are basically saying under 522(f) is that consumer goods should not be used as collateral for commercial loans

h. policy/message- we don’t want debtors to use necessary life equipment (like clothes and cars) as collateral for loans b/c we want to make sure they keep them

6. Asset protection trusts:a. Definition - a self-settled trust that hides all of a client’s assets so that they can’t

be reached by creditorsb. Settlor creates a trust and names himself both trustee and beneficiaryc. Most states consider them illegal but now 8 states permit these trustsd. In bankruptcy, debtor can claim that the property in such a trust is not property of

the estate: §541c17. Offshore trusts are overseas asset protection trusts

a. They’re located in sunny islandsb. They become unresponsive to the settlor’s instructions if those instructions are the

product of “coercion”c. There’s no US jurisdiction

8. There are 2 ways of running up your exemption i.e. increasing your total exemption value:

a. Changing property from non-exempt to exempt (In re Reed)i. Bankruptcy Court held that proceeds of sale of nonexempt property could

be used to pay off liensii. Circuit court held that a debtor who converts nonexempt assets to an

exempt homestead immediately before bankruptcy, w/ intent to defraud his creditors must be denied a discharge in bankruptcy—it is very difficult to prove intent to defraud

iii. Question remains whether planning activities to take max advantage of statutory exemptions are fraudulent or plain sensible

b. Changing jurisdictions (in re Coplan)i. Coplan lived in WI but it has bad exemption laws; Coplan moved to

Florida to take advantage of the better exemption laws; he converted his non-exempt assets into exempt property and then filed Ch. 7 Court held that his assets could NOT be discharged—Florida’s exemption had a good faith component

9. Problemsa. 9.1

i. ANALYSIS: 1) He has NOT been in a single state (IL) for 2 yrs (b/c of living in WI); 2) no single location for the 6 mos prior to the 2 yrs; 3) 91 / 180 days in FL = the MAJORITY of the time was in FL

ii. This will be litigated b/c of how huge FL Homestead statutes are [after all, if in IL, he would be limited to $15k]

iii. FL was likely his “domicile”—even though for just 91 days—b/c he changed voting / mail / drivers’ license

iv. POLICY: He is smart, not shady…and he has organized and planned this well. If we wanted the same results for all, we’d have uniform federal law.

v. NO ABUSE PROBS under § 707(b) b/c these are COMMERCIAL debts, not consumer debts

b. 9.2i. Facts

1. Woody Woodward ran a stock scam that was so tangled that it took years for his investors to figure it out. The SEC still can’t get an indictment. A civil jury just awarded victims $25MM. Woody and his fourth wife Ingrid just bought a home in Pennsylvania Dutch Country on 16 acres for $10MM

2. Woody wants to file for BR to deal with the judgment. Can they keep the house?

ii. 522(b)(3)(B)

1. (B) any interest in property in which the debtor had, immediately before the commencement of the case, an interest as a tenant by the entirety or joint tenant to the extent that such interest as a tenant by the entirety or joint tenant is exempt from process under applicable nonbankruptcy law;

iii. Any limitations on their ability to do this?1. 544/548??

c. 9.3i. Caleb Wiley just crashed a car into two people driving a jag. He will be

liable for the full amount of damages. 1. What do you ask him?

a. What assets does he have?b. What else do you want to know?

i. Are they exempt, or accessible to creditors?2. Assume that he has a large co-op apartment in NYC. Lots of

money in a bank account in NYC. That he is married, but he has all of the property in his own name.

3. Things he can do: a. Convey property to wife and friendsb. Sell assets and convert to exempt assetsc. Put assets in “asset protection trusts.”

i. Where?d. What are the risks?

i. Fraudulent conveyance?1. Twyne’s case

ii. Loss of bankruptcy discharge1. Reed

iii. Contempt1. – APT

d. 9.3(b)i. Facts

1. Dr. Panoply is a beloved doctor and member of the community. He’s worried about potential (not actual) malpractice claims. He wants to set up a trust to hold all of his investments safe from juries, “who don’t understand that medicine is an art, not a science.”

ii. What can you do for him? What should he worry about?1. Offshore asset protection schemes?

a. What happened in Affordable Media2. Alaska/South Dakota self settled trusts3. Giving assets to friends.

a. Does he trust them?4. May find himself held in contempt.

a. May be worth it.5. What if there’s a judgment in the works?

a. Much less sympatheticb. Possible fraudulent conveyance problems.

iii. Are asset protection trusts socially desirable?iv. Are there other ways to judgment proof yourself beside sending the assets

to the Cook Islands?1. Secured Credit?

a. Give a lien on all assets2. Securitization

a. Sell all of you assets to another corporationv. Should 522 be amended?

1. To create an aggregate federal exemption cap?2. To create uniform federal exemptions?3. To create a uniform federal exemption floor?

Claims and Distributions1. Analysis:

a. Is it a claim? 101(5)b. Is it an allowed claim?

i. Unsecured: allowed if enforceable against the debtor as of petition date. 502(b)

1. No unmatured interest 502(b)(2)ii. Secured: allowed if secured by a perfected interest in the debtor’s property

5061. Over-secured? Post petition interest and fees can be collected

506(b)2. Claim Defined - 101(5)

a. Right to payment, whether or not such right is reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal, equitable, secured, or unsecured

3. Proof of Claim (501)a. In bankruptcy, a demand filed by a creditor against a fund in possession of the

court for distribution.i. Must be filed by a creditor in chapter 7 and 13

ii. not necessary in 11 if properly filed

iii. The creditor presents an affidavit saying what the debtor owes according to the attached document (i.e. proof of claim)—in the alternative, the debtor is obligated to file a schedule of claims

4. Allowance of Claims (502)a. if you file your proof of claim, and there is no objection, you get what you asked

forb. the claim will be accepted unless:

i. the claim is unenforceable against the debtorii. the claim is for unmatured interest

1. For an unsecured creditor, interest stops maturing at the moment of filing

5. Disputed Claimsa. Sometimes the TIB objects to paying certain creditors, claiming that there was no

valid debt under state law or that the amount of the debt was lower than claimedi. Disputed claims sometimes require an evidentiary hearing

ii. In re Lanza 1. Onus is on debtor to overcome presumption of validity. Here,

bank’s proof of claim had different amounts, so court went w/ the lower.

6. Three Types of Claimsa. Secured Claims (506)

i. 506(a) grants secured creditors an allowed secured claim up to the value of its collateral

ii. Partially secured (a 506(a) creditor): 1. the claim is for more than the value of the collateral2. Partitioning Claims

a. If under-secured, the creditor essentially has two claims:i. An allowed secured claim for the value of the

collateralii. An unsecured deficiency claim for the remainder

b. HYPO:i. Debtor has 20K in assets, including a car worth 5K,

secured for 8K by bank. There are 10 other creditors w/ a total of 20K in unsecured claims.

1. Bank gets 5K for the car (allowed secured claim)

2. There is now 23K in unsecured claims (20 + bank’s 3K unsecured deficiency claim) and 15K in assets.

3. 15K/23K = 65%. Each unsecured creditor gets $.65 on the dollar.

4. Bank gets:a. 5K allowed secured claim; andb. 1950 unsecured deficiencyc. Total: $6950

iii. § 506 Secured Claims Interest1. Undersecured claimants: No unmatured interest

a. If you are undersecured, you’re not entitled to post-petition interest b/c your collateral is worth what it’s worth

2. Oversecured claimants: Unmatured interest and attorney’s fees up to collateral value provided that agreement granting security interest (or whatever else) says such interest (or whatever else) is due.

a. There is an equity cushion that the creditor can use to get post-petition interest

b. Not getting interest constitutes lack of adequate protection3. (c) allows TIB to deduct from secured property “value” the

administrative expenses of getting collateral back to claimant if secured claimant benefited from these expenditures.

iv. 506(b)1. Fully secured (a 506(b) creditor): the claim is less or the same as

the value of the collaterala. Interest and Fees: Over-secured creditors can receive

post-bankruptcy interest at its contract rate and reasonable fees as provided in the K, until the value of the collateral is exhausted

i. Interest exceeding the value of the collateral does NOT become unsecured debt

b. Why? Bankruptcy wipes out contractual debts, but respects property interests. Property interests which pre-exist the bankruptcy cannot be jumped by the TIB. It can collect interest until it reaches the extent of its property interest.

v. 506(c)1. if a secured claimant benefits from the TIB advertising its

collateral, then that cost is deducted from the creditors allowed secured claim, and added to their unsecured deficiency claim

b. Priority Claims (507) unsecured claims entitled to priority1. Numbered 1-8

c. Unsecured Claims (502)i. What’s an allowed unsecured claim? (502)

1. They are based on K and there is no property interest

2. (502a)—a claim or interest, proof of which is filed under §501, is deemed allowed, unless a party in interest objects

3. (502b)—if such objection to a claim is made, the court, after notice and a hearing, shall determine the amt of such claim as of the date of the filing of the petition, and shall allow such claim in such amount except to the extent that EXCEPTIONS to allowed unsecured claim:

a. 1. such claim is unenforceable against the debtor and property of the debtor, under any agreement or applicable law for a reason other than b/c such claim is contingent or unmatured

b. 2. such claim is for unmatured interest—this means that unsecured creditors get no post-petition interest

4. Unsecured creditor is entitled to pre-petition interest5. Discharge amount = unsecured creditor’s allowed claim – what

that the creditor actually gets6. When did the claim arise?

a. Pre-petition b. Post-petition (503)

7. Any special status?a. Priority (507)

8. Policy behind unsecured creditors collecting a pro rata share of whatever remains of the estate is Equality among these unsecured creditors. After everything is sold, the secured creditors get their money, the priorities are sorted out, then whatever percent of the general unsecured claims the proceeds equals, is the percent of the debts that each creditor gets

9. i.e., if proceeds equal 10% of total unsecured claims, each unsecured creditor gets 10% of their claim

ii. Interest: Unsecured creditors stop accruing interest at the time of filing 502(b)(2)

1. Why? Snapshot is taken at time of filing. If all unsecured creditors could continue adding interest, it would change the proportion of money being divided post sale of proceeds

iii. BUT NOTE that unmatured interest is part of claim under 101(5), which means it gets discharged. It just is not part of allowed unsecured claim.

7. Problems a. 10.1-10.4 and Problem 11b. 10.1

i. Problem 10.1: Corrine Zeppo lost her job last month and filed a Chapter 7 liquidation bankruptcy this month. One creditor, Miller Plumbing Co., claimed $3,000, plus (a) $200 in past-due interest accrued prior to bankruptcy; and (b) another $100 in interest accrued since the bankruptcy began. Interest was calculated for the pre-bankruptcy period according to the state law judgment rate for the post-bankruptcy period. Miller Plumbing, however, has no security interest in any of Corinne’s property. What s the amount of Miller’s allowed unsecured claim in bankruptcy?

1. UNSEC CLAIM = 3k (principal) + 200 (pre-petition int) = 3.2k total

2. Where do we look to determine the amount of Miller’s claim?a. See §§ 502(a) and (b).

3. On what basis might the debtor object to Miller’s claim for $3,000?

a. Who has the burden? – Lanza4. Is there any basis for objecting to Miller’s claim for prepetition

interest?5. Is Miller entitled to post-petition interest?

a. Look at §502(b)(2).b. NO POST-PETITION interest b/c it is

UNSEC/UNMATURED!c. 10.2

i. Corinne had only two non-exempt assets: her car, worth $10,000, and 1,000 shares of MacroSoft stock, worth $15,000. At the time of filing, she owed the bank $8,000 on the car and the bank had a valid and enforceable security interest in the car to secure its loan. In addition to the $8,000 principal, the bank claimed (a) past-due interest that accrued prior to bankruptcy of $500, (b) interest since the bankruptcy was filed of $400, and (c) attorneys’ fees of $1,000 expended in trying to collect. The bank was entitled to collect all these amounts under its loan and security agreement and under state law. What is the amount of the bank’s allowed secured claim in bankruptcy.

1. ALLOWED CLAIM = 8k (principal) + 500 (past int) + 400 (post int per § 506(b)) + 1k (attys fees = ok under state law) = 9.9k

2. Since the ALLOWED CLAIM is less than the VALUE of the car (10k), C’or gets all 9.9k

3. FEES per § 506(c): the TIB will take all fees out FIRST, so C’or likely gets a bit under 9.9k

4. Is the bank oversecured or undersecured?a. They are oversecured. The value of their collateral exceeds

the amount of their claim. $8,000 (principal) +$900 (past

due interest) + $1,000 (attorneys’ fees) < $10,000 (value of the car)

b. Estate receives: $10,000 -$9,900 = $100c. Section 506(b) applies to oversecured creditors. They are

entitled to a secured claim in the full amount if the collateral is valuable enough to support the claim.

5. Which expenses can be included in an allowed secured claim under §506(b)?

a. Past due interest? Yesb. Does it matter whether the interest accrued pre- or post-

petition? Not if collateral is sufficiently valuable.c. What rate applies for post-petition interest?d. Attorney’s fees? Yes, if set forth in K and reasonable.

d. 10.3i. Problem 10.3: If, contrary to the pre-sale estimates, the car had brought

only $5,000 when it was sold, how would the bank stand?1. See §§ 502(b), 506(a) and (b).2. They become undersecured and therefore 506(a) applies.3. ALLOWED CLAIM = 8k (principal) + 500 (past int) = 8.5k

a. 5k is SEC CLAIM (as the VALUE is only 5k)b. 3.5 k is UNSEC CLAIM

4. BUT while § 502(b) specifically disallows post-peition int, POST-PETITION ATTYS FEES ARE NOT DISALLOWED…up to the value of the collat:

a. 5k SEC claimb. 4.5k UNSEC claim (3k principal + 500 past int + 1k attys

fees)e. 10.4

i. Problem 10.4: Ten other creditors of Corinne are owed a total of $20,000, but none of them are claiming any interest. If you were appointed TIB in Corinne’s bankruptcy and collected $5,000 for the car and $15,000 for the stock, how should you distribute the money (ignoring other expenses, including your own cut as TIB).

ii. Answer 10.4:1. We have a total of 20k in the pot: 5k from car / 15k from the

stock.2. 5k IS SECURED…so that 5k goes immediately to the Bank.3. 15k IS UNSEC…so that is divided PRO RATA4. Who are the Unsecured Creditors?

a. 10 Creditors seeking 20k (unsecured)

b. Bank seeking either 3.5k or 4.5k (unsecured portion of their claim)

c. Miller Plumbing (see 10.1) seeking 3.2kd. TOTAL = 26.7k or 27.7k

5. DIVIDE: 15k / 26.7k or 15k / 27.7k = 56.2% or 54.2%a. This shows the percentage of their unsecured claim that

each unsecured creditor will collect (i.e., pro rata distribution).

f. 11 i. Problem 11: Harold Smith declared Chapter 7 bankruptcy in March 2006.

His non-exempt assets consisted of his condo in Kitty Hawk, which the TIB sold for $400,000 but which was subject to a $365,000 mortgage [remaining 35k into estate], and miscellaneous personal property that sold for $25,000. All his other property was exempt. Relating to the following claims filed in bankruptcy court, who will get what under Sections 507 and 726(a)(4), (b)?

a. Answer 11:i. NOTE: In total, amt to be distributed = 35k + 25k =

60k…but this is NOT PRO RATA…MUST LOOK TO PRIORITIES!

ii. Neil Nelson, a private duty nurse whom Harold hired while his father was quite ill: $12,000

1. 507(a)(4) – it’s a fourth priority claim. 2. 507(a)(4): PRE-PETITION WAGES up to

11,725 (so long as services were performed w/in 180 days b/f filing date or the date of the cessation of the debtors business, whichever occurs first.

3. IF 190 days b/f filing, he still has an allowed claim…but it is an a GEN UNSEC C’OR b/c more than 180 days

4. IF INDEP CONTRACTOR: this is NOT the same as the exception in 507(a)(4)(b) for people ON COMMISSION…so this goes to 762(a)(2) as GEN UNSEC C’OR

5. Why impose a 11,725 limit?a. Should the president of the company

get a priority for his full salary of 2million? No!

6. Why impose a 180 day limit?a. How many employees will wait 180

days? When they do wait that long

they begin to look like ordinary creditors.

iii. Social Security Administration, Social Security and withholding from Harry’s earlier pay checks: $1080

1. What if it’s the employee’s contribution?a. §507(a)(4) or (5).

2. What if it’s the employer’s contribution?a. §507(a)(8)(D). “Eighth . . . (D) an

employment tax on a wage, salary, or commission of a kind specified in paragraph (3) of this subsection earned from the debtor before the date of the filing of the petition, whether or not actually paid before such date, for which a return is last due, under applicable law or under any extension, after three years before the date of the filing of the petition;

3. Why should we be so favorable with the Social Security Administration?

i. City of Eden, property taxes: $3,000 per year for the last three years plus $500 per year penalties for each of the three years.

4. 507(a)(8)(b) = priority only for the most RECENT YEAR

a. Calc BEFORE: prop tax incurred B/F commencement of case and last payable w/o penalty

b. Calc AFTER: AFTER 1 yr b/f the date of the petition [look to 1 yr b/f the date of filng…all payment due in this period]

5. PENALTIES: these fall under 726(a)(4)—these are not for actual pecuniary loss!

6. Why the one year limit?a. Don’t want the taxing authority to sit

on its rights. b. Should file a tax lien and put the

world on notice. ii. George Nartowski, down payment against a

tractor lawnmower Harold had agreed to sell to George: $300.

a. Priority?i. $300 priority under §507(a)(7).

ii. “Seventh, allowed unsecured claims of individuals, to the extent of $2,600 for each such individual, arising from the deposit, before the commencement of the case, of money in connection with the purchase, lease, or rental of property, or the purchase of services, for the personal, family, or household use of such individuals, that were not delivered or provided.”

b. Why?i. What if your landlord went

bankrupt?i. State Department of Revenue and IRS, income

taxes: state $4,000, federal $14,000.7. 507(a)(8)

a. (A) a tax on or measured by income or gross receipts

i. (i) for a taxable year ending on or before the date of the filing of the petition for which a return, if required, is last due, including extensions, after three years before the date of the filing of the petition;

ii. (ii) assessed within 240 days, plus any time plus 30 days during which an offer in compromise with respect to such tax that was made within 240 days after such assessment was pending, before the date of the filing of the petition; or

iii. (iii) other than a tax of a kind specified in section 523(a)(1)(B) or 523(a)(1)(C) of this title, not assessed before, but assessable, under applicable law or by agreement, after, the commencement of the case;

8. Interaction with non-dischargeability

a. Priority tax claims are also non-dischargeable.

b. How does this affect the debtor’s attitude toward priority?

i. The debtor doesn’t care about priority. It’s not her money anyway.

ii. The priority for non-dischargeable tax claims promotes the debtor’s fresh start, by reducing the size of the non-dischargeable claim.

iv. Telephone, utility, and other regular bills following bankruptcy: $3,000.

1. NO PRIORITY HERE—these are AFTER BANKR, so nothing paid from estate

2. These are the D’or’s own liabilities3. If TIB had to pay these to PRESERVE

ITEMS FOR SALE…then could be expense of maintaining prop of estate (except for phone bill) and would be a priority administrative expense under §503.

i. Sara Fleet, Harold’s attorney: $1750 in fees ($500 for a will; $1250 for preparing this bankruptcy filing)

4. $500 for will = nothing to do w/ preserving estate; thus, this is GEN UNSEC

5. $750 for bankr = if not for preservation of estate, the atty is a GEN USEC b/c PROF FEES ARE ONLY FOR ESTATE PRESERV (may include atty in corp bankr for reorg); but here, the estate / D’or are separate…not included

ii. Suzan Smith, Harold’s ex-wife, negotiable note: $25,000

6. Is this DOMESTIC SUPPORT? If this is a lump sum alimony payment, it fits under 507(a)(1)

7. BUT if property settlement…this is NOT under 507(a) b/c it’s not for ‘ongoing support’

8. If a business deal? GEN UNSEC—no priority

iii. TIB as trustee and as trustee’s counsel: $4,000.

a. These are post-petition administrative expenses of the estate entitled to second priority under §507(a)(2)

b. Administrative expenses allowed under section 503(b) of this title, and any fees and charges assessed against the estate under chapter 123 of title 28.

i. Section 503(b)(1)(A) defines an administrative expense claim as:

1. “[T]he actual, necessary costs and expenses of preserving the estate, including wages, salaries, or commissions for services rendered after the commencement of the case

ii. Section 503(b)(2) covers:1. “The compensation and

reimbursement awarded under §330(a) of this title.” (Trustee’s fees)

c. Who ultimately pays these administrative expenses?

i. The lower priority claimants (if money runs out before getting to them) or

ii. The general unsecureds (whose percentage payback is lowered pro rata).

iv. Insurance premiums for insurance on the non-exempt personal property prior to its sale by the TIB: $750

9. Note: this is POST-PETITION10. Will have to argue this is NECESSARY

EXPENSE under 507(a)(2) for PRESERVATION OF ESTATE; and this likely falls under § 503(b)(1)(A)

i. Costs of sale of Harold’s non-exempt real estate and personal property, including advertising: $2,800

11. Admin expense per 507(a)(2); 12. a Realtor is a professional, so make sure his

expenses are REASONABLEii. Other unsecured, general claims: $17,000

13. NO PRIORITY FOR GEN UNSEC CLAIMS…everything left in the end is SHARED PRO RATA

14. Highly unlikely they’ll get anything2. Who goes first?

a. See 11 U.S.C. § 506(c)i. Costs of sale come out of collateral

b. See 11 U.S.C. § 503(a)(1)(A)i. If the amount owed to Suzan represents “lump-sum

alimony,” then it is entitled to “first” priority in distribution.

ii. $25,000c. See 11 U.S.C. § 503(a)(1)(C)

i. The TIB and burial expenses get paid before DSOii. $4,000

d. See 11 U.S.C. § 503(a)(2)i. Administrative expense claims come next

ii. Which are these?e. What’s left?

3. Who will raise the question about the treatment of the ex-wife’s claim?

a. You name it.....b. IRS and the TIB.c. Every creditor with priority wants to scrutinize the creditors

ahead of it, if paying them means it won’t get paid.d. The unsecured creditors won’t be very happy either, but

they were never likely to receive much from this estate.....

Week 6 Discharge and Reaffirmation

Read pages 229-257. Do problems 12.1-12.4. Use 11 U.S.C. §§ 523, 727.Read Casebook pages 258-271. Do problems 13.1-13.3 and 13.6. Use 11 U.S.C. § 524.

(1) Dischargea. Discharge is the entire reason to file for Chapter 7b. At the moment of discharge, the automatic stay ends, 362(c)(2)(C), and the

discharge injunction, 524, begins.i. Discharge injunction - forbids any attempt to collect a dischargeable debt

c. In Chapter 2 after TIB sells the property of the estate and distributes proceeds to the creditors, an individual debtor is discharged from any unpaid portion of the debt. THIS GUARDS/IS DEBTOR’S “FRESH START”

(2) Requirement:a. The only people entitled to discharge are “honest and unfortunate” debtors

2. Denying Discharge: 727 & 523

a. Global Denial 727i. Grounds for global denial:

1. (a)(1) debtor is not an individual (corps don’t get discharges in chpt 7)

2. (a)(2) debtor intentionally delayed, hindered, or defrauded w/in 1 yr of bankruptcy

a. i.e., fraudulent conveyancesi. In re Reed

1. ∆ conversion of non-exempt to exempt assets is not by itself enough to deny discharge b/c it was proof of actual intent to defraud creditors BUT

2. extrinsic evidence can round things out enough to get global denial

3. (a)(3) failure to keep records is so egregious it is impossible to do the case

a. TIB needs documents to ensure that ∆’s assets are accurately accounted for and distributed to creditors

4. (a)(4) debtor knowingly and fraudulently lied to the trustee5. (a)(5) failure to sufficiently explain a loss

a. In re McNamara (Explaining loss of 150K by gambling in winner-take-all poker game, where ∆ was driven there by someone no longer living in U.S. and when ∆ couldn’t provide any other details, esp. when coupled with ∆ testimony he “reserved just enough” to go to the Caribbean = unsatisfactory explanation)

6. (a)(6) failed to follow a bankruptcy court order7. (a)(8) and (a)(9) debtor received discharge less than 8 yrs ago in

another case b. “Rifle Shot” Denial 523

i. Creditor gets their bankruptcy distribution, then they can continue after the debtor for the remainder during their fresh start

ii. Grounds: 19 exceptions to discharge1. (a)(1) certain tax or customs duty2. (a)(2) money, property, services obtained by:

a. (A) false pretenses1. Dorsey: when you use a CC, you make a

representation that you intend to repay it. If no intent to repay, silent fraud

b. (B) use of a writing that is materially false regarding ∆’s financial condition on which creditor reasonably relied1 that ∆ made with intent to deceive

i. Policy1. concerned w/ debtors running up credit

cards pre-filing2. (a)(2)(c)(i)(I): luxury goods charged to a

single creditor aggregated over $500 w/in 90 days

3. Consider, depending on client (TIB, ∆ or creditor) what the purpose of something bought is – if tickets are bought for vacation, they may be luxury goods but if for job then maybe not.

c. (b) Cash advances of more than $750 (aggregate) that are extensions of consumer credit, which are extended w/in 70 days of BR petition

i. In re Dorsey (widow w/ only Social Security as her real income cannot discharge huge credit card bill she thought her BF would pay after she takes two children on trip around Europe)

ii. Rule: Court held her Amex debt be excepted from discharge under §523a2A—debtor made a “false representation” of her willingness and ability to repay when she incurred credit card debt to Amex w/in short period before bankruptcy filing; Court also found actual fraudulent intent

d. (a)(3) claims that were not listed or schedulede. (a)(4) claims for fraud or defalcation when acting as a

fiduciaryf. (a)(5) domestic support obligation (not property obligations

from divorce decree – like a house that needs to be transferred)

i. Domestic Support Order defined in § 101(14)(A) as payment “in the nature of alimony support or maintenance”

ii. Other spousal debt ((a)(15)) debt is dischargeable in Chapter 13 but not 7 – Domestic Support Order is not dischargeable in either

1 May well apply to creditors’ forbearance on collecting debt as well as their extension of credit – Field v. Mans

iii. This matters because of priority as well – alimony and support obligations get priority

g. (a)(6) claims for willful and malicious injury to person or property

h. (a)(7) debts that are a fine, penalty, or forfeiture payable to a gov’t unit

i. i.e., penalties on nondischargeable taxesi. (a)(8) student loans guaranteed by the gov’t

i. Undue Hardship test = would it be an Undue Hardship for ∆ to repay student loans?

ii. 3 questions – Brunner test:1. Can ∆ maintain minimal standard of living

for himself and dependents if forced to repay the loans, as ability to maintain is judged according to current expenses and income?

2. Do additional circumstances exist indicating state of affairs is likely to persist for significant portion of repayment period?

3. Has ∆ made good faith efforts to repay?iii. Gerhart (While expenses definitely exceed income

of musician there is no indication that ∆ cannot correct the “persistent state of affairs” by getting, e.g., a non-musical job. ∆ not entitled under BR law to choose to work only jobs in field in which he is trained. No discharge granted)

iv. Miller (Partial discharge granted to ∆ under court’s equitable relief powers/§ 105. ∆ failed the UH test, so total discharge denied)

j. (a)(9) debts related to death or injury caused by drunk driving/boating

k. (a)(10) unscheduled debts from an earlier casel. (a)(11) fraud settlement … federal depository institutionm. (a)(12) malicious failure to fulfill commitment…federal

depository institutionn. (a)(13) any payment of restitution under 18 USCo. (a)(14) debts incurred to pay nondischargeable tax claims

i. So you can’t pay of nondischargeable debt w/ dischargeable debt

p. (a)(15) any other debt laid out in divorce that isn’t domestic support … unless debtor does not have reasonable ability to

repay such debt or discharge of debt would result in benefit to debtor that outweighs detrimental consequences to debtor’s non-debtor ex-spouse or child of debtor

i. (a)(5) is better than (15) b/c it has priority under 507, and (15) is dischargeable in chapter 13

q. (a)(16) fees to condos and coopsr. (a)(17) fees on prisoners for filing motionss. (a)(18) money owed to a pension, profit-sharing, stock

bonus, etct. (a)(19) violation of fed securities law

3. Partial Dischargea. Some courts find the power to partially discharge in 105(a), which gives courts

general equity power to effectuate the bankruptcy code.b. Disputed how much courts can (or should) use this power

4. Choosing Rifle Shot or Globala. As a creditor, better to have rifle shot for your debt, b/c then after bankruptcy,

debtor has more money to pay you.b. Creditors should seek to except their debt from specific discharge rather than

general b/c all creditors benefit from a successful action under §727 but only the individual creditor benefits from 523a2

5. Problemsa. 12.1

i. Wallace Laymon has held a number of jobs over the past ten years; none for very long. He is unpleasant, walks of jobs, gets fired, and sometimes just quits. His personal financial records are a wreck – no checking statements, no bill receipts, no tax returns, hardly any documentation at all. Will Laymon receive a discharge in bankruptcy? Should he?

ii. Answer: iii. I think it really depends on a case by case situation, but look at § 727(a)

(3). It says that you can’t get a global discharge if its impossible to sort through your records. This makes sense!

a. 12.2 b. Question

a. Our client, Gordan Gram, has had money problems for several months now. A while back, he gave a financial statement to his creditor, Dina Chapman, to persuade her to hold off on collecting on the debt owed to her. The statement was false – in it he claimed to own 1,000 shares of AT&T stock. Gram subsequently transferred his ski chalet to his daughter. Chapman brought an action under state fraudulent transfer law to avoid the transfer, but before she obtained a judgment Gram filed a chapter 7 petition.

b. Can Chapment question Gram’s entitlement to a discharge?

c. Answera. Chapman can object to Gram’s discharge under §727(a)(2)(A), since the

transfer of the chalet to his daughter may have been an actual fraudulent transfer.

b. Chapman can also file a complaint to except her debt from discharge under §523(a)(2)(B).

i. But Dina didn’t make a new loan to Gram based on the false financial statement.

ii. Instead, she held back on collecting on the old debt.iii. Does § 523(a)(2)(B) apply both to “forebearance from collecting

on debt” and “extensions of credit”?1. Probably. See Field v. Mans, 516 U.S. 59 (1995).

c. Which objection will she prefer to bring?i. Chapman is more likely to seek to except her debt from discharge

than object generally to Gram’s discharge. Why?1. All creditors benefit from Chapman’s successful action

under § 727, But only Chapman benefits from her success under §523(a)(2).

2. Moreover, court is far more likely to allow Gram to settle §523 complaint by providing preferential treatment to Chapman.

3. It is ethically suspect to use withdrawal of § 727 complaint as leverage in settlement discussions.

a. 12.3 b. Question

a. Gerry and Beth were divorced in Iowa. The domestic relations court order provided that Beth would have custody of the children (ages 4, 9 and 10) and that Gerry would take the homestead and furnishings and pay Beth

i. An immediate $10,000 lump sum out of his separate assets;ii. $2,500 per month for next 5 years;

iii. $1,000 per month for next 9 years; andiv. $200 per month after that time until Beth dies

b. The day after the divorce was final, Gerry filed for bankruptcy – chapter 7. Beth’s divorce lawyer called you to ask what Beth will get.

c. Answera. Look at 523(A)(5)

i. DSO is not dischargeable. DSO must be “in the nature of alimony support or maintenance.”

a. 12.4 b. Question

a. Chickie Narduchi provides “creative debt collection services” for clients, and has been very successful. He’s suffered a series of financial reverses, and filed for bankruptcy. One of Chickie’s creditors obtained a $800,000 judgment against him based on various intentional torts.

b. Will the judgment be discharged?c. Answer

a. Chickie may have committed a willful or malicious injury or two. What public policy supports excepting debts like this from discharge?

b. Look at the various 18 exceptions (above) under 11 U.S.C. § 523. For instance, you may want to consider (a)(6) and (a)(11) as what to bring your claim under.

Reaffirmation 6. Introduction

a. § 524 discharge is the post-BR version of the automatic stay, in that it stays any creditor actions on pre-petition debts going forward

i. (a)(2): a discharge injunction “operates as an injunction against the commencement or continuation of an action, the employment of process, or an act, to collect, recover or offset any such debt as a personal liability of the ∆, whether or not discharge of such ∆ is waived.”

7. Reasons you would want reaffirmation a. Discharge injunction does not preclude creditors from refusing to deal with a ∆

any further b/c of non-payment of a debt that is discharged. i. [School can refuse to give transcript post-BR, but just could not require

repayment of debt]b. Lien - ∆ may choose to pay someone who continues to hold a lien like a car dealer

who cannot require repayment of the debt but can repossess a car post-BR8. Courts perspective

a. Courts are hesitant about reaffirmation b/c by signing an agreement, you create 1. an enforceable right to sue you; 2. once you get a discharge, you can’t get another one for 8 years

9. Discrimination post- bankruptcy by creditorsa. § 525 prohibits discriminatory treatment because of ∆’s former BR status by

i. Governmental units concerned with granting licensesii. Employers

iii. Student loan giversb. Note that these categories are v. limited

10. 524(c) allows a debtor to reaffirm a debt:a. Revives the debt and makes it (and any future penalties and interest provided in

the agreement) fully enforceable in courtb. It pokes a hole in this post-discharge protection

11. History of reaffirmation

a. Former bankruptcy act was silent on this issue, leaving it up to the state law to determine

b. 1978 Bankruptcy Act – required courts to approve reaffirmation to ensure that it is in the debtor’s best interest

c. 1984 Amendment – only need court approval when debtor is not represented by an attorney.

12. 524(f): nothing prevents a debtor from voluntarily repaying a debta. Incentives to Reaffirm:

i. Creditor must recognize that in the absence of reaffirmation, its debt will be discharged leaving recourse against its collateral as its sole remedy

ii. Creditor must consider reaffirmation in terms of expenses associated w/ repossession and foreclosure; also the resale value of its collateral Foreclosing would be a creditor’s least desirable option

iii. Secured Debt: keep the collateral that was either exempt or fully encumbered (so not sold)

1. Discharge injunction prevents creditors from seeking repayment through personal liability, but they can still repossess their asset (it is a property interest)

a. 506(d): debts are discharged, but liens are notiv. Unsecured Debt: offer of future credit, threat to object to discharge

1. Very infrequent that it is in the debtor’s best interest to reaffirm unsecured debt

2. Why would they?a. Debtor’s desire to protect a co-debtor; Gratitude (to a

doctor); Offers like “if you reaffirm this prepetition debt on a credit card, we will give you your credit card back for use”

v. Over-secured Debt1. Reaffirming very over-secured debts also not always in best

interest as it will probably result in ∆ paying much more than collateral is worth → in such a case

a. Redeem orb. Sell collateral and if subject to an exemption (a car, e.g.)

take that amount and buy something w/value closer to price13. Creditor can’t “ask” for reaffirmation (violation of discharge injunction)

a. There is some “wiggle room” in 524 for creditors to offer debtors something the debtors want, but needs to meet the other requirements too (including approval)

14. Decision to Reaffirm:a. Generally, good to reaffirm when the debtor has equity and can afford it.

Especially when it is something that will appreciate, like a houseb. Generally bad to reaffirm if it will depreciate (TV)

i. Cars: Hard decision, depends how badly debtor needs it15. 524(c) Requirements: (has to jump through hoops!)

a. The deal must be in compliance with applicable non-bankruptcy lawb. Creditor cannot ask for itc. Creditor has to explain to ∆ that he can rescind within 60 days of filing with

court or before discharge, whichever is laterd. Reaffirmation agreements must be entered into before conclusion of the BR case

or they are unenforceablee. BR courts must approve RA’s unless ∆ has a lawyer who will sign the “best

interests affidavit”f. Clear and conspicuous statement that advises ∆ agreement is not requiredg. And accompanied either by attorney affidavit or court “hearing”

16. Unsecured Debta. Almost always a bad dealb. But client wants it.

17. Studiesa. Study found that (1) reaffirmations are not uniform across the country (2) avg.

reaffirmation is 10K (3) 25% of Chap 7 cases have reaffirmations18. Rogue Reaffirmations:

a. Reaffirmations signed by the debtor but not filed w/ the courts as requiredi. Problem because it gives the court no opportunity to comply w/process

ii. Predatory conduct will not be tolerated 19. Counsel

a. In re Pendlebury : Reaffirmation process is one of K negotiation and if counsel signs off on affidavit, court less likely to get involved (here, $250.00 attorney fees creditor insisted on to let ∆s keep mobile home upheld by the court)

20. Consequences of a 1. pre-bankruptcy restructuring agreement and 2. a post discharge reaffirmation agreement

a. 1. if I do this and file for bankruptcy, the reaffirmation becomes discharged once I file bankruptcy

b. 2. if you do it after filing, you can’t go to the debtor and ask them to reaffirm b/c this violates the bankruptcy discharge

c. POINT_ the only time you can approach a debtor about reaffirmation is during the time in bankruptcy

21. Reaffirmation of a Secured Debta. 3 Alternatives to Surrendering the Collateral

i. Reaffirmation 1. Debtors sign a legally binding agreement to waive the discharge on

a given debt2. It is a negotiation

a. Doesn’t need to be the same terms as original K

b. Creditor doesn’t need to accept reaffirmationc. 525 protects the debtor against discriminatory treatment

from:i. (a) gov’t units

ii. (b) private employersiii. (c) gov’t unit regarding student loans

3. Pendlebury : Reaffirmations are voluntary, and the court won’t interject in the best interest decision if the debtor is represented by an attorney

a. SIG: Reaffirmations are voluntary—the process is left up to debtor and the debtor’s attorney

b. Facts: each of the 4 reaffirmation agreements at issue contained a clause requiring the debtor to pay $250 in attorney’s fees; in each case, the collateral securing the reaffirmation agreement consisted of the debtor’s mobile home; in each case, debtor was represented by counsel

c. Rule: Court held that where debtors were represented by counsel, the court should not interject itself into a process for negotiating a reaffirmation agreement

4. Alternatives are not always availablea. Redemption: need the money up frontb. Ride-through: not accepted everywhere

5. 524(c) requirements: see aboveii. Redemption

1. 722 allows a debtor to pay the creditor the full loan or the value of the collateral in cash, whichever is less

2. There is no undue hardship affidavit required b/c it’s one lump sum

3. Secured creditors must accept redemptions, in contrast with reaffirmations

4. Requirements:a. Has to be for personal property for personal, family, or

household useb. Has to be either exempted under 522 or abandoned under

554c. No need for lawyer to sign undue hardship affidavit

5. 522(a)(2)(B): you have 45 days to come up w/ the moneyiii. Ride-Through

1. Keeping the collateral and continuing to make payments w/o reaffirming or redemption

2. Creditor has no recourse against debtor, but could repossess at any time

3. 2005 Amendments Attempts to end Ride-throughs:a. 362(h): removes the collateral from the estate and lifts the

stay unless the debtor complies w/ 521i. 521(a)(6) debtor must state an intention to do one of

three things: surrender the property, reaffirm, or redeem w/in 30 days of filing and debtor must perform that intention w/in 45 days of filing

22. Cases a. 13.1

i. Problem 13.1: The Muscle Mart is the only complete bodybuilding gym in Missoula, Montana. It charges a monthly membership and adds assessments for use of the sauna and items ordered at a juice bar. MM has a firm policy (would they have flabby policies?): If two months of dues or sauna fees are left unpaid, the membership is revoked, and the former member is not permitted to use any of the equipment until the unpaid balance is paid in full. Peter Lanier has just filed for a Chapter 7 bankruptcy, discharging among his other debts two months’ worth of MM dues. MM has revoked Peter’s membership, and Peter is frantic to get back to his workouts. He has offered to pay a month in advance, but MM refuses. What would you advise Peter?

ii. Answer 13.1:iii. Rule:

1. The membership can be revoked w/o paying the past 2 months dues…BUT AFTER BANKR, per § 524(a), MM can no longer take action on the 2 months worth of dues! (you can discriminate, but you can’t take action on those 2 months worth of dues)

2. You can SHOW VIOLATION OF § 524(a) by showing that if he repaid the discharged dues, MM would let him rejoin.

3. But in reality, it might just be best to repay § 524(f) – it’s not worth litigating.

b. 13.2 i. Problem 13.2: Two months ago, you handled a routine Chapter 7

bankruptcy for Kevin James. Kevin is a gentle soul, and the bankruptcy has been bothering him. Last week, he was in a former creditor’s store when a clerk made a remark about “stiffing your friends.” Kevin sad he felt terrible and offered to repay the debt. The store manager, an enterprising young man, got this promise in writing. Now Kevin fears this was not very smart. He is struggling with his current obligations and is

not sure he can pay this creditor. He calls you to ask if that written agreement is enforceable. What do you tell him?

ii. Answer 13.2:1. This IS NOT A REAFFIRMATION…b/c reaffirm can happen

ONLY B/F THE DISCHARGE per 524(c)(1)!2. No action can be taken on this paper!3. Additionally, he was not represented by an attorney nor did the

court approve this reaffirmation. c. 13.3

i. Facts 1. Chauncy “Big Moon” Mooney’s job as dishwasher; has bike worth

$15,000 because he’s wrecked it twice (he owes $18,000); he is overwhelmed with unsecured debt, and declares bankruptcy; his only asset is his small house with a 7% mortgage; his equity in the home would yield about 16,000 after the sale - all which would be exempt; M wants promises to sell home & use money redeem his bike.. Will you (his attorney) sign “undue hardship” for M

ii. Answer 1. Under §722 (redemption) – not going to have to sign it. No

requirement with redemption. a. janger: perhaps congress views attorney monitoring as less

critical when the debtor is spending cash rather than encumbering his fresh start with more credit (reaffirmation).

b. Additionally, here is getting something in return. In reaffirmation, he is not necessarily getting anything in return.

d. 13.4i. Facts

1. Tawanda Johnson is a single mother of 2 kids and her husband died in a train crash- she lost her job when the company relocated to Asia- she held out for a better paying job, but after running up substantial bills, took several part time jobs at which she makes little more than min wage- she’s worried about keeping her house and her car; the credit union holds the mortgage and the car loan, as well as to other unsecured ‘signature’ loans

2. The bank says that they will agree to reaffirm the home loan, but only if tawanda also reaffirms in full all her other debts with the credit union.

ii. What should she keep?1. House

a. If she were to go along with the bank’s policy, it would be a horrible idea b/c she would need to pay for the house and all of her dischargeable debts

b. Keeping the house is a bad deal, but she could sell the house, take the equity to redeem the car and get a smaller house - THEN she can manage her debt

c. Her best bet is to NOT reaffirm – b/c selling the house and getting $ is her best bet, but by doing this, she can’t reaffirm

2. Cara. She can redeem her car as a legal matter- she could keep

the car for $5900 provided she can come up with the cash3. Are you prohibited from having a conditional reaffirmation?

a. Two problems:i. Affidavit hardship?

1. You wouldn’t sign an undue hardship affidavit, but 514(c) would put you in an adversary position w/your client b/c you aren’t going to let your client reaffirm her house

ii. Violation of automatic stay?1. The bank technically could be violating the

automatic stay but if you are trying to just re-establish a relationship, then this may not be a violation of automatic stay

e. 13.5i. Juan and Sally owe dischargeable taxes. The taxing authority sometimes

goes after debtors anyway.ii. What should you do?

1. Make sure that they are declared nondischargeable.a. 13.6

iii. Facts 1. Bank needs to know what to do when they have security interest in

automobile and debtor declares bankruptcy. 2. Banks’s agreement has a provision that says declaration of

bankruptcy is automatic default under the K; Bank brings a case to you.

3. Debtor owes $7899 on loan, secured by bank on car of $6000 (so they are undersecured); It would cost Bank $500 to repossess & sell car; If continued payments, the car would depreciate faster

than the loan would be paid off; Debtors says he wants to keep paying

iv. Question1. Bank wants to know if it can the car back? 2) If debtor keeps the

car, what portion of the amount owed will bank get paid? and 3) Overall advice about how to handle this?

v. Answer 1. Discretion

a. Generally, it’s going to depend on the bankruptcy judge because there’s no equity in the car, and will depend on if the judge finds it necessary

2. Repossessiona. if the car is repossessed – the Bank will get paid the $6000

– and they will be able to pay the $500 that they would spend dealing with the estate

3. Reputation?a. Advice about how to handle this? this brings up the

reputation issue – it may be better for the client to let the debtor pay down the loan; the client (the Bank) doesn’t want the car and won’t get anything selling it, but if the debtor continues to pay on it –then may get the $7899 of the loan – but might get the reputation on being “soft” on debtors

4. Ride througha. Most secured lendors prefer to allow the debtors to ride

through and make the payments; in most cases, the lendors are going to get more this way

f. 13.8i. Can Carlos Valdez fire his employee who just got his bankrutpcy

discharge?1. No. 525 prohibits employment decisions based “solely” on the

basis of a prior bankruptcy.ii. What is the alternative?

1. Document his performance.

Read Casebook pages 275-307. Do problems 14.1-14.4. Use 11 U.S.C. §§361,362, 506, 1322, 1325.Read Casebook pages 307-334. Do problems 15.1-15.3. Use 11 U.S.C. §§ 109(e), 1322, 1325, 1329.

Chapter 13 Bankruptcy

A. Introduction

1. Focuses on future earnings rather than accumulated assets to pay creditor (like 7)

B. Advantages of 13 1. Keep your stuff2. Strip liens to the value of the collateral3. Cure defaults (on Ks and secured loans)4. Somewhat broader discharge (like certain divorce, tort and tax claims are

dischargable in 13 but not 7)5. Unlike Chapter 7 where if debtor wants to keep his exempt assets after

discharge, he has to cut a deal w/ the secured creditor using redemption, reaffirmation. Here, he gets to keep his stuff w/o having to do redemption or reaffirmation.

6. Buy time: allows debtor to pay forecloseable debts over 3-5 yrsa. A lot happen on the eve of foreclosure. “Hurry up 13s” happen

the day before the mortgage is foreclosed. It gives more time for negotiation, even though you can’t modify your home mortgage.

C. Compare w/Chapter 7:1. Chapter 7 allows ∆ to keep post-petition wages and get discharge in return

for giving up all non-exempt assets2. Chapter 13: ∆ gets to keep non-exempt assets but has to commit

substantially all post-petition, disposable income2 to payment of creditorsa. Main advantages of Chapter 13:

i. ∆ gets to keep existing assetsii. More debts are dischargeable than in 7

b. Usually used before ∆ house is about to be foreclosed on – sometimes right after a Chapter 7 discharge, so ∆

2 Surplus, if any, after means test is run

i. Gets rid of all personal obligations andii. Can deal with the lien that remains on his house after

Chapter 7 though a court faced with this might refuse to confirm plan on grounds of bad faith

c. § 1328: Discharge granted if ∆ completes his payments under the Plan

D. BASIC Requirements for Confirmation: 1325 1. Length of plan – (3 or 5 years)2. Compliance w/ 1322(a), pay all priority claims in full3. Good faith4. Best interests of creditors are met

a. Unsecured creditors should get a value equal to or greater than the chapter 7 distribution

b. Secured creditors must get the value of their collateral5. Feasibility: can the debtor complete the plan?6. Must commit most of disposable income7. Can modify secured claims as long as not the debtor’s primary residence8. Limits on who can file for chapter 13

a. If you have too much debti. Secured debt limit: a little over a million

ii. Unsecured debt limit: a little more than 300ki. i.e. basically you can’t be too rich. And in that case,

you can file a chapter 11.OR

b. You don’t have income (doesn’t matter where that income comes from)

E. The plan of reorganization1. ∆ files plan with court setting out how future income will be used to pay

creditors 2. 1322(d) Length of plan

a. No longer than 3 years if ∆ is below median income andb. No longer than 5 years if ∆ is above median

3. 1322: Contents of plana. Full satisfaction, in deferred cash payments, of all allowed priority

claims and administrative expenses under § 507 (unless holder agrees to something else)

b. Distribution under the plan is > whatever unsecured creditors would have gotten under Chapter 7

c. Secured creditors get at least value of their collateral and balance is an unsecured claim and payments under plan must provide secured creditor with adequate protection

4. Best-interests test : If there are NO non-exempt assets, any payment to unsecured creditors will satisfy because they would have gotten nothing under Chapter 7 anyway

5. Plans must be proposed in good faith, be feasible for ∆ to comply withF. Timeline for Ch. 13:

1. File a Ch. 13 petition (§301)2. File a plan providing for the repayment of all or a portion of the claims

against the debtor out of the debtor’s future income3. Commencement of case creates an estate

a. Includes all legal or equitable interests of the debtor and property and earnings acquired after the start of the case but before the case is closed, dismissed or converted (§541)

4. § 362 automatic stay restricts the actions of creditors against the property of the estate or of the debtor

5. Court confirms a plan vests all property of the estate in the debtorG. Lien Striping (cramdown / modifying K)

a. 1325(a)(5) lets debtor strip the lien down to the value of the collateral and then basically CRAM this stripped lien down the under-secured creditor’s throat

i. basically have to pay the value of the collateral, which is determined on the petition date.

H. Over secured vs. under-secured 1. LOOK INTO THIS

I. Computing Payment to the Secured Creditor 1. Court has 2 factual determinations to make:

a. The amount of the allowed secured claim under 506(a)b. The present value of the allowed secured claim 1325(a)(5)(B)(iii)

2. Determining the Allowed Secured Claima. Debtor can lien strip

i. Interaction of 2 sections:i. 1322(b)(2) power to modify secured claims

ii. 1325(a)(5) defining allowed secured claim (adequate payment) as the present value of the value of the collateral. Determine market interest, and add it to the value = present value.

1. Determining Value: a. Rash: Value is determined by

replacement valueb. 506(a)(2) = replacement value w/o

deduction for costs of sale or marketing

i. Can let secured creditor receive more than they would have in 7

ii. Limits on Lien Stripping: i. 1322(b)(2):

1. Can’t lien strip on primary home mortgageii. 1325(a):

1. Can’t lien strip unless loan is more than 1 yr old

2. Can’t lien strip CAR loans unless more than 2.5 yrs old

3. Solution a. So you can’t strip it down! On the

other hand, it doesn’t say you can’t change the interest rate.

b. modification allows modifying the principal amount (reducing it to the amount of the value of collateral), the interest rate, and the payment plan. So this is very broad powers.

3. Cramdown a. Debtor can promise to pay the allowed secured claim in full, and

treat the deficiency like any other unsecured debt 506(a)i. This is one of 2 methods of lien stripping in which a debtor

can reduce an undersecured claim to the value of the collateral (the other is redemption, 722)

i. Cramdown can be paid over time; redemption is a lump sum payment

ii. Redemption discharges personal liability; cramdown there is no discharge until plan is completed

1. If the debtor fails to complete the plan, the secured creditor can once again enforce its security interest 1325(a)(5)(B)(i)

b. Determining Interest Ratei. Till : SC said: prime rate + 1-3% for risk of dealing w/ 13

debtori. Prime rate: rate commercial banks charge their best

customers on unsecured debt1. Weird: prime is usually higher than secured

loan interest

a. Screws debtor! Paying more than market interest

J. Lifting the automatic stay 1. Secured creditor can’t repossess unless the stay is lifted … OR:

a. 362(d)(1) interest is not adequately protected; orb. 362(d)(2) debtor has no equity and it is not necessary for an

effective reorganization2. Concerns:

a. Adequate protection i. Regarding secured creditors only

i. b/c they must be protected against the declining value of collateral during the automatic stay

1. secured creditors are entitled to what they would have gotten had they foreclosed on the day of filing for bankruptcy.

ii. Devaluation

i. Solution: debtor must pay the difference of any decrease in value.

iii. Remote chances of rehabilitation i. Solution: Interest rate calculated according to Till

decision – usually 1-3% over prime. “If the court determines that the likelihood of default is so high as to necessitate an ‘eye-popping’ interest rate, the plan should probably not be confirmed.”

3. Items for which the automatic stay can be lifted i. (A) ∆ has no equity in such property

ii. (B) such property is not necessary to an effective reorganization

K. Adequate protection under the statute

1. § 361. Adequate protection

2. When adequate protection is required under section 362, 363, or 364 of this title of an interest of an entity in property, such adequate protection may be provided by –

a. (1) requiring the trustee to make a cash payment or periodic cash payments to such entity, to the extent that the stay under section 362 of this title, use, sale, or lease under section 363 of this title, or any grant of a lien under section 364 of this title results in a decrease in the value of such entity's interest in such property;

b. (2) providing to such entity an additional or replacement lien to the extent that such stay, use, sale, lease, or grant results in a decrease in the value of such entity's interest in such property;

c. Or

d. (3) granting such other relief, other than entitling such entity to compensation allowable under section 503(b)(1) of this title as an administrative expense, as will result in the realization by such entity of the indubitable

A.

B. Adequate payment

3. Secured creditor must receive a distribution > present value of his ASC3 [TIB wants as much from ∆ for each asset as he could get if TIB sold it].

i. This basically means that you get interest. The interest you are getting is not interest on the prepetition claim, but interest on the distribution of the allowed claim.

4. What is the value of your collateral?a. § 506(a)(2): Valuation done according to replacement value w/o

deduction for costs of sale and marketing [codifies SC decision in Rash]

C. Mortgages

5. Home mortgage is exempt from cramdown, so only relief is to “cure and maintain” This means there is no lien stripping and no modification of contracts.

a. Look for evidence that it is not principal residence if you want to modify K

6. Note – these restricting rules don’t prevent you from de-acceleration.D. De-acceleration (even on primary residence)

7. In re Taddeo (landlord accelerates mortgage and ∆s file b/c of inability to pay it off)

a. Ch. 13’s allowance for ∆s to cure defaults includes de-acceleration of mortgages and reinstate original payment schedule

b. Policy

i. “Default is an event in the debtor-creditor relationship which triggers certain consequences…Curing a default commonly means taking care of the triggering event and returning to pre-default conditions. The consequences are thus nullified”

E. Secured claims in Chapter 13

8. Creditors w/ claims that would receive a priority in 507(a) are entitled to payment in full in 13. 1322(a)(2)

9. If debtor can’t pay, plan can’t be confirmed. Solutions: Sell collateral or File 7.

F. Tax Claims 10. In 7, nondischargeable, so little relief in 711. Advantages in Chapter 13

a. Debtor can pay taxes over timei. Auto stay holds off IRS until discharge (completion of plan)

3 Value of the property

12. Denial of post-petition interest on unsecured claims locks tax claim at its value of the date of bankr filing 502(b)(2)

II. Problems

III. 14.1

A. Fran Belinsky is a graphic artist with an income in excess of $52,000 per year. Last year she guaranteed a large business loan for her brother. Her brother skipped town, and now Fran is left to pay the loan. She has declared a Chapter 13 and plans to make a substantial repayment. Fran’s only asset of significant value is a six month old Apple Computer that is subject to a valid $4,600 purchase money security interest from Comp-U- Stor. Comp-U-Stor wants the computer back so that it can resell the computer (its present value is about $5,000) before Apple announces an even smaller, cheaper model. Comp-U-Stor asks for your help in getting it back.

B. What can you do?

C. Computer side:1. IC will want to argue under 362(d)(1) that there is NOT ADEQUATE

PROTECTION, and that the STAY SHOULD BE LIFTED FOR CAUSE. Computers drop quickly in value—esp if a new versions will be released.

D. Fran side:1. Fran will argue that the computer IS NECESSARY TO EFFECTIVE

REORGANIZATION, and that they only way to pay her Creditors is to use the computer to work. Also, THERE IS EQUITY CUSHION here of $400 {but this may be depleted if a new version comes out soon}

E. Likely outcome:1. Likely not able to lift stay: Debtor HAS equity AND it is NECESSARY

for reorg.F. If there’s equity then 362(d)(2) is not available. Under (d)(1) you could argue that

there is no adequate protection? You could argue that there is a lack of adequate protection because of how quickly the collateral is going to depreciate and if they default there will be nothing to reclaim. Look at section 361 to see what qualifies as adequate protection.

IV. 14.2A. George Grey has suffered a series of financial reversals. He was laid off from his

job as a steel worker for 17 months. He has incurred medical bills for over $90,000 for his younger daughter, and his son just wrecked the car. But things may be looking up for George now. He has been rehired and he is working nearly 20 hours per week overtime. Recognizing that he needs some protection from his creditors, he is prepared to file a Chapter 13. His chief concern at this point is his hunting cabin. Before he was laid off, he had bought the land from LeisureLand, Inc. for no money down and a $40,000 five year note. During the time he was unemployed, he went out to the site almost every day. He cleared the land and built a one room cabin with the materials he found on hand. The place has no plumbing or electricity, but George loves it and now he is afraid he will lose it.

B. Equity cushion1. Note - NO EQUITY CUSHION b/c he owes far more than the land is

worth.C. What any plan must provide

1. Any PLAN must provide at least the PRESENT VALUE OF ALLOWED SECURED CLAIM—which is $41k here.

2. See discussion of TILL case above re: Modifying terms of K w/ interest rates: Bankruptcy judge will have some discretion—likely prime + some risk premium.

D. What happens to the funds over 41k?1. For the funds over the $41k, this will be a pro rata distrib / under UNSEC

PAYOUT.E. Can the debtor keep the land and modify the contract with the secured creditor?

1. In re Taddeo2. Also, look at Section 1322(b):

a. (b) Subject to subsections (a) and (c) of this section, the plan may - . .

i. (2) modify the rights of holders of secured claims, other than a claim secured only by a security interest in real property that is the debtor's principal residence, or of holders of unsecured claims, or leave unaffected the rights of holders of any class of claims;

3. Since this is not a primary residency it can be modified. F. How much can it be modified?

1. 1325(a)(5) with respect to each allowed secured claim provided for by the plan—

a. < (B). . . – (ii) the value, as of the effective date of the plan, of property to be distributed under the plan on account of such claim is not less than the allowed amount of such claim;

G. Other exceptions1. You need to make sure that it was not bought with in a year and other

exceptions that you can see above.

I.A. 14.3

1. Facts: a. Jewel’s outstanding loan balance on the car is $30K. Between

filing of Ch. 13 and confirmation of payment plan, another $250 interest will accumulate. There’s a 10% market interest rate for fully secured car loans.

b. Retail value of car is $32,100; wholesale is $28,400; liquidation sale value is $26,300; private want ad value is $33,300

2. How much does Jewel pay for her car in Ch. 13a. Based on 506a2, which says replacement value, creditor uses retail

value as the standard

b. Therefore, creditor is oversecured and adequately protected the allowed secured claim is $30K + $250 = $30,250

i. 1325a says that secured creditor must be paid its allowed secured claim in full and it must be paid interest on that claim

c. What if the debt plus interest was 32,250?i. ASC would be 32,100

d. What about the remaining $150 in interest?i. – This was unmatured at the time of the filing, so it is not

allowable as an unsecured claim under §502(b)(2).ii. Note, that this means that an undersecured SP gets no

interest on its claim until payments under the plan commence.

iii. Allowed secured claim would still be full 32,250, because the loan is for a car, and is less than 1 year old. 1325(a)(9)

1. NOTE: choosing the correct value will determine whether it is over-secured or under secured.  Rash says use replacement value, i.e., FMV.  How much would you have to pay for it if you went out to buy it? p. 333, ftnt 6 “we leave it to the courts as triers of fact to ascertain what the replacement value is.”  Replacement value doesn’t necessarily mean retail value.

2. Open question to answer later:1. If the paint is chipped, who will want to point that out?

B. 14.41. Facts

a. Eric bought his truck for $42K. It’s now worth 28K and will depreciate 20% next year. The prime rate is 7.5% & car loans are still at 8%

2. What must he pay on his car loan? a. What is allowed secured claim? 42,000 or 28,000

3. Can he lien strip?a. That depends on when he bought the car. Last year?

i. Look at 1325a--§ 506 shall not apply if the creditor has a purchase money security interest… he cannot lien strip a car loan that is less than 2.5 years old and it’s the original loan. For a new car loan, the allowed amount is going to be the amount of the debt, which means the debt is not stripped.

4. -Then you have to calculate interest rate to determine present value of his full payment You use the formulation in Till case—you calculate the interest rate through a formula—you take the prime rate and you add 1-3% to compensate for the additional risk being that it’s a Ch. 13 debtor

5. How can he provide adequate protection?a. Need to distinguish the “allowed amount” from the “value of the

ASC.”

b. The “value” is what’s entitled to adequate protection. So, assuming no interest repayments, you need to cover the depreciation.

I. 14.5A. Facts

1. Donnie took out a 30-year home mortgage 7 years ago -the home is now valued at $155K; the outstanding mortgage is $182K -Donnie is req’d to make monthly payments of $250 -after 7 years of regular mortgage payments, Donnie missed 6 payments in a row ($1500)

B. Donnie files Ch. 13 and what must his plan provide?1. 1322b2 excepts home mortgages from the cramdown rule; Does this

mean that he loses his house? No! The plan may provide for curing of that default by paying the present value of the 1,500 plus any additional penalties and interest due under the contract as part of a section 506(b) allowed secured claim.

2. Donnie must “cure and maintain”—he must catch up on past-due payments while making current payments on mortgages as they come due

C. What is the policy for distinguishing home mortgage1. Encourage mortgage lending?2. Lower interest rates?3. Some history: Prior to the Supreme Court’s decision in Nobelman, some

courts used Section 506 to strip liens, notwithstanding 1322(b)(2). The Supreme Court put an end to this using, this time, a plain language reading of the statute. Statutory response to subprime crisis. Allow modification of home mortgages.

II. 14.6A. Facts

1. Joe and Ethyl Gertz have come to see you for help. They fell behind in the payments on their home after Joe was laid off. They received a notice of acceleration and foreclosure from the savings and loan, but they have lost the notice itself, and the man at the savings and loan hasn’t returned their calls.

2. Ethyl remembers that today’s date was in the notice, but doesn’t remember what it said would happen today.

B. What do you advise? What should you do?1. Run to the court house and file a chapter 13. Do this while running

Automatic Stay!C. Do you have to do anything first?

1. 109(h)(1) Subject to paragraphs (2) and (3), and notwithstanding any other provision of this section, an individual may not be a debtor under this title unless such individual has, during the 180-day period preceding the date of filing of the petition by such individual, received from an approved nonprofit budget and credit counseling agency described in section 111(a) an individual or group briefing (including a briefing conducted by

telephone or on the Internet) that outlined the opportunities for available credit counseling and assisted such individual in performing a related budget analysis.

2. 521(b) In addition to the requirements under subsection (a), a debtor who is an individual shall file with the court—

a. (1) a certificate from the approved nonprofit budget and credit counseling agency that provided the debtor services under section 109(h) describing the services provided to the debtor; and

b. (2) a copy of the debt repayment plan, if any, developed under section 109(h) through the approved nonprofit budget and credit counseling agency referred to in paragraph (1).

III. 14.7IV. Facts

A. The Poltzes are in a world of hurt. He has a 2900/ month pension. They have personal property of 4000 (exempt), and their equity in their house is exempt. They are three months behind on their mortgage (because of a computer error with his pension), and have 11K in unsecured debt. Their income after mortgage and expenses leaves over $150. They could use this to catch up on the mortgage arrearage. The bank is willing to work things out. What should they do?

B. Are they above the median income?1. No.

a. How much will they have to pay into a Chapter 13 plan?i. 150

ii. For five years.b. How much will they have to pay to cure their arrearage on the

mortgage??i. Not nearly that much.

2. What should they do?a. File a 7, wipe out the credit card debt, pay off the mortgage.

Consequences of Chapter 13 (secured claim)

Ability of debtor to “use” collateral (363) Secured creditors can’t repossess unless the stay is lifted(362).

Lift Stay– Lack of equity (and not essential to a reorganization that is reasonably in prospect) (362(d)(2))– Lack of adequate protection (362(d)(1), 361) P Ability of debtor to strip a secured creditors’ lien down to its value

Comes from the interaction of two sections:– 1322(b) – power to modify– 1325(a)(5) (allowed secured claim (506(a)).

Unless it’s a loan secured by the debtor’s principalresidence.

I. Payments to Unsecured Creditors

A. Pooled together for pro rata payment after secured and priority debts are paidB. Best enhance their position by arguing that debtor should be required to make

larger plan payments1. Can make the argument under 3 provisions in 1325

a. Best Interests 1325(a)(4)i. Requires all creditors receive at least the amount they would

have in chapter 7. Add market interest to hypothetical 7 payout.

b. Disposable Income 1325(b)i. Debtor must devote all disposable income to plan payments

during the life of the plani. Disposable income : income received by the debtor

that is not reasonably necessary for the support of debtor or his dependents. 1325(b)(1)(B)

c. Good faith 1325(a)(3), (7)i. Plan must be presented in good faith

ii. Pre 2005, no distribution to unsecured creditors was NOT good faith

iii. 2005: 1322(a)(4) permits a plan to be confirmed w/o paying all 507(a)(1)(B) priority debts (domestic support obligations owed directly to gov’t), but only if all disposable income has been dedicated to the task

i. If all disposable income dedicated to paying priorities, then nothing left for unsecured creditors. Implies a 0 payment plan is acceptable

C. DISPOSABLE INCOME TEST 1. Screening Test: Is the income below state median?2. Below Median Debtors (eligible for 7, but opted for 13)

a. (Discretionary standard)b. Must pay all disposable income for 3 years

i. Determining Income: i. As defined in 101(10A)

1. Total income for 6 months divided by 62. all income

ii. 1325(b)(2): Does NOT include:1. Child support payments2. Foster care payments3. Disability payments for a dependent child

iii. Includes spouse’s income 1. In re Carter

ii. Determining Expenses i. All reasonably necessary expenses +

ii. 1325(b)(2) Post-petition expenses for:1. Domestic support

2. Charitable contributions3. Running a business

iii. Court has power to modify and limit expenses1. In the matter of Wyant

iii. Determine Disposable Income i. Subtract Expenses from Income, multiply by 36

3. Above Median Debtors a. (Means test)b. Required to propose a 5 yr plan. 1325(b)(4)

i. Determining Income: i. As defined in 101(10A)

1. Total income for 6 months divided by 62. income from all sources

ii. 1325(b)(2): Does NOT include:1. Child support payments2. Foster care payments3. Disability payments for a dependent child

iii. Includes spouses income 1. In re Carter

ii. Determining Expenses i. 1325(b)(2) Post-petition expenses for:

1. Domestic support2. Charitable contributions3. Running a business

ii. Use the IRS Tables, plus 707(b)(2)1. (A)(ii)(I): Reasonable health/disability

insurance 2. (A)(ii)(I): Up to 5% increase in food and

clothing allowance if reasonable and necessary

3. (A)(ii)(II): Support costs for elderly, ill, or disabled household member if:

a. they are a continuation of payments made before filing,

b. reasonable and necessaryc. dependent is not able to pay the

expenses himself4. (A)(ii)(III): costs of filing the chapter 13, up

to 10% of planned payments5. (A)(ii)(IV): Additional educational expenses

up to 1500 p/child p/year6. (A)(ii)(V): Housing and utility allowance

above standards if it is his actual costs and he can demonstrate why it is necessary and reasonable

7. (A)(iii)(I): Average monthly payments on secured debts

8. (A)(iii)(II): Any additional payments necessary to maintain the Car loans and Mortgages (along w/ payment arrearages; allows them to be double counted against expenses!)

9. (A)(iv): Total amount of priority debts divided by 60

iii. Determining Disposable Income i. Subtract Expenses from Income, multiply by 60

II. 15.1A. Problem 15.1:

1. You are filing your first Chapter 13 plan since entering practice. In your jurisdiction, judges are randomly assigned as cases are filed. The three bankruptcy judges seem to have rather different views about the requirements for confirmation of a Chapter 13 plan—two are very strict and one is quite lenient. All three permit the debtor to amend if a plan is not confirmed. Your first client, Maria Jackson, is a single parent who supports herself and three children on the salary she earns as a department store clerk in Atlanta. Ms. Jackson earns $23,000 a year. She is left with $60 per week after she has paid her rent, utilities, insurance, food, gas, and $10 each Sunday to her church. This amount would give her creditors about 50 percent of their outstanding debt over three years or 80 percent over five, but it would not leave any cushion. Giving $60 to the trustee would also require termination of the piano lessons one child has already begun and prevent another child from starting needed orthodontic treatment

B. Answer 15.1: 1. First off, she is CLEARLY BELOW-MEDIAN INCOME b/c she makes

$23k; thus, we know NOT TO GO TO § 1325(b)(3); so, the IRS guidelines do not apply b.c she is below-median; STAY IN § 1325(b)(2)

2. What expenses should Ms. Jackson be able to deduct in her calculation?a. Piano lessons = not reasonable (but could argue req’d for

MAINTENANCE of family expenses)b. Orthodontics may be necessary (unless just cosmetic)

3. What if Creditors Challenge?a. USE THE CRAM DOWN: You can get plan confirmed over the

expenses so long as the plan (1) gives Unsecured Creditors as much as they would get in ch 7 AND (2) ALL disposable income is going to the plan [which is likely 0 after including orthodontics expenses]

4. How does the Bankruptcy Code’s good faith requirement (§ 1325(a)(3)) play into your considerations?

a. You can offer a plan IN GOOD FAITH that allows her to keep some extra money for food / clothes / long-term expenses / savings—she needs this, especially w/ kids—even though NO MONEY IS GOING TO UNSEC C’ORS.

b. Use the IRS guidelines—even though they don’t apply since she’s below-median—to make this argument.

5. What type of plan do you suggest?a. Ch 7 = has a certain date…and you get your future incomeb. Ch 13 = live under plan for 3-5 yrs; and if she devotes 60/wk to

the plan, she will have no money for clothes / food / savings / etc.

III. Problem 15.2(A): A. You represent Todd Cooper, a fast-food store manager in Orlando. With

incentive bonuses and income from his accumulated stock, Todd’s total income is slightly over $150,000. Todd lives as if it were even higher. He has a home with a mortgage larger than the annual income of some Third World nations, three cars on which he owes more than most people owe on their homes, two children in private school, and so on. In short, after he pays all these fixed expenses, plus a reasonable amount for food and clothing, he has about $30 per week for his unsecured creditors in his Chapter 13 plan. He owes these creditors almost $95,000. His total three-year payout at $30 per week will be $4,680, about 3 percent of his debt. Because most of his assets are subject to heavy liens and his state has generous exemptions, the unsecured creditors would get nothing in Chapter 7.

B. Can you get Todd’s plan confirmed? What are the weaknesses in your case?C. Answer

1. He has more money than the woman in 15.1—showing how ridiculous this situation is!

2. Best Interest Test does not help the creditors —they get nothing under ch 7 (he has no non-exempt assets)

3. Is all of his disposable income committed to payments under the plan?a. 1325(b)(3)

i. Maybeii. How much is the private school tuition?

i. If less than $1500, then is a zero payment plan okay1. Hmm. May have to go back to the discretion

approach used for below median debtors.ii. If more, then must be included in disposable

income. Then must pay the amount produced by the means test.

b. Yes.4. He will have to do a 5 year plan5. Weaknesses:

a. BAD FAITH: this looks like abuse

i. Point: the means test allows you to manipulate. But, there is a limit – bad faith. so the question is whether good limit imposes something on top of the means test:

B. Problem 15.2(B) 1. In an alternative universe, you represent two of Todd’s creditors, Perfection Motors,

the Mercedes dealer who holds a $35,000 pmsi on one of his cars, and Divine Cuisine, his caterer, who is owed $15,600 for a series of business receptions Todd gave for bosses and coworkers in the fast-food chain. What position will you take regarding Todd’s plan?

2. On behalf of the Mercedes dealership?a. The plan is fine with you. You want Todd to keep the car and keep paying,

especially because you are undersecured.1. On behalf of the caterer?

a. You want to object. You want Todd to sell the Mercedes to free up income to pay other creditors (including the Mercedes dealer).

1. Can you represent both?i. CANNOT REPRESENT A SEC Creditor AND UNSEC Creditor AT SAME

TIME: conflicting goals / interests.ii. There is a pseudo alliance b/w Debtor and Sec Creditor to allow the Debtor to

keep as much prop as possible out of bankruptcy —at expense of Unsecured Creditor

2. If he’d filed when his dad was sick could he have included dad’s medical expenses in his budget?a. Yes.

i. Can he do it now that it’s debt, and his Dad is dead? No.

3. How much must he pay?a. Whatever surplus is produced by the means test (1325(b)(3)).b. How long must he pay for (1322(d),1325(b)(4))?

i. If you’re below the median, the commitment period is generally 3 years.ii. If you’re above the median, the commitment period is – 5 years.

4. Can He file in 7?a. It depends on his expenses.b. 25% of his debt is > 6000>10,000c. So he’s eligible if his surplus is less than $10,000.

II. 15.3A. Christoph has listed all of his assets. You determine that he would turn over $9000 to the

trustee in a Chapter 7. You advise Christoph to propose a 5 year plan to pay $150 per month, which is the amount required by the means test.

B. Do his creditors have any objections?1. The question you need to ask is “does this plan satisfy the best interest test”?

a. How much would he give to the trustee in a Chapter 7?i. $9000

b. How much would he turn over to the trustee paying $150/month for 60 months?i. $9000

c. Is 1325(a)(4) satisfied?

i. What about the time value of money? The payments need to have a present value (as of the confirmation date) of

$9000ii. He has to pay interest on the distribution as well.iii. In a chapter 13, the debtor has to buy back the equity in his non-exempt assets

Doesn’t this mean that the creditor is getting post-petition interest? No. The debtor is getting interest on the distribution not interest on his

prepetition claim.iv. What if you applied the means test and found that he had no disposable

income? What would he have to pay? $0 (Kagenveama – ok) Good faith? (Farrar-Johnson – ok)

Looks okay in both instances because he complied with the “means test/projected dpi test”

Best interests? Does he have non-exempt assets that would be distributed?

III. 15.4A. Facts

1. Rebecca Nordhaus is a registered nurse who is rearing a small son while she works in a metropolitan trauma center. She was already carrying too much consumer debt when a serious car accident left her with more than $60,000 in bills that were not covered by insurance. Last year her base take home salary was $33,000/yr, which would yield about 400/month in disposable income.

2. However, her take home pay, with overtime, was $45,152. She says the overtime is exhausting her and she wants to spend more time with her son.

B. What do you list for her disposable income?1. In re Killough, 900 F.2d 61 (5th Cir.1990)2. Debtor who has worked overtime does not have to pay the extra money into her plan.3. Does this mean you should just disclose the base salary?4. NO!!!

a. Need to disclose the income.b. Propose the plan based on the base salary, but be up front about what you’re

doing!!IV. 15.5

A. Facts1. Finally, he looks at the expense list and says “I want to make contributions to my

church.” You ask the amount. He says $425/month. You ask if he’s made regular contributions in the past. He says “no, but I’m turning over a new leaf.” Can he confirm a no payout plan?

2. If a creditor objects, is tithing “reasonably necessary to support the debtor?”a. After the Tithing Protection Act of 1998 it is.

i. See 1325(b)(2)(A). (P. 2007).b. Here, $34,000*.15/12=$425

V. 15.6A. Facts

1. Last year you represented Doris Frankel in her Chapter 13 bankruptcy. When you met Doris she was recently widowed, and had never worked outside the home. Her husband had left her with huge medical bills and business debts for which she was jointly liable. She sold the business and used the proceeds, along with his life insurance to pay these debts, but when these assets were exhausted, she still owed $120,000.

2. Her creditors included some hostile and aggressive former business partners of her deceased husband. Doris took a job as a clerk at the local dime store, and asked you for help in keeping her creditors from taking everything.

3. You took her into Chapter 13, and she insisted on a 25% plan. At the time you thought this was risky, because it would stretch her to the limit, but she insisted that she wanted to try to do what she could.

4. Today, Doris is back in your office. While working at the dime store, she completed a real estate class, passed her broker’s exam and quit her other jobs. She’s been selling commercial real estate for four months. Last night she got a call from a well known developer. He has put her in charge of the completion and leasing of his latest office building. It’s a big job. Doris estimates that she will be working $60/hours a week, but that if she can pull it off, the bonuses for 95% leasing in the first year could be as much as $50,000.

B. Do you have any free advice?C. Does she pass the disposable income test now?

1. NoD. If she says nothing and nobody ever finds out, what happens?

1. The creditor gets 25% and she gets to keep the restE. What if she bumps into the cranky ex-partner and he finds out about. What can he do?

1. He can make a motion to modify the plan to increase payments. F. Does he care if the hospital gets repaid?

1. No!G. How might doris respond?

1. Offer to make additional payments to him alone.2. Will this work if she moves to modify the plan?

a. No. She’ll have to give notice to everyone else.3. Can they do it on the QT?

a. Sounds a lot like blackmail to me.4. What else does it sound like?

a. A violation of the automatic stay?5. Is it a violation of the automatic stay to move to modify the plan?6. Does this create a problem for confirmation?

§1322(a) provides:< (a) The plan shall -– (1) provide for the submission of all or such portion offuture earnings or other future income of the debtor tothe supervision and control of the trustee as isnecessary for the execution of the plan;– (2) provide for the full payment, in deferred cashpayments, of all claims entitled to priority undersection 507 of this title, unless the holder of aparticular claim agrees to a different treatment of suchclaim; and– (3) if the plan classifies claims, provide the same

1. treatment for each claim within a particular class.

Chapter 13 analysis is broken down into several parts:The first thing you must do is the best interest test. You have to ask what will the unsecured creditor get in the chapter 7 case? Whatever they get there has to be at least what they will get in chapter 13 at the date of petition. The second test is that if a creditor objects, you have to satisfy the disposable income test. To do this, you have to decide which version of the disposable income test applies. If your debtor is below median, then the test is a discretionary test made by the judge. If the debtor is above the median, then you need to do the 707 test. Commitment period – below avg -3 years. Above avg – 5 years.

The two recent supreme court cases that he put up on the web – need to know the holdings – lanning case – recognizes that the disposable income test can be and should be forward looking. So projected income should be forward income. And the ramson case – the view that allows you to deduct expenses that you don’t really have is kind of rejected: you cant take an ownership expense deduction unless you have some ownership. They base this decision on the wording, which says that you should take this expense “where applicable.” You can take this expense, no matter how small it is.

Problem 15.3—calculation using disposable income test: Christopher got his engineering degree and does well- he earns 60k a year- lives in a nice apt

in chicago with gf, who works as a physical therapist and shares the rent and other household expenses- when he first got out of college, he created a 40k debt on credit cards- he has settled down and has steadily been saving money and paying debt- unfortunately, his dad got sick and even w/medicare, he had to pay extra 60k in medical debt in addition to the credit cards- he wants to know his options are

The first question we need to ask is what is the surplus income (we don’t care about the debts right now, we care about what he has to pay – which is determined by (1) what he has and (2) what he is earning, which determines what his disposable income is)

Ask if he is above or below median income -

His income in 60k and Chicago’s median income is 60k so he is above the median. We want to get him below the median. One way to do that is to raise the median income and we can do that by expanding the household to 2 (he lives with his girlfriend). To do this, we need to know how much she makes to add that to the income test.

(his household size is 2 b/c household doesn’t require marriage (household means living under same roof)

questions: 1. does she count in his household and 2. does he have to include her income?

Income for means test turns on spouse’s income, not other members of the household- so chris could argue that she is a member of the household BUT OT a contributing spouse therefore, chris can say ‘I am a 2 person household with 1 income’

If he filed when his dad was sick, could he file the medical costs as part of the expenses? Yes – whether or not he is above or below the median. Can he bring those expenses in now?

Dad’s medical debts

If Chris had filed when his dad was sick, he could have included his dad’s medical expenses in his budget under the means test and qualified for ch 7

But since his dad is dead now, these are considered as unpaid debts, then it doesn’t matter- so he has to pay whatever surplus is given by the means test- and pay this for 5 years since above median

POINT- 707(B)(2) the means test used for 2 diff purposes in ch 13 and ch 7-

Remember the means test- you get to deduct the IRS allowed expenses and whatever else the means test allows you to deduct from your expense

Ch 13- used to calculate the disposable income for those who are above the median- if you are in ch 13, whatever surplus the means test produces is the amount you MUST pay in a chapter 13 plan if you are ABOVE the median

How much does he have to pay? Whatever surplus is produced by the means test (1325(b)(3))

How long must he pay? (1322(d), 1325(b)(4)

Note: if you are below the median, then you look at 1325(b)(2) which is the old test which is current monthly income less amounts reasonable necessary to be expended to determine the disposable income- all up to judge’s discretion

Doesn’t really matter here b/c even with just chris’s income, he is still above the median

How will you calculate his expenses? He is above the MEDIAN income and therefore, you look at 1325(a)(3) which sends you to 707(b) (the means test!)

Can he file under 7? The means test is going to knock him down, unless he is able to get in through his expenses.

Ch 7- 707(b)(2)(a)(i)- the means test has a double tier- you are presumptively eligible for ch 7 if your surplus times 60 would either be 1. 25% of debt>6k (i.e. debt of at least 24k debt) OR 2. if your surplus less than 10k if your debt is more than 100k

Point: in addition to satisfying the means test, you have to buy back the stuff you want. So you basically are saying to the creditors and you must pay interest on top of theat.

Week 8 Business Bankruptcy: The Automatic Stay and GovernanceRead 361-368, 387-427. Do Problems 19.1-19.3. 11 U.S.C. § 362Read 430-450. Do Problems 20.1-20.3

(1) 7 vs. 11a. Both are businesses and individuals. b. Very similar to the difference between 7 and 13.c. In chapter 7, corporations don’t get a discharge b/c it doesn’t need one. The

corporation just disappears. d. Re-organize or liquidate? Creditor wants as much money as possible. So it would

want an 11 when would it would make it more money. Best interest calculation of chapter 13.

(2) Lifting the stay a. A debtor can’t lift the automatic stay b/c it will often harm other creditors. But

there may be some ability to lift the stay so long as it benefits all of the creditorsb. Reasons for lifting the stay:

i. Lack of adequate protection1. Non-exclusive methods of providing adequate protection to an

entity with an interest in the property of the debtor:a. Periodic paymentsb. Additional or replacement lienc. Other means

ii. Debtor does not have equity in the property and it is not necessary to an effective organization.

1. Timbers dicta – “necessary to an effective reorganization” requires more than a showing that w/o the property, reorg would be inconceivable. It means, instead, that the property is necessary to an effective reorg that is in prospect.

c. Timing i. 362(e) requires that the automatic stay be lifted within 30 days of filing a

request unless the court affirmatively continues the stay.(3) Chapter 7 Liquidation

a. Last Choice!i. Chapter 7 for a business is the last choice.  Usually, they start with a Ch.

11 reorganization.  Ch. 7 for business would be death for that business.  ii. Basically, Ch. 7 says, here is our assets, come and get them.

(4) 11 v. 13 & 7a. In individual bankruptcy it is to give the honest but unfortunate debtor a fresh

start. b. We don’t have that moral undertone in 11 b/c these are businesses and people. c. Don’t have to give businesses a fresh start b/c they don’t need a fresh start, they

can just go away. Chapter 11 is therefore a plan for a fair distribution of assets to the creditors.

i. Interest is for the creditors1. Chapter 11 says we will allow the company to remain if that will

help the company pay off its debts. Whose interests are we serving here? For one, it may be increasing the pie for the creditors. Additionally, you are helping the employees. There may be other externalities which benefit by the company continuing with its business.

(5) Who gets whata. Outside of bankruptcy, the first group of people to get assets would be the secured

creditors, then unsecured, and then stock holders. In bankruptcy, you will assume that stock holders will not get anything, secured creditors will get their collateral and unsecured creditors will get cents on the dollar.

(6) Who runs the bankruptcy? a. Only appoint a trustee under specific conditions – when it is in the best interest

for the creditors. b. Under chapter 11, the debtor is often given the power of the trustee so that he may

continue running the business. c. Limit on Cash

i. Trustee doesn’t have the power to use cash collateral unless the court authorizes it to do so. The court must approve proper use of the businesses money and to the extent that a creditor has collateral on the cash, the creditor must be given sufficient protection.

Reorganization—Chapter 11.  (1) Who decides?

a. board of directors decides to file.  If closely held then probably the shareholders.  (2) Who is in control?

a. Chapter 7, the game is over, its means death, the TIB takes control.  But Chapter 11, who has control? The Debtor in possession, DIP. 

b. DIP has the rights and duties of the trustee in bankruptcy .  In a chapter 11, whoever is in control doesn’t lose that control as he would in chapter 7.  Unlike chapter 7 liquidation , the goal in Chapter 11 is reorganization. 

i. You renegotiate and come up with a plan.  So there is the opportunity for continuing in the business.  If you have the choice you would always file a

chapter 11.  One of the problems, though, is that companies file bankruptcy too late when there’s no hope of reorganization. So there are incentives in the Code to encourage someone to file a chapter 11, and not ch 7.

(3) What are the legitimate purposes of chapter 11?a. Good faith standard

i. Chapter 11 requires you to file in good faith. That means you must have a legitimate purpose in filing chapter 11.

(4) What does the automatic stay cover?a. It does not stay government prosecutions or criminal lawsuits. But, the court will

have to decide if the prosecution is really in fact a different form of debt collecting. If that is the case then I believe there is a stay. (2) the debtor in Seitles tried to get the action against the company president stayed as well. The president is just an employee of a company, not the company. But, it was stayed against the president as well b/c the president needed to be able to focus on succeeding in reorganizing the company. So there is a stay. Notice, the stay comes from a different section this time – section 105. This is an exercise by the court of a general equity power. The standard is “irreparable harm to effective reorganization” and “likely success of reorganization” to enable the stay to take place here.

(5) Timinga. “ Effective” reorganization means feasible within a reasonable amount of time.

i. Thus, the debtor must show that not only is an effective reorganization possible, but possible within a reasonable amount of time. 

ii. If it’s been 6 months then the court will say that you haven’t met your burden of showing that there is a reasonable chance you are going to be able to reorganize.

(6) Interesta. General Rule:

i. Interest stops on petition dateb. Exception:

i. You can get post-petition interest if there’s a cushion, i.e., if its over-secured. From the date of the plan “plan date” the debtor has to pay the present value of the secured claim over the period of the plan, i.e., the fair market value. So the creditor will be entitled to a market rate of interest on a the secured claim.

c. No pendency interest: i. Pendency Interest: Post-petition but pre-confirmation.

ii. So the debtor is not rushing to propose the plan, because he gets an interest free loan. He has an incentive to drag it out.

iii. Creditors : 

1. Creditors don’t like it that debtor can use their collateral without paying any interest on it.  So they ask for relief from the stay under 362(d)(1) and say that you’re not adequately protecting our interest, this include devaluation and inflation.

2. Supreme court says that 506(b) prohibits this claim [loss of pendency interest is not a valid claim of “lack of adequate protection] .  

iv. Strategy of debtors and Conflict of the Creditor1. Debtor will argue that the value of the collateral is lower, so the

creditors can’t get pendency interest.  But if the creditors argue that the collateral is worth more, then they won’t be entitled to relief from the automatic stay because they have adequate protection.

(7) Problems, p.  427a. 19.1b. Facts

i. Phoenix has a perfected security interest in Bike to secure a loan at prime plus 6% with a current balance of 180K. Bike is in chapter 11.

ii. Phoenix equipment: one year old specialized equipment. Purchased last year for 200k. Bike took a 20% depreciation deduction for tax purposes last year. Wholesale value of similar, new tools: 140K. Retail value: 220K. Bike thinks he can sell the equipment for 160K.

c. Assume, for the moment that your client does not think that the debtor’s reorganization is likely to succeed.

i. What does the creditor want?1. The collateral sold, ASAP, and the proceeds turned over.

ii. What does the debtor want?1. To keep the tools, and keep using them, in order to reorganize the

business.iii. How, as a procedural matter, would the creditor seek to have the collateral

sold immediately?1. Move to lift the stay pursuant to §362(d) (look above for the two

ways to get it)a. Let’s start with 362(d)(2)

i. Does the debtor have “equity” in the property?ii. If the value is $160,000, and the debt is $180,000

1. Equity=FMV-Debt2. 180,000-160,000= - 20,000 (so No!)

iii. Is the property necessary to an effective reorganization?

1. What business are we in?a. – A bike shop

2. What do you need to reorganize a bike shop?

a. – Bike tools!!!iv. Oh well!

2. Is that the end of the inquiry?3. What if you developed evidence that the owner was unreliable, and

that he didn’t know how to fix bikes?a. Bring in “lack of adequate protection” argument

d. What if you think that the reorganization is going to succeed? i. What do you want to do?

1. Get a $180,000 valuation plus adequate protection.ii. How do you do this?

1. – Move to lift the stay, then bargain for adequate protection and a stipulated valuation.

iii. What about a $200,00 valuation?e. When would they want the secured claim to be low?

i. If the creditor wants relief from the automatic stay, then under §362(d)(1) there must be lack of adequate protection. If all he wants is relief from automatic stay then he will focus on the lower amounts, the liquidation values.

a. 19.2b. Facts

ii. CWI is in Chapter 11. Atlanta (a creditor) wants to lift the stay so that it can sell CWI’s corporate jet. At the time of the bankruptcy filing, Atlanta was owed 3.8 million on a 12% note secured by the jet. Jet is appraised at 3.1 million. The Jet has a 40 year lifespan and it’s not predicted to lose any value over the next several years.

c. Law iii. 362(d) provides three grounds for lifting the automatic stay:

1. Lack of adequate protection; 2. Debtor does not have equity in the property, and such property is

not necessary to the effective reorganization, or; 3. A single asset of real estate (SARE)

iv. Adequate protection may be provided by: 1. Periodic payments, 2. Additional or replacement lien, or 3. Catchall providing other means of adequate protection “as will

result in the realization by such entity of the indubitable equivalent of such entity’s interest in such property.”

a. So in this case – b/c the plane will not fall in value any time soon, it seems to fall under this third category. 

d. Atlanta will argue : v. AtlantaFirst will argue that there is no adequate protection.

vi. CWI will counter : 1. The stay will not result in a decrease in the value of such entity’s

interest in the property.vii. Atlanta can therefore only invoke the second ground for lifting the stay -

no equity in the property and it is not needed for reorganization.e. Insurance . 

viii. What if the plane crashes?  The debtor will have to show that there is insurance.  The Creditor can argue that it would be injured by the automatic stay. 

f. Maintenance.  ix. The creditor also wants there to be proper maintenance.  So the debtor will

also have to show that it will be able to supply sufficient maintenance.  Thus, insurance, maintenance. 

g. Atlanta Claim: no equity and not necessary to effective reorganizationx. No equity

1. Equity = the value of the collateral in excess of the value of the debt. So the creditor can show that there is no equity in the plane If we were to sell the jet, there would be nothing left for the debtor because there’s no equity. 

xi. Not necessary for effective reorganization 1. Necessary - It must be necessary to effective reorganization, not

just important. Janger doesn’t answer this, but I guess it can go either way, but probably in the creditor’s favor.

h. 19.3a. Facts

i. To finance her heavy equipment leasing business, Reenah Kim borrowed $12 MM from Bank of the West. The loan was to be paid interest only, with annual payments of $1.2MM (10%).

ii. When Reenah filed Chapter 11, she was up to date, and immediately struck a deal to pay $100,000/month, in return for BoW withdrawing its adequate protection motion.

iii. Reenah just missed the 11th payment, and BoW has moved to lift the stay. Collateral was worth $12.2 on the petition date. It is now worth $11.4.

b. Were the 1MM in payments principal or interest?i. Is a creditor entitled to postpetition interest?

1. No, the creditor is undersecured.

c. (unsure about the rest of this)

i. 20.1xii. Facts

1. President of Telephone company wants to know if he can operate the business normally after filing for chapter 11?

xiii. What do you tell him?1. Yes

a. Ordinary course of businessi. Under 363(c)(1) he can operate his business in the

ordinary course of business as long as the creditor consents, pursuant to 363(c)(2)(A).

b. Debtor as trusteei. §1107 says that the DIP shall have all the powers of

the trustee. c. Ordinary course of business no need for approval

i. §363(c)(1) = as long as use, sale or lease of property of the estate is in the ordinary course of business, no hearing is required to approve that. 

d. Cashi. 363(c)(2) - the DIP may not use, sell or lease cash

collateral unless each party with an interest consents or after notice and a hearing.

e. What about sales “outside” the ordinary course of business?i. Is it possible to liquidate in Chapter 11?

ii. Is it possible to sell the whole business in chapter 11?

1. Um, Chrysler!!

a. 20.2xiv. Facts

1. Teddy owes bank 150K. Bank loan is unsecured. Teddy becomes obviously in trouble. Bank demands that Teddy maintain a 10% “compensating balance” that it keeps in its checking account. Teddy complies.

2. Teddy then files a chapter 11. On that date, teddy had $40k in his checking account.

xv. Is that money cash collateral?xvi. If a setoff right is cash collateral, how much, if any, right to a post-petition

setoff does the bank have and why?

xvii. Cash Collateral 1. Why does the bank care what the balance is in teddy’s bank

account if they have this huge loan? Why do they suddenly start asking for this?

2. B/c the cash can become a cash collateral3. It is cash collateral because cash collateral includes a deposit

account. 363(a).  4. But wait a minute – this is just cash in the bank, who else has an

interest? What is the creditor’s interest in the bank account? It’s just money in the bank account!

a. Right to Setoff b. The right to setoff is a common law concept. c. 553 - bankruptcy doesn’t make setoff rights go away. d. Here, the bank is owed money through the loan … and

teddy is owed money b/c the bank has his large bank account … the two debts can be set off!

e. Setoff rights is another way of getting a secured claim … to the extent of the money in the bank account.

f. BTW – this is still a violation of the automatic stay teddy has the right to use cash collateral, so the bank cannot withdraw this money.

5. Setoff rulea. 553(a)(3) - bank may setoff except to the extent that the

debt owed by the bank to the debtor was incurred for the purpose of obtaining a right to setoff.

1. (has to comply with preference rules – so if it’s 90 days, while debtor insolvent, purpose of obtaining a setoff – that is a preference) 

ii. Amount in account: 40k; amount obtained for obtaining the right to setoff: 15k.  Thus, the bank may setoff 25k.

iii. Does the bank have the right to setoff against the 150k loan?

1. 553(a)(3) the Code recognizes the right to setoff, except to the extent (1) it was incurred within 90 days of filing petition (2) while debtor was insolvent (3) for the purpose of obtaining a right to setoff.

a. Was this a debt incurred by the bank after 90 day prior to the petition? yes. 

b. Was the debtor insolvent? yes c. Obtained for the purpose of obtain\

ing the right to setoff? Yes, (why else require a compensating balance.)

b. 20.3xviii. Facts

1. Gretchen owns Funtime – a dealership of Winston Bikes. Funtime files Chapter 11. On the day before filing, Funtime had 61K in the bank. Funtime has a 50k unsecured debt with Winston.

2. Winston got the bank to buy its debt.xix. Does the bank now have setoff rights?

1. Under the rules of 553(a)(2) one of the ways that a setoff is not valid is if the claim was transferred by an entity other than the debtor (like Winston) to such creditor after the commencement of the case or after 90 days before the date of filing (like here!) and while the debtor was insolvent (that is debatable! b/c the money was needed for payroll and she would have nothing left afterwards)

2. Is there a way for Gretchen to avoid having to litigate this issue once she files?

a. Take the money out of the bank account!xx. How much of the cash in the checking account would Gretchen be able to

use w/o getting court permission?xxi. What is icky about this transaction? Who much would Winston get on its

50k claim in the bankruptcy? As an unsecured creditor – probably cents on the dollars. If the claim is owned by the bank, they should get all of it.

xxii. Can she avoid the problem? She can take the money out of the bank account and then they don’t have setoff rights.

Week 9 Debtor in Possession Financing and the Trustee’s Strong Arm PowerRead 452-468. Do problems 21.1-21.3Read 471-476. Do problems 22.1-22.4

(1) Post-petition financinga. Note

i. It an interesting concept to be allowing the debtor to be borrowing moneyb. Example:

i. Debtor owns property with some value, but with improvements the property would be worth a lot more.  Who will loan a bankrupt money?  Probably existing creditors.  Why do you think you will get the benefit of the increase in value?  There may not be a lot of assurance. 

c. Priority & Securityi. §364

1. Allows lenders to gain priority or security to encourage the lender provide additional funds. 

2. The new debt can be listed as an administrative expense3. If you’re having a hard time finding money, you can grant a post-

petition lien or give them priority over administrative expense claims you can even give them a senior lien.

d. Likely Synopsisi. Debtor is in big trouble and to succeed through bankruptcy they need more

money. The debtor is likely talking to a creditor he is dealing with already. Creditor says ok, but you need to show me why I should lend you more money.

ii. If that creditor is over-secured, are they likely to be willing to lend you money to go into bankruptcy? No, they are going to get paid anyways.

iii. How about the under-secured? One of their advantages is that it might increase their chances of getting paid – to protect their unsecured credit. This will also allow them to take a more active role in the bankruptcy proceeding. Good liquidation vs. a shitty job by whoever is in control. They may ask for some ridiculous stuff – like getting rid of priority to other creditors. The amount of chutzpah can be quite high and the courts know to look out for it. Furthermore, it’s not uncommon, that the unsecured creditor will try to get more stuff out of the debtor – like liens on different stuff. This is what is called cross-collateralization (two loans collateralized by the same asset) Look at the topic of cross-collateralization to understand why its usually not allowed.

Problem sets, p. 586

(1) 21.1a. Facts

i. Gogo is in bankruptcy. It owns a property and is grandfathered into the old rule of getting a really good deal on a sewage system that would dramatically increase the value of the property. But, once it advertises that it is selling the property, it loses that special use.

b. How can gogo raise the money?

i. Does the creditor want this to happen? Yes – it helps increase assets of the debtor.

c. (Rule - you are allowed to borrow money in general. You want to buy oil, why would anyone sell it to you in return for promise of money? What is the guarantee that you will get paid? The business is going away! The answer is that it is an administrative expense and therefore gets a priority!)

d. Who should get to decide whether the debtor gets to take out that loan? i. The unsecured creditor – because it is their money that the debtor is

playing with (the secured creditor gets the collateral, but the unsecured creditor’s future is in question in terms of how much money it is getting)

e. Let’s say however, that no one is willing to do on an unsecured basis? What can the debtor do?

i. Under 364(c)(1), the court may authorize (1) super-duper administrative priority (you get paid before even the lawyers) (2) or lien on encumbered property.

f. What if that doesn’t work? i. You go down to (d) and what you need to show is that obtaining the

money is in best interest of the creditors. Note – this is a pretty strange thing to do we are invading the creditors telling them what is right.

g. How should the court decide whether to approve the borrowing?i. Garland . . .

ii. Two questions:1. Are these the best terms available?2. Is the borrowing in the best interests of the estate?

a. What does that mean?b. Necessary for reorganization?c. Only if reorg is a good bet . . . ?

h. What forms of credit can the court authorize (364(c) and (d))?i. Administrative claim

ii. Superpriority unsecured claimiii. Lien on unencumbered property (Garland)iv. Junior lien on encumbered propertyv. Priming lien (Hubbard)

(2) 21.2a. Facts

i. Low Price has a loan from FSB for 500K secured by a lien on its inventory.

ii. Low price’s total unsecured debt is 250K.

iii. Low price files for chapter 11.iv. Low Price got a post-petition loan from HF for 250K secured by lien on its

equipment.v. FSB sought adequate protection and the trustee offered an additional lien

on Low Price’s receivables.vi. Since then, inventory much depleted, and there are no account receivables.

vii. Low price files for chapter 7viii. After the sale of inventory, and collection of receivables, FSB is still owed

250K.ix. HF only got 150 from the sale of equipment.x. There is 350K in other unencumbered assets.

xi. The only unpaid expense from chapter 11 is the 150K fee in lawyer’s fees.xii. The chapter 7 lawyers are owed 50K

b. Distributioni. Lawyer fees in 7

1. Administrative expenses for Chapter 7 go first. It goes in front of the administrative expense of the 11. This makes sense b/c we really need to liquidate everything now.

2. So the 50k is pushed to the very beginning. This is the first priority. It goes to the lawyers in the 7.

ii. Now, we have three sets of administrative costs in 11 – the lawyers fee (which get plain vanilla administrative priority), the unsecured administrative expense claim of the dip lender (HF) - that goes into the same administrative expenses as the lawyers.

iii. What happens to FSB? 1. It seems like it would be an unsecured claim. 2. BUT - What is the status of a secured claim that was supposed to

be adequately protected but turns out to be unprotected? a. (507b) – you get priority over all of administrative

expenses. You so you get super-duper inadequate adequate protection!

iv. Breakdown1. So of the 350K – 50 k goes to lawyers, then 250 goes to the

inadequate adequate protection for FSB, then you have a remaining 50k which gets split between the lawyers and the dip lender (HF).

(3) 21.3a. Facts

i. Vehement Entertainment manufactures and distributes video games.

ii. It is in Ch. 11. Your client MI holds the first $3MM mortgage on the company’s manufacturing facility. The factory is worth $2MM. The company has $1.5 MM in unencumbered assets.

iii. The DIP proposes to borrow $750K from Yankee.iv. Murphy thinks the interest rate is too high. He’s willing to loan the money

at a lower rate, secured by all of the debtor’s unencumbered assets Provided that the new lien also secure the prepetition debt.

b. Let’s split this problem apart.i. First, assume that the lien secures only postpetition advances.

c. Hmm. Is unsecured credit available?i. Which is a better deal for the creditors?

1. They don’t care. Either way they lose2. Except the other administrative claimants …

ii. What if the other lender drops out?1. Then unsecured credit is unavailable and the court is more likely to

approve the loan.iii. Can the post petition lien also be used to secure our deficiency claim?

1. Shapiro v. Saybrook?a. Texlon type cross collateralizationb. What’s the difference?c. Who gets hurt?

2. Issue of mootness and good faith. iv. How much cash do you need?

1. Pay for goods and services purchased post petition?2. What about prepetition trade debt?

a. K-martb. 2005 amendments

i. Priority for goods and services delivered within 20 days.

ii. Reclamation rights3. Help the argument you should be allowed to pay trade

a. Increase the amount of cash you need to operate.

AVOIDING POWERS(1) Trustee Powers

a. Powers of strong arm power and preference power allow the trustee to swipe stuff bank into the estate.

(2) Avoiding Powers: permit the TIB to undo pre-bankruptcy transactions between the debtor and certain creditors.

a. Gives the TIB/DIP much greater leverage to negotiate with the creditorb. Turnover Power - Power of trustee to gather things into the estate.c. Strong Arm Power - Power to avoid transfers of property that were unperfected as

of the moment of the bankruptcy filingd. Preference Power - Allows trustee to reach back and take money back from

creditors who received pre-petition payments from the debtor(3) §544

a. Ensures that the trustee gets the full status of someone who grabbed everything on the first day. It deals with the problem of other creditors somehow jumping ahead of the trustee. The trustee therefore is given (1) the status of a hypothetical lien creditor as of the moment of the bankruptcy (so it’s like everything was liened upon) and (2) the trustee is given Bona Fide Purchaser of real estate as of the moment of bankruptcy filing.

i. Effect:1. The trustee beats all security liens that were unperfected and all

real estate purchases that were not fully complied with the law2. The trustee beats all real estate conveyances that have not satisfied

the requirements established by the state’s statutes to beat a bona fide purchaser.

b. Money purchased securityi. Special rule for a purchased money security interest, which is a loan that is

used to buy the stuff that becomes the collateral. This, I believe is for example a mortgage.

ii. Non-purchase money is why I give Ms. Page 500 bucks and to ensure that she pays I take an interest in her laptop. The courts like this more and there is a special 20 day rule for that which you can see on the slides.

(4) PMSI Exception a. If PMSI creditor perfects w/in 20 days of delivery of the collateral to the debtor,

perfection dates back to attachment date.b. Not a violation of Automatic Stay:

i. 362(b)(3) allows any act to perfect… under 546(b)1. 546(b): if the trustee was subject to a perfected security interest,

but the creditor needs to take a step to maintain that perfection, it doesn’t violate the auto stay.

c. Policy: transactions that bring new property into the estate are the most beneficial and therefore deserve the greatest protection.

(5) Real Estatea. Bona Fide Purchaser: a good faith, unknowing purchaserb. Different states have 3 kinds of Recording Requirements and Priorities

i. Race: Whoever files first has priorityii. Race/Notice: Bona fide purchaser (no notice) takes priority if they file

first

iii. Notice: bona fide purchaser (no notice) takes priority regardless of when filing occurs

iv. Notice System’s Problem of Circular Priorities:1. Day 1: Y conveys a mortgage to A2. Day 2: Y conveys a mortgage to B (who knows about A)3. Day 3: B records its mortgage

a. A still wins, b/c B knew about A (not bona fide)4. Day 4: Y conveys a mortgage to C (who knows about B b/c B

recorded, but not about A)5. Day 5: C records its mortgage

a. A beats B, B beats C, C beats A(6) Problems

a. 22.1 Perfection of security interest problem b. Facts

i. Western fliers bought a plane a week before the filing. This plane was purchased from Aero for $10K down and a promissory note for $160K secured by the plane and “all Western fliers’ other planes, parts, and equipment.” But it didn’t properly file it with the state. When Aero learned of Western’s Ch. 11, it immediately filed copies of the financing statement in all the appropriate locations. What can Aero get in Ch. 11?

c. If there had been no BK, could they have filed the stuff today? i. Yes. That would be no problem even though its 8 months after the loan

was made.d. After the petition, can they then file the papers?

i. No1. But what’s wrong with perfecting a security interest after the

petition has been filed? What can’t you do after a petition is filed? a. An automatic stay, which says that you can’t perfect a lien

on property of the estate, which is what you would be doing here.

i. But let’s say you did somehow not violate the automatic stay, would it work to jump you ahead of the bankruptcy trustee?

1. No. why not? The code provision of 544(a) prevents that.

ii. Perfecting 1. The loan has attached, but it’s not perfected b/c what you need to

do is file a financing statement, which they didn’t do. Also, you need to worry about the federal law to perfect this – whatever is required.

iii. Would a hypothetical lien creditor that put a lien on the airplane, would it have priority over Mitchell aeronautics?

1. Yes. If the trustee has grabbed the airplane and thereby becomes a lien creditor, it gets the airplane over Mitchell aeronautics.

2. There is nothing you can do! File a malpractice lawsuit!(7) 22.2

a. Factsi. Western Fliers bought another plane 7 days before the filing. This plane

was purchased from Aero for $10,000 down and a promissory note for $160,000 secured by the Aero Leader being purchased and “all Western Fliers’ other planes, spare parts, and servicing equipment, including Western’s ten-passenger Thunderbolt.”

ii. When Aero learned of the Chapter 11, it immediately filed copies of the financing statement in all the appropriate locations.

b. What can Aero get in the Chapter 11?c. Is aero in a different position than Mitchell aeronautics?

i. As a general rule you can’t file a financing statement post-petition. Here, it is allowed b/c it is a purchased money loan. The effect of that is if they filed w/in the 20-day window, the PMSI in the Aero is perfected, and the TIB cannot touch it.

d. BUT, Can you file without violating the automatic stay?i. 362(b)(3) allows you to perfect to the extent that trustees are subject to

perfection under 546(b)(3) under this provision. Meaning:1. 546(b) is a relation back rule. It relates perfection to a date prior to

perfection. Is that what 362(b)(3) does? Yes. It says that if you perfect it within 20 days, we will consider it as if you filed it prior to the petition date.

a. Does this work for the thunderbolt? i. No! The thunderbolt is not a purchase money

agreement same position as Mitchell in the previous agreement. If they would file it, it would be a violation of the automatic stay and even if they did file it, it would be a junior claim to the trustee.

ii. Therefore, the TIP can use 544(a)(1) or (2) to avoid the security interest in everything but the Aero Leader.

(8) 22.3 (Let’s see how the strong arm statute relates to real estate)a. Facts:

i. Larry Cochran invested in home mortgages originated by Dynamic Investments. Dynamic promised high returns on safe loans secured by borrowers’ houses.

ii. Each investor put up the agreed amount and got a mortgage signed by the homeowner.

iii. Dynamic got a commission paid by the homeowner.iv. Although the investors were shocked when Dynamic closed its doors and

its president disappeared, they were not too concerned because their loans were secured by residential real estate.

v. This morning Cochran received a notice that his homeowner-borrower has gone into bankruptcy. He has come to you for reassurance that he is protected by his mortgage on the borrower’s house.

vi. You sent a paralegal to the courthouse and he has just reported that the Cochran mortgage was apparently never filed in the land records of the county.

i. What is your analysis of Cochran’s situation? a. Holding:

i. What is your analysis of Cocharan’s situation? Is this any different than Mitchell?

1. No! The unperfected mortgage loses to third parties. (State mortgage law is pretty tricky b/c it’s not uniform between states. You must do whatever that state says you must do.)

b. Recording Actii. A recording act is a state statute that says once a mortgage is recorded no

one else can be a bona fide buyer. iii. If the trustee would have found the mortgage if they had looked for it

(even though it wasn’t recorded properly), should it have worked for him to be the bona fide owner?

2. As a matter of logic, it should have. But, let’s take a look at the language of 544(a) – “w/o regard to any knowledge of the trustee or creditor” – so even if the trustee knew – that doesn’t make a difference because the trustee is a representative of all the creditors and not all them were on notice.

(9) 22.4a. Fixtures

i. It turns out that the world doesn’t always divide neatly between real property and personal property. Fixtures – sometimes you have personal property that is so fixed that it comes under the law of real property. Here, what you have is an A/C that is attached to real estate.

ii. The problem is that you have two different people – interest in the building and also an equipment lender that has a lien on the a/c as goods.

iii. What happens there?b. Answer

i. Article 9:

1. You can perfect a lien on a fixture in three ways: (1) look at slide (2) you can file a fixture filing where the fixture is located (3) record a mortgage

ii. Trustee1. Section 504(a)(3): trustee has position of real estate holder, besides

for fixtures. 2. So for fixtures you just have the status of sheriff.

c. Note: i. Janger: you need to know how a security interest (three requirements)

basic requirements for filing a security interest. ii. How do you perfect an interest in a car? This is one technical article 9

thing you need to know.

Week 10 PreferencesRead Casebook pages 476-490. Do problems 23.1-23.8Read Casebook pages 492-507. Do problems 24.1-24.4. Read pages 509-518Preference

(1) Strong Arm Statutea. Strong arm clause – allows trustees to void unperfected interests.

(2) Purpose of Preference:a. Avoids the dreaded race to diligence which undercuts the theory of equity in

equalityb. Preference: sometime a debtor will pay a friendly creditor on the eve of

bankruptcy at the expense of other creditors. The effect is that the friendly creditor does better than the other creditors.

(3) Power of the Trusteea. Under 547(b) TIB can reach back and avoid “preferential transfers”b. The hard part of this is that it must distinguish between normal business and debt

repayment on the eve of bankruptcy. i. This is a strict liability statute. We don’t look at intent here! The statute

makes conclusive decisions based on behavior.(4) Benefits of Preference:

a. Protects debtor from creditors right before they fileb. Encourages creditors to cooperate in informal workoutsc. Assures creditors that other creditors aren’t getting undue preference

(5) Liensa. All judgments liens levied with in 90 days of filing come under this rule

(6) Prima Facie Case of a Preference a. 547(b): Except as provided in 547(c), the trustee may avoid any transfer of an

interest of the debtor in property that is:

i. To or for the benefit of a creditor;ii. For or on account of antecedent debt owed by the debtor before such

transfer was madeiii. Made while the debtor was insolventiv. Made

1. On or w/in 90 days before the filing dateor

2. Between 90 days and 1 yr before the date of filing, if such creditor at the time of such transfer was an insider; and

v. Enables such creditor to receive more than they would receive if:1. The case were a case under chapter 7;2. The transfer had not been made; and3. Such creditor received payment of such debt to the extent provided

by the provisions of this title(7) Transfer , when does it occur?

a. “Transfer” occurs at the time of perfection, not of attachment(8) Different types of transfer to the creditor:

a. With moneyb. Debtor gives creditor anything with value that can be sold to paid debt owedc. Debtor increases the value of or gives a security interest in the debtor’s property

(turns them from being a plain old creditor to a secured creditor)d. Gives the creditor a judgment lien on property of the debtor

i. Judgment liens obtained within 90 days are voidable! As it happens, there are many bankruptcies that are filed on the 89th day of the lien, so that you can get rid of the lien.

(9) Antecedent Debt a. If perfection occurs “simultaneously” w/ the giving of value, then the transfer is

not “on account of antecedent debt”i. 547(e)(2)(A) makes “simultaneously” mean w/in 30 days of the giving of

valueii. If the transfer (perfection) occurs outside the grace period, it is securing

old debt and therefore is “antecedent debt” under 547(b)iii. Clock begins running at attachment iv. Attachment:

1. Attachment is whenever the goods are “identified to the debtor”(10) Improving Creditors Position 547(b)(5)

a. Payments to Fully Secured Creditors are not preferences: b. Payments to undersecured creditors w/in 90 days of bankr from an insolvent

debtor ARE preferences.(11) Exceptions to Preferences

a. The prima facie case of preference simply asks if there was a transfer within 90 days. If an answer to all 5 of those questions (like antecedent debt, etc), is no, then stop. If the answer is yes – then you have a prima facie case. But, then you must look at defenses:

b. 547(c) has 8 exceptions. Five commonly used ones (and one from 553):i. Contemporaneous Exchange

1. Trustee cannot avoid transfers that were:a. (A) Intended by the debtor and the creditor to or for whose

benefit such transfer was intended to be a contemporaneous exchange for new value given to the debtor; and

b. (B) Was in fact a substantially contemporaneous exchange.2. Policy:

a. Seller or lender should be able to deal w/ a buyer or borrower w/o worrying about whether the order in which the transaction took place could create a voidable preference

3. Checks a. Payment by check is ok b/c it is intended to be

contemporaneous under (A). The clearing of the check 3 days later would be considered “substantially contemporaneous under (B). But if the check bounces, the exchange becomes one of credit and is no longer contemporaneous

4. Contemporaneous Exchange for a Security Interest a. 547(e)(2)(A): Creditor has 30 days from attachment to

perfect the lien in order to make it a contemporaneous exchange.

5. When is attachment? a. When the equipment is identified to the debtor.

ii. Ordinary Course Payments 1. Trustee cannot avoid transfers that were in payment of a debt

incurred by the debtor in the ordinary course of business or financial affairs of the debtor and the transferee; and such transfer was

a. (A) made in the ordinary course of business or financial affairs of the debtor and the transferee; or

b. (B) made according to ordinary business terms2. Satisfying (A):

a. Court looks at “consistency of the transaction” in question as compared to other transactions between the parties

iii. Purchase Money

1. Trustee cannot avoid a transfer that creates a security interest in property acquired by the debtor

iv. New Value Rule 1. Trustee may not avoid a transfer to or for the benefit of a creditor,

to the extent that, after such transfer, such creditor gave new value to or for the benefit of the debtor

v. Floating Lien Exception 1. Typically covers inventory, but can include machinery

a. “whether now owned or after acquired”(12) Setoff

a. 553(b) creates a restraint similar to 547(c), which empowers TIB to recover from an offsetting creditor the amount by which the creditor’s setoff position improved during 90 days pre-bankruptcy

b. Only applies if creditor offsets pre-bankruptcy. If creditor waits and exercises its setoff after bankruptcy (w/ permission of the court under 362) then they are not required to surrender any improvement in setoff position in the 90 days

Problems (13) 23.1

a. Factsi. Mountain Lakes Fuel Oil is an unsecured creditor of Wilson

Manufacturing. Wilson owes Mountain Lakes $140,000. It makes a payment of $14,000 to Mountain Lakes 60 days before bankruptcy while Wilson is insolvent. Wilson is liquidated in bankruptcy, and the unsecured creditors receive a 10 percent pro rata distribution. Is Wilson’s payment to Mountain Lakes a voidable preference under section 547(b)?

b. Answeri. 1st: was there a transfer of an interest of the debtor in property? Yes – 14K

payment to Mountain Lakesii. Was the transfer to or for the benefit of a creditor?

1. Yes. Mountain Lakes was a creditor at the time of the transfer?iii. 3rd: 547(b) elements?

1. First 5 are met [1 - benefits ML 2 - antecedent debt = 140k loan 3 - 90 day insolvency presumed / 60 days ago]

2. Better off than under chapter 7?a. In the distribution, ML would receive 10% of $126k [as its

allowed claim would be 126k], or $12.6k; that, ADDED to what was already received [$14k]…and they actually get to

keep $26.6k in the end—so they are better off than under chapter 7

3. Therefore it’s a voidable preference

(14) 23.2a. Facts

i. Underdown is a wildcat driller. His last three holes have been dry and he fears he is insolvent. On October 1, one of his principal suppliers, OKC Supply, calls on him to discuss payment on a large unsecured account. OKC has been generous with Underdown and he is appreciative. Underdown suggests that OKC take some of the loose equipment still left at the warehouse and drilling sites, some of which OKC had originally sold to Underdown. On November 15, Underdown files for bankruptcy. Can the trustee get the equipment back from OKC?

b. Answeri. 1st: Is there a “transfer of an interest of the debtor in property”? = Giving

equipment to OKC is a transfer! Property is more than just cash!ii. 2nd: Interest = Owner of the equipment

iii. 3rd: 5 requirements:1. YES…to first 4 (to the benefit of the creditor, on account of

antecedent debt, debtor was insolvent, within 90 days of the petition)

2. For (5), Creditor is unsecured / has no rights in collateral. Even though we don’t know the pro rata distribution, we know that the Creditor will get to keep the equipment PLUS any distribution for its claim in Ch. 7—and that is much more than under this plan. Thus, (5) is met b/c he is much better off.

iv. Voidable Preference!c. What would have happened if the creditor had taken the equipment post-petition?

i. OKC would have violated the automatic stay.

(15) 23.3 a. Facts

i. When gasoline was scarce and prices were high, several creditors were eager to lend money to Raymond’s Chevron Station for expansion. When the gasoline glut appeared last winter, one of those creditors, Iowa Commerce Bank, decided it would prefer to be a secured creditor. On February 1, while Raymond’s was insolvent, the bank received a security interest for its previously unsecured debt in Raymond’s previously unencumbered equipment. The bank filed and perfected on the same day.

On April 25, Raymond’s filed a Chapter 11 reorganization. Is there a voidable preference?

b. Answeri. Bank was fully perfected as a Secured Creditor on 2/1

ii. Transfer = creation of lien.1. Perfection of an Article 9 security interest (or, for that matter of a

real estate mortgage) constitutes the conveyance of “Property”)iii. Interest = unencumbered ownershipiv. All 5 Reqs are met:v. CLASSIC EXAMPLE of ANY TIME A SECURITY INTEREST IS

GRANTED, THE CREDITOR IS BETTER OFF—you leap ahead of unsecured Creditors in a Chapter 7 distribution!

vi. VOIDABLE PREF.c. Does this mean that all security interests perfected within 90 days of a bankruptcy

are invalidated?i. No. A security interest which secures a contemporaneous advance is not a

preference b/c it’s not “for or on account of an antecedent debt.”

(16) 23.4a. Facts

i. North Woods, Inc. is a logging concern that has been insolvent for several months. It believes that a current upturn in the construction industry will allow the company to become profitable again, and it persuades VenCap, a venture capital company, to lend it $50,000 to survive the next few months. On June 1, VenCap makes the loan and takes a security interest in North Woods’ unencumbered equipment, which it perfects on July 1. On September 15, North Woods cannot meet its payroll and it declares a Chapter 11 bankruptcy. Has there been a voidable preference?

b. Answeri. Transfer? Yes. Perfection of a security interest can constitute a transfer.

ii. Why didn’t the transfer happen on June 1? 1. They just got the security interest then. If I gave you a security

interest and perfected and gave me money today, would there be a preference? Yes. Would it be transfer? Yes. Would it be to a creditor? Yes. Would it be for antecedent debt? No! it’s current debt. I gave you security interest at the time.

iii. Perfection is the relevant date1. Strong arm won’t work if you perfected interest. July 1 is the

relevant date when it becomes relevant against third parties b/c that is when it was perfected. The perfection is the relevant date. Here,

did they perfect simultaneously? No. they waited a month! So now it seems like it’s a transfer on account of antecedent debt.

2. What happens if the transfer happed on June 28? a. Would it be treated as antecedent debt for preference

purposes? No, b/c if you look at §547(e)(2)(b) it says that it must be 30 days. There are two dates you look at : (1) the date the security interest becomes effective between the parties (2) when the security interest perfects. If it is within 30 days between (1) and (2), then perfection relates back to attachment date.

3. As a practical matter, did the transfer account on antecedent debt? Yes. But since it happens within 30 days, it is not treated as antecedent debt.

4. The strong arm polices the late perfection by allowing trustee go after interests that are not perfected. The preference also polices through the 90 day transfer rule.

(17) 23.5a. Facts

i. On February 1, Hartford Baking, Inc. has two secured creditors. One, Magic Chef Co., sold Hartford four $10,000 specialized ovens a year earlier and perfected its security interest before delivery. (no perfection problem here) On February 1, the loan balance was $35,000 and the value of the ovens was $30,000. (so they are undersecured) The other creditor, Commercial Bank, made a loan to Hartford six months earlier. Commercial took a security interest in Hartford’s other baking equipment and perfected at the time of the loan. On February 1, Commercial’s loan had a balance of $40,000 and Commercial’s collateral was worth $50,000 (so they are oversecured). On February 2, Hartford paid each creditor $5,000. On April 2, Hartford filed for bankruptcy. Hartford was insolvent throughout, and the value of the collateral was stable. Would either creditor have a problem keeping the 5K payment under section 547(b)?

b. Answeri. MC = undersecured b/c balance of loan is greater than collateral value

1. Preferencea. b/c of transfer, MC received 5k plus the Secured Interest in

30k worth of collateral to secure 30k worth of debt; that’s 35k in total a big benefit

i. w/o transfer, MC would have rec’d 30k from collateral plus small percentage on its 5k worth of unsecured claim from pro rata (~30.5k)

2. A payment to an undersecured creditor is a preference. ii. CB = Oversecured b/c balance of loan is less than collateral value

1. For an Oversecured creditor, payment within the preference period is not voidable, as this Creditor will be fully paid in Ch. 7 Liquid anyway

iii. No Preference1. b/c of the transfer, CB rec’d 5k plus it has an SI in 50k worth of

collateral to secure at 35k debt; net payment of 40k2. w/o transfer, CB would have received 40k from its collateral—

PAYMENT IN FULL either way!

(18) 23.6a. Facts

i. Virginian Air Conditioning Service owes $250,000 to First Richmond Bank. The loan is secured by a perfected security interest in “all Virginian’s current and after-acquired equipment,” which on March 1 is worth about $150,000. On April 15, Virginian acquires another $200,000 in equipment from a supplier who sells on credit but fails to take a security interest in these goods. On May 25, after having been insolvent for six months, Virginian files for Bankruptcy. Has there been a voidable preference?

b. Transfer? 547(e)(3) says no transfer until debtor acquire right to property- here the new property was acquired by First Richmond Bank b/c they perfected security interest in ‘all Virginian’s current and AFTER acquired equipment’- called a floating lien – a lien that applies not just to property owned at the time but acquired by debtor afterwards-earmarking, i.e. floating lien UCC allows this

c. Has there been a transfer of an interest of the debtor in property?i. Yes. But how?

1. By perfecting a security interest in the equipment.ii. When did the transfer occur?

1. When was that security interest created (UCC 9-203)?a. The security agreement was signed when Virginian’s

borrowed the money from First Richmond.b. The bank gave value when it extended credit.

c. The debtor obtained rights in the collateral on April 15, when it purchased the equipment on credit from its supplier.

2. When was the security interest perfected (UCC 9-308)?a. On April 15, when the debtor obtained “rights in the

collateral.”b. The financing statement was already on file.

iii. Are the other requirements for a preference met?1. Yes – within 90 days, on account of antecedent debt, debtor is

insolvent, received more than they would have under chapter 7. i. On the bankruptcy petition date they are

oversecured. But they would have been undersecured had it not been for the extra 200k.

2. – The financing statement was already on file.d. Earmarking

i. In Calvert cases, the debtor borrowed money to pay a creditor. The lender (mom and dad) paid the creditor directly.

ii. Court holds no preference.1. The basis is unclear

a. No transfer (the loan proceeds never came into the estate).b. No depletion of the estate?

i. Simply traded one unsecured creditor for another.ii. Couldn’t one argue that the creditors should have

been able to save the benefits of the loan proceeds pro-rata, rather than have it all go to one creditor.

e. Examplei. 1000 in claims

ii. 100 in assetsiii. Distribution is 10%.iv. Debtor borrows $50 and pays off one of its creditors.

1. Claims are reduced by 50 and increased by 50, remain at 10002. Distribution remains 10%

v. Alternative1. Debtor borrows $50 and keeps the money.2. Now Claims =10503. Assets =1504. Distribution=14%

vi. On this reasoning, earmarking cases would appear to be wrongly decided. Problem 22.6 would appear to be the correct approach.

(19) 23.7a. Facts

i. Principal asset of bottling has a two ton machine. As of June 1 – clearsprings owed 200k to the bank. No one was worried b/c bank had a perfected interest in a machine that was worth 300k, so there won’t be a preference b/c they are over secured. On July 1, they make a 20k payment to an oversecured creditor. On july 15, a fire sweeps through the plant and destroys the machine. On august 1, clearsprings files for bankruptcy.

b. Has there been a preference?i. On July 1 – was there a transfer? Yes benefit of a creditor? Yes. Made

while insolvent? Yes. When they made the transfer, did it appear that they would have not gotten that anyways? Yes b/c they thought they were over-secured. But whatabout after the fact on bankruptcy day, they are fully unsecured and they would have only gotten cents on the dollar. Therefore, that 20k payment was a preference.

c. Which moment should control - the moment of bankruptcy or the moment of the transfer?

i. Courts have held that the moment of the petition controls, not the transfer.

(20) 23.8a. Facts

i. Same problem as 7, except clear bottle buys another bottle machine after the fire and lends to them on an unsecured basis. At the time of bankruptcy, the original bank is fully secured b/c the security agreement covered after fire acquired equipment. So the bank is fully secured on July 1 and on the date of bankruptcy on august 1. Is there a preference? (hint - there might not just be one preference, but there might be two preferences)

b. Is the new machine covered by Hillside’s lien?i. If no, the payment remains a preference, because Hillside would have

been “unsecured” in the hypothetical Chapter 7.c. Now assume the new machine was covered by an “after acquired property”

clause in the original security agreement?i. Is the purchase of the new bottle-capping machine a preference?

1. Yes, assuming that Hillside’s lien covered after-acquired property, on the same reasoning as 27.6.

a. – The proceeds of the machine should be available to the unsecureds

2. (I guess it would be no different than a floating lien!)d. What result?

i. Thus Hillside’s lien on the machine would be avoided.ii. Then, is the payment on Hillside’s Loan a preference?

1. Yes, because they would have been an unsecured creditor in a Chapter 7, and therefore received more as a result of the payment.

(21) 23.9a. Court’s Hardware borrows $50,000 to pay off a number of unsecured creditors.

Oregon City Bank cuts checks directly to the creditors. The loan is secured by a lien worth $20,000 on the debtor’s fork lift.

b. Preference?i. The grant of the SI to the Bank is an indirect preference.

ii. It also implicates the “Secured Loan” exception to earmarking.iii. Does it mean that $20,000 is a preference and $30,000 not, or is the whole

$50K preferential?iv. Since it’s to an insider, it may also be preferential under UFTA 5(b).

c. (Look into this question, especially the preferential rule)

(22) 24.1a. Background

i. 5 preference defenses (if you knew that if you did business with a debtor that is tinkering on bankruptcy you wouldn’t do business with them if you knew it would be preferred and possibly taken away by the executor): (1) cash like transaction (2) short term business transactions (3) purchase money transactions (4) protects a creditor who receives a payment as a result of that payment extends further credit to the debtor (5) the floating lien exception.

b. Factsi. Fun City Go-Carts was in failing financial condition and legally insolvent.

Its chief supplier, Exaco, knew of the difficulties and told Fun City it would only make gasoline deliveries for cash payments. (if I pay you and there is cash payment right away, there is no antecedent debt) Fun City and Exaco completed about two deliveries per week for about $2,400 each during the 90 days preceding bankruptcy. Three times during that period, however, the delivery truck arrived and Fun City did not have cash available. Rather than take Fun City’s check, the Exaco driver agreed simply to collect payment on his next delivery, which was accomplished each time. When Fun City files for bankruptcy within 90 days of these transactions, can the trustee recover any payments made to Exaco?

c. Answeri. Are these voidable preferences? Yes

ii. Transfer = cash paid for previous delivery, 3 or 4 days lateriii. Antecedent Debt = time b/w delivery and payment (so there is a violation

of 547(b))d. Exceptions (you only look at 547(C) after you have concluded that there is a

preference. i. 547(c)(1): Contemporary Exchange?

1. This was intended to be for New Value (intent to give cash on delivery); in close amount of time. (this is (1) in the above exceptions)

a. An example of this is giving a check when you buy something or filling up the gas of tank, smoking a cigarette and then gets the cash.

ii. What about the payments made with the next delivery?1. Was the exchange intended to be contemporaneous?

a. Here it looks like the creditor intends to extend credit.2. Was it in fact substantially contemporaneous?

a. We appear to be in a gray area here.b. Is a check transaction a “credit transaction?”c. Technically yes, but not for these purposes.d. How long does it take a check to clear?e. 2-3 days.f. How long was the gap here?g. – 3-5 days.h. This may be a gray area, but if there was intent to extend

credit, the length of the delay doesn’t matter3. How would you avoid this problem?

a. Take a checkb. Insist on cash

(23) 24.2: a. Facts

i. Big Rig Equipment is an Oklahoma rental company that has been insolvent for several months. It decided to take a final gamble and order ten new pieces of heavy equipment, begin an aggressive advertising campaign, trim its office staff, etc. The John Deere dealership was willing to finance the sale of ten new pieces of industrial and farming equipment to the business, taking a purchase-money security interest in the new equipment (specifications in the contract) on July 1. Big Rig agreed to pay $300,000, giving John Deere a security interest in the new equipment. On July 12 the equipment was identified to the Big Rig contract at the JD factory. On July 20 custom work was completed, and on July 24 the equipment was delivered to the local dealer. On July 28 the dealer delivered the equipment to Big Rig. On August 21 the JD dealership filed a financing statement in the Office of the Secretary of State (which was the correct form of perfection in Oklahoma). Big Rig’s new plans never got off the ground. On September 30, Big Rig filed for bankruptcy. The

only valuable assets in the estate are the new equipment. Oklahoma has adopted the standard version of Article 9.

b. Is there a defense?i. 547(c) “The trustee may not avoid under this section a transfer”

1. (3) that creates a security interest in property acquired by the debtor –

a. (A) to the extent such security interest secures new value that was –

i. (i) given at or after the signing of a security agreement that contains a description of such property as collateral;

ii. (ii) given by or on behalf of the secured party under such agreement;

iii. (iii) given to enable the debtor to acquire such property; and

iv. (iv) in fact used by the debtor to acquire such property; and

b. (B) that is perfected on or before 30 days after the debtor receives possession of such property;

c. The Purchase Money Exception 547(c)(3)i. Was the security interest given in return for "new value?" Yes

ii. Was the secured interest given "after the signing of the security agreement?" Yes

iii. Was the Secured Interest given in order "to enable the debtor to acquire such property?"

1. What does this mean?a. We're talking about purchase money here.

2. Yes, it's purchase money.iv. Was the SI perfected within 30 days after the debtor received possession

of the collateral? Yes.v. The purchase money defense insulates the transfer.

d. When does 547(3) matter?i. When attachment occurs well before delivery.

ii. Example:1. Day 1 – Debtor signs a security agreement, creditor loans the

purchase price, and the goods are identified in the contract.a. But more custom work is needed.

2. Day 50 – Goods are delivered.3. Day 65 – financing statement filed4. Day 80 – debtor files for bankruptcy

iii. Here, perfection would be a preference, because it is 80 days after attachment (547(e)(1) doesn’t help). But because it’s purchase money, and within 30 days of delivery, the defense applies.

(24) 24.3

(25) Facts a. GV Nursing Home filed for bankruptcy in Sept. Trustee later reviewed the books

and found evidence of the following transactions. 1. $14,200 in utility bills was paid 4 weeks before filing. GV had been more than 3 months behind in its payments and when the power company threatened to shut them off,, GV took a large portion of the August receipts and paid them off in full

(26) Was it incurred in the “ordinary course” of business Yes(27) Was it paid in the ordinary course of business (547(c)(2) defense)?? No. They only paid

after they were yelled at! It was late; the creditor made threats it probably wasn’t paid in the ordinary course it’s a voidable preference

(28) Would your answer change if the debtor always paid late, and only in response to threats?

a. Is this consistent with ordinary practice in the industry (c)(2)(c). See Roblin?

(29) Facts a. June, Jul and August mortgage payments were due on the first but made btwn the

20th and 25th of each month and each included a $50 late penalty charge. Mortgage is undersecured

(30) Was the debt incurred in the ordinary course of business? Yes(31) Was it paid in ordinary course? It was late but GV had been doing this for the last 3

months

(32) Factsa. Bank received a payment in full of a $10K unsecured 6-mo. Loan. The payment

was made in July 15, the date it was due(33) Is it a preference? Yes. Is it an avoidable preference?(34) Was the debt incurred in the ordinary course of business? Yes (Need to make sure that

it was really an ordinary business deal)a. Would LBO debt be incurred in the ordinary course? Probably not! There is a lot

of debt that can’t be called ordinary course of business debt. (35) Was it paid in the ordinary course? Yes, it was paid precisely as the K provided

a. Repayment of a long-term debt can be sheltered by 547c2 (Union Bank v. Wolas)

(36) Factsa. Jack, the principal stockholder in GV, was repaid on the due date of a 30-day loan

of $6K to help the business meet its payroll(37) Was the debt incurred in the ordinary course of business? Probably not. When an

insider loans money to make payroll, that is usually capital contribution and when he takes it out it is a dividend.

(38) For ordinary business terms, we need to look to the practice in the industry and market interest rate.

24.4Odd Notions is a button manufacturer that specialized in fine bone and shell buttons. It has been insolvent since January 1, but it has continued to operated based on an unsecured line of credit from the Des Moines People’s Bank. The arrangement has been that whenever Notions needs money to make its payroll or pay bills, it will call on its line of credit whenever Notions receives payments from its buyers, it deposits them directly to pay down the DMPB loan balance. The current year’s accounts between Notions and DMPB can be summarized as follows:

Date Transaction Amount Balanced owed

to DMPB1/1 Beginning balance $80,0001/3 Payment from Notions 5,000

$75,0001/15 New credit from DMPB 4,000

79,0002/10 Payment from Notions 2,000

77,0002/28 new credit from DMPB 8,000

85,0003/4 new credit from DMPB 9,000

94,0003/10 payment from Notions 1,000

93,0003/17 new credit from DMPB 6,000

99,0003/20 payment from Notions 10,000

89,0004/1 payment from Notions 9,000

80,0004/10 Notions files bankruptcy

How much of the payments from Notions can DMPB keep?i. First payment is not a preference b/c its more than 90 days. ii. What defenses might you argue for the other payments?

Could you use ordinary course of business defense? It doesn’t look ordinary b/c the numbers spike right before bankruptcy.

The earlier payments maybe. But is there a cleaner defense?

The new value defense (subsequent advance for new value) Which transfer will be protected under this rule?

The language of C4 – are there any payments after which the creditor gave new value to the debtor? Yes, the first two b/c more was loaned after that. But they didn’t receive anything in return for the last two.

iii. If on April 2nd the creditor had loaned another 6k, what would the preference be then on the last two payments? 13k (19 – 6)

iv. Answer 24.4: Highlight = outside of preference period, therefore out of analysis NOT CONTEMP EXCHANGE, b/c the agreement was not set up as such (c)(4) EXCEPTION might apply, as new value is given to D’or; but here,

the new value is A SECURITY INTEREST…WHICH IS NOT PERMITTED!

FIRST, FIND ALL PREF TRANSFERS = see bold SECOND, see if C’or gave credit or not afterwards = see italics

IF NO CREDIT GIVEN AFTER = VOIDABLE TRANSFER applies to 3/20 and 4/1

IF CREDIT GIVEN = can be OFFSET applies to 2/10 and 3/10

So, of the 27k in payments, Bank can keep 8k of it—only 3k of which was during the 90-day pref period

(1) Floating lien exception a. A floating lien is a security interest that covers debt that owes right now but also

property that may be acquired in the future. b. Problem:

i. Imagine you are lending to a grocery store that turns over its inventory after 45 days, so you would lose all your collateral within the 90 days and so you would never be secured … How does the bankruptcy code solve this problem? There is a simple, mechanical solution: 10% net improvement test – take two moments in time: preference day (90 days before bankruptcy) and bankruptcy day and you make two calculations. On preference day you look at the value of the collateral and the amount of the loan. If the creditor is oversecured, don’t worry about. If he is undersecured, you calculate the deficiency. Then over the course of 90 days, debt and inventory fluctuate. You can ignore all this. All you now need to look at is bankruptcy day. And you again look at the debt and inventory. If they are better off (more inventory) then you can cut off the extra and make it preferred. If they are worst off, we don’t make them worst off.

c. So the transfer will be insulated from preference attack under 547(c)(5) so long as the secured creditor does not “improve” his or her “position” within the 90 day period.

d. Note – this is another defense. You can use this defense, ordinary course of business defense, etc.

(2) Equipmenta. What happens if it’s a floating lien on “equipment”? b. As a practical matter, the “balance” is not as likely to fluctuate during the 90 day

period. c. Equipment tends to hang around once purchase.d. No defense (unless the equipment is proceed of a recievable)

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Executory Contracts

One of the things that a debtor has that is a value to a debtor are the bundle of contract rights. Some contracts are going to be losers – like just owing money. But other contracts are more complicated, like promising to mow lawn and them promising to pay me 10 bucks. How does bankruptcy deal with a contract like that? 365 language: the trustee, subject to the courts approval, may assume or reject any executor contract. What is an executor contract? There are obligations on both sides. If the one side has fully performed, then it is not an executor contract. Bankruptcy code : if the debtor wants to perform the contract, the debtor must make a motion to assume the contract. They then take the obligations of the contract as post petition obligation. Its like a post petition reaffirmation. To do this, you must also cure the pre-peitition default and make the remaining performances. Alternatively, the debtor may decide to breach. If the debtor rejects, he is rejecting post-petition, which we don’t like. So 365 does magic and backdates the breach and treats it as a pre-petition contract obligation. This means on bankruptcy day, the debtor gets too see which contracts he wants to keep and which he wants to breach.

Bankruptcy code has its own mini code on fraudulent conveyances, and it looks a lot like the UFTA. The main difference between the two codes is the statue of limitations is two years in the bankruptcy code.

The second way of bringing a fraudulent conveyance under the bankruptcy code is through the strong arm statute. The trustee has the power to bring a state law fraudulent convenyance to void a fraudulent conveyance on behalf of the estate.

If I am an individual bringing a FC, you can only get back what you are owed. In bankruptcy, bringing a FC, allows you to void the entire transaction.

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Some thoughts on reorganization:

Chrysler needed to put together a refinancing. Government was willing to kick in a package of loan guarantees to incentivize the creditors to sign off on the bankruptcy. The problem was that you still needed to get everyone sign off. The problem was that there were these two little banks that didn’t want to go along. There were these holdouts! How do they end up solving the problem? They gave them a really good deal. All the big banks took a haircut, and these two banks did actually well for themselves.

The following rules are to stop holdouts from causing too much problems. You can be bound to the plan even if you non-consent.

A. Negotiating the Plan

1. General Principles

a) Ch. 11 is a process. The rules only provide a framework for that process.

(1) All negotiations take place in the shadow of Ch. 7; thus, you always have to do a liquidation analysis to see how strong your bargaining position is.

(2) The debtor is in the drivers seat (though involuntary bankruptcy or foreclosure can force the debtor’s hand).

(3) Tax planning is really important – especially for the principle of debt forgiveness as income.

(a) Forgiveness of a debt by the creditors may be treated as “income” to the debtor. Usually a debtor can defer this tax to a later date so income stream can be paid to creditors.

b) “Prepackaged” Ch. 11’s – a debtor can often force little creditors to go along with a plan by rounding up the votes before filing and showing up in court with a plan already in hand.

2. Why do you need chapter 11? Why can’t they just do what they did in Chrysler?

a) Gives breathing room, automatic stay, gives you ability to sort through contracts and assets and sift through what you want to keep. And then you need to figure out how to distribute the value and that’s where negotiating the plan comes in.

1. Major difference between 11 and 13 –

a) In 11, all classes of creditors have to vote to approve the plan whereas in 13 all you need is the judge to approve the plan.

b) That means that you need to figure out how to classify the various claims. You also need to figure out which classes are impared, so they have a right to vote.

2. Best Interests and Feasibility

a) In order for a plan to be confirmed, it must be in the best interests of each creditor (not just creditors generally) and be feasible.

b) Best Interests Test – each creditor must either accept the plan, or get as much as he would in Ch. 7.

c) The Feasibility Test – the plan is likely to succeed (a case-by-case judgment based on the bankruptcy judge’s business judgment).

d) Problem 43 – Ch. 11 plan offers 50% to unsecured creditors ($50k total, your client has $10k). There was a $75k payment made to bank on a $100k secured loan for equipment (FMV$25k) within 90 days of bankruptcy (note this makes the bank fully secured).

(1) Do a hypothetical Ch. 7:

(a) The Ch. 11 proposal means there is $25k cash (50% of $50k) available to the unsecured creditors

(b) Recover the preference. The bank retains it’s $25k security interest (it’s undersecured, remember!); the recovery generates $50k more cash to distribute ($75k preference - $25k secured interest).

(c) Add the cash already available to the cash made available via the preference recovery: there is $75k to distribute ($25k + $50k)

(d) There is now $125k of unsecured debt to reach in a liquidation: the original $50k of unsecured credit and the $75k that the bank is undersecured.

(2) The Ch. 11 plan provides for 50% payment to unsecured creditors; in a Ch. 7, the unsecured creditors would have $75k/$125k, or a 60% payout, thus it’s not in their best interests.

(3) Note a creditor has no standing to bring a preference action by himself, but can petition the court to appoint an examiner for the DIP. § 1104.

Problem 32.1

FactsCountry Smokes produces corn cob pipes but has filed bankruptcy due to high gasoline prices and has proposed a plan of reorganization. Our client, Pany Chemicals produces chemicals for Country’s pipes and is owed $1 million as an unsecured creditor.

Bank insisted on a 7.5 million payment on the 10 million dollar payment bank in April, keeping only 2.5 million.

Country’s plan only proposes to pay $.50 on the dollar to unsecureds while secureds get paid in full. What legal ammunition do we have?

Answer

(1) Voidable Preferencea. $7.5 million dollar payment might be a voidable preference:

i. (1) behalf of creditor (YES)ii. (2) for antecedent debt (YES)

iii. (3) while debtor was insolvent (presumption under 547(f)iv. (4) made within 90 days before date of filing (YES)v. (5) Defenses to creditors: Do not apply (see below)

b. The Bank would have been an unsecured creditor for $7.5 million if the transfer had not occurred.

i. 7.5 / 12.5 (total unsecured claims) everyone would have received $.60 on the dollar

ii. Bank would have received $2.5 million secured + $4.5 million unsecured = $7 million is the total they should have received.

c. However, i. The Trustee (DIP) is the one who may challenge the voidable preference not

Pany. ii. If he goes to the debtor, bring the preference, the trustee is probably going to

say no bc/ they have already gotten to the plan. iii. Then the question is what can pany say in return? He can say I’ll vote against

it. Does that help him at all?iv. The best idea might be to get the DIP kicked out but that is difficult to do.

The court is very hesitant to bring in someone else.(2) Getting Creditors to block the plan

a. 1126 Acceptance of Plan i. 2/3 in amount of money and ½ majority of creditor in number must approve

the plan for the plan to gain court approval. ii. Trying to get the creditors to block the plan will probably not work in this

instanceiii. (so pany’s class is going to lose whether or not he objects)

(3) Best Interest Violationa. 1129(a) the court shall confirm a plan only if

i. plan proposed in good faithii. best interests test

1. If they hadn’t taken out 7.5 million, this would have been divided up between the unsecured creditors. The 7.5 million is a preference!

2. If we brought a chapter 7, I could have brought a preference action and have it the 7.5 million preferred.

iii. Does it matter if that the trade creditor class is going to accept the plan?1. Under 1129 – not necessarily. If you take a lot at best interest – it has

to be satisfied to each creditor. (4) Objection as to whether the projections of the plan are realistic.

a. Note i. A Judge would be hesitant to not confirm the plan in this instance because all

of the creditors except one is not on board with the plan. Pany’s challenge is based upon the assumption that a 547 voidable preference would be successful. Plus, Pany would only go from .5 to .6 in this challenge.

3. Classification and Voting

a) The creditors must approve the Ch. 11 plan. Approval is done by class. A class is deemed to have approved the plan if both of the following criteria are met: (§ 1126(c))

(1) > 50% of the number of creditors within the class approves.

(2) 2/3 of the amount of debt (i.e., holders of 2/3 of the dollar amount of the debt) within the class approves.

b) The debtor has a great deal of flexibility in setting classes. This permits “financial gerrymandering” (§ 1122).

(1) Each creditor need be “substantially similar” to other creditors within the class. § 1122(a)

(2) A plan can (with court approval) create a de minimis class for holders of insignificant amounts of unsecured debt for administrative convenience. § 1122(b)

(3) Any creditor doesn’t count for either of the above tests if he did not accept/reject in good faith or was solicited in bad faith. § 1126(e).

c) There is no requirement that all similar claims be classed together. US Truck (i.e., creditor interest vs. non-creditor interest).

d) Each class has to approve the plan or not be impaired, § 1129(a)(8), (unless there is a “cramdown,” see infra).

e) Problem 44 – same facts as 43 (assume you won). The debtor now proposes a 60% plan. Your client is still hacked off. Recall he has $10k of $50k total unsecured debt. Joining him in dissent is a holder of $6k of unsecured debt ($16k total held by the dissenters). $3k of the unsecured debt is held by multiple claimants of insignificant size. Can he prevent this plan from passing?

(1) The key here is that if you can edge the $3k holders out, you will have over 2/3 of the debt dissenting (16/47); if you can’t, you don’t (16/50).

(2) You could argue that creation of a de minimis class would be appropriate here for administrative convenience. You might argue that the little creditors weren’t solicited in good faith.

4. Impairment

a) If a class is not impaired, there is no need to get the approval of that class. § 1129(a)(8)(B).

(1) Members of non-impaired classes are deemed to have accepted the plan. § 1126(f)

b) What is meant by “impairment”? Legal impairment? Economic impairment? Both? The issue is fuzzy.

c) Each member of an impaired class must either approve the plan or get the same amount as they would in Ch. 7. §1129(a)(7)(A)(i).

(1) Note code words: “on the effective date of the plan” means they must get the same amount in present value terms as they would in Ch. 7.

5. Solicitation and Disclosure

a) § 1125(b) says acceptance of a plan cannot be solicited unless “adequate information” is disclosed.

(1) “Adequate information” (defined not-too-usefully in § 1125(a)(1)) includes information a reasonable investor would need to make an informed judgment about the plan.

(2) This includes things like a description of the business, a pre-filing history, financial information, a description of the plan, a liquidation analysis, management to be retained, pending litigation, insiders, and tax consequences. Malek.

b) Also note the “Safe Harbor Rule” that displaces SEC regulations. § 1125(e). So long as the plan is in good faith and complies with the bankruptcy laws, the solicitor can avoid those rules (including liability for fraud).

c) Problem 45 – same facts as 44. Plan is up to 70%. Debtor sues for a $2,500 preference paid to your client (which makes your client even madder). Also, the odds of the plan being successful are slim due to a backlog of orders is smaller than claimed. What to do?

(1) You could argue that the backlog claim means that there was not “adequate information” to confirm the plan. However, there is no liability for a bad faith failure to disclose (§ 1125(e)). So can you prove the debtor deliberately lied? If so, the court can revoke a plan procured by fraud. (§ 1144). (If you can’t, you could sue the company – but that’s useless. Can you sue the president personally?)

(2) It is unlikely that you could void the preference in a similar way. Your client knew about it from day one, even if he didn’t realize it was a preference. You could (weakly) argue that estoppel principles should govern.

547(c)(3) has a somewhat tortured history. When it was first incorporated in 1978, the intention was to insulate short term trade credit (like someone is paying balance every 30 days or so – continuing to pay like they always have. It said when the debt was incurred in the ordinary course of business and paid in the ordinary course of business and 45 days then it is immune and has to be paid according to ordinary business terms (standards in the industry). Then, people complained that 45 days is too short, so they took out the 45 day limit. Then, congress said that this rule applies to long term debt as well. Underlined is the three prong test that we have until 2005. Congress made it so that it must be incurred in the ordinary course of business and either paid according to normal industry standards (objective standard) or how it was usually paid between these two parties (subjective/private standard).

33.1

Plan offers $.60 on the dollar to USC which is what USC would receive in Chpt 7 but Pany wants to shut the business down (Bad faith). Business Reason: Pany wants to write off 40% now instead of in the future.

Pany is an impaired creditor 1124 “legal, equitable and contractual rights” altered. Only gets $.60 on the dollar.

1126(c) requires approval by simple majority of creditors (yes) and 2/3 majority of debt (yes) ($1,000,000 out of $5,000,000 unsecured. Only a $60,000 payout- impaired)68% 3.4mm of 5.0 mm will vote in approval so 2/3 approval. You only need 1/3 voting no to block the plan. You can buy the votes of some of the other unsecured creditors.

Is there an argument for having them separately classified? 1122(a) creditors in same class must be substantially similar.

1126(f) unimpaired creditor is conclusively presumed to have accepted the plan

1129 two means a reorganization plan can be confirmed (a) meet eleven requirements

(8) all impaired classes of claims accept the plan (b) “Cram Down” if (a)(8) isn’t met plus two additional requirements must be met Plan cannot discriminate unfairly and is fair and equitable. Court might approve

Creditors accept by class and not individually individual is protected by best interest and feasibility test

Impairment502(b)(6) Caps debtor’s legal, equitable, and contractual rights.

Debtor may propose that creditor is acting in bad faith (Pany wants to dissolve the business) BUTPany has a business reason (tax advantages) of proposing the plan

REQUIRED DISCLOSURES- similar to the disclosures required for publicly traded companies 1125 (a)(1) “adequate information”

(b)

1125(e) Safe Harbor Rule: no person connected with the solicitation of plan acceptances and rejections is liable for a violation of securities law, so long as person is acting in good faith and compliance of title 11.

Prepackaged Bankruptcies All of the elements of a bankruptcy (including post-petition negotiations) but worked out privately rather than by court order. 1126(b) SEC companies: pre-petition votes are effective as long as they comply with all disclosure laws and regulations 1125(a) Non-SEC companies: pre-petition votes are effective if comply with Bankruptcy Code

Supposedly cheaper and quicker for companies to pursue a prepack. The principal attraction of prepacks is that they provide little opportunity for opposition to form before the whole process is over.

So we haven’t been able to figure out a way to block the plan based on a forced reclassification.

What about the mortgage lender who may be willing to vote with you but has been classified has been unimpaired?

What does that mean unimpaired? That it won’t effect them either way. The mortgage lender right under state law is to foreclose right now. So the mortgage lender is saying I am impaired. How this will effect them is that they are de-eclarating them and it will be paid over time. In chapter 13, this would not be impairment, but how about in chapter 11?

It’s not. The deccelaration and cure is not an impairment.

-Last chance – some creditors have been bribed to vote for the plan.

1126(e) - that is not allowed – to do something like that under the table.

Review of last class: so we see feasibility and best interest here in 11 and in chapter 13. What is unique in chapter 11 is that creditors get some say in how the debt payments is distributed.

Chapter 11 is a bit more complicated in terms of distribution b/c of the reorganization, which makes the “pie” larger for the creditors. However, what you are an entitled to as a creditor does not expand. You are still only entitled to what you had gotten if the business did a chapter 7. This surplus of the pie is left to negotiation and voting. This is what we are doing here, when distribution is agreed to by consent.

We also recognize that getting everyone to agree is going to be impossible.

So the first question is who gets to vote? Only impaired classes of creditors. b/c if you are getting what you are entitled to under non-bankruptcy law, there is no particular reason to ask you your opinion. The more tricky part is what is considered to be impaired.

You are impaired if any of your rights or benefits have been changed.

Impairment -

Legal and equitable rights unchangedDefaults may be cured under the plan

Acceptance:½ in number of creditors2/3 in amount of debt

Most of what we will talk about today is solicitation in getting a vote.

Class members who were paid extra by the debtor – can’t bribe voters

Claims trading – one of the things that you wouldn’t necessarily expect, but often happens is people selling their debt to someone else. Are there any problems that might arise from selling debt?

One problem is if its appropriate to classify classes together when they are now owned by different kinds of creditors. Another is that interests change depending on the creditor so it can disrupt the debtor’s negotiations with the creditors.

Problem with a buyer who now has a voting right but also at the same time shorts the company and now hopes that the company will fail. This is usually not a problem b/c debt does not have governance power … except in bankruptcy.

The court has explored the option of designating these debt as being purchased in bad faith.

Another problem is that when you get this proposal you have no idea how to vote. So most logically you should look at the biggest creditors in your class. They have the resources to know what to do. However, now, there is a problem – the creditors may have sold off their debt and now we don’t know what their interests are and if their interests are the same as yours.

The court came out with rule 20 19 that requires all members of committees need to disclose their position (which I think would include these big buyers of debt)

Remedies to this problem (1) 20-19 disclosure (2) claims are designated and don’t get a vote. The problem is that it requires very bad behavior to get to that issue.

Prepackaged Bankruptcies All of the elements of a bankruptcy (including post-petition negotiations) but worked out privately rather than by court order. 1126(b) SEC companies: pre-petition votes are effective as long as they comply with all disclosure laws and regulations 1125(a) Non-SEC companies: pre-petition votes are effective if comply with Bankruptcy Code

Supposedly cheaper and quicker for companies to pursue a prepack. The principal attraction of prepacks is that they provide little opportunity for opposition to form before the whole process is over.

34.1

Country Smokes agrees to now pay $.70 on the dollar to USCs. But after confirmation turns around and sues Pany as a “preferred creditor” (received a preference payment prior to all this) even though there was nothing in the plan about pursuing “preferreds” and they want to take 40 cents on the dollar back.

Can you block the preference cause of action? Where would you have expected that Pany should have made this disclosure? In the disclosure statement! The disclosure statement will list who they have gotten so far under the preference cause of action and often there is boiler plate language that says that they will continue to go after preferreds. If the statement is silent about going after further actions, some jurisdictions will say this is estoppel.

It’s actually a pretty good idea by an atty. who represents a creditor to know if they have any preferences.

What about the misrepresentation about the backlog? The projections about the business are made in the disclosure statement. What is the requirement for approval of the disclosure statement:

1125 Postpetition Disclosure and Solicitation (a)(1) “adequate information” includes: description of business, financial information, description of plan, how plan is to be executed, projection of operations, it basically requires you to provide enough to make an informed decision. Section 1125 also provides a safe harbor for the plan proponent for the disclosure statement. Does that mean there is nothing we can do? you might be able to go after the disclosure statement and say that it didn’t provide adequate information. That’s true if the order was procured by fraud. Can you go after them for a securities violation? The safe harbor only applies if the plan was proposed in good faith (so 1125 insulates if he was just a dummy). Also would you be able to get him under 1144? It has to be procured by fraud / dishonesty.

Week 13

Cramdown If meets Best Interest Test of 1129(a)(7) and meets Test of Feasibility, still must be accepted by majority of creditors in each impaired class under 1129(a)(8). If 1129(a)(8) not satisfied, go to 1129(b) Cramdown.

1129(b) requires at least one impaired creditor class agreeing to the plan. Even if multiple classes reject, as long as one agrees, debtor can confirm the plan if 1129(b) requirements are met. So long as the plan is fair and equitable and there is no discrimination. The tricky part is what is a plan mean for a plan to be fair and equitable:

1129(b)(2) sets minimum requirements for a plan to be “fair and equitable”

(b)(2)(A) Secured Creditors- liens must be preserved, creditors paid the present value of their collateral plus interest payments at market rate. The undersecured amount becomes unsecured.

(B) Unsecured Creditors- Best interest test must be met and in addition, the Absolute Priority Rule. Unsecured must be paid in full before a class below them (equity holders) are paid anything. Unsecureds who reject plan, cannot be “crammed down on” unless equity holders get nothing. Absolutie priority rule – cannot be approved over an objection of a class unless that class is paid full or the stock holders have to be wiped out.

What happens if the old shareholders say we would like to continue to own the company. We recognize that our current shares will be canceled, so we will infuse 1 million and we want to be shareholders in the new company

(C) Equity Holders

1129(b)(1) permits cramdown of rejecting class only if plan does not discriminate unfairly between classes and is “fair and equitable.” 1129(b)(2) sets minimum requirements for a plan to be “fair and equitable”

(b)(2)(A) Secured Creditors- liens must be preserved, creditors paid the present value of their collateral plus interest payments at market rate. The undersecured amount becomes unsecured.

(B) Unsecured Creditors- Best interest test must be met and in addition, the Absolute Priority Rule. Unsecured must be paid in full before a class below them (equity holders) are paid anything. Unsecureds who reject plan, cannot be “crammed down on” unless equity holders get nothing.

(C) Equity Holders

Bank of Am. Nat'l Trust & Sav. Ass'n v. 203 N. Lasalle St. P'ship,   526 U.S. 434 FACTS:  Creditor, challenged an appeals court decision that allowed respondent to judicially cramdown under § 1129(b) the confirmation of a reorganization plan that petitioner had previously blocked on a consensual basis under § 1129(a)(8).

RULING:  The Supreme Court reversed the decision of the appeals court and remanded. Respondent's prebankruptcy equity holders were unable to, over creditor's objections,

contribute new capital and receive ownership interests in respondent because that opportunity was given exclusively to old equity holders under a reorganization plan adopted without consideration of alternatives.

Debtors failed to meet the requirements for cramdown under § 1129(a), o The absolute priority rule was not followed. o The disputed plan gave debtor's partners the exclusive right to retain their

ownership in the indebted property because of their status as prior interest holders and

o creditor's unsecured deficiency plan would not be paid in full. o Allowing old equity holders alone the opportunity to recover estate property was

unjust.

HOLDING: The Supreme Court reversed an appeals court decision that permitted respondent debtor to use cramdown to approve a reorganization plan over major creditor's objections. The plan, allowing respondent's prebankruptcy equity holders to contribute new capital and receive ownership interests in the reorganized entity, violated the absolute priority rule by rendering a property interest extended on account of the old equity position.

Cramdown on Secured Creditor1129(b)(2)(A) secured creditor receives present value of allowed secured claim and gets interest at market rate on amount equal to value of the collateral. “lien-stripping”- giving full value for the secured portion of collateral, putting undersecured portion in with unsecured claims.

1111(b) election- can force the debtor to pay the full number of dollars of its entire claim Non-recourse loan- debtor has no personal liability. Creditor cannot pursue a deficiency.

How long will the exam be – 3 or 3.5 hours.

Cram down on secured creditors – a secured creditor class does not accept the plan in chapter 11 can be forced to accept the plan as the same way as a secured creditor under chapter 13 – that means they retain their lien on the collateral but the size of the collateral is reduced to the allowed amount of the secured claim. Meaning the lien is stripped down to the value of the collateral. The distribution that he is entitled to has to equal at least the amount of the present value of the secured lien. (this is just a review of what we have done several weeks ago)

There is one bizzaro provision which is that the secured creditor can do something called the 1111(b) election. What is this? The secured cred. Can elect to have their secured lien not stripped down and their claim allowed in the full amount of the debt. Well – jee – why wouldn’t you always do that? What we are saying is the claim will be allowed in the full amount. Let’s imagine the following situation – a secured claim of 100k and collateral worth 50k. so they get 50k secured and 50k unsecured. So now if you don’t the 11 11 b election then you retain a lien to the allowed amount (50K) and you receive a claim to the present value of the 50k. what happens if you make an 11 11 b election? The allowed lien is now 100K and you are entitled to receive 100k with a present value of the collateral which is 50K! (so its only worth 50k now but is equal to payment of 100k – this is allowed thorugh the time value of money.) what does this mean? They can pay you 100k over 10 years but the present value is only going to be 50K. effect is that it usually prolongs the payment plan. Why would this be advantageous if you are delaying payment and you don’t get more money? You are betting that the value of the collateral will have rebounded. If the debtor decides to sell the property, they have to pay your debt off in full. So basically the effect is that you think the value of the collateral will increase and you want to carry the upside. (b)(2)(A) Secured Creditors- liens must be preserved, creditors paid the present value of their collateral plus interest payments at market rate. The undersecured amount becomes unsecured. (B) Unsecured Creditors- Best interest test must be met and in addition, the Absolute Priority Rule. Unsecured must be paid in full before a class below them (equity holders) are paid

anything. Unsecureds who reject plan, cannot be “crammed down on” unless equity holders get nothing.

What if the plan provided that pickens would make a new equite contribution of 200k and in return he would be issued all of the stock in the reorganized company? In order to satisfy best interest, you have to value the stock (and you do that by valuing the company) there is concern that that 200k may not reflect the real value. They may running down the value of the company to shrink the apparent value of the company.

Under the BK act recognized the (1) value problem and (2) old equity may be the most willing to contribute funds and we don’t want to squeeze them out just b/c of bad timing. The supreme court fashioned: the new value to the exception rule – if the old equity contributed money or money’s worth the plan could be confirmed so long as additional requirements (1) new value is substantial (2) the new value has to be reasonably equivalent in value to the new ownership interest (3) vital to the reorganization process.

It has been a puzzle as to whether this rule was part of the BK code or note. 1129 says fair and equitable and then states the absolute priority rule and then says nothing about the above rule. The supreme court looked at this problem and decided that they will not reach a conclusion. They are not sure they are going tomake a new value exception. So for instance, sweat equity is not considered money’s worth.

Then in 203 North lassale the court remained somewhat inscrutable.

Law – lower courts do approve new value plans but you have to prove up valuation both by showing evidence of value and that the equity has been exposed to the market in some way. So can pany object to the 200k? Yes. There hasn’t been any evidence that it’s been exposed to the market. It doesn’t tell us if we’re still in the exclusive part (we are concerned when old equity buys b/c we are concerned that they are getting a very good deal. If the debtor is proposing this during the exclusive time, you have definitely not exposed it to the market)

What does it mean that it’s been exposed to the market – unclear. Courts are wrestling with this problem.

Now, lets come back to a case with a secured creditor: Problem – imaging galactic is owed 100k by amphy secured by collateral worth 145k. wordl bank is secured by a second lien on the factor but is under secured. The two creditors were put in two different classes. Both secured creditors rejected the plan, but the unsecured accepted the plan, so we are now trying to cram down on the secured creditors. If we assume that world bank didn’t make an 11 11 election. The first thing yo uhvae to do is find out the value of each creditor in the property. Galactic is going to be 100k. world’s is going to be 45k with a deficiency. In order to figure out what galactic is entitled to is to retain its lien to the extent of the allowed amt (100k) and its entitled to payments of atleast 100k with a pv of 100k. what is world entitled to? A stripped down lien of 45K that is the allowed amount and pmts totaled 45 with a pv of 45K. Now, in the absence of an 11 11 , each of

the amounts is always the same. (you are always going to have to talk about interest – till is what we have talked about, but here we use something a bit lower). If world were to make an 11 11 election, how would that change things? Instead of having a 45k secured claim, they would have an allowed an 85 k secured claim, theya re entitled to retain a lien worth 85 k on collateral worth 45k and they are entitled to payments worth 85 with a pv worth 45 and the effect here is that all the numbers are no longer the same. The allowed secured claim and the lien amount remain 85k but the pv is only worth 45k.

35.1 (pg. 681)Pany wants to defeat Country’s plan. Country has offered to pay $.70 on the dollar but has recently been awarded a big contract and is able to pay more. Pany and other UCS want more money or will vote to defeat the plan. Can plan be confirmed over protest of USCs? Not unless one impaired class votes for the plan. If the bank agrees to less than full payment? The cram down might happen depending on the court.

Is the debtor the only person that can provide a new plan? No. for the first foru months of the case – it is the debtor’s exclusive right to reorganization. Afterwards, other interested parties can proposeAnother option is liquidation if the case crashes.

Requirements for cram down: If the bank sees they are going to lose as a result, they can make themselves impaired and then they can vote to get the plan passed.

If meets Best Interest Test of 1129(a)(7) and meets Test of Feasibility, still must be accepted by majority of creditors in each impaired class under 1129(a)(8). If 1129(a)(8) not satisfied, go to 1129(b) Cramdown.

1129(b) requires at least one impaired creditor class agreeing to the plan. Even if multiple classes reject, as long as one agrees, debtor can confirm the plan if 1129(b) requirements are met.

1129(b)(1) permits cramdown of rejecting class only if plan does not discriminate unfairly between classes and is “fair and equitable.”

1129(b)(2) sets minimum requirements for a plan to be “fair and equitable” (b)(2)(A) Secured Creditors- liens must be preserved, creditors paid the present value of their collateral plus interest payments at market rate. The undersecured amount becomes unsecured. (B) Unsecured Creditors- Best interest test must be met and in addition, the Absolute Priority Rule. Unsecured must be paid in full before a class below them (equity holders) are paid anything. Unsecureds who reject plan, cannot be “crammed down on” unless equity holders get nothing.

(C) Equity Holders

Look to Absolute Priority Rule if cramdown is attempted. If anybody under Pany is paid before Pany is paid in full, plan will not be confirmed. If Old Equity gets nothing, the cramdown is probably going to go down.