Chapter 13: INTRODUCTION TO BANKRUPTCY LAW

1. PURPOSE & DEFINITION

1.1. Purpose = A fresh start
The general goal of bankruptcy law is to grant a debtor relief from some of his/her/its burdensome
debts while protecting creditors.

DEFINITION Legal procedure for settling the debts of individuals or business entities that are
unable to pay debts as they become due.
The state of insolvency or inability to pay one’s debts when due (see text: “the
company is unable to pay its debts.”)

Bankruptcy protection allows the debtor to seek relief through court action that may work out or
erase debts.
= blanket of protection debtors have when they seek bankruptcy relief

Under court supervision, all or most of the debtor’s assets are used to pay his/her creditors, with
creditors of equal status (priority) each receiving the same proportions of the amounts owed to
them.
Once the liquidation, reorganization, or adjustment plan is judicially approved and then properly
completed, the bankruptcy serves the relieve the debtor from all or most of his/her debts even
though these debts have not been fully paid.

Top 10 Corporate Bankruptcies:

How could a company become  brand image
bankrupt?  competitors
 fraud  capital mismanagement
 market turned  lack of market innovation
 high-cost structure; high  bad business practices/decision
interest rates

1.2.The reasons?
- Over-expansion, resulting in too many stores/factories
- Cash flow problems, difficult to get credit
- Suppliers demand payment
- Major competitors force company to be reactive; no longer room for innovation
- Management cost / structure too high
- Cost cutting measures to save money; stop paying commission & high salaries; lose key management
staff
- Commercial credit becomes tight, fewer clients
- Global crisis, Wall Street/ Stock market Pressures
- High inventory costs
- Boom of internet retailers
- Bad business decisions = expensive failures

A look at UK company law:

Six grounds for compulsory liquidation (=sale of all assets) of a company:
1) Special resolution by shareholders
2) For public company; it has not received necessary certificate and more than one year has
passed since registration
3) For “old public companies” has not met re-registration requirements under new rules
4) Does not commence business within one year of its incorporation or suspends its business
for a whole year.
 5) Unable to pay its debts as become due
6) “The court is of the opinion that it is just and equitable that the company should be wound
up.” – this is a question of fact for the court and depends on the circumstances of the case.

The reasons: “just and equitable”  Court imposes bankruptcy

UK company law (con’t)
a) The substratum of the company has failed – “the main object for which the company was
formed fails for some reason.”
b) Deadlock in the Management of a small company
c) Justifiable lack of confidence in management
d) Company was formed for a Fraudulent Purpose

2 types of bankruptcies: voluntary vs. involuntary (creditors initiate bankruptcy petition)

Who initiates bankruptcy proceedings and how?
1) The Petition – the Bankruptcy proceeding begins by the filing of a bankruptcy petition with
the clerk of the Bankruptcy court
2) Voluntary vs. Involuntary Petition
a. Voluntary Petition – Debtor files for Bankruptcy belief
b. Involuntary Petition – Creditors initiate a Bankruptcy Petition against Debtor

Who initiates bankruptcy proceedings and how? (con’t)

What is the Bankruptcy Dividing Line?
 Filing a petition generally fixes a “Dividing Line”
i. Property acquired PRIOR to filing = Property of Bankruptcy Estate
ii. Property acquires AFTER filing = Remains the Debtor’s

1.3.Reorganization vs. Liquidation?

U.S. Bankruptcy Code:
 Reorganization: Chapter 11
- Plan to continue operating the business
- Develop a corporate restructuring plan
- Create more efficient expense structure
- Goal: position company to compete more effectively
- Typically, low rate of success.
Examples: Delta Airlines, GM (-> bailed out by Obama), Polaroid
Allows ongoing businesses to restructure their debts. Before restructuring occurs, a court-appointed trustee or
examiner conducts an investigation, files reports with the courts, and may submit a reorganization plan (if the debtor
has not) or (instead) recommend conversion to a liquidation.

 Liquidation: Chapter 7
- All assets collected and liquidated / reduced to cash
- To the extent possible, money is repaid to creditors.
The bankruptcy courts appoints a trustee to take charge of the estate. The trustee sells (“liquidates”) the debtor’s
nonexempt property, and the proceeds are then distributed to the creditors according to their priorities under law.
(ex. – taxes are usually paid before general creditors are paid)

Both Reorganization and Liquidation plans must be approved by the Bankruptcy Judge
A filing of any type of bankruptcy petition creates an Estate consisting of all of the debtor’s property
(less Exemptions)
What are Exemptions?
 A property owned by the Debtor which is protected from seizure by creditors or a trustee in
bankruptcy; such property cannot be sold or otherwise taken to satisfy a debt.

1.4.Next steps
 Automatic Stay
Entire accounts, all assets are frozen.
 Appointment of Trustee / Administrator
At the acceptance of the petition, a trustee is appointed, who is going to manage the debtor’s estate.
 Creditor’s meeting
The creditors meet (within 20 days after automatic stay). They prove their claim. Within 3 months all
creditors can file their proof of claim. Trustee decides which agreements are legally valid and
binding.
 Bankruptcy Timeline

At moment of petition: Automatic Stay; everything in bankruptcy estate is frozen. Trustee will decide what happens to
those assets. The trustee stands in the shoes of the debtor; its job is to build that pie. The creditors want that pie as
big as possible. The secured creditors stand outside of the pie.
The creditors work closely with trustee.
Ex.: as debtor owning a Picasso; knowing they’re going to go bankrupt; sell to sister: fraudulent transfer
Stink period = period of presumed insolvency  know that you’re going to go bankrupt; struggling  debtors make
preferential transfers; pay off one creditor at the expense of another.
Trustee’s job to negate preferential/fraudulent transfers.
The trustee then serves the pieces of the pie; unsecured creditors stand at the back of the line (before shareholders =
last)
Any secured collateral falls out of the bankruptcy estate.

2. ROLE OF THE TRUSTEE / ADMINISTRATOR

The Trustee acquires title of all the Bankrupt’s (debtor’s) property (“the estate”) and administers the
estate by collecting and liquidating any “non-exempt” assets as well as deciding claims.

Distribution of company’s assets

Trustee has an important role in deciding claims

 Revokes unperfected property transfers and
 Negates preferential or fraudulent transfers

Creditors with liens on or security interests in the debtor’s property may sell or otherwise dispose of the property in
order to collect the debt secured by that property. If a sale generates more than is owed, the excess goes into the
debtor’s estate. If, after disposition of the secured property, the debtor still owes money, the creditor becomes an
unsecured, general creditor for the remaining amount owed.

Based on claim of preferential transfers, creditors can still claim collateral.

3. PREFERENTIAL TRANSFERS
The role of Trustee / Administrator
 Transaction at undervalue: Trustee can set aside certain transfers of property made by the
Debtor that enabled the Creditor to receive more than otherwise would have received (US:
90 days prior to Filing of Petition; UK: period of presumed insolvency: 6 months – 2 years,
depending on status of the person receiving the benefit)
  Fraudulent Transfers: where transfer of assets was made to defraud creditors or where
transfer was made at undervalue (“claw back” period; can be several years; depending on
the jurisdiction - six months prior to filing or longer, depending on the jurisdiction)
The trustee carefully examines what happened during the stink period; depends on what the
preferential period. The bankruptcy always takes place in the court in which the bankrupt is located.
(be careful of where debtors are located)

Adequate protection doctrine: relief from automated stay (example: automatic stay: fish? stocks:
perishables: things that quickly lose value) => protects a secured creditor when value declines
(perishable goods)
The creditor can ask for the stay to be lifted because the collateral is losing value (or perishable
goods)

4. SECURED TRANSACTIONS
There are 2 types of Creditors:
 Unsecured creditor = handshake + promise to repay debt
 Secured creditor = requires the Debtor to provide some sort of “security” beyond the mere promise to
repay the debt
 Advantage: Secured Creditor is in a favored position in the event of Debtor’s default or bankruptcy

4.1. Collateral
 Property which is pledged as satisfaction for debt
 Property that Debtor offers as security
1) Must be legally “owned” by Debtor
2) In which Debtor has legal interest, and
3) Can include both Tangible and Intangible forms of property

TANGIBLE AND INTANGIBLE FORMS OF COLLATERAL

 Tangibles: All things movable at time the Security Interest attaches
Examples:consumergoods,equipment,farmproducts& livestock, inventory, etc.
 Intangibles: Non-physical property that exists only in connection with something else
Examples: stocks, bonds, certificates of deposit, accounts receivable, contract right payments, patents,
copyright, etc.

P273: personal bankruptcy

Is it fair that unsecured creditors get 0.10$ on a dollar while the debtor can get a new slate?
Example; filing for bankruptcy after getting degree (Harvard)
 A more favorable bankruptcy law promotes innovation.