Schermer Fall 2000

Bankruptcy Schermer – Fall 2000

I. Preliminary Stuff

 Types of Loans 1. Secured: Involves collateral, voluntarily transfer rights to lender (right to inspect, take, sell collateral and apply to loan balance) 2. Unsecured: no transfer of property rights

 2 Types of Secured Loans 1. Over-secured: collateral has greater value than debt  When it’s over-secured, you give the debtor the surplus. 2. Under-secured: collateral is of a lesser value than debt

 How do you get a secured loan? 1. Attachment a. Signed security agreement, or gives possession of the collateral b. Borrower must have rights in the collateral (title) c. Transfer of consideration from secured creditor to debtor (creditor gives value) 2. Perfection a. Record according to state law b. Possession

 Unsecured creditors- collection 1. Go to court and get a judgment 2. Take it to sheriff and he executes it 3. Levy: race to dismember assets (whoever gets there first gets paid first)  3 choices a. Date of filing at sheriff’s office b. Date that sheriff says, “I possess” (more secretive- who knows? Minority rule) c. Date that sheriff gets the car (majority rule)  What if sheriff delivers 2 writs of execution at same time? a. Majority: there’s a tie (50/50 distribution) b. Minority: first to deliver to sheriff

 Relation back 1. Record 2. Attach (security agreement) = relates back

2. Attach 2. Record = does not relate back

 Garnishment . Garnishee: employer (can be liable) . Garnishor: creditor . Can also garnish bank accounts 1  Garnishor steps into the debtor’s shoes (if debtor not entitled to something, garnishor not either) . If lease, Garnishor entitled to lease payments (gets possession or rental payments, depending on if there is a lease)

II. Chapter 7

 Majority of cases are filed here  Here’s all must stuff, pay off my creditors, now I’m debt free  Debts not discharged: child support, alimony, student loans, certain kinds of taxes, fraud

 3 things you need:

1. Automatic stay 2. Estate is created 3. Trustee is appointed

 What starts a chapter 7 case? . When petition is filed (lived there 91/90 days (1/2 time of preceding 180 days)

A. Property of the Estate § 541 (A) 1. Exempt Property (still need to live, fresh start) i. § 522 (d): lists exemptions ii. States can opt out of federal exemptions and use their own (41 states have done so) iii. Classifications: house, transportation to work, wages earned, clothes, furniture, etc. 2. Partially exempt property i. Need to have equity (FMV – debt = equity) in the item to get exemption b/c consensual security agreements come first (exemptions come before non- consensual liens (judgment creditors)) ii. Get cash from sale 3. Is exempt property property of the estate? i. Property can leave estate in two ways  Exemption  Abandonment: trustee will abandon if not worth anything to the estate §554 4. § 541 (c)(2) exception: applicable non-bankruptcy law includes both state and federal law (retirement plans ERISA qualified excluded) 5. Only exception to date of filing is an inheritance within 180 days of filing. §541(a)(5) 6. Life insurance policy: not part of estate b/c debtor has no legal or equitable rights (would change if debtor had contractual right) i. Distinction between interest and value ii. Estate’s right to debtor’s limitation in property should be equal (estate’s rights are no better than the debtor’s rights)

2 iii. On contingent interests & expectancies-these generally become property of the estate at the time of filing iv. Transfer restrictions- § 541 (c)(1)(a)  Will bring into the estate property that has restrictions on transfer  Will not remove restrictions on transfer B. §341 meeting 1. 20-40 days from order of relief 2. Notice sent to all creditors 3. Trustee can interrogate debtor, trustee conducts meeting

C. Automatic Stay § 362 1. Gets creditors off the debtor’s back: Automatic injunction 2. (a): extent of the stay; (b): exceptions; rest: odds & ends about the stay 3. Enforced against all creditors, wherever they may be. (Foreclosing on house: as long as you file b/f the sale, bank can’t foreclose §362 (a)(2 & 3) 4. Debtor also can’t appeal judgment in favor of creditor, b/c it’s a continuation under § 362 (a)(1) (Filing bankruptcy stops all litigation 5. Can’t not issue transcripts 6. What rights do you have if stay is violated??  § 362 (h): costs & attorney’s fees, & sometimes punitive (only applicable to individuals, not a corporation)  willful: intend collection, & know debtor is in bankruptcy 7. Can garnish paychecks for pay period up to date of filing. If haven’t made money yet, not property of the estate. a. Garnishment will not continue on post-petition wages: § 362 (a)(6) 8. Utility company: § 362 (a)(6) says it’s stayed, § 366 says it lasts for 20 days, & then have to give deposit 9. Also applies to IRS: applies to EVERYONE (also, can’t evict if you don’t pay rent) 10. Must pay past due alimony and child support § 362 (b)(2)(b) 11. How long does stay last? § 362 (c)(2) a. Until time case is closed b. Until time case is dismissed c. Until discharge is granted d. Until property is no longer property of the estate (c)(1) a. Ex: stay does not apply to abandoned or exempted property b/c they are no longer property of the estate 12. Relief from the stay: § 362 (d) 1. For cause (could be anything, including adequate protection: entitled to decline in value of collateral during the time you’re not allowed to collect the collateral, also right to inspect, insurance, routine maintenance) 2. Act against property, if: a. Debtor has no equity, (or?) b. Property is not necessary for an effective reorganization (if ch. 7, not necessary)  § 362 (e): judge must hear it w/i 30 days  § 362 (g): Party opposing (debtor) has burden of proof 3 D. Exemptions 1. § 522 (f): Lien Avoidance a. Judicial Lien: except one that includes spousal support, etc. b. Non-possessory, non-purchase-money security interest in any: 1. Household furnishings, etc. 2. Tools of the trade, etc. 3. Health aids 2. MUST impair an exemption under (f)(2), so if:  Lien + all other liens + exemption > FMV, then impairs (judicial lien can be reduced to allow exemption)

E. Secured Creditors a. Interest & Fees 1. § 506 (b): entitled to reasonable fees, interest etc., up to value of collateral 2. Non-consensual liens: argument that § 506 (b) says agreement, but case says it can be consensual or non-consensual 3. CANNOT get un-matured interest (after payment from estate) 502 (b)

 Date of filing Payment from estate

(Un-matured interest: can’t get)

. Entitled up to date of filing? Yes . Entitled up to date of payment? Yes, if secured: § 506 (b) . What about § 502 (b)—un-matured interest? NO

b. Value of Collateral 1. Determined at date of filing 2. Debtor wants low value, but Creditor wants a high value so they will be over- secured and get all of the interest & fees and stuff. 3. So what value do we choose? (auction price, retail, wholesale, etc.) 4. § 506 (a): tells us what value: what’s the creditor’s interest in the car?, (wholesale or liquidation) but also what is the purpose? (debtor retains car, retail or ad) 5. Supreme court says it’s replacement value: a little closer to retail than wholesale

F. Unsecured Creditors a. Interest & Fees 1. Not entitled to post-petition interest  Date of filing

2. Filing bankruptcy cuts off interest

b. Priorities § 507 1. § 507 (a)(1): who qualifies under this status? Look to § 503 (b)

4  Expenses incurred after date of filing (trustee, debtor’s attorney, ch.11 debtor’s business expenses) 2. Next come employees, certain pre-petition priorities 3. Rank above you gets paid in full before you get paid 4. Unsecured non-priority claims: bottom of the pile

G. Discharge 1. § 524 (a): discharges debts; § 524 (a)(2): lasts forever 2. Exceptions to discharge are in 2 sections: § 523 & § 727 a. § 523: objection to the dischargeability of a particular debt . What shouldn’t be discharged? a. Fraud: intent to deceive creditor b. Family support (interplay between 5 & 15) c. Student loans (except for undue hardship) d. Taxes e. Intentional torts (willful & malicious injury) f. Drunk driving g. Embezzling money h. Larceny i. Fiduciary to hold one’s money and then lose it . Creditor has the burden of proof: preponderance of the evidence . § 523 (a)(2)(c) : discourages people from loading up on luxury goods, dollar amount . § 523 (a)(5): looks at purpose, so look back, while § 523 (a)(15) looks at current . 3 Prong test a. Minimizing expenses b. Maximizing income c. History of repayment (good faith test) b. § 727: objection to the dischargeability of all debts (worse thing that can happen to a debtor)

H. Redemption § 722 1. Must pay creditor FMV (minus what you’ve already paid), and then pay equity to estate. If you have an exemption, subtract that total from what you have to pay to the estate. 2. If the estate abandoned the item, you just need to pay the FMV to the creditor. 3. CANNOT pay in installments, must do it all in one lump sum 4. You can force redemption on a creditor

I. Protection against Discrimination 1. Government unit can’t discriminate solely because of bankruptcy 2. Applies to private employers 3. Student loans

J. Reaffirmation 1. Required to obtain an undue hardship affidavit? 2. Can’t force it on a creditor

5 3. Continue to make payments after discharge to keep property 4. Need the following: 1. Clear and conspicuous statement 2. Filed with court before granting of discharge 3. Can rescind 60 days of signing 4. Undue hardship applicable  Most judges only reaffirm secured debt

III. Chapter 13  Estate is created, but also includes post-petition earnings  Automatic stay is exactly the same: only applies to pre-petition debt  Trustee appointed, but here the main duties are to collect the money and make payments to the creditors according to the plan  Why file a chapter 13? 1. Get to keep collateral § 1306 (b) 2. Super discharge (really, all that you have to still pay is § 523 5, 8, 9)  Must be a real person, partnership, not corporation: § 109 (e)  All disposable income is supposed to go to pay the plan  Still have § 341 meetings  Have up to 15 days to file schedule and plan  Once plan is confirmed, property of estate vests in debtor § 1327 (b) (but controversy over interplay with § 1306: new creditors garnishing, don’t want to disrupt the plan, but new creditors do not have to wait)  Payments made to trustees monthly, beginning 30 days after plan is filed; trustee can also withdraw money from paychecks sometimes  Plans last 3-5 years  Debtor unilaterally gets to write the plan

A. Secured Creditors  What entitled to? 1. Entitled to retention of their lien, and 2. Entitled to payment on the debt equal to the present value of the collateral . Present value of collateral: how much I should pay you so money I give you in a year from now equals what you give me today . This is not interest  Special protection for principle residence mortgages 1. Debtor can “cure and maintain” § 1322 (b)(5)  Cure gives the debtor the chance to make up missed payments as long as they’re also making current payments  Arrearage is not a modification  Debtor has “reasonable time” to cure arrearage  Monthly payments do not change (part of fixed expenses)  Most hold term of plan reasonable  If you file before foreclosure then you can still cure § 1322 (c)  Can deaccelerate upon the filing of a chapter 13 (acceleration: full amount now due because of the default) 6 2. Can’t modify the terms of the mortgage, though § 1322 (b)(2)

B. Good faith requirement 1. § 1325 (a)(3)  Must look at eligibility requirements under § 109, & also good faith must be met

C. Unsecured creditors  Minimum protections? 1. § 1325 (a)(4): Best interests: receive not less than amount that would have been paid under a chapter 7; have to get as much as you would under a chapter 7  Get money left and divide it by number of non-secured non-priority: this has to be the plan  You can have a plan where there’s 0% repayment of unsecured non-priority 2. § 1325 (b)(1): Best Efforts/Disposable income: must devote all of your disposable income to the plan  Net income – reasonable expenses = disposable income  Allows for church donation  Creditors can object  If judge doesn’t confirm plan, you can amend it, convert to chapter 7, or judge can dismiss it. . You cannot have a plan that goes less than 36 months, even if you meet both plans . You can have one that lasts longer than 5 years, if debtor wants to: but creditors can’t force you to have it be longer—remember, debtor writes the plan . If you miss payments on plan, it will be dismissed or converted under § 1307 . Can modify rights of secured creditor (make car payments longer, but only as long as the plan), unless it’s a home mortgage . Must make full payment to priority claims under § 507 (§ 1322 (a)(2)) . Can modify plan at any time § 1329

D. Substantial Abuse  § 707 (b)  Can creditor bring it? NO  Must be brought by U.S. trustee or court  Tactic of choice if you think someone is manipulating bankruptcy or not in good faith

E. Discrimination  Can you discriminate against unsecured creditors? Pay one more than another? NO § 1322 (b)(1), refers to § 1122 (b & a)  1122 allows you to classify them separately, but can’t discriminate (can’t pay one down more than the others)  So, what wouldn’t be discrimination?? Maybe child support. . Chapter 20 7  Can file a chapter 7 and get a discharge  Then file a chapter 13 and target the non-dischargeable debt  This is allowed

F. Discharge  2 types in chapter 13 1. § 1328 (a): broader discharge; get it when you complete the payment plan . Exceptions: § 523 5,8,9 and criminal restitution; home mortgage 2. § 1328 (b): narrower discharge; can get this if you have: . Not completed payments under the plan . Due to circumstances beyond your control . Creditors received at least as much as they would have gotten in chapter 7 . Modification is not practical

 Even if not discharged, payments made under the plan are credited to your debt

G. Chapter 7 vs. Chapter 13

Advantages to Chapter 7 Advantages to Ch. 13 Faster discharge Broader discharge Easier Debtor gets to keep all non-exempt property and keep creditors @ bay with installment payments Get to keep all post-petition income Co-debtor stay of § 1301 No qualifications under § 109 for income& Better reputation debt No good faith requirement (except § 707) Know you did your best

IV. Involuntary Bankruptcy  Why would you want to put someone in bankruptcy? . Equality of distribution among similarly situated creditors; stop debtor from paying someone else instead of you . Invalidate unperfected security interests  Any debtor can be brought in involuntarily. § 303 . If more than 12 creditors, need 3 or more creditors to bring the action and claims must aggregate @ least $10,775 more than  If bona fide dispute, does not count as creditor  If over-secured, you count as a creditor but do not contribute anything to the dollar amount  If under-secured, difference between FMV and lien counts toward dollar amount  If unsecured, entire amount counts . If less than 12 creditors, only need 1 creditor to bring the action  Excludes employees and insiders  Do subsidiaries of corporations count as creditors? YES  Usually only unsecured creditors will file, secured never do

8  What must you prove in order to put someone in bankruptcy? 1. Correct number of creditors; and 2. Debtor generally not paying debts a. Relative number calculation; don’t need to look at actual numbers (8 bills due, 5 on time, 3 not) b. Relative amount calculation: 2 months ago, debtor late on 30,000 of 77  What if you bring a petition and are not successful? § 303 (i) 1. Counter suit, asking for all expenses (legal, accounting, and can also ask for punitive if bad faith)

 GAP period 1. Only exists in involuntary bankruptcy period 2. Lasts during period between date of filing and time of trial (order of relief) 3. Continues business up until the time of order of relief 4. Debtor can convert to a chapter 11 after order of relief for a fee ($600) 5. Stay is in place during GAP period 6. GAP creditors (arising post-petition) get 2nd priority (§ 502 (f)) 7. § 549 (b): generally, if debtor pays post-petition a pre-petition debt, that can be recovered by debtor or trustee and put back into estate. There’s an exception for GAP creditors if the creditor provided good or services post-petition equal to the payment.

V. Chapter 11  Creation of the estate  No trustee; DIP runs the estate  Are trustees permitted to run businesses in chapter 11? YES 1. § 1104: how do you get a trustee? 2. § 1106: what does trustee do?  Chapter 11 procedural forum for negotiating a workout with creditors: 1. Automatic stay prevents collection 2. Debtor may get a plan approved over the objection of a minority of creditors 3. Debtor’s turnover and avoiding powers greatly augment that which is available under state laws (can reach back and recover preferential transfers)  What distinguishes a chapter 11 stay from any other stay?  Creditor entitled to adequate protection: § 361  Lasts until plan is approved  Periodic cash payments to cover the reduction in value  Does debtor in a chapter 11 keep all of its property? YES  Restrictions: can only use assets in the ordinary course of its business  Cash collateral: lenders of cash collateral are protected under the code § 363 (can’t be used without permission of lender or approval of the court)  Set-off §553, exceptions  Obtaining Credit post-petition  § 364 (a): ordinary course of business (buy oil & paint for car dealership)  § 364 (b): not in ordinary course of business, allowable if administrative expense st  If debtor doesn’t pay lender has § 503/§ 507 (a): 1 priority  Creditors can also request cash in advance

9  § 364 (c): if debtor is unable to get credit just by offering an administrative expense priority, court may allow a “super duper priority” (above a § 507 (a))  § 507 (b): “super priority”-- get this if your adequate protection proves to be inadequate  This is why you don’t like to extend credit in chapter 11, there could be other people ahead of you  § 364 (c)(2): can get a lien on unencumbered property and have that be secured  § 364 (c)(3): can get a junior lien on encumbered property  § 364 (d)(1): priming a loan; can bump someone else down & get a 1st priority on someone else’s lien and then bump them down to 2nd if there’s adequate protection  Court doesn’t have to approve it, and creditor doesn’t have to lend money  Ranking of claims: 1. Secured claims: need perfection and attachment, rank by first in time to record or perfect, follow rules of recording 2. Administration expenses under chapter 7: post conversion administrative expenses (§ 726 (b))—ch. 7 trustee gets paid first if case is converted 3. § 364 (c)(1): “super-duper priority,” unsecured, secured already paid 4. § 507 (b): “super priority,” adequate protection proved to be inadequate 5. § 503 (b): embraces § 507 (a)(1): whole list also includes §364 (a & b) 6. Rest of § 507 (a) claims (a2-a8) 7. Pre-petition claims: non-secured non-priority claims

VI. Avoiding Powers 1. Strong arm statute: § 544  Gives the DIP and trustee hypothetical powers  Can undo pre-petition transactions  Looks back before the date of filing to ensure equality of distribution  Turns unperfected secured creditors into unsecured  § 544 (a)(1): personal property; subject to 10 day grace period that creditor has to perfect  § 544 (a)(3): real property 2. Preferences: § 547  Deals with just pre-petition  Don’t want to treat creditors unequally  Undoes transactions 90 days before filing  1 year before filing if an insider  Insider defined in § 101: individual=relatives, corporation=officer, directors, etc.  Elements of a preference § 547 (b) 1. Transfer of an interest of the debtor in property to or for the benefit of a creditor (can be a security interest) 2. For or on account of an antecedent (debt before payment) debt owed by the debtor before transfer was made 3. When debtor was insolvent (§ 547 (f): presumed to be insolvent on and during 90 days before filing) 4. Made within 90 days, or one year if an insider 5. Enable creditor to receive more than they would under a chapter seven 10  When check clears a bank, that’s when payment is made for purposes of seeing it it’s within 90 days  #5: look at hypothetical bankruptcy  #1: sugar example, definition of a claim includes dollar amount can be assigned to it  If transaction is debtor’s payment, not a preference if you’re fully secured b/c you’ll get all the money regardless since you’re secured “hypothetical bankruptcy)  § 547 (e): tells you the time of transfer, when it is made . (e)(1)(a): describes when a transfer is perfected . (e)(1)(b): time of transfer is time of physical custody change—no longer in hands of debtor, in hands of transferee, and lien-holder cannot get hands on it . (e)(2): hard part- depending on facts one of the following events will determine the time of transfer  E= extension of credit  A= Attachment of security interest a. Creditor gives credit b. Security agreement signed by debtor c. Debtor has rights in the collateral  P= Perfection  C= Commencement of bankruptcy case 1. (e)(2)(a): If P occurs within 10 days of A, then P=A because P will relate back to date of attachment (so, P=A=T) 2. (e)(2)(b): If P is more than 10 days after A, then T=P 3. (e)(2)(c): If there is no P by the later of C or 10 days after A, then time T=C  Also, if P is first than T=P Questions to Ask:

1. Is the transfer a transfer of a security interest?  If yes, go to #2  If no, T= time of physical transfer and go to #3 2. When is the transfer?  Place your variables – EAPC  Decide which part of (e)(2) it’s under 3. Given the time of transfer, is E before T? And, is T within 90 days?  If answer to both questions is no, STOP= no preference  If yes, got to #4 4. Are all of the other elements of § 547 (b) met?  If yes = preference  If no = no preference

VII. Defenses to Preferences § 547 (c)  Designed to make you pay back stuff that deleted the estate that was not fair to other creditors, so, the defenses say that you replenished the estate for whatever you took; (c)(4) says you get credit for what you actually do replenish if delivering goods, etc. 1. Contemporaneous exchange defense: 2 elements a. Transaction was intended to be contemporaneous, and b. It was in fact contemporaneous 11 i. Also, you’re putting into the estate what you’re taking out ii. Not taking anything anyway 2. Ordinary Course of business: 3 prongs a. Debt incurred in ordinary course of the debtor’s business b. The transfer be made in the ordinary course of the business or the financial affairs of the debtor and the transferee (creditor)  Doesn’t measure if you’re in terms of contract, but are you in ordinary course between debtor and transferee  Have to look at the particular facts of the case  Look at whether transactions between them are consistent— compare transaction in preference period with those well before it c. Transfer must be made according to ordinary business terms  Industry wide standard, terms of industry