Bankruptcy - Spring 2012 Prof. Taggart Chapter 1: Introduction to Debt Collection and Bankruptcy A.

Difference between State Law Remedies & Bankruptcy 1. State Law (Individual Action) a. A person seeks a judgment to enforce payment of an outstanding debt. b. This results in a race to the courthouse to get the judgment recorded against the defaulting party. This is the opposite of bankruptcy because it entails an individual pursuit of limited assets 2. Bankruptcy Law (Collective Action) a. Automatic Stay → When someone files for bankruptcy, an automatic stay prevents the recording of any further judgments against the debtor. b. Unsecured v. Secured Creditors → bankruptcy system has a method for dealing differently with the claims of secured and unsecured creditors.
B. Collection Outside of Bankruptcy

1. Non-Judicial Collection a. Secured vs. Unsecured Creditors i. Secured Creditors → a creditor that in exchange for lending $$ to debtor has received a (i.e. collateral) to secure repayment. The personal obligation of the debtor to pay the debt is reinforced by a right in rem acquired by the creditor in certain property of the debtor. 1. Debt can become secured by a contractual agreement, statutory lien, or judgment lien. [Contractual agreements secured by a Purchase Money Security Interest (PMSI) loan – where creditor takes security interest in the items purchased (e.g. car, furniture, electronics)] 2. Most commonly, the debt is satisfied by the sale of property to satisfy the debt or by the creditor taking the property and keep it in full settlement of the debt. 3. Secured creditors can sometimes be secured and unsecured. How? If you are a secured creditor and the security interest you have is less than the total amount the debtor owes you, you have both a secured and unsecured claim. A secured creditor is a secured creditor only to the amount of the debt or to the amount of the collateral, whichever is lower. 4. If the creditor holds a lien on property in which the estate has an interest or if the creditor has a right of setoff against the debtor. a. Lien should be RECORDED in the recorder of deeds office. b. Title search at Records office should reveal the lien. c. Lien gives the creditor priority over unsecured creditor w/r/t the amount owed to the creditor up to the amount of the lien. 5. Secured creditors can ―foreclose‖ if debtor defaults by bringing a judicial action to foreclose on the collateral a. Sometimes called ―replevin‖ or ―claim and delivery‖ b. Creditor seeks judgment for amount allegedly due, an order to compel debtor to turn over the collateral to sheriff, and an order to have the collateral sold & turned over. c. Sometimes the debtor will hide the collateral once they are sued by creditor [especially true for a car/something moveable] so creditor needs remedy prior to judgment so that he can secure the collateral 6. UCC § 9-609(a)(1): Secured party may repossess w/out judicial process so long as they proceed without breach of the peace (2 factors): a. Whether creditor entered debtor‘s premises (if so, likelihood of breach goes up substantially); b. Whether debtor, or someone acting on behalf of debtor, either consented or objected i. Consented to entry and repossession = no breach

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ii. Contemporaneous consent required (i.e. not just purported ―consent‖ in original loan documents) – bc policy concern is to avoid immediate violence 1. Deciet or trickery in procuring consent likely negates consent 2. Objected to entry and repossession = breach c. Creditor could be liable for conversion if debtor‘s personal effects are taken d. Situations where breach of peace will likely be found = repossession took place in restricted area (e.g. debtor‘s home, closed garage, behind locked fence, etc). e. Situations where breach will NOT likely be found = repossession is from an open area (e.g. street, driveway, open garage, parking lot) and no objection is raised f. Liability for breach of peace in repossessing: Tort liability, Criminal penalties, Statutory liability under UCC § 9-625, a possible loss of deficiency judgment. 7. Secured Priorities a. General Priority Rule: First person to get a Security interest has priority over anyone else. First to file rule. i. Exceptions: PMSI gets priority. 1. If 3 perfected liens of $500 on a $900 collateral... a. Lien 1 – Recorded 1.1.11 b. Lien 2 – Recorded 2.1.11 c. Lien 3 – Recorded 3.1.11 2. Foreclosure Outcome: a. Lien 1 – Collects full $500 b. Lien 2 – Collects $400, $100 general unsecured claim. c. Lien 3 -- $500 general unsecured claim.

b. Outside Bankruptcy Priority Order:

i. Perfected property interests: judicial liens, mortgage, SIs ii. Administrative expenses (attorney/trustee fees) get paid after the perfected secured creditors. 1. Administrative Expense Priority: 2. Ex: C works as a P/T guard for D. D owes $100 to C at the time of filing. C continues to work after the filing, but that $100 is not an administrative expense. iii. General unsecured creditors iv. Shareholders, equity, debtor. ii. Unsecured Creditors – a creditor that has received no security for his debts (e.g. credit cards) 1. How do unsecured creditors collect on debts? a. File complaint; get judgment in court; Seize and convert assets; Attach assets to judgment [i.e. create a lien valid against debtor] b. Record the lien [in courthouse of county where debtor owns property] c. Perfection – makes lien binding on 3rd parties (ahead of their claims) i. 2 forms of perfection 1. Taking possession of tangible assets 2. Filing in a designated public office of a notice of a secured transaction. Usually a financing statement. This notice is not informative-―notice filing‖ – contains only name of debtor and SC

c. Inside Bankruptcy Priority Order:

i. Perfected property interests: judicial liens, mortgage, security interests. ii. Unperfected security interests iii. General unsecured creditors. iv. Last tier – Shareholders, equity, debtor.

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and indicates collateral. The burden is on the 3rd party to determine the nature of the transaction. (intangibles). ii. 2 effects of perfection: 1. W/R/T Real Property: It gives the unsecured an automatic lien on all property the debtor owns in that jurisdiction. 2. W/R/T Personal Property: The clerk must issue a writ that must be levied by the sheriff. [The money then waterfalls: Administrative costs (Court/Sheriff)  Creditor  Any money left over goes back to the debtor.] b. Tort Law i. Potential causes of action for outrageous collection practices: invasion of privacy, intentional infliction of emotional distress, defamation, assault, battery, interference with contractual relations, malicious prosecution of criminal or civil proceedings, conversion, fraud ii. To recover in tort, debtor must show creditor‘s conduct is ―extreme‖ or ―outrageous‖ iii. Problem with tort law: creditor has legitimate interest and are thus given a lot of leeway (hard to prevail for plaintiff debtor) c. Fair Debt Collection Practices Act – FDCPA i. Scope of coverage - Applies to ―debt collector‖ attempting to collect a ―debt‖ 1. ―Debt collector‖ = those in debt collection business a. In any business, the principle purpose of which is collection of any debts b. Or one who regularly attempts to collect, directly or indirectly, debts owed/due to another c. Does not apply to creditor who is attempting to collect its own debt 2. ―Debt‖ a. Debtor must be a consumer (natural person) b. Debt must be a consumer debt (i.e. for personal/family/household purposes) c. Does not apply to corporate/partnership/business debts ii. Violations of FDCPA 1. Communication w/ third parties and to acquire ―location information‖ a. Can‘t call consumer‘s place of work if employer prohibits communication b. Can‘t communicate about debt w/ third person without debtor‘s prior consent 2. Harassment, oppression, or abuse in connection with collection of debt 3. Prohibits use of false, deceptive, or misleading representations or means a. Can‘t contact at inconvenient time (before 8am, after 9pm – presumption) 4. Use of unfair or unconscionable means to collect debt 5. Requires debt collector to give consumer detailed information regarding debt a. Must send written ―validation notice‖ within 5 days of initial communication b. Give debtor 30 days to dispute and obtain verification 6. Debtor has ability to terminate any further communication if notifies debt collector in writing that he refuses to pay or that he wishes to stop communication iii. ―Bona Fide Error‖ Defense 1. Debt collector protected from liability if: a. Violation was not intentional, and b. Happened because of a ―bona fide error‖ notwithstanding maintenance of procedures reasonably adapted to prevent such an error iv. Remedies under FDCPA 1. Civil liability: actual + statutory damages + costs/attorneys fees 2. Administrative enforcement by FTC: injunctive relief or cease & desist 2. Judicial Collection – creditor invokes power of state to collect a. Postjudment remedies: Enforcement of Money Judgments i. Introduction 1. Priority dispute – arises when 2 or more non-debtors assert a claim against debtor‘s scarce assets [―first in time, first in right‖ -- first to obtain enforceable claim (lien) usually prevails in priority dispute]

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enforceable claim against debtor‘s assets Creditor‘s rights fixed at time when it gets a lien against debtor‘s property Judicial lien – lien obtained through judicial process Execution lien – obtained through execution of debtor‘s nonexempt property Consensual lien – lien obtained by agreement of creditor and debtor (usually at beginning of credit relationship) i. Security interest – lien on personal property ii. Mortgage/deed of trust – lien on real property iii. Secured creditor can enforce consensual lien by foreclosure – sometimes without judicial process iv. If ―perfected‖ under state law (by recordation, public notice, or possession of collateral) 1. Normally enforced against debtor and third parties 2. Honored in bankruptcy 3. Unsecured creditors‘ rights: a. Have court determine debtor owes creditor money, by entry of judgment b. Invoke power of state to seize nonexempt property to satisfy judgment 4. Characteristics of a money judgment a. Executable – judgment gives creditor right to use legal process to seize debtor‘s property and sell it in order to satisfy the judgment b. Lienable – judgment creditor may use judicial process to obtain lien on property of debtor to secure payment of judgment debt (i.e. previously unsecured creditor can become a secured creditor) c. Actionable – creditor may bring a civil action asserting the judgment itself as a basis for lawsuit [may be important if the creditor seeking to enforce its judgment is in other state – creditor must then bring new action in second state, and new action will be based on the judgment entered in the first state, rather than on the original underlying debt] ii. Execution 1. If debtor does not pay judgment voluntarily, creditor must resort to execution to enforce it. Execution is the common way for creditor to enforce money judgment 2. Procedure: Creditor has the state, acting through the sheriff, seize and sell the debtor‘s property, with the proceeds applied to pay off the judgment debt. 3. Execution is regulated by statute, and courts generally insist upon strict compliance w/ statutory requirements; will invalidate a deficient execution.

2. Lien = a. b. c. d.

a. Step 1: Final money judgment

b. Step 2: Issuance of writ of execution by clerk

i. Most states – final once clerk of court formally enters rendered judgment on docket ii. Appeal does not stop unless debtor obtains stay of execution by posting a ―supersedeas‖ bond

c. Step 3: Writ is Delivered to Sheriff

i. A time limit for issuing a writ → a creditor may not obtain writ if judgment is ―dormant‖ bc time limit has passed. 1. Today: statutory limitations period, 5-10 yrs ii. ―Revival‖ – creditor may revive judgment if dormant within limitations, and then seek execution iii. ―Renewal‖ – creditor may extend limitations period i. Minority of states (IL): delivery is precise moment at which execution lien arises 1. Inchoate (contingent) execution lien 2. Levy still necessary to perfect the lien 3. Priority rights from the date of delivery

d. Step 4: Levy and Return

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e. Step 5: Sale

i. Once sheriff has the writ of execution in his hand, he then has the power & responsibility to levy debtor‘s property ii. Levy = seizure of debtor‘s property by sheriff 1. Sheriff must assert dominion and control over property a. Physically possess, quarantine/put notice on it if too cumbersome to take. b. Note that other intangibles and personal property in the possession of a third party cannot be reached by a writ of execution but must be garnished 2. Can only levy within life of writ: 60-180 days a. If no legal authority to levy: sheriff liable to debtor for conversion 3. Cannot seize exempt property iii. After levy, seized property is ―in custodia legis‖ and sheriff files a return reporting on action taken and describing the property levied upon iv. If judgment remains unsatisfied bc sheriff found no property, sheriff submits a ―nulla bona return,‖ creditor can obtain another writ 1. Effect of ―nulla bona‖ return – sheriff loses legal authority to levy 2. Creditor should conduct postjudgment discovery to increase chances of success i. Notorious for bringing low prices! ii. States try to rectify problems of low execution sale prices 1. Appraisal statutes a. Upset price – sale disallowed if sell for less than minimum price b. Minimum credit – appraised amount must be credited against judgment, even if sold for less 2. Actions by debtor to set sale aside a. Sale procedures weren‘t followed, or b. Price inadequacy so extreme as to shock the conscience 3. Redemption rights a. Statutory right to purpose property sold at execution within specified time period, usually at purchase price b. Judgment debtor has principal right to redeem c. Dependents & junior lien creditors have secondary redemption rights

i. Costs and expenses of sale paid ii. Judgment creditor paid, up to amount of judgment iii. Liens senior to judgment creditor‘s execution lien are not adversely affected by sale, but follow property into hands of execution purchaser (minority – pay senior lienors first) iv. Balance paid to debtor 4. Priority v. third parties a. Identify exact point in time from which to measure each party‘s rights i. Execution lien 1. Majority: date of levy 2. Minority: date of delivery of the writ a. If third party acquires before levied upon, acquires property subject to inchoate execution lien ii. Priority of security interest in personal property (UCC Art. 9)

f.

Step 6: Distribution

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1. Rights v. third parties date from time of ―perfection‖ 2. Perfection occurs when secured party either: a. Files public notice (financing statement), or b. Takes possession of the collateral b. Judicial lien (i.e. execution lien) v. secured party i. Winner is first to ―perfect‖ or ―levy‖ ii. Thus, a judicial lien defeats an unperfected security interest, but a previously perfected security interest will take priority over a iii. Purchase money security interest (PMSI) exception 1. Where seller of goods on credit retains security interest in goods, or lender loans debtor money to enable him to buy collateral and gets security interest in the collateral to secure the loan 2. Secured party gets 20-day grace period to perfect & perfection relates back c. ―Nemo dat‖ – property principle: you cannot give what you do not have i. What right did debtor have in property ii. Default rule = race – first in time wins iii. Exception to default rule 1. Bona fide purchaser – good faith + value 2. PMSI lender iii. Judgment lien

subsequent judicial lien

1. Definition

2. Advantages (over execution lien)

a. An encumbrance on some part of the judgment debtor‘s property b. Creditor holding a judgment lien has the right to sell the property to satisfy the judgment a. May attach at an earlier point in time (because execution lien requires levy by sheriff) b. Automatically attaches to debtor‘s after-acquired property, while execution lien does not a. For property in county where judgment is rendered i. Majority: when judgment is docketed by clerk ii. Minority: when judgment is rendered by court iii. Trend: postpone creation of judgment lien until judgment creditor files a notice recording the judgment in the county‘s real estate records b. For property located in a different county i. Judgment lien arises after judgment creditor files notice in real estate records c. For property located in another state i. If state has not adopted UEFJA, creditor required to file a new lawsuit to obtain a judgment in the second state ii. Then, creditor can obtain a judgment lien by recording in the county where the property is located a. b. c. d. Normally only real property Personal property in a few states Exempt property is not subject to judgment lien Judgment lien reaches after-acquired property that debtor acquires during life of the judgment lien (statutory life 5-10 years)

3. Creation of Judgment Lien

4. Property subject to judgment lien

5. Priority v. third parties

a. Judgment lien‘s priority dates from the moment the lien is created i. Majority: docketing for in-county, or recordation for out-of-county

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6. Enforcement of judicial lien

ii. Minority: must file in real estate records for in-county property as well b. First in time wins i. Exception: purchase money mortgagee c. Judgment lien v. competing judgment lien i. Majority rule: two judgments liens are of equal rank 1. Both creditors acquired judgment lien at the instant debtor acquired the property ii. Minority rule: first creditor to take action to create lien has priority as to after-acquired property a. Use execution process b. Some states – direct foreclosure action

a. Does not terminate upon transfer to third party b. Lien enforceable as secured claim in bankruptcy c. Termination if: i. Underlying judgment is satisfied, ii. Judgment creditor formally releases the lien, or iii. Statutory limitation period on the life of the judgment lien expires iv. Garnishment

7. Eradication of judgment lien

1. Defined

2. Garnishment Procedure

a. Enables judgment creditor to capture property of the judgment debtor in the hands of a third party b. Garnishor-creditor steps into the debtor‘s shoes vis-à-vis the garnishee c. Typically used to (1) seize debtor‘s bank account, and (2) reach debtor‘s future wages a. File affidavit alleging garnishee owes a debt or holds property of debtor, and debtor owes a debt or liable on a judgment to creditor b. Court issues a writ of garnishment c. Writ delivered to sheriff and served on garnishee i. Garnishment lien created upon service of the writ ii. Lien captures all of debtor‘s property held by garnishee at the time of service d. Garnishee‘s answer i. Admit or deny liability ii. Defenses 1. Does not owe a debt to or hold property of debtor 2. Garnishee has its own defenses, or a right of setoff against the debtor 3. Any debt it owes to the debtor is exempt as to the debtor e. Trial is held if garnishor denies liability a. If garnishee‘s debt is reduced or property returned to debtor prior to service of the writ, nothing is captured by garnishor b. Some states allow garnishment to reach post-service debts, others do not i. After-acquired reach is not unlimited – terminates either at time of answer by garnishee or time of trial c. Subsequent debt restriction – unearned wages not subject to garnishment under normal garnishment rules i. But most states have special wage garnishment statutes permitting creditors to reach future wages through service of a single writ a. Federal ceiling on the amount of wages that can be garnished b. Limitation is the lesser of:

3. Garnishment Timing

4. Garnishment Limitations

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a. With regard to garnishor: i. Must hold any nonexempt property of or debt owing to debtor that is subject to garnishment lien – can be liable if fail to do so b. With regard to judgment debtor: 1. Garnishee‘s liability to judgment debtor is reduced in a corresponding amount of required to pay debt to creditor 2. Exception: if garnishee fails to comply with a statutory duty to either: (a) Give notice to debtor of the pendency of the action, or (b) Assert known exemptions of debtor b. Prejudgment remedies i. Introduction

5. Garnishee‘s duties and rights

i. 25% of disposable earnings, or ii. The amount by which debtor‘s disposable earnings exceed 30x the federal minimum hourly wage

1. Advantages of prejudgment remedy

2. Due process concerns

a. Secure possible judgment creditor might obtain by preventing debtor from disposing of property while case in progress b. Claim spot in line versus other creditors and purchasers c. If do not allow – judgment might be worthless b/c debtor would transfer or hide assets during trial d. Provisional remedy – only have ultimate effect if creditor prevails in lawsuit

ii. Types 1. 2. 3.

4. Procedure in Attachment & Garnishment

a. Ex parte proceedings, so debtor deprived of prop w/out chance to be heard b. Enormous coercive leverage for creditor to get debtor to pay disputed debt c. Supreme Court opinions create procedural safeguards i. Court involvement ii. Creditor must plead specific facts iii. Creditor must post bond – if found to be wrongful attachment or creditor loses on merits, debtor compensated for damages from bond of prejudgment remedies Attachment – seized property retained as security for a judgment that the creditorplaintiff may later win Garnishment – debtor‘s property seized from a third party (garnishee) Replevin – creditor alleges a property right superior to debtor in the property seized (Ex: secured party seeking to foreclose a security interest in collateral) a. Invoked unilaterally by creditor; awarded on ex parte basis (without notice)

b. Step 1: Creditor files affidavit requesting writ of attachment or garnishment

c. Step 2: Writ issued by Court

i. Filed in conjunction with pending lawsuit seeking money damages ii. Creditor must post bond iii. Affidavit must recite facts showing probable existence of a statutory ground for relief (ex – risk debtor will dispose of property) i. Court must hold earning before issuing the writ ii. Creditor must prove: 1. Likely to prevail on the merits of the case, and 2. That one of the statutory grounds exist to support attachment/garnishment

d. Step 3: Writ delivered to sheriff e. Step 4: Sheriff must levy on enough of debtor‘s property to ensure that any judgment creditor later obtains will be satisfied

i. Sheriff‘s levy creates an inchoate lien of attachment or garnishment on the property seized

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i. Debtor can post bond, which replaces seized property as security ii. Debtor can try to recover attached/garnished property by ―quashing‖ or ―vacating‖ the attachment/garnishment 1. Court will quash if debtor proves: a. Creditor is not likely to prevail on the merits, or b. Attachment/garnishment is defective 2. If debtor quashes, property is returned and may recover damages from creditor for wrongful attachment/garnishment g. Practical concerns i. Risk of wrongful attachment liability ii. If debtor files for bankruptcy within 90 days of attachment/garnishment, it will be set aside as a ―preference‖ and the creditor will become a general unsecured creditor 5. Issuance of an injunction a. Creditor may obtain an injunction, directing debtor not to dispose of its assets, or imposing restrictions on debtor‘s use of assets until suit concluded b. Brings creditor benefits associated w/ prejudgment remedies, but fewer risks c. Grupo Mexicano – district court has no authority to issue preliminary injunction freezing assets C. Introduction to Bankruptcy 1. Nature & Purposes of Bankruptcy Relief a. Goals and Policies of Bankruptcy i. Remedial nature of bankruptcy ii. Protection of Debtor and Creditor interests iii. Collective & Evenhanded Treatment of Creditors iv. Preservation of the Estate (this particularly benefits creditors) v. Debtor‘s ―Fresh Start‖ (see also p. 64 of casebook) vi. Minimal interference with Non-Bankruptcy rights vii. Efficient Administration viii. The Preference for Reorganization and Debt Adjustment ix. Broader concerns about keeping economy healthy, as well as idea that bankruptcy goals/priorities must always be measured against and reconciled w/ other public policies (e.g. debtor‘s environmental responsibility, debtor‘s familial support obligations, protection of contractual relationships, etc) b. Collective Proceeding i. State Law Collective Action Problem a. State law collection remedies, central premise = first in time is first in right b. When debtor is insolvent and has multiple creditors, state collection law fails to serve interests of creditor body as a whole

f.

Step 5: Debtor may be able to recover his property

ii. If creditor prevails on suit, its priority right to seized property relates to the date from the time the lien was first created by levy iii. Intervening third party takes subject to the prior attachment or garnishment lien, contingent on the ultimate entry of judgment

c. Two Downfalls with State Collection Law:

1. Unfair as a matter of distributive justice for similarly situated creditors to receive different amounts [a] which is exactly what would happen under the ―grab law‖ scheme of first in time, first in right when the debtor doesn‘t have sufficient assets to cover all debts. 2. State collection law is economically inefficient [a] Every creditor spends money trying to collect, or is certain to get nothing at all. [b] More efficient for creditors to agree to cooperate & share admin costs rather than each having own admin costs of collection.

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[c] Debtor (esp. an entity) may be worth more ―alive‖ than ―dead‖ [d] Creditors cannot just agree outside of court to cooperate bc one creditor can always defect and get it all! ii. Solution = Compulsory collective action a. None of the creditors can defect b. Creditors act as a single unit, share admin costs c. Trustee acts as agent for creditor group (maximize value, save costs, fairer distribution) d. Automatic stay (§ 362) prevents creditor or debtor from ―opting out‖ e. Bound to distribution (whether agree or not), either by statute, or in plan 2. Overview of Bankruptcy Proceedings a. Straight Liquidation (Chapter 7) i. Debtor‘s existing assets are collected, liquidated, and proceeds from the sale of assets are distributed to creditors on pro rata basis a. Debtor‘s exempt property is returned to debtor b. Trustee supervises the entire process ii. While process is pending, creditors are enjoined, or ―stayed‖ from attempting individually to collect their claims from the estate or debtor iii. Creditors are treated equally, on a pro rata basis a. Exception for secured creditors & unsecured creditors who are awarded priority in payment by Congress iv. Following distribution, individual debtor gets a discharge of debts a. No corporate discharge – corporation dissolves after bankruptcy b. Best for an individual debtor who has few current assets, but substantial earning capacity b. Reorganization (Chapter 11 or 13) i. Chapter 11 – business reorganization a. Purpose to restructure a business‘s finances so it may continue to operate b. Premise = assets used for production are more valuable than being sold for scrap c. Provides for compulsion by stay provision, and a rule binding dissenters to the terms of the reorganization plan agreed to by the bulk of the creditors ii. Chapter 13 – individual reorganization a. Designed for rehabilitation of individual consumer debtor – creditors cannot compel debtor to proceed under chapter 13 b. Debtor can keep his property by agreeing to a repayment plan c. An individual debtor who has few current assets but some future earning capacity would prefer a chapter 7 liquidation Chapter 2: Invoking Bankruptcy Relief A. Overview 1. Who may be a Debtor? a. 11 USC § 109 – specifies which debtors are eligible under each chapter i. § 109(a): [except as stated in § 109(b)-(e)], ―only a person that resides or has a domicile, place of business, or property in the US, or a municipality, may be a debtor.‖ b. § 101 – Definitions of above terms i. § 101(15): ―entity‖ defined ii. § 101(9): ―corporation‖ defined iii. § 101(41): ―person‖ defined 2. Who is a creditor? - Defined in § 101 3. How may a bankruptcy case commence? a. Two ways to commence a bankruptcy case – voluntary or involuntary b. Voluntary [99% of filings] i. By debtor - § 301 ii. By debtor & spouse - § 302 c. Involuntary i. Commenced by creditors of the debtor - § 303

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ii. Only permitted under Chapter 7 (liquidation) and Chapter 11 (reorganization) 4. Trustees in a Bankruptcy case a. Trustee i. Required in all cases except Chapter 11. In Ch. 11 case, may be debtor who handles estate. ii. Impartial administrator [usually an attorney, elected by creditors] whose role is to manage the affairs of the debtor, to enforce the rights of the estate, and to participate in litigation involving the estate‘s interests. iii. Fiduciary duty to maximize value of the estate for the benefit of all creditors iv. Entitled to some % of assets distributed v. Must conduct § 341 meeting→ trustee must examine debtor to ensure that debtor understands: (i) potential consequences of seeking a discharge in bankruptcy (e.g. credit history) (ii) debtor's ability to file a petition under a different chapter of this title (iii) effect of receiving a discharge of debts under this title (iv) effect of reaffirming a debt, including debtor's knowledge of provisions of § 542(d) b. The U.S. Trustee i. Appointed by the U.S. Attorney General/ different U.S. Trustee Regions. ii. Administrative responsibilities. iii. Right to appear on any bankruptcy case in any matter. B. Commencement of a Voluntary Bankruptcy Case (§§ 301, 302) 1. Debtor eligibility requirements - § 109(a) a. To be eligible as a debtor under ANY Chapter of the Bankruptcy Code, debtor must satisfy requirements of § 109(a), which provides that ―DEBTORS‖: i. Must be a ―Person‖ 1. Person is defined in § 101(41): includes human beings, partnerships, corporations (defined in § 101(9) 2. ―Person‖ does NOT include governmental units OR estates & trusts ii. Must have ―Connection to the U.S.‖ (residence, domicile, place of business, or property in the US) b. Insolvency of debtor not generally required i. Exception: under Chapter 9, insolvency of municipal debtor IS required 2. Chapter-specific eligibility requirements under § 109: a. Chapter 7 – § 109(b) i. Person – includes individuals, partnership, corporations b. Chapter 11 – § 109(c) i. Mostly tracks chapter 7 rules ii. Exception: railroads only eligible under chapter 11 c. Chapter 13 – § 109(e) i. Individual ii. Regular income (to find monthly payment plan) iii. Debt limit (meant for small debtors – if don‘t meet, must go under chapter 11) 1. $336,000 unsecured, $1,000,000 secured d. Chapter 12 – § 109(f) i. Individual ii. Family farmer/fisherman iii. $3.5M debt ceiling iv. Enough of a ―farmer‖ – 50% of debts attributable to farming e. Chapter 9 – § 109(c) i. Municipality ii. Must be specifically authorized to file iii. Must be insolvent iv. Pre-bankruptcy negotiation with creditors f. Misc. additional rules for specific types of entities: i. Partnerships - Eligible under 7 or 11 (―person‖); can‘t file under 13, but each individual partner could file under 13. ii. Railroads – only eligible under chapter 11

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iii. Municipalities – only eligible under chapter 9 iv. Insurance companies – not eligible 1. HMO = hybrid between insurance company & medical provider 2. Taggart says defer to state law classification: HMO likely classified under state law as an insurance co. and thus prevented from filing Problem 2.1 (p. 75)
Bill Gates GM Law Firm Yankees Blue Jays Greg Norman Justice Berger Reading RR Ins. Company Ind. on SSI Ind. Farmer $1.1m/900k Guillaum Type Ind. Corp Partnership Corp Non-US Corp Non-US Ind Estate Corp. Corp. Ind. Family Farmer Foreign Ch. 7 Y Y Y Y Y Y N N N Y Y N Ch. 13 Y N N N CONTACTS CONTACTS N N Maybe Y; SS = Reg Inc. N Debt HIGH N Ch. 11 Y Y Y Y Y Y Y Y; SubSec IV N Y Y N Ch. 9 N N N N N N N N N N N N Ch. 12 N N N N N N N N N N Y N Ch. 15 N N N N N N N N N N N Y

3. Exclusionary rules [i.e. who cannot be debtor under § 109(a)] a. Abusive serial filers – § 109(g) i. May not be a debtor if they have been a debtor in a case pending at any time in the preceding 180 days if-- (1) case was dismissed for willful failure of debtor to abide by court orders or to appear before court; or (2) debtor requested & obtained voluntary dismissal of the previous case following the filing of a request for relief from automatic stay provided by § 362‖ b. Failure to complete pre-bankruptcy credit counseling – § 109(h)

i.

BAPCPA added individual pre-bankruptcy counseling requirement

ii. Who is an ―approved‖ counseling agency?

1. Individual must have received briefing from approved nonprofit budget & credit counseling agency during 180-day period after bankruptcy filing 1. If a fee for the counseling services is charged, the fee must be reasonable and the agency must provide services without regard to ability to pay the fee (§ 111(c)(2)(C)) 2. Counseling may be via phone or internet (§ 109(h)(1)). 3. Individual counseling not mandated; group counseling is okay (§ 109(h)(1)).

1. Debtor can demonstrate ―exigent circumstances that merit a waiver‖; 2. Debtor cannot complete reqs. Bc of incapacity or disability; 3. Debtor is on active military duty in a combat zone; OR 4. Trustee determines counseling services are not reasonably available in debtor‘s district. c. ―Debtor Education‖ Provision i. Requires completion of an instructional course in personal financial management during the bankruptcy case ii. Failure to do so results in denial of discharge (§ 727(a)(11)). 4. Venue (28 USC § 1408) – see p. 76 for statute language! a. Bankruptcy cases are filed and processed in FEDERAL DISTRICT COURTS b. § 1408: A bankruptcy case may be commenced in the DISTRICT: i. That is the domicile, residence, PPB of person, or where principal assets of the person/entity . . . have been located for the 180 days (6 months) immediately preceding commencement; OR ii. Where there is a pending a case under Title 11 concerning the person's affiliate, general partner, or partnership.

iii. Waiver of pre-bankruptcy counseling requirement allowed IF:

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c. Exceptions: 1. Consumer debts of less than $16,425 2. Insiders sued for business debts of less than $1100 3. Non-insiders sued for business debts of less than $10,950 5. Mechanics of filing under § 301, 302 a. Debtor files a petition with bankruptcy Clerk (Fed. R. Bankr. P. 1002) i. Clerk means the bankruptcy clerk for the district (Rule 9001(3)). ii. Bankruptcy courts are ALWAYS open, so filing any time day or night is okay (Rule 5001(a)). b. Petition must be verified or contain an unsworn declaration (Rule 1008). i. Sign & declare under penalty of perjury that information is true & correct ii. Corporation or partnership – authorized agent must sign petition iii. Partnership – petition requires consent of all general partners (Rule 1004) 1. If any general partner does not consent, case must be commenced as an involuntary petition by consenting partners and the dissenters are permitted to contest the filing (§ 303(b)(3). c. Mandatory Filing Fee - Court MAY waive filing fee for individual debtor whose income is less than 150% of the income of the official poverty line – this is discretionary; US v. Kras (1973) → SCOTUS upheld mandatory filing fee scheme; due process does NOT require providing indigent debtors w/ access to a discharge in bankruptcy through bankruptcy court. d. Debtor must have attended mandatory credit counseling – § 109(h) i. Increases the real cost of filing! ii. Pre-bankruptcy credit counseling required regardless of debtor‘s income iii. Only way to avoid is if debtor obtains ―exigent circumstance‖ waiver under § 109(h)(3) e. File lists, schedules, statements – filed w/ petition or w/in 15 days of petition i. Documents required of ALL debtors: 1. List of creditors 2. Schedule of assets and liabilities 3. Schedule of executory contracts and unexpired leases 4. Statement of debtor‘s financial affairs 5. Ch. 9, 11 – name, address & claim amounts of creditors with 20 largest unsecured claims 6. Ch. 11 – list of equity security holders ii. Additional document filing requirements for individual debtors [See p. 79 for list] 1. § 521(i): failure to provide any info required by § 521(a) w/in 45 days of petition results in automatic dismissal of petition UNLESS debtor: (1) obtains extension from court; OR (2) trustee asks court to excuse debtor bc debtor in good faith attempted to comply AND the best interests of the estate would be served by administration of the case. 2. § 521(e)(2): failure to provide most recent tax return to trustee or any creditor who requests a copy will results in dismissal unless debtor demonstrates that failure to comply was due to circumstances beyond debtor‘s control. 6. Effects of Filing a. Filing of petition & fee with the clerk constitutes an Order for Relief - § 301 i. Entry of the legal order commencing the proceedings occurs automatically when clerk takes filing fee (important for automatic stay) ii. No need for judge to enter order adjudicating the debtor a bankrupt, but legal effect is if judge did exactly that b. Bankruptcy estate created by filing of petition - § 541(a) i. Estate is comprised of all of debtor‘s legal & equitable interests in property as of the time petition filed (more on estate property below- Ch.3) ii. All of debtor‘s property transferred to the estate iii. Trustee acts as representative of the estate (a separate legal entity) iv. Estate property within exclusive jurisdiction of bankruptcy court c. ―Automatic Stay‖ effectuated - § 362(a) i. Has effect of a federal statutory injunction ii. Stops collection efforts & safeguards estate property iii. Good against the world & valid without any notice required

iii. Failure to timely file required documents could lead to dismissal of case

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iv. Actions taken in violation of the stay are VOID d. Debtor protected from termination of utility services - § 366 i. Utility company may not terminate services based on debtor‘s failure to pay a prepetition debt (§ 366(a)), unless debtor fails to provide adequate ―assurance of future payment‖ w/in 20 days (§ 366(b)). 1. 6 types of acceptable ―assurances of payment‖ [§ 366(c)]: ―(i) cash deposit; (ii) letter of credit; (iii) a certificate of deposit; (iv) surety bond; (v) prepayment of utility consumption; or (vi) another form of security mutually agreed on between utility and debtor or trustee.‖ 2. Administrative expense priority for future payment amounts does NOT constitute adequate assurance. e. Bankruptcy filing may extend certain time periods - § 108 i. § 108(a) – statute of limitations for actions that could have been brought by debtor are tolled; trustee given 2 years to bring action on behalf of estate ii. § 108(b) – trustee gets 60-day grace period in which to take an action other than filing a lawsuit (e.g. to respond to a demand to cure a default) iii. § 108(c) – extends any statute of limitations for creditors to sue the debtor until 30 days after the automatic stay is terminated. C. Conversion and Dismissal 1. Once commenced, a bankruptcy case may be converted or dismissed a. Questions to answer: i. WHO may move to dismiss or convert? ii. Does debtor ever have an ABSOLUTE RIGHT to dismiss or convert? iii. What are the GROUNDS for dismissal or conversion? iv. May court CHOOSE between conversion & dismissal? If so, on what basis? v. What are the LEGAL EFFECTS of conversion or dismissal? b. Each chapter has its own set of conversion & dismissal rules: i. Chapter 7: § 706 – conversion; § 707 – dismissal ii. Chapter 11: § 1112 iii. Chapter 12: § 1208 iv. Chapter 13: § 1307 1. Note: 11, 12 & 13 combine conversion/dismissal rules; illustrates that court may choose between these 2 alternatives 2. Conversion or Dismissal by COURT [Standard is a showing of ―CAUSE‖] a. Chapter 7 Dismissal: § 707(a) i. ―Court MAY dismiss a Ch. 7 case only after notice/hearing & only for cause‖ 1. acceptable ―causes‖ (§ 707(a)(1)-(3)): (i) Unreasonable delay by debtor that is prejudicial to creditors; (ii) Nonpayment of any fees or charges required under 28 USC § 123; (iii) Failure of debtor in a voluntary case to file w/in 15 days or such additional time as the court may allow after filing of petition commencing such case, the info required by § 521(a)(1), but only on a motion by the U.S. trustee. b. Chapter 7 conversion OR dismissal: § 707(b) i. ―Court, on its own motion or on motion by U.S. trustee, trustee, or any party in interest, MAY dismiss a Ch. 7 case filed by a debtor w/ primarily consumer debts, OR, [with debtor‘s consent] convert it to a Ch. 11 or 13 case IF it finds that the granting of relief would be an abuse of Ch. 7 bankruptcy‖ ii. Abuse Test – § 707(b)(2)(A)(i) 1. [Abuse presumed if debtor‘s current monthly income (reduced by amounts determined under (A)(ii), (iii), and (iv) and multiplied by 60) is equal to or greater than the lesser of: (i) 25% of debtor‘s nonpriority unsecured claims in the case, or $7,025, whichever is greater, OR (ii) $11,375]

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2. If abuse is presumed, it may only be rebutted if debtor can demonstrate special circumstances (e.g. serious medical condition or active duty in military that justify additional expenses) [§ 707(b)(1)(B)] iii. Function of Abuse Test 1. Constraint on ability of individual consumer debtor to file Ch. 7 2. Designed to deny Ch. 7 relief to individual debtors who have at least a modest capacity to repay their creditors in a Ch. 13 plan iv. If debtor fails abuse test → Presumption of abuse applies & debtor MUST voluntarily convert case to Ch 13, OR judge SHALL dismiss the Ch. 7 case. c. Chapter 11 conversion OR dismissal: § 1112(b)(1): i. ―On request of a party & after notice/hearing, court SHALL dismiss the Ch 11 case OR convert it to a Ch 7 case, whichever is in the best interests of creditors & estate, for cause, unless court determines that the appointment of a trustee under § 1104 is in the best interests of creditors and the estate.‖ 1. Acceptable ―causes‖ at § 1112(b)(4)(A)-(P) [common theme of all causes = reorganization not likely to work at acceptable cost] 2. Two Exceptions: (§ 1112(b)(2) and § 1112(c)) (i) § 1112(b)(2): [court may not convert or dismiss IF: (a) court identifies unusual circumstances making it so that conversion or dismissal is not in the best interests of creditor/estate, AND (b) the debtor or other party in interest establishes that: [1] there is reasonable likelihood that plan will be confirmed within reasonable time period or (if in a small business case) the time frames set forth in § 1121(e) & § 1129(e), AND [2] grounds for conversion/dismissal include an act by debtor:  for which there exists reasonable justification; and  that will be cured within a reasonable period of time] (ii) § 1112(c): ―court may not convert IF. . . debtor is a farmer or a corp that is not a moneyed, business, or commercial corp, UNLESS debtor requests such conversion.‖ d. Chapter 13 conversion OR dismissal: § 1307(c) i. ―On request of a party or U.S. trustee & after notice/hearing, Court MAY dismiss a Ch. 13 case OR convert it to a Ch. 7 case, whichever is in the best interests of creditors & estate, for cause, including. . . ― 1. Acceptable ―causes‖ listed at § 1307(c)(1)-(7) [common theme: reorganization not likely to work at an acceptable cost] 2. Exceptions: listed at § 1307(f) 3. Conversion or Dismissal by DEBTOR a. Bankruptcy Code gives debtor several ―apparently absolute‖ privileges: i. To convert a Ch. 7 case to a Ch. 11, 12, or 13 case (§ 706(a); ii. To convert a Ch. 11, 12, or 13 case to a Ch. 7 case, subject to limited statutory exceptions (§§ 1112(a), 1208(a), 1307(a); iii. To dismiss a Ch. 12 or Ch. 13 case, subject to narrow statutory exceptions (§ 1208(b), § 1307(b) iv. ―Bad faith‖ is a limitation on this ―absolute‖ right (Marrama; SGL Carbon) b. Conversion by Debtor i. Chapter 7 conversion: § 706(a): Debtor may convert a Ch 7 case to a Ch. 11, 12, or 13 UNLESS case was already converted once. Any waiver of right to convert is unenforceable. 1. See also: the ―abuse test‖ of § 707(b) – comes into play here! ii. Chapter 11 conversion § 1112(a): ―Debtor may convert a Ch 11 case to a Ch 7 case UNLESS: (1) debtor is not a DIP; (2) case originally was commenced as an involuntary Ch 11 case; or (3) case was converted to a Ch 11 case other than on debtor's request.‖ iii. Chapter 13 conversion: § 1307(a): Debtor has absolute conversion right. ―Debtor may convert a Ch 13 case to a Ch 7 case at any time. Any waiver of right to convert is unenforceable.‖ c. Dismissal by Debtor i. Chapter 7 dismissal: § 707(a): NO absolute right of debtor to dismiss a Ch. 7 case; Court can only do it by showing cause; test = no ―legal prejudice‖

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ii. Chapter 11 dismissal: see above conversion analysis – same (§ 1112) iii. Chapter 13 dismissal: see above conversion analysis – same (§ 1307) 4. Judicial limitations on Conversion & Dismissal a. Courts impose additional limitations on the availability of bankruptcy relief outside of what the Code says, most specifically where ―good faith‖ is at issue b. Marrama v. Citizens Bank (SCOTUS 2007) – p. 86 i. RE: ―Bad Faith‖ negates absolute privilege to convert ii. Although privilege of debtor to convert Ch 7 to a Chapter 12/13 case is seemingly absolute, a ―bad faith debtor‖ does NOT have such an absolute right to convert. Court has equitable power to regulate good faith, even where statutory language seems to expressly allow conversion. c. In re SGL Carbon (3rd Cir. 1999) – p. 95 i. RE: what ―good faith‖ means in the context of filing ii. Ch. 11 petitions are subject to dismissal under § 1112(b) unless filed in good faith. Petition lacked valid reorganizational purpose where it filed bankruptcy seeking leverage in antitrust litigation, and thus was filed not in good faith. 5. Effect of conversion & dismissal a. § 348: Effect of Conversion i. Effect on property of estate when converting Ch. 12/13 to Ch. 7: bc property of Ch 7 estate is fixed at date of the petition while property & earnings continue to enter the Ch 12 or 13 estate after the petition, conversion from Ch. 12 or 13 to Ch. 7 gives rise to question of whether the converted Ch. 7 estate includes property acquired by detor after petition but before conversion... 1. § 348(a) (general rule): although the conversion constitutes the order for relief under the chapter to which the case is converted, the original petition date remains the effective date of commencement of the case for all purposes except those specified in the section. 2. § 348(f): if debtor‘s conversion was in good faith, the property of the Ch. 7 estate includes only the property of the original Ch. 13 estate that is still in the debtor‘s control or possession at the time of conversion. If conversion is in bad faith, the Ch. 7 estate expands to include all prop acquired by debtor (and hence by the Ch 13 estate) up to the time of conversion. b. § 349: Effect of Dismissal i. Dismissal of case does not bar discharge, in a later case, of debts that were dischargeable in dismissed case, unless court others otherwise for cause ii. Dismissal of case does not prejudice debtor w/ regard to the filing of a subsequent petition under this title, except as provided in § 109(g) Chapter 3: Property of the Estate A. Overview 1. Filing of bankruptcy petition instantaneously creates “estate” under § 541 a. Composed of all of debtor‘s legal and equitable interests in property as of the time the case is commenced, plus some post-petition additions i. Automatic transfer, no order need be entered ii. Even if nonbankruptcy law has transfer restrictions – overrides restrictions iii. Even debtor‘s exempt property initially goes into the ―estate‖ iv. Congress intended broad reading, desiring to bring ALL of debtor‘s legal and equitable property interests into the estate. b. Estate = separate legal entity, represented by the trustee or DIP i. Trustee/DIP can ―use, sell, or lease‖ estate property – § 363 2. Significance of the Bankruptcy Estate a. Protected by automatic stay – stops race for assets b. Federal courts have exclusive jurisdiction over property c. In Chapter 7, property of estate determines what creditors receive in distribution B. Inclusions in the Estate 1. Three basic parameters of the scope of estate property: a. Must meet definition of ―property‖;

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b. Must be property ―of the debtor‖; c. Must meet relevant timing point (―as of commencement of case‖) 2. § 541(a): “All legal/equitable property interests of debtor as of commencement of the case” a. ―Property‖ i. Almost any conceivable interest – legal, equitable, tangible, intangible, etc. ii. Whether interest is ―property‖ is a question of federal bankruptcy law iii. Estate gets everything of value b. ―Of the debtor‖ i. Property comes into the estate only to the extent it is property of the debtor ii. To the extent debtor‘s interest was limited in the instant before bankruptcy filing, estate‘s interest is identically limited a. Joint tenancy – estate gets debtor‘s undivided share in joint tenancy b. Subject to lien – estate takes subject to all liens and encumbrances c. Totally encumbered – where the lien is worth more than the value, trustee decides whether to use or abandon to secured creditor c. ―As of the commencement of the case‖ (and a few post-petition additions)

i.

Timing problems: where property has roots in both the prebankruptcy and postbankruptcy periods a. Segal v. Rochelle (1966) – CB p. 172

ii. Exceptions that allow for adding post-petition property to estate: a. § 541(a)(5): Any interest in property that would have been property of the estate that is

1. D had tax losses prepetition, but didn‘t get tax refund until postpetition [a] Court: refund fell within estate bc losses were rooted in the prebankruptcy period. [b] At instant of filing, D had a potential tax refund, so estate gets the possibility of receiving a refund (everything of value)

acquired within 180 days after petition date in the following ways: 1. By bequest, devise, or inheritance; 2. As a result of a property settlement agreement w/ debtor‘s spouse or a divorce decree; OR 3. As a beneficiary of a life insurance policy or death benefit plan b. § 541(a)(6): Proceeds rule – proceeds/products/offspring/rents/profits of or from estate property c. § 541(a)(7): Any interest of property that the estate acquires after commencement of case iii. At the same time bankruptcy estate is created, the individual Ch. 7 debtor begins to accumulate a new estate (note: a corp in liquidation cannot be rehabilitated, thus it does not acquire a new estate. When the corp‘s bankrupt estate has been liquidated, the corp ceases to exist) C. What is “Property?” 1. Two questions must be addressed: a. Does the debtor have any interest in the property as of the petition date? b. What is the extent of the debtor‘s interest in the property? (What is the alienability of the debtor‘s interest in the property?) 2. Butner v. US (1979) – p. 162 a. Rule: Property interests & their attributes are created & defined by state law, NOT by federal bankruptcy law b. Existence, nature, and character of property interest is determined by the underlying law that created the interest – typically state law c. Policy rationale for letting state law define ―property‖ i. Reduce uncertainty ii. Discourage forum shopping a. Creditors will shop for federal bankruptcy if they get a better result than they would have outside of bankruptcy b. Do not want parties to have an incentive to force a bankruptcy case for reasons that would not normally support a bankruptcy iii. Prevent windfall by the happenstance of bankruptcy

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iv. Bankruptcy not designed to restructure rights – rather it is meant to be a procedural means for sorting out various substantive rights & claims of creditors and debtors v. All the claims (and so the property interests) are created independently 3. Chicago Board of Trade v. Johnson (1924) – p. 167 a. Re: how to determine extent of property interest b. Facts: Henderson filed to transfer his seat (property interest?). Prior to getting approval for the transfer, he filed Ch. 7. Therefore, actual sale of the seat was going to take place post-petition. c. Issue: Is this seat property? d. Rule/Analysis: i. Butner says to look to state law to see what property interests are. Illinois state law said that this seat was ―not property.‖ However, Court held that it WAS property here. ii. Why aren‘t they applying state law? Because ―Question 1: does the debtor have interest in the property?‖ is determined by Fed Bankruptcy law, whereas ―Question 2‖ is addressed by state law to determine the extent of the interest. 4. Abele v. Phoenix Suns, aka In Re Harrell (1996) – p. 170 a. Facts: There are two property issues here; court needs to determine if each property interest/right is part of the bankruptcy estate: i. (1) Debtor‘s tickets left in the existing sports season; and ii. (2) Debtor‘s right to purchase next season‘s tickets b. Issue(s): i. (1) Do the tickets left in the existing season constitute ―property‖ for the bankruptcy estate? ii. (2) Does the right to renew season tickets constitute a ―property‖ right for purposes of including the future right to the tickets in the bankruptcy estate? c. Holding/Rationale: i. (1) Yes; Debtor has an interest in the tickets left over for this season, and they are alienable (to the extent of the interest). Therefore, those tickets go in the estate. ii. (2) No; A season ticket holder‘s expectation of renewal of season tickets is not a property right. As a matter of law, there is no right to renew season tickets. The court says that while renewal happens, the Suns are not contractually bound to doing it. D. Timing 1. General rule: Date of filing of petition establishes property of estate a. Difficult to fix timing in some cases where property has roots in both pre- and post-bankruptcy period i. Question → Whether the postpetition property is sufficiently rooted in the prebankruptcy past, taking into account the purposes and policies of federal bankruptcy law ii. Purposes/policies of this general rule: (1) Secure for creditors everything of value of the debtor as of the petition date; (2) Leave debtor free after petition date to accumulate new wealth 2. Examples of “contingent” interest in property a. Ex) Blank canvas at the date of filing, paint water lilies post filing i. Painting doesn‘t come into estate bc most value attributable to debtor‘s postpetition labor b. “In Re Schmitz” (2001) – p. 173 i. Facts: Fisherman filed for bankruptcy a year and a half before regulations creating post-filing fishing rights based on fisherman‘s pre-filing catch history ii. Held: Court held that the quota rights were not property of the bankruptcy estate bc 1) the regulations did not exist at the time debtor filed his petition; and 2) although the quota rights were calculated on the basis of debtor‘s pre-filing fishing history, they govern his post-filing right to fish. a. §541(a)(6) – future income is excluded from the estate – part of the ―fresh start‖ is that starting at the petition date, whatever the person makes from that date forward is NOT part of estate. Here, he is fishing for Halibut per a fishing regulation after the bankruptcy closed E. Exclusions from the Property of the Estate 1. Overview a. General Rule: not all property that would otherwise be included in the estate under § 541(a) will actually end up in the estate: i. Certain types of property interests excluded under § 541(b), (c), (d); AND

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ii. Debtor‘s post-petition earnings excluded under § 541(a)(6) (Andrews) b. Note that exempt property does initially come into the estate, but then it is removed from the estate pursuant to § 522 once debtor makes a claim of exemptions and that claim survives scrutiny. c. Policy Behind Exclusions i. Minimize forum shopping by creditors for pro-creditor bankruptcy courts. ii. Recognize superior equitable entitlements of third parties. iii. Promote debtor‘s interest in receiving a fresh start. 2. Employee Benefits/Pension Plans – EXCLUDED a. § 541(b)(7): ―Property of the estate does not include. . . any amount withheld by an employer from wages of employees for payment as contributions OR any amount received from employees for payment as contributions from he wages to . . .(I) an employee benefit plan; (II) a deferred compensation plan; (III) a tax-deferred annuity; or (IV) a health insurance plan.‖ b. Patterson v. Shumate (1992) – p. 178 i. Facts: Debtor was President of Coleman Furniture Co., had $250,000 in the company‘s pension plan at the time he filed bankruptcy under Chapter 7. ii. Issue: Was the $250,000 part of the bankruptcy estate? iii. Holding a. For a pension plan to qualify under ERISA, the plan should have no alienation or assignment clauses (Prevents creditors of employee from reaching the funds prior to it being distributed to the employee) b. Reading the plain language of § 542(c)(2) – ERISA is an applicable nonbankruptcy law, and the ERISA-mandated anti-alienation reading of the statutory text works with (c)(2). c. Thus, ERISA-qualified plans cannot become property of the estate. iv. Notes a. § 541(b)(7) codified Patterson! b. § 522(b)(3)(C) & § 522(d)(12): all tax-exempt retirement funds are exempt in bankruptcy [Limitation = exempt up to $1,095,000 for individual; $2,190,000 for couple filing jointly] 3. Debtor’s post-petition earnings – EXCLUDED a. § 541(a)(6): ―Earnings from services performed by an individual debtor after the commencement of the case are excluded from the estate.‖ a. Facts: Andrews got $1M for signing a non-compete agreement b. Issue: Whether payments to a bankrupt debtor pursuant to a non-competition agreement constitute ―earnings from services performed‖ under § 541(a)(6) c. Holding: No d. Debtor‘s argument: refraining from competition amounts to ―performing services‖ because it confers a benefit, and thus the payments are excluded from the estate e. Rationale for court holding that non-competition is NOT a ―service‖: The non-competition agreement was ancillary to a pre-petition transaction, and thus payments under the agreement did not fall within § 541(a)(6). f. Analysis: 1. There is no good definition for property of the estate. However, whatever the debtor has at the petition date goes into the ―bucket‖ of the estate. 2. The debtor has a right to future income received after petition date. 3. There is a two step analysis: [a] Does the debtor have an interest in the property? [b] What is the extent of the interest? 4. Legal vs. Equitable Title a. §541(d) – Property in which the debtor holds only legal title, and not equitable title, is property of the estate only to the extent of the debtor‘s legal title. a. Ex 1: If Bill were the trustee of an express trust for the benefit of Bob, Bob‘s beneficial interest in the trust res would not be in Bill‘s estate. b. Ex 2: Where the debtor sells a mortgage but retains the legal title to the mortgage for servicing. Protects the secondary mortgage market. 5. Transfer restrictions

i.

In Re Andrews (1996) – p. 184

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a. § 541(c)(1) General Rule: nonbankruptcy transfer restrictions (whether in an agreement, or in applicable law) are invalidated in bankruptcy— i. Whatever debtor has comes into the estate a. The ―transfer‖ from debtor to estate is permitted b. But, then the restriction might keep the estate itself from transferring b. Exception – § 541(c)(2) i. Exclusion from ―property of the estate‖ for a restriction of the transfer of a beneficial interest of the debtor in a plan or trust that contains a transfer restriction enforceable under any relevant nonbankruptcy law (not restricted to state law) ii. Ex) spendthrift trust where debtor is beneficiary, ERISA retirement plan 6. Postpetition/”Fresh start” exclusion a. Individual Debors i. § 541(a)(6) – ―Earnings for services performed‖ by an individual debtor after commencement of the case are excluded from the bankruptcy estate! (Segal) ii. § 1306(a): Ch. 13 individual debtor DEFERS fresh start; D‘s earnings during plan payment period are property of the estate b. § 1115: Ch. 11 individual debtor‘s postpetition earnings are also property of the estate c. § 522: Exempt property comes into the estate and individual debtor must make a claim of exemption to remove the property pursuant to § 522 d. Attribution issues (Where debtor does some work prebankruptcy & some work postbankruptcy, allocate among the estate (pre-), and debtor (post-)) i. Ex) non-compete agreement signed as condition of sale of business a. Court: payments do not fall within definition of ―earnings for services performed‖ and thus were properly included in estate b. Non-compete payments rooted in D‘s prepetition activities c. D should have structured deal so he did something affirmative, like consulting, so payment could be attributed between estate & debtor F. Trustee’s Power to Abandon Inconsequential/Burdensome Property 1. § 554 – Trustee or party has the power to abandon burdensome property or property of inconsequential value or benefit to the estate. a. POLICY: Some property that enters the estate is of no value or benefit to the estate, and the efficient administration of the estate & fairness to the debtor dictate that such property should be given up by the estate b. Note: the initiative to abandon property may be taken by the trustee under § 544(a) OR applied for by a party in interest under § 544(b) c. Some reasons property may have no value or benefit to estate: property is fully encumbered and not needed for debtor‘s rehab; it is fully exempt and cannot be liquidated for the benefit of creditors; it costs more to maintain than it is worth; OR it simply has no economic value 2. Midatlantic National Bank (1986) – p. 188 a. Holding: SCOTUS barred abandonment of property ―in contravention of a state statute or regulation that is reasonably designed to protect the public health or safety from identified hazards‖ b. Analysis: Court balanced estate‘s interest in abandoning polluted property against the public interest in having the owner remedy the pollution. c. Rule: where state law is reasonably designed to protect the public from imminent and identifiable harm, the protection of the public health outweighs the bankruptcy policy of maximizing the value of the estate. d. Effect: de facto priority in payment out of estate to govt‘s claim for cleanup expenses What is included in property of the estate for the following types of debtors/cases?  Individual Debtor in Ch. 7 → See § 541  Individual Debtor in Ch. 11 → See §§ 1115, 1123(a)(8), 1129(a)(15), 1141(b)-(c); (d)(5)  Corporate debtor in Ch. 11 → See § 541(a)(1), (6), (7)  Individual Debtor in Ch. 13 → See §§ 1306, 1322(a)(1), 1325(b)-(c), 1327(b)-(c), 1328(a)-(b)

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Chapter 4: Automatic Stay A. Overview of Automatic Stay 1. § 362 – Automatic stay is very important; it is an injunction that serves as a ―time out‖ immediately upon the commencement of a bankruptcy case; the stay maintains status quo until debtor‘s affairs can be sorted out in bankruptcy proceeding 2. Two-fold Role of Automatic Stay a. BENEFITS CREDITORS: Preserves integrity of collective action for creditors i. Stops all attempts by individual creditors to get paid before their peers and protects the bankruptcy estate (protects property) ii. Avoids chaos & grabbing for assets – instead, an orderly, supervised process iii. Creditors must get permission from the estate to proceed (relief from stay – § 362(d)) b. BENEFITS DEBTOR: Facilitates ―fresh start‖ for debtor i. Gives debtor a ―breathing period‖ during which she cannot be harassed by creditors on prebankruptcy debts 3. Six Characteristics of the Automatic Stay i. Injunction a. Prohibition on any activity to collect prepetition debts from debtor or to assert/enforce claims against debtor‘s prepetition prop or estate prop b. Prohibits attempts to interfere with estate property c. Does NOT interfere with (i.e. does not stay) efforts to collect postbankruptcy debts, or with attempts to collect from third parties ii. Automatic a. Goes into effect the instant bankruptcy petition is filed b. No court order needed to enforce it c. The stay is good against the whole world iii. Self-executing a. Actions taken in violation of the stay are void b. For practical purposes, unless the court acts to validate the stay-violating action, the action has no legal effect iv. Sanctions for Violation a. Anyone who knowingly violates stay is subject to sanctions under § 362(k) or under the court‘s contempt powers b. Court can award individual D actual damages, costs, attorneys‘ fees, and punitive damages for a willful violation of the automatic stay v. Stay is Temporary a. Terminates automatically upon occurrence of one of the events listed in § 362(c): 1. Closing/dismissal of case 2. Granting of discharge to individual D; permanent discharge injunction of 524(a) kicks in 3. Removal of property from the estate vi. Relief from Stay [dealt with in more detail below] a. § 362(d): Court SHALL grant relief from stay in certain circumstances: 1. For cause (including lack of protection) 2. With respect to stay of property in which debtor does not have equity AND such property is not necessary to effective reorganization; 3. With respect to stay of single asset real estate (SARE) 4. Etc (See § 362(d)(1)-(4)) b. § 362(g): Burdens of proof when relief from stay is requested: 1. burden on party requesting relief to prove issue of debtor‘s equity in property; 2. burden on party opposing relief to prove all other issues.

c. Important especially in Ch. 11 reorg. cases and in dealing w/ claims of an secured creditor

B. Scope of the Stay: Acts Stayed 1. Overview

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a. § 362(a) and (b) set out what activity is stayed and what is not. i. § 362(a)(1)-(8) prescribes 8 categories of activity that must stop when petition is filed ii. § 362(b)(1)-(28) lists a bunch of specific types of activity that are NOT stayed 2. Analysis under § 362: a. § 362(a): Ascertain whether an act is stayed in the first place i. IF nothing in subsection (a) applies, automatic stay does NOT bar the action ii. IF something in subsection (a) applies, turn to the long list of exceptions to stay in § 362(b) b. § 362(b): Exceptions to Stay i. IF an exception from (b) applies, then the stay will NOT bar the action 1. NOTE that if the automatic stay is not triggered [either bc the action is not covered by subsection (a) or it is excepted under (b)], it may still be possible to stop the action by obtaining an injunction from the court. All the procedural and substantive rules governing the issuance of injunctions would then be applicable. ii. IF no exception from (b) applies, then the WILL bar the action c. § 362(c): Termination provision i. Essentially contains stay executions and stay relief provisions (this will be discussed more below under ―Relief from Stay & Adequate Protection‖) 3. Scope of the Stay Generally a. Timing & Duration i. Stay comes into effect immediately & automatically upon filing of the petition a. This is true for both voluntary & involuntary cases [in voluntary case – stay precedes the order for relief & operates like an injunction prior to the adjudication of bankruptcy] b. Claims arising prior to petition are generally subject to the stay, while claims arising after bankruptcy are not generally subject to the stay. [See § 362(a)(1), (2), (6), (7)] ii. Stay remains in effect until the case is closed or dismissed b. What property is protected? i. § 362(a)(3): stay bars interference w/ estate property w/out court‘s express permission ii. Property of estate protected from ALL interference iii. Property of debtor from collection of prepetition debts iv. Any act to collect – using the ―coercive effect‖ test (repossession & sale, writ of execution, garnishment order, setoff); freezing of account ok 1. Citizens Bank v. Strumpf (1995): even though the freeze might be classified as an action exercising control over property of the estate the freeze does not violate the stay because the Bank has not setoff and the Bank is acting to preserve its right to seek relief from the stay. § 553(a) allows the Bank to set off post-petition. The Bank may not set off but it is entitled to be treated as secured to the extent of the funds in the account and the freeze protects the bank‘s right to come to court to get adequate protection. c. Who is protected? i. Debtor; Debtor‘s property; and Property of the bankruptcy estate. ii. Third parties do NOT enjoy the protective cloak that stay offers. d. Scope of Stay is Broad i. Stay is intended to be broad. Evidence of this is found in ―catch-all‖ provision of § 362(a)(6), which stays ―ANY ACT‖ to collect a prepetition claim. e. Does not protect criminal, illegal, or dangerous actions i. Even bankruptcy debtors must obey the law ii. Will not stay prosecution/punishment of debtor if debtor does something illegal iii. Stay exceptions: criminal prosecutions (§ 362(b)(1)); police power activities (§ 362(b)(4)). 4. List of Acts Stayed under § 362(a) a. Acts that Protect the Debtor i. § 362(a)(1) ii. § 362(a)(6) iii. § 362(a)(7) b. Acts that Protect Both the Debtor and Property of the Estate i. § 362(a)(2) c. Acts that Protect Property of the Estate

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i. § 362(a)(3) ii. § 362(a)(4) d. Acts that Protect Property of the Debtor i. § 362(a)(5) e. Acts that protect Tax Enforcement i. § 362(a)(8) C. Turnover of Repossessed Collateral by Secured Creditors upon Stay - § 542(a) 1. Fact Pattern where this issue arises a. Secured creditor (rightfully) repossesses collateral prebankruptcy bc the debtor is in default, but then debtor commences bankruptcy proceeding before creditor completes sale of collateral; Debtor demands immediate return of the collateral. b. Secured creditor refuses to relinquish possession unless debtor provides ―adequate protection.‖ c. Debtor claims that secured creditor‘s refusal to relinquish the property violates the stay. [In Thompson, 7th Cir. sided w/ debtor in this case – see below] 2. Applicable Code Provisions a. § 542(a) – ―Any entity . . . in possession of property that the trustee may use under § 363… shall deliver‖ that property to the trustee i. Secured creditor is required to turn over property to the trustee or DIP, BUT is granted ―adequate protection‖ as a substitute remedy a. If debtor can‘t provide adequate protection, court may grant relief from stay & allow secured creditor to foreclose on property/retain the collateral instead of turn it over to the debtor b. § 363(b), (c) – trustee may use ―property of the estate‖ c. § 363(e) – conditions use of property on providing adequate protection a. Make one group better off (residual claimants – unsecured creditors) without making other group (IRS) any worse off b. Unsecured creditors – will be paid more through successful operation of the business c. Secured creditor – give ―value‖ of their collateral (cannot be worse off); turnover right ends when debtor has NO property interest left at the time files bankruptcy (i.e. if secured party had sold collateral at foreclosure) 3. United States v. Whiting Pools (SCOTUS 1983) – p. 193 a. Facts: i. IRS seized Whiting‘s tangible property bc of non-payment of payroll taxes of about $92,000. Seized assets were worth $35,000 at liquidation value and $162,000 at going concern value. The day after the seizure, Whiting filed Chapter 11 case. Parties agreed that the IRS had a lien on the assets it seized per the Internal Revenue Code. ii. IRS moved for relief from stay, arguing that the stay was inapplicable to the IRS. Whiting demanded return of the assets pursuant to § 542(a) and the IRS refused. IRS argued that the assets were not property of the estate bc there was no equity and bc the Internal Revenue Code gives the IRS the right to sell the assets once they gain possession (the I.R. code, they argued, somehow pre-empted the bankruptcy code.) iii. 2nd Circuit held that turnover was proper subject to the debtor providing adequate protection. IRS appealed to SCOTUS. b. Analysis/Holding i. Held that the property is property of the estate pursuant to § 541(a) bc the transfer of possession to the IRS had not resulted in transfer of ownership. In fact, the debtor has the right to a surplus should the sale by the IRS generate a surplus. ii. SCOTUS ruled property must be turned over pursuant to the stay under § 542(a) since that section states that an entity holding property of the debtor at the time of the bankruptcy filing must return it to the debtor. a. Of course, had the pre-petition transfer of possession resulted in a transfer of ownership of the assets, § 542(a) would not apply.

i.

Congress‘ theory = Pareto efficiency

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b. But here, under the IRC, ownership remained with the debtor until the IRS actually sold the assets. Since it did not ―own‖ the assets at the time of filing, the assets must be returned to debtor under § 542(a). c. Rules: i. § 362 applies to the IRS just like any other secured creditor. (§ 362 applies to everybody, including gov't agencies), and thus § 542(a) authorizes the Bankruptcy Court to order the IRS to turn over seized property to debtor ii. Bankruptcy estate includes property of the debtor that has been seized by a creditor prior to the filing of a petition for reorganization. 4. Thompson v. GM Acceptance Corp. (7th Cir. 2009) – p. 197 a. Re: Turnover even without adequate protection? b. Facts i. Debtor had his car repossessed by General Motors Acceptance Corp (―GMAC‖), a secured creditor. A few days later Debtor filed for Chapter 13, and sought the return of his vehicle from GMAC through the automatic stay provision of § 362(a)(3), which provides that ―a petition filed [for bankruptcy] . . . operates as a stay . . . of any act to obtain possession of property of the estate . . . or to exercise control over property of the estate.‖ ii. GMAC refused, claiming debtor could not adequately protect its interest. c. Issue i. Whether an asset lawfully seized pre-petition must be returned to the estate after debtor files Chapter 13 bankruptcy, and if so, whether the asset must be returned even without a showing by the debtor that he can adequately protect the creditor‘s interest. d. Analysis i. Court looked at plain meaning of § 542(a) as well as SCOTUS‘ decision in Whiting Pools: a. § 542(a) states that an entity in possession of property ―that the trustee may use, sell, or lease . . . shall deliver to the trustee, and account for, such property . . . unless such property is of inconsequential value or benefit to the estate.‖ b. Court interprted § § 542(a) & 362(a) to mean that property seized pre-petition must first be returned before any creditor can claim adequate protection of his interest. c. This meant that GMAC first had to return the car before it could claim that Debtor could not adequately protect its interest. e. Bell-Tel Federal Credit Union v. Kalter [Competing 11th Cir decision] i. Contrary position was taken by 11th Cir on similar facts – Court in Bell-Tel held that a secured creditor DOES NOT have to return a vehicle that was seized pre-petition. While Thompson court analyzed whether the car must be returned without a showing by the debtor that the creditor‘s interest is protected, the Bell-Tel court focused on whether the car was even part of the estate. Court stated that if the property was not part of the bankruptcy estate, then debtor had no right to have the car returned. a. § Section 541(a)(1) states that property of the estate includes ―all legal or equitable interests of the debtor in property as of the commencement of the case.‖ 1. Since property seized before filing can be considered property of the estate only if the debtor still had a legal or equitable interest at the time of filing, the 11th Cir turned to Florida state law to determine whether the debtor had a legal or equitable interest in the car. 2. Specifically, Court looked to see if creditor took legal title to the car when it was repossessed. Court found that, following repossession, the debtor held a bare right of redemption and that, therefore, the car itself was not part of the estate. Because the car was not part of the estate, secured creditor did not have to return the car. [a] Note that whether the debtor had any legal or equitable interest in the repossessed vehicle was not at issue in Thompson. In Thompson, both parties agreed that the debtor had an equitable interest in the vehicle, and, therefore, the vehicle was part of the estate under § 541(a). [b] The 11th Cir. in Bell-Tel did not analyze any of the issues addressed by the 7th Cir in Thompson; 11th Cir. had no need to discuss whether the debtor must show adequate protection of the secured creditor‘s interest prior to receiving the vehicle bc the

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debtor must show his vehicle is considered property of the estate before it could be transferred to him from the creditor pursuant to the automatic stay provision. D. Scope of the Stay: Exceptions 1. § 362(b)(1)-(28) lists MANY exceptions to stay 2. Criminal proceedings - § 362(b)(1) a. Issue = whether court should read in ―debt collection‖ exception b. Theoretically debtor could get injunction against state crim action under § 105(a) c. In Re Gruntz (3rd Cir. 2000) – p. 206 i. Issue: Whether stay enjoins a criminal prosecution for the willful failure to pay child support ii. Holding: No iii. Analysis: a. ―Interpreting § 362(b)(1) as rendering the automatic stay as inapplicable to all criminal proceedings is consistent w/ the provisions of the whole law, its object, and policy‖ b. Debtor argued that purpose of bankruptcy is thwarted if criminal prosecution are allowed as a means of debt collection for dissatisfied creditors. Court rejects for few reasons: 1. Congress has specifically subordinated the goals of economic rehabilitation and equitable distribution of assets to the states‘ interest in prosecuting criminals; 2. Any criminal prosecution of debtor is on behalf of citizens of the state, not the creditor 3. Alimony and Support proceedings – NOT STAYED a. § 362(b)(2)(A): No stay of any civil action or proceeding, including: establishment of paternity; modification of support obligations; child custody or visitation; divorce; domestic violence. b. See § 362(b)(2)(B)-(G) for other similar acts not stayed 4. Perfection of PMSI – NOT STAYED a. § 362(b)(3): No stay of ―acts to perfect/maintain an interest in property to extent that trustee's rights & powers are subject to such perfection under § 546(b) or to the extent that such act is accomplished within period provided in § 547(e)(2)(A).‖ 5. Police Power – NOT STAYED a. § 364(b)(4): No stay of action/proceeding by a gov't unit to enforce such governmental unit's police and regulatory power, including the enforcement of a judgment [other than a money judgment]‖

b. This is one of the most important exceptions to the stay

c. Exception to this exception: Stay DOES bar gov't act to enforce money judgment i. Mere entry of a money judgment by governmental unit is not affected by the automatic stay, provided such proceedings are related to the government‘s police or regulatory powers ii. Pecuniary purpose test – if government is acting primarily to protect its pecuniary interests, rather than to protect public safety and welfare, than it is not acting pursuant to its police/regulatory powers iii. Public policy test – distinguishes between actions that primarily adjudicate the private rights of private parties (which is not within the police or regulatory powers), and governmental acts that are primarily directed at a larger public policy regarding public health, safety, welfare iv. Government wears 2 hats: regulator and creditor a. Government can act as regulator without worrying about the stay, but when it acts as creditor, it must play by the rules for other creditors b. Distinction of regulator vs creditor =whether gov't focusing on debtor‘s past or future conduct d. Penn Terra v. Dept. of Environmental Resources (1984) – p. 213 i. Re: Enviro. cleanup injunction where suit brought as equitable action to prevent future harm ii. Facts: when EPA brings an action for environmental violation, a potentially responsible party (PRP) is someone who could be responsible for the clean-up (including anyone who owned the property while the environmental problem existed). Banks don‘t like holding property because they could become one of those PRPs. Generally, when they foreclose on a property they have an environmental assessment done to ensure they won‘t have problems. iii. Issue: Can Penn Terra enforce an order given that it has to pay some money? iv. Analysis: a. Court concluded that the DER's action was not an action to enforce a money judgment, but rather an equitable action aimed at preventing future harm.

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b. In reaching this determination, Court recognized that "an important factor in identifying a proceeding as one to enforce a money judgment is whether the remedy would compensate for past wrongful acts resulting in injuries already suffered or protect against future harm." v. Holding: Enforcing that order is not same as enforcing money judgment. The amount Penn Terra would have to pay was not clear and it was not going directly from one party to another party. vi. Rule: 1) past/future harm distinction, 2) it is not a money judgment because there is no money involvement. Compare Penn Terra w/ Ohio v. Kovacs. Chapter 5: Unsecured Claims A. Definition of “Claim” 1. Claim defined BROADLY in § 101(5): a. A right to payment [whether or not such right is reduced to judgment]; OR b. A right to equitable remedy for breach of performance if such breach gives rise to a right to payment c. Any type of right to payment at all, including:

i.

Unliquidated

ii. Disputed

a. Ex) car accident, but debtor files for bankruptcy before get a judgment b. Claim exists, because cause of action arose prior to bankruptcy filing c. § 502(c) – court has power to estimate the amount of claims if it would delay the case to fix otherwise a. Claim exists, bankruptcy court will sort out the contested claim a. Ex) contingent reimbursement claim against debtor – if creditor is a guarantor for debtor b. Guarantor has a contingent claim

iii. Contingent

a. Ex) creditor holds a promissory note, due in the future b. Creditor has a claim, even though ―unmatured‖ – part of debtor‘s prebankruptcy financial past d. Equitable remedies i. Injunction or a right to specific performance can give rise to a claim when such breach gives rise to a right to payment (§ 101(5)(B)) a. Under state law, could remedy be satisfied by payment of $? b. Injunctive right itself (and not just liquidated damages clause) must give right to payment e. Breadth of bankruptcy ―claim‖ confirmed by SCOTUS in numerous cases: i. DPW v. Davenport – criminal restitution was a ‗debt‘ that could be discharged in a Ch. 13 ii. Johnson v. Home State Bank – a purely in rem right against collateral, remaining after discharge of debtor‘s personal liability in Ch. 7 case was a ―claim‖ eligible for treatment in a Ch. 13 plan. [See §§ 102(2), 502(b)(1)]. 2. Significance of having a “claim” a. Only a ―claim‖ may be paid in bankruptcy distribution b. Only a ―claim‖ may be discharged c. Holder of a ―claim‖ is stayed from collecting during bankruptcy d. For any debtor other than an individual – significance of non-claim finding depends on whether liquidating or reorganizing: i. If liquidating (chapter 7) → claimant out of luck; wont be paid anything in bankruptcy case and the entity won‘t exist post-bankruptcy thus mooting any opportunities to collect. ii. If reorganizing (chapter 11) → the obligation will be enforceable in full by claimant against postreorganization entity 3. Determining whether there is a claim a. Look to state law to determine if the act gives rise to a right to payment b. Look to federal law to fix when (accelerate all claims to filing date, even if no present right to sue) c. THREE TESTS: i. Conduct Test, Grady: Right to payment arises when conduct giving rise to alleged liability occurs ii. Relationship Test, Piper Aircraft: Requires (1) prepetition conduct, (2) prepetition relationship between C & D

iv. Unmatured

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iii. Fair Contemplation Test, Kovacs: claim finding requires knowledge of harm by creditor d. Grady v. A.H. Robins Co. (4th Cir. 1988) – p. 230 i. Re: Creditor injured by D-manufacturer‘s IUD device which was inserted in her prior to bankruptcy petition date ii. Facts: Mrs. Grady injured by IUD inserted by Robins Co sometime between 1971-1974. In 1985, Robins filed for Ch 11 bankruptcy. 2 months after Robins filed for bankruptcy, Mrs. Grady sued because of the IUD injury. iii. Arguments a. Mrs. Grady (C) → argued ―claim‖ did NOT arise pre-petition, but rather it arose when the harm manifested itself (post-petition) – thus claim NOT stayed under § 362 [Grady obviously wants no stay protection so she can collect in her civil suit against Robins] b. Robins (D) → argued ―claim‖ arose pre-petition bc the claim arises when the act giving rise to liability occurs – thus claim STAYED under § 362 iv. 4th Cir: a. Court adopts a ―conduct test‖ wherein a ―claim‖ arises upon performance of conduct giving rise to liability. b. ―We hold that when the IUD being inserted into the claimant prior to the time of filing the petition constitutes a ‗claim‘ that arose ‗before the commencement of the case‘ within the meaning of § 362(a)(1)‖ c. Creditor‘s claim was ―contingent‖ – depended upon a future uncertain event (the manifestation of injury from use of the device) v. Rule: To constitute a claim, there need not be a right to the immediate payment of money, where the acts constituting the tort or breach of warranty have occurred prior to the filing of petition. e. In Re Piper Aircraft Corp. (11th Cir. 1995) – p. 234 i. Re: D entered into reorganization plan, and as part of the plan, a legal representative was appointed to represent a class of Future Claimants. ii. 11th Cir: a. Court adopts a ―pre-petition relationship test‖ wherein a ―claim‖ arises due to a debtor‘s tortious conduct pre-petition: 1. Pre-petition relationship/Piper test → ―an individual has a § 101(5) against a debtor manufacturer if: (i) Events occurring before confirmation create a relationship, such as contact, exposure, impact, or privity, between the claimant and the debtor‘s product; and (ii) The basis for liability is the debtor‘s prepetition conduct in designing, manufacturing, and selling the allegedly defective or dangerous product.‖ [a] ―The debtor‘s prepetition conduct gives rise to a claim only if there is a relationship established before confirmation between an identifiable claimant or a group of claimants and that prepetition conduct.‖ (p. 237) b. Here there is no claim bc there is no preconfirmation exposure to a specific identifiable defective product or any other preconfirmation relationship between Piper and the broadly defined class of Future Claimants. c. No exposure to a specific identifiable defective product, or any other preconfirmation relationship f. Ohio v. Kovacs (SCOTUS 1985) - p. 238 i. Re: State injunction ordered D to clean up hazardous waste; enjoined from causing future pollution ii. Facts: a. 1979: State of Ohio obtained an injunction ordering Kovacs to clean up a hazardous waste site. Kovacs failed to do so and the state obtained a receiver to take possession of the property and do the cleanup. The receiver had not completed the work when Kovacs filed Chapter 7. b. State filed complaint to find the duty to clean up site non-dischargeable because it is not a debt or "liability on a claim." Bankruptcy court ruled against the state & the 6th Cir affirmed. iii. State‘s Argument & Court responses a. The state argued that it is not a claim bc it arose from a state statute and not an ordinary commercial transaction. → Court rejected this ―strained interpretation.‖]

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b. State also argued that the violation did not give right to payment and therefore was not a claim under §101(5)(B), which provides ―a right to an equitable remedy for breach of performance (is a claim) if such breach gives rise to a right to payment.‖ → Court stated that since the state dispossessed Kovacs from the property instead of ―prosecuting Kovacs under environmental laws or bring civil or criminal contempt proceedings,‖ and since it sought a receiver who now simply seeks money from Kovacs to fund the cleanup, the obligation has become a claim for money and therefore dischargeable. 1. [I.e., what was in place at the time of bankruptcy was ―a cleanup order that had been converted into an obligation to pay money‖ which of course is dischargeable unless excepted under § 523(a)] iv. Issue: Is an order to clean up a hazardous waste site a ―claim‖ which is discharged under § 727(a)? v. Held: Yes, cleanup order was a claim (here at least - on these facts) because, prior to the bankruptcy filing, State had sought appointment of a receiver to clean up the site thereby taking possession of site away from debtor Kovacs & essentially changing the duty to clean up the site to a duty to pay costs incurred by receiver to clean up the site g. Ex) Non-compete clause – is equitable remedy (injunction) a “claim”? i. Where under state law the covenant would be considered reasonable and thus enforceable, and would allow C to enforce the noncompete covenant by a negative injunction ii. No claim – injunctive right itself has to be compensable in $$s iii. Note: could implicate fresh start policy! B. Allowance of Claims – § 502 1. Significance of being “allowed” a. To be paid out of estate, an unsecured claim must be ―allowed‖ b. Only ―allowed‖ claims can vote on a Chapter 11 i. § 502(a): A claim is deemed allowed unless party in interest objects ii. § 502(b), (d), (e): set out grounds for disallowing a claim. c. It‘s possible for a claim to be reduced rather than completely disallowed d. Claim may be discharged, whether allowed or not 2. Allowance process a. File proof of claim with clerk - § 501 i. Only where there is purpose to be served by allowance (i.e. not in ―no asset‖ Ch. 7 cases) ii. Exception in Ch. 11 (§ 1111(a)) – proof of claim deemed filed if claim is listed on bankr. schedule, unless scheduled as disputed, contingent, unliquidated b. Notification of bankruptcy proceeding to creditors - § 342 i. If creditor was not listed or scheduled in debtor‘s schedule of creditors and thus does not receive notice of case in time to file a proof of claim, its claim will not be discharged in the case of an individual debtor – § 523(a)(3) ii. Also excluded where debtor listed incorrect address iii. Due process: can‘t eliminate claim if person did not get notice c. Time limit to file proof of claims i. Chapters 7, 11, 13 general rule: proof of claim ―timely filed‖ if it is filed not later than 90 days after the first date set for the § 341 creditors‘ meeting ii. Exception for claims of governmental units – § 502(b)(9) a. Timely if filed 180 days after date of the order for relief, or b. Timely if filed (in regards to tax claims in chapter 13 case), before 60 days after D files a return for such taxes iii. Tardily filed claims a. § 502(b)(9) – claim disallowed if not timely filed, except to the extent the tardy filing is permitted under 726(a)(1), (2), or (3) b. § 726(a)(1) – tardily filed priority claims still allowed and paid in first tier of proof is filed before: 1. 10 days after trustee mails to creditors a summary final report 2. If no report – trustee actually commences the final distribution

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c. § 726(a)(2) – tardily filed nonpriority claim still paid in second tier if creditor filed late because it did not have notice, and proof of time was still filed in time to permit payment 1. Pay timely nonpriority claims, then tardy nonpriority claims d. Effect of filed claim = prima facie allowed claim (unless someone objects) i. Payment order a. 1st tier – priority claims timely filed b. 2nd tier – nonpriority claims timely filed c. 3rd tier – tardily filed claims, generally ii. Objections a. Normally filed by trustee b. Court determines validity of claim & fixes the amount – § 502(b) 3. Grounds for Disallowance of Claims a. Claims arising after bankruptcy not allowed – § 502(b) a. Exceptions: for some claims that arise in pendency of bankruptcy case, but which are deemed for bankruptcy purposes to have arisen prior to case 1. Claims arising from rejection of an executory contract – § 502(g) 2. Claims arising from recovery of prop pursuant to trustee‘s avoidance powers – § 502(h) b. Substantive non-bankruptcy objections i. Bankruptcy doesn‘t give creditors new substantive rights against debtor ii. Bankruptcy estate succeeds to all defenses that debtor could have risen against creditor‘s claim – § 558 (e.g. expiration of SOL; material breach) c. Bankruptcy-specific disallowance of claims [listed in § 502(b)(1)-(9), (d), (e), (k)] i. Claim for unmatured interest not allowed – § 502(b)(2) a. Bankruptcy accelerates all obligations as of date of filing; stops the running of interest.

b. Exceptions:

ii. iii. iv. v.

vi.

1. Oversecured claims entitled to recover postpetition interest up to the amount of their excess security – § 506(b) 2. Solvent estates – § 726(a)(5) Tax assessed against property of the estate, to the extent the claim exceeds the value of the estate‘s interest in the property – § 502(b)(3) Claim for services of insider or attorney in excess of reasonable value of services – § 502(b)(4) Unmatured (postpetition) claims for alimony, maintenance, or support that are nondischargeable under § 523(a)(5) Limit on amount of landlord‘s rent claim – § 502(b)(6) a. Ceiling depends on remaining term of lease b. Lessor‘s allowable claim cannot exceed greater of: 1. 1 year‘s reserved rent, or 2. 15% of the remaining lease term (not to exceed 3 years‘ rent) c. Short-cut to § 502(b)(6) 1. If remaining term < 80 months, 1-year cap will apply 2. If remain term > 80 months and less than 20 years, 15% cap applies 3. If remaining term > 20 years, 3-year cap applies d. Exception: when lease is assumed and then rejected 1. All damages from rejection of an assumed lease generally are entitled to administrative expense priority under § 503, and § 502 rules generally are applicable only to prepetition claims allowed under § 501 2. § 503(b)(7) affords lessor an administrative expense claim in the amount of all sums due under the lease for 2 years after rejection, which can be reduced only to the extent the lessor mitigates the damages by re-letting 3. Any claim the lessor has for damages attributable to a lease term extending beyond such 2-year period are to be treated as a prepetition claim, to be allowed and limited in amount pursuant to § 502(b)(6) Limit on the amount of an employee‘s termination claim – § 502(b)(7)

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a. Employee-creditor restricted to compensation provided by the contract (without acceleration) for one year following the earlier of the filing of bankruptcy, or the termination of performance under the contract – § 502(b)(7)(A) b. Employee also entitled to any unpaid compensation due at earlier date – § 502(b)(7)(B) vii. Certain employment tax claims, relating to reduced tax credits upon late payment of tax – § 502(b)(8) viii. Tardily filed claims – § 502(b)(9) ix. Claim of a transferee of an avoidable transfer, if transferee has not paid the amount for which it is liable or turned over the property – § 502(d) x. Claim for reimbursement or contribution that is contingent or as to which a right of subrogation is asserted – § 502(e) xi. Reduction in the amount of a claim for a consumer debt if the creditor unreasonably refused to negotiate an alternative repayment schedule for the debt – § 502(k) a. Court will reduce claim by 20% - if proposed on behalf of debtor by an approved nonprofit budget and credit counseling agency b. D has burden of proving, by clear and convincing evidence, that C unreasonably ―refused to consider‖ D‘s proposal C. Distribution of Unsecured Claims 1. Overview a. Secured creditors are first to be paid (entitled to receive property or its value) b. Remaining assets then distributed to all general unsecured creditors (equality of distribution) 2. Chapter 7 a. § 726 provides for the order of distribution of claims; note: only applies to Chapter 7 cases, but is also applicable to other cases. b. Process: Trustee collects property of estate, reduces it to money, then distributes according to § 726(a) i. Six tiers of claims – all claims in each tier must be paid in full before any distribution is made to next tier ii. If estate does not have enough assets to satisfy all claims at a particular level, then all claims within that level share pro rata – § 726(b) iii. Tiers: a. Tier 1: Priority claims under § 507 (10 classes) b. Tier 2: Nonpriority unsecured claims (claim must be ―allowed‖) c. Tier 3: Tardily filed claims – § 726(a)(3) d. Tier 4: Noncompensatory penalty claims – § 726(a)(4) (fines, penalties, forfeitures) e. Tier 5: Unsecured creditors get postpetition interest on their allowed claim at legal rate – § 726(a)(5) f. Tier 6: Surplus after full satisfaction goes to debtor – § 726(a)(6) 3. Chapters 11, 12, & 13 a. Basic premise = debtor pays over time, out of future earnings, according to repayment plan b. Priority claims i. Reorganization plan may be confirmed by the court only if the plan provides for the full payment of § 507(a) priority claims ii. Holder of the claim may waive that privilege c. Non-Priority claims in Chapter 11 i. Determined by class – all class members treated alike ii. Plan designates classes of claims, specifies treatment, and provides the same treatment for each claim in a particular class – 1123(a)(1)-(4) iii. Only ―substantially similar‖ claims may be placed in same class – § 1122(a) iv. Class votes on plan (§ 1126) after receiving court-approved disclosure statement (§ 1125) a. Dissenting members of class are bound to majority class vote 1. Best interests test – § 1129(a)(7) [a] Protects class dissenter; class cannot force a claimholder to take less under plan than claimholder would get in Ch 7 liquidation

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b. ―Cram down‖ rules – § 1129(b) 1. Plan may be confirmed over negative vote of a class only if proponent seeks confirmation under & satisfies ―cram down‖ rules of § 1129(b) 2. Plan must not discriminate unfairly, and must be fair and equitable with respect to the dissenting classes [a] Any class senior to dissenting class may not be paid more than 100 cents on dollar [b] Any equal class may not be paid more than dissenting class, absent fair justification [c] No junior class can be paid unless dissenting class is paid in full v. At insistence of unsecured creditor, debtor must pay to creditors under the plan all of his ―projected disposable income‖ for a period of not less than 5 years – 1129(a)(15) d. Non-Priority claims in Chapters 12 & 13 i. Classes do not vote ii. Debtor proposes a plan, and court will confirm if statutory requirements are met – §§ 1225, 1324 iii. Creditor may object to confirmation – §§ 1224, 1324 iv. If debtor classifies claims, plan must provide for same treatment for each claim in a class – §§ 1222(a)(3), 1322(a)(3) v. Best interest test applies – §§ 1225(a)(4), 1324(a)(4) vi. Trustee, or any unsecured creditor can insist debtor devotes all of his ―projected disposable income‖ to payments for a minimum period of 3 years – §§ 1225(b), 1325(b) a. Minimum of 5 years, if at or above state median income D. Priority Claims 1. General principles a. Overview i. After secured claims are paid, priority claims then get paid ii. Reorganization must provide for full repayment of priority claims iii. § 507(a): exclusive list of priorities [courts have no discretion to establish non-statutory priorities] a. Only federal government may create bankruptcy policies b. State law priorities are preempted – but states can create lien that is applicable across board. iv. Courts narrowly construe priority provisions against claimant – violates equality principle b. Ranking of priority claims i. Claims in a higher class must be paid in full before claims of a lower priority class are paid anything ii. Within a priority class, all claims are of equal rank, so they will share pro rata if there is not enough to go around – 726(b) c. ―Super‖ priorities i. Statutory provisions – higher (super) priority a. § 364(c)(1) – postpetition lender (DIP financer) b. § 507(b) – adequate protection fails c. § 726(b) – ―burial‖ expenses – if chapter 11 if converted in chapter 7, administrative costs in 7 are paid before administrative costs in 11 d. De facto priorities i. Some code provisions not called priority rules, but practical effect is a priority ii. Ex) payments under collective bargaining agmt, prior to rejection § 1113(f) e. Priority order (§ 507) i. 1st – domestic support obligations – § 507(a)(1) ii. 2nd – administrative expenses – § 503(b) iii. 3rd – claims in an involuntary case that arise between time petition is filed and the bankruptcy relief is ordered – §§ 507(a)(3), 502(f) iv. 4th – employee wage claims – § 507(a)(4) v. 5th – unpaid contributions to employee benefit plans – § 507(a)(5) vi. 6th – grain producer and fisherman claims – § 507(a)(6) vii. 7th – consumer ―layaway‖ deposits – § 507(a)(7) viii. 8th – prepetition taxes – § 507(a)(8) ix. 9th – commitments to maintain capital of insured depository institutions – 507(a)(9)

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x. 10th – DUI caused death or injury claims – 507(a)(1) 2. Administrative expenses a. Get 2nd priority i. Administrative expenses allowed as claims under § 503(b) ii. Court fees & charges assessed against the estate – § 507(a)(2) iii. 9 types of administrative expenses – no ordinary preference, all of equal rank b. Not an exclusive list i. Court can recognize an unlisted admin expense, but only if it fulfills the statutory purposes ii. Courts strictly construe § 503(b) against claimant c. Prerequisites for most administrative expenses: i. Claim must be incurred postpetition in a transaction with the estate, and ii. Claim must benefit the estate d. Exception to postpetition requirement i. Seller of goods has a priority administrative expense for the value of any goods received by D within 20 days before petition date, as long as the goods were sold to D in the ordinary course of D‘s business – § 503(b)(9) ii. Seller‘s reclamation right for goods received on eve of bankruptcy – § 546(c) a. Those who sold goods on credit to debtor prepetition can enforce the reclamation right against debtor‘s bankruptcy estate b. Purpose of rule → encourages sellers to keep doing business on credit with a financially distressed debtor – form of inducement c. § 546(c) requirements – in kind reclamation 1. Goods must be sold in ordinary course of business 2. Goods received within 45 days before filing of petition 3. Debtor must have been insolvent when goods were received 4. Seller must make written demand for reclamation not later than 20 days after petition 5. Implicit in sellers right: goods must be in trustee or DIP possession; must be identifiable 6. Seller‘s reclamation right is subject to the prior rights of a holder of a security interest in the goods e. Categories of administrative expenses i. Actual and necessary operating and preserving expenses of the estate a. Operating expenses (rent, wages, insurance, utilities, trade credit, contracts, taxes, etc) b. Liquidating expenses (storage costs, sale costs like advertising & auctioneer fees)

a. Ex) fees and expenses of trustee, compensation of attorneys who work for estate, reimbursement of creditors and committee members b. Inducement principle – no one would do this if they could not get paid! f. Transaction with the estate i. Ex) D entered into prepetition K with C for ads, under which it was irrevocably committed to pay. C filed claim for administrative priority. (Jartran, p. 259) a. Court: claim did not arise from a transaction with a DIP, and was thus outside the scope of 503(b) b. It was the prepetition debtor and not debtor as DIP that induced C to perform services – deal was irrevocably committed prior to bankruptcy c. Need benefit + inducement g. What is a ―benefit‖? i. Reading Co. v. Brown (p. 264) a. Issue: whether tort claims from a negligently caused fire of an employee of the receiver during the receivership (predecessor to Ch 11) should be allowed as an administrative expense b. Court: tort claims entitled to administrative priority – actual & necessary expenses c. Prepetition general unsecured creditors could be viewed as the residual owner of the insolvent business at time bankruptcy is filed

ii. Compensation and reimbursement of entities that enable the bankruptcy process itself to function (i.e. people who work on the case)

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d. Should have to bear possible risks as well as rewards that might materialize during the bankruptcy proceeding 3. Other priorities a. Employees‘ claims i. Note that wage expenses for operating of business is actually going to be an administrative expense ii. 2nd priority: postpetition iii. 4th priority: 180 days prepetition, up to max of $10,950/employee for wages iv. 5th priority: benefits for the 180 day period, to the extent the $10,950 is not met v. No priority: prepetition wages & benefits, either > 180 days old or in excess of cap vi. Timing – from when services are performed, not when vested b. Taxes i. Tax debt is not dischargeable in the case of an individual debtor – § 523(a)(1)(A) ii. Postpetition taxes – 2nd priority administration expense iii. Prepetition – 8th priority, IF meet requirements of § 507(a)(8) a. Most important is income tax for past 3 years b. 3-year reach back: but all gov‘t need do is get a lien (then have a secured claim) c. Domestic support obligations i. 1st priority – prepetition claims ii. Alimony, child support iii. D‘s obligation to pay ongoing postpetition DSO‘s is paramount – must pay in full in reorganization cases to confirm iv. Additionally, prepetition debts for domestic support obligations are nondischargeable – § 523(a)(5) v. Debtor‘s failure to pay ongoing postpetition DSO obligations is grounds for conversion or dismissal of a chapter 11, 12, or 13 case d. Misc. Priorities i. Grain producers and fisherman – § 507(a)(6) ii. Consumer layaway deposits – § 507(a)(7) iii. DUI-caused death or personal injury claims – § 507(a)(1) → also nondischargeable Order of Distribution in Bankruptcy

1. Secured Claims

Fully Secured Debts ----- Secured Claim

2. Priority Claims

→ Paid in full plus interest and costs (to extent of equity cushion) Partially Sec‘d Debts ---- (a) Sec‘d Portion → Paid in full to extent of collateral (b) Deficiency → General unsecured claim

[Note: the priority classes denoted with an asterisk have dollar limits. To the extent that the claim exceeds the limit, it is a general unsecured claim] 1. Domestic Support Obligations 2. Administrative Expenses 1st Rank: superiority claims under § 364(c)(1) 2nd Rank: superiority claims under § 507(b) 3rd Rank: other admin. expenses under § 503 3. Ordinary-course business expenses in gap period between filing and order for relief, in involuntary cases 4. Wage and salaries (limited)* 5. Employee benefits (limited)* 6. Grain producers and fisherman – claims against processor or storehouse (limited)* 7. Deposits for consumer goods or services (limited)*

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3. General Unsecured Claims

8. Various taxes (limited)* 9. Claims arising out of federal depository insurance 10. Claims for wrongful death or personal injury resulting from debtor‘s driving while intoxicated

4. Claims for Fines, penalties, forfeiture, or punitive damages, which are not compensation for actual pecuniary loss 5. Interest on priority and general unsecured claims 6. Any surplus remaining goes to debtor
E. Subordination of Claims 1. Overview (§ 510) a. Subordination = demotion of a claim b. May result from agreement (consensual) or may be imposed by court (equitable) i. Consensual Subordination → Senior claimant may agree to subordinate its claim to induce another person to enter into a desirable transaction with debtor. § 510(a) recognizes such agreements and makes them enforceable in court ii. Equitable Subordination → Court has power to ―subordinate for purposes of distribution . . . an allowed claim to . . . another allowed claim‖ (§ 510(c)(1)‖ [to prevent inequitable results] 2. Conditions required to establish Equitable Subordination (Mobile Steel): a. PRONG #1: Claimant must have engaged in some type of inequitable misconduct; b. PRONG #2: Misconduct resulted in injury to creditors or conferred unfair advantage on the claimant; c. PRONG #3: Equitable subordination of claim must not be inconsistent with provisions of the Code 3. “Inequitable Conduct” (Prong #1) a. Courts have developed 3 general categories of ―inequitable conduct‖ sufficient to satisfy prong #1: i. Fraud, illegality, or breach of fiduciary duties; ii. Undercapitalization; and iii. A claimant‘s use of the debtor as a mere instrumentality or alter ego. b. Creditor as Insider i. Inequitable conduct sufficient to support a finding of equitable subordination is much easier to establish in the case of a creditor who is an insider or an alter ego shareholder of a corporate debtor. ii. SCOTUS frequently emphasizes the heightened fiduciary duties owed to a corporate debtor by an officer, director, or controlling shareholder. [Court will closely scrutinize the dealings of such insiders → if material evidence of unfair conduct by an insider is present, the burden will shift to the insider to prove good faith and fairness in its dealings with the debtor] iii. Courts are reluctant to subordinate the claim of an independent non-insider creditor → a creditor does not owe a fiduciary duty to the debtor or to other creditors in the collection of its claims. a. In Re Clark Pip and Supply, Inc – court held the creditor‘s claim should not be subordinated. In that case, the creditor steadily reduced its lending to the debtor and pursued a course of conduct that led to the payment of much of its own claim, as the debtor‘s financial position deteriorated. Court held that the creditor did not exercise such total control over the debtor‘s operations as to make the debtor its own instrumentality, but instead was merely exercising the rights it possessed under loan agreements that had been executed at arm‘s length) c. Is proof of inequitable conduct is always a necessary component of equitable subordination? i. UNCLEAR, but SCOTUS has held there SHOULD be inequitable conduct

[Includes balance of undersecured or limited priority claims together with all other claims proved and allowed and not covered by a priority category] 1. Timely filed general unsecured claims and late claims where creditor had no notice or knowledge of the case to file in time but filed early enough to be able to participate 2. Other tardily filed general unsecured claims

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ii. Nolad (1996) – Court cast doubt on propriety of equitable subordination in absence of inequitable conduct by the creditor. The claim subordinated by bankruptcy court was an admin expense claim for nonpecuniary tax penalties owed by the estate to IRS. Bankruptcy court subordinated claim even though IRS had not behaved inequitably on the grounds that it was unfair to pay nonpecuniary penalties ahead of the claims of general creditors. Although the Court did not decide if creditor misconduct must ALWAYS be found as a basis for subordination, it did hold that a court should not simply subordinate a claim bc it considered it unfair to pay it in priority over claims in a lower class. Chapter 6: Secured Claims A. Introduction to Secured Claims 1. Definition – What is a “Secured” claim? a. § 506(a)(1): A secured claim is an allowed claim of a creditor that is either: i. Secured by a lien on estate property, OR ii. Subject to setoff under § 553 b. Creditor entitled to enforce ―allowed secured claim‖ in bankruptcy if: i. Has an allowed claim, ii. Establishes it has a valid lien or right of setoff under nonbankruptcy law, and iii. That lien or setoff right is not avoided in bankruptcy c. Benefits of being a secured creditor i. Have priority over unsecured creditors in bankruptcy ii. Are entitled to be paid in full, up to the value of the collateral securing their claim, before unsecured creditors are paid at all. 2. What happens to estate property that is subject to a lien? a. Sale – if trustee wants to realize on property subject to a lien, all net proceeds must first be applied to the satisfaction of valid liens on the property b. Abandonment – if there is no equity in the property to pay unsecured creditors c. Exemption – if individual debtor claims exemption in equity value of property that is subject to a lien, trustee will abandon to D bc it has inconsequential value to estate d. Payment of lien – if debtor is not liquidating and wants to keep property, debtor must pay secured creditor its lien through the plan of reorganization e. Relief from stay – creditor can seek relief from stay to exercise its stay law remedies 3. Debtor’s mechanisms to prevent enforcement of lien a. In reorganization case, debtor can ―cram down‖ throat of an unconsenting secured creditor a proposed repayment of its allowed secured claim, but secured creditor must receive a stream of payments that, when discounted to present value, equals the amount of the creditor‘s allowed secured claim. b. Individual chapter 7 debtor must file a statement of intention with respect to retention or surrender of property, and if applicable, specifying that such property is claimed as exempt, that D intends to redeem such property, or that D intends to reaffirm debts secured by such property – § 521(a)(6) i. § 521(a)(2), (6): Debtor must redeem, reaffirm, or surrender collateral to secured creditor a. If a PMSI – after 45-day period stay terminates & prop no longer in estate if D does not EITHER: File statement of intention; OR Perform it ii. Redemption – D may redeem property by paying creditor the full value of its lien – § 722 a. Applies to collateral that is tangible personal property used for consumer purposes (i.e. personal, family, or household purposes) b. Payment must be in full at time of redemption – full retail price (not amount of debt) iii. Reaffirmation – agreement contains new payment terms for reaffirmed debt, typically allowing D to pay the secured creditor over time, rather than at once – § 524(c) c. § 521(a)(2)(B): Debtor must perform stated intention w/in 30 days after § 341 meeting of creditors i. If D fails to redeem/reaffirm within 45 days after first meeting, property immediately ceases to be property of the estate and automatic stay is terminated as to the property – 521(a)(6) ii. If D fails to file timely statement of intention or to timely perform its intention, property ceases to be property of the estate, and automatic stay terminates with respect to the property – 362(h)(1)

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B. Analyzing secured claims Analysis on exam: a. Does secured claim exist, and to what extent? i. Is the creditor‘s underlying claim ―allowed‖? ii. Is there a valid lien or setoff right under nonbankruptcy law? iii. Can the trustee avoid that lien in the bankruptcy case? iv. What is the value of the creditor‘s interest in the collateral? b. What is the substantive entitlement of the secured claim holder? c. By what procedural means may those substantive rights be enforced? 1. STEP 1: Does secured claim exist? a. ―Secured claim‖ defined at § 506(a)(1): i. An allowed claim that is secured by a lien; OR ii. An allowed claim that is subject to setoff under § 553 a. Lien defined broadly in § 101(37) as ―charge against or interest in property to secure payment of a debt or performance of an obligation‖ 1. Consensual lien – lien created by agreement (§ 101(51)) → ex: SI in personal property, mortgage, deed of trust on real estate 2. Judicial lien – obtained by judgment, levy, or other legal or equitable proceedings (§ 101(36)) [a] Ex) execution liens, judgment liens, garnishment liens, etc. 3. Statutory liens – liens arising solely by force of a statute on specified circumstances or conditions (§ 101(53)). [a] Ex) mechanic‘s lien, landlord‘s lien 4. NOTE: Underlying law controls: bankruptcy law doesn‘t create secured claims; claimant asserting lien on debtor‘s property must be able to establish that it obtained a valid lien b. Claim must be ―allowed‖ under § 501, 502 i. Normally claim is allowed if proof of claim filed under § 501 AND no grounds for disallowing the claim exist under § 502(b). c. Trustee‘s Avoidance Powers i. These powers that enable trustee to ―avoid‖ (i.e. set aside) a valid lien or a setoff right. ii. Upon avoidance, creditor relegated to unsecured status; collateral is freed from lien & becomes available for distribution to general unsecured creditor 2. STEP 2: Extent of Substantive entitlement? a. What is the extent of the SC‘s substanctive entitlement? i. § 506(a)(1) – Creditor‘s allowed claim is a secured claim... a. To the extent of the value of creditor‘s interest in the estate‘s interest in such property; OR b. To the extent of the amount subject to setoff under § 553 b. What is the valuation of Collateral i. Secured claim holder entitled to receive value of their interest in collateral ii. Entitled to have value protected iii. Not entitled to specific items, or specific processes c. I.e, it‘s a TWO-PART ANALYSIS: i. Estate‘s interest in collateral (entire interest, or share?) ii. Secured creditor‘s interest in the estate‘s interest (first lien, second lien?) 3. STEP 3: Procedure for SC to realize its substantive entitlement a. Adequate protection - § 361 i. Replaces secured creditor‘s nonbankruptcy remedies of seizure of sale ii. Maintains value of secured creditor‘s lien claim until claim can be satisfied b. Ways secured creditor might get paid i. Relief from stay granted – § 362(d) a. Can then go forward with state law foreclosure remedy, etc. ii. Collateral abandoned by trustee back to D, and is then still subject to secured creditor‘s lien rights – § 554

outside of bankruptcy

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iii. Collateral sold by trustee and net proceeds applied toward payment of secured creditor‘s claim – § 363 iv. Collateral redeemed by debtor – § 722 v. Secured creditor and debtor enter into a reaffirmation agreement – § 524(c) a. Debtor reaffirms personal liability on underlying debt and agrees to repayment schedule b. Permitted to retain collateral vi. Secured creditor‘s claim paid in lump sum or over time pursuant to confirmed reorganization plan vii. Collateral surrendered to secured creditor – § 725 4. STEP 4: Value the Collateral a. Rash; § 506(a)(1) & (2) [SEE BELOW] B. Valuation of a Secured Claim – § 506(a)(1) 1. Two competing sentences in § 506(a)(1) a. 1st Sentence: ―A claim is a secured claim to the extent of the value of such creditor‘s interest in the collateral.‖ b. 2nd Sentence: ―Such value shall be determined in light of the purpose of the valuation and of the proposed disposition or use of the property.‖ i. Question thus arises → Is the proper valuation focus (A) on the rights of the creditor in realizing on the collateral through forced sale (i.e. 1st sentence)? OR (B) on the value of the collateral to the debtor in its proposed use (i.e. 2nd sentence)? ii. In a typical reorganization plan in which debtor seeks to retain collateral, the 2nd sentence would require debtor to pay ―replacement value‖ as the price of keeping the property, an amount that would be higher than he ―forclosure value‖ produced under the 1st sentence. 2. Rash (1997) – CB p. 288 a. Re: valuation in context of cram down b. Facts: In Ch. 13 reorganization case, debtor proposed to keep a truck that was subject to a security interest. i. Under Ch. 13, debtor may keep collateral but plan must provide for debtor‘s payment of the present value of the secured claim. To peg truck‘s present value as low as possible, debtor argued that the liquidation value of the truck was the proper measure bc if the debtor‘s Ch. 13 plan did not provide for his retention of truck, creditor would foreclose & sell it at a forced sale. ii. Bc debtor proposed to keep truck, the ―proposed disposition‖ under § 506(a) was the truck‘s replacement value – a market standard based on what the debtor would have to pay to aquire the truck on the market. c. Court: Because the key to valuation is the proposed disposition/use, where debtor plans to retain the collateral, he must pay the REPLACEMENT VALUE i. So what does ―replacement value‖ mean? – [FN 6] a. Court says that it does not necessarily mean full retail value b. In calculating replacement value, may be appropriate to deduct the seller‘s costs of sale bc the debtor already owned the truck and would not actually be buying it (i.e. creditor should not receive portions of retail price that reflect the value of items that debtor does not receive when he retains his vehicle – like warranties, inventory storage, reconditioning) c. This is confined to the valuation of collateral in a Ch. 13 case – not clear how far if at all this application extends beyond Ch. 13 cases. 3. 2005 Amendments – § 506(a)(2) a. Amendment added subsection (a)(2) i. Partially codifies Rash & partly deviates from it ii. Subsection (a)(2) is confined to a narrow situation – where the valuation relates to personal property that is collateral for a scured claim in an individual debtor‘s case in Ch. 7 or 13. b. How (a)(2) Follows Rash i. Value of property must be based on replacement value of the property at date of the petition. c. How (a)(2) Deviates from Rash i. It rejects the Rash suggestion that it may be appropriate to deduct the costs of sale & marketing from the replacement value → (i.e. where (a)(2) applies, it calls for the use of the actual replacement cost on the market, without any deduction for the costs of sale or marketing)

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ii. Further, (a)(2) provides a definition of ―replacement value‖ that only applies where property is consumer goods (i.e. acquired for personal, family, or household purposes) then replacement value means the price a retail merchant would charge for property of that kind, consider the age and condition of the property at time of valuation 2. Combined Effect of Rash & § 506(a)(2) Amendment? a. In Ch. 7 & 13 involving individual debtor, personal property collateral must be valued under § 502(a)(2) replacement value, not taking sale costs into account b. In all other cases (e.g. Ch 13 cases involving real prop, or Ch. 7 & 11 cases involving real or personal property where the debtor is not an individual), § 502(a)(2) does not apply, but Rash might... i. Because Rash interprets the meaning of ―intended disposition or use‖ in § 506(a)(1), a good argument can be made that its interpretation is relevant beyond the narrow confines of the facts of the case. ii. Nevertheless, some courts have applied Rash narrowly and held that replacement value is NOT always the correct standard. 3. Valuation summary a. Full retail price – § 506(a)(2), 2nd sentence i. Individual debtor ii. Personal property iii. Chapter 7 or 13 iv. Personal, family, or household purposes (i.e. consumer purposes) b. Replacement value w/ no deductions for costs of sale or marketing, but possible deductions for warranties, storage, reconditioning – § 506(a)(2), 1st sentence i. Individual debtor ii. Personal property iii. Chapter 7 or 13 iv. Not for personal, family, or household use (i.e. for business use) c. Replacement value – all possible FN 6 deductions – 506(a)(1); (Rash) i. Any of the following: a. Corporate or partnership debtor b. Chapter 11 case c. Real property 4. Valuation Examples a. Facts: 5/1/04 D buys car & finances w/ PMSI to C. 5/1/06 files Chapter 7. i. Debt = $18K, Foreclosure value = $12K, Retail value = $15K, sale/marketing value = $500, warranties/reconditioning value = $1000 ii. To redeem under § 722 – 2nd sentence 506(a)(2) a. Individual D, personal property, chapter 7, acquired for personal use b. Pay full retail of $15,000, no deductions iii. Ex) For business use a. Can‘t redeem under § 722 – only if bought for consumer purposes iv. Ex) Files 13, wants to retain car a. ―Hanging paragraph‖ of 1325(a)(5) applies: 1. Motor vehicle 2. 910 days of bankruptcy 3. PMSI 4. Personal use b. D must pay full debt ($18K) – no bifurcation v. Ex) 13, wants to retain car, bought more than 910 days pre-bankruptcy a. No strip down prohibition b. 2nd sentence 506(a)(2) c. Full retail value = $15K (creditor gets $3K unsecured claim) vi. Ex) Ch. 13 filed 2 years after purchased; purchased for business use a. 506(a)(2) 1st sentence 1. Individual debtor, chapter 13, personal property (but not consumer use) b. Pay $14,000 (retail – warranties & reconditioning)

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1. No deduction for costs of sale/marketing vii. Ex) Filed chapter 11 a. 506(a)(2) does not apply – (must be chapter 7/13 case) 1. 506(a)(1) + Rash b. Pay retail ($15K) minus warranties & reconditioning ($1000), and minus costs of sale ($500) = $13,500 5. Cram down & Valuing of Interest Rates (§ 1325(a)(5)(B)) a. Cram down: To qualify for court approval, an individual debtor‘s Ch. 13 plan must accommodate each allowed secured creditor in one of 3 ways: a. (a)(5)(A): by obtaining the creditor‘s acceptance of the plan; b. (a)(5)(B): by providing the creditor both a lien securing the claim and a promise of future property distributions (such as deferred cash payments) whose total value, as of the effective date of thee plan. . . is not less than the allowed amount of such claim‖ c. (a)(5)(C): by surrendering the property securing the claim; OR ii. ―Allowed amount‖ a. Principal amount of the claim b. Goes to the value & extent of secured claim itself – § 506(a), Rash iii. ―As of the effective date of the plan‖ a. Means that the stream of payments made over the life of the plan must be discounted to b. Interest = the price of money 1. Compensation a borrower must pay for the use of money over time 2. Borrower must repay principal + interest

1. (a)(5)(B) is called the ―cram down‖ option bc it may be enforced over a claim holder‘s objection!

present value

a. Courts have developed several different methods for determining the proper cramdown interest rate, each of which purports to be determining ―market rate‖... (see next) b. Competing approaches to the interest rate for cram down: i. Rate based on the creditor‘s cost of borrowing – Several courts have agreed with debtors that present value under §1325(a)(5)(B) is provided to a secured creditor by paying an interest rate

iv. ISSUE ARISES = what is the ―appropriate amount of interest‖?

collateral. Borrowing an amount equal to the value of the collateral would put creditor in this same position. All that is then required is that the debtor pay interest equivalent to that charged on the creditor‘s loan, and the creditor is made whole. ii. Rate based on risk presented by the debtor‘s borrowing – Majority of circuits (Till) adopt this; emphasizes that creditors may not be able to borrow the funds lost to them through inability to foreclose; this approach therefore requires that creditor be paid the profit that would have been iii. Rate based on generalized determination of risk - Calculates the appropriate interest rate for cram down by adding a ―risk factor‖ interest rate to some standard measure of ―risk-free‖ lending. i. i.

equivalent to what the creditor would have to pay to borrow money—the ―cost of funds‖ approach. Theory is that, absent bankruptcy, creditor would foreclose and obtain the value of the

obtained had the creditor been able to make a new loan in the amount of the collateral value of the property retained by the debtor

c. Till – p. 291

8 justices agreed: Cram down interest rate must fully compensate creditor for risk of default by debtor, and fixing the rate necessitates an inquiry into the market for interest rates in light of the specific risks posed by this debtor Plurality vs. Dissent: Plurality says start with prime rate and adjust up; Dissent says start with presumptive contract and adjust upward. a. Plurality says prime plus bc court should select a rate high enough to compensate creditor for its risk but not so high as to doom the plan b. Result = systematic undercompensation for true risks of default – Scalia

B. Valuation & Strip Down of Undersecured Creditor’s Claim

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1. Overview a. Undersecured Creditor defined: collateral securing creditor‘s claim is worth less than the total claim [Ex: debt of $20k secured by collateral worth only $15k] b. § 506(a)(1): Undersecured claims are bifurcated into 2 claims: i. A secured claim in the amount of the value of the collateral, AND ii. An unsecured claim for the deficiency a. [in Ex above: creditor would be deemed to hold a secured claim of $15k (the collateral value) and an unsecured claim of $5k (difference between total claim and secured claim)] c. ―Lien stripping‖ – A strategy whereby debtor attempts to peg an undersecured debt (or a debt that has become unsecured) at the value of the collateral as determined by bankruptcy court, so that if the collateral appreciates after the bankruptcy case, the lien (which survives bankruptcy) cannot extend to the increase in equity but is frozen at the bankruptcy valuation. i. STRIP DOWN → Where lien is undersecured, the fixing of the amount of the lien at the current value of the collateral is called ―strip down‖ ii. STRIP OFF → If lien has become fully unsecured (bc it is a junior lien & the senior lien has taken up full value of collateral), the fixing of the lien at zero is called ―strip off‖ d. Example: In Ch. 7 case, the collateral is a sculpture securing a claim of $6,000. Based on appraisal, the court fixes the value of the sculpture at $5,000, giving the creditor a secured claim of $5,000 and an unsecured claim of $1,000. Bc the sculpture has no value to the estate, the trustee abandons it to the debtor. Creditor has the right to apply for relief from stay & to foreclose on the security interest immediately, but it does not do this for 6 months. In the interim, the value of the sculpture rises to $5,500. i. If the increase in value is added to the secured claim (i.e. without stripdown), it reduces the unsecured deficiency to $500. ii. But if the secured claim is pegged at the $5,000 value originally fixed by the court, the appreciation of $500 belongs to the debtor. e. Strip Down comes into play under §1325(a)(5) – where under cram down, the debtor keeps collateral but the secured creditor retains lien and has unsecured claim for deficiency 2. Strip down prohibitions [Exceptions to bifurcation of undersecured claim] a. Home Mortgages i. Cannot strip down mortgage in Ch 13 or 11 [§§ 1322(b)(2); 1123(b)(5)] a. To keep home, debtor must keeping paying the home mortgage on the original terms (principal amount + K interest rate) b. All debtor can do to a mortgage against the wishes of mortgagee (creditor) is to cure a default, and if secured creditor already accelerated, reinstate the original terms. ii. Completely underwater – with second mortgage: a. Ex) home worth $120K, 1st mortgage = $150K, 2nd mortgage = $25K b. Under § 506(a)(1) the 2nd mortgage is completely unsecured – has no collateral value. 1. Where home mortgage is totally valueless, courts allow debtor to treat the 2nd mortgagee has the holder of a secured claim of $0 2. Thus allow debtor‘s plan to strip off the mortgage and treat the 2nd mortgagee solely as the holder of an unsecured claim 3. Significance: post-bankruptcy, home no longer secures 2nd mortgages and debtor will own home free & clear once 1st mortgage satisfied iii. NOTE: Vacation home – can strip down, because anti-modification rule applies only to mortgage on debtor‘s ―primary residence‖ b. 910-day car loan exception – § 1325(a)(5) i. Prohibits strip down of many purchase money security interests (PMSI) for purposes of chapter 13 cram down ii. No strip down if: a. Creditor has PMSI securing the debt that is subject to the claim; b. Debt was incurred within 910-day period preceding petition filing; c. The collateral is a ―motor vehicle‖ acquired for the debtor‘s personal use iii. ―Any other thing of value‖

c. ―Strip off‖

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a. PMSI b. ―Any other thing of value‖ c. 1 year of bankruptcy iv. Result of prohibitions a. Cannot strip down the ―allowed secured claim,‖ because the only way to do so is via 506(a)(1) bifurcation b. However, can still use a lower cram down interest rate, because still do apply 1324(a)(5)(B) 1. Still cannot use cram down interest rate on primary residence homes c. Where debtor proposes to surrender collateral (under § 1325(a)(5)(C)) i. § 506 (which provides for bifurcation), no longer applies ii. So if debtor surrenders collateral, does creditor still enjoy an unsecured claim for the deficiency that can be asserted in the bankruptcy case? a. Majority of courts: No. plain meaning of hanging paragraph precludes creditor from asserting an unsecured claim for the deficiency remaining after foreclosure of a ―910‖ vehicle surrendered under 1325(a)(5)(C) b. Minority approach (In Re Wright): Yes. Creditor still has an unsecured claim – comes from state law rule under Art. 9 for an unsecured claim for deficiency of the collateral. C. Surcharging Secured Creditors: the Clash with Priority Claims 1. Secured creditors might not always recover the full value of their collateral 2. § 506(c): trustee may recover from property securing an allowed secured claim the reasonable, necessary costs & expenses of preserving/disposing of such property a. Example: Where collateral is being sold at auction, costs directly related to sale may be paid from proceeds (e.g. appraisal fees, auctioneer fees, advertising/marketing costs, storage expenses, etc.) b. Who benefits? i. Trustee argues that bankruptcy case (usually reorganization) more generally benefits the secured party by allowing secured party to recover a higher going concern value for its collateral. ii. However, prevailing view limits § 506(c) recoveries to cases involving direct and immediate benefits to the creditor‘s collateral, OR clear consent. iii. General rule: administrative expenses of bankruptcy case are payable only out of the unencumbered assets of the estate, not out of collateral 3. Hartford Underwriters (SCOTUS 2000) – p. 318 a. Facts: Hen House filed for reorganization under Ch 11. During reorganization attempt, Hen House obtained workers comp policy from Hartford. Hen House failed to make monthly premium payments required by policy. Ultimately, Hen House's reorganization failed & Court converted it to a Ch 7 liquidation case & appointed a trustee. Hartford, learning of the bankruptcy proceedings, sought to recover its premiums as an admin expense. Recognizing that estate lacked unencumbered funds to pay the premiums, Hartford attempted to charge the premiums to Union Planters Bank, the secured creditor for all of the property of Hen House, by filing a claim under § 506(c). b. Issue: Does § 506(c) allow an administrative claimant in a bankruptcy case to seek payment of its administrative claim from the property of a bankrupt estate encumbered by a secured creditor's lien? c. Holding: No. § 506(c) does not provide an administrative claimant an independent right to seek payment of its claim from property encumbered by a secured creditor's lien, or subject to secured claims. Plain meaning of § 506(c) = no one other than trustee has a right to seek payment of administrative claims d. Under what circumstances is it appropriate to surcharge the secured creditor‘s collateral to pay the administrative expense claims of other parties? i. § 506(c) surcharge allowed in this circumstance when either: a. The secured creditor is benefitted by the claimed expenditure, or b. The secured creditor consents to the expenditure Chapter 7: Relief from Stay and Adequate Protection A. Introduction to Relief from the Automatic Stay 1. Relief from Stay – § 362(d)

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2.

3.

4.

5.

a. An order from bankruptcy judge giving a party (usually secured creditor) permission to go ahead w/ some action (usually foreclosing collateral) that would otherwise be stayed under § 362(a) and not excepted under § 362(b). b. Court may grant such relief from stay where creditor‘s right to continue the stayed activity outweighs the interest of the estate/debtor in suspending it. Grounds for Relief from Stay – § 362(d)(1)-(4) a. Upon request of party in interest & after notice/hearing, Court SHALL grant relief from stay (such as by terminating, annulling, modifying, or conditioning such stay): i. § 362(d)(1): for ―cause‖ – including lack of adequate protection. ii. § 362(d)(2): if debtor has no equity in property AND property not necessary for effective reorganization iii. § 362(d)(3): SARE (single asset real estate). If debtor does not file feasible plan in 90 days, must pay interest to secured party for the delay) iv. § 362(d)(4): in rem stay relief in fraudulent schemes Burden of Proof – § 362(g) a. Movant – debtor has no equity – under § 362(d)(2)(A) b. Trustee or Debtor in Possession (DIP) – i. Secured party is adequately protected – § 362(d)(1) ii. Property is necessary to an effective reorganization – 362(d)(2)(B) Time periods a. Expedited time periods within which the court must act, or secured party gets relief b. § 362(e): 30 days: court must either rule, or find ―reasonable likelihood‖ trustee will win if continue to final hearing. Then, if carry over to final hearing, must enter final decision within another 30 days c. § 362(f): Emergency ex parte relief may be available – ―Irreparable damage‖ test Relief from Stay is Mandatory (“shall”) a. If secured party proves ground for relief under § 362(d), court required to order relief from stay b. Does not necessarily have to lift stay; might condition stay (e.g. on DIP making adequate protection)

B. Relief from Stay for Lack of Adequate Protection – § 362(d)(1) 1. Basic application a. Adequate protection is a fundamental substantive right of secured party in bankruptcy to receive the value of its collateral (§ 361) i. However, secured party‘s nonbankruptcy remedies are not necessarily honored in bankruptcy, so adequate protection replaces the remedies. b. Adequate Protection comes up in a number of bankruptcy provisions: i. § 362(d)(1): Stay relief (any attempts by SP to enforce its lien are stayed, but relief from stay will be granted unless creditor receives adequate protection); ii. § 363(e): Estate wants to use/sell/lease estate prop on which SP has a lien; iii. § 542(a): Turnover (creditor repossessed collateral prior to bankruptcy; court may order creditor to turn over collateral to trustee) – § 542(a) iv. § 364(d): Estate wants to borrow money & put up SP‘s collateral as collateral for a new loan. c. What will suffice as ―Adequate Protection?‖ – § 361 i. When adequate protection is required by § 362 (Automatic Stay); § 363 (Use sale or lease of property); or § 364 (Obtaining credit), it may be provided by one of the following: a. § 361(1): Trustee paying SC money to compensate for decline in value of collateral that results from stay of action, use/lease/sale of prop, or obtaining credit; b. § 361(2): Giving SC a lien on other collateral to make up for decline in value of collateral; OR c. § 361(3): Granting any other relief that will result in the realization by the SC of the ―indubitable equivalent‖ of the SC‘s interest in the collateral 1. Example: personal guarantee from financially responsible entity 2. Note – ―any other relief‖ cannot include giving the SC compensation as an administrative priority under § 503(b)(1) and have that suffice as adequate protection. . . UNLESS AP fails & superpriority under § 507(b) is implicated (see next) d. The Failure of Adequate Protection: ―Superpriorty‖ Under § 507(b)

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The determination that an interest is adequately protected is based on evidence of present value and predicted future value. But this evidence is speculative & could be wrong (in which case the interest is not adequately protected – i.e. AP fails) ii. § 507(b) provides a remedy for secured creditor in this situation – it states that if trustee provided adequate protection to claimant and the protection turned out to be inadequate, the shortfall is treated as a priority claim that ranks at the top of the administrative expense priority category. [remember: admin expenses are paid as a second priority under § 507(a)(2)] 2. Adequate Protection & The Opportunity Cost of Delay a. Issue: Whether a secured creditor is entitled to compensation not only for the petition-date value of its lien, but also for the time value of its lien interest b. In the case of OVERSECURED creditors → Oversecured creditor not entitled to adequate protection payments to preserve amount of its equity cushion, where value of collateral is constant but equity cushion being depleted by postpetition interest (Alyucan – p. 332) i. Adequate protection is about protecting the value of the collateral during the pendency of the case – as long as collateral is safe and not depreciating, creditor is not suffering any harm. ii. But where equity cushion being eaten up by both the accrual of postpetition interest and depreciation in value of collateral, courts are split – some allow SP to maintain the value of the collateral as of the petition date c. In the case of an UNDERSECURED creditors → Adequate protection does not entitle an undersecured creditor to receive compensation for delay in foreclosing caused by the automatic stay (Timbers – OPTIONAL at p. 337) a. No ―opportunity cost‖ payments for undersecured creditors b. Adequate protection protects value of collateral during pendency of case c. Winner = residual stakeholders (unsecured creditors or equity) – in effect get an interest-free ―loan‖ for duration of case d. Loser = secured creditor – lose time value of money e. Relief under § 362(d)(3) – applies to SARE debtors 1. No relief if: [a] Debtor files feasible plan (―reasonable possibility of being confirmed within a reasonable time‖) within 90 days after petition, OR [b] If debtor did not file feasible plan, begins paying monthly interest, computed on value of collateral 2. Overrules the Timbers no time-value rule in the special SARE context C. Relief from Stay where Debtor has no Equity AND Property is not necessary to effective reorganization – § 362(d)(2) 1. Overview a. Grounds for Relief under § 362(d)(2)(A) & (B): i. Debtor has no equity in the property [BOP on creditor], AND ii. Property not necessary to effective reorganization a. Burden of proof: on party opposing stay relief

i.

2. Regardless of need, whether successful reorganization is feasible (―effective‖) b. How grounds show bankruptcy need i. ―No equity‖ ground → If debtor has equity, then estate could sell collateral & capture that equity for benefit of unsecured creditors, and still pay off SCs ii. ―Not necessary for effective reorganization‖ ground → If debtor has chance to reorganize under Ch 11 and it needs the collateral to do so, keeping the property (and giving SC adequate protection) furthers reorganizational goal 2. Lack of equity in the property – § 362(d)(2)(A) a. Compute from viewpoint of estate, not from that of moving creditor i. Total up all liens and compare property value ii. Reason is that you are trying to determine if estate would get any $ if it sold the collateral and paid off all the liens

b. Two more inquiries then arise: 1. Whether DIP in fact needs the collateral if it is to be able to reorganize (―necessary‖)

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b. Valuation of collateral i. In Ch 11 case – value under § 506(a)(1) and Rash a. ―Proposed disposition or use‖ is that debtor is keeping collateral, but the purpose of the valuation is to determine whether estate would capture any $ over and above liens if it sold the property b. So, arguably should use liquidation value ii. In Ch 13 case, if personal property collateral, valuation under § 506(a)(2) a. Some version of replacement value b. Even though the purpose of the valuation is what the estate would get if it sells the collateral, which means should use liquidation value iii. In Ch 7 case, only issue under § 362(d)(2) will be equity a. If individual debtor & personal property – stuck with § 506(a)(2) replacement value [hurts SC here bc makes it harder to get stay relief (begin w/ a higher value)] 3. Necessity – § 362(d)(2)(B) a. Property at issue must be necessary to an effective reorganization b. Almost always find necessity – courts defer to DIP‘s business judgment 4. Feasibility – § 362(d)(2)(B) a. Usually the fight is over feasibility → whether the debtor has a ―reasonable possibility of a successful reorganization within a reasonable time‖ b. Timing matters i. Early in the case, bar for DIP to show feasibility is low ii. After that, the court will become more stringent c. Way to win for certain i. SP can prevail, even early in the case, by showing that the plan DIP is putting forward is legally unconfirmable without SP‘s consent ii. I.e., if under plan confirmation rules (1129(a)&(b)), plan could be vetoed by SP d. Nature of proof i. Some concrete evidence of actual and realistic reorganizational prospects ii. Make a legitimate business case, with documentation, financials, market analyses, etc. e. Pegasus (2nd Cir. 1999) – p. 348 – Plan ―not feasible‖ bc it was ―entirely conjectural‖ and made ―unfounded assumptions and dubious calculations.‖ D. Stay relief under § 362(d)(3) for SARE 1. Debtor must do 1 of 2 things to keep the stay in effect: a. File a feasible reorganization plan within 90 days (or time extended for cause) i. ―Reasonable possibility of being confirmed within a reasonable time‖ b. Start making monthly interest payments to SC i. Based on value of the lien (i.e. collateral value) ii. Rate of interest = applicable nondefault contract rate 2. “Single asset real estate” (SARE) – § 101(51B) a. Definition: i. Real estate that is ―single property or project‖ ii. ―Generates substantially all of the gross income of a debtor‖ iii. ―On which no substantial business is being conducted by a debtor other than the business of operating the real property and activities incidental thereto‖ b. Exclusions: Residential real estate with less than 4 units; Family farm c. Other substantial businesses i. If debtor makes virtually all of their money from operation of real estate itself, then SARE ii. Classic example: Limited partnership owns apartment complex/office building; income flow is solely the rents generated by that property iii. Ex) Sole asset is golf club (course, pro shop, driving range, pool; adjacent land for sale) a. Court: not SARE debtor, running the golf course, pool, etc. was the operation of a substantial business other than just holding the real property to generate income

OR

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E. Automatic Stay and Abusive Serial Filings 1. Overview a. Automatic nature of the stay invites abusive serial filings by people who would are not invoking the stay to accomplish any of the legitimate purposes of a bankruptcy filing, but rather to repeatedly interrupt and thereby frustrate a particular creditor‘s exercise of state-law remedies. b. Comes up a lot in mortgage foreclosures & in landlords‘ attempts to evict tenants c. Fact Pattern: debtor facing foreclosure files voluntary ―face sheet‖ petition, containing bare minimum necessary to commence case under § 301(a)— thereby automatically staying the foreclosure action 2. Provisions enacted to combat serial filing a. § 109(g) – an individual is an ineligible bankruptcy debtor if she was a debtor in a bankruptcy proceeding pending within the preceding 180 days that was dismissed by the court for willful failure of the debtor to abide by orders of the court or to appear before the court. b. § 362(b)(21)(A), (B) i. (A) – a subsequent bankruptcy petition filed in violation of 180-day refilling bar does not give rise to an automatic stay. ii. (B) – in dismissing a bankruptcy case, court can order a refilling ban is not limited by terms of § 109(g), and any ―subsequent petition filed in violation of a bankruptcy court order in a prior case . . . prohibiting debtor from being a debtor in another case will not give rise to automatic stay.‖ c. § 362(c)(3), (4) i. (3) – if an individual debtor‘s Ch 7, 11, or 13 case is commenced within 1 yr of the dismissal of an earlier case [other than dismissal under § 707(b)], the automatic stay in the second case will terminate 30 days after the petition filing, absent an affirmative demonstration that that subsequent case was filed in good faith, and thus, the automatic stay should continue in effect. ii. (4) – if subsequent case is filed on the heels of two dismissals within the previous year, ―the stay shall not go into effect upon the filing of the later case unless . . .‖ d. § 521(i) i. an individual debtor‘s failure to file financial schedules, statements, and certificates required by § 521(a)(1) within 45 days after petition date will result in automatic dismissal of case. 3. In Rem Stay Relief – § 362(d)(4) a. ―Fractional interest‖ transfer schemes → a homeowner transfers small portions of its interest to dozens of people, and one of these people files a ―face sheet‖ bankruptcy action staying foreclosure of his interest in the property b. § 362(d)(4) enacted to combat this practice – allows an alternative ground for relief from stay of an act against real property ―that the filing of the petition was part of a scheme to delay, hinder, or defraud creditors,‖ involving either: i. (A) transfer of any interest in the real property without consent of the SC; OR ii. (B) multiple bankruptcy filings affecting the same real property 4. Eviction Actions – § 362(b)(22) a. 2005 amendments added new stay exception [§ 362(b)(22)]: a bankruptcy filing does not stay a lessor‘s eviction of a residential tenant-debtor if the lessor ―obtained a judgment for possession of such property against the debtor‖ before commencement of the bankruptcy case. Chapter 9: Trustee’s Avoidance Powers A. Introduction 1. List of Trustee’s Avoidance powers – CB pp. 452-53 a. § 547: avoidance of prepetition preference transfers b. § 549: avoidance of postpetition preference transfers c. § 553: avoidance of setoffs to the extent they involve disallowed claims or arose out of certain transactions within 90 days prior to petition. d. § 545(1): avoidance of statutory liens that become effective only in the event of insolvency or bankruptcy; § 545(2): avoidance of unrecorded statutory liens e. § 544: avoidance of transfers and liens that could have been avoided under nonbankruptcy law by an actual unsecured creditor or by specified hypothetical claimants [strong-arm clause of (a) applies to liens that have not been perfected by the time petition is filed]

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2. Meaning & Effect of Avoidance a. What is Avoidance? i. Enables trustee to set aside certain transactions entered into by debtor ii. Most avoidance powers aimed at transfers of property by debtor, but some apply to obligations assumed by the debtor. iii. Two very important avoidance powers: a. § 547 preferences b. § 548 fraudulent conveyances/transfers iv. ―Avoidance‖ means that the transfer or obligation assumed by debtor is being set aside, or invalidated, pursuant to court order. v. Part of trustee‘s function to collect estate property & maximizing estate value vi. Trustee‘s avoidance powers = a qualification on the general rule that property enters the estate only to the extent that the debtor has an interest in the property (as determined under nonbankruptcy law). b. Premise & Goals of Avoidance i. Maintain integrity of bankruptcy as collective proceeding by protecting creditors from each other a. Preserve equality paradigm; avoid transfers that undermine;recover value b. Invalidate secret liens and transfers ii. Protect creditors from debtor action (e.g. fraudulent transfer) c. Effect of Avoidance – Depends on what‘s being avoided: (1) a transfer of property, or (2) a lien... i. If Transfer of Property: trustee will then attempt to recover property transferred (or its value) under § 550 ii. If Lien/Obligation assumed by debtor: lien eliminated; property free from lien & SC relegated to unsecured creditor status, or alternatively lienholder can retain lien & pay trustee for lien‘s value d. Recovery of Property following Avoidance i. Avoidance doesn‘t automatically bring money/value into estate. Rather, if something is avoidable, trustee must afterwards bring action under § 550 to recover property or its value: a. § 550(c) – trustee may not recover from a non-insider based upon a transfer made more than 90 days before bankruptcy that is avoided only as against the insider b. § 547(i) – if trustee avoids transfer to non-insider for benefit of an insider that was made between 90 days & 1 year before petition, the transfer is only considered to be avoided w/ respect to the insider creditor. ii. Recovery from whom?

a. Initial transferee – § 550(a)(1)

1. Secondary transferee is protected to the extent that it took for value, in good faith, and without knowledge of the voidability of the transfer – 550(b)(1) 2. Principle of derivative title – transferee taking from or through a protected transferee is similarly protected, if taken in good faith – 550(b)(2) c. § 550(d): Trustee may choose (a)(1) or (a)(2), but only a single satisfaction d. § 502(h) – if property is received from an entity under § 550, entity will have a general unsecured claim against estate (if otherwise allowable) e. Preservation - § 551 i. An avoided transfer is automatically preserved for the benefit of the estate with respect to property of the estate a. Applies to transfers avoided under §§ 522, 544, 545, 548, 549, or 724(a)

b. Subsequent transferee – § 550(a)(2)

1. Trustee has absolute right to recover from either the initial transferee, or the entity for whose benefit for transfer was made [a] Benefit – Ex) if debtor paid of a guaranteed debt, it also ―benefits‖ guarantor 2. Party is subject to strict liability 3. Rationale: burden of inquiry and risk of whether conveyance is fraudulent is placed on him – in best position to monitor 4. Mere conduit? [a] First party in the chain of possession who has independent dominion and control over the property, or who has a legal right to apply the property to his own purposes

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ii. Ensures estate will capture the economic value of the avoided transfer by stepping into the transferee‘s shoes [preserves status quo] iii. Ex 1) $20k property subject to $10k avoided senior lien & $25k junior lien → estate takes place of avoided senior lien – receives first $10k. iv. Ex 2) if there are 2 valid security interests in one piece of estate property, with the first having priority over the second. If the senior interest is avoidable in bankruptcy but the junior interest is not, the trustee avoids the senior interest and is then able to assert its priority over the junior one. a. Were it not for § 551, the avoidance of the senior interest would simply promote the junior lien, so that it becomes first in line as a claimant to the proceeds of the property. b. § 551 ensures that when the trustee exercises the avoidance power, it is the estate rather than he holder of the junior lien that benefits from the avoidance. 3. Statute of Limitations for Avoidance & Recovery a. There are SOLs within which trustee must act to assert avoidance powers and to recover property b. § 546 requires that actions for avoidance be commenced at the latest before the case is closed [§ 546(a)(2)]. However, the closing of the case is the outside limit; even if the case is not yet closed, the limitation period ends on the later of: i. 2 years after the entry of order for relief, OR ii. 1 year after appointment or election of first trustee, IF that appointment or election occurs before the 2 year period. [§ 546(a)(1)]. c. § 550(f) – Actions to recover prop following avoidance must be commenced within the earlier of: i. One year after the transfer has been avoided; OR ii. By the time the case is closed or dismissed.

B. Trustee’s Avoidance Powers as Hypothetical Lien Creditor or BFP of Real Property – § 544(a) 1. Overview a. Basic idea of § 544 is that trustee should have same avoidance rights that would be available in nonbankruptcy to the classes of persons identified in § 544 b. § 544(a) ―strong arm clause‖ confers 3 hypothetical roles on trustee: i. Judicial lienholder (§544(a)(1)) ii. Unsatisfied execution creditor (§ 544(a)(2)); and iii. Bona fide purchaser of real property (§ 544(a)(3)) c. Trustee‘s assumption of any of these hypothetical positions is not dependent on the existence of an actual creditor or purchaser. trustee is not a successor to the existing rights of any person, but rather obtains the status as a matter of law. i. NOTE: DON‘T PAY ATTENTION TO § 544(a)(2) → not really used 2. Four General Principles of § 544(a) a. Time frame is the time that bankruptcy case is commenced b. Each subsection of § 544(a)(1)-(3) gives trustee different powers:

c. Actual knowledge is irrelevant – trustee is deemed not to have knowledge d. Availability of avoidance i. Who wins under § 544(a) depends on who would have priority under governing law in a contest between holder of the security interest on the one hand & lien creditor, execution creditor, or BFP on the other. ii. Governing law under § 544(a)(1) = UCC Art. 9 iii. Governing law under § 544(a)(3) = state real property recording law 3. Trustee as Lien Creditor – § 544(a)(1)

i. (a)(1) trustee as a judicial lien creditor ii. (a)(2) trustee as an unsatisfied execution creditor; iii. (a)(3) trustee as a bona fide purchaser of real property.

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a. Overview - Gives trustee power to avoid any transfer of property or any obligation incurred by debtor that would be avoidable in nonbankruptcy law by a creditor who holds a judicial lien on all the debtor‘s property as of date of petition [Judicial lien defined in § 101(36)] b. Under Art. 9, an unperfected security interest loses to a ―lien creditor,‖ thus § 544(a)(1) empowers trustee to avoid a security interest that is unperfected at the time of commencement of case (the same way a lien creditor would win out over the unperfected security interest -- essentially allows trustee to step into shoes of imaginary lien creditor) c. Purchase money relation back (PMRB) exception i. In nonbankruptcy law, a SC holding a PMSI is given a 20-day grace period to perfect after debtor takes possession of property purchased w/ the PMSI ii. Perfection w/in grace period deemed to relate back to the time of attachment iii. Postpetition perfection of the security interest would not violate the automatic stay – § 362(b)(3) 4. Trustee as bona fide purchaser (BFP) of real property – § 544(a)(3) a. Vests trustee with rights & powers of a bona fide purchaser (BFP) → If under state law, BFP would prevail over unrecorded interest, then transfer of the unrecorded interest may be avoided b. Knowledge

i.

Ask – was the security interest perfected at the INSANT the case was filed?

i.

Actual knowledge of DIP/trustee irrelevant

a. Ex) adverse possession, or prebankruptcy purchaser who failed to record is in possession b. Bankruptcy gives effect to a notice that is good against the world (and thus acts as a substitute for recordation) c. Where D holds legal title subject to unrecorded equitable interests i. Nonbankruptcy law would permit D to convey prop to BFP, free of unrecorded equitable interests ii. Under bankruptcy law, only D‘s legal interest becomes property of bankruptcy estate, and equitable interests of others remain outside the estate - § 541(d) a. Majority view: avoidance permitted b. Minority view: avoidance should be denied C. Trustee’s Avoidance Power as Successor to Actual Creditor’s Power – § 544(b) 1. § 544(b) gives bankruptcy trustee the power of actual unsecured creditor to avoid transfers under the applicable nonbankruptcy (state) law IF: a. Actual creditor exists who has power under applicable nonbankruptcy law to avoid a transfer by debtor, AND b. Creditor holds an allowable unsecured claim in the bankruptcy case (§ 502) 2. Concept = if unsecured creditor has power to avoid, trustee should be able to take over that power for the benefit of all creditors! 3. Adds state fraudulent conveyance law to trustee‘s avoiding power a. Most cases decided under § 544(b)(1) involve FTs i. But note that 544(b)(1) often not needed bc § 548 gives trustee power to avoid FTs (see below) b. Longer reach-back period (up to 4 years instead of 2) i. Under § 544: trustee can avoid transfer made within 4 years before filing ii. Under § 548: trustee only has 2 year reach back period c. Might avoid certain transfer that § 548 would not i. Extent of Avoidance → Entire transfer is avoided, no matter how small the claims of the creditors whose standing the trustee assumes ii. Distribution → All creditors of the estate share in the recovery, even those who could not have avoided the transfer.

ii. Constructive notice – cannot be ignored

a. Still can avoid even w/ knowledge – ―without regard to actual knowledge‖

d. Some Charitable Contributions not treated as ―transfers‖
i.

§ 544(b)(2) states that (b)(1) does NOT apply to a transfer of a charitable contribution [defined in § 548(d)(3)] that would be exempted from avoidance under § 548 → intended to protect charitable orgs from having to return to the estate contributions of limited amounts that are made by debtors without actual intent to defraud creditors. ii. § 548(a)(2) contains similar provision (see below)

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D. Trustee’s Avoidance of Fraudulent Transfers 1. Overview a. Statute i. § 548: trustee may avoid fraudulent transfers made in prepetition period ii. Two elements: (a) ―transfer‖ (b) ―of debtor‘s property‖ iii. Includes both actually fraudulent and constructively fraudulent transfers 1. Actual – requires proof of fraudulent intent 2. Constructive – strict liability; no proof of intent required iv. § 101(54) defines transfer very broadly; includes every mode of disposing of property or an interest in it; may be voluntary or involuntary; may be an outright disposition of the property or the grant of an encumbrance or other interest in it. v. Note that trustee may also avoid a fraudulent transfer using the state fraudulent transfer law, § 544(b), as long as there is at least one actual creditor in existence who would be able to attack the transfer under state law. b. Function of FT law i. Protects creditors from unfair actions by the debtor that harms the creditor groups‘ financial interests ii. Permits creditors (or the trustee acting on their behalf) to set aside unfair transfers that place debtor‘s property out of the reach of creditors and hinder efforts of creditors to get paid. c. Transfer of Exempt Property? i. Not clear whether the transfer of exempt property qualifies as FT. ii. Minority → not avoidable as FT; if transfer doesn‘t harm creditors it should not be avoidable iii. Majority → avoidable as FT; fact that debtor could have claimed the property as exempt should not be taken into account. d. FT & Charitable Contributions i. § 548(a)(2) – charitable contributions to qualified orgs are not to be treated as a transfer for less than reasonable equivalent value provided that the contribution does not exceed 15% of debtor‘s gross annual income for the year in which given, OR if in excess of that percentage, the contribution was consistent with the debtor‘s practices in making such contributions. ii. § 548(d)(3) defines ―charitable contributions‖ and ―qualified religious or charitable entity‖ by referencing the tax definitions of each. e. State fraudulent transfer laws

i.

Statute of Elizabeth – 5 states

ii. Uniform Fraudulent Conveyance Act (UFCA) – 2 states

a. Actual fraud required (i.e. proof of mens rea/intent) b. Courts identified ―badges of fraud‖ – circumstantial factors believed to be indicia of debtor‘s actual fraudulent intent [similar to factors in UFTA] a. Actual fraud recognized, but not limited to this alone. b. Also recognized Constructive fraud – proof of objective facts in combination conclusively establish fraud, irrespective of debtor‘s intent. a. Party with standing must challenge transaction 1. Trustee (or DIP) has standing in bankruptcy 2. Outside of bankruptcy, individual creditors of debtor have standing [a] Present creditors – had claim at time of transfer 1. Universal standing [b] Future creditors – claim arose after challenged transfer 1. Lacks standing to challenge some types of constructive fraud, but can challenge actual fraud b. 4-year reach back period 1. Trustee can only use § 548 to avoid transfer made within 2 years before filing of bankruptcy petition 2. Trustee may use § 544(b)(1) to avoid a transfer made within up to 4 years by invoking the rights of an actual creditor (see above)

iii. Uniform Fraudulent Transfer Act (UFTA) – 43 states (MAJORITY)

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c. Remedy 1. Most commonly – set aside transfer and recover transferred property or its value from the transferee 2. Innocent transferee who gives value is protected – § 548(c), UFTA 8 [a] If transferee takes for value and in good faith (i.e. did not know of the fraud), then: 1. Transferee gets a lien in the property to the extent of the value he gave, thus captures later appreciation of transfer; 2. Plus, debt might be nondischargeable for fraud under § 523(a)(2), so transferee can go after D post-bankruptcy. f. In Re Costas (9th Cir. 2009) – p. 471 i. Re: does state law or fed law control what constitutes ―property‖ in the context of a bankruptcy case? ii. Law: § 548(a)(1) allows a trustee to avoid ―any transfer of an interest of the debtor in property‖ within a 2-year reach back period where the transfer was actually or constructively fraudulent. iii. Holding/Analysis a. The court ruled (in accordance with Butner) that fed courts must first look to state law definitions of property to determine whether a disclaimer of an interest in a trust or estate constitutes a fraudulent transfer under § 548 b. If state law permits beneficiaries to reject their interest in trusts or estates through disclaimers, and the disclaimer is valid under state law, there is no ―property‖ for the purposes of § 548. c. Federal law may determine whether a particular disclaimer constitutes a fraudulent transfer only when states do not permit such disclaimers, or when a disclaimer was not properly executed under applicable state law. 2. Actual Fraud a. Requires proof of the fraudulent intent of debtor in making the transfer i. Courts use ―badges of fraud‖ to establish debtor‘s fraudulent state of mind ii. Circumstantial evidence; subjective; facts & circumstances inquiry b. UFTA 4(b) – FACTORS relevant to proof of debtor‘s actual fraudulent intent 1. Transfer or obligation was to an insider 2. Debtor retained possession or control of the property transferred after the transfer 3. Transfer or obligation was disclosed or concealed 4. Before the transfer was made or obligation was incurred, debtor had been sued or threatened with suit 5. Transfer was of substantially all of debtor‘s assets 6. Debtor absconded 7. Debtor removed or concealed assets 8. Value of the consideration received by debtor was not reasonably equivalent to the value of the asset transferred or the amount of the obligation incurred 9. Debtor was insolvent or became insolvent shortly after the transfer was made or the obligation was incurred 10. Transfer occurred shortly before or shortly after a substantial debt was incurred 11. Debtor transferred the essential assets of the business to a lienor who transferred the assets to an insider of debtor c. Asset protection trusts i. Debtor sets up the trust with her own property, and ii. Is the beneficiary of that trust iii. Within 10 years before the bankruptcy iv. Actual intent to defraud present/future creditors d. Dean v. Davis (1917) – p. 484 i. Facts: An insolvent debtor got his brother-in-law to loan him $1,600 that he needed to satisfy a note from the bank. His brother-in-law advanced the money to him but took a mortgage on the debtor's assets to secure the loan. The proceeds of the loan were used to pay the bank and, shortly thereafter, an involuntary bankruptcy petition was filed against debtor. Although the

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mortgage was not voidable as a preference because it secured a new loan, SCOTUS agreed w/ the trustee that the mortgage was invalid as a fraudulent conveyance. ii. Holding: The transfer of a mortgage to secure an advance that was made to enable the debtor to make a preferential payment in contemplation of bankruptcy ―presents an element upon which fraud may be predicated.‖ Because the debtor & brother-in-law knew that the bank would be preferred, the mortgage constituted a fraudulent transfer. iii. Significance: The doctrine of Dean v. Davis is deliberately not contained in the present Code. Thus, transfers to secure advances for the purpose of enabling debtors to make preferential payments are no longer fraudulent per se. However, several courts have held that Dean v. Davis remains as ―applicable precedent in applying section 548(a)(1)‖ 3. Constructive fraud a. Proof of certain specified facts can conclusively establish that a transfer is fraudulent, irrespective of i. Strict liability; designed to protect creditor b. Rationale: i. May serve as useful proxy for actual fraud ii. More efficient to create per se rule iii. Some transactions by their very nature injure creditors of the debtor c. Three types of Constructive Fraud recognized:

the actual subjective intent of debtor

i.

§ 4(a)(2)(ii) d. What is ―reasonably equivalent value‖? i. UFCA – value prong is ―fair consideration‖ a. Fair consideration = fair equivalent + good faith of transferee b. Under UFCA, even if value was equivalent, no fair consideration if the transferee was not acting in good faith ii. Foreclosure sale a. Reasonably equivalent value for foreclosed property is the price in fact received at the foreclosure sale, so long as all the requirements of the state‘s foreclosure law have been complied with b. Irrebuttable presumption that whatever is received at a proper foreclosure sale is reasonably equivalent value for purposes of § 548 iii. Consumption? a. Not violating rights of creditors so long as debtor obtains reasonably equivalent value – compliance with an objective market determinant of value b. If creditors believe debtor is consuming too much, recourse is to commence an involuntary bankruptcy and strip debtor of the power to decide how to deploy his assets c. Church donations – not reasonably equivalent value, because can go to church for free, but there is a safe harbor for charitable contributions iv. Gambling a. Court: debtor received a reasonably equivalent value 1. Measure value at the time of the transfer, when the bet is made 2. Bet has value when it is placed, because there is a mathematical chance that the debtor will make money b. Problem: once debtor is insolvent, they are essentially gambling with creditors‘ money 1. Debtor gets all the upside of winnings, no downside 2. Creditors enjoy little of the upside of the winning bet, and all the downside from a losing bet e. Charitable contribution safe harbor – § 548(a)(2) i. Limited to constructive fraud cases

Transfer in exchange for less than ―reasonably equivalent value‖ by a debtor who is insolvent or who is rendered insolvent by the transfer – § 548(a)(1)(B)(i); (ii)(I); UFTA § 5(a) ii. Transfer in exchange for less than ―reasonably equivalent value‖ by a debtor with unreasonably small capital remaining after the transfer – § 548(a)(1)(B)(i) & (ii)(II); UFTA § 4(a)(2)(i) iii. Transfer in exchange for less than ―reasonably equivalent value‖ by a debtor who is about to incur debts beyond the debtor‘s ability to pay as they mature – § 548(a)(1)(B)(i) & (ii)(III); UFTA

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ii. Only applies for cash donations, or financial instruments iii. Where not exceed 15% of D‘s gross income, or if it does, where it is consistent with D‘s giving history f. BFP v. Resolution Trust (1994) – p. 488 i. Re: Constructive fraud in mortgage foreclosure context ii. Facts: BFP (a partnership) bought a home by obtaining a deed of trust from Imperial. Imperial owned the property until BFP could pay off the amount borrowed. BFP defaulted on the loan and Imperial proceeded to sell the property for $433,000 to settle the loan (foreclosure). Before the title of ownership transferred to the buyer, BFP filed for Ch. 11 bankruptcy. a. BFP asked bankruptcy court to nullify the original foreclosure sale because the home was valued at over $725,000. BFP argued that the low sales price constituted a fraudulent transfer under § 548(a)(2)(A), which guarantees that debtors receive "reasonably equivalent value" for property foreclosed. BFP claimed "reasonably equivalent value" was equal to the market value of the property in question. The bankruptcy court denied BFP's claim, and a District Court and the U.S. Court of Appeals for the Ninth Circuit affirmed. iii. Issue: Does a property's fair market value determine whether the amount of debt settled by a foreclosure sale is "reasonably equivalent" to the property's worth, as required by § 548(a)(2)(A)? iv. Holding: No. The value received for a property at a foreclosure sale can be reasonable even if it is different from the "fair market value." A foreclosure sale alters market conditions and can lower a property's selling price. If a foreclosure sale is necessary to settle a debt, the price at which the property is sold is reasonable so long as "all the requirements of the State's foreclosure law have been complied with." g. Allard v. Flamingo Hilton (6th Cir. 1995) – p. 496 i. Facts: Trustee sought to recover pre-petition gambling losses from a state-regulated casino. a. Trustee alleged that the debtors had been insolvent for six years prior to the filing of the petition; that during this time the debtor transferred various sums to the Casino for the purpose of gambling; that they made some of these transfers during the year preceding the filing; and that they did not receive a ―reasonably equivalent value‖ or ―fair consideration‖ in exchange. b. Casino argued that the opportunity for the debtors to win more than the sums they bet, coupled w/ the entertainment value of the casino, constituted "reasonably equivalent value" and "fair consideration" for the bets at issue. ii. Law: A trustee may undo as constructively fraudulent any property transfer made by the debtor within one year before the filing of the petition if the debtor was insolvent on the date of the transfer and "received less than a reasonably equivalent value in exchange for [the] transfer. ..." § 548(a)(2)(A) and (B)(i) a. ―Value" is defined in § 548(d)(2)(A). b. Timing – Court must determine whether debtors received property of reasonably equivalent value in exchange for the money they wagered at the casino at the point at which their bets were placed. ["The critical time is when the transfer is ―made.‖] iii. Issue: Are the bets voidable as fraudulent transfers? iv. Holding: No, the bets were not voidable as FTs under § 548 or under UFCA [court sides w/ Casino – trustee cannot avoid transfer as FT] 4. How to Analyze Fraudulent Transfers [in Bankruptcy & under UFTA] a. Was transfer at issue FRAUDULENT?

i.

STEP 1: Identify if there is a party with standing to challenge the transaction

ii. STEP 2: Statute of Limitations

a. § 548 or § 544(b) → Trustee has standing b. UFTA → Present vs. future creditors have diff standing: 1. Present creditor (i.e. one who was creditor at time of transfer) has standing to challenge ANY type of fraudulent transfer 2. Future creditor (i.e. one whose claim arose after the transfer) lacks standing to challenge some types of constructive fraud a. § 548(e) → trustee can only avoid fraudulent transfers made within 2 years before the bankruptcy filing [10 yrs for transfers to asset protection trusts]

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iii. STEP 3: Address substantive facts using analysis above (existence of actual or constructive

1. however, trustee may be able to use § 544(b)(1) to avoid a transfer made within 4 years of filing by invoking the rights of an actual bankruptcy creditor w/ standing to attack the transfer under state law b. UFTA § 9 → most types of fraudulent transfers must be challenged within 4 years of the transfer.

b. If transfer was fraudulent, what is the REMEDY? i. UFTA § 7 & Bankruptcy → Most common remedy is to set aside transfer & recover transferred property or its value from transferee ii. UFTA § 8 & § 548(c) → protection for innocent transferees (who take for value in good faith) iii. Remember that individual debtor who makes a FT within 1 year of bankruptcy will be denied a discharge in Chapter 7 – § 727(a)(7) E. Trustee’s Avoidance of Preference Transfers (§ 547) 1. Introduction a. A preference is a transfer that favors one creditor over another b. § 547: trustee may avoid preference transfers [prebankruptcy transfers that were legal when made] i. Problem: making the transition from state collection law, where the priority rule is ―race,‖ to bankruptcy, where the priority rule is ―equality‖ 2. Policy Rationale for Avoidance of Preferential Transfers a. Equality of Distribution i. If debtor is insolvent, state law regime fails to achieve distributive justice because paying one creditor in full directly harms other creditors ii. Preference law helps restore bankruptcy equality in such cases iii. Good preferences vs. bad preferences → § 547(c)(2) – contains exception for transfers in the ordinary course of business b. Deterrence i. Preference law helps to deter the ―race of diligence‖ by telling creditors that they will be forced to give back the spoils of victory in the ―race‖ ii. However – not much of a deterrent because the worst case is that they will have to give the money back (no sanction) 3. Overview of § 547(b) & (c) a. STEP 1: Establishing all the Elements of a Preference – § 547(b) i. To be avoidable under § 547(b), transfer must satisfy ALL of the following: 1. A transfer of the property of the debtor (§ 547(b)) 2. To or for the benefit of a creditor (§ 547(b)) 3. For or on account of an antecedent debt (§ 547(b)(1)) 4. Made while debtor was insolvent (§ 547(b)(3), (f)) 5. Made during preference period of 90 days before petition (1 yr for insiders) (§ 547(b)(4) 6. Enables creditor to receive more than it would have in a Ch 7 liquidation (§ 547 (b)(5)) ii. Trustee carries burden of proving existence of ALL elements of avoidable preference under § 547(b)

fraud?) to determine if transfer was in fact fraudulent . . .

a. ―Transfer‖

b. ―Of property of debtor‖

1. Dominion/control test – transfer of property will be a transfer of an interest of the debtor in property if debtor exercised dominion or control over the transferred property 2. Diminution of the estate test – debtor‘s transfer of property constitutes transfer of an interest in property if it deprives the bankruptcy estate of resources which would otherwise have been used to satisfy the claims of creditors 1. Earmarking doctrine [a] Court may find transaction is simply a substitution of creditors (and not property of D) [b] Question: did D have control and power to use funds for other purposes? 2. Trust claimants

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c. ―To or for the benefit of a creditor‖

[a] Department store with eyeglass section contracted out to independent company. Money paid to store is remitted to company. [b] Whether or not funds paid to the company constitute preference depends on the relationship between the store & company 1. Trust agreement – money is the property of company, no preference 2. Debtor-creditor relationship – preference [c] Money must be traceable to claimant

d. ―For or on account of an antecedent debt‖

1. obviously we don‘t want certain creditors getting special treatment that other creditors are not getting. 1. Preexisting obligation owed by debtor before transfer was made 2. Prepayments not preferential – will receive benefit later 3. Excludes gifts – no antecedent debt 1. § 547(f) – Debtor presumed insolvent for 90 days prior to petition 2. Creditor must rebut to prove debtor was solvent!

e. ―Made while debtor was insolvent‖ f. Made at correct prepetition time

1. Determined by actual effect of the payment when bankruptcy results 2. Transfers to fully secured creditors cannot be avoided 3. Any payment on an unsecured debt, even partial, will satisfy improvement-in-position test because they will receive more than other unsecured creditors 4. Prepetition payment to undersecured creditor prefers the creditor because the transfer is seen as paying off the unsecured debt first [a] Exception: when undersecured creditor is paid from creditor‘s own collateral b. STEP 2: Exceptions (safe harbors) § 547 i. If trustee establishes a prima facie case for avoidance under § 547(b) by meeting all criteria, burden shifts to creditor to establish any of exceptions available under § 547: 1. Contemporaneous exchange of new value (§ 547(c)(1)) 2. Ordinary course transfers (§ 547(c)(2)) 3. Enabling loans (§ 547(c)(3)) 4. Subsequent advances of new value (§ 547(c)(4)) 5. Floating liens (§ 547(c)(5)) 6. Statutory liens (§ 547(c)(6)) 7. Domestic relations debts (§ 547(c)(7)) 8. Transfers of less than $600 by an individual debtor whose debts are primarily consumer debts (§ 547(c)(8)) 9. Transfers of less than $5,475 by a non-consumer debtor (§ 547(c)(9)) 10. Transfers made as part of an alternative repayment schedule created by an approved nonprofit credit counseling agency (§ 547(h)). c. Most important defenses: i. No preference liability for business debtor if transfer is less than $5475 – (c)(9) a. Floor = $600 for consumer debtor ii. For unsecured creditors: a. $5475 immunity b. Ordinary course – (c)(2) c. New value – (c)(4) d. Contemporaneous exchange – (c)(1) iii. For secured creditors: a. Enabling loans – (c)(3) b. Floating liens – (c)(5)

g. That enables the creditor to receive more than it would have in a hypothetical Ch 7 liquidation

1. During the preference period of 90 days before filing; OR 2. Between 90 days & 1 year before filing if creditor at time of transfer was an insider

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d. Ordinary course of business safe harbor – § 547(c)(2) i. Where debt incurred in ordinary course of business, creditor can prevail by proving EITHER: a. Transfer was subjectively ordinary (between debtor & transferee), OR b. Transfer was objectively ordinary (measured against industry) 1. Payment made according to ordinary business terms in industry 2. Range of terms that encompasses the practice in which firms similar in some general way to the creditor engage 3. Only dealings so idiosyncratic as to fall outside the broad range should be deemed extraordinary (Tolono Pizza (1993) → before Congress amended the Code, you had to prove three things: 1) ordinary course of business b/w creditor and debtor, 2) ordinary course of financial transactions b/w debtor and creditor, AND 3) ordinary course of business in the industry. This was confusing, so Congress changed this from an AND to an OR – now you can prevail under any of the three three) [a] Issue of Scope: what is the scope of the ―industry‖ term? Is it the industry of selling pizza? of fast food? of restaurants generally? Can hire an expert to say what you want. An issue of FACT. e. New value defense – § 547(c)(4) i. Subsequent advances of new value from creditor to debtor are credited against prior preferential transfers ii. ONLY applies if new value is given AFTER D‘s preferential transfer (no ―incentive‖ rationale) iii. Creditor‘s preference liability is reduced to the extent that creditor returns value to debtor after receiving a preference iv. Justification: a. Estate has been replenished to the extent of the new value, and thus other creditors have not been harmed b. Encourages creditors to continue doing business with a financially troubled debtor v. Requirements a. After a preferential transfer, creditor gives new value to or for the benefit of debtor, b. New value is not secured new value, c. Debtor does not make an otherwise unavoidable transfer to or for the benefit of creditor on account of that new value vi. In practice, applied most often in a trade credit situation, involving ongoing extensions of credit on open account a. Add amount of preference to outstanding balance to get amount of claim vii. Ex) a. 4/1 – D pays $8500; Preference = $8500 b. 4/15 – C ships $4000 goods; Preference = $4500 c. 4/20 – D pays $3000; Preference = $7500 d. C only gets credit for $1,000 in new value, because D made an ―otherwise unavoidable transfer to C‖ ($3000 is protected under (c)(9)‘s $5475 safe harbor) f. Enabling loan – § 547(c)(3) i. Safe harbor for enabling loan a. Ex) On 5/1, lender loans D money to enable D to purchase equipment. D grants lender a SI in equipment and lender immediately perfects. On 6/1, D purchases the equipment. 1. Technically, the SI in the equipment does not ―attach‖ until D acquires rights in the collateral. So, ―transfer‖ is deemed to occur when the equipment was purchased (6/1) although the debt arose when the loan was made on 5/1. 2. So – because of artificial construction that ―transfer‖ occurred after ―debt‖ arose, technically a preference without safe harbor ii. Secured party has statutory 30-day grace period to perfect after debtor receives possession iii. Even though there is technically an antecedent debt iv. Delayed perfection a. Nonbankruptcy law might give secured party a grace period as well b. Ex) UCC 9-317(e) – PMSI valid against intervening creditors if secured party perfects within 20 days after debtor receives possession of collateral

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c. Note: where SP does not perfect within 30 days, transfer dates from date of perfection. Thus the debt will be antecedent to the transfer date. This could push the transfer into the 90-day period, making it voidable. g. Floating liens – § 547(c)(5) i. Protects secured creditors with ―floating liens‖ in inventory and receivables ii. Lien is said to ―float‖ when it attaches to collateral that debtor acquires after the initial security transfer a. Creditor‘s security interest cannot attach to collateral until D has rights in the collateral b. So absent a saving rule, the ―new‖ collateral would be deemed ―transferred‖ to SP for the ―antecedent debt‖ and thus constitute a preference iii. §547(c)(5) exempts floating lien that attaches to inventory or receivables during the preference period, except to the extent that creditor has improved its position during the 90day preference period iv. Requires a comparison of the creditor‘s security position at the beginning of the preference period with its position at the time of bankruptcy a. Safe harbor defense = 547(c)(5) – the ―2-point improvement in position‖ test 1. Compare secured party‘s position 90 days before bankruptcy, and see if ―improved‖ by the time of bankruptcy [a] Point 1 = beginning of preference perio 1. Unless creditor does not make a loan until a later date, in which event the date new value is first extended will be point 1 [b] Point 2 = date of bankruptcy [c] Comparison between the points: extent creditor is undersecured (i.e. the amount the debt exceeds the value of the collateral) [d] Preference is only found to the extent creditor‘s unsecured claim gets smaller 2. Formula [a] Point 1 deficiency (debt – collateral value) – [b] Point 2 deficiency (debt – collateral value) [c] = Amount avoided 4. Timing Issues a. Critical to know WHEN a transfer is deemed ―MADE‖ for preference purposes i. Needs to be made within the preference period; AND ii. Needs to be made on an antecedent debt b. Timing of transfer is when transfer is RECORDED [§ 547(e)(1)] i. In other words, when effective against third parties under state law? a. Real Property – beat BFP b. Personal Property – beat lien creditor ii. Subject to 30 day grace period, after transfer is effective as between D & SP – § 547(e)(2) a. If SP records within 30 days, deem ―transfer‖ to have occurred back when it was effective between D & SP b. Does not have to be an enabling loan for provision to apply c. Timing example: i. 4/1 – D buys car & gives C PMSI in car, D takes possession ii. 4/25 – C perfects iii. 6/1 – D files bankruptcy iv. SI effective between D & C on 4/1 v. SI perfected on 4/25 (within 30 days of effective date between D & SP) vi. Thus, deem transfer of SI as date effective b/w D & SP (4/1) vii. So, date of debt (4/1) is not ―antecedent‖ to date of SI transfer, and thus NO PREFERENCE! (not avoidable) d. In Re Freedom Group (7th Cir. 1995) – p. 522 i. Re: Garnishment/attachment – no transfer until final order of garnishment/attachment issued ii. Garnishment is where you go to a third party and say you have to pay the creditor, not the debtor you owe it to. The employer has the opportunity to go into court and, before an order is made to enforce the garnishment, raise defenses. Until court issues an order, no enforcement is

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in place. Therefore, fact that the enforcement took place inside 90 days is what makes this a preference e. Palmer Clay Products v. Brown (SCOTUS 1936) – p. 527 i. Facts: 90 days before petition date, Palmer gets a bunch of overdue payments. He gets paid less than the full debt. He asserts they aren‘t preferences b/c he says he did not get more than he would have gotten in a Chapter 7. ii. Rule: When the transfer takes place, that‘s when you should look at what ppl would get in liquidation. The rule is that you look at the petition date. F. Setoff and Recoupment – § 553 1. Overview a. Setoff is implicated when a creditor also owes money to a debtor, in addition to what debtor owes creditor (―setoff‖ of one debt against the other‖) b. General rule – § 533(a): whatever setoff rights creditor has outside of bankruptcy, creditor also can exercise in bankruptcy, subject to some qualifications [below] c. § 542(b): a creditor‘s obligation to pay the trustee a debt owing the debtor is subject to the creditor‘s setoff rights under § 553. d. Recognizing creditor‘s setoff right in bankruptcy effectively makes creditor‘s claim against the debtor a secured claim – see § 506(a)(1). 2. Qualifications on Creditors’ Setoff Rights under § 553(a): a. A creditor‘s setoff rights are subject to the automatic stay – § 362(a)(7). i. Thus, if a creditor wants to effect a setoff after the bankruptcy filing, the creditor must move to lift the stay under § 362(d). ii. This concept is identical to moving to lift the stay to foreclose a lien. b. Only mutual prepetition debts are recognized as a right of setoff i. Both debts must have arisen before the bankruptcy filing. ii. Exception to this timing rule applies if both debts arise out of same transaction a. in this situation, equitable doctrine of recoupment applies, permitting creditor to recoup its prepetition claim against debtor from debtor‘s postpetition claim against creditor c. Setoff must be of mutual debts i. In order for debt to be considered mutual under § 533, debtor & creditor must owe and be owed in the same capacity (i.e. parties must have normal debtor-creditor relationship on both sides). ii. Ex: if one of the party‘s obligations was that of fiduciary or bailee of property, this would not give rise to debts subject to offset. 3. Right of setoff may NOT be exercised by creditor if any of following occurs: a. § 553(a)(1) – Creditor‘s claim has been disallowed as a claim against the estate. b. § 553(a)(2) – Creditor has acquired the claim by transfer from another entity either during the 90day prebankruptcy period while the debtor was insolvent or after the commencement of the case. i. This exception aimed at transactions in which debtor of the estate takes over the claim of a creditor of the estate so that the debt and claim can be offset. ii. Such a transaction would enable former creditor to receive full value for its claim from estate‘s debtor, who then reduces its debt to estate by the full amount of the claim against the estate. iii. The estate is prejudiced bc it has given full creditor for a creditor‘s claim that would have received only partial payment under bankruptcy distribution. c. § 553(a)(3) – The debt due from the creditor was incurred during the 90-day prebankruptcy period, while the debtor was insolvent, and for the purpose of obtaining a right of setoff against the claim owed to the creditor. d. § 553(b) - Setoff has enabled the creditor to improve its position in a manner forbidden by § 553(b)‘s ―improvement-in-position test‖ i. § 533(b)(1) sets forth a two-point improvement test [similar to § 547(c)(5) test for floating liens] intended to prevent a creditor from using setoff in the 90 days before bankruptcy to recover more of its claim than it could have recovered If the mutual debts had been set off 90 days before the petition.

a. Creditor‘s ―insufficiency‖ is computed & compared on two dates:

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1. Point (1) is either 90 days before petition date, or, if there is no insufficiency on that date, then it is the first date within the 90 day period on which there is an insufficiency; 2. Point (2) is the date of the setoff. b. Rule: If the insufficiency in the setoff [that is, the amount of the creditor‘s claim in excess of the debtor‘s claim] is reduced between the 90-day date (point 1) and the setoff date (point 2), the offset is recoverable by the trustee to the extent of that reduction. [Calculation: (1) – (2) = avoidable amount of the setoff under § 533(b)(1)] Chapter 12: Reorganization A. Why Reorganization? 1. Receive more for creditors if keep the company & its assets as a ―going concern‖ 2. Necessity of compulsory process to bind all stakeholders (a) Holdout problem (b) Chapter 11 binds dissenters to confirmation of the plan (c) Automatic stay (§ 362) enjoins creditors from collecting B. Control and Management of a Chapter 11 Case 1. DIP has exclusive right for a period of time to put plans on the table 2. During interim period, strong presumption in favor of debtor management staying on as DIP 3. For whose benefit? (a) DIP is still elected by shareholders, but assumes fiduciary responsibilities to creditors that trustee has, as representative of the estate, to maximize the value of the estate for the benefit of creditors (b) Fiduciary duties of estate representative are not limited just to shareholders (c) Concern = who are the real parties in interest (whose money is on the line)? i. Wildly insolvent company – residual stakeholders are creditors, and shareholders are underwater ii. Maybe solvent, maybe insolvent (1) In re Spielfogel – valuation uncertainty + uncertainty of amount of going concern (2) Court: it was a breach of the trustee‘s fiduciary duty to ignore debtor‘s interests when there was a legitimate potential that debtor was solvent C. Operational Issues 1. DIP Financing (a) § 1108 – norm in a Chapter 11 case is for business to continue as usual, but DIP must obtain court approval for actions outside ordinary course of business i. If creditor wants to constrain debtor‘s business operations, can ask the court for a limiting order ii. If creditor believes reorganization is futile/wasteful, can seek dismissal/conversation under § 1112 (b) Securing Ch. 11 loans from creditors – CB p. 677 i. Obtaining financing is normally one of the first matters a DIP must attend to after filing for reorganization; ―DIP financing‖ is an important tool in reorganization ii. § 363(c)(2): Prepetition loan agreements cannot be assumed by DIPs – but DIPs can obtain authorization from the court to use ―cash collateral‖ as a form of working capital without the creditor‘s consent. Absent creditor‘s consent, debtor must provide creditor w/ adequate protection of its lien interest. iii. § 364 ―governs all obtaining of credit and incurring of debt by the estate‖ – it is designed to overcome creditors‘ reluctance to extend credit to a chapter 11 debtor by offering inducements & protecting existing creditors from debtor carelessly incurring excessive new debt (1) § 364(a): authorization to operate the business carries implied authority to engage in order course transactions [i.e. no separate approval required] (2) § 364(a) & (b) – gives creditor administrative propriety on par w/ other second priority claims (3) § 364(c)(1) – new lender may be granted ―superpriority‖ (i.e. a priority even over other admin claims) (4) § 364(c)(2), (3) – liens may be granted on unencumbered property or equity in property of the estate to secure ch. 11 loans

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(5) § 364(d) – ch. 11 lender may be given ―priming‖ lien on estate property (i.e. a first lien that subordinates prior lienholders) (6) § 364(e) – the above incentives are buttressed by the fact that an appellate reversal of the grant of a priority or lien under § 364 will not affect the validity of the debt incurred or the priority or lien awarded if the lender acted in good faith, assuming financing order was not stayed pending appeal. iv. Cross-Collateralization – Prospective ch 11 lenders can also seek benefits not expressly authorized by § 364 (e.g. cross-collateralization – see below) 2. Cross-collateralization (a) Context: Bc existing creditor has steak in debtor‘s rehabilitation, it has some incentive to provide new financing if it believes debtor‘s reorganization will be successful. Creditor has even stronger incentive to provide postpetition financing if its prepetition claim is unsecured or undersecured, and debtor is willing to provide collateral to secure both new credit & the unsecured prepetition credit. (b) What is Cross-Collateralization? Occurs when a prepetition Ch. 11 creditor (1) makes a postpetition loan, and (2) receives a security interest in postpetition assets to secure not only the postpetition loan, but also the prepetition loan. i. If lender‘s prepetition claim is undersecured, the effect of cross-collateralization is to prefer the lender‘s prepetition unsecured claim over all other unsecured claims (thus, incentivizing the new postpetition credit) (c) Majority rule = Allow cross-collateralization i. IF DIP can show (1) that the business won‘t survive without the proposed financing; (2) estate cannot obtain better financing; (3) proposed lender won‘t agree to better terms; and (4) transaction is in best interests of estate & creditors (d) Minority rule = Cross-collateralization not allowed (In Re Saybrook) - p. 678 i. NOT allowed as a method of post-petition financing under § 364(e), which authorizes only the granting of liens for postpetition loans and gives the court no power to extend the lien to a prepetition debt. (1) Under § 105(a), courts have power to issue any order necessary or appropriate to carry out provisions of the Code. a. Still not enough for cross-collateralization. Judge Easterbrook: ―§ 105(a) does not give bankruptcy courts power to depart from the code‖ b. Although bankruptcy courts do have general equitable powers to adjust claims to avoid unfairness, this does not entitle them to authorize the preferential treatment of a claim in contravention of the Code‘s priority scheme and the fundamental policy of evenhanded treatment of creditors. c. Separation of powers issue – legislature determines priority order 3. Critical Vendor Orders and the Doctrine of Necessity (a) Comes up where suppliers w/ leverage (necessary to successful reorganization) threaten to ruin the reorganization unless their prepetition claims are paid. (b) Court is authorized [using equitable powers] to allow payment of the claims of prepetition creditors who have sufficient leverage to demand the payment as a condition to continuing to deal with debtor postpetition (c) Majority rule = allow payment of prepetition claims i. Requirements: (1) D cannot acquire alternative financing, products, services, etc. (2) D needs creditor‘s financing, products, services, etc. for the postpetition operation of its business (3) Payment of prepetition claims is critical to D‘s reorganization (d) Minority rule = allow payment only when last resort (In Re Kmart) – p. 685 i. Statutory/equitable authority for court to approve? (1) § 105(a) – no, equitable powers may not be exercised in a way that is inconsistent with the other, specific provisions of the code (2) § 363(b) – use & lease of property section could justify paying critical vendors

ii. What about courts‘ equitable authority?

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a. § 363(b)(1) requires court approval of any proposed use of estate property outside the ordinary course of business, and courts generally defer to the articulated business justification proffered by trustee or DIP b. Stringent proof barriers  (1) Actual proof of why vendor is critical  Reorganizational failure test – but for this vendor, debtor will go out of business & reorganization will fail.  (2) Show vendors actually would not ship unless debt was paid, even if paid in cash D. Confirmation of a Plan of Reorganization

Top 10 things to know about Confirmation (pp. 690-704)

1. Effect of Confirmation (a) Confirmed plan sets forth all obligations of reorganized entity, discharges all prior obligations, and is binding on all parties, including dissenters i. Creditors‘ prior claims discharged; new claim substituted for old claim ii. Corporate debtors – discharge upon confirmation iii. Individual debtors – delay discharge until plan is confirmed 2. Contents of Plan – § 1123 (a) Plan may include just about anything, as long as parties agree (b) Why? Because Congress intended Ch. 11 to be flexible mechanism giving parties leeway to negotiate over allocation of value/means of implementation (c) § 1123 governs contents of the plan i. Mandatory provisions of the plan: § 1123(a) ii. Permissive provisions of the plan: § 1123(b) 3. Who may propose a plan? (a) Initially, debtor has exclusive right to propose the plan, but eventually other parties in interest might be allowed to propose a plan. . . (b) § 1121: Debtor has 120 days of exclusive rights to propose plan; if debtor wishes to extend exclusivity after 120 days, must show cause (court has ultimate power to decide whether to grant extension) (c) § 1121(d)(2): If debtor‘s exclusivity is extended, there is an absolute 18-month cutoff; 20-months to solicit acceptances.  The case is large and complex;  Plan negotiations are ongoing;  Negotiations suggest a reasonable profitability of success;  Debtor is negotiation in good faith & has not been stalling. (d) How debtor may lose exclusive right: (1) Trustee appointed by court – § 1104(a) (2) Party can make motion to reduce exclusivity period – § 1121(d) 4. “Class structure” (a) Claims and interests are dealt with by classes (b) Plan must do the following: i. designate the classes (§ 1123(a)(1)); ii. specify any class that is not impaired (§ 1123(a)(2); iii. specify the treatment of impaired classes (§ 1123(a)(3); iv. provide the same treatment for all claims or interests in a class, unless a particular holder agrees to a less favorable treatment (§ 1123(a)(4) (c) Class Voting/Plan Acceptance i. Dissenting class members are bound by vote of majority (§ 1126(c), (d)) ii. If all classes are either unimpaired or accept the plan, the plan will not have to comply with the ―absolute priority‖ rule (§ 1129(b), which means that a costly valuation of the debtor will be avoided. iii. If any class is impaired, at least one impaired class must accept the plan (§ 1129(a)(10) (d) Classification Rules:

(1) Factors that would support debtor‘s extension request:

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i.

Only ―substantially similar‖ claims may be put in the same class (§ 1122(a))

(1) Congress authorized the separate classification of small ―administrative convenience‖ claims (§ 1122(b)) – claims so small that it is not worth going through the voting process. Plans usually designate full payment of these claims. (2) This issue also important for SARE debtors, in which one large creditor (the major undersecured lender) would be able to control the class vote. Since at least one impaired class must accept the plan [§ 1129(a)(1)], the reality is that this large creditor might be able to veto a plan unless the plan proponent can place that creditor in its own class, and create a separate class of smaller unsecured creditors who would be more inclined to vote in favor of the plan. a. Current judicial trend is that debtor may NOT create separate classes solely to enable confirmation of the plan, but can create separate classifications if it can offer some ―good business reason‖ for the separate classification. 5. Creditors & interest holders vote on plan by class; majority rule applies (unless class is “impaired,” in which case it is deemed to accept) (a) As explained in [4] above, voting is done by classes (§ 1126(c), (d)) i. There are 16 requirements for confirmation in sc. 1129(a) – some are applicable to all Ch. 11 plans, but some apply only in particular cases. ii. For example: § 1129(a)(14) and (15) apply only to individual debtors. (b) § 1129(a)(8): ALL classes must: i. (8)(A): Affirmatively vote in favor of the plan; OR ii. (8)(B): Be unimpaired under § 1124 (in which case the class is deemed to accept the plan under § 1126(f).  IF neither (8)(A) nor (8)(B) is met, plan may still be confirmed by cram down under § 1129(b). (c) What does being ―impaired‖ mean? – § 1124

ii. Unclear from Code & case law whether all substantially similar claims MUST be placed in the SAME class.

(1) Similarity has reference to the relative priority and rights to payment against the debtor‘s assets enjoyed by the creditor or interest holder. a. Secured claims must usually be placed in classes by themselves. b. Unsecured claims are sorted by priority (i.e. with each priority ranking being similar – see § 507(a)). c. Non-priority unsecured claims have the same (low) classification d. Subordinated claims would have to be classified separately. (2) Only exception to this rule is for certain priority claims, which are dealt with on an individual basis (§1129(a)(9)).

i.

§ 1124(1): A class of claim or interests is IMPAIRED if the plan alters the claim holder or interest holder‘s legal, equitable, and contractual rights. (1) In other words → A class is UNIMPAIRED if the plan does not alter the

legal/equitable/contractual rights of that class, OR if defaults are cured and the original contract terms are reinstated ii. Examples of Impaired Claims/Interests: (1) The usual Ch. 11 unsecured creditor is impaired bc plan will pay him 5-10 cents on the dollar of what he was owed, thus his contractual rights are being altered (2) Plans often try to extend the maturity dates of secured debt like mortgages, so they are likewise impaired. (3) Claims of equity security holders are impaired if the plan calls for them to be cancelled. iii. How Does Impairment Affect Voting? (1) If ANY class is impaired under the plan, at least one impaired class MUST vote in favor of the plan – § 1129(a)(10). (2) If there is one or more impaired class that does NOT accept the plan, then confirmation can only occur under cram down rules of § 1129(b) (d) Only PARTIALLY IMPARED classes vote

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§ 1126(f): If class is not impaired at all, the class (and each holder in class) is conclusively presumed to have accepted the plan & thus will not vote. ii. § 1126(g): If a class is totally impaired, the class will also not be allowed to vote BUT will be deemed to reject the plan. [Since § 1129(a)(8) cannot be satisfied as to such a totally impaired class, the plan can only be confirmed if the cram down standards of § 1129(b) are met as to that class.] (e) To be eligible to vote (must first be within a partially impaired class, AND: i.

i.

Must be a holder of a claim or interest;

(1) To be allowed, a proof of claim/interest must be filed under § 501 and must survive any timely objections (§ 1111(a); § 502(a)) a. In Ch. 11 cases: claims & interests that are scheduled and are not listed as disputed, contingent, or unliquidated are deemed ―filed‖ even without holder of the claim actually filing a proof of claim or interest (§ 1111(a)) (f) What is the required vote for acceptance?

ii. Claim or interest must be allowed under § 502

(1) ―Claim‖ defined as right to payment (§ 101(5)). (2) ―Interest‖ defined as a share in a corporation, a limited partnership interest, or a warrant or right regarding those two forms of equity security (§ 101(16)).

i.

Required vote for acceptance of classes of CLAIMS: § 1126(b)

ii. Required vote for acceptance of classes of INTERESTS: § 1126(c)

(1) An affirmative class vote requires plan acceptance by creditors that hold: a. a majority in number; AND b. a two-thirds in amount ...of the allowed claims in the class that actually voted on the plan [§ 1126(c) says: only count those who actually voted; votes of creditors who are ―designated‖ under § 1126(e) are excluded from calculation] (1) An affirmative class vote requires plan acceptance by holders of interests that hold: a. Two-thirds in amount ...of allowed interests that actually voted on the plan (§ 1126(d), again excluding those who are designated under § 1126(e).

(1) Based only on creditors or interest holders who actually vote on the plan; (2) Only allowed claims or interests are counted; (3) Votes that are designated under § 1126(e) are excluded, both from the numerator (the acceptances) and the denominator (total votes casts) (g) Designating votes – § 1126(e) i. If a vote is ―designated‖ that means it is disallowed by the court bc it didn‘t meet some requirement of the Code. ii. Much of the litigation revolves around whether to ―designate‖ votes!! iii. Court may designate any entity whose acceptance or rejection: (1) Was ―not in good faith‖; OR (2) Was not solicited or procured in good faith or in accordance w/ Code a. This gives some teeth to the disclosure & solicitation rules of § 1125 – see point [6] below – bc it permits the designation of votes that were improperly solicited Courts have hard time deciding when an entity voted in bad faith or was solicited in bad faith since a creditor or equity security holder is always free to vote against a plan if they simply don‘t like it; voters allowed to act on own selfish interests and try to get as much as they want out of the plan.  Instances where bad faith may be found: if a creditor/interest holder has a conflict of interest; seeks an ulterior advantage; tries to drive a competitor out of business; resorts to blackmail; or tries to acquire a controlling block of interests by purchasing claims without disclosure. 6. Before voting occurs, must give FULL DISCLOSURE – § 1125(b) (a) Core principle of Ch. 11 confirmation is informed voting: before voting, creditors & equity security holders must be given enough info to make an informed choice about whether to accept or reject plan. 

iii. Summary: Some points to remember about the calculation of votes:

b. ―Bad Faith‖?

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(b) Thus, plan proponent required to send a court-approved disclosure statement to creditors & equity security holders when soliciting votes (§ 1125(b)). (c) One important qualification on the general rule that voters may not be solicited before the disclosure statement is sent out. i. § 1126(g) – an acceptance or rejection of the plan can be solicited if it complies with the applicable nonbankruptcy law and is solicited BEFORE the commencement of the bankruptcy case. ii. Exception intended to facilitate ―pre-arranged‖ plans involving ―lock up‖ agreements with creditors who before bankruptcy agree to vote in favor of a plan that will be filed post-petition. (d) Step by step process:

i.

Obtain court approval of disclosure statement

ii. All holders of claims & interests entitled to vote are mailed a package of materials that will include important voting materials (§ 1125(b)):

(1) Plan proponent files disclosure statement w/ plan or within a time fixed by the court & the court holds a hearing to approve it. (2) At hearing, court will consider objections to the disclosure statement (3) Court decides whether statement should be approved as containing ―adequate information‖ (defined in § 1125(a)(1)):  Will voters have enough info to make informed choice?  Targeted ―consumer‖ is a ―hypothetical investor typical of the holders‖ (defined in § 1125(a)(2))  Question of ―adequate information‖ is a bankruptcy question; any nonbankruptcy disclosure rules not to be considered (e.g. securities disclosure laws) (§ 1125(d))  What is ―reasonably practicable‖ to be disclosed? Court given leeway to consider the ―nature and history of the debtor‖ and ―the condition of the debtor‘s books and records‖ (§ 1125(a)(1)).  Disclosure statement does NOT need to provide info about any other possible or proposed plan (§ 1125(a)(1))  No full going-concern valuation or appraisal of debtor‘s assets required (§ 1125(b)) (1) Approved disclosure statement; Copy of court opinion approving disclosure statement; A ballot for voting; The plan or court-approved summary of the plan; Notice of the time of file ballots & objections to confirmation of the plan; Notice of the date of confirmation hearing. (2) Common for an official committee to take on responsibility of mailing the package of materials along w/ the committee‘s recommendation on whether to accept or reject the plan (§ 1103(c)(3))

(1) Any votes that are solicited or procured without complying w/ the rules may be ―designated‖ – meaning they will not be counted (§ 1126(e)) (2) A failure to comply with disclosure and solicitation rules of § 1125 could be fatal – could mean plan won‘t be confirmed (§ 1129(a)(2)) (3) A person who solicits votes on a plan without following the rules forfeits protection of the safe harbor in § 1125(e) [liability for securities fraud] (4) NOTE: these rules apply with equal force to solicitation of acceptances AND rejections of the plan (§ 1125(b)) [e.g. if rejections are solicited before a disclosure statement is sent, any dissenting votes that are procured will not be counted (§ 1126(e)] 7. Dissenting creditors are protected by “Best Interests” test (a) Dissenters in a class are bound to the terms of the plan as accepted – so the best interest test protects them. (b) § 1129(a)(7) ―Best Interests Test‖ → If ANY holder of a claim or interest would receive MORE in a Ch 7 liquidation than under the proposed Ch. 11 plan, and that holder does not accept the plan, that plan CANNOT be confirmed. i. Best interests test can be waived by a claim holder/interest holder if that holder accepts the plan (§ 1129(a)(7)(A)(i)) ii. Best interest test does not apply if the class is unimpaired.

iii. Soliciting Votes – must abide by the rules!

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(c) Application of the Best Interests Test requires court to engage in a hypothetical Ch. 7 liquidation analysis i. Must show concrete evidence of the likely estate assets that would be available for distribution in a Ch. 7 plan and their value, as well as a comprehensive assessment of the estimated claims in each class. ii. The comparison between the actual Ch. 11 & the hypothetical Ch. 7 case must be made as of the same point in time to be valid → this date is the ―effective date of the plan‖ (§ 1126(a)(7)(A)(ii)). [To compute the amount of distribution under the proposed Ch. 11 plan, the requirement that the plan must be fixed as of the effective date of the plan means that plan payments must be discounted/reduced to present value]

iii. Primary Ch 7 provisions applied in the hypothetical liquidation analysis:

(1) If unsecured claim holder objects to the confirmation, either: a. They must be paid in full (i.e. the value of the claim as of the effective date of the plan of property to be distributed on account of the claim cannot be less than the amount of such claim); OR b. The value of the property to be distributed under the plan is not less than the projected ―disposable income‖ of the debtor (defined in § 1325(b)(2)) to be received:  during the 5 yr period beginning when payments are made, OR  during the period provided by the plan [whichever is longer] 8. Court must find the plan is FEASIBLE (a) Court has independent power to VETO a Ch. 11 plan: even if all other requirements for confirmation are met – including the affirmative vote of all impaired classes – the plan will NOT be confirmed unless the court finds that the plan is FEASBILE. (b) § 1129(a)(11): Court must not find that the confirmation of the plan is not likely to be followed by: (a) the liquidation, or (b) the need for further financial reorganization of the debtor/debtor‘s successor. i. Only Exception: If plan itself proposes liquidation or further reorganization! ii. This veto power complements court‘s power to DISMISS or CONVERT a Ch. 11 case ―for cause‖ under § 1112(b) – ―cause‖ might include lack of reasonable prospects for rehabilitation. (c) In practice, feasibility requirement not very rigorous i. Threshold of proof is relatively low (mere potential that plan will fail = not enough to defeat confirmation) ii. Success only needs to be shown to be ―more probable than not‖ to establish feasibility iii. At same time, court‘s finding of feasibility cannot be based on pure speculation → some evidence of future viability of reorganized debtor is required → most relevant inquiry: whether reorganized (requires expert testimony, financial projections, economic conditions, projected value of property to be sold if plan incorporates an asset sale, etc) iv. The longer the payout term under the plan, the more difficult feasibility showing becomes (bc of uncertainty/speculation inherent in future projections) 9. If class votes against plan, plan still may be confirmed under CRAM DOWN rules - § 1129(b) (a) Confirmation of plan over a class dissent = a ―cram down‖ confirmation (b) If all confirmation requirements of § 1129(a) are met EXCEPT (a)(8), proponent may request plan to be confirmed by cram down under § 1129(b) (c) Plan will be confirmed by cram down under § 1129(b) if the following three requirements are met: i. All confirmation requirements in § 1129(a) are satisfied, EXCEPT for (a)(8) which requires acceptance by all impaired classes; ii. The plan does not discriminate unfairly against any impaired class that has not accepted the plan (§ 1129(b)(1));

iv. For Individual debtors – there is a ―disposable income‖ confirmation requirement under § 1129(a)(15):

(1) Distributional rule of § 726; (2) Subordination provisions of § 510; § 726(a)(3) & (4) (3) Any projected administrative expenses that would arise in a Ch. 7 case

debtor is likely to be able to pay its obligations under the plan while funding ongoing operations

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iii. The plan is fair & equitable with respect to each impaired clas that has not accepted the plan (§ 1129(b)(2)). (d) ―Unfair Discrimination‖ (§ 1129(b)(1)) i. Class that has rejected the plan MUST receive treatment under the plan consistent w/ that being given to other classes w/ comparable legal rights. (1) Thus, treatment given to dissenting class must be compared to that of others with claims/interests of similar rank. (2) If dissenting class is not treated as well, this is discrimination. ii. HOWEVER, discrimination IS permissible if its not UNFAIR (1) Question of fairness is resolved by evaluating the need & motive for the discrimination → if it is justifiable (has some reasonable basis; is not motivated by bad faith; is necessary to the success of the reorganization) then it will not likely be found unfair. (e) ―Fair & Equitable‖ (§ 1129(b)(2)) i. § 1129(b)(2) prescribes minimum level of treatment to be given to secured claims, unsecured claims, and interests for plan to qualify as fair & equitable ii. This test is treated more fully below (see next) 10. CRAM DOWN “Fair & Equitable” Test – § 1129(b)(2) (a) Overview i. Cram down requires full payment of secured classes, and incorporates the absolute priority rule for unsecured & equity security holders (i.e. ―interest‖ holders) (with a possible ―new value‖ corollary) ii. This requires a costly valuation of the debtor iii. Absolute priority rule means the plan must honor the nonbankruptcy priority ranking of various classes against the debtor and debtor‘s assets. (b) SECURED CLAIMS (§ 1129(b)(2)(A)) i. To be fair & equitable to a class of secured claims, the plan must allow secured class to receive present value of their allowed claim under the plan, and to retain their lien. This may be satisfied by one of the following three alternative tests:

(1) Retention of the lien & deferred payments – (b)(2)(A)(i)

(2) Collateral is sold free and clear of liens, and a lien on the proceeds – (b)(2)(A)(ii)

a. Lienholder will retain its liens to the extent of its allowed secured claim; AND b. Lienholder will be paid deferred cash payments that:  Total the allowed secured claim; and  Have present value equal to the value of the collateral [present value = face value + interest to compensate for delay in payment] a. Applies if debtor wishes to sell property free & clear of liens, so that the lien cannot be preserved as required by § 1129(b)(2)(A)(i). b. Debtor is permitted to sell the property free & clear of liens under § 363(K), which allows claimant to bid at the sale. c. Lien attaches to the proceeds of the sale. d. Claimant is given the same rights to preservation of the lien in the proceeds and to payment as are provided in § 1129(b)(2)(A)(i) & (ii).

a. Court has discretion to approve some other treatment of the secured claim that assures claimant will receive the ―indubitable equivalent‖ of the claim. [This term also used in § 363(3)] b. Question to be decided is whether some alternative treatment proposed in the plan will result in the holder of the claim receiving value that is unquestioningly equal to its claim (e.g. a proposal to surrender the collateral may satisfy the test) (c) UNSECURED CLAIMS (§ 1129(b)(2)(B)) i. For the plan to be fair & equitable to a dissenting class of unsecured claims, it must satisfy one of two alternative requirements:

(3) Indubitable equivalent – (b)(2)(A)(iii)

(1) Payment of the allowed amount of the claim – (b)(2)(B)(i)

a. Plan must provide that each holder of a claim in the class received property of value, as of the effective date of the plan, equal to the allowed amount of the claim.

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a. Unless the dissenting class is paid in full, no class junior to the dissenting class is entitled to receive or retain anything under the plan on account of their old claim or interest. FURTHER, no class senior to the dissenting class may be paid MORE than in full.  Thus, if unsecured creditors not paid in full, equity holders [who are behind unsecureds in priority], must take nothing (i.e. interests of stockholders or partners must be eliminated/wiped out) b. Only Exception → There is one situation in which some courts have allowed equity holders to retain their interest even though a senior nonaccepting class has not received full payment: the ―New Value‖ doctrine  If the equity holders contribute new capital to the debtor that is equal to or greater than the value of their interests, they can retain stock in the debtor in exchange for this new value.  The new contribution must be in cash; it cannot take the form of a promise of managerial services or other intangible benefits.  Effect of exception: equity holders can preserve their equity by making a contribution of capital reasonably equivalent to the value of their interests in the debtor.  This exception is not adopted in the Code & courts disagree on whether the exception continues to exist under the Code. (d) EQUITY SECURITY HOLDERS/‖INTERESTS‖ (§ 1129(b)(2)(C)) i. The fair & equitable standard applicable to classes of interests/equity security holders that have not accepted the plan is similar to that relating to unsecured claims. ii. If the class does not receive the present value of its interest, no junior interest may receive or retain any property under the plan. iii. Present value → must be based on the greater of the fixed liquidation preference or the fixed redemption price to which the holder is entitled, OR the value of the interest ((b)(2)(C)(i) & (ii)) E. § 363 Sales: The New “Chapter 3” Reorganization? 1. Overview of § 363 (a) Allows a trustee to dispose of estate assets (use, sale, or lease of property) (b) Makes a fundamental distinction between transactions that are in the ordinary course of business (where trustee has discretion) and those that are outside ordinary course of business (where trustee must give notice, have a hearing and get court approval). 2. Pre-Plan § 363 Sales of Substantially All Assets: Maximizing Aggregate Estate Value (p. 734) (a) Effect of a pre-plan § 363 sale of substantially all assets: essentially fixes the aggregate value of the estate that will then be separately & independently distributed to the debtor‘s creditors, either under a subsequent liquidation plan of reorganization or through a subsequent conversion to Ch. 7. i. Conducting a sale through a § 363(b) motion rather than through a plan of reorganization essentially disenfranchises individual creditors on the value maximization question: is this proposed sale of substantially all assets the best reasonably available means to maximize estate value? [whereas a Ch. 11 plan of reorganization – through its class voting procedures – would put this question directly to the individual creditors] (b) Governing standard: ―there must be some articulated business justification, other than the appeasement of major creditors, for using, selling, or leasing property out of the ordinary course of business before the bankruptcy judge may order such disposition under § 363(b)‖ 3. Sub Rosa Plans of Reorganization: Distribution of Estate Value Through a § 363 Sale (a) See p. 736 in casebook.

(2) No junior claim or interest receives or retains any property on account of its claim or interest – (b)(2)(B)(ii)

b. This is the present value test again: if deferred payments are to be made, the amount of the distribution must equal the full face amount of the claim + interest.

(c) There has been a shift in recent years from Ch. 11 plans to § 363 sales. . .

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