Bankruptcy

  1. Basic Purposes
  2. Saving creditors costs of destructive race to debtor’s assets
  3. Helping individuals overburdened with debt – only this affects substantive rights. a. and c. are procedural.
  4. Reorganize capital structure of firms in financial distress
  5. Basic Principles
  6. From three strands:
  7. English law (equitable process- no jury; discharge)
  8. Colonial law.
  9. Equity receivership common law.
  10. procedures of equity receivership codified in 1898 Bankruptcy Act.
  11. Butner principle: bankruptcy law respects the rights existing outside bankruptcy unless a specific bankruptcy provision or policy requires otherwise.
  12. Purpose of “Discharge” in Chapter 7 (liquidation, fresh start) are different from “discharge” in Chapter 11 (Reorganization)
  13. Chapter 7 is geared to giving individuals a fresh start: creditors do not get future income.
  14. corporations are already limited liability, so they do not get discharge under Chapter 7.
  15. Chapter 11 is geared toward giving corporations a new capital structure (i.e., a new balance sheet; substituting new claims for old): creditors get present & future income.
  16. Economic and Financial Distress
  17. Economic distress: fundamentally a bad business. E.g. Chicago dim sum (small plates of different Chicago neighborhoods. But the restaurant doesn’t get many customers)
  18. Financial Distress: not enough revenue to pay debt. E.g. English Channel Tunnel or 19th Century Railroads:
  19. may be fundamentally well-run, useful, etc.
  20. doesn’t make sense to split up piece by piece for individual creditors (and the pieces may not be useful for individual creditors)
  21. Economic distress and financial distress often go together.
  22. Why do we need Chapter 11 to make a new balance sheet?
  23. E.g., why not just sell to highest bidder, esp w/ sophisticated modern credit markets.
  24. how many businesses are like the English Channel Tunnel?
  25. What’s being saved?
  26. Why do we need the old company?
  27. Bankruptcy in the field
  28. Vast majority of bankruptcy judges’ docket: individual bankruptcies. Often don’t appear in front of judge b/c cases are routinely handled. (e.g., debts routinely discharged)
  29. Vast majority of value of bankruptcies are corporate: most lawyers do only large corporate bankruptcies.
  30. Automatic Stay
  31. Statutory Basis: Section 362:
  32. Purpose: to solve collective action problem of creditors’ “race to assets.”
  33. Creditors cannot bring actions or enforce judgments against the debtors when such actions or judgments arise before the bankruptcy petition.
  34. Stay prevents liens from being attached to debtor’s assets.
  35. Prevents anyone from taking possession of debtor’s property or exercising control over it.
  36. Section 362(d): petition to lift the stay:
  37. usually granted when property is not necessary to debtor’s reorganization and has no equity in. (362(d)(2))
  38. “for cause, including the lack of adequate protection of an interest in property of such party in interest”
  39. If 362 does not prevent someone from taking actions undermining the process, trustee of estate can ask court to issue stay under court’s general equitable powers in §105(a) (must be connected with discrete policies of Bankruptcy Code)
  40. Automatic Stay’s Effect on Creditors:
  41. See 362(a) for all the actions that are stayed.
  42. Does not apply to actions against third parties. (e.g., creditor can still draw on a letter of credit where a third party promises to pay if debtor does not; creditors may pursue guarantors or codefendants of debtor)
  43. Can creditor act in capacity other than creditor to bypass stay’s strictures?
  44. See Marvel case (Official Bondholders Committee v. Chase Manhattan Bank):
  45. Background:
  46. Marvel Holding Companies own 80% of the stock in Marvel, which in turn owns Toy Biz. Perelman owns the MHC.
  47. MHC raised $894 mil thr bonds, secured by pledges of 80% of Marvel’s stock and 100% of two MHC.
  48. Marvel and MHC subsequently filed for Ch 11.
  49. Bondholders Committeee formed in MHC cases to represent parties holding MHC bonds.
  50. Bondholders Committee and Indenture Trustee moved to lift automatic stay in MHC cases to allow bondholders to foreclose on and vote pledged shares b/c MHC defaulted on some indentures.
  51. Ct holds that the Bondholders Committee as shareholders have the right to vote their shares without having to first seek a lift from the automatic stay.
  52. Shareholders’ right to be represented by directors of their choice & control corporate policy.
  53. Shareholders also should be represented in conduct of debtor’s affairs.
  54. Election of new board of directors may be enjoined only when “clear abuse.” (when shareholders will “risk rehabilitation altogether” to win a bigger share for themselves)
  55. Shareholders cannot use their shareholder rights to make an end run around automatic stay just to get paid in their role as creditors (if they have such a role). See In Re Fairmont (p. 110); In re Bicoastal (id.)
  56. Automatic Stay’s Scope Re: Third Parties
  57. In Re CahokiaDowns
  58. State had already shut down racetrack.
  59. involuntary bankruptcy petition that creditor filed.
  60. Holland is not a creditor. Cancels policy after C’s bkrp.
  61. Does this violate automatic stay?
  62. Yes. b/c of property interest.
  63. Ct also sees Holland as doing roundabout ipso facto clause.
  64. ipso facto clauses in contracts: obligations to terminate in event of bankruptcy.
  65. Bankruptcy Code forbids most ipso facto clauses and bankruptcy law in general won’t enforce them.
  66. In re MJ & K (BrooklynLawSchool case)
  67. why in this case can BLS cancel contract w/I bkrt?
  68. good faith reasons by school? – but dean didn’t act until after bkrpt
  69. statute of fraud / license? – but the bankruptcy is in more trouble when dean ends relationship b/c that decreases busiess and confidence.
  70. Chrysler
  71. Cahokia Downs principle inapposite.
  72. Why can’t Chrysler repossess its own property?
  73. Chrysler is possessing (its own) property from the estate (much like picking up dry cleaning), not taking property of the estate.
  74. separate those w/ pre-bkrt rel and those w/o b/c bkrt only stays the former.
  75. Exceptions to the Automatic Stay:
  76. Nextwave: regulation vs automatic stay.
  77. uncontroversial propositions:
  78. 28 USC 959(b) and 11 USC 362(b)(4). Regulations can still be enforced.
  79. §525: gov’t can’t discrimination against someone just b/c applied for bkrc.
  80. But Ct holds bkrt ct had no jurisdiction over deciding whether gov’t violates aut. stay.
  81. This creates a circuit split since other cts do hold, at least implicitly, that bkrt cts have jurisdiction.
  82. The real problem is a 525 problem rather than 362 (stay exception) problem. FEC is just trying to get $ that it’s owed, not trying to apply regulation generally.
  83. FCC subsequently lost in DC Circ. b/c of 525
  84. think of spectrum license as as property (which comes into bkrt w/ its non bkrt attributes): so gov’t should be treated as a secured creditor.
  85. Nicolet: environmental liability case.
  86. if agency is simply exercising police powers, no weighing of interests involved. The debtor must follow the regulations.
  87. Bankruptcy court is not right place to challenge rationality or wisdom of policy.
  88. EPA is only trying to collect a debt: bankruptcy court holds EPA is excepted fr automatic stay to determine how much is owed (when EPA will be paid, its priority re other debtors, separate issue and not addressed here)
  89. Ct agrees that 362(b)(4) not just allow regulations but also fixing claim.
  90. EPA must have claim determined for Nicolet so as to determine liability of all defendants
  91. B/c Nicolet owns the site, post petition possession of asset generates post petition liability (?)
  92. Claims

-pre-petition claims vs post-petition “administrative expenses”

  1. Statute:
  2. 501: filing of proof of claim or interest
  3. 502(a): allowance of claims or interest
  4. 101(5): definition of “claim”
  5. “right to payment, whether or not such right is reduced to judgment…”
  6. “right to an equitable remedy for breach of performance if such breach gives rise to a right to payment…”
  7. Cases:
  8. Ohio v. Kovacs:
  9. State argues that Kovac’s obligation to clean up site not dischargeable b/c not a “debt or claim.”
  10. Ct holds this obligation is a debt, b/c “a debt is a liability on a claim.” See definition for claim in §101(5), which includes “right to an equitable remedy.”
  11. When Kovacs did not comply with injunction, state appointed Receiver who was ordered to take possession of Kovacs’s assets.
  12. State did not prosecute Kovacs under environmental laws, or bring civil or criminal contempt proceedings.
  13. Epstein (Piper Aircraft case):
  14. When does claim arise?
  15. Turns on definition of creditor in 101(10). At issue are future claimants. Epstein wants to argue future claimants possible just from conduct of company. Wants to establish fund future claimants can draw on.
  16. Interests of existing creditors conflict with future claimants. key problem is valuation.
  17. Implicit understanding: cannot affect future victims’ claims w/o due process. But present creditors have incentive to shortchange future creditors.
  18. Bankruptcy collapses everything to present value. Implications:
  19. equity is positive b/c even when debtor’s insolvent, there’s always some chance of gain to assets.
  20. All claims “look the same.” Unsecured claims all treated alike. Unsinsured interest does not matter. Just the principal.
  21. Tort claims do not take priority over bank claims (Butner principle: b/c outside bankruptcy, tort victims do not have priority. Alt bankruptcy does have some special priorities, such as tax).
  1. Property of the Estate
  2. Statute: 11 U.S.C. § 541.
  3. corporations: everything the debtor has (e.g., oil well, lawsuit against 3rd party, intellectual property – any property interest as determined by nonbkrc law).
  4. Individuals: all current assets (with statutory exceptions) but not future income.
  5. 541(a)(6): what’s the dividing line b/w future income and earnings in the future based on past work.

- “Proceeds, product, offspring, rents, or profits of and from property of the estate, except such as are earnings from services performed by an individual debtor after the commencement of the case.”

  1. Basic Principles:
  2. Chicago Board of Trade: property does come into bankruptcy but keeps all nonbankruptcy attributes.
  3. Ipso facto clauses not respected. Bankruptcy cannot eliminate a property interest.
  4. Cases:
  5. Cunningham v. Brown: Ponzi’s investment premise on postal rate arbitrage. But, actually, fraud: using new investors’ $ to pay off old investors.
  6. what counts as property of the estate.
  7. involuntary bankruptcy petition. Avoiding preferences as per 547: trustee can get $ back from investors who were paid back X days before bkrt filing.
  8. Creditors argue: simply taking back our $, not engaging in preferential conduct; not property of estate.
  9. Ct reasons: to say it’s your $, you’ve got to be able to trace it. Fraud -> $ placed in constructive trust.
  10. The problem is: no $ in the trust: therefore no tracing possible. Therefore, creditors cannot get their $ back.
  11. What’s relationship b/w 541, 544, and 547? (strong arm powers of trustee to bring property back into estate)
  12. In re LTV: special purpose vehicles as a way to get around bankruptcy.
  13. debtor - assets to SPV  creditor.
  14. w/ only debtor filing for bkrt. SPV not bkrt and creditors can reach SPV assets.
  15. Side deals where indexing how much debtor pays to SPV rel. to how much 3rd party’s paying) makes SPV look like a secured creditor rather than “true sales” occurring b/w debtor & SPV.
  16. LTV’s products belong to SPV, but seems to be pushing it to say they’re not LTV’s products.
  17. Perhaps why judge ruled in LTV’s favor.
  1. Executory Contracts
  2. Statute: 11 U.S.C. § 365.
  3. Definition: executory contracts are those where nonperformance by either party is a material breach.
  4. Assumption of executory contracts: demanding performance of the contract.
  5. Rejection of executory contracts: pay expectation damages for breach.
  6. Problems: could be dealt with under 541. Instead, placed in separate chapter (365).
  7. Rights of individuals and corporations are equally applied.
  8. Fundamental difference between assignment and assumption of contract (transfer & ownership different). Not addressed.
  9. Contract terms are default terms but Bkrc Code treats some of them as mandatory (such as assignment of tasks).
  10. Assumption:
  11. Cts typically allow debtors to assume contracts. But more contracts are assignable in bankruptcy than outside (but can’t change the terms while assigning). Restriction of ability of tenants in shopping centers to assign spaces (365(b)(3)).
  12. 2005: leases be assumed w/i 7 months of filing for bkrc. This has been a big problem for retailers. Since 2005, no retailer has successfully reogranzied under Bkrt Act.
  13. Catapult: Catapult wants to assume patents licensed by Perlman to transfer to MPath (although contract w/ Perlman had barred assignment to 3rd parties).
  14. Can Ch 11 and 365 allow it?
  15. Ct holds no: b/c applicable law (patent law) allows for assignment only w/ patentee’s consent).
  16. If can’t assume, then won’t reach question of assignment.
  17. BUT, Catapult is not followed outside of 9th Circuit.
  18. Rejection:
  19. Not an avoiding power. Does not give trustee power to get back asset that belongs to another (e.g. sale of good w/ warranty does not mean seller can get back good; the breach is only on the warrantee. The good already belongs to another. Same w/ license)
  20. 365(n): intellectual property as something licensee can keep. But this should be obvious even w/o 365(n). The section was added b/c cts had decided otherwise!
  21. But Section 101 does not include trademarks w/I definition of i.p.
  22. Rejection does not tell you what consequences of breach are (for example, collective bargaining agreements are different from sales contracts)
  23. §1113: a response to S.Ct. giving rejection right to cba. But the implications are broader than Ch 11!
  24. 1113 -> process. Not many cbas are rejected.
  25. Bkrc may provide “cover” unions can blame bkrt judge for worse terms that all parties know will have to be accepted.
  26. N.W.A.: RLA & §1113 problem. (very limited reach, however. Statute may be overturned. Also, typical case is under NLRA and not RLA)
  1. Avoiding Powers/ Strong-arm Powers
  2. Statutory Bases:
  3. 544(a): brings property into estate that didn’t belong to debtor but that creditors can reach under nonbkrtc. E.g, unperfected security interests which may be avoided b/c won’t survive outside bkrt.
  4. 544(a)(1): personal property. Trustee as hypothetical lien creditor.
  5. 544(b): gives trustee power to avoid transfer that would’ve been avoided by actual creditor.
  6. problem: one creditor for a small sum can undo a huge leveraged buyout.
  7. often boils down to looking fr “golden creditor”
  8. standard such case: corporate veil piercing. Trustee wants to be able to go after s.h. and recover to share among creditors.
  9. 551: preserves for benefit of estate interests avoided under 544.
  10. 550: permits trustee to recover an avoided transfer or its value.
  11. Cases:
  12. Kors, Inc. v. Howard Bank: subordination agreement cannot be avoided b/c Kors is not part of that agreement.
  13. In re Ozark Restaurant Equipment Co.: Ch 7 trustee does not have standing to bring alter ego claim on behalf of corporation’s creditors.
  14. trustee has power to assert actions belonging to debtor.
  15. Fraudulent Conveyance
  16. History:
  17. 1571: Statute of 13thElizabeth
  18. 1601: Twyne’s Case: “badges of fraud” sufficient for fraudulent conveyance. Do not need to prove actual intent.
  19. NY is one of the states that still cares about “badges of fraud” : even if transaction is for fair value & leaves debtor solvent.
  20. In most states, most impt badge is: when debtor makes transaction while insolvent (or makes debtor insolvent, or left it w/ unreasonably small capital) for less than reasonably equivalent value.
  21. this has swallowed up most other b/f’s (e.g. birthday present to relative while insolvent)
  22. Modern law: objective criteria. Does not matter what the intent is. Transactions while insolvent for less than reasonably equivalent value are facially fraudulent conveyances.
  23. purpose: to protect creditors.
  24. Look to economic substance, not to how transaction is structured.
  25. key question: are shareholders better off while creditors are worse off?
  26. Usual application in corporate context:
  27. any transaction that is equivalent to a dividend or stock purchase that is done w/o receiving reasonably equivalent value while insolvent (or w/ unreasonably small capital) is f/c w/ respect to creditors.
  28. increasing compensation to “insiders” “Not in ordinary course of business” w/o receiving “reasonably equivalent value” also f/c.
  29. no insolvency requirement.
  30. Insiders include: directors, officers, in control, partners, relatives of…
  31. “unreasonably small capital” question arises often in LBOs. LBOs are like big dividends to shareholders.
  32. If LBO leaves firm insovent, it is fraudulent conveyance. $ that goes to shareholders can be taken back alt difficult in practice.
  33. Banks may argue it gave value: even if debtor insolvent, not f/c for bank, b/c it gave reasonably equivalent value? In interest to be paid back)
  34. Trustee may still argue f/c: conduit test (as $ goes to s/h fr bank or firm
  35. was firm a conduit?
  36. was bank acting in good faith?
  37. Cases:
  38. BFP: For foreclosures, regularly conducted, noncollusive, arms-length transactions by 3rd party w/o relation to buyer simply is reasonably equivalent value.
  39. NOT “fair market value”
  40. Irridium: what was reasonably equivalent value for what Irridium was getting? ($5 bil for satellites that can only be used for such purpose)
  41. How to measure value?
  42. “ugly fountain” analogy? – the cost of it is a measure of value. B/c it doesn’t have resale value.
  43. How to measure solvency when it paid for the satellites:
  44. Look to public, well-informed markets.
  45. Solvency test is NOT book value.
  46. Rather, would a very solvent person pay a positive price to acquire the aseets and debts?
  47. And compare to outstanding debts.
  48. In Re Manhattan Investment Fund (Bear Stearns case): a transfer in intentional fraud (even when 1 party does not know it’s fraud) is f/c & can be avoided. Investors protected to extent they’ve given value (548(c)).
  49. here, Ponzi scheme. $ transferred to Bear Stearns w/ intent to mislead other investors. It’s f/c even if transfer itself not fraud.
  50. Bear Sterns must prove acted in good faith for $ to be protected.
  51. Preferences:
  52. Rationale: repaying creditors on eve of bankruptcy can be voided, to prevent collective action problem of each creditor racing to assets.
  53. Statute: 547. bright-line rule + exceptions:
  54. Payment voidable preference if: 547(b)
  55. debtor insolvent
  56. payment to creditor on account of an antecedent debt owed by debtor before the transfer
  57. creditor gets paid off 90 days before filing of the bkrtc petition w/ debtor’s property
  58. or between 90 days and one year before the date of the filing of the petition if creditor at time of transfer was insider.
  59. creditor better off than otherwise if it were a chapter 7 case
  60. then, creditor has received preference.
  61. Trustee may avoid the voidable preference (i.e.,When a creditor has received a voidable preference, he’ll need to give the $ back).
  62. Does NOT include:
  63. contemporaneous exchanges of substantial equivalence (i.e., buying stuff) (547(c)(2)
  64. contemporaneous exchanges of
  65. payments to fully perfected secured creditors (b/c they’re not made better off, just equally well off)
  66. inventory/ accounts receivable (547(c)(5)
  67. Cases/ Hypos:
  68. Hypo 1:
  69. Sh of closely held corp, which has unsecured loan fr bank, personally guarantees the loan.
  70. 1 yr window for insider
  71. if sh ensures bank is paid first by corporation, it’s a voidable preference
  72. “payment “to the benefit of” shareholder, b/c is a contingent creditor b/c of guarantee.
  73. But recovery fr sh is remedy at law, b/c of a statutory rule.
  74. Hypo 2:
  75. Debtor owes supplier $.