Bankruptcy. Assignment 6: Bankruptcy and the Automatic Stay. Chapter 7 (Liquidation) Chapter 11 Reorganization
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- Letitia Burke
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1 Assignment 6: Bankruptcy and the Automatic Stay Reference: Understanding Secured Transactions, 16.01, 16.02, Federal law affects state debtor-creditor law (e.g., Art. 9) when debtor files for bankruptcy Bankruptcy is, in some sense, akin to financial death All of debtor s nonexempt prebankruptcy assets go into the bankruptcy estate [BC 541] to be administered for benefit of creditors Bankruptcy Chapter 7 (Liquidation) Effects a property for discharge trade Debtor surrenders all of its pre-bankruptcy assets to trustee (except for exempt property) Trustee sells all these assets and distributes the proceeds to pay creditors Court discharges all pre-bankruptcy debts (except any that are nondischargeable or that the debtor reaffirms) Chapter 11 Reorganization Debtor remains in possession of pre-bankruptcy assets during case Debtor proposes a plan to repay creditor claims Creditors vote on plan (each class has a veto) Court can confirm despite veto ( cramdown ) if plan is fair and equitable Confirmed plan binds all creditors (prebankruptcy debt terms replaced by plan terms) 1
2 Chapter 13 (Wage-Earner) Reorganization Debtor keeps all pre-bankruptcy assets Debtor proposes plan to repay creditors some portion of debts over 3-5 year period Debtor must apply all of its post-bankruptcy disposable income toward plan payments No voting; court confirms plan if it meets statutory requirements If debtor performs plan, remaining unpaid portion of debt is discharged Client is CompuSoft (software company) 12 of their customers are in bankruptcy Bills being issued each month to these customers aren t being paid Client wants to know what efforts it can make to collect these debts Problem 6.1 Problem 6.1: The Client A. Should call each customer s CFO and politely ask when payment will be received B. Should call each customer s CFO and say pay for the software or return it immediately C. Won t have violated the stay if it doesn t make further contact with its customers D. Has already violated the stay Should call each custome... 0% 0% 0% 0% Should call each customer.. Won t have violated the... Has already violated the USC 362(a): petition is a stay (injunction) against: (1) any suit to enforce pre-petition claim vs. debtor (2) any act to enforce pre-petition judgment against debtor (3) repossession of estate property (4), (5) any act to perfect or enforce a lien vs. property of the estate or the debtor (6) any other action to collect prepetition claim Automatic Stay 2
3 Problem 6.1 CompuSoft legally can do nothing but file a proof of claim with the bankruptcy court [ 501(a)] If it files proof of claim, CompuSoft will hold an unsecured claim [ 502(a)], unless debtor or trustee establishes a defense to the claim [ 502(b)] Any other collection effort (even computergenerated monthly bills!) violates the stay Note: A willful violation of the automatic stay can result in imposition of punitive damages! [ 362(k)] Automatic Stay: Objectives Breathing space for reorganizing debtor Debtor can focus on getting back on its feet, rather than defending creditor collection efforts Resolution/payment of claims occurs on a collective basis, supervised by court This treats similar types of creditors similarly This avoids distress sale disposition of debtor s assets at low prices (calls off the state law race to the courthouse ) Problem 6.1: Suppose that one of the 12 customers places an order for new software (for cash payment). Can CompuSoft refuse to honor the order unless it receives payment for past due orders? A. Yes, that wouldn t violate the stay. B. No, that would violate the stay. Yes, that wouldn t violat... 0% No, that would violate th... 0% Likely result: refusal to sell to bankrupt customer would not violate automatic stay Stay is directed at actions to enforce prebankruptcy claims CompuSoft can refuse to sell new software licenses to debtor if it remains unpaid (Bankruptcy Code doesn t obligate CompuSoft to enter new contracts with debtor) Note: if CompuSoft was obligated to provide service on existing licenses, its refusal to provide service would be a breach of contract, and subject CompuSoft to liability 3
4 Bankruptcy and Secured Parties Bankruptcy generally respects state law property rights (like a mortgage or an Article 9 security interest) Thus, liens generally survive (remain valid in) bankruptcy, giving a secured creditor priority over other creditors vis-à-vis the collateral What impact(s) does bankruptcy have on secured parties? Problem 6.2: Client (Bank) gets replevin order. When Sheriff serves it, debtor says: I just filed for bankruptcy, but doesn t have copy of bankruptcy petition. Sheriff goes ahead and seizes the collateral. Which statement is correct? A. The seizure was lawful; the stay doesn t apply to the sheriff B. The seizure was lawful, b/c the Debtor didn t have proof of the petition filing C. The seizure was unlawful The seizure was lawful; th... 0% 0% 0% The seizure was lawful, b.. The seizure was unlawful Sheriff s repossession is a violation of the stay Stay applicable to all entities, including the Sheriff [ 101, 362(a)] Police power exception [ 362(b)(4)] does not let sheriff repossess collateral (it only permits enforcement of public regulations, like zoning) Acts taken in violation of stay have no legal effect Sheriff must turn over the collateral, which is property of the estate [ 542] Problem 6.3 PrimeCuts (restaurant chain) owes BankWest $250K PrimeCuts files Ch. 11 Collateral: all assets of one PrimeCuts restaurant (which is now closed); FMV of those assets <<= $250K Can BankWest go ahead and foreclose? Value $250K or less $250K Lien Collateral 4
5 Secured Creditors and the Stay Secured creditor is subject to stay like any creditor Repossession stayed by petition [ 362(a)(3)] Foreclosure sale stayed by petition [ 362(a)(4), (5)] But, staying BankWest from foreclosing here seems not to make much sense, b/c: FMV of collateral <<< debt (there s no value, or equity, in the collateral for other creditors) Debtor may not need the collateral (restaurant closed) Relief from the Automatic Stay Upon motion, secured party can seek relief from stay; if granted by court, secured party can pursue state law remedies (e.g., Article 9 foreclosure sale) Standards for relief (1) For cause, including lack of adequate protection of security interest [ 362(d)(1)] (2) Debtor lacks equity in the collateral, and the collateral is not necessary for an effective reorganization of debtor [ 362(d)(2)] Relief from Stay: Procedure After motion for relief is filed, stay remains in place for 30 days (60 days for individual debtors) [ 362(e)(1), (2)] After that period, stay is lifted unless court, after notice/hearing, orders it to be continued Secured party has burden of proof re: debtor s lack of equity in collateral [ 362(g)(1)] Debtor has burden re: necessity of collateral for effective reorganization [ 362(g)(2)] If BankWest moves for relief from stay under 362(d)(2), will it be granted? No equity in the collateral Is collateral necessary for effective reorganization of PrimeCuts? Con: restaurant already closed, debtor doesn t need it Pro: debtor may have plans to use it in new/different locations (cheaper than new equipment) Problem 6.3 5
6 If BankWest moves for relief from stay under 362(d)(1) (for cause ), will that motion be granted? Question: Does BankWest lack adequate protection of its interest in the collateral by virtue of the stay (and BankWest not being allowed to foreclose)? If so, BankWest is entitled to be adequately protected Problem 6.3 Adequate Protection Concern: debtor can use property of estate during bankruptcy [ 363(c)], but debtor s use may cause the value of that property to depreciate If this happens to the collateral, and debtor later still can t repay the debt, the secured party is made worse off due to the delay in exercising its remedies Adequate protection means preserving the secured party s overall secured position during pendency of bankruptcy case In Problem 6.3, suppose PrimeCuts planned to use the restaurant equipment in another restaurant Further, suppose this use will cause the equipment to depreciate by $3,000 per month If PrimeCuts pays BankWest $3,000/mo. during bankruptcy, BankWest s SI is adequately protected (motion for relief denied) Alternatively, PrimeCuts could provide adequate protection by granting a replacement lien on other unencumbered assets [ 361(2)] If PrimeCuts doesn t provide adequate protection, court must lift the stay and let BankWest foreclose Sprouts Up owes BankWest $210,000, secured by a mortgage on corporate headquarters (assume no other liens on the building) Sprouts Up has missed its last 4 mortgage payments FMV of HQ = $600,000 Sprouts Up has filed Chapter 11 petition. BankWest wants advice as to relief from stay Value $600K Problem 6.4 $210K Lien 6
7 Problem 6.4. If BankWest moves to lift the automatic stay to be allowed to foreclose on the HQ of Sprouts Up, the court should A. Grant the motion B. Deny the motion under 362(d)(1) ( cause ) C. Deny the motion under 362(d)(2) (equity/necessity of collateral for effective reorganization) D. Both B and C Grant the motion 0% 0% 0% 0% Deny the motion under... Deny the motion under... Both B and C Relief from stay under 362(d)(2) denied Debtor has significant equity ($390,000) in HQ, which should be administered for benefit of debtor s reorganization and for benefit of unsecured creditors (who have claim vs. that equity) Corporate HQ necessary to effective reorganization Relief from stay under 362(d)(1) denied No evidence presented that collateral is depreciating Even if it were, BankWest is adequately protected by $390,000 equity cushion Problem 6.5 Paradise Boat Leasing owns yacht BankWest has SI in the yacht Debt = $350,000 FMV of yacht = $700,000 Paradise has filed Ch. 11 petition Just prior to petition, Paradise allowed insurance coverage on the yacht to lapse Problem 6.5. If BankWest moves for relief from stay to foreclose on the yacht, the court should A. Grant the motion (there s cause ) B. Grant the motion for cause, unless the Debtor has gotten new insurance for the yacht C. Deny the motion under 362(d)(2) (Debtor has equity in the yacht and needs the yacht to reorganize) Grant the motion (there s... 0% 0% 0% Grant the motion for cau... Deny the motion under... 7
8 Problem 6.5 BankWest can provide alternative insurance coverage (forced placement) and tack the cost onto the debt without violating the stay Security agreement authorizes them to do so Not an act to control property of the estate BankWest can also move to lift stay (In re Paradise Boat Leasing, 2 B.R. 482) Cancellation of insurance is cause Equity cushion is no longer adequate protection (because it could disappear with one big wave) Problem 6.6(b) Your client is Hill Farms (HFI), which filed a Chapter 11 petition 3 months ago You get a call from the attorney for Macklin, a creditor that your client owes $50,000 Macklin has a security interest in HFI s equipment Value of equipment on petition date = $50,000 Value today = $40,000 Macklin is threatening to seek relief from stay Problem 6.6. What amount should HFI have to pay to adequately protect Macklin (and thus to keep the stay in place)? A. $10,000 (for depreciation that has already occurred since petition date) + enough to cover any depreciation for the rest of the bankruptcy B. Only enough to cover any depreciation for the rest of the bankruptcy, but not the $10,000 that already occurred $10,000 (for depreciatio... 0% Only enough to cover a.. 0% Certainly, HFI must compensate for any depreciation that occurs AFTER Macklin moved for relief from stay But, it is not clear that the Bankruptcy Code requires HFI to compensate Macklin for depreciation that occurred BEFORE Macklin moved for relief from stay Most courts: debtor need not provide adequate protection for secured party s interest unless and until secured party asks for it In re Craddock-Terry (see p. 106) takes opposing view. Which view makes more sense? 8
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