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Stanford Law School

Final Examination in Law 240 - Bankruptcy

Lecturer, Hon. Edward D. Jellen

May 13, 2003

Time: 3 hours

Five Questions

Instructions

1. This is an open book exam. You may refer to any materials

you wish.

2. The exam consists of five questions, many of which contain

multiple subparts. A total of 100 points may be scored on the exam.
Please note that some of the questions have additional instructions.
Budget your time carefully.

3. Please begin the answer to each of the five questions on a

new page.

4. In answering the questions, you need not waste time by

reciting the facts. If you need additional facts to answer a
particular question, make or state an appropriate reasonable
assumption.

5. Cite to Bankruptcy Code sections or case law where

appropriate. Assume that case law from all circuits is persuasive,
but not binding authority. Avoid lengthy summaries of general legal
doctrines.

6. Please write legibly. Use only one side of bluebook pages.

If you type, please double-space the answers.

7. Unless your exam paper is turned in promptly at the end of

the examination period, collectors will be required to report your
examination as being late. The decision whether to accept late
examinations will be dependent on faculty action.

8. Please write at the end of your examination the following

statement: AI acknowledge and accept the honor code.@ Sign your
examination number.

GOOD LUCK!
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Question One
(30 points; Recommended: 50 minutes)

Asparagus Enterprises, Inc. (AAEI@) manufactures and distributes

asparagus-themed products such as asparagus seasonings, asparagus
juice, and the popular AMr. Asparagus@ super-hero action figures.
Over the years, AEI=s business has been extremely profitable.
Unfortunately, following the release of its newest product, a line of
asparagus-scented perfumes and colognes, a large number of purchasers
complained of severe itching and developed temporary green-tinted
rashes. In many cases, the adverse reactions did not develop until up
to three months after the perfume was used.

Following the outbreak, numerous retail purchasers and wholesale

merchants across the United States filed law suits against AEI. In
recent weeks, AEI has paid out substantial sums to settle many of
these cases, incurring huge legal fees in the process. To do so, AEI
needed to draw on 75% of its $2 million line of credit with FuzzyBank.
(Before the outbreak, the outstanding balance of the line of credit
was only $100,000.) The line of credit, which is not in default and
does not come up for renewal for another six months, is secured by
AEI=s collectible accounts receivable having a value of $3 million,
and AEI=s inventory (other than unsold perfume) having a value of $1
million.

AEI has stored its stocks of unsold perfume and perfume

containers in a warehouse, which it leases from Good Space Amalgamated
(AGSA@) at the rate of $2000 per month. Although the lease has five
years left to run, AEI only needs the space for another three months,
by which time AEI hopes to have sold and delivered the entire stock to
local producers of weed killer and rat poison. AEI is not sure
whether the rent it has contracted to pay on its lease is below or
above current market rates, but to conserve cash, has not paid rent
for the past two months.

Mounting legal bills and financial demands, coupled with

declining sales, will soon exhaust AEI=s resources. AEI also fears
that, not only may it be insolvent, but that additional persons who
recently purchased the perfume but who are unaware of the risks might
suffer adverse reactions and file additional law suits.
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AEI is considering filing a chapter 11 petition. With reference

to the above facts, what are the benefits that AEI might derive and
problems that AEI might face, prior to the negotiation, formulation
and filing of a chapter 11 plan, were it to file a chapter 11 petition
immediately?

(End of Question One)

Question Two
(20 points; Recommended: 35 minutes)

Write on your exam- paper (not on the exam itself) the number and letter of each of the questions
below, together with the appropriate word, phrase, or Bankruptcy Code section that supplies the
appropriate answer.

1. Hal and Helvatia, husband and wife, live in California, a community property state. Hal files
chapter 7; Helvatia does not file a bankruptcy petition. Two months after the filing, Hal inherits
$50,000, and wins $25,000 in the lottery with a ticket he purchased with cash he earned the previous
month. For each of the following assets: (a) Helvatia=s interest in the community property,
(b) Hal=s inheritance, and (c) Hal=s lottery winnings, indicate whether the asset will be AIn@ or ANot in@
Hal=s bankruptcy estate, citing the appropriate Bankruptcy Code section as your authority.

2. Based on the holding of the following case, (a) _____________________________, a money

judgment on a dischargeable prepetition debt that a creditor obtains against the debtor after the filing of
a bankruptcy petition without having obtained (b) ___________________is (c) _____________.

3. Prior to the filing of its chapter 7 petition, the debtor fraudulently induced Pete to purchase
5000 shares of the debtor=s stock for a price of $1.00 per share. Although the debtor is insolvent, the
trustee has determined that all creditors having secured claims and priority claims will be paid in full,
and that all unsecured creditors can expect a dividend of $.50 on the dollar. Assuming Pete=s claim is
allowed in the sum of $5,000, Pete can expect a bankruptcy dividend in the following amount:
(a) ________, based on the authority of (b) Bankruptcy Code section ___________. The debtor
(c) _______ (Awill@ or Awill not@) receive a discharge in the case, because of the following Bankruptcy
Code section: (d) ________.

4. In a chapter 7 case in which all claims will not be paid in full, indicate whether the following
creditors are entitled to receive postpetition interest on their claims ( AYes@ or ANo@) and the Bankruptcy
Code section on which you base your answer - e.g. A(x) Yes - (y) section xxx@:

(a) and (b): A creditor holding a general unsecured claim based on a promissory note providing
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for interest to accrue at the rate of 10% per annum (the maximum permitted under applicable state law)
on the unpaid balance until payment in full.

(c) and (d): The Internal Revenue Service, which filed a $50,000 tax lien six months before the
petition against Blackacre, a previously unencumbered parcel of the debtor=s real property having a
value of $200,000.

5. An involuntary bankruptcy petition is filed against the debtor. For such petition to result in
the entry of the following kind of order: (a) ____________, it must be joined in by at least this number
of creditors: (b) _____ if the debtor has at least the following number of creditors (excluding certain
employees, insiders, and transferees): (c) ________ holding claims, not contingent as to liability or the
subject of bona fide dispute that total the following amount, over and above the value of any lien on
property of the debtor held by any such creditor: (d) __________.

6. Absent entry of any court orders that create or extend any deadlines not otherwise provided
by the Bankruptcy Code, and assuming the court does not appoint a chapter 11 trustee, then if a chapter
11 debtor does not file a chapter 11 plan within (a) _________ days following the filing of a voluntary
chapter 11 petition, the following adverse consequence to the debtor will result: (b) ________________.

7. A class of unsecured claims in a chapter 11 case includes 50 creditors, of which only 31 vote.
The claims of these 31 voting creditors total $60,000, and the claims of the non-voting creditors total
$40,000. In order for this class to have accepted the plan, at least the following number of creditors
(a) ______ holding allowable claims totaling (b) $_____________ must vote to accept the plan.

8. Prior to the vote on its chapter 11 plan, the debtor wishes to make some phone calls to
creditors, and send them some information, to persuade them to vote for the plan. The debtor, however,
may not do so until the following has happened: (a) _____________ . Afterward, may the debtor
provide the creditors with financial projections that they have not previously seen, and which have not
been filed with the court, in order to sway their votes? (b) _____________ (AYes@ or No@). The
reasoning of the following reported decision supports my answer to (b): (c) __________________ .

9. XYZ Corporation holds a valid lien on Greenacre, property of the estate worth $2 million, to
secure a debt in the sum of $1.5 million (principal and interest as of the effective date of the plan). The
debtor=s chapter 11 plan provides for XYZ to be paid $1.5 million, in cash, plus interest from the
effective date at a market rate, upon sale of Greenacre, but in no event later than one year after the date
of confirmation. Is XYZ Aimpaired@ under the plan? (a) _____ (AYes@ or ANo@) . If XYZ does not vote
to accept the plan, such failure to accept will not bar confirmation because (b) ________________ .
The authority for my answer to (b) is: (c) subsection ______ of Bankruptcy Code section _____.

10. A corporate debtor=s chapter 11 plan provides for the cancellation of all of the debtor=s
shares of common stock, and issuance of new shares to the holders of general unsecured claims. No
new cash will be contributed. If a class of general unsecured claims does not accept the plan, may the
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plan nevertheless be confirmed if all other confirmation requirements are met? (a) ______ (AYes@ or
ANo@). The authority for my answer to (a) is: (b) subsection ______ of Bankruptcy Code section
___________.

(End of Question Two)

Question Three
(30 points; Recommended: 50 minutes)

Write on your exam- paper (not on the exam itself) the number of each of the questions below,
together with a short discussion answering the questions below. When appropriate, cite any Bankruptcy
Code sections or cases that support your answer. Assume that the debtor is insolvent at all relevant
times, and that unsecured claimants in the debtor=s bankruptcy case will not be paid in full.

1. One year prior to the filing of a chapter 7 bankruptcy petition, Debtor borrows $10,000 from
Bank, concurrently signing a security agreement granting Bank a security interest in Debtor=s accounts
receivable. Two weeks later, pursuant to the loan agreement, Bank duly files a financing statement to
perfect its security interest. One month before the bankruptcy filing, Debtor pays off the loan. The
trustee sues Bank pursuant to Bankruptcy Code ' 547(b) to recover the cash. What result?

2. One year prior to the filing of a chapter 7 bankruptcy petition, Debtor borrows $10,000 from
Bank on an unsecured basis. The loan is due and payable six months later. Debtor defaults. Two
months prior to the bankruptcy filing, Debtor grants Bank a security interest in its accounts receivable to
secure the loan. One month before the filing of the petition, Debtor pays Bank $2,000. The trustee sues
Bank on all available grounds. What result?

3. Sixty days prior to the chapter 7 bankruptcy filing, Debtor signs a promissory note in the
sum of $25,000 in favor of his beloved nephew, Rodney, to compensate Rodney for the affection and
friendship Rodney has shown Debtor over the past two years. The note remains unpaid as of the date of
the petition, and Rodney files a general unsecured claim. The trustee takes all available steps to prevent
the allowance of the claim. The promissory note is enforceable under applicable state law. What result?

4. Debtor is a wholly owned subsidiary of Parent Corp. Parent Corp. is in need of additional
financing from ABC Bank, but ABC Bank is unwilling to loan Parent Corp. additional funds without
obtaining additional collateral, which Parent does not have. Ninety days before Debtor files chapter 7,
Debtor grants ABC Bank a security interest in its accounts receivable to secure a new loan that ABC
Bank makes to Parent in the sum $100,000. The trustee sues ABC Bank to avoid the security interest on
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all available grounds. What result?

5. Dagbert and Dagmar Daggit, husband and wife, owe the Internal Revenue Service $10,000
for income taxes that came due on April 15, 2002 (in respect of earnings for the calendar year 2001).
They file a chapter 7 petition on September 30, 2002. The assets of the estate are expected to total
approximately $15,000. Although the IRS has received timely notice of the bankruptcy, it has come to
the Daggits= attention that the IRS has not filed a proof of claim and that only 10 days remains until the
applicable claim deadline will pass. The Daggits have been advised by their counsel (correctly) that
they may, but are not required to, file a claim on behalf of the IRS. Should they do so? Why or why
not?

6. A chapter 11 debtor owns a machine with a fair market value of $1 million, and the machine
depreciates in value at the rate of $15,000 per month. The machine is essential to the debtor=s
operations, and is subject to liens that secure debts in the following amounts as of the date of the
petition: First priority lien held by creditor A: $700,000; second priority lien held by creditor B:
$400,000; third priority lien held by creditor C: $300,000. Based on the applicable promissory notes,
interest accrues on the debt owing to A at the rate of $6,000 per month. Interest accrues on the debt
owing to B at the rate of $3,500 per month. Interest accrues on the debt owing to C at the rate of $2,500
per month. Each lienholder moves for relief from the automatic stay pursuant to Bankruptcy Code
section 362(d)(1) and (2), seeking permission to foreclose its lien. The debtor opposes the motions,
telling the court that it is willing and able to make payments to each creditor in the minimum amount
necessary to avoid an adverse ruling lifting the stay. As to each creditor, can the debtor avoid an
adverse ruling, and if so, what amount should the debtor offer as a monthly payment?

7. Vultures, Inc. is owed $50,000 as of the date of the debtor=s chapter 11 petition, secured by a
security interest in a widget owned by the debtor. As of the date the debtor files a chapter 11 plan, the
fair market value of the widget is $25,000. The debtor can survive without the widget, but would like to
retain the widget if it can do so by paying no more than $10,000 to Vultures in respect of its secured
claim under the plan. (The unsecured claimants will receive $.25 on the dollar over three years, and are
expected to support the plan.) Vultures, however, has advised the debtor that it will reject any plan that
does not provide for payment on its secured claim of at least $25,000. In order for the debtor to assure
that Vultures=s opposition does not prevent confirmation without the debtor having to pay Vultures more
than it is willing to pay, how might the plan treat Vultures=s secured claim? How many claims may
Vultures vote, in what amount(s) and on what authority?

8. Macrohard Corp. is the lessee under a premises lease with Grump Bowers, Ltd. (AGrump@).
The monthly rent is $5,000. Macrohard fell six months in arrears on the payment of rent, but wishing to
retain the lease, paid Grump $30,000 one week before filing a chapter 11 petition to cure the arrearage.
Thereafter, Macrohard assumed the lease pursuant to a court order. Subsequently, the court appointed a
chapter 11 trustee, who then sued Grump to recover the $30,000 as a voidable preference. Assuming
Macrohard=s insolvency, that all unsecured creditors will not be paid in full, and that an affirmative
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defense under Bankruptcy Code section 547(c) is not available to Grump, how should the court rule and
why?

(End of Question Three)

Question Four
(10 points; Recommended: 20 minutes)

Before he filed his chapter 11 petition, Horton, a clothes designer, had entered into a contract
with Marlo, a movie producer, to design the costumes for an upcoming film. Horton was to receive
$100,000 under the contract. After the filing, Marlo decided that she preferred to hire Flossie, a
designer whose skills are equal to Horton=s, because she does not want to do business with a chapter 11
debtor. Work on the contract has not yet started, but Horton wants to do the work because he needs the
money. Marlo wants to hire Flossie, but does not want to pay both designers.

With reference to the foregoing facts, what are the respective rights and liabilities under the
Bankruptcy Code of Horton and Marlo?

(End of Question Four)

Question Five
(10 points; Recommended: 25 minutes)

Chauncy and Chelsea Chatham are unable to pay their bills, and have decided to file chapter 7.
Among their debts are the following: (a) Chauncy=s gambling debt in the sum of $5,000 to a Nevada
casino (enforceable under state law), which Chauncy incurred one month prior to the filing in the hope
that he would win enough money to pay off all his debts; (b) the Chathams= credit card debt to Bigga
Bank in the sum of $5,000, which they incurred six months prior to the filing to pay federal income
taxes that came due one year prior to the filing; (c) Chelsea=s judgment debt to Vicky Victim in the sum
of $50,000, arising from a motor vehicle collision that occurred while Chelsea was driving without a
valid drivers= license (which had expired 10 days earlier), at the rate of 40 miles per hour in an area
where the speed limit, clearly marked and known to Chelsea, was 20 miles per hour; (d) Chauncy=s debt
in the sum of $25,000 owing under a court-approved property settlement agreement to a former spouse
who subsequently earned a fortune publishing bankruptcy textbooks, and (e) the Chathams= debt to
Chelsea=s cousin, Dilwood, from whom the Chathams borrowed $2,000 the day following the
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bankruptcy filing, after assuring him that they were not going to include him in the bankruptcy.

Which of the foregoing debts may the Chathams discharge in their bankruptcy case, assuming
that the creditors take all appropriate and timely steps to assert their rights?

End of Examination