Corporate Bankruptcy and

Reorganization
Prof. Jesse M. Fried
U.C. Berkeley School of Law

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Course Details

1. Contents
-- Chapter 7 and Chapter 11 of US Bankruptcy Code
-- other statutory and non-statutory law relating to bankruptcy

2. Materials
Reading Packages (based on material of Prof. Mark Roe)
Statutory Appendix (“Appendix B”)

3. Exam – (24-hour) Take-home exam

-- questions in English
-- (typed) answers in English or Hebrew

4. Office Hours: after class

appointment by email:
friedj@law.berkeley.edu 2
 Course Outline
Introduction

I. A World Without Bankruptcy (Non-bankruptcy law)

II. Chapter 7: Liquidation Bankruptcy
III. Valuation in the Absence of a Cash Sale
IV. Chapter 11: Overview and Plan Requirements
V. Recovering Funds and Reranking Claims

)other topics if time permits(

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 Introduction

1. Sources of Business Financing

2. The Bankruptcy Code
3. Financial Claims on the Corporation
4. Basic Balance Sheet

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Sources of Business Financing in the
U.S.
Internal Financing
2% • Retained Earnings

Debt Financing

38% 60% Equity Financing

• Common Stock
• Preferred Stock
• IPOs & Secondary
Offerings

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 Bankruptcy Code
Chapter 1: Definitions, Power of Court
Chapter 3: Administration of Bankruptcy
Estate
Chapter 5: What is in the Bankruptcy Estate
Chapter 7: Liquidation Provisions
Chapter 11: Reorganization Provisions

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 Financial Claims on the Corporation

1.Creditors
– Banks
– Finance companies, insurance companies, etc.
– Public bondholders (including “debentureholders”)
– Trade Creditors (suppliers)
– Employees
– Contract breach creditors
– Tort Victims (sometimes)
– Government (tax, regulatory claims)
2. Equityholders
--- Preferred stockholders
--- Common stockholders

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 Basic Balance Sheet

Assets Liabilities (Debt) and

Shareholder Equity
Short-term Short-term debt
Inventory
Raw Material
A/R

+ Long-term +Long-term debt

Factory
Equipment
Shareholders’ Equity (=
$Assets - $Debt)

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$Assets = $Debt + $Equity
 I. A World Without Bankruptcy

A. Individual creditor remedies

1. Unsecured
2. Secured

B. Priorities Outside Bankruptcy

C. Common Pool Problem – loss of going concern

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 Creditors’ remedies outside bankruptcy

What happens when the borrower (debtor) does not

pay?

1. Unsecured creditor
-- goes to court to get judgment
-- if gets judgment, then gets “judgment (or judicial)
lien” – right to payment
-- if debtor does not pay, creditor asks “sheriff” to
seize property

2. Secured creditor: loan secured by “collateral”

-- can seize collateral (but only peacefully)
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 Article 9 in a Nutshell
– Creation and enforcement of security interests (“SI”) in
personal property. Similar rules for real property

– Two rights
1. Property right – right to repossess collateral from
defaulting debtor

2. Priority right – over third parties (other creditors,

purchasers)

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 Two steps to creating effective SI

I. Attachment
• written security agreement
• lender gives value, debtor owns
asset
II. Perfection
• for rights against 3rd parties
• must “perfect” SI by taking possession of
collateral or public filling
• judicial lien has priority over unperfected SI
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 What happens when there is “intercreditor
conflict” – 2 or more creditors attempting to seize
asset?

Unsecured vs. unsecured

“grab law” – first come, first served
(first to get judgment or first to seize assets)

Unsecured vs secured
secured wins

Secured vs. Secured

first to “perfect” (file) wins
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 Common Pool Problem – Loss of Going Concern
Value --
Business ABC
2 machines (“A”, “B”) each worth $20,000
“going concern value” of ABC: $50,000 =
$10,000 more than liquidation value of $40,000

3 creditors (“1”, “2”, “3”), each owed $20,000

ABC cannot pay its loans.

*All creditors are unsecured. What does Creditor #1 do?

#2? #3? How much do they recover in total?

**Creditor #1’s loan secured by machine A. What does #1 do?

•#2? #3? How much do they recover in total? 14
 Purposes of Bankruptcy

1. Preserve going concern value (if there is any)

(bankruptcy overrides “grab law”, which makes preservation of
going concern value impossible outside bankruptcy)
a. Automatic Stay (Part II)
b. Recovery of assets (Part V)

2. Divide the “pie” among creditors, equityholders

a. Liquidation – sale of entire business or asset-by-asset for

cash – cash divided according to Chapter 7 (Part II)

b. Reorganization – parties get equity, debt in reorganized

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firm -- Chapter 11 (Part IV)
 II. Chapter 7: Liquidation Bankruptcy

•Automatic Stay

B. Overview of Distribution in Chapter 7 (with exercises)

C. Statutory Priority in Chapter 7

D. Priority Unsecured Creditors

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 Automatic Stay

Stops individual collection efforts against debtor

--- cannot sue
--- cannot impose lien
--- cannot take property

Necessary to preserve going concern value

Section 362 of the Bankruptcy Code (p. 612)

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 Overview of Distribution in Chapter 7 (1 of 5)

General rule: all debt has equal priority – debt is

paid pro rata

3 creditors owed $6000

A. owed $1000
B. owed $2000
C. owed $3000

Debtor has $3000 in cash

>> Each creditor is paid ($3000/$6000) per $1 owed

>>>>> A. receives $500
B. receives $1000 18
C. receives $1500
 Overview of Distribution in Chapter 7 (1 of 5)

3 important exceptions

1. Secured debt
2. Subordinated debt
3. Priority unsecured debt (Section 507)

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 Overview of Distribution in Chapter 7 (3 of 5)

Secured debt: (debt secured by collateral)

paid the amount of collateral, up to amount owed
if there is a “deficiency”, gets unsecured
claim for that amount

Owed Value of Collateral Receives

$100 V > $100 $100
$100 V = $100 $100
$100 V < $100 V+
unsecured
claim for
($100 - $V)
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Overview of Distribution in Chapter 7 (4 of 5)

Subordinated debt
X is subordinated to Y =
X must give all of its share to Y
until Y is paid in full

Pro rata Subordination

X owed $5000 $2500 $1000
Y owed $3000 $1500 $3000
$4000 of assets 21
 Overview of Distribution in Chapter 7 (5 of 5)
1. Administrative expenses

2. “Gap Claims”

3,4. Wage claims, up to ~ $4K per

person earned within 90 days of
Section 507 (a)
filing, employee benefit contributions
Priority Unsecured
Creditors
5. Fishermen/farmers

6. Customer deposits

7. Unsecured tax claims (income,

excise, property, etc.)

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