Bankruptcy Outline
Modified Version
Part One
Introduction: Debt and the Need for Bankruptcy Law
Advantages of debt:
· Less risky than equity (creditors get paid b/f equity holders);
· Essentially, debt facilitates differing risk preferences;
Negative aspects of debt:
· It can create “financial distress” – this occurs when one can’t generate enough revenue to pay debts; it is what bankruptcy is designed to address. (Example of financial distress – acceleration of full principle amount of debt caused by default. (“Economic distress” is when a firm can’t succeed b/c of the market.)
· Instability is created by debt.
Nonbankruptcy rules suffer from 2 problems:
(1) They are premised on individual creditors pursuing their own remedies; the action of each creditor often run counter to what is in the best interest of the creditors as a group.
(2) Individual debt collection remedies rest on the premise that debtors have sufficient assets to pay what they owe.
I. Individual Debt Collection Outside of Bankruptcy
Keep 2 questions in mind:
· What rights does a particular creditor have against debtor or debtor’s property?
· What rights does a particular creditor have against other creditors? (The “priority” question.)
A. Rights of General Creditors
(1) Non-judicial remedies: (p. 5 hypothetical) Supplier sells suits to local stores, payment w/i 30 days. Discovers that Retailer has not paid for suits delivered more than 60 days before. Sends retailer another bill. Frost emphasized the importance of pursuing non-judicial remedies first. Options include ceasing supply, bargaining, reporting to credit bureau.
(2) Judicial remedies: (as an unsecured creditor, Supplier can’t take back suits w/o actual consent of Retailer – no self-help.) Getting priority over other creditors is important here, b/c Retailer probably doesn’t have enough resources to pay all debts.
(a) Prejudgment remedies: (to ensure that assets will be available if Supplier prevails in litigation)
· Notice filed in the real estate records or in records in which security interests are filed; OR
· Have sheriff seize (“attach”) some of Retailer’s physical assets.
if no prejudgment remedies available …
(b) Judgment: Supplier must win lawsuit to establish priority and obtain Retailer’s property.
· Judgment docketed (recorded on a judgment roll);
· Judgment lien: encumbers property in creditor’s favor, establishes creditor’s place in line and fixes rights against 3rd parties. (Gives right to go after the property and priority over all those who later acquire liens or who acquire the property after the lien arises.)
· Personal property: (such as suits) to reach personal property, Supplier would have to do more than get judgment docketed. Must get writ of execution, which directs the sheriff to seize and sell sufficient property to pay judgment.
· State-supervised sale: regulated to protect junior creditors; sometimes appraised and can only be sold if a minimum price is received (“upset price”).
(c) Limitations on what assets creditor can reach: (if D is corp., should be able to reach all assets)
· If Retailer individual, some kinds of property out of reach; (ex: equity in home, homestead exemptions, life insurance policies, pension funds, tools of one’s trade, clothes, household furniture – all subject to dollar amounts.)
· Consumer Credit Protection Act: limits extent to which any single creditor can garni
nders get “superpriorty” if they follow procedures – file promptly (before possession of goods by D) and notify creditors with security interests in after-acquired property.
(5) Exercises; page 18.
1B(1): Mfr. Sells machine to D on 1/1. D promises to pay Mfr. on 2/1. D never pays. On 3/1, Bank lends to D and takes security interest in machine. On 4/1 Bank files. Mfr. sues D, receives judgment 5/1. Sheriff seizes machine under writ of execution on 6/1. Who prevails w/respect to machine, Mfr. or Bank?
1B(2): D bought a drill press from Seller two years ago. D borrowed $50K from Bank on unsecured basis to pay for it. Last year, D borrowed $50K from Fi. Co., granted it a security interest in the drill press, and signed a written security agreement. Fi. Co. never files a financing statement. Last month, Bank sued D, but its claim has not been reduced to judgment, and no prejudgment remedies are available. Last week Fi. Co. took possession of the drill press. Who has priority?
1B(3): (page 19) Bank takes and properly perfects a s.i. in D’s inventory. Several months later, D defaults on an unsecured loan from Fi. Co., as it has on loans from many others. Fi. Co. threatens to sue, but before it does so, D sells the inventory and uses the proceeds to repay an unsecured loan from Fi. Co. Does Bank have any recourse against Fi. Co.? In answering this question, consider R9-332.