Bankruptcy Basics

for the Non-Bankruptcy Lawyer

Presentation by:
Manuel D. Leal, Victor A. Vilaplana,
Yolanda C. Garcia, James P.S. Leshaw, Omar J. Alaniz

© 2010
Overview of Today's Program
 General Bankruptcy Principles

 The Players

 The Claims Process

 Bankruptcy Court Jurisdiction

 Adversary Proceedings vs Contested Matters

 Preferences

 Fraudulent Transfers

 The Confirmation Process

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General Bankruptcy Principles

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General Bankruptcy Principles: Chapter 7 vs Chapter 11

Chapter 7 Chapter 11
 Trustee appointed - supplants debtor's  Debtor remains in possession of company
management and liquidates estate and management (Debtor-in-Possession); has
property; powers also include avoidance all rights, duties, and obligations of trustee
actions (e.g., preference, fraudulent
transfer actions)  Designed to preserve "going concern value"
of business (though liquidation is possible)
 Cessation of all business operations
 Orderly, court-supervised process that allows
 Expeditious liquidation of assets and entity or individual to reorganize
prompt distribution of proceeds to
creditors under court supervision  Reorganized company (if not liquidated)
emerges after court confirms the Chapter 11
 No restructuring obligations Plan (examples: Texaco, GM, Chrysler,
United Airlines)
 Provides a formulaic payment distribution
scheme  Chapter 7 distribution scheme serves as a
baseline; chapter 11 provides a forum for
negotiation

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General Bankruptcy Principles: Automatic Stay
 A statutory injunction that is automatic at the instant of the
bankruptcy filing
 The following are prohibited:
 Demand letters or emails to the debtor
 Phone calls to the debtor demanding payment
 Acceleration of debt or notices of default
 Dilution or squeeze out remedies affecting a debtor's interest in a joint venture,
partnership or corporation
 Filing lawsuits against the debtor or continuing prosecution of lawsuits that were already
filed - this includes private arbitration
 Posting property for foreclosure or conducting foreclosure sales
 Perfection of security interest in collateral by filing UCCs or by filing deeds of trust
 Taking possession of collateral
 Setting off any debt owing to the debtor against any claims against the debtor

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General Bankruptcy Principles: Automatic Stay
 The stay does not prevent actions against guarantors, non-
debtors, and non-estate property

 The stay is inapplicable to causes of action by the bankrupt

debtor

 The stay can be lifted on motion to the Court

 There are exceptions to the automatic stay

 For example, police powers of governmental entities and safe
harbor provisions

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General Bankruptcy Principles:
Anticipation of a Bankruptcy Filing
 Automatic Stay
 20-day Administrative Priority Claim
 Reclamation Rights
 Other Non-bankruptcy Law Rights
 Critical Vendor Payments
 Postpetition Trade Term Agreements
 Executory Contracts
 Setoff Rights
 Asserting Prepetition and Postpetition Claims
 Selling Your Claims
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The Players

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The Players: Debtor-in-Possession
 Debtor's management and board stay in possession and operate
and oversee the business

 This is what is colloquially referred to as the "Debtor"

 All references to "Trustee" in the Bankruptcy Code apply to the

Debtor-in-Possession if a Chapter 11 Trustee is not appointed
(discussed later)

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The Players: Statutory Committees
 Intended to provide a unified voice to similarly situated
stakeholders (especially those that can't afford their own counsel)

 Unsecured creditors' committee is appointed by the U.S. Trustee

and has a broad creditor profile

 Additional committees may be appointed (e.g., producer's

committee, asbestos committee, equity committee)

 Members owe fiduciary duty to constituents and commonly assert

that the Debtor's plan improperly favors one group over another or
does not maximize value (although maximizing value not always
required)

 Fees/expenses of committee professionals (including experts and

lawyers) are paid by the Debtor

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The Players: U.S. Trustee vs Chapter 11 Trustee
United States Trustee
 Often referred to as the "Police" in the bankruptcy case (though the
court is not obligated to rule in the U.S. Trustee's favor

 Division of U.S. Department of Justice

 May be heard on any issue in chapter 11 case

Chapter 11 Trustee
 Replaces debtor's management and board, runs debtor's business,
manages chapter 11 case, and can hire its own professionals
(including lawyers)

 Extreme remedy, which requires a showing of case (e.g., fraud,

dishonesty, incompetence, or gross mismanagement either before
or after commencement of case)

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The Players: Repeat Players
 There are Many Repeat Players
 Law firms

 Lawyers

 Banks/Secured Creditors

 Landlords

 Employees/Unions

 Distressed debt firms who oppose/support the plan

 Financial advisors

 Representatives of asbestos claimants

 Representatives of environmental claimants

 Representatives of tort/products liability claimants

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The Claims Process

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The Claims Process: General Principles

 In Chapter 11, the court will set a bar date, and all claims
must be filed before the date

 In Chapter 11, check the Debtor's Schedules to determine if

your claim is scheduled.
 If claim is scheduled, creditor need not file claim unless
(i) creditor disagrees with the scheduled amount or (ii) the
claim is listed as disputed, contingent, or unliquidated.

 Filing a claim does not guarantee a recovery, but not filing a

claim typically ensures no recovery

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The Claims Process: Allowance and Payment
 A timely filed claim is "allowed" until there is an objection

 If an objection to a claim is filed, the claim is "allowed" only after

resolution
 Basis for claim objection may be state law or bankruptcy law (see 11
U.S.C. § 502(b)).

 For large creditors, negotiations will often occur with the debtor,
and a deal may be reached to resolve the claim before confirmation

 Unless the debtor is solvent, the claimant will not recover 100% of
the allowed claim value but will, instead, recover a pro rata
distribution once the assets available to pay creditors are
determined

 In some instances, claimants may be out of the money entirely

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Bankruptcy Court Jurisdiction

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Bankruptcy Court Jurisdiction
 28 USC § 1334 – statutory jurisdiction to hear cases
“arising in,” “arising under” or “related to” cases
under title 11

 Statutory authorization to hear and determine core

matters and to make proposed findings of fact and
conclusions of law on non-core matters

 Supreme Court limited jurisdiction in Stern v. Marshall

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Adversary Proceedings vs Contested Matters

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Adversary Proceedings

 Related to but separate from the bankruptcy

 Assigned a different case number and separate docket is

maintained

 Most of the federal rules of evidence and civil procedure

apply (though they are not strictly followed)

 They are essentially their own trials stemming from the

bankruptcy

 Most often heard by the bankruptcy judge unless the

"reference" is withdrawn, in which case, the district court
hears the adversary proceeding

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Adversary Proceedings
 Rule 7001 defines causes of action that must be brought in an
Adversary Proceeding
 (1) recovery of money or property

 (2) determining the validity, priority, or extent of a lien

 (3) obtaining approval for the sale of both the interest of the estate and of a
co-owner in property

 (4) objection to or revoke a discharge

 (5) revoking a confirmation order

 (6) determining the dischargeability of a debt

 (7) obtaining an injunction

 (8) subordinating any allowed claim or interest

 (9) obtaining a declaratory judgment relating to any of the foregoing, or

 (10) determining a removed claim or cause of action

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Contested Matters
 Occur within the main bankruptcy case

 More akin to motion practice and are often resolved on dispositive

motions without a trial

 However, contested matters can become complicated and hotly

contested

 Hearing setting default is approx. 20-25 days after filing of motion

but court has flexibility to expedite setting or set the hearing for a
date certain

 If discovery is needed, parties can agree on a schedule and court

approves

 Some Federal Rules of Civil Procedure apply (see Rule 9014)

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Contested Matters

 Examples of Contested Matters

 Motions to Lift the Automatic Stay

 Claim Objections

 Motions to Assume, Reject, or Assign Unexpired Leases or

Executory Contracts

 Motions to Sell Property of the Estate

 Confirmation of a Plan of Reorganization

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Preferences

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Preference - Two Typical Scenarios
 Debtor is experiencing financial hardship so he/she
chooses to pay the car, cell phone, and electric bill,
but not his/her student loans, credit cards, or a
promissory note.
 Debtor has “preferred” the creditors whose collection action
are most likely to interrupt the debtor’s lifestyle.

 Sophisticated creditor is aware of a company’s

deepening insolvency and intensifies collection effort,
extracts a payment, or files a lawsuit.
 Creditor is attempting to obtain as much of the shrinking pie
before other creditors do. Sophisticated creditors have an
advantage.

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Preference - General
 Preference law is entirely a creature of bankruptcy law.

 Preference (and fraudulent transfer) law enables the

trustee or DIP to pull back property into the
bankruptcy estate and redistribute that property to
creditors according to the Bankruptcy Code’s priority
scheme (including to the parties whose transfers were
avoided).

 Preference law is intended to prevent the race to the

courthouse and to rebalance fair distribution among
creditors who undertake disparate collection action.

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Preference - Hypothetical
 Prior to a bankruptcy filing, debtor has four creditors with
the following unpaid claims: A - $100; B - $200;
C - $500; D - $200. Assume total assets = $500.

 Debtor pays off D ($200) and 2 months later decides to file

bankruptcy.

 Without preference law, remaining $300 is shared pro rata

among unpaid creditors. Total claim pool is $800. Creditors
receive 37.5% recovery: A - $37.50;
B - $175; C - $187.50. D was paid $200 prior to filing.

 Utilizing preference law, trustee/DIP sues D for $200;

bankruptcy estate increases to $500. Total claim pool is
$1,000. Creditors receive 50% recovery: A - $50;
B - $100; C - $250; D - $100.

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Preference - Elements
 A preference is only “voidable” if it meets all seven
elements, and affirmative defenses often apply (discussed
below).
 Seven elements of a voidable preference:
 a transfer
 of an interest in the debtor’s property
 on account of an antecedent debt
 made within the preference period (90 days before the bankruptcy
filing for non-insiders; 1 year for insiders)
 while the debtor was insolvent
 to or for the benefit of the creditor
 that permits the creditor to receive more than it would under chapter
7 (liquidation) had the transfer not been made

 Notably absent: intent or state-of-mind

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Preference - Affirmative defenses
 Examples of Affirmative Defenses:

 Substantially contemporaneous exchanges for new value

 Ordinary course (can be ordinary course between parties or

ordinary course in the industry)

 Purchase Money Security Interests

 Safe Harbor Provisions (protections for financial contracts

such as derivatives, swap agreements, etc.)

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Fraudulent Transfer

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Fraudulent Transfer - General
 Fraudulent transfer law exists outside the bankruptcy
context

 The Bankruptcy Code includes a fraudulent transfer statute,

but the trustee or DIP may sue under a state fraudulent
transfer law in addition to or instead of the bankruptcy law.

 Fraudulent transfer (like preference) law enables the trustee

or DIP to pull back property into the bankruptcy estate and
redistribute it to creditors according to the Bankruptcy
Code’s priority scheme (including to the parties whose
transfers were avoided).

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Fraudulent Transfer
 Three types:

 Actual Fraud: 11 U.S.C. § 548(a)(1)(A)

 Constructive Fraud: 11 U.S.C. § 548(a)(1)(B)

 Partnership Transfers: 11 U.S.C. § 548(b)

[not covered]

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Fraudulent Transfer - Actual Fraud

 Must prove an actual intent to delay, defraud, or hinder

payment to creditors.

 Must show that the debtor had an intent to interfere with

creditors' normal collection processes or with other
affiliated creditor rights for personal or malign ends.

 No requirement of insolvency.

 Presumption of actual fraud in Ponzi schemes

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Fraudulent Transfer - Actual Fraud
 Badges of Fraud

 the lack or inadequacy of consideration

 the family, friendship, or close associate relationship between the

parties

 the retention of possession, benefit or use of the property in

question

 the financial condition of the party sought to be charged both before

and after the transaction in question

 the existence or cumulative effect of the pattern or series of

transactions or course of conduct after the incurring of debt, onset of
financial difficulties, or pendency or threat of suits by creditors

 the general chronology of events and transactions under injury

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Fraudulent Transfer - Constructive Fraud
 Must show that
 (i) the debtor received less than reasonably equivalent value of
the asset and
 (ii)
 (a) the transfer was made while the company was insolvent,

 (b) the company was left with unreasonably small capital, or

 (c) the company believed that it would incur debts that would be
beyond its ability to repay as the debts matured.

 No state-of-mind requirement

 Transfers for the benefit of insiders or obligations such as

employment contracts during company's insolvency also
satisfy the second prong

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The Plan Process

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The Plan Process
 Debtor formulates its "plan" to emerge from bankruptcy
 Stand alone plan
 Obtain exit financing
 Sell some or substantially all assets
 Merge/consolidate entities

 Debtor negotiates with key stakeholders to arrive at a consensual

plan of reorganization

 Debtor drafts plan that will classify creditors and interest holders
and sets forth distribution and payment terms

 Once debtor formulates plan (with or without agreement from key

constituents), debtor will seek approval of a disclosure statement
and distributes plan and disclosure for voting

 Creditors and interest holders may vote on the plan (unless they
are not affected by the bankruptcy or they receive no property
under the plan)
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The Plan Process: Confirmation
 Confirmation is the court's approval of the plan of reorganization
or liquidation

 To confirm a plan, one must meet the statutory obligations under

1129 (15 tests for business cases)
 plan filed in good faith
 creditors receive at least as much as they would have in a chapter 7 unless
the agree otherwise
 confirmation is not likely to be following by another bankruptcy or further
restructuring
 voting thresholds are met

 Often, the court will consider only the Debtor's plan

 But if the Debtor's exclusivity is terminated, the court may

consider multiple plans but can only confirm one

 Many aspects of litigation may come before confirmation (and may

continue after)

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