Introduction a. Test i. Open book ii. Any materials you want to bring—Civil Code, Bankruptcy Code, nutshell, notes, etc. iii. No points for reciting/transcribing statutes iv. Will have review sessions and go through practice exams b. Generally i. Title 11 USC Federal Law is bankruptcy law ii. Art. I, Section 8 – Congress has the power to pass uniform laws respecting bankruptcy 1. 2. This constitutional power is to avoid having states pass their own bankruptcy laws and to promote interstate commerce Over very long periods of time there were no bankruptcy laws a. 3. 4. The power to promulgate laws doesn’t mean that there will be
Why would a state want to discharge its citizens from debt? Discharge a. b. c. Uniform Not really an elimination/reduction of debt So that citizens do not become wards of the state i. Maybe not as big an issue for corporations d. e. One component of discharge is that it is uniform, no matter where you live. What the debtor surrenders to obtain the discharge i. Once you get a discharge, you cannot get another one for a certain period of time ii. Have to surrender equity f. g. Discharge has emerged as the debtor perspective focus has emerged Federal law gives us the process of discharge
Congress’ power to promulgate “uniform” laws is uncommon in the Constitution, but it exists with respect to bankruptcy laws
iii. This class is about property rights, broadly 1. 2. 3. Therefore also about obligations Origins of rights and obligations Contract 1
a. b. c. d.
Defined – obligations between parties that are enforceable under law Obligation is a duty determined by the contract to perform The value of the contract is a huge component of bankruptcy law Another issue is the problem of proof – the cost of enforcement i. An oral loan is enforceable, but the cost of enforcement may be too high because there is no way to prove the loan ii. You can make a deal, but if it’s not legally enforceable, it’s not really a deal iii. Having a legal right does not mean that you will get the value of the right. 1. It may be too hard to collect or impossible to prove
A creditor must assume that if the debtor can’t pay the creditor, there are other creditors he can’t pay either i. Even if the debtor can pay the creditor and others, the debtor does not want to
Assuring payment from the debtor i. Get a surety or guarantor ii. Get a lien on property in case of default 1. Security interest in the property that gives priority in case the person doesn’t pay. It’s a contract that is ancillary. A security for payment of the principal obligation, the debt. Can be a mortgage if over real property. A lien gives the creditor a property interest in the debtor’s property The principal obligation, the debt, gives a right against the debtor personally, but not a right in the debtor’s property; whereas the lien actually gives the creditor a right in the debtor’s property. The claim against the debtor is the creditor’s incorporeal movable property. The lien is also property, but it is more advanced: a property interest in the debtor’s property. If the debtor defaults, the creditor gets the property.
2. 3. 4.
iii. Make sure that you as creditor get the debtor’s payment or property before other creditors do g. Perfection of Lien Rights i. Perfection is an act in time. Acts in time take time. Two parties cannot perfect simultaneously on the same property. 1. 2. 3. This creates ranking of liens. This is the priority of lien claims upon property. Determined by the timeliness of perfection. The earlier recorded, the more priority given to the particular lien on particular property. Value of the lien is the lesser of the value of the property and the amount of the debt. a. 2 Therefore, if house worth 100k and debt is 50k, 50k is the value of the lien.
b. 4. ii. Basics 1.
If house worth 45k and the debt is 50k. Then the lien is worth 45k.
Value of the lien often has no relation to the value of the claim, as a result.
The claim is the note. The lien is the ancillary obligation of the mortgagor/debtor by which the mortgagee obtains a property right in the property made subject to the mortgage.
iii. Perfection occurs through recordation of the following: 1. The mortgage in the parish where the property exists a. UCC as adopted in Article 9 applies to movables i. For movables, record the financing statement that describes the collateral in the parish of the obligor’s domicile b. h. Provide in the agreement that the property can be obtained in satisfaction of the lien
Principal and Ancillary Obligations i. Difference 1. 2. Principal obligation is the debt Ancillary obligation is the security interest a. b. Security interest generates the lien rights. The lien rights creates the interest of the obligee in the obligor’s property
Security Interests i. Can take many forms ii. Treatment differs based on whether the thing is movable or immovable property 1. 2. The security agreement gives rights in the property Louisiana adopted the UCC on security interests in movable property (but not immovable property)
iii. You can only grant a security interest on what you own iv. A party cannot hold a security interest on property that the party owns; when the obligee becomes the owner of the property, there is confusion v. Security interest on immovable property (lien) usually takes the form of mortgage. 1. 2. 3. Mortgage can take numerous forms. A mortgage in Louisiana may secure future advances Collateral mortgage principle – a fictional security interest.
There is a debt, but also a collateral mortgage note, which is itself secured by mortgage on real estate. Also known as a pledge. Pledge is possessory in nature. Pledge requires delivery of the thing pledged. Pawn is a type of pledge (as in pawn shop). i. Pawn shop lends money on things that it holds in pawn, subject to the right to redeem the pledge (get the stuff back), if you pay back the price pawn shop paid you plus an enormous charge. It’s not a sale.
The note can be held in pledge even if the debt is not outstanding Borrow 100k and buy house. Mortgage note has 100k principal balance and some amount of interest payable over 30 years in equal monthly payments of 480. Go back to lender to borrow another 50k because house note has been paid down to 50k, and they lend 50k to borrower; unless security agreement can include the new loan, it won’t. Collateral mortgage principle allows the mortgage to constitute collateral security for any and all debt that is owed or comes to be owed during the term of the pledge. i. So if you had 16 notes, they can all be secured by the original mortgage note. ii. The balance of the debt can go up and down (even to zero) because once there is debt outstanding, there is a principal obligation, which triggers the validity of the pledge, which triggers validity of the mortgage.
e. vi. The two issues: 1.
Does not exist outside of Louisiana
Want priority over debtor’s stuff over everyone else in the world a. Perfection of a security interest accomplishes this
Want priority in repayment from the debtor, to be paid back first
vii. Real estate mortgage must be recorded in the parish records where the property exists 1. From this moment, the security holder’s rights are perfected against the world
viii. Perfecting a lien on a car 1. 2. The finance company loans money to buyer to buy the car and the title gets mailed to the finance company It is the possession of the title that perfects the lien
ix. Liens on Movables 1. Examples a. b. 4 Receivables Inventory
UCC provides mechanisms for providing security interests on movable property, both corporeal and incorporeal Perfection is an act that takes time. Therefore, there is a ranking of liens.
x. An unsecured debt is one that can be exercised personally against the obligor. 1. Louisiana statutes grant architects, blacksmiths, attorneys etc. statutory liens or privileges. These individuals have a privilege on the debtor’s stuff. But this just means that the statutes create secured claims. A lien (secured) is a right to the property of the obligor. A claim (unsecured) is the property of the obligee. Louisiana Civil Code article 3383 says that property is held in the common pledge [meaning pro rata] of one’s creditors unless there be cause for a legal preference. Therefore, Louisiana says that there is no preference among claims of unsecured creditors, they are ranked equally. a. Problem with common pledge – there is no delivery. An actual pledge requires delivery to the pledgee. This by definition means that there is no actual pledge that the creditors can enforce. Unsecured creditors are similarly situated with respect to priority. The “common pledge” is not an enforceable pledge. We have to find a way to get a right to someone’s “stuff.” An unsecured creditor must go to court, file a petition against the debtor and get a judgment that says that the debtor owes the money. If suspensive appeal delay runs, then the judgment becomes executory. If the debtor loses the appeal, the creditor receives the bond that the debtor had to post to suspensively appeal. i. The judgment can be enforced if the debtor devolutively appeals. d. The winning creditor can record the judgment in whatever courthouse he wants, and from that moment, the judgment acts as a judicial mortgage upon any immovable or real property that the debtor owns or comes to own. To enforce the judgment, you obtain a writ of fieri facias (“fifa”) from the clerk of court. This writ is prepared by the judgment creditor. It directs the sheriff to seize identified property. i. The judgment debtor rule requires the debtor to identify property that can be seized. Allows the creditor to find out about the judgment debtor’s financial affairs. ii. After creditor obtains this information, go get the writ to seize. iii. The judicial lien on the movable property is perfected at the moment of seizure.
iv. To execute the lien, you have a sheriff’s sale. Can also do garnishment (a floating lien on a debtor’s earnings). f. Garnishment interrogatories – ask the employer how much the debtor earns. Can get a garnishment judgment, allowing the sheriff to collect out of every debtor paycheck, until the judgment is paid. The garnishment lien “floats” and priority is maintained even though the debtor will not earn the money until the future. i. Can send garnishment interrogatories to the bank if the debtor has an account there. The bank then holds the money. xi. Example: Two 200k claimants. Debtor has one 200k piece of real estate. Whoever records the judgments first has a right to property because the right is created the moment of recordation. What if Debtor only has 100k in the bank? Whoever seizes it first gets all the money. 1. Rule: As long as I can move stuff (like money), you have to be able to keep me from moving it or I can take it to Vegas and spend it.
xii. So debts are collected by getting property owned by the obligor, and the only way to do this is through obtaining a legal preference – a lien. If the lien is perfected correctly, it is perfected against the obligor and against the world. 1. 2. The judgment obtained via executory process is a personal judgment against the obligor. A judicial mortgage recognizes other property outside of the mortgage sued upon.
xiii. Executory Process 1. 2. 3. The process by which the mortgage/lien holder proceeds against the property to foreclose the lien. This only relates to consensual liens, those by contract. It is an expedited process because there is no summons, citation, and period of time for defendant to answer. The lawsuit asks for an order of seizure and sale of the mortgage property. If the documents are done correctly, the duty judge reviews the package and answers the prayer. The sheriff seizes the property and puts it up for sheriff’s sale as required by law. Any lien holder is entitled to notice of the sale to protect rights. Differences from ordinary process a. With executory, you only obtain the right to have collateral sold to satisfy your lien. You do not obtain a judgment against the obligor personally. Deficiency judgment is for the amount left due after the property has been seized and sold to satisfy the lien claim. The only way for the debtor to stop executory process is to obtain an injunction, which is obtained when the following are true: i. Irreparable harm 6
ii. Going to win on the merits iii. No legal alternative. d. The injunction halts the sheriff’s sale on some basis: i. Executory process was done improperly ii. Fraud 5. 6. We only have judicial foreclosure (by the sheriff) in Louisiana. Anyone can bid on the sale, but the creditor usually bids on the sale. The creditor bids with the lien by a credit bid. Creditor has already advanced money through the loan and should not have to advance cash until paid. When there is a judgment recognizing a claim of a debt, the judgment will say that the obligor owes money, and that the mortgage is recognized as a perfected mortgage. Recordation of this judgment, while creating a judicial mortgage on property of the obligor in the parish where recorded, this does not affect the ranking of the mortgage. a. b. The judicial mortgage is over immovable property only. Seizure is required to obtain a mortgage over movable property. i. Article 9 describes the types of things you must do to obtain the mortgage over different types of movable property: inventory, equipment, accounts, etc. For example, for equipment, have to describe the make and model number. Going through this process perfects the security interest. ii. Otherwise, the only way to obtain a lien over movable property is through physical seizure. iii. Therefore, creditors cannot in Louisiana have equal claims to obligor’s money in a bank account. 8. If debtor has 10k in bank, and 2 creditors are owed 10k each (20k total in debt). 50 cents on the dollar if the creditors could share. a. b. The debtor does not care who gets his 10k. A concursus proceeding would have to be filed by the debtor – a debtor in his right mind will never institute a proceeding to allow the creditors to have it divided up. i. Also, no concursus is available at this point because the 10k is the common pledge. Only the debtor has a claim to the 10k. The creditors only have a better claim to the debtor in principle. ii. Also, joinder of parties requires that the parties be related to the same transaction/occurrence. Joinder of claims addresses claims in favor of a single obligee. c. Intervention does not work. Because the claim of a creditor does not arise out of the same transaction/occurrence that generated the claim brought originally.
i. Intervention requires the intervenor to sue, saying that the claim belongs to the intervenor, not the plaintiff. ii. Does not work in Louisiana. d. 9. The way creditors enforce their rights is exclusionary – trying to beat other creditors because no one has a legal preference.
Contrasted with ordinary process a. Lawsuit by unsecured creditor against debtor. If the lawsuit is by an unsecured creditor, and the debtor has engaged in fraud, is exiting himself from the state, is evading service, or is causing diminution of property in an unlawful manner, the creditor can file the suit and ask for a writ of attachment. Have to post a bond because if the creditor is not telling the truth, he will have grabbed the debtor’s property merely based on alleging that payment is due. i. The writ of attachment is ex parte. The debtor does not have the chance to stop it until after it’s issued. This is why creditor must post a bond. ii. The purpose of the writ is to obtain a privilege (legal preference) upon seized property, from the moment of attachment. Even if it takes several years to get a judgment, the attachment will be the moment of obtaining the preference. b. Debtor who borrowed to construct office building collects rents to pay off note. Creditor calls and says debtor is in default, because rents are not sufficient to pay the note on the building. Debtor says, “I’ll pay it when I get it, rents will increase…” etc. If there is a lawsuit by a secured creditor seeking judgment, there may be situations where the debtor has the disincentive to maintain the property subject to the lien. The creditor needs to preserve the value of the property that is collateral, even before the creditor obtains a final judgment. i. Value of the secured claim is the lesser of (1) the value of the claim and the (2) the value of the collateral. So if value of collateral decreases, value of claim decreases. ii. If the obligor has the power to cause a diminution in value of collateral pending the creditor’s proceeding, and if the creditor has a secured claim of ownership in the property, the creditor can obtain a writ of sequestration. This protects value of the collateral. It is a seizure, and the collateral is held pending the proceeding. If creditor obtains judgment, the creditor obtains the collateral value being held. Not necessary to post bond, because you have to establish that you are a secured creditor – which shows a legal preference / outside the common pledge – you have a claim in the debtor’s property itself.
iii. Note that if a creditor is secured, the creditor has first dibs over the debtor (even if the debtor needs the money for a vital surgery). xiv. Executory Process 1. Requirements: Proper form, properly recorded, etc. If you meet them, you get order of seizure and sale and foreclose. Immovable property must be advertised twice before sale; property is then sold, in satisfaction of security interest. All lien holders must receive written notice of the sale (Mennonite case from SCOTUS).
xv. Public Records 1. Transactions involving immovable property must be recorded. For the sale to be good against the world, must be recorded in the conveyance records. Mortgage must be recorded in mortgage/public records. Recorded transactions affect the property. Our law does not place any importance upon actual knowledge. If the record shows that someone owns the house, anyone can buy from that someone and then record the sale to be the owner, against the world. For a movable property, must be perfected as of record, also. If obtaining a judgment, this is inferior to liens of record. When selling at sheriff’s sale, lien holders of record get notice.
2. 3. 4.
xvi. The judicial sale 1. 2. The lien holder gets to credit bid because he has already put money into the property. Lien holder can bid his claim. 100k lien holder. Property worth 200k. Unsecured creditor cannot bid its claim. Because an unsecured creditor has not obtained an interest in the property. An unsecured creditor must pay with cash and will only get his pro rata share back if he buys. An unsecured creditor won’t want to buy it back, therefore. a. b. c. There is no way for the unsecured creditors to share in the equity… Practically speaking, the secured creditor bids 100k claim and keeps 50k, if the property is worth 150k. Therefore, Example 1, the secured creditor who is owed 100k will bid his claim and get a 150k valued piece of property, and therefore, will make 50k out of the purchase at the judicial sale. Example 2, debt of 150k and property worth 150k. Secured creditor will bid, get the full value of the land, and practically receive payment in full of the debt. The law is that secured creditor must bid 2/3 of the value at the first notice of sale. This means secured creditor must bid at least 100k. In this case, the creditor may still collect 50k from the debtor. In other words, property worth 150k, debt owed is 150k, and creditor only required to bid 100k. Therefore, creditor makes 50k, but can still collect this 50k
from the debtor. Equals potential for creditor to make 50k out of the judicial sale. i. It is possible for a secured creditor to receive more than the amount of its claim, through judicial sales. ii. Therefore, not only is the common pledge not enforceable on a creditor by creditor basis, but also there is no way to trickle down equity to the common pledge group. iv. Discharge 1. It’s not remission, forgiveness, release, extinction, extinguishment, etc. a. b. c. Analogy: Even if the claim against a decedent is released by discharge, upon death could still file a claim against the estate It’s not ability to have a claim that makes “remission” the wrong term Other people that a creditor could collect from if a debt is actually “released”? (“No,” on the following two?) i. For an injured tortfeasor/obligee, he could sue the liability insurer of the obligor/debtor ii. Surety who promises to pay in case of obligor’s default; may be able to collect from the surety d. Consequences of release i. Lose rights against other obligors of the same thing ii. Lose rights against third parties (like guarantors and sureties of the debt) iii. This is why discharge cannot be a release e. Reasons that discharge is not a “release” of claims: i. Because this would result in claims against third parties becoming naught 1. This means that solidary obligees cannot collect
ii. Security rights (lien, mortgage interests) would fail because of the release of the primary obligation 1. f. Property interest which depends upon existence of the debtor’s debt would evaporate, essentially
It’s more like an injunction i. The creditors are enjoined from pursuing previous claims against the debtor
A petition is filed at a moment in time, and the discharge occurs shortly thereafter, after there is a space of time for determining if the debtor is entitled to a discharge i. Remember the green line on the board – this is when the petition for bankruptcy is filed. ii. And then time passes – we don’t know how much, but this is a temporary halt in the ability to collect on the debt – and then there’s a discharge, which is permanent (just like death)
iii. Why we need the temporary halt, between the filing and the discharge: it takes time to determine the amounts of claims and to which creditors they belong. 1. h. But if there is no more estate, then there’s nothing to halt the creditors from getting
Upon discharge, the creditor cannot pursue the debtor, but only the property itself i. The creditor can then get a pro rata share of the assets that remain in the estate ii. Note that even after the discharge, if the creditor has a security interest, could still foreclose upon the property (as in foreclosing on the mortgage)
Discharge for Corporation? i. Does not need one ii. A natural person might need it for a fresh start, but corporation does not need to eat, etc. iii. Individual could have future income stream that could be susceptible to collection, but corporation maybe not, so that discharge would do no good for a corporation iv. Corporation does not need a fresh start because if all the assets are gone, the ones who started the corporation can go form a new one 1. **FUNDAMENTAL: Corporations are different from their owners. a. 2. Corporations are different from their assets
Corporation still might get a discharge, even if it doesn’t need one a. b. Maybe more efficient to keep all the assets together However, maybe not. The corporation still owes debt, so there may be no reason to put new money into the old corporation, with debt outstanding. Just have the owners go invest money into a brand new corporation and start process of borrowing again. Corporate assets (employee base, company name, IP), etc., however, might be worth keeping in the old company.
The Basics of Bankruptcy a. Components i. Liquidation 1. Sale of all assets to pay cash to corporation 2. But if corporation has no assets, this is not worth anything to creditors. Unlike individual, who might move and have future income stream, post-liquidation, to pay creditors. 3. This process provides the least amount of value because it’s not interested in carrying on; the buyers will buy the stuff for what they would pay at a pawn shop. 4. Least favorable method of asset disposition. ii. Reorganization
A process that has to yield at least as much as a liquidation. Because if you can’t get as much in payment as a creditor as you would in liquidation, there’s no reason to reorganize.
2. If keeping the entity together is more valuable than splitting it up, then you reorganize. 3. Requires some form of discharge so that the reorganized corporation can go about its business with reorganized business and debt structure. 4. Chapter 11 a. There is a plan, that must be confirmed, to bring about the reorganization
There are reasons for a corporation to get a discharge: to not disturb existing jobs, preserve the value from having all these assets together, avoid environmental problems, etc.
c. Confirmation of the plan takes time i. To be discharged from the debt that existed as of the time of the temporary stay, there is a discharge that creates the pre-bankruptcy debt into Plan Debt. Then the company goes out into the world and operates. ii. The reorganized entity creates a better plan than a liquidated entity. d. Corporation basics i. Shareholders who own the stock; if corporation files for bankruptcy, the shares of stock are not assets that are divided up among creditors. ii. Shareholders get what is left, in bankruptcy iii. The shareholders come last in obtaining leftover value in chapter 11 bankruptcy 1. Shareholders only get a stake if everyone is taken care of or the debt holders agree that shareholders get something 2. Secured debt is valued at lesser of amount of claim and value of property 3. Secured debt is always paid with collateral. So secured debtholders do not care whether shareholders stay in to collect or not. 4. If the collateral is oil and gas property that must be operated, the secured creditor may not want to have to operate the collateral to get value out of it. 5. The unsecured creditors do care what the shareholders will claim. a. The unsecured creditors and stockholders share the pool of whatever is left after the secured creditors get their piece.
*Unsecured creditors have to be satisfied before stockholders get anything, or must agree, before
stockholders get anything. Because equity comes last (in a reorganization or a liquidation). 6. Priority: a. Secured creditors get the value of the property b. Unsecured creditors get the value of the corporation c. Equity holders get residual, whatever is left after debts are paid off. e. Equity as a Process
i. An action in equity is about getting stuff done, as opposed to resolving
Action at equity, as opposed to action at law (see Constitution)
2. There used to be common law courts and courts of equity a. The equitable process included figuring out what to do with estates that could not pay
Need a process to organize the claims.
Butner wants an equitable rule, see below a. He wants an equitable rule that if there is a mortgage on the real estate, you automatically get the rents, because this makes the process easier b. But if the process will not hurt Butner, then there is no need for an equitable rule
ii. The bankruptcy judge ought to know about state law. The judge should allow state law rules regarding property. If you have a good claim, bankruptcy process should not hurt you as a creditor. 1. If he couldn’t get the rents under state law, he can’t get them under the bankruptcy process 2. The equitable process would say that a lien holder is not being hurt by the passage of time; since the creditor is protected, the process should provide a vehicle for the estate value to be split so that secured creditor gets his share first, and then if there’s anything left, the unsecured creditors get it 3. The trustee can ask the court to appoint investment bankers, lawyers, etc. to help in the process. 4. The court can order the trustee to sell property and put the proceeds in a fiduciary account.
Butner Principle i. Butner v. U.S. 1. Facts
Plaintiff Butner is a second-in-line mortgage holder with a right in real property. The first proceeding: The reorganization/arrangement i. Under the 1898 Act, a process of attempting to realize real estate debt through a consensual process. ii. The mortgage holders and creditors would figure out what to do, and the plan would be confirmed. The real estate would be reorganized, and claims would be reorganized.
iii. A receiver is put in place – a third party who takes over the property and
presides over it while creditors work out their arrangement 1. The receiver collected the rents and put them into a separate fund 2. In this case, the receiver paid the funds to the first mortgage holder, taxes, interest on the second mortgage, principal on the second mortgage (in this order) iv. The arrangement never came into fruition v. Once this arrangement didn’t work, then adjudicate as bankrupt. vi. The purpose of an arrangement is to generate more money than and adjudication. Adjudication is the least valuable method of disposing of stock. At an adjudication a trustee is appointed. The difference between an agent and a trustee is that the trustee pays administrative costs and secured claims. This trustee was told to hold money until an order by the court. He paid only insurance and other necessary expenses. The agent was supposed to collect rents etc…. c. Second proceeding: An adjudication
i. Initiated with filing of petition – rental property goes into the estate, and
perhaps any rents collected previously. A trustee is also created upon the filing of the petition. ii. Then court appointed a trustee, different from the receiver in this case
iii. Trustee held the money as agent for either the debtor or the lien holders.
iv. Butner purchased this property through a credit bid. After the credit bid the deficiency is $186k. d. Upon the adjudication, there is an automatic stay. i. The trustee comes onto the scene at the same time as the adjudication. ii. At the time of the adjudication, the creditors flying through time hit the firm line and go “BONK,” because the automatic stay has prevented debt collection efforts. iii. Upon the adjudication, the estate is created and trustee oversees the estate.
iv. The creditors cannot collect, but the trustee administers the estate for the
creditors. The first mortgagee is not happy and wants to get the rents that were collected by the agent and trustee.
Second mortgage holder, Butler, claimed that under North Carolina law he was entitled to get the rents first i. Butner has a preference over the debtor
Under nonbankruptcy law, Butner could petition the court for an order of seizure and sale via executory process to get property sold to satisfy mortgage
2. AND Butner can sue in ordinary process to obtain a judgment for the amount of the debt a. This creates a judicial lien on real property, other than what the creditor already had as a mortgage over the real estate b. Could get seizure and sale of movables, also, under judgment to satisfy remaining debt
ii. In an executory process proceeding, nothing happens to the rents unless
the creditor utilizes the provisions in the mortgage to obtain a receiver to collect the rents while the executory process is ongoing. 1. The seizure is not real – it’s constructive. The receiver / keeper is appointed to take care of the collateral pending sale. At this point, the corporation is dispossessed of the property and the right to collect the rents.
Writ of attachment would be to preserve the property if the debtor might run off with it and it is shown that the debtor is doing so
b. However, can do writ of sequestration pending judgment if you have a secured interest in the property. This protects the rents from the debtor running off with them (to Las Vegas).
Under bankruptcy law, the rents don’t go off to Vegas. Trustee prevents this because of the “BONK.” The rents consisted of about $160k over a period of time. Sounds like a long time. During that period of time, Butner did nothing. This was because money went to the trustee (not to Vegas).
4. Butner did not move immediately to receive the rents. He just allowed the trustee to collect the rents. a. So it’s good that Butner allowed the trustee to collect the rents for the good of all the creditors, so the posse doesn’t have to chase the assets any more.
But Butner now claims that even in bankruptcy, he maintains a legal preference over the rents. He wants the automatic stay removed so he can obtain his rents. Wants an equitable rule that says if he has a mortgage on the real estate, he gets the rents regardless of whether he would have to sequester them to obtain a lien to assist
the mortgage. Three circuits had agreed with Butner. But the majority of circuits disagreed; don’t need an equitable rule. iii. But bankruptcy judge denied his motion to receive the rents iv. The rents went to everyone, all the creditors 1. And Butner is saying that he should have received a preference in receiving the rents 2. Trustee only gave a share to Butner and to each of the creditors f.
The corporation is being liquidated Main Points:
i. In bankruptcy there is someone (trustee) looking out for the interests of
the unsecured claim holders. Outside of bankruptcy they do not have these protections.
ii. State substantive law can control as long as it isn’t preempted, meaning it
can’t conflict with the federal law on the issue. 2. Analysis a. Butner acted like a member of the general pool of creditors, satisfied that the rents weren’t going to Vegas, and that he would get a fair share. This is how he acted. Just allowed trustee to collect the rents.
i. After sale of property to Butner, Butner demanded the rents. The rents
were no longer there – they were either in the pockets of other creditors . . . or in Las Vegas. b. Court used state law, NC, to determine Butner’s rights to rents. There, it’s a title state. To obtain lien on rents, you have to either sequester them or take possession of the property. i. Under Louisiana law, we know that Butner could sequester rents. But outside of bankruptcy, if he didn’t do that, he wouldn’t get the rents. 3. Court
The Butner Principle: Property rights are defined and created by state law. Unless there is a bankruptcy reason to differ from state law consequences with respect to property rights, respect the state law rights.
b. Congress has constitutional power to vary state rights. If state law rights conflict with bankruptcy law rights, state law rights are preempted. c. However, unless there is a conflict, state law will control the extent and substance of property rights.
Butner should not get a windfall just because of the happenstance of bankruptcy. Under state law, he would not get the rents.
i. Butner says that he could not use his state law rights because of
bankruptcy, because of the automatic stay.
ii. Court: That may be right. But you have to ask for state law to protect
your rights. The consequences are the same as what would have occurred outside of bankruptcy, so bankruptcy did not hurt Butner, with respect to legal preference. *If anything, bankruptcy helped Butner. Because the rents are not gone, they are in the estate. Each creditor gets a pro rata share. Butner failed to have rents sequestered under state law; outside of bankruptcy, they would have gone to Vegas. But because of bankruptcy, a trustee watched over the rents and now Butner gets some of the rents. 1. This is the common pledge in operation – creditors getting pro rata share of the rents on account of the claim. Butner gets his percentage of the money. 2. *Bankruptcy provides a process by which the common pledge becomes actualized.
The trustee is telling Butner, “You don’t have a legal preference because you did not do what state law required to get your lien on the rents. Bankruptcy will not give you a lien because under state law you wouldn’t have had one.”
e. Court’s Important points i. Bankruptcy is not designed to cause a loss of property rights
If the passage of time would hurt property rights, the bankruptcy court should put an end to the passage of time. The passage of time hurt Butner because he let the rents go. But this is the same thing that would have happened outside of bankruptcy. Butner should have asked because he would have been entitled to the rents. Yes, there was an automatic stay, but if Butner on Day 2 would have demanded rents, the court would have given the rents to him because he’s a secured creditor under state law.
ii. The creditor will not be hurt any more by the passage of time in bankruptcy than he would be hurt under nonbankruptcy law. 1. Property rights of creditors must be respected by bankruptcy law. iii. SCOTUS presumes that the bankruptcy judge is familiar with the state law where he sits. Therefore, he will only allow a delay that is legal under state law. iv. If there is a legal preference, it ought to be honored, not hurt. 1. The common pledge does not exceed the legal preference. The legal preference exists if there is one. 2. Hypo: If there is a 200k piece of property subject to a creditor’s preference, and the mortgage is worth 100k. There are 200k in unsecured creditors. a. The court does not have to immediately allow the creditor/mortgage holder to execute on his preference.
i. There are no rents to collect in this hypo, so the creditor will not be hurt by the passage of time. ii. There is a reason for allowing a passage of time before creditor executes on the mortgage: the trustee can sell/lease/etc. the property to generate the money necessary to pay the holder of the legal preference and the unsecured creditors.
If there will be loss by the passage of time and cannot protect secured creditor from the loss, the creditor gets to mimic state law time periods, so that bankruptcy law will not harm the value of the lien claim.
Owner of the property files for adjudication. 2nd Mortgagee (Butner’s son haha) asks for rent on day 2, learning from his father’s mistakes. If you don’t give out the rents 2nd mortgagee claims his security interests will be devalued by the passage of time, and SCOTUS said you can’t allow this to happen. Under LA law in current times, if the property won’t carry the debt, loss of rents will cause your lien harm. If the property is under water, it’s not worth what’s owed on it, then the delay hurts because the rents are going to Las Vegas. In this hypo, the property is not under water so passage of time doesn’t hurt.
Butner says that if the state law gives a lien upon default, that lien is not recognized in the bankruptcy process, and this is okay because bankruptcy law preempts.
2. Bankruptcy law preempts state law a. For example, if one creditor was paid 100 cents on the dollar, and other secured creditors still need to be paid, under state law, the payment would be valid. However, in bankruptcy, the trustee can require the payment to be given back to the estate. b. Reach Back Periods – have an estate that gives the most payments to greatest number of claimants c. A perfectly valid donation under state law might be undone, to bring the donation back into the debtor’s estate 3. Look to state law to determine what the creditor’s rights are with regard to the rents. Because in this case, there was no preemption of state law. No need for an equitable rule to supplement the bankruptcy process.
a. The court acknowledges that there might need to be individual tweaking in individual cases b. Application of equitable principles i. Bankruptcy process is about organizing claims that are pulled into one setting and then distributing. This process is equitable in nature. ii. There is a statutory basis for bankruptcy judges to follow, but the process comes from the equitable component in the English system. c. Pepper v. Litton i. Facts
A solely-owned company owes a debt
2. President/owner of company (Litton) says that the company owes him money in unpaid salaries. On balance sheet of company, it says that wage claims still need to be paid. 3. Company says to creditor (Pepper) that it does not owe anything and will fight in state court 4. Company and Litton agree that Litton is right, and company confesses judgment, voluntarily allows enforcement of judgment for Litton to obtain wages 5. Litton executes the judgment and bids in the property for a small amount of money; takes and puts property into new corporation. 6. Litton perfected a valid judgment under state law.
Pepper (the creditor) said something was wrong. Company files for bankruptcy. Company to be liquidated.
8. Litton says he has a first lien on the property because he is owed, as recognized by a valid state judgment. 9. Pepper tells the trustee that there’s something wrong with this picture. ii. Analysis
Litton argues the Butner principle that state law governing property rights will not be disturbed by bankruptcy process unless it’s required under bankruptcy law a. There has been a state law judgment that Litton has a valid claim against the corporation for unpaid wages b. Litton has a legal preference under state law
Court—SCOTUS a. The bankruptcy court has equitable power to inquire into the validity of Litton’s claim and to undo the state law judgment if the underlying claim was fraudulent
The corporation contested Pepper’s claim, but did not contest the claim of the owner of the company, Litton
How this fits with Butner
a. b. c.
In Butner, there was no reason to change state law because Butner had ample opportunity to protect himself In this case, there was a reason for analyzing state law property interests differently Litton’s wage claims had been on the books for about 5 years. He, as shareholder, could not demand any money in return after having bought stock. So instead, at time he bought the stock, put these unpaid wage claims on the balance sheet so he could withdraw later on. He was trying to create a lien for himself. Essentially, he turned his stock into secured debt, by having the corporation confess judgment.
d. This is the situation where an equitable fix is needed i. Equity allows turning the corporation right side up through subordinating Litton’s supposedly secured claim and undoing the judgment to put Litton back where he belongs, as a shareholder ii. Now, Litton is below Pepper in terms of preference, which is how it’s supposed to be (equity holders get paid last) iii. The judgment was granted by an abuse of control by the corporation’s owner, causing the corporation to act as his alter ego. 4. Federal law will control the analysis of where the claim falls to determine whether equity/equitable principles have been breached
iii. Stands for an example of the use of equity referred to in Butner.
1. Equity is interested in determining whether something is form over substance. In this case, the equity was actually secured debt (the owner said corporation owed money, and the corporation confessing that this was true was really one and the same person agreeing that the owner was a secured creditor). 2. Treat the secured debtor like what he really is – an equity holder d. Exemptions from Seizure i. Generally 1. Delineation of property exempt from seizure or involuntary enforcement of claims 2. Right to an exemption can be waived between the parties a. However, exemption for wages cannot be waived b. La. R.S. 13:3881 i. 25% of net earnings after necessary taxes and retirement plan contributions required by employer, health benefits, etc., can be seized. 1. So 75% is exempt 2. This cannot be waived as an exemption
ii. Family portraits, furniture, livestock, military arms and accoutrements
only if you were a member of the state militia, etc. is exempt 1. Television is not exempt
iii. Retirement plans are exempt iv. Insurance cash value is exempt v. The exemptions are “what is in your backpack” 3. These are policy decisions by the Legislature as to what the debtor is allowed to keep 4. Exemptions recognize that the discharge might not be enough. Exemptions are necessary for the fresh start. a. If everything is taken away, the debtor will become a ward of the state. b. Exemptions allow the debtor to keep assets necessary for subsistence c. The discharge only prevents the creditors from pursing the debtor personally. They can still go after the estate, however. d. Bankruptcy law allows opting out. The federal system has a scheme of exemptions, but the federal law gives the option to states to allow the state to use its own exemption scheme. Louisiana has done this. i. Anyone who files bankruptcy in Louisiana may choose the Louisiana exemptions, instead of the federal ones. 5. Corporations do not have exemptions. Individuals have them. Because individuals must be able to live, and corporations don’t have to eat. a. Without these exemptions, the debtor would be basically an indentured servant. Because everything he made for the rest of his life would be seized by the creditors. b. Exemptions prevent individuals from dying or becoming wards of the state. ii. States can opt out under 522(b) 1. State of Louisiana has opted out and has its own exemption scheme applicable to bankruptcy cases iii. Theory 1. The exemptions give the debtor a lien that is superior to the claim of any third party, unless the debtor waives it 2. Example: Homestead Exemption a. Is an amount of value in the home b. Every mortgage agreement will contain a provision waiving the exemption. So usually, the mortgage is first in preference, second is the debtor’s homestead exemption, and third in line is the judicial/involuntary judgment lien. c. For example, mortgage of 100k and homestead exemption of 35k. This means home is valued at 135k.
i. Instead, assume value is 175: Trustee sells house, 100k to mortgagee
and 35k to the debtor because of exemption. This leaves 40k in home equity. The trustee gets the remainder left over in equity. 3. Automobile exempt up to 75k in value.
4. Other than homes and autos, the property is exempted by its nature: a. Wedding and engagement rings up to a limited value b. Family portraits c. Utility trailer d. Cows and chickens e. Musical instruments that a member of the family plays f. Glassware and non-sterling silverware
g. Antiques? h. Etc. i. j. These exemptions are property based For life insurance, there is a reachback period because you should not be able to plan for your bankruptcy for a year before your bankruptcy. i. Contribute to cash life insurance policy or IRA or any other exempt vehicle, that is fine, but contributions made a year prior to bankruptcy are not exempt. 5. There are reachback periods for a number of items a. Debtor should not be able to make gifts if it owes debts b. If owe debts, there should be a period of time during which giving is okay because there is a period of time in which creditors should pursue claims
These are all policy; legislatively made decisions
iv. Section 522(d) – Federal Lien Right in favor of certain creditors holding “domestic support obligations” (child support, alimony, etc.) 1. Under federal law, state law exemptions must yield to a federal lien granted in favor of these certain types of creditors 2. These debts are not discharged in bankruptcy because Congress says so 3. Based upon the state law family law obligations owed, federal law creates these lien rights
v. Beneficial proceeds from life insurance policy are exempt, but once they are not life insurance
proceeds, they are no longer exempt. So debtor should only withdraw from the proceeds a little bit as a time and spend it immediately. Because only as long as they remain proceeds are they exempt. 1. This is a policy decision that beneficiaries should keep the money 2. Same with variable annuities
vi. Exempt property goes into the estate, and then is exempted out, if the debtor asserts the
exemption. e. Structure of the Code
i. Generally 1. Title 11 of USC 2. Art. I Sect. 8 of Constitution empowers Congress to pass “uniform” laws respecting bankruptcies
There are various constitutional Congressional powers that are to pass “uniform” laws. Currency is another.
b. Sovereign immunity can be superseded by legislative act, if related to bankruptcy i. Generally, there is no right to sue a state because of sovereign immunity ii. But if under the bankruptcy power, you may sue a state, because the states are deemed to have waived the immunity!
ii. Substantive Chapters
1. The Civil Code tradition is helpful a. This is a Code b. It is a self-contained body of law 2. Liquidation v. Reorganization a. Liquidation Chapter 7 i. Any party able to file a bankruptcy case may file here, unless S.109 excepts you out ii. Applicable to debtors iii. Some cannot be liquidated: 1. Railroad a. It is the backbone of many things in this country. b. Essential to transportation, essentially at the time the Code was passed. c. Liquidation would require pulling up the planks and stakes and selling them. This would interrupt the entire railroad network across the country. iv. Bad conduct can cause an individual to lose his discharge right v. S.725 The property subject to secured creditors will be distributed to those creditors. vi. S.726 Waterfalling of payments 1. Payment to unsecured creditors. The money trickles down to creditors and any leftovers are given to the debtor. vii. Stockbroker liquidation provision 1. Stockbrokers cannot reorganize
2. Because there must be an uninterrupted flow of capital and contractual resolution in the stock market 3. Allows for instantaneous liquidation of stock brokerages and prevents bankruptcy process from interfering with flow of contractual relationships b. Reorganization Chapter 11 i. Congress has “used its imagination” ii. Chapter 11 applies to corporations, entities, and people
Randolph v. ? held that an individual can be a Ch.11 debtor
iii. Involves time, a plan, and a confirmation process
iv. The only reason is to provide a value that is at least as much, if not greater, than liquidation v. The discharge applies unless the plan is really a liquidation vi. Individuals who reorganize 1. Example, tortfeasor sues you and you can’t pay the entire judgment a. Example, go through a divorce and life has become more costly b. Example, ran up too much credit card debt 2. If the individual gets to a point where the debt-causing thing is not a problem anymore, then reorganization may be a good option a. But if the thing keeps happening again (keep committing torts, keeping getting divorced, keep running up credit cards), then reorganization won’t be available vii. Debtor remains in possession, unless a trustee is elected 1. Trustee is the “BOD” and “CEO” essentially 2. The debtor in possession is the “trustee” 3. Dation en paiement
Debtor gave mortgage on property to creditor. The dation en paiement allows debtor to give property back to creditor. The giving in payment of the collateral back to creditor is treated as a sale. Creditor now owns the property and the mortgage/debt is canceled. Assume this happens but creditor does not record it. The company, that gave the dation en paiement, in bankruptcy says that it no longer owns the property. The creditor cannot record the dation once the bankruptcy petition is filed.
c. Point is that debtor in possession has power of the trustee even though it doesn’t seem right…
Like in this example, the creditor who got the property back never recorded the dation. So it’s like the debtor sold the property to himself.
viii. Creditors get a right to vote on reorganization under this chapter. c. Chapter 13 is for individual reorganization i. Requirements 1. Must be an individual or couple with regular income. Must be a wage earner 2. Must have certain amount of secured and of unsecured debt. a. This is the wage earner plan. Figure out a way to let the debtor keep their stuff. b. Example, house note. Protect the house note claimant and debtor has to fix the problem. Debtor keeps the house if he starts to pay now, and can cure the problem over reasonable amount of time.
If you buy the car 913+ days before bankruptcy, you can keep the car and schedule a way to pay off the car. Certain cars.
3. Provide a budget and live within it 4. Make monthly payments to a “trustee,” who is more like a credit counselor collection person. a. The trustee sets up a wage deduction order. The trustee collects payments and distributes in accordance with the plan. 5. Structure of liabilities/Chpt 13 plan a. Administrative costs i. Lawyer fees and domestic support b. Priority i. These are usually taxes c. Home Loan i. Cannot be modified, but you can cure default and maintain payments d. Vehicle loans
i. Special provisions for cars. If you bought within
30 months of bankruptcy the dealer has protection. Usually now people just give the car
back. Interest rate can be modified. Usually cant write it down to the value of the car anymore. e. Other secured claims i. Interest can be modified. f. Unsecured claims i. These go into a pool. ii. They are protected by 2 things. 1) You have to at least get what you would under Chapter 7 and 2) Your disposable income goes into this pool. g. By the end of the plan we hope you have discharged all your debt except for your home loan. The goal is to get everything else straightened out so you can continue to pay your long term liabilities. 6. Creditors have not right to vote in Chapter 13. 3. Chapter 12, the Family Farmer Reorganization Chapter a. Like Ch.13 on the farm (and for fishermen) b. Allows for restructuring of farm debt c. Rarely used anymore 4. Chapter 9 Municipalities a. A state probably cannot use this b. But other governmental entities can go into bankruptcy c. Essential i. Renegotiation of certain types of contracts and debt ii. A purely consensual process. Have to have consent to confirm the plan (because the bankruptcy judge cannot tell the taxpayer that he will pay more taxes to the state!). 5. Chapter 15 Cross Border and Foreign Insolvencies a. Sets up procedures for bankruptcy procedures that share laws with other countries 6. Chapters are numbered in the odd
Can move from one chapter to another, meaning you tried to reorganize but it didn’t work, so you can liquidate instead of reorganize, for example.
iii. Other Notes: 1. Reorganization chapters are structured based on debtor relief and creditor relief. If reorganization isn’t more valuable to the creditor, we don’t do it. 2. With liquidation, you get to walk away but you walk away with nothing as a debtor.
iv. Procedure 1. Chapter 1 General Provisions a. Applicable to all other chapters b. Section 101 Definitions i. If you’re reading a defined term in the Code, refer to this Section c. Section 105 Power of Court to Issue Writs d. Section 106 Waiver of Sovereign Immunity e. Section 108 Extension of Time i. Addresses the effect of filing a petition upon the time periods to bring and take actions f. *Section 109 Who May be a Debtor
2. Chapter 3 Case Administration a. Generally i. How to do a case ii. Effects of the case on other processes iii. Tells about voluntary and involuntary cases b. Commencement of a Case i. Voluntary v. involuntary cases ii. U.S. trustee – has oversight of the bankruptcy process nationwide c. Officers i. Qualification to be a trustee ii. Legal capacity of a trustee 1. Ch. 7 trustees are members of a panel, appointed individually for one year periods 2. There is a rotation, and the trustee is chosen at random iii. Ability to hire accountants and lawyers 1. They can’t have an interest in the estate to represent the estate representative (trustee) d. Administration i. Start with meeting of creditors and questions are asked ii. To get the case going, there must be disclosure of the company, the person, debts, assets, operations, what has happened in the past. Debtor has to give up this information. “Who have you paid anything within a year before bankruptcy? We want to analyze those.” “To which
creditors did you give preference in payment?” May bring back a payment into the estate to divide it up among creditors, if the debtor had made one huge payment to one of the creditors. e. Administrative Powers i. Automatic Stay 1. Exceptions, Scope, etc. 2. The passage of time should not hurt the passage of a lien claim, so S.361 discusses “adequate” protection.
ii. Trustee’s ability to use, sell, and lease estate property
iii. Rights of the trustee iv. Obtaining credit 1. Trustee may need to borrow money! v. Executory contracts and unexpired leases 1. Defines the rights of debtor and creditor under each vi. Utility service
Chapter 5 Creditors, the Debtor, and the Estate a. Creditors and Claims i. S.502 Bankruptcy overlay for allowing claims against the estate 1. Federal law can subordinate claims that are otherwise valid under state law
ii. S.503 Addressing claims that arise post-bankruptcy
1. Some claimants are entitled to administrative expense claims. These claimants have the right to get their full claim paid. Because there is no reason to confirm a plan if the debtor cannot pay administrative expenses. iii. S.506 Requires dividing claims into secured and unsecured 1. Secured claim equals the value of the estate’s interest in the property iv. State law creates the lien rights generally, but certain unsecured claimants are treated differently under the Code. Priority scheme of unsecured creditors under S.507 (“Priorities”) v. S.510 Subordination of claims 1. Equitable subordination
The court did it jurisprudentially in Pepper v. Litton, but now the Code provides for it
b. Debtor’s Duties and Benefits
i. S. 521 Debtor’s duties ii. S. 522 Exemptions
iii. Discharge ought to exist for debtors who don’t abuse: So S.523 has
certain exceptions to discharge 1. Generally a. Apply to individual cases b. Statute sets forth what gets discharged and what does not, and how to do it 2. Types a. Fraud or defalcation b. Tax liability c. Liability for intentional torts
Restitution (in criminal case, having to pay the prosecutor for embezzling funds (prosecutor then pays the guy who got stolen from))
e. Domestic support obligations f. Community property debts i. Ch. 7 cases it’s not discharged ii. Ch. 13 Congress messed up – can be discharged iv. S.524 Effect of discharge
(a)(1) Voids any judgment that is a determination of the debtor’s personal liability for a debt that has been discharged; and (2) Operates as an injunction to prevent any act to collect, recover, or offset any discharged debt as a personal liability of the debtor; and
3. (3) … v. S.525 Protection against discriminatory treatment
Neither private nor public employers can discriminate against you because you filed bankruptcy and got a discharge.
2. Private employers can however discriminate in hiring you. c. The Estate i. Property of the estate ii. Turnover of property to the estate iii. Turnover of property by a custodian
iv. S.544 – Trustee as lien creditor and as successor to certain creditors and purchasers
A suck-up/scoop-up provision. For example, sale of house by A to B. B does not record the title deed. A then files bankruptcy. Therefore trustee gets the house from A because B did not record her deed before the filing of the bankruptcy.
3. Strong arm section of the Code which gives the trustee and the estate that “giant vacuum cleaner” that grabs all unrecorded interests. 4. Important section. 5. Provides for reachback period
The filing of the bankruptcy case creates (1) estate having same power/rights through the trustee/debtor in possession as a bona fide purchaser of real property of the debtor and (2) situation where trustee has a contract and at the same time obtains a judgment and judgment lien into and upon all property that a judgment lien could attach to, and (3) trustee is treated like a creditor who extends credit and obtains a judgment, a writ of execution, writ attached to all applicable property, is returned unsatisfied (the writ can be executed against any and all property that it can be executed against). All this “magically” happens upon the filing of bankruptcy.
b. So it’s important to know substantive state law to determine if the estate gets particular assets.
i. For example, owner-financed car. Debtor does
not have the title, but the owner/seller does. Can the trustee seize the car to sell it? The owner who sold it never recorded his lien on the car, so the trustee gets to execute the “magical” judgment lien on the car and bring it into the estate. The owner/seller of the car loses because he did not perfect his lien as required by law.
ii. The magical lien that the trustee gets is
awesome. For example, in nonbankruptcy, the creditor would have to record the judgment in the particular parish where property is located. In bankruptcy, the judgment lien that the trustee magically gets is good against debtor’s real property all over the world.
iii. Revocatory action – creditor can undo
transaction debtor did that increased his insolvency. Revocatory action is basically a reachback period. A trustee essentially gets to do a revocatory action under bankruptcy law. For example, to undo a gift that the debtor made after the particular debt existed that increased
debtor’s insolvency (but not a gift made before a particular debt existed). v. S.545 Statutory Liens. State law landlord liens are destroyed by the filing of bankruptcy. 1. How?! 2. Congress has power to pass laws concerning bankruptcy, and this preempts state law. 3. Example, state statute says that you get a lien based upon a debtor’s change in financial position. S.545 causes avoidance of this lien. The Brcy. Code says they’re avoided. 4. Reasons a. If every state had a law that enforced contracts that provided for liens upon default, whenever someone filed bankruptcy, all those liens would spring into effect.
We don’t want state schemes that create property rights upon default, when the thrust of bankruptcy is that that the filing of the bankruptcy turns unperfected rights into the estate, which has the big lien for everybody
vi. S.546 Limitations on avoiding powers 1. Trustee has these rights, but has a statute of limitations in which to bring actions
Example, our state law creates a statutory lien for subcontractors upon the owner, even though there is no privity of contract. Private Works Act. This lien is triggered by when the owner starts his work. If someone else then buys the property, they buy it subject to the lien. The lien is given to the guy who provided the materials to the worksite.
3. If there is a right to obtain a lien right that would be binding upon an otherwise bona fide purchaser of real property, the automatic stay allows perfection of the interest. 4. Basically, the materials providers can perfect their liens after the bankruptcy is filed. vii. S.547 Preferences 1. Allows trustee to avoid preferential transfers, for the benefit of the estate
Paying a debt does not increase the debtor’s insolvency because he receives consideration equivalent to remission of his debt.
b. Therefore, the revocatory action does not work. i. The comments say that they leave to the bankruptcy code the avoidance of preferential transfers
2. So bankruptcy code can undo preferential transfers viii. S.548 Federal power of trustee to avoid fraudulent transfers 1. Types a. Actually fraudulent
i. Intended to actually defraud creditors
b. Constructively fraudulent i. No reasonably equivalent value for the transfer by the debtor 2. These transfers are avoidable by the trustee 3. 2 year reachback period for fraudulent transfers ix. S.551 If the trustee avoids the lien because it was preferential, the lien comes into the estate, and the estate gets the benefit of the lien. x. S.552 Postpetition effect of security interest
Addresses rents. Changes effect of Butner. a. If there is a mortgage on the real property, the creditor gets the rents. b. Now there is the express provision; all the mortgagee must do is send in a notice of perfection and he gets the rents.
If the lien was on accounts receivable . . . what if the debtor converts it into cash? Debtor will often take the cash to Vegas. So then the lien is worth zero.
If however, debtor took the cash which turns it into new a/r or inventory. The lien floats and follows the new assets. So even if it’s different stuff, the lien still attaches.
b. This UCC “floating lien” concept is that you don’t have to go get a new lien every single day. The lien stays and floats.
However, unlike rents, S.552 says that the postpetition generated inventory/accounts receivable/etc. are not subject to the pre-bankruptcy lien. Therefore, a lien creditor needs to protect himself by getting a replacement lien.
xi. S.553 Setoff xii. S.554 Abandonment of property out of the estate if it’s of no value or could diminish value 1. There are limits
Example, in the estate is a barge on fire in the Miss. River that is full of toxic chemicals!
3. SCOTUS law says you can’t abandon the barge. Because there are limits on what the trustee can abandon.
But generally the trustee can abandon the property of the estate; the property goes back to the debtor as a pre-bankruptcy entity.
5. How do you abandon? This is quitting the owning of stuff. a. Weed lien – in favor of the city parish. Where the debtor just ran off and abandoned the house. So parish seizes and sells the house. xiii. Complicated provisions deal with financial contracts. III. Commencement of the Case a. Eligibility in Bankruptcy i. Section 109 – Who May Be a Debtor 1. The definitions in S.101 are important to determine what is meant by “individual,” “corporation,” etc. 2. Requirements a. “Person” i. Individual, partnership, corporation, but not a governmental unit. 1. Only “corporation” is defined, among these sub-categories
“Corporation” includes under S.101 an association having a power that private corporation has, partnership association, jointstock company, unincorporated company or association, joint venture, business trust, but not a partnership.
b. Resides or has domicile in U.S.
Persons under Ch. 7 who are NOT eligible: a. A railroad i. Congress determined that railroads are so integral to commerce of the country that you can’t risk liquidation of the railroad, which could end the link to other railroads b. A domestic insurance company, bank, savings and loan association, credit union
i. Also, foreign insurance company, bank, savings and loan association,
credit union ii. Historically, these types of persons were subject to state or federal regulation, and in the regulatory scheme, law provides for liquidation. iii. A bank liquidation looks very much like a company closing for business on Friday evening.
1. State regulators go close the bank. There’s no seizure or suit. 2. Then the FDIC just liquidates the corporation by selling the deposits and banking relationships to other banks; paying out depositor claims first, then secured debt. 3. Banks that are insolvent cannot be banks. a. They are not allowed to operate under federal or state law. b. The bank provisions have particular, instantaneous methods on closing a bank, stopping operation, and liquidating assets. iv. Insurance companies are historically created and regulated under state law. 1. Because of their public function, they are not allowed to be insolvent. a. If insolvent, they will not be able to pay out claims. b. If can’t pay claims, then shouldn’t keep accepting premiums from policyholders. c. Liquidation within the insurance code calls for receiver to be appointed, etc. d. Policyholders are unsecured creditors, who are paid after secured creditors. 2. Has to have a reserve, as well as banks v. Banks and insurance companies must have reserves. 1. Money that a bank lends is an asset a. The interest earned is earnings
Insurance companies also must ensure that they have a capital base that will pay out claims
3. If you cannot pay, you’re liquidated; because these institutions serve public functions. That’s why they can’t be in Ch.7 bankruptcy.
S. 109(d): Debtors under Ch.11 are railroads, and those who can be debtors under Ch.7, except a. Stockbroker/Commodity Broker b. Etc.
Ch. 13 Eligibility for Reorganization as Individual a. Have to be an individual b. Have to have regular income
c. Debt limit i. Want this to apply to consumers ii. Don’t want the process to be overly complicated iii. The limit is 1M of secured debt and 336,900 in contingent, unliquidated debt 1. For example, you can have a large tort claim against you that has not been reduced to judgment. This is a contingent debt because it has not been proven. Unliquidated because plaintiff has to prove quantum a. Liquidated is a contract claim or claim on promissory note because even if there’s a dispute, we know the quantum. 6. (f) Family farmer or fisherman under Ch.12 a. Basically a Ch.13 case “down on the farm” ii. In Re Treasure Island Land Trust 1. Facts a. Old time format – set up a trust and all the documents are written such that you’re not a corporation and you are selling trust certificates to potential beneficiaries. i. This allows avoiding submitting to SEC regulation, because these are not securities. Not shares of interest in a business, but rather trust certificates purchased by beneficiaries. b. Beneficiaries have purchased these certificates. c. Treasure Island filed a bankruptcy. d. Motion to dismiss based on claim that Treasure Island Land Trust cannot be a debtor. i. The debtor says it can be a debtor because it’s a business trust ii. But in the documents creating a business, it says that the trust will not be for business.
The debtor argues that under Illinois law, the debtor is doing business, so it’s a business trust
2. SEC had found that they were a business trust and that they weren’t supposed to sell securities. So SEC had fined the debtor. Therefore, ironically the debtor now goes to bankruptcy claiming it’s a business trust because the SEC came after the debtor and said it was a business trust. 2. Statute a. Corporation includes business trusts, but not simple trusts. 3. Court
a. Failure to qualify to do business under state corporation law does not determine whether or not the debtor is a corporation in bankruptcy. (“Unincorporated association,” for example.) b. Equity requires consistency i. Because the debtor had said it was not a business trust, it cannot now claim that it is a business trust to be able to be eligible for bankruptcy
ii. Simple trusts cannot be debtors because the trust is just to look after the
res, the thing in the trust 1. The only way that it can be messed up is by doing something wrong 2. The question of whether the trust looked after the res is a state law question. iii. Prof. doesn’t buy into this equitable rule 1. State law is preempted to the extent it conflicts with federal law 2. When the SEC won and found that debtor was a business trust, the judge in this case should not have created an equitable rule that this is a simple trust
Compare to Green v. Champion
State law said that the insurance agencies authorized to sell policies for Champion Ins. Co. were an SBE (single business enterprise) with the insurance company, so under state law they could not file bankruptcy. Because they were all together one SBE, one insurance company not eligible for bankruptcy under S.109. Here, a state court determined that the SBE should be liquidated as if it’s one big insurance company, so it cannot be a debtor.
c. Prof. says this decision is wrong, too i. The effect is to control who can and cannot be a debtor by placing the debtor into a regulatory scheme because of misconduct ii. This creates the power of the state to give a company insurance status upon misconduct/default/other action that state determines should preclude the company from getting bankruptcy relief under the federal bankruptcy code iii. In Re Medcare HMO 1. Facts a. The HMO provides the medical care. Kind of like a hospital/insurance company.
Issue: Is the HMO an insurance company under the Code that prevents eligibility for bankruptcy?
2. Court a. There is no federal definition of insurance company b. The court has a problem with solely relying on state law for determining what an insurance company is i. For example, state should not be able to legally say that if law student buys a green car, it’s really an insurance co. and can’t file bankruptcy
If a state law classifies a person as the type of excluded person (insurance company, bank, etc.) and classifies the person based on the reasoning that the person is regulated by state law from its inception, then the classification by state law will usually control i. However, who can be a debtor is a federal question
ii. Need to determine if the state is passing individually applicable
designations that frustrate the federal Section 109 Gatekeeper function d. In this case, the HMO is created by the Ins. Code, regulated by the Ins. Code, and liquidated under the Ins. Code i. HMO argues that it can’t sell life insurance; therefore, it must not be an insurance company ii. Court says that’s ok, lots of insurance companies cannot sell a particular kind of insurance
In this case, the state determination is okay because it’s not a de facto determination of ins. co. status based on the company’s misconduct (as in Green v. Champion)
2. The federal control is that federal bankruptcy court has the last word e. Held: The HMO is an insurance company, so is ineligible for bankruptcy filing. i. There is no indication that the insurance company status is related to the company going into default.
That’s where Green v. Champion went wrong – state was able to say that because of the fraudulent shell game, this misconduct would lead to all the various entities being treated as one insurance company. The state asserted unbridled control on determining eligibility for bankruptcy. And the state cannot do this.
b. Filing the Bankruptcy Petition i. Voluntary 1. Filed under S.301 by a proper voluntary petition 2. Serves as “order for relief” 3. Have to pay a filing fee
4. S.302 creates the right for a joint case a. Husband and wife can file a joint bankruptcy case b. This is the only bankruptcy rule allowing more than one person to be a debtor in a single case c. Cannot file a joint case unless you’re married
The estates are not necessarily consolidated; the husband’s separate estate and wife’s estate each stays separate
e. Only one filing fee f. ii. Involuntary
However, the estates can be consolidated if appropriate
S.303 requirements a. Basic Requirements i. Debtor generally not paying debts as they become due ii. 12 or more creditors, 3 petitioners; if less than 12, one can petition b. Each petitioner creditor must hold a claim “not contingent as to liability or amount”
These noncontingent, undisputed claims must “aggregate at least $13,475 more than the value of any lien on the property of the debtor securing such claims by the holder of such claims.”
2. Not available under Ch. 13 – cannot involuntarily place an individual into Ch. 13 bankruptcy
Toy v. Randolph – SCOTUS found a difference between placing an individual into Ch.11 and Ch. 13. i. In Ch. 13, property of the estate includes property acquired by the debtor postpetition and wages/salaries postpetition ii. In other words, the estate continues to be created postpetition in Ch. 13. iii. Whereas in Ch. 11, after estate is created, individual wages do not become property of the estate. iv. Therefore, involuntarily placing an individual debtor under Ch.11 is okay, but not okay under Ch.13 because of the 13th Amendment (involuntary servitude) v. However, now, Congress has amended Ch.11 to allow wages to become part of the estate. 1. So now this is a conundrum; creditors can file an involuntary Ch.11, but the future wages become property of the estate. 2. Therefore, this has not be resolved yet, but the individual Ch.11 involuntary bankruptcy could run into problems with the 13th
Amendment by requiring future wages to be taken and requiring debtor to modify plan if creditors want this. 3. Hard cases a. You have to find three creditors that will file the petition b. In Re Kingston Square Associates i. Background 1. Companies will set up mechanisms that control what is required to file a bankruptcy
For example, require the board of directors to vote to file bankruptcy a. Often the independent director will be a creditor
3. In this case, the company went to some of its creditors and asked them to file an involuntary bankruptcy petition
What about when the operating agreement of the company says that the company may not file a bankruptcy?
Equity holder of the debtor had agreed to not file bankruptcy without mortgage holder’s consent
2. So equity holder gets his lawyers to find three creditors will file an involuntary bankruptcy petition. Doing indirectly what the equity holder has agreed not to do directly. iii. This case demonstrates that though involuntary individual petitions are rare, they can be useful if the debtor cannot file bankruptcy for some reason. c. Agreements to not file bankruptcy i. An operating agreement may say that a particular member’s vote is necessary to file a bankruptcy. That member is usually appointed by the bank creditor. He is a special manager. 1. The special manager still owes fiduciary duties to the company. But has a responsibility to the bank, too. So this creates conflict. IV. The Automatic Stay
The Statute: Section 362 i. (a) Scope of the Stay 1. It’s effective whether you know about it or not
It’s automatic, triggered by commencement or other operation of law.
3. (1) Commencement or continuation of a judicial, administrative, or other proceeding against the debtor that was or could have been commenced before the bankruptcy case if the claim arose before commencement of the case 4. (2) Enforcement against debtor or property of the estate of a judgment obtained before the commencement of the case 5. (3) Any act to obtain possession of property of the estate or of property from the estate or to exercise control over property of the estate a. This means that a mortgagee cannot enforce his lien because of the automatic stay b. Unless you get relief from the automatic stay c. When you ask the court with good reason for relief, they will give it to you and allow you to get past the automatic stay 6. (4) Any act to create, perfect, or enforce any lien against the property of the estate a. Section (4) deals with the State b. This means if the judgment debtor files bankruptcy, you cannot thereafter record your judgment c. Credit union cannot perfect its lien over the car after the automatic stay begins
Purchaser of new house who does not record lien. Then the seller fraudulently sells to a second purchaser and seller declares bankruptcy. Then the first purchaser is out of luck – didn’t record his title, so he’s out of luck.
7. (5) Any act to create, perfect, or enforce against property of the debtor any lien to the extent that such lien secures a claim that arose before the case.
This section is different – focuses on property of the debtor. Property of the debtor includes property exempted from the estate (using the property exemptions). Therefore, even if the property gets exempted out of the estate, it then becomes considered property of the debtor—but the creditor with a lien in the debtor’s property still cannot enforce unless (a) creditor gets relief from the stay, or (b) there is a confluence of (i) property not being property of the estate and (ii) the discharge [because when there is a discharge the automatic stay is gone]
(6) Any act[,] to collect, assess, or recover a claim[,] against the debtor that arose before commencement of the case a. A hard one b. Foreclosing on a mortgage to get the property and satisfy the debt of the debtor is also forbidden
The “law of the last antecedent” requires this reading: an act against the debtor to recover a claim is stayed. i. In other words cannot take any action against the debtor, but you are free to take action against the guarantor. Not going after property of the estate, but the act technically is to collect the claim, even though from a third party.
ii. So you can pursue a claim against a third party, even though claim originated because of some relationship with the debtor. iii. Also, you have obligor and his guarantor. The guarantor files bankruptcy, making him the debtor. You can still sue the original obligor, just not the debtor-guarantor. d. In Ch. 13, there is a specific provision to protect co-debtors i. Example, Grandma guaranteed my car loan. I’m the debtor. The stay would extend to protect Grandma under Chapter 13. ii. The fact that S.1301 says this means that this does not apply to other cases. 9. (7) Setoff of any debt owing to the debtor against a debt owed by the debtor
Compensation (Louisiana) – mutually owed and liquidated debts are offset to come up with the residual liability.
i. Setoff is the common law term for this process.
Example, debtor owes bank 20k. Bank has agreement that if debtor doesn’t pay, bank can set off the funds it owes in the account with the debt owed to the bank.
c. This provision says you cannot use setoff upon filing of the case. d. To the extent of your lien or right of setoff, you as a creditor have a lien. But this cannot be enforced during the automatic stay. The setoff cannot be exercised. 10. (8) Commencement…of a proceeding before Tax Court. a. IRS cannot bring action against you to determine pre-petition tax liability. ii. Official Bondholders Committee v. Chase Manhattan Bank 1. Facts
Note: These facts are a bit confusing, but the Part One is the holding companies’ bankruptcy. Part Two is Marvel’s bankruptcy. Three parent/holding companies owned 80% of Marvel Entertainment’s stock.
c. The remaining 20% is owned by public stockholders and Mr. Perelman (18% and 2% respectively).
Perelman owns the three parent companies who are also bankrupt. i. These holding companies were bankrupt first.
The three holding companies did a bond offering. Parent companies owe the bondholders.
g. Marvel has a separate debt owed to Chase Bank. h. Marvel has filed bankruptcy. Marvel is the debtor in possession. i. To issue bonds in the public market, there must be an indenture trustee to hold the note for the bondholders. The indenture trustee holds all the bonds; that
trustee is the holder of the bonds for the owners of the bonds and can take actions to enforce the bonds. j. Perelman elected Marvel’s BOD – because Perelman owns the parent companies, and the parent companies own 80% of Marvel.
k. The collateral for the bond issuance is the holding companies’ stock in Marvel. l. The indenture trustee requests relief from the automatic stay to be able to sue on the bonds issued by the three holding companies; foreclose and get the stock of Marvel. Have to request relief because the stock in Marvel is the property of the holding companies. against Marvel so that the bondholders may recover against Marvel in the event that Marvel is liable for wrongdoing with respect to amounts owed by the holding companies. i. Not smart because this is an act to collect the claim that violates the automatic stay that Marvel has. ii. But the court says that this is not a claim against the debtor, but to exercise corporate governance rights. iii. Indenture trustee had foreclosed on the pledged stock of the holding companies that issued the bonds. So now bondholders are getting the shares in Marvel. iv. Indenture trustee notified Marvel of its intention to vote the pledged shares that it foreclosed on, in order to replace Marvel’s BOD. v. Marvel as debtor then files for an injunction, claiming that indenture trustee is violating the stay. 2. Analysis a. Property of the Estate b. Getting Relief from the Stay i. Filing a motion, etc.
m. What the indenture trustee did that was dumb was to file several proofs of claims
Involvement of Bankruptcy Process in an Activity that is a Claim Against the Parent Companies but Not Necessarily Against Marvel
3. The Stay a. Voting the stock in Marvel to change the BOD is not a violation of the stay.
How would the stay be implicated? i. Obviously not an action against the debtor ii. Not an attempt to perfect a lien against property of the estate iii. Not an attempt to institute process iv. The only argument is that it is an act to collect, assess, or recover a claim against the debtor that arose before commencement of the case ((a)(6))
Court says that it is not concerned about allowing voting of the stock to pursue a claim But court addresses the unpublished cases saying that if the act is being used to otherwise collect a debt, that this violates the stay. Because this generates abuse. a. The court doesn’t buy these cases because it’s like saying that we’re not going to allow someone to use their rights to vote because of the possibility that the shareholders of the debtor will use this to lead to breach of fiduciary duty b. Stock of corporation is not property of the corporate estate c. Enforcing corporate governance rights is not a violation d. Foreclosing on stock of the corporation does not necessarily constitute an act against the corporation, because stock is not an asset of the corporation
The any act portion of Section 362 refers to actions against the debtor only
1. When respondent filed for relief under the Bankruptcy Code, he had a checking account
with, and was in default on the remaining balance of a loan from, petitioner bank. Under the Code, a bankruptcy filing gives rise to an automatic stay of a creditor's "setoff of any debt owing to the debtor that arose before the commencement of the [bankruptcy case] against any claim against the debtor." 11 U. S. C. § 362(a)(7). Mter respondent had filed in bankruptcy, petitioner placed an "administrative hold" on so much of respondent's account as it claimed was subject to setoff-that is, it refused to pay withdrawals that would reduce the account balance below the sum it claimed to be due on the unpaid loan and filed a "Motion for Relief from Automatic Stay and for Setoff" under § 362(d). In granting respondent's motion to hold petitioner in contempt, the Bankruptcy Court concluded that petitioner's "administrative hold" constituted a "setoff" in violation of § 362(a)(7). The District Court disagreed and reversed, but was in turn reversed by the Court of Appeals.
2. Held: (Reversed) a. Petitioner's refusal to pay its debt to respondent upon the latter's demand was not
a setoff within the meaning of § 362(a)(7), and hence did not violate the automatic stay. Petitioner refused to pay, not permanently and absolutely, but merely temporarily while it sought relief under § 362(d) from the automatic stay. The requirement of an intent to permanently settle accounts is implicit in the prevailing state-law rule that a setoff has not occurred until (i) a decision to
effectuate it has been made, (ii) some action accomplishing it has been taken, and (iii) a recording of it has been entered. Even if state law were different, the question whether a setoff under § 362(a)(7) has occurred is a matter of federal law, and other provisions of the Bankruptcy Code such as §§ 542(b) and 553(a) would lead this Court to embrace the same intent requirement. i. Basically, act quickly, but you don’t have to give up your lien to seek relief? Look this up.
b. Petitioner's refusal to pay its debt to respondent also did not violate § 362(a)(3)
or § 362(a)(6) of the Bankruptcy Code. b. Scope of the Automatic Stay i. In Re Cahokia Downs 1. Facts a. Corporation operating a race track files for bankruptcy, triggering the stay
Insurance company provides fire casualty insurance protecting the racetrack i. Insurance company claims the policy is terminable at will.
ii. The insurance company saw the racetrack as high risk.
iii. Insurance company terminated the policy and attempted to return the premiums 2. Court
Held: This was a violation of the stay i. The termination of the contract was a direct response to the filing of bankruptcy ii. Potential violation is (a)(3), that cancellation of the policy was an act to exercise control over the property of the estate
b. The policy was a contract that was an asset of the estate. i. If damage occurs, the policy limits must be paid to the estate. This is a contractual right, property, of the estate. ii. The question is whether there is an attempt to exercise control over estate property in a way that is inconsistent with the stay 1. The problem is that the policy is terminable at will; bankruptcy should not give the debtor the indeterminate right to keep the policy
True, the asset belongs to the estate; but the asset cannot be more than the policy. a. Section 363(l) says that an ipso facto clause in a contract is not applicable to prohibit the trustee from selling stuff
b. A default-upon-filing clause is not enforceable in bankruptcy. But this has nothing to do with a terminable at will provision.
iii. So essentially the court is saying “you can terminate at will,” “but only
for a good reason.” ii. Is a tort claim a violation of the automatic stay? 1. No, in LA we have the direct action statute. You can sue the insurance company directly, and not violate the automatic stay. If you have to subpoena the debtor, this gets a little more tricky. You have to make sure you don’t name the debtor as a party. Make sure you are only trying to collect from your direct claim against the insurance company. iii. In Re M.J. & K. Co. 1. Facts a. The debtor is a law school bookstore. The only client constitutes the law school professors and students. b. Debtor claimed that the law school terminating the contract violated the stay 2. Court a. Issue is matter of state law b. Held: State relief should be granted to allow termination because under nonbankruptcy law the contract is terminable at will and the law school/creditor is in good faith. i. A license is real property revocable at will of licensor as long as made in good faith. The contract allowing the bookstore to operate was a license; therefore, under state law the law school could terminate at will in good faith. ii. The difference between this case and the last case is that … 1. In the last case, the only reason for terminating the insurance contract was because the debtor was in bankruptcy 2. HERE, the termination is instead made in good faith, so applicable state law can be enforced.
Note that if the estate did assume the contract, it would not just have the contract right, but also the obligation to the law school. And the contract still would have been terminable at will once the estate assumed the contract.
b. The debtor has the right to cure a default, and show that it will give performance within a reasonable time.
The contract is terminable at will. Even if the court awarded the bookstore contract to the debtor, then the law school could later terminate at will under the contract anyway; so the court is not harming the debtor through its finding that the creditor can terminate the contract at will in good faith.
c. Exceptions to the Stay i. Section 362(b) 1. There are 27 exceptions 2. Easy Categories a. (b)(1) Commencement or continuation of a criminal action or proceeding against the debtor
i. Hypo: Write a check that bounces. DA has a check collection program.
Wal-Mart made a claim and submitted with DA who intervenes and orders payment within a certain amount of time. This is an alternative to prosecution. 1. The cases are all over the place on this:
This is not a violation of the stay. Because the debtor has the option of not complying and instead being arrested, which would clearly be allowed. This is a violation. It’s really the collection of a civil debt. Not going to let the DA act as a civil collection agency.
2. This crime requires knowledge that the check will not clear. Not just recklessness. b. (b)(2) Family Law i. Establishment of paternity ii. Establishment or modification of domestic support obligations iii. Child custody or visitation determinations iv. Dissolution of marriage v. Domestic violence proceeding vi. Can maintain a garnishment for child support purposes if you have an existing right to garnish wages vii. Withholding, suspension, or restriction of driver’s license or professional or occupational license, or recreational license, under state law viii. Interception of a tax refund ix. Enforcement of medical obligation x. Collection of a domestic support obligation from property that is not property of the estate c. (b)(3) Rights of trustee subordinate to rights of lienholders who can perfect under nonbankruptcy law. i. There are various lien rights that can be of record that can be recorded during the bankruptcy.
ii. Example, build a house and don’t pay the contractor. If the
contractors/architects are within the lien period and the house is sold, the purchaser will be subject to the liens for the lien period.
If file bankruptcy and don’t sell the house, the estate will be subject to those liens for the lien period.
2. Point is, that if I get a mortgage in your house, and you declare bankruptcy, general rule is I can’t perfect. However, if I deliver lumber to your work site, and then you file bankruptcy, I can perfect the lien during the lien period under this exception. 3. (b)(4) Commencement or continuation of action or proceeding by a governmental unit to enforce such governmental unit’s police and regulatory power, including the enforcement of a judgment other than a money judgment, obtained in an action or proceeding by the unit to enforce such unit’s police or regulatory power. a. It has to be an action to enforce the police and regulatory power, by the government, to fit this exception. b. It can even be the enforcement of a non-money judgment. c. Very important provision 4. (b)(6)-(7) Exceptions to ensure that capital markets work
Financial institutions that have certain contracts as part of their collateral are allowed to terminate the contracts and apply that to the debt. Hedging contracts may be terminated.
b. Repurchase agreements, used to provide leverage. These can be netted out without regard to the stay.
(b)(10) If you have a nonresidential real property lease that is over with, the lessor may evict the lessee. a. In Louisiana, the lease term may be over. But it may be reconducted in Louisiana if the parties are silent as to what happens at the end of the lease. i. The debtor is entitled to another term of possession, unless either party gives notice of termination. ii. A party may be able to terminate at any time under state law, but it’s safer to ask the court for relief from the stay.
6. (b)(14) State can terminate your educational license if you’re an educational institution filing bankruptcy. 7. (b)(17) Another capital markets exception from the automatic stay – swap agreements. ii. Cases 1. In Re FCC a. Facts i. The FCC issues licenses for broadband spectrum. The debtor purchased one of these licenses.
ii. The debtor was supposed to give a note to the FCC to close on the purchase agreement. The debtor realized it had too much spectrum and couldn’t pay. iii. The FCC canceled the contract after the bankruptcy. b. Issues i. FCC claimed the (b)(4) regulatory enforcement power exception to the automatic stay ii. Debtor claimed this was an attempt to exercise control over the debtor’s property; not merely exercise of police power c. Court i. The FCC has the power to determine whether or not its action is a regulatory action 1. If the FCC says it’s acting in its regulatory police power, the court will agree that it is 2. The debtor had no jurisdiction in determining whether or not this was the police power or not ii. Putting the determination of whether an entity is violating the stay into the entity’s hands will practically allow the exception every single time. But this is what this court does (2d Cir). 2. U.S. v. Nicolet a. Issue: Can you take a matter to judgment? b. Facts i. EPA seeks reimbursement to clean up asbestos site owned by the debtor c. Court i. Can’t enforce a money judgment; but you can obtain one in the exercise of police and regulatory authority ii. Seeking a money judgment is a pecuniary action usually; but in the government’s case it can be a regulatory action.
The statute only prevents enforcing a money judgment, but does not prevent obtaining one
d. Why obtain a judgment that you can’t enforce? i. Many times there are multiple defendants. It’s easier to keep the debtor in the case with the other defendants and obtain a judgment with all the defendants (including the debtor) present in the same case.
Penn Terra v. Dept. Env. Resources a. Facts
i. State wants an injunction to compel cleanup of debtor’s coal surface
ii. State had found the debtor was in violation of environmental statutes; signed a consent agreement iii. State wants to enforce the consent agreement 1. Wants a mandatory injunction – which requires the defendant to do something, i.e. go clean up the worksite, even if it costs all the money in the estate to comply. b. Court i. The use of governmental regulatory police power is expansive; what constitutes a “money judgment” is a narrow analysis. ii. A money judgment involves identification of the defendant and definition of the amount owed. But there must be a separate action to enforce. iii. Not any order which requires the debtor to expend money is a money judgment. 1. Yes, the debtor will have to spend money to comply with the judgment obtained by DER. But the judgment is part of the regulatory power of the state. So this fits within the (b)(4) exception to the stay. iii. 362(c)
(c)(3) If debtor has one case within 12 months and it is dismissed for a reason other than x, then when there is a re-filing, the automatic stay expires within 30 days, unless it is extended. (c)(4) If there were two or more cases already pending within a year but were dismissed, upon the third filing, you don’t get an automatic stay…
Claims Against the Estate a. A Claim and When It Arises i. General Rules 1. Claims get discharged a. Therefore it is immediately necessary to determine whether rights are claims, to determine if a right is discharged
The fact of discharge has nothing to do with the right to recover from the estate. The discharge only disallows pursuance of the debtor; but creditor can still pursue the estate.
2. “Claim” Defined a. S. 101(5) i. The term claim means— ii. (A) right to payment, whether or not such right is reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal, equitable, secured, or unsecured; or
1. Under state law, some of these claims cannot be brought. For example, an unmatured claim. But in bankruptcy, an unmatured claim is still a claim. Because it will be discharged. a. For example, right to receive rents several months later. This is a claim in bankruptcy. 2. The downside of having a creditor’s “claim” recognized is that the claim will be discharged. The bankruptcy process takes away the right to choose. 3. NYCERS v. Villarie a. Facts i. Fireman filed bankruptcy. Fireman had borrowed from his retirement account. ii. Fireman had put money into his retirement account through having amounts automatically withdrawn from his paycheck. iii. With 401k accounts, the employer matches your withdrawals to go into your retirement account… iv. The fireman had borrowed out of his city retirement plan. Thereafter, he had money taken out of his paychecks to repay the loan. v. So fireman filed bankruptcy, thinking he would have a claim that would be discharged in the form of employer’s deduction from his paycheck of amounts to repay the loan. b. Court i. The fireman was borrowing money from himself, not from the city retirement plan.
ii. The fireman claims that they have a right to
payment – he’s being forced to pay them back. The retirement plan claims it only has a right to payment as long as the fireman works. Whereas if he quits, the plan cannot sue or collect—the retirement plan is just reduced by the amount of the loan. iii. Court agrees that because plan had no legal right to repayment, there was no claim. iv. Because there was no right to payment, there was no claim, and thus no discharge of plan’s ability to continue to deduct from debtor’s paycheck after bankruptcy.
v. There must be an ability to bring an independent
lawsuit to collect for it to be a claim.
vi. The retirement plan only had a right to offset the loan balance with the money deducted from debtor’s paychecks – this was not a “right to payment.”
iii. (B) Right to an equitable remedy for breach of performance if such
breach gives rise to a right of payment, whether or not… 3. Claim Bar Date a. The discharge can be issued prior to the claim bar date ii. Claims v. Not Claims 1. Hypo a. Woman sues dentist on basis of malpractice after the claim bar date in state court, based on prepetition conduct. b. The dentist will assert that she had a claim that was discharged.
The problem is a procedural denial of due process. The woman who had a claim against the dentist may not have been aware that the dentist was filing bankruptcy, and should have received notice of the bankruptcy so that she could file her claim before it was discharged.
d. Another problem here is that the woman did not know that she had a claim. Under state law, she would not have had a claim upon which prescription began to accrue until after the discharge. Because she did not know or should have known of the injury until after the bankruptcy case. e. The statutory answer is that under 101(5)(A), the fact that a claim is unmatured does not mean that there is not a claim. i. The courts have focused on the fact that there must be something in the relationship that puts the creditor on notice that he may have a right based on that relationship. 2. Epstein v. Official Committee a. Facts
i. Aircraft manufacturer files bankruptcy. Epstein wants to file a proof of
claim based on a class of “future claimants.” The other creditors object because creation of a fund to pay these claims reduces the amount of recovery that the creditors can get in the bankruptcy process. ii. The claimants are those will possibly get hurt based on prepetition negligent manufacture, distribution, etc. of aircraft and parts of the debtor. b. Analysis i. There is prepetition conduct, which is the defective manufacture.
ii. The court finds that what is missing is the relationship between the
prepetition conduct and the claimants. c. Several proposed tests
i. Conduct Test – a right to payment arises when the conduct giving rise to
the alleged liability occurred. Rejected.
ii. State Law Test – rejected. iii. Prepetition Relationship Test – requires some prepetition relationship
(contact, exposure, impact, or privity) between debtor’s prepetition conduct and the claimant. d. Bridges Example
i. Statistically a company could determine how many bridges that it made
will fail and determine the percentage of people that will be injured as a result of the number of bridges that will fail. ii. This cannot be a claim 1. There is no way to give notice because these potential claimants are not identifiable 2. Potential future exposure is not a claim e. Bound up in the definition of a claim is the concept of notice. i. The debtor is required to give notice of the bankruptcy to known claimants. ii. Notice serves two functions in claims analysis: 1. Determines whether the right is a claim. a. Because you have to have notice that the relationship will somehow generate the right. b. The conduct has to be within a relationship that foreshadows the rights emanating from the relationship.
This gives notice to the lady who went to the dentist that it is foreseeable that there may be a malpractice claim.
d. The relationship to the conduct provides some baseline foreseeability – this is a hard notion to swallow. f.
The definition of claim is broad: right to payment. But still must do careful analysis. The Piper Test for a claim: i. Prepetition relationship ii. Prepetition conduct that is the basis for liability
h. In the present case, there is no established prepetition relationship between these potential claimants and the debtor. Because these potential claimants were not actually injured by the prepetition conduct. 3. Lemelle v. Universal Manufacturing Corp. a. Facts
i. Winston, manufacturer of mobile homes, made the defective mobile
home at issue long before the bankruptcy. ii. Winston declared bankruptcy and as part of it sold the assets to one group and sold the “shell” of the company to another company. The successor corporation went through several mergers. iii. Sometime post-bankruptcy, the defective mobile home caused a fire that killed the plaintiff’s children. iv. Defendant moved for summary judgment. b. Successor Liability i. Popular in the labor law realm – a successor corporation owes what the former corporation owed under a collective bargaining agreement. ii. If two corporations merge, and the successor emerges as successor corporation, it incurs whatever liability that old corporation had. iii. If the new corporation then sells all its assets to a different corporation, the purchaser is really a successor company because it bought the assets. iv. The successor takes the debt of the predecessor.
Trial Court i. The claim was discharged. And the corporation is not a successor. 1. This is inconsistent because if the claim is discharged, then there is no successor liability because the successor is the same as the predecessor, who obtained a discharge.
d. Court i. Reversed the trial court.
Held: This was a successor corporation. No discharge because no claim.
ii. The record has no facts showing the date of purchase of mobile home, notice given within plan process; so the court cannot tell whether there was a relationship pre-bankruptcy that would have made the injury foreseeable. iii. Given this absence of evidence, the court reversed. To have proven the pre-bankruptcy relationship, the defendant debtor would have had to show: 1. Proof of sale
Notice to all purchasers of the defective mobile homes. The debtor would have had to give notice to the potential class of claimants that the mobile homes might be defective.
4. Asbestos Cases a. There was an asbestos fund created to provide recovery for asbestos victims; fund created by Congress
b. The process of developing how the claim gets dealt with defines the claim as something that an injured person has the right to bring 5. S. 101(5)(B) – Right to an equitable remedy for breach of performance if such breach gives rise to a right to payment a. Equitable remedies i. Examples 1. Injunction/restraining order 2. Specific performance ii. Different from a remedy at law, i.e. damages 1. What makes it equitable as opposed to legal? Equitable requires a person to do or not do something.
Breach of Performance – this would mean not giving something you are supposed to do, but would not include the obligation to not commit a tort. i. If he doesn’t perform, he is in contempt. This is different from a legal remedy because there you just find some property to seize.
c. Right to Payment – The ability to obtain money/damages instead of the equitable remedy i. For example, can’t grant specific performance to give the house that was purchased because the house was sold to someone else. In this case, the creditor demanding performance can seek damages as an alternative equitable remedy. The debtor can also assert that it can’t give specific performance and therefore get a discharge of its obligation through giving appropriate damages. So this is a “right to payment.”
ii. Example, Professor beats on my house with a stick for a month, and then
continues to do it for months. Plaintiff sues for an injunction. The defendant could not pay a monthly amount to be allowed to continue with this behavior. The plaintiff could not be forced to accept damages to allow the defendant to continue the tortious behavior. Therefore, there is no right to payment as an equitable remedy for breach of performance. This is not a claim. d. In Re Chateaugay i. Summary
Pollution occurred prepetition; the state’s right to address pollution is a claim, debtor asserts
2. Debtor asserts that the claim can be discharged 3. EPA had gone ahead and expended funds from Superfund to clean up these hazardous sites and demands response costs from the debtor ii. Claim status
1. Reducing rights to claim status, prepetition claim status, is a way of dealing with them through reorganization and providing for discharge of the claim iii. Court
If the cost to address pollution is fixed, that might be a claim because you can send a bill for it. The breach of performance would be the act of polluting. There would normally be an equitable remedy—injunction—to prevent the debtor from polluting. However, the equitable remedy gives rise to a right to payment because the pollution has already occurred.
2. However, “current pollution” is different situation
It is “pollution that moves.” The pollution had the potential to continue seeping into groundwater and spreading.
b. The court found that this is like the guy who wants to beat on the house with a stick every night and say that he has the right to pay damages to be able to continue the tortious behavior. c. The debtor did not have the right to make payments to be able to continue polluting. The government had the right to injunctive relief to compel clean up of the hazardous waste. d. Another example: franchisor seeks injunction to force the franchisee/debtor to stop using the trademark. When a trademark is violated, this is unlawful. The violation of the trademark will generate a claim for damages every day it occurs, but the franchisee cannot pay the holder damages to continue to be allowed to violate the trademark.
The fact that damage claims are created by misconduct does not mean that the debtor can continue to engage in the conduct with impunity because the conduct is unlawful and the creditor has the right to cause the debtor to stop the conduct.
e. Davis v. Davis i. 5th Cir. ii. Court
“Alternative right” – the creditor can be compelled to take the alternative.
If there is a right of specific performance because you ordered a painting and the debtor cannot give the painting, the creditor can be forced to accept damages as an alternative to specific performance.
If the creditor keeps demanding the painting, the debtor can go to court and demand a declaratory judgment that the debtor owes a specified amount of money, in lieu of the right of specific performance. The debtor has the right to obtain that type of judgment.
c. This is why the right to specific performance is a claim, but the right to an injunction is not a claim. f. Ohio v. Kovacs i. SCOTUS ii. Facts
Debtor refused to clean up environmental hazards as government demands
2. State obtains a judgment against the debtor and has the debtor ousted from his position in the company, in favor of a receiver who takes over the company’s affairs iii. Court 1. Held: This is a claim because it is a judgment that can be enforced 2. The violation occurred in the past; you can’t get an injunction to prohibit past conduct. 3. Because the state ousted the debtor, he is not doing anything bad now. There is nothing to enjoin him from doing. Therefore, the only right the state has is to collect money under the judgment. Therefore, it’s a claim. iv. What the creditor should have done 1. Sought an injunction 2. Go after the debtor for contempt for refusing to comply with court orders obtained 3. In other words, court is saying that the creditor had the right to stop the behavior and did not. The right under the judgment is a claim. g. La. DEQ v. Crystal Oil i. Facts 1. Another hazardous waste case 2. State is claiming that 10 years after the bankruptcy case, it may late file a claim against the debtor 3. Wants to file a proof of claim, notwithstanding confirmation of the plan—so state has to prove that it never got notice of the bankruptcy ii. Court
1. But notice is not really relevant in this case; because notice means that you lose the right to seek damages for prepetition conduct; but you can still seek the equitable remedy that is not a right to payment. The state just wants the pollution cleaned up; so it doesn’t care about seeking damages for the prepetition conduct. State just wants to force the debtor to clean up the waste! 2. Further, if the state would have won (which it didn’t) and had been able to file a proof of claim, it wouldn’t matter, because it would receive a judgment making it an unsecured creditor able to recover out of a plan that was confirmed years ago! 3. The state should have gone into state district court and filed a DEQ version of CERCLA injunction and obtained an injunction to get the waste cleaned up.
Summary: If the holder of the right can be forced to take money, in lieu of the right, it’s a claim.
b. Allowing and Estimating Claims i. S.501 Filing of Proofs of Claims or Interests 1. The process of claim satisfaction begins when creditor files a proof of claim. 2. The claim is deemed allowed unless a “party in interest” objects under Section 502. 3. Allowance of a claim recognizes the creditor’s right to share in the assets of the estate.
Example: Estate worth 5k and 10 creditors file proofs of claims totaling 10k. If claims are allowed and enjoy same priority, each creditor is paid half of her allowed claim.
ii. S.502 Allowance of Claims or Interests 1. Statute a. (a) A claim is deemed allowed i. As long as filed properly, deemed allowed unless someone objects 1. This is not the case with a regular lawsuit
(b) If there is an objection made to the claim, after notice and a hearing, the court shall determine the amount of such claim in lawful currency of the U.S. as of the date of the filing of the petition, and shall allow the claim in such amount except to the extent that— i. (1) the claim is unenforceable against the debtor under any agreement or applicable law for a reason other than because such claim is contingent or unmatured 1. This means that even if the cause of action would be premature outside of bankruptcy, or the claim is contingent, the court still assesses the value of the claim.
There is never a claim for unmatured interest. The claim for unmatured interest is cut off in bankruptcy. a. The reasoning is that some creditors have unmatured interest in their documents and some don’t.
The debtor is probably insolvent, so it’s better to collect the res and split up the money on account of claims determined as of the petition date.
Tax claims against property, and the property won’t pay the tax claim. To the extent that the tax claim exceeds the value of the property, the amount is not allowed.
3. Claim for services of an insider or attorney of the debtor, to the extent such claim exceeds the reasonable value of such services.
The bankruptcy court is allowed to determine the reasonable value of services under a federal standard, notwithstanding state law. Unreasonable amounts are not allowed.
4. Domestic support obligations are not subject to being a claim. a. If they are unmatured, the estate shouldn’t have to pay. b. Because they are not claims, domestic support obligations are not discharged.
Claims of lessor for damages resulting from the termination of a lease of real property, if over certain amounts. a. Ordinarily lessor can either evict or obtain accelerated rents as a remedy for lessee’s default. (This assumes that the lease has an acceleration clause.) i. If lessor pursues eviction, he can only recover rents up until the moment of eviction; cannot accelerate future rentals. ii. However, if lessor obtains judgment giving accelerated rents and lessee does not pay, lessor has judicial lien on lessee’s property. So lessor can then foreclose on the lessee’s possessory right in the lease, which has the effect of kicking lessee off the premises. The right of possession would be seized and posted for sheriff’s sale—a movable corporeal possession right. Lessor could then purchase the right of possession at the sheriff’s sale and receive a credit against the judgment. Lessor therefore now has right to possess…and institutes an eviction procedure against lessee! And if lessee ever gets any money, lessor can get a deficiency judgment. b. This is why the Code says that claims of lessors are limited in the amount of future rents that can be claimed.
Employee for damages resulting from termination of employment contract—this is limited in amount.
7. Claim resulting from a reduction, due to late payment, in the amount of an otherwise applicable credit available to the debtor in connection with an employment tax on wages, salaries, or commissions earned from the debtor. 8. Proof of claim is not timely filed—this means that value of the claim will not be allowed. c. (c) Estimation i. There shall be estimated for purpose of such allowance under this section: 1. (1) any contingent or unliquidated claim, the fixing or liquidation of which would unduly delay administration of the case, or 2. (2) any right to payment arising from a right to an equitable remedy for breach of performance. d. (d) Avoidance power
i. There is no claim until you return the avoidable transfer, if you’re the
(e) If a guarantor of the debtor has a claim for contribution, this claim is disallowed unless the guarantor has paid. i. Otherwise, the debtor would have to pay the same thing twice: the principal obligor and the guarantor who both had claims with values assigned to them.
Under 726, claims fall into different “buckets” i. Top priority ii. Timely filed iii. Untimely filed with notice iv. Unsubordinated v. Federal Interest on the above 4 claims vi. Debtor gets if anything is left
2. Estimation of Claims that are unmatured/unliquidated a. Bittner v. Borne Chemical Co. i. Facts 1. Chapter 11 case 2. This case shows what the estimation process looks like 3. Shareholder suit for $50 million in tortious interference with contract
4. Shareholders only had a tort claim, which is unliquidated 5. Court held an estimation hearing: found that more probably than not, the shareholders would not collect. They would not meet the preponderance standard. 6. Shareholders claimed that they had 40% of evidence on their side, so the claim should be estimated at 40% of the maximum claim amount. ii. Court 1. 40% is less than 50% preponderance, so the claim is validly estimated at zero. 2. The claims estimation process is designed to allow streamlined valuation, as opposed to a trial that takes up time. 3. In this case, the court held that there was zero value of the claim for purposes of confirming the plan, but that the shareholders could sue post-bankruptcy to liquidate their claim. Professor says court should not have done this…
Court has authority to fix the claim for purposes of allowance, unless the claim is for wrongful death or personal injury.
b. Raleigh v. IL Dept. of Revenue i. Facts 1. Claimant is state Department of Revenue 2. In normal tax law, the burden of proof is on the taxpayer to prove that he does not owe the money; taxing authority does not have to prove that the taxpayer owes the money 3. Tax claimant filed estimated claim. 4. Taxpayer objected; said that State could only estimate, therefore it couldn’t prove the claim because the claimant should bear the burden of proof. 5. State claimant said “nope, under state law the taxpayer has the burden.” ii. SCOTUS
Property rights are created and defined by state law.
2. The burden of proof is an element of the claim for tax revenue, in this case. 3. The state’s right to revenue includes the burden of proof. a. Therefore, the claimant’s claim means that the debtor as taxpayer has the burden of proving it does not owe taxes. b. State and federal law that incorporates the burden of proof as part of the claim is not undone.
In Re A.H. Robbins i. Confirmation will cause disallowance of punitive damage ii. $700 million from a fund paid to shareholders (plan was confirmed by voting parties) iii. Others filed suits alleging you cant get rid of the punitive damages iv.
c. Secured Claims i. Generally 1. Secured credit is a loan supported by a contingent property interest 2. Value is the lesser of (i) value of the collateral and (ii) amount of the claim
Section 506(a) – Court must value the creditor’s interest in the property and designate the creditor’s claim a secured claim to the extent of the value of such creditor’s interest.
Bifurcation: The court values the portion of the claim up to the value of the collateral as a secured claim, and the remainder of claim above value of collateral as unsecured. Code also treats the portion of a claim subject to a setoff right as a secured claim and the balance as an unsecured claim.
The property of the estate must be the collateral for the claim to be secured. If there is a guarantor of a claim backed by collateral, there is a secured claim over principal obligor’s property, but the claim against guarantor is not secured. 506(b) – if the value of the collateral is greater than the amount of your claim, you as creditor can get postpetition interest and attorney’s fees—and this is a secured claim. a. SCOTUS interprets this as calling for payment of interest/reasonable fees and charges. Even if the agreement does not provide for interest, you still get interest if you’re oversecured and only reasonable fees if provided for in the agreement
6. 506(c) – Allows a trustee to surcharge collateral. a. This means that trustee’s fees and attorney’s fees related to creating a benefit/increasing property value gets turned into a secured claim that is above that of other secured creditors. b. Once the property is sold, you can’t surcharge it. So if the bank forecloses and bids its credit bid at the sale, the trustee cannot then demand the administrative expenses of the sale because the property is no longer property of the estate after the sale. (5th Cir.) c. Where there is property serving as collateral to secured creditors that is not of much value and needs to be managed, the creditor and trustee can agree that instead of trustee taking care and getting a claim for administrative expenses, the trustee can surcharge the collateral. Just give it a secured claim above the other secured creditors. 7. 506(d) – What happens when you hold a lien and there is a discharge entered?
a. The discharge does not affect the lien because discharge only relates to personal liability. b. If proofs of claims are not filed timely they are disallowed. c. You don’t lose your lien if you don’t file a proof of claim timely; you might lose the right to collect more than the lien (an unsecured claim), but you don’t lose your secured claim. i. This makes sense because disallowed claims are not extinguished but just not allowed against the estate. But the collateral right underlying the disallowed claim is maintained. d. However, if lien secures a claim against debtor that is not an allowed secured claim, the lien is void unless (1) the claim is not allowed because of failure to timely file proof of claim or (2) claim was disallowed under 502(b)(5) or 502(e).
Dewsnup – SCOTUS.
i. 506(d) seems to allow: where mortgage is over property worth 150k but
claim is for 200k, that if the secured claim is allowed, the debtor can obtain a judgment reducing the lien to 150k. This is the language that “to the extent that a lien secures a claim…that is not an allowed secured claim, such lien is void.” Argument that the “allowed secured claim” is only up to the value of collateral, so the excess amount is not allowed. ii. But legislative history suggests that if the property grows in value, the creditor should be able to capture that. Therefore, debtor cannot obtain a judgment reducing the lien down to the amount of the allowed secured claim. iii. This holding was limited to Ch. 7 cases.
In Ch. 11 and Ch. 13, the bankruptcy courts do not apply this case. They give the debtor the judgment stripping down the mortgage claim to 150k, which is the value of the property subject to the mortgage.
ii. Valuation of Collateral that Secures Claims 1. Associates v. Rash a. SCOTUS b. Facts i. Creditor claimed it wanted the trucks (collateral) valued at replacement cost. 1. Debtor wanted valuation to be at the foreclosure cost—because this is what the creditor would receive if it pursued its interest in the collateral. ii. Issue: Should the debtor have to pay replacement value when creditor would not have obtained replacement value had it foreclosed on the collateral? iii. 5th Cir. only valued claim as foreclosure value of the collateral
c. Court i. Debtor wanted to keep the trucks under Ch. 13; so replacement value should be used. If the debtor wants to keep the collateral, he has to theoretically buy the collateral. 1. Choosing the cramdown option of keeping the collateral is treated as a purchase of the collateral. 2. However, the replacement value is reduced by sales commissions, etc.
ii. Secured claims can be satisfied in a couple ways:
1. Pay value of secured claim over time; determine value of secured claim. This is what is being pursued in this case. 2. Foreclose on collateral and sell the property d. Dissent i. The issue is not what the debtor gets out of the trucks. The issue is the creditor’s interest in the trucks—and this is equal to foreclosure value, all that the creditor could get if it exercised its rights.
506(b) – Codification of Rash
If debtor is an individual under Chapter 7 or 13, the value with respect to personal property securing an allowed claim is determined based on replacement value of property as of date of filing of petition without deduction for costs of sale or marketing. With respect to property acquired for personal, family, or household purposes, replacement value shall mean the price a retail merchant would charge for property of that kind after considering the age and condition of the property at the time value is determined. i. The only retail merchants for used property includes pawn shops, garage sales, and Salvation Army! ii. Note that this does not apply to Ch.11. The replacement value is usually limited to individual, not corporate, cases.
Priority of Claims i. Schematic 1. Administrative expenses of trustee 2. Secured claims 3. Unsecured claims ii. Administrative Expense Claims 1. Section 503 a. Allowance of administrative expenses includes the actual, necessary costs and expenses of preserving the estate… i. By definition these expenses are incurred post-bankruptcy
ii. Expended by the trustee
(b)(9) – If a claimant sold goods within 20 days before bankruptcy, if there is a reclamation right, the claimant has an administrative expense claim for that reclamation right i. This is a problem because some debtor companies have huge reclamation claims against them. They have administrative priority, which is a problem. To get reorganized, the corporation has to pay these administrative expenses. This is running companies out of Ch.11 and/or preventing confirmation of bankruptcy plans.
c. Taxes postpetition, expenses of administration, trustee’s and attorney’s fees all have this priority d. Ordinary course of business claims are paid notwithstanding the discharge, but are not given administrative expense priority. 2. Reading v. Brown a. Facts i. Trustee administering the estate failed to get liability insurance. The estate building burned down and caught other buildings on fire. ii. The neighboring buildings sued in negligence, claiming damage was the debtor’s fault.
iii. The tort claimants want to be paid as administrative expense claimants 1.
Claimed that he was no different from someone who did business with the trustee, but the claimant just did business involuntarily through debtor causing claimant’s building to burn down
2. Trustee defends that the trustee did not expend these costs to preserve the estate; therefore, payment of tort claims would not preserve the estate. b. Court
i. Held: Tort claims arising during an arrangement are actual and
necessary expenses of the arrangement rather than debts of the bankruptcy
ii. Court understands that the expenses of paying the claim appear to
provide no benefit. But the purpose of bankruptcy is to provide a procedure that is better for the group than what would occur outside of bankruptcy. iii. If trustee had paid for insurance, the payment would have been an administrative expense claim. It just didn’t work out this way in this case, but still the policy is that the world needs to be encouraged to interact with the bankruptcy estate, for reorganization to occur. Therefore, the court says it has to give administrative priority to accomplish the goal of rehabilitation of the debtor. iv. This case is still good law.
3. In Re Wall Tube a. Facts i. Prepetition hazardous waste but postpetition expenses of trustee to clean up ii. The government gives two options, both require compliance: trustee cleans up, or government cleans up and sends the bill. b. Court i. These were actual and necessary expenses to preserve the estate because the debtor has to comply with state law for the estate to be preserved ii. This case is also still good law. iii. Section 507—Priorities
Among unsecured claims, there is a priority of distribution. The following claims and expenses have priority in the following order: a. (1) Domestic support obligations i. Alimony maintenance historically has always been collectible; no automatic stay ii. Do we really need this priority? Domestic support obligations are not even discharged, so there is no need to give first priority. b. (2) Administrative Expenses
i. Other than trustee fees, which are FIRST, above domestic support
(3) Claims that arise between filing of the petition and order of relief (Claims in the involuntary gap period)
d. (4) Allowed unsecured claims up to a certain amount earned 180 days before the petition for wages, salaries and other commissions i. These are claims of employees e. (5) Claims for contributions to employee benefit plan f.
(6) Grain farmers (7) Claims arising before the case in connection with purchase, lease, or rental of property, or purchase of services for consumers’ use that were not delivered or provided. (8) Claims of governmental units (pre-petition taxes) (9) Commitments to make capital commitments to federally chartered bank (10) Death or personal injury resulting from DWIs in vehicles
i. j. VI. The Bankruptcy Estate
a. The Debtor’s Interest in Property
Bankruptcy process requires both fixing the value of claims of the creditors and assembling the assets available for distribution to these creditors. The task of determining what assets are available for claimants—identifying the “property of the estate”—begins by identifying the property interests of the debtor that become property of the estate.
2. The estate obtains property deriving through the trustee’s ability to assert the rights of the debtor. ii. Section 541 1. The estate is created upon commencement of the case
The general rule under Section 541(a)(1) is that upon commencement of the case, all legal and equitable interests of the debtor in property as of the commencement of the case become property of the estate. As a first approximation, therefore, the estate is simply any right the debtor enjoys that has value in the debtor’s hands at the time of the commencement of the case
Trustee gets to sell the debtor’s equipment, collect money owed the debtor, and bring the lawsuits debtor has against third parties for the benefit of general creditors
b. This is limited in scope to the debtor’s interests in property; the happenstance of bankruptcy does not increase the property rights of the debtor that become property of the estate
Hypo: Prepetition tort claim of debtor. i. Is this property of the estate? Is it an interest of the debtor in property? Generally, a cause of action is a person’s property. ii. Several components of the claim: 1. Loss of earning capacity—post petition earnings?
Medical services and surgery needs--?
3. Continued pain and suffering iii. The claim existed as of the filing of the bankruptcy petition. All these listed elements of recovery are all part of the claim. iv. Therefore, the claim, with all its elements of recovery, becomes property of the estate.
Postpetition consequences, as in loss of earnings postpetition, are still part of the claim that becomes property of the estate upon filing of the bankruptcy petition
d. Hypo: Debtor’s policy of liability insurance. Debtor hurts someone. The injured sued the insurer. Four injured people are suing. Debtor files bankruptcy. We have a direct action statute in Louisiana, so the injured sues the liability insurer.
1. Is this an attempt to exercise control over the debtor’s property?
No; the injured is only trying to recover the proceeds of the policy.
b. True, the liability insurance policy is property of the debtor; but trying to recover proceeds is not an attempt to control the policy itself.
Are the proceeds property of the estate? a. No because they are not property in which the debtor has an interest. The persons that have interests in the proceeds as property are the beneficiaries, who are the plaintiffs that bring a direct action against the liability insurer.
The 5th Circuit went wrong by thinking this way: the proceeds that are recovered by plaintiffs will reduce the amount of claims against the debtor; therefore the debtor has an interest in the proceeds and therefore the proceeds of the policy are the property of the estate. But this misses the point because when the insurance proceeds are paid, this does nothing to the estate; it only releases the plaintiffs’ claim.
c. However, there could be a settlement in the suit that brings the insurance proceeds into the estate, to then distribute pro rata to the 4 injured people, to prevent a race to the courthouse. But courts only do this with the consent of the claim holders. 3. What if the suit is against the debtor and the liability insurer? a. The automatic stay prevents the lawsuit from proceeding against the debtor. ii. On the other hand a casualty insurance company that is first party insurance—the proceeds are property of the estate.
Exclusions from Estate: 541(b) a. The statute exempts certain property from becoming property of the estate b. Categories
i. For individual cases, earnings from services performed after
commencement of the case 1. On the other hand, creditors can look to all of a corporation’s future earnings ii. Certain exempt property iii. Power of attorney that debtor has over property
iv. An interest of the debtor as lessee under a lease of nonresidential real
property that has terminated before the commencement of the case. v. Eligibility of debtor to participate in higher educational institution [value of the institution’s accreditation]
vi. If you have a farm-out agreement (farmee drills oil wells because of
farmee’s contract with lessee, who finds a farmee to drill on behalf of someone who owns the well; farmee’s contract with lessee is that farmee will get an interest in the oil well) and do not record the lien interest, and the person who granted the farm-out agreement (i.e. less9r) filed bankruptcy, the interest in the oil well is not property of the estate. The trustee does not win; farmee—the holder of the farmout agreement, gets the mineral rights, even if it has not recorded the farmout agreement! 5. Avoidance Powers a. Trustee’s ability to bring additional assets into the estate b. These powers translate individual creditor rights to the bankruptcy forum and in the process may bring additional property into the bankruptcy estate
Property, Not of the Debtor, that Comes into the Estate:
These provisions are over and above property interests that the debtor had prebankruptcy
b. (a)(2) All interests of the debtor and debtor’s spouse in community property as of commencement of the case… i. The estate is comprised in part of all property that is community property ii. So if one spouse files, the entirety of the community becomes property of the bankruptcy estate iii. Community property is the marital estate that exists between two spouses iv. So the spouse that does not file bankruptcy does not own the property any more! The non-filing spouse has to “deal with it.” v. Fairness? 1. Under state law, when the community is dissolved via partition, this is not effective against creditors under state law. 2. The fairness is that the non-filing spouse gets a limited discharge: all debts of the community are discharged in bankruptcy. 3. The community property that went into the estate was used to satisfy all community debts; in effect, the community receives the discharge, so it makes sense that the non-filing spouse has a “partial discharge.” 4. Note that non-community debt of the non-filing spouse is not discharged. For example, if non-filing spouse personally signed a community note, there is a discharge of the community debt, but not of the obligation to personally pay the note.
Mortgage note signed by one spouse, who later files bankruptcy. The mortgage is on community property that is real estate, so both spouses have to sign the mortgage, so that the note is secured by a mortgage on community property, but the debt is a community
property debt to the non-filing spouse and a community/separate property debt to the filing spouse. c. (a)(3) Any interests in property that the trustee recovers under various sections of the Code. i. Addresses the following: various pre-bankruptcy contracts with professionals ii. Property that trustee sold where the bidding was rigged iii. Property turned over by a custodian in response to a turnover demand made by the estate—property seized pre-bankruptcy, custodian is appointed—this is property of the estate iv. Certain illicit transfers (fraudulent conveyances, transactions increasing insolvency, etc.) v. Trustee can recover against general partner to the extent partnership assets are not sufficient to pay off all claims d. (a)(4) …
i. First Category: Equitable subordination—use control and take a position
that you shouldn’t (Pepper v. Litton). A creditor has the right to obtain a judgment equitably subordinating these claims. The recovery from an equitable subordination claim becomes part of the estate. ii. Second Category: Pre-bankruptcy, debtor gives creditor a lien. Then second creditor obtains a lien at the time of creation of the debt. Trustee in bankruptcy cannot attack the second lien because it was not preferentially given. However, the first lien was a preference—the lien was given to a creditor who already had a claim; the lien and creation of debt were not contemporaneous. So trustee wants to avoid. 1. Property value is 100k. Lien One is 60k (should be avoided because of preference). Lien Two is 40k. 2. Lien One gets avoided, but does this mean that Lien Two moves up and retains an additional lien of 60k? or does the trustee get the first 60k? 3. Lien One is preserved for the benefit of the estate, if it’s perfected and avoided.
(a)(5) Any interest that would have been an interest of the debtor as of commencement of the case, if within 180 days after the commencement of the case, the debtor acquires an interest in: i. Categories 1. Bequest, device or inheritance; 2. As a result of property settlement with spouse; or 3. As a beneficiary of a life insurance policy or of a death benefit plan
a. (Of course in Louisiana, after this becomes property of the estate, avail of state law exemption of life insurance proceeds) ii. What this means, for example, is that if the debtor is listed as an heir in a will, and then the testator dies within 180 days of the commencement of the case such that debtor becomes the heir, the proceeds become property of the estate.
iii. Hypo: Death of testator and debtor is listed in a will, but debtor
renounces the claim, and then files bankruptcy. 1. In Texas, you either renounce in favor of someone, or you just renounce. If you just renounce, then you’re deemed to never have had a claim. 2. When you renounce post-bankruptcy:
Case law says that the right of renunciation becomes property of the estate. Therefore the debtor cannot renounce--use the right of renunciation--post-bankruptcy. Because it would be a violation of the automatic stay.
(a)(6) Proceeds, product, offspring, rents, or profits of or from property of the estate, except such as are earnings from services performed by an individual debtor after commencement of the case. i. Debtor’s postpetition earnings are not property of the estate unless filed under Ch.11 or Ch. 13. 1. Vast majority of cases find that (a)(6) provides this rule.
But this statute is NOT the source of the earnings exclusion because of the clear language of the statute—this statute just exempts proceeds from property of the estate. A debtor’s postpetition wages are not from property of the estate.
3. On the other hand, if debtor owns a hotel and trustee asks debtor to run the hotel during the bankruptcy, the debtor’s proceeds (e.g. rents) from the property of the estate (the hotel rental contracts with customers) become property of the estate.
ii. So the key provision is that these profits, offspring, etc. must come from
property of the estate for the profits themselves to become property of estate g. (a)(7) Any interest in property that the estate acquires after commencement of the case. iii. Gunder 1. Facts a. Chapter 13 case. b. Debtor had a car that had been repossessed prepetition, but the original title to car was in debtor’s father’s name
c. The bank that repossessed filed an unsecured claim for the deficiency. The trustee is trying to get the car back into the estate. d. The car had already been foreclosed upon. i. In many states there are rights of redemption, but not in Louisiana. Debtor can pay off the note and then get the collateral back. ii. Debtor claims that right to redeem is a claim secured by the car… e. Bank responds that it’s not the debtor’s car because the car is in the father’s name and state law in Ohio provided a conclusive, irrebuttable presumption that the name on the title certificate is the owner: this was the father, not the debtor’s name. Therefore, state law would not even allow the introduction of evidence to prove that the debtor was in fact the owner of the car. i. Debtor wants to argue that he paid all the notes and the insurance premiums. He only placed the car in father’s name to get cheaper insurance. 2. Court a. Held: The car was property of the estate because the debtor had an equitable interest. i. The statute refers to an “equitable interest” and bankruptcy is an equitable process. ii. The court seems to say that this equitable interest of the debtor trumps the legal interest of the father in whose name the car is. b. Problem with court’s analysis are two words in the statute: All legal or equitable interests of the debtor in property “AS OF” the commencement of the case.
i. Equitable interests must exist at the commencement of the case for the
interest to come into the bankruptcy estate. They didn’t exist at the time of filing of the case because the court is saying that these equitable interests exist as a result of federal bankruptcy law! ii. State law which created the property right for the bank is what existed “as of” commencement of the case. iii. AS OF the commencement of the case, the debtor had nothing; the bank had repossessed; debtor did not own the car under state law. And then once the case was filed, only then did any equitable interest under bankruptcy law arise; therefore, the car is not property of the estate. The court’s holding is wrong! iv. Begier v. IRS 1. Facts a. Debtor corporation pays the IRS withholding taxes that the debtor had to withhold from its employees i. The problem is that the often employers dip into the withholding tax money set aside and spend that money that should be paid to the IRS
ii. The corporation designated funds and sent checks to the IRS to pay the
withholding. However, the law was that these funds were supposed to be placed in a separate account.
iii. The trustee claims that IRS was paid in preference with money of the
estate. IRS defends that the money was held in trust for the benefit of IRS. Trustee responds that there was no separate account. Debtor did not designate a res, so there was no trust. iv. IRS then rebuts that the payment of the funds designated demonstrates that there was a constructive trust. b. Analysis
i. If the transfer of money would not have been made, would the funds
have been property of the estate? This is the standard for determining if the transferred funds belongs to the estate. 1. This analysis that SCOTUS uses is problematic. 2. The debtor commingled funds, so all the funds were property of the estate. ii. So SCOTUS says that from the moment the debtor paid withholding, this is when the money becomes held in trust by the debtor. 1. The opinion is “miserable” and circular. 2. The designation of the res was the payment to the IRS. If the money had not been paid, however, the court would not have been able to conclude that the money was not property of the estate—because it was all in the same operating account. v. In Re LTV Steel CO. 1. Facts a. LTV is the debtor and creates two subsidiary companies, one for inventory financing and one for receivables financing.
The creditor loans money to the subsidiary companies. Because LTV has sold its inventory and receivables to the subsidiary companies; and these transferred assets serve as collateral for the loans that bank makes to subsidiary companies. LTV has sold its receivables and inventory to the subsidiary companies and LTV has received money in the sale.
c. Now debtor asserts that the receivables are property of the estate in bankruptcy; but the bank contends that the receivables were sold to the subsidiary company, so they are not property of the estate.
i. Debtor wants to use its receivables that have been sold to the subsidiary
entity. Note that the debtor already received money when it sold the receivables to the subsidiary. But now the debtor wants to get access to his receivables that he sold. ii. The problem is that this is Ch.11—and the debtor’s business won’t survive and get reorganized. 2. Court
The debtor has an equitable interest—debtor must have some ownership interest in products in creates with its own labor, as well as the proceeds to be derived from that labor.
i. Professor says this equitable interest stuff is junk—the court is only
saying, “This equitable interest must exist!” ii. The court is making this up because it needs to create some sort of equitable interest to allow the debtor to access these receivables and survive as a going concern
In any case, the court finds that the debtor an equitable interest in property under 541(a)(1), so this became property of the estate upon filing of the case
vi. Landry 1. Court a. Debtor’s liability insurance policy is property of the estate, but the proceeds are not because the interest in them is one of beneficiaries, not the debtor
Property does not become property of the estate merely because the property (the insurance proceeds in this case) has the effect of reducing the estate’s liability
b. TEST NOTES: This is not an issue spotting exam. Look for things a client wants you to do that are illegal. He tests hard and grades easy. c. Ipso Facto Modifications i. Statute: 541(c)(1) 1. An interest of the debtor in property becomes property of the estate notwithstanding any provision in an agreement, transfer instrument, or applicable nonbankrutpcy law a. that restricts or conditions transfer of such interest by the debtor; or
that is conditioned on the insolvency or financial condition of the debtor, on the commencement of a bankruptcy case, or…etc.
2. Interpreted a. Many contracts say that if there is a material change in financial position, insolvency, etc., then there is a limit of transfer of the contract. Basically, that filing of the bankruptcy forfeits certain rights.
This provision says that a nondebtor party cannot keep property out of the estate by agreement. “Ipso facto” clauses are prohibited. i. For example, if debtor has a contract that says the filing of bankruptcy by a party to the contract will terminate the contract, this is an unenforceable provision because the contract may still become property of the estate.
3. 541(c)(2), Exception: If under applicable nonbankruptcy law, the debtor holds a beneficiary interest in a trust, it cannot be transferred. This restriction on transfer will be maintained in a bankruptcy case.
State law says that the beneficial interest cannot be held by the settlor of the trust; in other words, I can’t set up a spendthrift trust for my own benefit.
b. The trust is not subject to alienation voluntarily or involuntarily; in other words, someone cannot transfer their beneficial interest. It cannot be executed to satisfy a judgment, and the beneficiary cannot sell or otherwise transfer the beneficial interest. c. The state law prohibiting the trust interest from becoming property of the estate is made enforceable by this (c)(2) exception. Think of the professor’s case where the lady had a huge several million dollar interest in a trust and filed bankruptcy: she got to keep this because state law prevented it from becoming property of the estate.
ii. Seminal Case: Chicago Board of Trade v. Johnson
Debtor owned a seat, a right to do business, on the Chicago Board of Trade. Under the state law rules, members could only sell their seats if they first repaid debts owed to other members of the board.
b. The debtor filed bankruptcy and owed many debts to the other members of the board. 2. Court a. The seat becomes property of the estate. b. The law could not operate as an ipso facto provision to prevent the debtor’s interest in the seat from becoming property of the estate. iii. In Re Lou Allen 1. Facts a. Motor carriers had claims for underpayment b. Congress passed a law that says a motor carrier does not have a claim for underpayment once the motor carrier is no longer operating the business. c. In this case, the motor carrier filed for bankruptcy and claimed that the federal law was an ipso facto clause because it was triggered by the debtor going out of business. 2. Court a. Held: Although the federal law is applicable nonbankruptcy law, it is not conditioned on the financial condition of the debtor, so it is not an impermissible ipso facto clause. b. The condition was not really a change in financial condition, it was just the motor carrier going out of business.
i. Court says that true, going out of business may be due to a financial
condition, but there are other reasons, like a conglomerate deciding to leave the motor carrier industry or the owner retiring/closing up shop.
iv. **541(d) – If you only have legal title to an asset and not an equitable interest, the legal title does
not become property of the estate. 1. The mortgage industry is run as a pooling of loans. You get a loan from the mortgage lender/bank and they sell it immediately into a pool. The pools are put into trusts or put into servicing agreements, which allow the servicer to hold legal title to the notes so that someone can foreclose. The mortgages are in fact owned by thousands of people, but only the servicer holds the title.
If the servicer goes into bankruptcy, the estate is not comprised of the mortgages who only hold equitable title, but is only comprised of the servicer’s interest, who has legal title.
3. The servicer has title for servicing reason; the servicer is doing this for the actual owners. And thus the servicer’s estate does not obtain the benefit of the mortgages. VII. Executory Contracts a. Executory Contracts Defined i. Background
**The professor is “really good at this stuff”—remember that for the exam.
2. What is a Contract? a. A relationship among parties whereby the parties are bound by mutual consent and obligations to perform their obligations. b. Contracts have a right part and a performance part. An asset element and a liability element. c. So why are executory contracts so complicated? Why not just say that they are property of the estate like any other contract?
i. A contract involves at least two parties having interests. Therefore, if the
contract just is property of the estate, it might end up being a net liability that actually drains the estate. ii. If a contract just automatically became property of the estate, there would be a corresponding obligation that the estate would be required to perform. iii. It may be that we don’t want all contracts in the estate because if we have them, we have to perform them. 3. Net Asset v. Net Liability a. Can the debtor obtain the benefit of the contract without having to perform? i. No. Have to perform the obligations post-bankruptcy.
ii. The estate undertakes the obligation to perform. The expenses incurred
by the trustee in undertaking the performance become administrative expenses that have priority. b. Section 365 is designed to address these issues
Under Louisiana state law, these contract rights would be incorporeal movables (or immovables if bearing on immovable property)
The theory is that trustee will assume the executory contract if it is a net asset to the estate: when the benefit is greater than the required performance.
4. Circuit Split: What happens when trustee neither accepts nor rejects? a. In Ch.11/13, if there is neither assumption nor rejection, the contract “rides through” the bankruptcy i. 5th Cir. says that the debtor owes on the claims if they ride through bankruptcy
But this would mean that if a promissory note is an executory contract and it rides through the bankruptcy, this would mean that the debtor is not discharged from the note. This cannot be.
ii. The other circuits say that the debt is discharged; if the debtor stops performing the executory contract, then the creditor can terminate. The creditor cannot terminate the contract unless the debtor breaches after the bankruptcy.
However, in Ch. 11/13, the trustee may assume or reject at any time before confirmation of a plan, but the court upon request may order the trustee to determine within a specified period of time whether to assume or reject such contract or unexpired lease of residential real property or of personal property. 365(d)(2). i. (p)(1): If lease of personal property is rejected or not timely assumed, it is no longer property of the estate and the stay is terminated.
In Ch. 7 case, if the trustee neither assumes nor rejects within 60 days after the order for relief (petition), or within such additional time as the court, for cause, within such 60-da period, fixes, then such contract or lease is deemed rejected. 365(d)(1).
Professor’s Definition: A contract so far unperformed that breach by either party will excuse performance of the other party a. Any contract that is not performed is executory under normal contract law. But executory contract means something more than that in bankruptcy. b. There should be an “asset side” to it. c. The process of determination whether something is an executory contract is: i. Determining whether both sides actually owe material performance ii. Determining whether it’s a good deal and the estate can perform or assume and assign the contract rights to someone who can perform.
ii. Examples 1. Option Contract a. ADD IN HEMS CASE b. Prof thinks the option contract is not one that if he holds the option he must assume or reject it.
c. Even if you get an offer that is 1.5x the option, he still doesn’t think its an executory contract. 2. Promissory Note a. The holder of the note has the obligation to apply the money collected correctly between principal and interest b. So there are still mutual obligations: the borrower has to repay, and the lender must send financial statements, apply the money paid back correctly, etc. c. However, this may not be material performance on both sides
A trustee would not assume a promissory note: i. The estate already owes the promissory note, because upon filing, the estate owes. But the note is a prepetition claim. ii. Assumption of the note would turn the note into a postpetition claim that gets administrative expense priority. iii. And the estate would get no benefit from assuming the note; therefore, the executory contract would be a net liability.
e. A trustee may assume a secured note, but not because it is an executory contract. Because the trustee may want to make payments so that the secured creditor cannot foreclose on the property. i. If the terms are good, the trustee may assume secured debt. f. A promissory note doesn’t really have an asset side to it. The trustee does not receive an asset through assumption because the debtor had already received the loan proceeds earlier on.
3. Energy Enterprises Corp. v. U.S. a. Facts i. Class action lawsuit by sellers of gas against a big pipeline/purchaser of gas ii. The class action suit settled. The settlement had components: 1. Payment of $30 million in two installments 2. Rewriting contracts between the purchaser and each class member, according to a master contract provision 3. A mutual release of all claims. iii. $15 million was paid. And part of the settlement required individual contracts to be executed by each class member. Essentially, each member had to send in a secondary release, an individual release, in order for each class member to receive its money. iv. Then the purchaser/defendant in the class action filed for bankruptcy. v. The debtor moved to assume the settlement.
vi. The IRS opposes the motion because it does not want the settlement to
get administrative expense priority over the IRS’s claims b. Court i. The contract is not executory because simply executing the individual agreements is not material performance ii. Executory contract is one in which performance remains due to some extent on both sides
iii. Where the creditor has fully performed, it makes no sense to talk about
an executory contract. There is a simple claim against the debtor. The debtor has already received a benefit and “assumption” would just give administrative expense priority. 1. When debtor has fully performed, the performance owed by the creditor is an asset of the estate. Acceptance makes no sense, therefore. And to reject would just be an exercise of the avoidance power, which would not make sense because the contract would only be an asset to the debtor.
iv. Majority definition: a contract under which the obligation of both the
bankrupt and the other party to the contract are so far unperformed that the failure of either to complete performance would constitute a material breach excusing performance of the other. v. In this case, the settlement agreement imposing a condition of payment is not material performance that is owed. Therefore, not an executory contract. vi. Prof. says the court got it wrong: 1. The individual settlement agreements may have been severable and able to stand on their own 2. There were several “layers” to the settlement agreement: a. $15 million remainder that had to be paid b. Release (already done) c. Overarching gas supply and purchase contract i. This is clearly an executory component ii. The problem with the court’s ruling is that it focuses on the settlement payment and ignores the fact that the settlement governs the future performance of the overarching gas supply agreement.
iii. The settlement agreement needs to be executory
so that the trustee can assume. This component is executory because the debtor has to purchase and the creditors have to sell. b. Assumption
i. Law 1. Gives the estate the right to assume a contract that is in default. a. There is no such right under state law.
Therefore, Bankruptcy Code regarding executory contracts preempts state law.
2. The court can approve assumption of the contract as long as the court assures that the debtor will cure the default or provide adequate assurance of cure. a. Clairmont i. Dealership has financial difficulty, closes for 7 days longer than the maximum amount of consecutive days allowed under the contract. If closed for x number of days, this places dealer in default. ii. Dealer then opens doors; dealership files Ch.11 and moves to assume the dealership franchise agreement. iii. The problem in this case is that the default cannot be cured, because the debtor cannot go back in time and reduce the number of days that the dealership was closed. 1. Dealership says it does not have to cure penalty rates or nonmonetary defaults under the Code. Claims that this is a nonmonetary default that does not have to be cured. 2. Held: This is not a penalty provision, therefore, it must be cured, and since it can’t be cured, there can be no assumption. a. Only penalty provisions do not have to be cured in order for there to be assumption. 3. Section 365(a) General Rule: Trustee, subject to court’s approval, may assume or reject any executory contract or unexpired lease of the debtor.
Section 365(b)(1)(A): If there has been a default of executory contract or unexpired lease of the debtor, the trustee may not assume unless at time of assumption the trustee cures or provides adequate assurance that trustee will promptly cure the default; and (C) the trustee provides adequate assurance of future performance. However, there are exceptions:
For leases of nonresidential property, Clairmont is overruled. Nonmonetary defaults that can’t be cured don’t have to be cured for the trustee to assume the contract. However, for all other executory contracts or unexpired leases, Clairmont is good law. For all contracts other than nonresidential leases of real property, the trustee has to cure nonmonetary and monetary defaults to assume the contract. Only if there is a default of a penalty provision is the trustee not required to cure the default in order for the contract to be assumed. 365(b)(2)(D).
c. The default does not have to be cured if it resulted from an ipso facto clause—the default under the executory contract was triggered by insolvency or commencement of the bankruptcy case. 365(b)(2). 5. Chapter 7 debtor cannot assume.
ii. Section 365(c): Limit of Right to Assume 1. Text
Trustee may not assume or assign any executory contract or unexpired lease of the debtor whether or not such contract or lease prohibits or restricts assignment of rights or delegation of duties, if-i. (1)(A) applicable law excuses a nondebtor party to such contract/lease from accepting performance from or rendering performance to an entity other than the debtor or debtor in possession, whether or not such contract or lease prohibits or restricts assignment of rights or delegation of duties; and 1. (B) such party does not consent to such assumption or assignment; or
ii. (2) such contract is a contract to make a loan or extend debt financing or
financial accommodations to the debtor, or to issue a security of the debtor.
Debtors who file bankruptcy cannot compel you to continue to make loans to them.
2. So loan agreements calling for the extension of financing to the debtor or calling for issuance of a security are not subject to assumption.
If there can be no assumption, the estate can never obtain an interest in the contract. Therefore, if 365(c) prevents assumption, there is only one question: whether if the debtor breaches there is a claim or not.
3. (c)(1) a. It does not matter whether the contract restricts assumption or assignment. So we throw out provisions in the contract that restrict assignment.
Next, look to applicable law to determine if it prevents the contract from being assigned.
i. Hypo: basketball player in NBA files bankruptcy. If trustee accepts the
contract to play ball, the trustee would be the one performing! Ridiculous. Trustee should not be allowed to play the NBA game on behalf of the basketball player. The fact that the basketball player’s contract contains a restriction on assignment of the contract does not prevent assignment. We have to look to applicable law to determine if it prevents assignment of the contract rights.
ii. Where applicable law says that the contract is what we call in Louisiana
a strictly personal obligation, the trustee may not assume such a contract. iii. The harder question is if the trustee may not assume such a contract, does the debtor then have the power to reject it? 1. The book says yes. The Code is silent on the issue. 2. Prof. says that if you don’t have the power to assume, then you don’t have the power to reject. Therefore, the debtor cannot reject.
c. If applicable law prohibits assignment without the consent of the nondebtor, then the contract is not assumable.
i. Note that under (c)(1)(B), if the nondebtor party does consent to
assignment, then the contract may be assumed by the trustee. Because “applicable law excusing performance”—i.e. law that prohibits assignment—does not absolutely restrict assignment. The parties may always agree to assignment (unless assignment is against public policy), and therefore this Section 365(c) provision would not apply.
ii. If the contract is by its nature one that cannot be assigned without
consent of the other party, then it cannot be assumed. iii. Whether the contract contains a restriction of assignment is of no moment. iv. Louisiana: Personal v. Heritable 1. Heritable contracts may be transferred. By their nature, they are not so specifically related to the peculiarities of the other party that the other party may not transfer. The obligee may be required to receive performance from a different person. 2. Strictly personal contracts may not be transferred.
This prohibition on assignment doesn’t just meaning selling contract rights. It also means that the party cannot give a bank a lien on the contract. A contract can be made strictly personal either by the nature of the contract or if there is a provision in the contact that makes its strictly personal (unless the provision is contra bonas mores). i. It goes both ways: as long as it’s not against public policy, you can make a strictly personal obligation into a heritable one, or vice versa, by consensual agreement.
Leases are heritable in Louisiana. If the lease says that it may not be assigned, under 365(c)(1)(A), we ignore the prohibition in the lease itself. The restriction is not a provision in “applicable law”. (This does not address the argument that once there is a provision restricting enforcement, the law then recognizes that the contract is not transferrable…) Therefore, the trustee could assume such a contract.
Text: (1) Except as provided in (b) and (c), notwithstanding a provision in a contract or unexpired lease of the debtor, or in applicable law, that prohibits, restricts or conditions assignment, the trustee may assign as follows: i. (2) The trustee may assign only if— 1. (A) the trustee assumes such contract or lease in accordance with this section; and
2. (B) adequate assurance of future performance by the assignee of such contract or lease is provided, whether or not there has been a default in such contract or lease. b. Courts have found a conflict between 365(f) and 365(c)(1)(A)
i. But if under subsection (c) the contract is not assignable, then (f) doesn’t
ii. (c) addresses contracts which by their nature are not assignable under
applicable law. (f) addresses all contracts, including heritable ones, which include provisions in contracts that purport to make them strictly personal.
iii. Professor’s theory for reconciling (f) and (c): 1.
(f) means that all the contracts that would be otherwise heritable, but which (1) contractual language restricting assignment or (2) default of the debtor that makes the contract non-assignable (applicable law) purports to make strictly personal, may still be assumed by the trustee, if there is adequate assurance of future performance by the assignee.
5. Perlman v. Catapult Entertainment a. Facts i. Perlman is a licensor of patents ii. Catapult is the debtor and licensee iii. Perlman wants to prevent the estate from assuming the patent licenses iv. The patent license contains a provision that it cannot be assigned. v. Patent law 1. The patent owner may license the patent for use to someone else 2. But the license is not assignable because: a. The patent is valuable property and should only be used by someone that that the patent owner says can use it b. Also the patent holder does not want the patent to be used by the holder’s competition; so it makes sense that patents are not assignable without the licensor’s consent 3. The licensee may only use the patent subject to the license agreement and has no right to transfer the license without the consent of the licensor b. Analysis i. Under patent law the license is not assignable under state law; so the trustee should not be able to assume it ii. Applying 365(c):
1. Catapult may not assume the Perlman licenses if federal patent law excuses Perlman from accepting performance from or rendering performance to an entity other than Catapult, and Perlman does not consent to such assumption… 2. The plain language bars the debtor-in-possession from assuming the license agreement.
iii. Held: even if the debtor does not plan on actually assigning the contract,
the fact that applicable law makes the contract non-assignable means that the contract cannot be assumed
iv. This type of holding adopts the hypothetical test—reads the ambiguous
statutory language as its written, which says that if the applicable law makes the contract non-assignable, regardless of whether the debtor plans on assigning the contract after assumption, the trustee may not assume. 6. Institut Pasteur v. Cambridge Biotech a. Facts i. Cross-licensing agreements existed; similar to patent licenses in previous case. ii. The reorganization plan called for a merger into a new entity.
iii. The nondebtor argues that this is not an assignment; that the assets and
contracts don’t get assigned, but remain with the same company that has new ownership. The merger of the debtor into another company will not bring about an “assignment” of the contract. b. Court
i. This is the actual test type of holding.
1. If the debtor is not planning on assigning the contract, the trustee may assume the contract
Only if the debtor plans to assign the contract may it not be assumed. Where the nondebtor party is not being “forced to accept performance under its executory contract from someone other than the debtor party,” the contract may be assumed. The company merging with another did not constitute an assignment in this case; therefore, because of the actual test, the debtor in possession may assume the contracts.
ii. There is no authority in the statute for this position; but there is vast
support for this in the jurisprudence
Other cases read that 365(c) only applies to contracts for personal services. And that if it’s not a contract for personal services, then (f) and not (c) applies. Professor says this is wrong.
8. Supernatural Foods
Facts: There is a right to assign in the contract, but applicable law says it is not assignable. The contract’s terms allow assignment, if certain conditions are met.
b. *This is the Professor’s case, as Judge.
You can opt out of (c) by saying that a contract that is non-assignable under state law is assignable because of the parties’ agreement in the contract. And once you do, (f) applies because (c) is no longer applicable.
d. And under (f), all the limitations in the contract on assignability are ignored and the contract becomes assumable. e. This case also stands for the proposition that if the executory contract is a good deal but the trustee cannot afford it, the trustee may assume so that he can assign/sell the contract to someone else. 9. In Re Mirant
Issue: What if the trustee does nothing? No assumption or rejection.
b. 5th Circuit said the contract rides through unaffected i. There is an argument that the statute won’t let you.
ii. 365(e)(1) is the prohibition against ipso facto clauses that purport to
terminate or modify executory contracts based upon the commencement of the case, insolvency of the debtor, etc. 1. However, (e)(2) says essentially that the rule of (c) trumps (e)(1). That even if there is an otherwise impermissible ipso facto clause in an executory contract that would purport to terminate the contract, if the contract is not assumable under (c), the nondebtor may terminate the contract.
Argument that if the contract is a (c) contract and it cannot be assumed, then (e)(1)—which says that you can’t use ipso facto clauses or default to prevent assumption—means that if the license agreement contains a bankruptcy default clause and cannot be assumed under (c), the nondebtor can, under (e)(2), terminate the contract because the debtor filed bankruptcy.
c. Facts i. Debtor had power contracts with government-related entities. The contracts were not assignable under the regulatory scheme.
ii. The trustee did not do anything with these contracts. Because the trustee
neither assumed nor rejected, the nondebtor party attempted to terminate the contracts. d. Court i. Under (e)(2), debtor loses the protection of (e)(1), which says that the filing of bankruptcy may not allow the nondebtor to terminate. Because (e)(2) says that the contract may be terminated if the contract is not assignable under (c). ii. **On the exam, he will ask the difference between the language in (e) and (c).
(e)(2)’s language may be limited to …
iii. Court says that contract rights cannot be terminated in violation of the automatic stay. The Court punts because it denies the motion to lift the stay. iv. But in dicta there is language suggesting that the nondebtor will never be allowed to terminate; that the contract will ride through. c. Rejection i. Effects of Rejection 1. The estate is no longer under any obligation to perform 2. The estate is no longer entitled to receive the benefits of the contract 3. The rejection is a breach of the contract creating an unsecured prepetition claim for the nondebtor party; and 4. This “claim” (and nothing else) is dischargeable in the bankruptcy proceeding. ii. Section 365(g)
Rejection is deemed a breach immediately before the date of the filing of the petition.
2. The estate does not have to perform postpetition, but there is a prepetition breach entitling the nondebtor to state law remedies triggered by the breach. 3. Breach
Does NOT extinguish the contract! Breach does not affect the existence of the contract. “You don’t win by breach.”
b. Therefore, the trustee will determine the cost of breach. c. The cost of breach is the damages prepetition; trustee will compare this with the cost of performing the contract postpetition subtracted from the benefit reaped. iii. Case hypos
Natural Gas Contract (Transamerica) a. After debtor party files bankruptcy, the nondebtor files a claim for liquidated damages. b. Debtor asserts that there can be no claim for liquidated damages because debtor rejected the contract. c. The nondebtor will get his stipulated damages because there is no other way to calculate damages than by using the contract. Because the contract creates the remedy for the prepetition breach.
If the trustee assumes, and then breaches, the creditor imposing stipulated damages would be impermissible, on the other hand.
Licensor files for bankruptcy.
b. License: i. Is or is not exclusive
ii. Licensor must update it from time to time (e.g. new software upgrades) c. Licensor rejects the contract. d. Licensee claims that it couldn’t be rejected because it was not executory i. But the court found that the contract was executory—because the licensor owed rights to update the technology and such
ii. Therefore licensee claiming that it wasn’t executory was the wrong
argument. Because the court says that if it’s not executory, this just means that the trustee can’t assume it, which is what the trustee wants anyway. iii. But the court was wrong because it ignored the fact that if it is executory and is rejected, the licensee keeps the license; there is no termination upon rejection. 3. Mineral Property
Debtor sells mineral property via a purchase agreement in exchange for $300 million
b. In such agreements, the operator under an operating agreement runs the property. The operator drills, processes, sells minerals, collects money, sends out distributions, accounts, etc. c. In this particular agreement, there had to be a formalization of operation, but the purchaser is the informal operator d. Seller files for bankruptcy. Trustee is appointed. e. Formal designation of operator has not occurred. f. Trustee moved to reject the purchase and sale agreement.
g. 5th Circuit addressed whether it was executory and found that it was not, therefore rejection could not occur
i. The problem is that if the court had found that it was executory,
assumption would have been cheaper for the estate! Because the prepetition damages for rejection would have been more costly than the debtor simply assuming the contract and designating the formal operator. ii. Rejections costs: 1. Nondebtor will have $30 million claim for the cloud on the title due to the debtor not having designated a formal operator iii. Assumption costs: 1. $14 parking 2. $275 trip to sign documents 3. $1.87 copy costs iv. This assumes that the nondebtor purchaser had recorded its title to the minerals. If the nondebtor did not record its title, then the title is with the
debtor in bankruptcy and the title is property of the estate, so the purchaser could not obtain it. h. Summary: the court’s better response would be to say not that the contract is not executory, but that it is executory but to reject it would be stupid—too costly for the estate. 4. Leasing Services Corp. v. First Tenn. Bank a. Facts i. Good law and good case ii. Financed lease. Lease of cranes. iii. Debtor is the lessee; lessor received the lease through assignment. Lessor obtained a security interest in debtor’s assets to secure lease payments. Bank has a second priority lien on the same assets as lessor’s lien. iv. Lessee filed for bankruptcy and rejected the lease. The property is sold and the creditors fight over the proceeds. The debtor gave the value of the collateral to the bank; lessor got some rejection damages but sues Bank, claiming since the lessor had a superior lien, it should have the first rights to receive rejection damages from the collateral. b. Court i. Rejection does not extinguish the contract; it simply constitutes default. ii. The lessee’s rejection could not terminate the lessor’s security interest in the assets that collateralized the lease. Therefore, lessor gets to obtain value of the collateral to pay for its rejection damages. 5. In Re Register a. Facts i. Franchisee signed a franchise agreement, which include a noncompetition agreement. Because the franchisor did not want to give the franchisee training and then have the franchisee leave the business and compete. ii. Franchisee filed for bankruptcy and moved to reject the franchise, including the noncompete agreement. b. Court i. The noncompete agreement was terminated when the contract was rejected. 1. There is a problem with the court’s analysis. 2. It related to whether or not the contract is executory. ii. If the debtor breaches, depending upon the state, there may or may not be a right to payment for the breach of a noncompete agreement. In some states, all you can obtain is an injunction; in other states you can be made to take money for the claim.
1. Therefore, if the breach of noncompete agreement gives rise to a right to payment, this is a claim that is discharged. 2. But in a state where you can only obtain injunctive relief, there is no claim that is discharged, and therefore the nondebtor can enforce the noncompete agreement post-bankruptcy. 3. This shows that the court’s focus was wrong: the issue is the particular state law and whether there is a claim that would be discharged. 6. Section 365(n) a. Special statute on licensor bankruptcy rejection of licensing agreement. b. Background i. There is an obligation of confidentiality placed upon the licensee. ii. Can the obligation of confidentiality be rejected? The problem is that once you agree to do it, you’re always bound. c. Permits a licensee of intellectual property to retain its rights despite rejection. 7. Northwest Airlines Corp. v. AFA a. Section 1113 i. Deals expressly with collective bargaining agreements (CBAs) with union ii. Addresses the specific consequences of rejecting CBAs iii. CBAs govern all the relations between employees and employers iv. Addressed the problem of big companies filing for bankruptcy and rejecting their CBAs v. Big points:
Under this section, the contract is extinguished upon rejection.
Note that outside of 1113, rejection of contracts does not extinguish those contracts.
There must be a need to reject; it’s a heightened analysis for the court to actually permit rejection.
In Chapter 7, the contract is deemed rejected unless it’s not assumed within 60 days of the petition.
2. The debtor does not have the right assume or reject an executory contract a. But under Section 365(e) the lessor cannot terminate the lease based upon the filing of bankruptcy b. Therefore, the debtor can continue to inhabit the place that is leased, though the lessor has a claim against the lessee…
The Avoiding Powers a. The Trustee’s Strong-Arm Power i. Background 1. Strong-Arm Power a. Arises from state law b. Section 544 ii. Asserting Rights of Hypothetical Creditors and Purchasers 1. Section 544(a)—The Hypothetical Lien a. This section is about lien perfection
Rule: The estate takes as the perfected party all rights that the best claimant to property rights could have
c. Perfection of Liens i. Hypo: Creditor reduces a claim to judgment. This is only a recognization of rights. If the judgment is recorded, however, there comes a judicial lien on all property owned by the judgment debtor in the parish of recordation. Once appeal delays have run and the judgment becomes executory, creditor can obtain seizure and sale through executory process. 1. Hypo: purchase of house. Purchaser doesn’t have rights good against the world until he records the sale; this perfects his interest. ii. Section 544 is the hypothetical power that the trustee has as though all rights obtained have been perfected as best possible. d. Text: (a)(1) The trustee shall have as of the of commencement of the case the rights and powers of a creditor that extends credit to the debtor at the time of the commencement of the case, and that obtains, at such time and with respect to such credit, a judicial lien on all property on which a creditor on a simple contract could have obtained such a judicial lien, whether or not such a creditor exists. i. Meaning: The creditor gets an ideal lien on any property that he could have obtained one over; this lien is deemed to have been created at the time of filing the petition. ii. This means that for actual creditors with unperfected interests, the trustee beats them in priority because of this deemed perfected interest of the trustee e. Text: (a)(2) The trustee shall have as of the of commencement of the case the rights and powers of a creditor that extends credit to the debtor at the time of commencement of the case, and obtains, at such time and with respect to such credit, an execution against the debtor that is returned unsatisfied at such time, whether or not such a creditor exists; or
i. Meaning: The trustee obtains an execution right on all property of the
debtor against which a creditor could execute. This means that, for example, with a car, the creditor is deemed to have obtained a judicial lien through obtaining a judgment and therefore having a right of execution on the car. ii. This means that for actual creditors with unperfected interests, the trustee beats them in priority because of this deemed perfected interest of the trustee f. Text: (a)(3) The trustee shall have as of the of commencement of the case the rights and powers of a bona fide purchaser of real property, other than fixtures, from the debtor, against whom applicable law permits such transfer to be perfected, that obtains the status of a bona fide purchaser and has perfected such transfer at the time of the commencement of the case, whether or not such a purchaser exists. i. Hypo: Creditor has claim against company and it is secured by immovable property. Company does a dation, in payment of the debt. But company wants to sell it, so creditor agrees to allow company to sell the property. But the company files for bankruptcy and says that the dation is no good. 1. Note that between the debtor and the creditor, the dation was good. The debtor could not get the property back after giving the dation. But the creditor’s interest was not perfected because the creditor did not record the dation. So in bankruptcy, the trustee has a superior interest to the creditor. ii. This statute means that because the creditor did not record its act of transfer, the trustee of the company wins because it has this hypothetical bona fide purchase that has been hypothetically recorded by the debtor, giving the debtor a superior interest over the creditor. g. Summary i. Hypothetical interest ii. Applies (1) only to unperfected interests that could be beat by (2) the holder of a judicial lien who obtains such a lien immediately upon filing of the case; a writ of execution that could be obtained upon commencement; or a bona fide purchaser that purchased and perfected at time of commencement iii. If you can use the 544(a) avoiding powers, this is the best case scenario. 1. Don’t need to use reachback periods. 2. Don’t have to address insolvency.
iv. NOTE that if a creditor holds a perfected interest (meaning that it is a
secured creditor), it has a superior interest over this trustee with the hypothetical powers. 2. Purpose of These Powers
a. 544(a) allows the trustee to take advantage of the rights that would otherwise accrue to third parties, to obtain the value of what could have been obtained by the third party, for the benefit of all the creditors. i. If there are any unperfected security interests, the trustee obtains these for the benefit of the estate to the maximum extent allowed. b. The reason for (a)(1)-(3) i. (3), the bona fide purchaser, is the best position to be in. ii. Each of these three imports applicable state law. 1. Louisiana is a rigid public records doctrine state. There are very few exceptions to the pure public records doctrine mechanics of obtaining rights. If the property is unencumbered per the public records, you can get it unencumbered!
iii. This frees up property, that third parties only believe that they hold
security interests upon, for the benefit of the estate.
iv. This strong-arm power even cuts through alleged legal preferences.
3. Kors, Inc. v. Howard Bank a. Facts
i. Subordination Agreement—creditors of the same debtor agree that
although one creditor has superiority over the others, he will subordinate his interest to others. 1. Essentially, one creditor agrees with the others that the others will “beat” that creditor. 2. Therefore, whatever that creditor obtains will go first to the others. 3. This is typical in lending transactions where the lenders agree between themselves who will have priority.
ii. The bank’s mortgage was unperfected because the bank failed to obtain
the debtor’s signature on the financing statement. Therefore, the trustee gets the benefit of this unperfected interest.
iii. Additionally, although the bank’s interest was obtained after that of other
secured creditors, there was a subordination agreement among the creditors that the bank would have a superior interest over the other creditors, who technically perfected their interests first in time. 1. Section 550—liens avoided are preserved for the estate. a. This means that if a lien is avoided, the lien belongs to the estate, and the estate succeeds to that position.
The estate wins and obtains the bank’s mortgage.
iv. In Summary: The bank had obtained a mortgage second in time, but had
obtained an agreement from the other creditors that the others would be subordinated to the bank. But the bank never perfected its interest.
i. The trustee clearly obtains the value of the Bank’s unperfected security
interest under 544(a). But the trustee also wants to obtain the benefit of the subordination agreement, to have the other creditors’ interests subordinated to the Bank’s interest.
ii. Held: trustee gets the value of bank’s unperfected lien, but it is trumped
by the other creditors. The bank’s security interest in the debtor’s property did not include the right to have other liens subordinated—this was a separate agreement among creditors. Thus the trustee did not have subordination rights.
When trustee avoids the unperfected security interest, the trustee obtains the security interest, but does not obtain the right to have other interests subordinated by virtue of a subordination agreement among creditors because that contract is not a part of the unperfected security interest—it is a separate personal contract of the unperfected interest holder with other interest holders.
4. In Re Guillot a. Facts i. Bogus donation. ii. Can the debtor get the property back? b. Analysis
i. Debtor participated in donation, so it can’t get the property back.
ii. The debtor’s rights are limited to what it would have under state law. c. Ordinarily, parol evidence is not allowed where there is an authentic act showing that the debtor validly made a transfer. But under 544(a), the trustee can introduce evidence showing that the transfer was not validly perfected because of fraud or some other reason. iii. Asserting Rights of Actual Creditors 1. Section 544(b) Actual Rights a. Hypo i. Creditor is owed by debtor and debtor gives huge donation to Grandma. ii. Under state law, we have a revocatory action in Louisiana that allows the creditor to undo the donation.
Text: 544(b)(1) Except with regard to charitable contributions, the trustee may avoid any transfer of an interest of the debtor in property or any obligation incurred by the debtor that is voidable under applicable law by a creditor holding an unsecured claim that is allowable under Section 502 or that is not allowable only under Section 502(e). Trustee has the authority under this section to avoid a transfer made by a creditor holding an unsecured claim as of the commencement of the case. Unlike 544(a), under 544(b), the trustee can avoid even perfected transfers.
i. Derivative Power—the trustee only has this power under 544(b) if there
is an actual creditor that exists who may undo a transfer under applicable nonbankruptcy law. ii. Use of Applicable Nonbankruptcy Law 1. Requires looking to state law to avoid a transfer of an interest of the debtor in property. 2. If creditor has 5k claim and debtor transfers 50k CD, increasing insolvency by 10k, the creditor is only actually damaged by 5k. 3. Creditor has 5k claim; transfer is 250k in property. a. Under state law, creditor has 5k claim against transferee and creditor gets 5k personally through the Louisiana revocatory action.
Under bankruptcy law, the estate gets the 5k for the benefit of all the unsecured creditors; it also gets the remaining 245k in property value back for the benefit of the estate—all the creditors.
4. Use the applicable state reachback period under 544(b). 5. Other states have versions of the Uniform Fraudulent Transfer Act; we do not in Louisiana.
Under the Louisiana revocatory action, payment of a lawful debt is not something that increases insolvency; there is no net change. Therefore, these transfers cannot be undone.
iii. This is a Personal Right of the Creditor, to the Extent Creditor is Damaged by the Transfer 1. But the trustee is not acting for the one creditor. The trustee acts for the benefit of the estate. 2. Hypo a. Only one creditor holds a claim that occurred before the transfer that increased the debtor’s insolvency: claim for $4.27. There are $494,995.73 in claims that arose after the transfer. (The transfer was of 250k in property).
The Moore case has held that regardless of the amount of avoidance power—a minimal $4.73 in this case, the entire transfer--$250k in this case—is avoidable to the extent of the claims against the estate. This is terrible for the transferee who did business with the debtor! But this is the result under applicable nonbankruptcy law in Louisiana—which is the revocatory action. i. Requires that claimant preexist the transfer. ii. And that the transfer must cause or increase debtor’s insolvency.
c. In other states, they have the Uniform Fraudulent Transfer Act.
Although it is the right of the “actual creditor,” when the transfer is undone, it is avoided not only for the sake of the creditor who had the right, but also for the sake of the entire estate—all the creditors!
e. Why use the 544(b) mechanism rather than 548 automatic reachback period of 2 years? i. In Louisiana, the peremptive period for a revocatory action is 3 years, so you might get an extra year. f. “Actual” Creditor
i. Most of the case law says that the trustee does not have to identify the
exact creditor that has the right to avoid the transfer. ii. But some case law requires identification of the actual creditor who may avoid the transfer. 1. Hypo a. Credit card balance paid to zero. Then a transfer was made for no consideration. Then credit card debt was accrued again, equaling 40k at time of the petition.
The only claim before the transfer was the credit card claim, which equaled zero.
c. One analysis is that the only claim before the transfer was not a claim because it equaled zero, so there is no actual creditor that has a right to transfer. So trustee cannot avoid. i. 5th Cir. agreed with this analysis. d. Another analysis is that a credit card agreement is an “obligation” under the revocatory action. For there to be a contract, there must be an obligation that exists under Louisiana law. The credit card company, even with a zero balance, still had an obligation to pay the debtor’s charges under the credit card agreement. iii. The creditor’s rights must exist at the time of the bankruptcy case, and there must be an actual right to avoid. 2. In Re Ozark Restaurant Equipment Co. a. Facts i. The debtor is a corporation with two shareholders. ii. Generally, a corporation has separate existence from its shareholders 1. The exception is veil-piercing, which allows creditors of the corporation to pursue the shareholders
2. In this case, the trustee claims that the creditors’ veil-piercing claims against the shareholders belong to the trustee b. Analysis i. 544(b) addresses right of a creditor to avoid a transfer an interest of the debtor in property ii. The claim against the shareholders is not an interest of the debtor in property; they belong to the creditors. c. Policy i. The basis is giving power to the trustee to avoid damage to a creditor through the debtor transferring property away ii. True, the creditors may have a revocatory action or other state law action against the debtor corporation for transferring money to the shareholders. But this is an action against the debtor.
iii. On the other hand, where the claim is a veil-piercing claim against the
debtor corporation’s shareholders, this is not an attempt to bring the transfer back into the debtor’s estate, but an independent cause of action against shareholders. Therefore a veil-piercing action against a debtor’s shareholders has no 544(b) action available. iv. Held: Trustee cannot assert the veil-piercing action. 1. (b)(1) allows a trustee to undo contracts between the debtor and third parties, but not to sue the third parties directly on behalf of creditors
When 544(b) Often Applies (Is Useful), as Opposed to 548
i. Where a trustee cannot avoid a fraudulent conveyance under Section 548
because of the permitted period of recovery ii. Where a trustee wants to recover under the applicable state bulk sales statute iii. Where there has been an illegal payment of corporate dividends or purchases of stock and the local law allows an unsecured creditor to bring the action iv. In Louisiana, the revocatory action has a three year peremptive period, longer than the 2 years for fraudulent conveyances under 548 3. Limitation: 544(b)(2) a. Background i. Trustees were suing churches to recover “fraudulent transfers”—namely tithes and offerings. They “caused or increased insolvency” of the churchgoer debtors and were for “less than reasonably equivalent value.” b. The trustee cannot avoid charitable transfers to charitable institutions. iv. There is a 10-year reachback period under 544(b) for the IRS. b. Fraudulent Conveyances
i. Section 548 1. Generally a. This is an independent avoidance power held by the estate; do not need an actual creditor b. 2 year reachback period c. Essentially the same as the Uniform Fraudulent Transfer Act d. Two categories:
i. Actual Fraud—involves actual, subjective intent to defraud. The value
of the transfer does not matter. If the transfer is for equivalent value but there is intent to defraud, the transfer is avoidable. This type of fraud is hard to prove.
Example, Ponzi Scheme. The transfers are “for value” because it has the appearance of paying regular returns; but there is intent to defraud.
ii. Constructive Fraud—is all about a standard of value.
Involves lack of “reasonably equivalent value.” Not lack of absolutely equivalent value.
Under Louisiana state law, there is no avoidance power for fraudulent transfers. There is an action for damages due to fraud, but no action to undo the transfer. 548 provides for fraudulent transfers that the transfer can be undone.
Statute, 548(a)(1) The trustee may avoid any transfer of an interest of the debtor in property, or any obligation incurred by the debtor, that was made or incurred on or within 2 years before the date of the filing of the petition, if the debtor voluntarily or involuntarily—
(A) made such transfer or incurred such obligation with actual intent to hinder, delay, or defraud any entity to which the debtor was or became indebted, on or after the date that such transfer was made or such obligation was incurred; OR
b. (B) i. (i) received less than a reasonably equivalent value in exchange for such transfer or obligation; and ii. (ii)
(I) was insolvent on the date of the transfer or incurrence of the obligation, or became insolvent as a result of the transfer or incurrence of the obligation;
2. (II) was engaged in a business or a transaction for which any property remaining with the debtor was an unreasonably small capital; 3. (III) intended to incur, or believed that the debtor would incur, debts that would be beyond the debtor’s ability to pay as such debts matured; OR
4. (IV) made such transfer to or for the benefit of an insider, or incurred such obligation to or for the benefit of an insider, under an employment contract and not in the ordinary course of business.
Avoidance of “transfer” or “obligation a. Avoiding a transfer means undoing the money that was paid. b. Sometimes it’s an obligation that is avoided. i. Example, debtor agrees to do a million dollars worth of services in exchange for the other party doing six dollars worth of services. ii. This obligation could be avoided because the debtor gets less than reasonably equivalent value through incurring this obligation.
4. Transfer that is Payment of Debt a. If the debtor transferred money to pay a creditor, the debtor gets a reduction of debt. Therefore, there is reasonably equivalent value. b. Payment of debt that is (a) unavoidable and (b) for which there is good credit, cannot be avoided under Section 548. c. Payment of debt has a neutral effect on insolvency. Assets decrease by the same amount that liabilities decrease. ii. Reasonably Equivalent Value 1. Analysis: Is what the debtor gave worth what the debtor got? 2. BFP v. Resolution Trust Corp. a. Facts i. There was a real estate foreclosure upon the debtor’s property. ii. The creditor had a seizure and sale, obtained proceeds from the sale and deficiency judgment for remainder of amount of secured debt.
Issue: What does “reasonably equivalent value” means in the context of an involuntary transfer, like a foreclosure?
c. In this case, $100k was paid for a $3mil property d. SCOTUS
i. Circuit split (until this case)
1. Some courts had found that if the creditor obtained less than 70% of the market value of the property foreclosed upon, there was less than reasonably equivalent value obtained and the transfer is avoidable
Initially, the Court notes that reasonably equivalent value is not equal to fair market value.
ii. 4 Elements of Constructive Fraud
1. Debtor had an interest in property 2. A transfer of that interest occurred within two years of the filing of the bankruptcy petition 3. The debtor was insolvent at the time of the transfer or became insolvent as a result thereof
Debtor received “less than a reasonably equivalent value in exchange for such transfer.”
iii. Held: A foreclosure price under state law is necessarily lower; so
whatever is bid at a state law foreclosure is irrebuttably presumed to be reasonably equivalent value. 1. Unless the bid process is polluted by collusion or unlawful conduct, a “reasonably equivalent value” for foreclosed property is the price in fact received at the foreclosure sale. 2. The bid process is created by state law; and the foreclosure value is established by the bid. Even if foreclosure value is less than market value, this does not make it not reasonably equivalent. 3. Basically, the only requirement is that all the requirements of the State’s foreclosure law be complied with. 3. Purchase of House Case a. Debtor purchases house for 260k. b. Trustee asserts that debtor paid too much; did not get reasonably equivalent value, such that the purchase was a fraudulent conveyance. c. Four appraisals of the property were made: 200k, 215k, 234k, and 260k. d. There was owner financing—debtor made a smaller down payment, so the purchase price was a higher price. e. Court i. Only “reasonable equivalence” is required. ii. Here there was an arm’s length transaction. One of the appraisals, 260k, was exactly the purchase price paid. The lowest appraisal was 70% of the purchase price. iii. Held: The purchase was not a fraudulent conveyance under 548 because there was reasonably equivalent value. iv. Held: Court would not grant summary judgment under 544(b), which uses applicable state law—the revocatory action in this case. 1. The revocatory action allows avoidance of the transfer only if insolvency is caused or increased by the transfer.
We know the increase in liability—the 260k paid for the house. But the court could not ascertain the increase in assets received— the fair market value of the house received—because of the differing appraisal values.
3. If at trial, there is proof by a preponderance that the house had a fair market value of 260k, then there would be no increase in insolvency—therefore no revocatory action and no avoidance of the transfer under 544(b). a. On the other hand, if the value of the house was any less than 260k, then the debtor’s insolvency is increased by the transaction—he receives an increase in assets that is less than the increase in liabilities. Thus, the revocatory action would be available under applicable nonbankruptcy law, and the transfer could be avoided under 544(b)(1).
Under Section 548, the transfer is avoidable if there was less than reasonably equivalent value, AND either (i) there was an increase in insolvency or (ii) the transfer left the debtor with unreasonably small capital or (iii) the debtor intended to incur or believed that the debtor would incur debts that would be beyond the debtor’s ability to pay as such debts matured or (iv) made such transfer to or for the benefit of an insider, or incurred such obligation to or for the benefit of an insider, under an employment contract and not in the ordinary course of business.
iii. Unreasonably Small Capital 1. Generally a. If the transfer left the debtor with unreasonably small capital and the transfer was for less than reasonably equivalent value, the transfer is avoidable. b. Corporate Finance 101 i. Capital is the equity component of the corporate structure. It is the “ballast” for the corporation. ii. Equity is the residual interest in the corporation, ranked below secured debt and unsecured debt. iii. Companies declare dividends to shareholder at $x/share. The shareholder then decides whether to buy more stock or take the money. But the dividends are issued out of the profits of the corporation. 1. Companies also declare share dividends, in lieu of cash. 2. But the “cash drain” on the company is not a drain because it’s removed from profits. The equity holder has put money into the company, which floats the company to provide backup value. 3. The smaller the equity value, the more the corporation will have to pay out and the worse off the company will be in times of financial stress. 2. Moody v. Security Pacific Business Credit Inc. a. Leveraged Buyouts (LBOs) i. Often a private company owned by the developers will do an initial public offering (IPO), taking the company “public” by selling the shares in the company to the public.
1. The company gets some of the proceeds from selling shares, but a lot of it goes to the former owners. 2. The IPO raises equity to go into the company. The equity holders who sold at the IPO have a smaller percentage ownership, but in a company that has a lot more capital now. ii. The LBO is a different animal—created by Wall Street. Company shareholders want to sell. An acquirer wants to buy the shares. The acquirer uses someone else’s money—debt—to buy these shares. 1. The acquirer uses loan proceeds to pay shareholders of the target company. 2. The target company gets new management and a lot of debt out of the LBO.
Essentially the acquirer company uses the assets of the target to obtain the target’s stock. The target’s assets serve as collateral for the acquirer’s loans that are used to purchase the target.
iii. Analysis 1. If everything works, fine. But this is highly risky. Whatever equity existed has been exchanged for debt. 2. The former equity is now collateral for the loans. 3. The potentially fraudulent transfer is: a. Less than reasonably equivalent value b. Increase in insolvency i. Probably not met in this case. An LBO does not usually lead to insolvency. ii. Insolvency under 544 and 548 is balance sheet insolvency: liabilities exceed assets. c. Unreasonably small capital i. This might apply. ii. The LBO cases center around whether there is unreasonably small capital. iii. The future of the company requires a good interest rate, making operating profit to generate cash to pay the debt that comes due every month b. Facts
i. Jeanette’s owners (Coca-Cola Bottling) wanted to sell out, and J. Corp.
decided to purchase ii. J. Corp is owned by Brogan. J. Corp obtains loan from Security Pacific, collateralized with Jeanette’s assets.
iii. Jeanette obtains a loan from Security Pacific and transfers the loan proceeds to J. Corp. The loan is secured by all of Jeanette’s assets. iv. J. Corp uses the loan proceeds to buy out Coca-Cola’s interest in Jeanette. v. See page 338 sketch. vi. The debtor (Jeanette) gets new management and a line of credit out of the LBO; and that’s all it obtains out of the deal. c. What is Being Avoided i. Corporation granted lien on its assets to the lender ii. But the bank-lender will argue that the bank gave proceeds to the corporation, thus the corporation got reasonably equivalent value and there was no fraudulent transfer iii. Trustee of debtor (Jeanette) will not pursue J. Corp. because the only thing J. owns is stock in Jeanette. Jeanette will not try to obtain stock in itself. iv. Transactions 1. Incurrence of debt by Jeanette 2. Pays off debt owed by J. Corp to Security Pacific a. But J. Corp. argues that it was only a conduit; the money flowed through J. Corp. to Security Pacific. Therefore, there was no transfer to J. Corp. d. Court i. Insolvency 1. The court does not believe insolvency was increased. ii. Unreasonably small capital
It is difficult to determine whether the LBO or unforeseeable events afterward created the small amount of capital
2. The test for unreasonably small capital is reasonable foreseeability of the LBO failure 3. In this case, it is close, but the transfer did not create the lack of capital iii. Reasonably Equivalent Value 1. There was less than reasonably equivalent value because all that Jeanette obtained was new management and a line of credit. 2. However, neither the Insolvency nor Unreasonably Small Capital prongs were met.
e. Note: Sometimes it’s not immediately apparent that the debtor is insolvent. But as events occur, it may show that the debtor was insolvent at the time of the transaction. f. It is important to identify the transfer sought to be avoided.
g. Remember that 544(b) is the revocatory action (civilian) and the UFTA (like 548). h. 548 is an independent avoidance power. i. The question to ask in all fraudulent transfer cases is “whats the value of the corporate loan to the corporation?”
3. ADD IN CROWN CASE FROM HANDOUT (email) a. iv. Good-Faith Transferee 1. In Re Manhattan Investment Fund Ltd. a. Facts i. Ponzi Scheme—a fraudulent investment scheme in which money contributed by later investors is used to pay artificially high dividends to the original investors, creating an illusion of profitability, thus attracting new investors ii. Issue: If a transferee is in good faith and gave for value, under Section 550, the transferee may either keep what it received to the extent of the value given by the transferee or retain a lien on what it must give back to secure its right to get its value from the transfer. 1. If not a good faith transferee, the transferee has to give all of the avoided transfer back to the trustee iii. The head of the debtor—the Fund—is a guy who has set up a margin account with Bear Stearns. The guy borrows shares from Bear Stearns and sells them, hoping that the price will go down, so he will buy them back and make a profit. 1. Sell at 100 and buy at 60; this is a 40 profit through the short sale. 2. The beauty of the short sale is that it involves using someone else’s money. The Fund is borrowing Bear Stearns’ shares. 3. The margin debt is what accrues from losses on short sales. Loss occurs, for example, if the short sale is for 100 and the price rises to 130. The short seller would have to pay 30 dollars more than what the seller sold for. The seller has no way to make up for this loss—so it sets up a margin account with Bear Stearns. The margin account that the Fund has with Bear Stearns is collateral that the Fund places in an account with Bear Stearns to cover the Fund’s short sale losses on transactions with Bear Stearns’ stock. 4. Bear Stearns has to watch the margin account closely. If the stock prices are rising really high, Bear Stearns will buy back the
stock for the Fund and then cut off the Fund from doing future short sales. iv. The Fund was issuing statements to its investors showing huge profits. But Bear Stearns was monitoring the margin account, and it looked like Fund was losing its money.
v. The transfer sought to be avoided includes the fees Bear Stearns received
and the value of the collateral in the margin account that belonged to the debtor; Bear Stearns obtained this collateral in the margin account. b. Law i. Section 550(a)—the trustee may recover the property transferred, or if the court so orders, the value of such property, from (1) the initial transferee of such transfer… ii. 548(c) to the extent that a transfer is voidable, a transferee that takes for value and in good faith may retain any interest transferred to the extent that such transferee gave value to the debtor in exchange for such transfer or obligation. iii. 546(e) c. Court i. There was actual fraud in this transaction; the debtor had actually fraudulent intent. 1. There was reasonably equivalent value because Bear Stearns was owed money when it received the funds in the margin account.
But this does not matter because the debtor was actually fraudulent.
3. This is a bad result for Bear Stearns as a transferee, because it means that Stearns will have to return the money to the trustee.
ii. Stearns claims that it was just a conduit, but the court doesn’t believe it
because Stearns held the collateral in the margin account and had total control over the account, with the ability to wipe it out at any time. The court finds that Bear Stearns was an “initial transferee” under Section 550. Essentially, Stearns had dominion and control over the money in the margin account, using the funds to cover all open positions the Fund has with Stearns. iii. Stearns next claims that it was a good faith transferee 1. Court holds that Stearns was not a good faith transferee. 2. Court cites to communications within Stearns that indicated that Stearns knew that there was the possibility of fraud. Stearns was put on notice that it needed to look into the Fund’s financial position. 3. Stearns normally would not be on notice of fraud just by seeing the Fund lose on all of its short sales. But the fact that Stearns also knew that the Fund was telling all its investors that the Fund
was highly profitable put Stearns on notice of fraudulent actions by the Fund/debtor.
Held: not a good faith transferee even though the transfer was on account of short sales gone bad and the transfer was 100% equivalent value. Bear Stearns must transfer the money back. Also, the trustee may avoid the incurrence of an obligation, so Bear Stearns had no lien to recover the money back.
c. Voidable Preferences i. Scope of Preference Law 1. Purpose of Voidable Preferences a. If we allowed creditors to keep payments they extracted on the eve of bankruptcy, this would hurt the bankruptcy process. Thus transfers can be avoided to the extent made to the unsecured creditors who are all supposed to share in recovery. b. A transfer to a creditor on account of an antecedent debt will not often be a fraudulent conveyance; thus the avoidance of a preference is an important tool for the trustee. c. Essentially, if we allowed creditors to keep payments that they extracted when they knew bankruptcy was imminent, bankruptcy might do more harm than good. d. Bankruptcy is a method for assuring equality of distribution—essentially enforcing the common pledge.
Section 547(b)’s 5-Part Test. The trustee may avoid any transfer of an interest of the debtor in property-a. To or for the benefit of a creditor
On account of an antecedent debt
c. Made while the debtor was insolvent d. Made within the reachback period
i. On or within 90 days before petition date ii. and 1 year before petition date if the creditor at the time of the transfer
was an insider
That allows the transferee to receive more than the transferee would have received if (1) there had been no transfer and (2) the estate was liquidated in a Ch.7 case.
3. Insider, who has 1 year period applicable: a. E.g. president of debtor corporation who has guaranteed the debt b. Payments by the debtor to the creditor reduce the guarantor’s exposure. Because this reduces the amount that the guarantor would be liable for if debtor does not pay.
Summary of General Rule: A transfer is presumptively preferential if it is made to or for the benefit of a creditor on account of an antecedent debt, during the 90 days [one year
for insider creditor] before the bankruptcy petition, and while the debtor is insolvent, provided that the transfer leaves that creditor better off than it would have been had the transfer not been made and had the debtor’s assets been liquidated. 5. Hypo a. Debtor owes 7 people 3k each. b. Debtor has 7k and debtor decides to give the whole amount to just one creditor. c. One creditor has been paid 100 cents on the dollar, and the other six creditors have received 0 cents on the dollar. 6. Rules
If debtor is insolvent, transfers made will allow creditors to obtain more than they would have if the estate was liquidated in a Ch.7 case. This is because if a debtor is insolvent, he does not have enough money to pay creditors 100 cents on the dollar. Therefore, any transfer made while the debtor in insolvent will allow an unsecured creditor to receive more than the creditor could receive under a pro rata distribution in a Ch. 7 case. Therefore, necessarily, the creditor received an avoidable preference.
b. There is a presumption of insolvency if the transfer was made within 90 days before the petition.
To be voidable, the transfer must have been on account of an antecedent debt: the debt must have existed before the transfer was made. i. If Creditor lends money to Debtor and takes a security interest in Debtor’s assets, there is no antecedent debt
ii. This includes the 547(e)(2) provision of a 30 day grace period—if the
security interest is perfected within 30 days of the transaction between Creditor and Debtor, the date of the transfer will be deemed to be the date of the transaction. Thus even though technically the security interest was perfected after the debt was created, the perfection will be deemed to occur upon the creation of the debt. 7. Defenses to Preferences: 547(c)
These are “safe harbors.” See infra.
8. Hypos a. If the debtor transfers a security interest to an unsecured creditor during the reachback period, this is avoidable because the transfer allows the creditor to receive (1) more than the creditor would have made without the transfer and (2) more than he would have received in liquidation. b. Set of transactions i. Same avoidable transfer as above is made. But then, debtor pays the same creditor and obtains a cancelation of the security interest. ii. It seems like you cannot avoid the transfer of the security interest because it does not exist any more.
iii. However, professor says you break down this transaction. Ask
hypothetically if the payment had not been made, look at the hypothetical security interest that would have existed when the debtor initially transferred the security interest to the creditor. Basically, the initial transfer of security interest allowed the creditor to receive more than he would have received in a liquidation. Therefore, the trustee would have to avoid the initial transfer of security interest; can’t avoid the payment on account of the security interest because at that point, creditor was secured. But trustee can look back to the previous transfer that would have been avoidable if the later payment, which canceled the security interest, would not have been made. c. Note that if the transfer is not perfected, you don’t need avoidance under 547— you can use 544(a). 9. P.A. Bergner & Co. v. Bank One a. Facts i. AMC and Liberty are suppliers to debtor (Bergner). ii. Letter of credit agreement between debtor and Bank One, that Bank would give credit on debtor’s behalf, and bank gets security interest in debtor’s bank accounts. iii. Letter of Credit Defined 1. Letter issued by financial institution; says that if the beneficiary fulfills certain conditions, the bank will send money 2. Bank gets fees from the borrower for issuing letters of credit 3. The borrower always has a guarantee up to the amount of the letter of credit draws. If the bank pays the letter of credit to beneficiaries, the borrower owes the bank that money.
As between beneficiaries (suppliers in this case) and bank, the letter of credit is unconditional. The bank upon receiving a draw must send the money. Not a “line” of credit.
5. The bank issues the letter of credit to beneficiaries, as long as conditions in the letter are fulfilled by beneficiaries. And the borrower has guaranteed the letter of credit—obligated to repay to the bank the amounts of any draws on the letter of credit. a. Not a suretyship; an independent obligation of issuer (bank) to send money. b. The transfer at issue in this case is the transfer from borrower to bank to repay the obligation generated by draws on the letter of credit.
iv. The suppliers are drawing on the letter of credit because the debtor needs
goods. v. Analysis of bank’s transfers 1. The transfer from Bank One is not a transfer of the debtor’s money.
2. Not a transfer to Bank’s creditors. 3. Not a transfer on account of an antecedent debt of debtor, because it is prepayment. vi. Bank sends notice of nonrenewal of letter of credit to beneficiaries/suppliers. So debtor prepays the supplier’s draw on letter of credit by borrowing from Swiss Bank Group, and using these borrowed funds to pay Bank One. vii. Debtor files bankruptcy within 90 days, and so trustee files suit against Bank One for avoidable preference. b. Analysis i. Elements of preference 1. It was a transfer of an interest of the debtor in property for the benefit of Bank One 2. This sounds like earmarking—the funds were borrowed by the debtor from Swiss Bank but flowed through the debtor to pay Bank One. a. However, we don’t have enough facts. Perhaps, the borrowed funds from Swiss would be earmarked to go to Bank One once it came into debtor’s bank account with Bank One. But we don’t know. b. But Prof. says the court should have addressed the earmarking argument. 3. Court: Bank One was allowed to be paid in full without the other creditors receiving payment. 4. We don’t know if Bank One had collateral for the agreement with debtor. ii. Setoff 1. Recognized by Section 553 2. Example, debtor owes Bank One the prepayment obligation. Bank One owes the debtor the amount of money held in the bank. The amount deposited by debtor is owed by the Bank to the debtor. The bank would say that it may setoff funds owed by debtor against its obligations to the debtor; bank is secured to this extent. This is not a preference because this is the same amount the Bank would receive in a liquidation case—the bank would receive the amount of its collateral, which is the amount owed by debtor up to the amount of deposits that the debtor has in the bank. 3. Bank One is a secured creditor to the extent of the right of setoff. 4. Setoff is a right that must be effectuated. Whereas in Louisiana, compensation is the “setoff” of mutually liquidated debts that happens automatically and immediately.
Because Bank had this right of setoff, it was secured, and Professor says that this was not an avoidable preference.
c. Court i. Held: There was an avoidable preference. ii. Elements 1. There was a transfer on account of debtor’s antecedent obligation under the letter of credit agreement to pay Bank One the amount of a draw under the letter of credit 2. The transfer was made while the debtor was insolvent and occurred within 90 days of the filing of the petition 3. Transfer allowed Bank One to be paid in full, even though other unsecured creditors would not have received full payment in a liquidation of the debtor. 10. 547(e)(2)
Text: A transfer is made at the time the transfer takes effect between transferor and transferee, if such transfer is perfected at, or within 30 days after, such time.
b. Rule: The transfer is perfected as of the moment of issuance of transfer if perfected under applicable law within 30 days. i. Example, buy a car and finance it. The lien gets perfected whenever the title is issued, which occurs after the seller sends the papers into DMV to get the title issued. If the seller does within 30 days, the lien is deemed perfected at the time of the transfer. If not done within 30 days, the transfer is deemed to be done at the actual time of the transfer—and thus this will be a transfer on account of antecedent debt, and it will be preferential. ii. Earmarking Doctrine 1. “Earmarking “Defined a. If the debtor can use the money to go to Vegas, it cannot be earmarking i. If there is a balance transfer with credit cards—meaning that debtor has one credit card company pay off his current company, in essentially swapping credit card creditors—the debtor has no say so at all. He cannot use the funds to go to Vegas; therefore, the funds were earmarked, and there is no avoidable preference. b. Example i. Bank has claim against obligor. Bank says that it needs payment, which obligor does not have. President of obligor says that if Bank would lend the President the money, the President would make the payment of obligor’s debt. President in fact does make payment with the funds. Loan proceeds went into obligor’s account, and then into Bank’s account. ii. Analysis
President put money into obligor’s account; the loan funds belonged to the President. Obligor immediately paid the bank on account of an antecedent debt, thus this looks like a preference.
2. Earmarking doctrine says this is not a preference c. Judicial doctrine that says that property that would otherwise be property of the debtor, but over which the debtor has no control, is deemed to not be property of the debtor. i. The funds were earmarked for payment of the note. Funds came from a third party source, and would not have been available except for the earmarking to the Bank. ii. The debtor touches the loan proceeds like a faucet touches water. The debtor is a channel through whom the money passes.
iii. Technically, the property transferred belongs to the debtor. But because
of lack of control by debtor and because no one is injured, the courts will hold that there was no preference.
One creditor has been swapped for another. Bank has claim against President instead of company. And company no longer owes Bank; instead owes the President.
2. Case a. Financing designed to pay off labor liens. The borrower/debtor uses the money to pay off liens. Thereafter, Bank then perfects its security interest. b. Debtor borrowed money only to pay off liens. c. However, the problem is that the perfection was late. Bank claims that it was an exchange of secured debt for secured—thus this was earmarking. i. However, the problem is that Bank’s perfection was preferential. ii. Professor: The late perfection doomed the mortgage as a preferential transfer. Earmarking cannot protect against late perfection of a lien. 3. Professor’s Case a. Loan made to debtor that the debtor subsequently used to pay off unsecured debt. Debtor gave a security interest and used the loan to pay off debt. b. Bankruptcy court said this was earmarking. c. The money was in the debtor’s account for several days, but court focused on the fact that the debtor always intended to use the loan proceeds to pay another bank. i. Trustee argues that debtor could have gone to Vegas because the funds were in an unrestricted account. ii. 5th Circuit agreed with trustee. Held: No earmarking. The debtor had control of the money, and then decided to use the money to pay the creditor. This was, therefore, an avoidable preference. 4. Another Case a. Borrow from lender, giving security interest, and pay an unsecured creditor.
b. The security interest given to the lender is not avoidable; it is a contemporaneous exchange. c. The problem is the payment to the unsecured creditor, with use of the other lender’s funds. d. Earmarking does not protect making an unsecured creditor into a secured creditor. In this case, the payment to the unsecured creditor is avoidable because earmarking does not protect the transfer of a security interest that did not exist prior to the earmarking.
Earmarking requires swapping unsecured for unsecured or secured for secured; there can be no change of the status of the creditor’s property interest.
5. Another Example of Earmarking a. If there is a mortgage on a house, and then you borrow money from a new lender, granting him a mortgage, and use the proceeds to pay off the old mortgage holder, this is an example of earmarking. b. This just involves swapping secured debt for secured debt. iii. Safe Harbors 1. Categories a. 547(c)(1)
i. Debtor makes a transfer to a creditor as part of a substantially
contemporaneous exchange for new value to the debtor. ii. Example, debtor takes out a loan to purchase car and will then give lender a lien on the car to secure the loan. 1. Any time that a security interest is given, it’s on account of an antecedent debt. The interest secures the debt that the debtor incurred with the creditor. 2. This technically is a preference: the debtor giving the lien to the creditor is on account of an antecedent debt. 3. But it is not fair for the trustee to be able to avoid this transfer. 4. The Code says that in this situation, the transfer is substantially contemporaneous. b. 547(c)(2) i. Example, debtor uses electricity and pays at the end of every month. 1. The payment for the electricity is not substantially contemporaneous with the benefit that the debtor obtains. 2. Still, it would not be fair for the trustee of the debtor to sue the utility company and ask for 90 days of worth of money paid for electricity. ii. Example2, debtor pays supplier on account of antecedent debt for goods every month.
iii. If the transfer is made in payment of a debt incurred by the debtor in the
ordinary course of business and the transfer is made in the ordinary course of business, it may not be avoided.
iv. Scope of “ordinary course of business”: 1.
(c)(2)(A) made in the ordinary course of business or financial affairs of the debtor and the transferee [particularized business between the parties]; or
2. (c)(2)(B) made according to ordinary business terms. a. This takes care of the argument that the transferee has only done business with the debtor on one occasion. c. 547(c)(3) i. Enabling loan defense
The loan is given to enable the debtor to acquire property and the debtor actually uses the money to buy the property. Debtor grants the security interest when he borrows the money. The security interest attaches to the asset that the debtor purchases with the loan proceeds. If the security interest is recorded within 30 days after debtor obtains possession of the property, the creditor has an enabling loan defense—this will fit the safe harbor and not be a preference.
2. This federal time period preempts state periods. There is now 30 days for a creditor to record its security interest, and state law periods are preempted. ii. Example, borrow money to buy an asset. Lender enables debtor to buy the asset. iii. The enabling loan allows the creditor to defend against the preference. d. 547(c)(4) i. Subsequent advances of new value [“know your left from your right”— use timeline]. ii. Example, not in ordinary course, but debtor sends payments to creditor. Creditor then sells the debtor more stuff on credit. 1. This subsequent extension of credit is a defense.
iii. If after paying a preference, the debtor receives unsecured credit or
unsecured new value…the exception applies iv. The new value that is given the debtor is usually goods that are shipped. v. Hypo, 90 days before bankruptcy, creditor has $100k of unsecured debt. Then debtor pays 10k on account of debt. Then debtor receives new value of 3k, then a couple days later, new value of 20k. Then debtor makes another 30k payment. Then bankruptcy is filed. 1. 30k is the avoidable amount.
2. Because the 10k initial preference is “written off” by the 3k + 20k new value that occurred later in time. However, the final 30k payment has no new value that to write it off. Therefore, the 30k is an avoidable preference. e. 547(c)(5) i. Floating lien 1. Example, debtor borrows money through a floating lien. The floating lien’s collateral is not static; it changes as inventory, receivables, etc. turns over.
The problem is that the lien can’t attach to the new assets until the debtor comes to own it. Because the lien doesn’t attach until the debtor comes to own the new assets, the potentially avoidable transfer occurs whenever the debtor comes to own the new assets that are subject to the lien.
3. However, this provision is that new assets to which the floating lien attaches—this transfer is not avoidable if… ii. Hypo
90 days prepetition, there is 100k debt and collateral value of 50k. So there is an insufficiency of 50k
2. At the time of bankruptcy, debt of 90k and collateral is 88k. So insufficiency of 2k. 3. Therefore, the avoidable transfer is 48k. The amount of the insufficiency changed by 48k. 4. You compare the insufficiency amount as of 90 days prepetition with the insufficiency amount as of the date of the petition.
The creditor’s security interest in the floating lien is not avoidable, except for the 48k—the difference in insufficiency between (1) 90 days prepetition and (2) date of the petition.
547(6)—(9). We did not cover these.
g. 547f h. 547b5 iv. Avoidance Hypos 1. Hypo 1
Mortgage servicer has big mortgage pool. Servicer sells mortgage service rights to Servicer2.
b. The transfer involves Servicer giving accounts with money in them, contracts, servicing agreement; and the payment from Servicer2 is a note and cash. c. The transfer occurs within 90 days of Servicer2’s bankruptcy. d. The cash was paid 41 days after the contract is signed.
i. It was paid 41 days—so obviously on account of antecedent debt. And no contemporaneous change, nor 30 day (e)(2) exception. ii. So trustee claims that the cash was paid on account of antecedent debt and allowed Servicer as seller to obtain more than he would have in Ch. 7 liquidation—thus that Servicer2 gave a preferential transfer.
iii. The issue is whether this is a transfer of an interest of the debtor in
property. iv. Who owns the cash? 1. The cash from the accounts that were transferred as part of the sale.
Thus the cash belonged to the mortgage owners for whom the servicers were servicing. The payment was made with someone else’s money—thus it was not a transfer of an interest of the debtor in property.
3. This was a 5th Circuit case. 2. Hypo 2 a. Facts i. Daddy sells to Janet via authentic act—but not real—because Daddy’s creditors are coming after him. The unrecorded counterletter says that the sale is an absolute simulation.
ii. Next, within a year of Janet’s bankruptcy, Janet obtains a mortgage loan
upon the property. This was a substantially contemporaneous exchange. (Thus this transfer cannot be avoided.) iii. Third, the counterletter is recorded. iv. Fourth, Janet sells the property back to Daddy. v. Lastly, Janet files bankruptcy. b. Analysis
i. Daddy is an insider of Janet. Thus under Section 547, the transfer may
be avoidable within a one-year period.
ii. Janet never obtained the property because the transfer from Daddy to her
was an absolute nullity. However, third parties could rely on the public records—which showed Janet as owner—until the recordation of the counterletter.
iii. In Louisiana, the transferee can still transfer the property as long as the
counterletter is not recorded.
iv. If there is no counterletter, then Janet can do what she wants with the
property; additionally, the parol evidence rule probably prevents introduction of the counterletter to vary the terms of the authentic act. Thus, the absolute simulation loses some of its sting.
v. The sale of the property back to Daddy is not a transfer of an interest of
the debtor in property, because the counterletter has been recorded, meaning that it is deemed that Janet never owned the property. Thus trustee cannot avoid the sale of the property back to Daddy. Because Janet had no interest in the property. This was the 5th Circuit’s analysis, but it was wrong, says Prof. c. Answer i. Hypothetical Level One – Undo the sale back to Daddy. A counterletter exists, so Janet does not own the property.
ii. Hypothetical Level Two – Undo the counterletter. Janet has the property
and owns it vis-à-vis everyone else (third parties), except Daddy.
iii. Therefore, we go back in time to pre-recording of counterletter—where
Janet is the owner of the property. The recording of the counterletter can be avoided as a transfer of an interest of the debtor in property because the counterletter was recorded within one year. The antecedent debt was the fact that Daddy had a claim to receive the property back, because it was an absolute simulation. But still, as between Janet and the world, she owned the property within a year of the case, and therefore, when the counterletter was recorded, this was an avoidable preference. iv. Note you can only go back as far as one year—the one year applicable to insiders. 3. QSI Holdings a. Facts i. LBO. ii. Assets of corporation are mortgaged to fund the LBO. iii. Corporation files bankruptcy and seeks to avoid transfers to sellers. The money flowed through the bank as agent. Section 556 protects settlement payments and payments made to financial institutions. iv. The avoidance action is against the receiving shareholders. b. Court i. No avoidance is allowed. 1. The bank is not liable. 2. The ultimate selling shareholders who got the money are not liable because the bank acted as agent in connection with a settlement. ii. Thus if you run an LBO through a bank agent that collects money, it is a settlement payment that is not avoidable. 4. Section 550—How to Avoid
The trustee may recover the property transferred from the initial transferee or the entity for whose benefit the transfer was made…
i. The transfer to the bank in an LBO is a transfer to an initial transferee.
…Or recover from a transferee of the initial transferee.
i. However, if initial transferee transfer is avoidable, then this is not
avoidable from subsequent transferees, as long as they gave value, were in good faith, and did not know about the avoidability of the initial transfer.
ii. Note that the only good faith/for value defense is for a subsequent
transferee. The preference always may be avoided from an initial transferee.
550(e)—If property is recovered from good faith transferee, the transferee has a lien on the property recovered to secure the lesser of (i) cost of improvements made after transfer less amount of profit realized from the property and (ii) increase in value of property as result of the improvement.
5. ABI a. Facts i. Avoidance action against initial transferee law firm. ii. Law firm transferred to transferee2. iii. Trustee sued both separately. iv. Trustee settled with law firm; the settlement agreement provided that there is no liability awarded and the defendant denied the avoidability of the transfer. Because it’s a settlement of the lawsuit.
v. Trustee then sues transferee2. Transferee2 defends that to the extent a
transfer is avoided, the transfer can be recovered a subsequent transferee. There has been no avoidance because there was a settlement with initial transferee! b. Court i. The court says that an avoided transfer really just means “if the transfer was avoidable.”
ii. Prof. says this is wrong—the initial transfer must have been avoided in
order to recover from a subsequent transferee.
Where guarantor guaranteed the debt to secured creditor, and creditor paid the secured creditor, the transfer was avoidable as to the guarantor. Because the guarantor was allowed to receive more than he would have in Ch.7—through the debt being paid off, guarantor was off the hook. Also, the guarantor was an insider, so the reachback period was one year.
Also, in this case, the court found that the creditor was the initial transferee! Therefore, notwithstanding that secured creditor’s good faith, the trustee could recover the property from the secured creditor. So the statute tried to fix this: Section 547(i): If the trustee avoids a preferential transfer made between 90 days and one year before the date of filing of the petition, by the debtor to an entity that is not an insider for the benefit of a
creditor that is an insider, such transfer shall be considered to be avoided under this section only with respect to the creditor that is an insider.
Section 551—Any transfer avoided is preserved for the benefit of the estate but only with respect to property of the estate. a. The estate gets the lien position for the avoided lien. b. If it’s a 100k mortgage, the estate gets 100k. c. Therefore, if the lien is avoided, the trustee is obtaining the property transferred, which is the lien, for the benefit of the estate. d. Whereas, with 544(a), if the first-ranked unperfected lien is avoided, the other perfected lienholders move up in rank, and the estate’s lien comes last in ranking. Whereas with 548, 544(b), and 547, if the estate avoids a first-ranked lien, the trustee gets the lien and the status of first ranking.
d. Setoffs i. Generally 1. In Louisiana, it is compensation—if there are mutually liquidated debts, they are netted. a. A owes B $100, and B owes A $50. Therefore, A owes B $50 after setoff; and B owes nothing. b. Essentially, A gets to pay B with what B owes A. c. B has a secured claim for $50.
So in this hypo, A is the debtor in bankruptcy, and B is the creditor. B ultimately owes 50, but A owes 100. The secured claim is the 50 that B owes to A. B may preserve its right to setoff, in the future, the 50 that it owes to A against the 100 that A owes to B.
3. The money that the creditor owes to the debtor—the creditor has a security interest in it, to not have to pay the debtor/estate, but to be able to preserve its right to set this amount off against the amount owed the creditor.
ii. The right of setoff cannot be exercised upon filing of case—there is the stay. iii. Section 553—Preference Version of Setoff
1. Text: If a creditor offsets a mutual debt owing to the debtor against a claim against the debtor on or within 90 days before the date of the petition, then the trustee may recover from such creditor the amount so offset to the extent that any insufficiency on date of setoff is less than the insufficiency on the later of (A) 90 days before petition and (B) first date within 90 days before the petition on which there was an insufficiency. a. “Insufficiency” is the amount by which creditor’s claim exceed debtor’s claim.
In Essence: If a right of setoff is obtained during 90 days within bankruptcy that causes the creditor to be “less underwater,” this creates an avoidable setoff, like an avoidable preference.
2. Braniff Airways v. Exxon a. Facts i. A payment was made within the 90 days
b. 5th Circuit i. There was a right of setoff within the 90 days—therefore, the creditor was fully secured. 1. Therefore, the payment made to the creditor was not avoidable because it did not allow the creditor to receive more than he would have in Ch. 7 ii. However, remand for consideration of whether right of setoff itself was avoidable under Section 553 1. Hypothetical trustee has to pretend the setoff did not exist, and ask whether the right of setoff itself was obtained within 90 days of bankruptcy. iv. Recoupment
Defined—mutual debts offset against each other, where the debts arise from the same transaction. It is the method by which the relationship as to whether or not there are debts is determined.
2. It is not a claim, and it is not stayed. 3. Hypo
Subcontractor has contract to build boat. General contractor says the boat was not built fast enough, so he has a right to liquidated damages. General doesn’t pay Sub. Sub says he has a claim for payment. Even if Sub has to pay liquidated damages, the Sub has a claim for payment. So Sub could plead recoupment.
4. Recoupment is not stayed. It is a matter of determining who owes what and to whom. It arises out of the same contract. IX. Managing the Estate a. Turnover of Property i. Generally
Section 542 requires the turnover of property, to the estate, that the trustee may use, sell, or lease…
2. The trustee can gather property in which the debtor has an interest even if another, such as a secured creditor, also has an interest, and no matter to whom the bankruptcy process will ultimately award the property or its value. b. Adequate Protection i. Generally 1. Once in possession or control of property that comprises property of the estate, the trustee/debtor-in-possession is charged with maintaining the property for the benefit of the creditors. For example, the trustee must protect the interest of others in property.
Think back to Butner—should have asked for the stay to be lifted so Butner could enforce his lien, to not be hurt by the passage of time.
3. The trustee has to pay the secured creditor because the creditor is being harmed by the passage of time. The property is decreasing in value, so the value of the secured claim is decreasing. This may be in part because the trustee is using the property, and there is wear and tear on the asset. 4. Development of amortization plan a. The equipment will go down in value over time, and the amortization accounts for this decline in value of the collateral b. Hypo—debt is 150k. Property is worth 100k. Trustee doesn’t need the property because there’s no equity in the property; it’s not worth what is owed on it. ii. Section 361 Adequate Protection 1. When adequate protection is required, such adequate protection may be provided by: 2. (1) Requiring the trustee to make a cash payment or periodic cash payments to such entity, to the extent that the stay; the use/sale/lease of the property; or grant of a lien would result in a decrease in the value of such entity’s interest in such property; or 3. (2) Providing to such entity an additional or replacement lien to the extent that such stay, use, sale, lease, or grant results in a decrease in the value of such entity’s interest in such property; or 4. (3) Granting such other relief…as will result in realization by such entity of the indubitable equivalent of such entity’s interest in such property.
iii. U.S. Savings Assoc. v. Timbers (still good law)
1. Issues a. The entitlement to foreclose and have the proceeds protected
Claim that the value of collateral must be protected against diminution, so that the security interest has the same value as at the filing of the case
2. SCOTUS a. There is no protection for the right to reinvest the proceeds.
i. There is no allowance of interest if the creditor is undersecured. ii. 506(b)—if you have more collateral than debt (oversecured), interest
payments are available. 1. However, the person won’t be oversecured forever. The property will keep decreasing in value, and the value of the interest is going up due to attorney fees, etc. Thus, eventually, the value of collateral will equal the value of the claim, and the creditor may even become undersecured. 2. The value of the collateral, where it is equal to the value of the claim, is what must be maintained. b. You can’t be damaged by the passage of time, until the value of collateral equals value of claim, or the creditor is undersecured. At the point where the collateral and claim value intersect, this is what triggers the right to protection.
362(d)—The court must grant relief from the stay upon the request of a party in interest (1) for cause, including the lack of adequate protection of an interest in property of such party in interest; or (2) if the debtor has no equity in the property and the property is not necessary to an effective reorganization.
d. What’s protected under 361 is the value of your alleged lien. iv. Rules 1. If the property is undersecured, the creditor can get hurt because as the value of the property goes down, the creditor becomes more undersecured.
A certain amount of damage will happen—the amount of time it takes to get a keeper appointed, the time it takes to get the sheriff’s sale, etc. Timbers recognizes that there is a right to protect the foreclosure interest…you can collect interest of the collateral that will pay it. But under 502(b)(2), a claim for unmatured interest is not allowed. Because a creditor is not entitled to interest if unsecured, and entitled to interest if oversecured creditor, then there is no interest on undersecured debt.
i. There is no interest accrual on undersecured debt. ii. The accrual of interest is not necessary for adequate protection.
Adequate protection is what is needed to prevent the collateral value from declining.
iii. There is accrual of interest if the creditor is oversecured.
2. If the property is oversecured, there is no entitlement to adequate protection.
Under Section 502, the security interest applies to rents from the property if this is permissible under state law (this changes the particular result in Butner—Butner is still good law, but if the case arose today, the rents would have become part of Butner’s security interest). However, this does not apply to the floating lien on non-real estate collateral.
Under Section 552, once the case is filed, the lien stops floating. If the creditor does not take action, the collateral goes away because the lien will not attach to post-petition assets.
b. Therefore, in bankruptcy, even a creditor who is technically oversecured who has a floating lien will argue that he needs adequate protection because as the assets turnover, the value of the collateral is going away. Therefore, under 361, you can get a replacement lien on new work in process, accounts receivable, etc. Get an order of the court to allow the lien to float.
In return, the debtor gets to use the creditor’s cash based on all the collateral the debtor had.
4. The debtor will have to convince the creditor that he will maintain the collateral, so that it won’t depreciate in value too much.
For single asset real estate companies, there is only one piece of property. If it is not worth what is owed on it, there’s no point in the debtor keeping it. So 362(d)(3) carves out a special exception: if a plan is not filed within a certain amount of time, the estate must start paying interest. Not interest as adequate protection, but just a Code requirement to pay interest.
Timbers: If using 362(d)(1), the adequate protection given is keeping the collateral value as of the petition date, maintained until the plan, or the sale. There has to be a reason to pay adequate protection if creditor is undersecured. a. The creditor only asked to foreclose because of adequate protection. It was not entitled to interest on its debt. b. (d)(2) is a different test. It says that if the debtor has no equity in the property and the property is not necessary to an effective reorganization, the creditor may foreclose. i. Creditor bears the burden on proving no equity, and debtor bears the burden of proving that the property is necessary for the reorganization.
ii. The debtor must show that there is a reasonable prospect of a reasonable
plan being confirmed to show that there will be a reorganization.
Adequate protection is available to undersecured creditors only. An undersecured creditor is not entitled to interest (the alleged value of use foreclosure proceeds). Creditor is entitled to maintain the value of collateral through replacement liens, cash payments, etc. Actual depreciation must be shown in order to obtain protection for it. Creditor can foreclose under 362(d)(2) if the creditor can show that there is no equity in the property and the property is not necessary to an effective reorganization.
9. The adequate protection is that which will maintain the value such that value of claim equals value of the collateral.
10. At the time the plan is confirmed, the creditor is entitled to the equivalent of what it had
at the time of filing of the petition. 11. **Exam: What are the banks going to do?
They’re going to want their stuff or say the property is not necessary for an effective reorganization, or say that they need interest payments, or that they need adequate protection, etc. Remember Timbers: if undersecured, no interest. If oversecured, you get accrual of interest. But you don’t get interest payments as adequate protection; because interest is money on top of the debt. It has nothing to do with collateral value.
c. If creditor is owed 100k and property goes down to 90k, what should the creditor get? Protection against diminution in value, which should be dollar for dollar to cover principal amount due. It is what the creditor needs to be compensated for the loss of the 10k. Essentially, if it was worth 100k at filing of the petition, the creditor should get 100k in value at the time of the plan confirmation.
Section 507(b)—superpriority unsecured claim is given to the creditor if the creditor is entitled to adequate protection, and the adequate protection has proved to be not enough. This will not often lead to the creditor getting paid, though: because if the estate does not have enough to pay the creditor the adequate protection, how will it have money to pay any unsecured claims?!
c. Administering Property i. Generally 1. The business must function more or less as usual during the bankruptcy
2. There are rules governing how the trustee deals with business operations involving the debtor’s assets. It is an inherently risk process. 3. §363: Sale, Use, Lease: Trustee can sell, use, or lease property of the estate conditioned on the trustee’s obligation to adequately protect the secured creditor’s interest. The trustee can do this free and clear of an interest in the property, and creditors can’t chase the purchasers post-bankruptcy (because of the discharge).
The trustee can only use post-bankruptcy property to pay pre-bankruptcy debt if he can show that it’s a business judgment and that the trustee needs to do so to be able to reorganize. This is the Kmart case: really, a supplier will usually sell to the debtor for cash without the need to have the trustee pay old debt to him first.
ii. Use of Assets 1. Section 363 governs the sale, lease, or use of property of the estate. 2. Rules:
The trustee cannot sale, lease, or use the property unless adequate protection is provided, or the creditor consents.
b. The assets can be sold free of any liens or claims.
In Re Kmart: Debtor wants permission to repay prepetition claimants—critical vendors. Critical vendors are those whom the debtor has to pay, or else they won’t continue to do business with the debtor. Held: Perhaps a case can be made that under Section 363 payments should be made, but 363 does not give this authority to pay critical vendors. This would impair assets available to other classes of unsecured creditors.
iii. Sale of Assets 1. Governed by Section 363.
In Re Lionel: The fact that the creditor’s committee insisted on the sale was not a sufficient reason for approving the sale outside the ordinary course of business because it was not a sound business reason. a. No sales outside of plan unless very good business reasoning.
3. Generally across the country, Chapter 11 has been turned into giant sales as well. See GM and Chrysler. 4. How do you clean up assets that are burdened with too much debt. a. 363f: says that if…. iv. Abandonment 1. Generally a. Property that is burdensome or worthless to the estate—the trustee wants to rid the estate of it. b. For example, if the estate includes property subject to a lien that exceeds the property’s value, a trustee might abandon it, if it is not needed for reorganization, rather than administer it for the benefit of the lienholder. Once the property is
abandoned, the secured creditor can quickly foreclose under state law and take the proceeds.
Mid-Atlantic: Even though the asset can be abandoned out of the estate, if it will create an imminent and substantial endangerment under environmental laws, the asset may not be abandoned. This doesn’t address what happens next, though.
3. Section 554: After notice and a hearing, the trustee may abandon any property of the estate that is burdensome to the estate or that is of inconsequential value and benefit to the estate. d. Financing the Estate i. Generally 1. The debtor needs financing to continue its business operations during the bankruptcy reorganization process ii. Debtor-in-Possession Financing 1. Section 364 allows the estate to borrow money.
a. b. c.
Trustee has to get a court order granting permission to obtain financing if it’s not in the ordinary course of business. If the property will support it, and no one will get hurt, trustee can get financing on a priming lien basis. Such a lien will be paid as an administrative expense. Saybrook: Prepetition general creditor who gives financing to the debtor during the reorganization may get a lien, but the lien may only secure the postpetition debt, not the prepetition debt. However, there is an exception when using the postpetition collateral to secure the prepetition debt is necessary for adequate protection of the prepetition security interest.