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Course: Bankruptcy Outline Winter 2001
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Year: 2001
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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




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



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



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





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



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


(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



(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



(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




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


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



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



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



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


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



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



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



(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


(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)


(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



(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


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



(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



(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


(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



(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



(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



(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


(a) D has no equity in the property

(b) Property is not necessary to an effective


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

effective reorganization


(3) Issue is usually whether the reorganization will be



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




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.


g. Interest Payments during a Stay

(1) oversecured & secured creditors can get interest during a Stay (up to the value of

the collateral)

(2) Unsecured cannot get interest

(3) Undersecured creditors also have no right to interest accruing during the Stay


h. Operation of Stay during "gap period": During the period between filing and

finalization of the reorganization plan, stay remains in effect and business continues to be

operated by the DIP in the ordinary course of business. C. Chapter 7 vs. Chapter 13: a debtor's choice


1. Generally

a. Code was drafted to encourage debtors to choose Chapter 13 over Chapter 7; Congress

believed that this would allow creditors to get more


2. Incentives for Choosing Chapter 13


a. Statutory Incentives


(1) Property Incentives

(a) Ch. 13 allows debtor to keep property subject to a security interest

and continue to make lower payments (1322(b)(2)). Under Ch 7, D

would have to redeem or reaffirm in order to keep property.

Note: D is permitted to keep all property, as long as D

promises to devote future income to future creditors. Under

Ch. 7, D is entitled to keep future income.

(b) Ch. 13 especially appropriate for homeowners trying to forestall the

repossession of their home

(c) Debtor can also cure and de-accelerate a mortgage and lien strip

(Bellamy). Under Ch. 7, D cannot lien strip (Dewsnup)


(2) Discharge Incentives: Chapter 13 affords debtor a Broader discharge from debt

than Chapter 7. In Ch. 13, only a few types of debt are not dischargeable:

(a) 1328(a)(1) - can't discharge home mortgage

(b) 1328(a)(2) - can't discharge domestic payments (child support,


(c) 1328(a)(2) - can't discharge student loan payments

(d) 1328(a)(2) - can't discharge liability for death or injury caused by


(e) 1328(a)(3) - can't discharge restitution payments made in connection

with debtor's conviction for a crime

(f) Kourtakis further limits ability to discharge by requiring D to propose

plan in "good faith"


(3) Judicial "Incentives" - (Substantial Abuse Provision) Bankruptcy Judge can act

sua sponte to deny Ch7 access using 707(b) and "push" D into Ch13.

(a) 3 requisites

(1) Debtor must be an individual

(2) Debts must be primarily consumer debts

(3) Court must determine that granting Chapter 7 relief would be a

"substantial abuse" of Chapter 7


(b) In re Walton: Party had $497 surplus income per month; court was

allowed to take this future income into account in determining

"substantial abuse." Court held that dismissal for substantial abuse

appropriate in this instance, since facts rebut statutory presumption in

favor of granting the relief requested by the debtor.


(c) Walton is now the majority law with certain reservations:

(1) Court must act sua sponte (creditors barred from moving

to dismiss for substantial abuse)

(2) only applies to debtor with high consumer debt (Substantial

abuse test not applicable to individual with debts arising

primarily from stock market acquisitions, see 101(8))

(3) Presump in favor of granting relief requested by D.


b. Strategic and Systemic Incentives


(1) Attorney may encourage debtor to file Chapter 13 (so that attorney's will get

more fees paid)

(a) In re San Miguel

i) It appeared that only the atty benefitted from Ch. 13; attorney's

fees paid over longer period of time seems to be only reason

for choosing Chapter 13

ii) court raises issue of good faith sua sponte based on minimal

payments and short duration of plan

iii) Held: confirmation denied, 15 days to move to convert to

Chapter 13 or dismiss

(2) "Chapter 20" - Filing Chapter 7 discharge does not bar filing Chapter 13



(a) In re Saylors (D obtained discharge under Ch. 7 of mortgage payments

in arrears, then filed Ch. 13 in order to keep his house).

i) getting Chapter 7 discharge does not bar Chapter 13 plan

ii) must not be filed in bad faith; good faith question of fact

iii) debtor maintains rights after discharge


c. Societal Incentives


(1) calling yourself a bankrupt still involves a stigma


(2) credit ratings are more adversely affected by Chapter 7 than Chapter 13

Note: However, many credit companies will welcome you after you file

bankruptcy, due to part of the "Global Denial" provision 727(a)(8),

which prohibits D from discharging subsequent debts in another Ch. 7

proceeding if filed within 6 years of the first Ch. 7 bankruptcy)


(3) local legal culture (Chapter 13 may be what's currently "in fashion" in your

jurisdiction or your atty may be more familiar with Ch. 13)IV. REORGANIZATION FOR FAMILY FARMERS (CHAPTER 12)


A. Based upon Chapter 13 Enacted in response to farm crisis of 1980's; many farmers were not eligible for

Ch. 13 because their debt loads were too high.


B. Differences from Ch. 13


1. Debtor can be eligible with far higher debts:

a. Under Ch. 12, a total of $1.5 million is allowable

b. Under Ch. 13, fixed unsecured debts may not exceed $100K, fixed secured debts may not

exceed $350K (under 109(e))


2. restricted to family farmers

a. a partnership or corporation can be a Chapter 12 debtor as long as the entity is owned by a

single family and meets certain additional family farmer tests. 101(17),(20)


3. family farmer must have regular income but may be regular annual income


4. 1205 sets forth modified standards for stay-lifting procedures,


a. 1205(b)(3) makes payment of a reasonable and customary rent sufficient for adequate

protection regardless of any threatened decline in the value of the mortgaged land


5. expressly permits the family farmer to modify a residential mortgage along with all other

secured debt;


6. permits the plan to last more than five years


7. must devote all disposable income for the three to five year period, but disposable income is

determined after deducting business expenses


8. discharge is substantially narrower than chapter 13, individual debtor remains liable on the

same debts made nondischargeable in Chapter 7 (ie., D can only discharge debts that are also

dischargeable under Ch. 7)V. LIQUIDATION BANKRUPTCY (CHAPTER 7)


A. Who is eligible to file Ch 7?

(1) individuals (Sec 109(a) provides that D not eligible for bankruptcy unless D is resident of U.S., is

domiciled in U.S., or has property in the U.S.)

(2) businesses (although no incentive to voluntarily do so)

(3) Railroads can not file Ch. 7 (although they can file Ch. 11)


B. Operation of Businesses in Ch. 7

(1) 727(a)(1) businesses cannot receive discharge (under any Ch?)

(2) businesses cannot recieve exemptions (under any Ch?)

(3) business has no incentive to file voluntary proceeding: Ch 7 offers no real benefit to the

corporation. Therefore, it is usually filed by creditors through involuntary proceedings.


C. General Procedure:


1. Trustee in Bankruptcy (TIB) gathers all of debtor's property


2. TIB distributes property according to the following "pecking order"


a. Secured Parties

b. Applicable Exemptions

c. Unsecured Creditors - in the following order:

(1) Priority Unsecured Creditors (Trustee's fees) 507, 503 ???

(2) General Unsecured Creditors (C has no Article 9 security interest eg. Visa)

(3) Subordinated UnsecuredCreditors (due to some wrongdoing)

d. Debtor (if assets exceed liabilities) (rare - no reason to file bkrtcy)


D. Exemptions (522)


1. Debtor must choose either the State or Federal Exemption Statute. The 1898 Act

incorporated state exemptions. The 1978 Code allows states to "opt out" and require D to take the

state exemptions. In Minnesota, D can choose to take federal or state exemptions.


2. Exemptions cannot be waived


3 Specific Federal Exemptions - 522(d)(1-11)


a. Summary of Federal Exemptions (see HANDOUT)

522(d)(1) real property up to $7500

522(d)(2) motor vehicle up to $1200

522(d)(3) household items/clothes: $200/item, up to $4000 toal


b. "Wild-Card" Provision - 522(d)(5) D can exempt:

(1) any unused portion of 522(d)(1) [residence of debtor - $7500 limit] up to

$3,750 plus debtor's aggregate interest in any property up to $400 ($4,150


(2) See In re LaFlamme, holding cause of action to be "any property" for purposes of

(d)(5) "wild card" exemption


4. 522(f) - Judicial liens & certain types of voluntary sec interests are not recognized in Bkrtcy

a 522(f)(1) - D can avoid C's judicial liens (liens created by a judge)


b. 522(f)(2) - Debtor can void non-possessory, non-purchase money security interests

(permist D to void regular security interest in certain household goods, tools of the trade &

health aids


c. General effect - D can void liens in household goods, tools of trade, and health aids

because security interest in these items would generally come before exemption. Voiding

a lien does nothing more than allow D's exemption


5. Valuation of Property - 522(a)(2):

a. Code provides that value of property is the Fair Market Value (FMV) of the property at

the date of filing


b. Majority Rule: FMV = liquidation value (See In re Walsh) (Note: liquidation value

usually is artificially low, which permits D to exempt more property from the estate)


c. Minority Rule: FMV = value under normal selling conditions. In re Nellis


E. Procedure for filing Claims:

a. Creditor files a Proof of Claim form; indicates creditor has an interest in debtor's estate

b. Most of time, TIB does not object to the claim

c. When TIB objects, there is a mini-trial (See In re Lanza, holding filing of Proof of Claim

establishes prima facie evidence of a valid claim and shifts burden of proof to TIB to deny the



F. Types of Claims / Order of Distribution


1. Secured Claims - governed by 506


a. Creditor receives 1 of the following:

(1) The Collateral; or

(2) A payment equal to the value of the Collateral


b. Types of Secured Creditors:

(1) Undersecured

(a) Collateral is worth less than the amount owed to Creditor

(b) Secured claim is limited to the amount of the collateral, with the rest of

the debt classified as unsecured

Note: D cannot lien-strip in Ch. 7

(2) Oversecured

(a) Collateral is worth more than the amount owed to Creditor

(b) Secured claim is limited to the amount of the debt, with any excess

value of collateral going to pay off unsecured debt

(c) if you are oversecured, you can get post-petition interest, up to the full

value of the collateral


c. Atty's fees: Secured parties can get attorney's fees


d. Post-Petition Interest: Oversecured C receives post-petition interest until value of

collateral is exhausted


2. Exemptions (in order of distribution, D's exemptions come after secured claims)


3. Unsecured Claims (no article 9 security interest [or judicial lien?]) Governed by 502


a. Amount of Claim: 522(b) - creditor gets whatever the amount of claim is as of the date

of filing of the petition


b. "Overclaims": If a C "overclaims", C will be allowed the claim unless the D objects (If a

creditor claims that debtor owes him [some amount], creditor will be allowed this amount

unless TIB objects to it - 522(a))


c. No post-petition interest is permitted on Unsecured Claims - 522(b)(2)


d. TIB can assert all defenses against the unsecured claim - 522(b)(1)


e. Unsecured Cs can get attorneys fees

(1) if contract provides for them (is this required?)

(2) for post-petition efforts


Note: (CB p. 247) There is a significant debate over this issue.


(a) Arguments in favor of awarding fees: (Adam's view) Code does not

prohibit atty's fees for unsecured creditors. United Merchant


(b) Arguments against awarding fees: The code does not explicitly

provide for atty's fees to unsecured parties. Some argue that because

the code does provide atty's fees for secured parties, by negative

implication, unsecured parties are not entitled to them. In addition,

permitting unsecured parties leads to the perverse result that secured

parties are only entitled to fees up to the value of the secured collateral,

while unsecured parties would be entitled to unlimited atty's fees.


f. Procedure for Unsecured claims:

(1) determine the amount of each claim

(2) determine the pro rata share for each C

(Note: Most unsecured C's unsually get 10 cents on the dollar)

(Note: unsecured C may be better off seizing the property prior to bkrtcy)


g. Priority Unsecured Claims - 507(a)(1-7), 503(?)

See handout re: priority claims G. Discharge


1. Generally:

a. Discharge is the main object of declaring Bankruptcy; it gives the debtor a fresh start

b. Discharge is not a matter of right, but it is usually granted as a matter or course

c. 524(e) - 3rd parties (guarantors) are not discharged (or stayed)


2. Objections to discharge

a. 523 - Rifle Shot Objection


(1) C must object to prevent discharge - Under 523(b)(1), most of these debts are

dischargeable unless C objects


(2) Effect of Granting Objection: 523(a) - if C establishes a 523 exception, C

can continue to collect the claim


(3) Grounds for objection

(a) 523(a)(1) - taxes


(b) 523(a)(2)(A) Debts for property obtained through fraud

To make out fraud, court must be able to infer from all the

circumstances that the debtor incurred debts without intending the repay



(c) 523(a)(2)(B) - Debts for property obtained through false financial


(1) C must show (1) debtor made a materially false statement; (2)

reasonably relied upon by creditor; (3) debtor intended to


(2) In re Milbank - loans obtained through false pretenses are not


(3) In re Ward - C must make some credit check to obtain

exception to loan discharge (this is the majority rule: C cannot

rely on D's financial statements without conducting credit


(4) Minority Rule: C can rely on D's good faith


(d) 523(a)(3) - Debts not listed under schedule of debts required by

521 are not discharged unless creditor had notice or actual knowledge

of Bankruptcy filing (Note: D may amend filing within certain time

(add section on this)


(e) 523(a)(5) - Domestic obligations are not discharged (e.g., child

support, alimony, etc.)


(f) 523(a)(6) - Liabilities for wilful or malicious injury to a person or a

person's property are not discharged


(g) 523(a)(7) - criminal sanctions ("a fine, penalty or forfeiture payable

to and for the benefit of a governmental unit") are not dischargeable


(h) 523(a)(8) Educational debts are not discharged unless repayment would

pose an undue hardship to the debtor [or payments were made for 7(?)

years already]


In re D'Ettore, held repayment of student loans constituting 82% of total

debt merely "garden variety" hardship, & therefore not dischargeable.

A high percentage of student loans leads to a presumption of

nondischargeability. Factors showing undue hardship:

(1) Whether D has total incapacity now and in the future to pay

debts for reasons not within control of D

(2) Whether D has made good faith efort to negotiate a deferment

or forbearance of payment

(3) Whether the hardship will be long-term

(4) Whether D has made payments on the student loan

(5) Whether there is permanent or long-term disability of the D

(6) Ability of D to obtain gainful employment in the area of study

(7) Whether D has made good-faith effort to maximize income

and minimize expenses

(8) Whether dominant purpose of the bankruptcy petition was to

discharge the student loans

(9) The ratio of the student loan to total indebtedness


b. 727 - Global Objection ("The court shall grant the discharge unless. . .") 727(a)


(1) Effect of Global Denial: All creditors can attempt to collect their debts


(2) Bases for Global Denial:


(a) 727(a)(1) - Corporations cannot receive a discharge


(b) 727(a)(2) - If Debtor, with intent to "hinder, delay or defraud" C

has transferred, destroyed, or concealed property of the D within 1

year of filing or after the date of filing

Note: this is the same as 523 (WHAT DOES THIS




(See In re Reed, holding attempt to convert property from non-exempt to exempt status ok absent some intent to defraud



(c) 727(a)(3) - If Debtor knowingly destroyed or failed to preserve

records of financial position

i) Has the debtor failed to keep financial records?

ii) Is such failure justified under the circumstances of the case?

(See In re Harron, holding debt not dischargeable, as debtor

had no justification for failure to keep records)


(d) 727(a)(4) - If D deprives TIB of property or information; 4 ways:

i) (A) making a false oath or account

ii) (B) presenting a false claim

iii) (C) deceiving or giving consideration for action or inaction

(i.e., Bribery)

iv) (D) withholding books & records from TIB


(e) 727(a)(8) - If Debtor has already received a discharge under

Chapter 7 or 11 (or 13???) Bankruptcy proceeding within the past

6 years (ie, bankruptcy will permit D to discharge debts only once

every 6 years)


3. 525 Protects Bankrupt Party from Discriminatory Treatment


a. 525(a) government may not discriminate solely on the basis of Bankruptcy by

denying, revoking, suspending, or refusing to renew a license, permit, charter, franchise,

or similar grant.

Note: Courts have read this provision narrowly (if other reasons motivate

government's decision to deny D a license, franchise, etc., there is no violation).

See In re Elter, holding mandatory granting of student loan following Bankruptcy

not required by 525(a)

b. 525(b) Private employers cannot discriminate due to debtor's Bankruptcy filing


Note: this does not apply to refusal to grant credit H. Debtor's Post-Bankruptcy Position (After Ch. 7)?

1. Generally:

a. Golden Rule: Liens pass through Bankruptcy unaffected

b. Property will be taken back by secured creditors unless D redeems secured collateral

or reaffirms the secured debt


2. Redemption - 722

a. In a Nutshell:

(1) Debtor pays the creditor the full value of the collateral (see c below)

(2) Debtor can force this upon a creditor

(3) Purpose: allows debtor maximum freedom to choose the assets he wants to keep

(4) Very Rare, since all unsecured creditors must be paid off before debtor may


redeem, and if they could all be paid off, why did debtor declare bankruptcy in

the first place?


b. You can only redeem personal tangible property intended primarily, but not

exclusively, for personal, family, or household use


c. Amount which must be paid:

(1) Under UCC 9506, you must pay off the entire value of the loan, even if the

fair market value of the collateral is less than the amount of the loan

(2) Congress felt this was too harsh, so under 722 debtor only needs to pay off

the value of the collateral to redeem property


3. Reaffirmation - 524(c)

a. In a Nutshell:

(1) Debtor waives discharge of debt & agrees to be bound by the loan


(2) Debtor cannot force this upon a creditor


b. Requirements of valid reaffirmation:

(1) 524(c)(1) - Reaffirmation must be executed before discharge is granted


(2) 524(c)(2) - Agreement must contain a clear & conspicuous statement giving the

debtor the right to rescind anytime prior to discharge or within 60 days after

such agreement is filed with the court (whichever is later)


(3) 524(c)(3) - If debtor is represented by an attorney, attorney must supply

an affidavit stating 3 things:

(a) Debtor was fully informed

(b) Agreement was voluntary

(c) Agreement does not impose undue hardship on debtor


(4) 524(c)(6) - if debtor is not represented by an attorney, the Judge must

evaluate the agreement to determine that the reaffirmation agreement does not

impose undue hardship & that it is in the best interest of the debtor


(See In re Pendlebury, holding Court will not negotiate for the parties in

reaffirmation agreement - the proper role of the court is to review, not

negotiate, the agreement)


d. 524(f) - Note: Debtor can still voluntarily repay any debt


4. D may Redeem or Reaffirm Old UNSECURED Debt. Party may redeem or reaffirm unsecured

debt as well as secured debt, pursuant to the same requisites listed above (However, See In re

Brown, holding Court will refuse to uphold reaffirmation of unsecured debt upon finding agreement



A. Generally

1. Chapter 13 is reorganization for individuals. The focus is on the court or TIB using future

earnings, not assets, to pay off Creditors. The Debtor usually agrees to pay future income for the

next 3-5 yrs according to court-appointed reorganization plan, but keeps assets.

2. TIB's Duties under Chapter 13 (1302)

a. object to improper Creditor claims & also improper discharge of any debts.

b. assist the Debtor in the Debtor's duties.

c. recommend approval or denial of the plan.

d. ensure that payments commence w/in 30 days of filing of the plan.

e. orchestrate successful completion of the plan.

3. 3 primary criteria for Filing Chapter 13:

a. only individuals can file chapter 13; no corporations or partnerships

b. the individual must have regular income under 101(30); income must be sufficiently

stable & regular to enable individual to make normal payments under chapter 13.

Note that just about anything that comes in regularly counts as "regular income."

McMonagle (eg UE benefits, social security payments)

c. dollar limitations: fixed unsecured debts must be < $100K; fixed sec d's must be <

$350K (109(e))

Note: contingent & unliquidated claims do not count in this tabulation

(a) contingent claim: one Debtor may or may not have to eventually pay.

(b) unliquidated claim: liability is admitted, but the amount of the debt is in


B. Elements of an acceptable plan (ie, protections necessary for secured, semi-secured, and unsecured Cs)

1. For Secured Creditors:


a. Relief from Automatic Stay. The automatic staty (362) limits the activities of Secured

Cs. Even though the automatic stay is in place, however, secured parties are protected by:

(1) 362(d)(1) Adequate Protection: If C can show that its interest in the collateral

is not adequately protected, stay can be lifted

(2) 362(d)(2) D has no equity in property and property not necessary for

effective reorganization. Stay can be lifted: if Creditor can show

i) Debtor has no equity in the encumbered property; and

ii) the property is not necessary for an effective reorganization

(both tests must be met)


(3) Example: Radden - Although D had no equity in car, court held that car

financing lender was "adequately protected" if debtor party takes out car

insurance; court also found that car was "necessary for an effective

reorganization," since debtor needed car to get to work - to make money - to keep

paying creditors. b. Secured Creditor is guaranteed "Adequate Payment":

(1) 1322(b)(2): debtor can modify the rights of the secured party in return for

"adequate payment",

(a) can't modify rights if the Creditor has a security interest solely in the

Debtor's principle residence (i.e., a mortgage) [but deacceleration is

not considered a "modification"]

(b) However, if the Creditor has an interest in the Debtor's home and car,

then the Creditor's rights may be modified

(2) 1325(a)(5): restricts the power of modification

(a) For debtor to modify the rights of a secured creditor, one of the

following factors must be present:

i) acceptance of plan by the Creditor; or

ii) continuation of the lien & payments proposed to the

creditor of a present value (see present value computation,

infra) that at least equals the value of collateral

iii) surrender of the collateral to Creditor

(3) 2-part computation of the valuation of the collateral:

(a) first, determine the amount of the allowed secured claim (i.e., FMV of

collateral) or the amount of the loan, whichever is less;

i) Smith illustrates importance of valuation of the collateral,

since it bears on the amt of interest, etc. The interest rate

typically chosen to compute present value is the contract rate.

(b) second, determine the present value of the secured claim (account for

interest, inflation, etc.)

(4) Deaccelaration of home mortgage is not considered a "modification" for

purposes of 1322(b)(2), which prohibits the modification of home


(a) Acceleration occurs when a term of the loan provides that upon certain

condition (eg. D misses 3 consecutive payments), the C can "accelerate"

the morgage and collect the entire debt. Under Ch. 13, D can

"deaccelerate" by curing the default and reinstating the original payment


(b) In re Taddeo court says de-acceleration of mortgage is allowed, as this

is not considered a modification

i) court says "de-acceleration" is necessary under 1322(b)(3)

and 1322(b)(5) (these provisions permit D to cure default)

ii) However, debtor must cure the default to de-accelerate the

mortgage under 1322(b)(3) and 1322(b)(5) in order to

reinstate the original payment schedule.

iii) This case suggests that if foreclosure occurs before the Debtor

cures the default, it is too late

(c) Timing of Deacceleration: So when can debtor de-accelerate a loan?


5 approaches have been advanced:

iv) Never: de-acceleration can't be done after creditor has

exercised right to accelerate (minority view)

v) de-acceleration can't be done after mortgagee has obtained


vi) de-acceleration allowed, but these cases don't talk about the

effect of judgments

vii) de-acceleration possible even after mortgagee has obtained

judgment (majority view - Taddeo)

viii) possible even after foreclosure (so long as state exemption

period has not expired)

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

a. Generally:

(1) Controversial, due to high potential for abuse (remember you don't need to

actually be insolvent to declare bankruptcy; equitable insolvency will do)

(2) Debtor permitted to reduce undersecured debt down to the value of the collateral

(3) 506(a): if a claim is undersecured (i.e., secured collateral's FMV < loan

amount), it gets bifurcated into:

(a) secured portion: Fair Market Value of collateral

(b) unsecured portion: remainder of the loan amount over and above

the FMV of collateral

(4) Then 506(d) voids the unsecured portion of the claim which was "excised"

by 506(a) (i.e., the creditor "eats" the excess of FMV of collateral)

b. Lien Stripping in Chapter 7 (not allowed)

(1) Dewsnup v. Timm: D cannot lien strip in Ch. 7

(a) Debtor wanted to void unsecured portion of claim under 506(d) in

chapter 7; this would have effectively reduced the value of the debt to

the value of the secured property (from $120K to $39K);

(b) Held: No, 506(d) only voids claims not allowed pursuant to 502.

That is, 506(d) does not allow lien stripping of a fully allowed claim

under 502. The court reads "allowed sec claim" as a claim that is 1st

allowed, and then secured, not allowed secured claim.

(2) The effects of denial of lien-stripping on Creditors:

(a) Sec Creditor assured of recovering any appreciation in value of property

during or after filing of Bankruptcy.

i) ex: Debtor owes Creditor $100K, property worth $60K at

filing; then property increases $20K in value. The benefit goes

to the sec party.

(b) Secured party does not have to foreclose immediately to assure that

Debtors redeem collateral

(c) Lien avoidance by 506(d) applies only to secured parties if claim is

disallowed under 502. (e.g., barred by Statute of Limitations)

(3) The effect of denied lien-stripping on Debtors:

(1) forces Debtor seeking to retain collateral either to redeem or reaffirm


c. lien-stripping under chapter 13 (allowed)

(1) In re Belamy

(a) Court allowed lien stripping in chapter 13

(b) Method: 506(a) bifurcates claim into secured and unsecured portions;

1322(b)(2) says can't modify secured claim, but 506(d) can void the

unsecured portion

(c) you can lien strip in chapter 13 3. For Unsecured Creditors

a. 3 Primary Protections - if these tests are not met, the court will not confirm the plan

(1) Best Interest Test: 1325(a)(4)

(a) Present value of the proposed payments to the holder of the unsecured

claim must be at least equal to the present value of the amt the

Creditor would have received in chapter 7 liquidation (minimum


(b) This is rarely an issue, since chapter 7 unsecured Creditors usually get

very little

(2) All Disposable Income Test: 1325(b): Plan must either:

(a) provide for payment in full of all claims, 1325(b)(1)(4); or

(b) commit all the Debtor's disposable income for 3 yrs,


i) "disposable income": all income which is not "reasonably

necessary" to support the Debtor & his/her dependents

ii) Cases generally hold that debtor cannot have a standard of

living greater than the bankruptcy judge

iii) Note: Plan can be modified later if D's disposable income

subsequently changes

(3) Good Faith Test: 1325(a)(3)

(a) Debtor must "act equitably in proposing a plan"

(b) In re Greer: Debtor attempted to confirm plan in which unsecured

creditors got almost nothing (1› on the dollar)

i) This was confirmed, since debtor acted equitably

ii) nominal or zero payment to general unsecured creditors

may be evidence of bad faith, however, other evidence of

bad faith is required to justify the denial of confirmation

of a proposed Chapter 13 plan

b. Classification of Unsecured Claims

(1) In general, D cannot unfairly discriminate between unsecured Cs by giving

priority to one class over another

(2) Some discrimination between unsecured Cs is acceptable

(a) 1322(b)(1) - unsecured claims with co-debtors (consumer debts)

can be treated differently under the plan (therefore, these claims can

be given preferential treatment)

(b) In re: Hosler: it is possible to discriminate among unsecured

creditors, but you must consider 4 factors:

i) whether discrimination has a reasonable basis

ii) whether debtor can carry out the plan without such


iii) whether discrimination was proposed in good faith

iv) How the discriminated class is treated

C. Chapter 13 Discharge

1. 1328 - debtor can discharge virtually all debts in chapter 13 except:

(1) 1328(a)(1) - can't discharge home mortgage

(2) 1328(a)(2) - can't discharge domestic payments (child support, alimony)

(c) 1328(a)(2) - can't discharge student loan payments

(d) 1328(a)(2) - can't discharge liability for death or injury caused by DWI

(e) 1328(a)(3) - can't discharge restitution payments made in connection with

debtor's conviction for a crime

2. D must propose reorganization plan in good faith: In re Kourtakis - Debtor tried to get criminal

assault judgment discharged pursuant to a 3 year plan devoting all "discretionary" income: struck

down by court as not proposed in good faith

a. Unless Chapter 13 filing is shown to be part of a scheme to defraud, the mere fact that

the debtor's primary debt is nondischargeable in Chapter 7 does not by itself

preclude Chapter 13 relief

b. Length of plan is a relevant consideration in deciding good faith, because it reflects

the debtor's state of mind and intentions, as well as the amount of repayment to creditors

c. statute on face allowed debtor to discharge tort judgment; however, court holds that plan

would not be proposed in good faith if trying to exclude a particular nondischargeable debt

was the entire purpose of declaring Chapter 13

D. Modification, Conversion and Dismissal of Chapter 13 Plans


1. 1329 - Plan can be modified at request of debtor or creditor if debtor's status changes (e.g.,

debtor wins the lottery)

2. 1307 Motions to convert or dismiss

a. 1307(a) - debtor can convert plan from Chapter 13 to Chapter 7

b. 1307(b) - debtor can request dismissal of the plan

c. 1307(c) - creditor can request dismissal or conversion of the plan pursuant to a


showing of cause (e.g., constant default) *See statute for other reasons "for cause"

(1) courts will rarely grant request by creditor to dismiss a plan In re Phalen

(2) courts will give debtor a chance to complete plan if default was caused by factors

beyond the debtors control (See In re Bond)

(3) if plan is dismissed (i.e., debtor not allowed to complete the plan), the automatic

stay is lifted and it's "open hunting" for creditors

3. Hardship Discharges - 1328

a. some debtors can avoid dismissal upon default and receive hardship discharge under

1328(b) (the court "waves its magic wand and debts are gone"), 3 factors must be met

(See In re Bond):

(1) failure to meet the plan must be the result of circumstances beyond

debtor's control; and

(2) value of payments under plan to each creditor must be at least what each

creditor would have received under Chapter 7; and

(3) modification of the plan cannot be practicable (i.e., if you can possibly

modify, hardship discharge won't be granted)

4. Filing then Re-Filing - 109(g)

a. Prevents debtor from abusing Chapter 13 Stay

b. Debtors used to be able to abuse Chapter 13 Stay by (1) filing for Chapter 13, (2) not

proposing a plan, (3) waiting for bankruptcy court to dismiss their Chapter 13 filing, then

(4) filing another Chapter 13 again

c. 109(g) put in place to stop this, if plan is dismissed debtor can't refile again for six

months (gives creditors some time to "pick at debtor's bones")VII. CHAPTER 11 REORGANIZATION (BUSINESS)


A. In General

1. DEFINITION: involves the rehabilitation of the business entity pursuant to a reorganization

plan by which the entity remains in business but with a different ownership structure

2. WHO CAN FILE: businesses can file; Railroads can file (although they can't file Ch 7) ;

stockbrokers cannot file, individuals can file (but rarely do)


a. Chapter 7: relinquishes all control over assets to TIB, who sells them & distributes

proceeds to creditors (i.e., Liquidation)

b. Chapter 11: Creditors sell their claims & receive in return a share of the reorganized entity

(i.e., a sale to the claimants themselves)


a. Debtor takes advantage of Stay to reorder its affairs; it "trims down"

b. Business is restructured so that it is once again a viable business entity

5. Advantages to Chapter 11

a. Protects employees of the bankrupt corporation

b. Helps creditors get more of their debts repaid (business has greater "going concern" value

than liquidation value)

c. General benefit to community: economic stability, payment of more taxes, continued

availability of goods and services to the community, etc.

d. Gives corporation which is insolvent (but economically viable) a second chance


6. Disadvantages to Chapter 11

a. Can hurt the industry by undercutting competition (Ch 11 gives economic advantage to Ch

11 corporations)

b. Managers, who control the filing, have a strong incentive to improperly file Chapter 11 (in

order to keep their jobs)

c. No guarantee to creditors that they will get more later


a. Law & Economics School (Barnett & Jackson)(Vaird?? & Jackson)

(1) Argue that Bankruptcies only serve 2 functions:

(a) They regulate the process by which actors make exchanges against the

common pool of assets in their efforts to increase individual wealth (i.e.,

regulates how the "pie" is regulated)

(b) They serve to maximize the outcome for those same individuals as a

group by maximizing the size of the pool (i.e., makes the "pie" bigger)

(2) From these two propositions, they argue that Chapter 11 is no good; they argue

that Chapter 11 does not serve to maximize the common pool

b. Non-economic School: (Warren)

(1) Argues that bankruptcy is a complex process which serves many interests, not

just the interests of the creditors (eg. interests of debtor, creditors, and


(a) You cannot evaluate the usefulness of Chapter 11 by looking only at the

value to the creditors

(b) Chapter 11 exists for broader reasons & should therefore continue to


c. Note: Less than 10% of all Chapter 11 Plans Succeed

B. Mechanics of Chapter 11

1. Petition can be filed voluntarily (301) or involuntarily (303)

2. Procedure After Petition is filed:

a. Debtor files a list of creditors required by 521 (they are notified pursuant to 342)

b. Automatic Stay is imposed under 362 (gives D breathing space and provides for orderly

distribution of assets)

c. During period between filing & proposal of plan (Gap Period) the business

continues to be operated by DIP)

(1) DIP runs day-to-day business

(2) Management usually serves as DIP

(3) Although DIP is the same management their role has changed in two ways

(a) DIP No longer controls the corporation, DIP controls the bankruptcy

estate of the corporation; since DIP controls the Bankruptcy estate he

has powers he previously did not have

(b) DIP acts for the benefit of the creditors & shareholders now, rather than

just the shareholders

d. DIP has powers of TIB

(1) Power to obtain financing during bankruptcy (364)

(2) Power to avoid preferences (547)

(a) this is the most important power

(b) preferences = a transfer to a favored creditor within 90 days of the

bankruptcy or within 1 year for an "insider"

(3) Power to assume or breach outstanding existing contracts (365)

(4) Power to avoid fraudulent conveyances (548, 544(b))

(5) Power to set aside unperfected or late perfected security interests (544(a), 547)

(6) Power to require the return of certain property to the estate (542 - turnover of

property of the estate)

d. Negotiation:

(1) DIP uses avoidance power to arrive at a consensus regarding a reorganization


(2) After all parties agree to the plan it is voted on (1126); then plan is submitted to

bankruptcy judge who decides whether or not to approve it (1127)

(3) Negotiation is a large factor in the above process

i) Debtor has leverage to compel creditors to come to the

bargaining table (e.g., automatic Stay - if they don't come to

bargain, they get a raw deal in the reorganization plan)

ii) Debtor can adopt the plan even though a minority of creditors

reject it

(4) Chapter 11 negotiations are held in the shadow of Chapter 7

e. Alternatives to Regular Chapter 11 negotiations:

(1) Prepackaged plans: everybody signs on before the debtor files for bankruptcy;

then the debtor files for bankruptcy to force the minority position Cs to accept the


(2) Non-bankruptcy Workouts: party negotiates the credit arrangement in the

shadow of possible bankruptcy

C. Operating in Chapter 11

1. Who runs the entity?

a. Either a DIP or TIB

(1) Under the 1898 Act, trustee was appointed automatically.

(2) Under the 1978 Act, in most instances, the management remains in control

as the Debtor in Possession (DIP) under the theory that it is better to let

management continue to run the business due to familiarity

(3) However, any party in interest (usually a creditor) can request the

appointment of a trustee in bankruptcy (TIB) if s/he is unhappy with the way


the company is being run (1104(a)) -- must show:

(a) Good cause (Fraud, dishonesty, mismanagement); or

(b) That it is in the best interest of creditors, equity holders (shareholders),

& other interest of the estate

(c) appointment of a TIB is the exception rather than the rule

In Sharon Steel, the issue was whether appointment of trustee was

appropriate. C must show clear and convincing evidence that

removal of DIP is warranted. Court held that company was being run

for the benefit of management and abuses were obvious; court

appointed trustee.

(d) Appointment of trustee is a crucial decision in attempt to reorganize a

corporation. The decision usually involves an intense struggle

between management and Cs.

(4) If TIB is not appointed, the Court can appoint an Examiner under 1104(b)

(a) Requisites for appointing an examiner:

i) a request for an examiner from a party in interest; and

ii) must be in the best interest of the estate to make the

appointment; or the debtors unsecured debts must exceed $5


(b) Examiners duties include investigating & reporting on the honesty and

competence of the DIP

(c) The estate pays for the Examiner

2. Use of Collateral during Ch. 11

a. Unencumbered Collateral (i.e., not subject to lien)

(a) can be sold, leased or used in any matter within the ordinary

course of business (363(c))

(b) If unencumbered collateral is not used in the ordinary course of

business, sec 363 provides for automatic judicial review

b. Encumbered Collateral -- 2 types:

(a) Non-cash Collateral: 363(e)

i) can be used in the ordinary course of business; creditor

can request the court to condition use on DIP/TIB

providing adequate protection (363(e))

ii) If not used in ordinary course of business, sec 363(b) provides

for automatic court review

(b) Cash Collateral: 363(c)

i) Defined as cash, negotiable instruments, or cash equivalent

ii) Accounts receivable are not cash collateral, but inventory is

considered cash collateral

iii) TIB/DIP cannot sell, use or lease cash collateral unless:

a) each entity who has an interest in the collateral

consents; or

b) the court authorizes such use after notice &

hearing on adequate protection (363(c)(2))

iv) Earthlite C sought to prevent Earthlite from using cash

collateral. Court noted that cash collateral is special because

it is highly volatile and prone to misuse. To protect creditors,

DIP can only use cash collateral upon court approval even if in

the regular course of business. However, court cannot deprive

DIP of cash needed to survive; thus, court must engage in

balancing of interests.

v) Use of Cash Collateral is also constrained by Bank's right of

Setoff, which is a cancellation of cross-demands between D

and C - 553(a):

a) Party with right of setoff is treated as a secured party;

b) Account subject to setoff is treated as cash collateral;

therefore, it cannot be touched without court approval

c) 362(a)(7) provides that the filing of the bankruptcy

petition stays the right of setoff. Hoffman illustrates

that courts are unlikely to lift the stay in order to

allow bank to exercise setoff.

d) "mini-preference" provision of 553(a)(3) 3. Post-Petition Financing in Chapter 11

a. Question: how does a DIP insure cash infusion? only two alternatives:

(1) High risk lenders

(2) Prior lenders

b. 3 Important Sections re: inducement to lenders: 552(a), 552(b), & 364

(1) 552(a): prepetition security interests do not attach to property acquired

by DIP after the filing of the Bankruptcy petition; therefore, DIP/TIB can

offer the lender a security interest in collateral acquired post-petition

(a) only applies to consensual liens

(b) applies to after-acquired property clause, giving security interest in

"all property now & in the future" (the effect of 552 is that no security

interest will exist, notwithstanding such a clause)

(2) 552(b): Exception to 552(a)

(a) if pre-petition security interest encumbers proceeds of pre-petition

collateral, the post-petition proceeds of such collateral will also be

subject to the C's prepetition security interest

Note: A security interest in inventory would not extend to after-aquired inventory, but a security interest in accounts recievable would

cover accounts receivable generated from the sale of pre-petition



(b) "Exception to the exception" Under 552(b)

i) court can order otherwise, based on "equities of the case"

ii) this provision iis used by the court in situations where property

of the estate is used to convert collateral into proceeds.

Anderson illustrates the exception to the exception: it is

designed to cover situations where the collateral is

converted into proceeds at some expense to the estate.

(c) Under the 552(a) exception, C only gets interest in proceeds

generated from pre-petition collateral

(3) 364 - Inducement to New Lenders: 364 Gives DIP/TIB ability to tempt

potential creditors with the following inducements:

(a) 364(a) - allows DIP/TIB to give a post-petition unsecured credit

transaction in the ordinary course of business an administrative

expense priority over pre-petition unsecured creditors (without a

hearing / without court approval)

(b) 364(c) - DIP/TIB can authorize, after notice & hearing, can authorize

1 of the following 3 things:

i) can give creditor priority over other administrative

expenses, including attorneys

ii) can give creditor a lien on unencumbered property

iii) can give creditor a junior lien on encumbered property

(c) 364(d) - DIP/TIB can request the Court to grant "Super Priority"

which gives creditor a lien equal or superior to existing liens on

secured property

i) This can only be done if DIP/TIB can show he can't obtain

credit any other way

ii) TIB/DIP must give adequate protection to the secured party

(Unsecured creditors do not need adequate protection


(d) 364(e) - Protects Creditors who are given priority

i) if creditor made the loan in good faith they are protected & the

reversal of creditors priority by a higher court does not affect it


ii) EDC Holding Co. Court found that lender was not a lender in

good faith because it had knowledge that proceeds of loan


were to be used for an improper purpose. A portion of the

proceeds were designated to pay lawyers whose claims were

not allowable under bankruptcy law.


(e) Importance of Obtaining Post-petition priority: Remember, if the

Ch. 11 fails, the post-petition Cs will be fighting among the existing Cs

for the D's remaining assets D. Avoiding Powers of the TIB/DIP NOTE: AVOIDING POWERS APPLY TO ALL CHAPTERS

1. Generally

a. TIB/DIP can use avoiding powers to invalidate certain pre-bankruptcy transfers of

property (in effect, TIB/DIP can invalidate its own transfers)

b. Avoiding Powers can be used in any bankruptcy - but they occur most often in Chapter 11

c. Avoiding Powers give the TIB/DIP leverage in dealing with creditors by threatening Cs

with avoidance if Cs do not agree to a reorganization plan

d. DIP/TIB is not the old debtor with respect to avoiding powers; DIP/TIB can invalidate

transfers to preferred creditors months before petition was filed (in effect, avoiding powers

permit DIP/TIB to recreate the common pool that existed before the pre-bankruptcy risk

behavior began).


2. Why have avoiding powers?

a. contributes to policy of allowing business to effectively reorganize by putting everything

back into the "common pool"

b. it allows everyone to be put back into the position before bankruptcy skewed their

behavior (before everybody started grabbing for assets)

3. Avoiding Powers Analyzed Individually

a. Strong-Arm Provision - 544(a)

(1) Sec 544(a) and Sec 9301 of the UCC provide that perfected secured

creditors or lien Cs trump unperfected Cs. This is also true under state law

as to mortgage holders. Article 9 identifies who has an interest in the

property and cures the ostensible ownership problem through

"perfection." The bankruptcy code is consisten with Article 9. The

bankruptcy requires notice through filing; without notice, the C basically

becomes an unsecured creditor Remember the hierarchy of creditors: (a)

perfected creditors & judicial lien creditors (b) unperfected creditors (c)

unsecured creditors

(2) TIB/DIP can trump unperfected creditors due to conference of 3 powers

under 544(a): Under the bankruptcy code, the TIB/DIP acquires:

(a) the rights of a hypothetical judicial lien creditor 544(a)(1)

(b) the rights of an execution creditor 544(a)(2)

(c) the rights of a bona fide purchaser 544(a)(3) - for real estate purposes

McCannon Rule: If the C does not record a mortgage, the

TIB/DIP is treated as a bona fide purchaser and the interest of

a bona fide purchaser trumps the unperfected mortgage holder.

However, the court finds that mere occupation constitutes

constructive notice and is enough notice to trump the trustee.

(minority rule?)

(3) 3 Rules of 544(a):

(a) if the transfer was recorded or perfected prior to the date the

bankruptcy petition was filed, the TIB/DIP cannot invalidate the

transfer under 544(a)

(b) If the transfer was not recorded or perfected by the date the

bankruptcy petition was filed, the TIB/DIP can invalidate the

transfer under 544(a)

after unperfected debt is "trumped" it becomes general, unsecured debt

(the transfer is invalidated and the property goes back into the estate)

(c) A TIB/DIP cannot invalidate a PURCHASE MONEY SECURITY

INTEREST (PMSI) perfected within 10 days after delivery of

collateral to the debtor even if the debtor files a bankruptcy

petition in the gap between creation of the security interest & its


Note: 362 Automatic Stay normally extends to perfection. Sec

362(a)(4) provides that a C cannot perfect a security interest after the

bankruptcy filing. 362(b)(3) provides an exception: C with a Purchase

Money Security Interest has a 10 day grace period to perfect a security

interest after the date of filing.

(4) Strong- Arm Trumps Unrecorded Federal Tax Liens

(a) 6321 of IRC: if a person fails to pay income taxes, a lien is

automatically created on his property in the amount owed

(b) 6323(a) of IRC: the above lien will not be valid against a judgment

lien creditor (the DIP/TIB) until notice is provided (i.e., it must be

recorded); once it is filed it trumps the TIB/DIP b. Power to Avoid Preferences - 547

(1) Generally:

(a) 544 permits TIB/DIP to avoid preferences under state law (???)

(b) 547 permits TIB/DIP to avoid preferential treatment of 1 creditor

(c) discourages "races to the courthouse" (since preferred Cs will only have

to return the transfers later) and equality of distribution

(2) Elements: 547(b) sets forth 7 elements which = oidable preference:

(a) transfer (under 101(54) transfer = voluntary or involuntary disposing

of or parting with property (doesn't have to be cash))

(b) of an interest of the debtor in property

i) See Sun Railings, where court held that when 3rd party loans

money to a debtor for the express purpose of repaying a debt,

the money never becomes part of the estate, & therefore not an

interest of the debtor

ii) Rule: a 3rd party's payment only becomes part of the

estate if the debtor, not the creditor, designates which

creditor will be paid with the proceeds)

(c) to or for the benefit of a creditor

i) creditor = an entity who the debtor owes money to

ii) Note: No preference exists if recipient of transfer is not a C of

the D at the time of the transfer (eg. owner of Co takes a

security interest in Debtor company's property - there is no

preference if owner was not a C of the Co [although there may

be a fraudulent conveyance])

(d) on account of an antecedent debt (i.e., cannot be a contemp.

exchange; also, GIFTS generally are not voidable)

i) antecedent debt = a debt owed prior to the time of the transfer.

Thus, the court looks to when the debt was incurred and then

to when the transfer was made. If the debt was incurred prior

to the transfer, the transfer meets the "antecedent debt"


ii) Note: (???) 547(e) applies; thus, a transfer of a security

interest occurs on the date of the transaction if C perfects the

security interest within 10 days. (This rule helps a C because

a transfer of a security interest to C at the time D becomes

indebted to C is not "on account of an antecedent debt," (it is

treated as contemporaneous) even if C does not perfect the

security interest until later)

(e) while the debtor was insolvent

i) insolvent = liabilities exceed assets

ii) debtor is presumed to be insolvent 90 days prior to date of

filing bankruptcy petition under 547(f)

iii) Is the presumption rebuttable (?????)


(f) within 90 days of petition, or in the case of an insider, within 1 year

of petition

i) in In re Sportsco, transfer by check held to take place when it

was honored, rather than when it was mailed. Barnhill adopts

Sportsco as the proper rule (this helps TIB?DIP invalidate

transfers by check because they are more likely to fall within

the preference period

ii) 101(31) defines insider - generally a director or officer (or

relative of individual D)

(g) which has the effect of increasing the amount the transferee would

have received in a ch 7 bankruptcy Almost always satisfied unless

i) transferee is fully secured before the transfer took place; or

ii) the estate is sufficiently large to permit payment of 100% of

unsecured claims (rare)

(3) Criticism of Preference Provision

(a) Overinclusive because it may void ordinary payments needed to keep a

business going

(b) Underinclusive because Cs can avoid the 90 day time limit by obtaining

the transfer before that time period commences if they have warning of

impending bankruptcy


(4) Remedy for Voidable Preference: 550: gives TIB/DIP right to compel

creditor to return the property; no additional penalty is incurred by the creditor

(5) 547(e): 10 day grace period to perfect security interest

(a) a transfer takes place at the time it is effective between the parties,

(not on the date that security interest is perfected) provided that

the secured party perfects within 10 days

(b) If security interest is perfected after 10 days, the transfer occurs on

the date of perfection

(c) Effect of (a): It is easier for C to fall outside of the (90 day/ 1 year)

preference period. (eg. If C received security interest 99 days before

filing, and C perfects 89 days before filing, TIB/DIP cannot avoid the

transfer even though security interest was perfected during the

preference period)

(d) also applies to antecedent debt provision in 547(b)


(a) Burden is on C to establish the exception once TIB/DIP establishes

a prima facie case of preferential transfer (547(g))

(b) Why give an exception to voidable preference?

i) gives creditors a safety net so they will lend debtors money on

the eve of bankruptcy

ii) This benefits all creditors, by keeping the business going

(c) As a practical matter, the creditor does not "give the money back"

when a voidable preference is found; the amount owed to the

creditor is simply reduced by the amount of the voidable


(d) Contemporaneous Exchange For New Value exception 547(c)(1)

i) Elements

a) Contemporaneous Intent: must be intended to be a

transfer to the creditor for new value given to the

debtor (cannot be on account of an antecedent debt)

b) Contemporaneous in fact: transfer has to occur at

a time "substantially contemporaneous" with the time

the debt arose (factual issue; See, e.g., In re Strom,

where court held that 9 months was not substantially


ii) To complete transfer, C must perfect security interest:

(ie, exchange is not contemporaneous unless C perfects near

the time of the transaction). In In re Strom, C did not perfect

until 9 months after the transaction due to mistake; court held

that defense did not apply.

a) Argument in favor of treating exchange as

contemporaneous where C fails to perfect: some

argue that defense should still be valid if C had no

intent to deceive.

b) Response: C's failure to perfect may induce other Cs

to extend credit to D based on D's perceived (but not

actual) position. Thus, prohibiting a

contemporaneous exchange defense in this situation

eliminates fraud by the D; D cannot induce other Cs

to loan funds by having other Cs delay perfection

after transfer.

iii) Cash payment for goods is excepted: These type of

payments are not preferences because they are not on account

of an antecedent debt and they are not made


(e) Ordinary course of business exception 547(c)(2)

i) Elements:

a) Debt must be in the ordinary course of business

b) Payment must be made in the ordinary course of


c) Payment must be made according to ordinary

business terms

ii) Only applies to payments - not transfers of property

iii) Majority Rule: "Ordinary Course of Business" is

determined by the particular parties' usual practice. In

Steel Improvement, court held that late payments were in the

"ordinary course of business" where the D historically had a

practice of paying late

iv) Minority Rule: "Ordinary business practice" is

determined by industry practice. This rule gives effect to

the theird prong of 547(c)(2) by looking not only at the parties'

prior practice, but also looking to the ordinary business terms

within the industry. This approach limits the exception to

almost no practical application.

v) The exception applies to long term debts: In ZZZZ Best,

Sup Ct held that the exception is applicable to long-term debt

payments, because the Code does not distinguish between

short-term and long-term debt.

vi) Threats by C are not in the "ordinary course of

business": Family Home Center held that any time payment

is made after threats by a C, the payments will not be

considered to be in the ordinary course of business.

(f) Purchase Money Security Interest (PMSI) Exception - 547(c)(3)

i) 4 Elements:

a) Creditor must extend new value to D so D can

acquire certain real or personal property

b) Debtor must sign a security agreement giving the

creditor a security interest in the property

c) Debtor must use the money loaned to him to acquire

the property in (b)

d) Creditor must perfect its security interest no later

than 10 days after debtor receives possession of


ii) Rationale for treating PMSI as an exception: A PMSI has


no net effect on the estate. There is basically no addition or

subtraction to the estate, thus other Cs are not hurt by granting

the PMSI exception (CWT: in fact, encouraging PMSIs may

help the D avoid bankruptcy in the same way the new value

exception operates to help keep D afloat)

(g) New Value Exception - 547(c)(4)

i) Primary Purpose: to provide protection to a creditor who

receives a preference & after such preference extends further


ii) Rationale for Exception: we want to keep the business

going; even though the creditor got a preference, he extended

further credit & should not be penalized

iii) 3 easy steps:

a) Identify a payment that is preferential under 547(b)

b) Ask whether after the preference the creditor

advanced new credit value to the debtor which was


c) if the creditor did advance new value to the debtor,

reduce the amount of the preference which was

voidable by the new value advanced

iv) Note: for the exception to apply, the D must not have

subsequently made another transfer to the C. The Code

requires that "on account of which new value the D did not

make an otherwise unavoidable transfer to or for the benefit of

such C"


v) Hypo re: New value exception:

on 3/1 Norwest loans you $10,000 pursuant to revolving credit

arrangement; on 3/15 you repay $6,000; on 4/1 NW loans you

$5,000; on 4/15 you declare Bankruptcy


Since there is a voidable preference of $6,000 on 3/15

followed by new unsecured credit of $5,000 on 4/1 the

voidable preference is reduced to $1,000 ($6,000 - $5,000) (h) Floating Lien Exception - 547(c)(5)


i) When applicable: the exception covers situation where

creditor holds a security interest in all present & after-acquired

inventory of the debtor and the D acquires new inventory that

betters the position of the C after the preference period begins.


Arguments that increase in value is a preference: Should be

voidable to maximize the pool of assets. If an increase in

amount (and hence value) of collateral is not treated as a

preference, C could manipulate D by influencing the D to buy

inventory during the preference period.

ii) Rule: Under 547(c)(5), a Creditor with a security interest

in inventory and accounts receivable is subject to a

preference attack to the extent that the preference

improves C's position during the preference period. This

section benefits unsecured Cs.

iii) Use two-part test to determine if C's position has

improved: look at secured party's position (1) 90 days prior

to bankruptcy vis-a-vis his position on (2) the date of filing.

Two-part test is administered using the following 7 step


a) Determine amount of debt on date of bankruptcy

petition filing (e.g., $100,000)

b) determine the value of debtor's receivables or

inventory encumbered by secured party's lien on the

date of bankruptcy petition (e.g., $75,000)

c) Subtract (b) from (a) ($100,000 - $75,000 =


d) Determine the amount of debt 90 days before the

petition (e.g., $90,000)

e) Determine the value of debtor's receivables or

inventory encumbered by secured party's lien 90 days

before the petition (e.g., $30,000)

f) Subtract (e) from (d) ($90,000-$30,000 = $60,000)

g) Subtract (c) from (f) ($60,000-$25,000 = $35,0000 -

this is the voidable preference)

iv) If C is worse off at the time of filing (you end up with a

negative number at step (g)) there is no voidable pref.

v) If creditor is oversecured (value is greater than amount

owed) 90 days prior to petition, there can be no voidable

preference, since the creditor cannot be made better off

vi) In valuing collateral, measure value from the creditor's

perspective - (use the liquidation value; See Clark Pipe)

vii) Nivens: an increase in the VALUE of inventory (as

opposed to an increase in the AMOUNT of inventory)

does not improve the position of the C for purposes of the

exception. Specific holding: An increase in value of certain

collateral (e.g., crops) will not create a voidable preference

(See In re Nivens) (is this general rule?????)


c. Indirect Preferences (Levit Situation)

(1) Hypo: a corporation borrows $1 million from Norwest (unsecured); Corp.

promises to pay back $50,000 per month; Norwest insists on a guarantee from

the president of Corp.; Corp. falls behind on all its bills except for Norwest;

Corp. then files for bankruptcy; Question: can these payments to Norwest be


(2) 547(b)(1) - a transfer to a party other than a creditor can be voided if

transfer is "to or for the benefit" of a creditor

(3) Levit: Mr. Deprizio had signed & guaranteed the notes from the bank; as

president, Deprizio was an insider under 101; moreover, he is a guarantor & a

creditor of the firm; creditor is defined in 101(5)(a) as someone who has a claim

which includes a contingent right to payment against the company; if he pays,

he can seek reimbursement & subrogation against the company; for insiders, the

period is lengthened from 90 days to 1 year

(a) Held: because the payment to the lender benefits the guarantor by

reducing his exposure (547(b)(1)) payments made by the

guarantor/debtor are voidable preferences within 1 year

(b) Rule: whenever you have an insider guarantee, the period for

voidable preferences is 1 year

(c) 550(a)(1) - DIP/TIB can recover the value of a preferential

transfer from either the transferee (lender) or the entity for whose

benefit the transfer was made (guarantor/insider) (alhtough the

lender can then recover from the guarantor) As a practical matter this is

very important, because very rarely will the guarantor have the money,

but the lender often will

(d) Levit has no effect on oversecured C: Levit only adversely affects an

unsecured C. Levit has no impact on an oversecured C because such a

creditor cannot be given a voidable preference.

(e) Available Defenses: Southwest Equipment Rental adopts the Levit

analysis. However, the court holds that the C can use its own defenses


as well as the defenses of the indirect beneficiary (the guarantor) [CWT:

but Guarantor probably cannot use all of C's defenses)

(f) Adams' Criticism of Levit:

i) In its reading of sec 547, the court mixes two transfers: the

transfer between the lender and the debtor and the transfer

betweent he insider and the lender. The language of 547(b)

does not seem to suport this mixing and matching of transfers.

(C-arg: the transfer to the lender is for the benefit of the


ii) The legislative history of sec 550 does not support the result

reached by the Levit court (Nickles)

(g) Validity of personal guarantees after Levit

i) Reasons why C may seek a guarantee: a guarantee gives

the bank additional assets to reach in the event of bankruptcy;

creates a leveraging device to coerce payment; ensure that the

guarantor gives his best efforts in support of the D; the

guarantor may have sufficient assets to reimburse the lender if

the preference is recovered from the lender

ii) Reasons why D may give a personal guarantee: guarantee

may help the D acquire creditt; it may also reduce D's cost of

acquiring credit (interest rates)


(h) Effect on Conglomerates: Where a bank lends money to a

conglomerate that subsequently files bankruptcy, and each sub-part of

the conglomerate has guaranteed the debts of the others, every payment

made by any part of the corp. within 1 year of the petition is a voidable


(i) Application to Senior and Junior Lien Creditors: Where there is

both a senior & junior creditor, & the senior creditor is fully secured,

any payments made by the D to the senior creditor improve the position

of the junior creditor (by freeing up collateral) & are therefore voidable

preferences; DIP/TIP can recover these preferences from either the

Senior or Junior creditors [I disagree with this last proposition].


(j) Creditor's Responses to Levit: Require Guarantor to waive rights

of subrogation against D: If the guarantor waives its

right of subrogation against the D, the whole analysis

falls apart, since the guarantor is no longer a

contingent creditor of the estate. Majority of courts

accept this type of waiver, although some courts

reject this as being in bad faith d. Executory Contracts - 365

(1) Definitions

(a) Most widely accepted definition - Countryman: contract that is so

far unperformed on both sides that the failure of either party to complete

their performance would be a material breach, excusing further

performance by the other party

(b) Informal Definition: one that is negotiated before filing, for which

performance is continuing or due in the future

(c) Recent Definitions:

i) Rovine: any obligation unperformed on both sides

ii) Lubrizol: any contingent obligation unperformed on both


iii) Warren & Westbrook: any contract not fully performed on

either side

(2) Effect if Contract is not Executory: (CB p. 572-73) Courts generally have not

explored this issue. In some circumstances, courts have held that the TIB cannot

reject the contract and therefore must perform the contract. Other courts have

held that because the TIB cannot assume a contract, it cannot force the terms of

the contract on the other party. Warren and Westbrook find both arguments


(3) Powers of TIB/DIP under 365:

(a) Three Choices: Under 365(a) DIP/TIB can do 1 of 3 things with

respect to Executory Contracts:

i) reject the contract

ii) assume the contract

iii) assume & assign the contract


(b) Rationale: DIP/TIB should have the power to keep valuable and

profitable contracts and dispose of less valuable or detrimental

contracts. DIP attempts to arrive at the most economically efficient

solution by assuming those contracts that are economically beneficial to

the DIP. These contracts benefit the estate and hence the other

unsecured creditors.

(c) Effect of each choice? (assume a lease scenario)

i) Reject: The D can no longer use the property, but the D is no

longer liable for payments. Since the D has breached the

contract, C is entitled to an unsecured claim against the

bankrupt estate for damages (i.e., a garden variety breach of

contract claim). Damages usually consist of the difference

between the contract price and the market price, but because

this claim is classified as unsecured, the C will only receive the

same pro rata share that other unsecured Cs will receive.

ii) Assume: debtor continues to be liable for rent & is able to use

the property; creditor continues to receive rent payments

(note: rent is a first priority administrative expense)

iii) Assume/Assign: debtor is relieved of any liability for breach

of lease (365(k)); creditor must look to assignee for payment

(4) Limitations on Rejection

(a) Landlords: Where the debtor is a landlor

i) 365(h)(1): a debtor/landlord can't use 365 to evict tenants;

however, the landlord can cancel the lease, but the tenant can

maintain possession of the property (365(h)(2))

ii) When the lease is cancelled, the debtor/landlord no longer has

to perform the services required by the lease (e.g., water, heat,

etc.) but the tenant can offset for damages against rent owed.

Note: Lessee cannot maintain a claim for damages over the

amount of the offset if the amount of the damage is greater

than the lessee's rent obligation.

iii) Majority View: 365(h) only applies to Real Property - not

personal property (e.g., leasing a car)

(b) Under collective bargaining agreement

i) 1113: a debtor (employer) must engage in negotiations &

discussions with the union & seek court approval before

altering the agreement



[insert p. 50-51] (5) Limitations on Assumption or Assumption & Assignment

(a) Some Contracts Cannot be Assumed or Assumed & Assigned

i) Contracts terminated before bankruptcy cannot be

assumed or assumed & assigned (In re Mimi & In re

Mulkey - court looks at the provisions of the lease to see

whether party complied with termination procedure before

bankruptcy filing. If the party fulfills the requirements for

proper termination, DIP/TIB cannot assume or assume and


assign the contract)


365(c)(3) - prohibits the assumption of a lease of non-residential real property that is terminated before bankruptcy

ii) Loan Commitments cannot be assumed [& or ???]

assigned (365(c)(2)); rationale: a lender doesn't want a

debtor who was solvent at the time of the loan to assign a loan

to an insolvent party


iii) Contract not assignable by State Law cannot be assigned

nder Bankruptcy (365(c)(1)); rationale: to allow this would

allow bankruptcy code to "re-write" state law (orreverse

?????) Typically applies to contracts for personal services or

contracts for law enforcement (?)

(b) Requirements for Assumption & Assignment:

i) if there has been a default on the contract, the party

assuming the contract must meet the criteria of 365(b); 2

main requirements:

a) Cure or provide "adequate assurance" that the default

will be cured

b) provide adequate assurance of future performance

ii) To assign a contract:

a) assuming party must provide adequate assurance of

future performance by the assignee (365(f)(1),

365(f)(2) - it doesn't matter whether or not there

has been a default for assignment purposes

b) What is adequate assurance?

In re Sapolin Paints: defines adequate assurance as a

factual question of whether assignor exercised good

faith & observed commercial standards. The

assuming party (assignor) must investigate assignee

to determine assignee's financial viability.

iii) To assume a lease, you must assume the entire lease - so if

a contract has both a loan commitment & a lease commitment,

the contract cannot be assumed (i.e., C can "get around"

365(e)) (by drafting contract in such a manner???)

(c) Contracts which prohibit or limit the assumption & assignment of

contracts in bankruptcy are not effective (365(e))


(d) Obligation of the parties to the contract, pending decision by the

TIB to assume, assign or reject (i.e., during the "gap period")

i) In re Feyline Presents, Inc.: contract is enforceable against the non-bankrupt party

but not against the bankrupt party. (Note: Thus, the effect

on the other party is severe if the D declares bankruptcy. The

other party must continue to perform under the contract, but

only receives an unsecured claim for a breach of the contract

by D)

ii) 365(d)(2) Other party can bring an action to force the

TIB make an early election

(e) In re Rovine: Burger king forced TIB to make an election re:

assumption or rejection; TIB chose rejection; Burger King later sought

injunction to enforce a non-compete agreement that was part of contract

a) Holding #1: A contract is executory when, at the

time of filing, both parties have any obligation to

perform - the obligation need not be a

MATERIAL obligation. This was an executory

contract, since both parties have an obligation to

perform (regardless of whether these obligations

were material)

b) Holding #2: Executory contract must be rejected in

its entirety or not at all. Therefore, the covenant was

not enforceable b/c DIP rejected the contract

(f) Lubrizol: Holder of patent license (licensor) wanted to reject a license

agreement & sell to another party - court held this was OK because a

contract is executory if there is any CONTINGENT obligation on

both sides under the contract

Note: Congress reacted with 365(n) - Licensee can retain their license

& sue for any damages for breach of license (an affirmative damage

action) so long as the licensee continues to make payments for the

license. However, the Lubrizol approach to executory contracts

still has validity. e. Fraudulent Conveyances - 548

(1) Generally

(a) Similar to Uniform Fraudulent Conveyance Act

(b) Fraudulent Conveyance = property is transferred to a party for less than

a reasonable value--to the disadvantage of all other creditors

(c) We are basically trying to put as much as possible back into the "pool"

(2) Elements

(a) Under 548 the TIB/DIP can avoid a transfer of assets by a debtor

within 1 year of the transfer if the transfer was made either:

i) with the actual intent to hinder, delay or defraud creditors

(548(a)(1)); or

ii) if the debtor received less than a reasonable equivalent

value in exchange for the transfer (548(a)(2)) AND

a) was insolvent or became insolvent as a result of

the transaction; or

b) was engaged in a business or about to engage in a

business transaction for which the remaining

property was unreasonably small capital; or

c) intended to incur or believed he would incur

debts beyond his ability to pay


Note: d/n have to be a conveyance to a C (infact, usually it isn't)

(b) Cases re: Fraudulent Conveyances:

i) Actual Intent to Defraud: In re Tri-State Paving (owners of

corp took corporate funds, claiming as past salary, & went to

Las Vegas): Held: paying yourself as a director in full, while

leaving the other creditors with nothing constitutes actual

intent to defraud

a) actual intent may be proven using "badges of fraud"

(are these same as in UFCA???)

b) as an officer, you should pay yourself regularly (if the

salary had been paid in regular course of business,

there would have been no fraud)

ii) Less than Reasonably Equivelant Value:

Date of Transfer of security interest:

Durett (D filed bankruptcy 9 days after foreclosure sale, in

which house with FMV = $200,000 was sold for $115,000

a) 70% Rule: reasonably equivalent equals at least

70% of FMV

b) For purpose of one year limitation, Transfer

deemed to take place on date of foreclosure sale,

not when the security interest was created

(typically years before)

c) As a consequence of Durett, banks simply pass the


transaction costs on to their customers

iii) Consideration for 3rd Party:

Date of security of guarantee:

Definition of insolvency:

Rubin (subsidiary company's used collateral from parent corp.

to secure loans) - issue: did parent corp. receive "reasonably

equivalent value"

a) Holding: a debtor can receive fair consideration

for his property, even though the consideration

goes initially to a third party, so long as economic

benefit is conferred to the debtor in exchange for

the property

b) Sub-issue 1: when did "transfer" take place?

Transfer by way of guarantee occurs on the date

the guarantees were exercised, not granted

c) Sub-issue 2: was the debtor insolvent? insolvency is

when the sum of the debts is greater than the

FMV of assets (don't use book value)


(3) Good Faith Defense for subsequent transferees: The initial transferee has no

good faith protection under 550 (??) however, the transferee of the initial

transferee is protected by good faith under 551

f. State Law Avoiding Powers - 544(b)

(1) Generally

(a) 544(b) gives the TIB the ability to use any avoiding powers

provided by state law

(b) There must be at lease 1 unsecured creditor to use 544(b) It

provides that TIB can avoid any pre-bankruptcy transfer that is

avoidable under applicable state law by a creditor holding an unsecured


(2) For example, TIB can use the UFTA or UFCA to avoid transfers

(a) TIB can avoid a transfer if it is fraudulent toward an actual

creditor with an unsecured claim (TIB steps into shoes of unsecured

creditor & voids the transfer on his behalf)

Note: this is different than under 544(a) (Strong Arm

Provision), where TIB can avoid unperfected security

interests whether or not there is an unsecured C because the

TIB assumes the position of a hypothetical lien creditor.

(b) This gives the TIB state substantive law & state statute of

limitations (e.g., O.P.M. Leasing: TIB lost under 548 because transfer

occured outside of one year, but had a valid claim under 544(b), since

state statute of limitations was 6 years

(c) Also gives the TIB the ability to use any voiding powers of State

Corp. law; specifically, state corp. law usually prohibits payment of

dividends when corp. is insolvent

(d) The asset which is the product of a voided transfer is returned to

the common pool - it doesn't go to the unsecured creditor on whose

behalf the transfer was voided (this is not a "mirror" of what happens

outside of Bankruptcy, yet it comports with the "theory" of Bankruptcy,

in that nobody should get preferential treatment)

(3) The TIB can void the entire transfer, even though the resulting liability

may be greater (?) than that owed the unsecured creditor on whose behalf

the transfer is voided (e.g., if there is 1 unsecured creditor owed $10 the TIB

can wipe out a $10,000,000 transaction!) Moore v. Bay

(4) Once the transfer is voided, the party who lost the asset becomes an

unsecured creditor in the amount of the asset


(5) Under 544(b), the holding of Durett (under the Code, fraudulent conveyance

occurs if D receives less than 70% of FMV) does not apply. UFTA sec 3(b)

provides that reasonably equivelant value is realized at a justly-held

foreclosure sale. Therefore, the 70% minimum requirement is not

applicable to a claim under 544(b).


g. Statutory Liens - 545

(1) Generally, allows TIB to avoid certain liens created by state law (e.g., landlord


(2) 2 Threshold questions:

(a) Is the claim the TIB seeks to avoid a statutory lien?

i) Statutory Lien = any non-consensual lien which arises by

force of statute (except Art. 9)

(b) If So, is it the type of lien described in 545? 2 main types:

i) landlord's liens 545(3),(4) - landlord's liens (lien for

nonpayment of rent). Thus, TIB can void a lien fixed on D's

property for non-payment of rent. Rationale: combats

incredible leverage landlords would have over tenants


Note: 545 does not apply to consential liens. Thus, a lien

for nonpayment of rent created by virtue of a lease would

not be affected

ii) Bankruptcy priority liens 545(4) - (i.e., a lien that becomes

effective upon bankruptcy filing) are voidable; rationale: don't

want states to "re-write" the Bankruptcy code


In re National Sugar Refinery: UCC 2-702, which allows a

party to withhold shipment of goods to a known insolvent

party does not create a "hidden priority lien", thus TIB

cannot avoid under 545.


Rationale: 546(c) allows creditor to reclaim goods if the D

has recieved such goods while insolvent; since the seller has

the power to reclaim goods it certainly has the power to stop

goods from being transferred

h. Equitable Subordination - 510(c)

(1) Principles of Equitable Subordination

(a) CWT: effect of Equitable subordination under code can be to

subordinate the C's claim OR to avoid the claim (transfer lien back to

the estate (???)


(b) Rationale: 510(c) penalizes Cs who have taken undue advantage of D

and other unsecured Cs.

(c) After notice and hearing, court (under principles of equitable

subordination) may subordinate a C's claim:


(d) 3 Pre-requisites for Equitable Subordination (Mobile Steel):

i) creditor must have engaged in some type of inequitable

conduct (advantage taking)

ii) such conduct must have resulted in injury to other creditors or

conferred an unfair advantage to the party being subordinated

iii) Equitable Subordination must not be inconsistent with the

Bankruptcy code

(e) 3 Fact patterns

i) where there is an allegation of wrongdoing, & the wrongdoer

is an insider (e.g., trying to convert equity into secured debt is

inequitable conduct)

ii) where there is an allegation of wrongdoing, & the wrongdoer

has exercised control over the debtor, making itself almost

an insider (e.g., bank making a debtor pay it first; or where

the lender persuades the debtor to use suppliers who charge

higher prices because the lender owns the suppliers)


iii) where corporate owners or investors capitalize a corp.

with a very small equity investment plus a much larger

amount "loaned" to the corp., & the loan/investment is

treated like an equity investment (see Carolee's Combine)

a) Carolee's Combine: D conducted auctions. In order

to get money to finance acution, D promises a high

return to investors and first priority on the proceeds

of the auction. Aucntion took place and overall D

owed 230M. D pays off the investors first and the

other Cs goth nothing. Court held that these investors

were more similar to equity holders; and equitably

surbordinated them.

b) 2 holdings: (1) court will focus on the effect of the

arrangement -- did it put a favored party in an

advantageous portion over other parties; (2) then

court applies the 3-part Mobile Steel test, supra


(2) Equ insub may be applied to situation where equity holder is given security

interest prior to bankruptcy. (eg. owner of corp takes security interest in corp

to defraud Cs) This "preference" cannot be attacked under 547, because an

equity holder is not a creditor. however, it could be attacked as a fraudulent

conveyance, or court could equitably subordinate C's claim.

(3) Hypo: Adams buys Golf-ball factory then takes a security interest in the

machinery; 3 questions:

(a) is this a voidable preference under 547? No, he is not a creditor; must

be a creditor before the transfer was made

(b) is this voidable as a fraudulent conveyance under 548? Yes

(c) is this voidable under 510(c)? Yes, because he is an insider

(d) Suppose now the bank steps in & runs the corp. into the ground -- what

result? Lender Liability!

(4) Note there is no time frame with respect to 510(c) equitable subordination


(5) Consensual Subordination - 510(a)

(a) Generally

i) Party consents to being subordinated

ii) Creditors agrees to subordination in a contractual arrangement;

i.e., mutual consent, consideration

iii) This is the rule in practice, 510(c) is the exception

(b) 3 important points

i) governed by general contract principles of mutual assent and


ii) does not have to be in writing

iii) no public filing required

iv) If a party with a higher priority agrees to be

subordinated, all other parties with lower priority to the

party agreeing to be subordinated are also subordinated

to the new party.


A. Generally

1. While business continues to operate the DIP/TIB attempts to reach an acceptable reorganization


2. A DIP can propose a reorganization plan during the first 120 days after the filing (1121(b) gives

an exclusive right to the DIP/TIB)

3. Typically, the plan is not proposed for a year after the filing

4. Proposed plan will usually already have been worked out & agreed to prior to filing

B. DIP/TIB has 3 Main Objectives:

1. Evaluate the Firm's current financial situation

2. Determine any changes necessary in the viability of conducting future operations

3. Reconcile goals (1) & (2) with those of the various claimants

a. e.g., In Northwest Situation, different classes of creditors have very different agendas;

Secured creditors prefer liquidation; just about everybody else (unsecureds, equitys,

government, union, etc.) prefers reorganization

4. DIP/TIB cannot look at bankruptcy in a vacuum; must also consider:

a. Tax Law - loan forgiveness is treated as income (108, 1017 of I.R.C.); a discharge of

indebtedness can be excluded from income, but only as an offset against certain tax

advantages (most importantly Net Operating Loss [NOL] carryovers)

b. Labor Law - (ERISA generally protects pensions)

c. Environmental Law

C. Confirmation: Once plan is formulated it must be confirmed

1. Under 1126 a statutory majority of each class of creditors must vote in favor of a plan for the plan

to be confirmed

2. If creditors vote for the plan then the court will confirm the plan if 13 requirements are met

(1129(a) - the 2 most important (we will focus only on these) are:

a. "Best Interest Test" - Unless the creditor voted for the plan, he must receive at least as

much under the plan as he would have received under a chapter 7 liquidation

(1129(a)(7)) - remember: this does not apply unless a party votes against the plan

b. "Feasibility Test" - Bankruptcy Judge asks what is the likelihood that the plan will

succeed (e.g., what his the likelihood that initial reorganization will not be followed by an

immediate liquidation) (1129(a)(11)) - a safeguard against "over-optimism"; no matter

how many creditors voted for a plan, it will not be confirmed unless it meets the feasibility

test; the following 4 factors are considered in the "feasibility test"

(1) Adequacy of capital structure

(2) Earning Power of the new business

(3) General Economic Conditions

(4) Ability of Management

3. Under the feasibility test, the court looks at the performance of the entity during the "gap" period

(time after filing petition & before proposing a plan)

4. Final Note: under 1129(a)(10) at least 1 impaired class must vote for the plan to confirm

D. Voting Under the Plan

1. 1126 - Voting Provisions

a. 1126(a) - all parties with claims (creditors) or interests (equity holders) can vote

b. 1126 eliminates 2 classes from voting:

(1) 1126(g) - if a class will receive nothing under a plan, it is deemed to have

rejected the plan

(2) 1126(f) - if a class is not impaired under the plan, it is deemed to have

accepted the plan

c. 1126(c) - (applies to all other classes of impaired creditors) 2 requirements for approval:

(1) it must be approved by a simple majority in number of creditors in the class who

voted; &

(2) a 2/3 majority in the amount of debt must vote for the plan

2. Classification of Claims

a. Question: under what criteria can creditors be separated into different classes?

(1) a class may be grouped together only if they are substantially similar

(2) conversely, class can be grouped separately if their claims are substantially


b. Remember, under 1129(a)(10) at least one class of impaired creditors must vote for the

plan in order to confirm

3. Impairment

a. 1124 sets forth requirements for impairment; a class is impaired unless:

(1) the legal, equitable, or contractual rights of a holder are left unaltered; or

(2) if the only alteration of legal, equitable, or contractual rights is a reversal of an

acceleration of default by curing the default & reinstating the debt; or

(3) there is a cash payment to the creditor on the effective date of the plan equal to

the amount of the claim

4. Solicitation of Disclosure - 1125

a. Question: how do the parties know how to vote?

(1) 1125 - prescribes that people should have enough information to make an

informed decision

(2) 1125(b) - before creditors vote, they must be supplied with:

(a) a copy of the plan (or summary)

(b) a written disclosure statement containing "adequate information"

(3) 1125(a)(1) defines "adequate information" as information which is reasonably

practicable to enable a hypothetical reasonable investor to make an informed

judgment regarding the plan (See In re Malek, which sets forth a "celebrated" list


of what is required in a disclosure statement)

b. Since there is a great deal of litigation involved in disclosure, 1125(e) sets forth the Safe

Harbor Rule:

(1) under 1125(e), no person connected with the solicitation of a plan is liable for a

violation of the securities laws, so long as that person acts in good faith & in

compliance with Chapter 11's disclosure requirements

(2) This issue generally arises because debtors often solicit creditors with stock

offerings (i.e., selling securities in exchange for capital)

5. Cramdown - 1129(b)

a. Generally - confirming the plan even if all parties don't vote for it; i.e., cramming it down

the creditor's throats

(1) Remember, for a judge to confirm a plan we need 2 things:

(a) "Best Interest" test must be met

(b) Plan must be accepted by a statutory majority of each class (1126(c))

b. The Statute:

(1) 1129(b) - a plan accepted by less than every impaired class can only be

confirmed if:

(a) at least 1 class of impaired creditors has accepted the plan

(1129(a)(10); and

(b) the plan does not discriminate unfairly between classes

(c) the plan is fair & equitable (this is the key to Cramdown)

(2) 1129(b)(2) defines "fair & equitable" according to which class is dissenting to

the plan:

(a) For Secured Creditors (2 criteria):

i) Liens of the secured creditor must be preserved by the plan

ii) Creditors must be paid the present value of their allowed


(b) For Unsecured Creditors & Equity Holders:

i) Must either be paid in full; or

ii) the plan must provide that any parties junior to them get


(3) For all practical purposes, the equity holders are screwed, so. . .

6. New Value Rule

a. created because equity holders have no leverage; they are at the mercy of the senior.


b. Equity holder, notwithstanding absolute priority rule, can retain their equity interest if 3

prerequisites are met:

(1) the new value must be contributed in money or money's worth of new value (no

"sweat equity"; and

(2) Contribution from the shareholders must be substantial & necessary to the

reorganization; and

(3) Shareholders must receive in return a participation interest reasonably equivalent

to their contribution (e.g., similar to what new equity holders are getting for their


c. Therefore, there are 2 options for an Equity Holder who wants to stay "on board":

(1) Make a new contribution to the company; or

(2) convince senior creditors to vote for the plan

d. Benefits: encourages cash contributions to a company that desperately needs it

e. Disadvantages: equity holders will never exercise this option if the corp. is overvalued;

conversely, they will always exercise this option if the judge undervalues the corp.

7. Secured Creditor Cramdown - 2 cases

a. Secured Creditor who is fully secured or oversecured

(1) DIP/TIB has several options if he believes this creditor will vote against the plan:

(a) leave the creditor unimpaired

(b) pursue alternative's outlined in cramdown provision (i.e., cramdown all

junior creditors)

(c) offer the creditor additional stock equity

b. Secured Creditor who is undersecured - 1111(b)

(1) Generally: 1111(b) sets up special rules for non-recourse secured claim (a

claim secured merely by the collateral; no personal liability) - Congress enacted

1111(b) to prevent bankrupts from "stripping down" non-recourse loans

(2) 1111(b)(1) - Unless a non-recourse creditor makes a 1111(b)(2) election

(discussed below), he has a right of recourse against the debtor:

(a) on secured claim: for fair market value of property;

(b) on unsecured claim: for the rest of the loan

(3) 1111(b)(2) - if a non-recourse creditor makes this election, he is treated as

having a secured claim for the entire obligation/loan

(a) Under this election, the debtor must, during the course of the plan, pay

the creditor:

i) the full amount of the non-recourse loan; &

ii) the present value of these payments must equal the "secured"

portion of the loan (e.g., the fmv of the collateral) - this

prevents a debtor from stretching out the payments for an

inordinate amount of time

(b) If creditor makes the 1111(b)(2) election he loses both his unsecured

claim (no big deal, since it becomes "secured") & the right to vote as an

unsecured party

(c) Generally, if the plan is one of short duration, a creditor will make the

1111(b)(2) election, since the present value of the payments won't

"catch up" to the value of the loan





Statute Index




101 (9), (13), (22), (25)

1017 (30)

105 (8), (18)

108 (8), (30)

109 (13), (16)

1104 (19)

1111 (33)

1113 (26)

1121 (30)

1124 (31)

1125 (31), (32)

1126 (18), (30-32)

1127 (18)

1129 (31), (32)

1205 (9)

1302 (13)

1307 (16)

1322 (8), (13-15)

1325 (13), (15)

1328 (8), (16)

1329 (16)

1983 (5)

2-702 (29)

262 (19)

301 (7)

303 (7)

342 (17)

362 (7), (8), (13), (17-20)

363 (19), (20)

364 (17), (20), (21)

365 (17), (25-27)

4 (6)

5 (6)

502 (10), (14), (15)

506 (10), (14), (15)

507 (11), (19)


510 (29), (30)

522 (10)

523 (11)

524 (12)

541 (7)

544 (17), (18), (21), (28), (29)

545 (29)

546 (29)

547 (17), (18), (22-25), (30)

548 (27)

550 (23), (25), (28)

551 (28)

552 (20)

553 (20)

605 (1)

606 (1)

609 (1)

610 (1)

611 (1)

612 (1)

613 (1)

615 (1)

616 (1)

617 (1)

6321 (22)

6323 (22)

707 (8)

722 (12)

727 (9), (11), (12)

8 (6)

805 (1)

806 (2)

807 (2)

9506 (12)











































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