TABLE OF CONTENTS

I. GENERAL 1
a. Creditors’ bargain 1
b. Goals of bankruptcy 1
c. Security interests 2
d. Social benefits and costs of debts 3
e. Butner 3
f. Adequate protection 4

II. ENTERING BANKRUPTCY 4

a. Bankruptcy proofing 6
b. Dismissing bankruptcy 6
c. Substantive consolidation 6

III. CLAIMS 7
a. Equitable subordination 8

IV. THE AUTOMATIC STAY 9

a. Ending the stay 10

V. PROPERTY OF THE ESTATE 11

VI. TRUSTEE’S AVOIDANCE POWERS 11

a. General rules of avoidance 11
b. Fraudulent transfers 12
c. Preferences 13
d. Setoffs 14
e. Strong-arm powers 14

VII. EXECUTORY CONTRACTS 15

a. Automatic stay and contracts 16
b. Assumption 16
c. Rejection 16

VIII. PRIORITY 17
a. Admin expense 17
b. Paying prepetition claims before exit 17
c. DIP financing 18

IX. CHAPTER 11 REORGANIZATION 18

a. Formulating and voting the plan 19
b. Protections for individual creditors 19
c. Gerrymandering protections 19
d. Good faith for voters 20

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 e. Cramdown (1129(b)) 20
f. § 1111(b) election 21

X. SECTION 363 22
a. Ordinary or extraordinary? 22
b. Outside ordinary course (363(b)) 22
c. Free-and-clear sales 2

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 GENERAL
Creditors’ bargain:

1. Bankruptcy policy does or should reflect how creditors would have agreed ex
ante to do in a given situation

2. E.g. one creditor getting paid at the expense of all others on the eve of
bankruptcy would not be agreed to by all creditors, so BK doesn’t allow it
(preferences)

Goals of bankruptcy:

1. Correct financial distress and restore solvency

a. By de-leveraging or correcting for economic shocks
b. Assuming it’s not economically distressed, allowing it to emerge
solvent to preserve going concern value for creditors and avoiding Ch.
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c. BK forces all parties to come to the table and talk about the future of
the company

2. Solve the collective action problem

a. Pie will be smaller if we allow all creditors to seize individually, since
they will always liquidate (reorganization will be impossible)
b. Distribution of assets without BK would be based on speed to
courthouse, not preservation of going concern value, voting, etc.

3. Relatedly, to buy time for parties

a. To assess whether liquidation or reorganization is value maximizing
b. To minimize costs of speedy liquidation (e.g. fire-sale discounts)
c. To allow the sale, liquidation, reorganization, etc. to proceed in a
logical manner

4. Correct debt overhang:

a. Even if a company is a sure thing, creditors won’t invest because any
added value will be soaked up by existing creditors
b. BK allows assets and debt to even out, so company can begin
attracting creditors again
c. If the company is economically viable, this is socially desirable

5. Preserve the estate: maintain or increase the pie by continuing business,

preventing disruptive seizures and even obtaining more credit when
necessary

6. Pareto superior

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 a. Best interest test: every creditor gets at least as much as it would get
in liquidation
b. Secured creditors protected by adequate protection; everyone else
benefits from solving collection action problem
c. But we know this actually isn’t true: SCs get bled

Security interests:

1. Five types of liens:

a. Consensual liens: set by contract, generally a loan in exchange for a
security interest (e.g. a mortgage)
b. Judicial liens: either judgment (by court on real property) or
execution liens (levied by sheriff on personal or real), created by a
court so that a creditor can collect on his unpaid debt
c. Statutory lien: created by the legislature, so doesn’t require contract
i. Landlord’s lien: only for commercial; landlord can seize
personal property (seizing = perfection)
ii. Repairer’s lien: repairer can keep property to satisfy debt
(prior possession = perfection)
iii. Construction lien: anyone who works on real property (e.g.
subcontractor) can have lien on property, even without
contracting with owner (again, think of sub) (notice, filing and
suit within specified period of time = perfection)
d. Common law lien (mostly codified now)
e. Equitable lien: when court establishes a lien in interest of equity (e.g.
employee embezzles, court orders restitution with a lien on his car)

2. Attachment requires:
a. Written agreement that there’s a security interest
b. Debtor must actually own collateral
c. There must be a form of consideration

3. Remember that a security interest only gives priority on that collateral—

there is no priority for the deficiency or for the creditor in general

4. Priority over the collateral is determined by first to perfect (with a few

exceptions, e.g. repairer’s lien takes priority over previously filed liens)

5. Liens survive purchases, assuming the lien was perfected prior to the
purchase (otherwise the lienholder only has a security interest in any rights
retained by the seller-borrower)
a. There are exceptions, e.g. good faith routine consumer purchases
(customers wouldn’t buy if they had to check every piece of
merchandise for potential liens)

6. PMSI may supersede first in time first in right

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 7. Secured creditors have a right to self-help if they don’t “breach the peace”

8. Policy:
a. Theoretically the additional rights of SI mean that unsecured creditors
charge additional interest, so there’s no advantage over a system of
100% unsecured
b. But because SIs are over specific assets or types of assets, they allow
comparative advantages
c. E.g. a company that knows a lot about cars can loan for an especially
low interest rate if the collateral is a car
d. SIs also account for differences in risk tolerance

Social benefits and costs of debts:

1. “Fire alarm”: financial distress forces an accompany to make changes

immediately, like change management or sell off non-core businesses
a. Stockholders must wait for board meeting, etc.

2. Relatedly, contractual aspect of debt allows creditors to maintain oversight in

whatever way they prefer—stockholders are limited to SEC rules
a. And in general allows customization not possible with equity
ownership
b. A company holding only cash can abuse that—bonuses, private jets,
etc.; a creditor will screen the purpose of the initial loan and provide
oversight afterwards

3. Gives risk-averse parties a way to inject capital

a. Gives companies an artificial discount because of tax code

4. Problems:
a. Financial distress might be consequence of exogenous shocks and so
the fire alarm is a false alarm (what if you change what had been
effective management?)
b. Insolvency is expensive and distracting
c. Contagion effect of debt
d. Seizing assets disrupts synergy
e. Being overleveraged means too much of your cash flow can go to debt
service, preventing you from making capital investments

5. This balancing is why over- and under-leveraging are both dangerous (and
an efficient BK process allows you to rebalance ex post)

Butner:

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 1. In order to avoid forum shopping, we should override state law rules as little
as possible (Butner)
a. Put another way, state law is changed only when BK requires it

2. Every change gives people an incentive to file for BK, so we should make sure
that those incentives are aligned with BK policies

Adequate protection:

1. Adequate protection is available to anyone with an interest in property of the

estate or debtor, including SCs and lessors leasing property to D; interest is
determined by applicable nonbankruptcy law

2. § 361 provides three methods for giving adequate protection:

a. Cash payments to maintain the ratio of value of collateral to debt (i.e.
lowering debt as the collateral’s value falls)
b. Providing additional collateral (i.e. providing a lien on an
unencumbered piece of property, or replacing collateral with
something of higher value)
c. Granting “indubitable equivalent”; two ways:
i. Showing that creditor has equity cushion
1. SCs don’t like this because cushion was bargained for,
but courts ignore this
2. If value is fluctuating a lot, a bigger cushion might be
necessary to be considered IE
ii. Reorg plan is good enough to guarantee SC will be paid in full
1. Basically a mini confirmation battle over how good the
plan is

3. The nature of BK means that it’s highly unlikely D will have sufficient cash or
unencumbered property to use § 361(1)-(2), so indubitable equivalent is the
most common
a. This is a way SCs get “bled” in BK, but it’s thought to be worth it so
that D has some freedom to maneuver during reorg

4. Value of the property itself is protected, not the benefit of seizing it (so
interest or profits SC would get by possessing property aren’t counted)
(Timbers)

5. Use of cash collateral will pretty much always require adequate protection

ENTERING BK
1. Tight screens on BK cut down on forum shopping

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 a. E.g. we don’t want a terrible restaurant with one creditor (no
collective action problem) to file just to buy time (social negative)

2. § 101: “debtor” means person or municipality; “person” includes individual,

partnership or corporation
a. Individual: real human being (and a real hero)
b. Partnership is defined by state law; can be distinct from the partners
(i.e. partners do not have to be in BK for p’ship to be in BK)
c. 101(9) defines corporation, includes variety of incorporated and
unincorporated and “business trusts”

3. § 109: only “person” that resides, domiciles or has property in US can be D;

sets out what kinds of debtors are eligible for each chapter
a. 109(g): indiv or family farm can’t be D (so no involuntary?) if in
proceeding 180 days:
i. Dismissed by court for willful failure to obey or
ii. D requested and obtained voluntary dismissal “following” filing
of § 362 request for relief from automatic stay
1. Courts differ on whether “following” simply means
“after” or “because of”

4. Eligibility by chapter (§ 109):

a. Ch. 7: anyone except RRs, insurance and various kinds of banks
i. § 707(b): court must dismiss if indiv with consumer debt and
BK would be abuse; abuse assumed based on means test
b. Ch. 11: same as Ch. 7 plus RRs and some banks
i. Can’t avoid means test by filing under Ch. 11 and proposing
liquidation
c. Court can convert to Ch. 7 for cause at request of a party in interest
(§ 1112)

5. Requirements for involuntary petition (§ 303):

a. Must be in payment default (i.e. non-payment default like “must stay
open seven days a week can’t trigger BK)
i. Not as strict as it sounds—banks can accelerate for non-
payment default, then trigger BK due to failure to pay
accelerated schedule
b. At least three creditors must petition
i. Prevents one creditor filing in bad faith (e.g. competitor)

6. Treasure Island: land trust is not person (because it just passively holds
land), business trust is a person
a. Court kicks out TI for not being a person because it claimed it wasn’t a
business trust to avoid SEC regs (equity)
b. Once you get outside corporation, “person” is a standard, but if TI had
incorporated it would have been eligible no matter what (rule)

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 c. Policy reasons for not allowing in BK: unlikely to have many creditors,
no synergy (just a bunch of property), no employees or goodwill

BK proofing:

1. Anti-BK clauses are voidable

a. Policy: K is only with one creditor, anti-BK affects all creditors

2. Potential methods:
a. Put assets in trust that isn’t person (e.g. Treasure Island)
b. Corporate bylaws: unanimous vote necessary for BK
c. Creditors can appoint directors (but directors still have fiduciary duty
to corporation)
d. Punishments for BK like reducing exec pay or doubling debt

3. Kingston Square: not collusion when D funded involuntary petition by

attorneys and accountants (who were also creditors)
a. Policy-driven result: “independent manager” (who needed to approve
BK) was clearly a meatpuppet for secured creditor
b. Other creditors had plan to maximize value while SC had no incentive
(only would want to protect its own collateral)
i. SCs get bled in BK, so even though it was secured it would
oppose any BK—all downside, no up

Dismissing BK:

1. § 305(a)(1): court can dismiss at any time if “the interests of creditors and
the debtor would be better served by such dismissal or suspension”
a. Easier for a creditor to just get the automatic stay lifted
b. Debtor could have a broader view than just the managers—could
include employees

2. Colonial Ford: Code has general preference for out-of-court workouts (incl.
§ 305(a)(1)), so BK dismissed
a. There is a strong presumption to allow BK (see ways to avoid below)
b. But dismissing here fit into creditors’ bargain: everyone was
negotiating post-distress
c. Ex post, without information issues, courts are likely to allow avoiding
BK
d. Other policy considerations (collective action problem, preserving
going concern value) weren’t present—would’ve had to balance in
that case

Substantive consolidation:

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1. SC is an equitable power of the court, so it will only be ordered if the equities
weigh in favor of it

2. Generally consolidation is by consensus because creditors realize that

different subs’ affairs are so intertwined transaction costs will overwhelm
any minor differences in asset:debt ratios

3. Owens Corning requirements:

a. Creditors must have treated corporations as a single entity
b. All creditors must be better off
c. Extremely high bar to meet; basically must show that D didn’t observe
any formalities and there will be huge savings lumping everything
together

CLAIMS
1. Two distinct questions: what goes into the estate and how can take things out
of the estate (claims)
a. Knowing claims is essential to establishing a priority scheme and plan
to reorganize

2. D must give proper notice of BK, but creditors need not have actual notice
a. All debts are discharged in BK, even if a creditor didn’t get notice
b. Policy: can’t manage with hypo claims out there, don’t sleep on rights

3. § 101(5) defines claim broadly: any right at law or equity, even if

unliquidated, unfixed, unsettled, contingent, unmatured or disputed
a. Must give rise to payment (e.g. injunction is not a claim)

4. Ohio v. Kovacs: Obligation from equitable breach that gives rise to payment is
a claim under § 101(5)(B)
a. D had failed to clean up a hazardous site, so state appointed a receiver
who started to seize assets to pay for cleanup; SCOTUS found that this
meant claim could be reduced to payment
b. “Breach of performance” language in 101(5)(B) means statutory too
c. Creditors often don’t want a claim because obligation won’t be
discharged and they won’t be paid cents on the dollar
d. Courts have distinguished if state only has recourse to cleanup order

5. Piper Aircraft: people with no relationship to D and no prepetition injury

don’t have a claim (Piper standard)
a. In this case creditor wanted a claim because otherwise D would
liquidate and there would be nothing to collect from after an injury
i. And if D did survive post-petition claims would counteract
fresh start, so two reasons to allow the claims

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 b. Special case because class was entire world (impossible to predict
who would be injured)
c. But general policy is to get as many claims into estate as possible
because that saves the most going concern value
d. Chateaugay standard: as soon as EPA knew about and could act on
environmental violation claim arose
i. So violation without EPA knowledge isn’t prepetition and
knowledge without acting is prepetition

6. Bittner: BK court has significant discretion to value unliquidated/contingent

claims
a. Two ways to handle: estimate the potential winnings and discount by
chance of winning, or estimate and then allow all or nothing
depending on whether more likely than not that a party wins
b. BK court went with latter, probably because other party was a
competitor that had bad-faith reasons for interfering

7. A.H. Robins: BK court can use equity power to disallow punitive damages as
claims (they’re still discharged)
a. Allowing PDs would distort payouts from the estate
b. But decision is at odds with Butner (changes state law rights when not
necessary)

Equitable subordination:

1. Authority is from § 510(c), but that section is too vague to be useful

a. Can be subordinated from secured to unsecured, or from unsecured to
last priority
b. ES is useful because it can deal with a host of abusive behaviors in one
shot, instead of avoiding a bunch of individual transfers with
preferences or other methods

2. Clark three-prong test:

a. Claimant engaged in inequitable conduct
b. Misconduct injured creditors or resulted in unfair advantage
c. ES isn’t contrary to other parts of Code

3. “Inequitable”:
a. Fraud/illegality/breach of fiduciary duty
b. Undercapitalization (unclear whether it’s conduct that leaves D
undercapitalized or if it’s taking advantage of D’s undercapitalization)
c. Use of D as instrumentality or alter ego

4. ES generally involves a bank abusing its covenants to protect itself when a

company is failing

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 a. Bank can force out managers and things like that, which benefits all
creditors, or it can merely take steps to distribute D in a way that
benefits the bank
b. We want to encourage behavior that creditors not at the table like
while disincentivizing stuff they wouldn’t like feeding the lien

5. Clark: bank controlled line of credit so company would just barely stay out of
bankruptcy; because it never went beyond terms of lending agreement, no ES
a. Cf. Am. Lumber: held D hostage in order to get a security interest

6. Yellowstone: clearly fraudulent loan to allow owner to cash out using

company’s assets as security leads to ES of security interest
a. Indicia of fraud: no control over what can be done with funds, due
diligence designed to inflate value of company

THE AUTOMATIC STAY

1. § 362: petition also acts as stay against a long list of things
a. If act does not fall within § 362(a) (and can’t be read in) D must rely
on § 105(a) and show it’s in the interest of the estate to stay
b. Stay operates until dismissal of case; unclear if improper filer (e.g. not
a person) gets protection of stay (majority view is yes, until eventual
dismissal)

2. Broad categories of stay’s bar:

a. Actions against debtor ((a)(1), (2), (6)-(8)) , including debt collection
and non-debt-related litigation (but not for criminal or intentionally
tortious conduct)
i. Could be like denying a transcript to a student in default, if it’s
a means to coerce payment
b. Actions against property of debtor ((a)(5) proscribes creating,
perfecting or enforcing liens against D’s property)
i. Marvel: “exercising control over property of D” ((a)(3)) does
not bar shareholder votes (even when the shareholders are
creditors)
1. But reelecting board as a right in default is probably
stayed (Bicoastal)
2. Worried about creditors controlling directors because
they might privilege that creditor or fail to take legal
action against it (but it aligns incentives)
c. Against action property of estate (unlike other two, applies to post-
petition debts as well)

3. 362(b) excludes some actions from stay to deter forum shopping:

a. Criminal actions (as long as prosecution isn’t just to coerce payment)

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 b. Proceedings by gov’t units to enforce police/regulatory duties (up to
but not including monetary judgment)
i. FCC: FCC could revoke license because it had a legitimate
regulatory purpose (maintain legitimacy of bidding and make
sure spectrum is being used)
ii. Solis: Labor can continue parallel proceeding because no
pecuniary gain (monetary payment goes through BK),
increases deterrence and build case law
1. This deterrence argument seems exclusive to gov’t: tort
Ps will get stayed even if action would deter
iii. Nicolet: gov’t fixing damages for violations of regs (e.g.
environmental, public safety) is not subject to automatic stay
iv. Gov’t can’t use this to just get paid in front of other creditors,
must have legitimate police/regulatory purpose
v. Gov’t still must respect contracts (can’t revoke driver’s license)
c. Others (look at Code)

4. Know that what’s a claim and what’s stayed don’t necessarily line up: an
injunction against D could be stayed by 326(a)(1) but not be a claim (because
there’s no monetary aspect), in which case P has to get relief from stay

Ending the stay:

1. § 362(d) gives four forms of relief:

a. Termination: prospectively ends stay
b. Annulment: extraordinary remedy, retroactively ends stay
c. Modification: applicant can proceed in some ways, but doesn’t have
full rights (e.g. can proceed with litigation but can’t enforce judgment)
d. Conditioning: stay remains in place if trustee meets some condition
e. See § 362(g) for complicated burden-of-proof rules

2. § 362(d)(1): stay can be lifted “for cause”

a. Most common is failure to give adequate assurances that collateral’s
value is protected
b. Outside of that, balancing virtue against harm (e.g. abusive behavior
by D, better for another court to decide a matter)

3. § 362(d)(2): if collateral is 1) D has no equity in the property and 2) it’s not

essential to reorganization, SC can seize it
a. Hard case is cash or bonds: not physically essential but D will argue it
needs cash for an effective reorg
b. Timbers: to bar lifting stay, reorg must be probable in reasonable
period of time

4. Two other 362(d):

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 a. Single-asset real estate D (mortgagor) who files in Ch. 11 as delaying
tactic
b. Repeated filing in an attempt to stop a secured creditor from
foreclosing on its collateral

PROPERTY OF THE ESTATE

1. § 541: “property of the estate” is all legal and equitable interests of D at
moment of petition

2. § 542: all property that trustee may use must be turned over to trustee
a. Allows trustee to get out and get property that’s not currently in D’s
possession (e.g. Whiting Pools below)

3. Chi. Bd. of Trade: property that enters the estate carries the same state law
rights and obligations as before

4. Whiting Pools: When D has title over a property, but not possession, property
is property of the estate
a. In this case it was about to be auctioned—since D had title and right of
redemption, it could bring the property into the estate

5. Plastech: D’s possessory interest in tools is enough of a basis for them to be

part of the estate
a. Arrangement (bailment) was 100% meant to keep the tools from
becoming part of the estate
b. There was literally nothing D could do to own the tools sans
Chrysler’s permission, so this is far from Whiting
c. Importance of equities: saved hundreds of jobs, ripple effects during
financial crisis

6. LTV: D has a right to the fruits of its labors, so accounts receivables and
inventory are part of estate even though D sold them to SPE
a. There is no real interest here—no title, no right of redemption, no
possession; most courts decline to follow something this extreme
b. D could also challenge that this wasn’t a “true sale,” just a scheme to
hide a security interest

TRUSTEE’S AVOIDANCE POWERS

General rules of avoidance:

1. “Transfer” is very broad per § 101(54): could be involuntary, indirect,

conditional, could be a gift, could be a lien

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 2. § 550: Trustee can recover property (or if court orders, cash equivalent)
from avoided transfers under FT, preferences and strong-arm powers
a. T can recover from first transferee or person for whose benefit
transfer was made, or from a later transferee
i. Can’t recover from later transferees if taken for value in good
faith

3. § 551: when an interest is avoided, estate gets that interest (so a junior
lienholder is still junior)

4. § 101(53B) insulates “swaps” (including commodity forward agreements)

from avoidance
a. D could avoid all losing bets while keeping all winning bets, possibly
destroying swaps market
b. Contagion: bet winner not being able to collect would prevent them
from paying other counterparties, grinding swaps market to a halt
c. Nat’l Gas: fixing price of future gas deliveries several months in
advance is a swap (hard to distinguish from normal prepaying)

Fraudulent transfers:

1. Avoiding fraudulent transfer can come from § 548 (can go back two years) or
state law using strong-arm power (§ 544) (UFTA is four years)

2. Actual fraud: trustee can avoid a transfer by D made with actual intent to
hinder, delay or defraud any creditor (548(a))
a. Any activity related to a Ponzi scheme is presumptively actual fraud
b. Badges of fraud: signs, like transferring to family member or
transferring in response to collection activity, that imply actual fraud

3. Constructive fraud:
a. D did not receive reasonably equivalent value in exchange for transfer
i. Not a purely mathematic consideration; context matters and
value can be unequal (“reasonably equivalent”)
b. D was:
i. Insolvent at time of transfer;
1. Insolvency can be balance sheet or unable to pay debts
as they come due
ii. Made insolvent by transfer; or
iii. Left with unreasonably small capital by transfer

4. § 548(c): value given to D, if in good faith, is protected (by a lien)

a. Manhattan Investment: bank was on inquiry notice, so did not receive
proceeds of Ponzi scheme in good faith

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 5. “Mere conduit theory”: if transferee never had dominion and control of funds,
can’t be subject to avoidance action

6. TOUSA: helping D avoid bankruptcy isn’t “reasonably equivalent value” for

guaranteeing loan
a. The exchange was a guarantee (like a suretyship) for better financial
health
b. But court acknowledges that an intangible benefit can be REV

7. LBOs disadvantage unsecured creditors, so if one leads to BK the USs will

challenge the LBO as a fraudulent transfer
a. See Jeannette for the things courts will look for:
i. D gave security interest so that buyer to repay their loan was
transfer without equivalent value but
ii. LBO did not leave D insolvent and
iii. It was external shocks that doomed D, so LBO did not leave D
with unreasonably small capital, so no fraud transfer
b. Make sure you tie in a deep pocket to a transfer without REV (in
Jeannette, D giving money to buyer was for bank’s benefit, so under
§ 550 that transfer can be avoided)

8. Courts often use fraud transfer doctrine to incentivize due diligence by

lenders
a. In TOUSA the bank should’ve looked to see whether the guarantee
they were receiving would lead to insolvency
b. In Jeannette bank should only fund LBO if it won’t leave target
insolvent
c. In Manhattan, bank that is suspicious of Ponzi scheme should
investigate to protect investors

Preferences:

1. 547(b) lays out the rule:

a. Transfer
b. To or for the benefit of a creditor
c. Made on account of antecedent debt
d. Within 90 days of the petition
e. While D is insolvent
i. Rebuttable presumption that D is insolvent 90 days prior to
petition
f. Making transferee better off than it would be in Ch. 7 proceeding

2. “Improvement-in-position test” (f above) means that repaying a fully secured

creditor is not a preference (since it would receive 100% in liquidation), but
paying in full an undersecured creditor creates an avoidable transfer in the
deficiency

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 3. Involuntary preferences (e.g. court giving a judgment lien to an unsecured
creditor) are also avoidable

4. 547(c) exceptions to preference rules:

a. Substantially contemporaneous exchange
i. Where there’s technically antecedent debt, but it’s so close in
time (like 24 hours) that we ignore it)
b. Debt in ordinary course of business and same terms as always
i. E.g. buying inventory on credit and paying it back 15 days later
—as long as this is what D always did, not a preference
c. PMSIs that are perfected within 30 days
d. When new value comes from preferred creditor
i. E.g. amount repaid is offset by new loan

5. 547(c)(5) is the important safe harbor; it allows perfected security interests

in inventory and/or receivables (i.e. after-acquired collateral)
a. To prevent feeding the lien, it is a preference to the extent that the
creditor’s deficiency was reduced by these new security interests

Setoffs:

1. Setoff is considered akin to a security interest and is exempted from

preference avoidance by § 553
a. Requires mutuality, but can be completely separate transactions (e.g.
Braniff, savings acct. in bank and a loan from the bank)

2. Three important limitations:

a. 553(a)(2): selloff right acquired within 90 days of petition while
debtor is insolvent
i. Creditors could swap claims to get paid in full at expense of
estate
ii. E.g. X owes D $10k, Y is owed $10k from D, D pays unsecured
at 10%; X pays Y $3k to take debt, Y offsets $10k claim with X’s
$10k debt
1. X saves $7k (would pay $10k, now pays $3k); if Y makes
$2k (would make $1k (10% of $10k), now makes $3k)
b. 553(a)(3): new debt was specifically to create offset right
i. E.g. bank forces D to open an account—that setoff is avoided
c. 553(b): similar to preference’s “improved-in-position test,” measure
deficiency 90 days prepetition and at moment of petition; if deficiency
has declined that amount can be avoided

Strong-arm powers:

1. § 544(a): trustee can avoid any transfer that is voidable by:

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 a. a hypo creditor who holds a judicial lien on all D’s property on date of
petition
b. a bona fide purchaser of real property (in case state law makes an
unperfected real estate lien > a judicial lien)

2. Strong-arm powers are stronger than a judicial lienholder because the whole
interest is avoided, not just superseded to the extent of the lien

3. 544(a) is generally used to avoid unperfected security interests

a. Strong incentive to announce to the world the security interest, which
benefits creditors in general
b. While also enlarging the estate for unsecured creditors

4. Kors: 544(a) allows T to avoid unperfected security interest, but T can’t step
into the shoes of a creditor to benefit from a subordination agreement
a. I.e. a subordination agreement is contractual, so 544 doesn’t apply; it
only applies to property rights enforced against the world

5. § 544(b): T can assert any right an actual unsecured creditor has

a. Used when state law differs from the Code
b. Most common is when fraud transfer reach-back period is longer in
state, but could also involve illegal dividends under state corp. law
c. Moore v. Bay: T can avoid entire transfer, even if actual UC is only
owed nominal amount

6. Ozark Restaurant: 544(b) doesn’t allow T to collect money owed to creditors,

only money owed to estate
a. So creditor’s alter ego cause of action couldn’t be appropriated by T
b. T can still avoid individual abuses using fraud transfer, but much less
efficient than alter ego action
c. Goes against policy: creditors would want to centralize litigation

EXECUTORY CONTRACTS
1. Contract is executory if the obligation is so unperformed that a failure to
perform would be a material breach
a. If counterparty has performed enough and D hasn’t, it’s just a normal
claim on the estate
b. If D has performed but counterparty hasn’t, estate has a right to
performance under § 541
c. Assumption/rejection is only involved when both sides are
unperformed

2. Contract must be assumed or rejected within 60 days or deemed rejected

(365(d)(1))

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 3. Between petition and A/R counterparty must continue to perform but will
receive admin priority for reasonable value of this performance
a. Non-assignment clauses are not enforceable in BK, so D can assign
while counterparty is stuck performing
i. Background statutory or common law rules can bar
assignment, like fed rules on nonexclusive patent licenses

Automatic stay and contracts:

1. Cahokia Downs: automatic stay prevents ins. co. (i.e. third party) from
terminating policy (even though policy would allow it)

2. M.J. & K: licensor acted in good faith and had reasons besides BK (wanted
shorter licenses, licensee had inadequate inventory) so termination of license
isn’t stayed
a. So acting earlier makes it more likely to avoid being stayed

3. A court may require adequate assurances to a K counterparty because BK

increases risk, even though counterparty can’t terminate

Assumption:

1. Assumption of K in default follows § 365(b)(1):

a. Cure the default
b. Compensate for any loss caused by default
c. Give adequate assurance of future performance

2. Two types of default need not be cured (365(b)(2)):

a. Ipso facto clause
b. Penalty rates on nonmonetary defaults

3. Assumption is generally beneficial for counterparties because they get paid

in full (& admin priority) instead of at a fractional rate as unsecured creditors

4. K can’t be assumed if nonbankruptcy law prohibits assignment to someone

other than D and counterparty contests (365(c)(1))

Rejection:

1. LSC: a security interest granted by a rejected contract survives rejection

2. Register: a covenant-not-to-compete is rejected with the K (so it’s part of the

claim but it doesn’t survive)

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 3. Rights closer to pure property (LSC—an SI enforced against the world) are
more likely to survive than rights closer to pure contract (Register—a right
enforced only against the franchisee)

PRIORITY
Admin expenses:

1. Admin expenses are the highest priority unsecured (after dom support)

2. They are incurred post-petition from a variety of sources, including

executory Ks, fees for managing the estate and post-petition taxes

3. § 503(b): admin expenses for “actual and necessary” expenses of preserving

the estate
a. Reading Co.: continuing operation of D’s business was actual and
necessary, so negligence damages arising post-petition get AEP
i. Deters risky behavior during BK and internalizes costs
ii. But reduces possibility of rehab and harms prepetition tort
victims (theoretically just luck whether you’re pre- or post-)

4. Microsoft v. Dak: deal where D paid per copy sold (incl. a floor royalty) was
prepayment, not pay for an IP license (which would’ve been AEP)
a. How could Microsoft avoid being rejected?
i. Terminate prepetition, then enter a K during BK (which would
get AEP)
ii. Shorter Ks (reducing vulnerability)
iii. Each Dak sale is a sale from Microsoft to Dak to customer (so
can’t be prepetition payment)

5. Wall Tube: post-petition cleanup of pre- and post-petition hazardous waste

by state was “actual and necessary” to comply with law, so AEP granted

Paying prepetition claims before exit:

1. Paying prepetition claims in cash before the end of bankruptcy disturbs

priority, so a court will need a strong basis (105(a) is not enough)
a. H.R. Robins: even though paying for tort victims’ surgery would save
estate hundreds of millions of dollars, not within BK court’s equitable
powers
i. Creditors were all in favor because it was Pareto superior;
should’ve grounded it in 363(b) instead

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 2. Kmart: paying “critical” unsecured vendors out of priority requires showing
that they would stop delivery sans payment and that the payments will
create enough value
a. Alternatives to paying out of priority:
i. Use DIP financing to pay cash to vendors
ii. Convince vendors to be fine with AEP
iii. Get a standby letter of credit from a bank
b. Suppliers not delivering because of BK would cost them a lot, so not a
real concern

DIP financing:

1. § 364 provides four methods of finance during BK:

a. Any debt in ordinary course of business gets AEP
b. Outside ordinary course can get AEP if court approves
c. If AEP isn’t enough, D can offer:
i. Super AEP (basically never happens)
ii. SI in unencumbered property (but if in BK it’s unlikely there’s
much unencumbered)
iii. Junior SI in something already encumbered
d. Can prime existing SC
i. Give adequate protection to existing SC (for reasons already
explained, will always be indubitable equivalent)
ii. Give a senior SI to a new financer
iii. This requires notice and hearing where trustee shows that
financing can’t be obtained any other way (but this is mostly
pro forma now)
iv. Still, hearing will be mini-confirmation: what’s value of D,
what’s being preserved, do you need money to do that?

2. These methods are in order of increasing strain on the estate, so court will
generally expect to be show the less onerous method wasn’t possible when a
more onerous method is requested

3. Encumbering property to secure new financing and prepetition loans (cross-

collateralization) is generally not allowed or considered extremely
extraordinary

4. Priming is in line with creditors’ bargain

a. Virtue of debt is fire alarm, but once fire alarm goes off debt can make
it very difficult to rehab corporation
b. Priming allows D to protect/expand going concern value, helping all
creditors

CHAPTER 11 REORGANIZATION
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 1. § 1129 lays out basic reorg process
a. § 1112 allows conversion to Ch. 7 for cause

Formulating and voting the plan:

1. DIP has 120-day exclusive period to propose a plan; after that any party in
interest can propose
a. If D proposed within 120 but it hasn’t been accepted, has an
additional 60 to get it accepted
b. D’s ability to make take-it-or-leave-it-offer gives it huge bargaining
power—creditors have to wait out period if they don’t like it, which
costs $$$

2. After writing the plan, D must circulate a disclosure (similar to SEC

disclosures)

3. 1129(a)(8): all impaired classes must accept plan for it to be approved

a. A non-impaired class is deemed to vote yes; non-impaired means paid
in full or D cures and reinstates K (1124)
b. A class receiving nothing is deemed to vote no
c. To accept, you need 2/3 in $ amount and majority in number of claims
within a class

4. If an impaired class won’t approve, D can cram down using § 1129(b)

a. So three ways to approve: vote yes, don’t impair or cram down

5. After vote court must still find that the plan is feasible

Protections for individual creditors:

1. Best interest test: each creditor must receive as much as it would have
received in a Ch. 7 liquidation
a. As in Crowthers it can be difficult to tell why some things are worth
less in liquidation (assuming no fire sale), but court generally gives
benefit of doubt

2. Protection from gerrymandering (see below)

3. All individuals in a class must be treated the same (unless discriminated

claimholder agrees)

Gerrymandering protections:

1. All claims and interests in a class must be “substantially similar” (1122(a));

this prohibits lumping dissimilar claims

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 a. Secured and unsecured are not similar; claims of different priority are
not similar
b. Different secured creditors are generally put into different classes
c. One group of low-value unsecured claims can be put together for
expediency (1122(b))

2. Splitting similar claims into separate classes is not prohibited by the Code,
but courts will ensure it has a reasonable basis and look at if it’s benign or
malign
a. Woodbridge: deficiency is dissimilar because it would be treated
differently in Ch. 7 and 11, unlike other unsecured claims

Good faith for voters:

1. § 1126(e) requires voting in good faith

2. Figter: purchasing other classes’ shares to propose alternate plan is not bad
faith
a. Holding both senior and junior debt aligns interest, but a secured
creditor gaining influence is dangerous because they might feed their
lien
b. Signs it’s legitimate:
i. Creditor’s alternate plan actually seemed better
ii. Offered to buy all claims, not just enough to kill plan

3. Cf. DBSD where it was a competitor buying claims and it admitted it wanted
to be in position to block the plan and possibly grab spectrum when D failed

Cramdown (1129(b)):

1. Three requirements for cramdown:

a. All protections of 1129(a) are maintained (except obviously that all
impaired classes approve)
b. No unfair discrimination against any impaired class that didn’t accept
c. Plan is fair and equitable as to each impaired class that didn’t accept

2. Discrimination against dissenting classes is allowed, as long as it’s not unfair

a. Fair if it has a reasonable basis, is in good faith, is necessary to reorg,
etc.

3. Fair and equitable depends on type of claim

4. F&E for SC (1129(b)(2)(A)) gives three options:

a. Plan must satisfy two-prong test: 1) sum of payment = secured claim;
2) present value of payments = value of collateral

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 i. Generally present value of collateral will be limiting factor, but
if heavily
b. Free-and-clear auction with SC holding lien in proceeds
c. Indubitable equivalent is offered

5. F&E for UCs (1129(b)(2)(B)): absolute priority rule (no junior creditor or
shareholder can be paid before its senior creditors are paid in full) must be
respected
a. Exception is that Old Equity can remain a part of the plan if they inject
“new value”
b. New value must be money or equivalent, can’t be something
intangible like managerial ability
c. La Salle: there must be some external check to see if Old Equity is
providing value (i.e. an exclusive sale of new shares to Old Equity is
not “new value”)

6. Sometimes senior claimholders want to bribe junior claimholders over

objections of creditors in between (“gift doctrine”)
a. SPM (1st, Ch. 7): creditors can use proceeds of sale however they wish
(so pre-liquidation agreement of post-liquidation distribution is OK)
b. DBSD (2d): senior creditor who is receiving new equity can’t gift that
equity to Old Equity as part of plan
c. Armstrong (3d): unsecured creditors can’t give equity to Old Equity as
part of plan
d. So debate whether gifting is just disallowed for UCs (Armstrong) or
everyone (DBSD)
e. While gifting can make the process smoother, it increases the
likelihood of holdouts (mini collective action problem: better for THIS
BK but not BKs in general)
f. Probably OK to agree to give something post-plan out of BK though
i. But if it’s a crucial piece of reorg (e.g. employees) might be
hard to contract this

§ 1111(b) election:

1. Under 1111(b) undersecured creditor can choose between having the entire
debt be considered secured or bifurcating the claim between the secured
interest and the unsecured deficiency
a. In a cramdown, nominal value of secure claim actually is important if
they elect to keep it all secured
b. If there is a decent chance that it all will be paid back, they should
elect to keep it all secured
c. If it’s unlikely they’ll be paid back, taking the unsecured claim is
better:
i. Gives voting rights in another class

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 ii. Get a guaranteed payment now (even though it’s at cents on
the dollar)

SECTION 363
Ordinary or extraordinary?:

1. § 363 establishes the fundamental distinction between use, sale or lease of

assets within and without the ordinary course of business
a. 363(c): in ordinary course of business transactions are within T’s
discretion, but can later be challenged by parties in interest
i. In Ch. 7 all business must be approved because it’s probably
unnecessary
b. 363(b): extraordinary transactions require notice and hearing

2. Two-prong test for determining (extra)ordinary:

a. In view of hypo creditor, imposes greater risk than you would expect
based on D’s prepetition business
b. Activity is “ordinary” in context of D’s industry

3. Use of cash collateral (incl. things like commercial paper) requires

permission from SC or court even for ordinary trans because it’s easy to get
rid of this collateral free and clear

Outside ordinary course (363(b)):

1. Lionel factors are still commonly used even though they were formulated
when 363(b) sales were rare
a. Proportion of assets sold to the whole enterprise
i. Smaller the assets the more likely the sale—court wants to
have Ch. 11 procedural protections for big deals
b. Likelihood that a plan will be proposed
i. But if one’s going to be proposed in the near future, why bother
selling outside the plan (except for procedural reasons)
c. Effects on reorg in the future
d. Whether price is right
e. Whether asset is appreciating or depreciating in value
i. Unclear how the court could guess this better than a market
actor

2. In Lionel there was no business purpose to sell now instead of later (it
seemed the property would grow in value) so court refused
a. This was merely about placing the burden—if the burden was on
saying why not to sell, it would’ve been sold because there was no real
business purpose to keeping the stock

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 3. Major 363(b) sales are about which procedure we prefer: a judge-run
hearing or a vote by all parties
a. D obviously prefers the former because it’s an easier bar and quicker
b. Ch. 11’s procedural protections do cost a ton of time and money, so
there’s a legitimate debate here
c. There are times, due to the price or timing, where putting it in a plan
is impossible and 363(b) is extremely useful
i. Chrysler: there is no other potential buyer in the world
ii. Think of A.H. Robins and Kmart: had they used property pre-
plan they would’ve saved creditors millions

Free-and-clear sales:

1. When selling an asset free of a lien, you must give adequate protection (363)
a. Protection will almost certainly be indubitable equivalent because no
point in selling asset and then just giving proceeds (or same amount
of cash) to SC

2. TWA: employment discrimination claim is an interest in property, so asset

can be sold free and clear of it
a. Successor liability is similar to property, because it can follow the
property like a lien
b. If TWA came out differently, secured lenders would lose their interest
due to 363(f) but unsecured lenders would still be able to sue using
successor liability, breaking priority

3. RedLAX: indubitable equivalent can’t replace the option to credit bid (unless
there is cause 363(k))

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