©2001 West Legal Studies in Business. All Rights Reserved. 1 Chapter 16: Creditor-Debtor Relations and Bankruptcy

©2001 West Legal Studies in Business. All Rights Reserved. 2 §1: Laws Assisting Creditors Liens: –Consensual; –Statutory; or –Judicial. Other Remedies: composition agreements, ABC’s. Suretyship.

©2001 West Legal Studies in Business. All Rights Reserved. 3 Liens [1] Consensual Liens. –Personal property as collateral (UCC Art. 9 UCC Secured Transactions). –Real property as collateral (Mortgage). Statutory Liens. –Mechanic’s Lien: Nonpossessory filed lien on real estate for labor/services. –Artisans’ Lien: Possessory lien on personal property for labor done to property. –Innkeeper’s Lien: Possessory lien on baggage for unpaid hotel charges.

©2001 West Legal Studies in Business. All Rights Reserved. 4 Liens [2] Judicial Liens: Court-ordered seizure/sale of property. Judicial Liens: Attachments, Writs of Execution, Garnishment: –Case 16.1: U.S. v Smith (1995).U.S. v Smith

©2001 West Legal Studies in Business. All Rights Reserved. 5 Mortgage Foreclosure [1] Mortgagor (Debtor-Borrower). Mortgagee (Creditor-Lender). Foreclosure: Mortgagor defaults; Mortgagee petitions court to have sheriff seize, advertise, and sell property. –Money goes to expenses of sale, creditors in descending order of priority, then debtor if any left.

©2001 West Legal Studies in Business. All Rights Reserved. 6 Mortgage Foreclosure [2] If there is still money owed to creditor after foreclosure there is a deficiency, and the debtor is still liable for this. Equity of Redemption: Mortgagor can “redeem”: the property by paying full amount plus any penalties and taxes.

©2001 West Legal Studies in Business. All Rights Reserved. 7 §2: Suretyship and Guaranty When a 3 rd party promises to pay a debt owed by a Debtor who doesn’t pay, either a suretyship or guaranty is created. Principal Debtor Creditor Surety / Guarantor

©2001 West Legal Studies in Business. All Rights Reserved. 8 SuretyshipSuretyship Express contract between the surety and the creditor. Creditor can demand payment from surety at any time after debt is due. Creditor need not exhaust all legal remedies against the debtor before holding the surety responsible.

©2001 West Legal Studies in Business. All Rights Reserved. 9 GuarantyGuaranty Secondarily liable, debtor must default, creditor has attempted to collect from the debtor. Statute of Frauds requires guaranty to be in writing. –Case 16.2: Wilson Court Limited Partnership v. Tony Maroni’s (1998).

©2001 West Legal Studies in Business. All Rights Reserved. 10 Defenses of the Surety & Guarantor [1] Surety can use any of the Debtor’s defenses EXCEPT incapacity, bankruptcy, or statute of limitations. Surety can use his own defenses, EXCEPT fraud between Debtor and Surety that is unknown by creditor.

©2001 West Legal Studies in Business. All Rights Reserved. 11 Defenses of the Surety & Guarantor [2] Material contract modification between Debtor and Creditor will release a gratuitous surety and a compensated surety to the extent he suffers a loss. Surrender or impairment of the Debtor’s collateral releases surety to the extent he is damaged. Release of a co-surety releases surety to the extent he is damaged.

©2001 West Legal Studies in Business. All Rights Reserved. 12 Rights of the Surety & Guarantor Right of Subrogation. Right of Reimbursement. Right of Contribution from Co-sureties: –Sureties in equal amounts. –Sureties in equal amounts, one or more co- sureties missing or insolvent.

©2001 West Legal Studies in Business. All Rights Reserved. 13 §3: Protection for Debtors Exemptions (Federal and State): –Homestead; and. –Personal property Holder in Due Course does not work against consumers. Consumer Credit Protection Act. Truth-in-Lending Act.

©2001 West Legal Studies in Business. All Rights Reserved. 14 §4: Bankruptcy and Reorganization Article I, Section 8 of the U.S. Constitution. Federal jurisdiction. Bankruptcy Reform Act of 1978, amended by Reform Act of Federal court under U.S. district court, can appeal to district courts. Secured vs. Unsecured creditors.

©2001 West Legal Studies in Business. All Rights Reserved. 15 Types of Bankruptcy Relief [1] Bankruptcy code has 8 chapters. 1,3, 5 - general definitional provisions and provisions covering administration, creditors, debtor and estate Chapter 7 - liquidation proceedings. Chapter 9 - adjustment of debts of a municipality.

©2001 West Legal Studies in Business. All Rights Reserved. 16 Types of Bankruptcy Relief [2] Chapter 11 – reorganizations. Chapter 12 - adjustment of debts of family farmers with regular incomes. Chapter 13 - adjustment of debts of individuals with regular incomes.

©2001 West Legal Studies in Business. All Rights Reserved. 17 Chapter 7: Liquidation Chapter 7: Ordinary or straight bankruptcy. –All assets are turned over to a trustee. –Trustee sells nonexempt property and distributes the proceeds to the creditors. Remaining debts are discharged. –Available for any person, individual, corporation, partnership. –Railroads, insurance companies, banks, savings and loan and investment companies licensed by the SBA, and credit unions cannot be debtors.

©2001 West Legal Studies in Business. All Rights Reserved. 18 Filing the Chapter 7 Petition Straight bankruptcy is commenced by the filing of a voluntary or involuntary petition in bankruptcy with the bankruptcy court. Voluntary Petition. Involuntary Petition.

©2001 West Legal Studies in Business. All Rights Reserved. 19 Voluntary Petition [1] Petitioner must understand there are other chapters available. Debtor does not have to be insolvent. List secured and unsecured creditors and addresses and amount of money owed. List of all property owned including property claimed; current income and expenses. Swear to these and sign. Federal crime to misrepresent.

©2001 West Legal Studies in Business. All Rights Reserved. 20 Voluntary Petition [2] Court issues order of relief. Clerk of court gives trustee and Creditors mailed notice of the order within 20 days. Court will deny if “substantial abuse” of Chapter 7. –Case 16.3: In Re Lamanna (1998).In Re Lamanna

©2001 West Legal Studies in Business. All Rights Reserved. 21 Involuntary Bankruptcy [1] Creditors force Debtor into bankruptcy proceedings, but not against a farmer or charitable institution. If there are 12 or more creditors, need three or more with unsecured claims totaling at least $10,000 to join in petition.

©2001 West Legal Studies in Business. All Rights Reserved. 22 Involuntary Bankruptcy [2] If there are less than 12 creditors, one or more having a claim of $10,000 may file. Court will order relief if: –Debtor is generally not paying debts as they come due. –A general receiver, assignee, or custodian took possession of, or was appointed to take charge of, substantially all of debtor’s property within 120 days before filing. Severe penalties for frivolous petitions against debtors, including Punitive damages.

©2001 West Legal Studies in Business. All Rights Reserved. 23 Automatic Stay Either voluntary or involuntary. Creditors cannot commence or continue most legal actions. Damages for violation of stay. Creditors can get “adequate protection.” –periodic or one time cash payments or indubitable equivalent.

©2001 West Legal Studies in Business. All Rights Reserved. 24 Property of the Estate [1] Debtor’s Estate includes: –All Debtor’s legal and equitable interests in property presently held, including community property; –Property transferred in a “voidable” transaction; and –Property which Debtor becomes entitled within 180 days after filing.

©2001 West Legal Studies in Business. All Rights Reserved. 25 Property of the Estate [2] Estate includes (cont’d): –Proceeds and profits from the property of the estate; and –After-acquired property such as inheritances, property settlements, and life insurance death proceeds. Case 16.4: In Re Andrews (1996).In Re Andrews

©2001 West Legal Studies in Business. All Rights Reserved. 26 Creditor’s Meeting and Claims [1] Ten to thirty days after filing, Court calls meeting of creditors. Debtor is examined under oath about his debts and assets. Within 90 days, Creditors must file “proof of claim” with court clerk. Leases cannot be for more than one year.

©2001 West Legal Studies in Business. All Rights Reserved. 27 Creditor’s Meeting and Claims [2] Claims allowed unless disputed. If claim is disputed or unliquidated, court will decide value. It is a crime to file a false claim. Employment contracts and real estate.

©2001 West Legal Studies in Business. All Rights Reserved. 28 ExemptionsExemptions See list in text pages States may pass law requiring Debtor use state exemptions. In some states, Debtor may choose state or federal exemptions.

©2001 West Legal Studies in Business. All Rights Reserved. 29 Bankruptcy Trustee Court-appointed until first meeting of creditors. Creditors elect permanent trustee Administers estate. Collects proceeds, liquidates assets and pay Creditors in order of priority.

©2001 West Legal Studies in Business. All Rights Reserved. 30 Trustee’s Powers Trustee has rights to get Debtor’s property back from those Creditors that he can defeat by asserting the rights of: –Debtor against the creditors. –Lien creditors against the creditors. –Bona fide purchaser against the creditors. –Trustee still loses to the PMSI creditor who perfects within his “magic” 10-day period.

©2001 West Legal Studies in Business. All Rights Reserved. 31 Voidable Rights Trustee can stand in shoes of debtor and assert any lack of capacity or lack of assent.

©2001 West Legal Studies in Business. All Rights Reserved. 32 Preferential Transfers [1] A Debtor is not permitted to transfer property or make a payment that favors—or gives a preference to—one creditor over another. For a Trustee to recover preferential payment, Debtor must be insolvent and transferred property for pre-existing debt within previous 90 days.

©2001 West Legal Studies in Business. All Rights Reserved. 33 Preferential Transfers [2] Trustee can use preferential payment to pay a real preexisting debt, not for current consideration. Creditor gets more than he would in a Chapter 7. Consumer can transfer up to $600 without constituting a preference.

©2001 West Legal Studies in Business. All Rights Reserved. 34 Liens on Debtor’s Property Trustee can avoid statutory liens that became effective when bankruptcy petition filed, or when debtor became insolvent. Can avoid liens which were unperfected on date of bankruptcy.

©2001 West Legal Studies in Business. All Rights Reserved. 35 Fraudulent Transfers Trustee may avoid fraudulent transfers made within one year of filing of petition. Trustee may proceed under state law for fraud with a 3 year statute of limitations.

©2001 West Legal Studies in Business. All Rights Reserved. 36 Distribution of Secured Property Consumer debtors: –Have 30 days from filing petition or before first meeting of creditors. –Debtor must tell what she intends to do with collateral-- keep or surrender. –Trustee must enforce within 45 days. If Consumer surrenders: Creditor can keep or sell –If creditor keeps collateral the debt is fully satisfied. –If creditor sells the collateral, she can use extra for costs, or can become unsecured creditor for deficiency.

©2001 West Legal Studies in Business. All Rights Reserved. 37 Distribution of Unsecured Property Paid according to bankruptcy law. All of one class must be paid before moving to next. Creditor within last class receive proportionately if not enough: –See Priority List on page 353. –All creditors paid, trustee gives extra back to debtor.

©2001 West Legal Studies in Business. All Rights Reserved. 38 DischargeDischarge Exceptions (p.354). Objections to Discharge. Effect of Discharge. Revocation of Discharge. Reaffirmation of a Debt.

©2001 West Legal Studies in Business. All Rights Reserved. 39 Exceptions to Discharge (List on p.354) Claims for back taxes. Claims for amounts borrowed by Debtor to pay federal taxes. Claims against property/money obtained by Debtor under false pretenses. Claims by Creditors who did not know about bankruptcy. –Case 16.5: In Re Seixas (1999).

©2001 West Legal Studies in Business. All Rights Reserved. 40 Reaffirmation of Debt Debtor may wish to pay a debt notwithstanding the debt could be discharged in bankruptcy. Agreement is filed with court. Debtor can rescind agreement at any time.

©2001 West Legal Studies in Business. All Rights Reserved. 41 ReorganizationsReorganizations Chapter 11—Corporations. Debtor and Creditors formulate a plan under which the Debtor pays a portion of its debts and is discharged of the rest. Same debtors as are eligible under Chapter 7. Creditors and debtors can settle private “workouts” outside of bankruptcy proceedings.

©2001 West Legal Studies in Business. All Rights Reserved. 42 Reorganizations [2] “Fast tract” Chapter 11 for small business debtors whose liabilities do no exceed $2 million and who do not own or manage real estate. Debtor in Possession (DIP): –Trustee may be appointed. –DIP has same powers as trustee in Chapter 7. »Strong-arm clause

©2001 West Legal Studies in Business. All Rights Reserved. 43 Reorganizations [3] Collective Bargaining Agreements. Creditors Committees. The Reorganization Plan: –Designate classes of claims and assets. –Specify treatment of classes. –Provide adequate means of execution.

©2001 West Legal Studies in Business. All Rights Reserved. 44 Chapter 13: Individual Repayment Plans Chapter 13: For individuals with regular income who owe fixed unsecured debts of <$269,250 or fixed secured debts of <$807,750. Not for partnerships, corporations.

©2001 West Legal Studies in Business. All Rights Reserved. 45 Law on the Web U.S. Bankruptcy Code at Cornell U.U.S. Bankruptcy Code at Cornell U Creditor-Debtor relationships at Cornell U..Creditor-Debtor relationships The Bankruptcy Law Finder.The Bankruptcy Law Finder The American Bankruptcy Institute.The American Bankruptcy Institute Legal Research Exercises on the Web