Problem 7.1. Assignment 7: Secured Creditors in Bankruptcy. Interest on Unsecured Claims

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1 Assignment 7: Secured Creditors in Bankruptcy Reference: Understanding Secured Transactions, 16.01, 16.02, Argossy owes CompuSoft $30,000 Work done: Feb. 15 Work billed: March 15 Petition date: Sept. 15 Today: Dec. 15 Contract interest rate: 18% ($450/month) Attorney fees incurred prior to bankruptcy: $400 Amount of CompuSoft s claim? Problem 7.1 Permissible elements of claim Liability for services provided = $30,000 Pre-petition interest = 18% = $2,700 Impermissible elements of claim Post-petition interest [ 502(b)(2)] Unclear elements of claim Pre-bankruptcy attorney fees ($400), but only if Argossy is liable for them under its contract with CompuSoft Thus, permissible claim is either: $32,700 (if K doesn t obligate Argossy for atty fees), or $33,100 (if K does obligate Argossy for atty fees) Interest on Unsecured Claims Why disallow post-petition interest on unsecured claims? [ 502(b)(2)] In liquidation, distribution is a zero-sum game Allowing unsecured creditors to accrue interest would just diminish dividend rate by increasing total claims Note, however: interest would still accrue on the debt under state law! [distinguish a debt and a claim] If case is dismissed (or discharge denied), creditor can recover interest that accrued on debt during bankruptcy 1

2 Payment of Claims As unsecured creditor, CompuSoft will be paid on its claim pro rata along with other unsecured creditors (after all priority creditors are paid) Problem 7.2: $59,575 available to unsecured creditors; $1,191,500 unsecured claims = dividend of 5% CompuSoft will get paid 5% of its total claim Balance of claim will be discharged (and written off, unless CompuSoft has a guarantor) Speedo Printing files Ch. 11 Speedo owes Commercial Investors (CI) $340,000 on petition date, plus 6 months of unpaid interest (prior to 12% Loan is secured by equipment (FMV = $400K) For what amount should CI file a proof of claim? Problem 7.3 In Problem 7.3, CI is an oversecured creditor (i.e., collateral s value >> amount of claim) Oversecured creditor can include any unpaid prepetition interest as part of its claim, and is also entitled to pendency interest (i.e., post-petition interest from petition date until discharge is granted or plan is confirmed) [ 506(b)] Contrast: unsecured creditors are not entitled to pendency interest [ 502(b)(2)] Right to accrue post-petition interest from equity cushion protects oversecured creditors from impact of delay caused by imposition of automatic stay Problem 7.3(a): CI s Claim Principal = $340,000 Accrued but unpaid interest pre-petition = $20,400 Total claim = $360,400 Because claim is oversecured, 506(b) entitles CI to receive pendency interest on its claim At 12%, this is $3,604 per month Debtor must either pay this amount to CI each month during pendency (i.e., until plan is confirmed), or CI gets to add that amount to the claim each month 2

3 Secured Claims and Chapter 11 A Chapter 11 debtor begins repaying its creditors once its plan has been confirmed Plan creates new payment terms for each creditor, replacing terms that existed pre-bankruptcy To confirm the plan over creditor objections, the plan must be fair and equitable [ 1129(b)(1)] For a secured claim, this means the plan must make total payments to the secured creditor = present value of creditor s secured claim [ 1129(b)(2)] Suppose Speedo s plan is confirmed after 3 months in bankruptcy, and Speedo didn t pay post-petition interest in cash during pendency At plan confirmation, CI s claim = $360,400 (secured claim at petition date) + $10,812 (3 months pendency interest at 12%) = $371,212 Under plan, Speedo must pay CI either: (1) a lump sum of $371,212 (or other property worth that amount) on the effective date of the plan, or (2) payments in installments, over time, that have a present value of $371,212 (i.e., $371,212 + interest) Problem 7.3(c): What if it takes Speedo 1 year to get its plan and get it confirmed by the court? Unpaid post-petition interest will be added to CI s claim until total claim reaches $400,000 (the value of the collateral) At that point, CI is no longer be oversecured At that point, CI won t be entitled to pendency interest any longer under 506(b) Speedo s secured claim thus maxes out at $400,000 Speedo Printing files Ch. 11 On petition date, Speedo owes CI $360,400 (including 6 mos. accrued but unpaid 12%) Loan secured by equipment (FMV = $325,000) For what amount should CI file a proof of claim? Problem 7.4 3

4 Problem 7.4: Which Is Correct? A. CI has a secured claim for $360,400, which will accrue postpetition (PP) interest B. CI has a secured claim for $325,000 (which accrues PP interest) and an unsecured claim for $35,400 (which doesn t) C. CI has a secured claim for $325,000 and an unsecured claim for $35,400; neither will accrue PP interest CI has a secured claim fo... 0% 0% 0% CI has a secured claim for... CI has a secured claim for... Bifurcation of Claims CI is an undersecured creditor (amount of the debt >>> value of the collateral) 506(a) bifurcates undersecured claims (i.e., it treats 1 claim as 2, for purposes of bankruptcy) Claim is secured, up to value of the collateral Rest of the total claim is unsecured claim Unsecured claim is only paid, pro rata, with claims of other unsecured creditors Problem 7.4 CI s total claim = $360,400 This total claim is deemed to be 2 claims: Secured claim = $325,000 (value of collateral) Because CI is not oversecured, no pendency interest accrues on this claim [ 506(b)] Unsecured claim = $35,400 No interest accrues on this claim [ 502(b)(2)] Problem 7.4(b): If Speedo s Plan Is Confirmed, What Is CI s Treatment? Secured claim: CI will get either (a) $325,000 lump sum in cash, or (more likely) (b) installment payments totaling $325,000 + interest [ 1129(b)(2)] Unsecured claim = percentage dividend (total assets/total unsecured claims) X $35,400 (this will be paid, typically, in a lump sum or in installments, but without interest) 4

5 Bankruptcy Distribution Problem 7.4(c) Does it matter to CI whether Speedo s plan is confirmed 3 months after petition date, or 1 year after petition date? Yes! The sooner, the better Because CI is undersecured, CI is not entitled to any pendency interest on its claim Thus, the longer Speedo takes to confirm its plan, the greater is CI s lost opportunity cost (we could ve loaned to someone who COULD pay!) Undersecured Claims and Interest Payments: Prior to effective date (during pendency of bankruptcy), Debtor pays no interest on secured portion of claim Petition Date Effective Date of Plan of Reorganization Debtor must pay interest on secured claim under plan (if not paid in full on effective date) [BC 1129(b)(2)(A)] Oversecured Claims and Interest Payments: Prior to effective date (during pendency of bankruptcy), Debtor must pay interest on oversecured claim [ 506(b)] Petition Date Effective Date of Plan of Reorganization Debtor must pay interest on secured claim under plan (if not paid in full on effective date) [BC 1129(b)(2)(A)] Assume you are a Chapter 7 trustee for Smith. On petition date, Smith owed Bank $10,000, secured by a SI in Smith s car. FMV of the car is only $4,000. What should trustee do? A. Abandon the car and let Smith and Bank fight it out B. Sell the car along with the other property of the bankruptcy estate Abandon the car and let... 0% Sell the car along with th... 0% Trustee may abandon property of the estate if it is burdensome to the estate or if the equity in the property is of inconsequential value to the estate [ 554(a)] Rationale: don t want to waste limited assets; trustee doesn t want to incur costs of preserving and selling collateral where there s nothing in it for the estate Abandonment re-vests title back into the debtor If trustee doesn t abandon voluntarily, court can order trustee to do so [ 554(b)] 5

6 Problem 7.6 You are Ch. 7 bankruptcy trustee for Perez On petition date, Perez owned home, subject to $850,000 mortgage debt Interest rate on mortgage = 10% Broker has offered to sell home for 6% commission (+ $10,000 in sale expenses) Broker: house worth $1MM, but market is slow Broker wants a 1-year listing agreement. Should you agree? What Should Trustee Do? A. Abandon the house now B. Don t abandon the house; sell it, however long it takes C. Try to sell the house for about 6 months, then abandon it, if it is still unsold Abandon the house now 33% 33% 33% Don t abandon the house... Try to sell the house for... If FMV = $1,000,000, First Capital is oversecured If house can be sold for $1,000,000 six months from now, that sale would produce total net surplus proceeds of $37,500 Principal = $850,000 6 months additional interest = $42,500 Expected broker fee, expenses of sale = $70,000 Total debt/costs of sale = $962,500 If sale takes >> 6 months, additional interest will consume most/all of remaining equity; thus, trustee probably won t list w/broker for longer than six month period 6