Bankruptcy Outline

BANKRUPTCY MORRISON SPRING 2014

I. Introduction

General Notes:

· Claim – bankruptcy term for the amount of money owed to a creditor

o 101(5) The term “claim” means—

§ (A) right to payment whether or

· Debt Overhang and Creditors’ Bargain Example

o PowerCo can produce $100 worth of energy at a cost of $50 ($50 profit)

o The power plant can be scrapped for $10

o Going concern value = $40

o Creditor 1 is owed $100

o Creditor 2 is owed $100

o PowerCo has no cash

o PowerCo should be able to borrow $50 from Creditor 3 and pay a reasonable interest rate

· Two types of insolvency—balance sheet insolvency & cash flow insolvency

o Balance sheet insolvency–When the value of the debt exceeds the value of the assets

§ Common to never declare BK

o Cash flow insolvency—the firm has insufficient cash to pay obligations as they come due

§ Illiquidity

· Financial vs. Economic distress

o Economic—the firms assets are worth more liquidated than used for its existing purpose

§ The law cannot save economic distress

o Financial—cannot occur w/o debts–debts that you cannot service—cash flow of the firm are insufficient to pay the debts of the firm–the going concern value is greater than the liquidation value

· Going concern value—the present value of the firm’s future cash flows

· Liquidation value-value of the assets liquidated—value of the firm dead

· The delta between going concern and liquidation value is the positive going concern surplus

· If the going concern value is less than the liquidation value it is in ECONOMIC DISTRESS

· We are looking for firms that are worth more alive than dead but that the market will nonetheless kill them if things keep going the same way

o Must have multiple creditors—

o Firm can benefit from the process (not economically distressed)

o Non-BK law is inadequate

o Collective action problem (

· Unless there is debt there is nothing that the law can do.

· One of the jobs of BK is to mitigate the costs created by the collective action problem

· Debt Overhang—viable projects wont be funded bc the upside is shared by multiple creditors—distress can lead to underinvestment

· A distressed firm may overinvest in inefficient projects

o this is known as asset substitution or risk shifting problem—bc in a corporation equity holders cannot do worse than 0.

· Butner Principle

o Rights that exist under state law will control in bankruptcy unless the code provides otherwise.

· Stern v. Marsahll

o Bankruptcy Courts are not Article III Courts

o They cannot exercise autonomous judicial power

o May hear and determine “core matters”

§ Core matters cannot include state law counterclaims

· 28 U.S.C. §1408

o Can file in the district “in which the domicile, residence, principal place of business in the United States, or principal assets in the United States” are located…

· Voluntary (§301) vs. Involuntary (§303)

o Involuntary cases are significantly harder:

§ Number of Creditors: There must be 3 or more unsecured creditors

· Unless the firm has less than 12 unsecured creditors

§ Claim Size: total claims exceed $15,325

§ Solvency requirement: “equitable” (i.e., cash-flow) insolvency

§ Penalties: creditors punished if filing dismissed

Good Faith Filing

· 1112(b): may dismiss for cause

o Non-exhaustive list of cause

o Basic argument is that it was not in good faith

In re Integrated Telecom—eligibility for BK (pg. 5)—preserve going concerns & max value of Ds assets

· Insolvency is not a prerequisite to filing under Chapter 11

· Two inquiries that are relevant to the question of good faith:

o (1) Whether the petition serves a valid bankruptcy purpose

§ protecting a viable business

§

o (2) Whether the petition is filed merely to obtain a tactical litigation advantage

§ redistribution cant be the sole purpose

· “Courts…have consistently dismissed Chapter 11 petitions filed by financially healthy companies with no need to reorganize under the protection of Chapter 11.”

· “To be filed in good faith, a petition must do more than merely invoke some distributional mechanism in the Bankruptcy Code. It must seek to create or preserve some value that would otherwise be lost – not merely distributed to a different stakeholder – outside of bankruptcy.”

· Its almost like there isn’t a multi-creditor problem here since the LandL is the only real creditor

In re Kingston Square Associates (pg. 12)

· Debtor induced the involuntary filing does not alone equal bad faith

· Section 1112(b) bad faith filing of involuntary petitions

· Federal Deposit Ins. – “a collusive filing of a bankruptcy case is a fraud upon the jurisdiction of the Bankruptcy Court and therefore susceptible to immediate dismissal.”

· Establishes a pretty high bar for getting an involuntary petition to be filed in bad faith

· Test:

o “Bad faith will not normally be found where the primary motivation of petitioning creditors was to prevent further dissipation of assets through foreclosure in an attempt to facilitate an orderly workout among all the creditors.”

· Holding:

o Collusion alone does not establish bad faith

o Here the goal of the collusion was to protect value so it is permissible

II. Commencement

General Notes:

· Absolute Priority Rule: When a company is liquidated we pay in order of non-bankruptcy priority:

o First: Secured Creditors and Lien Creditors

o Second: Unsecured creditors

§ General