Bankruptcy (Debtor Creditor Law)

Part II

Bankruptcy - Table of Contents

I. COLLECTION WITHOUT COURTS . . . . . . . . . . . . . . . . 1

A. Nonjudicial Collection Methods . . . . . . . . . . . 1

B. Restrictions on non-judicial collection. . . . . . . 1

C. Lender Liability . . . . . . . . . . . . . . . . . . 2

II. STATE LAW DEBT COLLECTION . . . . . . . . . . . . . . . . 3

A. 5 Principle ways to collect judgments. . . . . . . . 3

B. Judicial Sales . . . . . . . . . . . . . . . . . . . 3

C. Garnishment. . . . . . . . . . . . . . . . . . . . . 4

D. Pre-Judgement Remedies . . . . . . . . . . . . . . . 4

E. Exemptions . . . . . . . . . . . . . . . . . . . . . 5

F. Fraudulent Conveyances & Shielding Debtor Assets . . 5

III. BANKRUPTCY - GENERALLY. . . . . . . . . . . . . . . . . . 6

A. Introduction . . . . . . . . . . . . . . . . . . . . 6

B. Elements Common to Consumer Bankruptcies . . . . . . 7

1. The Estate (541) . . . . . . . . . . . . . . . 7

2. The Automatic Stay (362) . . . . . . . . . . . 7

C. Chapter 7 vs. Chapter 13: a debtor's choice. . . . . 8

IV. REORGANIZATION FOR FAMILY FARMERS (CHAPTER 12). . . . . . 9

V. LIQUIDATION BANKRUPTCY (CHAPTER 7). . . . . . . . . . . 10

A. Generally. . . . . . . . . . . . . . . . . . . . . 10

B. Exemptions (522). . . . . . . . . . . . . . . . . 10

C. Claims & Distributions . . . . . . . . . . . . . . 10

D. Discharge. . . . . . . . . . . . . . . . . . . . . 11

E. Debtor's Post-Bankruptcy Position. . . . . . . . . 12

VI. CHAPTER 13 BANKRUPTCY - REORGANIZATION FOR INDIVIDUALS. 13

A. Generally. . . . . . . . . . . . . . . . . . . . . 13

B. Elements of an acceptable plan . . . . . . . . . . 13

1. For Secured Creditors . . . . . . . . . . . . 13

2. For "Semi-Secured" Creditors - Lien Stripping 14

3. For Unsecured Creditors . . . . . . . . . . . 15

C. Paying Otherwise Nondischargeable Claims in Chapter 13 15

D. Modification, Conversion and Dismissal of Chapter 13 Plans 16

VII. CHAPTER 11 REORGANIZATION . . . . . . . . . . . . . . . 16

A. In General . . . . . . . . . . . . . . . . . . . . 16

B. Mechanics of Chapter 11. . . . . . . . . . . . . . 17

C. Automatic Stay Revisited . . . . . . . . . . . . . 18

D. Operating in Chapter 11. . . . . . . . . . . . . . 19

E. Avoiding Powers of the TIB/DIP . . . . . . . . . . 21

1. Generally. . . . . . . . . . . . . . . . . . . . . 21

2. Avoiding Powers Analyzed Individually. . . . . . . 21

a. Strong-Arm Provision - 544(a). . . . . . . . 21

b. Power to Avoid Preferences - 547 . . . . . . 22

c. Indirect Preferences. . . . . . . . . . . . . 25

d. Executory Contracts - 365. . . . . . . . . . 25

e. Fraudulent Conveyances - 548 . . . . . . . . 27

f. State Law Avoiding Powers - 544(B) . . . . . 28

g. Statutory Liens - 545. . . . . . . . . . . . 29

h. Equitable Subordination - 510(c) . . . . . . 29

VIII. NEGOTIATING & CONFIRMING THE PLAN. . . . . . . . . 30

A. Generally. . . . . . . . . . . . . . . . . . . . . 30

B. DIP/TIB has 3 Main Objectives. . . . . . . . . . . 30

C. Confirmation. . . . . . . . . . . . . . . . . 30

D. Voting Under the Plan . . . . . . . . . . . . 31

1. 1126 - Voting Provisions. . . . . . . . 31

2. Classification of Claims . . . . . . . . 31

3. Impairment . . . . . . . . . . . . . . . 31

4. Solicitation of Disclosure - 1125 . . . 31

5. Cramdown - 1129(b). . . . . . . . . . . 32

6. New Value Rule . . . . . . . . . . . . . 32

7. Secured Creditor Cramdown - 2 cases. . . 32 Bankruptcy Outline

I. COLLECTION WITHOUT COURTS

A risk inherent in litigation is that one party will net nothing by losing the case entirely. Further, the Creditor has the

risk that the Debtor will be judgment-proof or that the Creditor will be adjudged not to own a valid debt.

A. Nonjudicial Collection Methods

1. Weighing & Leveraging Process:

a. The Debtor-Creditor payment process can best be viewed as a constant balancing - a

weighing & leveraging process. The Debtor weighs which bills to pay, if not to pay or if

to sue. The Creditor weighs which bills on which to collect, whether to threaten to sue,

whether to stop credit or whether to deny access to future credit by filing a negative credit

report.

b. Note that securing capital equipment serves the functions of providing leverage, collateral

control & possible loss reduction. Most leverage factors involve both formal legal rules &

informal collection devices.

2. The Credit Information Process

One form of leverage Creditors can use is to deny access to future credit. Reporting services

provide credit info for potential Creditors.

3. The Fair Credit Reporting Act (FCRA) has two themes: (1) giving the Debtor access to credit

report info & (2) prescribing procedures to assure accuracy of info. Willful noncompliance by a

Creditor can result in punitive damages. Negligent noncompliance can result only in actual

damages, costs & atty fees.

a. Giving Debtor access to info:

(1) 609 - 610: Intended to give debtor free access to information if negative credit

rating is given

(2) 612: allows debtor free access to credit information if negative credit report is

given

(3) 615: requires creditor to inform debtor whenever credit is denied due to

negative credit information

b. Prescribing procedures to assure accuracy of info in files

(1) 605, 606, 613: controls on the use of obsolete info & requirements to verify

adverse info

(2) 611: consumer can dispute

(3) 616 - 617: provides remedies for willful or negligent noncompliance (punitive

damages are available for willful noncompliance)

Interestingly, to the extent that the statute has enhanced the credibility of the credit reports,

Creditors are increasingly likely to rely on them, raising the leverage effect of a negative credit

report by a member-Creditor.

B. Restrictions on non-judicial collection

1. Common law remedies

a. Emotional distress (Public Finance Corp.)

(1) Very high burden to meet -- must show conduct constitutes a prolonged course

of hounding

(2) Requisites for IIMD: (1) extreme, outrageous conduct; (2) Emotional Distress

must be severe; (3) actor knows Emotional Distress is certain or substantially

certain to result; & (4) conduct is result of abuse of authority or power position.

This is difficult, b/c hi b/p. See Public Finance Corp v. Davis.

b. Invasion of right of privacy

(1) Also a hard case to make -- must show conduct constitutes publicity which is

unreasonable regarding a private fact See Vogel v. WT Grant Co.

2. Fair Debt Collection Practices Act (FDCPA)

a. Prohibited Practices under FDCPA

(1) 805 - communication at an unusual time or place

(2) 806 - conduct which harasses, oppresses or abuses a debtor

(3) 807 - false & misleading representations (e.g., falsely threatening legal action)

b. Available Remedies ( 813)

(1) Actual Damages

(2) Additional Damages up to $1,000.00

(3) Actual Costs (i.e., Attorney's Fees)

c. Who does FDCPA apply to? (see CB p.27 - parties not covered)

(1) Debt collectors -- not employees of creditors

(2) Debt collector is a party who uses the instrumentalities of interstate commerce to

collect debts owed to another

(3) See Crossley v. Lieberman: The Act does not apply to Employee's of Creditor,

presumably b/c Debtor's & Creditors have a "good" relationship & therefore do

not need the FDCPA to protect them; d collectors have no relationship w/

Debtor's (collectors are usually more abusive). Paradoxically, the Act is narrow,

but should be broader. Note that the Debtor can get atty fees under the FDCPA,

but not under the c.l. torts.

d. Advantages/Disadvantages of Debt Collectors

(1) The advantages of d collectors is that they're specialized, they treat Debtor's

fairly, & they're liable under the Act.

(2) The disadvantage is that they keep a good portion of the d's as fees.

e. Alternatives to d collectors is using own Employee's, but the disadvantages are that they

may hurt the Debtor-Creditor relationship & they may be liable in tort. A third option is

using an atty, but attorneys fall w/in the scope of FDCPA. C. Lender Liability (the exception -- not the rule)

1. Applies to COMMERCIAL debt, not CONSUMER debt

2. State Nat'l Bank El Paso v. Farah: origin of LL. Lender threatened to call laons with no intention of

doing so in order to force president of company out of office so lender could grab control.

3. Typically, debtor claims the lender acted improperly during the course of a loan; Lender liability

involves lawsuits in which a Debtor claims the lender (L) acted improperly, i.e., causing the Debtor

loss or destruction of bus through misrepresentations, breaches of K or bad-faith conduct, during

the course of a transaction, usually during the period in which the borrower (B) was in financial

trouble. Lender-liability puts limitations on the collection of commercial d's. The effect is that the

Lender often owes the B $.

a. Debtor seeks damages for loss or destruction of business which allegedly was caused by

lender's misrepresentations, breach of contract, or bad faith conduct.

b. Effect of a successful lender liability suit is a reversal of debtor/creditor positions!

(1) K.M.C. Co. v. Irving Trust Co - the prototypical case. The B had a blocked acct

set up, where it could not touch the $, rather the $ was for the Lender. It was a

sec interest. The K said the Lender was to lend $1.7 M, but up to $3.5 M in its

discretion.

(2) Held: the Lender has an obligation to act in good faith under the UCC. That is,

the Lender has to give the B notice or an opportunity to obtain alternative

financing BEFORE REFUSING TO ADVANCE FUNDS.

(3) This case can be read narrowly as a technicalities case or read broadly as a

comment on the Debtor-Creditor relationship whereby the Creditor has an

affirmative obligation to assist the Debtor. The latter reading leads to slippery

slope problems. Courts have read this case fairly narrowly. Lender-liability suits

are the exception, not the rule.

c. Some states say that KMC will not apply, i.e., no UCC good faith provision, in cases of

demand notes.

d. LL does not apply to repossession . . . Repossession is governed by Art 9)

e. Advantages to Lender-liability: is that it protects Debtor's from zealous Creditors, permits

businesses to cont to run, & may even protect other Creditors.

f. Disadvantages: Lenders apprehensive to lend, removes "discretion" in K's & thus

transaction costs rise, hurts business in general, & hurts consumers by increasing interest

rates.

THE 10 COMMANDMENTS OF AVOIDING LENDER LIABILITY

1. Thou shall not make a sudden move (which could violate duty of good faith)

2. Thou shall not tell a lie or fudge the truth:

1. with respect to credit inquiries (and if a 3rd party makes an inquiry, the bank must be honest); and

2. during workout negotiations, a bank cannot make threats it does not intend to carry out

3. Thou shall honor thy commitments to the letter

4. Thou shall not run thy borrower's business

5. Thou shall not bail thyself out with thy brother's money (bank cannot injure others in the process of working out a loan

6. Thou shall keep thine own files clean (bank should write objective, non-emotional memos re: lenders)

7. Thou shall transfer a troubled loan to a workout officer (to avoid conflicting loyalties)

8. Thou shall confer with thy workout counsel

9. Thou shall think carefully before suing on a deficiency

10. Thou shall not be arrogant (make sure your actions are fair)II. STATE LAW DEBT COLLECTION

A. 5 Principle ways to collect judgments:

1. Judgment Lien

a. Only creates a lien on the debtor's real estate

b. Arises by force of statute from the judgment itself (i.e., it arises as a result of recordation

of the judgment)

c. Usually only applies to liens on Debtor's real estate.

(1) The advantages are that for a small fee, a Creditor can tie up the Debtor's prop &

that the Creditor gets ahead of other Creditors.

(2) Recordation procedures make it easier to obtain a lien w/o going through

execution by encumbering the Debtor's real prop. Creditor is now in line before

other Creditors & provides protection if the Debtor goes Bankrupt.

2. Writ of Execution

a. Deals generally with personal property

b. Court issues writ which authorizes sheriff to seize & sell property of the debtor to then

give the proceeds to the creditor

c. The collection process begins w/ a writ (a ct order). The Creditor has the court issue a

writ after the judgment. A writ of attachment orders the sheriff to levy (seize) the Debtor's

non-exempt prop, sell it & pay the proceeds to the C. The Creditor then becomes a

judgement lien Creditor. The entire process is called execution. A writ of execution deals

w/ personal prop only. Real prop is seized by posting notice.

3. Writ of Garnishment (see below)

a. reaches debts owed to the debtor by 3rd parties (garnishees)

b. A writ of garnishment, an ancillary suit against the 3rd-party garnishee, is used to attach

debts owed to the Debtor for the benefit of the C. The garnishment writ asks the garnishee

if she owes a debt & orders her to w/hold prop pending further order of ct. As a

procedural matter, a garnishment is an ancillary lawsuit against the 3rd-party garnishee.

(see below)

4. Other State Writs - vary from state to state

5. Art. 9 - Voluntary Consensual Agreements

a. Voluntary Liens are usually called security interests.

(1) Usually perfected by recording so as to give public notice.

(2) Examples are home mortgages (sometimes called deeds of trust) & car loans.

(3) Seizure of the realty collateral is foreclosure; seizure of personalty is

repossession.

B. Judicial Sales

1. Next step after judgment and collection of property

1. Judicial sales bring low prices, as a result of the prop being distressed & having no warranty of

title for buyer in most states, and a "buyer's market" exists. Often the Debtor has other Creditors

who stand to gain for higher prices, either b/c they will yield assets for them to attach or simply b/c

a more financially secure Debtor is more likely to be in a position to pay.

2. If the procedures in the sale are unfair, the sale might be set aside.

a. At beginning of century, courts would set aside if low sale price

a. The mere inadequacy of price, w/o technical difficulties, will not in itself suffice to vacate

a sale. See Guardian Loan Co v. Early. Cf. Corbitt v. Burkette (holding wife's failure to

appear & bid on property resulted from husband's illegal threats of violence if wife

appeared to bid, leading to grossly inadequate price).

3. Advantages/Disadvantages:

a. The advantage to making sales easier is that sale prices will increase.

b. The disadvantages: We want to protect the D, to encourage the Debtor to pay & these

sales get sophisticated bidders anyway. C. Garnishment

1. The Creditor attempts to reach money, goods or obligations owed to the Debtor through a suit

against the garnishee, i.e., the party holding it.

2. Most states provide the garnishing Creditor with a temporal "net," in which the Creditor gets to

catch obligations arising in favor of the Debtor in the time between service of the garnishment &

the garnishee's answer.

3. Garnishee has 2 duties

a. answer the garnishment summons (liability for failure to answer may be full value of

judgment against debtor -see below)

b. impound property hled or owed by garnishee (note: liability for failure to impound is the

amound of the property transfered)

4. In most states a judgement can be entered against a defaulting garnishee for the full amount of the

judgement against the . Thus, garnishee may be liable for a debt that is significantly greated than

the debt owed by the garnishee to the Debtor)

5. Extraordinary Circ's: Webb v. Erickson held that in extraordinary circ's, a defaulting garnishee may

be relieved from a default judgement against her. The extraordinary circ's here was that the

defaulting garnishee was experiencing lengthy hospital stays & a troubled marriage.

6. DEFENSES TO GARNISHMENT: The garnishee may defend garnishment by:

a. arguing that no obligation is owed,

b. attacking the validity of the garnishee's claim directly or by

c. arguing that any obligation owed is offset by an obligation of the judgement Debtor to the

garnishee. Valley National Bank v. Hasper held that a garnishor cannot obtain rights

against a garnishee superior to the rights held by the judgement Debtor against the

garnishee at the time of garnishment.

3. Restrictions on Wage Garnishment: Restrictions on Garnishment Act restricts the extent the

Debtor's wages may be garnished, so as not to reduce the Debtor's incentive to work & not give the

Creditor excess leverage against a defaulting D. Some states have additional limitations.

a. The max amount which may be garnished from the earnings of an individual for any work

wk, set out in 303 of the Restrictions on Garnishment Act, is (1) 25% of her disposable

earning, i.e., those after tax. See GMAC v. Met Opera; or (2) amount by which disposable

earnings exceed 30 times the fed min hourly wage for a wk, whichever is less. 304 of the

Act prevents Employer's from firing Employee's whose wages have been garnished.

b. Advantages/Disadvantages

(1) The advantages of wage garnishing is that it is effective.

(2) The disadvantages are that it discourages people from working & that it really

affects low-income people.

D. Pre-Judgement Remedies

1. Three pre-judgement remedies:

a. Attachment: is like a writ of execution. The sheriff seizes prop, holds it until the

judgement, & sells after a successful judgement (under writ of execution, sheriff does not

hold the property until judgment b/c judgment already exists).

b. Replevin: is an action similar to attachment for specific personal prop, not a general

action.

c. Lis Pendis Action: file a notice of pending litigation of rights in prop; no taking of prop.

2. State Law Procedural Safeguards (Will be governed by statute)

a. Just indebtedness must be shown.

b. Attachment must not be for harassment.

c. Generally, other specific grounds must be shown relating to urgency or risk. Include

things like the is a non-resident of the state, the is in hiding, the is hiding her prop

or about to remove it from the state, & the owes the ã for prop obtained by false

pretenses.

NOTE: debt must not be exempt

3. Constitutional Safeguards

a. Federal Constitution: The 14th Amend says no state can deprive any person of life, liberty

or prop without Due Process of law. The test is (1) when is there state action; & (2) if

there is state action, what Due Process is required?

(1) Three tests for state action:

(a) Symbiotic Relationship Test: actions of private party attributable to

govt when they act as joint participants.

(b) Nexus Test: nexus when govt & private parties actions may be fairly

treated as that of the other (for ex, when the govt requires the party to

act in a certain way).

(c) Public-Function Test: if the private party performs a traditional pub

function (ex, collecting taxes).

(2) Due Process Analysis:

(a) In Sniadach v. Family Finance Corp, 1969, the US S.Ct. held that as a

general rule, a seizure of prop must be preceded by (1) notice to Debtor

of impending seizure; & (2) the opportunity for Debtor to be heard in

opposition to seizure.

(b) Fuentes v. Shevin, 1972, laid out two exceptions to the Sniadach rule:

(1) where the Debtor waives her rights voluntarily, knowingly &

intelligibly; & (2)(a) if seizure is necessary for an important

governmental interest; & (b) there's a special need for prompt action; &

(c) the state strictly controls the process for initiating the action.

(3) The Debtor can sue under 18 USC 1983 if she feels her rights have been

violated "under color of state law." (Fuentes)

b. CWT: State Constitution: Due Process claim under various state constitutions are also

possible. In some states, due process is broader under state constitution than under federal

constitution.

c. Thus, there are 4 rules:

(1) Pre-judgment remedies are not unconstitutional per se.

(2) Use of pre-judgment remedies are subject to DP.

(3) DP requires notice & opportunity to be heard in adversary hearing.

(4) In at least some situations, a pre-seizure hearing coupled w/ a prompt post

adversary hearing will satisfy DP.

E. Exemptions (see Handout re MN exemptions and see p. ___ of outline)

1. Policy reasons for exemptions include (1) the desire to avoid results so draconian so as to threaten

the social fabric of the community; (2) the state's concern that the Debtor or the Debtor's family not

become a drain on the community; (3) that every Debtor have the chance to make a fresh start; &

(4) that some items of personal property have little resale value to the C, but are crucial to the

Debtor (e.g., clothing)

2. Classification

a. Commonly classified by dollar amount and type of property

b. Classifications may be ambiguous. Many legal battles hinge on classific - always argue it

c. In In re Johnson, it was held that a bus is classified as a car for KY exemption purposes.

d. In re England held a screw machine constituted "equipment for trade or profession."

3. Proceeds from Exempt property

a. Secured Cs can force sale of exempt property b/c secured creditors have higher priority

than exemptions on distribution list)

b. Distribution: Following a judicial sale of exempt prop, the proceeds are allocated first to

the sec Creditors, then to the Debtor to the full amount of the exemption, w/ the remainder

going to the Creditors. Thus, if property is valued greater than the exemption,

property is levied and sold, proceedings go to secured Cs, D (up to exemption), then

to unsecured Cs.

4. Exemption of Property already received:

a. Havelock Bank v. Hog Confinement Systems held that money paid by the SS

Administration under the SS Act & on deposit in a bank is wholly exempt from state

garnishment.

b. Holmes v. Blazer Fin Svc's held that a state exemption stat exempting from garnishment

wages due the head of a household do not apply to wages already received.

5. Homesteads

a. This is the most important exemption.

b. Household exempt; mortgage is not: If one buys a house w/ a mortgage, the house is

exempt, but the mortgage is not.

c. Tenancy by entirety: In jurisdictions where there is no exemption for the homestead, the

homestead of married persons is often protected by tenancy by the entirety. The doctrine

protects the homestead from a Creditor of only one spouse, & thus, Creditors often attempt

to obligate both husband & wife on substantial d's. F. Fraudulent Conveyances & Shielding Debtor Assets

1. Fraudulent Conveyances:

a. Definition: Fraudulent conveyance occurs when D conveys property to another for little or

no consideration in order to avoid attachment by C, with understanding that property will

be returned at later date

b. Twyne's Case stood for the proposition that a secret transfer in trust, made solely to defeat

the rights of other Creditors, was fraudulent.

c The Uniform Fraudulent Transfer Act:

(1) History: The Uniform Fraudulent Conveyances Act, based on the Stat of

Fraudulent Conveyances (1571), was adopted in 1918. The UFTA was adopted

in 1984 retains the basic principles of its predecessors, prohibiting "constructive

fraud" or "presumptive fraud," intent being irrelevant.

(2) Prohibits Intentional Fraud: Like the Stat of Elizabeth, the UFTA condemns

the transfer of prop that is intentionally fraudulent. 4(a)(1). Section 4(b) lists

circumstantial indicators, i.e., "badges of fraud." This section shifts the

presumption from the Creditor to the D.

(a) 4(b)(1): transfer to insider.

(b) 4(b)(2): Debtor retains possession after transfer, not title.

(c) 4(b)(3): After threatened w/ suit, Debtor transfers.

(d) 4(b)(4): transfer of all Debtor's assets.

(3) Prohibits Constructive Fraud: The UFTA extends the Stat of Elizabeth by

codifying the concept of constructive fraud. The Creditor does not have to show

actual intent. Must show the 5(a) requirements: (1) conveyance; (2) w/o

receiving reasonably equivalent value; (3) Debtor was then or as a result of

transfer insolvent. Insolvent means Debtor d's > assets

(4) Remedy: If transfer is voidable, C can recover judgment for value of asset

transferred or amount necessary to satisfy C's claim, whichever is less. (Note:

Under 544(b) (state avoidance power under Bkrtcy Code), TIB/DIP can recover

the entire value of the transfer and return property to common pool)

(5) Innocent Parties: If the transferee was an innocent party & paid fair csn, she

keeps the prop. 8(a). If she was innocent but did not pay fair csn, she gets a

lien on the prop for amount paid, but C gets property back. 8(d)(1). If she was

guilty (not innocent and did not pay fair consideration), she keeps nothing.

(6) Caselaw: A fraudulent conveyance is one made w/ the actual intent to hinder,

delay or defraud present or future Creditors or made w/o receipt of fair csn &

which has the effect of rendering the conveyor insolvent. See ACLI Govt

Securities v. Rhoades (holding that Rhoades' conveyance of 60% interest in his

interest in 68 acres worth $325M to his sister for one dollar one day b/f a

judgement of $1.5 M against him was fraudulent).

(7) Transaction leaving business with unreasonably small capital:

a. Rule: A conveyance of a bus will be deemed to be fraudulent as to

current & subsequent Creditors when it is made w/o fair csn & the bus

has been left after the conveyance w/ unreasonably small capital.

b. Application to Leveraged Buy-Outs:

1. Buyer Financing: Usual scenario involves buyer financing -

lender gives buyer money in return for security interest in all

company assets. Buyer takes money and pays shareholders.

Shareholders transfer stock to buyers.

2. Seller-Financing: Optional scenario involves seller financing

- shareholders sell stock for cash and note from buyer. Buyer

then issues a company bond as collateral for note which is

secured by all the assets of the company.

3. Fraudulent Conveyance Attack on LBO: Prior to LBO,

company usually has large amount of unencumbered assets.

After LBO, all assets are subject to security interest.

Unsecured Cs are how behind the secured C in priority. So

unsecured Cs attack LBO as fraudulent conveyance under

theory that company granted a security interest in all its assets

but received nothing in return.

4. Sharrer v. Sandlas (Unsecured Cs attacked seller-financed

LBO on the grounds of fraudulent conveyance. Ct found that

transfer was fraudulent conveyance because fair consideration

was not paid and business was left with unreasonably small

capital.

2. Other Ways to Hide Assets from Creditors

Apply Proceeds of non-exempt property to exempt property: In In re Reed, Reed sold non-exempt prop to friends & applied the proceeds to liens on exempt prop (his homestead). The ct

held his activities valid, even though he did it w/ the intent to keep the non-exempt prop from his

Creditors.III. BANKRUPTCY - GENERALLY

A. Introduction

1. History: 1705 Statute of Ann provided that Ds could discharge debts but a D who was not

forthcoming was subject to the death penalty. 1898 Bankruptcy Act was first act of significance

because it addressed both C and D rights but it only applied to individuals. 1938 Chandler Act

provided coverage to insolvent corps.

2. Structure of Bankruptcy Code:

Ch 1 - definitions

Ch 3 - case administration

Ch 5 - trustee powers

Ch 7 - liquidation bankruptcy (individuals and businesses)

Ch 9 - municipality bankruptcy

Ch 11 - Business reorganization

Ch 12 - family farmer reorganization

Ch 13 - individual reorganization

3. Why Bankruptcy?

a. Prime Advantages for Creditor

(1) There is no "race" to get to the assets

(2) Pools all of debtor's assets

(3) Debtor must "schedule" all of his assets

(4) easier, uniform, more predictable for Cs

b. Prime Advantages for Debtor

(1) Gives Debtor a "fresh start" by discharging debts (Chapter 7)

(2) Gives temporary Stay of harassment from creditors / temporary reprieve

(3) Allow reorganization (Chapters 11 & 13) without liquidating assets

c. Disadvantages of Bankruptcy

(1) Provides an out for debtors (moral hazard problem - recognizing bankruptcy

provides social insurance for risky financial behavior)

(2) Impugns reputation of Debtor

4. You cannot waive your right to Bankruptcy

a. if you could, people would always do so (Cs would compel Ds to waive bankruptcy rights;

individual D may be unrealistically optomistic and therefore willing to agree)

b. this could adversely affect debtor's dependents

5. 2 Types of Bankruptcy Filing

a. Voluntary

(1) Debtor files a voluntary petition for Bankruptcy under 301

(2) Debtor need not be insolvent; he need only be unable to "service his debt"

b. Involuntary: Creditors force debtor into bankruptcy by filing a petition under 303

(1) Creditor may only force debtor into Bankruptcy under Chapters 7 & 11

(2) Certain debtors are protected from involuntary Bankruptcy (eg. banks,

farmers, and not for profit associations/charities). Corporations are not

protected.

(3) Petition (303) must be filed by the requisite number of creditors:

(a) 3 creditors of unsecured claims totaling $5,000 must join; or

(b) a single creditor with an unsecured claim of $5,000, if debtor has less

than 12 total unsecured creditors

(c) Definition of "Creditor"

(1) Insiders are not creditors (303(b)(2))

(2) Wholly-owned subsidiaries of same corporation are treated as

separate creditors absent showing of abuse or fraud. In

Gibraltar Amusements, court held that wholly owned

subsidiary can be counted as a separate C along with the

parent corp absent abuse or fraud.

(4) Debtor has right to file answer under 303(b). Under 303(h), court will grant

relief under petition if D fails to file anwer.

(5) Elements Necessary for Court to grant petition: If D files answer, court wil

grant petition only if Cs prove

(a) Equitable insolvency (i.e., debtor is not paying debts as they come

due).

(1) C don't usually have access to D's financial records, so C

usually must rely on credit reports

(2) Majority Rule: HIJR Properties To determine whether D is

equitably insolvent, court looks at four factors: (1) number of

debts, (2) amount of delinquency, (3) materiality of

nonpayment, (4) general nature of D's conduct regarding

financial affairs. Nonpayment of one particular C does not

establish that D is equitably insolvent unless there are

exceptional circumstances. Exceptional circ's can be shown

if (1) creditor does not have remedy under state law unless

relief is granted or (2) D commits fraud.

(3) Minority Rules: (a) D is equitably insolvent if D fails to pay

largest debts, (b) D is equitably insolvent only if not paying all

debts, (3) D is equitably insolvent if D is not paying certain

percentage of debts.

(b) OR a receiver has taken control of D's property within 120 days

before petition filed.

(6) Advantages of Involuntary Proceedings

(a) protects Cs from actions of D and other Cs (protects the common pool)

(b) provides significant leverage to C over D

(7) Disadvantages of Involuntary Proceedings

(a) can be used by C to harass D

(b) may force D off the market even though unnecessary

c. Safeguards against unjustified involuntary filings

303(i) provides that if C files an unfounded petition, D can receive atty's fees and costs

plus punitive damages B. Elements Common to Consumer Bankruptcies

1. The Estate (541)

a. Composition of Estate: At the moment the Bankruptcy petition is filed, a Bankruptcy

Estate is created pursuant to 541(a). Under 541(a) - Bankruptcy Estate includes all

property of the debtor at the time of filing petition

b. Limitations of Estate

(1) Property is limited to the interest of the debtor (i.e., creditor gets no more

rights in the property than the debtor)

(2) After-Acquired Property generally excluded: Estate Property is limited to the

debtors property as of commencement of the filing (i.e., property acquired

subsequent to filing is not part of the estate) 541(a)(7).

(3) Some After-Acquired Property included:

(a) 3 exceptions (if within 180 days of filing) 541(a)(5)

(1) Any Bequest of Devise of Property

(2) Property settlement or divorce decree

(3) Property acquired as a beneficiary of a life insurance policy

(b) Other exceptions (not necessarily within 180 days of filing)

541(a)(6)

(1) Proceeds of property, even if received post petition (e.g., rent)

(2) Proceeds from sale of property

(3) Payment of Services Performed pre-petition: In re Ryerson

expands definition of estate: D was terminated from

employment and received settlement payment post-petition.

Court held that the payment was part of estate because it

represented payment for services rendered pre-petition.

c. Specific Application:

(1) 541(a)(6) Wages earned after filing are not part of estate

(2) Garnished wages are generally not part of estate (although, in a controversial

move, 7th Circuit has allowed creditors to continue garnishing wages after Stay)

(3) ERISA Funds are not part of estate. In In re Graham, court held that trust funds

in ERISA plan were part of estate. Case was overruled by Sup Ct in Patterson v.

Shumate, which held that ERISA/Keough plans are not part of estate

(4) Spend Thrift Trusts are not part of estate: Under 542(c)(2), proceeds from

trust received before filing are part of estate, but corpus of trust is exempt

(5) Puppies are considered proceeds of property of the estate under 541(a)(6)

(6) Dividends from stock are part of estate [under 541(a)(6)???]

(7) Money Market Account is considered earnings of property of the estate

(8) Lottery Ticket: If purchased prior to filing, is considered proceeds of property

of the estate 2. The Automatic Stay (362)

a. Generally

(1) Creditors are prohibited from collecting on debtors's property

(2) This prevents creditor from "fishing out the pond" and improving their position

(3) Assures that unsecured creditors will get something

(4) Gives the debtor some "peace & quiet"

(5) Stays creditor's actions, but not government actions (e.g., criminal prosecutions)

b. 362 in detail

(1) 362 only Stays action against the debtor & property of the debtor

(a) Stay doesn't apply to 3rd parties such as guarantors. Thus, if

someone promises to pay debts of debtor they can still be reached

(b) 105(a) - the Court's "Wildcard"

(1) Allows Court to use any power to move the Bankruptcy along.

(2) Often used to Stay actions against officers of debtor's

company. For instance, in In re Seitles, court uses this

provision to protect the officer of a corporation, where the

officer is necessary for effective reorganization. Test for

whether non-debtor co-defendant may be granted a stay

under sec 105: irreparable harm and either likelihood of

success on the merits or sufficiently serious questions going to

the merits to make them a fair ground for litigation and a

balance of hardships tipping decidedly toward the party

requesting relief.

(2) 362(a)(1),(2),(8): Operate to stay most litigation efforts of creditors directed at

collecting pre-Bankruptcy debts; seeks to Stay creditors from filing post-petition

suits

(3) 362(a)(3-5),(7) Stays actions by secured creditors attempting to collect

(4) 362(a)(6) Stays informal collection practices

(a) See In re Sechuan City, Inc., holding creditor's attempt to coerce

payment from debtor by erecting embarrassing signs violated

362(a)(6)

(b) permitted activities are very limited, but mere "annoyance" is not

prohibited

(5) 362(a)(3) C cannot "exercise control over estate property". Eg, cancelling

fire insurance policy may constitute violation of the Stay

(6) 2 Principle exceptions to Stay - 362(b): (generally governmental actions)

(a) 362(b)(1) - Debtor cannot use Bankruptcy Stay to avoid criminal

prosecution

(b) 362(b)(4) - Stay does not apply to the commencement or continuation

of an action or proceeding by a governments police or regulatory power E.g., D cannot pollute a lake just because D has

been granted Stay

(2) Test for police power: In In re Seitles, the issue was whether

the automatic stay applies to governmental action brought

under the false claims act. Court applies two tests:

(a) Pecuniary Purpose Test: Whether the

governmental action relates to a pecuniary interest in

the D's property or to public safety. If action relates

to public safety, it is excepted from the stay.

(b) Public Policy Test: Whether the governmental

action adjudicates private rights or those that

effectuate public policy. If action effectuates public

policy, it is excepted from the stay.

(7) 362(c)(1) - Auto Stay ends when the property is no longer part of the

estate

(8) Damages for Violation of the Stay: 362(h) - The violation of a Stay will

allow the estate (?) to collect actual damages & possibly punitive damages

against the creditor

(a) Notice of Stay Irrelevent:

See In re Holman, holding actions in violation of a Stay invalid even if

creditor has no knowledge of the claim; creditor who violates Stay

must reinstate status quo to avoid actual damages. [If C would have

returned property upon notice, however, there would have been no

liability (?)]

See Fidelity Mortgage, holding that creditor violates the automatic Stay

if he knows of the Stay & refuses to release DIP's property; formal

notice is not necessary if there is actual knowledge

(b) Standard for Punitive Damages: In re Krauss: punitive damages

proper only wher C's conduct is "egregious, intentional misconduct."

c. Statutes of Limitations: 108(c) extends statute of limitations until 30 days past the

ending of Automatic Stay

d. Declaratory Judgments to determine whether action will violate stay: Creditors can

get declaratory judgments to find out if their actions will violate the Stay

e. Lifting the Stay

(1) Methods of Lifting the Stay

(a) Lack of Adequate Protection: (for secured parties only??)

(1) 362(d)(1) Creditor can lift stay for lack of adequate

protection

(2) 3 methods for assuring adequate protection:

a) 361(1): DIP/TIB can make periodic cash

payments to the creditor equal to the decrease in

value of the creditor's interest in the collateral (e.g.,

payments equal to depreciation of asset)

b) 361(2): DIP/TIB can substitute or give an

additional lien on property to the creditor (on

another piece of property) - court approval is

necessary for this

c) 361(3): DIP/TIB can give the creditor other

protection which will result in the secured party

realizing the "indubitable equivalent" of value of

its interest in the collateral -- this must be approved

on a case-by-case manner by the judge

(1) Code does not define "indebitable

equivelant" - usually, it takes the form of a

personal guarantee or cash payments

(2) 361 is not "all inclusive" - Rogers

Development holds that adequate protection

can be provided in a variety ways (eg.

"equity cushion" where value of property is

increasing)

(3) If judge makes the wrong call the Code

provides 507(b): if guarantee is no good,

the unsecured claim goes to the "top of the

list," i.e, it is given administrative claim

priority

(b) Debtor has no equity in property and property not necessary for reorganization:

(1) Elements: To lift the Stay under 262(d)(2) C must prove 2

things:

(a) D has no equity in the property

(b) Property is not necessary to an effective

reorganization

(2) Courts almost always find the property necessary to an

effective reorganization

(3) Issue is usually whether the reorganization will be

"effective"

Timbers holds that D cannot just show that reorganization is

conceivable. D must show that property is necessary for an

effective reorganization that is in prospect.

Cartwright illustrates that courts should consider adequacy

of the plan early in the proceeding before costs become too

high.

f. 362(e) - In theory, Court must act on a request to lift Stay within 30 days, or else

the Stay is automatically lifted. In practice, this doesn't happen too often, since if attorneys

"push it" too hard, the judges would be spending all of their time in these "mini-trials,"

deciding whether to lift Stays.