Class 1 Bankruptcy, Spring, 2009 Case Initiation & Property of the Estate Randal C. Picker Leffmann Professor of Commercial Law The Law School The University.

Class 1Bankruptcy, Spring, 2009

Case Initiation & Property of the Estate

Randal C. PickerLeffmann Professor of Commercial Law

The Law School

The University of Chicago

773.702.0864/[email protected] © 2005-09 Randal C. Picker. All Rights Reserved.

April 19, 2023 Copyright © 2005-09 Randal C. Picker 2

The Dark Side of Bankruptcy?

The Hypo Zero real rate of interest Project requires $100 cash investment Firm want outside financing 10% of the time the project yields $50 90% of the time the project yields $V > 50


Social Q: Do We Want This Project?

Expected Value of the Project .1*50 + .9*V – 100 Want the project undertaken if V > 105.55


Outside Funding of the Project

Assume lending market is competitive Funding decision, with zero interest rate,

requires recovery of $100 investment Let D be the amount of debt to be owed to

the lender Then we need 100 = 0.1*50 + 0.9*D D = 105.55


Take Stock

Social Incentives = Private Incentives Want project undertaken if V > 105.55 Lender will finance with D = 105.55 Lender will finance if and only if project is

socially useful


Introduce Bankruptcy

If project fails ($50 value of project results) Assume mechanism exists that will enable

firm to undertake new investment project With project, invest $50 90% of the time get nothing, 10% of the

time get $300


Social Q: Do We Want This Project (and this Mechanism)? Expected Value of the Project

.9*0 + .1*300 – 50 = -20 Bad Investment!


What will the Firm Do?

With D = 105.55 On failure with $50, firm keeps nothing

(Lender owed 105.55 is entitled to all of the money)

But if Firm undertakes new investment .9*0 + .1*(300-105.55) = 19.45 Firm will undertake bad project if allowed to

do so


What will the Firm Do?

Lender gets .9*105.55 + .1*(.9*0 + .1*105.55) = 96.05


How will Lender Respond?

Needs new debt amount upfront, call it F, where F needs to satisfy .9*F + .1*(.9*0 + .1*F) = 100 .91*F = 100 F = 109.89


What Does This Mean?

Is Lender Harmed by this Mechanism that Allows the Bad Investment when Firm Fails? Not in this example Lender takes into account ex ante

anticipated bad investment when Firm fails Lender raises debt amount from 105.55 to

109.89


What Does This Mean?

Is Firm Harmed by this Mechanism? Yes Firm can’t fool Lender Firm loses ability to finance projects where

105.55 < V < 109.89 Is Society Harmed?

Yes, in exactly the same way


More Meaning

Possible Downside of Bankruptcy If bankruptcy makes it possible for firm to

undertake bad investments, lenders will anticipate that and adjust lending accordingly

Good upfront investments will be lost We would be better off without bankruptcy

or if we allowed firms to waive access to bankruptcy


Other People’s Money

Investment Incentives with Debt Firm is willing to undertake bad project

because it isn’t spending its own money Presence of debt changes investment

incentives


Other People’s Money

Bankruptcy Rules Matter If bankruptcy rules facilitate bad in-

bankruptcy investments, rules matter Creditors will adjust but we will lose socially

valuable investments upfront Is this a Fair Characterization of

Bankruptcy?


Initiating a Case: Statutes

109 Eligibility Rules

301 Voluntary Petitions: Mechanics and

Consequences 303

Involuntary Petitions


Initiating a Case: Statutes

305 Abstention

When may the bankruptcy court decline to exercise jurisdiction over a case within its power?


109: Relation to the U.S

Who may be a debtor (a) Notwithstanding any other provision of

this section, only a person that resides or has a domicile, a place of business, or property in the United States, or a municipality, may be a debtor under this title.


109: Chapter 7 Eligiblity

Who may be a debtor (cont.) (b) A person may be a debtor under chapter

7 of this title only if such person is not— (1) a railroad; (2) a domestic insurance company, bank,

savings bank, cooperative bank, savings and loan association, building and loan association […]; or


109 (cont.)

Who may be a debtor (cont.) (3)(A) a foreign insurance company, engaged in

such business in the United States; or (B) a foreign bank, savings bank, cooperative

bank, savings and loan association, building and loan association, homestead association, or credit union, that has a branch or agency … in the United States.


109: Chapter 9 Eligibility Who may be a debtor (cont.)

(c) An entity may be a debtor under chapter 9 of this title if and only if such entity--

(1) is a municipality; (2) [omitted]; (3) is insolvent; (4) desires to effect a plan to adjust such

debts; […]


109: Chapter 11 Eligibility Who may be a debtor (cont.)

(d) Only a railroad, a person that may be a debtor under chapter 7 of this title (except a stockbroker or a commodity broker), and an uninsured State member bank, or a … may be a debtor under chapter 11 of this title.


109: Chapter 13 Eligibility

Who may be a debtor (cont.) (e) Only an individual with regular income

that owes, on the date of the filing of the petition, noncontingent, liquidated, unsecured debts of less than $336,900 and noncontingent, liquidated, secured debts of less than $1,010,650


109 (cont.)

Who may be a debtor (cont.) or an individual with regular income and such

individual's spouse, except a stockbroker or a commodity broker, that owe, on the date of the filing of the petition, noncontingent, liquidated, unsecured debts that aggregate less than $336,900 and noncontingent, liquidated, secured debts of less than $1,010,650

may be a debtor under chapter 13 of this title.


109: Chapter 12 Eligibility

Who may be a debtor (cont.) (f) Only a family farmer or family fisherman

with regular annual income may be a debtor under chapter 12 of this title.


109: Serial Filings Limit

Who may be a debtor (cont.) (g) Notwithstanding any other provision of

this section, no individual or family farmer may be a debtor under this title who has been a debtor in a case pending under this title at any time in the preceding 180 days if—


109 (cont.)

Who may be a debtor (cont.) (1) the case was dismissed by the court for

willful failure of the debtor to abide by orders of the court, or to appear before the court in proper prosecution of the case; or

(2) the debtor requested and obtained the voluntary dismissal of the case following the filing of a request for relief from the automatic stay provided by section 362 of this title.

109 (cont.)

2005 Amendments on Prepetition Counseling See 109(h)



301: Commencing A Voluntary Case

Voluntary Cases (a) A voluntary case under a chapter of this

title is commenced by the filing with the bankruptcy court of a petition under such chapter by an entity that may be a debtor under such chapter.

(b) The commencement of a voluntary case under a chapter of this title constitutes an order for relief under such chapter.


Bankruptcy Forms

Go to http://www.uscourts.gov/bkforms/bankruptc

y_forms.html Voluntary Petition Form


303: Involuntary Cases: Eligibility

Involuntary Cases (a) An involuntary case may be

commenced only under chapter 7 or 11 of this title, and only against a person, except a farmer, family farmer, or a corporation that is not a moneyed, business, or commercial corporation, that may be a debtor under the chapter under which such case is commenced.


303: Dollar Amounts and Numbers

Involuntary Cases (cont.) (b) An involuntary case against a person is

commenced by the filing with the bankruptcy court of a petition under chapter 7 or 11 of this title -

(1) by three or more entities, each of which is either a holder of a claim against such person that is not contingent as to liability or the subject of a bona fide dispute, or an indenture trustee representing such a holder, if such claims aggregate at least $13,475 more than the value of any lien on property of the debtor securing such claims held by the holders of such claims;


303 (cont.)

Involuntary Cases (cont.) (b)(2) if there are fewer than 12 such

holders, excluding any employee or insider of such person and any transferee of a transfer that is voidable under section 544, 545, 547, 548, 549, or 724(a) of this title, by one or more of such holders that hold in the aggregate at least $13,475 of such claims;


303: Substantive Standard for Involuntary Petition

Involuntary Cases (h) If the petition is not timely controverted, the

court shall order relief against the debtor in an involuntary case under the chapter under which the petition was filed. Otherwise, after trial, the court shall order relief against the debtor in an involuntary case under the chapter under which the petition was filed, only if -

(1) the debtor is generally not paying such debtor’s debts as such debts become due unless such debts are the subject of a bona fide dispute; or …


305: Abstention

Abstention (a) The court, after notice and a hearing,

may dismiss a case under this title, or may suspend all proceedings in a case under this title, at any time if

(1) the interests of creditors and the debtor would be better served by such dismissal or suspension; or …


More Ways to Make the Case Go Away

707 Dismiss the case for “cause”

1112 Dismiss or convert the case (to another

chapter) for cause


Shawmut Bank

Equipment Trust

Eastern$500MM Sale

and Leaseback

Trust Certificates

1st Priority Secured $200MM

2nd Priority Secured $200MM

3rd Priority Secured $100MM

1. How should we characterize this transaction? 2. Why does it matter?

I1 --- IN


Two Characterizations

Transaction Between Trust and Eastern Nominally a sale and leaseback That means title to the planes leaves

Eastern and comes to the Trust If Eastern files for bankruptcy, planes won’t

be part of the bankruptcy estate created when Eastern files a bankruptcy petition


Two Characterizations

Status of the Trust What kind of entity is the trust? Is it bankruptcy eligible or is it “bankruptcy

remote”?


Sale and Leaseback as Secured Transaction

Parties Agree Deal is Secured Transaction Implications

Trust makes loan to Eastern and is a creditor of Eastern

Title to Assets Remain with Eastern and assets will be part of Eastern bankruptcy

Trust as secured creditor will have priority over other creditors as to the planes


Sale and Leaseback as Secured Transaction

Why? Historically, parties seek to use form to

control results in deals Law frequently looks through form to

underlying substance


The Eastern Bankruptcy

Follow the Airplanes 3/9/89: Eastern files Chapter 11 (official

name of the bankruptcy “In re Ionsophere Clubs”)

1/23/91: Eastern cuts deal with collateral trustee to turnover planes and $230MM in cash from sales of planes


Why File?

Why was an involuntary bankruptcy petition filed against the Trust?


Why the Filing? Conf Call April 5, 1991: David Sherman, a vice

president of Charter National Life Insurance Company MR. SHERMAN: [One reason for the filing is that the

First Series certificate holders are seeking payment of] interest on interest and redemption premium if entitled to it. And they have been very strongful [sic ] with that way. And as a result if that were to happen there would be no cash left in the estate for the Second or the Thirds to take care of their planes and generate asset sales or even help upkeep their lease requirements. …


Why the Filing? Two, the structure between the Indenture Trustees and

the Collateral Trustee, as Barbara has experienced, is horrible. The Collateral Trustee really won't do anything if he can avoid it because he is afraid of getting sued. And the Indenture Trustees say we think you should do this but we're not going to instruct you. So no one ... nothing ever gets done. If Northwest or some other firm came to the Collateral Trustee and said we can sell you, we can sell 20 planes tomorrow, we'll buy them, but it's a one week offer and you have to decide, the Collateral Trustee would say "Gee, I don't know. What should I do.“


Why the Filing?

The Firsts would say "We don't care as long as we can get our cash out." The Seconds would probably say "as long as it's relatively reasonable price we should do this because we could hopefully get our cash out." The Thirds would be objecting because they won't be satisfied in today's market prices because, you know, they figure they get wiped out.

Class 1 Bankruptcy, Spring, 2009 Case Initiation & Property of the Estate Randal C. Picker Leffmann Professor of Commercial Law The Law School The University.

Documents

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bankruptcyif project

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f needs

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