Bankruptcy Outline Baird Spring 2002

Bankruptcy Outline Baird Spring 2002

I. Introduction / Background

Generally

·  Few people file for B: lower-middle class mainly

·  Rising use of revolving credit arrangements (credit cards) since 1985

·  Most debt discharged in B wouldn’t be repaid anyway

·  B code is currently being reviewed and is subject to change

o  Most changes will focus on individual B

·  Economic distress: can’t compete in marketplace b/c of inferior product, e.g.

o  Exists regardless of firm’s capital structure

·  Financial distress: cannot generate sufficient revenue to repay its debts

Goals of Bankruptcy Law

·  Provides collective creditors’ remedy

o  Prevents race to courthouse for assets (waste $ on legal fees, recovery)

o  Solves collective action problem (justification for automatic stay)

·  Gives individuals a fresh start

·  Allows viable enterprises to continue notwithstanding financial condition (it’s a good thing to preserve the enterprise even though it can’t pay its debts)

II. The Automatic Stay

Creditor Actions and the Automatic Stay

·  Purposes

·  If you are creditor, must stop what you’re doing: can’t sue debtor, collect debt, repossess property

·  To the extent that you are trying to get property of estate or in debtor’s possession, you also must stop what you are doing

·  §362

·  Begins automatically w/ B petition: no need for court order

·  All efforts by creditors to obtain debt repayments must stop, regardless of whether petition was voluntary or involuntary

·  Parties can ask for stay to be lifted

o  Easier to do when debtor ahs smaller property interest in property

·  Debtors can ask for stay to be issued under general equitable powers of court under §105(a)

·  Limits

o  Does not apply to actions a/g third parties or property of third parties

o  Creditors may pursue guarantors (letters of credit) or codefendants of debtor

(1)  Can’t invoke legal remedies if you are a pre-petition creditor

(2)  Similar

(4): Applies to property of state

(5): If you have pre-petition claim, can’t go after property of debtor

u  For individuals, property of debtor includes post-petition earnings

·  Official Bondholders Committee (Ichan) v. Chase Manhattan Bank (DE, 1997, p. 92):

·  Marvel (Debtor) borrowed $ from Chase and gave Chase security interests in all Marvel assets; Marvel Holding (Marvel’s parent) owned all shares of Marvel; Parent (owned by Perelman) issued bonds and gave Marvel stock as collateral; largest bondholder was Carl Icahn

  When Marvel files, Icahn becomes sole shareholder of Marvel; he is not a creditor of Marvel

  Icahn seeks to exercise his power and remove BOD of Marvel (and get rid of Perelman)

  Chase claims that regardless of whether Icahn is creditor, he is trying to exercise control over Marvel (and its assets); thus, §362(a)(3) should be triggered

  Holding

  Someone has to appoint BOD; should be shareholders (Icahn)

  Icahn (shareholder) is not stopped by automatic stay b/c he is not a creditor

  Cases cited by Marvel both invoked auto stay to prevent creditors gaining control of debtor’s estate by exercising corporate governance rights

  However, Icahn did not acquire shareholder rights in Marvel as its creditor, but rather as creditor of Marvel Holding Co.

  Ability of shareholders to have meeting (and oust BOD) is not encompassed by automatic stay

  Comparing Marvel to RR

  IP, like RR, has high fixed costs and low marginal costs

  Baird: fixed costs aren’t that high anymore (computers): not clear all these assets need to be kept together

Scope of the Automatic Stay

·  In Re Cahokia Downs (IL, 1980, p. 101)

·  Cahokia Downs (Debtor); SportService (Creditor); Holland America (Debtor’s insurer); Logger (Insurance agent); Holland wants to cancel automatic stay and void Debtor’s insurance after debtor files Ch. 11

  Court disregards clause in insurance policy permitting cancellation for any reason at all

Ø  Not an ipso facto clause, which kicks in when party files for B

  Court will not let B filing serve as wake-up call

Ø  OK to cancel if it can show that it would have done so otherwise (e.g., higher arson risk)

  Don’t want to discourage people from filing for B

Ø  Don’t want to let Holland benefit from info it received only b/c of B filing

  Baird: tough to squeeze Holland into 363(l)

  RR analogy

Ø  Like RR

Ø  Relatively specialized asset (Racetrack)

Ø  Highest and best use is as racetrack

Ø  Unlike RR

Ø  Not obvious we have collective action problem

Ø  Races aren’t happening anymore

Ø  Winners and losers here

·  Ipso Facto Clauses: Why B does not allow them

  Ipso facto clauses are not respected in B (§363(l))

Ø  §§541(c) and 365(c) both have similar provisions

Ø  §362a3: can’t exercise control of property/debtor even if you have termination right

o  Line drawing problems

  Baird: don’t want person to benefit from happenstance of B

Ø  Ex: Martha Stewart and Kmart: Once Martha became popular and wanted to renegotiate better deal with K once it filed for B

  Counter: Freedom of K

Ø  Counter to this: Managers who negotiated deal won’t be around during and a/f B

·  CBOT v. Johnson

  Owner of seat on CBOT filed for B; per seat agreement, seat could not be sold until all other members of exchange who were owed $ by debtor were repaid

  Holding: Trustee gets property and can sell it; however, property (seat) is still subject to non-B limitations

·  Butner Principle: Debtor’s property rights aren’t expanded due to happenstance of B

  If debtor has right to run Plum Café for one year lease, he can file for bankruptcy; however, once his lease expires, he cannot insist it be renewed

·  In re MJ&K (SDNY, 1993, p. 103)

·  Brooklyn Law School entered K w/ Debtor for debtor to sell books at BLS; right to terminate for any reason; Debtor was unable to meet orders in timely manner

  363(a) requires Dean of Law School to go to court to terminate K a/f D has filed

  Holding: OK for BLS to terminate K

Ø  Law school has very impt. interest (need books to teach)

Ø  Dean learned a/b problems of bookstore independently of bankruptcy filing

Ø  Dean would have dumped bookstore independent of filing

o  Part of school’s strategic vision to use short-term leases

  Can’t use info obtained in B filing to change your decision

Ø  Like Cahokia Downs

  General

Ø  This debtor is typical Ch. 11: small mom and pop store, usually service firms w/ high mark-up

Exceptions to the Automatic Stay

·  Generally

·  Auto stay is only a presumption: can be lifted

·  §362(B)

·  Criminal prosecution: B laws are not trying to prevent prosecution of a crime

·  B10: Lease of non-residential RE

o  Baird: bad provision b/c expresio unius

§  However, he feels as if it is actually just redundant, like other code provisions

·  Congress just wanted to be doubly clear

§  Should include more than non-residential real property; however, special interests group only want this much (no general land-owning lobbyists)

·  B4: stay does not apply to G agency trying to enforce its regulatory powers

o  Possible explanation: Clause is no different than §b10; the only thing it’s doing is saying that you get no special breaks vis-à-vis G regulations; as long as things were valid outside, they should be valuable inside

§  If there are G regulations that don’t make sense, we will honor them anyway

o  One extreme: 2nd Cir (In Re FCC)

o  Other extreme: Auto stay does not affect post-petition life of debtor

·  In Re FCC (2nd Cir. 2000, p. 113)

·  Next Wave was high bidder at auction for PCS licenses; G had program in place to assist small businesses: so long as Next Wave could make 10% down payment, FCC would accept bonds for the remainder ; Subsequent auction revealed that Next Wave overpaid grossly; NextWave filed for bankruptcy; FCC sought to revoke licenses when NW didn’t comply (since, value of license has skyrocketed)

  Issue: Did FCC have right to revoke licenses for non-compliance? Icahn seeks to exercise his power and remove BOD of Marvel (and get rid of Perelman)

u  Holding: FCC is entitled to limit the use of the license; anything will bind Next Wave, irrespective of bankruptcy

o  Restrictions posed outside of bankruptcy can be imposed w/in bankruptcy

o  FCC claims that it is merely exercising its regulatory power

u  Baird: if you buy this argument, then there is nothing that G entity can do that is picked up by automatic stay

o  Here, there was an auction; only thing FCC had was promissory note: they were only trying to get paid; no exercise of regulatory power

o  FCC was only taking actions it did in the case b/c it had not been paid

§  If this is not stopped by automatic stay, then nothing G does will be stopped

§  Always ask: if G agency were not owed any money, would it act any differently

§  Here, acting as a creditor, not a regulatory agency

·  US v. Nicolet (2nd Cir. 1988, p. 116)

·  EPA sought reimbursement of clean-up costs for asbestos site; D later filed Ch. 11; G argued its claim was exempt from auto stay under §362(b)(4) as enforcement of regulatory power; G acknowledged that it could not collect but wanted trial to fix damages; D wants debt/reimbursement treated as if G were normal creditor; EPA argues for judicial economy

  G argues that it can litigate in non-B court even though it is a pre-petition obligation b/c it is exercising its police and regulatory power

Ø  I.e., police and regulatory power mentioned in 262b4 includes right of regulator to vindicate its powers once in bankruptcy

Ø  I.e., Wants to litigate in same way as if bankruptcy petition had never been filed

  Holding: G cannot collect judgment but can obtain entry of judgment consistent w/ auto stay

Ø  Action was not private tort suit, rather G using regulatory powers

  Accepted logic: Nicolet is rightly decided and FCC is incorrectly decided

  Side note: liability attaches merely b/c of status (Nicolet was liable even though it acquired polluter a/f polluting had already occurred

III. Claims and Property of the Estate

When a Claim arises

·  §502

·  Disallows certain types of obligations even though they qualify as “claims” under §101(5)

·  Claim is necessary but not sufficient for collection from debtor in B

·  Qualifying as a “claim”

o  Upside: can participate in B proceeding

o  Downside: claims are discharged in B

§  If indiv. or corp. reorganizes under Ch. 11, holder of a claim can no longer look to the debtor for repayment

·  Not having a claim

o  No participation in B proceeding but claim exists a/f B

·  Kovacs v. Ohio (US, 1985, p. 126): D pollutes; admits liability and agrees to clean up mess and pay G $75K; G cleans up mess; seeks reimbursement; argues that this is not a claim under §105

  If this is a claim, it will get discharged; thus G argues it’s not a claim

  Holding

o  This is a claim

o  State was seeking payment of money

o  Claim is defined broadly so as to give debtor “fresh start” a/f B

  Individuals v. Corp.

o  Corps. in Ch. 7: no discharge: future income doesn’t matter

§  No downside to having a claim; but strong upside b/c only claimants can share in proceeds of asset sales

o  Ch. 11: ex. corp. owns toxic waste dump and reorganizes thru Ch. 11

o  Might try to argue that you didn’t have a claim; however, environmental claims usually attach by virtue of debtor filing for B

§  Toxic waste dump is part of estate; liability attaches by virtue of having had it (they own the property)

§  Baird: people don’t want toxic waste dumps, regardless of whether EPA has signed off on prior liabilities

o  Baird

o  If pollution were willful and malicious, then no discharge in B

o  If D were individualize, lawmakers could criminalize the activity

o  If D were corp.,

§  Could try to pierce the corp. veil: tough to do

§  Legislature could give this type claim priority

·  Consistent w/ Butner principle: take non-bankruptcy rights as we find them so long as state legislature establishes this priority outside of bankruptcy

§  Problem w/ this: will hurt corps. dealing w/ environmental issues b/c banks will be less willing to extend credit to them w/o priority of repayment

·  Epstein (11th Cir., 1995, p. 131): Piper builds planes; product liability suits in the past; Epstein tries to get payment for future claims of people injured by D by predicting number of injuries; argues that these people, in absence of B petition; would have future claims a/g D

  Three tests

Ø  Conduct test (what Epstein wants): right to payment arises when conduct giving rise to liability occurred (here, manufacture of planes)

Ø  Pre-petition relation test (dist. court): requires some pre-petition relationship b/t debtor’s pre-petition conduct and claimant in order for person to have a claim

Ø  Piper Test (what court adopts): indiv. has claim under §105 if a) event occurring b/f confirmation create a relationship b/t claimant and debtor’s product; and b) the basis for liability is debtor’s pre-petition conduct in designing, manufacturing the defective product

o  In this case, Ps do not satisfy Piper test b/c there is no pre-confirmation exposure to specific, identifiable defective product or any other relationship b/g D and class of future claimants

  Baird

Ø  If court adopted Epstein’s position, person who didn’t file claim b/f killed in crash would be left out in the cold; unsecured creditor would get bigger piece of pie

Ø  Case is backward in that people you would think wouldn’t want a claim (future tort victims) are saying that they have one

Ø  Epstein: let Piper go forward w/o pre-petition obligations; Tort victims will be better off putting $ aside now and paying $.50 on dollar than if the general firm is liquidated in future