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Bankruptcy
University of Kansas School of Law
Ware, Stephen J.

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. State Law Debt Collection
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, pg 53:Three different creditors recovered judgments against debtor Rollins – each for $100,000. A received judgment on 11/1 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 delivered the writ on 11/22. C gets sheriff to execute on 11/25. Appliances of debtors are likely to sell for $150,000. 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

Consensual

Judicial

Pers

9-610
Creditor sale- private sale

Writ of execution
Sheriff levies
Sheriff sale

Real

Mortgage foreclosure
Public auction
Court confirmation

Judgment lien
Sheriff or court sells
Court restrictions

i)
2. Priorities
a) Background
(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
e) Execution
(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 47: 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 55: 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

either balance sheet insolvency (debts > assets) or debtor can’t pay debts as they come due (latter creates a presumption of insolvency)
(2) Test #2 (UFTA § 5(b))
(a) A transfer is fraudulent to a present creditor if it made to an insider for an antecedent debt (i.e., debt existing prior to the transfer), and the insider had reasonable cause to believe the debtor was insolvent.
g) Remedies, UFTA §7- generally avoiding the transfer
(1) 7A: avoidance of a lien
(2) No property transfer
(3) 7A1 & 8B: j’ment against the transferee for the amount owed to the C.
(4) There is an actual transfer of property
(5) 7B: lien on the property
(6) Direct levy on the property; allows the property to be followed. There must be a j’ment against the D before this can be done
h) Defenses, UFTA § 8
(1) 8A: good faith transferee who gave reasonably equivalent value for the good
(a) This should only occur in the context of a 4A1 FT
(2) 8D1: lien that works against an 8B action when the C wants to levy the property wherever it sits. There must be some value given
(3) 8D?: reduction in judgment works against a 7A action
(4) There is a reduction for the amount that is given in good faith
3. Fraudulent Conveyances Under Bankruptcy (§ 548)
a) The TIB has the right to void the transfer of assets for less than their FMV if that transfer amounts to a fraudulent conveyance. Most of the fraudulent conveyance material is covered supra.
b) Note that § 548 provides a baseline for fraudulent conveyances; state law can provide more. § 544(b) (part of the “strong-arm” clause) lets the TIB opt to use state law provisions.
c) Federal fraudulent conveyance law (§ 548).
(1) The TIB can avoid a transfer within one year of filing if the debtor:
(a) Had actual intent to defraud, or
(b) Received less than reasonably equivalent value and was insolvent, had unreasonably low capital, or intended to incur debts beyond his ability to pay.
(i) Recent Congressional amendments remove religious and charitable contributions (up to 15% of gross income or consistent with debtor’s prior practice) from this provision.
(ii) Also note that there is no presumption of insolvency for this section (unlike preferences).
(iii) Note the test for insolvency in § 101(32) is balance sheet insolvency.
(2) Unless voidable under another section, a transferee taking a fraudulent transfer in good faith and for value has a lien on the interest transferred to the extent of value given.
(3) Also: § 550 – TIB can get value from initial transferee; good faith transferee also has lien to the extent of the lesser of any improvements and increase in value related to such improvements.
d) An interesting point: fraudulent conveyance provisions permit a debtor to attack a transfer he made, something he can’t normally do, because the “debtor” isn’t the “debtor” – he’s the DIP, taking the place of the TIB, who can void such transfers.
D. Problems
1. Problem 4.1, pg 91 – A is insolvent, owing $50k to FF; she sells her piano [FMV $40k, asks $20k, sells for $15k] for food money. Is this a fraudulent conveyance?
a) Probably not, arms length transaction and no intent to defraud
b) Maybe yes – the debtor is insolvent and it isn’t for reasonably equivalent value, so it meets UFTA § 5(a). But valuation is everything! $15k is probably the “real” FMV given the hurried conditions of sale; it could also be reasonably equivalent value because it’s a crisis sale.
(1) Note UFTA § 3(b) – “reasonable value” includes what is received at a foreclosure sale. You could argue that this ought to be extended to mean the value that would have been received at a foreclosure sale.
c) Note that if this transaction was invalidated, the purchaser of the piano would have a lien against the debtor for the $15k. Of course, he loses his TVM and his bargain.
2. Problem 4.2 – B is insolvent. She sells her coin collection (FMV $75k) to her cousin for $5k to “keep it in the family.” B then buys $25k of furniture on American Express. Can AmEx use the UFTA to void the coin collection transfer?
a) Yes, not arms length, intent to defraud
Maybe not. AmEx is a future creditor – the furniture debt did not arise until after the coin collection was