Bankruptcy
Skeel
Spring 2012
I. Consensual and Judicial Liens
a. Introduction
i. Bankruptcy law is federal law although the substantive rights in bankruptcy of debtors and creditors are governed largely by state law.
ii. If a debtors does not voluntarily pay a debt a creditor normally takes an interest in the debtor’s property in the form of a lien. A lien may be created by (1) voluntary grant (consensual liens) (2) judicial action (judicial liens) (3) statute based on status (statutory liens).
1. Consensual liens are defined in § 101(51). In personal property they are governed by Art. 9 of the UCC and in real property by the law of the situs.
2. Judicial liens are defined in § 101(36). A judicial lien results from the creditor seeking a money judgment and then seizing property of the debtor.
3. Statutory liens are defined in § 101(53). E.g., mechanic’s lien, attorney’s lien, tax lien.
iii. Liens are of paramount importance in bankruptcy because a creditor whose debt is secured by a lien has absolute priority to those with no lien or a lower priority lien. This highlights a struggle within bankruptcy to create an equitable balance betweens secured and unsecured creditors.
Three types of Liens (§101(37)):
Consensual
Nonconsensual
Consensual Lien §101(51)
Judicial Lien §101(36)
Statutory Lien §101(53)
*Voluntary Grant by the debtor
*Security interest – personal and real property
*Arise at the inception of a credit transaction
*Lien gives creditor a secured status like a creditor holding a security interest
*Arise either before or after judgment when a creditor seeks a money judgment in court
*Arises according to statute due to status of the creditor
*Key type is tax lien
*Also consensual – relate to personal property; Art 9
b. Consensual Liens
i. Security Interests in Personal Property
1. Types of Security Devices
a. Common law pledge
b. The Chattel Mortgage- akin to a real property mortgage.
c. The Condition Sale- similar to a chattel mortgage except the condition seller was the owner of the goods until title passed not merely a lienholder.
2. Creation of the Security Interest
a. A security interest, according to UCC §1-201(b)(35) is “an interest in personal property . . . which secures payment or performance of an obligation.”
i. The Bankruptcy Code § 101 defines a security interest more narrowly only as consensual liens.
b. An art. 9 security interest “attaches” when (1) value has been given; (2) the debtor has rights in the collateral; and (3) either the debtor has authenticated a security agreement describing the collateral or the debtor has agreed to the security interest and the collateral is in the possession of the secured party pursuant to that agreement.
i. The security interest remains notwithstanding sale or transfer to third party unless authorized by the secured party to be transferred free of the interest. If the debtor sells the property the “proceeds rule” is applied and the security interest attaches to the proceeds as well.
3. Perfection and Priorities
a. Attachment of a security interest means that the lien of the secured party may be enforced against the debtor. By perfecting the security interest it will become effective against third parties. Perfection is defined according to UCC § 9-308(a). The applicable requirements are generally possession of the collateral or filing of a notice of the secured transaction.
i. The purchase money security interests in consumer goods are automatically perfected when the security interest attaches with one exception, motor vehicles.
ii. Security interests in assets held by financial intermediaries may be perfected if the creditor obtain control over the intermediary.
iii. A security interest may be perfected by the filing of the security agreement.
b. Unperfected security interests are enforceable but do not have priority and may be avoided in bankruptcy.
c. In the event of competing security interests, priority is given to the security interest of the creditor who files a financing statement first.
i. This rule is trumped only by security interests perfected by control and in certain circumstances purchase money security interests in after-acquired property.
4. Default
a. If the debtor refuses or is unable to pay: (1) an unsecured creditor must obtain a judgment (2) a secured creditor may take possession of the collateral. However, taking possession must be accomplished “without breach of the peace.”
ii. Security Interest in Real Property
1. Introduction
a. Historically, a mortgagee (creditor) took possession. The mortgagor had until law day to repay. If not he lost the interest in the land although retained the equity of redemption. The creditor could take action to foreclose that equitable right.
2. Types of Security Devices
a. Mortgage–Historically, this followed the title theory however, presently the lien theory is applied.
b. Deed of Trust– The settlor (debtor) conveys legal title to a trustee in trust for the benefit of the beneficiary (creditor).
c. Installment Sale Contract– Historically, the seller sells land to the buyer on the condition that title will pass to the buyer only when the buyer has completed the installment payments under the contract. Many jurisdictions have seen this become assimilated with a mortgage while other have not.
3. Creation of the Security Interest
a. There must be an underlying obligation.
b. A transaction such as a loan, disguised as a secured transaction will have mortgage principles applied to it. A court will not enforce a security agreement where the debtor gives up basic rights as a mortgagor.
4. Perfection and Priorities
a. Perfection is achieved by recoding the mortgage document in the county of the where the property is located.
i. The majority view is that a good faith purchaser of real property without knowledge of the mortgage takes free of an unrecorded mortgage while a judicial lien creditor does not. Contra UCC § 9-317.
ii. What happens in the event of open-ended mortgages?
1. Advances made pursuant to commitment take their priority from the date of commitment.
2. Optional advances relate back to the date of the mortgage only if made by the mortgagee without knowledge of an intervening security interest.
5. Rents
a. The UCC does not apply to real property rentals.
6. Foreclosure
a. Once a debtor is in default on a security interest in real property the creditor must either sue on the debt or foreclose on the collateral. Both options are not available. [One-action rule].
b. Foreclosure may be achieved by the mortgagee exercises the power of sale contained in the mortgage. However, this forfeits the rights of the mortgagee to a deficiency judgment.
i. Some states allow the mortgagor to redeem after the sale.
c. Judicial Liens
i. Judgment and execution Liens
a. A money judgment against a defendant can be collected by a levy and subsequent sale of the property. The process of judgment and execution of judgment can result in two types of liens: (1) execution lien, which attahces to the property on which levy is made or (2) a judgment lien, which arises as a result of the judgment itself.
2. Judgment Liens
a. For the majority of jurisdictions a judgment lien only applies to real property (both presently owned and after-acquired) in the county where the judgment is docketed.
i. Some jurisdictions such as CA, allows for a judgment lien to apply also to specific personal property. This provides the creditor with the equivalent of an Art. 9 security interest.
3. Execution Liens
a. The method of carrying out levy pursuant to a writ of execution varies based on jurisdiction as well as proerpty involved. The levy may be executed by physical seizure, garnishment. However, there isa question as to when the execution lien arises.
i. Common law: The delivery of the writ of execution to the levying officer gives rise to an execution lien the personal property of debtor covered by the writ. However, the lien is inchoate and if no valid levy is made the lien lapses. If in the alternative the levy is made, the liens become perfected and dates from the date of delivery of the writ.
ii. Attachment Liens
1. Attachment (unlike its context within the creation of an Art. 9 security interest) is a prejudgment seizure. The basis for obtaining this varies between jurisdictions such as fraud or a readily ascertainable damage in contract.
2. The levy is similar to a levy under a writ of execution. The attachment lien arises at the time the levy. Attachment may be prevent by the posting of surety bond.
Pre-Judgment (Attachment) Liens
Post-Judgment Liens
· (1) Garnishment
· (2) Right of prejudgment attachment of property if there is a fear of ∆ moving assets out of reach. NOT a SI.
· Remedies curbed by SCOTUS and now are usually limited to cases of fraud, basis to believe ∆ will conceal assets, ∆ not a resident of the state, contract claims where amount owed is ascertainable
· Only granted if court decides the probable validity of the creditor’s claim
· ∆ can usually prevent with a surety bond
· These are unconstitutional unless the ∆ is provided with hearing and notice
· Arises after judgment is obtained in favor of
i. Historically, bankruptcy was a creditor’s remedy however, currently it is largely a debtor’s remedy.
b. Types of Bankruptcy
i. Chapter 7: bankruptcy liquidation. Pursuant to § 541 all property owned at the date of bankruptcy become part of the estate with exempt property released to the debtor. Lienholders will be paid. A discharge of personal liability will be given to the debtor.
1. Chapter 7 is only available to individuals that satisfy the means test.
ii. Chapter 11, 12, or 13: reorganization. The debtor does not lose nonexempt property but creates a plan to repay debts.
1. Chapter 13: For individuals with noncontingent, liquiadated unsecured debt less that $336,900 and noncontingent, liquidated secured debts of les than $1,101,650. Creditors need not approve the plan. The plan is funded by future earning based upon disposable income. Disposable income means the total income received less the amount reasonably necessary for the maintenance or support of the debtor. Pursuant to § 1328(a) a discharge is warranted after all payments are made.
2. Chapter 11: Applies to both individuals and firms and allows for the DIP to retain assets and operate the business. Plan confirmation requires votes of classes of creditors and stockholder interests.
3. Chapter 12: family farmers
4. Chapter 9: Muncipalities
c. Eligibility for Bankruptcy
i. Under § 301 only an entity that may be a debtor can file. This includes persons (individuals, partnerships and corporations). Corporations are defined to LLCS, unincorporated associations and business trusts. The debtor need not be insolvent.
d. The Petition in Bankruptcy and the Automatic Stay
i. Commencement of a voluntary case occurs upon filing of the bankruptcy petition. This triggers the automatic stay under § 362. The automatic stay bars judicial proceeding, enforcement of claims, attempt to obtain possession or acts to create or perfect a lien.
e. The Trustee in Bankruptcy
i. Chapter 7: the trustee administers the bankruptcy estate. The trustee has avoidance powers to recover property of the debtor. Trustees are paid modest fees from the assets of the bankruptcy estate as an administrative expense receiving priority.
ii. Chapters 12/13: The trustee merely disburses payments according to the plan.
iii. Chapter 11: No trustee. The DIP has the powers of the trustee.
f. Meeting of Creditors
i. Pursuant to § 341, the US Trustee must in a reasonable time convene of meeting of creditors after the bankruptcy petition is filed. The debtor according to § 343 must attend to be examined under oath.
1. Trustee election is conducted by majority on the basis of the amount of claims if creditors holding 30% of the eligible claim request an election. A qualifying claim must be allowable, undisputed, liquidated and fixed. Not all claims qualify. Secured or priority creditors may not vote.
ii. Unsecured creditor’s committee is comprised of the 7 largest creditors willing participate.
g. Claims in Bankruptcy
i. Claims are the basis of distribution and require the filing of a proof of claim. An allowed claim is a claim recognized by the court as valid in the amount stated.
ii. Types of claims:
1. Secured: A claim based upon a security interest in collateral to the extent the claim is covered by the value of the collateral. Whatever portion is not covered is unsecured by § 506(a)(1).
2. Unsecured: A claim with no security interest or the bifurcated portion of secured claim resulting from undersecured collateral.
h. Distribution of Assets to Unsecured Creditors
i. Claims are paid in order of priority as stated in § 507(a)
1. Domestic support obligations
2. Administrative expenses
3. Employee of the debtor
4. Taxes
