I. GENERAL BANKRUPTCY INFORMATION
A. Brief overview of the bankruptcy code (Title 11 of the US Code):
1. Chapters of General Application
a) Ch. 1 – definitions, types of eligibility
b) Ch. 3 – administration of the bankruptcy estate
c) Ch. 5 – creditor’s claims, debtor’s duties, and the definition of the estate
2. Operating Chapters
a) Ch. 7 – “straight” liquidation (property of the estate is used to pay creditors)
b) Ch. 9 – municipal bankruptcies
c) Ch. 11 – business reorganizations (some individuals use, also)
d) Ch. 12 – family farms
e) Ch. 13 – individual reorganizations (“payouts” for natural persons-future income is used to pay creditors)
B. Classic bankruptcy dichotomies
1. Individual vs. Creditors – under state law, it’s all a race to the courthouse (the law of the jungle); bankruptcy is different – it is based on collective action, preventing one creditor from getting ahead of another.
2. Liquidation vs. Payout – Bankruptcy is divided into liquidations (Ch. 7) and payouts/reorganizations (Ch. 11 and 13.)
3. Purpose: Business vs. Consumer Bankruptcy – consumer bankruptcy is premised on the idea of a “fresh start” for an overwhelmed debtor; business bankruptcy is focused more on saving the business (not killing the goose that lays golden eggs).
C. Historical tidbits on bankruptcy
1. The first US bankruptcy law was enacted in 1800 and lasted 1½ years; another was passed in 1841 (lasted about 2 years) and another right after the Civil War. Finally, in 1898 a bankruptcy code was passed and the US has had one ever since.
2. Congress is expressly given the power to create a bankruptcy law in Art. I, § 8, cl. 4 of the U.S. Constitution.
3. This is mostly to deal with the problem of the north-south division between pro-creditor and pro-debtor states by creating a uniform law. It’s also important to note that bankruptcy represents a serious interference with private economic arrangements.
II. DEBT COLLECTION OUTSIDE OF BANKRUPTCY
A. The concept of leverage and collection outside of court
1. Leverage is an extremely important concept. It basically means using your legal position to gain a better bargaining position in negotiations.
2. For instance there is “hostage value” – debtors pay high-priority items like their house or their car first because the consequences of losing them are so great. Thus, the threat of collection is a more powerful tool than collection itself.
3. Perhaps the biggest source of leverage is the adverse impact collection proceedings have on a person’s credit ratings. Since that rating is important for access to future credit, the threat of damaging it is an extremely powerful tool.
B. State-law debt collection remedies
1. Judgment collection
a) Execution (by a lien creditor) – being a judgment creditor alone gives no interest in the debtor’s property or income; you have to go get a writ of execution and have the sheriff levy (or execute) on a specific piece of the debtor’s property.
(1) Note that in most states, judicial sales are governed by antiquated statutes – returns on the sales are typically quite low. A low price alone won’t invalidate the sale, but it might increase judicial scrutiny for other problems.
(2) Problem 2.1:Three different creditors recovered judgments against debtor Rollins – each for $10,000. A received judgment on 11/ but does not appear to have delivered writ. B received judgment on 11/10 and delivered writ on 15. C received judgment on 11/20 and delievered the writ on 11/22. C gets sheriff to execute on 11/25. Appliances of debtors are likely to sell for $15,000. As it stand who will get what? Depends on if the state sees the delivery of the writ by B as providing priority, what actions does the state expect a creditor to make to ensure that the sheriff executes?
b) Judgment liens by recordation – some states have a “short-cut” process, typically for real estate only, that permits a creditor to get a lien via a simple filing process.
c) Consensual liens – secured creditors get a voluntary lien on collateral that permits them to collect via self-help (i.e., repossession).
d) Statutory liens/trust funds – state law often provides special rules for certain types of creditors, such as landlords and mechanics.
e) Turnover order – used primarily for intangible or when someone has possession but not ownership
f) Deficiency judgment – when the sale of an item does not cover the debt in full; if this is done by a secured creditor, he is now an unsecured creditor for the deficiency
g) Pre-judgment remedies – there’s a basic tension between due process rights and insuring a remedy. In most states there is a bond requirement, and you have to allege the debtor is a flight risk (or will damage property, etc.). Not important for this course, but very important for real life
h) Property exempt from the collection process
(1) Each state has its own guidelines – but can include the family home, household goods-explored more under bankruptcy context
(1) General Rule: 1st in time wins (“the race of the diligent”)
(2) Unsecured creditor v unsecured creditors
(a) 1st to levy wins; levy date may be deemed to be the date the sheriff is given the writ, depending on the state.
(3) Unsecured judgment creditor versus secured creditor
(a) 1st to perfect wins. Unsecured perfects by levy; secured perfects by filing
(4) Judgment creditors and secured creditors versus buyers
(a) Typically 1st to perfect, but buyers of inventory almost always win regardless of timing.
(5) Statutory liens and trust funds
(6) Unsecured Judgment creditor and secured party versus the trustee in bankruptcy
b) USC has a contractual right – whereas the secured creditor also has a property right
c) Consensual lienà exemption cap à judicial lien
(1) For the consensual to take priority must have perfected before the judicial lien
d) Competing unsecured creditors
(1) Race of diligence: this means that the first to perfect or to turn an inchoate into a choate lien wins. This generally must be done item by item because there is no general levy power. A secured creditor will win over an unsecured one. The first to record a judgment usually has the right to the good
(2) In re estate of Robbins, pg 53: the D inherited his mother’s estate after he became indebted. One warrant was docketed 10-18-65, the other 5-10-68, and another 9-28-62. Decedent dies 4-27-67. D had no interest in the property before this. The court held that the creditor that gave after the D had an interest in the property would take first
(a) There cannot be a judgment on property one does not own or control.
(3) Weaver v. Weaver, pg 54: the weavers were divorced but before the property was split there were 3 judgments entered against the husband. 2 were in 1981, one was in 1986. The 2 in 1981 did not renew their interests, so the wife was given the house free and clear. The one in 1986 did object. The wife had to give the husband 3K for the house. The money may go to the creditor but the liens do not go with the house. Since 2 were not renewed, they are expired and are no unsecured.
(1) Get a judgment and then what – you have a nice piece of paper
(2) Need to obtain a writ of execution
(3) Levy is the sheriff delivering the writ and collecting property or immobilizing it?
(4) Nulla bona – no property found
(5) What must sheriff do to complete a priority conferring levy
(a) Credit Bureau of Broken Bow v. Moninger, pg 56: B got a lien against M in 1977. M renewed a loan with B in 1978 using his pigs and his truck to secure it. On 6-27, 1978, B got a writ of execution after the loan was renewed. On 7-7-78 the sheriff levied on the truck but did not remove it. On 7-10-78 bank and M signed a security agreement on the truck. On 7-13 the truck was seized and sold on 8-14. The bank wants it money, claiming it was secured and the sheriff had notice of a possible lien. The court held that the creditor, b, became perfected in his security when the sheriff levied the truck.
(i) Rationale: a lien is perfected when the sheriff executes the lien; whether or not he removes it is up to him. If one becomes a secured creditor after that date, then they are second in time and nothing can be done to change these priorities.
(ii) The act to prefect a lien is to levy on it.
(iii) A symbolic lien executed at the courthouse should date back to the date it was entered
(iv) Some courts do not think that there has to be a physical interference with the property for there to be perfection of the attachment.
(v) If the goods are left in the hands of the debtor for a long time then the inaction of the creditor will destroy the lien.
f) Dormant judgments
(1) If a judgment creditor fails to seek enforcement of a judgment for a period of time-usually a year, the judgment becomes “dormant”
(2) It is no longer enforceable unless “revived”
(3) Although dormancy can be cured, expiration of the statue of limitation to enforce a judgment is usually terminal
(4) The statute of limitations is commonly ten years and runs regardless of dormancy or attempts to enforce. Judgment creditor can avoid expiration by filing a new action
3. Garnishment – going after an asset of the debtor held by a 3rd party. It creates a “temporal net” that “catches” money placed in an account.
(1) Collection typically requires a writ of garnishment, especially if it’s an intangible, like money in an account (be it bank or payroll).
(2) Courts are generally more lenient with a garnishee who defaults than they are with a defaulting debtor, especially if the garnishee is a natural person.
(a) Webb v. Erickson, pg 62: W obtained a default judgment against E, a realtor. W served a writ of garnishment against B who bought his house from E. B never answered the petition because he thought his house was in escrow and had no control of payment to E. W then obtained a full default judgment against B who learned of these 3 years later when his wages were garnished. The court held that a writ against a defaulting garnishee should be dismissed if he does not understand the garnishment.
(i) Rationale: although a garnishor can obtain full judgment against a defaulting garnishee, the laws allowing this should be construed in the favor of the garnishee. This is because he is an otherwise disinterested party but one that is in danger of being injured. This writ did not contain clear directions on how or when to answer so B’s failure to answer was excusable neglect.
(ii) A defaulting garnishee may be held liable for the full amount of the default.
(3) Garnishment of a bank account – the key is that banks have the right to setoff, i.e., to offset any amount owed to them by the debtor before they pay the garnishor (that is, the creditor).
(a) The setoff language must be in the bank’s agreement with the debtor (it’s boilerplate, so every bank has it).
(b) Setoff is in essence a security interest held by the bank; the bankruptcy code explicitly treats it as such.
(c) Problem3.1: FF gets garnishment writ on WS’s bank account for $3k; he has a ($10) balance. On 2/5, he deposits $5k; on 2/7, SF gets $3.5k judgment and does same; on 2/9 both writs are served.
(i) Bank gets $10 setoff, leaving $4,990 balance. Who gets what depends on the state; either FF wins (if writ date relates back); otherwise, they split pro-rata.
(4) Wage Garnishment
(a) The basic problem with wage garnishment is that the debtor still has to provide food and shelter, etc. for himself – you obviously can’t take every dollar of his paycheck.
(b) 15 USCA § 1671, et seq. sets federal limits (lesser of 25% of disposable income or 30x minimum wage).
(a) This acts as a floor – state law can provide additional protections to the debtor.
(c) Commonwealth Edison v. Denson, pg 66: D owed money to ConEd who delivered a writ of garnishment on D’s employer, CAT. CAT sent ConEd money but not the full amount because they were already withholding money for child support. The court held that support order deductions should be taken into account when computing the amount of the debtor’s earnings.
(i) Rationale: the law must allow only a deducti
e creditor – the furniture debt did not arise until after the coin collection was transferred. Thus, they can’t use UFTA § 5. (If there was prior debt on the card, you could use that; you could also argue that the line of credit the card represents is the functional equivalent of present debt).
b) They are therefore left with UFTA § 4. Under (a), you’d have to prove actual intent to defraud. There is a “badge of fraud” here, but that’s not conclusive on the issue. Under (b) you’d have to prove B’s cousin had reason to believe B was insolvent.
3. Problem 4.3 – JS owned homestead free and clear-worth $100K. His other assets total $55K and he owes debt of $75K. Wants to do something nice for his son and conveys his homestead to the son. Can JS’s creditors reach the homestead? Homestead exempt under bankruptcy.
4. Problem 4.5 – KW loans $100k to her friend PR to start a business (money lent to the company directly), repayable in six years. Six years later, PR says she sold all stock to RL (who has no business know-how). The sale was on credit, with the company guaranteeing RL’s payments to PR with all of the company’s assets. The company’s assets > its liabilities, but its bills are piling up. KW is worried about the business failing. Can she invalidate the sale?
a) First of all, what transaction are you trying to undo? Answer: the company’s security of the loan on the stock sale, since the company is what owes KW.
b) There’s no actual fraud, so UFTA § 4(a)(1) doesn’t apply. Thus, we are left with UFTA § 4(a)(2), which probably also doesn’t apply because there is reasonably equivalent value given (presumably the stock sale reflects the value of the company; there’s no indication in the facts of a bargain-basement sale).
c) The company isn’t balance-sheet insolvent, but it can’t pay its debts as the come due so they are presumed insolvent, UFTA § 2, so UFTA § 5 applies. Company is an insider, and it would have reason to know of its insolvency. Thus, can void under UFTA §5(b).
5. Problem 4.6 – The big point: by the strict statutory language, a tithe to a church while insolvent is a fraudulent transfer under UFTA § 5(a) unless value was exchanged (and spiritual fulfillment probably does not fit in UFTA § 3’s definition of “value).
E. State Collective remedies
1. Assignments for the Benefit of Creditors (ABC’s) and other remedies
a) A debtor can assign all his nonexempt property to a 3rd party and have his creditors go deal with him; it gets all the creditors off his back.
b) Property is in the custody of the court; trustee acts in much the same way as a bankruptcy TIB.
2. Composition – Creditors all agree to a partial payment in full satisfaction of the debt.
a) This is used in bankruptcy as well, but with important differences – such as the inability in bankruptcy for a creditor to “revive” the debt once the composition has been accepted.
3. Extension – Creditors give debtor more time to pay.
4. Receivership – Similar to how a guardian takes over the property of a minor or incompetent; it is commonly used when the debtor is exempt from bankruptcy protection (such as churches, non-profits, certain insurance companies)
a) There are two types of receivership: regulatory (ex.: SEC takes over a financial institution for breaking regulations) and financial (to protect creditors.)
5. Why use a state alternative to bankruptcy? Procedures can be faster and less expensive; some options are less public (like compositions); full bankruptcy protections aren’t always necessary.
III. INTRODUCTION TO BANKRUPTCY
A. Deciding what type of bankruptcy to file
1. The first thing a lawyer should do is to determine if there are any conflicts of interests he might have by representing one of the parties to a bankruptcy proceeding.
a) § 327(a) – an attorney must be “disinterested” – meaning no interest at all in the outcome of the case. This is a tough standard to meet.
2. Next, a lawyer should see if a non-bankruptcy proceeding would be better.
3. Finally, a lawyer should consider whether a liquidation (Ch. 7) or a payout (Ch. 13) would be better. Some individuals with large debts not qualifying for Ch. 13 may want to use Ch. 11.
4. Converting to other Chapters
a) You can convert your case from a Ch. 7 to another chapter once. § 706
b) You can convert a Ch. 13 to a Ch. 7 any time. § 1307.
c) You can convert a voluntary Ch. 11 only under certain conditions. § 1112.
5. Involuntary consumer bankruptcies
a) Creditors can force a debtor into Ch. 7 (or 11) if… (§ 303(b))
(1) 12 or more creditors, and 3 or more of those creditors have undisputed, non-contingent, unsecured claims totaling $10k in the aggregate over any lien on the debtor’s property.
(2) Less than 12 creditors, if one or more has an undisputed, non-contingent, unsecured claim totaling $10k in the aggregate over any lien on the debtor’s property.