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09/08/2003 I. If this is a money obligation, and there is not enough to go around.

Establishes the boundary line for how hard the creditor can squeeze. Also, boundary line of how long the creditor can squeeze. When there are several creditors all vying for the same pool of assets, which one comes first. Article I, Section 8 provides that Congress can establish a uniform law of bankruptcies. a. Constitution usually has no commercial provisions to it. b. Bankruptcy has a checkered history. Tell you a little bit about the fortunes of the people who signed the declaration of independence. c. 1898: first bankruptcy law that is fixed. i. Substantially amended in 1903 that gets more balance in it ii. Also substantially amended during the depression. 1. Repayment element of bankruptcy iii. Amended in 1970s: 1973 commission recommends lots of changes. Bankruptcy act of 1978 goes into effect 1979. d. In 1984, more creditor provisions and other business provision. In 1986, a new provision was added for family farmers (Chapter 12). e. In 1994, pursuant to credit industry, got what well do is appoint another commission. i. Results in commission report in 1997. As bankruptcy becomes more polarized, in October 97, the credit industry said was dead on arrival. So congress put in credit versions to Congress. 1. Congress that adjourned in 98, passed in house but not senate. 2. Clinton vetoed in 2000. Bankruptcy is a course in corporate refinance. This is where any business in financial trouble looks (11 U.S.C. ). What would happen if this business files for Chapter 11? Businesses who get into financial trouble and decide not to and go to creditors instead to work something out in corporate refinance. a. If this went into Bankruptcy, here are what my rights might be. The second way that it is important in corporate refinance and as more companies have become more leveraged. What has begun happening is that as more deals come about, the more sophisticated players try to figure out what the bankruptcy position is. If at different points down the time line and the other party to the deal collapse, how much could you still squeeze, leverage, and get services or could you back away cleanly to find other sources for goods/services. b. Bankruptcy has now moved transnationally. c. Bankruptcy established a framework for negotiation. i. When Maxwell (publisher) collapsed financially a few years back with the suicide of the CEO and financial troubles, where did it file for bankruptcy. It was a UK company but had huge assets in US. They filed dual actions in UK and US and both courts negotiated what law would apply. What was the very first thing negotiated? Attorneys fees (at US rates). ii. There is another game going on. The US is way down on one spectrum on bankruptcy on debtor relief and creditor power. US bankruptcy law provides more protection for debtors than any law in the world. 1. But now, more countries are adopting bankruptcy laws like the US. (See Canada, Mexico). iii. Many things that happen in transnational business is that they try to get enough assets in the US so that they can file a domestic bankruptcy. Once a filing in the United States, we claim to deal with property across the world. 1. There is a shift of how world deals with financial problems since US is asserting jurisdiction across the world. Macro-economics a. Organized system for dealing with failure in free-market economy. b. Not having a bankruptcy system may mean that the fastest guy, or biggest guy, or guy that gets the sheriff moving first.

II.

III.

IV.

c.

V.

I.

When soviet fell apart, big problem was that people were working in state-owned businesses. They didnt want to close the businesses so what they did was enact strong bankruptcy law and use it as a way to transfer from state to private owned. i. Also important is contract law, judicial system that you can rely on. d. When something fails, how do we get the people and services back to productive use? i. It makes no sense to tear building down and lay people off. ii. The horror of acknowledging what went wrong (acknowledging losses) is what is dragging down the Asian economies. e. Sovereign Insolvency i. Countries going bankrupt (those who took out large loans from the IMF) ii. The real question when you understand bankruptcy is that should we do this with countries as well. Perhaps we should start thinking about these in the international economy. 1. Should we take losses with respect to countries. Social Policy a. About job, families, healthcare. i. Bankruptcy law has become the insurer of last resort. ii. Half of families that file for bankruptcy do so after a serious medical problems (800,000 families / year) iii. 2/3 of all families that file for bankruptcy do so after they have had a job loss (1.2 million / year) b. So if we dont liquidate factories, perhaps we may save 50K jobs for those already there. c. Middle-class social safety net (along with social security and unemployment) i. Public safety net is there largely for the poor (welfare, subsidized medical care) d. When you use a measurement of the middle-class (education, whether you have a home, prestige job), well over 90% have 1 criteria of the 3 and over half have 2 of the 3 characteristics. e. A family with minor children is 3x more likely to file for bankruptcy. i. This year, more children will live though parents bankruptcies than divorces, cancer, graduate from college. General Topics a. Leverage b. Distinction between secured and unsecured credit c. Garnishment d. Fraudulent conveyances *** e. Bankruptcy i. Consumer in Chapter 7 (liquidation) ii. Chapter 13 iii. Chapter 11 (reorganization) P. 14 (Problem Set 1) a. Problem 1.1 i. Consumer 1. Debtors a. Where they owe money? i. Mortgage on their home ii. Student loans iii. Car loans iv. Credit Cards v. Tax liability (sold something where no one collected money) vi. Business liability (not incorporated and personally liable) 1. the might have become personally liable on a note (personal guarantee secondarily liable) a. Order of liability i. Go to business first vii. Are you a debtor in this action before there has been a lawsuit? (running stop sign and hitting someone) yes

II.

viii. ix. x. xi. xii. xiii.

xiv.

Liability is not yet fixed. A jury might find that you are not liable (contingent liability). 2. Unliquidated liability (dont know the judgment amount) Alimony or child support Anything youve gotten something and havent paid for it yet. Gambling debts Falling behind on payments of rent Property taxes (many jurisdictions for past services) Home equity loans 1. Contract says that well lend you money, and if you dont pay, then we will come get your house. 2. Compare to credit cards: balance on credit cards can go up and down (revolving loans compared to fixed loans of fixed term (home equity)) Payday loans 1. Short term cash loans. Distinct from credit cards. 2. Payday loans have fixed term (i.e. 14 days). 3. Payday loans have fixed amount. 4. Tricks: a. Effective interest rate: $50 interest on $150 loan (i.e. 1,000% APR) b. Rollover to next period for a fee

1.

2.

Creditors a. Money is owed to you (whenever you prepay) b. Where you prepay rent. Why do landlords want you to prepay? (its a leverage point) c. Prepaid insurance (1 month, 6 months into future) i. Why do most insurance companies insist on being the debtor? If you paid the premium for past periods, then you know if youve been in a wreck. d. Bank accounts (i.e. you lent money to Fleet when you put your money into checking account) e. Bonds f. College Tuition g. Creditor to your employer h. Warranty on appliances (you are a creditor for the period of the warranty) i. Pension plan j. Vacation Plan / Sick Day (you are putting in work now for something promised in the future) k. Airline Miles / Rebates l. Down payments (i.e. layaways) m. Utility deposits n. Tort Victim o. If you lent someone money (personal loan) p. Uncashed lottery ticket q. (Contingent creditor) unscratched lottery ticket r. Postage stamp s. Cash value in your life insurance (riskier that someone dies as time goes up so cost goes up). i. Whole life insurance is stable fixed amount every year. That amount exceeds the insurance amount, so they invest the rest of the amount so in effect what you are buying is a mutual fund and life insurance together.

b.

Business Context

i. Creditor 1. Account Receivable ii. Debtor 1. Account Payable 09/09/2003 I. II. III. Contingent, liquidated, unliquidated debts Contracts usually happen over time. a. When an individual goes bust, there may be several mid-steps (pre-contract, post-contract actions) Problem 1.2 (Leverage) p. 15 a. Pathologist brings 10K a month. Owes 1,200 / month. Before exploring any legal action is to look at leverage each of the other creditors have. i. Central Bankhome mortgage: they can take her home away so very high leverage. If you lose your home, what may happen to you financially? Your living expenses may actually increase. Tax advantages. For middle class, it is your largest asset. Cant get job without address. If you cant keep a home in that zip code, kids cant stay in the same school or cub scouts (social ramifications). 1. Why would people be willing to go 1 or 2 months without paying mortgage? a. Its not so easy to toss people out of their homes. The ramification of paying 1 month late is the $150 penalty and interest. The peculiar point is that it is hard to exercise the leverage. ii. Watkins Savings, car loanthey can take your car. Seems like less leverage because attachment is less. But in reality, you need it for work/food, but the real leverage is that they can repossess the car. You fall behind on the car payment, and they can take away the car really fast. iii. Veterinarianunsecured obligation. The special leverage is that the vet can always refuse future services. How often does the dog get sick? The leverage comes from denial of future services. iv. Reich, the coworker: He can ruin your reputation at work. Why dont you like owing money to coworkers? because you have to see them everyday. (personalized pressure) v. Farmington Country Club: clearly something about social embarrassment. Country club posts delinquent lists. vi. Shell Oil: can deny future services but not much leverage because there is big supply, so no leverage. 1. Only leverage is that the credit rating can be hurt. a. This is painful because they are finding another way to get future denial of services. b. They are also trying to accomplish scarcity c. They are also trying to make it cost you a lot more money because they will keep you from buying at the cheap rate. They will also increase the default rate of interest. vii. MASTERCARD, bank card: Mastercards success has turned out to be its downfall. If the margin (difference b/w what credit card has to get the money and what they can charge you) is small, they must ensure that you pay it back. If the margin is great (borrow at 3% and lend it on CCs at 15.5%), then the decision to lend from the CCs point of view is that it is a marketing game rather than careful screening. The game is loaded that even if you cant pay forever, but maybe 7 months, they will be in the black on your loan. 1. MASTERCARDs problem is that this is a market share game, in fact, it is astonishing to watch the competitionwhether there is leverage, its a question of (1) credit reporting (2) costs and (3) whether you will be cut off from other types of CCs viii. Talbots Clothing Store: Leverage is that if you really like to shop there, you may not be able to. But today, is that you can use general credit cards. So retailers have lost capacity for you to come into store.

IV.

ix. John South, alimony payment: can get remedy from judge. If you dont have alimony, you can have (1) wages garnished, (2) humiliation (3) state has an interest 1. The law got tweaked up because state had an interest because they have no good leverage otherwise. Further, politicians sought women votes by making stronger alimony laws. 2. The best leverage is that you can actually send them to jail. 3. Govt agencies are now spending 10X more on enforcement of child support than they were a generation ago. b. Our client doesnt have much leverage except for reporting to credit card agencies. i. Perhaps you could sue for $53,666. Downside is that she might be judgment proof and the litigation costs are not recoverable. Chance is that you might lose (sympathetic jury, some defect, some clause that turns out is not lawful, some defense available that you didnt know about) 1. This is not like a default judgment (where they dont come in at all) a. People who usually dont come in are usually in default b. These are poor people (not sophisticated, not stable addresses) c. Our debtor here is sophisticated so she will not default, and is a high risk. ii. You could report her to the IRS for cancellation of debt (but then she is unlikely to repay) 1. The leverage is the threat to tell the IRS. Once you tell, you have little leverage left. iii. What other advice do you have? 1. Get all three loans consolidated into one and get house for leveragethe legal problem is her permission is to take that loan and link it to the house and car. 2. Perhaps, Security Bank can renegotiate the loan and offer lower payments. (looking for credit rating reporting, threaten to sue her). Make it cheaper for her to pay and more expensive not to pay. a. A safe bank is a count of number of non-performing loans to performing loans. i. What kind of cheating problems do you have? 1. I can turn any non-performing loans into performing loans (i.e. turn it into $1 / month and a balloon payment at the end). b. You could also offer to renegotiate the payment terms 3. Id rather have 2/3 of the amount of the loan, but what I want is a second security interest on your house, and your car. P.30 (Problem 2.1) a. Payday lending problem (Your failure to respond to this notice will result in apply for a warrant for your arrest.) i. Violation of state usury laws? No violation of usury laws. You become a national bank, and make your home state a jurisdiction with no usury rate or a very high one (MD, DEL). 1. Interest rate in the home jurisdiction controls. ii. Fair Debt Collections Act? 1. Is Payday loan a debt collector? a. 803(6): A debt collector is one who is in the business of collecting debts. i. Offers no protection from the bank. ii. Includes any creditor who in the process of collecting his own debts, not in their own name 1. If under Payday-lending then they dont care if they violate that. 2. It says that the action is not wrong but only wrong if done by others. a. (Policy) Why? Political pressure from banks and other lenders. i. Debtors testified that they were being harassed. So credit industry said that: 1. let me tell you who the bad guys are, the debt collectors, and let the debt collectors in the cold. a. The debt collectors are the guys on the bikes.

b.

These debt collectors are not the same guys. Department stores bolstered their argument by: i. Common law is not an effective against Sears and two-guys. When you get the giant judgment against two-guys, you cant get any money. ii. Not many lawyers would sue two-guys. Sears argument is that they have larger assets and lawyers will sue us. If you cut out the debt collection agencies, you will get the worst folks out of the game. d. Reputational Argument: they cant afford to hire people who will piss off their (thats why you cant do debt collection under a different name and still claim the exemption). What are the options for a dentist (who really pays for the FDCA)? i. Prices are raised. So if two-guys have to double their prices (because they might get hit), who pays it? Sears is big enough so that it can form its own collection agency and not subject to FDCA. However, a dentist, a small creditor, MUST to outsource it. 1. Interesting competitive effects (big stores v. small stores) Why is it that Payday lenders use post-dated checks? i. Having a check in hand is that they can deposit it. In a sense, its like an assignment. ii. What are Payday lenders looking for? 1. It is a felony in many states when you write a post-dated check. They can go to sheriff and get you thrown in jail or sheriff will say that they will throw you in jail if you dont pay. What could be the violations here? i. 808(3) Intent to threaten with criminal sanctions ii. 808(4) depositing check early iii. 808(2) Taking more than 5 days and not giving notice within 10 days iv. 808(?) Threatening action that you dont intend to take. This seems like a good investment

b. c.

c.

d.

e. V.

VI.

Problem 2.2 a. Lawyers as debt collectors. L represents Ms. Chalmers and a tenant who left with $2000 on damage. Debtor charges Fair Debt Collections action. i. Does FDCA apply to you? Are you a debt collector? 1. Lawyer is collecting for someone else? Argue no, FDCA does apply to you. a. Argue not a principal business of collecting debts for others. I represent people who are trying to get paid. ii. Is this a debt collection action? 1. Trying to enforce a legal right, and this is not a debt. iii. Did L violate any action of FDCA? 1. How many times did you haul youself down and litigate for $2,000? If I can show you never litigated anything below $2,000, if 807(5): huffing and puffing is not OK if you are a debt collector. 2. Threaten to sue in small claims court (lends credibility, but not for a lawyer bringing it). 3. Are you absolutely sure that $2000 is the actual damage. If it turns out that it is only $1000 worth of damage, then perhaps 808(1) violated (falsely represent the amount of the debt). Problem 2.3 a. K-market hires a debt collector. Debt collector, Fiddle, returns 85%. Debt collector tacks on own collection fees to the debt. Violation of FDCA? i. Fiddles first defense is that he is not a debt collector:

Hes paying 85% of what he collects that makes him a squarely a debt collector When customer handed check, they never went into a credit-debtor relationship because K-Market doesnt take debt. a. It turns out to be a debt. They ran the risk that you would run into a debt. ii. Consequence of adding fee on in violation of FDCA? 1. FDCA prohibits tacking on the fee unless provided by contract. 808(1) a. By posting a terms of the contract, does the person agree when using a check? VII. 09/15/03 I. Problem 3.1 (p. 42) a. Flora-Ship has asked to have a line of credit above the current $6 million. DiSilvia believes Flora-Ship is a failing business. i. How closely is this debtor tied to the bank economically? 1. Very closely tied. What are the things that tie Flora-Ship to DiSilvia? a. They have 1 creditor. Look at their cash flow: They are making all of their payments out of borrowed money. They pay down weekly. b. The put all of the money they get all day and deposit it into a blocked account. The next day, they get their money by their revolving account. A blocked account is an account that you cant access. Economically, it is always a payment on a loan. All of their receipts go to the bank and pay down the loan, and the next day they borrow again. c. You have a blocked account because i. (1) to keep the debt lower and ii. (2) so that continued existence is at the banks mercy (this is a leverage point to make sure that they get paidif you dont pay them, they have a lot of leverage iii. (3) very seasonal debtors like this because they arent borrowing a lot of money when they dont need it (they are just paying down when they have it) iv. (4) You are standing in front of someones books everyday. d. Remember there are no other accounts. Also, bank has security interest in the flowers, van, and equipment. The first bank has taken a security interest in almost everything, and this ties the debtor to the creditor tightly. They cant put their receipts anywhere. Can they raise cash anywhere else? No, there is no collateral left. 2. This loan is not ever supposed to pay off. They make money off the interest. ii. How secure is the loan? 1. Book Value of equipment is the $3.5 million. It may not actually be $3.5 million (either high or low) depending on the amount of depreciation. Book value comes from the purchase price according to either a tax/accounting formula. 2. You also have accounts receivable of $2.1 million. There is no way they are worth $2.1 million. What would you want to know if you wanted to value? a. Do they tend to collect 90%, 94% of what they have outstanding? b. The number of people whose bills will fall to lower priority (because if they are going out of business, customers will not be able to return). c. If you have lots of small ones, they may be expensive to collect. d. Also want to know how many of the accounts are past due. i. Accounts have discount rates (i.e. 5%, 10%, 40%) for those 30/60/90 days past due. 3. Inventory has value of $0.5 million. Usury a. Usury laws were removed when inflation was really high, and these usury laws seemed not so bad.

1. 2.

a. b.

You have no time before this one falls apart. You must have contacts to sell it to someone else.

c.

What should the bank do to back out of the deal? i. Do NOT unblock the account receivables (because then you increase the amount of losses by the amount of the account receivables). ii. Current debt is $5.7 million. If the equipment is worth $5.8 million, you would want to liquidate. iii. If the equipment is actually worth $2.5 million, then what are you inclined to do? 1. The worst shape the debtor is, the impulse is to hang in there for longer. If you cancel the deal, then you take a guaranteed hit. a. But if you hang on, a year from now, the value of the equipment may depreciate further. iv. When you decide that you want out of this business decision, what is the debtors first move? 1. Uncooperative debtor can destroy much of the accounts receivable (or destroy anything of value that you have). a. What would you have to show on a lender liability suit? i. If you live in the 2nd circuit, then no lender liability suit possible. ii. KMC (p. 34): Flora-Ship has to show for a lender-liability suit: 1. Notice Issue: That bank sprung this on the debtor and didnt give debtor chance. So you would make it seem that it was a blocked account (tightly tied), and if you pull the line of credit, you knew that my company would not survive under those circumstances. You knew that my company would fail. 2. Debtor may bring a lender liability suit? v. DaSilva needs to give notice to avoid lender liability suit. 1. The more notice you give your client, your client has more time to make your collateral worthless. 2. It may take weeks to get new credit. The other banks are going to want to know why they want new credit if they also have a relationship with DaSilvia (commercial bank). 3. If creditor comes and seize everything, the business is gone. Assume that there is a personal guarantee. i. Creditor has more leverage to get debtors cooperation if business is going down by offering to remove the personal guarantee if cooperation is given (by bringing $3 million on liquidation). ii. If no personal guarantee, then have lesser leverage. Here, there is no personal guarantee. The advice for DiSilva is to take everything and run. No notice. Get assets and get them out there. Possible lender liability and you may have to pay a couple hundred thousand, but Flora-Ship will settle.

d.

II.

Problem 3.2 a. Sympathetic debtor here. This lender (Maury) is equity holder in a competing business. Whether KMC ultimately is about technicalities, leverage for debtors, or just crazy? i. Creditor has the right, negotiated right to repossess property. ii. We dont really know if KMC is right. But it is part of the leverage. Problem 3.3 a. Two examples of people who possibly would fall into lender liability. i. Small business guy. Received notice. Couldnt get another loan. 1. There have been a few cases where consumers or small business people have brought lender liability suits.

III.

In re Boone (FL): Mortgage company put in a dragnet clause to take interest in house and furnishings. Jury said that it was overreaching (including punitive damages). b. Mississippi jury: fell behind on car payment, and because of that increased charges on the life policy. Jury brought $38 million recovery. ii. Another womans car was repossessed and they took her refrigerator. IV. Secured and Unsecured Credit: a. Difference between secured and unsecured creditor. i. How do you get money? 1. Get a final judgment (by suing them) 2. Court issues a writ (i.e. the order to pay) 3. take writ to a sheriff in the locality where the persons goods are located. Tell sheriff to execute on writ. Sheriff goes to the house/business of person and says that hes there to seize goods. They walk through the house. They pick stuff up, and put it back in the sheriffs office and then the sell goods. After sale, sheriff gets paid first and then distributed to the creditor, and excess will be given back to the debtor. a. Every state allows debtors to keep some stuff. (in DE, gets to keep up to $5000 total thingsincluding house) i. In TX, get to keep life insurance policy, 60K personalty, the house ii. There are state law determined things. (exemption statutes) b. Whoever is first gets paid in full before those with subordinate claims. i. First to get judgment ii. First to get writ iii. First to get sheriff to execute. iv. Relation back: 1. If two people get writs simultaneously, then you might be able to relate back to the time of judgment. a. A gets judgment, then B gets a judgment. B then gets a writ and execution on the writ. Now A gets a writ and then an execution. Relationback to the judgment means that A wins as long as before sale is made and cash distributed. ii. Remember, once you are first, you get first dibs until you are fully paid. 1. In bankruptcy, you are pro-rata distribution. b. Secured Creditors i. Promise attached: If I dont pay when I said I would, you can come and get the collateral (A/R, ring, house, etc) ii. (1) No exemptions as to secured creditors on the collateral. In TX, you cant reach furniture unless more than $60K. A secured creditor can reach those things directly. iii. (2) Secured creditor has easier time in court or dont need to go to court. 1. Entitled to self-help (i.e. repo man) a. But not allowed to breach the peace. b. Really only good against the ignorant 2. If you have to go to court, you are given a shorter game in court. You get in and out of court faster. iv. (3) You beat out unsecured creditors in priority v. However, security interest must be filed in order to be perfected. 1. First in time to get perfected (in notice) is the first in right-- priority (because you can have 2 secured creditors on same property). Securitization i. In a regular loan, you have the debtor and the bank. The bank gives the debtor cash, and debtor promises cash + interest (unsecured). Throw in collateral, and now it is secured. ii. Securitization is where the Seller (debtor) sells its A/R, inventory, Everythings to this company (the Special Purpose Entity, SPE) for cash. Now the SPE is the owner of the A/Rs.

a.

c.

The bank or investors are the ones that lend that same amount of cash to the SPE, and the SPE promises to pay back to the bank money, interest, and any collateral that the SPE owns. 1. Ordinary sales are not dragged into bankruptcy courts. 2. This is called Asset Securitization. Sometimes SPEs sell shares to stock to raise the money that will be lent back to the seller. SPE will never go into bankruptcy because the Bank has its directors it on the board of the SPE. The SPE will not file for bankruptcy because it requires a vote from the board. 3. This means that all the other creditors (of the seller) cant reach assets of the seller because its all been moved into the SPE. -------------------------I. Credit Card Company (lends $1000 to consumer) Consumer (owes $1000 interest) Consumer has an employer (consumer performs service. Employer pays money to consumer at the end of the week) CC Company

Consumer

Employer

A lawsuit garnishment by CC company against Employer. The lawsuit says that the consumer owes me $1000 + interest (by a judgment). The CC company, judgment creditor, and the Consumer, the judgment debtor. The judgment creditors lawsuit against the employer says: (1) that the judgment debtor owes me money, (2) you owe the judgment debtor money; and (3) that monesy should be paid to me. CC company is now known as the garnishor while the employer is the garnishee. II. Problem set 5.1 a. 2/1, First finance gets $2000 judgment and gets writ to sheriff ( -10) b. 2/5, Wayne deposits $5000 (4990) c. 2/7, Second finance company gets writ for $3000 d. 2/9, Sheriff delivers both writs e. What are the questions we ask? i. How much money is available for the creditors? 4,990 (Bank paid itself the $10 overdrawn before the writ was delivered). Creditors get whatever is there at the time they come in when the writ arrives. ii. Which creditor beats who? 1. Backdated to date of judgment? First Bank gets entire $3000; Second creditor gets $1990. 2. If dated back to writ? Same result above 3. If leaves with Sheriff? Pro-rata, or depends on which one the sheriff delivered first, and which one was delivered second.

09/16/2003

10

I.

2/1: Writ to Sheriff: FF $3000 2/5: Deposit 2/7: J, Writ to Sheriff, SF $3000 2/9: Sheriff delivers writs 2/9: D writes the check $500 2/10:Bank Pays Check $500 2/11:D deposits $200 2/15: Bank answers 2/16: D Deposits

(-10) (4,990)

(4,490) (4,690) (4,490)

You are testing two parts: (1) status of account is frozen when the writ arrives. What matters is when the sheriff delivers the writ to the bank. What does that mean? If you havent received anything from a sheriff, then you can continue to operate as normal. Notice to the third parties? Nothing happens until something happens in an overt way. Whats the purpose of relation back? Intersect between the creditors that determines who gets ahead. But doesnt make the garnishment go back. Writ served on 2/9: Whats the legal consequence of the debtor writing a check and handing it over vis-vis this garnishment action? This check does not affect the garnishment. Nothing happens when you write the check. It is not an assignment of money in the account, at least not legally. The bank then pays the check for $500. Bank is still responsible for the entire $4,990, at least to the garnishor. Now, bank becomes the creditor of $500 that was paid. The banks error falls on the bank. ---Debtor deposits $200 on 2/1l. The rule of garnishment is: if deposits keep coming in, they are falling into the garnishment net. The bank answers on 2/15: what does this mean? You want all activity since the writ was delivered. Can you reach the new deposit after the Bank answers? Suppose the bank does not contest. When was the answer due? The answer was due 2/20. Does the next extend to the date the answer is due or when the date. The court guarantees you the temporal net. It does not matter if the bank answers early (so after the bank answers, but before the deadline, catches all deposits in the net). What is the bank thinking about? --Banks incentives may be with the customers rather than the garnishor. What aligns the incentives between the bank and the customers is if there is a loan. What else may be at that bank? Probably a loan outstanding from the bank. The juiciest asset is cash. You would be asking the bank to give up the cash for another creditor. What does the bank always do? The bank has 2 incentives(1) theyd like to take the money in the account and take it themselves (feast off carcus) (2) or alternatively, theyd like to keep the business alive so that they can get the money later. What is the bank likely to do when they get a garnishment order? Theyd like to apply the money to their own debt (set off the money in the account vis--vis their loans). You can do offsets before you receive the garnishment? Yes, but NOT after the garnishment writ is delivered. Whats going to happen at a bank where there is an outstanding loan? Banks remarkably set off moments before garnishment orders arrive. When bank gets the garnishment order, what else might they do? Does the bank call and say stop putting money into the account? What is the best chance of keeping you alive? Depends on what is better chance of keeping you alive. II. Problem 5.2

J. Creditor (Judgment collections)

11

J. Debtor (Baker)

Garnishee (Nicholson)

Here, it is a garnishment order because what is happening here is that Nicholson owns something that belongs to the J. Debtor (it can be anything, not just cash). What is the dispute about? You, as garnishor, are only allowed (entitled) to seize what Im holding that belong to Baker. If Baker has no right, then Bakers judgment creditor have no right. Bakers right is right to possession of physical property at end of the lease term. Baker may also have the right to money payments from Garnishee to Baker. If this is a straight up deal, 2 things can be garnished: (1) money payments owed to Baker and (2) property at the end of the lease termso at the end of the lease term, you have to give property back to garnishor. If Doyle is telling the truth, what is the legal consequences? They can garnish because the garnishment order already delivered, then Nicholson has no freedom. The consequence of the garnishment order has been served, so Nicholson is now holding the property in trust for the creditor. If they disobey the order after the garnishment order, then you set aside the lease that was made after the garnishment order was delivered. All you have to do is that you get a garnishment order that says I want all things that you have that are owed to the judgment creditor. If garnishee has superior right that predated the garnishment order, the garnishing creditor CANT defeat that. Who are the two parties to the litigation? Judgment Collections and Garnishee (Nicholson) will litigate regarding the relationship of Nicholson to J. Debtor (Baker). You can do anything with your property (sell, lease, etc) right until the court order arrives. III. Problem 5.3 a. Valdez wants to fire the employee after a garnishment order arrives. What do you advise?

1674. Restriction on discharge from employment by reason of garnishment (a) Termination of employment No employer may discharge any employee by reason of the fact that his earnings have been subjected to garnishment for any one indebtedness. If employer gets two garnishments, and you can fire them. Why? You want to give them a chance. But a second garnishment is OK, because employers argument for this is: (1) it is expensive to administer (2) further less incentive for someone to come to work because wages will be garnished (3) you might be pulled into litigation and be liable for the entire judgment. Why fire them outright anyways? The teeth in the statute is $1,000 or imprisonment. There is NO private cause of action means that it is not there. Fire him, what are the chances that you will get charged? Little. What will happen to you if the worse goes wrong?

I. Problem 7.1 a. Fraudulent conveyance? i. No bad intent. She was in good faith. Is that a defense to fraudulent conveyance? No. we dont care about the good-faith of the seller. 1. 4(a)(1): with actual intent to hinder, delay, or defraud (set aside for past and present)

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b. c.

5(a) (applies to previous creditors at the time of transaction): a. Without (1) receiving an equivalent value and (2) the debtor was insolvent or rendered insolvent by the transaction. 3. Do we care about the good-faith of the buyer? a. 8(a): A transfer or obligation is not voidable under Section 4(a)(1) against a person who took in good faith and for a reasonably equivalent obligation. i. Here, we are doing a 5(a), and there is no defense of good faith. b. Fraudulent conveyances: 2 rules when a creditor set aside: i. no reasonably equivalent value AND debtor is insolvent or rendered insolvent ii. 4(a)(1): actual intent to hinder, delay, or defraud. ii. What is the buyers best defense? Reasonably equivalent value (because good-faith no available) 1. It was used, big scratch. 2. Whats the rule that what constitutes reasonably equivalent value? a. Suppose you were advising the buyer? Some deals are too good a deal but there is always one other fact (i.e. insolvency). i. Its too good of a deal if you are insolvent. So you can give your money away unless you owe it to someone else. 1. This is the constraint of fraudulent conveyance. You can give your stuff away as long as you are SOLVENT. Look at the remedy if you engage in a not-reasonably equivalent value and insolvent? i. I.e. you pay $750 for $15,000 piano? What happens to the buyer? 1. If it turns out down the line, you would lose your deal (benefit of the bargain or the expectancy)this would have been the difference between the $750 and $15,000. a. What position am I put in? status quo ante (same position if you never had the contract) b. So you should go ahead and do it. Because the creditor has to pay the person $750 to get the piano back. ii. What if you destroyed the piano and now need to give you back? 1. Fraudulent conveyance law does not answer it.

2.

II. Problem 7.6 a. They were insolvent and whatever spiritual value was not equivalent value. b. You can do a fraudulent conveyance claim on a donation. c. What about the chiropractor? III. Problem 7.7 a. They are not absolutely void, just voidable. b. Can you come back and say that you intended to have a fraudulent conveyance. i. Will that work? Courts of equity said that only relief given for clean hands. One court has said (in peri delecto). Other court has said that the bargain should be honored. 09/23/03 I. Problem 7.2 a. Can AX successfully claim a fraudulent conveyance? i. 5(a) only applies to pre-transaction creditors so doesnt apply here ii. 4(a): applies to present OR future creditors 1. Here, AX is a future creditor at the time of transaction. 2. Maybe 4(a)(1) applies: a. Requires actual intent to hinder, delay, or defraud any creditor of the debtor. i. Part (b) lists certain factors to consider, listing from (1) . . .(7) 1. Actual intent means listed in (b) or othersactual intent is that someone is determining it and can infer from circumstances of the case.

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3.

4. II.

4(a)(2): didnt receive reasonably equivalent value AND a. (i): debtor was engaged or about to engage in a business or transaction for which the remaining assets of the debtor were unreasonably small in relation to the business or transaction; or i. b. (ii): debtor intended to incur, or believed or reasonably should have believed that he would incur, debts beyond his ability to pay as they became due i. difference from 5(a): in 5(a), there is no intent as there is here. 1. as a practical matter, what is the difference in the standard? Didnt know is not a defense. 2. The real test in 4 (a)(2)(ii) is that you need to prove that debtor reasonably should have known that they would have been insolvent. ii. If preexisting creditors, all you have to show is that they are insolvent (this is easier than 4 (a)(2)(ii)) 1. There is a sense that perhaps there really isnt much difference. c. Why are present and future creditors treated differently? i. Present creditors can tell debtor, under fraudulent conveyances, not to make transfer with actual intent to hinder, delay, or defraud PLUS also cant tell them transfer less than reasonably equivalent value if debtor was insolvent or under 4a(ii) that they reasonably knew that they should have been insolvent. Future creditors should check the ship to see if it is seaworthy. a. If indeed 4(a)(ii) and 5(a), then we are diminishing the importance of future creditors of checking out the debtor themselves before lending.

Securitization a. Loan to the bankruptcy vehicle and the bank lent to the bankruptcy vehicle. D BRV Creditor

i. The attack here is that there may be actual intent to hinder, delay or defraud under 4(a)(i).
Convey assets out of hands of shareholders to defraud them (to pump up Enrons balance sheet). To reduce the amount of debt to keep their high credit lending. III. Problem 7.3 a. Its only fraudulent if you transfer an asset, but an asset does not mean things that are exempt under non-bankruptcy law. i. Preserves exemptions under State Law. What makes property valuable that you can convey it. ii. Additional notion are creditor expectations: 1. You can transfer exempt property, because creditor does not have any expectations to the property. Problem 7.5 a. Pats letter explained that the business is struggling with bills piling up. b. Structured transaction:

IV.

Magic Clean --------------if liquidated, Up to $100,000

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Goes to Kim. (if sells for $120K, $100 to Kim, $20K to Pat) shares of the stock Kim $100K Pat $20 K Lance $X If Pat wants to sell ownership of the business to Lance, then contract b/w Pat and Lance. Pat will transfer stocks of business and Lance would pay Pat money. Suppose Lance doesnt have the money? Lance will get a loan from bank, probably offering security interest in the thing he is about to buy (the stock). How much will you lend against the shares? (remember Kim is secured on assets to $100K). Bank will probably lend less than 50% of the face value of the value of the stock. What would happen if this is a leveraged buy-out? Security interest Paid cash rcvd from bnk Pat Lance Bank Shares of stock + MC Loan based on security interest guarantees + secuirities If there is a security interest in all the assets given to the bank, what is the distribution on liquidation, then the Bank comes first, then Kim gets paid. Call a leveraged buyout because new owner put nothing up front. A lender will lend to you (the buyer) because of security interest in hard collateral. Legally, what happened when you switched an ordinary sale of stock financed to a leveraged buyout? Fraudulent conveyance: Lance puts nothing into this. All upside and no downside. His return on investment is pure cream on the top. If it goes down the tubes, he walks away. (Pat and Lance like the leveraged buyouts and the bank does as well). Here, the old creditors are put in last position. Is there a fraudulent conveyance? Under 5, must prove that (ii) Magic Clean made insolvent: Old Balance Sheet: Assets: 120 Debts: $100K debt to Kim, $20K of Pats Equity

After the transaction, Lance Pays $80K. So new Balance Sheet: Assets: $120K Debts: 100K debt to Kim, Contingent liability of $80K to bank, Equity: -60K.

Instead, what they did was to call Equity $60K in goodwill instead so it shows up in Assets and then canceled Pats Equity of -60K. (or do $61K and $1K to have positive equity). Fraudulent conveyance: If can prove business is insolvent, then also must show reasonably equivalent value. In this case, was there reasonably equivalent value? What went out and what came in? Not what Pat got, but what the company gotthe company put up the guarantee and the security interest and all that they got was debt. So looks like fraudulent conveyance. Remember that Kim could have a security interest or by contract (i.e. will be in default if makes guarantee). What this does is to give protection to those who can contract or not contract. Fraudulent conveyance law is not contract around of. How do you solve it? Three ways to fix 5 (give reasonably equivalent value; dont be insolvent; you pay off all present creditors at the time of the transaction(but then you lose your leveraged buyout trick)also you could cancel 1st loan with a second loan with a higher interest rate) To the extent that 4(a)(ii) overlaps with 5, you are stuck with present and future creditors.

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-----------------V. Problem 8.1 a. Toto and furniture (exempt property): Yes, part of the estate even if exempt. i. 541(a): Such estate is comprised of all the following property . . . 1. General rule is that everything that they have is in the estate, including their exempt property. b. Pinto, that has no value (because subject to excess security interest): i. Pinto is in the estate because they have legal title to it. 1. The person can use the car. c. The photos: i. Yes, no requirement of value to be part of estate. d. Michael Jackson Tickets: i. Still part of estate whether you can transfer it or not (no requirement of value, just need legal title or equitable interest) e. Catchers Mitt? i. Yes, wherever located and by whomever held f. Bank Account held by Donald in trust for Sherry? i. Legal title to bank account, but equitable ownership by Sherry. What comes into the estate then? 1. Legal ownership comes into estate, but corpus (equitable interest) stays out of estate. g. Baby Parakeets? i. In estate because of 541(a)(6). h. Retirement Account? i. Under state or federal law, must be spendthrift trust. 1. What is a spendthrift trust? You cant get in there to play around the money. Also, the creditors couldnt touch it outside of bankruptcy. Spendthrift trust says that creditors cant touch the corpus. ii. If you have a retirement account, and if that retirement account is a spendthrift trust, creditors cant reach it. Thats the key feature. 1. State law or ERISA-qualified plan (spendthrift provisions) iii. Look at what happened to property of the estateit is a big definition with a carved out for spend-thrift trust. Why? 1. Because creditors had no expectation to it. 2. You also dont have to litigate what comes in. 3. You protect it from other creditors 4. Trustees have control over all the property

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09/29/03 I. Problem 8.2 a. Ticket is property of the estate. The fact that it is more valuable later is great the estate (estate takes good/bad news) b. Why is an engagement to a rich person not part of the estate (compared to the lottery ticket)? i. There is a continuum of expectancies. 1. Suppose I expect you to sell me wheat on contract, and it turns out to become more valuable. Yes, this is property of the estate. Problem 8.3 a. The estate gets it: 541(a)(1)legal or equitable interest for the wheat i. contracts can be property of the estate (property exempted is still part of the estate and just determines what debtors will get back ) b. 541(a)(6): proceeds, products, 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 i. Whatever value he added post-bankruptcy does not belong to the estate. Thus, the value of his post-bankruptcy services should be excepted. ii. Negotiation for this with trustee should have happened after bankruptcy. 1. Ask trustee what they are you going to do with the wheat? 2. Remember trustee can hire someone else to harvest wheat. 3. Trustee can give %ge repayment scheme, a percentage on sale. a. Farmer is not obligation to contribute services post-petition. (like watering, fertilizing, threshing the estates wheat) b. Debt must realize that this is not their wheat anymore. i. But his human capital is still his. Problem 8.4 a. Cratchet gets to keep $1,000 because his continued performance was necessary for him to receive his payment. Therefore, it reflects labor done post-petition. (but-for test). b. Whats the trustees argument? i. This was at least earned prepetition, and thus would be a & 1/4 split. ii. Further, more aggressively, the notion is that by teaching for of the year fabulously, he actually won the award by the petition. He only had to do a trivial amount of post-bankruptcy work. All the hard work was done early, and this tiny amount of work post-petition. Discrimination Claim: a. She should have mentioned that lawsuit against TWA because it was part of the estate Problem 8.6 a. Yes, its property of the estate. Bankruptcy Code in 541(C)(1) on transferability (restriction on transfer doesnt keep it out of the estate): nothwithstanding any provision in an agreement, transfer, instrument, or applicable nonbankruptcy law(A) that restrict or conditions transfer of such interest by the debtor. b. How can debtor keep license out of the estate? i. Debtor argues that its not property that its only a privilege and not property. ii. When you file for bankruptcy, is it valuable to have a drivers license? Yes. 1. Is the drivers license property of the estate? 2. How about a license to practice medicine valuable? Yes, and its something you had prepetition. But not a property right. c. Branoff Airlines was a victim of growth. Branoff decided that it was going to buy up landing slots/planes and expanded nationally. Branoff has a meeting with its creditors and could not meet interest paymentsit did not have any secured debt at all. i. So Branoff divided up all the creditors, and gave them security interests to stave off payments.

II.

III.

IV. V.

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ii. 1 year to the date Branoff filed for bankruptcy. But, what did Branoff have? All the landing slots on earth. East Coast, West Coast, Europe. 1. There was big arguments in 5th circuit: 1 group says property of the estate and other says that it was not. a. The other airlines said was not property of the estate because the Federal Aviation owns the strips. (1) if not part of estate, then Branoff will definitely fold because cant be sold i. If Branoff folds and landing slots not part of the estate, then (2) FAA will distribute the landing slots (but not through money) 1. But small airlines wanted it to be property of the estate because they wanted to buy it (since FAA doesnt sell it). They wanted Branoff to pare itself down, and sell of the rest. b. Creditors of Branoff would want it to be property because more money to pay off debts. c. Trustee wants big estate because big money for trustee. d. Branoff managements view is that they want to be property of the estate because only chance they have of a going-concern but bankrupt airline. e. The district court says that it is part of the estate. (Branoff would live). Fifth circuit said no property (Branoff died from this ruling) VI. Problem 9.1 a. Joe wants to know what he can expect to happen in the next few weeks. i. He especially wants to know if he will get his full paycheck, undiminished by the garnishment, tomorrow and every two weeks later. 1. 362(a)(6): operates a stay operable to all entitiesany act to collect, assess a claim a. Cant send a bill b. No phone calls c. No lawsuit and cant continue of a lawsuit. i. Ongoing litigation stops. 2. What about car loan, for secured creditors? a. Cant repossess. 362(a)(3): cant try to obtain possession of property. So even property subject to security interest is property of the estate. 3. What about wages? a. Are wages property of the estate? Only past wages. Future wages are not part of the estate i. No garnishment because that would be violation of 362(a) Old Wages No, because prepetition wages are property of the estate. 362(a)(3) prohibits attempt to obtain possession of the property of the estate (property of estate is always protected) New Wages No-- not property of the estate. Cant garnish because 362(a)(6): cant collect, assess or recover a claim against the debtor that arose before the commencement of the case. (debtor is always protected)

Can you garnish?

b. What is the policy behind protecting the estate against liens (under 362(a)
(4)? i. Dont let existing law control and force all defaults into bankruptcy scheme. ii. Also, protects debtors because freezing everything because gives debtors breathing room. What if it turned out alimony or child support? i. 362(b): You can go forward and establish liability for alimony or paternity.

b.

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1. 2.

Why? to Give special place for support of children. But, what can you collect against? You can collect against property not part of the estate ( 362(b)(2)(B)). a. So if you were garnishing wages, you dont get anything for this paycheck, but something from future paychecks.

c.

VII.

Action for hot check. (See exception in 362(b)(1)) i. You question of the D.A. is: if he pays off on the check, will you drop the action? 1. Now your pitch is that this is a creditor trying to collect on a pre-petition debt not state enforcement of its own laws. 2. Sometimes, bankruptcy courts prevent creditors for showing up on the hot-check charges so that the DA loses. d. Utility Payments: i. 366(a): they cant discontinue service unless you pay once you file for bankruptcy (because would be action to collect) 1. However, the protection is under 362(b), it means that they can ask court for a deposit. They cant say pay or well cut you off, but we dont have to provide future services unless we have a deposit (must be reasonable according to the court). If no deposit, can shut them off. Problem 9.2 a. The association has asked you to prepare a general outline of what creditor behavior is appropriate once a debtor files for bankruptcy. i. There is nothing you can do. Problem 11.1 a. What is part of the claim? Principal loan: $180,000 Pre-petition int. $14,000 Post-Petition Atty $1,000 502(a): money is presumed owed as soon as debtor lists it; (b) has objections Is there anything to litigate under 502(b)? Yes, the post-petition attorneys fees. Remember, post-petition interest is not in under 502(b)(2) under unmatured interest. So should you get post-petition attorneys fees? Nope, just like unmatured interest. Here, assume general unsecured is $194,000 (dont follow second circuit): 10% of $194,00 = $19,400 is actually what the client gets. The remainder of the claim ($194,000 - $19,400 = $174,600) is discharged.

VIII.

09/30/03 I. Problem 11.2 a. What do you explain to Buckeye about its financial position in bankruptcy? i. Under 506(b): There is $225,000 in collateral. What can client get? $180,000 loan $14,000 interest $1,000 attorneys fees if provided for by contract ( 506(b): allows reasonable fees, cost, or charges provided for under the agreement under which such claim arose) ---------------$195,000 If the secured creditor pays broker fees, then their claim would then be $197,750 (+ $2750). However, if trustee sells it, the secured creditor cant include the $2750. ii. Who pays the broker fees? 1. Oversecured: Collateral worth $225,000. Broker fees decrease amount of estate if they were paid by the secured creditor. Their claim is for $195,000.

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2.

Now assume secured party pays the fees: i. They would net $195,000 still because estate recovery is reduced by $2750. Undersecured: Collateral worth $165,000. Because you dont have room for the rest, you dont get attorneys fees, and the remaining unsecured claim is $29,000. The amount the creditor walks away with is $165,000 + 0.10 ($29,000) = $167,900. a. Now if secured party pays the fees: i. They lay out $2750. Whats going to change is that their unsecured claim increases from $29,000 to ($29,000 + 2,750 = $31,750). 1. so then 10% of the $31,750= $3,175 b. Total recovery is $165,000 + $3,175 = $168, 175, but remember he paid the $2750 so his recovery really is $165,425: i. (secured creditor shouldered 90% of the cost of selling). 1. So residual claimant paid.

a.

II.

III.

Problem 11.4 a. Explain what happens to CF: Collateral: $23,800 i. Claim under 502 (unsecured claim): $24,600 1. Is there anything else besides the $24,600? Can only get post-petition interest if oversecured (only up to value of the collateral). ii. His 506 secured claim is for $23,800 and there is a 502 unsecured for $800. Assuming 10% on the dollar, then recovers $80. 1. $23,880 total. THE ESTATE

506 506 502 Exemptions


IV. V. Estate size is 50,000 Problem Set 12 a. 507 controls priority i. (1) John Harry, a private duty nurse whom Harold hired while his father was quite ill: $5,000 1. He is third here in priority. He gets $4650 first (cap and must be earned within 90 days before the date of filing the petition). And then general unsecured claim of $350. Why do they get a special break? a. This is really for the employee benefit sections. Why do you want to give employees a better deal? i. They want to stop the echo effect of bankruptcy. If these employees cant get their paychecks, they may have their entire lot with this company (no risk spreading). We want employees to continue working. b. But why do we have these limits $4,650 and within 90 days?

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i. Who would have unclaimed wages for more than 90 days old and over $4,650? These would be CEOs. We care less about CEOs and if we gave them priority for unpaid wages over the past two years. What might really be going on here? If you didnt take your paycheck for more than 90 days or more than $4,650, those people have a different relationship (an interest in the company compared with $9/hr workers) ii. (2) Social Security Administration, social security and withholding from Harrys earlier paychecks: $534 1. Eighth priority 2. 507(a)(8)(C) is a trust fund tax 3. 507(a)(8)(D) is just a wage tax; taxes owed because they were your obligation that are required by the employer to collect 4. Policy: a. They want to protect the public fisce. One dollar less means one dollar more that someone else has to pay. (the externalities argument) b. You also cant discharge tax debts. Why dont give up the priority then? i. Who gets protected as a result of the priority? The debtor. Because it means that taxes are being paid first from the estate. So the general unsecured debts will be discharged, and they will emerge with less taxes owed, which are non-dischargeable anyways (this is debtor protection as well as protection for the govt). iii. (3) City of Eden, property taxes: $3,000 per year for the last 3 years, plus $500 per year penalties for each of the 3 years. 1. 507(a)(8)(B): a property tax assessed before the commencement of the case and last 1/92 1/93 1/94 1/95 3/1 (assessed) Bkrpty

(so the tax must have first been assessed at least 1 year before and without penalty) So really only the 94 tax payable.s Assume assessment is made in March of the year. 94 is last payable one year before after the date of the filing. (really it is within 1 year so long as you understand it to not be after the date of bankruptcyit really is a one year statute of limitations on property taxes) We want to protect localities for their tax. Also, as a matter of policy, we are telling localities that if someone is not paying their priority taxes (if they are behind a year, well give you priority; otherwise, you are at your risk). We want them (localities) to keep up on their records so that other creditors will know how they are doing financially (UCC filings, check real estate records and liens). This is a little kick at municipalities to keep their records up. Can they also collect the penalty with a priority? 726(a)(4) places them very far back in line (behind the 507 priorities, the unsecured creditors . . .). But 507(a)(8)(G) (has to be actual pecuniary loss-- which is something akin to interest) Why do penalties have to happen like this (subordinating penalties under 726(a)(4)? The penalty would actually be paid by the unsecured creditors. iv. (4) George Nartowski, down payment against a tractor lawnmower Harold had agreed to sell to George: $300 1. 507(a)(6): Sixth priority. Unsecured claims arising from deposits. Limited to $2,100 priority.

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a.

Why does this one get priority? i. Might refer to rent deposits. ii. People of modest means, before credit cards, used to do lawaway. This part of the statute is for these consumers at Woolsworth on layaway, and Woolsworth files for bankruptcy. We dont want their $40 to be $0.04 in discharge.

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v. (5) State Department of Revenue and IRS, income taxes: state $4,000, federal $14,000. 1. Falls under 507(a)(8) 92 93 94 95 B

3/1 94 taxes are included. 93 taxes are included, 92 are included, and 91 are included (4 year reachback because filed before 4/15). You are permitted under 26 USC to bifurcate the taxes. Thus, you can get a 1/6, for your priority. Why priority for IRS: harder for IRS to place a lien on property. But, IRS collects 99.99% of all money deemed owed (reasons for 4 year reachback). Anything over three years is actually dischargeable. You can reach back some distance but not forever. vi. (6) Telephone, utility, and other regular bills following bankruptcy: $5,000 1. Post-bankruptcy bills get no priority. vii. (7) TIB as trustee and as trustees counsel: $4,000 1. 507(a)(1): administrative expenses under 503(b). viii. (8) Insurance premiums for insurance on the non-exempt personal property for $750 1. Also 507(a)(1). Policy for it: to preserve the property. Estate pays not only administrative fees but also to protect itself. If utility bills are necessary to preserve the estate, then may also be an administrative expense. ix. (9) Costs of sale of Harolds non-exempt real estate and personal property, including advertising: $2,800 1. 507(a)(1) x. (10) Sara Fleet, Harolds attorney: $1,250 in fees ($500 for a will; $750 for preparing this bankruptcy filing) 1. Preparing Will would be classified as independent contractor. No priority on the will. (no 507 priority) 2. Preparing bankruptcy filing: this is 507(a)(1)-- most courts say that this is no! because created before estate was created. a. Would you take someone on credit even if you are in a 507(a)(1)? i. No. you will ask up front. Lots of consumer cases cant even get a 507(a)(1). ii. Instead of paying all your other creditors, give me your paycheck first. iii. The second way to do it is to skip the house payment. P.S. check and see where it says that IRS taxes older than 3 years are discharged. 09/29/03 (makeup class) I. What you can protect under state law is what you can protect under Bankruptcy (ratifies state exemption clauses) a. This also permits strongly held differences to come together and still do a bankruptcy law. b. W: Bankruptcy offers discharge of debt. In order to get discharge, this is what you should give up. Argues for uniform exemption to trump state law exemptions. States can opt out of federal exemptions (so there is no floor for exemptions) a. W: recommends flooring and ceiling for these exemption amounts.

II.

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III.

First Legal Issue: Classification Problems a. Is a bus a car? b. Is a diamond ring wearing apparel? c. What is an annuity? d. Is the thing you have within the specified categories? Second legal issue: What do you do when things transform? a. You sold your house, then went to escrow, then into a check, then into a new house. Is it continuously a homestead trxn? What if you are in the middle of the transaction? (i.e. holding the money as cash). When are the proceeds of something that is clearly exempt also exempt? Third issue: Many of the exemption statutes are dollar capped. But 7 have unlimited home exemption. Some have unlimited health aids. Or unlimited tools of the trade. Whenever they are capped, you have to ask what is the value of the property. a. What makes valuation so hard is because you really arent really selling anything. i. Is this fair market value (listed with a real estate agent)? ii. Liquidation value (seized by creditor and sold) iii. Before Expenses of sale? iv. After expenses of sale? b. Assume you are in a state with $50,000 homestead agent. Say you could get $300,000 if sold by a real estate agent (this is maximum). Assume $200,000 mortgage. The expenses of sale would be 9% or $27,000. If liquidated at Sheriffs sale, would bring $200,000 (remember no one gets to see inside of it. And if you buy it, you have to get the debtor out of there.) i. If you have a $50,000 exemption, do you force sale of the house? 1. You either allow the person to keep too much property or too little property. c. You have backwards incentives here. i. For example, state might have $5K exemption for cars. Lets suppose the value on this car ranges from $18K-$22K. It has a $10,000 security interest on it. 1. If the car has been scratched, in a fender bender, what is the value? Perhaps $14K $18K. a. If it is in debtors exemption, then keeps it. d. In most states, businesses have zero exemption. e. Partial exemption i. Suppose you end up with a $300,000 valuation on the house. $50K exemption, $27K cost of sale, $200K mortgage. 1. Cost of sale first 2. Mortgage next 3. Left over $23K paid back to debtor. (b/c still within the exemption) What happens if you go into bankruptcy? a. Exemptions look like they did before. Same issues as state courts. Sometimes federal courts certify questions to state courts. Problem 10.1 a. If they go into Chap 7, what exemption options will they have and what would you advise them to do? i. 522(b): both spouses have to take the same exemption for jointly filed caseseither federal or state. 1. What Chris filed first? And then Lisa buys stuff and then make it look hard to join estates together and then file for bankruptcy? 2. It is also possible that they each left half of the house unprotected. ii. Start with their biggest asset, worth $100,000 with $23,000 in equity. 1. The homestead is $17, 245 ( 522(d)(1)). If you dont use the homestead exemption, it is a spillover that you can use on anything up to $8,725. a. Lisa could save $17, 245 of the home plus $925 in (d)(5).

IV.

V.

VI. VII.

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2. 3. VIII.

i. Chris would claim the remainder in value of the house ($5,575), plus he would get a spillover over of $8725 + his $925. (see 522(d)(5)). People who dont have a home at all get $8725 dollars plus the $925 ( 522(d)(5)) Under 522(d)(6), they can bring both exemptions together (includes debtor and dependent) and combine the spillovers in (d)(5).

Problem 10.4-10.5 a. Estate planning has been inconsistentsame advice, different results. b. Exemptions: pick possible categories (like in houses), but then you can sink all your money into c. Why dont we just go to money caps? i. But people have different trades and money distributions.

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10/06/03 I. Problem 12 contd: $750 pre-petition attorneys fees? a. One is a question of 507 priority for unsecured creditors (even if allowed as administrative expense), but another is a requirement of reasonableness. i. What does it take for the attorney of the debtor to get an allowable claim? 1. The nurse only had to show the real contract price. IRS only has to show that is what they assessed. ii. They review attorneys especially-- 503(b)(2)for a reasonable amount under 330(a)(1). 1. 330(a)(1): reasonable compensation for services on attorneys iii. Why is there the reason of reasonableness? (contracts signed as part of bankruptcy process) 1. Whose money is being spent here? a. Whoever are the residual claimants of the game (so it really comes out of the creditors pocket). So creditors get claims at face value (assuming debtor was negotiating in best interest) but when negotiating for bankruptcy, the game changesin effect the debtor is spending the residual creditors money. i. Nobody argues with someone who has the last lifeline (debtors will spend the general unsecured money to get the lifeline) 1. Like decedents estate: attorneys fees must always be disclosed and approved by court: there really is not someone negotiating on behalf of the decedent iv. Suzan Smith negotiable note could be a 507(a)(7) priority for alimony, support; otherwise ordinary business loan (no priority); or part of property settlement, which gets no priority loan. 1. Why special priority? a. Making sure that children get taken care of, ex-spouses get taken care of (stop the echo effect) b. Also, the children are terrible risk spreaders (they only have 1 parent) c. Congress, as part of proposed Bankcy reform, proposes moving them from 507(a)(7) to a 507(a)(1).should all womens groups love them? i. If they move ahead of administrative fees, you are really moving ahead of the trustees. That is very bad for you because they dont have incentive to work for youthe trustees will say that all the money goes to you and his expenses will not be paid. 2. What else would you want to know to evaluate this plan? a. How much is actually left for the unsecured creditors. 507(a)(1) priorities actually dont get that much anyhow. b. Trustee gets $4,000 (a)(1), insurance $750 (a)(1), nurse $4650, George-- $300(a)(6)all the rest may go to Susan if alimony/child support and then. Taxes would get about 60% on the dollar and general unsecured gets nothing (a)(8)s get pro-rata. If susan is not priority creditor, then the general unsecured bumps up, the taxes will get paid in full ($21,534).$16,000 left for general unsecured. i. Who objects to Susans priority claim? (trustee b/c acts on behalf of general unsecured creditors) ii. Who objects to calculation of taxes? (Trustee and also debtor because the tax is not dischargeable). Dischargeability a. Property of the estate and automatic stay b. Then secured creditors who continue to take liens c. Exempt property for debtor d. Money left over for distribution ( 507 first), and then 502 e. 3 kinds of claims in terms of dischargeability: i. 523: 1. If alimony, not dischargeable ( 523(a)(5)) 2. If business debt, dischargeable

II.

25

III.

If property settlement, under 523(a)(15), then dischargeabilty depends on: a. Who is more miserable (there really is no standard is) i. How bad off is he if he has to pay? How bad off is she if she doesnt get the money? b. Why this standard of fairness? i. It tells the judge to do whatever is fair. ii. Do something that kind of looks right under the circumstances. f. What else is nondischargeabile? i. 523(a)(1): Taxes (those under 507(a)(2), (a)(8)) ii. 523(a)(2): if you lie about your financial condition in writing, then that debt is not dischargeable. 1. Why not dischargeable? a. If a debt is non-dischargeable, then out of bankruptcy, then still have to pay it. In other words, is bankruptcy a way to get off the hook for fraud? NO 2. 523(a)(2)(C): luxury goods on consumer debt is not dischargeable iii. 523(a)(3): If you dont list creditors, you dont discharge those debts iv. 523(a)(4): fiduciaries involved in embezzlement not discharged v. 523(a)(5): alimony/support vi. 523(a)(6): for intentional torts OR selling collateral (for malicious and willful injury by the debtor to another entity) vii. 523(a)(7): fines are not dischargeable (automatic stay, 362, does not apply to criminal proceedings) 1. Once you get dinged, you dont get out in bankruptcy viii. 523(a)(8): student loans are not dischargeable 1. afraid that people are feeding on the public trough of student loans 2. students dont have any collateral; lenders are not lending based on collateral. 3. So very difficult to discharge student loans ix. 523(a)(9): drunk drivers who hit others 1. MADD got their interests taken care of it. x. 523(a)(10): If you dont get a discharge the first time, stays not dischargeable forever. xi. 523(a)(15): separation agreements xii. 523(a)(16): condo fees xiii. 523(a)(17): court filing fees xiv. 523(a)(18): when they give out welfare checks, they make them sign over support rights from the father as a condition for getting support from the state. That one will be nondischarageable. Its the dad who wasnt paying. The state can collect the same way that the mother could. 1. Whats the downside to putting this provision in? a. It could impair the ability to pay the child support (he would now have 2 nondischargeable claims1 to the state and 1 to the mother) 727 a. 727(a)(1): The court shall grant the debtor a discharge unless the debtor is not an individual i. Not as harsh on business as individual ii. This is Chapter 7, you dont discharge any debt because the corporation doesnt exist anymore. 1. It is a liquidated entity. b. 727(a)(2): If you have a 727(a)(2), you dont get ANY discharge at all including any nonfraudulently obtained debt. i. Whats happening in (a)(2): you get someone under fraudulent conveyances, you can keep someone from any discharge in bankruptcy c. 727(a)(3): the debtor has concealed, destroyed, mutilated, falsified, or failed to keep or preserve any recorded information, including books, documents, records, and papers d. 727(a)(4): Self-discipling, if you lie in bankruptcy, then cant get discharge. e. 727(a)(5): fail to explain satisfactorily any loss of assets or deficiencies f. 727(a)(6): self-actuating (refused to obey any lawful order of the court; or taking the immunity)

3.

26

g. h. i. j. IV.

727(a)(7): try to catch serial filers 727(a)(8): Keeping you from refiling until 6 years have lapsed (so only once in seven years) i. Whats the new market in the credit industry? (who is the best customer Bank 1 is looking for today?) People who just got out of bankruptcy (because cant file for bankruptcy for 6 years). 727(a)(9): someone who got a discharge in Chap 12/13, and if you pay off your creditors, you dont have to wait 6 years (or 70% and in good faith). 727(a)(10): voluntary waiver of discharge (as part of the settlement of litigation, you can agree to waive instead of being found guilty under another provision)

V.

Problem 14.1 a. Can MM refuse to give Peter Service? i. Yes. But there is protection against discriminating against bankrupts? 525 scope is narrow 1. But MM cant say well let you now if you paid. They have violated 524(a)post discharge injunction to collect. ii. What is MM doing here? 1. We really dont know. iii. What can you do about it? 1. You chew up what would have been 2 months of payments in attorneys fees. iv. MM cant say that well let you in unless you pay. You can still get to point B with a wink and an elbow. b. Why do we draw a line between reaffirmation and post-bankruptcy attempt to collect? i. Reaffirmations can only occur between the date of filing petition and discharge. 1. Reaffirmations dont work before filing of the petition. (otherwise you would have them contracting around bankruptcyno contract waivers not to enter into bankruptcy). 2. Can do it during bankruptcy, but cant do it after bankruptcy a. Want to give them a fresh start. b. It devalues the value of discharge under bankruptcy. i. Otherwise, the creditors, 2 or 3 months after bankruptcy, would hound you to pay your debts. c. Part of the cleanup in 1978 was to make the reaffirmation during this time period, because at least you are still within the system (and have lawyer to approve it). i. We dont want debtors to make an improvident promise. Problem 14.3 a. under 722 doesnt require that an attorney must sign it. b. Why do you get attorney protection for a 524 (reaffirmation) but not a 722 (redemption) i. You are paying off your secured debt (total amount of loan here is $18,000 and you have to pay $15,000 to redeem). 1. The policy that is being articulated in 722 is you get to redeem for less than face value of the note (value of the collateral) BECAUSE secured creditor could repossess and sell it off for value of the collateralso creditor loses ability to pull it out but would get what he would have gotten anyways but what creditor really lost is the $3,000 by either getting you to reaffirm or continue to paying it off until the lien is removed. a. You can use this provision to break this leverage off. b. The trick is that debtors really dont have the cash to do it.

10/07/03 I. Problem Set 15.1 a. 362(d)(1): once stay is lifted, the secured creditor could then go seize the car under state law (repossess, get a judicial judgment).can claim lack of adequate protection i. 361 defines alternative ways of providing adequate protection: 1. (1) cash payment

27

2.

(2) a replacement lien

II.

III.

ii. Is Comp-u-Store adequately protected? 1. Adequate protection means protection against loss in value (that value will not decline) 2. Comp-u-store needs under 362(d)(1), a. A lift of the stay or b. Alternatively, i. A lien on other property for the value of the expected loss ( 361(1))this keeps value of collateral up ii. Cash payments 1. For example, things depreciate over time so add cash payments to keep time. iii. Suppose court doesnt buy loss in value to lift the stay on Comp-u-stores behalf. 1. then can argue for loss of the collateral itself (i.e. power surge). b. Could you argue 362(d)(2)? i. Must show: No equity in the property and not necessary to reorganization 1. So cant use it, because debtor has equity, 362(d)(2) is inapplicable. ii. Why do we have this provision? 1. Here, estate doesnt have interest in the property. So if estate has no equity in the property and not necessary for the estates reorganization, then you give it to the creditor. Problem 15.2 a. If George files, what happens first (foreclosure)? Automatic stay will fall into place. b. What would happen in his Chap 13 for reorganization? i. 506 claim is $21,000 for the value of the collateral. ii. 502 claim is $5,280. iii. What does this secured creditor get in a Chap. 13 reorganization? 1. Creditor will get payments that have a present value of $21,000 a. Under 1322(b)(2), the plan may modify claims of secured creditors (if not a home). How will they modify it? They will bifurcate the claim into 2 parts under this sectiona secured claim under 506 ($21K) and unsecured under 502 ($5280). 2. 1325(a)(5)(B)(ii): value as of the effective date will be paid a. Secured creditor will get $21,000 plus interest to reflect time value of money (present value of $21,000). b. What interest rate do they get? i. In re Till: debtors purchased subprime at 21%. So when they went into Bankruptcy, court said present value at 9%. This is equality among creditors. If 3 creditors, one would get 0%, 9%, or 21%, then equality among creditors would be different interest rate and the risk of defaulting is the same with all. Problem 15.3 a. You see that how much she, debtor, pays depends on the value of the collateral. i. Also the accumulation of post-petition interest can grow up to the value of the collateral. b. Argument was liquidation value (value if sold at foreclosure); retail replacement (value debtor is keep). c. Today, people are no more certain about the correct value (see footnote 6 in In re Rash). Now, halfway between wholesale and retail. d. The more nicked and banged up, the less the debtor will have to pay. (payment to value of the collateral). But the key is that they are moving in tandem. 506 claim depends on high valuation. Home mortgage a. Must continue to make payments. i. Otherwise, creditor can make motion to life the stay

IV.

28

b. c.

Can only decelerate the mortgage. (plan to make up the deficiency only). Some courts have said that second mortgage, wholely unsecured, doesnt qualify for protection under 1322. Allows stripping off the wholely unsecured mortgage. (what does it mean to strip it down? probably to strip 506 secured down to value of the house; most courts wont let you strip it down)

V.

Chapter 13 payment to Unsecureds a. 1322(a)(2)priority 507 debt gets paid in full b. 1325(b)(1)(B): General unsecured debt i. (1) has to pay all of your disposable income. ( 1322(a)(1)) ii. (2) Plan has to be proposed in good faith ( 1325(a)(3)) 1. Like already filed Chap 7, and now only thing left is the house. iii. 1325(a)(4): Best interest testfigure out what general unsecured would have been paid under hypothetical liquidation (so at least that present amount that they would have gotten paid) 1. So creditors will do at least as well as they would have under a liquidation. Why do people do Chapter 13s? a. Installment redemptions for car loans. b. Decelerating in Chap 13s. c. (really just keeping his stuff) Problem 21.3 When the reporter asks whether Sansorts story is legally right, what do you say? a. If he goes into Chap 13, he has to end up paying ? i. All of it, will pay off all debt because disposable income is too high. b. If in Chapter 7, i. Will pay nothing on the debt because he has enough property to pay it all off. c. Notice what d. Best interest (hypothetical interest) test allows you to buy your equity in 3 5 years from your creditors. (as opposed to Chap 7 liquidation) Median 2 earner family is about $52,000. Theyve run a bunch of debt, and there is about $1,000 month of disposable income if they try. a. Should everyone go through a screen before Chap 7? i. Whos going to pay through the screen? (perhaps a self-supporting system) ii. What principal are you protecting by allowing Chap 7? iii. How did you get into trouble? What is your capacity to repay? Maybe were all paying .01% more on the credit but spreads risk among all debtors. 1. The pitch may be because we are encouraging risks and innovation and is better than anyone. 2. Perhaps we should shift the risk to the creditor because they should do their own homework. Why is the first response that if you have the income, you should pay it? a. Is it the notion that it is the responsibility of the law to enforce the obligations? b. Did your unsecured creditors have any capacity to reach your future income? Nope. i. But they could have gotten a garnishment order. c. If the answer is that we will take 5 years of your disposable income, how productive will they be in 5 years? d. Do we want a judge evaluating the disposable income (See problem 20.5 does Changing does make it substantial abuse; does the young lawyer have to stay with the firm that pays more? Or is it a trade for a discharge?).

VI.

VII.

VIII.

IX.

29

e.

Contracts is the law on the front end (2 entities come together to make private law). We are permitted to call on law to enforce that promise. Then Bankruptcy can eliminate those private laws (rights will be reordered).

30

10/13/03 Business Bankruptcies I. Problem 22.1 a. You should develop several different theories of what constitutes generally not paying and what facts one might be able to uncover about a medium-sized firm in a troubled industry that would support these theories. Be sure that you can tell your firm the strengths and weaknesses of each theory. i. What constitutes generally not paying under 303(h)? 1. Ramsco is not secured (they cant take security interest in mud, but mud has been injected deep into the ground). 2. Factors: a. Generally not paying now (its present sense)this is about something that is happening now. b. Theories i. (1) No paying a high proportion of the number of bills outstanding. 1. maybe not counting insiders in the number ii. (2) Not paying a large proportion of the debt (either 1 big debt ) 1. So getting 15 tiny ones and missing 3 huge ones. iii. (3) Whether you are paying all the creditors late. iv. (4) Look to see whether there are disputed claims (turning this around, perhaps they may be disputing claims just to scissor off their debt) 1. If there is no doubt that the debtor owes the money . . . and the debtor 2. If the debtor just scissors out part of the debt and doesnt pay them (a long period where I have taken and carved out some debts and not paying them) v. (5) Suppose you are not paying the rent or utilities, or employees. 1. If the business is dead (because not paying things that are needed to stay alive), then it should be considered generally not paying. a. Inference that the business is dead and that we shouldnt wait and should move in now. c. Why dont we use a balance sheet standard? i. Really hard for creditors to know (like unsecureds who have less information) ii. Even if I know your balance sheet, I dont know if your numbers are right. 1. Balance sheet could be off in either direction. iii. Probably a lot of people are balance-sheet insolvent, but there is a positive value to your stock. How was it that dot-coms were trading at positive value? (so it is overinclusive, and this company is not dead) iv. Doesnt include people who arent paying if they are balance-sheet solvent (under the generally not paying standard, we dont care why you arent paying)

b.

How do you know if someone is generally not paying? i. You know if you are not getting paid and how long. ii. You could call the other suppliers and see if they have an debts outstanding (client should do itcheap and current). iii. Credit report 1. It tells you who the other creditors are.

31

iv. Go to public records and find out who has a mortgage 1. You might alert them, and those are scary people because they are secured. a. What the secured people might do is that they might foreclose (like inventory, where they can come by and shut them down). b. What kind of other risks do you run with the secureds? i. You also may tip off the debtor, and the knowing debtor might give the secured creditor more security interest or speed up the payments (plot against you) 1. You dont want to get there and end up with an empty box. v. If they are publicly traded, you can look at their quarterlys, but not very good (too general) 1. Could also be wrong vi. Hire a private investigator vii. Or maybe trade journals viii. Who among the employees knows whose been paid? 1. Account clerk, but they may be fired or sued by the company ix. See if anyone else has sued them. x. You could also sue them under state law 1. You get discovery. a. Then ask who they owe and how much. II. What is the risk if you file the involuntary petition and then do discovery? a. 303(i): you might pay costs or reasonable attorneys fees b. 303(ii): punitive damages requires showing of bad faith (like not doing your homework)you might be so negligent in filing that you could be held in bad faith. Problem 22.2 a. Ask him key questions, give him your analysis of the situation, and describe the action you might take on his behalf. What do you want to ask him? i. How many creditors you have? 303(b) 1. If there are 24, then this guy needs another 2 to join SSB. So have to wonder if any of these 24 are clients of SSB as well and might join. ii. Can you pay the bank? 1. What are you asking him to do? He might be able to sell something off? Nope. All encumbered with rights of 1st refusal and will take 6 months to go through. a. When you cant sell something, perhaps could borrow against it. i. However, if hard to sell, banks dont like to lend against stuff thats hard to sell. iii. Creditor can make a credible threat to file for involuntary bankruptcy and gives you enormous leverage. (so might get paid off while others arent). Then what is the consequence of what happened here? 1. If you dont get paid, you could get a security interest with terms good for the creditor (Or renegotiated loans with great interest rates) iv. If you represent the debtor who doesnt want to go into bankruptcy, the debtor might offer great renegotiated terms (preferential deal). Problem 22.5 a. What advice will you give to Universal? i. Numerosity requirement: What you have to figure out if these are 3 separate entities. 1. This should not meet the numerosity requirement. But Why? (Policy) a. Ultimately, this is not creating any separate balance. They dont think independently and think that this is in financial trouble. 2. Whats the argument the other way? (why isnt it an abuse of the corporate form?) a. Plain meaning of the code says 3 entities!!! Bright-line rule. If set up 3 corporations and observed corporate formalities.

III.

IV.

32

V.

What is the policy advantage behind this approach? i. they didnt want to litigate against this (the advantage is the efficiency of non-litigation) ii. If he doesnt have 12 creditors, Universal can do it alone. 1. Wetumka probably does not have 12 others. a. 303(b)(2): insider excludable and brother-in-law. b. Five and Dime i. De Minimus Argument: If I owe a buck to someone, is that enough to count as another creditor. 1. On one hand, a creditor is a creditor no matter how small. ii. Remember that it does not work if you pay off the creditor after the petition (Faberge) iii. So, as Universal, you would go to the Five and Dime and pay off the debt. (or take an assignment of the debt). Then did you just buy a second creditor? Does the creditor really need bankruptcy? What does he get out of bankruptcy? What is his alternative? a. His alternative is to sue for the judgment in state court. If he gets into bankruptcy, he gets automatic stay, but if this guy is not dissipating, the he might not care. It may just be a forum choice. But anything he gets in bankruptcy would be pro-rata share. But under state court, would be a race of the diligent. Problem 22.6 a. 303(a): only requires a person to file an involuntary bankruptcy. i. corporation includes unincorporated company or association. ii. Here, the committee is a corporation that is not a moneyed corporation (a non-moneyed corporation) (so exception for 303(a) and no involuntary bankruptcy) iii. So charities cant have non-voluntary bankruptcies. (same with these campaign committees) b. So since you cant sue the committee, what can you do for the creditor? i. What can you do to the guy in state law? (receivershipplaces where you cant put person in bankruptcy but are falling apart; a state law collective proceeding) c. Why do you except non-moneyed corporations from involuntary bankruptcies? (like churches) (or even farmers?) i. Farmers made the argument that they make money once a year and one bad crop means that they are not paying for the entire year. 1. In the world of agri-business, written for aggregate group ii. Anyone who does business with charities--- you knew that they were dealing with non-money corporations. iii. Misdeeds should be handled at state courts. Problem 22.7 a. Can they do an involuntary? i. What business are they in? They might claim that it is farming operation, but is this a farmer? Is the real money coming in from the skinning of these animals or is the principal money coming from top end (where they are losing money right now). See 101(18)(B)(i) Problem 22.8 a. Explain to the Congresswoman why you would or would not recommend an amendment to the Code along the lines suggested by Professor LoPucki. i. Whats the downside to paying someone a little more to file under 303? 1. Whats wrong with the empirical analysis? a. He measures all the ones who fall off, but not the ones who didnt fall off.

b.

VI.

VII.

VIII.

10/14/03

33

I.

II.

Problem 23. 1 a. What do you advise Phoenix American to ask for in the Chapter 11? i. What kind of valuation do you want (representing the bank, a secured creditor)? 1. Bank wants a low valuation-- under 362(d)(1), you look like you are in a strong protection because no equity cushion and strong position to get stay lifted. a. If Stay is lifted, you can foreclosethe case will fall out of Chap 11 (basically pull the plug on the business) b. The debtor will fight you like crazy. There is a way within 362(d)(1) to not pull the plug--i. So even if we have a depreciating piece of propertythe debtor can make periodic payments or some other property to retain adequate protection. c. If you have low valuation on depreciating property, it will survive or fold depending on whether debtor generates enough cash on month to month basis to pay the depreciation plus whatever it takes to keep this thing afloat. 2. If low valuation, you are pinning your hopes on (for secured creditors) either getting money month to month , or better yet, you get the collateral. ii. What we really want is the elimination of the equity cushion. iii. In order to do depreciation: 1. Assume 200,000 on date of purchase. Today it is $198,000. So looks like a slow depreciation (and will not get that much money) iv. How can you get in trouble of strategy? 1. If they dont lift the stay, the danger is that in arguing low valuation, then at confirmation of the plan, the secureds will get up to the present value of the collateral (remember that nothing is sold)the court may remember your arguing the low valuation so that is the present value of the secured claim (and you get unsecured claim for the remainder). v. Secured creditor may say that I will let you keep this property but what I want postbankruptcy is the high value of the collateral 1. So if you dont think that you can win on 362(d)(1), then both of you might agree that the collateral is worth is high (so you can get post-petition interest, fees)so you will be out clean (no haircut). 2. Whats the downside of this? a. Debtor cant pay it anyways. So what good is it that debtor agrees it was worth $200,000. What did you lose? i. You didnt get payments during the game ii. You did lose real depreciation iii. Time value of money 1. If you would have prevailed with low valuation, you would have gotten interim payments or they would have lifted the stay and sold that item, and gotten money that you could have placed elsewhere. What value do they use? i. In re Rash: if reorganization in Chap 13, then replacement value Problem 23.2 a. What will you argue at the hearing, and what will likely happen? i. If 362(d)(1) motion, who will win? Debtor, because the value will not change for a couple of years and to extent, Cameron can probably manage the cash. 1. If you were secured creditor, what questions would you ask? Is it insured, taken care of ii. 362(d)(2): 1. does the debtor have equity in the collateral? No, ($1.8 million debt v. $1.1 million value)

III.

34

2. 3.

required for effective reorganization? Probably need some hard counseling with debtor because might lose on this. Policy articulated here? a. Estate has no interest in equity AND b. Estate has no interest in effective reorganization

IV.

V.

Problem 23.3 a. What did Reenah pay post bankruptcy? $1,000,000 b. What could these payments have been for? i. Perhaps Interest (argument for secured creditor) 1. Loan a. Initial i. Loan principal was $12 million b. Now i. Still $12 million 2. Collateral a. Initial i. $12.2 million b. Now i. $11.4 million (it is now below value, and inadequately protected under 362(d)(1); what are you supposed to do? Make payments to keep up the value so that you reduce the balance of the loan; 362(d)(2)you are ok on no equity but they probably need it for necessary reorganization ii. Perhaps depreciation Payments (youve increased the cushiondebtors analysis) 1. Loan a. Initial i. $12 Million b. Now i. $11.0 Million (when are you entitled to post-petition interest-- 506(b)only allowed if only oversecured. 3rd Circuit says that you couldnt get more than $200,000 on interest. So you made $1 million in payment-- $200,000 in interest and $800,000 in payments against the collateral. ii. What does that mean when you negotiate over? 1. How to treat payments? Against principal or to interest? 2. Collateral a. Initial i. $12.2 Million b. Now i. 11.4 million Problem 23.4 a. Two issues: i. (1) 362(d)(2): does the debtor have equity in the collateral? No (estate is not interested $55,000 debt against $50,000 in collateral) Is it necessary for effective reorganization? There is not business here because this is a non-starter. That puts another issue on the table. ii. How much can you advance the question of confirming a plan of reorganization 1. Does it give you a right to pull the plug on the first day (say that creditor has ability to prevent plan confirmation) a. But they Can accelerate the inquiry

10/20/03 I. Problem 23.5

35

a.

b.

This is a problem with single asset cases. What happens is that the secured creditor wants to take the property back and Chap 11 wants to reorganize or refinance or wait for market upturn. i. 362(d)(3): New special rule for only little single assets (up to $4.3 million, which is actually relatively small) ii. Valuation of the property here is about $4 million. 1. If you are above 362(d)(3), you dont get access to it, and now you dont get this protection. 2. What happens if you have 362(d)(3), you have to start making payments again. (is this interest payments or against principal? Hasnt been consistently answered) a. Under these 2 party cases, not many cases being litigated. Who cares how we treat single-asset cases? i. Are third-parties actually being affected? You get cases where debtors deliberately dont want to be single asset cases because you dont want to be rule out of bankruptcy under 362(d) (3), so they create another creditors. 1. So you change the shape of certain transactions ii. Business forms are infinitely malleable. It is always possible to use subsidiaries and now hard businesses would always turn into 2 businesses (the employer, the manufacturer).and then the second business would be a single asset case leasing to the operating company. If you can sever the 2 and make it non-reorganizable and can pop the physical space out of the reorganization, then you make other companies non-reorganizable. 1. So you want to see a new possibilitybreaking businesses into component parts that if you respect corporate forms and the whole thing will collapse.

II. a. B Chap 11 Plan Confirm. June10 Sept. 10 Problem 24.1 a. 363(c)(1): If the business of the debtor is authorized to be operated under section 1108 (the trustee can continue to operate the business), the trustee may enter into transactions in the ordinary course of business. i. As long as you are in the ordinary course of business, you can continue to operate. 1. And you dont need the courts permission (if the ordinary course of business) ii. Whats the policy for these rules for when you are in or out of court? 1. Shutting a plant places high costs to get it running up again. a. So these rules are more efficient if you believe that there is going concern value here. 2. Presumption that current management knows the business best. a. The unspoken assumption in Chap 11 is that the reason why you are in Chap 11 is external conditions (markets, etc.) b. Whats this guys problem? i. Secured party has interest in inventory. The cash from the sale of inventory is cash collateral ( 363(a))includes cash and cash equivalents, whenever acquired (captures preand post-filing), that are proceeds from the sale (another interest group is hotels because they were having trouble in determining whether they have proceedsis it the room or is it services also). 1. Most likely cash collateral here. With cash collateral, under 363(c)(2), you cant use cash collateral unless you get court authorizes and party in interest to consent. a. Court, under 363(e), may allow use of cash collateral with adequate protection. b. Once a business is loaded with a security interest, there is nothing left what is available for the debtor?you may actually kill of a business entity immediately.

III.

36

i. A fully-emcumbered business is starting behind the line in bankruptcy. ii. If a business is doing services, how is it different that they are going to survive (compared to this inventory business)? a. You arent generating cash collateral IV. Problem 24.2 a. Whats a compensating balance? i. If you keep $15,000 in the bank, how much money are you borrowing? Whatever minus $15,000. Now youve created an offset remedy of $15,000. ii. Why do people have this compensating behavior (instead of paying down the loan directly)? 1. (1) Makes debtor look like they have more money (make debtor look more credit worthy; looks like $15,000 in unencumbered business and fools rest of the world) 2. (2) Debtor is paying more interest because according to the formal paper, you are borrowing $15,000 more and paying more interest on the money that they cant use. iii. Only one way to figure out the offsets? 1. Youd have to see the balance sheets of the debtor and creditor to match it up. iv. Why cant you rely on the debtor? Because they may lie to you. A second cause of action doesnt buy you anything because they already owe you the money anyways. b. Whats the effect of this compensating balance in bankruptcy? i. The setoff functions as a security interest for that amount of money (the secured claim under 506(a))(the $15,000) (so the bank has a secured claim up to the $15,000 506(a)) UNLESS they hit some trouble:: 1. 553(a)(3)(A) (C): Since was after 90 days before the date of petitionsince the bank told them that they had to keep it in within the 90 day period. ii. So what amount is available for setoff? 1. $40,000 - $15,000 (excepted under 553(a)(3)) = $25,000 available for setoff. a. The principle at work, by limiting the amount of offset in bankruptcy, is that the deal gets unsecured. But if you dont negotiate for the deal (assuming no other security interest), but the money is there, then you can get it. i. The misbehavior for which the creditor is using their inside information or leverage in that last click before the debtor collapses. iii. What should debtors counsel have recommended to debtor, when the money goes into the account? 1. When you are ready to file, you should withdraw all money from the bank account. 2. You should put the money into another bank. c. Whats the policy of a presumption of insolvency? i. Uniform Fraudulent Conveyance Act 1. Were importing the same notion back in. 2. This is improper behavior on behalf of the creditor because we have an insolvent debtor. a. So there is little litigation over this and very likely that it is true. A compensating balance really doesnt affect the setoff here. If you get the money by good luck, then it is just good luck. Here, if the compensating balance was done 90 days before bankruptcy, then they would have secured claim up to $15,000 (but doesnt matter here because they had more money in bank account anyways).

d. e. V.

Problem 25.1 a. How could you get someone to lend you the money to install the water and sewage service and thus greatly increase the value of the property? i. What alternatives are available?

37

VI.
10/21/03 I.

364(a): The trustee may obtain unsecured debt in the ordinary course of business, which will be treated as a 507(a)(1) unsecured priority. a. What is this telling us? i. You can stay in business under 363, and also can incur debt. The debt you incur will be treated differently than pre-petition debt. ii. What was Levis trying to do by pushing Macys into bankruptcy? 1. Suppliers wanted to push them into Bankruptcy before Christmas because they wanted to get a higher priority for new (general unsecured paid as 507(a) rather than 502 unsecured) 2. 364(c)(1): First security interest in anything that is not otherwise a security interest (other assets of the estate). a. You can do inside bankruptcy what you could have done outside of bankruptcy. b. But now that you are in bankruptcy, the court must approve it after notice and a hearing. i. Why court approval? 1. The difference is that you are setting aside assets from these guys and going ahead of 507(a)(1)s, ahead of the priority creditors and general unsecureds. 2. We also have a little bit of constraint on the ordinary course of business provision. 3. Whenever you are doing something special, you are charting the course for the business somewhere else. The general unsecureds should have a right to object. 3. 364(c)(2): you can offer lien on property of the estate not otherwise subject to lien 4. 364(c)(3): can offer a junior lien (subordinate liens) 5. 364(d)(1): you can actually bump a secured creditor down in their priority but we gave them adequate protection. a. Policy for this? i. Makes the pie bigger for all of estate (unsecured creditors) ii. This tool also changes the negotiation. ii. What happens the possibilities? 1. Recreate what you could have done in state law 2. Can actually beat out a priority position that previously existed. Only 1st 4 problems will be done tomorrow.

1.

Problem 25.2 a. How much money is there to be divided up? $350,000 available b. What are the competing parties and claims for this $350,000? i. Hanratty: $100,000because they have liquidated collateral (but was a $100K deficiency) ii. FSB: $250,000 post-sale iii. Debtors Lawyer: $150,000 iv. General Unsecureds: $250,000 v. Chapter 7 trustee: $50,000 c. When you have Chap 11 that converts to Chap 7, figure out priority in Chap 11 first. i. If they were in a Chap 11, what would be priorities? 507(a)(1): gets 40% of $100,000 -No 502 claim because he is postpetition and not pre-petition. Its clearly a 364(c)(2) since a lien was

Hanratty (this is a post-petition claim for the $100,000 deficiency)

38

FSB (this is pre-petition secured creditor asking for adequate protectiongot more collateral)-$250,000 Debtors attorney $150,000 (they are working for the general unsecureds). General Unsecureds d.

507(b) super-priority-$250,000 will be given away now we have $100,000 left to be distributed among the 507(a) (1)s 507(a)(1): gets 40% of $150,000 (they are in front of pre-petition debt, but inadequately protected debt) 502: Zero

given. So the priority is 507(a)(1) 507(b): super-priority: having asked for adequate protection and not gotten that, it is elevated (guarantee behind what Judge had guaranteed in 362) The DIPs lawyer in Chap 11 was an administrative expense under 507(a) (1) because it was post-petition administrative expense

e. f.

g.
II.

If Hanratty had gotten a 364(c)(1) super-super priority (better than 503(b) or 507(b))? i. Hanratty: Gets the $100,000 (Down to $250,000) ii. FSB: Gets the $250,000. iii. Nobody else gets anything. If you represent a secured creditor, you should always ask for adequate protection because of the 507(b) super priority. Now we are in Chapter 7 (Chap 7 trustee now jumps in). i. 726(b): you pay expenses of Chap 7 first, and then whatever is leftover will go to Chap 11 the way it would have been. 1. So now, $50,000 will be paid to Chap 7 trustee! ($300,000 left) 2. FSB-- $250,000 507(a)(1)s will get 20 cents on the dollar ($20,000 to Hanratty / $30,000 to Debtors attorney)

III.

Problem 25.3 a. What are the chances of getting court approval for Murphys proposal, if VEIs management agrees? i. Cross-collateralization: well lend you some new money but agree that this collateral will secure pre- and post-petition debt. Court did not allow it in Saybrook. 1. Why not? (policy) a. Hes trying to take pre-petition debt and give a little bit of money and take me out of the order that was locked at the instant of filing (screwing over the other general unsecureds) b. Court says in Saybrook that this is no. i. If you take an appeal on post-petition financing, you usually cant overrule on appeal (i.e. interest rates) 1. Otherwise, lenders will not release money until it is affirmed on appeal. But here, the business needs the money now. a. Saybrook says that it is true ONLY if it is authorized. Cross-collateralization was never authorized and never gotten protection of no appeals. 2. Why should it be allowed? (Policy) a. Because without this loan, you die. If this business is worth saving, and this is just one more tool for paying. i. What would be the First Circuits response? 1. We have to set a boundary or in every case, there is not a Chap 11 case where they will argue it. The line-drawing case is too difficult during the Chap 11 case. Strong-Arm

39

IV.

B Problem 26.1 a. Are they a secured or unsecured creditor? i. They are unsecured because they are not perfected. b. 544(a) i. (1) Judicial lien ii. (2) execution lien iii. (3) bona-fide purchase c. Under state law, must look to see if it is perfected. State law says that an unperfected security interest loses to a lien creditor ( 9-317(e)) Problem 26.2 i. Non-purchase money security interest portionyou get no special windows and are dead meat. ii. Purchase-money security interest: They are entitled under state law to have 20 days under non-bankruptcy law to perfect (find this section under state law 9-317(e)). 1. 326(b)(3): if you are in a window, you can do relation back. (if you have an act that you need to finish as part of an exception given at state law, you can finish). Problem 26.3 a. He is unperfected, and at state law a bona fide purchaser would have had priority. This means the trustee does not have to acknowledge the mortgage. Problem 26.4 a. The lien is valid. The TIB loses. This is fixtures. Are fixtures BFP or Article 9 rule. The perfection is ok by article 9. Problem 27.1 a. Is Wilsons payment to Mountain Lakes a voidable preference under 547(b)? i. 547(b): trustee may avoid any transfer (here it is the payment of $1400) : 1. (1) to or for the benefit of the creditor (yes) 2. (2) on account of an antecedent debt owed by the debtor before such transfer was made (yes) 3. (3) made while debtor was insolvent (yes) 4. (4) made within 90 days before the date of filing of the petition (yes & presumed) 5. (5) and gives such creditor more than he would have gotten in Chap 7 (no). a. did it enable him to receive more than he would have received in Chap 7 liquidation? Yes i. he keeps the $1400 and the 502 claim is $14000 - $1400 = $12,600 (paid $1260) ii. He would walk away with $1400 + $1260 = $2860 b. In Chap 7 liquidation, he would have only gotten $1400. c. So he did better. 6. Whats the general principle is that all payments within 90 days to general unsecured creditors are voidable preferences. a. Only 1 time does not apply (only if debtor is paying 100% on the dollar) Problem 27.2 a. Can the trustee get the equipment back from OKC? i. Yes, the transfer is the equipment (compared to cash) and everything else is the same in the previous problem. 1. The broad definition of transfer is because of estate depletion and retiring old debt. Problem 27.3

V.

VI.

VII.

VIII.

IX.

X.

40

a.

Is there a voidable preference? i. Yes. Transfer of security interest. When did the transfer occur? Within the 90 days. ii. What makes this a voidable preference? For an antecedent debt. iii. Suppose they had not perfected it? Then use 544, not 547(b) with the 90 day reachback.

11/03/03 I. Voidable Preferences a. Debtor has filed for bankruptcy (estate and automatic stay) b. Now reshaping the estate (reshaping classifications or pulling more money in) c. 544 Strong Arm (knocked off mortgages and security interests not properly perfected) d. Here, on voidable preferences are getting assets back into estate (or break encumbrances that would be set aside for secured creditors) Problem 27.4 a. On September 15, North Woods cant meet payroll and it declares a Chap 11 bankruptcy. Has there been a voidable preference? i. 6/1: Loan with security interest ii. 6/20: Perfection iii. 9/15: bankruptcy b. When does the transfer occur? i. If they had never perfected, they would not have a 506 secured claim. 544 strong arm would apply because you would have unperfected security interest. ii. The consequence of perfection is that it makes it good in bankruptcy compared to strong-arm. iii. Does the transfer occur within 90 days of bankruptcy? 1. The transfer for the perfection occurs within 90 days of bankruptcy. 2. The only thing that you can do to save this transaction is: a. If transfers and security interest occurred on the same day, would it be a preference? ( 547(b)) i. You have a transfer, ii. To or for benefit of creditor iii. BUT not on account of antecedent debt (since it happens at same time) iv. Contemporaneous exchanges are not shut down (or otherwise you would shut down a business for sure). 1. What are the transactions that we are shutting down? a. How is 547(b) different from UFTA? i. If I owe you $1 million and am insolvent and within 90 day s make a payment of account, not fraudulent conveyance. ii. Voidable preference law is focused on payment of antecedent debt (a voidable preference doesnt change the balance sheet; here, distribution problem among all the debtors; what we care about in this 90 days is did one creditor already existing, benefit over other creditorsonly triggers on one event90 days proceeding bankruptcy). Fraudulence conveyance law is payment of antecedent debt is not a fraudulent conveyance (reasonably equivalent value)the whole estate value has shrunk (this is state lawthis applies whenever debtor is insolvent, depletion of estate). c. d. What would not have made this not avoidable? i. Only scrubbing transactions within 90 days of bankruptcy We have perfection within 90 days of bankruptcy. Now we ask is there any way to do a relation back?

II.

41

e. III.

i. Whats the rule regarding relation back? 1. 547(e)(2)(B): must perfected by 6/11, it would technically be an antecedent debt, but this section makes it deemed to have happened at the same moment. Here, there is a voidable preference.

Problem 27.5 a. MC 35K 30K 5K (this is voidable) Commercial 40K 50K 5K (No voidable preference betcause oversecured; when you receive the $5K, the loan balance is $35K)

Loan Collateral Pmt

b. IV.

The legal principle is that: If oversecured, any payment is not a voidable preference. Any payment to undersecured is voidable preference.

Problem 27.6 a. 3/1: loan is $250,000 (collateral is $150,000) b. 4/15: loan is $250,000 (collateral is $350,000) c. 5/25: date of filing of bankruptcy d. 547(b): requires a transfer to or for the benefit of the creditor i. 4/15 (date of the transfer): they have security interest in after-acquired property clause. 1. the creditor benefited from this.

V.

Problem 27.7 a. Timeline i. 6/1: Collateral-- $300,000, Loan-- $280,000 ii. 7/1: Payment drops the loan to $260,000 iii. 7/15: Fire (Collateral drops to Zero) iv. 8/1: Bankruptcy b. Is there a voidable preference? i. Presume insolvency. ii. Legal Issue is: The moment of bankruptcy controls (not the date of transfer). What does this tell you about the intent? Intent is not legally relevance. 1. This is about equality of distribution (overriding principle) 2. 547(b)(5): time is for date of bankruptcy

VI.

Problem 27.8 a. The collateral went to zero, and then the collateral shot back up to $300,000. b. $20,000 payment and acquisition of collateral. i. Get rid of the new collateral, voidable preference because new property brought in on new after-acquired property clause. At the moment it comes in, he is in a better position so it is a voidable preference. 1. $20,000 payment is knocked down as well because now undersecured. Problem 27.9 a. Can the trustee recover the payments to Granny and First Oregon? i. Granny would argue not a voidable preference. 1. 547(b): $50,000 is not property of the estatewas the $50,000 of the estate ever property of the debtor then is not covered.

VII.

42

If you borrow $50,000 in cash and get that in your hands and then pay $50,000 to someone else, you have created a voidable preference (because is property of the debtor) ii. King and Minnesota Mining: 1. Argues that voidable preference. It was property of the estate because the debtor initiated this transaction and directed the transfer to occur. iii. Where should we end up in this case? (is it or isnt it property) 1. Debtors direction and what are we trying to accomplish? a. The number #1 creditor that got socked was the NY Bank. If you dont treat this as property of the estate, you have debtor substituting one creditor for another. b. What left the estate? A security interest left the estate so the substation of a secured creditor for an unsecured creditor. Can you take the security interest from the bank? NO, under 547(b) is not antecedent debt. But can bring the proceeds back in. iv. Here, Grannys 20,000 is voidable under 547(b) or UFTA 5(b) VIII. Problem 27.10 a. Looks like there is a voidable preference. How long can you reach back on a voidable preference to an insider? 1 year under 547 (b)(4)(B). i. Why 1 year for insiders? 1. Assume that they have a lot better information. Notion that they are more likely to have a longer breath-holding period. b. Does it matter whether they file an involuntary petition now or later? i. But you should file within 90 days even though against an insider? 1. To get the presumption of insolvency within 90 days of bankruptcy ( 547(f)) Problem 28.1 a. Can the trustee recover any payments made to Exaco? i. Do you have a voidable preference? Yes 1. The 3 preferences are the payments that are made the next week (on account of an antecedent debt) 2. There is no security interest here. ii. Is there a 547(c)(1) exception? 1. intended by the debtor and the creditor to or for whose benefit such transfer was made to be a contemporaneous exchange for new value given to the debtor a. Possibly was it in fact substantially contemporaneous b. What in fact did the parties agree on? i. No intent to be substantially contemporaneous. It is a loan (goods now, payment in the future). So now you dont qualify for (c)(1) 2. 3. Is there a 547(c)(2) because not in the ordinary course of business (Ordinary course of business if of the debtor and transferee and made according to ordinary business terms.)probably not good enough as between parties. 547(c)(3) exception: No, because no security interest here. 547(c)(4) exception: Must have new value in order to get thisafter the 1st one, the second extension of credit saves the first one, and the third one saves the second, but nothing saves the third one.

2.

IX.

4.

X. Date 1/1

Problem 28.4 Transaction Beginning balance Amount $80,000 Saveable under 547(c) Balance owed to DMPB

43

1/3 1/15 2/10 2/28 3/4 3/10 3/17 3/20 4/1 4/10

Payment from Notions New credit from DMPB Payment from Notions New credit from DMPB New credit from DMPB Payment from Notions New Credit from DMPB Payment from Notions Payment from Notions Notions files for Bankruptcy a.

5,000 4,000 2,000 (voidable payment to unsecured creditor) 8,000 9,000 1,000 (voidable) 6,000 10,000 (voidable) 9,000 (voidable)

Not voidable because outside 90 day period Saveable

$75,000 79,000 77,000 85,000 94,000 93,000 99,000 89,000 80,000

saveable under 547(c)(4)) Cant save this one Cant save this one

How much of the payments from Notions can DMPB keep? i. Start by finding out where 90 days hits. (1/10) ii. Save under 547(c)(4) or alternatively, try ordinary course of business in 547(c)(1).

XI.

XII.

Problem 29.1 a. 90th day: Collateral (4.2 M), Loan (4.0M) b. B: Collateral (5.2M), Loan (4.6M) c. Is there a 547(b) problem: yes, because here you have inventory, and in the 90 days before bankruptcy, there was potential movement in inventory (it is possible that the loan could have gotten ahead of collateral). i. 547(c)(5): Improvement in position test. 1. Snapshot at 90th day and at Bankruptcy. Because he is oversecured on 90th day, not a voidable preference under (c)(5). 2. But if undersecured loan (3.2 collateral, 4.0 loan) on 90th day, then on Bankruptcy (5.2 M Collateral, Loan 4.6 M). a. On 90th day, -800K deficiency. b. On Bank, they can can keep 3.8 (so that they are down -800K) i. 1.4 million in freed-up collateral. Problem 29.6 a. If you call the loan, you will only get the $30,000 (repossessing during the period when the amount is $30,000, the bank only gets the $30,000). b. The minute the bank comes to seize the inventory, the debtor will file for bankruptcy. Youll lock in the bankruptcy date. Youll go back 90 days, and the secured creditor will be limited to $30,000 on a $90K loan. So you wait 90 days when the inventory was valued at $100K. i. What else do you want to know: how fast the inventory will plummet? 1. Plummeting inventory might not be bad because they are selling the inventory. a. So if the cash or accounts receivables comes in, two things should happen: (1) paying back the loan or (2) purchasing new inventory. ii. If you seize 90 days after that run-up occurs, and there have been lots of sales and new purchases such that the inventory runs up? 1. Debtor files for bankruptcy. 2. Voidable preference under 547(b)? Might be a voidable preference because might be dropping up and down undersecured. This is a 547(c)(5) because at the beginning point at 90 days, you were oversecured, so you are ok. iii. What do you tell the secured lender?

44

iv.

v.

vi.

vii. c. d.

If where you stand today (back 90 days) and that number is larger than this 90 day runup date, then you should file right away. (not only do you keep payments but also the full value of the inventory to the full extent of the loan). 2. If it looks like an upward trend, you might want to wait. (But the danger there is that if there is nothing there when they file, you get nothing). When you are below $30,000, you might want to file fast. What is the test for waiting at least until the end of July? 1. If there was a runup in April and then decreases after that, (post 90 days post-runup), you should repossess on the 91st day (and force them to bankruptcy) 2. If you see the value going up, you want the peak to hit on the 91st day. If they are 90 day apart (if sinusoidal), you want to file on a hump. Remember that the debtor may not file for bankruptcy right away (and they might wait for the debtors filing date (90 days after the worst trough). 1. The best creditor counter strategy? a. Involuntary Bankruptcy: When does the creditor want to file (at the same time of repo) Whats the debtors incentive to file for bankruptcy instantly? (why would the debtor might not wait for the trough measurement) 1. Debtor is looking for the automatic stay if it files for bankruptcy. It buys it time for the inventory. What happens to the inventory? They took the inventory, and business would fold. 2. Even if they have already repossessed, you can still stop them from not moving further: a. This is a voidable preference that brings it back into the estate (automatic stay under 362(d) if post-petition). 3. If the debtor does not file instantly, the debtor has decided to liquidate the business. a. Thus, it is likely that the secured creditor will be picking the date. What should businesses be doing when they get in trouble? 1. Have lawyer already prepare the documents for bankruptcy.

1.

Secured creditor, here is allowed protection under 506 secured claim. If you are at high valuation, adequate protection to where the 90 day hump was up until the value of the loan.

XIII.

Whats the best deal you can cut for the debtor if you are in July (you are now in the 90 days before, the value of the inventory was $30,000), i. If only I had another $5,000, I could make it. Otherwise, if I go into bankruptcy today, here is how the division of $90,000 worth of collateral will go-- $30,000 to you, $60,000 to others pro-rata. There can be an agreement not to file today. ii. Is this fair? Why is this the right way to go? Whats the policy being played out in this case? 1. This gives debtor power (to hold onto the goods longer). 2. The amount of time is limited, and give them another 20, 30, 40 days, and what might happen in the next 20 or 30 days? Might turn around ( a reorganization twist) 3. Who benefits from debtor that turns around? a. Everyone benefits. b. But, if you made a bad guess, you are sucking up assets every day. e. What is the importance of monitoring on the facts where the value of the inventory peaks and then continues to decrease after than? i. In order to engage in any of these negotiations, we knew whether the inventory was going up or down. ii. For secured creditors, the secured creditors need to know: 1. How much inventory is there? a. Send someone to count b. Let inventory counters by independent agency. c. See invoices and See receipts for things going out. Problem 30.1

45

a.

XIV.

Reject the contract because: i. The contract price is $15/barrel * 100,000 = $1.5 Million 1. Market price is $25/barrel. ii. If you have a breach here, the claim is contract market differential ($10/barrel * 100,000 = $1 million claim) b. If you assume 30% repayment, they recover $300,000. i. Who will get the other $700,000 in bankruptcy? 1. If liquidation? a. Pro-rata distribution. 2. Whats the policy for 365(a)? a. Code tells us that you can reject the contract. b. Why should debtors (DIPs, TIBs) be permitted to reject contracts? i. (1) We have a bankruptcy filing. If there had been a breach prior to bankruptcy, then ConEd would have had contract claim of $1 million. What would they have gotten paid in Bankruptcy? $300,000 and the debtor would have kept the oil and the value of the estate would have at least the $2.5 million it got back from selling the oil. 1. timing issue ii. (2) Assume 365(a) is not in the code. What happens if they must perform after bankruptcy. ConEd would get all of the oil and estate would be smaller (ConEd gets it and general unsecureds get paid less) 1. Policy is that those who got breach pre-bankruptcy and those after bankruptcy (assuming no 365(a)), then on distribution, the pre-bankruptcy breach people get less and the ones after bankruptcy get paid in full (inequality of distribution, and better yet, the debtor is making all the decisions). iii. Whats happening on distribution by having 365(a)? 1. Equalizing all people who took a contract. (equality of distribution) 2. Debtor cant decide who will get 100 cents on the dollar and who gets pro-rata share (this is like 547(b) voidable preferences). a. 547(b) was taking away from debtors the ability to pick and choose. b. 365(a) prevents debtors from choosing which ones will get paid in full. i. Taking away capacity to pick and choose. ii. Equalizing over time also (does not matter when the time of bankruptcy happensjust asks who took the contract risk). Problem 30.2 a. What are Jamesons options? i. He knows that the information is coming out tomorrow. So, he will wait until he has the information to decide whether to assume or reject under 365(a). 1. Under 365(d)(1), in Chap 7, has 60 days to assume or reject 2. Under 365(d)(2), in Chap 11, anytime before confirmation of plan unless the other party to the contract can force a decision. ii. This is terrific because time is money (assume if turns out to be a good contract, reject if it is lousy). iii. If you are in bankruptcy and you breach, you only pay in bankruptcy dollars. But if not in bankruptcy, you are paying in 100% dollars.

46

iv. What would you like to know about the people who you negotiate contracts with? 1. Whether they are planning to file for bankruptcy. v. Many courts dont let people confirm or reject until confirmation of the plan. Why? 1. What is the court worried about? a. Things are changing constantlyif you assume that contract and then breach it, tell me about what happens in repayment? i. You breached it after filing and after you accepted it, it becomes a 507(a)(1) priority. (I think this is 364(a)) 1. Why? Equality among creditors and maximizing value of the estate. vi. Are you allowed to assume or reject on your own? 1. Notice and hearing by a court. Court is watching out for the DIP. XV. Problem 30.3 a. 541 gets this into the estate i. 541(c)(1): part of the estate even if contract restricts or conditions transfer of such interest by the debtor (preventing other party from bailing by contract, everyone would contract around bankruptcy; you cant opt around bankruptcy). ii. Can the debtor assume it? 365(c)(1): Trustee may not assume or assign if applicable law prevents this. 1. Can the estate assume the contract? We need to assume it in order to assign it. 2. Outside bankruptcy, are those contract provisions (no assignment) enforceable? a. Yes, they are outside bankruptcy. iii. If you put a clause in contract that this deal is off if the debtor files for bankruptcy, its no good (See 365(e)) iv. Can you assume and assign in this case? 1. The problem is still the no assignment clause. 2. If you dont have a no assignability clause, can you assign it? (outside bankruptcy). The assumption is that it is assignable except where you dont get what you contracted for. 3. The question is what do you do with a general no assignability clause? a. How does that get resolved under the code? i. 365(c)(1): refers to applicable lawbackground common law rule that says that Pablo Picasso cant assign it because the other party wont perform it (personal services contract) or a regulation. 1. One way to read this is that it just means look at the contract for canteens and look to common law, which for canteens would say perfectly assignable (which is assumable and assignable) a. Why in favor of this? Because you are creating contracts around bankruptcy. If you make your contract non-assignable, then it violates the equality principle (because the only people who are being pinched are those whose contract gets taken up) 2. Government would say that applicable law would say follow the contract law would say (the personal services rule only applied to a specific situation not present here). So if you put non-assignability, you get non-assignability. a. Why in favor of the restriction of assignability? i. As between those two parties, these parties negotiated for this non-

47

assignability clause. So to X out the clause is to take away value. XVI. Problem 30.4 a. What should AM&Ms DIP management do? i. Assume and Assign. ii. 365(f): allows contract to be assigned. Why? So debtor can extract value from this option. Problem 30.5 a. Can she keep the franchise in Chap 11? i. Is she under default under the lease? 1. If yes, then she must cure before assumption. ( 365(d)(3)) 2. Then after assuming, she must provide adequate assurance of performance. a. If the other party has to be performing, then you also must be performing. The other party to the contract will be stuck with you for years.

XVII.

11/10/03 I. Businesses who have filed for bankruptcy a. Automatic stay, property of estate created b. Post-petition financing c. Now reshaping the estate (determining what emerging business will look like) i. See Executory contracts ( 365) Problem 30.5 a. Can she keep the franchise in Chap 11? i. Executory Contracts 1. Can buy some real estate: 5% down and 20 year mortgage 2. Buy supplies at 90 days and low interest 3. Can Borrow up to $100,000 at a low interest rate 4. Lease ii. Are there any clear rules on these? 1. 365(a): Except as provided in (b),(c), or (d), a trustee can assume or reject a. (b) If in default . . . b. (c) cant assume if applicable laws applies (when you CANT) c. (d) time limitation in bankruptcy 2. So she can assume the lease under the franchise. iii. What about the $100,000 loan? NO 1. She can assume or reject ( 365(a)) except under (b),(c),(d) 2. However, 365(c)(2): cannot assume if (2) such contact is a contact to make a loan, or extend other debt financing or financial accommodations, to or for the benefit of the debtor, or to issue a security of the debtor. iv. Buying supplies at favorable financing terms? 1. Does it fit under the statute? (a) tells us we can assume or reject. Under (c)(2), is this debt financing or financial accommodations? a. Possibilities: i. Any time you are selling something on credit, then you would have any problem under (c). ii. The narrow reading is just cash and cash equivalents. b. If you use the narrow reading, the consequence under the debtors power under executory contract, the debtors power is greater. c. How can you do it as a matter of statutory construction get to the narrow reading? i. Reading loan, debt financing to mean cash equivalents

II.

48

2. 3.

Why is it that if you made a contract to make a loan, why should you be able to get off the hook? How does a debtor get any cash in bankruptcy, then? ( 364) a. 364 is about getting credit. b. Super-priorities, ordinary course How does 364 and 365(c)(2) intersect? a. If you want to do post-petition borrowing of money, you must go to 364 and must work through all of the restrictions.

d.

b.

v. The supply guy that has to supply: He must supply under 365(a). 1. Why doesnt it make much sense (compared to the loan contract)? Because the company needs this just as much as the money. a. We also treat cash differently because cash can be used in different ways, not to further the business. (ew has argued against different) i. Youre either giving debtor too much power or too little otherwise (if treating cash similarly) 2. Assuming the contract results in 507(a)(1) priority. vi. 365(a) requires court approval (so you will have to send notice to all other unsecureds) 1. Strong statement that we want you in 364. vii. Can I take a purchase agreement and put enough financing into it that it becomes a financing agreement? Excepted under 365(c)(2) 1. So is buying real estate5% down/20Yr mortgage: a. Perhaps it falls under 365(c)(2) because it involves so much financing b. But, on the other hand, this is a contract to buy land. Just has a juicy financing statement with it. i. This is an agreement to sell a piece of real estate that the franchise company had, not just any piece of real estate. 2. When you mush two aspects together? a. Whats the argument that says that this is assumable? i. Its a contract to buy a thing ii. If you like this finance thing non-assumable, then what will happen? Any long term contract becomes assumable and the value of the business cant be saved. b. On the other hand, this is too much financing. Maybe the court looked at the dollar value and it was too big. c. EW doesnt know how this should end up (9th Cir. Said not assumable) Now you have a franchise contracthow many contracts do you have? i. Just one (but with two or three assumable clauses and several non-assumable clauses). 1. If you werent in bankruptcy, could you sever those provisions? No. The fundamental rule of contracts is that it is assignable (subject to Picasso rule), but not assignable with pieces of it. a. Why shouldnt you be able to sever it? i. You cant know where the benefit of the bargain lays because it is intertwined. ii. Nonetheless, you think they can take out the bad parts in Bankruptcy: 1. If you didnt let them sever the contract, you could make then opt out of bankruptcy by putting certain provisions in. a. If we permit parties to stick in a money borrowing provision then you would kill every contract. 2. The asymmetry in breaching in Bankruptcy is that he gets paid in bankruptcy dollars. 3. EW doesnt know if you can sever.

III.

Problem 31.1 a. What arguments would the landlords attorney make against you, and how could you reply? i. Tell him to file for Chap 11.

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ii. Then tell him to cure and then assume the lease contract. ( 365 can be used when you are about to be moved out of your apt, rental space for business) 1. Jackie must cure by the time he assumes iii. He has a problem that he has 5 day under state law. If he waits past the 5 days, and then the lease will terminate. If the lease terminates post-petition, not assumable. 1. He has at the end of business two days. (you have a time clock running under 365 (or watch for 547(90 days)). iv. If he files for bankruptcy today, how long does he have to cure? 1. 5 day limit doesnt hold (debtors argument) a. 365(d)(4): gives 60 days. b. 108(b): you have 60 days to cure a default. 2. 5 day does hold? (landlords argument) a. Landlords argument is that 365 gives you the power to assume or reject, not change the terms of the contract. i. So if under 5 days notice, then the game plays under the contract and you get nothing more. v. Because he is a shopping center, there are more restrictions (see 365(b)(3)) than if he werent a shopping center. IV. Problem 31.2 a. What remedies will FB have if the lease is rejected? i. The debtor here is the landlord (Rancho) 1. The legal issue is what the tenant is entitled to. ii. The landlord has rejected in this case. 1. But, the landlord could have accepted the lease. a. Tenants dont get to bug out if landlord accept it. i. If you are the tenant and he assumes it, but doesnt keep hallways, you can pursue state law claims (sue for damages; if you sue for damages against landlord, then you get 507(a)(1) priority-administrative expense) iii. The tenants two options are: 1. (1) A breach of contract claim ( 502 general unsecured claim) a. If the lessee accepts the rejection, 365(h)(1)(A)(i) tells you that you can treat it as terminated. 2. (2) The second option available is that: a. The lessee can reject the rejection. If you reject the rejection, then you get to stay. If this guy doesnt provide water, you can truck it in, and offset so the guy here would eat the $10,000. (h)(1)(B). 3. The economic decision in this case, then his lease would have gone up by $10,000 (look and see how much other leases). a. What else do you want to know about the bankruptcy? i. Would it matter to you if he were paying 80 cents on the dollar? You might get more money by taking the rejection. What would it cost me to stay? (or taking the losing). 4. Why is there the power to reject rejection? a. We are worried about collateral effects on other parties (by making them move). b. Think about NY apartments (what this says is that rent control stays in effect in bankruptcyso it cant go into Chap 11 to scrape off those leases that are not in favorable terms; keeps Chap 11 from being attractive to other bankruptcies.)

V.

Problem 31.3 a. What do you advise Novelty?

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i. File a bankruptcy to get the profits from the $300,000 for the unsecured creditors (might be a distribution). ii. Assume Chap 11. iii. Clause (1): 1. 365(e)(1): termination clauses dont work in bankruptcy iv. Clause (2): 1. 365(f)(1) & (3) v. Clause (3): 1. invalidated by 365(e)(1)(A) vi. So what about the fact that you assign, but want all the money: 1. 365(f)(1) This is a restriction on assignment a. Want debtor to capture value on behalf of the other unsecured creditors. b. In re Jamesway: 365(f)(1),(3) allows court to scrutinize anti-assignments. vii. Proposed legislation: 1. Landlords have asked for 2 more provisions: a. (1) an absolute time cap on the ability to assume or rejecting non-residential leases (like 120 days) i. I.e. K-mart just went into Chap 11. K-marts problem is that they have profitable stores, so they will reject non-profitable leases. What does K-mart really want to do is?wait until I have maximized revenue to reject; they wanted to wait to figure out what the thing ends up looking like (400 stores or 500 stores) . As soon as you put a 4 month or 5 month cap, they dont have enough time to see how things are turning out. 1. If they were under a hard 100 day cap, they might overreject (scared of keeping too many stores. Any that you accept and reject and have to pay in 507(a)(1), which the general unsecureds end up paying for). 2. Want to put a provision that you cant cure non-monetary defaults. Shopping centers will usually have a going dark clause, which says that you agree when you sign the lease, that everyday the shopping center is open, you agree to be open. Why do shopping centers want this clause? When you go to a shopping center, it may lead to a domino effect. a. Suppose your business had gone dark because you couldnt pay the utilities or the employees or your inventory financer. If you were closed 4 days before bankruptcy and now you are up and running. Under current law, you could file for bankruptcy, the fact that you went dark (if it has an economic effect, what do you do? They will file a claim and to assume, you will have to cure (pay in full dollars) and assume the contract and go forward. For non-monetary defaults usually, there is no consequence. i. What are businesses trying to accomplish with non-monetary defaults? 1. It changes the leverage in bankruptcy because many businesses have a non-monetary default. Our watch repair service had a non-monetary default by having insurance lapse. The landlord has more leverage because once the tenant is in bankruptcy and unable to cure a nonmonetary default, the landlord is holding all the cards. What will it take for the tenant to stay? The negotiation of the new contract will include all the terms that the landlords wanted. 2. If you have the capacity to make everyone in a breach, then they cannot assume, and once they cannot assume, the minute they file for bankruptcy, youre cutting a new deal under 364.

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a. 11/11/03 I.

The debtor could no longer play the waiting game. If there is real economic value, you will have to pay me in favorable money.

Problem 32.1 a. Help him file for bankruptcy so that he can reject the contract. What would be the consequence of that? i. Reject the contract. Under 502, would have calculate the damages (agents portion of that). 1. They would file a claim and this guy would give up probably nothing (or pennies on the dollar). ii. Then what happens to the guy post-bankruptcy? 1. He can sign a new contract with someone else because the old contract has been resolved. iii. Suppose the fight promoter rejects this. What is the bank promoters best argument? 1. Are there unpaid obligations on both sides? (argument that it is not executory) a. That he must still show up for fights b. Promotors: schedule the fight; these are obligations being breached on either side (either one would be a material breach). c. This is not a great 365 argument. 2. How do you frame this as a legal argument? a. 1112 (if he brings the case in bad faith, and should be tossed out on equitable grounds) i. If you deny him the relief of bankruptcy, what happens to him? 1. then hes locked into the contract b. Suppose he goes through Bankruptcy, the promoter says that he wants specific performance. i. Does this work? No, because 502 is where the claim falls. 1. Because rather than taking a money damages claim, you cant get specific performance. a. If you have a low-sale contract of Picasso, what should you do in Bcy? (1 million contract, now worth $10 million) Reject contract, sell it somewhere, and a 502 claim against you for ($9 million). i. Why is it? Debtor to capture the value for the benefit of all creditors. If we didnt we would have distortions in bankruptcy. ii. Would you be able to get specific performance in State Law? Yes, the reason why we make you perform is because damages are not the same thing. (the only way you can give them what they contract for is because there is no dollar equivalent (or not requiring someone to take assignment that is not the same). ii. What happens when you take this into Bankruptcy? 1. 502(g): When the debtor rejects it post-petition, they consider it a breach pre-petition. The provision is important because if were post-petition, then it would become a 503 administrative expense with 507(a)(1) payment. 2. 502(c)(2): any right to payment arising from a right to an equitable remedy for breach of performance

52

a.

b.

Why do we not allow specific performance? i. If we gave specific performance to one party, then you are giving them 100% performance (which would be an asymmetry in the code) Whats the downside of thisnot allowing specific performance? (policy point of this) i. Because value was so uncertain, we give a double blow for people who would have otherwise enforced through specific performance. (in common law, no specific performance of personal services, because would be involuntary servitude; courts dont want to oversee it.)

iv. Why is this guy really trying to reject? 1. The exclusivity of it. 2. What if he signs up for a second contract, and he is breach? What will he happen? a. Promoter #1 will ask for injunctive relief for the subsequent fight. b. This is fighting over an equitable remedy. v. What will determine whether the fighter can get relief in bankruptcy? 1. In order to strike this contract, what does he have to prove (not about executoriness)? a. Official Test is whether this is a good faith filing i. financially distressed or insolvent? 1. So you should advised him to stop paying all of your creditors ii. Those criteria say that he is in good faith if he: 1. really needs bankruptcy. (so if he is in good faith, he can get all the good bankruptcy remedies). 2. Compare with someone who is trying to scrape off a bad contract. 3. Should Bankruptcy be available under those circumstances? a. He otherwise would not have been using bankruptcy. b. POLICY (should Bcy be a tool to scrape off a bad contract if you otherwise are not in trouble): i. Want to keep Bcy open for those financially distressed. ii. Anybody can put themselves into insolvency anyways. iii. If the person is not insolvent, and they can scrape off contracts, but they will be paid in 100%. (the scrape off costs is to put yourself in insolvencymost companies will not become insolvent just to get rid of contracts; Holmes makes a point that contract is either to do the thing or pay the damages; The twist on Holmes is that as long as contracting parties know what the law is to do the thing or to file for bankruptcy for IBM, they must do the thing or pay money equivalent. For someone

53

who is insolvent, he can scrape it off every deal you negotiate is that they wont perform and either have money to pay or not money to pay (and file for bankruptcy)). vi. The different contract is a franchise (ie. Burgerking ) for downtown Boston. It doesnt work out, and I went through Bcy. I decide that I want to reject the contract and become a Jolly King in the same spot. There is nothing to do on the franchise but a 5 year non-compete clause. Can I go into Bcy and reject the Burger-King contract, and then not be enjoined when I compete. 1. What will this answer turn on? (Good faith is already met) a. Under 365, question of whether you can reject because: i. Argue that it is not executory: 1. the part that is non-executory is: a. there is nothing left for Burger-King to do. b. How will you see whether it is executory? i. Must be obligations left open on both sides. ii. You have more power when you are in the middle than when you are the only one left with things to do. b. The point here is that under the contract, Burger King has done all it has to do. Whether you can enforce the covenant to compete depends on whether Burger Kings still needs to ship buns? (this is an ancillary question over the real issue of the negative covenant). 2. Should you be able to use Bcy code to scrape injunctions? a. If you give 100 percent enforcement on equitable remedies, you give some creditors better enforcement than other remedies. b. But someone who took a liquidated damages, then 10 cents on the dollar. 3. Why did you get specific performance in the first choice? a. So we can overcompensate you, or undercompensate you. 4. If a contract is not executory here, what are the implications? a. So you cant reject. But are you still bound? Its just a 502 claim. (the contract can be breached, just not rejected because not executory) b. But most courts will stick BurgerKing to the non-compete clause. II. Can you reject a patent assignment? a. Bcy code 365(n): inability to reject intellectual property contracts (but 101(35)(a), an IP contract does not include trademarks (but includes patent and trademark) i. So what happens to my licensing of a trademark? Can you reject real estate sales? a. 365(i): if the buyer is already in possession, seller cant reject the buyer out. (real estate deals may be single asset situations) i. The old title concept: remember the notion of when you have equitable conversion, when title passes and then have specific performance. ii. There is a notion in property law that the paperwork tells you when you become the owner, but property law says that if you go into possession, you become the buyer for purposes of being protected as a buyer with a mortgage outstanding. Bankruptcy recognizes that. Why dont we allow contracting around Bankruptcy? a. One of the problems you have is whether you can get all stakeholders to agree to the contract. (what matters in Bankruptcy is what happens to all of you) i. When you build in a tilt for reorganization, it benefits people who are not stakeholders but who have an interest. (i.e. employees, creditors)

III.

IV.

54

V.

Statutory liens a. We are still reshaping legal rights. Statutory liens are usually created in state law. They say that as a matter of state law, someone gets priority (artisans lien; mechanics lien). Bankruptcy says that if the rule applies to everyone, we will acknowledge it in Bcy (if it gives them a security interest or puts them ahead in priority). i. But under 545(2), if there is any perfection requirement, you must do it before bankruptcy and the provision cant trigger on bankruptcy. 1. Also, cant trigger for rent payments. (partly protecting the tenants, a sophistication issue, and 365 would not help you if you got priority in 542) Fraudulent Conveyances ( 548) a. 1 year minimum SOL. b. 544 gives you what you would have had under state law. c. Why do we import fraudulent conveyance law into Bankruptcy? i. Whatever you had in state law, you also have available in Bankruptcy. ii. So if state law says that you cant make a distribution when you are insolvent, then what should happen if you are in bankruptcy? 1. DIP can get this back as well under 544. Problem 34.1 a. 548(a)(1)(B): fraudulent conveyance if the corporation received less than equivalent value and the corporation was insolvent. i. From whom do you recover? 1. Burt? a. 2. CruiseLine? a. When you try to recover from the cruiseline, what is their defense? i. It went from BeWell to Burt to the Cruiseline. This saves the cruiseline because under 550, the trustee can can recover from a subsequent transferee ( 550(a)(2)), but under 550(b), a subsequent transferee who takes in good faith, then cant recover from the Cruiseline. ii. Another argument that Cruise can make is that: 1. they received money from Burt and they gave Burt, and Burt got the reasonably equivalent value. b. But there is a fraudulent transferee as between BeWell and Burt. i. But Burt can argue that it is fee for services. (best argument) c. What if it is a BeWell Check to the Cruiseline directly? i. In re Video Depot: case law supports them too. 1. 550(a) says that it is the initial transferee and their good faith doesnt insulate them. ii. Policy reason for this: 1. Its a real easy rulethe money you take should be from the person you give value to. a. Otherwise, you may risk that they are insolvent and reasonably equivalent value given to wrong person. iii. It would be too hard to get back from grandma if she took in goodfaith. 1. She was not part of the scam. iv. Burt and his company now have directly opposite interests (Company wants to collect from Burt) Problem 35.1 a. The second security agreement that they gave the bank could be a voidable preference under 547. i. Because it is an antecedent debt.

VI.

VII.

VIII.

55

ii. The banks defense is that 547(c)(4), they gave new value, and therefore not a voidable preference to the extent of the new value. 1. For a secured creditor, this was liquidation expenses. You dont get a 547(c)(4), wasnt a loan to company, was just loan to the company. iii. Second argument was by the bank? That it was a contemporaneous exchange. We gave you a line of credit in exchange for a security interest at that point. iv. Equitable subordination claim: 1. First and Second security interest 2. Equitably subordinate the entire debt (bank will collect last and likely nothing) a. Helps all the other undersecureds. b. Other creditors might use involuntary petition. i. They debtor might do it to maintain future relationships. v. What does it take for equitable subordination: 1. Bank acts like equity. vi. If in fact, they acted like equity (or equitable subordination), 1. less certain about whether equitable surbordination requires injury to other creditors. vii. The problem with lender liability is that the business was already going under (hard to prove damages)

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11/17/03 I. II. III. Pre-bankruptcy power a. Fraudulent Conveyance Act Lender Liability a. Where creditor injured the business Reshaping the estate a. Voidable Preference i. 90 days of trxns are unraveled and assets pulled back into estate b. Executory Contract How bad can you ding a creditor? i. Fraudulent Conveyance Law ii. Strong Arm iii. Voidable Preferences iv. Executory Contracts v. Equitable Subordination vi. Lender Liability (finding that the lender has engaged in actual injury to the debtor) The secured creditor is dealing with the debtor. a. The secured creditor sends $100 million to the debtor. b. Debtor promises collateral, also that he will pay $100 million, and interest $100M, Collateral, Interest Secured Creditor $100M Debtor

IV.

V.

VI.

Securitization $$ Guys $100M (Sale of A/R) $100 M SPV $110 Million of A/R

Debtor (Guys who need $$)

$110 Million A/R classified as loan (or Equity)

Why do people do this? The benefit of the transaction (if it works) is because you have reduced the bankruptcy risk. These things are most valuable if you have a highly risky debtor. If you have a solid debtor, no benefit. Whats the thing that makes this securitization costly? You have to get a true sale opinion from the lawyers. They say nothing because if they turns out they were wrong, but some judge says not a true sale, then they might be liable. Then the investors (lenders) will sue the lawyers who wrote the true sale opinions. These are designed to be insurance contracts. The rating agencies say to the lawyers, we dont do law so we need a lawyer to tell us this is a true sale. So you cant give them good ratings if you mention LTV steel, which states that these may not be bankruptcy remote.

57

Is this a true sale by debtor, and then debtor agrees to service it? Is this a sale or a true loan? ---- What is the debtor still doing with the property? (are they still servicing it; who had physical control over the A/R) - What if these accounts receivable generate more than $110 million? (the present value of $130 million)if this was an Article 9 security interest, the residual $20 million would be kept by the debtor. If it is a true sale, then the $20 million is moved over to the investors. The way the game is played is that the debtor takes a reversionary interest in the value that exceeds the $100 million. What about downside? (i.e. if turns out to be $95 million) Does the debtor somehow have to guarantee $100 million of value (then looks like security interest) - Might look at taxes: question is how are you treating this for tax purposes (did you take an interest deductionif so, looks like a security interest). - Look at what parties called it themselves - How did you treat it to third parties (in your contracts) - How independent is your SPV? - Also want to know who is carrying it on their balance sheet and how. - Was the SPV only there to receive the paper? If there is no other business here, then it is a sham transaction (should have between just between the debtor and the creditors) o Why did otherwise secured creditors want to claim previously? The secured party would say that he lent it and was a lessor of the property. Looks just like interest plus principal. The lessors benefit in bankruptcy. The lessor was claiming executory contract. As an executory contract, if you rejected it, the lessor gets the property back, and they get to sue you for anything that they lost. But the debtor can keep it but must stay current on the payments. o What subsequently happened? A true lease v. disguised security interest. So Article 9 spends some time distinguishing true lease v. security interest? Who has residual value at the end of the lease o If there is a 5 year lease where the life of the product is 5 years with only a nominal payment to buy the thing, then it is a loanso that you have to do article 9 perfection. o If there is strong residual value, then it is true leases Instead of lending to a business, can you lend to the asset? But you cant lend to an asset, only to a business and Bcy law overrides. o This SPV is contracting around bcy. o If it works, it lets one party contract around bankruptcy. Ask whether it is an executory contract or actually a secured loan (if the debtor still has to do something) HYPO: What would airline industry asked Congress for? a. You are high risk and cant get capital. b. So you securitize like crazy. c. What happens to a debtor in bcy that already has the A/R sold. What does that debtor look like? i. Debtor can only use checks (as cash collateral) if the court approves it if you can supply adequate protection. ii. If this SPV works, then how is this different? 1. Then you cant ever use the A/R. What you say is that these incoming checks are not mine (the debtors) because you dont own it. What are your reorganization prospects between (i) and (ii)? a. In the first one, you are more likely to reorganize because you might be able to fiddle with judge in valuation. b. So if you ran an airline, you would borrow like crazy, and then lobby to say that this is not a true sale and review these transactions, and then if they are

VII. VIII.

58

dumb enough to count on true sale and not take backup security interest, then if you collapse, then they are generally unsecureds. i. You want the $$ guys to believe that this works when you try to get them to lend for you, but at time 2, when you have borrowed, you want to recollapse it. 1. 912 Proposal: it said that if Moodys call it a true sale, then the federal court cannot make a form v. substance argument. 2. Who pushed for that? The specialists in the industry. (it blesses all their deals) a. How did law firms view of 912? i. They liked it because they were making legal opinions and all of their opinions are effective and wont get sued in malpractice. IX. Whats the Delaware statute trying to do? a. It makes these things true sales. (no matter how they are treated for tax purposes) i. Best argument that it will work? 1. State law defines what is property. Bcy transparent to state law in many places and should be here as well. b. Whats the argument in the other direction? (that it does not work) i. 541(a): supremacy argument makes it a federal supremacy argument. ii. 546 regarding statutory liens (if they triggered on bankruptcy, then does not have any effect) There is another federal interest at stake and should trump the state law interest. iii. The court always gets rid of sham transactions, and substance controls. Even when the transaction collapses, would argue equitable subordination because they tried to opt out of bcy and tried to get them out of bcy. Or perhaps fraudulent conveyance (actual intent to hinder, delay or defraudpoint of transaction was to sock it to trade creditors)

X.

11/18/03 I. HYPO: You are Johns-Mansville, manufacturing asbestos products in the 1940s. In the 1970s, you are getting sued by your workers or others who have used your items. Johns-Mansfield have stopped making asbestos products. You are the accounting firm that certifies that their records are right. What are you worrying about? a. Possible liabilitylook at how many people used your product, market share, and age of the workforce (since takes time to show up) b. Johns Mansvilles accounting report says that it should have set aside more money for tort liability. i. What happens to them in the accounting market for this report? No one wants to give them any more money. ii. Whats the only way that you lend to Johns Mansville if you get asset-based lending (on security interests). iii. John Mansville is then cut off on credit. (for operating capital) c. How do you get profitable operation from the tort liability? i. If they get into bankruptcy, they are looking to stay in business by severing the claims from operations. 1. The instant you file for bankruptcy, the stay falls into effect (it is stopping every lawsuit against the corporationvery useful for mass torts) a. Dow Corning has two shares of stock. Manufactured breast implants. Corning argued that the science showed that silicon never hurt anyone (nonspecific diseases). The lawsuits would say that of the 1 million who got breast implants and how many would we predict would get these non-

59

2.

3.

4.

specific diseases. Now, you get 6 women together with these non-specific diseases and jury would award them to the women. Dow Corning filed for bankruptcy because: a. Get cut off from market financing b. How many lawsuits can you do in a week? i. Dow Corning can only handle several lawsuits at a time. The lawsuits were multiplying and set for trial (and go on trial on 30 locations every Monday). They didnt have enough lawyers. They were spending $1 million per week on fees. ii. Dow wants all the lawsuits into 1 big lawsuit. 1. One big causation trial. 2. Substantively they want 1 causation trial. The lawsuit is a statistical nightmare. They will have all the plaintiff at once with disparate complaints (chronic fatigue, arthritis, lupus) 3. And Dow argues how many of these would have been naturally anyhow. What is the problem that Fairchild is answering? a. Fairchilds problems is of tail-liability. Whats wrong with Fairchild is that over time, Fairchild will be hit with a lawsuit, but will continue forever. (could possibly be product liability). i. What made Fairchild end up in Bankruptcy? 1. Fairchilds business plan was to continue to manufacture small planes. The guy who buys it will continue to sell it (outside the to the US (and that they wont be brought into US AND sell them to small aviation branches of airlines). Whats their insight? It cuts their liability into almost nothingforeigners are outside of the US jurisdiction; and large airlines have a deeper pocket and more insurance. a. What will insurance cost under this new plan? i. Insurance for all they were going to do (without no tail liability) less than $1 million per year; if they had tail liability, it would be $17 million per year. ii. Without tail liability, they could make about 11-15 million per year. ii. Fairchild was posted for liquidation; Can you sell it as a going concern? (Or in pieces?) 1. A new investor comes in to buy this. When he found it was for salehell bid a few million if the court promises that they will cut off tail liability. The court promises no tail liability, and then a plane crashes in TN. Court then decides that they have tail liability (under successor liability). iii. Two problems: (1) Massive lawsuits and (2) tail liability 1. Dow Corning was not a tail liability case. a. You dont know if you have asbestos, but you do know if you have breast implants (you could close the class). How does bankruptcy take the next step to solve the problem of tail liaiblity? a. Life of a tort: i. Manufacture bad goods ii. Sell the defective goods iii. Consumer uses them defective goods

60

iv. Consumer is injured by the defective goods v. Consumer discovers the injury. (compare with asbestos, where dont discover for 20 years) vi. Consumer sues vii. Consumer wins (this is the first time you have a right to money) 1. If you sue solvent companies, then everything is good. a. Now in bankruptcy, the question is whether there is a claim? i. On the lawsuit scale, you can have consumers who are on the entire spectrum of the lawsuit scale. (in every state of use). b. The legal question is whether there a claim? The company wants to argue that they were claims because if they are claims, they are taking care of them in bankruptcy. So the emerging company has washed off all the claims themselves. To be resolved in bankruptcy (1) decide there is a claim (2) put them in a class (some notice) (3) give them some type of representation (4) decide how much they get paidpro-rata dollarsgeneral unsecured (5) then claims are discharged. c. Whats the problem in Dow Corning? i. Massive number of lawsuits. They have 8 zillion lawsuits. Maybe have some new techniquesyou have a 502 claim. What tools are available to the court? 502(b) can be used to determine the amount owed to each claimant; 502(c)(1) allows estimation of contingent or unliquidation claims. ii. They want to bind all of these claimants to 0% claims and pay the rest of the creditors the full amount of the money. (Why not insolvency? Dont want to litigate it; you can be cash poor; and we can use it to resolve mass liability). Dow Corning files a massive objection to claim to every womans claim. They try to get a single trial on causation. Bcy says it can estimate, but not a 1 massive lawsuit; Bcy judge denied; and upheld on court of appeals. Plaintiffs wanted a dozen lawsuits, but Dow Corning. They ended up doing estimation and doing a trustthe matrix is for what is wrong with you, and take each claimant and check off the box and well give you a particular dollar maount. And Dow Corning says it will not contest liability (and put $4 billion into trust), and claimants only have to show that they fit. iii. Now the problem is whether there is a legally confirmable planyou cant get a jury trial under these circumstances.

61

So they put a leak that says that this is what you can get if you dont want it, all you have to do is wait till we have paid out of the trust, and go to court and you win (if you win, you get paid in general unsecured claim). b. II. Bcy judges should not do personal injury cases (so they brought a district court judge there).

III.

Asbestos Cases a. Flyover is that they use the same structure as Dow Corning. The issue, not present in asbestos cases, is that peoples rights are being litigated and they dont even know they are sick. i. (so they appoint future claims representative, who litigates and negotiates) 1. The principal is serving equality of distribution in bankruptcy a. If all the people who have judgments or people who know are negotiating for quick payouts, then there might be nothing left. 2. The other risk is constitutional is: due process. You lost property without due process of law (a takings argument) a. For that constitutional law to take effect, what will you have to prove? i. Future claims bracket is to say that you were there in the presence of the claims. b. Was there a loss of property actually? i. When does this become property actually? 1. That there is no property until you reach the end (and then will be a present claimant) What was the problem in Fairchild? a. The judge said that Im not sure these were not claims, but guarantees that he couldnt have discharged them. i. Was he right when he said that he couldnt discharge those people? 1. No future claims representative was appointed, no money was set aside, and these were foreseeable. b. 11th Circuit come up with an analysis: In asbestos cases, you can deal with future cases, but not in the case of airplane crashes? i. In asbestos and dalkon shields, everyone is potentially a defined class. People who go into airplanes are unknown. c. Whats the counter argument? (policy argument) i. If Fairchild goes the other way, Bankruptcy becomes a tort reform and they manufacture them and then go into bankruptcy and then to sell after foreigners. ii. The counter argument is that: If J. Clark doesnt sign the release, then there is no money left and lose 700 jobs and there is no one to sue when the plane crashes anyhow. 1. If the question is that corporations will murder and maim and then walk away because they can liquidate anyways since there is no shareholder liability. Why havent tobacco companies filed for bankruptcy? a. Part of it may be that in the time game, they are still before the lawsuits have blown up. b. Bankruptcy wouldnt help it because they dont have a plan on the other side, then they will be liable post-petition. i. If they develop a safe product, they will file for bankruptcy and cut off liability for the old dangerous product. Bank. Code 542(g) a. Dow Corning had all potential claimants; asbestos doesnt have the same. b. 542(g) says that asbestos companies shall be able to get rid of these future interests through a matrix and a trust and that more than half the stock of the company must be used to fund the trust. i. What has just happened in this case?

IV.

V.

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VI.

Gets around the problem of liquidating. You try to keep the value there but have it pay out on the victims. ii. Bankruptcy as Tort Reform: 1. When torts are huge, you can: a. Eliminate rush to courthouse i. Article 9 is about rights of secured creditors ii. Bcy puts some rights back in debtor b. In the tort system, it gives company another place to run (if the equitable ownership of half the company strikes the right balance) Environmental a. Variation on the above problem is: i. T1: Debtor Pollutes ii. T2: State discovers iii. T3: State orders cleanup iv. T4: State cleans up for debtor v. T5: State sends a bill b. c. In bankruptcy, the state is unsecured creditor so will be pro-rata distribution. How do they solve the problem? i. If the state has not yet cleaned up (if it is still dirty), and if debtor files for bankruptcy, do you have a claim. 1. You have a legal obligation to clean up. 2. If you file for bcy and dont clean up and emerge on the other side, then you have a post-bankruptcy (its not the dont pollute law, but the second law is that you arent allowed to sit on a dirty sitefailure to remediate). a. The point is that if you file for bcy and come out of the other side, you havent washed off your obligation. ii. But if you file for bcy, and during the interim, the state cleans up between the two periods. The state can have a 507(a)(1) claim for preserving the estate under 503(b). When a business is in financial trouble, telling state to clean it up. State says either you clean it up, or go to bankruptcy an get a 507(a)(1) priority. State has incentive not to clean because they want you to go to bcy first.

1.

d.

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