Bankruptcy – Ayotte, Spring 2019
Table of Contents
Introduction..............................................................................................................3
Policy............................................................................................................................... 3
Problems.................................................................................................................... 3
Goals of Bankruptcy................................................................................................... 3
Normative Tools......................................................................................................... 3
Structure of the Bankruptcy Code.................................................................................. 4
Code Overview........................................................................................................... 4
Debt Collection Outside Bankruptcy..........................................................................5
Commencement of a Case........................................................................................7
Ex-ante Filters – Eligibility.............................................................................................. 7
Voluntary Cases (§301).............................................................................................. 7
Involuntary Cases (§ 303).......................................................................................... 8
Avoiding Bankruptcy.................................................................................................. 9
Ex-post Filters – Dismissal.............................................................................................. 9
Automatic Stay.......................................................................................................11
Claims.....................................................................................................................15
Claim Onion................................................................................................................... 15
Timing of a Claim..................................................................................................... 18
Estimating Claims......................................................................................................... 20
Valuing Secured Claims................................................................................................ 21
Property of the Estate............................................................................................23
Debtor’s Interest in Property................................................................................... 23
Scope of the Estate.................................................................................................. 24
Ipso Facto Clauses................................................................................................... 25
Executory Contracts...................................................................................................... 25
Assumption of a Contract......................................................................................... 27
Rejection of a Contract............................................................................................ 29
Expanding the Estate – Avoidance Powers...................................................................31
Strong-Arm Powers.................................................................................................. 31
Fraudulent Transfers............................................................................................... 32
Preferential Transfers.............................................................................................. 36
Operations: Use of Assets and Financing..............................................................38
Use of Assets (§ 363)..................................................................................................... 38
Asset Sales............................................................................................................... 38
Adequate Protection................................................................................................ 41
Critical Vendor Motion............................................................................................. 42
Debtor in Possession Financing (§ 364)........................................................................43
Plan of Reorganization...........................................................................................46
Absolute Priority Rules – Vertical Equity.................................................................49
Classification............................................................................................................ 52
Personal Bankruptcy..............................................................................................53
Page 1 of 62
,Bankruptcy – Ayotte, Spring 2019
Chapter 7...................................................................................................................... 53
The Fresh Start........................................................................................................ 54
Chapter 7 Estate...................................................................................................... 56
Abusive Chapter 7 Cases......................................................................................... 58
Chapter 13.................................................................................................................... 59
Page 2 of 62
,Bankruptcy – Ayotte, Spring 2019
Introduction
Policy
Problems
Problem 1: Creditor Race
o Non-bankruptcy debtor-creditor law can lead to a socially destructive
creditor race
Law follows a “first-in-time, first-in-right” principle
Economically viable firms might be liquidated anyway as
creditors race each other to grab assets
o Bk Solution: pauses the process so assets can be allocated
appropriately
Problem 2: Holdout/Free-Rider problem
o Bk Solution: unanimity not required
Problem 3: Debt Overhang Problem
o Hard to get a new loan when you’ve given away too much seniority to
prior lenders
Distressed debtor can’t get new money, even though new money
would increase the value of the firm
o Bk Solution: bankrupt debtor can give new lenders seniority
Goals of Bankruptcy
Force multiple creditors to work together and tries to deal with Problem 1:
Creditor Race
Deal with financially distressed debtors
o Economic Distress – firm is in trouble because it cannot succeed in
the marketplace
o Financial Distress – company cannot meet its financial obligations to
creditors; problem might be caused by capital structure
Purposes
o Save creditors the cost of a destructive race to debtor’s assets
o Helping individuals overburdened with debt
o Reorganize the capital structure of firms in financial distress
Normative Tools
Butner Principle
o Interpretative Tool
1. What would happen outside bankruptcy under state law?
2. Does anything in the Bankruptcy Code explicitly provide for a
different result?
o Normative Principle
Page 3 of 62
, Bankruptcy – Ayotte, Spring 2019
Bankruptcy should only alter procedural rights. Keep
substantive rights the same
Otherwise, there would be perverse incentives to
seek/avoid bankruptcy
Efficiency Principle
o Best bankruptcy rules are generally the ones that create incentives to
maximize the value of the estate
Maximizing the value of assets will create greater collective
recovery
Keep the firm alive if it is worth more alive than dead, and vice
versa.
Ayotte: If efficiency goals conflict with normative Butner principle, then
efficiency will dictate that the substantive rules should change.
o Ex. Debtor in possession financing alters substantive non-bankruptcy
rights, but is essential to create value
o Ayotte – Butner is a good tool for analyzing/predicting outcomes, but
the efficiency principle is better for normatively determining if the law
works
Structure of the Bankruptcy Code
Code Overview
General Provisions
o Chapter 1
§ 101 Definitions
§ 103 Applicability of chapters
§ 105 Discretionary power of judge
§ 109 Eligibility requirements for each type of case
o Chapter 3 Case Administration
§§ 301-308 Case commencement (see page 7)
§§ 321-333 Rules governing administrators of estate
§§ 361-366 Rules that preserve the estate and run the business
(see page 38)
o Chapter 5 Claims and Asset Identification
§§ 501-510 Claims against the estate (see page 15)
§§ 541-562 Assets of the estate (see page 23)
Chapter 7 Simple Liquidation
o Liquidation of bankruptcy estate’s assets applied to pay allowed
claims essentially in the order of non-bankruptcy priority, but subject
to some special bankruptcy rules (§ 726, see page 48)
o Management is replaced by a trustee who sells the assets
o Can be used by individuals and corporations
Chapter 11 Reorganization
o Most relevant chapter for corporate debtors if survival is possible
o Ch. 7 is relevant
Page 4 of 62
Table of Contents
Introduction..............................................................................................................3
Policy............................................................................................................................... 3
Problems.................................................................................................................... 3
Goals of Bankruptcy................................................................................................... 3
Normative Tools......................................................................................................... 3
Structure of the Bankruptcy Code.................................................................................. 4
Code Overview........................................................................................................... 4
Debt Collection Outside Bankruptcy..........................................................................5
Commencement of a Case........................................................................................7
Ex-ante Filters – Eligibility.............................................................................................. 7
Voluntary Cases (§301).............................................................................................. 7
Involuntary Cases (§ 303).......................................................................................... 8
Avoiding Bankruptcy.................................................................................................. 9
Ex-post Filters – Dismissal.............................................................................................. 9
Automatic Stay.......................................................................................................11
Claims.....................................................................................................................15
Claim Onion................................................................................................................... 15
Timing of a Claim..................................................................................................... 18
Estimating Claims......................................................................................................... 20
Valuing Secured Claims................................................................................................ 21
Property of the Estate............................................................................................23
Debtor’s Interest in Property................................................................................... 23
Scope of the Estate.................................................................................................. 24
Ipso Facto Clauses................................................................................................... 25
Executory Contracts...................................................................................................... 25
Assumption of a Contract......................................................................................... 27
Rejection of a Contract............................................................................................ 29
Expanding the Estate – Avoidance Powers...................................................................31
Strong-Arm Powers.................................................................................................. 31
Fraudulent Transfers............................................................................................... 32
Preferential Transfers.............................................................................................. 36
Operations: Use of Assets and Financing..............................................................38
Use of Assets (§ 363)..................................................................................................... 38
Asset Sales............................................................................................................... 38
Adequate Protection................................................................................................ 41
Critical Vendor Motion............................................................................................. 42
Debtor in Possession Financing (§ 364)........................................................................43
Plan of Reorganization...........................................................................................46
Absolute Priority Rules – Vertical Equity.................................................................49
Classification............................................................................................................ 52
Personal Bankruptcy..............................................................................................53
Page 1 of 62
,Bankruptcy – Ayotte, Spring 2019
Chapter 7...................................................................................................................... 53
The Fresh Start........................................................................................................ 54
Chapter 7 Estate...................................................................................................... 56
Abusive Chapter 7 Cases......................................................................................... 58
Chapter 13.................................................................................................................... 59
Page 2 of 62
,Bankruptcy – Ayotte, Spring 2019
Introduction
Policy
Problems
Problem 1: Creditor Race
o Non-bankruptcy debtor-creditor law can lead to a socially destructive
creditor race
Law follows a “first-in-time, first-in-right” principle
Economically viable firms might be liquidated anyway as
creditors race each other to grab assets
o Bk Solution: pauses the process so assets can be allocated
appropriately
Problem 2: Holdout/Free-Rider problem
o Bk Solution: unanimity not required
Problem 3: Debt Overhang Problem
o Hard to get a new loan when you’ve given away too much seniority to
prior lenders
Distressed debtor can’t get new money, even though new money
would increase the value of the firm
o Bk Solution: bankrupt debtor can give new lenders seniority
Goals of Bankruptcy
Force multiple creditors to work together and tries to deal with Problem 1:
Creditor Race
Deal with financially distressed debtors
o Economic Distress – firm is in trouble because it cannot succeed in
the marketplace
o Financial Distress – company cannot meet its financial obligations to
creditors; problem might be caused by capital structure
Purposes
o Save creditors the cost of a destructive race to debtor’s assets
o Helping individuals overburdened with debt
o Reorganize the capital structure of firms in financial distress
Normative Tools
Butner Principle
o Interpretative Tool
1. What would happen outside bankruptcy under state law?
2. Does anything in the Bankruptcy Code explicitly provide for a
different result?
o Normative Principle
Page 3 of 62
, Bankruptcy – Ayotte, Spring 2019
Bankruptcy should only alter procedural rights. Keep
substantive rights the same
Otherwise, there would be perverse incentives to
seek/avoid bankruptcy
Efficiency Principle
o Best bankruptcy rules are generally the ones that create incentives to
maximize the value of the estate
Maximizing the value of assets will create greater collective
recovery
Keep the firm alive if it is worth more alive than dead, and vice
versa.
Ayotte: If efficiency goals conflict with normative Butner principle, then
efficiency will dictate that the substantive rules should change.
o Ex. Debtor in possession financing alters substantive non-bankruptcy
rights, but is essential to create value
o Ayotte – Butner is a good tool for analyzing/predicting outcomes, but
the efficiency principle is better for normatively determining if the law
works
Structure of the Bankruptcy Code
Code Overview
General Provisions
o Chapter 1
§ 101 Definitions
§ 103 Applicability of chapters
§ 105 Discretionary power of judge
§ 109 Eligibility requirements for each type of case
o Chapter 3 Case Administration
§§ 301-308 Case commencement (see page 7)
§§ 321-333 Rules governing administrators of estate
§§ 361-366 Rules that preserve the estate and run the business
(see page 38)
o Chapter 5 Claims and Asset Identification
§§ 501-510 Claims against the estate (see page 15)
§§ 541-562 Assets of the estate (see page 23)
Chapter 7 Simple Liquidation
o Liquidation of bankruptcy estate’s assets applied to pay allowed
claims essentially in the order of non-bankruptcy priority, but subject
to some special bankruptcy rules (§ 726, see page 48)
o Management is replaced by a trustee who sells the assets
o Can be used by individuals and corporations
Chapter 11 Reorganization
o Most relevant chapter for corporate debtors if survival is possible
o Ch. 7 is relevant
Page 4 of 62
