b'\x0cBANKRUPTCY LAW\nAND PRACTICE\nThird Edition\n\nA Casebook Designed to\nTrain Lawyers for the\nPractice of Bankruptcy Law\n\n__________\nGregory Germain\nProfessor of Law\nSyracuse University College of Law\nCALI eLangdell\xc2\xae Press 2018\n\n\x0cAbout the Author\nGregory Germain is a professor at Syracuse University College of Law where he teaches\ncourses in Contracts, Commercial Transactions, Corporations, Taxation and of course Bankruptcy\nLaw. He also runs a pro bono bankruptcy program for first year law students, and a bankruptcy\nclinic for upper division students. The clinic represents indigent individuals in bankruptcy cases.\nProfessor Germain received his JD Degree Magna Cum Laude from the University of\nCalifornia Hastings College of Law, practiced law for 15 years in Los Angeles and San Francisco,\nand then obtained his LLM in Tax from the University of Florida. Following tax school, he worked\nas an attorney advisor for the Honorable Renato Beghe of the United States Tax Court before\nbeginning his teaching career at Syracuse University College of Law.\n\ni\n\n\x0cNotices\nThis is the third edition of this casebook, updated May 2018. Visit http://elangdell.cali.org/\nfor the latest version and for revision history.\nThis work by Gregory Germain is licensed and published by CALI eLangdell Press under\na Creative Commons Attribution-NonCommercial-ShareAlike 4.0 International (CC BY-NC-SA\n4.0). CALI and CALI eLangdell Press reserve under copyright all rights not expressly granted by\nthis Creative Commons license. CALI and CALI eLangdell Press do not assert copyright in US\nGovernment works or other public domain material included herein. Permissions beyond the scope\nof this license may be available through feedback@cali.org.\nIn brief, the terms of that license are that you may copy, distribute, and display this work, or\nmake derivative works, so long as\n\xef\x82\xb7\n\nyou give CALI eLangdell Press and the author credit;\n\n\xef\x82\xb7\n\nyou do not use this work for commercial purposes; and\n\n\xef\x82\xb7\n\nyou distribute any works derived from this one under the same licensing terms as this.\n\nSuggested attribution format for original work:\nGregory Germain, Bankruptcy Law and Practice, Third Edition, Published by CALI eLangdell\nPress. Copyright CALI 2018. Available under a Creative Commons BY-NC-SA 4.0 License.\nCALI\xc2\xae and eLangdell\xc2\xae are United States federally registered trademarks owned by the\nCenter for Computer-Assisted Legal Instruction. The cover art design is a copyrighted work of\nCALI, all rights reserved. The CALI graphical logo is a trademark and may not be used without\npermission.\nThis material does not contain nor is intended to be legal advice. Users seeking legal advice\nshould consult with a licensed attorney in their jurisdiction. The editors have endeavored to provide\ncomplete and accurate information in this book. However, CALI does not warrant that the\ninformation provided is complete and accurate. CALI disclaims all liability to any person for any\nloss caused by errors or omissions in this collection of information.\n\nii\n\n\x0cAbout CALI eLangdell Press\nThe Center for Computer-Assisted Legal Instruction (CALI\xc2\xae) is: a nonprofit organization with\nover 200 member US law schools, an innovative force pushing legal education toward change for\nthe better. There are benefits to CALI membership for your school, firm, or organization.\nELangdell\xc2\xae is our electronic press with a mission to publish more open books for legal education.\nHow do we define "open?"\n\xef\x82\xb7\n\nCompatibility with devices like smartphones, tablets, and e-readers; as well as print.\n\n\xef\x82\xb7\n\nThe right for educators to remix the materials through more lenient copyright policies.\n\n\xef\x82\xb7\n\nThe ability for educators and students to adopt the materials for free.\n\nFind available and upcoming eLangdell titles at elangdell.cali.org. Show support for CALI by\nfollowing us on Facebook and Twitter, and by telling your friends and colleagues where you\nreceived your free book.\n\niii\n\n\x0cForward\nThis book is intended for a three credit law school course covering the fundamentals of\nbankruptcy law and practice. Students should recognize that this is a \xe2\x80\x9cCode\xe2\x80\x9d class, and that the\nstarting place for solving most bankruptcy problems is the Bankruptcy Code itself. Students should\nread the materials and work through the problems by direct reference to the provisions of the\nBankruptcy Code. Bankruptcy lawyers simply must be comfortable with the Code in order to be\neffective.\nThe book contains many cases interpreting the Bankruptcy Code. The cases have been\nstripped to the essentials to minimize reading. Most cross-citations have been deleted. Issues\ndiscussed in the cases that are not relevant to the point for which the case is included in the\nmaterials have been stricken. Bolding has been added to important language the students should\nfocus on. The practitioner, of course, should always read full cases and not rely on the edited\nversions in this book or on headnotes or other secondary sources. This book contains the bones of\nthe case, with flesh left only where essential to understanding the court\xe2\x80\x99s reasoning on the\nparticular issue of relevance to the material in the book.\nMuch of the learning will come through working with the problems. Many students have\ndeveloped the bad practice of reading the questions without trying to solve them. Don\xe2\x80\x99t do that.\nYou need to try to solve the problems by reading and working through the statute. The best way\nto learn and be comfortable with using the statutory language is to work through the statute to\nsolve the problems.\nSome of the problems contain case references. I do not expect my students to read the cases\nthat are merely cited in the problems, and not reprinted in the book. I discuss some of these cases\nwith the class when covering the problems. Students interested in the problems are always free to\nread the cases for greater understanding, as time permits.\n\niv\n\n\x0cTable of Contents\nAbout the Author ....................................................................................................... i\nNotices ...................................................................................................................... ii\nAbout CALI eLangdell Press ................................................................................... iii\nForward .................................................................................................................... iv\nChapter 1: A World without Bankruptcy ..................................................................1\n1.1.\n\nA Wee Bit of History ....................................................................................................... 1\n\n1.2.\n\nEnforcing Claims ............................................................................................................. 1\n\n1.3.\n\nThe Self-Help System for Collecting Unsecured Claims ................................................ 2\n\n1.4.\n\nPractice Problems: Fair Debt Collection Practices Act (FDCPA) .................................. 2\n\n1.4.1.1.\n2017)\n\nHENSON V. SANTANDER CONSUMER USA INC., 582 U.S. ___ (June 12,\n............................................................................................................................... 3\n\n1.5. The Judicial System for Collecting Unsecured Claims: Obtaining and Enforcing a\nJudgment ..................................................................................................................................... 6\n1.6.\n\nProvisional Remedies....................................................................................................... 7\n\n1.7.\n\nCASES: The Sheriff\xe2\x80\x99s Duty to Enforce Writs ................................................................ 8\n\n1.7.1.1.\nDAVID J. VITALE v. HOTEL CALIFORNIA, INC., 184 N.J. Super 512, 446\nA.2d 880 (1982) ....................................................................................................................... 8\n1.8.\n\nProperty Garnishments................................................................................................... 11\n\n1.9.\n\nWage Garnishments ....................................................................................................... 12\n\n1.10.\n\nState Wage Garnishment Exemptions ........................................................................ 12\n\n1.11.\n\nExceptions to Wage Garnishment Limits ................................................................... 13\n\n1.12.\n\nPractice Problems: Calculating Wage Garnishment Limits ...................................... 13\n\n1.13.\n\nState Law Execution Exemptions ............................................................................... 14\n\n1.14.\n\nPractice Problems: Enforcement of Judgments .......................................................... 14\n\n1.15.\n\nOther Federal and State Exemptions .......................................................................... 14\n\n1.16.\n\nFederal Tax Collection ............................................................................................... 15\n\n1.17.\n\nState Law Avoiding Powers ....................................................................................... 15\n\n1.18.\n\nPractice Problems: Fraudulent Transfers ................................................................... 16\n\n1.19.\n\nThe Race to the Courthouse and the Concept of Bankruptcy..................................... 17\n\nChapter 2: Secured Claims .......................................................................................19\n2.1.\n\nLiens and Priority........................................................................................................... 19\nv\n\n\x0c2.2.\n\nAttachment of Consensual Liens ................................................................................... 19\n\n2.3.\n\nAttachment of Consensual Liens on Real Property. ...................................................... 20\n\n2.4.\n\nAttachment of Consensual Liens on Personal Property ................................................. 20\n\n2.5.\n\nAttachment of Judicial Liens ......................................................................................... 21\n\n2.6.\n\nAttachment of Statutory Liens. ...................................................................................... 22\n\n2.7.\n\nThe Concept of Perfecting Liens ................................................................................... 23\n\n2.8.\n\nPerfection of Consensual Personal Property Liens ........................................................ 23\n\n2.9.\n\nPriority of Consensual Liens. ......................................................................................... 24\n\n2.10.\n\nPractice Problems: UCC Article 9. ............................................................................ 26\n\n2.11.\n\nPurchase Money Security Interests............................................................................. 27\n\n2.12.\n\nPractice Problems: Purchase Money Security Interests ............................................ 27\n\n2.13.\n\nPerfection and Priority of Real Property Liens .......................................................... 27\n\n2.14.\n\nPractice Problems: Real Estate Priority ..................................................................... 29\n\n2.15.\n\nForeclosing the Right of Redemption ......................................................................... 29\n\n2.16.\n\nCases on Enforcement of Liens .................................................................................. 31\n\n2.16.1.1.\n\nCHAPA v. TRACIERS & ASSOCIATES, 267 S.W.3d 386 (Ct. App. Tex. 2008)\n............................................................................................................................. 31\n\n2.16.1.2. JORDAN v. CITIZENS & SOUTHERN NAT\xe2\x80\x99L BANK OF SOUTH\nCAROLINA, 278 S.C. 449 (1982) ........................................................................................ 33\n2.16.1.3.\n\nCHERNO v. BANK OF BABYLON, 54 Misc.2d 277 (NY 1967) .................... 34\n\n2.16.1.4.\n\nBIG THREE MOTORS, INC., v. RUTHERFORD, 432 So.2d 483 (Ala. 1983) 35\n\n2.16.1.5.\n\nWALTER KOUBA v. EAST JOLIET BANK, 135 Ill. App. 3d 264 (1985) ..... 37\n\n2.17.\n\nPractice Problems: Enforcement of Liens and Claims .............................................. 40\n\nChapter 3: The Bankruptcy System .........................................................................42\n3.1.\n\nPurposes of Bankruptcy ................................................................................................. 42\n\n3.2.\n\nStructure of the Bankruptcy Code.................................................................................. 43\n\n3.3.\n\nJurisdiction and Venue of Bankruptcy Cases ................................................................ 45\n\n3.4.\n\nCases on the Constitutional Limits of Bankruptcy Jurisdiction..................................... 45\n\n3.4.1.1.\n(1982)\n\nNORTHERN PIPELINE CO. v. MARATHON PIPE LINE CO., 458 U.S. 50\n............................................................................................................................. 45\n\n3.5.\n\nThe Aftermath of Northern Pipeline.............................................................................. 49\n\n3.6.\n\nCases on the Constitutional Limits of Bankruptcy Jurisdiction after Marathon ........... 50\nvi\n\n\x0c3.6.1.1.\n\nSTERN v. MARSHALL, 564 U.S. 2, 131 S. Ct. 2594 (2011) ........................... 50\n\n3.6.1.2.\nWELLNESS INTERNATIONAL NETWORK, LTD., v. SHARF, 135 S. Ct.\n1932 (2015)............................................................................................................................ 57\n3.7.\n\nPractice Problems: Bankruptcy Court Jurisdiction ....................................................... 61\n\n3.8.\n\nVenue of Bankruptcy Cases ........................................................................................... 61\n\n3.9.\n\nCases on Bankruptcy Venue .......................................................................................... 62\n\n3.9.1.1.\n\nIN ENRON CORP., 274 B.R. 327 (2002) .......................................................... 62\n\n3.10.\n\nPractice Problems: Filing Voluntary Petitions .......................................................... 66\n\n3.11.\n\nVoluntary Bankruptcy Petitions ................................................................................. 67\n\n3.12.\n\nInvoluntary Bankruptcy Petitions ............................................................................... 68\n\n3.13.\n\nPractice Problems \xe2\x80\x93 Involuntary Petitions.................................................................. 68\n\n3.14.\n\nDismissal of Properly Filed Bankruptcy Petitions for \xe2\x80\x9cCause.\xe2\x80\x9d ................................ 69\n\n3.15.\n\nBad Faith Dismissals after the 2005 Amendments ..................................................... 70\n\n3.16.\n\nDismissal of Cases Properly Filed under Other Chapters .......................................... 71\n\n3.17.\n\nCases on Bad Faith Dismissals ................................................................................... 71\n\n3.17.1.1.\n\nIN RE JOHNS-MANVILLE CORP., 36 B.R. 727 (Bankr. S.D.N.Y. 1984) ...... 71\n\n3.17.1.2.\n\nIN RE SGL CARBON, 200 F.3d 154 (3d Cir. 1999) ......................................... 75\n\n3.18.\n\nVoluntary and Involuntary Conversion and Dismissal............................................... 78\n\n3.19.\n\nDismissal of Consumer Chapter 7 Cases for \xe2\x80\x9cAbuse\xe2\x80\x9d \xe2\x80\x93 The Means Test ................. 79\n\n3.20.\n\nPractice Problems: Dismissal for Abuse \xe2\x80\x93 The Means Test, Part One...................... 80\n\n3.21.\n\nDismissal for \xe2\x80\x9cAbuse\xe2\x80\x9d - The Means Test, Part Two .................................................. 81\n\n3.22.\n\nRebutting the Presumption of Abuse under the Means Test ...................................... 82\n\n3.23.\n\nAttorney Sanctions for Means Test Violations........................................................... 82\n\n3.24.\n\nEligibility after Prior Bankruptcy Cases ..................................................................... 82\n\nChapter 4: The Bankruptcy Estate ...........................................................................84\n4.1.\n\nThe Estate....................................................................................................................... 84\n\n4.2.\n\nCases on Property of the Estate ..................................................................................... 84\n\n4.2.1.1.\n\nBOARD OF TRADE OF CHICAGO v. JOHNSON, 264 U.S. 1 (1924) ........... 84\n\n4.2.1.2.\n\nBUTNER v. UNITED STATES, 440 U.S. 48 (1979)......................................... 86\n\n4.3.\n\nAftermath: Application to the Bankruptcy Code .......................................................... 88\n\n4.4.\n\nPractice Problems. Property of the Estate ...................................................................... 88\n\n4.5.\n\nCases on Mixed Prepetition and Post-Petition Earnings as Property of the Estate ....... 89\nvii\n\n\x0c4.5.1.1.\n\nIN RE BAGEN, 186 B.R. 824 (Bankr S.D.N.Y. 1995) ...................................... 89\n\n4.5.1.2.\n\nTOWERS v. WU, 173 B.R. 411 (9th Cir. BAP 1994) ......................................... 91\n\n4.5.1.3.\n\nSHARP v. DERY, 253 B.R. 204 (E.D. Mich. 2000) .......................................... 92\n\nChapter 5: Exemptions .............................................................................................95\n5.1.\n\nExemptions .................................................................................................................... 95\n\n5.2.\n\nPractice Problems: Which State\xe2\x80\x99s Exemptions Apply? ................................................. 96\n\n5.3.\n\nElecting the State or Federal Exemption Scheme .......................................................... 96\n\n5.4.\n\nPractice Problems: The Federal Exemptions. ............................................................... 98\n\n5.5.\n\nCases on the Allowance of Exemptions......................................................................... 99\n\n5.5.1.1.\n\nTAYLOR v. FREELAND & KOONZ, 503 U.S. 638 (1992) ............................. 99\n\n5.5.1.2.\n\nSCHWAB v. REILLY, 30 S. Ct. 2652 (2010) .................................................. 101\n\n5.6.\n\nExemption Planning ..................................................................................................... 103\n\n5.7.\n\nCases on Exemption Planning ..................................................................................... 104\n\n5.7.1.1.\n1988)\n\nNORWEST BANK NEBRASKA v. OMAR A. TVETEN, 848 F.2d 871 (8th Cir.\n........................................................................................................................... 104\n\n5.8.\n\nNotes on Tveten............................................................................................................ 109\n\n5.9.\n\nAvoiding Liens that Impair Exemptions ...................................................................... 109\n\n5.10.\n\nPractice Problems: Avoiding Liens that Impair Exemptions ................................... 110\n\n5.11.\n\nCases on Avoiding Liens that Impair Exemptions ................................................... 111\n\n5.11.1.1.\n\nFARREY v. SANDERFOOT, 500 U.S. 291 (1991) ......................................... 111\n\nChapter 6: The Automatic Stay..............................................................................114\n6.1.\n\nWhat is the automatic stay? ......................................................................................... 114\n\n6.2.\n\nPractice Problems: The Automatic Stay ..................................................................... 114\n\n6.3.\n\nCases on Using the Automatic Stay as a Sword .......................................................... 117\n\n6.3.1.1.\nSPORTFRAME OF OHIO V. WILSON SPORTING GOODS, 40 B.R. 47\n(Bankr. N.D. Ohio 1984) ..................................................................................................... 117\n\nChapter 7: Operating the Estate .............................................................................120\n7.1.\n\nThe United States Trustee. ........................................................................................... 120\n\n7.2.\n\nThe Case Trustee.......................................................................................................... 120\n\n7.3.\n\nThe Section 341 Meeting ............................................................................................. 121\n\n7.4.\n\nNo Asset Cases ............................................................................................................ 122\n\n7.5.\n\nUse, Sale and Lease of Property .................................................................................. 122\nviii\n\n\x0c7.6.\n\nPractice Problems: Sale of Property ........................................................................... 123\n\n7.7.\n\nCases on the Sale of Property ...................................................................................... 124\n\n7.7.1.1.\n\nMARATHON PETROLEUM v. COHEN, 599 F.3d 1255 (11th Cir. 2010) ..... 124\n\n7.8.\n\nPost-Bankruptcy Financing .......................................................................................... 127\n\n7.9.\n\nPractice Problems: Post Petition Financing ................................................................ 129\n\n7.10.\n\nCases on Post Petition Financing.............................................................................. 130\n\n7.10.1.1.\n1992)\n\nIN RE SAYBROOK MANUFACTURING CO., INC., 963 F.2d 1490 (11th Cir.\n........................................................................................................................... 130\n\n7.10.1.2.\n\nREADING v. BROWN, 391 U.S. 471 (1968) .................................................. 133\n\n7.10.1.3.\n2011)\n\nIN RE RESOURCES TECHNOLOGY CORP., 662 F.3d 472, 474 (7th Cir.\n........................................................................................................................... 136\n\n7.11.\n\nExecutory Contracts and Unexpired Leases \xe2\x80\x93 Assumption and Rejection .............. 138\n\n7.12.\n\nPractice Problems: Executory Contracts - Assumption and Rejection.................... 139\n\n7.13.\n\nCases on Executory Contracts .................................................................................. 141\n\n7.13.1.1.\n\nIN RE JAMESWAY CORP., 201 B.R. 73 (Bankr. S.D.N.Y. 1996) ................ 141\n\n7.13.1.2.\n\nIN RE GARDINIER, INC., 831 F.2d 974 (11th Cir. 1987).............................. 143\n\n7.13.1.3.\n\nIN RE COMPUTER COMMUNICATIONS, INC., 824 F.2d 725 (9th Cir. 1987)\n........................................................................................................................... 144\n\n7.13.1.4.\n\nRIESER v. DAYTON COUNTRY CLUB CO., 972 F.2d 689 (6th Cir 1992). 146\n\nChapter 8: Enhancing the Estate ............................................................................152\n8.1.\n\nFraudulent Transfers (11 U.S.C. \xc2\xa7 548) ....................................................................... 152\n\n8.2.\n\nThe Trustee\xe2\x80\x99s State Law Powers (11 U.S.C. \xc2\xa7 544(b)) ............................................... 152\n\n8.3.\n\nPractice Problems \xe2\x80\x93 Fraudulent Transfers ................................................................... 153\n\n8.4.\n\nCases on Fraudulent Transfers ..................................................................................... 154\n\n8.4.1.1.\n\nBFP v. RESOLUTION TRUST CORP., 511 U.S. 531 (1994) ......................... 154\n\n8.4.1.2.\n\nALLARD v. FLAMINGO HILTON, 69 F.3d 769 (6th Cir. 1995)................... 157\n\n8.5.\n\nIntroduction to Bakersfield Westar .............................................................................. 160\n\n8.6.\n\nCases on \xe2\x80\x9cProperty\xe2\x80\x9d and Fraudulent transfers ............................................................. 160\n\n8.6.1.1.\n\nIN RE BAKERSFIELD WESTAR, INC., 226 B.R. 227 (9th Cir. BAP 1998) . 160\n\n8.7.\n\nThe Strong Arm Power (11 U.S.C. \xc2\xa7 544(a)) .............................................................. 166\n\n8.8.\n\nPractice Problems: The Strong Arm Power ................................................................ 166\n\n8.9.\n\nCases on the Strong Arm Power .................................................................................. 167\nix\n\n\x0c8.9.1.1.\n\nIN RE PROJECT HOMESTEAD, INC., 374 B.R. 193 (Bankr. MD NC 2007) ....\n........................................................................................................................... 167\n\n8.9.1.2.\n\nIN RE LOUISE CARY MORENO, 293 B.R. 777 (Bankr. D. Col. 2003) ....... 169\n\n8.10.\n\nPreferences (11 U.S.C. \xc2\xa7 547) .................................................................................. 171\n\n8.11.\n\nPractice Problems: The Preference Law .................................................................. 172\n\n8.12.\n\nCases on Preferences ................................................................................................ 173\n\n8.12.1.1.\n\nBEIGIER v. IRS, 496 U.S. 53 (1990) ............................................................... 173\n\n8.12.1.2.\n\nIN RE CASTILLO, 39 B.R. 45 (Bankr. D. Col. 1984) ..................................... 175\n\n8.12.1.3.\n\nPARKS v. FIA CREDIT SERVICES, N.A., 550 F.3d 1251 (10th Cir. 2008) . 176\n\n8.12.1.4.\n\nIN RE UNICOM COMPUTER CORP., 13 F.3d 321 (9th Cir. 1994) ............... 179\n\n8.13.\n\nPreference Defenses \xe2\x80\x93 11 U.S.C. \xc2\xa7 547(c) ............................................................... 181\n\n8.14.\n\nCases on Preference Defenses .................................................................................. 183\n\n8.14.1.1.\n\nUNION BANK v. WOLAS, 502 U.S. 151 (1991) ............................................ 183\n\n8.14.1.2.\n\nIN RE TOLANA PIZZA, 3 F.3d 1029 (7th Cir. 1993)..................................... 184\n\n8.15.\n\nPractice Problems: Preference Exceptions .............................................................. 187\n\n8.16.\n\nStatutory Liens. 11 U.S.C. \xc2\xa7 545 .............................................................................. 189\n\n8.17.\n\nSetoffs. 11 U.S.C. \xc2\xa7 553 ........................................................................................... 190\n\n8.18.\n\nPractice Problems: Setoff Preferences ..................................................................... 191\n\n8.19.\n\nCases on Setoffs........................................................................................................ 191\n\n8.19.1.1.\n\nDURHAM v. SMI INDUSTRIES, INC., 882 F.2d 881 (4th Cir. 1989) ........... 191\n\n8.20.\n\nStatute of Limitations on Avoiding Powers. 11 U.S.C. \xc2\xa7 546(a). ............................ 193\n\n8.21.\n\nRelation-back Perfection Rules. 11 U.S.C. \xc2\xa7 546(b) ................................................ 193\n\n8.22.\n\nReclamation Rights. 11 U.S.C. \xc2\xa7 546(c) .................................................................. 193\n\n8.23.\n\nCases on Reclamation Rights ................................................................................... 194\n\n8.23.1.1.\n\nIN RE ARLCO, INC., 239 B.R. 261 (Bankr. S.D.N.Y. 1999) ......................... 194\n\n8.23.1.2.\n\nPHAR-MOR v. McKESSON CORP., 534 F.3d 502 (6th Cir. 2008) ............... 198\n\n8.24.\n\nRecovering Avoided Transfers. 11 U.S.C. \xc2\xa7 550 ..................................................... 201\n\n8.25.\n\nPractice Problems: Recovering Avoided Transfers ................................................. 201\n\n8.26.\n\nCases on Recovering Avoided Transfers.................................................................. 201\n\n8.26.1.1. BONDED FIN. SERV., INC., v. EUROPEAN AMERICAN BANK, 838 F.2d\n890 (7th Cir. 1988) .............................................................................................................. 201\n8.26.1.2.\n\nKELLOGG v. BLUE QUAIL ENERGY, 831 F.2d 586 (5th Cir. 1987) .......... 207\nx\n\n\x0c8.27.\n\nPractice Problems: The Debtor\xe2\x80\x99s Avoiding Powers ................................................. 212\n\nChapter 9: Secured Claims in Bankruptcy .............................................................213\n9.1.\n\nThe Section 506(a) Split .............................................................................................. 213\n\n9.2.\n\nCases on Valuation and the Section 506(a) Split ......................................................... 213\n\n9.2.1.1.\n\nASSOCIATES COMMERCIAL v. RASH, 520 U.S. 953 (1997) .................... 213\n\n9.2.1.2.\n\nIN RE BROWN, 746 F.3d 1236 (11th Cir. 2014)............................................. 215\n\n9.3.\n\nPractice Problems: The \xc2\xa7 506(a) Split ........................................................................ 217\n\n9.4.\n\nPractice Problems: Post-Petition Interest, Fees, Costs and Charges (11 U.S.C. \xc2\xa7 506(b))\n...................................................................................................................................... 218\n\n9.5.\n\nCases on Post-Petition Interest under Section 506(b) .................................................. 219\n\n9.5.1.1.\n\nIN RE RESIDENTIAL CAPITAL, INC., 508 B.R. 851 (Bankr. S.D.N.Y. 2014) .\n........................................................................................................................... 219\n\n9.6.\n\nThe Section 506(c) Surcharge ...................................................................................... 224\n\n9.7.\n\nSection 506(d) and Striping-down or Striping-Off Liens ............................................ 224\n\n9.8.\n\nCases on Stripping Liens under Section 506(d) ........................................................... 225\n\n9.8.1.1.\n9.9.\n9.10.\n\nDEWSNUP v. TIMM, 502 U.S. 410 (1992) ..................................................... 225\n\nStripping Wholly Unsecured Liens in Chapter 7 ......................................................... 228\nRedemption. 11 U.S.C. \xc2\xa7 722. .................................................................................. 229\n\n9.11.\nDebtor\xe2\x80\x99s Treatment of Secured Claims in Chapter 7: Surrender, Redeem or Reinstate\n\xe2\x80\x93 or Maybe \xe2\x80\x9cRide Through.\xe2\x80\x9d................................................................................................... 229\n9.12.\n\nPost-Petition Effect of Security Interests: Section 552 ........................................... 231\n\n9.13.\n\nPractice Problems: Floating Liens in Bankruptcy ................................................... 232\n\n9.14.\n\nRelief from Stay and Adequate Protection ............................................................... 232\n\n9.15.\n\nCases on Relief from Stay ........................................................................................ 234\n\n9.15.1.1.\n\nUNITED SAVINGS v. TIMBERS OF INWOOD FOREST, 484 U.S. 365 (1988)\n........................................................................................................................... 234\n\n9.15.1.2. BANKERS LIFE INS. CO., v. ALYUCAN INTERSTATE CORP., 12 B.R. 803\n(Bankr. D. Utah 1981) ......................................................................................................... 237\n9.15.1.3.\n9.16.\n\nFORD MOTOR CREDIT CO. v. DOBBINS, 35 F.3d 860 (4th Cir. 1994) ..... 238\n\nPractice Problems: Relief from Stay ........................................................................ 242\n\nChapter 10: Unsecured Claims in Bankruptcy ......................................................243\n10.1.\n\nWhat is a \xe2\x80\x9cClaim\xe2\x80\x9d? ................................................................................................... 243\n\n10.2.\n\nCases on Claims and Due Process ............................................................................ 243\nxi\n\n\x0c10.2.1.1.\n(1950)\n\nMULLANE v. CENTRAL HANOVER BANK & TRUST CO., 339 U.S. 306\n243\n\n10.2.1.2.\n\nA.H. ROBINS CO. v. GRADY, 839 F.2d 198 (4th Cir. 1988)......................... 248\n\n10.2.1.3.\n\nIN RE JOHNS-MANVILLE CORP., 36 B.R. 743 (Bankr. S.D.N.Y. 1984) .... 250\n\n10.2.1.4.\n\nKANE v. MANVILLE, 843 F.2d 636 (2d Cir. 1988) ....................................... 252\n\n10.2.1.5.\n\nEPSTEIN v. PIPER AIRCRAFT, 58 F.3d 1573 (11th Cir. 1995) .................... 257\n\n10.2.1.6.\n1995)\n\nIN RE FAIRCHILD AIRCRAFT CORP., 184 B.R. 910 (Bankr. W.D. Tex.\n........................................................................................................................... 260\n\n10.2.1.7.\n\nIN RE GROSSMAN\xe2\x80\x99S INC., 607 F.3d 114 (3d Cir. 2010) .............................. 269\n\n10.2.1.8.\n\nMAIDS INT\xe2\x80\x99L., INC., v. Ward, 194 B.R. 703 (Bankr. D. Mass. 1996) ........... 274\n\n10.3.\n\nClaim Procedures ...................................................................................................... 281\n\n10.4.\n\nPractice Problems: Landlord, Employer and Certain Contingent Claims ............... 282\n\n10.5.\n\nCases on Claim Estimation and Limitations............................................................. 283\n\n10.5.1.1.\n\nIN RE RADIO-KEITH-ORPHEUM CORP., 106 F.2d 22 (2d Cir. 1939) ....... 283\n\n10.5.1.2.\n\nIN RE EL TORO MATERIALS CO., INC., 504 F.3d 978 (9th Cir. 2007) ..... 284\n\n10.6.\n\nPriority Claims \xe2\x80\x93 11 U.S.C. \xc2\xa7 507 ............................................................................ 286\n\n10.7.\n\nPractice Problems: Priority Claims.......................................................................... 288\n\n10.8.\n\nSubordination: 11 U.S.C. \xc2\xa7 510 ............................................................................... 288\n\n10.9.\n\nAbandonment: 11 U.S.C. \xc2\xa7 554 ............................................................................... 289\n\n10.10.\n\nCases on Abandonment of Property in Bankruptcy ................................................. 289\n\n10.10.1.1. MIDLANTIC NAT\xe2\x80\x99L BANK v. NJDEP, 474 U.S. 494 (1986) ....................... 289\n10.11.\n\nDistribution to Creditors: 11 U.S.C. \xc2\xa7 726 .............................................................. 292\n\nChapter 11: The Discharge ....................................................................................294\n11.1.\n\nThe Discharge Order ................................................................................................ 294\n\n11.2.\n\nCases on Violation of the Discharge Order .............................................................. 294\n\n11.2.1.1.\n\nIN RE ANDRUS, 189 B.R. 413 (N.D. Ill. 1995) .............................................. 294\n\n11.3.\n\nDenial of Discharge .................................................................................................. 296\n\n11.4.\n\nCases on Denial of Discharge ................................................................................... 298\n\n11.4.1.1.\n\nDAVIS v. DAVIS, 911 F.2d 560 (11th Cir. 1990) ........................................... 298\n\n11.4.1.2.\n\nIN RE BAJGAR, 104 F.3d 495 (1st Cir. 1997) ................................................ 299\n\n11.5.\n\nExceptions to Discharge: 11 U.S.C. \xc2\xa7 523 .............................................................. 301\n\n11.5.1.1.\n\nAutomatically Non-Dischargeable Debts.......................................................... 302\nxii\n\n\x0c11.5.1.2.\n11.6.\n\nDebts Non-Dischargeable Only On Timely Request of the Creditor................ 303\n\nCases on Exceptions to Discharge ............................................................................ 304\n\n11.6.1.1.\n\nFAHEY v. MASS. DEP\xe2\x80\x99T OF REVENUE, 2015 BL 41157 (1st Cir. 2015) ... 304\n\n11.6.1.2. BRUNNER v. NEW YORK STATE HIGHER EDUC. SERV. CORP., 831 F.2d\n395 (2d Cir. 1987) ............................................................................................................... 308\n11.6.1.3. ELLINGSWORTH v. AT&T UNIVERSAL CARD SERV., 212 B.R. 326\n(Bankr. W.D. Mo. 1997)...................................................................................................... 309\n11.6.1.4.\n\nIN RE SHARPE, 351 B.R. 409 (Bankr. N.D. Tex. 2006) ................................ 318\n\n11.6.1.5.\n\nARCHER v. WARNER, 538 U.S. 314 (2003).................................................. 322\n\n11.6.1.6.\n\nKAWAAUHAU v. GEIGER, 523 U.S. 57 (1998) ........................................... 325\n\n11.6.1.7.\n\nBULLOCK V. BANKCHAMPAIGN, 133 S. Ct. 1754 (2013) ........................ 327\n\n11.7.\n\nReaffirmation: 11 U.S.C. \xc2\xa7 524(c) .......................................................................... 328\n\n11.8.\n\nPractice Problems: Protecting the Discharge........................................................... 329\n\nChapter 12: Wage Earner Reorganizations under Chapter 13 ...............................331\n12.1.\n\nIntroduction .............................................................................................................. 331\n\n12.2.\n\nReasons for Filing under Chapter 13 ........................................................................ 331\n\n12.3.\n\nThe Chapter 13 Process ............................................................................................ 331\n\n12.4.\n\nThe Chapter 13 Plan Term (and \xe2\x80\x9cCommitment Period\xe2\x80\x9d). ........................................ 332\n\n12.5.\n\nRestructuring Secured Claims in a Chapter 13 Plan................................................. 332\n\n12.6.\n\nCases on Restructuring Secured Claims in Chapter 13 ............................................ 335\n\n12.6.1.1.\n\nTILL v. SCS CREDIT CORP., 541 U.S. 465 (2004) ....................................... 335\n\n12.6.1.2.\n\nNOBELMAN v. AMERICAN SAVINGS BANK, 508 U.S. 324 (1993) ........ 338\n\n12.6.1.3.\n\nIN RE POND, 252 F.3d 122 (2d Cir. 2001)...................................................... 339\n\n12.7.\n\nQuestion: Is In re Pond Still Good Law? ................................................................ 341\n\n12.8.\n\nUnsecured Claims in Chapter 13 .............................................................................. 341\n\n12.9.\n\nCases on Unsecured Claims in Chapter 13 ............................................................... 343\n\n12.9.1.1.\n\nHAMILTON v. LANNING, 560 U.S. 505 (2010)............................................ 343\n\n12.9.1.2.\n\nIN RE GAMBOA, 538 B.R. 53 (Bankr. S.D. Cal. 2013) ................................. 346\n\n12.10.\n\nModification. ............................................................................................................ 348\n\n12.11.\n\nPractice Problems: Developing a Chapter 13 Plan ................................................... 348\n\nChapter 13: Business Reorganizations under Chapter 11.....................................352\n13.1.\n\nIntroduction to Chapter 11 of the Bankruptcy Code ................................................ 352\nxiii\n\n\x0c13.2.\n\nThe Chapter 11 Process ............................................................................................ 352\n\n13.3.\n\nThe Exclusivity Period ............................................................................................. 353\n\n13.4.\n\nNegotiating a Plan and the Disclosure Statement ..................................................... 353\n\n13.5.\n\nClassification ............................................................................................................ 355\n\n13.6.\n\nVoting and Impairment ............................................................................................. 356\n\n13.7.\n\nNon-Recourse Debt and the Section 1111(b) Election ............................................. 356\n\n13.8.\n\nCases on Classifying Claims in Chapter 11 Reorganizations................................... 357\n\n13.8.1.1.\n\nIN RE US TRUCK CO., 800 F.2d 581 (6th Cir. 1986) .................................... 357\n\n13.8.1.2. IN RE BERNHARD STEINER PIANOS USA, INC., 292 B.R. 109 (Bankr.\nN.D. Tex. 2002) ................................................................................................................... 359\n13.8.1.3. PHOENIX MUT. LIFE v. GREYSTONE III JOINT VENTURE, 995 F.2d 1274\n(5th Cir. 1991) ..................................................................................................................... 361\n13.8.1.4.\n\nIN RE SM 104 LIMITED, 160 B.R. 202 (Bankr. S.D. Fla. 1993) ................... 365\n\n13.9.\n\nPractice Problems: Classification, Voting and Impairment..................................... 369\n\n13.10.\n\nConfirmation Requirements under 11 U.S.C. \xc2\xa7 1129(a) .......................................... 370\n\n13.11.\n\nThe Cramdown: 11 U.S.C. \xc2\xa7 1129(b). ..................................................................... 371\n\n13.11.1.1. Cramdown of Secured Claims........................................................................... 371\n13.11.1.2. Cramdown of Unsecured Claims. ..................................................................... 372\n13.12.\n\nCases on Cramming Down Secured Claims in a Chapter 11 Plan of Reorganization ...\n.................................................................................................................................. 373\n\n13.12.1.1. IN RE ARNOLD & BAKER FARMS, 85 F.3d 1415 (9th Cir. 1996) ............. 373\n13.12.1.2. BANK OF AMERICA v. 203 N. LaSALLE STREET P\xe2\x80\x99SHIP, 526 U.S. 434\n(1999)\n........................................................................................................................... 376\n13.13.\n1129)\n\nPractice Problems: Confirmation and Cramdown under Chapter 11 (11 U.S.C. \xc2\xa7\n.................................................................................................................................. 381\n\n13.14.\n\nThe Chapter 11 Discharge - 11 U.S.C. \xc2\xa7 1141 ......................................................... 382\n\n13.15.\n\nProtecting the Integrity of the Bankruptcy Process .................................................. 382\n\n13.16.\n\nCases on Protecting the Integrity of the Bankruptcy Process ................................... 383\n\n13.16.1.1. IN RE LIONEL CORP., 722 F.2d 1063 (2d Cir. 1983).................................... 383\n13.16.1.2. IN RE CHRYSLER, 576 F.3d 108 (2d Cir. 2009) ............................................ 387\n13.16.1.3. IN THE MATTER OF KMART CORP., 359 F.3d 866 (7th Cir. 2004) .......... 392\n\nAPPENDIX A: The Fair Debt Collection Practices Act .....................................395\nAPPENDIX B:\n\nFederal Wage Garnishment Limits ...........................................403\nxiv\n\n\x0cAPPENDIX C:\n\nNew York Exemptions ..............................................................405\n\nC.1. CPLR \xc2\xa7 5205. Personal property exempt from application to the satisfaction of money\njudgments. ............................................................................................................................... 405\nC.2. CPLR \xc2\xa7 5206. Real property exempt from application to the satisfaction of money\njudgments. ............................................................................................................................... 406\nC.3.\n\nNew York Debtor Creditor Law, Art. 10A, \xc2\xa7 282. ...................................................... 407\n\nC.4.\n\nNew York Debtor Creditor Law, Art. 10A, \xc2\xa7 283. ...................................................... 408\n\nC.5.\n\nNew York Debtor Creditor Law, Art. 10A, \xc2\xa7 284 [OLD]. .......................................... 409\n\nC.6.\n\nNew York Debtor Creditor Law, Art. 10A, \xc2\xa7 285 [NEW]. ......................................... 409\n\nAPPENDIX D: Social Security Act \xc2\xa7 207, 42 U.S.C. \xc2\xa7 407 .............................410\nAPPENDIX E: Uniform Fraudulent Transfer Act, 740 ILCS 160/1 (Illinois) ..411\nAPPENDIX F:\n\nArticle 9 of the New York Uniform Commercial Code ............418\n\nF.1.\n\nIndex ............................................................................................................................ 418\n\nF.2.\n\nStatutory Provisions ..................................................................................................... 424\n\nAPPENDIX G:\nAPPENDIX H:\n\nExample of Promissory Note ....................................................533\nExample of Security Agreement ...............................................534\n\nAPPENDIX I:\n\nExample of UCC-1 Financing Statement ..................................538\n\nAPPENDIX K: Bankruptcy Code & Selected Provisions of Federal Law ...........540\nCHAPTER 1............................................................................................................................ 553\nCHAPTER 3\xe2\x80\x94CASE ADMINISTRATION .......................................................................... 589\nCHAPTER 5\xe2\x80\x94CREDITORS, THE DEBTOR, AND THE ESTATE ................................... 637\nCHAPTER 7\xe2\x80\x94LIQUIDATION ............................................................................................. 718\nCHAPTER 9\xe2\x80\x94ADJUSTMENT OF DEBTS OF A MUNICIPALITY .................................. 753\nCHAPTER 11\xe2\x80\x94REORGANIZATION .................................................................................. 759\nCHAPTER 12\xe2\x80\x94ADJUSTMENT OF DEBTS OF A FAMILY FARMER OR FISHERMAN\nWITH REGULAR ANNUAL INCOME ................................................................................ 799\nCHAPTER 13\xe2\x80\x94ADJUSTMENT OF DEBTS OF AN INDIVIDUAL WITH REGULAR\nINCOME ................................................................................................................................. 810\nCHAPTER 15\xe2\x80\x94ANCILLARY AND OTHER CROSS-BORDER CASES .......................... 827\n\nSELECTED UNITED STATES CODE PROVISIONS .......................................839\nTITLE 18 - CRIMES AND CRIMINAL PROCEDURE ......................................839\nTITLE 26 \xe2\x80\x93 INTERNAL REVENUE CODE ........................................................843\nxv\n\n\x0cTITLE 28 \xe2\x80\x93 JUDICIARY AND JUDICIAL PROCEDURE .................................860\n\nxvi\n\n\x0cChapter 1: A World without Bankruptcy\n1.1.\n\nA Wee Bit of History\n\nWe begin the study of bankruptcy law by imagining a world in which bankruptcy does not\nexist. That was in fact the state of affairs during most of the 18th and 19th centuries. While the\nConstitution gave Congress the power to \xe2\x80\x9cestablish uniform laws on the subject of bankruptcies,\xe2\x80\x9d\nit did not require Congress to enact bankruptcy laws. U.S. Constitution, Article I, Section 8, Clause\n4. There were short-lived federal bankruptcy laws in effect from 1800-1803, 1841-1843, and 18671878. Federal bankruptcy law only became a permanent with the passage of the 1898 act, which\nremained in effect (with substantial revisions) until the passage of the current bankruptcy code in\n1978. The 1898 Act, as amended, remains known as the \xe2\x80\x9cBankruptcy Act,\xe2\x80\x9d and the 1978 law is\nknown as the \xe2\x80\x9cBankruptcy Code.\xe2\x80\x9d\nEarly bankruptcy laws both internationally and in the United States were primarily methods\nfor creditors to join together to efficiently collect their debts. There were no voluntary bankruptcy\ncases filed by debtors until the late 19th Century - bankruptcy cases could only be commenced by\ncreditors filing involuntary petitions against debtors who were in default. In the early days, debtors\nwho were unable to pay their debts were sent to languish in prison until their debts were paid. For\nmost, this was a life sentence \xe2\x80\x93 only those fortunate enough to have family members able to pay\ncould buy their freedom. The original concept of a \xe2\x80\x9cdischarge\xe2\x80\x9d was a release from prison given by\ncreditors to cooperative debtors, not the modern concept which bans creditors from attempting to\ncollect the discharged debts. Debtors prisons were abolished in the middle of the 19th century, but\nsome vestiges remained well into the middle of the 20th century, when the Supreme Court finally\nmade it clear that debtors could not constitutionally be imprisoned for their inability to pay debts.\nSee Williams v. Illinois, 399 U.S. 235 (1970); Tate v. Short, 401 U.S. 395 (1971). Note that debtors\ncan still today be imprisoned for refusing to pay debts that the debtor is able to pay \xe2\x80\x93 generally on\na finding of contempt for disobeying a turnover order. We begin therefore with process by which\ndebts are collected outside of bankruptcy.\n\n1.2.\n\nEnforcing Claims\n\nAn unsecured claim arises from a debtor\xe2\x80\x99s legal obligation to pay money or property to a\ncreditor. The legal obligation can be created by a debtor\xe2\x80\x99s promise to pay money or deliver\nproperty to a creditor (contract), from a debtor\xe2\x80\x99s receipt of money or property under circumstances\nrequiring restitution (quasi-contract), or from a debtor\xe2\x80\x99s commission of a tort.\nIt is important to distinguish unsecured claims from secured claims, which will be\ndiscussed in Chapter 2. A secured claim arises when a debtor voluntarily gives a lien on some or\nall of the debtor\xe2\x80\x99s property to secure repayment of the debt (consensual lien), or when the law\nimposes a lien on debtor\xe2\x80\x99s property to secure repayment of the debt (involuntary lien). In order for\na lien to exist, there must be some specific property that is subject to the lien. A lien is a creditor\xe2\x80\x99s\nlegal right, \xe2\x80\x9cin rem,\xe2\x80\x9d to enforce a claim against specific property owned by the debtor upon default.\nA lien is an interest in the property itself, and must be distinguished from the unsecured, \xe2\x80\x9cin\npersonam,\xe2\x80\x9d right that the creditor has against the debtor. We will start with a review of the system\n1\n\n\x0cfor collecting unsecured claims that are based on the borrower\xe2\x80\x99s legal obligation to pay, and then\nwe will look at the creation, enforcement and priority of secured claims or liens in Chapter 2.\n\n1.3.\n\nThe Self-Help System for Collecting Unsecured Claims\n\nAt one time creditors were permitted to use violence and enslavement to collect their\nclaims. In medieval times, the law even assisted creditors by allowing pillory, under which debtors\nwere restrained and subjected to maiming and death at the hands of their creditors. That is no\nlonger the case. It is a crime in every state to threaten to or use violence to collect debts. Short of\nviolence and threats of violence, however, the state laws on debt collection are ill defined and\npoorly enforced. Creditors are generally free to call or visit their debtors to ask for payment, to\nreport defaults to credit bureaus (which can result in the modern equivalent of a scarlet letter), and\neven to engage in various forms of conduct that many would consider to be harassment. The\nlimitations are generally embodied in criminal laws like extortion, although some states have\nenacted fair collection statutes modeled after the federal Fair Debt Collection Practices Act, but\napplied to the creditors themselves rather than to third party debt collectors. There are also general\nconsumer protection statutes that provide some protection for debtors, but these tend to apply only\nto specific industries and practices.\nThe main uniform limitation on debt collection activities is the federal Fair Debt Collection\nPractices Act. The first thing to note about the Act is that it generally applies only to debt collectors\n\xe2\x80\x93 those who regularly collect debts owed to another. It is entirely inapplicable to creditors who\ncollect their own debts in their own names, and to the collection of business debts. Nevertheless,\nthe act is extremely important because creditors often utilize third party debt collectors to collect\nconsumer debts. The debt collection industry is enormous \xe2\x80\x93 it is a multi-billion dollar industry \xe2\x80\x93\nand its practitioners range from professional law firms to sleazy boiler room operations. In most\nstates, no license or professional training is required to engage in the debt collection industry, and\nviolations of the federal Act abound.\n\n1.4.\n\nPractice Problems: Fair Debt Collection Practices Act (FDCPA)\n\nRead the Fair Debt Collection Practices Act (FDCPA), 15 U.S.C. 1601 et seq, which is\nreprinted in Appendix A at the end of the book. If you are using an electronic version of this book,\nyou should be able to click any of the underlined links to take you directly to the relevant appendix\nor code section in this document. If you have internet access, you should also be able to click case\nlinks to read the full text version of the cited case using the free Google Scholar service.\nProblem 1. Debtor owes $15,000 on her BofA Visa card, and has not made a payment in\ntwo months. A BofA employee calls the Debtor at 2:00 in the morning, and allows the phone to\nring 10 times before it is answered. The employee tells the debtor that he is an employee of BofA,\nand threatens to have the debtor put in jail unless payment is made by the close of business that\nday. What provisions of the FDCPA have been violated? FDCPA \xc2\xa7 803(6).\nProblem 2. How would your answer to Problem 1 change if the BofA employee falsely\ntold the debtor that he worked for the district attorney\xe2\x80\x99s office? See FDCPA \xc2\xa7 803(6)(A).\n\n2\n\n\x0cProblem 3. You are a new lawyer working at a debt collection law firm. Your firm has been\nasked to collect a debt owing to Bank of America. You want to send a demand letter to the debtor\noffering to accept 80% of the debt for immediate payment. If the 80% is not paid within 10 days,\nyou want the debtor to know that you will file suit and seek to recover attorney fees and costs\nunder the agreement. Are you subject to the FDCPA? See FDCPA \xc2\xa7 803(6). If so, what must you\nsay in the letter? See FDCPA \xc2\xa7\xc2\xa7 807(11), 809. For example, may you say (1) that you are an\nattorney, and (2) that you intend to file suit if the debtor does not timely accept your 80% payment\noffer? See FDCPA \xc2\xa7 807.\nProblem 4. Assume the same facts as in Problem (3), except that the debtor borrowed\nmoney for its business rather than owing money on a credit card. Would this change any of your\nanswers? See FDCPA \xc2\xa7 803(5).\nProblem 5. You are now the debtor. You have received a letter from an attorney like the\none in Problem (3). You have no idea what this debt is, and believe it may be a mistake or identity\ntheft. What should you do? See FDCPA \xc2\xa7 809(b). What must the debt collector do in response to\nyour action?\nProblem 6. Assume that the debtor owes the debt, but does not have the money to pay it,\nand is tired of getting collection calls constantly. What can the debtor do to stop the calls? See\nFDCPA \xc2\xa7 805(c).\nProblem 7. What can an individual consumer recover in an action against a collector for\nviolating the FDCPA? See FDCPA \xc2\xa7 813.\nProblem 8. The statute of limitations is an affirmative defense to an action filed by a\ncreditor to collect a debt after the statutory period has expired. Is it a violation of the FDCPA for\nan attorney representing a creditor to file a collection action after the statutory period has expired?\nIs it a violation of the FDCPA for the attorney or a debt collector to file a proof of claim in a\nbankruptcy proceeding on a debt that is time barred under the statute of limitations? Midland\nFunding, LLC v. Johnson, 581 US ___ (2017).\nProblem 9. Your client owes $10,000 to Citicorp on a credit card, and has not made\npayments for over a year. After failing to collect the debt, Citicorp sold the debt (along with many\nother debts that were in default) for to Santander Bank. Is Santander Bank liable under the FDCPA\nif it violates the statutory provisions? Consider both (1) whether Santander is a \xe2\x80\x9cdebt collector\xe2\x80\x9d\nunder FDCPA \xc2\xa7 803(6), and (2) whether Santander is a \xe2\x80\x9ccreditor\xe2\x80\x9d under FDCPA \xc2\xa7 803(4)?\n\n1.4.1.1.\nHENSON V. SANTANDER CONSUMER USA INC.,\n582 U.S. ___ (June 12, 2017)\nJUSTICE GORSUCH delivered the opinion of the Court.\n\nDisruptive dinnertime calls, downright deceit, and more besides drew Congress\xe2\x80\x99s eye to\nthe debt collection industry. From that scrutiny emerged the Fair Debt Collection Practices Act, a\nstatute that authorizes private lawsuits and weighty fines designed to deter wayward collection\npractices.\nSo perhaps it comes as little surprise that we now face a question about who exactly\nqualifies as a \xe2\x80\x9cdebt collector\xe2\x80\x9d subject to the Act\xe2\x80\x99s rigors. Everyone agrees that the term embraces\n3\n\n\x0cthe repo man\xe2\x80\x94someone hired by a creditor to collect an outstanding debt. But what if you\npurchase a debt and then try to collect it for yourself\xe2\x80\x94 does that make you a \xe2\x80\x9cdebt collector\xe2\x80\x9d too?\nThat\xe2\x80\x99s the nub of the dispute now before us. The parties approach the question from common\nground. The complaint alleges that CitiFinancial Auto loaned money to petitioners seeking to buy\ncars; that petitioners defaulted on those loans; that respondent Santander then purchased the\ndefaulted loans from CitiFinancial; and that Santander sought to collect in ways petitioners believe\ntroublesome under the Act. The parties agree, too, that in deciding whether Santander\xe2\x80\x99s conduct\nfalls within the Act\xe2\x80\x99s ambit we should look to statutory language defining the term \xe2\x80\x9cdebt collector\xe2\x80\x9d\nto embrace anyone who \xe2\x80\x9cregularly collects or attempts to collect . . . debts owed or due . . .\nanother.\xe2\x80\x9d 15 U. S. C. \xc2\xa7 1692a(6). Even when it comes to that question, the parties agree on at least\npart of an answer. Both sides accept that third party debt collection agents generally qualify as\n\xe2\x80\x9cdebt collectors\xe2\x80\x9d under the relevant statutory language, while those who seek only to collect for\nthemselves loans they originated generally do not. These results follow, the parties tell us, because\ndebt collection agents seek to collect debts \xe2\x80\x9cowed . . . another,\xe2\x80\x9d while loan originators acting on\ntheir own account aim only to collect debts owed to themselves. All that remains in dispute is how\nto classify individuals and entities who regularly purchase debts originated by someone else and\nthen seek to collect those debts for their own account. Does the Act treat the debt purchaser in that\nscenario more like the repo man or the loan originator? [The Court then recognizes a split between\nthe circuit courts which it must resolve]. Before attending to that job, though, we pause to note two\nrelated questions we do not attempt to answer today.\nFirst, petitioners suggest that Santander can qualify as a debt collector not only because it\nregularly seeks to collect for its own account debts that it has purchased, but also because it\nregularly acts as a third party collection agent for debts owed to others. Petitioners did not,\nhowever, raise the latter theory in their petition for certiorari and neither did we agree to review it.\nSecond, the parties briefly allude to another statutory definition of the term \xe2\x80\x9cdebt collector\xe2\x80\x9d\xe2\x80\x94one\nthat encompasses those engaged \xe2\x80\x9cin any business the principal purpose of which is the collection\nof any debts.\xe2\x80\x9d \xc2\xa7 1692a(6). But the parties haven\xe2\x80\x99t much litigated that alternative definition and in\ngranting certiorari we didn\xe2\x80\x99t agree to address it either. With these preliminaries by the board, we\ncan turn to the much narrowed question properly before us. In doing so, we begin, as we must,\nwith a careful examination of the statutory text. And there we find it hard to disagree with the\nFourth Circuit\xe2\x80\x99s interpretive handiwork. After all, the Act defines debt collectors to include those\nwho regularly seek to collect debts \xe2\x80\x9cowed . . . another.\xe2\x80\x9d And by its plain terms this language seems\nto focus our attention on third party collection agents working for a debt owner\xe2\x80\x94 not on a debt\nowner seeking to collect debts for itself. Neither does this language appear to suggest that we\nshould care how a debt owner came to be a debt owner\xe2\x80\x94 whether the owner originated the debt\nor came by it only through a later purchase. All that matters is whether the target of the lawsuit\nregularly seeks to collect debts for its own account or does so for \xe2\x80\x9canother.\xe2\x80\x9d And given that, it\nwould seem a debt purchaser like Santander may indeed collect debts for its own account without\ntriggering the statutory definition in dispute, just as the Fourth Circuit explained. [The Court then\nrejects Petitioner\xe2\x80\x99s argument that \xe2\x80\x9cowed\xe2\x80\x9d is a past participle that would not apply to purchased\ndebts].\nElsewhere, Congress recognized the distinction between a debt \xe2\x80\x9coriginated by\xe2\x80\x9d the\ncollector and a debt \xe2\x80\x9cowed or due\xe2\x80\x9d another. \xc2\xa7 1692a(6)(F)(ii). And elsewhere still, Congress drew\na line between the \xe2\x80\x9coriginal\xe2\x80\x9d and \xe2\x80\x9ccurrent\xe2\x80\x9d creditor. \xc2\xa7 1692g(a)(5). Yet no similar distinction can\nbe found in the language now before us. To the contrary, the statutory text at issue speaks not at\n4\n\n\x0call about originators and current debt owners but only about whether the defendant seeks to collect\non behalf of itself or \xe2\x80\x9canother.\xe2\x80\x9d\nEven what may be petitioners\xe2\x80\x99 best piece of contextual evidence ultimately proves\nunhelpful to their cause. Petitioners point out that the Act exempts from the definition of \xe2\x80\x9cdebt\ncollector\xe2\x80\x9d certain individuals who have \xe2\x80\x9cobtained\xe2\x80\x9d particular kinds of debt\xe2\x80\x94for example, debts\nnot yet in default or debts connected to secured commercial credit transactions. \xc2\xa7\xc2\xa7 1692a(6)(F)(iii)\nand (F)(iv). And because these exemptions contemplate the possibility that someone might\n\xe2\x80\x9cobtain\xe2\x80\x9d a debt \xe2\x80\x9cowed or due . . . another,\xe2\x80\x9d petitioners submit, the word \xe2\x80\x9cowed\xe2\x80\x9d must refer only to\na previous owner. This conclusion, they say, necessarily follows because, once you have\n\xe2\x80\x9cobtained\xe2\x80\x9d a debt, that same debt just cannot be currently \xe2\x80\x9cowed or due\xe2\x80\x9d another.\nThis last and quite essential premise of the argument, however, misses its mark. As a\nmatter of ordinary English, the word \xe2\x80\x9cobtained\xe2\x80\x9d can (and often does) refer to taking possession of\na piece of property without also taking ownership. You might, for example, take possession of a\ndebt for servicing and collection even while the debt formally remains owed another. Or as a\nsecured party you might take possession of a debt as collateral, again without taking full ownership\nof it. So it simply isn\xe2\x80\x99t the case that the statute\xe2\x80\x99s exclusions imply that the phrase \xe2\x80\x9cowed . . .\nanother\xe2\x80\x9d must refer to debts previously owed to another. By this point petitioners find themselves\nin retreat. On their view, debt purchasers surely qualify as collectors at least when they regularly\npurchase and seek to collect defaulted debts\xe2\x80\x94just as Santander allegedly did here. [U]nder the\ndefinition at issue before us you have to attempt to collect debts owed another before you can ever\nqualify as a debt collector. And petitioners\xe2\x80\x99 argument simply does not fully confront this plain and\nimplacable textual prerequisite.\nLikewise, even spotting (without granting) the premise that a person cannot be both a\ncreditor and a debt collector with respect to a particular debt, we don\xe2\x80\x99t see why a defaulted debt\npurchaser like Santander couldn\xe2\x80\x99t qualify as a creditor. For while the creditor definition excludes\npersons who \xe2\x80\x9creceive an assignment or transfer of a debt in default,\xe2\x80\x9d it does so only (and yet again)\nwhen the debt is assigned or transferred \xe2\x80\x9csolely for the purpose of facilitating collection of such\ndebt for another.\xe2\x80\x9d Ibid. (emphasis added). So a company collecting purchased defaulted debt for\nits own account\xe2\x80\x94like Santander\xe2\x80\x94 would hardly seem to be barred from qualifying as a creditor\nunder the statute\xe2\x80\x99s plain terms.\n[Petitioners then argue that] had Congress known this new [debt collection] industry would\nblossom, they say, it surely would have judged defaulted debt purchasers more like (and in need\nof the same special rules as) independent debt collectors. Indeed, petitioners contend that no other\nresult would be consistent with the overarching congressional goal of deterring untoward debt\ncollection practices.\nAll this seems to us quite a lot of speculation. And while it is of course our job to apply\nfaithfully the law Congress has written, it is never our job to rewrite a constitutionally valid\nstatutory text under the banner of speculation about what Congress might have done had it faced\na question that, on everyone\xe2\x80\x99s account, it never faced.\nIn the end, reasonable people can disagree with how Congress balanced the various social\ncosts and benefits in this area. We have no difficulty imagining, for example, a statute that applies\nthe Act\xe2\x80\x99s demands to anyone collecting any debts, anyone collecting debts originated by another,\nor to some other class of persons still. Neither do we doubt that the evolution of the debt collection\n5\n\n\x0cbusiness might invite reasonable disagreements on whether Congress should reenter the field and\nalter the judgments it made in the past. After all, it\xe2\x80\x99s hardly unknown for new business models to\nemerge in response to regulation, and for regulation in turn to address new business models.\nConstant competition between constable and quarry, regulator and regulated, can come as no\nsurprise in our changing world.\nBut neither should the proper role of the judiciary in that process\xe2\x80\x94to apply, not amend,\nthe work of the People\xe2\x80\x99s representatives. The judgment of the Court of Appeals is affirmed.\n\n1.5.\n\nThe Judicial System for Collecting Unsecured Claims: Obtaining\nand Enforcing a Judgment\n\nIn order to collect an unsecured debt using the judicial process, an unsecured creditor must\nfile a lawsuit against the debtor, win the suit by obtaining a money judgment from the court, and\nthen enforce the judgment against the debtor\xe2\x80\x99s property. The process for obtaining a money\njudgment can be long and expensive if the debtor files an answer to the complaint. Fortunately for\ncreditors in consumer cases, most debtors does not have the knowledge (or financial ability to hire\nsomeone with the knowledge to represent them) to file an answer to the complaint. If an answer is\nnot timely filed after service, the creditor can obtain a fast and cheap default judgment, and can\nthen proceed to enforce that judgment.\nThe lawsuit process is slowed down considerably if the defendant/debtor files an answer\nto the complaint. The creditor must either win the suit by summary judgment or prove the case at\ntrial \xe2\x80\x93 a process that can take years in many jurisdictions and can be extremely costly. In New\nYork, collection firms often let the suit languish or drop the suit entirely if the debtor merely files\nan answer to the complaint, because it is simply not worth the money for a creditor in a small\nconsumer case to have to prove the claim. I advise debtors to always file an answer to a complaint,\neven if they have no real defenses. There is nothing wrong with making a creditor prove its case.\nUnfortunately, by the time debtors seek legal assistance, they are usually facing the loss of\nproperty, and have often waived legitimate defenses by failing to file a timely answer.\nAfter the creditor recovers a money judgment (usually by default, or after summary\njudgment or trial), the creditor can apply to the clerk of the court for a writ of execution or\nsomething similar (in the old days it was called a \xe2\x80\x9cwrit of fieri facias\xe2\x80\x9d or \xe2\x80\x9cfi fa,\xe2\x80\x9d and it is still called\nthat in some jurisdictions). The writ by whatever name is used in the state instructs the levying\nofficer (usually the County Sheriff) to recover and sell the identified property to satisfy the\ncreditor\xe2\x80\x99s judgment. The creditor must identify property owned by the judgment debtor that is\navailable for execution, and provide the levying officer with the location of the property.\nIn order to determine what property is available for execution, the creditor after obtaining\na judgment can take discovery from the debtor to determine the existence and location of the\njudgment debtor\xe2\x80\x99s non-exempt property. In small cases this is done by written interrogatory \xe2\x80\x93 in\nlarger cases this is done by oral examination (deposition). Creditors can also discover the location\nof assets using governmental and database searches, or from information provided by the debtor\nwhen the original credit was extended.\nUpon receipt of the writ of execution, the levying officer must drive his or her pickup truck\nto the location of the property, physically seize the property (using force if necessary), bring the\n6\n\n\x0cproperty back to the levying officer\xe2\x80\x99s place of business, and proceed to follow a statutory procedure\nfor selling the property (normally through an advertised auction process). The proceeds from the\nauction sale are used to pay first the levying officer\xe2\x80\x99s costs of execution and then the creditor\xe2\x80\x99s\nclaim. Any excess is returned to the debtor.\nThe process is slightly different for real property, since the levying officer cannot put land\nin the back of a pickup truck. The levy on real property is generally made by the levying officer\nposting some sort of notice that the land is being seized. Some states require other symbolic acts\nby the levying officer, such as grabbing some soil and saying a magic incantation in addition to\nposting the notice of levy. Following levy, a similar sale procedure is utilized to sell real property.\n\n1.6.\n\nProvisional Remedies.\n\nProvisional remedies are prejudgment remedies that can be issued by a court to preserve\nthe status quo during the lawsuit. Traditional prejudgment remedies are preliminary injunctions,\nprovisional receiverships pending foreclosure, and prejudgment writs of attachment. Under a prejudgment writ of attachment, the levying officer would hold and protect the property pending the\nfinal outcome of the case.\nAt one time, state statutes allowed creditors to recover collateral or obtain prejudgment\nattachment and garnishment using court process without prior notice to the judgment debtor, and\nwithout requiring proof to the satisfaction of a judge. Indeed, often defendants could be deprived\nof the possession of property based on nothing more than an attorney\xe2\x80\x99s allegation.\nBeginning in the 1970s, the Supreme Court struck down a number of state provisional\nremedy statutes for failing to provide Debtors with due process prior to allowing their property to\nbe taken. See Sniadach v. Family Fin. Corp. of Bay View, 395 U.S. 337 (1969) (striking down\nprejudgment wage garnishment statute); Fuentes v. Shevin, 407 U.S. 67 (1972) (striking down\nstatutes allowing prejudgment replevin without notice and without a judicial hearing), Mitchell v.\nW.T. Grant Co., 416 U.S. 600 (1974) (allowing prejudgment replevin without notice but only after\na judicial hearing and with the posting of a substantial bond to protect the debtor); North Georgia\nFinishing, Inc. v. Di-Chem, Inc. 419 U.S. 601 (1975) (striking down prejudgment garnishment\nstatute); and Connecticut v. Doehr, 501 U.S. 1 (1991) (striking down statute allowing prejudgment\nattachment of real estate without prior notice or hearing and without posting a bond).\nI read these cases to require unsecured creditors to give their debtors notice of the\nproceeding and an opportunity to appear and object before debtors can be deprived of the\npossession and control of their property, unless the creditor can prove to the judge\xe2\x80\x99s satisfaction\nthat the property will likely be lost if prior notice is given. Even after meeting a heavy showing of\nnecessity, the creditor must be required to post a bond to protect the debtor from financial loss\nshould the creditor not prevail, and the debtor must be given the opportunity for a prompt postdeprivation hearing.\nThe reason that there have been so few published cases involving ex parte (that is, without\nnotice) pre-judgment writs is that state courts no longer grant ex parte relief except upon the most\nextraordinary showing of cause. Your author once tried to get a California state court to issue a\nprejudgment writ of attachment upon a substantial showing that the defendant was hiding assets\nthat would likely be dissipated if notice was given. The judge denied the application without even\n7\n\n\x0coffering me a hearing, saying that this kind of relief \xe2\x80\x9cjust isn\xe2\x80\x99t granted anymore.\xe2\x80\x9d While there may\nbe courts in less liberal parts of the country that would entertain ex parte relief, the burden of proof\non the applying creditor will likely be heavy.\nPrejudgment remedies are available on notice, but the required showing is heavy. The\ncreditor must show a probability of success on the merits, a likelihood of harm during the pendency\nof the case if relief is not granted, and must post a bond to protect the defendant from loss should\nthe debtor ultimately prevail on the merits. Even though their role has been diminished,\nprejudgment remedies have an important role to play in the race between creditors to the court\nhouse that is discussed later in this chapter.\n\n1.7.\n\nCASES: The Sheriff\xe2\x80\x99s Duty to Enforce Writs\n1.7.1.1.\nDAVID J. VITALE v. HOTEL CALIFORNIA, INC.,\n184 N.J. Super 512, 446 A.2d 880 (1982)\n\nPlaintiff David J. Vitale, Jr. brings this motion pursuant to N.J.S.A. 40A:9-109 to amerce,\nthat is, hold liable the Sheriff of Monmouth County, William Lanzaro, for failing to execute a writ\nbased on a judgment against defendant Hotel California, Inc. (California). The chronology of\nevents is as follows: Vitale obtained a final judgment against California in the amount of $6,317\nplus costs on August 12, 1980 and thereafter learned that California held the liquor license for\n"The Fast Lane," a bar featuring "punk rock" entertainers, located in Asbury Park, New Jersey. A\nwrit of execution issued on June 23, 1981, and on July 9 the sheriff received the writ along with a\ncover letter from plaintiff instructing him to levy upon all monies and personal property at The\nFast Lane.\nThen began plaintiff\'s travail with the sheriff\'s office which gave rise to this proceeding.\nOn July 27 the office indicated to plaintiff\'s attorney that a levy was not possible since the bar was\nonly open late in the evening, from about 10 p.m. to 2 a.m., and that the writ would be returned\nunsatisfied. [Plaintiff\xe2\x80\x99s attorney] advised a deputy sheriff that it was absolutely necessary to\nproceed to make the levy during the open hours.\n[The sheriff reported that he] went to The Fast Lane on July 31 accompanied by an Asbury\nPark police officer, identified himself and announced his purpose at the door, but was denied\naccess by the bar\'s "bouncers." Fearing that violence might ensue, the officers left. [Plaintiff\xe2\x80\x99s\nattorney advised the sheriff] to make the levy and arrest anyone interfering with execution. [The\nsheriff refused to proceed without a further court order, which the plaintiffs obtained. The sheriff]\nwent [to the bar] on the morning of August 15 and was able to seize $714 in cash and other personal\nproperty. [The sheriff] reported back . . . his belief that additional money may have been secreted\nbefore he was able to levy upon it. [The Sheriff refused to make further levies contending] that\nonly one levy need be made under a writ of execution.\nThe sheriff maintains that "it is unreasonable to expect any Sheriff, to command his officers\nor deputies to go forth on an unknown number of occasions, at an unreasonable hour, to seize\nproceeds of an establishment such as The Fast Lane."\nThree basic, interrelated questions are presented for resolution: (1) Are successive levies\npossible under one writ of execution? (2) When may a sheriff refuse to levy as instructed by a\n8\n\n\x0cplaintiff, on the basis that the request is unreasonable or onerous? (3) Was the conduct of Sheriff\nLanzaro and his office in respect to the writ such as to subject him to amercement?\nBefore proceeding to answer the first question, a brief overview of execution procedure\nwould be beneficial. A successful plaintiff who obtains a judgment against a defendant may cause\nthe personal property of the defendant/judgment debtor to be seized and sold and the proceeds\napplied to the judgment and costs by way of execution. To do this, plaintiff obtains a writ of\nexecution, directing the sheriff to levy and make a return within three months after the date of\nissuance. (A "return" is the physical return of the original writ to the court clerk, endorsed with the\nexecuting officer\'s brief description of what was done. In addition, the officer must file a verified\nstatement of when and how much money was collected and the balance due on execution fees or\ncosts.).\nThe writ may be returned before the return date if, notwithstanding diligent effort, the\njudgment cannot be satisfied any further. Once an execution has been returned, a sheriff cannot\nthereafter levy upon any property under the writ. Nor can a valid levy be made after the return\ndate. Successive executions upon the same judgment are possible. Therefore, if the first seizure is\ninsufficient, the creditor may seek an alias writ for levy upon other goods. Thereafter, the plaintiff\nmay seek an unlimited number of pluries writs until the judgment is satisfied. The proceeds from\nthe sheriff\'s sale of seized property are paid to the judgment creditor or to his or her attorney or to\nthe court clerk.\nThroughout the process plaintiff plays a crucial role. Plaintiff must prepare the writ, have\nit entered by the court clerk and see that it is delivered to the sheriff with instructions as to levying.\nIf necessary, plaintiff should conduct discovery to locate and identify property to be levied upon.\nComplementary to plaintiff\'s responsibility is the sheriff\'s duty to execute the writ according to the\nplaintiff\'s instructions. The writ is in the "exclusive control" of the judgment creditor; the sheriff\nmust follow the creditor\'s reasonable instructions regarding the time and manner of making the\nlevy and must abide by special instructions to make an immediate levy, if practicable, when\nplaintiff demonstrates necessity.\nI. Successive Levies Under One Writ\nThe first question presented, whether successive levies can be made under one writ, can be\nsimply answered \xe2\x80\x94 "yes." . . . . If property levied on is not sufficient to satisfy the execution, a\nreturn should not be made without a showing that attempting another levy would be fruitless.\nII. Reasonableness of Requested Levies\nThat brings us to the second question, whether the sheriff rightly refused to honor an\nunreasonable request to levy. The particular elements of the request perceived as unreasonable\nmust be reviewed.\nThe sheriff first objects to the "unknown number of occasions" that he and his deputies\nwould have to go forth to attempt levy in order to comply with plaintiff\'s wishes. There is\ntechnically no limit to the number of times that a sheriff might be required to levy. Nevertheless,\npractical, operational considerations of a sheriff\'s office impose an obligation on a plaintiff not to\nrequest inordinately frequent and numerous levies. The one successful levy netting $714 on August\n15 can be used to project what was entailed by plaintiff\'s request for levies on successive weekend\nnights. By extrapolation, the sheriff might have had to levy approximately nine times in the space\n9\n\n\x0cof one to two months to comply with the request. This many potential levies under one judgment\nmay be unusual but is not in itself unreasonable.\nThe objection as to the unreasonably late hour requested for the levy also cannot be\nsustained. Levy under a writ of execution may be made at any hour of the day; there is no issue of\nprivacy here that might dictate otherwise. The Fast Lane\'s late open hours impelled the late-atnight levy. Like police officers, sheriffs and their deputies may be obliged to work at times of the\nday and week when the rest of the populace sleep or recreate.\nThe threat of violence engendered by attempting the levy goes to the heart of the sheriff\'s\nobjections. "[T]o seize proceeds of an establishment such as The Fast Lane" un-camouflages what\nmay have been the most unappetizing aspect of the requested levy. (Emphasis supplied). . . .\nNevertheless, the refusal to make further levies implies that a conscious decision may have been\nmade to risk amercement rather than further confrontations at the bar.\nWhen is physical force appropriate in making a levy? The general rule is that:\n[an] officer may force an entry into any enclosure except the dwelling house of\nthe judgment debtor in order to levy a fieri facias on the debtor\'s goods and\neven in the case of the debtor\'s home, when the officer is once inside, he may\nbreak open inner doors or trunks to come at the goods.\nOn July 31 The Fast Lane bouncers did in fact, obstruct the officer from "performing an\nofficial function by means of intimidation," giving the officers probable cause to arrest them. Their\nresistance to the lawful process might have been a basis for criminal conviction. Although the\nofficers did not believe themselves to be in a position to use physical force, they apparently did\nnot summon back-up help to effectuate the levy or make arrests incidental thereto.\nAre sheriffs\' deputies to be faulted for not using physical force in a nonemergency\nsituation? The nature of law is to physically force people, if need be, to do things or refrain from\ndoing things that they would be free to do or not do in the "natural state"; the hope is that the\nbenefit to society will more than compensate for the loss of individual freedom. Sheriff\'s officers\nact as the physical extension of the power of the court, and thus, of the law and the will of the\npeople. Necessarily, then, the privilege of such civil service occasionally demands risking bodily\nharm to oneself. Only in this way will the lawless be kept from becoming the de facto law makers.\nPhilosophy aside, the record is barren of facts showing any imminent harm to the sheriff\'s officers\non July 31 other than the vague averment that attempting to carry out the levy may have triggered\na violent reaction. I find this unembellished defense insufficient to justify not making the levy.\nIII. Amercement\nConsequently, by concluding that the sheriff failed to abide by plaintiff\'s proper requests\nto levy, I reach the question of amercement. By proceeding in amercement, a judgment creditor\nmay hold a sheriff liable for failing to properly execute against a judgment debtor:\nIf a sheriff or acting sheriff fails to perform any duty imposed upon him by law in respect\nto writs of execution resulting in loss or damage to the judgment creditor, he shall be subject to\namercement in the amount of such loss and damage to and for the use of the judgment creditor.\nThe delinquent sheriff or acting sheriff shall also be subject to attachment or punishment for\ncontempt.\n10\n\n\x0cThe cases demonstrate uniform application of the principle that a "sheriff is not liable to\namercement until he shall have disobeyed positive, reasonable, lawful directions." From the above\ndiscussion it is clear that plaintiff has carried his burden. Plaintiff\xe2\x80\x99s instructions were consistent\nand direct and the successive levies requested were lawful and reasonable under the circumstances.\nThe sheriff understood but did not comply with those instructions. Insofar as potential physical\nresistance thwarted the levy on July 31 and may have inhibited further levies after August 15, there\nwas a definite failure to perform a duty with regard to an execution. It is not denied that plaintiff\nrepeatedly expressed a willingness to pay the mileage costs and fees associated with the levies.\nThe sheriff\'s failure to abide by plaintiff\'s instructions therefore renders him liable to be amerced.\nThe final issue is whether plaintiff has demonstrated a loss. Plaintiff must show that the\nofficer\'s conduct has deprived him of a "substantial benefit to which he was entitled" under the\nwrit; that but for the officer\'s conduct, he would have received such benefit through the execution.\nPlaintiff is not bound to prove the value of the property subject to levy because\n[i]t would be highly inconvenient and unjust to require an innocent plaintiff to\nprove the value of the goods which had been in the sheriff\'s power but which,\nthrough his neglect, may have been eloigned beyond the reach of plaintiff\'s\ninvestigation. [Id.]\nI conclude that plaintiff was denied the benefit of the writ and that the consequential loss\namounts to the judgment debt of $6,317 less any amounts heretofore collected.\nThe difficult, distasteful aspects of executing writs demand that sheriffs be dealt with fairly,\nwith an eye to the practicalities of their job. My reluctance to amerce a sheriff beset with such\nunpleasant tasks is only overcome by the convincing proof that Sheriff Lanzaro owed and breached\na duty to plaintiff to make the successive levies as requested. In short, by invoking the remedy of\namercement, I choose to satisfy plaintiff\'s debt where the sheriff has not.\n--------------------------------------\n\n1.8.\n\nProperty Garnishments\n\nGarnishment is similar to execution. It is a procedure to recover property belonging to the\ndebtor that is held by a third person. The writ of garnishment is directed to the third person holding\nthe judgment debtor\xe2\x80\x99s property (often a bank or an employer). The writ directs the garnishee to\nfile a \xe2\x80\x9creturn\xe2\x80\x9d identifying any property belonging to the judgment debtor in the garnishee\xe2\x80\x99s\npossession. The writ covers any property held by the garnishee and owing to the judgment debtor\nfrom the time the writ is served until the garnishee files the \xe2\x80\x9creturn\xe2\x80\x9d with the court. The judgment\ndebtor is given a copy of the return and has an opportunity to claim exemptions or make other\nobjections before the property is turned over by the garnishee to the levying officer. The writ thus\ncovers not only property in the garnishee\xe2\x80\x99s hands on the date the writ is served, but any property\ncoming into the garnishee\xe2\x80\x99s hands from the date of service until the writ is returned. The period\nbetween service and return is known as the \xe2\x80\x9cnet.\xe2\x80\x9d\nAs soon as the writ of garnishment is served on the third party holding property belonging\nto the judgment creditor, the creditor receives a judicial lien on the property that is subject to\ngarnishment. If the garnishee does not comply with the writ, the garnishee is personally liable for\nthe judgment debtor\xe2\x80\x99s loss. The garnishee must freeze the judgment debtor\xe2\x80\x99s property or accounts\n11\n\n\x0cupon being served with the writ of garnishment, or run the risk of personal liability for failing to\ncomply with the writ.\nIt is common for debt collectors to \xe2\x80\x9cspray\xe2\x80\x9d writs of garnishment on local banks in order to\ncapture money which the judgment debtor may have in any accounts at those banks. Collection\nlawyers also use databases to find bank accounts in which a judgment debtor may have deposit\naccounts or safe deposit boxes. The power to freeze a judgment debtor\xe2\x80\x99s accounts provides a\npowerful incentive for payment, because judgment debtors are effectively frozen out of the\nbanking system.\n\n1.9.\n\nWage Garnishments\n\nWage garnishments are similar to property garnishments but cover present and future\nwages owing by an employer to the judgment debtor. Because wage garnishments threaten the\njudgment debtor\xe2\x80\x99s ability to survive, there are special exemption statutes at both the state and\nfederal level exempting from garnishment a significant portion of the judgment debtor\xe2\x80\x99s earnings.\nThere are at least two sets of laws that protect judgment debtors from wage garnishments:\nThe Federal Wage Garnishment Law, 15 U.S.C. \xc2\xa7 1672 et seq, reprinted in Appendix B, applies\nthroughout the United States and provides two sets of limits: (1) a floor preventing any wage\ngarnishment for low income workers, and (2) a maximum percentage that may be garnishment\nfrom higher income workers. 15 U.S.C. \xc2\xa7 1673.\nIn computing garnishment limits, you must first determine the base pay to which the\ngarnishment limits are applied. The federal law uses \xe2\x80\x9cdisposable earnings\xe2\x80\x9d as the base. 15 U.S.C.\n\xc2\xa7 1672. You must then determine the limits based on the judgment debtor\xe2\x80\x99s actual paycheck.\nThe current federal minimum wage is $7.25 per hour. The garnishment floor is this 30\ntimes the minimum wage per week, or $217.50 of disposable earnings per week: If the judgment\ndebtor makes less than $217.50 per week in disposable earnings, all of the judgment debtor\xe2\x80\x99s\nwages would be exempt and would not be subject to garnishment. If the judgment debtor made\nmore than $217.50 per week, a private creditor could garnish the excess disposable earnings over\n$217.50 per week UP TO 25% of the judgment debtor\xe2\x80\x99s disposable earnings. To comply with the\nfederal garnishment limits, an employer must make two calculations: (1) By how much did the\njudgment debtor\xe2\x80\x99s disposable earnings exceed $217.50? (2) What is 25% of the judgment debtor\xe2\x80\x99s\ndisposable earnings? Whichever of these two numbers is lower is the federal garnishment limit.\nIf the judgment debtor gets paid bi-weekly, double the limits. If the judgment debtor gets paid\nmonthly, multiply the limits by four.\n\n1.10.\n\nState Wage Garnishment Exemptions\n\nMany states offer more generous wage garnishment exemptions than the federal\ngarnishment limitations. State laws cannot be less generous than the federal limits, but they can be\nmore generous. See 15 U.S.C. \xc2\xa7 1677.\nSome states have no limitations on wage garnishment (allowing the 25% limit from the\nfederal statute to govern); others allow no wage garnishment at all. Some states provide that\namounts reasonably necessary for support are exempt rather than specifying limits. In these states,\n12\n\n\x0ca judgment debtor would have to file a claim of exemption with the court to get a determination\nthat wages above the federal limits are exempt. As of the date of publication, this website has links\nto the various state garnishment limitations.\nIn New York, for example, wage garnishment cannot exceed 10% of the judgment debtor\xe2\x80\x99s\ngross wages. Thus in New York, the employer must make three calculations: (1) the amount of\njudgment debtor\xe2\x80\x99s disposable wages over $217.50 per week, (2) 25% of the judgment debtor\xe2\x80\x99s\nweekly disposable wages, and (3) 10% of the judgment debtor\xe2\x80\x99s weekly gross wages. Whichever\nof the three numbers is LOWER is the garnishment limit in New York.\nBecause of the complexity of these rules, I have seen many employers in New York simply\nwithhold 10% of the judgment debtor\xe2\x80\x99s gross wages without applying the federal limits, which is\na clear violation of federal law.\n\n1.11.\n\nExceptions to Wage Garnishment Limits\n\nThere are several important exceptions to the federal wage garnishment limits.\nFirst, as provided in the statute, family support claims have a much higher federal limit\n(50-65% of disposable earnings).\nSecond, the Federal Wage Garnishment Law does not apply to state or federal tax\ncollections. The Internal Revenue Service can garnish wages after assessing unpaid taxes without\nsuing and obtaining a judgment. The IRS can garnish all of your wages above the amount that it\nhas determined is necessary for a person to survive, which is based on the filing status and tax\nexemptions claimed by the debtor on its tax return. The IRS has published a chart showing the\nexemption amounts.\nThird, federal student loan garnishments are subject to different limits. 31 U.S.C. \xc2\xa7 3720d,\npart of the Debt Collection Improvement Act of 1996, Pub. Law 104\xe2\x80\x93134, 110 Stat. 1321-362\n(Apr. 26, 1996) (federal student loan garnishments limited to 15% of disposable earnings). Federal\nstudent loan garnishments are also subject to the federal floor of 30 times the minimum wage. Id.\nFourth, the statutory limits reflect the total amount that may be garnished by all creditors.\nI had a case where an employer received several garnishments from different creditors, and\nwithheld the 10% New York limit for each creditor, taking 30% of the employee\xe2\x80\x99s wages. That\nwas clearly wrong. The limits are aggregate limits designed to preserve to the debtor a living wage.\nIf there are multiple garnishments, the first garnishee gets paid; the others have to wait to be paid\nin order until the prior garnishees are fully paid. See Department of Labor Fact Sheet 30; and the\nfull regulations at 29 CFR Part 870.\n\n1.12.\n\nPractice Problems: Calculating Wage Garnishment Limits\n\nCalculate the maximum garnishment amount for a judgment debtor who resides in New\nYork and earned the following amounts every two weeks:\n\n13\n\n\x0cGross\nWages\nMar 01\nMar 15\nApr 01\nApr 15\nMay 01\nMay 15\nJun 01\n\n1.13.\n\n$\n$\n$\n$\n$\n$\n$\n\n500\n500\n500\n440\n560\n350\n500\n\nOvertime\nTaxes\nPay\nWithheld\n\n$\n$\n$\n$\n\n248\n20\n50\n\n$\n\n540\n\n$\n$\n$\n$\n$\n$\n$\n\n(14)\n(37)\n(26)\n(22)\n(31)\n(18)\n(52)\n\nVoluntary\nPension\nContribution\n$\n(90)\n$\n(90)\n$\n(90)\n$\n(90)\n$\n(90)\n$\n(90)\n$\n(90)\n\nMandatory\nUnion\nDues\n$\n(30)\n$\n(30)\n$\n(30)\n$\n(30)\n$\n(50)\n$\n(60)\n$\n(60)\n\nPayment\nReceived\n$\n$\n$\n$\n$\n$\n$\n\n366\n591\n374\n298\n440\n183\n838\n\nState Law Execution Exemptions\n\nState laws also commonly exempt many kinds of personal property, as well as real estate\nused as a principal residence (homestead), from execution. State exemption statutes vary widely \xe2\x80\x93\nsome states provide an unlimited homestead exemption regardless of the value of the home, while\nother states only exempt a homestead up to a few thousand dollars. Household goods (clothes,\nfurniture and the like) are usually exempt, as are cars up to a certain value. In most states, the\nexemption applies to the judgment debtor\xe2\x80\x99s equity in the property (the value of the property above\nother liens). A list of state exemption statutes is available at\nhttp://www.legalconsumer.com/bankruptcy/laws/. The New York exemption statute is reprinted\nin Appendix C.\n\n1.14.\n\nPractice Problems: Enforcement of Judgments\n\nA creditor has obtained a $100,000 judgment against an unmarried debtor who lives in\nNew York. The debtor asks you whether the creditor can collect the judgment from the following\nassets owned by the judgment debtor. Review the New York exemption statute and answer the\nfollowing questions:\nProblem 1. The debtor has $10,000 in a bank account. How much can the creditor take?\nProblem 2. Can the creditor take the debtor\xe2\x80\x99s car, worth $5,000?\nProblem 3. May the creditor force the sale of the debtor\xe2\x80\x99s house in Syracuse (Onondaga\nCounty) worth $125,000? The house is subject to a $40,000 mortgage?\nProblem 4. What if the house is worth $110,000?\nProblem 5. The Debtor purchased a car for $3,000, paying $300 down, and borrowing the\n$2,700 balance from the car dealer. The car dealer has a security interest in the car. If the debtor\nstops paying, what can the car dealer do?\n\n1.15.\n\nOther Federal and State Exemptions\n\nThere are many exemptions from execution that are not contained in the general state\nexemption statute, but instead are buried in other federal and state statutes. The most important\n14\n\n\x0cexemption is for Social Security payments. Read the exemptions in the Social Security Act, 42\nU.S.C. \xc2\xa7 407, which is contained in Appendix E. After reading the Social Security exemption\nstatute, can you understand why social security recipients should be advised to keep their social\nsecurity proceeds in an account that contains only social security proceeds (and not any other form\nof income)?\n\n1.16.\n\nFederal Tax Collection\n\nThe one creditor who is not subject to state and federal exemptions laws (outside of the\nInternal Revenue Code) is the Internal Revenue Service. The IRS does not have to go to court to\nobtain a judgment or levy. Instead, the IRS only needs to make an \xe2\x80\x9cassessment\xe2\x80\x9d before the process\nof collection can begin.\nThere are three basic ways that the IRS can make an assessment: (1) the taxpayer can file\na return showing taxes due (this is referred to commonly as a \xe2\x80\x9cself-assessment\xe2\x80\x9d), (2) the IRS can\nfile a substitute for return if the taxpayer does not file one (generally based on reported income\nand the standard deduction) and assess the taxes shown as owing, or (3) the IRS can follow\nstatutory procedures to recover a deficiency judgment. The IRS makes the assessment by simply\nrecording the taxpayer\xe2\x80\x99s obligation in its records.\nAs part of its collection power, the IRS can offset federal tax refunds, garnish social\nsecurity benefits, and levy upon real or personal property without regard to state or non-tax federal\nexemption laws. The Internal Revenue Code provides "Notwithstanding any other law of the\nUnited States, no property or rights to property shall be exempt from levy other than the property\nspecifically made exempt by subsection (a)." 26 U.S.C. 6334(c). The IRS exemptions (26 U.S.C.\n6334(a)) include wearing apparel; school books; fuel and provisions, furniture, and personal\neffects, not to exceed $500 in value; books and tools of a trade, business, or profession, not to\nexceed $250 in value.\nDespite its broad statutory collection power and its reputation in many quarters, the IRS\ntends to be a gentle creditor if the debtor communicates promptly and openly with the IRS. If a\ndebtor ignores the IRS\xe2\x80\x99s tax notices, the IRS computers will proceed with the automated process\nof collection. On the other hand, the IRS tends to be very generous with those who call the IRS to\nexplain their situation. The IRS will negotiate payment plans and put people who cannot afford to\npay in uncollectable status. The important thing is to communicate with the IRS rather than hoping\nthe problem will go away on its own.\n\n1.17.\n\nState Law Avoiding Powers\n\nA creditor with an avoiding power can set aside or avoid a transaction between the debtor\nand a third party that harmed (or is presumed to have harmed) the creditor. The most important\navoiding power is the right of creditors to avoid fraudulent transfers. There is a long history to the\nfraudulent transfer law dating back to the English Statute of 13 Elizabeth (13 Eliz 1, c 5) in 1571.\nA Uniform Fraudulent Conveyance Act (\xe2\x80\x9cUFCA\xe2\x80\x9d) was promulgated in 1918 by the National\nConference of Commissioners on Uniform State Laws, and became the law in most states until a\nsimilar but more modern version called the Uniform Fraudulent Transfers Act (\xe2\x80\x9cUFTA\xe2\x80\x9d) was\nadvanced in 1984. Virtually every state has adopted the UFTA, except notably New York which\n15\n\n\x0cstill uses a modified version of the UFCA. The Illinois version of the UFTA is set forth in\nAppendix E.\nIt is important to note several things about the UFTA (and the UFCA before it). First, the\nAct covers two kinds of transfers: (1) transfers with actual intent to delay or harm creditors, and\n(2) transfers that are constructively fraudulent because the debtor did not receive reasonably\nequivalent value (\xe2\x80\x9cREV\xe2\x80\x9d) in return for the transfer, and was or became insolvent (or something\nlike insolvent) by the transfer. The concept of a constructive fraudulent conveyance is that an\ninsolvent debtor is giving away money that should rightfully belong to its creditors in making a\ngift.\nSecond, act covers not only transfers of property, but also the incurrence of fraudulent\nobligations which would dilute the distributions to other unsecured creditors.\nThird, the definition of \xe2\x80\x9cvalue\xe2\x80\x9d includes the satisfaction or securing of an antecedent debt.\nTherefore, the debtor\xe2\x80\x99s payment of a valid debt in preference to other creditors, or the debtor giving\na lien on collateral to secure certain creditors and not others, is not a fraudulent conveyance (with\none exception specified in Section 6(b) of the Uniform Act).\nThird, the Act gives greater protection to unsecured creditors who have claims at the time\nthe transfer is made as opposed to those who become creditors in the future.\nFinally, the statute of limitations requires a creditor to act promptly after the transfer is\nmade (or in certain cases after learning of the transfer).\nReview the Uniform statute and answer the questions below:\n\n1.18.\n\nPractice Problems: Fraudulent Transfers\n\nReview the Uniform Fraudulent Transfers Act (Illinois), 740 ILCS 160/1, listed in\nAppendix F, and answer the following questions:\nProblem 1. Debtor owes $100,000 to creditors. Debtor\xe2\x80\x99s assets are worth $50,000. Debtor\nuses a $10,000 tax refund to help her adult son rent an apartment and buy a car to get to work. Can\nthe creditors do anything about the expenditure? Would your answer change if debtor\xe2\x80\x99s assets\n(excluding the tax refund) were worth $101,000? Read carefully UFTA \xc2\xa7 5 and UFTA \xc2\xa7 6\nProblem 2. Debtor owes $100,000 to creditors, and has assets worth $50,000. Debtor\xe2\x80\x99s\nson needs an apartment. The landlord is not willing to rent the apartment to Debtor\xe2\x80\x99s son unless\nDebtor guarantees the rent. Would creditors be harmed by the guaranty? If so, what can creditors\ndo if Debtor guaranties the rent?\nProblem 3. Debtor owes $100,000 to her father, and $50,000 to EasyBank. Debtor owns a\n(non-exempt) house worth $75,000. Debtor offers her father a lien on her house to secure the\n$100,000 debt. Would EasyBank be harmed by the granting of the lien? Could EasyBank avoid\nthe granting of the lien as a fraudulent transfer? See UFTA \xc2\xa7 4.\nProblem 4. In need of fast money, Insolvent Al pawns his only valuable asset, a 1935\nMartin Guitar, at a local pawn shop called PawnWorld for $500 cash. A similar guitar recently\nsold on EBay for $1,500. Is the pawn a fraudulent conveyance? Would Al\xe2\x80\x99s failure to redeem the\n16\n\n\x0cpawn be a fraudulent conveyance? If so, what could creditors recover and from whom? See\nUFTA \xc2\xa7\xc2\xa7 9(b), (d). Does it matter whether or not PawnWorld knew that Al was insolvent?\nProblem 5. Suppose after Al in Problem (4) failed to timely redeem the pawn, you\npurchased the guitar from PawnWorld for $1,000 knowing nothing about Al or his financial\nproblems. Could creditors recover the guitar or its excess value from you? See UFTA \xc2\xa7 9(b)(2).\nProblem 6. Would your answer to Problem (5) be the same if the guitar was worth $20,000\nrather than $1,500? If they could not recover the guitar from you, is there anything Al\xe2\x80\x99s creditors\ncould do about the fraudulent transfer?\n\n1.19.\n\nThe Race to the Courthouse and the Concept of Bankruptcy\n\nAn unsecured creditor is like a caterpillar with a few suasion powers to enforce payment,\nbut no power to sell the debtor\xe2\x80\x99s assets to obtain money to satisfy the debt. The unsecured\ncaterpillar cannot sell a debtor\xe2\x80\x99s assets and can only use legal suasion to obtain voluntary payment.\nOnly a butterfly (a secured creditor) can cause the sale of the debtor\xe2\x80\x99s assets to obtain money to\npay the debt.\nBut the unsecured caterpillar turns into a secured butterfly through the judicial lien process.\nOnce becoming a butterfly, the former caterpillar has rights in the debtor\xe2\x80\x99s property that can be\nenforced through sale. But secured butterflies must compete with each other over the proceeds\nfrom the sale of the debtor\xe2\x80\x99s property. State law favors the swiftest creditors. The first unsecured\ncreditor to obtain a judgment and cause the levying officer to levy against the debtor\xe2\x80\x99s property\ngets paid first out of the proceeds. Slow creditors may not get paid at all, as faster creditors devour\nthe debtor\xe2\x80\x99s assets. This is known as the \xe2\x80\x9crace to the courthouse,\xe2\x80\x9d as creditors rush to be the first\nto get a judgment and levy on the debtor\xe2\x80\x99s property.\nThere are two basic rules governing judgment creditor priority (which creditor gets paid\nfirst). In the majority of states, the first creditor to levy has priority over later levying creditors. In\na minority of states, the first creditor to deliver a writ of execution to the levying officer has priority\nover later delivering creditors if the sheriff ultimately successfully levies. In either case, it is the\nlaw of the jungle, survival of the fittest, with creditors pushing to be the first to obtain their\njudgment, deliver it to the sheriff, and levy on the debtor\xe2\x80\x99s property.\nThe race to the courthouse makes it difficult for debtors to negotiate with creditors for\nadditional time to pay, because those generous enough to grant additional time fall behind in the\nrace to become a secured butterfly and have priority over later butterflies.\nHistorically, the process of bankruptcy was designed by creditors to avoid the race to the\ncourthouse. Instead of creditors competing with each other and often forcing quick sales of the\ndebtor\xe2\x80\x99s property for low prices, creditors join together in a bankruptcy proceeding to obtain the\norderly sale of the borrower\xe2\x80\x99s property and distribution of the sale proceeds to all creditors\nproportionally. The historical process of bankruptcy was a method for collective action by\ncreditors. Today, however, almost all cases are initiated by debtors who seek bankruptcy protection\nin order to obtain the benefits of a bankruptcy automatic stay and discharge. See David S.\nKennedy, James E. Bailey, III & R. Spencer Clift, III, THE INVOLUNTARY BANKRUPTCY PROCESS:\nA STUDY OF THE RELEVANT STATUTORY AND PROCEDURAL PROVISIONS AND RELATED MATTERS,\n17\n\n\x0c31 UMEM L. REV. 1, 3 (2000) (In 1998 less than 1/1000 of one percent of all filings were\ninvoluntary).\nThere is one more part of state law that we must understand before we begin the study of\nbankruptcy law. The process by which the faster judgment creditor has priority over slower\njudgment creditors, at its core, recognizes that the faster levying creditor has a special interest in\nthe property. This special property interest is known as a \xe2\x80\x9clien,\xe2\x80\x9d specifically a judicial lien. A lien\nis an interest in property to secure a debt or other obligation. In the next chapter we will look at\nthe various kinds of liens that exist under state law, the special rights given to lienholders over\nunsecured creditors, and how priority between competing lien creditors is determined.\n\n18\n\n\x0cChapter 2: Secured Claims\n2.1.\n\nLiens and Priority\n\nIn Chapter 1, we looked at the process for collecting unsecured claims and noted that\ncreditors have two basic options \xe2\x80\x93 (1) obtain voluntary payment from the debtor, or (2) use the\njudicial process for obtaining and enforcing a judgment. The judicial process is slow and\nexpensive, and fraught with the risk that other creditors will win the race to the courthouse, and\nthus render the judicial effort fruitless.\nThere are three kinds of liens. We have already looked at judicial liens obtained when a\njudgment creditor causes a levy on the debtor\xe2\x80\x99s property. In this chapter, we will look at two other\ntypes of liens: (1) consensual liens, and (2) statutory liens.\nWe will also look at the priority between lienholders. Priority is the most important\nquestion in the process for it determines the order in which lienholders get paid from the sale of\nthe property that is subject to the lien, which we call the \xe2\x80\x9ccollateral.\xe2\x80\x9d Under the absolute priority\nrule, creditors with higher priority get paid in full before creditors with lower priority get anything\nfrom the proceeds of sale.\nThe first step is the process of creating a lien, known as attachment. Once the lien is\ncreated, or attaches, it is enforceable between the debtor and the creditor, but it does not necessarily\nprotect the creditor from later creditors or buyers who also obtain liens against the collateral or\npurchase the collateral.\nThe second step, known as perfection, is normally the process of giving constructive\nnotice of the existence of the lien to the world in the hope of preserving the lienholder\xe2\x80\x99s priority\nagainst later lien creditors or buyers. However, some liens are perfected without giving notice.\nGiven the number of exceptions to the general concept, it is difficult to define the concept of\nperfection in a coherent way. Maybe the best way to think about perfection is as the point where\nthe lienholder has done all that the lienholder can do under the statute to obtain priority over later\ncreditors and buyers, but it does not necessarily determine that the lienholder will have priority\nover later lienholders or buyers.\nThe final step, priority, is the conclusion about which secured creditors or lienholders gets\npaid first out of the proceeds from the sale of the collateral. Priority is the key to getting paid out\nof the collateral.\n\n2.2.\n\nAttachment of Consensual Liens\n\nConsensual liens are an alternative to unsecured credit. A consensual lienholder obtains a\nproperty interest (a lien) in the debtor\xe2\x80\x99s collateral to secure repayment of the debt.\nIt is always important to remember that a lien is a property interest, but it does not entitle\nthe lienholder to ownership of the property. The debtor retains the right to redeem the property\nfrom the lien by paying the debt in full (until the debtor\xe2\x80\x99s right of redemption is foreclosed).\nDifferent documents are used to create consensual liens on real property and personal\nproperty (everything other than real property).\n19\n\n\x0c2.3.\n\nAttachment of Consensual Liens on Real Property.\n\nConsensual liens on real property are created when the debtor transfers a lien in the\ndebtor\xe2\x80\x99s property to the creditor by way of a written mortgage or deed of trust. In some states,\ncalled \xe2\x80\x9ctitle states,\xe2\x80\x9d the instrument transfers legal title to the property to the creditor who holds\ntitle to the property subject to an obligation to re-convey title to the debtor when the debt is paid.\nIn other states, called \xe2\x80\x9clien states,\xe2\x80\x9d only a lien interest in the property rather than title to the\nproperty is transferred by the debtor to the creditor, and the lien is terminated upon repayment. In\npractice the distinction between title and lien states is one of form rather than substance, but will\naffect the language used in the instrument of transfer (the mortgage or deed of trust).\nA mortgage is a two party instrument under which the owner of the property transfers title\n(subject to re-conveyance) or a lien (subject to termination) to the creditor as security for the loan\nor other credit. A deed of trust is a three party instrument under which title or a lien is transferred\nto a trustee to hold for the benefit of the creditor if the loan or other credit is not repaid. Once\nagain, in practice the distinction between a mortgage and deed of trust is one of form rather than\nsubstance and is not very important. It is important for a lawyer (or other party) documenting a\ntransaction to use a proper form for the jurisdiction in which the property is located.\n\n2.4.\n\nAttachment of Consensual Liens on Personal Property\n\nConsensual liens on personal property (everything other than real property) can be\ncreated with a pledge or with a written security agreement. A pledge is a physical delivery of the\ncollateral to the creditor to hold until payment is made. A security agreement is a written document\nby which the debtor (or owner of the property) conveys a lien, called a security interest, in the\nproperty to the creditor.\nConsensual liens on personal property are governed by Article 9 of the Uniform\nCommercial Code (\xe2\x80\x9cUCC\xe2\x80\x9d), which has been enacted as law in every state (although some states\nhave non-standard provisions). Article 9 is one of the most uniform provisions of the UCC. It has\nbeen enacted in every state with only minor variations between states. New York\xe2\x80\x99s version of UCC\nArticle 9 is reprinted in Appendix G. For your convenience, the Article 9 code sections in this\nbook are linked \xe2\x80\x93 if you are reading an electronic copy of this book you may click on the links to\njump to the full code sections.\nThere are exceptions to the application of Article 9 for special kinds of property under state\nor federal law, such as personal use automobiles that are registered with the motor vehicles\ndepartment, and aircraft that are registered in a special federal filing office in Oklahoma City. In\nmost states, a security interest in a personal use automobile must be noted on the vehicle\xe2\x80\x99s official\ntitle document to be perfected. However, vehicles held by a dealer in inventory for sale or rental\nare generally governed by the Article 9.\nA security interest (or lien) does not exist under Article 9 of the UCC until the requirements\nfor attachment of the lien have occurred. Attachment is a key concept under the UCC, and should\nnot be confused with the provisional remedy of prejudgment attachment in a law suit discussed\nabove.\n20\n\n\x0cThe basic rules for the attachment (or creation) of a security interest are contained in UCC\n\xc2\xa7 9-203, which is so important that you should commit its terms to memory. Note the three\nrequirements in 9-203(b) that all must occur before the lien exists. The lien exists as soon as all\nthree of those requirements occur, and the creditor (now the \xe2\x80\x9csecured party\xe2\x80\x9d) may then enforce the\nlien against the debtor\xe2\x80\x99s property upon default.\nA simple security agreement contains a grant by the debtor to the creditor of a security\ninterest in the debtor\xe2\x80\x99s property. It must describe the collateral in sufficient detail to reasonably\nidentify it, but it is sufficient to identify the property by items and types. UCC \xc2\xa7 9-108(a). For\nexample, the security agreement may cover \xe2\x80\x9call inventory\xe2\x80\x9d or \xe2\x80\x9call equipment,\xe2\x80\x9d or may identify a\nparticular item (i.e. Morganthaler Printing Press Serial Number 87645374-9863).\nThe security agreement must identify the obligations that are secured by the collateral. The\nlanguage can be quite broad in covering all debts to the creditor, such as \xe2\x80\x9call of the debtor\xe2\x80\x99s past,\npresent and future obligations to the creditor,\xe2\x80\x9d or it may apply to a particular obligation, such as\n\xe2\x80\x9cto secure creditor\xe2\x80\x99s loan in the original principal amount of $1,000,000 made on July 15, 2015.\xe2\x80\x9d\nThe security agreement should provide for a lien on any proceeds from sale, lease or loss\nof the collateral, as well as anything that grows out of the collateral such as products, offspring, or\nrents, although a lien on proceeds is automatic for a certain period of time. See UCC \xc2\xa7 9-315(a)(2).\nThe security agreement may contain buyer warranties regarding the maintenance and use\nof the collateral (i.e. \xe2\x80\x9cborrower will maintain the property in good order and repair, will keep\nproperty insured . . .\xe2\x80\x9d).\nThe security agreement must consider whether special rules are needed for the sale of the\ncollateral. For example, a lender who has a security interest in the inventory of a grocery store may\npermit the sale of the collateral in the ordinary course of the debtor\xe2\x80\x99s business before default, and\nmay set up procedures for the proceeds (or some percentage of the proceeds) to be segregated in a\nlock box account for the creditor\xe2\x80\x99s benefit, or may permit the proceeds to be used only to purchase\nadditional inventory subject to the security agreement. The security agreement should contain the\nterms of the \xe2\x80\x9cdeal\xe2\x80\x9d between the borrower and lender regarding the collateral.\nThe security agreement should also specify what constitutes an \xe2\x80\x9cevent of default,\xe2\x80\x9d and what\nrights the creditor has upon default (including self-help, discussed below).\nIn order to be valid, the security agreement must -- in the language of the UCC -- be\nauthenticated, which generally means signed by the debtor. NYUCC \xc2\xa7\xc2\xa7 9-102(a)(7); 9203(b)(3)(A).\n\n2.5.\n\nAttachment of Judicial Liens\n\nWe have already looked at the basic process for creating judicial liens in Chapter 1. A\njudicial lien on personal property is created, or attaches, when the sheriff levies against the debtor\xe2\x80\x99s\nnon-exempt personal property under a writ of execution.\nWhile a judicial lien on real property can be created by levy, in most states there is a less\nexpensive procedure for creating judicial liens on real property \xe2\x80\x93 by filing evidence of the\njudgment in the county real property records. States have different names and procedures for the\nprocess of obtaining judicial liens on real property by filing. In California, an \xe2\x80\x9cabstract of\n21\n\n\x0cjudgment\xe2\x80\x9d must be recorded in the real property records. Cal. Civ. Proc. Code \xc2\xa7 697.310. In New\nYork, it is a \xe2\x80\x9ctranscript of judgment\xe2\x80\x9d that must be docketed with the clerk of the county where the\nproperty is located. NYCPLR \xc2\xa7 5203. Some state laws give judgment creditors an automatic lien\non real property located in the entire state or located in the county where the court is located as\nsoon as the judgment is entered, requiring buyers or creditors to search both the county real\nproperty records where the property is located, and court records where actions against the owner\ncould be filed. In states where real property judgment liens can only be created by filing evidence\nof the judgment in the real property records, a single search of the county records where the\nproperty is located will be sufficient.\nJudgment liens last a long time (for example 10 years in New York), and make it difficult\nfor the borrower to sell the property or use the collateral for an additional loan without paying off\nthe lien (because a buyer or subsequent lender would take the property subject to the lien unless it\nis paid). Buyers and lenders will generally require a policy of title insurance at closing to assure\nthat title is clear. The title insurance company must do a search of the required filing offices to\ndetermine what liens exist, and the buyer will typically require that any liens be paid in full at the\nclosing of the sale.\nIn addition to waiting for a voluntary sale to occur, judicial lienholders can also foreclose\ntheir liens through a judicial sale conducted in accordance with a statutory procedure.\nA few states have enacted statutes permitting judgment liens on personal property to be\ncreated by filing evidence of the judgment with the secretary of state, rather than going through\nthe levy process. See e.g. Cal. Civ. Proc. Code 697.510. These filing procedures usually prevent\nthe judgment debtor from selling the property, or using the property that is subject to the lien as\ncollateral for a loan, without paying off the judgment.\nOne big difference between the filing process and the levying process to obtain a judgment\nlien is that the creditor does not have to identify the specific property when filing. When evidence\nof the judgment is filed in the county real property records (or with the secretary of state in those\nstates that permit judicial liens by filing on personal property), the lien automatically attaches to\nall real property owned by the judgment debtor in the county (or all non-exempt personal property\nowned by the judgment debtor in the state). Furthermore, a lien will attach to any real property\nacquired by the judgment debtor in the county (or non-exempt personal property acquired by the\njudgment debtor in the state) after the filing. The filing office will index the judgment by the name\nof the judgment debtor, allowing later buyers or creditors to perform a search on the judgment\ndebtor\xe2\x80\x99s name to determine the state of title to the judgment debtor\xe2\x80\x99s property.\n\n2.6.\n\nAttachment of Statutory Liens.\n\nStatutory liens are, as you may surmise, created by statute for certain favored creditors.\nThe best known statutory lien is the mechanics\xe2\x80\x99 lien, typically given to a contractor who improves\nthe debtor\xe2\x80\x99s real property or automobile. There are many other kinds of statutory liens for creditors\nlike laborers, farmers who sell food, milk producers and many others. Governments also give\nthemselves special statutory liens for things like property taxes and withholding taxes. These liens\noften require the creditor to follow strict procedures in order to obtain lien rights, such as filing a\nnotice in the real property records within a specific period after commencing work under the\ncontract, and filing suit within a specific period if payment is not forthcoming. Other statutory\n22\n\n\x0cliens arise automatically and require buyers or consensual lien creditors to obtain releases from\npotential statutory lienholders.\n\n2.7.\n\nThe Concept of Perfecting Liens\n\nPerfection is usually the process by which a lienholder gives constructive notice to the\nworld that the lienholder has a lien on the collateral. Through the process of perfection, later buyers\nor lienholders are given constructive notice of the existence of a particular lien, and will either take\nan interest in property subject to (or subordinate to) that lien, or will require the lien to be satisfied\nbefore new credit is given. Perfection generally requires a creditor to follow some statutory act\nthat will put later parties who wish to obtain an interest in the property on notice that the creditor\nholds a lien. The act may be the creditor taking possession of the property in a pledge, or filing\nnotice of the lien in a designated filing office. However, some liens against certain kinds of\nproperty are automatically perfected upon attachment, requiring no action on the part of the\ncreditor to perfect, and no obvious way for later parties to know of the existence of the lien. In\nthese situations, later parties bear the risk of a secret perfected security interest, making the\nproperty difficult to use as collateral for a loan or to sell. In most cases, however, there is a process\nthat must be followed to perfect a security interest, and if followed later parties will be able to\ndetermine that the lien exists before extending credit to the debtor on the basis of the collateral.\n\n2.8.\n\nPerfection of Consensual Personal Property Liens\n\nArticle 9 of the UCC contains the rules governing the priority of personal property liens\nbetween secured creditors. Article 9 of the UCC contains rules that also address the relative priority\nof judicial liens and consensual liens. We will focus first on the general Article 9 rules addressing\nthe perfection and priority of consensual liens on personal property, and then on the relative\npriority of those consensual liens against judicial liens on the same property.\nStatutory liens must have their own rules of priority because they are not addressed in\nArticle 9. Some statutory liens (like real property liens) become a first charge against the property\nhaving priority over even earlier consensual or judicial liens. Other statutory liens like most\nmechanic\xe2\x80\x99s liens date from the commencement of services or the sale of property. A lawyer must\nlook to the specific state law statute under which the statutory lien was created to determine the\npriority accorded to the lien.\nWe have previously looked at the three requirements for a security interest to attach - the\npoint at which the lien or security interest exists and is enforceable by the creditor against the\ndebtor\xe2\x80\x99s property. UCC \xc2\xa7 9-203.\nMost security interests in personal property are perfected by the filing of a UCC-1\nfinancing statement with the office of the Secretary of State where the debtor resides. UCC \xc2\xa7 9301(1), 9-307(b) (residence for individuals, chief executive office for unregistered entities, and\nstate of incorporation for registered entities, Washington DC for foreigners). The UCC-1 financing\nstatement is a simple one-page form that lists the name and address of the debtor, the name and\naddress of the creditor, and a general description of the collateral. A UCC-1 financing statement\nform is printed in Appendix J.\n23\n\n\x0cMany security interests can also be perfected by the secured creditor taking physical\npossession of the collateral (this is known as a \xe2\x80\x9cpledge\xe2\x80\x9d). Indeed, certain kinds of collateral (money\nand negotiable instruments, for example) can only be perfected by the secured creditor taking\npossession or control over the collateral. The theory is that the debtor\xe2\x80\x99s inability to produce the\nphysical property gives notice to the world that the debtor does not hold free unencumbered title\nto the property. A potential creditor or acquirer who expects to have priority in the collateral needs\nto be sure (1) that the debtor has possession of the collateral, (2) that the debtor has legal title to\nthe collateral, and (3) that no UCC-1 financing statements have been filed with the Secretary of\nState by other creditors.\nHowever, even these steps are not fool proof, because some security interests are\nautomatically perfected upon attachment without filing or pledge; most notably purchase money\nsecurity interests in consumer goods. UCC \xc2\xa7 9-309(1). An understanding of these general rules is\nimportant for this course; therefore the general rules are reprinted below.\nUniform Commercial Code\n\xc2\xa7 9-302. WHEN FILING IS REQUIRED TO PERFECT SECURITY\nINTEREST; SECURITY INTERESTS TO WHICH FILING\nPROVISIONS OF THIS ARTICLE DO NOT APPLY.\nA financing statement must be filed to perfect all security interests\nexcept the following: [exceptions omitted]\n\xc2\xa7 9-303. WHEN SECURITY INTEREST\nCONTINUITY OF PERFECTION.\n\nIS\n\nPERFECTED;\n\n(1) A security interest is perfected when it has attached and when all\nof the applicable steps required for perfection have been taken. Such\nsteps are specified in Sections 9-302, 9-304, 9-305 and 9-306. If such\nsteps are taken before the security interest attaches, it is perfected\nat the time when it attaches.\n\xc2\xa7 9-309. SECURITY INTEREST PERFECTED UPON ATTACHMENT.\nThe following security interests are perfected when they attach:\n(1) a purchase-money security interest in consumer goods, except as\notherwise provided in Section 9-311(b) with respect to consumer\ngoods that are subject to a statute or treaty described in Section 9311(a).\n[Balance omitted; emphasis added].\n\n2.9.\n\nPriority of Consensual Liens.\n\nAs a practical matter, priority is the most important stage in the process. Priority tests a\nsecured creditor\xe2\x80\x99s right to be paid first out of the collateral against the rights of other secured\ncreditors. Under the absolute priority rule that applies both in and out of bankruptcy, senior priority\nsecured creditors must be paid in full from the collateral before junior secured creditors receive\n24\n\n\x0cany distribution. Attaching and perfecting a security interest puts the secured creditor in the race,\nbut it is the creditor that has priority who wins the race and gets paid first.\nArticle 9 contains separate provisions dealing with the priority of conflicting (multiple)\nconsensual security interests, and consensual security interests vis a vis judicial liens. Following\nare the main priority rules of Article 9. There are a number of specialized exceptions to these\ngeneral rules. A bit later we will cover one of the exceptions, for purchase money security interests.\nBut there are other exceptions that must be carefully considered in actual practice. You must refer\nto the whole of Article 9, covered in more detail in a course in commercial or secured transactions,\nto learn the full gamut of specialized Article 9 rules.\nUniform Commercial Code\n\xc2\xa7 9-317. INTERESTS THAT TAKE PRIORITY OVER OR TAKE\nFREE OF UNPERFECTED SECURITY INTEREST.\n(a) Conflicting security interests and rights of lien creditors. An\nunperfected security interest . . . is subordinate to the rights of:\n(1) a person entitled to priority under Section 9-322; and\n(2) except as otherwise provided in subsection (e), a person that\nbecomes a lien creditor before the earlier of the time\n(a) the security interest . . . is perfected or\n(b) one of the conditions specified in Section 9-203(b)(3) is\nmet [authenticated security agreement] and a financing\nstatement covering the collateral is filed.\n\xc2\xa7 9-322. PRIORITIES AMONG CONFLICTING SECURITY INTERESTS\n. . . ON SAME COLLATERAL.\n(a) General priority rules. Except as otherwise provided in this section,\npriority among conflicting security interests . . . in the same collateral is\ndetermined according to the following rules:\n(1) Conflicting perfected security interests . . . rank according to\npriority in time of filing or perfection. Priority dates from the\nearlier of the time a filing covering the collateral is first made or\nthe security interest . . . is first perfected, if there is no period\nthereafter when there is neither filing nor perfection.\n(2) A perfected security interest . . . has priority over a conflicting\nunperfected security interest or agricultural lien.\n(3) The first security interest . . . to attach or become effective has\npriority if conflicting security interests . . . are unperfected.\n[Emphasis added]\n\n25\n\n\x0c2.10.\n\nPractice Problems: UCC Article 9.\n\nProblem 1: For each party, explain (1) when does the security interest attach, (2) when\nis the security interest perfected, and (3) which party has priority (and thus gets how much\nmoney):\nA.\nOn January 1, Year 1, Bob Drain, a licensed plumber, borrowed $20,000\nfrom his uncle, Ed Drain, to purchase a new machine for his business. Bob signed a\npromissory note at the time the loan was made agreeing to repay the loan on January 1,\nYear 3.\nB.\nOn January 1, Year 2, Bob went to Flushing Bank to borrow $100,000 for\nbusiness operating expenses. He signed a security agreement under which Bob granted\nFlushing Bank a security interest in all of his business property to secure any and all\noutstanding loans from Flushing Bank. Flushing Bank filed a UCC-1 financing statement\nwith the Secretary of State. However, on January 3, Bob decided not to go through with\nthe Flushing Bank loan. Flushing Bank tore up the promissory note, but left the security\nagreement in its files. Flushing did not terminate the UCC-1 financing statement it had\nfiled with the Secretary of State.\nC.\nOn July 1, Year 2, Bob went to Prime Bank to borrow $100,000 for his\nbusiness. Prime performed a secretary of state database search, which disclosed the\nFlushing UCC-1 financing statement. Bob told Prime Bank that he had not gone through\nwith the Flushing Bank loan. Prime Bank called Flushing Bank and confirmed that the\nFlushing Bank loan had not been made, and that Bob did not owe Flushing Bank any\nmoney. Prime therefore agreed to make the loan to Bob. Bob signed a promissory note and\nsecurity agreement with Prime Bank covering all of his business property on July 1, Year\n2. Prime Bank filed a financing statement with the Secretary of State on July 4, Year 2, and\ngave Bob the $100,000 on July 8, Year 2.\nD.\nOn September 1, Year 2, Bob went back to Flushing Bank to borrow an\nadditional $20,000. Flushing had Bob sign a new promissory note, and then gave him the\n$20,000.\nE.\nBecause of continuing cash flow problems in his business, Bob was unable\nto repay Uncle Ed on January 1, Year 3. Uncle Ed obtained a default judgment against\nBob on February 1, Year 3, and had the Sheriff levy under a writ of execution on Bob\xe2\x80\x99s\nbusiness assets on March 1, Year 3.\nF.\nBob\xe2\x80\x99s business assets have been liquidated for $70,000 by the Sheriff.\nUncle Ed, Prime Bank and Flushing Bank all claim that they should get the money. Who\ngets the money?\nProblem 2: Would the result change if the Uncle Ed loan was due on May 1, Year 2, Uncle\nEd got his default judgment against Bob on June 1, Year 2, and had the sheriff levy against Bob\xe2\x80\x99s\nbusiness property on July 7, Year 2?\nProblem 3: Same facts as problem 2, except Uncle Ed caused the Sheriff to levy against\nBob\xe2\x80\x99s business property on June 3, Year 2.\n26\n\n\x0c2.11.\n\nPurchase Money Security Interests\n\nPurchase money security interests (also known as \xe2\x80\x9cenabling loans\xe2\x80\x9d) are created in one of\ntwo ways. First, a seller of goods can agree to accept payments for the goods in the future (carry\nback a loan to finance the purchase), and secure the buyer\xe2\x80\x99s obligation to make payments with a\nsecurity interest in the property sold. Second, a lender\xe2\x80\x99s loan proceeds can be traced directly into\nthe purchase of the goods in which the lender takes a security interest. UCC \xc2\xa7 9-103(a)(2). In both\ncases, the lender\xe2\x80\x99s actual or constructive loan proceeds were used to enable the purchase of the\nproperty. It is essential that the lender be able to trace the loan proceeds directly into the\npurchase \xe2\x80\x93 if the funds are first commingled in the debtor\xe2\x80\x99s bank account, it will be difficult to\nestablish purchase money status. Therefore, purchase money lenders often issue loan proceeds\nchecks in the joint names of the borrower and seller of the goods, or directly remit the loan\nproceeds to the seller \xe2\x80\x93 thereby assuring that the actual loan proceeds are used to purchase the\ncollateral.\nPurchase money loans are given special status in Article 9. Read UCC \xc2\xa7 9-317 and UCC \xc2\xa7\n9-324 carefully, and answer the problems that follow.\n\n2.12.\n\nPractice Problems: Purchase Money Security Interests\n\nProblem 1: A corporate debtor operates a printing business. It owes $1 million to\nBusinessBank, secured by a perfected first priority security interest in all of the debtor\xe2\x80\x99s\nequipment, currently worth in liquidation about $700,000. The debtor believes it could make a lot\nmore money if it could get into the new digital publishing field. In order get into digital publishing,\nthe Debtor needs $100,000 worth of new equipment. BusinessBank is having its own financial\nproblems, and is not willing to lend any more money to the debtor. BankTwo, however, is willing\nto lend the debtor the additional $100,000 it needs, but only if it can have a first priority security\ninterest in the new digital publishing equipment. Can you assure BankTwo that if it makes the\n$100,000 loan to the debtor to acquire the new equipment its security interest on the new\nequipment will have priority over Business Bank\xe2\x80\x99s existing security interest in all of the debtor\xe2\x80\x99s\nequipment?\nProblem 2: Assume the same facts in problem 1, except that the debtor is a retail store,\nBusiness Bank has a security interest in the debtor\xe2\x80\x99s inventory rather than equipment, and the\ndebtor wants to buy some specialized new inventory for $100,000. What would you have to do to\nassure BankTwo that its new $100,000 loan would be secured by a first priority security interest\nin the new inventory ahead of Business Bank\xe2\x80\x99s existing security interest in the inventory?\n\n2.13.\n\nPerfection and Priority of Real Property Liens\n\nWhile the three types of liens - judicial, consensual, and statutory, all provide a creditor\nwith special accelerated rights of collection from the collateral over the unsecured creditors, the\nmain advantage of lien rights is in preserving priority over other secured creditors. A commercial\nlawyer must have a firm grasp of the rules governing the priority of liens in order to protect clients\nwho are about to engage in commercial transactions, and in order to be able to enforce the client\xe2\x80\x99s\nlien rights after default.\n27\n\n\x0cReal property liens are perfected by recording evidence of the lien in the real estate records\noffice for the county in which the property is located.\nThe priority of real property liens is determined by recording acts in the 50 states. There\nare three kinds of priority rules in the recording acts in the United States: race statutes, notice\nstatutes, and the majority race-notice statutes. Race statutes are the easiest to understand \xe2\x80\x93\nwhoever records first (either a mortgage, judgment lien, or deed) wins the priority race.\nWhile the first to record rule of race statutes is the easiest to understand and implement,\nmany states deem it unfair to give priority to a recorder who knew about a prior unrecorded interest.\nThe notice and race-notice statutes attempt to address this unfairness.\nA pure notice system minimizes the effect of recording by giving priority to later takers\nwho did not have notice of prior interests. Under a pure notice system, recording only gives\nconstructive notice to later purchasers of the prior lien. Prior interests retain priority over later\ntakers who were aware (actually or constructively) of the prior interests. A later taker is always\nsubordinate to a prior recorded interest because the taker will have constructive notice of the\ninterest.\nA race-notice system is similar to a notice system but focuses on the time of recording\nrather than the time of taking the instrument. The first to record has priority unless the first to\nrecord had actual knowledge of a prior interest at the time of recording. Under all three systems,\nthe first to record without any notice of the prior interest always wins.\nThere is a third kind of notice besides actual and constructive notice that is much less\nverifiable, known as \xe2\x80\x9cinquiry notice.\xe2\x80\x9d Inquiry notice arises when a buyer or lender through an\ninspection of the property would be on notice to inquire regarding the interest of a third person.\nUnrecorded buyers or tenants who are in possession of property are often protected by the concept\nof inquiry notice.\nThe recording systems work off of the debtor\xe2\x80\x99s name, not off of the location of the\nproperty (except for determining which recording office to use which is based on the county in\nwhich the property is located). Recorded documents are indexed under the debtor\xe2\x80\x99s name. A chain\nof title is established by tracing conveyances (deeds, mortgages) from the original owner of the\nproperty. Recorded documents that are not indexed by an owner are \xe2\x80\x9cout of the chain of title\xe2\x80\x9d and\ndo not constitute a lien against the property until the indexed party becomes a record owner. One\ncannot determine title to or liens against property without performing a title search tracking the\nchain of title back to the original governmental grant.\nIn many states, large title insurance companies have set up \xe2\x80\x9ctitle plants\xe2\x80\x9d under which all\ndocuments recorded in the official records in each county are scanned and indexed by the insurance\ncompany to make title searches quicker. The system also encourages lenders and buyers to obtain\ntitle insurance to protect against search errors or discrepancies. In states without title plants, an\nabstractor will be required to rummage through the county recording office to develop an abstract\nof title. The county recorder does not determine who is the owner of property or whether liens are\nvalid \xe2\x80\x93 all the recorder does is record and index the documents as filed. The only way to settle\nownership of real property (other than through title insurance) is through a judicial action to quiet\ntitle.\n28\n\n\x0cA few states have experimented with the Torrens System under which ownership and liens\nare tracked by property much like an automobile title, rather than through title searches. The\nTorrens experiments have been attacked by the title insurance lobby and have been rejected in\nmost states, although a few states continue to utilize a Torrens System in certain circumstances.\n\n2.14.\n\nPractice Problems: Real Estate Priority\n\nProblem 1: Determine who would have priority under a race statute, a notice statute, and\na race-notice statute, if the following transactions occurred on the dates indicated:\nJan 1, Year 1:\nJan 10, Year 1:\nJan 15, Year 1:\nJan 20, Year 1:\n\nA delivers Blackacre deed to B\nA delivers Blackacre deed to C\nC records Blackacre deed\nB records Blackacre deed\n\nProblem 2 Determine who would have priority under a race statute, a notice statute, and a\nrace-notice statute if the following transactions occurred on the dates indicated:\nJan 1, Year 1\nJan 10, Year 1\nFeb 1, Year 1\nMar 1, Year 1\n\nA delivers Blackacre deed to B\nA delivers Blackacre deed to C\nB records Blackacre deed\nC records Blackacre deed\n\nProblem 3: Determine who would have priority under a race statute, a notice statute, and\na race-notice statute if the following transactions occurred on the dates indicated: Assume that C\ndid not know about B\xe2\x80\x99s deed on Feb 1, but did know about B\xe2\x80\x99s deed before Mar 1.\nJan 1, Year 1\nJan 10, Year 1\nFeb 1, Year 1\nMar 1, Year 1\n\n2.15.\n\nA delivers Blackacre deed to B\nB records Blackacre deed\nA delivers Blackacre deed to C\nC records Blackacre deed.\n\nForeclosing the Right of Redemption\n\nAs discussed earlier, a lienholder does not have legal ownership to the collateral because\nthe lienholder must re-convey or terminate the lien if the debtor redeems the debt by satisfying the\nobligation in full. The debtor\xe2\x80\x99s right to recover the property upon full payment of the debt is known\nas the equitable right of redemption. Historically the right of redemption was recognized and\nprotected by courts of equity, and thus the value of the property in excess of the cost of redemption\nbecame known as the \xe2\x80\x9cequity of redemption,\xe2\x80\x9d or simply as \xe2\x80\x9cequity.\xe2\x80\x9d In common language,\n\xe2\x80\x9cequity\xe2\x80\x9d is the excess value of the property over all of the liens and encumbrances against the\nproperty \xe2\x80\x93 it is the amount that the debtor would receive if the property were to be sold and the\nliens paid off. Attempts by creditors to \xe2\x80\x9cclog\xe2\x80\x9d the equitable right of redemption by private\nagreement (such as by providing that title will vest in the creditor upon default) have been rejected\nby courts of equity for hundreds of years.\n29\n\n\x0cForeclosure is the process of terminating the debtor\xe2\x80\x99s equitable right of redemption.\nJudicial foreclosure of the right of redemption is available in all states and for all types of liens.\nMany states have statutory rules governing the judicial foreclosure procedure. Judicial foreclosure\ncan be a long and expensive process if opposed by the debtor, even when the debtor does not have\nlegitimate defenses. The judicial foreclosure process requires a lawsuit, proof by summary\njudgment or trial of entitlement to foreclose, followed by a judicially supervised auction sale of\nthe property. The sale terminates all liens and interests junior to the lien being foreclosed, including\nthe debtor\xe2\x80\x99s equity of redemption. In most states, the debtor can redeem the property from the lien\nat any time prior to the drop of the hammer at the auction sale. In some states (such as New York),\njudicial foreclosure is the only method available for foreclosing the borrower\xe2\x80\x99s equity of\nredemption on real property.\nSome states have statutory procedures for non-judicially foreclosing the equity of\nredemption on real property. These procedures generally require the foreclosing creditor to provide\ncertain statutory notices of sale to the borrower and junior lienholders, and to advertise and hold a\npublic auction for the sale of the property. Following a properly conducted non-judicial sale in\naccordance with the statutory procedures, the rights of junior lienholders and owners to redeem\nthe property are foreclosed.\nSenior liens are generally not terminated by a junior lienholder\xe2\x80\x99s foreclosure. The junior\nlienholder is selling the state of title as of the recording of the junior lien, thus foreclosing all\ninterests junior to the junior lien. Senior liens and interests survive the foreclosure, allowing the\nsenior lienholder to later foreclose the redemption rights of the buyer at the junior lienholder\xe2\x80\x99s\nforeclosure sale if buyer does not redeem the senior lien.\nPersonal property foreclosure is governed by Article 9 of the Uniform Commercial Code,\nwhich authorizes both judicial (UCC \xc2\xa7 9-601(a)(1)) and non-judicial methods of foreclosure (UCC\n\xc2\xa7 9-610(a)). Generally, the secured creditor must first obtain possession of the collateral, and then\nhold a \xe2\x80\x9ccommercially reasonable\xe2\x80\x9d sale of the property. Possession can be obtained judicially under\nexpedited procedures allowed under state law. These expedited procedures have different names\nin different states. In New York, for example, the procedure is called \xe2\x80\x9creplevin,\xe2\x80\x9d while in\nCalifornia it is called \xe2\x80\x9cclaim and delivery.\xe2\x80\x9d\nThe creditor may also repossess the collateral non-judicially using self-help. The primary\nrestriction on self-help is that the creditor or its agent must proceed \xe2\x80\x9cwithout breach of the\npeace.\xe2\x80\x9d UCC \xc2\xa7 9-609(b)(2). The repossessor must discontinue the repossession whenever there\nis a risk of breaching the peace. After discontinuing the repossession to prevent a breach of the\npeace, the repossessor may always come back another day and try again to repossess.\nThe UCC does not define a breach of the peace, leaving the question for the courts. There\nis great inconsistency in the reported decisions. May the repossessor use trickery? May the\nrepossessor break a chain or lock to enter premises for repossession (if permitted to do so in the\nsecurity agreement)? May the repossessor pick a lock? The cases that follow give a small taste of\nthe wide variety in reported decisions.\nJudicially authorized repossession by a court officer is not subject to the \xe2\x80\x9cbreach of the\npeace\xe2\x80\x9d restriction. UCC \xc2\xa7 9-609(b)(1). As we saw in Vitale v. Hotel California, a sheriff under a\ncourt issued writ must use whatever reasonable force is necessary to execute the writ.\n30\n\n\x0cAfter the secured creditor recovers possession of the collateral, the secured creditor may\ncomplete the foreclosure process by selling the collateral in a \xe2\x80\x9ccommercially reasonable manner.\xe2\x80\x9d\nUCC \xc2\xa7 9-610(b). Again, what is \xe2\x80\x9ccommercially reasonable\xe2\x80\x9d is not defined in the UCC, and the\nreported cases on the margin often depend on the length of the chancellor\xe2\x80\x99s foot.\nIn most situations, the creditor must give the debtor notice of the time and place of sale so\nthat the debtor can appear and bid to protect the debtor\xe2\x80\x99s interest. Read UCC \xc2\xa7\xc2\xa7 9-611 and 9-612.\nA waiver of the right to notice is only effective if executed after default. UCC \xc2\xa7 9-624.\nIf the creditor does everything properly, the creditor may recover a deficiency judgment\nfrom the court to the extent that the sale proceeds are less than the outstanding debt. Read UCC \xc2\xa7\n9-615. Similarly, the creditor must account to the debtor for any surplus. Id. The difficulty comes\nin when the creditor does not do everything properly. Read UCC \xc2\xa7\xc2\xa7 9-625 and 9-626 carefully,\nand consider the ramifications of the creditor failing to follow the requirements, especially the\ndeafening silence in the case of consumer debtors.\n\n2.16.\n\nCases on Enforcement of Liens\n2.16.1.1.\nCHAPA v. TRACIERS & ASSOCIATES, 267 S.W.3d\n386 (Ct. App. Tex. 2008)\n\nIn this appeal, we must determine whether appellants, the parents of two young children,\nhave legally cognizable claims for mental anguish allegedly sustained when a repossession agent\ntowed their vehicle out of sight before he realized their children were inside.\nFord Motor Credit Corp. ("FMCC") hired Traciers & Associates ("Traciers") to repossess\na white 2002 Ford Expedition owned by Marissa Chapa, who was in default on the associated\npromissory note. Traciers assigned the job to its field manager, Paul Chambers, and gave him an\naddress where the vehicle could be found.\nOn the night of February 6, 2003, unseen by Chambers, Maria Chapa left the house and\nhelped her two sons, ages ten and six, into the Expedition for the trip to school. Her mother-inlaw\'s vehicle was parked behind her, so Maria backed her mother-in-law\'s vehicle into the street,\nthen backed her Expedition out of the driveway and parked on the street. She left the keys to her\ntruck in the ignition with the motor running while she parked her mother-in-law\'s car back in the\ndriveway and reentered the house to return her mother-in-law\'s keys.\nAfter Chambers saw Maria park the Expedition on the street and return to the house, it took\nhim only thirty seconds to back his tow truck to the Expedition, hook it to his truck, and drive\naway. Chambers did not leave his own vehicle to perform this operation, and it is undisputed that\nhe did not know the Chapa children were inside. When Maria emerged from the house, the\nExpedition, with her children, was gone. Maria began screaming, telephoned 911, and called her\nhusband at work to tell him the children were gone.\nMeanwhile, on an adjacent street, Chambers noticed that the Expedition\'s wheels were\nturning, indicating to him that the vehicle\'s engine was running. He stopped the tow truck and\nheard a sound from the Expedition. Looking inside, he discovered the two Chapa children. After\nhe persuaded one of the boys to unlock the vehicle, Chambers drove the Expedition back to the\nChapas\' house. He returned the keys to Maria, who was outside her house, crying. By the time\n31\n\n\x0cemergency personnel and Carlos Chapa arrived, the children were back home and Chambers had\nleft the scene.\nMaria testified that the incident caused her to have an anxiety attack, including chest pain\nand numbness in her arm. She states she has continued to experience panic attacks and has been\ndiagnosed with an anxiety disorder. In addition, both Carlos and Maria have been diagnosed with\npost-traumatic stress disorder.\nActing individually and on behalf of their children, Carlos and Maria Chapa sued Traciers,\nChambers, and FMCC. Appellees settled the children\'s claims but contested the individual claims\nof Carlos and Maria.\nThe Chapas contend that they have legally cognizable causes of action against Traciers and\nFMCC for the physical and psychological injuries they sustained as a result of the appellees\' breach\nof the duties imposed by section 9.609 of the Texas Business and Commerce Code.\nThe Chapas first argue that the trial court erred in granting summary judgment against them\non their claim that appellees are liable under section 9.609 of the Business and Commerce Code.\nThe Chapas correctly point out that this statute imposes a duty on secured creditors to take\nprecautions for public safety when repossessing property. Thus, the creditor who elects to pursue\nnonjudical repossession assumes the risk that a breach of the peace might occur. A secured creditor\n"remains liable for breaches of the peace committed by its independent contractor."\nThe Chapas assert that FMCC and Traciers, who employed Chambers as a repossession\nagent, are liable for any physical or mental injuries sustained by Carlos and Maria as a result of\nChambers\'s breach of the peace. But this argument presupposes that a breach of peace occurred.\nAlthough the material facts regarding Chambers\'s conduct are not in dispute, appellees deny that\nhis conduct constituted a breach of the peace. Without further explanation, the Chapas assert that\n"[t]he act of taking children from the possession of their mother which leaves her in a hysterical\ncrying state, is clearly a breach of peace."\nWhether a specific act constitutes a breach of the peace depends on the surrounding facts\nand circumstances in the particular case. [H]ere the parties do not assert that Chambers behaved\nviolently or threatened physical injury to anyone. Further, it is undisputed that Chambers did not\nknow the children were in the vehicle when he moved it; thus, his actions cannot be appropriately\ncharacterized as "contrary to ordinary human conduct." When Chambers learned of the children\'s\npresence, he immediately ceased any attempt to repossess the vehicle and instead drove the\nchildren home. He did not communicate by word or gesture with Carlos or Maria Chapa before or\nduring the attempted repossession. On these facts, we cannot say that Chambers\'s conduct\nconstitutes a "breach of the peace" as that phrase ordinarily is used in criminal or common law.\nThe Chapas also rely on cases from other jurisdictions specifically addressing breaches of\nthe peace as described in the Uniform Commercial Code concerning repossession of property.\nThey cite Robinson v. Citicorp National Services, Inc., a Missouri case in which Clarence\nRobinson defaulted on his automobile payments. 921 S.W.2d 52, 53 (Mo.Ct. App.1996). Agents\nof the financing company\'s assignee attempted to repossess the car from property owned by Marie\nRobinson. Id. Marie\'s husband, Odell Robinson, Sr., "told [a repossession agent] to get off the\nproperty numerous times to no avail. The alleged trespass and breach of peace ensued, and Odell\nsuffered a heart attack and died." Here, however, Chambers removed the vehicle without\nconfrontation and without trespassing on the Chapas\' premises.\n32\n\n\x0cThe Chapas also point to Nixon v. Halpin, 620 So.2d 796 (Fla. Dist. Ct. App.1993). In that\ncase, Halpin, a repossession agent, was seen by the vehicle\'s owner and mistaken for a car thief.\nThe car\'s owner summoned his office mate, Nixon, and the two men attempted to detain Halpin.\nWhile driving away, Halpin struck Nixon. The Nixon court concluded that the creditor "had not\nalready peaceably removed the vehicle when the owner objected, it\'s [sic] continuation with the\nattempt at repossession was no longer `peaceable and without a breach of the peace.\'" Id. In this\ncase, however, the repossession agent had "already peaceably removed the vehicle" and did not\ncontinue to attempt repossession after he learned of the Chapa children\'s presence. Thus, the\nreasoning in Nixon supports the conclusion that Chambers did not breach the peace.\nMost frequently, the expression "breach of the peace" as used in the Uniform Commercial\nCode "connotes conduct that incites or is likely to incite immediate public turbulence, or that leads\nto or is likely to lead to an immediate loss of public order and tranquility." In addition, "[b]reach\nof the peace... refers to conduct at or near and/or incident to seizure of property." Here, there is no\nevidence that Chambers proceeded with the attempted repossession over an objection\ncommunicated to him at, near, or incident to the seizure of the property. To the contrary, Chambers\nimmediately "desisted" repossession efforts and peaceably returned the vehicle and the children\nwhen he learned of their presence. Moreover, Chambers actively avoided confrontation. By\nremoving an apparently unoccupied vehicle from a public street when the driver was not present,\nhe reduced the likelihood of violence or other public disturbance.\nIn sum, the Chapas have not identified and we have not found any case in which the\nrepossession of a vehicle from a public street, without objection or confrontation, has been held to\nconstitute a breach of the peace.\n\n2.16.1.2.\nJORDAN v. CITIZENS & SOUTHERN NAT\xe2\x80\x99L\nBANK OF SOUTH CAROLINA, 278 S.C. 449 (1982)\n[Appellants] Larry and Kathy Jordan [bring this action] to recover actual and punitive\ndamages from the Respondents for having repossessed a 1978 Ford pick-up truck in what is alleged\nto be a wrongful manner.\nThe Appellants financed the truck and failed to make at least two monthly installment\npayments. On September 29, 1978, at about 11:00 p.m., a Midland Recovery employee, at the\nbehest of the bank, found the truck with keys in it at the Appellants\' residence. The employee\nstarted the motor and drove it from the driveway into the public streets. They heard the motor\nrunning but did not see the truck until it was proceeding down the street. Thinking their truck had\nbeen stolen, they pursued it in another vehicle. The pursuit lasted some thirty minutes over a\ndistance of several miles beginning at Lexington and ending in Columbia. There is evidence from\nthe Appellants\' depositions that the driver of the truck exceeded the speed limit, failed to observe\ntraffic signals and drove recklessly. After they were unable to apprehend the driver of the truck,\nthey reported it as a stolen vehicle to the police and later learned that the truck had been repossessed\nby the bank.\nIn oral argument, counsel for the Appellants conceded that under the mortgage contract,\nand the law of this state, the repossession was proper unless it was accompanied by a breach of the\npeace. It is admitted that the taking of the truck from the premises of the Appellants did not amount\nto a breach of the peace but it is argued that the conduct of the driver of the truck in speeding,\n33\n\n\x0cfailing to observe traffic signals and in driving recklessly some distance from the residence\nconstituted a breach of the peace and, accordingly, made the repossession actionable.\nWe are not at all sure that the alleged violations of the traffic laws amounted to a breach of\nthe peace, but even if it be assumed that they did, the conduct was not incident to seizing the truck\nat the residence of the Appellants. The breach of the peace as contemplated by the statute and our\ncases refers to conduct at or near and/or incident to the seizure of the property.\nWe, therefore, hold the lower court properly granted the Motion for Summary Judgment and its\nOrder is, accordingly,\nAffirmed.\n\n2.16.1.3.\nCHERNO v. BANK OF BABYLON, 54 Misc.2d 277\n(NY 1967)\n[T]he security agreement . . . gave the bank the right in the event of default "(a) to declare\nthe Note and all Obligations due and payable * * * without notice or demand; (b) to enter the * *\n* premises * * * where any of the Collateral may be located and take and carry away the same * *\n* with or without legal process." The undisputed facts are that the assignor was in default under\nthe security agreement . . . and an order made on May 31, 1966 by the Supreme Court, Suffolk\nCounty, authorizing the assignee, upon filing bond and after notice to creditors, to sell the\nassignor\'s physical assets, . . . that on June 2, 1966 . . . one of the auctioneer\'s employees let the\nbank\'s senior vice-president into the premises so that he could view the assets in question, that on\nJune 3, 1966 the bank\'s employees entered the premises of the assignor at the direction of the\nsenior vice-president and removed the assets in question, that admittance of the bank\'s employees\nto the premises was obtained by means of a key which was not received from anyone of the\nassignor\'s firm, the assignee, auctioneer or landlord, but was obtained from a representative of a\nlocksmith, and that the assets seized by the bank were thereafter sold by the bank.\nThe contention that, assuming the validity of the security agreement, the action of the\nbank\'s employees nevertheless constituted a conversion is predicated on the propositions that . . .\n(2) the unauthorized entry by the bank\'s employees constituted a breach of the peace. Neither\ncontention withstands analysis.\nBut, argues the assignee, under the default provisions of the security agreement, rights and\nremedies are given to the bank only "to the extent permitted by applicable law" and section 9-503\nof the Uniform Commercial Code provides that "In taking possession a secured party may proceed\nwithout judicial process if this can be done without breach of the peace." The unauthorized entry\nby the bank\'s employees, it is said, was a breach of the peace and their taking of possession,\ntherefore, a conversion.\nThe short answer to it is that there was no breach of the peace. The uniform code "makes\nno attempt to articulate the standards for determining whether the repossession can be\naccomplished without breach of the peace" The phrase was, however, part of the Uniform\nConditional Sales Act (and other uniform laws) in similar context, and was construed according to\nthe common law. The classic definition of breach of the peace is "a disturbance of public order by\nan act of violence, or by an act likely to produce violence, or which, by causing consternation and\nalarm, disturbs the peace and quiet of the community" Thus, when in the course of repossession,\n34\n\n\x0cthe conditional vendee received a black eye, it was a question for the jury whether a breach of the\npeace had occurred, and when padlocks on a building are broken there is such force and violence\nas to constitute a violation of section 2034 of the Penal Law and, presumably, a breach of the\npeace. Here, however, the bank\'s employees entered by use of a key, unauthorizedly obtained.\nSuch an entry, the assignor\'s consent aside, would constitute a breaking, but it is at least\nquestionable whether in view of the consent to entry set forth in the security agreement (and to\nwhich the assignee took subject) the acts of the bank\'s employees could be held to be a breaking.\nBut, breaking or not, there was nothing in what they did that disturbed public order by any act of\nviolence, caused consternation or alarm, or disturbed the peace and quiet of the community. Nor\nwas the use of a key to open the door an act likely to produce violence; indeed, it produced from\nthe landlord only (1) a call for the police and (2) a request to the bank employees that they leave\nthe key when they were through. Under the circumstances that existed during the times the bank\'s\nemployees entered the premises, there was as a matter of law no breach of the peace.\n\n2.16.1.4.\nBIG THREE MOTORS, INC., v. RUTHERFORD,\n432 So.2d 483 (Ala. 1983)\nA car dealership repossessed an automobile in the possession of one plaintiff, Christine\nRutherford, and owned by a second plaintiff, her common law husband, C.W. Rutherford.\nOn this appeal, this Court is asked to decide these questions: whether the car dealer had a\nlegal right to use self-help in the repossession of the automobile; whether the car dealer repossessed\nthe automobile in a reasonable manner without a breach of the peace. . . .\nThe pertinent facts of this case are as follows: Appellees are Christine Rutherford and her\ncommon law husband, C.W. Rutherford. C.W. Rutherford purchased a 1974 Cadillac from the\ndefendant/appellant Big Three Motors, Inc. A second defendant/appellant, Fred E. Roan, Jr.,\nworked for Big Three Motors and was involved with the repossession of the automobile, which is\nthe subject of this controversy.\nThe evidence was conflicting regarding the event surrounding Big Three Motors\'\nrepossession of Rutherford\'s automobile. The Rutherfords asserted that Big Three Motors breached\nthe peace when it repossessed the car; on the other hand, Big Three Motors and Roan claim that\neverything which Roan and other employees of Big Three Motors did was legally justified.\nWhile the evidence was conflicting, the tendencies of the evidence indicate that while\nChristine was driving the Cadillac automobile on Interstate 65 in Mobile County, Roan and another\nBig Three Motors employee forced her to pull her car off the road. Roan and Christine exchanged\nwords while they were standing on the shoulder of the Interstate. They do not agree on the exact\nwords exchanged; therefore, they disagree on whether Roan\'s conduct at this time constituted a\nbreach of the peace.\nThe Rutherfords presented evidence that Roan used the truck he was driving to block\nChristine\'s direct access back onto the Interstate. Roan denied this, but both parties agree that at\nsome point in time, Roan got into the Cadillac and rode with Christine to the Big Three Motors\ndealership. After arriving at the dealership, Christine locked the car, took the keys with her, and\nwent into an office of Big Three Motors. The parties disagree about the details of what took place\nin the office, but it is clear that at one point Christine spoke with C.W. Rutherford by telephone\n35\n\n\x0cand told him about the events which transpired on the Interstate. Christine finally left the office\nand discovered that someone had then taken the Cadillac automobile from the spot where she had\nparked it. An employee of Big Three Motors informed her that the car had been put "in storage"\nbecause C.W. Rutherford owed payments. The parties disagree whether Big Three Motors offered\nChristine transportation away from the dealership. She finally left Big Three Motors in a taxicab.\nC.W. Rutherford, the owner of the automobile, sued Big Three Motors and claimed . . . (3)\nwrongful repossession of the automobile. Mrs. Rutherford also sued Big Three Motors and in\naddition, sued Fred E. Roan, Jr. and Cadillac Discount Corporation. The jury returned a verdict in\nfavor of Christine Rutherford for $15,000 and in favor of C.W. Rutherford for $10,000. Big Three\nMotors appealed.\nOn appeal, Big Three Motors claims that it legally repossessed Rutherford\'s automobile\nunder the terms of their contract because Rutherford had defaulted in his payments, and because\nhe had failed to maintain insurance coverage on the Cadillac. In Alabama "... a secured party has\non default the right to take possession of the collateral. In taking possession a secured party may\nproceed without judicial process if this can be done without breach of the peace...." Code 1975 \xc2\xa7\n7-9-503 (1975). This section does not permit repossession through fraud, trickery, artifice or\nstealth, nor may the creditor "use force or threats of violence against the person having possession."\nRutherford does not deny that he was behind in his payments, but he contends that he had\nreached an agreement with one Tom Walley, the assistant credit manager of Big Three Motors.\nSeveral days prior to the time of the repossession, Rutherford claims Walley told him he could\nhave a few extra days to make his payments without the automobile\'s being repossessed. Big Three\nMotors contends that any agreement between Walley and Rutherford, if made, would modify the\nwritten agreement between them, and a clause in the contract prohibited any modification of the\ncontract. Rutherford does not dispute that the agreement could not be modified, but he contends\nthat "[e]ven assuming, arguendo, that the agreement between Mr. Walley and Mr. Rutherford was\nineffective, it would certainly pose a question for the jury as to whether the Rutherfords relied on\nthe representations and whether they were made in order to deceive and lull the Rutherfords into\na false sense of security with respect to keeping the vehicle and being allowed to make the\npayments in several days." Rutherford also argues that the witnesses for Big Three Motors testified\nthat they were on the way to Hattiesburg, Mississippi, to repossess the vehicle. The Rutherfords\nargue that Big Three Motors intended to repossess the car on the day it was taken from the\npossession of Mrs. Rutherford. Further, the Rutherfords assert these actions are indicative of the\nfact that Big Three Motors had no intention of allowing Mr. Rutherford to wait several days to\nmake his payments and, therefore, that the representations in the agreement to allow him to pay\nlater were made with a fraudulent intent. Rutherford sums up his argument by stating that "[t]he\nfacts clearly show that the repossession conducted by Big Three Motors was conducted by force\nand with use of trickery and fraud." As we have previously pointed out, the evidence in this case\nwas conflicting and this Court has held on many previous occasions that where the evidence is\nconflicting, the credibility of the testimony is for the jury. Our review of the record reveals that\neven though the evidence was conflicting, the Rutherfords introduced ample evidence to support\ntheir claims against Big Three Motors. The jury could reasonably conclude and find that Big Three\nMotors used force, trickery and fraud in the repossession. In short, the evidence was sufficient to\nshow that the actions of the agents of Big Three Motors amounted to a breach of the peace because\n36\n\n\x0cof the manner in which they pulled Mrs. Rutherford off the road and repossessed her husband\'s\nautomobile.\nTORBERT, Chief Justice (concurring specially).\nI agree with the majority that the evidence concerning the manner in which agents of Big\nThree Motors Company pulled Mrs. Rutherford off the highway and escorted her to the car dealer\'s\noffice was sufficient to show a breach of the peace under Code 1975, \xc2\xa7 7-9-503. I write to point\nout that any oral offer by Mr. Wally to extend the time of payment would not be enforceable.\n\n2.16.1.5.\nWALTER KOUBA v. EAST JOLIET BANK, 135 Ill.\nApp. 3d 264 (1985)\nThis is an appeal from an order of summary judgment entered in favor of defendants East\nJoliet Bank and Dave Kiester, d/b/a Kiester\'s Garage. The bank held a security interest in a Ford\nBronco truck purchased by the plaintiffs, Walter and Acelia Kouba. Because the plaintiffs were in\ndefault on their monthly loan payments, the bank contracted with Leroy Campbell, d/b/a\nRecoveries Unlimited, to repossess the truck. Campbell in turn hired defendants Mau, Sullivan\nand Schroll, who went onto plaintiffs\' property to recover the truck. When confronted by the\nplaintiffs, defendant Mau allegedly grabbed Acelia Kouba by the neck, threw her to the ground\nand took the truck by force. The repossessors then allegedly started the truck on fire and dropped\nit off of a tow truck hoist shortly before the police arrived. Later, the vehicle was destroyed by fire\nwhile being stored at Kiester\'s Garage.\nDefendants Sullivan and Schroll have never been found for service of summons and were\ndismissed by plaintiffs. A default judgment was entered against defendants Mau and Campbell.\nThe plaintiffs submit the following issues on appeal: (1) whether the grant of summary\njudgment as to the bank contradicts the intent of the Uniform Commercial Code; (2) whether there\nis an issue of fact as to the bank\'s vicarious liability for the tortious conduct of the repossessors.\nIn its motion for summary judgment, the bank argued that there was no genuine issue of\nfact as to its liability since the pleadings and affidavits established that the repossessors were\nindependent contractors. The plaintiffs ask this court to ignore agency principles and subject the\nbank to statutory liability under article 9 of the Uniform Commercial Code. In the alternative, the\nplaintiffs argue that the doctrine of respondeat superior is applicable to the bank because the\nrepossessors were its agents. Therefore, the bank is liable for the common law torts of the\nrepossessors.\nSection 9-503 [now UCC 9-609] of the U.C.C. permits a secured party to take possession\nof the collateral following default without judicial process if repossession can be accomplished\nwithout a breach of the peace. It is beyond dispute that the repossessors hired by the bank caused\na breach of the peace in the present case. However, section 9-503 itself does not provide an\naggrieved debtor with a cause of action. The remedy is found in section 9-507 [now UCC 9-625],\nwhich has been construed as granting statutory relief for any violation of article 9, part 5. This\nincludes a breach of the peace under 9-503.\n\n37\n\n\x0cThe statutory remedies are twofold. First, if the collateral is consumer goods, the debtor\nmay recover the credit service charge plus 10% of the principal amount of the debt, plus 10% of\nthe cash price. Second, the secured party may be denied a deficiency judgment.\nThere are a number of problems with applying these remedies to the present case. Section\n9-507, by its terms, applies after disposition of the collateral. There has been no disposition here.\nThere is also a question as to whether 9-507 applies to secured parties in cases where an\nindependent contractor rather than an employee is charged with committing a breach of the peace\nin violation of section 9-503. There are no Illinois cases on point.\nAfter examining count I of the plaintiffs\' complaint, we find that we need not consider the\napplicability of 9-507. The plaintiffs have failed to specifically plead a statutory remedy under 9507. Therefore, they must rely on common law remedies for wrongful repossession. The plaintiffs\nallege that the repossession is wrongful due to the tortious acts of the repossessors, i.e., assault,\nbattery, trespass and conversion. Since we are now dealing with common law rather than statutory\nliability, we must first determine whether the bank is responsible under the law of agency for the\nconduct of others.\nAn employer is generally not liable for the acts of independent contractors. The test of\nwhether one is an independent contractor or employee is the extent of the employer\'s right to\ncontrol the manner and method in which the work is to be carried on. We agree with the bank\'s\nassertion that the repossessors were independent contractors.\nThe record reveals that the repossessors were not on the bank\'s payroll and were paid on a\nper car, flat-fee basis. The repossessors exercised complete discretion as to how and when the\nvehicles were to be repossessed and used their own tools and equipment. The bank had no right of\ncontrol.\nThe plaintiffs concede that the repossessors fit within the commonly accepted description\nof an independent contractor but insist that they are also agents and that principals are liable for\nthe torts of their agents. A master is liable for the acts of his servant committed within the scope\nof employment, and a principal is liable for the acts of an agent performed within the scope of the\nagency, but neither is liable for the acts of an independent contractor. Therefore, an employer is\nnot responsible for the physical acts of an independent contractor who also happens to possess the\npowers of an agent.\nThere are exceptions to the rule which insulate an employer from liability for the acts of\nan independent contractor, but none are applicable here. An employer could be liable if he fails to\nexercise reasonable care in selecting a competent contractor or if the employer orders or directs\nthe injurious act. However, the plaintiffs do not allege that the bank was negligent in hiring the\nrepossessors or directed the tortious acts complained of.\nThe complaint and affidavits fail to raise any genuine issue as to the bank\'s statutory\nliability or accountability for the tortious acts of the repossessors. Accordingly, we affirm the order\nof summary judgment entered in favor of the bank.\nJUSTICE STOUDER, dissenting:\nI do not agree that the bank has no liability for the acknowledged breach of section 9-503\nby breaching the peace in retaking plaintiff\'s truck. There is no dispute that plaintiff Acelia Kouba\nwas dragged from the truck by her neck during the repossession or that such an action on the part\n38\n\n\x0cof the repossessors constituted a breach of the peace. The majority relies upon an agency theory to\nrelieve the bank of potential liability seemingly on the premise that because the plaintiff did not\nspecifically plead a remedy under section 9-507 of the Uniform Commercial Code that the Code\ndoes not apply and that the common law must be resorted to. Section 9-507 is available "if it is\nestablished that the secured party is not proceeding in accordance with the provisions of this Part\n[part 5]." [An official comment to the UCC] indicates that, contrary to the majority view, section\n9-507 encompasses a number of remedies, i.e., conversion and denial of a deficiency judgment,\nwhich are not specifically set out in the statute. White and Summers in their treatise on the Uniform\nCommercial Code discuss at length not only denial of deficiency judgment but possible tort\nliability incurred by a secured party for a breach of the peace under section 9-503. Therefore,\nrecovery of a liquidated amount is by no means an exclusive remedy for a breach of the peace.\nIn my opinion, in this case, where there is no dispute that a breach of the peace occurred in\nthe attempted repossession of plaintiff\'s truck by the bank, the plaintiff has its choice of remedies\nunder 9-507. Merely because the plaintiff may not be effectively compensated by the liquidated\namount or there has been no disposition of the collateral does not foreclose recovery under 9-507,\nnor does it mean that the bank has no liability for failing to comply with 9-503. The proper action\nin this case, when the collateral has little or no value due to its destruction in the hands of the\nsecured party, is conversion. Because the repossession was not accomplished by lawful means as\nacknowledged by both parties, the collateral was never rightfully in possession of the bank,\nalthough the bank certainly exercised control over the truck. Although there are no cases in Illinois\nwhere a debtor has maintained an action for conversion for a breach of the peace under 9-503,\nthere is considerable authority in other jurisdictions for maintaining a conversion suit against a\nsecured party when force or threat of force is used to obtain possession. In Henderson v. Security\nNational Bank (1977), 72 Cal. App.3d 764, 140 Cal. Rptr. 388, a California court confronted the\nagency argument upon which the majority based its decision and found that conversion "[does]\nnot depend upon authorization, or ratification, or upon the knowledge, or intent, or bad faith of the\nBank." In Henderson, the Bank had employed an independent contractor (a licensed repossessor)\nto repossess plaintiff\'s Cadillac. The plaintiff alleged that his garage door lock was broken during\nthe repossession of the automobile in violation of section 9-503 of the California Uniform\nCommercial Code. The court in Henderson found that a conversion action against the bank was\nproper because "the * * * right of redress [in a conversion action] no longer depends upon his\nshowing * * * that the defendant did the act in question from wrongful motives, or generally\nspeaking, even intentionally; and hence the want of such motives, or of intention, is no defense."\nTherefore, this is not a matter of imposing absolute liability on the bank but rather redressing the\nplaintiff for the injury imposed for the unlawful deprivation of his property.\nIn my opinion, the bank is liable for the damages to the truck after it wrongfully repossessed\nthe truck. Section 9-503 provides that self-help repossession can only be accomplished if the peace\nis not breached. Plaintiff had a right to possession of the truck which the bank held unlawfully.\nThe bank prevented operation of section 9-504, not the plaintiff, and is, therefore, liable at a\nminimum for the diminution in value of the collateral while it was wrongfully held. I believe the\nplaintiff stated a reasonable theory for recovery against the bank under the Code, and I would\nreverse the trial court\'s decision granting summary judgment in favor of the bank.\n\n39\n\n\x0c2.17.\n\nPractice Problems: Enforcement of Liens and Claims\n\nProblem 1: Creditor has a security interest in the Debtor\xe2\x80\x99s piano. Debtor has defaulted in\nits obligation to make monthly payments to secured creditor. Can secured creditor enter the\nDebtor\xe2\x80\x99s house at night by picking the lock to repossess the piano? What if the front door was\nopen? Does it matter whether the security agreement allows the creditor to enter the debtor\xe2\x80\x99s\npremises to repossess the collateral? Suppose the piano was in a local repair shop being repaired.\nCould the creditor enter the repair shop at night to repossess the piano?\nNOTES: Girard v. Anderson, 257 N.W. 400, 402\xe2\x80\x9303 (Iowa 1934)\n(Repossession of a piano by entry through the door of a debtor\xe2\x80\x99s residence\nwas found to be a breach of the peace even though the door was supposedly\nunlocked). Martin v. Dorn Equip., 821 P.2d 1025, 1026\xe2\x80\x9328 (Mont. 1991)\n(cutting chains connected to a lock is breach of the peace); Williamson v.\nFowler Toyota, Inc., 956 P.2d 858, 859, 862 (Okla. 1998) (cutting gate\xe2\x80\x99s\nchain without permission is a breach of the peace); Davenport v. Chrysler\nCredit Corp., 818 S.W.2d 23, 26, 29\xe2\x80\x9330 (Tenn. Ct. App. 1991) (entering\ngarage and cutting chains that attached car to post in garage to repossess the\ncar is a breach of the peace).\nProblem 2: Debtor purchased a car with financing from CarBank, and failed to make the\nrequired payments. Fearing trouble, CarBank hires an off-duty sheriff to show up in uniform to\nrepossess the car. The debtor cooperates and there is no trouble. Has CarBank breached the peace?\nWhat if a private repossession agent told the police to stand by out-of-sight in case of trouble\nduring the re-possession?\nNOTES: Assistance of law enforcement is a per se breach of the peace. See\nHarris v. City of Roseburg, 664 F.2d at 1121 (9th Cir. 1981) (no violation\nwhere officer out of sight); Jackson v. Richards, 433 A.2d 888, 895\xe2\x80\x9396,\nn.11 (Pa. Super. Ct. 1981); Stone Mach. Co. v. Kessler, 1 Wash. App. 750,\n757, 463 P.2d 651, 655 (1970).\nProblem 3: After repossessing the car, CarBank sells it at a private auction without giving\na notice of sale to the debtor. What are the consequences to CarBank of failing to give notice of\nthe sale to the debtor, if any? Read UCC \xc2\xa7 9-610(a) and (b), 9-611(b), 9-625(b) and (e), 9-626(a)(3)\nand (b).\nProblem 4: CarBank sends a letter to the Debtor offering to accept the car in full\nsatisfaction of the debt. The letter says that CarBank\xe2\x80\x99s failure to respond within 20 days constitutes\nacceptance of its offer. Assume that the car is worth more than the debt. Is this effective to\nterminate the Debtor\xe2\x80\x99s equity of redemption? See UCC \xc2\xa7 9-620 (validating strict foreclosure letters\n40\n\n\x0clike these, but only if the debtor has not already paid at least 60% of the cash price of the consumer\ngoods); see also Reeves v. Foutz & Tanner, 94 N.M. 760 (1980).\n\n41\n\n\x0cChapter 3: The Bankruptcy System\n3.1.\n\nPurposes of Bankruptcy\n\nAs we\xe2\x80\x99ve seen in the previous chapters, state laws favor the swiftest creditors by granting\npriority to those unsecured creditors who are first to obtain a judgment, execute on the debtor\xe2\x80\x99\nassets and cause them to be sold. Meanwhile, debtors can generally prefer favored creditors by\npreferentially paying their claims or granting them security interests before paying other creditors,\neven if the preferential payments render the debtor insolvent and unable to pay other claims. The\nstate law process is expensive and time consuming for creditors, and because of the holdout\nproblem makes it difficult for debtors to enter into consensual workouts with creditors.\nThe state law system also results in creditors (and, if solvent, the debtor) receiving fire sale\nprices for the debtor\xe2\x80\x99s non-exempt assets. Although many states have statutes allowing collective\naction by creditors (assignments for the benefit of creditors and equity receiverships), these\nprocedures lack the nationwide organizational structure of a national bankruptcy system and also\nface significant obstacles from the holdout problem.\nState laws also provide no ready mechanism for debtor relief outside of the statutes of\nlimitation. There are generally long statutory periods for filing contractual debt collection suits\n(generally 3-6 years from default), and even longer periods (generally 10 or more years) for\ncollecting judgments. In some states, like New York, the debtor can unwittingly revive an expired\nlimitations period by acknowledging the debt. New York General Obligations Law 17-101. In New\nYork, any payment on a debt \xe2\x80\x93 even one that could not be collected in court due to the expiration\nof the statute of limitations - renews the entire liability and starts a new limitations period if the\ncourt determines that the partial payment constitutes an acknowledgment of the debt. See Empire\nPurveyors v. Weinberg, No. 603282/06, 2008 N.Y. Misc LEXIS 8842, 2008 Slip Op 31380U (N.Y.\nCo. 2008), aff\xe2\x80\x99d, 60 A.D.3d 508, 885 N.Y.S.2d 905 (1st Dept. 2009). Debt collectors often request\na small token payment, claiming that it would be a sign of good faith, when in fact they are seeking\nto extend or renew a limitations period that that debtor did not know expired and was not intending\nto renew. In many states the judgment limitation periods can be extended by filing renewal suits\nbefore the limitations period expires, potentially saddling a debtor with liability for a lifetime. The\nstatute of limitations on the enforcement of liens can run for a decade or more. Statute of limitations\nperiods thus provide only limited relief for debtors.\nDebtors saddled with debts that they are unable to pay are discouraged from engaging in\ngainful employment when much of the benefit would go to the debtor\xe2\x80\x99s creditors, creating a cycle\nof poverty. Debtors who know that they would be unable to rid themselves of debt may be unable\nor unwilling to incur debt for entrepreneurial investment, hampering the growth of the economy.\nFor these basic reasons, successful economies have recognized that debt relief is an important\ningredient for both fairness and economic growth.\nThe bankruptcy system is designed to pick up where state law leaves off by providing for\norderly collective creditor action, providing for the discharge of debts that are not paid through the\nbankruptcy process, and addressing the holdout problem by facilitating orderly and fair\nreorganization proceedings. In liquidation cases, an independent trustee will have time to achieve\nhigh sale process, and the distribution rules assure that similarly situated creditors will be treated\n42\n\n\x0csimilarly. Individual debtors can receive a discharge of their debts, allowing them to receive a\nfresh start and return as productive members of society. In reorganization cases, creditors are\nassured of receiving more than they would receive in a liquidation, and are protected by detailed\nrules designed to assure a measure of fairness to all parties. All parties are also protected by a legal\nframework designed to provide full and prompt financial disclosure by the debtor, and an\nexpeditious hearing process before specialized bankruptcy judges who are experts in bankruptcy\nlaw to resolve any disputes that may arise.\n\n3.2.\n\nStructure of the Bankruptcy Code\n\nThe federal bankruptcy system is grounded on a grant of power contained in the United\nStates Constitution. The grant gave Congress the power to create \xe2\x80\x9cuniform laws on the subject of\nbankruptcies.\xe2\x80\x9d While there were long periods during the 18th and 19th Centuries during which\nCongress decided not to enact uniform bankruptcy laws, there has been a continuous federal\nbankruptcy system in effect since 1898.\nCongress revamped the bankruptcy laws in 1978 by passing the Bankruptcy Reform Act\nof 1978 (Pub.L. 95\xe2\x80\x93598, 92 Stat. 2549, November 6, 1978), which has become known simply as\nthe \xe2\x80\x9cBankruptcy Code\xe2\x80\x9d or \xe2\x80\x9cCode,\xe2\x80\x9d and will be referred to as such throughout this book.\nThe original structure of the Code remains intact, although there have been several\nsignificant amendments, the most significant being the Bankruptcy Abuse Prevention and\nConsumer Protection Act of 2005, Pub.L. 109\xe2\x80\x938, 119 Stat. 23, known as \xe2\x80\x9cBAPCPA.\xe2\x80\x9d BAPCPA\nwas a poorly drafted law cobbled together by special interests without the usual vetting process by\nthe bankruptcy bench and bar that had been used in previous amendments. Major portions of\nBAPCPA did not go into effect immediately, and the media spread alarm that bankruptcy would\nno longer be available to consumer debtors, resulting in a tremendous rush by individuals to file\nprior to the effective date. As a result, nearly 2 million people filed bankruptcy in 2006, with\nbankruptcy lawyers serving lines of people waiting to get their cases filed before the deadline.\nIn fact, as we will see, while the law created a great deal of unnecessary paperwork and\ncomplexity, and substituted rigid tests that are easily circumvented for the flexible tests that the\ncourts used previously, the law did not disqualify most of the people who need relief from\neligibility. However, BAPCPA\xe2\x80\x99s complexity and confusion have made it more difficult for general\npractitioners to handle bankruptcy cases part time. The bankruptcy bar has become smaller and\nmore specialized as a result of BAPCPA. We will look in this chapter at the some of the most\nsignificant changes wrought by BAPCPA, including the dreaded \xe2\x80\x9cmeans test\xe2\x80\x9d and the automatic\ndismissal rules.\nThe Bankruptcy Code is Title 11 of the United States Code. It is divided into chapters \xe2\x80\x93 all\nodd numbers except Chapter 12. Chapters 1, 3 and 5 contain general rules applicable to each of\nthe remaining chapter proceedings. Cases are filed under a specific chapter proceeding:\nChapter 7: Straight bankruptcy liquidation\nChapter 9: Municipalities (government entities)\nChapter 11: Business reorganizations\nChapter 12: Family farmer and fisherman reorganizations\n43\n\n\x0cChapter 13: Mostly consumer reorganizations\nChapter 15: Transnational reorganizations\nChapter 7 is what most people think bankruptcy is about. The debtor turns over all of his,\nher or its non-exempt assets to an independent Chapter 7 trustee. The trustee liquidates the assets\n(turns them into money usually by selling them), and uses the proceeds of the liquidation pay\nclaims in an order of priority: expenses of liquidation and administration first, certain priority\nclaims second, and then general unsecured claims. Individual debtors receive a discharge of their\ndebts. Entity debtors become empty shells and for all practical purposes suffer corporate death. A\nbetter term may be corporate zombies, since the entity must technically be wound up and\nterminated under state law to cease to exist, but they are empty shell entities that cannot generally\nbe used for any other purpose since the shells continue to owe all unpaid creditors. Chapter 7\nproceedings are fast, with most cases completed within four to six months after filing.\nUntil recently, Chapter 9 was a sleepy and ill-defined chapter of the Bankruptcy Code.\nRecently, however, it has become a hotbed of activity, with major cities like Detroit, Michigan,\nfiling for bankruptcy relief, and great uncertainty about what can be done to revitalize moribund\ngovernmental entities. These cases pit former government workers relying on promised pensions\nagainst bondholders, creditors, continuing workers and taxpayers. Many municipalities appear to\nbe sitting on the sidelines awaiting clarity from the courts about what can be done in a Chapter 9\ncase.\nChapter 11 is the most important reorganization chapter in terms of the amount of money\nat stake, but involves only a tiny fraction of the cases that are filed each year. Chapter 11 is\nexpensive. Even small simple Chapter 11 cases can cost $100,000 in fees, and large cases can cost\nhundreds of millions of dollars in fees. Chapter 11 cases pit the largest and most expensive law\nand investment firms in the country against each other. Chapter 11 is designed for flexibility,\nallowing virtually limitless reorganization agreements to be reached between creditors and debtors,\nand overcoming the holdout problem with a special majority voting structure. Because of its\nflexibility and consequent expense, Chapter 11 is appropriate only for individuals or businesses\nseeking to reorganize significant assets.\nAlmost anything can be done to reorganize a debtor in Chapter 11 with the requisite levels\nof consent from creditors. The trick is proposing a plan which will cause as much pain to creditors\nas possible while still receiving the affirmative votes of the requisite majorities. Debtor who\ncannot obtain the requisite votes must \xe2\x80\x9ccramdown\xe2\x80\x9d the plan on non-consenting classes of creditors\nin the limited ways allowed by the bankruptcy code.\nWhile lawyers handling Chapter 11 cases perform legal work that is custom tailed to the\nparticular case, those handling Chapter 12 and 13 cases work from an off-the-rack reorganization\nplan structure. Like Chapter 7, Chapters 12 and 13 are structured simply, limiting what the debtor\ncan do to reorganize its business. There is no voting and no need to reach agreements with the\nmajority of creditors \xe2\x80\x93 the plan either meets the requirements for confirmation or it does not, and\nthe bankruptcy law says what can and cannot be done to restructure creditor claims.\nChapter 15 is a new provision for foreign parties that have filed a bankruptcy or\nbankruptcy-like proceeding in another country to obtain assistance through an ancillary proceeding\nin the United States to deal with assets located in the United States.\n44\n\n\x0c3.3.\n\nJurisdiction and Venue of Bankruptcy Cases\n\nThe Bankruptcy Code has been plagued by jurisdictional uncertainty since it was enacted.\nThe main source of dispute has been the tension between Congress\xe2\x80\x99s power under Article I of the\nConstitution to create uniform bankruptcy laws, and the requirements of Article III for an\nindependent judiciary. The tension results from Congress\xe2\x80\x99s decision not to form the bankruptcy\ncourts in conformity with the mandates of Article III \xe2\x80\x93 specifically, bankruptcy judges do not have\nlife tenure and un-diminishable salaries as required by Article III. Ironically, Congress\xe2\x80\x99s decision\nnot to establish the bankruptcy courts under Article III was made to placate the existing Article III\njudiciary who felt that their prestige and power would be diminished by the granting of Article III\nstatus to the large number of bankruptcy judges needed to administer the bankruptcy system.\nThe entire bankruptcy system was plunged into a crisis in 1982 (only four years after the\nenactment of the new law) when the Supreme Court issued its famous decision in Northern\nPipeline, printed below, holding that the bankruptcy system was unconstitutional because it gave\nthe non-Article 3 bankruptcy judges the power to adjudicate an ordinary breach of contract dispute.\nIt is important to distinguish the bankruptcy jurisdictional problem (Article I v. Article III)\nfrom the normal subject matter jurisdiction issue involving the power of the federal government\nvis a vis the states (which cannot be waived by the litigants since it involves state rights). What is\nat stake under Article 1 is the litigant\xe2\x80\x99s constitutional right to have a judge with the protections of\nlife tenure and un-diminishable salary decide the case. Congress could easily cure the Article 1\nproblem by endowing bankruptcy judges with the protections of Article III, but that solution has\nnot been in the political cards, so doubts about the constitutionality of the bankruptcy system\npersist.\n\n3.4.\n\nCases on the Constitutional Limits of Bankruptcy Jurisdiction\n3.4.1.1.\nNORTHERN PIPELINE CO. v. MARATHON PIPE\nLINE CO., 458 U.S. 50 (1982)\n\nJUSTICE BRENNAN\nThe question presented is whether the assignment by Congress to bankruptcy judges of the\njurisdiction granted in 28 U.S.C. \xc2\xa7 1471 (1976 ed., Supp. IV) by \xc2\xa7 241(a) of the Bankruptcy Act\nof 1978 violates Art. III of the Constitution.\nIn 1978, after almost 10 years of study and investigation, Congress enacted a\ncomprehensive revision of the bankruptcy laws. The Bankruptcy Act of 1978 (Act) made\nsignificant changes in both the substantive and procedural law of bankruptcy. It is the changes in\nthe latter that are at issue in this case.\nBefore the Act, federal district courts served as bankruptcy courts and employed a "referee"\nsystem. Bankruptcy proceedings were generally conducted before referees, except in those\ninstances in which the district court elected to withdraw a case from a referee. The referee\'s final\norder was appealable to the district court. The bankruptcy courts were vested with "summary\njurisdiction"\xe2\x80\x94that is, with jurisdiction over controversies involving property in the actual or\nconstructive possession of the court. And, with consent, the bankruptcy court also had jurisdiction\n45\n\n\x0cover some "plenary" matters\xe2\x80\x94such as disputes involving property in the possession of a third\nperson.\nThe Act eliminates the referee system and establishes "in each judicial district, as an\nadjunct to the district court for such district, a bankruptcy court which shall be a court of record\nknown as the United States Bankruptcy Court for the district." The judges of these courts are\nappointed to office for 14-year terms by the President, with the advice and consent of the Senate.\nThey are subject to removal by the "judicial council of the circuit" on account of "incompetency,\nmisconduct, neglect of duty or physical or mental disability." In addition, the salaries of the\nbankruptcy judges are set by statute and are subject to adjustment under the Federal Salary Act.\nThe jurisdiction of the bankruptcy courts created by the Act is much broader than that\nexercised under the former referee system. Eliminating the distinction between "summary" and\n"plenary" jurisdiction, the Act grants the new court\xe2\x80\x99s jurisdiction over all "civil proceedings arising\nunder title 11 or arising in or related to cases under title 11." This jurisdictional grant empowers\nbankruptcy courts to entertain a wide variety of cases involving claims that may affect the property\nof the estate once a petition has been filed under Title 11. The bankruptcy courts can hear claims\nbased on state law as well as those based on federal law.\nThis case arises out of proceedings initiated after appellant Northern filed a petition for\nreorganization in January 1980. In March 1980 Northern, pursuant to the Act, filed in that court a\nsuit against appellee Marathon. Appellant sought damages for alleged breaches of contract and\nwarranty, as well as for alleged misrepresentation, coercion, and duress. Marathon sought\ndismissal of the suit, on the ground that the Act unconstitutionally conferred Art. III judicial power\nupon judges who lacked life tenure and protection against salary diminution.\n"A Judiciary free from control by the Executive and Legislature is essential if there is a\nright to have claims decided by judges who are free from potential domination by other branches\nof government." United States v. Will, 449 U.S. 200, 217-218 (1980). As an inseparable element\nof the constitutional system of checks and balances, and as a guarantee of judicial impartiality,\nArt. III both defines the power and protects the independence of the Judicial Branch. The judicial\npower of the United States must be exercised by courts having the attributes prescribed in Art. III.\nIt is undisputed that the bankruptcy judges whose offices were created by the Bankruptcy\nAct of 1978 do not enjoy the protections constitutionally afforded to Art. III judges.\nAppellants suggest two grounds for upholding the Act\'s conferral of broad adjudicative\npowers upon judges unprotected by Art. III. First, it is urged that Congress may establish legislative\ncourts that have jurisdiction to decide cases to which the Article III judicial power of the United\nStates extends. Second, appellants contend that even if the Constitution does require that this\nbankruptcy-related action be adjudicated in an Art. III court, the Act in fact satisfies that\nrequirement. [T]he exercise of [bankruptcy] jurisdiction by the adjunct bankruptcy court was made\nsubject to appeal as of right to an Article III court. Analogizing the role of the bankruptcy court to\nthat of a special master, appellants urge us to conclude that this system established by Congress\nsatisfies the requirements of Art. III. We consider these arguments in turn.\nCongress did not constitute the bankruptcy courts as legislative courts. Appellants contend,\nhowever, that the bankruptcy courts could have been so constituted, and that as a result the\n"adjunct" system in fact chosen by Congress does not impermissibly encroach upon the judicial\npower.\n46\n\n\x0c[There are only] three narrow situations in which the grant of power to the Legislative and\nExecutive Branches was historically and constitutionally so exceptional that the congressional\nassertion of a power to create legislative courts was consistent with, rather than threatening to, the\nconstitutional mandate of separation of powers. [The court discusses territorial courts applying\noutside of the home jurisdiction of the United States, courts martial involving the military, and\npublic rights courts involving claims against the United States government to recover money.]\nWe discern no such exceptional grant of power applicable in the cases before us. The courts\ncreated by the Bankruptcy Act of 1978 do not lie exclusively outside the States of the Federal\nUnion. Nor do the bankruptcy courts bear any resemblance to courts-martial, which are founded\nupon the Constitution\'s grant of plenary authority over the Nation\'s military forces to the\nLegislative and Executive Branches. Finally, the substantive legal rights at issue in the present\naction cannot be deemed "public rights."\nRecognizing that the present cases may not fall within the scope of any of our prior cases\npermitting the establishment of legislative courts, appellants argue that we should recognize an\nadditional situation beyond the command of Art. III, sufficiently broad to sustain the Act.\nAppellants contend that Congress\' constitutional authority to establish "uniform Laws on the\nsubject of Bankruptcies throughout the United States," Art. I, \xc2\xa7 8, cl. 4, carries with it an inherent\npower to establish legislative courts capable of adjudicating "bankruptcy-related controversies."\nIn support of this argument, appellants [argue] that a bankruptcy court created by Congress under\nits Art. I powers is constitutional, because the law of bankruptcy is a "specialized area," and\nCongress has found a "particularized need" that warrants "distinctive treatment."\nAppellants\' contention, in essence, is that pursuant to any of its Art. I powers, Congress\nmay create courts free of Art. III\'s requirements whenever it finds that course expedient. This\ncontention has been rejected in previous cases. Although the cases relied upon by appellants\ndemonstrate that independent courts are not required for all federal adjudications, those cases also\nmake it clear that where Art. III does apply, all of the legislative powers specified in Art. I and\nelsewhere are subject to it. The flaw in appellants\' analysis is that it provides no limiting principle.\nIt thus threatens to supplant completely our system of adjudication in independent Art. III tribunals\nand replace it with a system of "specialized" legislative courts. True, appellants argue that under\ntheir analysis Congress could create legislative courts pursuant only to some "specific" Art. I\npower, and "only when there is a particularized need for distinctive treatment." They therefore\nassert that their analysis would not permit Congress to replace the independent Art. III Judiciary\nthrough a "wholesale assignment of federal judicial business to legislative courts." But these\n"limitations" are wholly illusory [citing the broad powers given to Congress under Article I). The\npotential for encroachment upon powers reserved to the Judicial Branch through the device of\n"specialized" legislative courts is dramatically evidenced in the jurisdiction granted to the courts\ncreated by the Act before us. The broad range of questions that can be brought into a bankruptcy\ncourt because they are "related to cases under title 11" is the clearest proof that even when Congress\nacts through a "specialized" court, and pursuant to only one of its many Art. I powers, appellants\'\nanalysis fails to provide any real protection against the erosion of Art. III jurisdiction by the\nunilateral action of the political Branches. In short, to accept appellants\' reasoning, would require\nthat we replace the principles delineated in our precedents, rooted in history and the Constitution,\nwith a rule of broad legislative discretion that could effectively eviscerate the constitutional\nguarantee of an independent Judicial Branch of the Federal Government.\n47\n\n\x0cIn sum, Art. III bars Congress from establishing legislative courts to exercise jurisdiction\nover all matters related to those arising under the bankruptcy laws. The establishment of such\ncourts does not fall within any of the historically recognized situations in which the general\nprinciple of independent adjudication commanded by Art. III does not apply. Nor can we discern\nany persuasive reason, in logic, history, or the Constitution, why the bankruptcy courts here\nestablished lie beyond the reach of Art. III.\nAppellants advance a second argument for upholding the constitutionality of the Act: that\n"viewed within the entire judicial framework set up by Congress," the bankruptcy court is merely\nan "adjunct" to the district court, and that the delegation of certain adjudicative functions to the\nbankruptcy court is accordingly consistent with the principle that the judicial power of the United\nStates must be vested in Art. III courts. As support for their argument, appellants rely principally\nupon cases in which we approved the use of administrative agencies and magistrates as adjuncts\nto Art. III courts. Congress possesses broad discretion to assign fact-finding functions to an adjunct\ncreated to aid in the adjudication of congressionally created statutory rights, Congress [does not]\npossess the same degree of discretion in assigning traditionally judicial power to adjuncts engaged\nin the adjudication of rights not created by Congress. When Congress creates a statutory right, it\nclearly has the discretion, in defining that right, to create presumptions, or assign burdens of proof,\nor prescribe remedies; it may also provide that persons seeking to vindicate that right must do so\nbefore particularized tribunals created to perform the specialized adjudicative tasks related to that\nright. Such provisions do, in a sense, affect the exercise of judicial power, but they are also\nincidental to Congress\' power to define the right that it has created. No comparable justification\nexists, however, when the right being adjudicated is not of congressional creation.\nThe Bankruptcy Act vests all "essential attributes" of the judicial power of the United States\nin the "adjunct" bankruptcy court. First, the subject-matter jurisdiction of the bankruptcy courts\nencompasses not only traditional matters of bankruptcy, but also "all civil proceedings arising\nunder title 11 or arising in or related to cases under title 11." Second, the bankruptcy courts exercise\n"all of the jurisdiction" conferred by the Act on the district courts [not just a fact-finding function].\nThird, the bankruptcy courts exercise all ordinary powers of district courts, including the power to\npreside over jury trials, the power to issue declaratory judgments, the power to issue writs of habeas\ncorpus, and the power to issue any order, process, or judgment appropriate for the enforcement of\nthe provisions of Title 11. Fourth, the judgments of the bankruptcy courts are apparently subject\nto review only under the deferential "clearly erroneous" standard. Finally, the bankruptcy courts\nissue final judgments, which are binding and enforceable even in the absence of an appeal. In short,\nthe "adjunct" bankruptcy courts created by the Act exercise jurisdiction behind the facade of a\ngrant to the district courts, and are exercising powers far greater than those lodged in the adjuncts\napproved [in our prior decisions.]\nWe conclude that the Bankruptcy Act of 1978 has impermissibly removed most, if not all,\nof "the essential attributes of the judicial power" from the Art. III district court, and has vested\nthose attributes in a non-Art. III adjunct. Such a grant of jurisdiction cannot be sustained as an\nexercise of Congress\' power to create adjuncts to Art. III courts.\nHaving concluded that the broad grant of jurisdiction to the bankruptcy courts is\nunconstitutional, we must now determine whether our holding should be applied retroactively to\nthe effective date of the Act. . . . We hold, therefore, that our decision today shall apply only\nprospectively.\n48\n\n\x0cThe judgment of the District Court is affirmed. However, we stay our judgment until\nOctober 4, 1982. This limited stay will afford Congress an opportunity to reconstitute the\nbankruptcy courts or to adopt other valid means of adjudication, without impairing the interim\nadministration of the bankruptcy laws.\nIt is so ordered.\n\n3.5.\n\nThe Aftermath of Northern Pipeline\n\nIn Northern Pipeline, the Supreme Court took the highly unusual step of allowing the\nunconstitutional bankruptcy court system to continue operating by staying its decision to allow\nCongress time to fix the jurisdictional problem. After Congress continued to diddle, the Supreme\nCourt granted a further stay of its decision to December 24, 1982, hoping that Congress would\nreach agreement on a bankruptcy bill before then. No resolution could be reached, and the\nBankruptcy Courts were set to be closed on Christmas Day, December 25, 1982.\nTo avert the crises that would be caused by the closure of the Bankruptcy Court system,\nevery District Court in the country passed an \xe2\x80\x9cemergency rule\xe2\x80\x9d drafted by a group of judges in last\nminute negotiations. The emergency rule required each District Court to appoint the Bankruptcy\nJudges as \xe2\x80\x9cadjuncts,\xe2\x80\x9d operating under a modified jurisdictional scheme.\nIn 1984, Congress codified the emergency rule into 28 U.S.C. Section 157, under which\nthe Bankruptcy Courts now operate. The new jurisdictional scheme allows but does not require\nthe District Courts to refer bankruptcy matters to the Bankruptcy Courts, but every District Court\nin the country promptly followed the procedure by issuing a general order referring all bankruptcy\ncases to the Bankruptcy Courts.\nThe new jurisdictional scheme creates two classes of matters that may come before the\nBankruptcy Courts: \xe2\x80\x9ccore matters\xe2\x80\x9d that the Bankruptcy Courts can finally decide subject to appeal,\nand \xe2\x80\x9cnon-core related\xe2\x80\x9d matters that the Bankruptcy Courts can hear, but can only issue proposed\nfindings of fact and conclusions of law to the District Courts for final determination. However, the\nlist of \xe2\x80\x9ccore matters\xe2\x80\x9d was (and is) quite broad raising the specter of further clashes in the Supreme\nCourt. The bankruptcy world braced for another eminent crisis in the Supreme Court, but what\nfollowed was more than 20 years of silence. After the procedural mess that followed the Marathon\ndecision, the Supreme Court simply refused to hear any major challenges to the Bankruptcy\nCourt\xe2\x80\x99s jurisdictional scheme \xe2\x80\x93 until recently. The silence came to an end in the next two cases,\nwhich have left many in the bankruptcy community wondering exactly what the non-Article III\nbankruptcy court can and cannot do.\n\n49\n\n\x0c3.6.\n\nCases on the Constitutional Limits of Bankruptcy Jurisdiction\nafter Marathon\n3.6.1.1.\nSTERN v. MARSHALL, 564 U.S. 2, 131 S. Ct. 2594\n(2011)\n\nCHIEF JUSTICE ROBERTS\nThis "suit has, in course of time, become so complicated, that ... no two ... lawyers can talk\nabout it for five minutes, without coming to a total disagreement as to all the premises. Innumerable\nchildren have been born into the cause: innumerable young people have married into it;" and,\nsadly, the original parties "have died out of it." A "long procession of [judges] has come in and\ngone out" during that time, and still the suit "drags its weary length before the Court."\nThose words were not written about this case, see C. Dickens, Bleak House, in 1 Works of\nCharles Dickens 4-5 (1891), but they could have been. This is the second time we have had\noccasion to weigh in on this long-running dispute between Vickie Lynn Marshall and E. Pierce\nMarshall over the fortune of J. Howard Marshall II, a man believed to have been one of the richest\npeople in Texas. The Marshalls\' litigation has worked its way through state and federal courts in\nLouisiana, Texas, and California, and two of those courts\xe2\x80\x94a Texas state probate court and the\nBankruptcy Court for the Central District of California\xe2\x80\x94have reached contrary decisions on its\nmerits. The Court of Appeals below held that the Texas state decision controlled, after concluding\nthat the Bankruptcy Court lacked the authority to enter final judgment on a counterclaim that\nVickie brought against Pierce in her bankruptcy proceeding. To determine whether the Court of\nAppeals was correct in that regard, we must resolve two issues: (1) whether the Bankruptcy Court\nhad the statutory authority under 28 U.S.C. \xc2\xa7 157(b) to issue a final judgment on Vickie\'s\ncounterclaim; and (2) if so, whether conferring that authority on the Bankruptcy Court is\nconstitutional.\nAlthough the history of this litigation is complicated, its resolution ultimately turns on very\nbasic principles. Article III, \xc2\xa7 1, of the Constitution commands that "[t]he judicial Power of the\nUnited States, shall be vested in one supreme Court, and in such inferior Courts as the Congress\nmay from time to time ordain and establish." That Article further provides that the judges of those\ncourts shall hold their offices during good behavior, without diminution of salary. Those\nrequirements of Article III were not honored here. The Bankruptcy Court in this case exercised the\njudicial power of the United States by entering final judgment on a common law tort claim, even\nthough the judges of such courts enjoy neither tenure during good behavior nor salary protection.\nWe conclude that, although the Bankruptcy Court had the statutory authority to enter judgment on\nVickie\'s counterclaim, it lacked the constitutional authority to do so.\nOf current relevance are two claims Vickie filed in an attempt to secure half of J. Howard\'s\nfortune. Known to the public as Anna Nicole Smith, Vickie was J. Howard\'s third wife and married\nhim about a year before his death. Although J. Howard bestowed on Vickie many monetary and\nother gifts during their courtship and marriage, he did not include her in his will. Before J. Howard\npassed away, Vickie filed suit in Texas state probate court, asserting that Pierce\xe2\x80\x94J. Howard\'s\nyounger son\xe2\x80\x94fraudulently induced J. Howard to sign a living trust that did not include her, even\n50\n\n\x0cthough J. Howard meant to give her half his property. Pierce denied any fraudulent activity and\ndefended the validity of J. Howard\'s trust and, eventually, his will.\nAfter J. Howard\'s death, Vickie filed a petition for bankruptcy in the Central District of\nCalifornia. Pierce filed a complaint in that bankruptcy proceeding, contending that Vickie had\ndefamed him by inducing her lawyers to tell members of the press that he had engaged in fraud to\ngain control of his father\'s assets. The complaint sought a declaration that Pierce\'s defamation\nclaim was not dischargeable in the bankruptcy proceedings. Pierce subsequently filed a proof of\nclaim for the defamation action, meaning that he sought to recover damages for it from Vickie\'s\nbankruptcy estate. Vickie responded to Pierce\'s initial complaint by asserting truth as a defense to\nthe alleged defamation and by filing a counterclaim for tortious interference with the gift she\nexpected from J. Howard. As she had in state court, Vickie alleged that Pierce had wrongfully\nprevented J. Howard from taking the legal steps necessary to provide her with half his property\nOn November 5, 1999, the Bankruptcy Court issued an order granting Vickie summary\njudgment on Pierce\'s claim for defamation. On September 27, 2000, after a bench trial, the\nBankruptcy Court issued a judgment on Vickie\'s counterclaim in her favor. The court later awarded\nVickie over $400 million in compensatory damages and $25 million in punitive damages.\nIn post-trial proceedings, Pierce argued that the Bankruptcy Court lacked jurisdiction over\nVickie\'s counterclaim. In particular, Pierce renewed a claim he had made earlier in the litigation,\nasserting that the Bankruptcy Court\'s authority over the counterclaim was limited because Vickie\'s\ncounterclaim was not a "core proceeding." The Bankruptcy Court in this case concluded that\nVickie\'s counterclaim was "a core proceeding" under [28 U.S.C.] \xc2\xa7 157(b)(2)(C), and the court\ntherefore had the "power to enter judgment" on the counterclaim under \xc2\xa7 157(b)(1).\nThe District Court disagreed. It . . . understood this Court\'s precedent to "suggest[] that it\nwould be unconstitutional to hold that any and all counterclaims are core." 264 B.R. 609, 629-630\n(C.D. Cal. 2001). Because the District Court concluded that Vickie\'s counterclaim was not core,\nthe court determined that it was required to treat the Bankruptcy Court\'s judgment as "proposed[,]\nrather than final," and engage in an "independent review" of the record. Although the Texas state\ncourt had by that time conducted a jury trial on the merits of the parties\' dispute and entered a\njudgment in Pierce\'s favor, the District Court declined to give that judgment preclusive effect and\nwent on to decide the matter itself. Like the Bankruptcy Court, the District Court found that Pierce\nhad tortiously interfered with Vickie\'s expectancy of a gift from J. Howard. The District Court\nawarded Vickie compensatory and punitive damages, each in the amount of $44,292,767.33.\nThe Court of Appeals reversed the District Court on a different ground, and we\xe2\x80\x94in the\nfirst visit of the case to this Court\xe2\x80\x94reversed the Court of Appeals on that issue. On remand from\nthis Court, the Court of Appeals held that \xc2\xa7 157 mandated "a two-step approach" under which a\nbankruptcy judge may issue a final judgment in a proceeding only if the matter both "meets\nCongress\' definition of a core proceeding and arises under or arises in title 11," the Bankruptcy\nCode. The court also reasoned that allowing a bankruptcy judge to enter final judgments on all\ncounterclaims raised in bankruptcy proceedings "would certainly run afoul" of this Court\'s\ndecision in Northern Pipeline. With those concerns in mind, the court concluded that "a\ncounterclaim under \xc2\xa7 157(b)(2)(C) is properly a `core\' proceeding `arising in a case under\' the\n[Bankruptcy] Code only if the counterclaim is so closely related to [a creditor\'s] proof of claim\nthat the resolution of the counterclaim is necessary to resolve the allowance or disallowance of the\n51\n\n\x0cclaim itself." The court ruled that Vickie\'s counterclaim did not meet that test. That holding made\n"the Texas probate court\'s judgment ... the earliest final judgment entered on matters relevant to\nthis proceeding," and therefore the Court of Appeals concluded that the District Court should have\n"afford[ed] preclusive effect" to the Texas "court\'s determination of relevant legal and factual\nissues."\n[The Court then reviewed the operation of 28 U.S.C. \xc2\xa7 157.]\nVickie\'s counterclaim against Pierce for tortious interference is a "core proceeding" under\nthe plain text of \xc2\xa7 157(b)(2)(C). That provision specifies that core proceedings include\n"counterclaims by the estate against persons filing claims against the estate." In past cases, we\nhave suggested that a proceeding\'s "core" status alone authorizes a bankruptcy judge, as a statutory\nmatter, to enter final judgment in the proceeding. We have not directly addressed the question,\nhowever, and Pierce argues that a bankruptcy judge may enter final judgment on a core proceeding\nonly if that proceeding also "aris[es] in" a Title 11 case or "aris[es] under" Title 11 itself.\n[The Court concludes that all proceedings that \xe2\x80\x9carise under\xe2\x80\x9d or \xe2\x80\x9carise in a case under\xe2\x80\x9d Title 11 are\n\xe2\x80\x9cCore Proceedings\xe2\x80\x9d within the meaning of 28 U.S.C. \xc2\xa7 157, and that only matters merely \xe2\x80\x9crelated\nto\xe2\x80\x9d Title 11 are non-core matters.]\nPierce argues, as another alternative to reaching the constitutional question, that the\nBankruptcy Court lacked jurisdiction to enter final judgment on his defamation claim. Section\n157(b)(5) provides that "[t]he district court shall order that personal injury tort and wrongful death\nclaims shall be tried in the district court in which the bankruptcy case is pending, or in the district\ncourt in the district in which the claim arose." Pierce asserts that his defamation claim is a "personal\ninjury tort," that the Bankruptcy Court therefore had no jurisdiction over that claim, and that the\ncourt therefore necessarily lacked jurisdiction over Vickie\'s counterclaim as well. Vickie contends\nthat \xc2\xa7 157(b)(5) simply specifies the venue in which "personal injury tort and wrongful death\nclaims" should be tried. Given the limited scope of that provision, Vickie argues, a party may\nwaive or forfeit any objections under \xc2\xa7 157(b)(5), in the same way that a party may waive or forfeit\nan objection to the bankruptcy court finally resolving a non-core claim. Vickie asserts that in this\ncase Pierce consented to the Bankruptcy Court\'s adjudication of his defamation claim, and forfeited\nany argument to the contrary, by failing to seek withdrawal of the claim until he had litigated it\nbefore the Bankruptcy Court for 27 months. On the merits, Vickie contends that the statutory\nphrase "personal injury tort and wrongful death claims" does not include non-physical torts such\nas defamation.\nWe need not determine what constitutes a "personal injury tort" in this case because we\nagree with Vickie that \xc2\xa7 157(b)(5) is not jurisdictional, and that Pierce consented to the Bankruptcy\nCourt\'s resolution of his defamation claim.\nWe agree with Vickie that Pierce not only could but did consent to the Bankruptcy Court\'s\nresolution of his defamation claim. . . . Pierce identifies no point in the record where he argued to\nthe Bankruptcy Court that it lacked the authority to adjudicate his proof of claim because the claim\nsought recompense for a personal injury tort. Indeed, Pierce apparently did not object to any court\nthat \xc2\xa7 157(b)(5) prohibited the Bankruptcy Court from resolving his defamation claim until over\ntwo years\xe2\x80\x94and several adverse discovery rulings\xe2\x80\x94after he filed that claim in June 1996. Given\n52\n\n\x0cPierce\'s course of conduct before the Bankruptcy Court, we conclude that he consented to that\ncourt\'s resolution of his defamation claim (and forfeited any argument to the contrary). . . . Instead,\nPierce repeatedly stated to the Bankruptcy Court that he was happy to litigate there. We will not\nconsider his claim to the contrary, now that he is sad.\nAlthough we conclude that \xc2\xa7 157(b)(2)(C) permits the Bankruptcy Court to enter final\njudgment on Vickie\'s counterclaim, Article III of the Constitution does not.\n[The Court then reviews its prior jurisdictional decisions through Northern Pipeline]\nAfter our decision in Northern Pipeline, Congress revised the statutes governing\nbankruptcy jurisdiction and bankruptcy judges. In the 1984 Act, Congress provided that the judges\nof the new bankruptcy courts would be appointed by the courts of appeals for the circuits in which\ntheir districts are located. 28 U.S.C. \xc2\xa7 152(a). And, as we have explained, Congress permitted the\nnewly constituted bankruptcy courts to enter final judgments only in "core" proceedings.\nWith respect to such "core" matters, however, the bankruptcy courts under the 1984 Act\nexercise the same powers they wielded under the Bankruptcy Act of 1978 (1978 Act), 92 Stat.\n2549. As in Northern Pipeline, for example, the newly constituted bankruptcy courts are charged\nunder \xc2\xa7 157(b)(2)(C) with resolving "[a]ll matters of fact and law in whatever domains of the law\nto which" a counterclaim may lead. As in Northern Pipeline, the new courts in core proceedings\n"issue final judgments, which are binding and enforceable even in the absence of an appeal." And,\nas in Northern Pipeline, the district courts review the judgments of the bankruptcy courts in core\nproceedings only under the usual limited appellate standards. That requires marked deference to,\namong other things, the bankruptcy judges\' findings of fact. See Fed. Rule Bkrtcy. Proc. 8013\n(findings of fact "shall not be set aside unless clearly erroneous").\nVickie and the dissent argue that the Bankruptcy Court\'s entry of final judgment on her\nstate common law counterclaim was constitutional, despite the similarities between the bankruptcy\ncourts under the 1978 Act and those exercising core jurisdiction under the 1984 Act. We disagree.\nIt is clear that the Bankruptcy Court in this case exercised the "judicial Power of the United States"\nin purporting to resolve and enter final judgment on a state common law claim, just as the court\ndid in Northern Pipeline. . . . Here Vickie\'s claim is a state law action independent of the federal\nbankruptcy law and not necessarily resolvable by a ruling on the creditor\'s proof of claim in\nbankruptcy.\nNor can the bankruptcy courts under the 1984 Act be dismissed as mere adjuncts of Article\nIII courts, any more than could the bankruptcy courts under the 1978 Act. The judicial powers the\ncourts exercise in cases such as this remain the same, and a court exercising such broad powers is\nno mere adjunct of anyone. . . .\nVickie\'s claimed right to relief does not flow from a federal statutory scheme. It is not\n"completely dependent upon" adjudication of a claim created by federal law. And Pierce did not\ntruly consent to resolution of Vickie\'s claim in the bankruptcy court proceedings. He had nowhere\nelse to go if he wished to recover from Vickie\'s estate.\nFurthermore, the asserted authority to decide Vickie\'s claim is not limited to a\n"particularized area of the law." This is not a situation in which Congress devised an "expert and\ninexpensive method for dealing with a class of questions of fact which are particularly suited to\n53\n\n\x0cexamination and determination by an administrative agency specially assigned to that task." The\n"experts" in the federal system at resolving common law counterclaims such as Vickie\'s are the\nArticle III courts, and it is with those courts that her claim must stay.\nWe recognize that there may be instances in which the distinction between public and\nprivate rights\xe2\x80\x94at least as framed by some of our recent cases\xe2\x80\x94fails to provide concrete guidance\nas to whether, for example, a particular agency can adjudicate legal issues under a substantive\nregulatory scheme. Given the extent to which this case is so markedly distinct from the agency\ncases discussing the public rights exception in the context of such a regime, however, we do not\nin this opinion express any view on how the doctrine might apply in that different context.\nWhat is plain here is that this case involves the most prototypical exercise of judicial power:\nthe entry of a final, binding judgment by a court with broad substantive jurisdiction, on a common\nlaw cause of action, when the action neither derives from nor depends upon any agency regulatory\nregime. If such an exercise of judicial power may nonetheless be taken from the Article III\nJudiciary simply by deeming it part of some amorphous "public right," then Article III would be\ntransformed from the guardian of individual liberty and separation of powers we have long\nrecognized into mere wishful thinking.\nVickie and the dissent next attempt to distinguish Northern Pipeline on the ground that\nPierce . . . had filed a proof of claim in the bankruptcy proceedings. Given Pierce\'s participation\nin those proceedings, Vickie argues, the Bankruptcy Court had the authority to adjudicate her\ncounterclaim under our decisions in Katchen v. Landy, 382 U.S. 323, 86 S. Ct. 467, 15 L.Ed.2d\n391 (1966), and Langenkamp v. Culp, 498 U.S. 42, 111 S. Ct. 330, 112 L.Ed.2d 343 (1990) (per\ncuriam).\nWe do not agree. As an initial matter, it is hard to see why Pierce\'s decision to file a claim\nshould make any difference with respect to the characterization of Vickie\'s counterclaim.\n"`[P]roperty interests are created and defined by state law,\' and `[u]nless some federal interest\nrequires a different result, there is no reason why such interests should be analyzed differently\nsimply because an interested party is involved in a bankruptcy proceeding.\'" Pierce\'s claim for\ndefamation in no way affects the nature of Vickie\'s counterclaim for tortious interference as one\nat common law that simply attempts to augment the bankruptcy estate\xe2\x80\x94the very type of claim that\nwe held in Northern Pipeline must be decided by an Article III court.\nContrary to Vickie\'s contention, moreover, our decisions in Katchen and Langenkamp do\nnot suggest a different result. Katchen permitted a bankruptcy referee acting under the Bankruptcy\nActs of 1898 and 1938 (akin to a bankruptcy court today) to exercise what was known as "summary\njurisdiction" over a voidable preference claim brought by the bankruptcy trustee against a creditor\nwho had filed a proof of claim in the bankruptcy proceeding. A voidable preference claim asserts\nthat a debtor made a payment to a particular creditor in anticipation of bankruptcy, to in effect\nincrease that creditor\'s proportionate share of the estate. The preferred creditor\'s claim in\nbankruptcy can be disallowed as a result of the preference, and the amounts paid to that creditor\ncan be recovered by the trustee.\nAlthough the creditor in Katchen objected that the preference issue should be resolved\nthrough a "plenary suit" in an Article III court, this Court concluded that summary adjudication in\nbankruptcy was appropriate, because it was not possible for the referee to rule on the creditor\'s\nproof of claim without first resolving the voidable preference issue. There was no question that the\n54\n\n\x0cbankruptcy referee could decide whether there had been a voidable preference in determining\nwhether and to what extent to allow the creditor\'s claim. Once the referee did that, "nothing remains\nfor adjudication in a plenary suit"; such a suit "would be a meaningless gesture." The plenary\nproceeding the creditor sought could be brought into the bankruptcy court because "the same issue\n[arose] as part of the process of allowance and disallowance of claims."\nIt was in that sense that the Court stated that "he who invokes the aid of the bankruptcy\ncourt by offering a proof of claim and demanding its allowance must abide the consequences of\nthat procedure." Our per curiam opinion in Langenkamp is to the same effect. . . .\nIn ruling on Vickie\'s counterclaim, the Bankruptcy Court was required to and did make\nseveral factual and legal determinations that were not "disposed of in passing on objections" to\nPierce\'s proof of claim for defamation, which the court had denied almost a year earlier. There was\nsome overlap between Vickie\'s counterclaim and Pierce\'s defamation claim that led the courts\nbelow to conclude that the counterclaim was compulsory, or at least in an "attenuated" sense\nrelated to Pierce\'s claim. But there was never any reason to believe that the process of adjudicating\nPierce\'s proof of claim would necessarily resolve Vickie\'s counterclaim.\nIn both Katchen and Langenkamp, moreover, the trustee bringing the preference action was\nasserting a right of recovery created by federal bankruptcy law. Vickie\'s claim, in contrast, is in no\nway derived from or dependent upon bankruptcy law; it is a state tort action that exists without\nregard to any bankruptcy proceeding.\nVickie additionally argues that the Bankruptcy Court\'s final judgment was constitutional\nbecause bankruptcy courts under the 1984 Act are properly deemed "adjuncts" of the district\ncourts. We rejected a similar argument in Northern Pipeline, and our reasoning there holds true\ntoday.\nTo begin, as explained above, it is still the bankruptcy court itself that exercises the\nessential attributes of judicial power over a matter such as Vickie\'s counterclaim. The new\nbankruptcy courts, like the old, do not "ma[k]e only specialized, narrowly confined factual\ndeterminations regarding a particularized area of law" or engage in "statutorily channeled factfinding functions." Instead, bankruptcy courts under the 1984 Act resolve "[a]ll matters of fact\nand law in whatever domains of the law to which" the parties\' counterclaims might lead.\nIn addition, a bankruptcy court resolving a counterclaim under 28 U.S.C. \xc2\xa7 157(b)(2)(C)\nhas the power to enter "appropriate orders and judgments"\xe2\x80\x94including final judgments\xe2\x80\x94subject\nto review only if a party chooses to appeal. It is thus no less the case here than it was in Northern\nPipeline that "[t]he authority\xe2\x80\x94and the responsibility\xe2\x80\x94to make an informed, final determination\n... remains with" the bankruptcy judge, not the district court. Given that authority, a bankruptcy\ncourt can no more be deemed a mere "adjunct" of the district court than a district court can be\ndeemed such an "adjunct" of the court of appeals. We certainly cannot accept the dissent\'s notion\nthat judges who have the power to enter final, binding orders are the "functional" equivalent of\n"law clerks and the Judiciary\'s administrative officials." And even were we wrong in this regard,\nthat would only confirm that such judges should not be in the business of entering final judgments\nin the first place.\nIt does not affect our analysis that, as Vickie notes, bankruptcy judges under the current\nAct are appointed by the Article III courts, rather than the President. If\xe2\x80\x94as we have concluded\xe2\x80\x94\nthe bankruptcy court itself exercises "the essential attributes of judicial power [that] are reserved\n55\n\n\x0cto Article III courts," it does not matter who appointed the bankruptcy judge or authorized the\njudge to render final judgments in such proceedings. The constitutional bar remains.\nFinally, Vickie and her amici predict as a practical matter that restrictions on a bankruptcy\ncourt\'s ability to hear and finally resolve compulsory counterclaims will create significant delays\nand impose additional costs on the bankruptcy process. It goes without saying that "the fact that a\ngiven law or procedure is efficient, convenient, and useful in facilitating functions of government,\nstanding alone, will not save it if it is contrary to the Constitution."\nIn addition, we are not convinced that the practical consequences of such limitations on the\nauthority of bankruptcy courts to enter final judgments are as significant as Vickie and the dissent\nsuggest. The dissent asserts that it is important that counterclaims such as Vickie\'s be resolved "in\na bankruptcy court," and that, "to be effective, a single tribunal must have broad authority to\nrestructure [debtor-creditor] relations." But the framework Congress adopted in the 1984 Act\nalready contemplates that certain state law matters in bankruptcy cases will be resolved by judges\nother than those of the bankruptcy courts. [28 U.S.C. \xc2\xa7] 1334(c)(2), for example, requires that\nbankruptcy courts abstain from hearing specified non-core, state law claims that "can be timely\nadjudicated[] in a State forum of appropriate jurisdiction." \xc2\xa7 1334 (c)(1) similarly provides that\nbankruptcy courts may abstain from hearing any proceeding, including core matters, "in the\ninterest of comity with State courts or respect for State law."\nAs described above, the current bankruptcy system also requires the district court to\nreview de novo and enter final judgment on any matters that are "related to" the bankruptcy\nproceedings, \xc2\xa7 157(c)(1), and permits the district court to withdraw from the bankruptcy court any\nreferred case, proceeding, or part thereof, \xc2\xa7 157(d). Pierce has not argued that the bankruptcy\ncourts "are barred from `hearing\' all counterclaims" or proposing findings of fact and conclusions\nof law on those matters, but rather that it must be the district court that "finally decide[s]" them.\nWe do not think the removal of counterclaims such as Vickie\'s from core bankruptcy jurisdiction\nmeaningfully changes the division of labor in the current statute; we agree with the United States\nthat the question presented here is a "narrow" one.\nIf our decision today does not change all that much, then why the fuss? Is there really a\nthreat to the separation of powers where Congress has conferred the judicial power outside Article\nIII only over certain counterclaims in bankruptcy? The short but emphatic answer is yes. A statute\nmay no more lawfully chip away at the authority of the Judicial Branch than it may eliminate it\nentirely. "Slight encroachments create new boundaries from which legions of power can seek new\nterritory to capture." Although "[i]t may be that it is the obnoxious thing in its mildest and least\nrepulsive form," we cannot overlook the intrusion: "illegitimate and unconstitutional practices get\ntheir first footing in that way, namely, by silent approaches and slight deviations from legal modes\nof procedure." We cannot compromise the integrity of the system of separated powers and the\nrole of the Judiciary in that system, even with respect to challenges that may seem innocuous at\nfirst blush.\nArticle III of the Constitution provides that the judicial power of the United States may be\nvested only in courts whose judges enjoy the protections set forth in that Article. We conclude\ntoday that Congress, in one isolated respect, exceeded that limitation in the Bankruptcy Act of\n1984. The Bankruptcy Court below lacked the constitutional authority to enter a final judgment on\n56\n\n\x0ca state law counterclaim that is not resolved in the process of ruling on a creditor\'s proof of claim.\nAccordingly, the judgment of the Court of Appeals is affirmed.\nIt is so ordered.\n\n3.6.1.2.\nWELLNESS INT\xe2\x80\x99L NETWORK, LTD., v. SHARF,\n135 S. Ct. 1932 (2015)\nJUSTICE SOTOMAYOR delivered the opinion of the Court.\nArticle III, \xc2\xa71, of the Constitution provides that \xe2\x80\x9c[t]he judicial Power of the United States,\nshall be vested in one supreme Court, and in such inferior Courts as the Congress may from time\nto time ordain and establish.\xe2\x80\x9d Congress has in turn established 94 District Courts and 13 Courts of\nAppeals, composed of judges who enjoy the protections of Article III: life tenure and pay that\ncannot be diminished. Because these protections help to ensure the integrity and independence of\nthe Judiciary, \xe2\x80\x9cwe have long recognized that, in general, Congress may not withdraw from\xe2\x80\x9d the\nArticle III courts \xe2\x80\x9cany matter which, from its nature, is the subject of a suit at the common law, or\nin equity, or in admiralty.\xe2\x80\x9d Stern v. Marshall\nCongress has also authorized the appointment of bankruptcy and magistrate judges, who\ndo not enjoy the protections of Article III, to assist Article III courts in their work. The number of\nmagistrate and bankruptcy judgeships exceeds the number of circuit and district judges. And it is\nno exaggeration to say that without the distinguished service of these judicial colleagues, the work\nof the federal court system would grind nearly to a halt.\nCongress\xe2\x80\x99 efforts to align the responsibilities of nonArticle III judges with the boundaries\nset by the Constitution have not always been successful. In Northern Pipeline and more recently\nin Stern, this Court held that Congress violated Article III by authorizing bankruptcy judges to\ndecide certain claims for which litigants are constitutionally entitled to an Article III adjudication.\nThis case presents the question whether Article III allows bankruptcy judges to adjudicate\nsuch claims with the parties\xe2\x80\x99 consent. We hold that Article III is not violated when the parties\nknowingly and voluntarily consent to adjudication by a bankruptcy judge.\n[Omitted is the Court\xe2\x80\x99s discussion of jurisdiction through the\nstatutory revisions made in 28 U.S.C. \xc2\xa7 157 after Marathon.]\nAbsent consent, bankruptcy courts in non-core proceedings may only \xe2\x80\x9csubmit proposed findings\nof fact and conclusions of law,\xe2\x80\x9d which the district courts review de novo. \xc2\xa7 157(c)(1).\nPetitioner Wellness International Network is a manufacturer of health and nutrition\nproducts. Wellness and respondent Sharif entered into a contract under which Sharif would\ndistribute Wellness\xe2\x80\x99 products. The relationship quickly soured, and in 2005, Sharif sued Wellness\nin the United States District Court for the Northern District of Texas. Sharif repeatedly ignored\nWellness\xe2\x80\x99 discovery requests and other litigation obligations, resulting in an entry of default\njudgment for Wellness. The District Court eventually sanctioned Sharif by awarding Wellness\nover $650,000 in attorney\xe2\x80\x99s fees. This case arises from Wellness\xe2\x80\x99 long-running\xe2\x80\x94and so far\nunsuccessful\xe2\x80\x94efforts to collect on that judgment.\n\n57\n\n\x0cIn February 2009, Sharif filed for Chapter 7 bankruptcy in the Northern District of Illinois.\nThe bankruptcy petition listed Wellness as a creditor. Wellness requested documents concerning\nSharif \xe2\x80\x99s assets, which Sharif did not provide. Wellness later obtained a loan application Sharif\nhad filed in 2002, listing more than $5 million in assets. When confronted, Sharif informed\nWellness and the Chapter 7 trustee that he had lied on the loan application. The listed assets, Sharif\nclaimed, were actually owned by the Soad Wattar Living Trust (Trust), an entity Sharif said he\nadministered on behalf of his mother, and for the benefit of his sister. Wellness pressed Sharif for\ninformation on the Trust, but Sharif again failed to respond. Wellness filed a five-count adversary\ncomplaint against Sharif in the Bankruptcy Court. Counts I\xe2\x80\x93IV of the complaint objected to the\ndischarge of Sharif\xe2\x80\x99s debts because, among other reasons, Sharif had concealed property by\nclaiming that it was owned by the Trust. Count V of the complaint sought a declaratory judgment\nthat the Trust was Sharif\xe2\x80\x99s alter ego and that its assets should therefore be treated as part of Sharif\xe2\x80\x99s\nbankruptcy estate.\nIn his answer, Sharif admitted that the adversary proceeding was a \xe2\x80\x9ccore proceeding\xe2\x80\x9d under\n28 U.S.C. \xc2\xa7 157(b)\xe2\x80\x94i.e., a proceeding in which the Bankruptcy Court could enter final judgment\nsubject to appeal. Indeed, Sharif requested judgment in his favor on all counts of Wellness\xe2\x80\x99\ncomplaint and urged the Bankruptcy Court to \xe2\x80\x9cfind that the Soad Wattar Living Trust is not\nproperty of the [bankruptcy] estate.\xe2\x80\x9d A familiar pattern of discovery evasion ensued. Wellness\nresponded by filing a motion for sanctions, or, in the alternative, to compel discovery. Granting\nthe motion to compel, the Bankruptcy Court warned Sharif that if he did not respond to Wellness\xe2\x80\x99\ndiscovery requests a default judgment would be entered against him. Sharif eventually complied\nwith some discovery obligations, but did not produce any documents related to the Trust. In July\n2010, the Bankruptcy Court issued a ruling finding that Sharif had violated the court\xe2\x80\x99s discovery\norder. It accordingly denied Sharif\xe2\x80\x99s request to discharge his debts and entered a default judgment\nagainst him in the adversary proceeding. And it declared, as requested by count V of Wellness\xe2\x80\x99\ncomplaint, that the assets supposedly held by the Trust were in fact property of Sharif\xe2\x80\x99s bankruptcy\nestate because Sharif \xe2\x80\x9ctreats [the Trust\xe2\x80\x99s] assets as his own property.\xe2\x80\x9d Sharif appealed to the\nDistrict Court.\nSix weeks before Sharif filed his opening brief in the District Court, this Court decided\nStern. In Stern, the Court held that Article III prevents bankruptcy courts from entering final\njudgment on claims that seek only to \xe2\x80\x9caugment\xe2\x80\x9d the bankruptcy estate and would otherwise\n\xe2\x80\x9cexis[t] without regard to any bankruptcy proceeding.\xe2\x80\x9d Sharif did not cite Stern in his opening\nbrief. Rather, after the close of briefing, Sharif moved for leave to file a supplemental brief, arguing\nthat in light of In re Ortiz, 665 F.3d 906 (CA7 2011)\xe2\x80\x94a recently issued decision interpreting\nStern\xe2\x80\x94\xe2\x80\x9cthe bankruptcy court\xe2\x80\x99s order should only be treated as a report and recommendation.\xe2\x80\x9d The\nDistrict Court denied Sharif\'s motion for supplemental briefing as untimely and affirmed the\nBankruptcy Court\xe2\x80\x99s judgment.\n[The Court then reviewed the lower courts opinions, including the Seventh Circuit\xe2\x80\x99s\nconclusion that Wellness\xe2\x80\x99s claims were \xe2\x80\x9cStern\xe2\x80\x9d claims \xe2\x80\x93 designated by 28 U.S.C. \xc2\xa7 157 as core\nclaims but not constitutionally subject to core jurisdiction \xe2\x80\x93 and that Stern could not consent to the\nBankruptcy Court\xe2\x80\x99s jurisdiction because separation of powers considerations were implicated.]\nWe . . . now reverse the judgment of the Seventh Circuit.\nOur precedents make clear that litigants may validly consent to adjudication by bankruptcy\ncourts. Adjudication by consent is nothing new. Indeed, \xe2\x80\x9c[d]uring the early years of the Republic,\n58\n\n\x0cfederal courts, with the consent of the litigants, regularly referred adjudication of entire disputes\nto non-Article III referees, masters, or arbitrators, for entry of final judgment in accordance with\nthe referee\xe2\x80\x99s report.\xe2\x80\x9d The foundational case in the modern era is Commodity Futures Trading\nComm\xe2\x80\x99n v. Schor, 478 U.S. 833 (1986). . . . [In Schor, the Court] explained why this waiver\nlegitimated the [parties\xe2\x80\x99] exercise of authority: \xe2\x80\x9c[A]s a personal right, Article III\xe2\x80\x99s guarantee of an\nimpartial and independent federal adjudication is subject to waiver, just as are other personal\nconstitutional rights\xe2\x80\x9d\xe2\x80\x94such as the right to a jury\xe2\x80\x94 \xe2\x80\x9cthat dictate the procedures by which civil and\ncriminal matters must be tried.\xe2\x80\x9d The Court went on to state that a litigant\xe2\x80\x99s waiver of his \xe2\x80\x9cpersonal\nright\xe2\x80\x9d to an Article III court is not always dispositive because Article III \xe2\x80\x9cnot only preserves to\nlitigants their interest in an impartial and independent federal adjudication of claims . . . , but also\nserves as \xe2\x80\x98an inseparable element of the constitutional system of checks and balances.\xe2\x80\x99 . . . To the\nextent that this structural principle is implicated in a given case\xe2\x80\x9d\xe2\x80\x94but only to that extent\xe2\x80\x94 \xe2\x80\x9cthe\nparties cannot by consent cure the constitutional difficulty . . . .\xe2\x80\x9d Leaning heavily on the importance\nof Schor\xe2\x80\x99s consent, the Court found no structural concern implicated by the . . . adjudication of the\ncounterclaims against him.\nWhile \xe2\x80\x9cCongress gave the CFTC the authority to adjudicate such matters,\xe2\x80\x9d the Court wrote\n\xe2\x80\x9cthe decision to invoke this forum is left entirely to the parties and the power of the federal\njudiciary to take jurisdiction of these matters is unaffected. In such circumstances, separation of\npowers concerns are diminished, for it seems self-evident that just as Congress may encourage\nparties to settle a dispute out of court or resort to arbitration without impermissible incursions on\nthe separation of powers, Congress may make available a quasi-judicial mechanism through which\nwilling parties may, at their option, elect to resolve their differences.\xe2\x80\x9d The option for parties to\nsubmit their disputes to a nonArticle III adjudicator was at most a \xe2\x80\x9cde minimis\xe2\x80\x9d infringement on\nthe prerogative of the federal courts. [The Court also discussed two cases under the Federal\nMagistrates Act, Gomez v. United States, 490 U.S. 858 (1989), and Peretz v. United States, 501\nU.S. 923 (1991) \xe2\x80\x9cthat reiterated the importance of consent to the constitutional analysis.] The\nlesson of Schor, Peretz, and the history that preceded them is plain: The entitlement to an Article\nIII adjudicator is \xe2\x80\x9ca personal right\xe2\x80\x9d and thus ordinarily \xe2\x80\x9csubject to waiver,\xe2\x80\x9d\nArticle III also serves a structural purpose, \xe2\x80\x9cbarring congressional attempts \xe2\x80\x98to transfer\njurisdiction [to non-Article III tribunals] for the purpose of emasculating\xe2\x80\x99 constitutional courts and\nthereby prevent[ing] \xe2\x80\x98the encroachment or aggrandizement of one branch at the expense of the\nother.\xe2\x80\x99\xe2\x80\x9d But allowing Article I adjudicators to decide claims submitted to them by consent does\nnot offend the separation of powers so long as Article III courts retain supervisory authority over\nthe process.\nThe question here, then, is whether allowing bankruptcy courts to decide Stern claims by\nconsent would \xe2\x80\x9cimpermissibly threate[n] the institutional integrity of the Judicial Branch.\xe2\x80\x9d And\nthat question must be decided not by \xe2\x80\x9cformalistic and unbending rules,\xe2\x80\x9d but \xe2\x80\x9cwith an eye to the\npractical effect that the\xe2\x80\x9d practice \xe2\x80\x9cwill have on the constitutionally assigned role of the federal\njudiciary.\xe2\x80\x9d The Court must weigh \xe2\x80\x9cthe extent to which the essential attributes of judicial power are\nreserved to Article III courts, and, conversely, the extent to which the non-Article III forum\nexercises the range of jurisdiction and powers normally vested only in Article III courts, the origins\nand importance of the right to be adjudicated, and the concerns that drove Congress to depart from\nthe requirements of Article III.\xe2\x80\x9d Applying these factors, we conclude that allowing bankruptcy\nlitigants to waive the right to Article III adjudication of Stern claims does not usurp the\n59\n\n\x0cconstitutional prerogatives of Article III courts. [the Court then reviews the pervasive power of\ncontrol exercised by the District Courts over the Bankruptcy Court\xe2\x80\x99s jurisdiction under 28 U.S.C.\n\xc2\xa7 157].\nOur recent decision in Stern, on which Sharif and the principal dissent rely heavily, does\nnot compel a different result. That is because Stern\xe2\x80\x94like its predecessor, Northern Pipeline\xe2\x80\x94\nturned on the fact that the litigant \xe2\x80\x9cdid not truly consent to\xe2\x80\x9d resolution of the claim against it in a\nnon-Article III forum. [The Court distinguishes these prior cases as not involving true consent, and\nresponds various arguments made by the dissent].\nSharif contends that to the extent litigants may validly consent to adjudication by a\nbankruptcy court, such consent must be express. We disagree. Nothing in the Constitution requires\nthat consent to adjudication by a bankruptcy court be express. Nor does the relevant statute, 28\nU.S.C. \xc2\xa7 157, mandate express consent; it states only that a bankruptcy court must obtain \xe2\x80\x9cthe\nconsent\xe2\x80\x9d\xe2\x80\x94consent simpliciter\xe2\x80\x94\xe2\x80\x9cof all parties to the proceeding\xe2\x80\x9d before hearing and determining\na non-core claim. \xc2\xa7 157(c)(2). . . . It bears emphasizing, however, that a litigant\xe2\x80\x99s consent\xe2\x80\x94\nwhether express or implied\xe2\x80\x94must still be knowing and voluntary. . . . [T]he key inquiry is whether\n\xe2\x80\x9cthe litigant or counsel was made aware of the need for consent and the right to refuse it, and still\nvoluntarily appeared to try the case\xe2\x80\x9d before the non-Article III adjudicator. 1\nIt would be possible to resolve this case by determining whether Sharif in fact consented\nto the Bankruptcy Court\xe2\x80\x99s adjudication. . . . But reaching that determination would require a deeply\nfact bound analysis of the procedural history unique to this protracted litigation. Our resolution of\nthe consent question\xe2\x80\x94unlike the antecedent constitutional question\xe2\x80\x94would provide little\nguidance to litigants or the lower courts. Thus, consistent with our role as \xe2\x80\x9ca court of review, not\nof first view,\xe2\x80\x9d we leave it to the Seventh Circuit to decide on remand whether Sharif \xe2\x80\x99s actions\nevinced the requisite knowing and voluntary consent, and also whether, as Wellness contends,\nSharif forfeited his Stern argument below.\nThe Court holds that Article III permits bankruptcy courts to decide Stern claims submitted\nto them by consent. The judgment of the United States Court of Appeals for the Seventh Circuit is\ntherefore reversed, and the case is remanded for further proceedings consistent with this opinion.\n\n1\n\nFOOTNOTE 13 Even though the Constitution does not require that consent be express, it is good practice\nfor courts to seek express statements of consent or nonconsent, both to ensure irrefutably that any waiver of the right\nto Article III adjudication is knowing and voluntary and to limit subsequent litigation over the consent issue.\nStatutes or judicial rules may require express consent where the Constitution does not. Indeed, the Federal Rules of\nBankruptcy Procedure already require that pleadings in adversary proceedings before a bankruptcy court \xe2\x80\x9ccontain a\nstatement that the proceeding is core or non-core and, if non-core, that the pleader does or does not consent to entry\nof final orders or judgment by the bankruptcy judge.\xe2\x80\x9d Fed. Rule Bkrtcy. Proc. 7008. The Bankruptcy Court and the\nparties followed that procedure in this case.\n\n60\n\n\x0c3.7.\n\nPractice Problems: Bankruptcy Court Jurisdiction\n\nProblem 1: Creditor files a proof of claim against the estate. Is a counterclaim brought\nagainst the creditor under Section 548 of the Bankruptcy Code to recover a fraudulent conveyance\na \xe2\x80\x9ccore\xe2\x80\x9d matter under Section 157? See 28 U.S.C. \xc2\xa7 157(b)(2)(C). If so, is it constitutional for the\nclaim to be a \xe2\x80\x9ccore\xe2\x80\x9d matter?\nProblem 2: If the creditor in the previous problem did not file a proof of claim, would\nStern v. Marshall apply \xe2\x80\x93 would it be a \xe2\x80\x9ccore\xe2\x80\x9d matter under the statute, but unconstitutional to treat\nit as a \xe2\x80\x9ccore\xe2\x80\x9d matter? If so, can the bankruptcy court hear the claim at all, and if so how would the\nbankruptcy court\xe2\x80\x99s decision be treated? See Exec. Benefits Ins. Agency v. Arkison, 134 S. Ct. 2165\n(2014).\nProblem 3: Is 28 U.S.C. \xc2\xa7 157(b)(2)(O) constitutional? Can you think of any legal matters\nthat might arise in a bankruptcy case that would not affect the debtor-creditor or equity security\nholder relationship?\nProblem 4: Suppose a creditor who was injured by the debtor\xe2\x80\x99s defective product files a\nproof of claim in the bankruptcy proceeding. The debtor then files an objection to the claim. Who\nwill determine the merits of the claim? See 28 U.S.C. \xc2\xa7 157(b)(5). Does the creditor need to do\nanything if the creditor does not want the matter to be heard by the bankruptcy court? See\nBankruptcy Rule 5011. Can the Bankruptcy Court estimate the claim for purposes of determine\nthe size of the creditor\xe2\x80\x99s vote on confirmation of a plan of reorganization? Read 28 U.S.C. \xc2\xa7\n157(b)(2)(B) carefully.\nProblem 5: Suppose that prior to the debtor filing bankruptcy in the previous problem, the\ncreditor had brought a claim in state court against the debtor that was about to go to trial. As we\nwill see, the debtor\xe2\x80\x99s bankruptcy filing prevents the creditor from proceeding with the state court\nlawsuit. Can the creditor do anything to return jurisdiction over the amount of the claim to the state\ncourt. See 28 U.S.C. \xc2\xa7 1334(c)(1) and (2).\nProblem 6: What is the \xe2\x80\x9cde novo\xe2\x80\x9d review required by 28 U.S.C. \xc2\xa7 157(c)(1)? See\nBankruptcy Rule 9033(d)? When is withdrawal of reference mandatory under 28 U.S.C. \xc2\xa7 157(d)?\n\n3.8.\n\nVenue of Bankruptcy Cases\n\nIn which bankruptcy court should the debtor file his, her or its case? With respect to\nconsumer debtors the test looks at which judicial district the debtor has lived in the longest during\nthe 180 day period prior to bankruptcy. 28 U.S.C. \xc2\xa7 1408(1). You have to count days in each\njurisdiction if the debtor has moved during the 180 day period before the bankruptcy is filed.\nThe statute is not so clear for entities or individuals with significant business assets. The\nstatute focuses on where the debtor has been domiciled or resided the most during the 180 day\nperiod, but also where the debtor\xe2\x80\x99s \xe2\x80\x9cprincipal place of business or principal assets\xe2\x80\x9d have been\nlocated. This would, in essence, allow a Delaware corporation, with a principal place of business\nin New York and principal assets in Wyoming to forum shop.\nAn even greater forum shopping loophole is contained in 28 U.S.C. \xc2\xa7 1408(2), which\nthrough simple planning allows entities even greater leeway to forum shop. This section allows an\n61\n\n\x0centity to file bankruptcy wherever a subsidiary has filed. One would think, however, that the court\nwould be duty bound to transfer the case to the most proper and convenient forum if the debtor\nabused the venue rules by engaging in forum shopping. 28 U.S.C. \xc2\xa7 1412 provides for transfer on\n\xe2\x80\x9cforum non-conveniens\xe2\x80\x9d grounds. But as the famous case of Enron Corporation printed below\ndemonstrates, courts have been extremely proprietary in exercising their discretion to transfer\ncases to a more convenient forum.\nThere has been much criticism of the broad venue shopping rules, which many believe has\ncorrupted the bankruptcy system by allowing corporations to choose management friendly locals\nfor their bankruptcy filings. Indeed, many believe that the courts in Delaware and New York City\nhave competed for Chapter 11 cases by issuing increasingly management friendly rulings. The\nfollowing decision, involving one of the largest bankruptcy cases ever filed by the most Texan of\ncompanies, does nothing to dispel these criticisms.\n\n3.9.\n\nCases on Bankruptcy Venue\n3.9.1.1.\n\nIN RE ENRON CORP., 274 B.R. 327 (2002)\n\nARTHUR J. GONZALEZ, Bankruptcy Judge.\nThe issue before the Court is whether venue of these bankruptcy cases should be transferred\nfrom the Southern District of New York to the Southern District of Texas.\nEnron is a large, multifaceted national and international corporation with operations,\nfinancial interests, creditors and stockholders across the United States and around the world. Enron\nmaintained the world\'s largest online energy trading site and was the world\'s largest trader of\nelectricity and natural gas.\nNone of the Debtors own real property located in New York. With the exceptions of Garden\nState Paper Company, LLC, EMC and Operational Energy Corp., all of the Debtors have identified\ntheir principal place of business as being Houston, Texas.\nAll or substantially all of certain of the Debtors\' corporate books and records (such as\ncorporate minute books) are located at the corporate headquarters of Enron Corp. in Houston.\nApproximately fifty-five current or former officers of Enron Corp. reside in Houston,\nTexas or in the Southern District of Texas. Most of these inside directors reside in Houston, Texas\nor elsewhere in the Southern District of Texas.\n[The Court reviews Enron\xe2\x80\x99s bank loans, noting that the loans were administered in the\nBank\xe2\x80\x99s Houston offices, although the Banks\xe2\x80\x99 main offices were in New York.]\nAs of December 2, 2001, the bankruptcy petition date, Enron Corp. and its affiliates\nemployed approximately 25,000 full and part time employees worldwide. Of these employees of\nthe Debtors, 4,681 worked in Houston, and sixty-three of these employees of the Debtors worked\nin New York.\nOn November 30, 2001, Enron Corp. and/or its affiliates paid $55 million in bonuses to\n587 of its "key employees." The vast majority of these key employees are located in Houston.\n62\n\n\x0cMost of the Debtors\' real property is located in Houston. Subsidiaries of the Debtor, Enron\nCorp., own interstate pipelines. The amount of ad valorem taxes owed to Texas taxing authorities\nby Enron is $139,878,630.\nENRON METALS & COMMODITY CORP.\nEMC is a Delaware corporation with its principal place of business in New York, New\nYork. EMC is engaged primarily in the business of commodities metals trading.\nUsing the asset values assigned by the Debtors on the date of filing, Enron Metals\' assets\n($265,622,903) are less than 0.5% of the assets of the consolidated Debtors ($51,523,148,911).\nEMC has approximately fifty-five employees working in New York, New York. EMC has three\nemployees in St. Louis, five in Chicago and none in Texas.\nAFFILIATED DEBTORS (INCLUDING ENRON CORP.)\nOf the twenty-eight affiliated debtors, including Enron Corp., twenty-six have their\nprincipal place of business located in Houston. For most of the affiliated debtors, including Enron\nCorp., the location of the principal assets and the location of the corporate books and records is\nalso in Houston. Nearly all of the executives and officers reside in Houston.\nTHE DEBTORS\' PROFESSIONALS\n[The Debtor\xe2\x80\x99s law firms have their main offices in\nNew York, but also substantial offices in Houston]\nPrior to their bankruptcy, the Debtors employed 145 lawyers in their Houston offices.\nFOREIGN INSOLVENCY PROCEEDINGS\nA number of Enron affiliates are in insolvency, bankruptcy or administration proceedings\nworldwide.\nACCESSIBILITY OF NEW YORK\nNew York is one of the world\'s most accessible locations. New York is served by three\nairports with international flights, as well as major rail stations making it accessible to parties in\ninterest located worldwide. It is convenient with respect to both the diversity of locations served\nand the frequency of service provided.\nNew York is located over 1,600 miles from Enron\'s corporate headquarters in Houston\nwhich is located a few blocks from the United States Bankruptcy Court for the Southern District\nof Texas. A roundtrip flight from Houston to New York takes approximately seven hours. The\naverage price of a roundtrip ticket from Houston to New York, full coach fare, is $1,807.85. No\nflights departing from Houston, Texas arrive in New York prior to 10:00 a.m. Eastern Time.\nREORGANIZATION PROCEEDINGS\nThere are six principal employees of the Debtors who are expected to be responsible for\nthe financial restructuring and development of a plan of reorganization, and they are based in\nHouston.\n\n63\n\n\x0cDISCUSSION\nSection 1408 of title 28 of the United States Code governs venue in Chapter 11 cases. 28\nU.S.C. \xc2\xa7 1408 provides . . . . Under \xc2\xa7 1408(1), a prospective debtor may select the venue for its\nChapter 11 reorganization. Specifically, venue is proper in any jurisdiction where the debtor\nmaintains a domicile, residence, principal place of business or where its principal assets are located\nfor at least 180 days before the filing of the bankruptcy petition. Pursuant to 28 U.S.C. \xc2\xa7 1408(2),\nvenue is also proper for any affiliate that files a bankruptcy petition within a venue where there is\nalready a bankruptcy case pending under \xc2\xa7 1408(1).\nApplied here, EMC filed a petition under the Bankruptcy Code on December 2, 2001 For\npurposes of venue under 28 U.S.C. \xc2\xa7 1408(1), the Court finds that EMC\'s bankruptcy petition was\nproperly venued in the Southern District of New York because EMC maintains its principal place\nof business within this district.\nEnron Corp. is the holding company that directly or indirectly owns all the other Debtors.\nImmediately after EMC\'s case was filed in this Court, Enron Corp., as an affiliate of EMC, filed\nits petition under the Bankruptcy Code on December 2, 2001 and was assigned case number 0116034. Its selection of this venue was proper under 28 U.S.C. \xc2\xa7 1408(2).\nWhen venue is determined to be proper in the district where the bankruptcy case was filed,\nthe case may nevertheless be transferred, on motion by a party, pursuant to 28 U.S.C. \xc2\xa7 1412. A\nmotion to transfer venue is a core matter, as it concerns administration of the estate. The burden is\non the movant to show by a preponderance of the evidence that the transfer of venue is warranted.\nThe decision of whether to transfer venue is within the court\'s discretion based on an individualized\ncase-by-case analysis of convenience and fairness. A debtor\'s choice of forum is entitled to great\nweight if venue is proper.\nPursuant to 28 U.S.C. \xc2\xa7 1412, the Court must grant relief if it is established that a transfer\nof venue would be proper if it is in (1) the interest of justice or (2) the convenience of the parties.\nIn considering the convenience of the parties, the Court weighs a number of factors: [proximity of\ndebtor, creditors, witnesses, location of assets, economic administration of estate]. The factor given\nthe most weight is the promotion of the economic and efficient administration of the estate.\nIn the context of the Debtors\' cases, the factors considered cannot be viewed in an insular\nmanner. Rather, the standards must be applied with a broader perspective, taking into account the\nnational and international scope of the Debtors\' businesses as well as the geographical dispersal of\nthe creditors involved. Moreover, the standards must be applied considering the realities of the\nadministration of a complex chapter 11 debtor seeking to reorganize.\nAlthough the business relationship between the Debtors and the creditors may have been\ninitiated from a desk in Houston, its impact is far reaching and geographically diverse.\nWith respect to accessibility of this Court to all parties-in-interest, the dockets of all of the\ncases pending before the Southern District of New York are currently available on the internet at\nthe Court\'s web-site by obtaining a PACER password. The electronic filing system allows those\nwith an interest to have access to all pleadings filed in any case.\nThe location of the assets is not as important where the ultimate goal is rehabilitation rather\nthan liquidation. Although the Debtors are seeking to sell a portion of their assets to facilitate their\nfinancial restructuring, this is not a Chapter 7 liquidation. Furthermore, while a debtor\'s location\n64\n\n\x0cand the location of its assets are often important considerations in single asset real estate cases,\nthese factors take on less importance in a case where a debtor has assets in various locations.\nWhile the majority of the Debtor entities have their headquarters in Texas, Enron\'s assets\nare geographically located throughout the world. Aside from the office building and other tangible\nassets which are located in Texas, much of the Debtors\' assets consist of contracts and trading\noperations which have no tangible location. Furthermore, the presence of the books and records in\nHouston is not a major concern because with modern technology that information, which is\nordinarily computerized, can be readily transported via electronic mail.\nEconomic and efficient administration of the estate\nIt is clear that the most important of these considerations is the economic and efficient\nadministration of the estate. One must examine the realities of this case. It is the largest bankruptcy\ncase ever filed, the complexities of which are yet to be fully appreciated. Its reorganization will\ndepend in great part on the ability of the Debtors\' advisors and senior managers to achieve a\nfinancial restructuring that will result in the capital markets regaining confidence in the Debtors,\nthereby affording the Debtors full and complete access to those markets.\nNew York is a world financial center and, as such, has the resources that will be required\nto address the Debtors\' financial issues. Most of the entities and individuals expected to be\nresponsible for the financial restructuring and development of a plan of reorganization in this case\nare located in New York or have ready access to New York, including most of the Debtors\' legal\nand financial advisors as well as the legal and financial advisors to the Committee and the lenders.\nThose members of the financial community that provide access to capital necessary to the Debtors\'\nfinancial restructuring are located in New York. Furthermore, while the Debtors\' management and\noperations are predominantly in Houston, New York is a more convenient location for those\nresponsible for negotiating and formulating a plan of reorganization. The Court finds that New\nYork is the more economic and convenient forum for those whose participation will be required\nto administer these cases. Accordingly, New York is the location which would best serve the\nDebtors\' reorganization efforts-the creation and preservation of value.\nThis Court has gained familiarity with many of the issues that have and will continue to\narise in these cases. The Movants argue that since they timely filed their motions to transfer venue,\nthe "learning curve" should not be considered. However, the importance of maintaining stability\nin these bankruptcy cases required the Court to direct its immediate attention to the proper\nadministration of these cases. A review of the docket shows that many requests for shortened notice\nwere filed for matters to be heard concerning a myriad of issues, including claims that supplies of\nenergy were to be imminently discontinued. These issues had to be immediately addressed.\nMaintaining the stability of these cases and ensuring their proper administration had to take\nprecedence over the request for an expedited venue hearing. Further, as previously discussed, the\nlearning curve that has been established in the Enron Debtors\' cases contributes to judicial\neconomy. A transfer at this time would not promote judicial economy as it would only delay\npending matters while a transferee court familiarized itself with the intricacies of these cases.\nThe fact that New York is a financial center and the presence in New York of those who\nwill participate on a consistent basis in these cases make New York the most efficient forum for\nadministering these cases.\n65\n\n\x0cThe Court finds that in considering matters of judicial economy, timeliness and fairness as\nwell as the efficient administration of the estate, the interest of justice is served by retaining\njurisdiction.\n\n3.10.\n\nPractice Problems: Filing Voluntary Petitions\n\nThe eligibility rules for filing bankruptcy are very liberal. Review 11 U.S.C. \xc2\xa7 109 and\nanswer the following questions:\nProblem 1: How can a corporation or partnership file bankruptcy when Section 109(a)\nlimits filings to \xe2\x80\x9cpersons?\xe2\x80\x9d See 11 U.S.C. \xc2\xa7 101(41).\nProblem 2: Can a business trust file bankruptcy? How about a non-business trust? 11\nU.S.C. \xc2\xa7 101(9).\nProblem 3: Can a foreign citizen living in the United States file bankruptcy here? How\nabout a foreign citizen living abroad who has a business in the United States? 11 U.S.C. \xc2\xa7 109(a).\nProblem 4: Can a railroad file under Chapter 7? How about Chapter 11? 11 U.S.C. \xc2\xa7\n109(b), (d).\nProblem 5: Can a bank or insurance company file under Chapter 7 or Chapter 11? 11\nU.S.C. \xc2\xa7 109(b), (d). Can you think of a reason for this rule?\nProblem 6: Only \xe2\x80\x9cmunicipalities\xe2\x80\x9d are eligible for Chapter 9. What is a municipality? 11\nU.S.C. \xc2\xa7 101(40). Could a state file a Chapter 9 case?\nProblem 7: Chapter 12 is available only to \xe2\x80\x9cfamily farmers\xe2\x80\x9d and \xe2\x80\x9cfamily fisherman\xe2\x80\x9d with\nregular income. Where would we look for a definition of these terms?\nProblem 8: Can a small family corporation that otherwise meets the requirements file\nunder Chapter 13? 11 U.S.C. \xc2\xa7 109(e).\nProblem 9: Can an individual who works on commission file under Chapter 13? How\nabout an individual who has no job but receives a monthly support payment from a relative?\nProblem 10. Can a stockbroker file under Chapter 13? See 11 U.S.C. \xc2\xa7 101(30).\nProblem 11. Can a debtor with the following debts file under Chapter 13? 11 U.S.C. \xc2\xa7\n109(e).\nHome Mortgage:\n\n$600,000\n\nGuaranty of Mother\xe2\x80\x99s Home Mortgage: $700,000\nStudent loan debts: $175,000\nGuaranty of Son\xe2\x80\x99s student loan debts: $250,000\nCredit card debts $50,000\nPending lawsuit filed by driver of car rear-ended by the Debtor:\n$1,000,000.\n\n66\n\n\x0c3.11.\n\nVoluntary Bankruptcy Petitions\n\nAn eligible debtor commences a voluntary bankruptcy case by filing the official petition\nform with the Bankruptcy Court and paying the required filing fee. As of the date this was written,\nthe filing fee for Chapter 7 case is $335.\nA debtor whose income is less than 150% of the poverty guidelines may file an in forma\npauperis request for a fee waiver. 28 U.S.C. \xc2\xa7 130(f). Alternatively, a debtor unable to pay the fee\non the petition date may request to pay the filing fee in installments. Bankruptcy Rule 1006(b).\nThe Court will accept the petition without the fee if the debtor files with the petition a request\neither for a waiver of the fee or to pay the fee in installments. It is entirely within the bankruptcy\njudge\xe2\x80\x99s discretion whether to grant a fee waiver or installment request. Since there are no real legal\nstandards for granting or denying these requests (other than the requirement to be below 150% of\nthe poverty guidelines for a waiver), there is a wide variance throughout the country as to how\nreceptive judges are to the requests.\nDebtors are required to make extensive financial disclosures as part of the bankruptcy\nprocess. 11 U.S.C. \xc2\xa7 521(a); Bankruptcy Rule 1007(b). Specifically, debtors must file a set of\nschedules on official forms listing (1) their assets (real and personal property), (2) each of their\ncreditors (name, address, account number, and amount), (3) their current income and expenses\n(and any anticipated increases or decreases); (4) their executory contracts and leases, (5) a\nStatement of Affairs form listing much additional personal and financial information, and (6) pay\nstubs received from an employer during the 60 days before bankruptcy; (7) a statement of\nexemptions. Id. In addition, individual debtors must file (8) a certificate of completion from an\napproved credit counseling agency, and (9) a statement of intention with respect to leased or\nsecured property. 11 U.S.C. \xc2\xa7 521(b); (a)(2); Individual debtors whose debts are primarily\nconsumer debts must file (10) a form showing compliance with the means test; (11) a certificate\nof completion from an approved credit counseling agency. Id.; Bankruptcy Rule 1007(a).\nAttorneys representing debtors must file a statement disclosing fees and certifying that certain\ndisclosures have been made to the debtor. See 11 U.S.C. \xc2\xa7 329.\nThe Schedules and statements are normally filed with the petition. However, in emergency\nsituations debtors often file \xe2\x80\x9cbare bones\xe2\x80\x9d petitions which do not contain all of the required\ninformation. In that case, the Court will automatically issue an order noting the deficiencies and\nsetting a deadline for compliance (at least if the clerk\xe2\x80\x99s office notices the deficiency).\n11 U.S.C. \xc2\xa7 521(i)(1) contains an extremely draconian rule for consumer cases if the\nrequired information and forms are not filed within 45 days after the petition is filed. The section\nprovides that the case is to be \xe2\x80\x9cautomatically dismissed\xe2\x80\x9d effective on the 46th day. This rule has\nworked an extreme hardship on debtors who were unaware of their technical filing deficiency. The\nauthor of this book has argued in a law review article that the automatic dismissal rules as written\nare unconstitutional, and that notice and an opportunity for hearing is required before dismissal.\nGregory Germain, Due Process in Bankruptcy: Are the New Automatic Dismissal Rules\nConstitutional, 13 U. Pa. Journal of Business Law 547 (Spring 2011). After that article was written,\nmany Bankruptcy Courts discontinued the practice of automatic dismissals and have begun to\nprovide notice and opportunity for hearing before dismissing bankruptcy cases.\n67\n\n\x0cAfter filing bankruptcy, debtors must send the trustee (and any creditor who requests one\nin writing) a copy of their most recent federal tax return (at least 7 days before the official meeting\nof creditors under Section 341. 11 U.S.C. \xc2\xa7 521(e)(2).\nFollowing the filing, the Court will send notice of the bankruptcy filing to all creditors\nlisted in the schedules. The notice will list the date for the official meeting of creditors under\nSection 341 of the Bankruptcy Code, the deadline for objecting to the debtor\xe2\x80\x99s discharge, the\ndeadline for filing claims (if applicable), and other important information.\nThe debtor must attend the meeting of creditors under Section 341 in person, and answer\nquestions. The trustee presides at the meeting and will ask the debtor questions about the case and\nthe schedules. In addition, creditors are allowed to ask questions of the debtor, but the trustee will\ngenerally limit the time for questions in order to get through all of the other 341 hearings pending\non the same date and time. Trustees generally require the debtor to bring original identification to\nverify the debtor\xe2\x80\x99s identity and social security number (generally a driver\xe2\x80\x99s license and social\nsecurity card will suffice).\n\n3.12.\n\nInvoluntary Bankruptcy Petitions\n\nInvoluntary bankruptcy petitions are filed by creditors against the Debtor. Involuntary\npetitions have become very rare. With all the benefits of collective action, financial disclosure and\nequal treatment for creditors, why are so few involuntary petitions filed every year? To answer\nthis question, one must understand the involuntary bankruptcy process. Read 11 U.S.C. \xc2\xa7 303 and\nanswer the following questions:\n\n3.13.\n\nPractice Problems \xe2\x80\x93 Involuntary Petitions\n\nProblem 1. Farmer John owes money to everyone in town, and is not paying. Can creditors\njoin together and file an involuntary bankruptcy petition?\nProblem 2. Can an involuntary bankruptcy petition be filed under Chapter 13?\nProblem 3. Debtor owes Bank $200,000 secured by a mortgage on the debtor\xe2\x80\x99s home.\nProperty values have fallen dramatically, and the house is worth only $120,000. Debtor has\nstopped making payments to the bank. You are the Bank\xe2\x80\x99s lawyer. The Bank asks you whether it\ncan file an involuntary bankruptcy petition against the Debtor. What would you need to know to\nanswer that question? See 11 U.S.C. \xc2\xa7 303(b)(2); 303(h). How would you go about getting the\ninformation you would need to answer your client\xe2\x80\x99s question?\nProblem 4. After reviewing the best available information you determine that the Debtor\nhas only 9 other eligible creditors, and based on your analysis the Bank files an involuntary\npetition. You find out, however, that the Debtor owed money to 4 other creditors who you had no\nway of knowing about. What is the consequence to the Bank (and to you) of filing a one-creditor\ninvoluntary petition? See 11 U.S.C. \xc2\xa7 303(i).\nProblem 5. The Bank asks you what the phrase \xe2\x80\x9cgenerally not paying such debtor\xe2\x80\x99s debts\nas such debts become due\xe2\x80\x9d in 11 U.S.C. \xc2\xa7 303(h) means. What do you tell them? How would you\ndetermine whether the Debtor is \xe2\x80\x9cgenerally not paying?\xe2\x80\x9d\n68\n\n\x0cProblem 6. Assume that the Bank, without consulting you, correctly determined that the\nDebtor had only 9 other creditors, and filed an involuntary bankruptcy petition. It turns out,\nhowever, that the Debtor only had a few other small creditors, and the debtor was paying all of his\nsmall debts on time. The Bankruptcy Court determines that the Debtor had been \xe2\x80\x9cgenerally paying\xe2\x80\x9d\nits debts when due, even though your client was not being paid and held the large bulk of the\ndebtor\xe2\x80\x99s debts. Could the Bank be held liable for damages or punitive damages for filing the\ninvoluntary petition? See In re Silverman, 230 B.R. 46 (Bankr. D. N.J. 1998) (holding creditor\nliable for $50,000 in punitive damages for not checking debtor\xe2\x80\x99s credit report to see whether debtor\nwas \xe2\x80\x9cgenerally paying\xe2\x80\x9d before filing bankruptcy, and for filing involuntary on the basis of a\npartially disputed debt); In re Macke International Trade, Inc., 370 B.R. 236 (Bankr. 9th Cir. 2007)\n(holding the creditor liable for $20,000 in attorney fees under 11 U.S.C. \xc2\xa7 303(i), even though the\npetition was proper and dismissal was granted under 11 U.S.C. \xc2\xa7 305(a)(1) because \xe2\x80\x9cthe interests\nof creditors and the debtor would be better served by such dismissal . . . .\xe2\x80\x9d)\nProblem 7. Three creditors join together in properly filing an involuntary petition against\nthe Debtor. Debtor immediately pays the three creditors and moves to dismiss the involuntary\npetition. Must the court dismiss the case?\nProblem 8. Creditor owns three separate corporations: one corporation leases equipment,\none services the equipment, and one sells supplies for the equipment. Debtor owes money to all\nthree subsidiaries. Can the three subsidiaries be counted as three separate entities for filing an\ninvoluntary petition? See In re Gibraltar Amusements, Ltd., 291 F.2d 22, 28 (2d Cir. 1961), cert.\ndenied, 368 U.S. 925 (1961).\n\n3.14.\n\nDismissal of Properly Filed Bankruptcy Petitions for \xe2\x80\x9cCause.\xe2\x80\x9d\n\nSection 707(a) of the Bankruptcy Code allows the Court to dismiss a bankruptcy case for\n\xe2\x80\x9cCause.\xe2\x80\x9d \xe2\x80\x9cCause\xe2\x80\x9d is not specifically defined, although it includes a debtor\xe2\x80\x99s unreasonable\nprejudicial delay, failure to pay fees, and failure to file schedules and other information required\nby 11 U.S.C. \xc2\xa7 521(a) in a timely manner. It is important to contrast dismissal \xe2\x80\x9cfor cause\xe2\x80\x9d under\nSection 707(a), which requires notice and an opportunity for hearing, with the automatic dismissal\nrules in Section 521(i)(I) which offer no due process prior to dismissal.\nDoes \xe2\x80\x9ccause\xe2\x80\x9d exist for dismissal if the debtor has the ability to pay his, her or its debts from\nfuture earnings? The legislative history suggests that ability to pay is not a factor that should be\nconsidered by the Courts in determining \xe2\x80\x9ccause.\xe2\x80\x9d\n\xe2\x80\x9cThe section does not contemplate, however, that the ability of the\ndebtor to repay his debts in whole or in part constitutes adequate\ncause for dismissal. To permit dismissal on that ground would be to\nenact a non-uniform mandatory chapter 13, in lieu of the remedy of\nbankruptcy.\xe2\x80\x9d\nH.R. Rep. No. 595, 95th Cong., 1st Sess. 380 (1977), S. Rep. No. 989, 95th Cong., 2d Sess. 94\n(1978).\nMost courts follow the legislative history and preclude issues of ability to pay from\nconsideration under Section 707(a). Note that the next section of the Bankruptcy Code, Section\n69\n\n\x0c707(b), discussed at length below, focuses on ability to pay, although it is based on the assumption\nthat the past is a reliable proxy for the future, which is not always true.\nThe courts are divided on whether prepetition bad acts can constitute \xe2\x80\x9ccause\xe2\x80\x9d for dismissal.\nThe fundamental issue is whether a debtor must file a bankruptcy petition in \xe2\x80\x9cgood faith\xe2\x80\x9d \xe2\x80\x93 for a\nproper bankruptcy purpose. Should the case be dismissed if the debtor is using bankruptcy as a\nlitigation tactic \xe2\x80\x93 for example to delay a lawsuit \xe2\x80\x93 rather than having any legitimate and immediate\nneed for financial relief? Outside of the consumer context most courts have said \xe2\x80\x9cyes.\xe2\x80\x9d We will\nread one such a case shortly.\nHowever, the Court of Appeal for the Ninth Circuit suggested that bad faith is not a factor\nthat should be considered in 707(a) \xe2\x80\x9cfor cause\xe2\x80\x9d dismissals of consumer cases. In re Padilla, 222\nF.3d 1184 (9th Cir. 2000). The debtor in that case, Mr. Padilla, incurred over $100,000 in credit\ncard debt shortly before bankruptcy (he claimed to have had a gambling addiction problem). The\nbankruptcy court granted the trustee\xe2\x80\x99s motion to dismiss Padilla\xe2\x80\x99s case for \xe2\x80\x9ccause\xe2\x80\x9d under Section\n707(a), claiming he was acting in bad faith and abusing the Bankruptcy Code by incurring large\namounts of credit card debt in anticipation of filing bankruptcy and receiving a discharge (a process\nknown as a \xe2\x80\x9cbust out\xe2\x80\x9d scheme). The Court of Appeals held that bad faith conduct should not be a\nfactor in determining \xe2\x80\x9ccause\xe2\x80\x9d for dismissal under Section 707(a). Rather, such conduct could be\nconsidered under Section 707(b), which at the time allowed dismissal of consumer cases for\n\xe2\x80\x9csubstantial abuse.\xe2\x80\x9d As we will see, the theory that bad faith in consumer cases should only be\nconsidered under Section 707(b) creates structural problems after Congress adopted the Means\nTest in Section 707(b).\n\n3.15.\n\nBad Faith Dismissals after the 2005 Amendments\n\nWith the 2005 BAPCPA amendments, Congress added Section 707(b)(3), clarifying that\nthe Bankruptcy Court should consider both the totality of circumstances and whether the debtor\nfiled the petition in bad faith in deciding whether to dismiss a consumer case for general \xe2\x80\x9cabuse\xe2\x80\x9d\nunder Section 707(b). The general \xe2\x80\x9cabuse\xe2\x80\x9d test in Section 707(b) only applies to consumer\ndebtors. Furthermore, as is discussed below, only the judge or the United States Trustee has\nstanding to seek dismissal for general \xe2\x80\x9cabuse\xe2\x80\x9d if the means test is satisfied. 11 U.S.C. \xc2\xa7\xc2\xa7 707(b)(1),\n707(b)(6). Because of this limitation, most creditors will be unable to seek the dismissal of\nconsumer cases filed in bad faith. The interplay of the means test and the \xe2\x80\x9cabuse\xe2\x80\x9d test appear to\nhave undermined Congress\xe2\x80\x99s goal of cutting down on abusive bankruptcy filings.\nWhat about bad faith petitions in non-consumer cases? Did Congress eliminate\nconsideration of bad faith in the \xe2\x80\x9cCause\xe2\x80\x9d test for businesses under Section 707(a) by including bad\nfaith in the definition of \xe2\x80\x9cabuse\xe2\x80\x9d under Section 707(b) (which only applies to consumer cases)?\nSome make this argument, but I doubt that was Congress\xe2\x80\x99s intent. Indeed, Congress may not have\neven considered the effect of an amendment to Section 707(b) on an entirely unrelated Section\n707(a).\nThe cases are split on whether bad faith can be considered in non-consumer dismissals for\n\xe2\x80\x9ccause\xe2\x80\x9d under Section 707(a). See In re Adolph, 441 B.R. 909 (Bankr. N.D. Ill. 2011) (bad faith\nnot a factor under Section 707(a) after 2005 BAPCPA amendments); In re Perlin, 497 F.3d 364,\n369-70 (3d Cir. 2007) (bad faith continues to be a factor in non-consumer dismissals under Section\n707(a)).\n70\n\n\x0cThe Padilla panel\xe2\x80\x99s argument that \xe2\x80\x9ccause\xe2\x80\x9d can have different meanings under different\nchapters, allowing dismissal of Chapter 11 business filings for \xe2\x80\x9ccause,\xe2\x80\x9d but not allowing dismissal\nof consumer filings for \xe2\x80\x9ccause,\xe2\x80\x9d is troubling. A better approach would be to focus on whether the\nconduct constituting bad faith is an abuse of the bankruptcy process, in which case \xe2\x80\x9ccause\xe2\x80\x9d should\nexist for dismissal under any chapter. The elastic approach to \xe2\x80\x9ccause\xe2\x80\x9d utilized in the Johns\nManville decision reprinted below strikes me as a far better approach to the problem than Padilla\xe2\x80\x99s\nsuggestion that bad faith conduct cannot be considered in determining whether \xe2\x80\x9ccause\xe2\x80\x9d exists for\ndismissal in consumer cases. In using a broad term like \xe2\x80\x9ccause,\xe2\x80\x9d Congress must have intended to\ngive the courts the power to determine whether a case constitutes an abuse of the bankruptcy\nprocess and should be dismissed.\n\n3.16.\n\nDismissal of Cases Properly Filed under Other Chapters\n\nThe chapter proceedings contain similar broad \xe2\x80\x9cfor cause\xe2\x80\x9d language for dismissal. See 11\nU.S.C. \xc2\xa7 1112(b)(1), 1208(c) and 1307(c). Unlike Chapter 7, however, the reorganization chapters\nalso require the debtor to affirmatively show that the plan of reorganization has been proposed in\n\xe2\x80\x9cgood faith\xe2\x80\x9d in order to obtain confirmation of the plan. See 11 U.S.C. \xc2\xa7\xc2\xa7 1129(a)(3), 1225(a)(3),\n1325(a)(3). Because bad faith would preclude plan confirmation, and something has to be done\nwith a case that cannot be confirmed, one could certainly argue that the concept \xe2\x80\x9cbad faith\xe2\x80\x9d must\nbe \xe2\x80\x9ccause\xe2\x80\x9d for dismissal. On the other hand, filing a petition in bad faith may be different from\nproposing a plan in bad faith, since the bad faith inquiry focuses on a different act taking place at\na different point in time. The cases that follow struggle with the relationship between \xe2\x80\x9ccause\xe2\x80\x9d and\n\xe2\x80\x9cgood/bad faith in seeking bankruptcy relief.\xe2\x80\x9d\n\n3.17.\n\nCases on Bad Faith Dismissals\n3.17.1.1.\nIN RE JOHNS-MANVILLE CORP., 36 B.R. 727\n(Bankr. S.D.N.Y. 1984)\n\nWhether an industrial enterprise in the United States is highly successful is often gauged\nby its "membership" in what has come to be known as the "Fortune 500." Having attained this\nmeasure of financial achievement, Johns-Manville Corp. and its affiliated companies (collectively\nreferred to as "Manville") were deemed a paradigm of success in corporate America by the\nfinancial community. Thus, Manville\'s filing for protection under Chapter 11 on August 26, 1982\nwas greeted with great surprise and consternation on the part of some of its creditors and other\ncorporations that were being sued along with Manville for injuries caused by asbestos exposure.\nAs discussed at length herein, Manville submits that the sole factor necessitating its filing is the\nmammoth problem of uncontrolled proliferation of asbestos health suits brought against it because\nof its substantial use for many years of products containing asbestos which injured those who came\ninto contact with the dust of this lethal substance. According to Manville, this current problem of\napproximately 16,000 lawsuits pending as of the filing date is compounded by the crushing\neconomic burden to be suffered by Manville over the next 20-30 years by the filing of an even\nmore staggering number of suits by those who had been exposed but who will not manifest the\nasbestos-related diseases until sometime during this future period ("the future asbestos claimants").\nIndeed, approximately 6,000 asbestos health claims are estimated to have arisen in only the first\n71\n\n\x0c16 months since the filing date. This burden is further compounded by the insurance industry\'s\ngeneral disavowal of liability to Manville on policies written for this very purpose. Indeed, the\nissue of coverage has been pending for years before a state court in California. It is the propriety\nof the filing by Manville which is the subject of the instant decision.\nFour separate motions to dismiss the petition pursuant to Section 1112(b) of the Code have\nbeen lodged before this Court. Manville has opposed all four dismissal motions and has been joined\nin opposition to them by the Unofficial Committee of School Creditors, the Equity Holders\nCommittee [and] . . . the Unsecured Creditors Committee. . . .\nThe Asbestos Committee, which is comprised with one exception of attorneys for asbestos\nvictims, initially moved to dismiss this case on November 8, 1982 citing Manville\'s alleged lack\nof good faith in filing this petition. However, the Asbestos Committee did not press its motion\nbefore the Court until now, more than one year later. In the interim, while engaging in plan\nformulation negotiations, it has vigorously pursued discovery in order to bolster its factual\ncontention that Manville knowingly perpetrated a fraud on this Court and on all its creditors and\nequity holders in exaggerating the profundity of its economic distress in 1981 so as to enable it to\nfile for reorganization in 1982. Thus, the Asbestos Committee submitted in November 1983 a\nmultitude of volumes of materials consisting of 55 days of depositions of Manville officers in\nalleged support of the inference that in 1981 a small Manville group "concocted" evidence to meet\nthe requirements for filing a Chapter 11 petition. The Asbestos Committee alleges that this group\nmanufactured evidence of crushing economic distress so as to demonstrate falsely that pursuant to\nrequired principles of accounting . . . Manville had to book a reserve of at least $1.9 billion for\nasbestos health liability, and thus had no alternative but to seek Chapter 11 protection. The booking\nof such a reserve would, in turn, have triggered the acceleration of approximately $450 million of\noutstanding debt, possibly resulting in a forced liquidation of key business segments. Thus, the\nmultitudinous submissions by the Asbestos Committee are aimed at showing their challenge to the\nmotive, methods and data used by Manville\'s accounting consultants, its management and its\nLitigation Advisory Group in determining whether relief under Chapter 11 should be sought.\nMindful that there is no insolvency requirement for Chapter 11 debtor status, the issue\npresented for determination by this Court is whether these allegations of error by the Asbestos\nCommittee, even egregious error, in over-calculation of Manville\'s financial problems are relevant\nto establish the kind of bad faith in the sense of an abuse of this Court\'s jurisdiction which will\nvitiate the filing of a Chapter 11 petition. This opinion will thus elucidate whether the tomes of\nmaterial submitted by the Asbestos Committee defeat the essential fact that as of August 26, 1982\nManville is a real company with real debt, real creditors and a compelling need to reorganize in\norder to meet these obligations.\nThe motions to dismiss Manville\'s petition . . . must be denied. Preliminarily, it must be\nstated that there is no question that Manville is eligible to be a debtor under the Code\'s statutory\nrequirements. Section 109 of the Code contains its eligibility requirements . . . .\nClearly, Manville meets the requirements contained in subsection (a) for debtors under all\nchapters of the Code in that it is domiciled and has its place of business in the United States. Also,\nthe word "person" used in subsection (a), as defined in Code section 101(30), includes an\nindividual, a partnership, and a corporation, but not a governmental unit.\n72\n\n\x0cIn addition, Manville meets the eligibility requirements contained in subsection (b) and\nmade applicable to Chapter 11 debtors by subsection (d). Manville is obviously not any of the\nprohibited entities described in subsection (b). . . . Moreover, it should also be noted that neither\nSection 109 nor any other provision relating to voluntary petitions by companies contains any\ninsolvency requirement. . . . Accordingly, it is abundantly clear that Manville has met all of the\nthreshold eligibility requirements for filing a voluntary petition under the Code. This Court will\nnow turn to the issue of whether any of the movants have demonstrated sufficient "cause" pursuant\nto Code Section 1112(b) to warrant the dismissal of Manville\'s petition.\nSection 1112(b) of the Code provides for conversion or dismissal of a case for "cause". . .\n. What constitutes cause under Section 1112(b) is subject to judicial discretion under the\ncircumstances of each case." [M]uch of the argument in support of all of the motions to dismiss is\npitched to the confirmability of Manville\'s proposed plan. This argument is misplaced. Under the\nstatutory reorganization scheme, there can be many plans advanced by many interests. Also, the\nconcept of perpetual debtor-in-possession is not unlimited, nor is the possibility of liquidation or\nother forms of asset management beyond speculation. The essential determination here is the\npropriety of the filing, and whether "cause" exists to vitiate it, not the confirmability of a particular\nplan. If Manville is unable to effectuate a particular plan that is not tantamount to finding that no\nplan can be effectuated.\nThe Asbestos Committee premises its motion to dismiss the petition on what it contends is\nManville\'s "bad faith" in filing for protection under Chapter 11. "The Asbestos Committee is\nprepared to prove that Manville\'s Chapter 11 petition is purely a bad faith maneuver by Manville\nto curtail its liabilities. . . ." And, in its papers in support of that motion to dismiss, the Asbestos\nCommittee states: "These Chapter 11 cases were filed in bad faith, are an abuse of the provisions\nof Chapter 11 and an imposition on this Court\'s jurisdiction and should therefore be dismissed\nwithout further delay".\nBecause the allegations of the Asbestos Committee are not supported by concrete facts and\nthus do not rebut the essential fact that Manville is a real company with a substantial amount of\nreal debt and real creditors clamoring to enforce this real debt, the Asbestos Committee has not\nsustained its burden of demonstrating sufficient fraud to vitiate the filing ab initio. [T]these\npetitions were filed only after Manville undertook lengthy, careful and detailed analysis. . . .\nAccording to Manville, the results of the studies by ERI and SERC corroborated each other\'s\nprojections of runaway asbestos health costs within the foreseeable future.\nIn addition, the Compendium cites to testimony of Manville officers which details the slow\nand deliberate process of data commissioning and review and "soul-searching" antedating the\nfiling, including the employment and review of results of studies. . . . The data submitted by\nManville also supports the accepted inference that the $1.9 billion projected debt figure ratified by\nManville was the result of careful, conservative and perhaps understated projections.\nIn so doing, Manville has succeeded in rebutting . . . the Asbestos Committee\'s allegations\nof fraud regarding the size of its projected debt . . . . Manville was advised by Robert O.F. Bixby\nof the Price Waterhouse accounting firm that it was necessary to book a $1.9 billion reserve for\ncontingent liability according to the accrual principle in FASB-5. On balance, Manville\'s decision\nto follow this advice was neither unreasonable, illogical, nor in any sense fraudulent. Therefore,\n73\n\n\x0con balance, the Asbestos Committee has failed to sustain its burden of proof of fraud as to either\nthe magnitude of the reserve to be booked or the necessity of so booking this reserve.\nIn determining whether to dismiss under Code Section 1112(b), a court is not necessarily\nrequired to consider whether the debtor has filed in "good faith" because that is not a specified\npredicate under the Code for filing. Rather, according to Code Section 1129(a)(3), good faith\nemerges as a requirement for the confirmation of a plan. The filing of a Chapter 11 case creates an\nestate for the benefit of all creditors and equity holders of the debtor wherein all constituencies\nmay voice their interests and bargain for their best possible treatment. . . . It is thus logical that the\ngood faith of the debtor be deemed a predicate primarily for emergence out of a Chapter 11 case.\nIt is after confirmation of a concrete and immutable reorganization plan that creditors are\nforeclosed from advancing their distinct and parochial interests in the debtor\'s estate.\nAccordingly, the drafters of the Code envisioned that a financially beleaguered debtor with\nreal debt and real creditors should not be required to wait until the economic situation is beyond\nrepair in order to file a reorganization petition. The "Congressional purpose" in enacting the Code\nwas to encourage resort to the bankruptcy process. This philosophy not only comports with the\nelimination of an insolvency requirement, but also is a corollary of the key aim of Chapter 11 of\nthe Code, that of avoidance of liquidation. The drafters of the Code announced this goal, declaring\nthat reorganization is more efficient than liquidation because "assets that are used for production\nin the industry for which they were designed are more valuable than those same assets sold for\nscrap." Moreover, reorganization also fosters the goals of preservation of jobs in the threatened\nentity.\nIn the instant case, not only would liquidation be wasteful and inefficient in destroying the\nutility of valuable assets of the companies as well as jobs, but, more importantly, liquidation would\npreclude just compensation of some present asbestos victims and all future asbestos claimants.\nManville\'s purported motivation in filing to obtain a breathing spell from asbestos litigation\nshould not conclusively establish its lack of intent to rehabilitate and justify the dismissal of its\npetition. On the contrary, there has been submitted no evidence that Manville has not bargained to\nobtain a reorganization plan in good faith.\nIt is this Court\'s belief that there is no strict and absolute "good faith" predicate to filing a\nChapter 11 petition. Earlier bankruptcy laws, for example, former Chapter X relating to corporate\ndebtors specifically required that the court find that the petition "had been filed in good faith".\nHowever, the present Bankruptcy Code contains no such express requirement.\nThis Court, along with others, has opined that the concept of good faith is an elastic one\nwhich can be read into the statute on a limited ad hoc basis. However, this Court also cautioned\nthat slavish adherence to a good faith concept may redound to the detriment of those non-debtor\nclaimants who are or may putatively be beneficiaries of the reorganization process. [A] Chapter\n11 filing creates a bankruptcy estate which exists for the benefit not simply of the debtor, but rather\nalso for the benefit of all of the debtor\'s creditors and equity holders. The filing triggers the\nspringing into existence of important constituencies which, along with the debtor, must be\nprotected by a reorganization court. Accordingly, the intense focus on the debtor\'s motives in filing\nis misplaced.\nMoreover, courts have generally held that the concept of good faith as of the filing date\nmay only be applied where it is demonstrated that the jurisdiction of the bankruptcy court has been\n74\n\n\x0cabused. One frequently cited decision declares that "[D]ismissal for lack of `good faith\' . . . is\nmerged into the power of the court to protect its jurisdictional integrity from schemes of improper\npetitioners seeking to circumvent jurisdictional restrictions and from petitioners with demonstrable\nfrivolous purposes absent any economic reality." For example, this kind of abuse of jurisdiction\nis demonstrated where a reorganization debtor never operated legitimately or was formed for the\nsole purpose of filing.\nIn addition, where there has been a change in legal form prior to the filing from an ineligible\nentity to one able to file under this Chapter in order to avoid a foreclosure sale, a court should\ninquire into the debtor\'s good faith to ensure that the Code\'s purposes are not being abused and that\nthe debtor is the kind of entity within the contemplation of the Code. However, whereas here a\nonce viable business supporting employees and unsecured creditors has more recently been\nburdened with judgments that threaten to put it out of existence, unless and until rehabilitation has\nbeen shown to be unfeasible, the bankruptcy courts are a most appropriate harbor within which to\nweather the storm.\nClearly, none of the justifications for declaring an abuse of the jurisdiction of the\nbankruptcy court announced by these courts are present in the Manville case. In Manville, it is\nundeniable that there has been no sham or hoax perpetrated on the Court in that Manville is a real\nbusiness with real creditors in pressing need of economic reorganization.\nIn short, there was justification for Manville to elect a course contemplating a viable courtsupervised rehabilitation of the real debt owed by Manville to its real creditors. Manville\'s filing\ndid not in the appropriate sense abuse the jurisdiction of this Court and it is indeed a "once viable\nbusiness supporting employees and unsecured creditors [which] has more recently been burdened\nwith judgments [and suits] that threaten to put it out of existence." . . . Thus, its petition must be\nsustained.\n[A] filing so as to substitute bankruptcy court procedures for estimation of these claims in\nand of itself does not constitute an abuse of the bankruptcy court\'s jurisdiction.\nIn sum, Manville is a financially besieged enterprise in desperate need of reorganization of\nits crushing real debt, both present and future. The reorganization provisions of the Code were\ndrafted with the aim of liquidation avoidance by great access to Chapter 11. Accordingly,\nManville\'s filing does not abuse the jurisdictional integrity of this Court.\nFor the reasons set forth above, all four of the motions to dismiss the Manville petition are\ndenied in their entirety.\n\n3.17.1.2.\n\nIN RE SGL CARBON, 200 F.3d 154 (3d Cir. 1999)\n\nSGL Carbon is a Delaware corporation. In 1997, the United States Department of Justice\ncommenced an investigation of alleged price-fixing by manufacturers, including the SGL Carbon\nGroup. Soon thereafter, various steel producers filed class action antitrust lawsuits . . . against SGL\nCarbon.\nOn December 16, 1998, at the direction of [its parent], SGL Carbon filed a voluntary\nChapter 11 bankruptcy petition. The bankruptcy filing contained a proposed reorganization plan\nunder which only one type of creditor would be required to accept less than full cash payment for\n75\n\n\x0cits account, namely the antitrust plaintiffs who obtained judgments against SGL Carbon. Under\nthe plan, potential antitrust judgment creditors would receive credits against future purchases of\nSGL Carbon\'s product valid for 30 months following the plan\'s confirmation. The proposed plan\nalso bars any claimant from bringing an action against SGL Carbon\'s affiliates, including its parent\n"based on\xe2\x80\x9d their claims against SGL Carbon.\nThe next day, on December 17, in a press release, SGL Carbon explained it had filed for\nbankruptcy "to protect itself against excessive demands made by plaintiffs in civil antitrust\nlitigation and in order to achieve an expeditious resolution of the claims against it.\nSGL CARBON Corporation is financially healthy," said Wayne T.\nBurgess, SGL CARBON Corporation\'s president. "If we did not face\n[antitrust] claims for such excessive amounts, we would not have\nhad to file for Chapter 11. We expect to continue our normal\nbusiness operations. . . . However, because certain plaintiffs\ncontinue to make excessive and unreasonable demands, SGL\nCARBON Corporation believes the prospects of ever reaching a\ncommercially practicable settlement with them are remote. After\nmuch consideration, SGL CARBON Corporation determined that\nthe most appropriate course of action to address the situation without\nharming its business was to voluntarily file for chapter 11\nprotection.\xe2\x80\x9d\nContemporaneous with the press release, SGL AG Chairman Robert Koehler conducted a\ntelephone conference call with securities analysts, stating that SGL Carbon was "financially\nhealthier" than before and denying the antitrust litigation was "starting to have a material impact\non [SGL Carbon\'s] ongoing operations in the sense that ... [it was] starting to lose market share."\nHe also stated that SGL Carbon\'s Chapter 11 petition was "fairly innovative [and] creative"\nbecause "usually Chapter 11 is used as protection against serious insolvency or credit problems,\nwhich is not the case [with SGL Carbon\'s petition]."\nThe District Court denied the motion to dismiss on April 23, 1999 assuming, without\ndeciding, that 11 U.S.C. \xc2\xa7 1112(b) imposes a duty of good faith upon bankruptcy petitioners. It\nfurther assumed this duty requires the proposed reorganization to further what it characterized as\nChapter 11\'s purpose: "`to restructure a business\'s finances so that it may continue to operate,\nprovide its employees with jobs, pay its creditors and produce a return for its stockholders.\'" The\ncourt made no findings that SGL Carbon filed for bankruptcy for reasons other than to improve its\nnegotiating position with plaintiffs. But the court concluded the petition furthered the purpose of\nChapter 11 because plaintiffs\' litigation was imperiling SGL Carbon\'s operation by distracting its\nmanagement, was potentially ruinous and could eventually force the company out of business. . .\nThe threshold issue is whether Chapter 11 petitions may be dismissed for "cause" under 11\nU.S.C. \xc2\xa7 1112(b) if not filed in good faith. . . . Chapter 11 bankruptcy petitions are subject to\ndismissal under 11 U.S.C. \xc2\xa7 1112(b) unless filed in good faith.\nReview and analysis of [the bankruptcy laws and relevant cases] disclose a common theme\nand objective [underlying the reorganization provisions]: avoidance of the consequences of\neconomic dismemberment and liquidation, and the preservation of ongoing values in a manner\nwhich does equity and is fair to rights and interests of the parties affected. But the perimeters of\n76\n\n\x0cthis potential mark the borderline between fulfillment and perversion; between accomplishing the\nobjectives of rehabilitation and reorganization, and the use of these statutory provisions to destroy\nand undermine the legitimate rights and interests of those intended to benefit by this statutory\npolicy. That borderline is patrolled by courts of equity, armed with the doctrine of "good faith." A\ndebtor who attempts to garner shelter under the Bankruptcy Code, therefore, must act in\nconformity with the Code\'s underlying principles.\nHaving determined that \xc2\xa7 1112(b) imposes a good-faith requirement on Chapter 11\npetitions, we consider whether SGL Carbon\'s Chapter 11 petition was filed in good faith.\nAlthough there is some evidence that defending against the antitrust litigation occupied\nsome officers\' time, there is no evidence this "distraction" posed a "serious threat" to the company\'s\noperational well-being. . . . We also find clearly erroneous that SGL Carbon\'s Chapter 11 petition\nwas filed at the appropriate time to avoid the possibility of a significant judgment that "could very\nwell force [SGL Carbon] out of business." There is no evidence that the possible antitrust\njudgments might force SGL Carbon out of business. To the contrary, the record is replete with\nevidence of SGL Carbon\'s economic strength. At the time of filing, SGL Carbon\'s assets had a\nstipulated book value of $400 million, only $100,000 of which was encumbered. On the date of\nthe petition, SGL Carbon had $276 million in fixed and non-disputed liabilities. Of those liabilities,\nonly $26 million were held by outsiders as the remaining liabilities were either owed to or\nguaranteed by SGL AG. . . . In documents accompanying its petition, SGL Carbon estimated the\nliquidation value of the antitrust claims at $54 million. In contrast, no evidence was presented with\nrespect to the amount sought by the antitrust plaintiffs beyond SGL Carbon\'s repeated\ncharacterization of their being "unreasonable."\nWhether or not SGL Carbon faces a potentially crippling antitrust judgment, it is incorrect\nto conclude it had to file when it did. As noted, SGL Carbon faces no immediate financial\ndifficulty. All the evidence shows that management repeatedly asserted the company was\nfinancially healthy at the time of the filing. Although the District Court believed the litigation\nmight result in a judgment causing "financial and operational ruin" we believe that on the facts\nhere, that assessment was premature. . . . The District Court was correct in noting that the\nBankruptcy Code encourages early filing. It is well established that a debtor need not be insolvent\nbefore filing for bankruptcy protection. It also is clear that the drafters of the Bankruptcy Code\nunderstood the need for early access to bankruptcy relief to allow a debtor to rehabilitate its\nbusiness before it is faced with a hopeless situation. Such encouragement, however, does not open\nthe door to premature filing, nor does it allow for the filing of a bankruptcy petition that lacks a\nvalid reorganizational purpose.\nWe do not hold that a company cannot file a valid Chapter 11 petition until after a massive\njudgment has been entered against it. Courts have allowed companies to seek the protections of\nbankruptcy when faced with pending litigation that posed a serious threat to the companies\' long\nterm viability. In those cases, however, debtors experienced serious financial and/or managerial\ndifficulties at the time of filing. In Johns-Manville, the debtor was facing significant financial\ndifficulties. A growing wave of asbestos-related claims forced the debtor to either book a $1.9\nbillion reserve thereby triggering potential default on a $450 million debt which, in turn, could\nhave forced partial liquidation, or file a Chapter 11 petition. Large judgments had already been\nentered against Johns-Manville and the prospect loomed of tens of thousands of asbestos healthrelated suits over the course of 20-30 years.\n77\n\n\x0cFor these reasons, SGL Carbon\'s reliance on those cases is misplaced. The mere possibility\nof a future need to file, without more, does not establish that a petition was filed in "good faith. . .\n." SGL Carbon, by its own account, and by all objective indicia, experienced no financial difficulty\nat the time of filing nor any significant managerial distraction. Although SGL Carbon may have\nto file for bankruptcy in the future, such an attenuated possibility standing alone is not sufficient\nto establish the good faith of its present petition.\nChapter 11 vests petitioners with considerable powers\xe2\x80\x94the automatic stay, the exclusive\nright to propose a reorganization plan, the discharge of debts, etc.\xe2\x80\x94that can impose significant\nhardship on particular creditors. When financially troubled petitioners seek a chance to remain in\nbusiness, the exercise of those powers is justified. But this is not so when a petitioner\'s aims lie\noutside those of the Bankruptcy Code. Courts, therefore, have consistently dismissed Chapter 11\npetitions filed by financially healthy companies with no need to reorganize under the protection of\nChapter 11. . . . Statements by SGL Carbon and its officials confirm the company did not need to\nreorganize under Chapter 11. . . . We are not convinced by SGL Carbon\'s claim that a Chapter 11\nfiling was necessary because we see no evidence the antitrust litigation was significantly harming\nits business relationships with the antitrust plaintiffs.\nWe also believe reliance on In re Johns-Manville is misplaced. As an initial matter, the\nJohns-Manville Court had a narrow view of what constitutes "good faith." After expressing doubt\nthat \xc2\xa7 1112(b) imposes a good-faith requirement in all Chapter 11 cases, the court suggested that\na Chapter 11 petition lacks good faith only if filed by a creditor-less company formed as a sham\nsolely for the purpose of filing a bankruptcy petition, by a company that never operated\nlegitimately, or by a company wishing to forestall tax liability or deed of trust powers. [M]ost of\nthe courts of appeals believe other facts and circumstances may evidence lack of good faith.\nJohns-Manville is also factually distinguishable. In Johns-Manville, the bankruptcy court\nfound the company had a "compelling" and "pressing" need to reorganize. As we have explained,\nSGL Carbon has no such need. . . .\n[Petition Dismissed].\n\n3.18.\n\nVoluntary and Involuntary Conversion and Dismissal.\n\nEach chapter of the Bankruptcy Code contains rules for converting and dismissing a\nbankruptcy case. The general rule is that voluntary conversion (at the debtor\xe2\x80\x99s request) from any\nchapter to Chapter 13 is freely available to the debtor, while involuntary conversion to Chapter 13\nis never available: Chapter 13 is always voluntary. See 11 U.S.C. \xc2\xa7\xc2\xa7 706(a) (debtor\xe2\x80\x99s right to\nconvert to Chapter 11 or 13); 1307(a) (debtor\xe2\x80\x99s right to convert to Chapter 7), 1112(4)(d) (debtor\xe2\x80\x99s\nright to convert to Chapter 13).\nSimilarly, debtors have an absolute right to dismiss their Chapter 13 cases at any time. 11\nU.S.C. \xc2\xa7 1307(b). However, a few courts have ignored the clear mandate of the voluntary\nconversion statute in cases where the debtor was attempting to escape from the trustee\xe2\x80\x99s scrutiny\nof fraudulent conduct. See In re Parker, 351 B.R. 790 (Bankr. N.D. Ga. 2006); In re Fileccia, No.\n06-0541, 2007 Bankr. LEXIS 1924, *11 (Bankr. M.D. Tenn. June 6, 2007). A case that was\nvoluntarily converted from Chapter 7 to Chapter 13 can be reconverted back to Chapter 7 over the\ndebtor\xe2\x80\x99s objection. See 11 U.S.C. \xc2\xa7 1307(b).\n78\n\n\x0cCases may be involuntarily converted from Chapter 7 to 11, Chapter 11 to 7, or dismissed\nfrom any chapter, after notice and a hearing upon a showing of \xe2\x80\x9ccause\xe2\x80\x9d for conversion or dismissal.\n11 U.S.C. \xc2\xa7\xc2\xa7 706(b); 1112(b)(1); 1307(c). Most of the cases involving involuntary conversion\narise under Chapter 11, where a creditor seeks liquidation rather than further plan negotiations and\ndelay. The Bankruptcy Code contains a long list of conduct constituting \xe2\x80\x9ccause\xe2\x80\x9d for converting\nfrom Chapter 11 to Chapter 7, with the focus being on the debtor\xe2\x80\x99s post-petition Bankruptcy Code\nviolations, or an inability to effectuate a plan after a reasonable time. See 11 U.S.C. \xc2\xa7 1112(b)(4).\nPrepetition bad faith is not a factor listed as examples of \xe2\x80\x9ccause\xe2\x80\x9d in the Chapter 11 dismissal\nrules. Yet, the Courts have generally found prepetition bad faith to constitute grounds for dismissal.\nSee In re Little Creek Dev. Co., 779 F.2d 1068, 1071 (5th Cir. 1986) (\xe2\x80\x9cEvery bankruptcy statute\nsince 1898 has incorporated literally, or by judicial interpretation, a standard of good faith for the\ncommencement, prosecution, and confirmation of bankruptcy proceedings."); 7-1112 Collier on\nBankruptcy P 1112.07[5] (noting overlap between bad faith and \xe2\x80\x9ccause\xe2\x80\x9d for dismissal).\nSome courts have added an objective futility requirement to bad faith dismissals of chapter\nproceedings, refusing to dismiss cases subjectively filed in bath faith if the case has a proper\nreorganization purpose and likelihood. In re Harmony Holdings, LLC, 393 B.R. 409, 418 (Bankr.\nD.S.C. 2008); Carolin Corp. v. Miller, 886 F.2d 693, 701 (4th Cir. N.C. 1989). In any case, the\ncourts have continued to recognize bad faith dismissals in Chapter 11 cases, even after the 2005\nBAPCPA amendments defined pre-petition bad faith as an element of \xe2\x80\x9cabuse\xe2\x80\x9d by consumer\ndebtors under Section 707(b), rather than as an element of \xe2\x80\x9ccause\xe2\x80\x9d for dismissal generally under\nSection 707(a).\n\n3.19.\n\nDismissal of Consumer Chapter 7 Cases for \xe2\x80\x9cAbuse\xe2\x80\x9d \xe2\x80\x93 The Means\nTest\n\nSection 707(b) of the Bankruptcy Code provides for dismissal in consumer bankruptcy\ncases if the granting of relief would be an \xe2\x80\x9cabuse\xe2\x80\x9d of Chapter 7. Prior to 2005, the standard was\n\xe2\x80\x9csubstantial abuse.\xe2\x80\x9d Courts engaged in a case-by-case analysis to determine whether the filing\nwas abusive. Specifically, Bankruptcy Courts could dismiss cases if debtors could afford to pay\ncreditors, using a forward looking approach based on the debtor\xe2\x80\x99s expected income and reasonable\nliving expenses.\nIn performing the case by case analysis under Section 707(b), bankruptcy judges developed\nreputations in the local community for leniency or strictness. Debtors who leased or financed fancy\nhomes or cars ran the risk of having their expenses disallowed in the calculation of reasonable\nliving expenses. This practice led to the axiom that it was dangerous for a debtor filing bankruptcy\nto drive a better car than the bankruptcy judge.\nIn the 2005 BAPCPA amendments, Congress lowered the standard from \xe2\x80\x9csubstantial\nabuse\xe2\x80\x9d to \xe2\x80\x9cabuse\xe2\x80\x9d (not a very important change since both standards would ultimately be decided\non the basis of the Bankruptcy Judge\xe2\x80\x99s personal views), and created a presumption of abuse for\nconsumer debtors who failed to satisfy a complex and rigid mathematical \xe2\x80\x9cmeans\xe2\x80\x9d test. The stated\ngoal of the means test was to force debtors who could afford to pay some portion of their debts\ninto Chapter 13. Unfortunately, the rigid means test is subject to manipulation, is overbroad, and\nis poorly tailored to its objective.\n79\n\n\x0cIt is important to first note that the entirety of Section 707(b) (dismissal for abuse and\npresumption of abuse under the \xe2\x80\x9cmeans test\xe2\x80\x9d) applies only to individual consumer debtors \xe2\x80\x93 legal\nentities like corporations and partnerships, and individual debtors with primarily business debts,\nare not subject to the \xe2\x80\x9cabuse\xe2\x80\x9d standard at all.\nSecond, many debtors easily satisfy the \xe2\x80\x9cmeans test\xe2\x80\x9d without performing all of the complex\nmathematics. The place to begin reading the means test statute is in the middle - Sections 707(b)(6)\nand (b)(7). Actually, the place to begin reading is Section 101(10A) \xe2\x80\x93 the definition of \xe2\x80\x9ccurrent\nmonthly income\xe2\x80\x9d \xe2\x80\x93 which is the cornerstone of the test. Read these three provisions, Section\n101(10A), Sections 707(b)(6) and (b)(7), carefully and answer the following questions.\n\n3.20.\n\nPractice Problems: Dismissal for Abuse \xe2\x80\x93 The Means Test, Part\nOne\n\nProblem 1: Individual debtor filed her bankruptcy petition on October 17 of the current\nyear. The following schedule shows the debtor\xe2\x80\x99s income and expenses for the current year.\nCalculate the Debtor\xe2\x80\x99s \xe2\x80\x9ccurrent monthly income.\xe2\x80\x9d See 11 U.S.C. \xc2\xa7 101(10A).\nINCOME\nWages\nTips\nSocial Sec Disability\nUnemployment\nFamily Gifts (tax free)\nTotal Income\nEXPENSES\nRent\nFood\nUtilities\nCell Phone\nCable TV and Internet\nCar Payment\nGas\nCredit Card Payments\nTotal Expenses\nNET INCOME (LOSS)\n\nJan\n$ 1,200\n$ 245\n\nFeb\n$ 1,200\n$ 290\n\n$\n$\n\nMar\n1,200\n265\n\nApr\n$ 1,200\n$ 225\n\nMay\n$ 1,200\n$ 200\n\nJun\n\n$ 1,445\n\n$ 1,490\n\n$\n\n1,465\n\n$ 1,425\n\n$ 1,400\n\n$\n$\n$\n$\n\n$ 375\n$ 150\n$\n60\n$\n90\n$ 120\n$ 145\n$\n50\n$\n50\n$ 1,040\n$ 405\n\n$ 375\n$ 160\n$\n55\n$\n90\n$ 120\n$ 145\n$\n48\n$\n50\n$ 1,043\n$ 447\n\n$\n$\n$\n$\n$\n$\n$\n$\n$\n$\n\n375\n145\n50\n90\n120\n145\n51\n50\n1,026\n439\n\n$\n$\n$\n$\n$\n$\n$\n$\n$\n$\n\n$ 375\n$ 160\n$\n35\n$\n90\n$ 120\n$ 145\n$\n53\n$\n50\n$ 1,028\n$ 372\n\n$\n$\n$\n$\n$\n$\n$\n$\n$\n$\n\n375\n125\n40\n90\n120\n145\n49\n50\n994\n431\n\nJul\n\nAug\n\n350\n150\n200\n700\n\n$\n$\n$\n$\n\n350\n150\n200\n700\n\n$\n$\n$\n$\n\n350\n150\n200\n700\n\n375\n120\n35\n90\n120\n145\n45\n930\n(230)\n\n$\n$\n$\n$\n$\n$\n$\n$\n$\n$\n\n375\n110\n35\n90\n120\n145\n48\n923\n(223)\n\n$\n$\n$\n$\n$\n$\n$\n$\n$\n$\n\n375\n98\n35\n90\n120\n145\n46\n909\n(209)\n\nSep\nOct 1-17 TOTAL\n$ 1,200 $ 800 $ 8,000\n$ 250 $ 125 $ 1,600\n$ 1,050\n$\n450\n$\n600\n$ 1,450 $ 925 $ 11,700\n$\n$\n$\n$\n$\n$\n$\n$\n$\n$\n\n375\n120\n35\n90\n120\n145\n43\n928\n522\n\n$\n$\n$\n$\n$\n$\n$\n$\n$\n$\n\n375\n62\n15\n90\n120\n145\n22\n829\n96\n\nProblem 2: Assume that the median income for a single person in the debtor\xe2\x80\x99s state in the\ncurrent year is $14,400. Does the debtor satisfy the means test? If so, what is the effect of satisfying\nthe means test? See 11 U.S.C. \xc2\xa7 707(b)(6) and (b)(7).\nProblem 3: Suppose the Debtor\xe2\x80\x99s adult son lives with the debtor and pays $300 per month\nto the Debtor to cover the son\xe2\x80\x99s share of rent, food, and other expenses. Should the Debtor\xe2\x80\x99s son\xe2\x80\x99s\npayment be included in the calculation of Debtor\xe2\x80\x99s current monthly income?\nProblem 4: If the Debtor were married, would the Debtor\xe2\x80\x99s spouse\xe2\x80\x99s income be included\nin calculating the Debtor\xe2\x80\x99s \xe2\x80\x9ccurrent monthly income\xe2\x80\x9d? How about in determining whether the\n80\n\n$\n$\n$\n$\n$\n$\n$\n$\n$\n$\n\n3,750\n1,250\n395\n900\n1,200\n1,450\n455\n250\n9,650\n2,050\n\n\x0cpresumption of abuse applies, or whether a creditor could move for dismissal under the general\n\xe2\x80\x9cabuse\xe2\x80\x9d test? Compare 11 U.S.C. \xc2\xa7\xc2\xa7 707(b)(6) and 707(b)(7).\n\n3.21.\n\nDismissal for \xe2\x80\x9cAbuse\xe2\x80\x9d - The Means Test, Part Two\n\nA debtor whose annualized \xe2\x80\x9ccurrent monthly income\xe2\x80\x9d is above the median income in the\ndebtor\xe2\x80\x99s state must run the gauntlet of the means test to avoid having the case dismissed under the\nmeans test\xe2\x80\x99s presumption of abuse. The gauntlet requires a significant amount of additional\ncalculation.\nThe calculations start with the same \xe2\x80\x9ccurrent monthly income\xe2\x80\x9d computed earlier (average\nprior six months\xe2\x80\x99 gross income), but then deduct a series of actual and hypothetical expenses to\ncalculate the debtor\xe2\x80\x99s permitted net monthly income. The allowed expenses consist of:\n1. The monthly expenses allowed under the Internal Revenue Services\xe2\x80\x99 (the \xe2\x80\x9cIRS\xe2\x80\x9d)\nnational and local standards for putting a tax debtor in uncollectable status (11 U.S.C.\n\xc2\xa7 707(b)(2)(A)(ii)(I));\n2. Actual monthly expense incurred by the debtor which would be allowed by the IRS as\n\xe2\x80\x9cother necessary expenses\xe2\x80\x9d for putting a tax debtor in uncollectable status (11 U.S.C.\n\xc2\xa7 707(b)(2)(A)(ii)(I));\n3. Actual expense for providing care and support for an elderly, chronically ill, or disabled\nfamily member (11 U.S.C. \xc2\xa7 707(b)(2)(A)(ii)(II));\n4. Private school tuition for a child under 18 years of age, up to an annual limit currently\n$1,775 per child (11 U.S.C. \xc2\xa7 707(b)(2)(A)(ii)(IV));\n5. Reasonable and necessary utilities expenses over the amount allowed by the IRS in the\nnational and local standards (11 U.S.C. \xc2\xa7 707(b)(2)(A)(ii)(V)); and most importantly\n6. Average contractual secured debt payments over the 60 months following the filing of\nbankruptcy (11 U.S.C. \xc2\xa7 707(b)(2)(A)(iii)(I)).\nIt is this last deduction that is most controversial, because it allows debtors who have\nsignificant car or mortgage debt to satisfy the means test by using their excessive debt incurred to\nmaintain a high standard of living to satisfy the means test. Many believe that debtors with high\nincomes and excessive secured debts used to maintain a bloated lifestyle are precisely the kinds of\ndebtors who should be forced to trim their luxurious debt-ridden lifestyles and to use their high\nincomes to repay their unsecured creditors.\nA net hypothetical monthly income figure is calculated by reducing \xe2\x80\x9ccurrent monthly\nincome\xe2\x80\x9d by these allowed expenses. The net monthly income number is then to be multiplied by\n60 to compute the amount of net income that the debtor should be able to accumulate over the next\nfive years. The five years of hypothetical net income is then compared with some statutory\namounts.\nIf the Debtor\xe2\x80\x99s five years of hypothetical net income is less than $7,025 as of 2014 ($117.09\nper month), the debtor will satisfy the means test and there will be no presumption of abuse.\nIf the Debtor\xe2\x80\x99s five years of hypothetical net income is more than $11,725 as of 2014\n(195.42 per month), the debtor will fail the means test and the presumption of abuse will apply.\n\n81\n\n\x0cIf the debtor\xe2\x80\x99s five years of hypothetical net income is less than $11,725 but more than\n$7,025, then the net income must be compared with 25% of the Debtor\xe2\x80\x99s non-priority unsecured\nclaims. If the five years of income is more than 25% of non-priority unsecured claims, the\npresumption applies; if less than it does not apply. 11 U.S.C. \xc2\xa7 707(b)(2).\n\n3.22.\n\nRebutting the Presumption of Abuse under the Means Test\n\nIn most cases the presumption of abuse is a death sentence \xe2\x80\x93 the case will be dismissed.\nThe presumption can only be rebutted by showing special circumstances for which there was no\nreasonable alternatives (the examples being military service and serious medical conditions). 11\nU.S.C. \xc2\xa7 707(b)(2)(B). The debtor must show that the special circumstances were the sole cause\nof means test failure. Id.\n\n3.23.\n\nAttorney Sanctions for Means Test Violations\n\nCongress showed special animus towards consumer debtor lawyers by bolstering the\ngeneral rules for sanctioning an attorney for filing a pleading without evidentiary support. See Fed.\nR. Bankr. Proc. Rule. 9011. Section 707(b)(4)(C) adds a requirement that attorneys perform a\nreasonable investigation into the \xe2\x80\x9ccircumstances\xe2\x80\x9d of the petition, and are deemed to certify that\nthe attorney has no knowledge after inquiry that anything in the petition is incorrect. Further, with\nrespect to the means test, debtor attorneys can be sanctioned for the reasonable cost incurred by\nthe United States Trustee in seeking dismissal of cases that do not satisfy the means test, but only\nif the court determines that the attorney violated Bankruptcy Rule 9011 in signing the petition\n(known inaccuracies or failing to make proper inquiry). Section 707(b)(4)(A). Attorneys must ask\nthe right questions, investigate as red flags answers from clients that do not add up or make sense.\nBut attorney are not private investigators charged with ferreting out fraud. Attorneys should and\ngenerally are not held liable if a client hides assets or files false schedules as long as the attorney\nasked the right questions and had no reason to suspect the fraud. Attorneys can be held liable for\ninformation provided by a client that the client asks the attorney to ignore. Bankruptcy attorneys\nneed to make it clear to their clients that they have special duties of disclosure under the bankruptcy\nlaws that over-ride confidentiality rules. I tell clients \xe2\x80\x9cIf you tell me something, I have to make\nsure that it is disclosed in your petition if I am going to represent you.\xe2\x80\x9d\n\n3.24.\n\nEligibility after Prior Bankruptcy Cases\n\nPrior bankruptcy cases pose a number of separate problems that are considered in various\nchapters of this book. As discussed in Chapter 11 (dealing with the discharge), debtors may not be\neligible for a discharge in a current case if they received a discharge in another bankruptcy case\nfiled within 2-8 years before the current case was filed. As discussed in Chapter 6 (dealing with\nthe automatic stay), the automatic stay preventing creditors from foreclosing on property after\nbankruptcy may automatically terminate in 30 days or never go into effect if one or more\nbankruptcy cases were previously filed and dismissed within a year before the new bankruptcy\ncase. These provisions do not prevent the filing of a new case per se, but may prevent the debtor\nfrom receiving the benefits that the debtor expects to receive from filing the new bankruptcy case.\n82\n\n\x0cSection 109(g) of the Bankruptcy code, on the other hand, directly prevents the filing the\nnew case if a previous case was dismissed within 180 days before the filing of the new case if (1)\nthe prior case was dismissed because the debtor failed to comply with court orders or properly\nprosecute the case, or (2) if the prior case was dismissed after the filing by a creditor of a motion\nfor relief from stay. 11 U.S.C. \xc2\xa7 109(g).\nThe second part of the provision is grossly overbroad and unfair if interpreted as written.\nThe statute assumes that the debtor dismissed the case because of the prior motion for relief from\nstay, and is abusing the bankruptcy process by filing a second case. But by its terms, section 109(g)\nwould apply even when the dismissal had nothing to do with the motion for relief from stay \xe2\x80\x93\nindeed even if the motion for relief from stay was denied!\nSome courts have mitigated the statutory language to prevent unfairness and hardship by\ninterpreting the statute purposively, where there was no connection between the relief from stay\nmotion and the dismissal. See In re Luna, 122 B.R. 575 (B.A.P. 9th Cir. Cal. 1991) (denying\ndismissal when result would be illogical, unintended and unjust); In re Santana, 110 B.R. 819\n(Bankr. W.D. Mich. 1990) (same). Some courts have read the words \xe2\x80\x9cfollowing the filing of a\nrequest for relief from the automatic stay\xe2\x80\x9d to mean that the request for dismissal must be prompted\nby the relief from stay motion. In re Duncan, 182 B.R. 156 (Bankr. W.D. Va. 1995). Most courts\nrequire that a proper motion for relief from stay be pending at the time the debtor requests and\nobtains the voluntary dismissal. See In re Jones, 99 B.R. 412 (Bankr. E.D. Ark. 1989); In re Milton,\n82 B.R. 637 (Bankr. S.D. Ga. 1988). In any case, the 180-day refiling rule remains a trap for the\nunwary that should be carefully considered by a debtor before seeking dismissal of a bankruptcy\ncase.\nIn cases of extreme abuse involving multiple bankruptcy re-filings, some courts have\nissued special injunctions prohibiting refiling. These injunctions might not affect the validity of\nthe new case, but should serve as a basis for holding the debtor in contempt of court for violating\nthe injunction.\n\n83\n\n\x0cChapter 4: The Bankruptcy Estate\nThere are two fundamental purposes of Chapter 7 of the Bankruptcy Code: (1) to establish\nan orderly system for liquidating (selling) the debtor\xe2\x80\x99s assets to pay creditors\xe2\x80\x99 claims, and (2) to\nprovide the debtor with a fresh start by discharging the debtor\xe2\x80\x99s pre-bankruptcy debts. In this\nchapter we begin the study of the process of liquidation and distribution to creditors.\n\n4.1.\n\nThe Estate\n\nSection 541 of the Bankruptcy Code provides that the filing of bankruptcy automatically\ncreates a new legal entity called the bankruptcy \xe2\x80\x9cestate.\xe2\x80\x9d The estate separates what property is\nowned by the debtor after bankruptcy from what property is to be sold to pay creditors. Section\n541 starts with a broad rule that everything owned by the debtor \xe2\x80\x93 all legal or equitable interest\nof the debtor in property \xe2\x80\x93 wherever located and by whomever held, as of the date that the\nbankruptcy case is filed \xe2\x80\x93 belongs to the bankruptcy estate. 11 U.S.C. \xc2\xa7 541(a). This creates a clear\nline dividing the property acquired by the debtor after bankruptcy from post-bankruptcy earnings\n(which belongs to the debtor free of the claims of pre-bankruptcy creditors), and property owned\nby the debtor on the petition date (which will be used to pay creditors).\nHowever, this broad language disguises many subtleties. To start with, what is \xe2\x80\x9cproperty\xe2\x80\x9d?\nDid the debtor have an \xe2\x80\x9cinterest\xe2\x80\x9d in the \xe2\x80\x9cproperty\xe2\x80\x9d on the petition date? If not, the non-property\nrights belong to the debtor not the bankruptcy estate.\n\n4.2.\n\nCases on Property of the Estate\n4.2.1.1.\nBOARD OF TRADE OF CHICAGO v. JOHNSON,\n264 U.S. 1 (1924)\n\nCHIEF JUSTICE TAFT\nWilson F. Henderson, the bankrupt, a citizen of Chicago, was admitted to membership in\nthe Board of Trade in 1899, and for many months prior to March 1, 1919, was president and one\nof the principal stockholders in a corporation known as Lipsey and Company, and actively engaged\nin making contracts on its behalf for present and future delivery of grain on the Board of Trade. In\nMarch, 1919, Lipsey and Company became insolvent and ceased to transact business, being then\nindebted to thirty or more members of the Exchange on its contracts in an aggregate amount of\nmore than $60,000.\nThe District Court, finding that the [bankrupt\xe2\x80\x99s] membership [in the Chicago Board of\nTrade] was property and under the rules of the Board passed to the trustee in bankruptcy free of\nall claims of the members, ordered that it be held for transfer and sale for the benefit of the general\ncreditors. [W]as its decree right upon the merits?\n[The Board of Trade alleged] that the membership was not property, or capable of being\ntreated as an asset of the bankrupt, that transfer of it had been duly objected to by respondents as\nmembers, and that they had adverse claims.\n84\n\n\x0cAny male person of good character and credit and of legal age . . . may be admitted to\nmembership in the Board of Trade by ten votes of the Board of Directors, provided that three votes\nare not cast against him and that he pays an initiation fee of $25,000, . . . signs "an agreement to\nabide by the Rules, Regulations and By-Laws of the Association." The rules further provide that a\nmember, if he has paid all assessments and has no outstanding claims held against him by\nmembers, and the membership is not in any way impaired or forfeited, may, upon payment of a\nfee of $250, transfer his membership to any person eligible to membership approved by the Board,\nafter ten days posting, both of the proposed transfer and of the name of substitute.\nNo rule exists giving to the Board of Trade or its members the right to compel sale or other\ndisposition of memberships to pay debts. The only right of one member against another, in securing\npayment of an obligation, is to prevent the transfer of the membership of the debtor member by\nfiling objection to such transfer with the Directors.\nThe membership of Henderson was worth $10,500 on January 24, 1920, when the petition\nin bankruptcy was filed against him. All assessments then due had been paid and the membership\nwas not in any way impaired and forfeited. On May 1, 1919, Henderson had posted on the bulletin\nof the Exchange a notice and application for a transfer of his membership. . . . [F]ive days after the\npetition in bankruptcy was filed, members, creditors of Lipsey and Company on its defaulted\ncontracts signed by Henderson, lodged with the Directors objections to the transfer.\nPetitioners insist that the membership is not property. The Supreme Court of Illinois, from\nwhich State this Board of Trade derives its charter, has held that the membership is not property\nor subject to judicial sale, basing its conclusion on the ground that it cannot be acquired except\nupon a vote of ten Directors, and cannot be transferred to another unless the transfer is approved\nby the same vote, and that it cannot be subjected to the payment of debts of the holder by legal\nproceedings.\nCongress derives its power to enact a bankrupt law from the Federal Constitution, and the\nconstruction of it is a federal question. Of course, where the bankrupt law deals with property\nrights which are regulated by the state law, the federal courts in bankruptcy will follow the state\ncourts; but when the language of Congress indicates a policy requiring a broader construction of\nthe statute than the state decisions would give it, federal courts cannot be concluded by them.\nCounsel for petitioners urges that the rules of the associations [do not give the board or its\nmembers who are creditors the power to sell the debtor\xe2\x80\x99s membership]. Their only protection is in\nthe power to prevent a transfer as long as the member\'s obligations to them are unperformed. We\ndo not think this makes a real difference in the character of the property which the member has in\nhis seat. He can transfer it or sell it subject to a right of his creditors to prevent his transfer or sale\ntill he settles with them, a right in some respects similar to the typical lien of the common law.\nWe think the seat is held by the Board for the bankrupt, and that in bankruptcy the right to\ndispose of it under the rules passes into the control, and therefore into the possession, of the trustee.\nThe District Court ordered the transfer and sale of the seat free from all the claims and\nobjections of the petitioners. The view of the court was that . . . the right of the member creditors\nto object to the transfer had been lost. We think that the District Court and the Circuit Court of\nAppeals erred on the merits of the case. The claims of the petitioners amount to more than sixty\nthousand dollars, and these must be satisfied before the trustee can realize anything on the transfer\nof the seat for the general estate.\n85\n\n\x0cReversed.\n\n4.2.1.2.\n\nBUTNER v. UNITED STATES, 440 U.S. 48 (1979)\n\nJUSTICE STEVENS\n[The] bankruptcy trustee and a second mortgagee [are engaged in a dispute] over [who has]\nthe right to the rents collected during the period between the mortgagor\'s bankruptcy and the\nforeclosure sale of the mortgaged property. [We] granted certiorari to decide whether the right to\nsuch rents is determined by a federal rule of equity or by the law of the State where the property\nis located.\n[P]etitioner acquired a second mortgage securing an indebtedness of $360,000. Petitioner\ndid not, however, receive any express security interest in the rents earned by the property.\n[After a failed attempt at reorganization,] Golden was adjudicated a bankrupt, and the\ntrustee in bankruptcy was appointed. At that time both the first and second mortgages were in\ndefault. The trustee was ordered to collect and retain all rents [pending a further order of the\nbankruptcy court.] [T]he properties were ultimately sold to petitioner by reducing the estate\'s\nindebtedness to petitioner from $360,000 to $186,000.\nAs of the date of sale, a fund of $162,971.32 [in rents from the property] had been\naccumulated by the trustee. . . . [P]etitioner filed a motion claiming a security interest in this fund\nand seeking to have it applied to the balance of the second mortgage indebtedness. The bankruptcy\njudge denied the motion, holding that the $186,000 balance due to petitioner should be treated as\na general unsecured claim.\nThe District Court recognized that under North Carolina law a mortgagor is deemed the\nowner of the land subject to the mortgage and is entitled to rents and profits, even after default, so\nlong as he retains possession. But the court viewed the appointment of an agent to collect rents\nduring the arrangement proceedings as tantamount to the appointment of a receiver. This\nappointment, the court concluded, satisfied the state-law requirement of a change of possession\ngiving the mortgagee an interest in the rents; no further action after the adjudication in bankruptcy\nwas required to secure or preserve this interest.\nThe Court of Appeals reversed. Because petitioner had made no request during the\nbankruptcy for a sequestration of rents or for the appointment of a receiver, petitioner had not, in\nthe court\'s view, taken the kind of action North Carolina law required to give the mortgagee a\nsecurity interest in the rents collected after the bankruptcy adjudication.\nWe did not grant certiorari to decide whether the Court of Appeals correctly applied North\nCarolina law. Our concern is with the proper interpretation of the federal statutes governing the\nadministration of bankrupt estates. Specifically, it is our purpose to resolve a conflict between the\nThird and Seventh Circuits on the one hand, and the Second, Fourth, Sixth, Eighth, and Ninth\nCircuits on the other, concerning the proper approach to a dispute of this kind.\nThe courts in the latter group regard the question whether a security interest in property\nextends to rents and profits derived from the property as one that should be resolved by reference\nto state law. In a few States, sometimes referred to as "title States," the mortgagee is automatically\nentitled to possession of the property, and to a secured interest in the rents. In most States, the\n86\n\n\x0cmortgagee\'s right to rents is dependent upon his taking actual or constructive possession of the\nproperty by means of a foreclosure, the appointment of a receiver for his benefit, or some similar\nlegal proceeding. Because the applicable law varies from State to State, the results in federal\nbankruptcy proceedings will also vary under the approach taken by most of the Circuits.\nThe Third and Seventh Circuits have adopted a federal rule of equity that affords the\nmortgagee a secured interest in the rents even if state law would not recognize any such interest\nuntil after foreclosure. Those courts reason that since the bankruptcy court has the power to deprive\nthe mortgagee of his state-law remedy, equity requires that the right to rents not be dependent on\nstate-court action that may be precluded by federal law. Under this approach, no affirmative steps\nare required by the mortgagee\xe2\x80\x94in state or federal court\xe2\x80\x94to acquire or maintain a right to the rents.\nWe agree with the majority view. The constitutional authority of Congress to establish\n"uniform Laws on the subject of Bankruptcies throughout the United States" would clearly\nencompass a federal statute defining the mortgagee\'s interest in the rents and profits earned by\nproperty in a bankrupt estate. But Congress has not chosen to exercise its power to fashion any\nsuch rule. Congress has generally left the determination of property rights in the assets of a\nbankrupt\'s estate to state law.\nProperty interests are created and defined by state law. Unless some federal interest\nrequires a different result, there is no reason why such interests should be analyzed differently\nsimply because an interested party is involved in a bankruptcy proceeding. Uniform treatment of\nproperty interests by both state and federal courts within a State serves to reduce uncertainty, to\ndiscourage forum shopping, and to prevent a party from receiving "a windfall merely by reason of\nthe happenstance of bankruptcy."\nThe minority of courts which have rejected state law have not done so because of any\ncongressional command, or because their approach serves any identifiable federal interest. Rather,\nthey have adopted a uniform federal approach to the question of the mortgagee\'s interest in rents\nand profits because of their perception of the demands of equity. The equity powers of the\nbankruptcy court play an important part in the administration of bankrupt estates in countless\nsituations in which the judge is required to deal with particular, individualized problems. But\nundefined considerations of equity provide no basis for adoption of a uniform federal rule\naffording mortgagees an automatic interest in the rents as soon as the mortgagor is declared\nbankrupt.\nIn support of their rule, the Third and Seventh Circuits have emphasized that while the\nmortgagee may pursue various state-law remedies prior to bankruptcy, the adjudication leaves the\nmortgagee "only such remedies as may be found in a court of bankruptcy in the equitable\nadministration of the bankrupt\'s assets." It does not follow, however, that "equitable\nadministration" requires that all mortgagees be afforded an automatic security interest in rents and\nprofits when state law would deny such an automatic benefit and require the mortgagee to take\nsome affirmative action before his rights are recognized. What does follow is that the federal\nbankruptcy court should take whatever steps are necessary to ensure that the mortgagee is afforded\nin federal bankruptcy court the same protection he would have under state law if no bankruptcy\nhad ensued. This is the majority view, which we adopt today.\nThe judgment is affirmed.\n87\n\n\x0c4.3.\n\nAftermath: Application to the Bankruptcy Code\n\nThe bankruptcy laws have changed since Board of Trade of Chicago and Buttner, calling\ninto question the actual holdings. Whether the members\xe2\x80\x99 hidden liens in Board of Trade of Chicago\nwould withstand a trustee\xe2\x80\x99s assault under the strong arm powers is a question to be considered\nlater in the course. Similarly, the Bankruptcy Code now contains a specific procedure for creditors\nlike Buttner to perfect their assignment of rents in bankruptcy. If state law requires the creditor to\nfile suit for foreclosure or seek the appointment of a receiver to perfect an assignment of rents, the\ncreditor can perfect the assignment of rents after bankruptcy by filing and serving a simple notice\nwith the bankruptcy court. See 11 U.S.C. \xc2\xa7 546(b)(2).\nHowever, these classic cases remain crucially important for the twin propositions that (1)\nfederal bankruptcy law defines whether the bundle of rights owned by the debtor on the date of\nbankruptcy constitutes \xe2\x80\x9cproperty,\xe2\x80\x9d and (2) in the absence of specific federal legislation state law\ndefines the bundle of rights owned by the debtor on the date of bankruptcy.\n\n4.4.\n\nPractice Problems. Property of the Estate\n\nAre the following \xe2\x80\x9cproperty of the estate\xe2\x80\x9d under 11 U.S.C. \xc2\xa7 541?\nProblem 1: Compromising photos (selfies) taken by the debtor (a well-known actress)\nwith her ex-boyfriend.\nProblem 2: Life insurance payments received by the debtor 200 days after the death of\nthe debtor\xe2\x80\x99s father. 11 U.S.C. \xc2\xa7 541(a)(5)(C).\nProblem 3: The debtor\xe2\x80\x99s dog \xe2\x80\x9cfluffie,\xe2\x80\x9d raised by the debtor since he was a puppy.\nProblem 4: The winning lottery ticket purchased by the debtor several days before\nbankruptcy for a drawing held several days after bankruptcy. 11 U.S.C. \xc2\xa7 541(a)(6).\nProblem 5: The debtor\xe2\x80\x99s winnings on the TV show \xe2\x80\x9cthe price is right\xe2\x80\x9d taped 2 days after\nbankruptcy. The debtor had been given the ticket to attend the TV show a month before\nbankruptcy. 11 U.S.C. \xc2\xa7 541(a)(6).\nProblem 6: Money held in an attorney\xe2\x80\x99s trust account, representing the proceeds from the\nsettlement of client cases. 11 U.S.C. \xc2\xa7 541(d).\nProblem 7: Money held in a spendthrift trust account administered by trustee Bank of\nNew York. The debtor\xe2\x80\x99s parents set up the account to provide for the debtor\xe2\x80\x99s support. The trust\nprevents the debtor from wasting the money by providing that the funds in the account could be\ndistributed by the Bank to the debtor only in an amount which the Bank determined was\nappropriate based on the debtor\xe2\x80\x99s needs. The debtor had no right to withdraw or assign the funds,\nand the trust provided that the funds were not subject to the claims of the debtor\xe2\x80\x99s creditors.\nCompare 11 U.S.C. \xc2\xa7 541(c)(1) and (c)(2).\nProblem 8: The debtor\xe2\x80\x99s right to royalties earned post-petition from the sale of the debtor\xe2\x80\x99s\nbestselling book \xe2\x80\x9chow to make $1,000,000 in the stock market without even trying.\xe2\x80\x9d See 11 U.S.C.\n\xc2\xa7 541(a)(6).\n88\n\n\x0cProblem 9: The debtor\xe2\x80\x99s interest in a rent controlled residential apartment in New York\nCity. The debtor has lived in the apartment since 1975, pays $300 per month in rent, and the fair\nrental value is $3,200 per month. The debtor failed to pay rent for the month prior to bankruptcy,\nthe landlord sent a 5 day notice to quit, and the debtor filed bankruptcy 6 days later. See 11 U.S.C.\n\xc2\xa7 541(b)(2).\nProblem 10: The debtor\xe2\x80\x99s right to receive a tax refund for the 2014 calendar tax year if the\ndebtor filed bankruptcy in 2015.\nProblem 11: The debtor\xe2\x80\x99s right to receive a tax refund for the 2014 calendar year if the\ndebtor filed bankruptcy in November 2014.\n\n4.5.\n\nCases on Mixed Prepetition and Post-Petition Earnings as\nProperty of the Estate\n4.5.1.1.\n\nIN RE BAGEN, 186 B.R. 824 (Bankr S.D.N.Y. 1995)\n\n[Debtor] Gregory W. Bagen ("Bagen"), and his wife filed a joint petition for bankruptcy\nrelief under Chapter 7 . . . on October 22, 1992. At the time of the bankruptcy filing, Bagen was\nthe attorney of record for various plaintiffs in personal injury actions pending in state courts. His\nprepetition retainer agreements provided for payment of attorney\'s fees to him contingent upon\nsettlement of or recovery in those actions. At the commencement of his bankruptcy case, the\npersonal injury actions were in various stages of litigation, from initial discovery to appeal.\nThe Chapter 7 Trustee seeks to apportion and recover for this estate only those attorney\'s\nfees earned prepetition (i.e., fees attributable to Bagen\'s prepetition services) and paid or to be paid\npostpetition.\nBagen advances two arguments: (1) the Second Circuit Court of Appeals has held, albeit\nunder the former Bankruptcy Act, that a debtor/attorney\'s contingent right to payment of fees is\nnot property of the bankruptcy estate; and (2) case law under the Code supports the proposition\nthat fees received postpetition, and attributable to prepetition contingent contracts, are not property\nof the bankruptcy estate if all acts necessary to earn those fees were not completed prepetition.\nPursuant to retainer agreements with his clients, Bagen is to receive payment only if the\ncondition precedent \xe2\x80\x94 successful resolution of the prepetition personal injury claims \xe2\x80\x94 occurs.\nThe issue, therefore, is whether a prepetition contingent contract right to payment is property of\nthe bankruptcy estate even though the debtor is entitled to nothing unless and until the condition\nprecedent occurs?\nIn In re Coleman, 87 F.2d 753 (2d Cir. 1937), the Second Circuit Court of Appeals held\nthat the fee earned under a bankrupt/attorney\'s prepetition contingent-fee contract, which had not\nresulted in a fund as of the petition date, was not property of the bankruptcy estate within the\nmeaning of section 70 of the Bankruptcy Act. The Second Circuit Court of Appeals conclude[ed]\nthat under New York State common law, an attorney would have no rights under a contingent-fee\ncontract until the "services were fully performed and a fund was created." Section 475 of the New\nYork Judiciary Law created a "new remedy," which does not give an attorney the right "to\ncompensation unless and until a fund was created by a judgment or settlement." Thus, the remedy\ncreated by the New York Judiciary Law was not property or a property right on the date bankruptcy\n89\n\n\x0cwas filed. Moreover, the Coleman court noted that for an asset to be considered property of the\nestate under section 70 [of the Bankruptcy Act], the asset must have a "calculable value." It\nconcluded that since there was no fund at the time the bankruptcy petition was filed, "[t]he services\nperformed [by the attorney] were then without property value within section 70 and might very\nwell have gone altogether uncompensated."\nWith the passage of the Code, Congress substantially broadened the scope of property of\nthe estate. According to the legislative history \xe2\x80\x9cThe bill determines what is property of the estate\nby a simple reference to what interests in property the debtor has at the commencement of the case.\nThis includes all interests, such as interests in real or personal property, tangible and intangible\nproperty, choses in action, causes of action, rights such as copyrights, trade-marks, patents, and\nprocesses, contingent interests and future interests, whether or not transferable by the debtor.\xe2\x80\x9d\nAs the legislative history to section 541 indicates, Congress intended property of the estate\nto include all interests of a debtor, including a debtor\'s contract right to future, contingent property.\nThus, the Coleman conclusion that section 475 of the New York Judiciary Law did not create a\nproperty right under the former Act does not preclude a finding that property of the estate under\nthe Code includes a debtor\'s contingent, contractual right to postpetition property.\nIn In re Sloan, 32 B.R. 607 (Bankr.E.D.N.Y.1983), the Chapter 7 trustee sought to include\nas property of the estate a finder\'s fee received by the debtor postpetition. The court concluded that\n"[t]he decisive factor in determining whether postpetition income of the debtor will be deemed\nproperty of the estate is whether that income accrues from post-petition services of the debtor." It\nnoted that postpetition income will be property of the estate only when "all the acts of the debtor\nnecessary to earn it are rooted in the pre-bankruptcy past." Thus, the court held that since the debtor\nwas not required to perform additional services postpetition, the finder\'s fee paid postpetition was\nproperty of the bankruptcy estate.\nIn concluding that the finder\'s fee was property of the bankruptcy estate, the court\ndistinguished In re Coleman: \xe2\x80\x9cNot only was Coleman decided under more stringent standards of\nthe former Bankruptcy Act, . . . but it involved a situation in which the bankrupt continued to\nperform services under his contingency fee. According to Sloan, the Trustee would be barred from\nrecovering anything under Bagen\'s prepetition contingent-fee contracts because of Bagen\'s\nobligation to perform post-petition services under those contracts.\nI respectfully disagree with that analysis. A debtor\'s continuing obligation to perform\npostpetition services . . . should not prevent the debtor\'s contingent contract right to future payment\nfrom becoming part of the bankruptcy estate. Although a right to payment may depend and be\nconditioned upon future performance, that right, nevertheless, may be property of the bankruptcy\nestate. By defining the term "property of the estate" broadly, Congress intended to encompass\ncontingent future payments that were subject to a condition precedent on the date of bankruptcy.\nAccordingly, those portions of Bagen\'s contingent attorney\'s fees which may be paid postpetition,\nbut were nevertheless earned and rooted in his prepetition past, should be includable in his\nbankruptcy estate.\nBagen\'s prepetition contingent contractual right to postpetition property is property of the\nestate pursuant to Code section 541(a)(1). Any postpetition payment made under the prepetition\ncontingent-fee contracts is property of this estate to the extent earned prepetition. The estate\'s\n90\n\n\x0cinterest in the future payment includes the entire sum paid less the amount attributable to services\nrendered postpetition.\nThe fact that a debtor must continue to perform services after bankruptcy (as a condition\nprecedent to payment) does not preclude a finding that the bankruptcy estate has an interest in the\ncontingent contract right to future payment. (Valuation of this interest is not before me on this\nmotion.) Accordingly, the Debtor\'s Motion to Dismiss Trustee\'s Complaint is denied.\n\n4.5.1.2.\n\nTOWERS v. WU, 173 B.R. 411 (9th Cir. BAP 1994)\n\nThe debtor, Sophia C.Y. Wu, has been employed as a "career agent" by State Mutual Life\nAssurance Company of America since 1983. As a career agent for State Mutual, the debtor is\nresponsible for selling insurance and annuity policies. Section 12 of the Career Agent Agreement\nobligates State Mutual to pay to the debtor while the agreement is in force, commissions on first\nyear and renewal premiums paid to State Mutual on insurance and annuity policies sold by the\ndebtor.\nThe debtor filed a Chapter 7 petition on March 29, 1991. From the commencement of the\nbankruptcy case through August 31, 1992, State Mutual paid the debtor $50,472.56 in renewal\ncommissions for policies sold prepetition.\nThe Chapter 7 trustee, Edward F. Towers, filed an adversary proceeding seeking to avoid\nthe payment of the postpetition renewal commissions under section 549(a) and to recover the value\nof these payments under section 550(a). On cross-motions for summary judgment, the bankruptcy\ncourt determined that the renewal commissions were not property of the estate because the\npayment of the commissions depended upon postpetition services by the debtor and the\ncommission payment structure adopted by the Career Agent Agreement reflects that the renewal\ncommissions are allocated to services performed postpetition. The trustee filed this timely appeal\nfrom the order denying his motion for summary judgment and granting the debtor\'s motion for\nsummary judgment.\nSection 541(a)(6) provides that the bankruptcy estate includes the "[p]roceeds, product,\noffspring, rents, and or profits of or from property of the estate, except such as are earnings from\nservices performed by an individual debtor after the commencement of the case." This case\nrequires us to determine whether the postpetition renewal commissions are included within the\nscope of the postpetition earnings exception contained in section 541(a)(6).\nWhile the Ninth Circuit has not addressed the question of postpetition renewal\ncommissions, it has addressed section 541(a)(6) in situations involving postpetition earnings that\narise, at least in part, out of prepetition services or prepetition property. In In re FitzSimmons, 725\nF.2d 1208 (9th Cir.1984), the court determined that while the earnings exception of Section\n541(a)(6) applied in the Chapter 11 case of a debtor engaged in a law practice as a sole proprietor,\nit did not remove all of the postpetition earnings of the law practice from the estate. The court held\nthat the earnings exception applies only to the earnings generated by services personally performed\nby the individual debtor postpetition. To the extent postpetition earnings are not attributable to\nsuch personal services but to the business\' invested capital, accounts receivable, goodwill,\nemployment contracts with the firm\'s staff, client relationships, fee agreements, or the like, the\nearnings are property of the estate.\n91\n\n\x0cSeveral courts in other jurisdictions have specifically addressed whether postpetition\nrenewal commissions are property of the estate. In order to determine this question, these courts\nhave generally focused upon the rights and obligations of the debtor pursuant to the employment\nagreement and whether the receipt of the commissions was dependent upon the performance of\npostpetition services. Where a debtor\'s postpetition services were not necessary to generate the\nrenewal commissions, courts have found the renewal commissions to be property of the estate.\nWhere, however, the contract required a debtor to remain employed by the insurer and to service\nthe existing policies or perform certain other services in order to receive the renewal commissions,\ncourts have found that postpetition services were necessary to generate the renewal commissions\nand the commissions were not property of the estate.\nThe opinions addressing the renewal commissions are helpful in analyzing whether\npostpetition services are necessary for renewal commissions under a given contract. These cases,\nhowever, make the entire analysis turn upon the presence of a requirement of postpetition services.\nUnder these cases, if there is such a requirement, all of the renewal commissions will be excluded\nfrom the estate. If there is not such a requirement, then all renewal commissions will be included\nin the estate.\nThis all or nothing approach is inconsistent with FitzSimmons which caution[s] us to\ndetermine the extent to which the earnings are attributable to prepetition property or prepetition\nservices. The proper analysis is to first determine whether any postpetition services are necessary\nto obtaining the payments at issue. If not, the payments are entirely "rooted in the pre-bankruptcy\npast,\xe2\x80\x9d and the payments will be included in the estate. If some postpetition services are necessary,\nthen courts must determine the extent to which the payments are attributable to the postpetition\nservices and the extent to which the payments are attributable to prepetition services. That portion\nof the payments allocable to postpetition services will not be property of the estate. That portion\nof the payments allocable to prepetition services or property will be property of the estate.\nIn this case, the bankruptcy court essentially followed this analysis. It determined that\nbecause the contract required that the debtor remain employed and provide a fixed amount of new\nbusiness in order to receive renewal commissions, postpetition services are required. The court\nthen determined that, although it is difficult to allocate the renewal commissions to prepetition or\npostpetition efforts, the manner in which the contracts in question provide for most of the\ncommission to be paid in the initial year of the policy and a much smaller percentage to be paid in\nsubsequent years reflects an allocation of the renewal commissions to the postpetition services\nrequired to generate renewals.\n[The Court then discusses whether post-petition services were required to receive the\nrenewal commissions, and determined that the question is not clear.] We determine that there is a\ndisputed factual issue as to whether the debtor\'s postpetition efforts are required for the receipt of\nthe renewal commissions. If postpetition services are required, there is also a disputed issue of\nmaterial fact\xe2\x80\x94 to what extent are the earnings properly allocable to postpetition and/or prepetition\nefforts of the debtor.\n\n4.5.1.3.\n\nSHARP v. DERY, 253 B.R. 204 (E.D. Mich. 2000)\n\nDebtor filed a Chapter 7 petition on December 21, 1998. At that time through February,\n1999, Valasis Communications, Inc. employed Debtor. On February 22, 1999, Debtor received an\n92\n\n\x0cemployee bonus of $11,331.63. The bonus plan was based upon a fiscal year of January 1 to\nDecember 31. To receive the bonus under the plan, a worker must have been employed in good\nstanding when the company issued the bonus checks; i.e., he must not have been fired or resigned\nduring the plan year or before issuance of the dividend. An exception existed for employees who\nretired, were disabled, or died during the fiscal year. In those cases, the plan administrator may\nhave, at his discretion, issued the employee a pro rata dividend.\nThe employer had the right to amend, suspend, or terminate the bonus plan at any time.\nThe timing of any bonus checks under the plan also was at the employer\'s sole discretion.\nDebtor did not disclose that he would receive a bonus when he filed his bankruptcy petition\nand schedules. At the \xc2\xa7 341 meeting, which was held just before Debtor received the bonus on\nFebruary 22, 1999, Debtor stated that the bonus\'s value would be lower than it ultimately was.\nPartly because of these factors, Debtor failed to qualify for a discharge under \xc2\xa7 727 of the\nBankruptcy Code.\nTrustee sought a determination from the bankruptcy court that the post-petition bonus was\nproperty of the estate. The bankruptcy court decided that it was, and ordered Debtor to turn over\nthe post-petition bonus to Trustee. Trustee is now holding those funds in escrow pending the\noutcome of this appeal.\nThe determinative issue in this case, therefore, is whether Debtor had an enforceable right\nto receive the bonus check when he filed his petition, December 21, 1998. The court below thus\nreasoned that, because the employer had no discretion as to the amount and timing of any bonus\nthat it decided to pay, Debtor had a right to the bonus as of December 21, and that bonus was\ntherefore the estate\'s property.\nThe bankruptcy court misconstrued the significance of the above fact. Although the\nemployer may have had no discretion over the amount of any bonus that it actually paid Debtor,\nas both parties agree, the bonus plan\'s terms gave the employer discretion as to whether it would\npay any bonus at all.\nThe bonus plan in this case requires that "an employee must be currently employed in good\nstanding." It is hard to imagine how an employer [employee?] who does not "satisfactorily perform\nhis job" could be "employed in good standing." Even if there were a difference between those two\nterms, however, the bonus plan at bar [has the following] dispositive characteristic: the employer,\nas of the date the debtor filed for bankruptcy, could have decided not to pay any bonus at all under\nthe terms of the bonus plan itself. [Under Michigan law] an employee who ends his employment\nbefore the closing date of a bonus period, thereby failing to establish a contractually-mandated\ncondition for receipt of the bonus, forfeits eligibility for the bonus dividend. As of December 21,\ntherefore, Debtor would have had no legally-recognized interests in the bonus check he later\nreceived on February 22.\nWhen post-petition income "is dependent upon the continued services of the debtor\nsubsequent to the petition, the amounts do not constitute property of the estate."\nThe post-petition services that a debtor need perform in order to trigger this rule are,\nmoreover, exceedingly slight. In Matter of Haynes, 679 F.2d 718 (7th Cir.1982), for example, the\nSeventh Circuit held that the pay of a military retiree was not part of the bankruptcy estate, because\nit was conditioned on his obligation to perform certain military duties if called upon to do so. The\n93\n\n\x0cHaynes court cited no example of the debtor ever actually having had to perform such an\nobligation. It merely reasoned that because the debtor "remained subject to the Uniform Code of\nMilitary Justice ... and could be recalled to active duty" in an emergency, his retirement pay was\ndependent upon continued services subsequent to the petition, and thus did not constitute property\nof the estate.\nIn this case, Debtor had to labor for his employer more than two months after the date of\nfiling in order to be eligible for his bonus pay. [I]t is apparent that his bonus check was "dependent\nupon the continued services of the debtor subsequent to the petition," such that it does "not\nconstitute property of the estate."\nAttempting to refute this conclusion, Trustee cites Towers v. Wu, 173 B.R. 411 (9th Cir.\nBAP 1994) for the proposition that the bonus check "will constitute property of the estate if it is\nsufficiently rooted in pre-petition activities." Trustee argues that the rationale of Wu would lead\nthe Court to apportion the bonus between the parts that Debtor earned pre-petition and postpetition, the former going to Trustee and the latter to Debtor. The Court rejects this argument for\nthree reasons.\nFirst, apportionment would be contrary to the plain language of \xc2\xa7 541. That statute, in\npertinent part, dictates that only "legal or equitable interests of the debtor in property as of the\ncommencement of the case" are included in the bankruptcy estate. 11 U.S.C. \xc2\xa7 541(a)(1).\nRegardless of how rooted Debtor\'s bonus might have been in prepetition activities, he had, for\nreasons discussed above, no "legal or equitable interests" in that dividend when the case began on\nDecember 21, 1998. Under the clear language of the statute, therefore, the Court cannot apportion\nany part of that bonus dividend to the estate.\nEven if the text were unclear, legislative history would provide a second reason for this\nCourt\'s conclusion. As both the House of Representatives and Senate Reports make plain, \xc2\xa7 541\n"is not intended to expand the debtor\'s rights against others more than they exist at the\ncommencement of the case." A trustee, moreover, "could take no greater rights than the debtor\nhimself had" on the day of filing the bankruptcy petition. The Court, accordingly, may apportion\nno part of the bonus plan to pre-petition services and allot that portion to the estate.\nThe third reason that this Court decides it cannot apportion the part of Debtor\'s bonus\nattributable to his pre-petition services to the estate is that the chief decisions upon which the Wu\ncourt relied are consistent with such a holding. . . . Thus did the Ninth Circuit gives its imprimatur\nto apportionment, but only to the extent that it would allocate funds to the estate in which the\ndebtor had cognizable rights as of the petition date. Here, Debtor had no discernible right to his\nbonus check as of the petition date.\nThe plain text of \xc2\xa7 541(a)(1) does not allow for apportionment, and apportionment would\nbe contrary to Congress\'s intent. What authority there is to the contrary, moreover, is unpersuasive.\nThe Court may not, therefore, apportion Debtor\'s bonus dividend.\nREVERSED. Trustee will transfer the $11,331.63 in bonus-dividend funds that it holds in\nescrow to Debtor within seven days of receipt of this order.\n\n94\n\n\x0cChapter 5: Exemptions\n5.1.\n\nExemptions\n\nThis chapter follows what may have appeared to be a pretty bleak picture for debtors\nseeking bankruptcy protection. In the last chapter we learned that debtors must turn over to the\ntrustee all of their property, which becomes property of the estate, for liquidation. That picture is\nnot accurate, however, because an individual debtor is allowed to remove from the property of\nthe estate, and keep, any property that is exempt. 11 U.S.C. \xc2\xa7 522(b)(1). Determining what\nproperty is exempt is therefore extremely important to the individual Chapter 7 debtor.\nWhile the statute suggests that the debtor recovers exempt property from the estate after\nturning over all property, in practice the debtor simply does not turn over to the trustee the exempt\nproperty. Instead, the debtor turns over to the trustee only that property which is not exempt.\nExemptions are not directly relevant to the reorganization chapters because an individual\ndebtor is allowed to keep all of his or her property in reorganization, regardless of whether the\nproperty is exempt or not. However, the exemptions come into play indirectly in reorganization\ncases as well, because the individual debtor must show that creditors will receive more in present\nvalue under the reorganization plan than they would receive in Chapter 7 liquidation. Thus, the\nreorganizing debtor does not have to \xe2\x80\x9cpay\xe2\x80\x9d out of future earnings for property that would be\nexempt in Chapter 7.\nNote that entity debtors, such as corporations and partnerships, are not entitled to\nexemptions. 11 U.S.C. \xc2\xa7 522(b)(1), emphasis added (\xe2\x80\x9can individual debtor may exempt from\nproperty of the estate . . .\xe2\x80\x9d). All property owned by corporate debtors becomes property of the\nestate. A corporate debtor in Chapter 7 has no post-petition earnings that are separate from the\nbankruptcy estate since the corporation is nothing more than the property it owns, and therefore\nall corporate post-petition earnings must have grown out of the bankruptcy estate. See 11 U.S.C.\n\xc2\xa7 541(a)(6) (property of the estate includes all post-petition earnings from property of the estate).\nThe corporate debtor after a Chapter 7 liquidation has been completed is an asset-less shell that\nhas no ability to continue in business. Chapter 7 is corporate death (although the process for\nterminating the corporation\xe2\x80\x99s legal status under state law should be followed). An individual\nhuman debtor, however, lives on, keeping his or her exempt property and all post-petition earnings\nfrom the individual debtor\xe2\x80\x99s labor.\nThere are two separate exemption schemes recognized in bankruptcy: (1) a federal\nexemption scheme in section 522(d) of the Bankruptcy Code, and (2) the applicable nonbankruptcy exemption scheme in the debtor\xe2\x80\x99s applicable state (which is used under state law to\nprevent judgment creditors from levying the debtor\xe2\x80\x99s exempt property), plus any non-bankruptcy\nfederal exemptions that are available to the debtor.\nThe Bankruptcy Code allows the debtor to elect to use either the Bankruptcy Code\xe2\x80\x99s\nexemptions, or the applicable state exemptions plus the non-bankruptcy federal exemptions, unless\nthe debtor\xe2\x80\x99s applicable state as \xe2\x80\x9copted out\xe2\x80\x9d \xe2\x80\x93 by prohibiting its debtors from using the federal\nbankruptcy exemptions. 11 U.S.C. \xc2\xa7 522(b). In \xe2\x80\x9copt out\xe2\x80\x9d states, the debtor must use the state\nexemptions (together with non-bankruptcy federal exemptions).\n95\n\n\x0cThe first step in analyzing exemptions is to determine which state\xe2\x80\x99s exemption laws are\napplicable to the debtor. In order to discourage debtors from moving between states in an attempt\nto utilize more favorable exemptions, the Bankruptcy Code looks at two time periods in\ndetermining which state\xe2\x80\x99s exemption laws apply.\nFirst, if a debtor has been domiciled (resided) in a single state continuously for the 730\ndays (2 years) before filing bankruptcy, the debtor will use that state\xe2\x80\x99s exemption laws. 11 U.S.C.\n\xc2\xa7 522(b)(3)(A).\nSecond, if the debtor has not been domiciled in a single state continuously for 730 (2 years)\nbefore bankruptcy, then the applicable period is the 180 days (6 mos) before the 730 day period.\nIn that case, the question becomes \xe2\x80\x9cin what state was the debtor domiciled the most during the\n180 day period.\xe2\x80\x9d Id.\n\n5.2.\n\nPractice Problems: Which State\xe2\x80\x99s Exemptions Apply?\n\nRead 11 U.S.C. \xc2\xa7 522(b)(3)(A), and answer the following questions:\nProblem 1. Debtor was born and lived in Georgia for 50 years before deciding that he\nneeded to file bankruptcy. After visiting a local bankruptcy lawyer, debtor learned that the\nexemption laws in the State of Florida are much more generous to him than the exemption laws in\nthe State of Georgia. On the advice of his attorney, debtor moved to Florida, waited two years and\ntwo days, and then filed bankruptcy in Florida, claiming the Florida exemptions. Is he eligible for\nthe Florida exemptions?\nProblem 2. Suppose that the debtor in Problem 1, after living in Florida for only 100 days,\nreceived a good job offer in North Dakota, and decided to move. If the debtor wants to use Florida\xe2\x80\x99s\nexemptions (rather than Georgia\xe2\x80\x99s or North Dakota\xe2\x80\x99s), what is the shortest amount of time he\nshould wait after moving to North Dakota before filing his bankruptcy petition?\n\n5.3.\n\nElecting the State or Federal Exemption Scheme\n\nDebtors subject to the exemption laws of a state that has opted out by precluding its debtors\nfrom electing the federal bankruptcy exemptions must use the state\xe2\x80\x99s exemption scheme. 11 U.S.C.\n\xc2\xa7 522(b)(1). About two thirds of the states have opted out (as of this writing, 19 states allow the\nelection between the state and federal exemptions).\nThe exemptions provided by state law vary greatly across the county. Some states have\nextremely generous exemptions (such as Florida and Texas, allowing debtors to exempt an\nunlimited amount of equity in a home), while others states are rather miserly (no homestead in\nNew Jersey and Pennsylvania). Most states exempt the basics: clothing, household goods, a few\nthousand dollars of equity in a car, tools of the trade, and the like. State exemption statutes were\ndrafted primarily to protect the debtor\xe2\x80\x99s necessary property from the claims of unsecured judgment\ncreditors. Both in and out of bankruptcy, exemptions do not protect against consensual liens. It\nis the value of the property in excess of any consensual liens, the debtor\xe2\x80\x99s equity in the property,\nthat is subject to exemption.\nThe federal bankruptcy exemptions are set forth in 11 U.S.C. \xc2\xa7 522(d). Most debtors who\nare allowed to elect, and do not have a lot of home equity, are better off using the federal\n96\n\n\x0cexemptions rather than the state exemptions because of the so-called \xe2\x80\x9cwild card,\xe2\x80\x9d 11 U.S.C. \xc2\xa7\n522(d)(5), which allows a debtor who does not claim a homestead exemption to exempt nearly\n$12,000 of \xe2\x80\x9cany property,\xe2\x80\x9d which includes cash, tax refunds, and property having a value\nexceeding the limited exemption amounts otherwise available.\nState homestead exemptions are often larger than the federal homestead exemption \xe2\x80\x93 often\nsignificantly larger. If the debtor has a large amount of equity in a home, and the state allows a\nlarge homestead exemption, then the debtor may be better off using the state exemptions even at\nthe cost of giving up the federal wild card exemption. Also, the federal exemptions are not\navailable in states that have opted out of the federal scheme. Choosing exemptions is thus a\ncomplex matter of determining whether both the federal and state schemes are available to the\ndebtor, and then evaluating whether the debtor is better off under the federal or state scheme.\nIt is important to remember that exemptions do not free the debtor\xe2\x80\x99s property from liens.\n11 U.S.C. \xc2\xa7 522(c). What is exempted is the debtor\xe2\x80\x99s equity in the property (the value of the\nproperty in excess of liens). However, as is discussed below in Section 5.9, two kinds of liens can\nbe avoided if they impair exemptions: (1) judicial liens, and (2) non-possessory, non-purchase\nmoney liens on household goods. 11 U.S.C. \xc2\xa7 522(f). Avoidance is not automatic \xe2\x80\x93 the debtor must\nfile a separate adversary proceeding to avoid the liens.\nValuing property for exemption purposes is a complex and confusing issue. The\nBankruptcy Code requires the use of \xe2\x80\x9cfair market value,\xe2\x80\x9d a term that is not defined in the\nBankruptcy Code. 11 U.S.C. \xc2\xa7 522(a)(2). In the business world, fair market value is the price a\nwilling buyer would pay a willing seller with full information and neither under compulsion. It is\nalways a hypothetical value because there is no market transaction taking place. One thing is clear,\nit is the \xe2\x80\x9cfair market value\xe2\x80\x9d of the property in its current condition \xe2\x80\x93 not the value of the property\nwhen new.\nA purposive approach to valuation would require the court to determine the amount that\nthe trustee could receive from the sale of the property, which may well be lower than the traditional\nmeasure of fair market value. The purpose of the exemptions is to determine whether the trustee\ncan sell the property and use the proceeds above the exemption amount to pay creditors. The debtor\nwould have to receive the exempt amount from the sale, and the estate would get the benefit of the\nproceeds over the exempt amount. Some courts have accepted this purposive approach, while\nothers have rejected it. Compare In re Walsh, 5 B.R. 239 (Bankr. D.C. 1980) (use of \xe2\x80\x9cliquidation\nvalue\xe2\x80\x9d appropriate), and In re Sumerell, 194 B.R. 818 (Bankr. D.D. Tenn. 1996) (liquidation value\ninconsistent with fair market value).\nIt is not clear what would happen in those jurisdictions that have rejected the trustee resale\nvalue approach. For example, assume the debtor has a diamond ring that is exempt in the amount\nof $1,550 under 11 U.S.C. \xc2\xa7 522(d)(4). Assume that the bankruptcy court has determined that the\nring has a \xe2\x80\x9cfair market value\xe2\x80\x9d of $1,800, but the trustee is only able to sell it for $1,400. If the\ntrustee were allowed to sell it for less than the exemption amount on the basis of the court\xe2\x80\x99s\nvaluation, the debtor would be deprived of the full value of the exemption, which would not serve\nthe purpose of the exemption statute. On the other hand, if the trustee were able to sell it for $1,600,\nthen the Debtor would receive the $1,550 exemption amount and the trustee would keep the\nremaining $50 to pay creditors \xe2\x80\x93 serving the purpose of the statute. Using a value different from\nthe amount the trustee could recover does not work in practice to preserve the debtor\xe2\x80\x99s exemption.\n97\n\n\x0cAs we will discuss later, a different question arises in the reorganization chapters when the\ncourt is valuing property to determine the portion of a claim that is secured under Section 506 of\nthe Bankruptcy Code. As will be discussed later, valuation serves a very different purpose under\nthe reorganization chapters than it does under the exemption statutes. The proper measure of value\nfor exemption purposes is the value that the trustee would receive from an orderly sale of the\nproperty.\n\n5.4.\n\nPractice Problems: The Federal Exemptions.\n\nProblem 1: Debtors (husband and wife filing jointly) own the following property. What\ncan be exempted under 11 U.S.C. \xc2\xa7 522(d) of the Bankruptcy Code?\na.\nThe mobile home that the debtors live in (costing $30,000, but currently\nworth $6,000). The mobile home sits on a 100 acre farm worth $24,000;\nb.\nA John Deere tractor worth about $7,000;\nc.\nFurniture (couch, chairs, beds, dressers and the like) costing $4,000, but\ncurrently worth very little, maybe $500. But the debtors also own a 200 year old antique\ndining table inherited years ago from the husband\xe2\x80\x99s grandmother worth $3,000;\nd.\nClothing costing $800, worth very little;\ne.\nThe debtors\xe2\x80\x99 champion Siamese show cat purchased as a kitten for $1,000\nnow worth $2,500;\nf.\nThe wife\xe2\x80\x99s diamond wedding ring, costing $3,000, and having an appraised\ninsurance value of $2,800. Debtors took the ring to a local jewelry store/pawn shop, and\nwas offered only $400 for the ring.\ng.\n$5,400 in the debtor\xe2\x80\x99s checking account, and $300 in the debtor\xe2\x80\x99s cash jar.\nh.\nDebtor\xe2\x80\x99s farming tools costing $7,000 and having a liquidation value of\n$500;\ni.\nTwo 50 inch plasma flat screen TVs, one in the living room and one in the\nbedroom. Each cost $3,000 new, but the current liquidation value is $400 each. See 11\nU.S.C. \xc2\xa7 522(f)(4)(A).\nj.\n$250,000 in the debtor wife\xe2\x80\x99s retirement account at work.\nProblem 2: If your client rolled over a $1,400,000 company retirement account (401(k))\ninto an IRA after losing her job, will her exemption be limited? See 11 U.S.C. \xc2\xa7 522(n).\nProblem 3: Debtor filed bankruptcy in New York on December 31, 2014. Debtor lived in\nTennessee from January 2010-December 31, 2013, and in New York from December 31, 2013 to\nDecember 31, 2014. Debtor sold his house in Tennessee on December 20, 2013 for $250,000, paid\noff the $200,000 mortgage, and invested the $50,000 balance in a new home in Syracuse, New\nYork. The new home cost $200,000, and the debtor borrowed $150,000 from a bank to make the\npurchase. The bank currently holds a mortgage with a loan balance of $140,000, and the house is\nworth $250,000. New York allows a $75,000 homestead exemption for property owned in New\nYork, and Tennessee allows a $75,000 homestead exemption for property owned in Tennessee.\nAssume that Tennessee has opted out of the federal exemptions. Can the debtor claim a homestead\nexemption on the New York home, and if so in what amount?\n98\n\n\x0cNOTE: The cases on this dealing with this question are all over the map. Some\ncourts say a former state\xe2\x80\x99s exemptions always apply to a new state (even if\nrestricted in the state\xe2\x80\x99s exemption statute), while other courts restrict a state\xe2\x80\x99s\nexemptions to its own state even if the statute is silent about where the exemptions\napply. Compare In re Drenttel, 403 F.3d 611 (8th Cir. 2005) (applying old states\nexemptions in new state where old state\xe2\x80\x99s statute does not specifically limit\nexemptions to property held in state); In re Tanzi, 287 B.R. 557 (Bankr. W.D.\nWash. 2002) (debtor could use either Washington or California exemptions on\nFlorida residence), and In re Stratton, 269 B.R. 716 (Bankr. D. Or. 2001) (Oregon\nhomestead exemption could be used for California property) with In re Sipka, 149\nB.R. 181 (D. Kan. 1992) (cannot use Kansas homestead exemptions after moving\nto Michigan), and In re Peters, 91 B.R. 401 (Bankr. W.D. Tex. 1988) (Texas\nhomestead exemption, which was limited by statute to homesteads in Texas, cannot\nbe used to exempt an out-of-state residence). In the states that interpret the old\nstates\xe2\x80\x99 statutes not to apply in the new state, the debtor is generally entitled to use\nthe federal exemptions even if the old state opted out of the federal exemptions. See\nflush language following 11 U.S.C. \xc2\xa7 522(b)(3).\n\n5.5.\n\nCases on the Allowance of Exemptions\n5.5.1.1.\nTAYLOR v. FREELAND & KOONZ, 503 U.S. 638\n(1992)\n\nJUSTICE THOMAS delivered the opinion of the Court.\nSection 522(l) of the Bankruptcy Code requires a debtor to file a list of the property that\nthe debtor claims as statutorily exempt from distribution to creditors. Federal Rule of Bankruptcy\nProcedure 4003 affords creditors and the bankruptcy trustee 30 days to object to claimed\nexemptions. We must decide in this case whether the trustee may contest the validity of an\nexemption after the 30-day period if the debtor had no colorable basis for claiming the exemption.\nThe debtor in this case, Emily Davis, declared bankruptcy while she was pursuing an\nemployment discrimination claim in the state courts. Davis alleged that her employer, Trans World\nAirlines (TWA), had denied her promotions on the basis of her race and sex. In October 1984,\nDavis filed a Chapter 7 bankruptcy petition, and petitioner Robert J. Taylor, became the trustee of\nDavis\' bankruptcy estate. On a schedule filed with the Bankruptcy Court, Davis claimed as exempt\nproperty the money that she expected to win in her discrimination suit against TWA. She described\nthis property as "Proceeds from lawsuit\xe2\x80\x94[Davis] v. TWA" and "Claim for lost wages" and listed\nits value as "unknown." [emphasis added]\nTaylor decided not to object to the claimed exemption. The record reveals that Taylor\ndoubted that the lawsuit had any value. Taylor at one point explained: "I have had past experience\nin examining debtors . . . [.] [M]any of them . . . indicate they have potential lawsuits. . . . [M]any\nof them do not turn out to be advantageous and . . . many of them might wind up settling far within\nthe exemption limitation." Taylor also said that he thought Davis\' discrimination claim against\nTWA might be a "nullity."\n99\n\n\x0cTaylor proved mistaken. In October 1986, the Pennsylvania Supreme Court affirmed the\nCommonwealth Court\'s determination that TWA had discriminated against Davis. In a subsequent\nsettlement of the issue of damages, TWA agreed to pay Davis a total of $110,000. Upon learning\nof the settlement, Taylor filed a complaint against respondents in the Bankruptcy Court. He\ndemanded that respondents turn over the money that they had received from Davis because he\nconsidered it property of Davis\' bankruptcy estate. Respondents argued that they could keep the\nfees because Davis had claimed the proceeds of the lawsuit as exempt.\n[Bankruptcy Rule 4003(b) provides:] "The trustee or any creditor may file objections to\nthe list of property claimed as exempt within 30 days after the conclusion of the meeting of\ncreditors held pursuant to Rule 2003(a) . . . unless, within such period, further time is granted by\nthe court."\nThe parties agree that Davis did not have a right to exempt more than a small portion of\nthese proceeds either under state law or under the federal exemptions specified in \xc2\xa7 522(d). Davis\nin fact claimed the full amount as exempt. Taylor, as a result, apparently could have made a valid\nobjection under \xc2\xa7 522(l) and Rule 4003 if he had acted promptly. We hold, however, that his failure\nto do so prevents him from challenging the validity of the exemption now.\nTaylor argues that his failure to object does not preclude him from challenging the\nexemption after expiration of the 30-day period if the debtor did not have a good-faith or\nreasonably disputable basis for claiming it. In this case, Taylor asserts, Davis did not have a\ncolorable basis for claiming all of the lawsuit proceeds as exempt and thus lacked good faith.\nWe reject Taylor\'s argument. Deadlines may lead to unwelcome results, but they prompt\nparties to act and they produce finality. In this case, despite what respondents repeatedly told him,\nTaylor did not object to the claimed exemption. If Taylor did not know the value of the potential\nproceeds of the lawsuit, he could have sought a hearing on the issue, see Rule 4003(c), or he could\nhave asked the Bankruptcy Court for an extension of time to object, see Rule 4003(b). Having\ndone neither, Taylor cannot now seek to deprive Davis and respondents of the exemption.\nTaylor suggests that our holding will create improper incentives. This concern, however,\ndoes not cause us to alter our interpretation of \xc2\xa7 522(l). Debtors and their attorneys face penalties\nunder various provisions for engaging in improper conduct in bankruptcy proceedings. See, e. g.,\n11 U.S.C. \xc2\xa7 727(a)(4)(B) (authorizing denial of discharge for presenting fraudulent claims); Rule\n1008 (requiring filings to "be verified or contain an unsworn declaration" of truthfulness under\npenalty of perjury); Rule 9011 (authorizing sanctions for signing certain documents not "well\ngrounded in fact and . . . warranted by existing law or a good faith argument for the extension,\nmodification, or reversal of existing law"); 18 U.S.C. \xc2\xa7 152 (imposing criminal penalties for fraud\nin bankruptcy cases). These provisions may limit bad-faith claims of exemptions by debtors. To\nthe extent that they do not, Congress may enact comparable provisions to address the difficulties\nthat Taylor predicts will follow our decision. We have no authority to limit the application of \xc2\xa7\n522(l) to exemptions claimed in good faith.\n\n100\n\n\x0c5.5.1.2.\n\nSCHWAB v. REILLY, 30 S. Ct. 2652 (2010)\n\nJUSTICE THOMAS delivered the opinion of the Court.\nThis case presents an opportunity for us to resolve a disagreement among the Courts of\nAppeals about what constitutes a claim of exemption to which an interested party must object\nunder \xc2\xa7 522 (l). The issue is whether an interested party must object to a claimed exemption where,\nas here, the Code defines the property the debtor is authorized to exempt as an interest, the value\nof which may not exceed a certain dollar amount, in a particular type of asset, and the debtor\'s\nschedule of exempt property accurately describes the asset and declares the "value of [the] claimed\nexemption" in that asset to be an amount within the limits that the Code prescribes. We hold that,\nin cases such as this, an interested party need not object to an exemption claimed in this manner in\norder to preserve the estate\'s ability to recover value in the asset beyond the dollar value the debtor\nexpressly declared exempt.\nRespondent Nadejda Reilly filed for Chapter 7 bankruptcy when her catering business\nfailed. The assets Reilly listed on Schedule B included an itemized list of cooking and other kitchen\nequipment that she described as "business equipment," and to which she assigned an estimated\nmarket value of $10,718.\nOn Schedule C, Reilly claimed two exempt interests in this equipment pursuant to different\nsections of the Code. Reilly claimed a "tool[s] of the trade" exemption of $1,850 in the equipment\nunder \xc2\xa7 522(d)(6), and she claimed a miscellaneous exemption of $8,868 in the equipment under\n\xc2\xa7 522(d)(5), which, at the time she filed for bankruptcy, permitted a debtor to take a "wildcard"\nexemption equal to the "debtor\'s aggregate interest in any property, not to exceed" $10,225 "in\nvalue. The total value of these claimed exemptions ($10,718) equaled the value Reilly separately\nlisted on Schedules B and C as the equipment\'s estimated market value.\nSubject to exceptions not relevant here, the Federal Rules of Bankruptcy Procedure require\ninterested parties to object to a debtor\'s claimed exemptions within 30 days after the conclusion of\nthe creditors\' meeting held pursuant to Rule 2003(a). If an interested party fails to object within\nthe time allowed, a claimed exemption will exclude the subject property from the estate even if\nthe exemption\'s value exceeds what the Code permits. See Taylor v. Freeland & Kronz, 503 U.S.\n638 (1992).\nPetitioner William G. Schwab, the trustee of Reilly\'s bankruptcy estate, did not object to\nReilly\'s claimed exemptions in her business equipment because the dollar value Reilly assigned\neach exemption fell within the limits that \xc2\xa7\xc2\xa7 522(d)(5) and (6) prescribe. But because an appraisal\nrevealed that the total market value of Reilly\'s business equipment could be as much as $17,200,\nSchwab moved the Bankruptcy Court for permission to auction the equipment so Reilly could\nreceive the $10,718 she claimed as exempt, and the estate could distribute the equipment\'s\nremaining value (approximately $6,500) to Reilly\'s creditors.\nReilly opposed Schwab\'s motion. She argued that she had put Schwab and her creditors on\nnotice that she intended to exempt the equipment\'s full value, even if that amount turned out to be\nmore than the dollar amount she declared, and more than the Code allowed. [The Bankruptcy Court\nand] the Court of Appeals agreed that by equating on Schedule C the total value of her exemptions\nin her business equipment with the equipment\'s market value, Reilly "indicate[d] the intent" to\nexempt the equipment\'s full value. In reaching this conclusion, the Court of Appeals relied on our\n101\n\n\x0cdecision in Taylor: "`[A]n unstated premise\' of Taylor was `that a debtor who exempts the entire\nreported value of an asset is claiming the "full amount," whatever it turns out to be.\'"\nWe conclude that the Court of Appeals\' approach fails to account for the text of the relevant\nCode provisions and misinterprets our decision in Taylor. Accordingly, we reverse.\nThe portion of \xc2\xa7 522(l) that resolves this case is not, as Reilly asserts, the provision stating\nthat the "property claimed as exempt on [Schedule C] is exempt" unless an interested party objects.\nRather, it is the portion of \xc2\xa7 522(l) that defines the target of the objection, namely, the portion that\nsays Schwab has a duty to object to the "list of property that the debtor claims as exempt under\nsubsection (b)." (Emphasis added.) That subsection, \xc2\xa7 522(b), does not define the "property\nclaimed as exempt" by reference to the estimated market value on which Reilly and the Court of\nAppeals rely. section 522(b) refers only to property defined in \xc2\xa7 522(d), which in turn lists 12\ncategories of property that a debtor may claim as exempt. As we have recognized, most of these\ncategories (and all of the categories applicable to Reilly\'s exemptions) define the "property" a\ndebtor may "clai[m] as exempt" as the debtor\'s "interest"\xe2\x80\x94up to a specified dollar amount\xe2\x80\x94in the\nassets described in the category, not as the assets themselves.\nViewing Reilly\'s form entries in light of this definition, we agree with Schwab and the\nUnited States that Schwab had no duty to object to the property Reilly claimed as exempt (two\ninterests in her business equipment worth $1,850 and $8,868) because the stated value of each\ninterest, and thus of the "property claimed as exempt," was within the limits the Code allows.\nFor all of these reasons, we conclude that Schwab was entitled to evaluate the propriety of\nthe claimed exemptions based on three, and only three, entries on Reilly\'s Schedule C: the\ndescription of the business equipment in which Reilly claimed the exempt interests; the Code\nprovisions governing the claimed exemptions; and the amounts Reilly listed in the column titled\n"value of claimed exemption." In reaching this conclusion, we do not render the market value\nestimate on Reilly\'s Schedule C superfluous. We simply confine the estimate to its proper role:\naiding the trustee in administering the estate by helping him identify assets that may have value\nbeyond the dollar amount the debtor claims as exempt, or whose full value may not be available\nfor exemption because a portion of the interest is, for example, encumbered by an unavoidable\nlien.\nThe Court of Appeals erred in holding that our decision in Taylor dictates a contrary\nconclusion. The debtor in Taylor, like the debtor here, filed a schedule of exemptions with the\nBankruptcy Court on which the debtor described the property subject to the claimed exemption,\nidentified the Code provision supporting the exemption, and listed the dollar value of the\nexemption. Critically, however, the debtor in Taylor did not, like the debtor here, state the value\nof the claimed exemption as a specific dollar amount at or below the limits the Code allows.\nInstead, the debtor in Taylor listed the value of the exemption itself as "$ unknown":\nThe interested parties in Taylor agreed that this entry rendered the debtor\'s claimed\nexemption objectionable on its face because the exemption concerned an asset (lawsuit proceeds)\nthat the Code did not permit the debtor to exempt beyond a specific dollar amount. Accordingly,\nalthough this case and Taylor both concern the consequences of a trustee\'s failure to object to a\nclaimed exemption within the time specified by Rule 4003, the question arose in Taylor on starkly\ndifferent facts. In Taylor, the question concerned a trustee\'s obligation to object to the debtor\'s\nentry of a "value claimed exempt" that was not plainly within the limits the Code allows. In this\n102\n\n\x0ccase, the opposite is true. The amounts Reilly listed in the Schedule C column titled "Value of\nClaimed Exemption" are facially within the limits the Code prescribes and raise no warning flags\nthat warranted an objection.\nTaylor supports this conclusion. In holding otherwise, the Court of Appeals focused on\nwhat it described as Taylor\'s "`unstated premise\'" that "`a debtor who exempts the entire reported\nvalue of an asset is claiming the "full amount," whatever it turns out to be.\'" But Taylor does not\nrest on this premise. It establishes and applies the straightforward proposition that an interested\nparty must object to a claimed exemption if the amount the debtor lists as the "value claimed\nexempt" is not within statutory limits, a test the value ($ unknown) in Taylor failed, and the values\n($8,868 and $1,850) in this case pass.\nWe adhere to this test. We take Reilly\'s exemptions at face value and find them\nunobjectionable under the Code, so the objection deadline we enforced in Taylor is inapplicable\nhere. Where, as here, it is important to the debtor to exempt the full market value of the asset or\nthe asset itself, our decision will encourage the debtor to declare the value of her claimed\nexemption in a manner that makes the scope of the exemption clear, for example, by listing the\nexempt value as "full fair market value (FMV)" or "100% of FMV." Such a declaration will\nencourage the trustee to object promptly to the exemption if he wishes to challenge it and preserve\nfor the estate any value in the asset beyond relevant statutory limits. If the trustee fails to object,\nor if the trustee objects and the objection is overruled, the debtor will be entitled to exclude the\nfull value of the asset. If the trustee objects and the objection is sustained, the debtor will be\nrequired either to forfeit the portion of the exemption that exceeds the statutory allowance, or to\nrevise other exemptions or arrangements with her creditors to permit the exemption. Either result\nwill facilitate the expeditious and final disposition of assets, and thus enable the debtor (and the\ndebtor\'s creditors) to achieve a fresh start free of the finality and clouded-title concerns Reilly\ndescribes.\nWhere, as here, a debtor accurately describes an asset subject to an exempt interest and on\nSchedule C declares the "value of [the] claimed exemption" as a dollar amount within the range\nthe Code allows, interested parties are entitled to rely upon that value as evidence of the claim\'s\nvalidity. Accordingly, we hold that Schwab was not required to object to Reilly\'s claimed\nexemptions in her business equipment in order to preserve the estate\'s right to retain any value in\nthe equipment beyond the value of the exempt interest. In reaching this conclusion, we express no\njudgment on the merits of, and do not foreclose the courts from entertaining on remand, procedural\nor other measures that may allow Reilly to avoid auction of her business equipment.\n\n5.6.\n\nExemption Planning\n\nSuppose your client owns a $1 million home in California which has a $100,000 homestead\nexemption, and is about to file bankruptcy due to massive unpaid unsecured debts. Can you advise\nyour client to sell the California home, use the money to buy a home in Florida or Texas (which\nhave unlimited homestead exemptions), and exempt the property?\nIn the 2005 BAPCPA amendments, Congress limited this ploy, which had been used by\nmany high profile debtors including former Commissioner of Baseball Bowie Kuhn and O.J.\nSimpson, by first requiring debtors to live in the new state for 730 days before using the new state\xe2\x80\x99s\nhomestead exemptions, but also by directly targeting interstate homestead conversions. If a debtor\n103\n\n\x0csells a homestead in one state and buys one in another state within a 10 year period prior to\nbankruptcy with the intention of hindering, delaying or defrauding creditors, the debtor\xe2\x80\x99s increased\nexemption is disallowed. 11 U.S.C. \xc2\xa7 522(o). The disallowance in Section 522 is not limited to\nhomestead to homestead conversions, but would also cover the conversion of other non-exempt\nproperty into a state law homestead. In 1985, Congress also added two confusingly worded\nprovisions limiting homesteads to $146,450, applicable to debtors who convert non-exempt\nproperty into an exempt homestead within 1215 days before bankruptcy (unless by rollover in the\nsame state), or committed certain crimes or torts. 11 U.S.C. \xc2\xa7 522(p), (q). The limits are adjusted\nfor inflation, and at the time of this writing are $155,675.\nThese specific limitations do not address the general question of exemption planning. Is it\nacceptable for a debtor to convert non-exempt to exempt property in planning for bankruptcy, as\nlong as the debtor is careful not to trip one of the wires in Section 522(o)-(q)? Read the following\ncases and ask yourself, where is the line between legal exemption planning and bankruptcy abuse?\n\n5.7.\n\nCases on Exemption Planning\n5.7.1.1.\nNORWEST BANK NEBRASKA v. OMAR A.\nTVETEN, 848 F.2d 871 (8th Cir. 1988)\n\nAppellant Omar A. Tveten, a physician who owed creditors almost $19,000,000, mostly in\nthe form of personal guaranties on a number of investments whose value had deteriorated greatly,\npetitioned for Chapter 11 bankruptcy. He had converted almost all of his non-exempt property,\nwith a value of about $700,000, into exempt property that could not be reached by his creditors.\nThe bankruptcy court denied a discharge in view of its finding that Tveten intended to defraud,\ndelay, and hinder his creditors. On appeal, Tveten asserts that his transfers merely constituted\nastute pre-bankruptcy planning. We hold that the bankruptcy court was not clearly erroneous in\ninferring fraudulent intent on the part of Tveten. We affirm.\nWe shall summarize only those facts and prior proceedings believed necessary to an\nunderstanding of the issues raised on appeal.\n[Tveten invested in highly leveraged real estate developments with various physician\nfriends.] The physicians, including Tveten, personally had guaranteed the debt arising out of these\ninvestments. In mid-1985, Tveten\'s investments began to sour. He became personally liable for an\namount close to $19,000,000 \xe2\x80\x94 well beyond his ability to pay.\nBefore filing for bankruptcy, Tveten consulted counsel. As part of his pre-bankruptcy\nplanning, he liquidated almost all of his non-exempt property, converting it into exempt property\nworth approximately $700,000. This was accomplished through some seventeen separate transfers.\nThe non-exempt property he liquidated included land sold to his parents and his brother,\nrespectively, for $70,000 and $75,732 in cash; life insurance policies and annuities with a forprofit company with cash values totalling $96,307.58; his net salary and bonuses of $27,820.91;\nhis KEOGH plan and individual retirement fund of $20,487.35; his corporation\'s profit-sharing\nplan worth $325,774.51; and a home sold for $50,000. All of the liquidated property was converted\ninto life insurance or annuity contracts with the Lutheran Brotherhood, a fraternal benefit\nassociation, which, under Minnesota law, cannot be attached by creditors. Tveten concedes that\n104\n\n\x0cthe purpose of these transfers was to shield his assets from creditors. Minnesota law provides that\ncreditors cannot attach any money or other benefits payable by a fraternal benefit association.\nMinn.Stat. \xc2\xa7\xc2\xa7 550.37, 64B.18 (1986). Unlike most exemption provisions in other states, the\nMinnesota exemption has no monetary limit. Indeed, under this exemption, Tveten attempted to\nplace $700,000 worth of his property out of his creditors\' reach.\nTveten sought a discharge with respect to $18,920,000 of his debts. Appellees objected to\nTveten\'s discharge. The bankruptcy court concluded that, although Tveten\'s conversion of nonexempt property to exempt property just before petitioning for bankruptcy, standing alone, would\nnot justify denial of a discharge, his inferred intent to defraud would. The bankruptcy court held\nthat, even if the exemptions were permissible, Tveten had abused the protections permitted a\ndebtor under the Bankruptcy Code (the "Code"). Accordingly, the bankruptcy court denied Tveten\na discharge.\nThe sole issue on appeal is whether Tveten properly was denied a discharge in view of the\ntransfers alleged to have been in fraud of creditors.\nAt the outset, it is necessary to distinguish between (1) a debtor\'s right to exempt certain\nproperty from the claims of his creditors and (2) his right to a discharge of his debts. The Code\npermits a debtor to exempt property. . . . When the debtor claims a state-created exemption, the\nscope of the claim is determined by state law. It is well established that under the Code the\nconversion of non-exempt to exempt property for the purpose of placing the property out of the\nreach of creditors, without more, will not deprive the debtor of the exemption to which he\notherwise would be entitled. Both the House and Senate Reports regarding the debtor\'s right to\nclaim exemptions state:\n"As under current law, the debtor will be permitted to convert nonexempt property into\nexempt property before filing a bankruptcy petition. The practice is not fraudulent as to creditors,\nand permits the debtor to make full use of the exemptions to which he is entitled under the law."\nH.R.Rep. No. 595, 95th Cong., 1st Sess. 361 (1977), reprinted in 1978 U.S.Code Cong. &\nAd.News 5963, 6317; S.Rep. No. 989, 95th Cong., 2d Sess. 76 (1978), reprinted in 1978 U.S.Code\nCong. & Ad.News 5787, 5862. The rationale behind this policy is that "[t]he result which would\nobtain if debtors were not allowed to convert property into allowable exempt property would be\nextremely harsh, especially in those jurisdictions where the exemption allowance is minimal." This\nblanket approval of conversion is qualified, however, by denial of discharge if there was extrinsic\nevidence of the debtor\'s intent to defraud creditors.\nA debtor\'s right to a discharge, however, unlike his right to an exemption, is determined by\nfederal, not state, law. The Code provides that a debtor may be denied a discharge under Chapter\n7 if, among other things, he has transferred property "with intent to hinder, delay, or defraud a\ncreditor" within one year before the date of the filing of the petition. Although Tveten filed for\nbankruptcy under Chapter 11, the proscription against discharging a debtor with fraudulent intent\nin a Chapter 7 proceeding is equally applicable against a debtor applying for a Chapter 11\ndischarge. The reason for this is that the Code provides that confirmation of a plan does not\ndischarge a Chapter 11 debtor if "the debtor would be denied a discharge under section 727(a) of\nthis title if the case were a case under chapter 7 of this title." 11 U.S.C. \xc2\xa7 1141(d)(3)(C) (1982).\nAs the bankruptcy court correctly found here, the issue in the instant case revolves around\nwhether there was extrinsic evidence to demonstrate that Tveten transferred his property on the\n105\n\n\x0ceve of bankruptcy with intent to defraud his creditors. The bankruptcy court\'s finding that there\nwas such intent to defraud may be reversed by us only if clearly erroneous.\nThere are a number of cases in which the debtor converted non-exempt property to exempt\nproperty on the eve of bankruptcy and was granted a discharge because there was no extrinsic\nevidence of the debtor\'s intent to defraud. In Forsberg [v. Security State Bank, 15 F.2d 499 (8th\nCir. 1926)], a debtor was granted a discharge despite his trade of non-exempt cattle for exempt\nhogs while insolvent and in contemplation of bankruptcy. Although we found that the trade was\neffected so that the debtor could increase his exemptions, the debtor "should [not] be penalized for\nmerely doing what the law allows him to do." We concluded that "before the existence of such\nfraudulent purpose can be properly found, there must appear in evidence some facts or\ncircumstances which are extrinsic to the mere facts of conversion of nonexempt assets into exempt\nand which are indicative of such fraudulent purpose."\nThere also are a number of cases, however, in which the courts have denied discharges\nafter concluding that there was extrinsic evidence of the debtor\'s fraudulent intent. In Ford [v.\nPostin], 773 F.2d 52 (4th Cir. 1985)], the debtor had executed a deed of correction transferring a\ntract of land to himself and his wife as tenants by the entirety. The debtor had testified that his\nparents originally had conveyed the land to the debtor alone, and that this was a mistake that he\ncorrected by executing a deed of correction. Under relevant state law, the debtor\'s action removed\nthe property from the reach of his creditors who were not also creditors of his wife. The Fourth\nCircuit, in upholding the denial of a discharge, found significant the fact that this "mistake" in the\noriginal transfer of the property was "corrected" the day after an unsecured creditor obtained\njudgment against the debtor. 773 F.2d at 55. The Fourth Circuit held that the bankruptcy court, in\ndenying a discharge, was not clearly erroneous in finding the requisite intent to defraud, after\n"[h]aving heard ... [the debtor\'s] testimony at trial and having considered the circumstances\nsurrounding the transfer".\nIn In re Reed, [700 F.2d 986, 990 (5th Cir.1983)], shortly after the debtor had arranged\nwith his creditors to be free from the payment obligations until the following year, he rapidly had\nconverted non-exempt assets to extinguish one home mortgage and to reduce another four months\nbefore bankruptcy, and had diverted receipts from his business into an account not divulged to his\ncreditors. The Fifth Circuit concluded that the debtor\'s "whole pattern of conduct evinces that\nintent." The court went further and stated: "It would constitute a perversion of the purposes of the\nBankruptcy Code to permit a debtor earning $180,000 a year to convert every one of his major\nnonexempt assets into sheltered property on the eve of bankruptcy with actual intent to defraud his\ncreditors and then emerge washed clean of future obligation by carefully concocted immersion in\nbankruptcy waters."\nIn most, if not all, cases determining whether discharge was properly granted or denied to\na debtor who practiced "pre-bankruptcy planning", the point of reference has been the state\nexemptions if the debtor was claiming under them. Although discharge was not denied if the debtor\nmerely converted his non-exempt property into exempt property as permitted under state law, the\nexemptions involved in these cases comported with federal policy to give the debtor a "fresh start"\n\xe2\x80\x94 by limiting the monetary value of the exemptions. This policy has been explicit, or at least\nimplicit, in these cases. In Forsberg, for example, we stated that it is not fraudulent for an\nindividual who knows he is insolvent to convert non-exempt property into exempt property,\nthereby placing the property out of the reach of creditors "because the statutes granting exemptions\n106\n\n\x0chave made no such exceptions, and because the policy of such statutes is to favor the debtors, at\nthe expense of the creditors, in the limited amounts allowed to them, by preventing the forced loss\nof the home and of the necessities of subsistence, and because such statutes are construed liberally\nin favor of the exemption." Similarly, in Ellingson [63 B.R. 271 (N.D. Iowa 1986)] in holding that\nthe debtors\' conversion of non-exempt cash and farm machinery did not provide grounds for denial\nof a discharge, the court relied on the social policies behind the exemptions. The court found that\nthe debtors\' improvement of their homestead was consistent with several of these policies, such as\nprotecting the family unit from impoverishment, relieving society from the burden of supplying\nsubsidized housing, and providing the debtors with a means to survive during the period following\ntheir bankruptcy filing when they might have little or no income.\nIn the instant case, however, the state exemption relied on by Tveten was unlimited, with\nthe potential for unlimited abuse. Indeed, this case presents a situation in which the debtor\nliquidated almost his entire net worth of $700,000 and converted it to non-exempt property in\nseventeen transfers on the eve of bankruptcy while his creditors, to whom he owed close to\n$19,000,000, would be left to divide the little that remained in his estate. Borrowing the phrase\nused by another court, Tveten "did not want a mere fresh start, he wanted a head start." His attempt\nto shield property worth approximately $700,000 goes well beyond the purpose for which\nexemptions are permitted. Tveten\'s reliance on his attorney\'s advice does not protect him here,\nsince that protection applies only to the extent that the reliance was reasonable.\nThe bankruptcy court, as affirmed by the district court, examined Tveten\'s entire pattern of\nconduct and found that he had demonstrated fraudulent intent. We agree. While state law governs\nthe legitimacy of Tveten\'s exemptions, it is federal law that governs his discharge. Permitting\nTveten, who earns over $60,000 annually, to convert all of his major non-exempt assets into\nsheltered property on the eve of bankruptcy with actual intent to defraud his creditors "would\nconstitute a perversion of the purposes of the Bankruptcy Code". Tveten still is entitled to retain,\nfree from creditors\' claims, property rightfully exempt under relevant state law.\nWe distinguish our decision in Hanson v. First National Bank, 848 F.2d 866 (8th Cir. 1988),\ndecided today. Hanson involves a creditor\'s objection to two of the debtors\' claimed exemptions\nunder South Dakota law, a matter governed by state law. The complaint centered on the Hansons\'\nsale, while insolvent, of non-exempt property to family members for fair market value and their\nuse of the proceeds to prepay their preexisting mortgage and to purchase life insurance policies in\nthe limited amounts permissible under relevant state law. The bankruptcy court found no extrinsic\nevidence of fraud.\nTo summarize:\nWe hold that the bankruptcy court was not clearly erroneous in inferring fraudulent intent\non the part of the debtor, rather than astute pre-bankruptcy planning, with respect to his transfers\non the eve of bankruptcy which were intended to defraud, delay and hinder his creditors.\nARNOLD, Circuit Judge, dissenting.\nThe Court reaches a result that appeals to one\'s general sense of righteousness. I believe,\nhowever, that it is contrary to clearly established law, and I therefore respectfully dissent.\nDr. Tveten has never made any bones about what he is doing, or trying to do, in this case.\nHe deliberately set out to convert as much property as possible into a form exempt from attachment\n107\n\n\x0cby creditors under Minnesota law. Such a design necessarily involves an attempt to delay or hinder\ncreditors, in the ordinary, non-legal sense of those words, but, under long-standing principles\nembodied both in judicial decisions and in statute, such a purpose is not unlawful.\nTo be sure, if there is extrinsic evidence of fraud, or of a purpose to hinder or delay\ncreditors, discharge may and should be denied, but "extrinsic," in this context, must mean\nsomething beyond the mere conversion of assets into exempt form for the purpose of putting them\nout of the reach of one\'s creditors. If Tveten had lied to his creditors, like the debtor in McCormick\nv. Security State Bank, 822 F.2d 806 (8th Cir. 1987), or misled them in some way, like the debtor\nin In re Reed, 700 F.2d 986 (5th Cir. 1983), or transferred property for less than fair value to a third\nparty, like the debtor in Ford v. Poston, 773 F.2d 52 (4th Cir. 1985), we would have a very different\ncase. There is absolutely no evidence of that sort of misconduct in this record, and the Court\'s\nopinion filed today cites none.\nOne is tempted to speculate what the result would have been in this case if the amount of\nassets converted had been $7,000, instead of $700,000. Indeed, the large amount of money\ninvolved is the only difference I can see between this case and Forsberg. It is true that the Forsberg\nopinion referred to "the limited amounts allowed to" debtors by exemptions, but whether\nexemptions are limited in amount is a legislative question ordinarily to be decided by the people\'s\nelected representatives, in this case the Minnesota Legislature. Where courts punish debtors simply\nfor claiming exemptions within statutory limits, troubling problems arise in separating judicial\nfrom legislative power.\nIf there ought to be a dollar limit, and I am inclined to think that there should be, and if\npractices such as those engaged in by the debtor here can become abusive, and I admit that they\ncan, the problem is simply not one susceptible of a judicial solution according to manageable\nobjective standards. A good statement of the kind of judicial reasoning that must underlie the result\nthe Court reaches today appears in In re Zouhar, 10 B.R. 154 (Bankr. D.N.M. 1981), where the\namount of assets converted was $130,000. The Bankruptcy Court denied discharge, stating, among\nother things, that "`there is a principle of too much; phrased colloquially, when a pig becomes a\nhog it is slaughtered.\'" Id. at 157. If I were a member of the Minnesota Legislature, I might well\nvote in favor of a bill to place an over-all dollar maximum on any exemption. But sitting as a judge,\nby what criteria do I determine when this pig becomes a hog? If $700,000 is too much, what about\n$70,000? Would it matter if the debtor were a farmer, as in Forsberg, rather than a physician? (I\nask the question because the appellee creditor\'s brief mentions the debtor\'s profession, which ought\nto be legally irrelevant, several times.)\nDebtors deserve more definite answers to these questions than the Court\'s opinion provides.\nIn effect, the Court today leaves the distinction between permissible and impermissible claims of\nexemption to each bankruptcy judge\'s own sense of proportion. As a result, debtors will be unable\nto know in advance how far the federal courts will allow them to exercise their rights under state\nlaw.\nWhere state law creates an unlimited exemption, the result may be that wealthy debtors\nlike Tveten enjoy a windfall that appears unconscionable, and contrary to the policy of the\nbankruptcy law. I fully agree with Judge Kishel, however, that \xe2\x80\x9c[this] result ... cannot be laid at\n[the] Debtor\'s feet; it must be laid at the feet of the state legislature.\xe2\x80\x9d\n108\n\n\x0cI submit that Tveten did nothing more fraudulent than seek to take advantage of a state law\nof which the federal courts disapprove.\n\n5.8.\n\nNotes on Tveten\n\nOn the same day that the opinion in Tveten was issued, the court also issued an opinion in\nHanson v. First National Bank in Brookings, 848 F.2d 866 (8th Cir. 1988), in which they allowed\nthose famer debtors a discharge even though they had, after consulting with an attorney, converted\napproximately $30,000 in non-exempt property to exempt property on the eve of bankruptcy. The\nnon-exempt property was sold to family members, and the debtors bought exempt life insurance\npolicies and paid down their mortgages to the maximum amounts allowed under the state\xe2\x80\x99s\nhomestead exemption. The only apparent distinctions between the cases were: (1) the professions\nof the debtors (farmer v. medical doctor), (2) the amounts involved ($30,000 v. $700,000), (3) the\ntypes of exemptions utilized (limited v. unlimited dollar amount exemptions), and (4) the\ndetermination by the bankruptcy court that the debtor had crossed the line into \xe2\x80\x9cactual intent to\nhinder, delay or default creditors\xe2\x80\x9d under 11 U.S.C. \xc2\xa7 727(a)(2). Does the outcome in exemption\nplanning cases depend on the length of the chancellor\xe2\x80\x99s (or bankruptcy judge\xe2\x80\x99s) foot?\n\n5.9.\n\nAvoiding Liens that Impair Exemptions\n\nChapter 8 will be devoted to the trustee\xe2\x80\x99s (and the debtor\xe2\x80\x99s) avoiding powers, under which\nthe trustee is given the power to set aside certain transactions that occurred pre-petition because\nthe transactions were likely made in anticipation of filing bankruptcy. One important avoiding\npower is to be considered now, however, because it relates to exemptions.\nSection 522(f)(1) of the Bankruptcy Code allows the debtor to avoid two kinds of liens\nobtained by creditors prepetition if and to the extent that the liens impair the debtor\xe2\x80\x99s exemptions.\nThe two kinds of liens are: (1) non-possessory non-purchase money liens on consumer goods, and\n(2) judicial liens. When a lien is avoided, the creditor returns to unsecured status, and the exempt\nproperty is freed from the creditor\xe2\x80\x99s security interest.\nConsumer goods lien avoidance is rarely used because other federal laws broadly prohibit\nmost creditors from taking non-possessory non-purchase money security interests in consumer\ngoods. See FTC Credit Practices Rule, 16 CFR \xc2\xa7 444.2(4); Federal Reserve Board Credit Practices\nRule (Reg AA), 12 CFR \xc2\xa7 227.13(d) (prohibiting finance companies, retailers, credit unions and\nbanks from taking non-purchase money security interests in consumer goods). Therefore, it is the\npower to avoid judicial liens that is most important.\nUnder Section 522(f)(1), the debtor can avoid only judicial liens (not consensual liens) on\nboth real and personal property if the liens impair the debtor\xe2\x80\x99s exemptions. Judicial liens are those\nobtained by an unsecured creditor after obtaining a judgment against the debtor. The debtor cannot\navoid consensual liens (except in the unusual case of non-possessory non-purchase money liens\non consumer goods).\nThere is a statutory test for determining the extent to which a potentially avoidable lien\nimpairs the debtor\xe2\x80\x99s exemption. The test starts by adding (i) all liens against the property (including\nthe lien being avoided) plus (ii) the full amount of the debtor\xe2\x80\x99s exemption. It then deducts the fair\n109\n\n\x0cmarket value of the property. The negative amount (the amount by which liens and exemption\nexceeds value) is the amount of the judicial liens that may be avoided. 11 U.S.C. \xc2\xa7 522(f)(2). A\npositive number (value exceeds liens and exemptions) means that judicial liens cannot be avoided\nbecause there is sufficient value to pay the liens in full and still provide the debtor with a full\nexemption.\nLien avoidance under Section 522 does not occur automatically. The debtor must file a\nmotion to avoid the judicial liens. See Bankruptcy Rule 4003(d). If the motion is opposed, the\ncourt must hold a hearing to determine whether and to what extent the lien can be avoided. See\nBankruptcy Rule 9014. In general, courts require the debtor to establish the value of the property,\nthe amount of all liens, and the amount of the exemption.\nThe trickiest part of avoiding judicial liens is properly serving notice of the motion. Notice\nmust be served in the same manner as a complaint. Bankruptcy Rule 9014. Bankruptcy Rule 7004\nallows complaints to be served by mail, but they must be addressed \xe2\x80\x9cto the attention of an officer,\na managing or general agent, or an agent authorized by appointment or by law to receive service\nof process,\xe2\x80\x9d and upon the creditor. Bankruptcy Rule 7004(b)(3). Courts are very strict about\ncompliance with the service requirement. It is good practice to serve the creditor and attorney at\nthe addresses listed in the judgment, and also serving the creditors\xe2\x80\x99 officer or designated agent for\nservice of process. A corporate search is required to determine the identity of the officer or agent.\nIt is also difficult to determine who to serve for state of municipal entities. It is necessary to\ndetermine the appropriate method for service designated by state law. Bankruptcy Rule 7004(b)(6).\nFinally, there is a special trap hidden at the end of the rule requiring an officer of an insured\ndepository institution to be served by certified mail. Bankruptcy Rule 7004(h).\n\n5.10.\n\nPractice Problems: Avoiding Liens that Impair Exemptions\n\nDetermine whether the debtor can avoid the following liens on the following property:\nProblem 1. The debtor owns a house worth $300,000, subject to a first mortgage of\n$175,000, a second mortgage of $75,000, a senior judicial lien of $40,000, and a junior judicial\nlien of $30,000. The Debtor has a $100,000 homestead exemption. How much of which liens can\nbe avoided? 11 U.S.C. \xc2\xa7 522\nProblem 2. Same facts as (1) except the property is worth $400,000.\nProblem 3. Same facts as (2) except the senior judicial lien is $15,000, and the junior\njudicial lien is $10,000.\nProblem 4. The debtor\xe2\x80\x99s house is worth $300,000, and is subject to a first mortgage of\n$250,000, a judicial lien in second position of $40,000, and a junior mortgage in third position of\n$50,000. The debtor has a $100,000 homestead. See Kolich v. Antioch Laurel Veterinary Hospital,\n328 F.3d 406 (8th Cir. 2003).\nProblem 5. Ten years before bankruptcy, the debtor\xe2\x80\x99s son was in a car accident driving the\ndebtor\xe2\x80\x99s car. The other party to the accident sued the debtor\xe2\x80\x99s son and the debtor in tort, and\nrecovered a default judgment for $50,000. The judgment creditor followed the state procedure for\nobtaining a judicial lien on any property owned by the debtor in the county. No lien attached at the\ntime, however, because the debtor did not own any property in the county. Three years before\n110\n\n\x0cbankruptcy, the Debtor purchased a house in the county for $100,000, paying $25,000 cash and\nborrowing $75,000 from a bank secured by a first mortgage against the property. The debtor has\nfallen on hard times, has filed bankruptcy, and wants to avoid the $50,000 judicial lien. The\nproperty is currently worth $120,000, and the Debtor has a $100,000 homestead exemption. Can\nthe lien be avoided? Before you answer the question, read the next case and consider how the\nSupreme Court\xe2\x80\x99s ruling might apply to this situation.\n\n5.11.\n\nCases on Avoiding Liens that Impair Exemptions\n5.11.1.1.\n\nFARREY v. SANDERFOOT, 500 U.S. 291 (1991)\n\nJUSTICE WHITE delivered the opinion of the Court.\nPetitioner Jeanne Farrey and respondent Gerald Sanderfoot were married on August 12,\n1966. The couple eventually built a home on 27 acres of land in Hortonville, Wisconsin, where\nthey raised their three children. On September 12, 1986, the Wisconsin court grant[ed] a judgment\nof divorce and property division.\nThe decision awarded each party one-half of their net $60,600.68 marital estate. The decree\ngranted Sanderfoot sole title to all the real estate and the family house, which was subject to a\nmortgage and which was valued at $104,000, and most of the personal property. For her share,\nFarrey received the remaining items of personal property and the proceeds from a court-ordered\nauction of the furniture from the home. The judgment also allocated the couple\'s liabilities. Under\nthis preliminary calculation of assets and debts, Sanderfoot stood to receive a net award of\n$59,508.79, while Farrey\'s award would otherwise have been $1,091.90. To ensure that the\ndivision of the estate was equal, the court ordered Sanderfoot to pay Farrey $29,208.44, half the\ndifference in the value of their net assets. Sanderfoot was to pay this amount in two installments:\nhalf by January 10, 1987, and the remaining half by April 10, 1987. To secure this award, the\ndecree provided that Farrey "shall have a lien against the real estate property of [Sanderfoot] for\nthe total amount of money due her pursuant to this Order of the Court, i. e. $29,208.44, and the\nlien shall remain attached to the real estate property . . . until the total amount of money is paid in\nfull."\nSanderfoot never made the required payments nor complied with any other order of the\nstate court. Instead, on May 4, 1987, he voluntarily filed for Chapter 7 bankruptcy. Sanderfoot\nlisted the marital home and real estate on the schedule of assets with his bankruptcy petition and\nlisted it as exempt homestead property. Exercising his option to invoke the state rather than the\nfederal homestead exemption, Sanderfoot claimed the property as exempt "to the amount of\n$40,000." He also filed a motion to avoid Farrey\'s lien under [Section 522(f)(1) of the Bankruptcy\nCode], claiming that Farrey possessed a judicial lien that impaired his homestead exemption.\nFarrey objected to the motion, claiming that \xc2\xa7522(f)(1) could not divest her of her interest in the\nmarital home.\nFarrey does not challenge the Court of Appeals\' determination that her lien was a judicial\nlien, and waived any challenge as to whether Sanderfoot was otherwise entitled to a homestead\nexemption under state law. The sole question presented in this case is whether \xc2\xa7522(f)(1) permits\n111\n\n\x0cSanderfoot to avoid the fixing of Farrey\'s lien on the property interest that he obtained in the\ndivorce decree.\nThe key portion of \xc2\xa7 522(f) states that "the debtor may avoid the fixing of a lien on an\ninterest . . . in property." Sanderfoot, following several Courts of Appeals, suggests that this phrase\nmeans that a lien may be avoided so long as it is currently fixed on a debtor\'s interest. Farrey,\nfollowing Judge Posner\'s lead [in the Court of Appeals decision below], reads the text as permitting\nthe avoidance of a lien only where the lien attached to the debtor\'s interest at some point after the\ndebtor obtained the interest.\nWe agree with Farrey. No one asserts that the two verbs underlying the provision possess\nanything other than their standard legal meaning: "avoid" meaning "annul" or "undo," and "fix"\nmeaning to "fasten a liability upon." The statute does not say that the debtor may undo a lien on\nan interest in property. Rather, the statute expressly states that the debtor may avoid "the fixing"\nof a lien on the debtor\'s interest in property. The gerund "fixing" refers to a temporal event. That\nevent\xe2\x80\x94the fastening of a liability\xe2\x80\x94 presupposes an object onto which the liability can fasten. The\nstatute defines this pre-existing object as "an interest of the debtor in property." Therefore, unless\nthe debtor had the property interest to which the lien attached at some point before the lien attached\nto that interest, he or she cannot avoid the fixing of the lien under the terms of \xc2\xa7 522(f)(1).\nThe text, history, and purpose of \xc2\xa7 522(f)(1) also indicate what the provision is not\nconcerned with. It cannot be concerned with liens that fixed on an interest before the debtor\nacquired that interest. Neither party contends otherwise. Section 522(f)(1) does not state that any\nfixing of a lien may be avoided; instead, it permits avoidance of the "fixing of a lien on an interest\nof the debtor." If the fixing took place before the debtor acquired that interest, the "fixing" by\ndefinition was not on the debtor\'s interest. Nor could the statute apply given its purpose of\npreventing a creditor from beating the debtor to the courthouse, since the debtor at no point\npossessed the interest without the judicial lien. There would be no fixing to avoid since the lien\nwas already there. To permit lien avoidance in these circumstances, in fact, would be to allow\njudicial lienholders to be defrauded through the conveyance of an encumbered interest to a\nprospective debtor. For these reasons, it is settled that a debtor cannot use \xc2\xa7 522(f)(1) to avoid a\nlien on an interest acquired after the lien attached. As before, the critical inquiry remains whether\nthe debtor ever possessed the interest to which the lien fixed, before it fixed. If he or she did not,\n\xc2\xa7 522(f)(1) does not permit the debtor to avoid the fixing of the lien on that interest.\nWhether Sanderfoot ever possessed an interest to which the lien fixed, before it fixed, is a\nquestion of state law. Farrey contends that prior to the divorce judgment, she and her husband held\ntitle to the real estate in joint tenancy, each possessing an undivided one-half interest. She further\nasserts that the divorce decree extinguished these previous interests. At the same time and in the\nsame transaction, she concludes, the decree created new interests in place of the old: for\nSanderfoot, ownership in fee simple of the house and real estate; for Farrey, various assets and a\ndebt of $29,208.44 secured by a lien on the Sanderfoot\'s new fee simple interest. Both in his briefs\nand at oral argument, Sanderfoot agreed on each point.\nOn the assumption that the parties characterize Wisconsin law correctly, Sanderfoot must\nlose. Under their view, the lien could not have fixed on Sanderfoot\'s pre-existing undivided half\ninterest because the divorce decree extinguished it. Instead, the only interest that the lien\nencumbers is debtor\'s wholly new fee simple interest. The same decree that awarded Sanderfoot\n112\n\n\x0chis fee simple interest simultaneously granted the lien to Farrey. As the judgment stated, he\nacquired the property "free and clear" of any claim "except as expressly provided in this [decree]."\nSanderfoot took the interest and the lien together, as if he had purchased an already encumbered\nestate from a third party. Since Sanderfoot never possessed his new fee simple interest before the\nlien "fixed," \xc2\xa7 522(f)(1) is not available to void the lien.\nThe same result follows even if the divorce decree did not extinguish the couple\'s preexisting interests but instead merely reordered them. The parties\' current position notwithstanding,\nit may be that under Wisconsin law the divorce decree augmented Sanderfoot\'s previous interest\nby adding to it Farrey\'s prior interest. If the court in exchange sought to protect Farrey\'s previous\ninterest with a lien, \xc2\xa7 522(f)(1) could be used to undo the encumbrance to the extent the lien\nfastened to any portion of Sanderfoot\'s previous surviving interest. This follows because\nSanderfoot would have possessed the interest to which that part of the lien fixed, before it fixed.\nBut in this case, the divorce court did not purport to encumber any part of Sanderfoot\'s previous\ninterest even on the assumption that state law would deem that interest to have survived. The\ndecree instead transferred Farrey\'s previous interest to Sanderfoot and, again simultaneously,\ngranted a lien equal to that interest minus the small amount of personal property she retained.\nSanderfoot thus would still be unable to avoid the lien in this case since it fastened only to what\nhad been Farrey\'s pre-existing interest, and this interest Sanderfoot would never have possessed\nwithout the lien already having fixed.\nFarrey obtained the lien not to defeat Sanderfoot\'s pre-existing interest in the homestead\nbut to protect her own pre-existing interest in the homestead that was fully equal to that of her\nspouse. The divorce court awarded the lien to secure an obligation the court imposed on the\nhusband in exchange for the court\'s simultaneous award of the wife\'s homestead interest to the\nhusband. We agree with Judge Posner that to permit a debtor in these circumstances to use the\nCode to deprive a spouse of this protection would neither follow the language of the statute nor\nserve the main goal it was designed to address.\nWe hold that \xc2\xa7 522(f)(1) of the Bankruptcy Code requires a debtor to have possessed an\ninterest to which a lien attached, before it attached, to avoid the fixing of the lien on that interest.\nAccordingly, the judgment of the Court of Appeals is reversed, and the case is remanded for further\nproceedings consistent with this opinion.\n\n113\n\n\x0cChapter 6: The Automatic Stay\n6.1.\n\nWhat is the automatic stay?\n\nThe automatic stay, 11 U.S.C. \xc2\xa7 362, protects the debtor and the estate from the harassment\nof collection actions during the bankruptcy case. The stay is very broad, prohibiting creditors from\ndoing or continuing most kinds of collection activity against the debtor or the estate. 11 U.S.C. \xc2\xa7\n362(a).\nSection 362(b) identifies certain acts that are not stayed, including criminal actions (11\nU.S.C. \xc2\xa7 362(b)(1)), certain family law proceedings (11 U.S.C. \xc2\xa7 362(b)(2)), so-called \xe2\x80\x9cpolice and\nregulatory powers\xe2\x80\x9d (buried in 11 U.S.C. \xc2\xa7 362(b)(4)), and eviction actions against residential\ntenants in certain situations (11 U.S.C. \xc2\xa7 362(b)(22-23)).\nThe stay terminates automatically when the bankruptcy case is completed or the discharge\nis issued (11 U.S.C. \xc2\xa7 362(c)), and there are important provisions for creditors to obtain relief from\nthe automatic stay by motion (11 U.S.C. \xc2\xa7 362(d)). We will cover relief from stay when we look\nat claims and distribution in Chapter 8.\nCreditors who violate the automatic stay are in contempt of court and subject to severe\npenalties. See 11 U.S.C. \xc2\xa7 362(k). The following problems explore the statutory language.\n\n6.2.\n\nPractice Problems: The Automatic Stay\n\nRead Section 362(a) and (b) and determine whether the following acts violate the automatic\nstay:\nProblem 1. Continuing a deposition of the Debtor scheduled before the bankruptcy case\nwas filed in a collection action against the Debtor.\nProblem 2. The debtor was one of 100 defendants in an environmental lawsuit filed by a\nprivate landholder prior to bankruptcy. On the eve of trial the debtor filed bankruptcy. May the\ntrial proceed? What can the plaintiff do to avoid a significant waste of time and money in its action\nagainst all of the other defendants? See 11 U.S.C. \xc2\xa7 362(d)(1).\nProblem 3. On the day of bankruptcy, the debtor was in default under a car loan to\nSyracuse Credit Union, and also had $1,000 in a checking account at Syracuse Credit Union. New\nYork law gives banks and credit unions a right to setoff money owing to the credit union by a\ncustomer against money owing by the bank or credit union to the customer in the form of deposit\naccounts. May Syracuse Credit Union exercise the right of setoff after bankruptcy? 11 U.S.C. \xc2\xa7\n362(a)(7). What should be bank do if the debtor asks to withdraw the $1,000 from her checking\naccount after bankruptcy? Citizens Bank of Maryland v. Strumpf, 516 U.S. 16 (1995) (allowing\nadministrative freeze).\nProblem 4. A Credit card company sent the debtor her regular monthly invoice of charges\nmade during the prior month. Does it matter whether the credit card company received the\nbankruptcy notice before sending the invoice? See 11 U.S.C. \xc2\xa7 362(k). Does it matter that on the\n114\n\n\x0cback of the invoice, in small print, is the following language: \xe2\x80\x9cif the debtor has filed bankruptcy,\nthis is not an attempt to collect a debt but is merely a notice of the balance of the account.\xe2\x80\x9d?\nProblem 5. After filing bankruptcy, the debtor calls her credit union to ask whether they\nwill continue to allow her to use her credit card. The credit union tells the debtor that they will\nrestore her privileges only if she pays her credit card balance in full. Did the credit union violate\nthe automatic stay? 11 U.S.C. \xc2\xa7 362(a)(6).\nProblem 6. Credit union sends the debtor a letter offering to restore her credit card\nprivileges if she reaffirms her credit card. Is this a violation of the automatic stay?\nNote: as discussed below in Section 11.7, reaffirmation is a process by which the\ndebtor requests that a debt not be discharged. See Jamo v. Katahdin Federal Credit\nUnion, 283 F.3d 392 (1st Cir. 2002) (\xe2\x80\x9cA creditor may discuss and negotiate terms\nfor reaffirmation with a debtor without violating the automatic stay as long as the\ncreditor refrains from coercion or harassment\xe2\x80\x9d); Matter of Duke, 79 F.3d 43 (7th\nCir. 1996) (Permissible to send non-threatening offer to provide small additional\ncredit line if debtor will reaffirm dischargeable debt).\nProblem 7. Prior to bankruptcy and after obtaining a default judgment against the debtor,\ncreditor delivered a writ of garnishment to the sheriff directing the sheriff to garnish the debtor\xe2\x80\x99s\nwages. The Sheriff served the writ on the debtor\xe2\x80\x99s employer before bankruptcy was filed. Debtor\ndemands that the creditor and Sheriff withdraw garnishment. Creditor refuses, saying he has no\nobligation to do anything since he has not taken a post-petition \xe2\x80\x9cact\xe2\x80\x9d in violation of the automatic\nstay. Who is right? See In re Sucre, 226 B.R. 340, 347 (Bankr. S.D.N.Y. 1998) (\xe2\x80\x9cThe provisions\nof the automatic stay place the responsibility to discontinue any pending collection proceedings\nsquarely on the shoulders of the creditor who initiated the action."); ln re Sams, 106 B.R. 485, 490\n(Bankr. S.D. Ohio 1989) ("incumbent upon creditors to take necessary steps to halt or reverse\npending state court actions or other collection efforts commenced prior to the filing of a bankruptcy\npetition"); In Re Henry, 328 B.R. 664 (Bankr. E.D.N.Y. 2005) (attorneys for creditor who failed\nto remove bank account garnishment liable for willfully violating automatic stay).\nProblem 8. Debtor\xe2\x80\x99s college refuses to issue a diploma or transcript for the debtor because\nthe debtor owes prepetition fees to the college. Is the refusal to issue a diploma or transcript a\nviolation of the automatic stay? Does it matter that the fees are not dischargeable? See Merchant\nv. Andrews University, 958 F.2d 738 (6th Cir. 1992) (holding Andrews University liable for\nviolating the automatic stay even though the debt was not dischargeable); but see In re Watson, 78\nB.R. 232 (9th Cir. BAP 1987) (after obtaining non-dischargeability determination, creditor may\nattempt to collect debt from non-estate property).\nProblem 9. Debtor filed a prepetition tort action against the driver of a car who rear-ended\nhim at a stop light. The driver has refused to attend his deposition, claiming that the action is stayed\nby the Debtor\xe2\x80\x99s bankruptcy filing. Is the driver right? See 11 U.S.C. \xc2\xa7 362(a)(1).\nProblem 10. National Gridlock, the local gas and electric company, has informed the\ndebtor that his utility services will be discontinued unless he gives the utility company a deposit\nequal to the highest two month\xe2\x80\x99s charges during the prior 12 months. Can they do that? See 11\nU.S.C. \xc2\xa7 366(a) and (b).\n115\n\n\x0cProblem 11. The debtor filed bankruptcy one hour before the Bank\xe2\x80\x99s scheduled foreclosure\nsale. The Bank held the foreclosure sale as scheduled and sold the property to a bidder who knew\nnothing of the bankruptcy. Did the Bank violate the automatic stay? Does it matter whether the\nBank knew about the bankruptcy before the sale? In either case, what liability would the bank\nhave? See 11 U.S.C. \xc2\xa7 362(k). Must the Bank do anything after learning of the bankruptcy to avoid\nliability for punitive damages?\nProblem 12. After receiving debtor\xe2\x80\x99s bankruptcy notice, creditor called debtor and\nthreatened to file a criminal complaint with the district attorney unless the debtor\xe2\x80\x99s bad check was\nimmediately paid. Is this a violation of the automatic stay? 11 U.S.C. \xc2\xa7 362(a)(6). What if creditor,\nwithout making a threat, simply filed a criminal complaint after receiving the debtor\xe2\x80\x99s bankruptcy\nnotice?\nProblem 13. Debtor embezzled money from his employer, pled guilty, and agreed to pay\n$500 per month in criminal restitution to the employer as part of a plea bargain deal. Debtor is two\npayments behind and the state has filed an action to impose jail time for the debtor\xe2\x80\x99s failure to pay\ncriminal restitution. Is the action stayed? See 11 U.S.C. \xc2\xa7 362(b)(1); Mead v. Director, Office of\nAdult Probation, 41 B.R. 838 (Bankr. D. Conn. 1984).\nProblem 14. Prior to filing bankruptcy, the debtor operated a silver mine, and used\nhazardous chemicals in its mining operation. The debtor no longer operates the mine. The State\nenvironmental protection agency commenced an action against the debtor prepetition seeking a\nmandatory injunction requiring the debtor to clean up the site. The sole purpose of the suit is to\nforce the debtor to pay money for the cleanup. Is the action stayed? See 11 U.S.C. \xc2\xa7 362(b)(4). If\na money judgment is recovered after the debtor fails to comply with the cleanup order, can it be\nenforced against property of the estate? Is there a distinction under the statute between public\nsafety and welfare on the one hand and the government\xe2\x80\x99s pecuniary interest on the other?\nThe meaning of the \xe2\x80\x9cpolice powers\xe2\x80\x9d exception has been fertile ground for litigation.\nThe courts have broadly interpreted the exemption to allow the government to bring\nactions to obtain a money judgment. The problem is when the government crosses\nthe line into enforcement of a money judgment. Does a mandatory injunction,\nordering the debtor to clean up the site, cross the line? See Penn Terra, Ltd. V.\nDepartment of Env. Resources, 733 F.2d 267 (3d Cir. 1984) (no because\nenvironmental policy supersedes bankruptcy policy even if compliance with the\ninjunction would require the payment of money); Ohio v. Kovacs, 469 U.S. 274\n(1985) (yes where debtor no longer in control of property); Board of Governers v.\nMCorp Financial, Inc., 502 U.S. 32 (1991) (bankruptcy court has no power to\nenjoin non-final administrative proceedings); Berg v. Good Samaritan Hosp. Inc.,\n230 F.3d. 1165 (9th Cir. 2000) (award of attorney fees against a debtor for engaging\nin frivolous litigation not stayed)\nProblem 15. After filing bankruptcy, debtor borrowed $500 from a friend, promising to\npay it back within 10 days. Debtor failed to pay the money back, and stopped returning the friend\xe2\x80\x99s\ncalls. May the friend sue the Debtor to recover the $500 plus interest without violating the\nautomatic stay? 11 U.S.C. \xc2\xa7 362(a)(1).\n116\n\n\x0cProblem 16. After receiving notice of the debtor\xe2\x80\x99s bankruptcy, the debtor\xe2\x80\x99s credit union\ncalled the debtor to demand payment of the debtor\xe2\x80\x99s car loan balance. Debtor\xe2\x80\x99s attorney filed an\naction against the credit union for violating the automatic stay. Credit union sought to avoid\nliability for attorney\xe2\x80\x99s fees by offering to pay any actual damages incurred by the debtor. Debtor\ndemanded payment of legal fees and penalties, and threatened to recover more legal fees\nprosecuting the case if the amounts demanded were not paid. Can the Debtor recover legal fees\nincurred to recover damages, or only legal fees incurred to prevent a continuing violation of the\nautomatic stay? Compare Sternberg v. Johnson, 595 F.3d 937 (9th Cir. 2010) (\xe2\x80\x9cactual damages,\nincluding costs and attorneys\xe2\x80\x99 fees\xe2\x80\x9d meant to apply only to attorneys\xe2\x80\x99 fees incurred to prevent\nactual damages); In re Repine, 536 F.3d 512 (5th Cir. 2008) (successful plaintiff can recover\nattorneys\xe2\x80\x99 fees incurred in recovering damages and penalties). Can credit union defend a request\nfor sanctions on the grounds that it did not \xe2\x80\x9cintend\xe2\x80\x9d to violate the stay because it was unaware of\nthe law? See e.g. In re AP Industries, Inc., 117 B.R. 789, 803 (Bankr. S.D.N.Y 1990) (willful\nviolation if debtor acts deliberately with knowledge of the bankruptcy petition).\nProblem 17. Debtor filed a Chapter 13 case 4 years ago, was unable to complete her\npayments, and her case was dismissed nine months ago. The debtor would like to file a new case\nunder Chapter 7. Is there anything the debtor will need to do with respect to the automatic stay?\nSee 11 U.S.C. \xc2\xa7 362(c)(3).\n\n6.3.\n\nCases on Using the Automatic Stay as a Sword\n6.3.1.1.\nSPORTFRAME OF OHIO V. WILSON SPORTING\nGOODS, 40 B.R. 47 (Bankr. N.D. Ohio 1984)\n\nPlaintiff\'s complaint [seeks] an injunction to require defendant to sell inventory to it on a\ncash basis, [plus an award of] attorney\'s fees and costs for an alleged violation of the automatic\nstay of 11 U.S.C. \xc2\xa7 362(a).\nPlaintiff Sportfame runs four retail sporting goods stores in Ohio. Defendant, Wilson has\nsold its line of sporting goods to plaintiff at wholesale for almost 10 years until recently when it\nrefused to ship any further goods to plaintiff.\nOn February 14, 1983 plaintiff filed a voluntary petition under Chapter 11 of the\nBankruptcy Code. Sometime prior to the filing of the petition, plaintiff became in arrears with\ndefendant for shipments of goods in the amount of approximately $18,000. Due to the arrearage,\ndefendant ceased shipping goods to plaintiff prior to the filing of the petition.\nIn March and April of 1983 Sam R. Shible, president of Sportfame, contacted defendant\'s\ncredit manager by telephone in an attempt to have shipments of inventory resumed. Mr. Shible\nattempted to buy goods from defendant for cash. Defendant, while aware of the Chapter 11\nproceeding, refused to resume shipments of goods unless plaintiff brought its account current or\nmade arrangements to pay 100% of the arrearage.\nAs a result of defendant\'s refusal to fill plaintiff\'s orders, plaintiff can no longer supply its\ncustomers with the Wilson line of sporting goods. Plaintiff asserts that defendant\'s refusal to\nresume shipments of goods absent full payment of its debt contravenes 11 U.S.C. \xc2\xa7 362(a)(6)\nwhich stays "any act to collect, assess, or recover a claim against the debtor that arose before the\n117\n\n\x0ccommencement of the case. . . ." Plaintiff seeks an injunction that would require defendant to\nresume supplying it with inventory on a cash basis and attorney\'s fees and costs for the present\naction.\nPlaintiff first contends that defendant\'s refusal to ship goods to it is in violation of \xc2\xa7\n362(a)(6) of the Code which provides that a petition in bankruptcy operates as a stay of "any act\nto collect, assess, or recover a claim against the debtor that arose before the commencement of the\ncase under this title. . . ." Defendant denies this contention, instead asserting that it cut off shipment\nof goods prior to the filing of the petition in this case and that, instead of asking for repayment of\nits debt, it only sought to encourage debtor to submit a plan calling for 100% repayment of its\ndebts. Upon the evidence adduced at trial in this case, the Court concludes that defendant\'s actions\ncontravene \xc2\xa7 362 of the Code.\nDefendant\'s sole animus in refusing to ship goods to debtor for cash was its desire to coerce\ndebtor\'s repayment of its prepetition indebtedness and that this act, albeit a passive one, was an\n"act to collect, assess, or recover a claim against the debtor" in contravention of 11 U.S.C. \xc2\xa7\n362(a)(6). As one commentator has remarked, "[t]he stay of section 362 is extremely broad in\nscope and . . . should apply to almost any type of formal or informal action against the debtor or\nproperty of the estate." 2 Collier on Bankruptcy, \xc2\xb6 362.04 at 362-27 (15th ed. 1979). Section\n362(a)(6), in particular, was intended to prevent any kind of attempt to collect prepetition debts:\nIn the present case, although it was the debtor and not the creditor who initiated the contact and\ndespite the fact that this is not a consumer bankruptcy, under the circumstances of this case,\nWilson\'s act was inherently coercive and against the spirit of the bankruptcy laws.\nWhile perhaps unremarkable otherwise, Wilson\'s actions take on an added significance\nupon the filing of a petition in bankruptcy. Wilson could have simply refused, for any reason, to\nsell goods to debtor or offered no explanation for its refusal to do business. Instead, its sole reason\nfor refusing to sell goods to debtor was its desire to collect its prepetition debt. The act in this\ncontext had the effect of interfering with the reorganization effort, a result at odds with the purpose\nof the bankruptcy laws.\nAs plaintiff points out, an analogy can be drawn from those cases that have found that a\nstate university\'s refusal to issue a transcript to a debtor absent payment of prepetition debt, in\naddition to constituting a type of discriminatory treatment by a governmental unit proscribed by\n11 U.S.C. \xc2\xa7 525, when motivated by the sole purpose of attempting to collect a prepetition debt,\nviolated \xc2\xa7 362(a)(6). In re Parkman, 27 B.R. 460 (Bkrtcy. N.D. Ill. 1983). In addition, the Court\nin Parkman enjoined the university from barring the debtor from classes during the pendency of\nthe Chapter 13 proceeding.\nMore directly on point is In re Haffner, 25 B.R. 882, 9 BCD 1293 (Bkrtcy. N.D. Ind. 1982).\nIn Haffner [farmer debtors who] sought to store grain with the Commodity Credit Corporation\n(CCC) were told the transaction could be made only if CCC retained, or setoff from the amount\nthat otherwise would be paid to the debtors, amounts which were due or allegedly due from a\nprepetition transaction of a similar nature in accordance with federal regulations. The Court found\nthat the regulations, to the extent that they require the retention of money to recover prepetition\ndebts in a postpetition transaction, violated the automatic stay of \xc2\xa7 362(a)(6). The court went on\nin Haffner to order the CCC to enter into the transaction with debtor and to pay over the usual\namount to debtor without any setoff.\n118\n\n\x0cIt seems clear from the foregoing discussion that ample authority exists for the finding that\nWilson violated the automatic stay by refusing to enter into cash transactions with debtor absent\npayment of its prepetition debt where its sole motivation was to collect its prepetition debt. While\nclear, in retrospect, that the stay was violated, due to the relatively obscure nature of the violation\nin this case, the Court is inclined to deny debtor\'s prayer for costs and attorney\'s fees in this case.\nDebtor\'s prayer for an injunction requiring Wilson to fill postpetition orders for goods, however,\nshould be granted.\nThere remains the question of the terms and duration of the order. The debtor shall be\nrequired to pay cash either in advance of or upon receipt of goods. Upon receipt of debtor\'s order,\nWilson should ship goods without undue delay and shall not unreasonably discriminate against\ndebtor\'s orders. As far as possible, the parties shall operate on a normal business relationship\nconsistent with their previous course of dealing over the past ten years. Although debtor has\nrequested an order of unlimited duration, the spirit of this order, to remedy the violation of stay\nand promote the rehabilitation effort, can only justify its continuance through the course of this\nreorganization proceeding.\n\n119\n\n\x0cChapter 7: Operating the Estate\n7.1.\n\nThe United States Trustee\n\nThe Office of the United States Trustee is part of the executive branch of the federal\ngovernment supervised by the Attorney General of the United States. A United States Trustee is\nappointed by the Attorney General for each judicial district, and the people who work in the United\nStates Trustee\xe2\x80\x99s office are civil servants. The job of the United States Trustee is to supervise the\nbankruptcy system; not to administer individual bankruptcy cases (which is the job of the similarly\ntitled \xe2\x80\x9ctrustee.\xe2\x80\x9d). The United States Trustee reviews bankruptcy petitions for compliance with the\nrules (and carefully scrutinizes compliance with the means test), reviews fee applications, plans\nand disclosure statements, refers cases for criminal prosecution to the United States Attorney,\nsupervises the appointment and election of trustees, maintains statistics on bankruptcy cases, and\ngenerally appears in bankruptcy cases to protect the integrity of the bankruptcy system from abuse.\nThe specific duties of the United States Trustee are set forth in 28 U.S.C. \xc2\xa7 586. Although the\nUnited States Trustee has the power to act as a case trustee by administering cases, the exercise of\nthat power would be extremely unusual. Because of the United States Trustee\xe2\x80\x99s independence and\nexpertise, a competent bankruptcy attorney must endeavor to address any concerns raised by the\nOffice of the United States Trustee in a prompt and courteous manner, because an objection by the\nUnited States Trustee is generally given significant weight by the courts.\n\n7.2.\n\nThe Case Trustee\n\nThe case trustee\xe2\x80\x99s primary job is to maximize the value of the bankruptcy estate for\nunsecured creditors in a liquidation. The trustee must question the debtor to make sure the filed\nschedules are accurate and reflect all of the debtor\xe2\x80\x99s property. As will be discussed in Chapter 8,\nthe trustee is also given avoiding powers to set aside prepetition transactions that are presumed to\nhave been made in contemplation of bankruptcy and have harmed other unsecured creditors.\nA trustee is appointed automatically in every Chapter 7 case. The United States Trustee\nmaintains a panel of private attorneys or other professionals who have qualified to serve as trustees\nin bankruptcy cases. The cases are generally assigned randomly to a trustee on the panel to act as\nthe \xe2\x80\x9cinterim trustee.\xe2\x80\x9d See 11 U.S.C. \xc2\xa7 701.\nThe Bankruptcy Code contains an elaborate procedure for the election of a permanent\ntrustee who is different from the interim trustee if creditors holding 20% of undisputed liquidated\nunsecured claims timely request an election. See 11 U.S.C. \xc2\xa7 702. Such elections are very unusual\nin Chapter 7 cases. Elections generally happen only in large cases where sophisticated organized\ncreditor groups seek the appointment of professionals experienced in a particular industry. In most\nordinary cases, the interim panel trustee will automatically serve as the permanent trustee in the\ncase because no election is requested.\nTrustees must be independent and disinterested, bonded, and have no conflicts of interest\nwith the debtor or the creditors. See 11 U.S.C. \xc2\xa7\xc2\xa7 321, 322, 701. The trustee is a fiduciary of the\nestate, holds legal title to property of the estate in trust, and has the capacity to sue and be sued in\nhis or her official trustee capacity. A trustee receives a flat fee (currently $60) from the debtor\xe2\x80\x99s\nfiling fees for acting as a trustee in the case. In addition, the trustee is entitled to reasonable\n120\n\n\x0ccompensation for services rendered in the case limited to a percentage of the money or property\ndistributed to creditors. 11 U.S.C. \xc2\xa7 326(a). Payment must come from the estate as an\nadministrative claim. Trustees routinely seek to be paid the maximum percentage allowed based\non the amount of money distributed, but the statute by its terms only allows compensation for the\nvalue of services rendered, limited by the maximum percentage fee. For significant compensation\nrequests, judges should require the trustee to show the fees earned on a case, based on the hours\nworked on the case multiplied by an appropriate hourly rate. Trustees are expected to maintain\ntime records just like other professionals.\nThe Trustee will review the debtor\xe2\x80\x99s petition and schedules, review the debtor\xe2\x80\x99s tax returns,\nand often will request additional documentation from the debtor to review (commonly 90 days of\nbank statements, copies of insurance policies, title documents for real estate, and pay stubs). A\ngood lawyer will endeavor to provide the trustee with whatever documentation the trustee requests\nto avoid additional scrutiny and trustee objections.\n\n7.3.\n\nThe Section 341 Meeting\n\nThe first major event in most Chapter 7 bankruptcy cases is the Section 341 meeting (after\n11 U.S.C. \xc2\xa7 341), also known inappropriately as the first meeting of creditors. The meeting is\nbadly named because, in most cases, creditors do not bother to come to the first meeting of\ncreditors. At the meeting, the debtor is sworn in, provides identification documents to the trustee\n(driver\xe2\x80\x99s license and social security card), and is questioned by the trustee about the schedules.\nThe proceeding is tape recorded. No judge is present during the meeting. Creditors may attend the\nmeeting and ask a few questions, but will be told by the trustee to schedule an examination if the\ncreditor starts to take up too much time. The election of a trustee is supposed to occur at the 341\nmeeting, but elections are only rarely requested. In typical consumer cases, there are 20-50 341\nhearings scheduled back to back, and the hearings take about 10-15 minutes, with the following\nprocedure:\n(1) Debtor sworn in.\n(2) Debtor provides driver\xe2\x80\x99s license and social security card to the trustee. Trustee verifies\nthe numbers.\n(3) Trustee gives tax returns back to the debtor and asks whether the returns correctly\nreflect what was filed with the tax authorities.\n(4) Debtor is shown signature page from petition and is asked to verify signature. Debtor\nis asked if he or she read and reviewed the petition before signing it, and if it is true\nand complete, or if the debtor is aware of any inaccuracies or changes.\n(5) Debtor is asked general questions about other possible assets: does the debtor have any\nclaims for personal injury or property damage against anyone; did the debtor own any\nreal property in the past several years (and if so, what happened to the property); what\nis the debtor\xe2\x80\x99s employment status; does the debtor expect any tax refunds; what is the\nstatus of the debtor\xe2\x80\x99s secured loans; does the debtor have liability insurance to protect\nthe public from the debtor\xe2\x80\x99s continued operation of a vehicle?\n(6) Debtor is asked about valuable property listed in schedules, such as vehicles and\ncollections.\n121\n\n\x0c(7) If information in the Debtor\xe2\x80\x99s schedules raises suspicions, the trustee will inquire\nfurther.\nIt is important to remember that most trustees have handled many cases, and can often tell when\ndebtors are not telling the truth or are trying to hide something. It is important for debtor lawyers\nto ask thorough questions when preparing the petition and schedules to avoid the embarrassment\ncaused at the 341 hearing when information not reflected in the schedules comes to light.\n\n7.4.\n\nNo Asset Cases\n\nIn many cases, the trustee will determine at the 341 hearing that all of the debtor\xe2\x80\x99s assets\nthat have any value are exempt, and will file a \xe2\x80\x9cno asset\xe2\x80\x9d report. The \xe2\x80\x9cno asset\xe2\x80\x9d report indicates\nthat the trustee has determined that nothing will be available to distribute to creditors. Following\nthe trustee\xe2\x80\x99s \xe2\x80\x9cno asset\xe2\x80\x9d report, the debtor simply waits for the time period for parties in interest to\nobject to the debtor\xe2\x80\x99s discharge to run, and then the discharge will be issued automatically by the\nbankruptcy court. Shortly thereafter, the case will be closed and the bankruptcy concluded. Most\nconsumer debtors will complete their bankruptcy cases without ever appearing before a judge, and\nafter having had to endure only brief gentle questioning by the trustee at the Section 341 meeting.\nThe primary job of the debtor\xe2\x80\x99s lawyer in consumer Chapter 7 cases is to properly complete the\npetition and schedules.\n\n7.5.\n\nUse, Sale and Lease of Property\n\nThe trustee has broad powers to use, sell and lease property of the estate in the ordinary\ncourse of business. 11 U.S.C. \xc2\xa7 363(c)(1). The statutory starting place for this power is Section\n363(c)(1), which gives the trustee the power to use, sell or lease property of the estate in the\nordinary course of business without a court order, unless the court requires otherwise (or unless\nthe court has prohibited the trustee from continuing to operate the debtor\xe2\x80\x99s business). Business as\nusual continues after bankruptcy under the trustee\xe2\x80\x99s supervision.\nBut the trustee\xe2\x80\x99s power to use, sell or lease property of the estate are limited by three\nautomatic statutory restrictions.\nFirst, under Section 365(b)(1), the trustee must obtain court approval, on notice to creditors\nand an opportunity for hearing, to use, sell or lease property of the estate outside of the ordinary\ncourse of business. When is the trustee\xe2\x80\x99s use, sale or lease of property within the \xe2\x80\x9cordinary course\xe2\x80\x9d\nof business, and when is it outside the \xe2\x80\x9cordinary course\xe2\x80\x9d of business (requiring court\nauthorization)? Unfortunately, there is no clear line here. If it is the type of transaction that the\ndebtor conducted on a regular basis in connection with the operation of its business before\nbankruptcy, then it will generally be within the ordinary course. For example, for a grocery store\ndebtor, the sale of food to ordinary customers at regular prices would be in the ordinary course of\nbusiness, but the sale of all of the store\xe2\x80\x99s inventory to a single buyer (or the sale of store\xe2\x80\x99s real\nproperty) would not be in the ordinary course of business. The line between what is ordinary and\nwhat is not can easily become blurred, however. A cautious lawyer will advise a client to obtain\napproval when in doubt.\n122\n\n\x0cSecond, the trustee cannot use \xe2\x80\x9ccash collateral\xe2\x80\x9d without either (1) the consent of the\nsecured creditor or (2) court approval on notice to the secured creditor. 11 U.S.C. \xc2\xa7 363(c)(2).\nCash collateral is money (or money like property) that is subject to a creditor\xe2\x80\x99s security interest.\n11 U.S.C. \xc2\xa7 363(a)(1). Most commonly, cash received as proceeds from the sale of a secured\ncreditor\xe2\x80\x99s collateral will be \xe2\x80\x9ccash collateral.\xe2\x80\x9d On the other hand, the Trustee is allowed to use\n\xe2\x80\x9cfree cash\xe2\x80\x9d that is not subject to a creditor\xe2\x80\x99s security interest in the ordinary course of business\nwithout court approval. It may be difficult for someone dealing with a trustee at arm\xe2\x80\x99s length to\nknow the source of cash payments, so special care and attention is required when doing business\nwith a trustee for cash.\nThird, upon the request of a secured creditor at any time, the court must restrict the use,\nsale or lease of property of the estate if the creditor is not \xe2\x80\x9cadequately protected.\xe2\x80\x9d 11 U.S.C. \xc2\xa7\n363(e). The Bankruptcy Code does not explicitly define when secured creditors are entitled to\n\xe2\x80\x9cadequate protection,\xe2\x80\x9d and thus the courts have been required to define the doctrine. One thing is\nclear about adequate protection \xe2\x80\x93 creditors may be entitled to receive adequate protection only if\nthey ask the bankruptcy court for protection. Creditors who sleep on their rights cannot\nretroactively seek adequate protection. The fundamental concept of adequate protection \xe2\x80\x93 what it\nmeans, when creditors are entitled to it, and how it can be provided, will be discussed later in\nSection 9.14. For now, simply recognize that secured creditors who are at risk of losing some or\nall of the value of their collateral during the bankruptcy case by the trustee\xe2\x80\x99s use, sale or lease of\ntheir collateral are entitled to court protection if they request it.\nThese restrictions on the trustee\xe2\x80\x99s power to use, sell or lease property are important not\nonly for the trustee but also for anyone dealing with the trustee, because the failure to obtain court\napproval for a transaction requiring court approval results in a transaction that can later be undone. 11 U.S.C. \xc2\xa7 549(a). Thus, anyone dealing with the trustee must assure that the transaction is\nauthorized before proceeding, or risk the later revocation of the transaction and the consequences\nthat follow from revocation. The risk of avoidance is well illustrated by the Marathon Oil case,\nreprinted below.\n\n7.6.\n\nPractice Problems: Sale of Property\n\nProblem 1: Debtor and her former husband owned a house together for 20 years before\ntheir separation and divorce. As part of the divorce decree, each spouse retained a 50% interest in\nthe house as tenants in common, with the husband remaining in possession of the house subject to\nan obligation to pay all accruing interest on the mortgage. Upon sale, each spouse was to get 50%\nof the remaining proceeds after satisfying the mortgage. The house was worth $100,000 more than\nthe amount owing on the mortgage. The trustee would only be able to obtain about $10,000 for the\nDebtor\xe2\x80\x99s interest in the house, because anyone buying the house for its full value would want to\nlive in it - not be a half owner with an ex-husband who is in possession of the house. Can the\nTrustee sell the entire house and throw the husband out? If so, how would the proceeds from sale\nbe divided between the trustee and the husband? If it costs a 6% sales commission, and the trustee\xe2\x80\x99s\nfees are $8,000, how much would the husband and the bankruptcy estate get? See 11 U.S.C. \xc2\xa7\xc2\xa7\n363(g)-(j).\nProblem 2: Bank of Armenia holds a $200,000 mortgage against the house in the last\nproblem, and has an ongoing lucrative business relationship with the Debtor\xe2\x80\x99s husband. At the\n123\n\n\x0chusband\xe2\x80\x99s request, the Bank will not consent to a sale of the property. Can the house be sold free\nof Bank of Armenia\xe2\x80\x99s $200,000 mortgage without its consent? 11 U.S.C. \xc2\xa7 363(f).\nProblem 3: Bank of Armenia\xe2\x80\x99s mortgage contains the following clause: \xe2\x80\x9cIf either\nmortgagor files a petition under Title 11 of the United States Code at any time, this mortgage will\nbe fully due and payable immediately, and if the full balance of the loan is not paid within 10\ncalendar days, the mortgaged property will be deemed owned by Bank of Armenia free and clear\nof any interest in the mortgagors.\xe2\x80\x9d Assume that this provision is valid under applicable state law,\nand that 10 days have passed since the bankruptcy filing without the loan being paid. Is the property\nno longer property of the estate that can be sold by the trustee? See 11 U.S.C. \xc2\xa7 363(l); 541(C)(1).\nProblem 4: Suppose the bankruptcy court in Problem (1) decides to authorize the sale of\nthe house over the husband\xe2\x80\x99s objection. The husband appeals. While the appeal is pending, the\ntrustee sells the property for fair value to the highest bidder at a public sale. The bidder knew about\nthe appeal, but did not think the husband would win. After the buyer evicted the husband and lived\nin the house for more than a year, the appellate court finally issued a decision reversing the\nbankruptcy court\xe2\x80\x99s approval of the sale by finding that the detriment to the husband from the sale\nexceeded the benefit to the estate. Does the bidder have to give the house back to the husband?\nSee 11 U.S.C. \xc2\xa7 363(m). What could the losing party have done to prevent this result?\nProblem 5: Debtor is a corporation that owns a hotel in a small tourist town. Your client\nis a bank that holds a mortgage on the hotel to secure a loan with a balance of $1.2 million. The\nhotel property is worth about $1.5 million. The Debtor is behind on the mortgage payments and\nhas been having trouble making ends meet during the recent recession, but there seems to be a\npickup in business as the economy recovers. Under the terms of the mortgage, the bank has a\nsecurity interest in the rents generated by the hotel. The Debtor has filed a petition under Chapter\n11 of the Bankruptcy Code, under which the Debtor, as a \xe2\x80\x9cdebtor-in-possession,\xe2\x80\x9d has the powers\nand duties of a trustee in the case. See 11 U.S.C. \xc2\xa7 1107(a). The Debtor needs to use the rents from\nthe hotel to pay the continuing expenses of operations, and asks your client to promptly consent to\nthe Debtor\xe2\x80\x99s use of cash collateral so that payroll can be met the day after tomorrow, needed\nsupplies can be purchased, and the Debtor can continue to pay the expenses of the business going\nforward while the Debtor puts together a plan of reorganization. What do you say in response to\nthe Debtor\xe2\x80\x99s request for consent? What can the Debtor do if you simply say \xe2\x80\x9cno\xe2\x80\x9d?\n\n7.7.\n\nCases on the Sale of Property\n7.7.1.1.\nMARATHON PETROLEUM v. COHEN, 599 F.3d\n1255 (11th Cir. 2010)\n\nDelco Oil, Inc. (Debtor) is a distributor of motor fuel and associated products. Debtor began\npurchasing petroleum products from Marathon in 2003 pursuant to a sales agreement. Debtor also\nentered into a financing agreement with CapitalSource Finance in April 2006, in which\nCapitalSource agreed to provide financing to Debtor in exchange for Debtor\'s pledge of all rights\nto Debtor\'s personal property, including collections, cash payments, and inventory.\nOn October 17, 2006, Debtor filed for Chapter 11 bankruptcy protection and filed an\nemergency motion with the bankruptcy court requesting authorization to use cash collateral to\n124\n\n\x0ccontinue its operations. CapitalSource objected. On November 6, 2006 the bankruptcy court denied\nDebtor\'s request to use its cash collateral (later reduced to a written order). Between October 18\nand November 6, however, Debtor distributed over $1.9 million in cash to Marathon in exchange\nfor petroleum products pursuant to its sales agreement.\nIn December 2006, Debtor voluntarily converted its bankruptcy to a Chapter 7 proceeding\nand the bankruptcy court appointed Cohen as trustee. Cohen filed an adversary proceeding against\nMarathon to avoid the post-petition cash transfers and ultimately filed the motion for summary\njudgment that is the subject of this appeal. The bankruptcy court granted summary judgment in\nfavor of Cohen and entered a judgment for $1,960,088.91 against Marathon, concluding Debtor\nused CapitalSource\'s cash collateral to pay Marathon without authorization.\nThe Bankruptcy Code prohibits the post-petition use of cash collateral by a trustee or a\ndebtor-in-possession, unless the secured party or the bankruptcy court after notice and a hearing\nauthorizes the use of cash collateral upon a finding that the secured party\'s interest in the cash is\nadequately protected. See 11 U.S.C. \xc2\xa7 1107; 11 U.S.C. \xc2\xa7 363(c)(2); 11 U.S.C. \xc2\xa7 363(e). Section\n363(c)(2) balances competing interests in a Chapter 11 reorganization. [A] debtor reorganizing his\nbusiness has a compelling need to use cash collateral in order to meet its daily operating expenses\nand rehabilitate its business. At the same time, however, unhindered use of cash collateral, i.e.,\n"secured `property\' may result in the dissipation of the estate." Section 363((c)(2) resolves this\ntension between a debtor and a secured creditor by only allowing the debtor to use cash collateral\nafter it has procured either the secured creditor\'s or the bankruptcy court\'s permission upon a\nshowing that the secured creditor\'s interest is adequately protected.\nSection 549(a) of the Bankruptcy Code authorizes a trustee to recover unauthorized postpetition transfers of estate property. To avoid a transfer under Section 549(a) a trustee need only\ndemonstrate: (1) a post-petition transfer (2) of estate property (3) which was not authorized by the\nBankruptcy Code or the court. After the trustee makes that showing, the party asserting an\nestablished transfer\'s validity bears the burden of proving it valid. Fed. R. Bankr.P. 6001. Once a\ncourt finds a transfer avoidable, Section 550(a) allows the trustee to recover the property\ntransferred from the initial transferee.\nMarathon asserts [that] the funds it received from Debtor [did not constitute]\nCapitalSource\'s cash collateral under [a Florida statute] which provides that "[a] transferee of funds\nfrom a deposit account takes the funds free of a security interest in the deposit account unless the\ntransferee acts in collusion with the debtor in violating the rights of the secured party."\nDespite Marathon\'s contentions otherwise, [the Florida statute] does not alter the fact that\nCapitalSource had a security interest in Debtor\'s deposit account funds as proceeds of\nCapitalSource\'s properly secured collateral while they were in Debtor\'s hands. Therefore, those\ncash proceeds constituted cash collateral as defined by 11 U.S.C. \xc2\xa7 363(a), and pursuant to 11\nU.S.C. \xc2\xa7 363(c)(2), Debtor could not transfer them to anyone without the authorization of\nCapitalSource or the bankruptcy court. Marathon correctly notes that under [the Florida statute]\nafter Debtor transferred the funds to it, the funds in its hands were no longer subject to\nCapitalSource\'s security interest. Such a result, however, has no bearing on the following\ndispositive facts: (1) The bankruptcy code prohibited the transfer to Marathon altogether, because\nCapitalSource had a perfected security interest in Debtor\'s cash proceeds while they were in\nDebtor\'s hands, and (2) the bankruptcy code allows the trustee to avoid and take back unauthorized\n125\n\n\x0ctransfers. Marathon does not cite a single case from any circuit to dispute this conclusion, nor are\nwe aware of any.\nLest any confusion exist, Cohen may avoid and recover from Marathon the funds Debtor\ntransferred to it not because CapitalSource continued to have a security interest in the funds once\nthey were in the hands of Marathon, but because Debtor was not authorized to transfer the funds\nto anyone post-petition without the permission of CapitalSource or the bankruptcy court.\nOtherwise, a debtor could circumvent Section 363(c)(2)\'s prohibition on the use of cash collateral\nwithout the secured creditor\'s or bankruptcy court\'s permission by distributing cash proceeds it\nknows are subject to a security interest as it likes, knowing that once distributed the proceeds\nwould not be defined as cash collateral under Section 363(a) and, therefore, the transfer would not\nviolate Section 363(c). Such an outcome would render Section 363(c) virtually meaningless,\nleaving a debtor generally free to transfer cash or its equivalent that is subject to a security interest.\nCohen, therefore, retains the power to avoid and recover these funds because before Debtor\ntransferred them they constituted the proceeds of CapitalSource\'s perfected security interest in all\nof Debtor\'s personal property and, therefore, they constituted cash collateral which Section 363\nprohibited Debtor from transferring to anyone without CapitalSource\'s or the court\'s permission.\nMarathon also argues that the deposit account funds that Debtor transferred to it did not\nconstitute cash collateral because CapitalSource did not perfect an interest in Debtor\'s deposit\naccount by filing a deposit control agreement. But this argument is equally unpersuasive. No one\ndisputes CapitalSource had a perfected security interest in all of Debtor\'s personal property. Thus,\nif the cash transferred constituted the proceeds of CapitalSource\'s collateral, CapitalSource need\nnot have had a deposit account control agreement to perfect its security interest in the cash\ntransferred.\nMarathon, however, maintains a genuine issue of fact exists as to whether the funds it\nreceived from Debtor\'s accounts were identifiable proceeds of CapitalSource\'s secured collateral.\nIn support of its motion for summary judgment, Cohen submitted the affidavit of Todd Gehrs, an\nofficer of CapitalSource. In his affidavit, Gehrs stated that CapitalSource had duly perfected, firstpriority security interests in all of Debtor\'s personal property, including all of Debtor\'s cash,\naccounts receivable, inventory, all cash collections, all rights to payment, and all proceeds thereof\nas of the bankruptcy petition date. Gehrs further stated all cash and all bank deposits maintained\nby Debtor as of the bankruptcy petition date constituted CapitalSource\'s cash collateral.\nAdditionally, he noted that the bankruptcy court in the underlying bankruptcy proceeding had\nalready concluded that "CapitalSource [had] established that the post-petition funds in Debtor\'s\nbank accounts, constitute direct proceeds of its pre-petition collateral without the addition of other\nestate resources."\nMarathon has failed to present any specific facts or even a possible theory as to where the\nalmost $2 million transferred could have come from, if not from CapitalSource\'s cash collateral.\nMarathon concedes CapitalSource had perfected security interests in all of Debtor\'s personal\nproperty, including inventory, cash payments, rights to collections, and all proceeds thereof. When\nasked at oral argument "if there is anything in this record ... that creates a genuine issue of material\nfact" as to whether the funds were anything but CapitalSource\'s cash collateral Marathon\'s counsel\nadmitted "I don\'t think there is anything in this record specifically on that point." Given those\nconcessions and the evidence Cohen presented, we fail to see where else Debtor\'s cash could have\ncome from other than the proceeds of its inventory, cash payments, or collections, in all of which\n126\n\n\x0cCapitalSource had a security interest. Thus, Marathon\'s suggestion that there might have been\nsome unidentified source of the deposit account funds that was beyond the ambit of\nCapitalSource\'s blanket lien is pure speculation and does not create a genuine issue of material\nfact.\nIn addition, Marathon also argues assuming that the funds constituted cash collateral Cohen\nmay not avoid the payments because any violation of Section 363(c)(2) caused no harm to\nCapitalSource or the estate. Marathon asserts it gave equivalent value in inventory for the funds\ntransferred to it by Debtor through a series of ordinary course transactions. Because CapitalSource\nadmittedly had a perfected security interest in all of Debtor\'s personal property, Marathon claims\nCapitalSource\'s interests were not diminished when Debtor received equivalent value in petroleum\nproducts from Marathon in exchange for the funds.\nBut a "harmless" exception to a trustee\'s Section 549(a) avoiding powers does not exist.\nAll Cohen needs to demonstrate to avoid the transfers under Section 549(a) is: (1) an unauthorized\ntransfer occurred; (2) the property transferred was property of the estate; and (3) the transfer\noccurred post-petition. Section 549 does not require any analysis of the adequacy of protection of\nsecured creditors\' interests nor does it provide a harmless error exception. No genuine doubt exists\nthat Debtor\'s transfers to Marathon were unauthorized because Debtor completed them without the\npermission of CapitalSource or the bankruptcy court in express violation Section 363(c)(2).\nFinally, Marathon argues that as a matter of policy an implicit defense exists under Section\n549 for ordinary course transfers and for innocent vendors who deal with a debtor-in-possession.\nThese arguments do not persuade us. Congress\'s prohibition on the use of cash collateral in (c)(2)\nis a specific limitation on the express ability provided in (c)(1) to use estate property in the ordinary\ncourse of business. Congress evidently did not intend to allow the use of cash collateral without\nthe permission of the interested secured creditor or the bankruptcy court, even if used in the\nordinary course of business.\nAs to Marathon\'s status as an "innocent vendor," Sections 549(a) and 550(a) by their terms\ncontain no reference to, let alone an actual defense based on, the transferee\'s status (vendor,\npurchaser, etc.) or upon its state of mind (innocent, culpable, etc.). Congress knew how to create\nexceptions based on transferee\'s status and culpability. But it chose not to do so when it came to\ninitial transferees of post-petition transfers of cash collateral. We will not create such exceptions\nin Congress\'s absence.\nAFFIRMED.\n\n7.8.\n\nPost-Bankruptcy Financing\n\nMoney and credit are the life blood of a business. Without money or access to credit, the\ntrustee (or the debtor-in-possession in a Chapter 11 case) cannot pay employees, cannot pay for\nutilities, supplies, additional inventory, or the other costs and expenses of the business, and the\nbusiness will quickly die.\nThe Trustee or Debtor-in-possession has several potential sources of financing. First, the\nestate may have free cash \xe2\x80\x93 cash that is free of liens \xe2\x80\x93 which money can then be used in the\nordinary course of business.\n127\n\n\x0cSecond, as discussed in the last section, the estate may have prepetition cash (or collect\nprepetition accounts) on which a creditor has a security interest. This is cash collateral which can\nonly be used with the secured creditor\xe2\x80\x99s consent, or the approval of the bankruptcy court upon a\nshowing that the secured creditor is adequately protected. Consent to use cash collateral must first\nbe sought from the secured creditor. If the creditor denies consent, then the trustee may seek\npermission from the court to use cash collateral over the secured creditor\xe2\x80\x99s objection.\nThird, the estate may generate cash from the sale of property post-petition. That cash too\nmay be restricted cash collateral if the property sold was subject to a security interest.\nIt is important to be able to determine whether cash from the sale of property is \xe2\x80\x9cfree cash,\xe2\x80\x9d\nor \xe2\x80\x9ccash collateral.\xe2\x80\x9d If the property is sold and the cash is collected prepetition, state law will\ndetermine whether the secured creditors\xe2\x80\x99 lien attached to the proceeds. Under most security\nagreements, proceeds from the sale of collateral continue to be covered by the lien on the collateral.\nFloating liens in bankruptcy raise special problems. A floating lien is a lien on collateral\nthe constituency of which changes over time. For example, a lender may have a lien on all of the\ndebtor\xe2\x80\x99s inventory. The particular items of inventory will change as inventory is sold, cash\nreceived, and new inventory purchased. Under most security agreements, any inventory purchased\nby the debtor after the loan is made will be subject to the lender\xe2\x80\x99s floating lien.\nSection 552(a) of the Bankruptcy Code cuts off floating liens in bankruptcy, but contains\nan important exception that often swallows the rule. Under the general rule of Section 552(a),\nproperty acquired post-petition is not subject to a prepetition floating lien. Thus, inventory\npurchased by the debtor after bankruptcy would not be part of the prepetition secured creditor\xe2\x80\x99s\nsecurity interest, as it would have before bankruptcy.\nHowever, Section 552(b) contains a very important exception to the general rule. If so\nprovided by the security agreement, proceeds, products, offspring, rents and property from\nprepetition collateral will continue to be covered by the prepetition security interest. Thus, if a\ncreditor\xe2\x80\x99s prepetition security interest covers inventory and its proceeds, then sales of inventory\nwill result in cash collateral proceeds, and the lien will also continue in any additional inventory\npurchased with the cash collateral (the new inventory will be proceeds of the cash collateral).\nTherefore, under Section 552, it is imperative to determine whether new collateral is purchased\nwith the estate\xe2\x80\x99s free cash (in which case the new inventory will not be subject to the lender\xe2\x80\x99s\nsecurity interest), or is purchased with cash collateral (in which case the new inventory will be\nsubject to the lender\xe2\x80\x99s security interest).\nThe rules of Section 552 play into cash collateral negotiations. When the debtor asks for\nconsent to use cash collateral, the lender has a strong interest in assuring that its security interest\nwill continue in the property purchased with the cash collateral, and that proper records are\nmaintained to determine what property is covered by the lender\xe2\x80\x99s security interest and what\nproperty is not covered by the lender\xe2\x80\x99s security interest. If the sole source of funding for future\ninventory is cash collateral, the exercise is easy \xe2\x80\x93 the floating lien will continue post-petition.\nHowever, if the debtor has both free cash and cash collateral, it will be important to require careful\nrecordkeeping of what is the lender\xe2\x80\x99s collateral (prepetition collateral and any collateral purchased\nwith cash collateral), and what is not (property purchased with free cash).\nCourts generally require the debtor-in-possession or trustee to attempt to negotiate a cash\ncollateral stipulation with the secured creditor before asking for court authorization to use cash\n128\n\n\x0ccollateral. Only after good faith negotiations fail should a motion requesting authorization from\nthe bankruptcy court be filed. Creditors who take unreasonable positions in cash collateral\nnegotiations are often dealt with harshly when a request to use cash collateral comes before the\ncourt. This puts pressure on both the debtor and the creditors to negotiate a cash collateral\nstipulation in good faith.\nFinally, the debtor may be able to borrow new money or obtain new credit on a secured or\nunsecured basis post-petition. Creditors who are willing to lend money or give the estate credit\npost-petition (often by selling goods to the trustee based on the estate\xe2\x80\x99s promise to make payment\nin the future) are given a special priority in bankruptcy. The Bankruptcy Code gives a creditor\nextending new post-petition credit an \xe2\x80\x9cadministrative priority\xe2\x80\x9d over prepetition unsecured claims\n(and many other types of pre-petition priority claims). The new credit (whether in the form of a\nmoney loan or the provision of goods or services to be paid for in the future) is considered an\n\xe2\x80\x9cactual, necessary cost or expense of preserving the estate\xe2\x80\x9d under Section 503(b)(1)(A) of the\nBankruptcy Code, and receives the second highest unsecured priority given to unsecured claims\nunder Section 507(a)(2) of the Bankruptcy Code. The trustee can borrow money on an\nadministrative priority basis in the ordinary course of business without bankruptcy court approval.\n11 U.S.C. \xc2\xa7 364(a). Incurring credit on an administrative basis outside of the ordinary course of\nbusiness requires mere court approval, which is easily obtained (but requires a noticed motion and\ntakes time). 11 U.S.C. \xc2\xa7 364(b).\nIf creditors want more than an administrative claim in return for their post-petition loan of\nmoney or extension of credit, they must obtain court approval and make the showing required by\nthe strictures of 11 U.S.C. \xc2\xa7 364 of the Bankruptcy Code. 11 U.S.C. \xc2\xa7 364 creates a hierarchy of\nrequirements that must be met depending on what level of security the post-petition creditor\nrequires. Each higher level requires a showing that needed credit is not available using the lower\nlevels. Super administrative priority, a lien on property not already subject to a lien, or a junior\nlien on property subject to a lien is only available upon a showing that such credit would not be\navailable on a grant of simple administrative priority. 11 U.S.C. \xc2\xa7 364(c).\nAn equal or priming lien on property already subject to a lien is available only if the credit\ncould not be obtained with an administrative or super administrative priority, or even with a lien\non unencumbered or junior lien on encumbered property. 11 U.S.C. \xc2\xa7 364(d). In addition, the court\nmust find that the secured creditor being equaled or primed is \xe2\x80\x9cadequately protected,\xe2\x80\x9d a concept\nthat we will study in more detail in Section 9.14. Equal or priming liens are harsh, and should not\nbe granted unless there is ample equity to fully protect both the old and new secured creditors.\n\n7.9.\n\nPractice Problems: Post Petition Financing\n\nProblem 1: Corporate Debtor operates a printing business. Its assets consist of printing\npresses, supplies of ink and paper, and some furniture. It fully utilized its $300,000 line of credit\nwith PressBank, and when it asked for more money the Bank said \xe2\x80\x9cno.\xe2\x80\x9d The Bank\xe2\x80\x99s line of credit\nis secured by a perfected first priority security interest in all of the Debtor\xe2\x80\x99s printing presses,\nsupplies and furniture, worth about $200,000 in liquidation. The Debtor claims, however, that the\nproperty is worth \xe2\x80\x9cat least $400,000\xe2\x80\x9d in fair market value using the income that can be generated\nfrom the equipment in a going concern. After filing a petition under Chapter 11 of the Bankruptcy\nCode, the debtor-in-possession (with the powers of a trustee under Section 1107(a) of the\n129\n\n\x0cBankruptcy Code) searched high and low for financing without success. Only PrimeBank was\nwilling to make the Debtor a $100,000 loan, but only if it would be given a first priority security\ninterest in all of the Debtor\xe2\x80\x99s property ahead of PressBank. The Debtor filed a motion to obtain the\npriming loan needed to stay in business. With payroll due the next day, and a courtroom full of\nanxious employees, the Bankruptcy Court approved the priming lien over PressBank\xe2\x80\x99s objection,\nfinding that the debtor\xe2\x80\x99s testimony regarding the going concern value to be \xe2\x80\x9cnot sufficiently\nincredible enough to justify shutting down the business.\xe2\x80\x9d The Bankruptcy Court denied\nPressBank\xe2\x80\x99s request for a stay pending appeal. The PrimeBank loan was funded the next day, the\nemployees were paid, and the company continued to muddle along until the appellate court\nreversed the Bankruptcy Court\xe2\x80\x99s order, determining that there was insufficient evidence of equity\nto approve a priming lien. After the appellate court\xe2\x80\x99s decision, the Debtor\xe2\x80\x99s case was converted to\nChapter 7 and the property liquidated by the trustee for $200,000. Who gets the money? See 11\nU.S.C. \xc2\xa7 364(e).\nProblem 2: Debtor is a corporation in the business of making candles. The Trustee\ncontinued to operate the business after bankruptcy while looking to sell the business as a going\nconcern. During the trustee\xe2\x80\x99s operations, one of the company\xe2\x80\x99s employees who was testing candles\nto determine the life of the flame knocked a burning candle into a pile of wicks, setting off an\ninferno that burned down the entire block of stores in which the factory was located. The neighbor\nstores filed administrative claims against the estate for the value of their buildings and inventory\ndestroyed by the post-petition fire. The trustee objected, arguing that the damage caused by the\nfire was not an \xe2\x80\x9cactual, necessary cost or expense of preserving the estate\xe2\x80\x9d under Section\n503(b)(1)(A) of the Bankruptcy Code. Indeed, argued the trustee, the fire and the damage done to\nthe neighbors did not benefit the estate at all, and destroyed the debtor\xe2\x80\x99s business. Is the trustee\nright? See Reading Co. v. Brown, reprinted below.\n\n7.10.\n\nCases on Post Petition Financing\n7.10.1.1.\nIN RE SAYBROOK MFG. CO., INC., 963 F.2d 1490\n(11th Cir. 1992)\n\nSaybrook Manufacturing Co., Inc., initiated proceedings seeking relief under Chapter 11\nof the Bankruptcy Code on December 22, 1988. On December 23, 1988, the debtors filed a motion\nfor the use of cash collateral and for authorization to incur secured debt. The bankruptcy court\nentered an emergency financing order that same day. At the time the bankruptcy petition was filed,\nthe debtors owed Manufacturers Hanover approximately $34 million. The value of the collateral\nfor this debt, however, was less than $10 million. Pursuant to the order, Manufacturers Hanover\nagreed to lend the debtors an additional $3 million to facilitate their reorganization. In exchange,\nManufacturers Hanover received a security interest in all of the debtors\' property--both property\nowned prior to filing the bankruptcy petition and that which was acquired subsequently. This\nsecurity interest not only protected the $3 million of post-petition credit but also secured\nManufacturers Hanover\'s $34 million pre-petition debt.\nThis arrangement enhanced Manufacturers Hanover\'s position vis-a-vis other unsecured\ncreditors, such as the Shapiros, in the event of liquidation. Because Manufacturers Hanover\'s prepetition debt was undersecured by approximately $24 million, it originally would have shared in a\n130\n\n\x0cpro rata distribution of the debtors\' unencumbered assets along with the other unsecured creditors.\nUnder the financing order, however, Manufacturers Hanover\'s pre-petition debt became fully\nsecured by all of the debtors\' assets. If the bankruptcy estate were liquidated, Manufacturers\nHanover\'s entire debt--$34 million pre-petition and $3 million post-petition--would have to be paid\nin full before any funds could be distributed to the remaining unsecured creditors.\nSecuring pre-petition debt with pre- and post-petition collateral as part of a post-petition\nfinancing arrangement is known as cross-collateralization, [or Texlon Cross Collateralization\nbecause it was first defined in In re Texlon Corp. 596 F.2d 1092, 1094 (2d Cir. 1979). Another\nform of cross-collateralization involves securing post-petition debt with pre-petition collateral.\nThis form of non-Texlon-type cross-collateralization is not at issue in this appeal. The Shapiros\nchallenge only the cross-collateralization of the lenders\' pre-petition debt, not the propriety of\ncollateralizing the post-petition debt.\nThe Shapiros [who were unsecured creditors of the Debtor] filed a number of objections to\nthe bankruptcy court\'s order on January 13, 1989. After a hearing, the bankruptcy court overruled\nthe objections. The Shapiros then filed a notice of appeal and a request for the bankruptcy court to\nstay its financing order pending appeal. The bankruptcy court denied the request for a stay on\nFebruary 23, 1989. The Shapiros subsequently moved the district court to stay the bankruptcy\ncourt\'s financing order pending appeal; the court denied the motion on March 7, 1989. On May\n20, 1989, the district court dismissed the Shapiros\' appeal as moot under 11 U.S.C. \xc2\xa7 364(e)\nbecause the Shapiros had failed to obtain a stay of the financing order pending appeal, rejecting\nthe argument that cross-collateralization is contrary to the Code. The Shapiros then appealed to\nthis court.\nThe lenders argue that this appeal is moot under section 364(e) of the Bankruptcy Code.\nThat section provides that a lien or priority granted under section 364 may not be overturned unless\nit is stayed pending appeal. Even if this appeal were not moot, the Shapiros are not entitled to\nrelief. Cross-collateralization is a legitimate means for debtors to obtain necessary financing and\nis not prohibited by the Bankruptcy Code.\nThe Shapiros contend that their appeal is not moot. Because cross-collateralization is not\nauthorized under bankruptcy law, section 364(e) is inapplicable. Permitting cross-collateralization\nwould undermine the entire structure of the Bankruptcy Code by allowing one unsecured creditor\nto gain priority over all other unsecured creditors simply by extending additional credit to a debtor.\nWe begin by addressing the lenders\' claim that this appeal is moot under section 364(e) of\nthe Bankruptcy Code. The purpose of this provision is to encourage the extension of credit to\ndebtors in bankruptcy by eliminating the risk that any lien securing the loan will be modified on\nappeal.\nThe lenders suggest that we assume cross-collateralization is authorized under section 364\nand then conclude the Shapiros\' appeal is moot under section 364(e). This is similar to the approach\nadopted by the Ninth Circuit in In re Adams Apple, Inc., 829 F.2d 1484 (9th Cir. 1987). That court\nheld that cross-collateralization was "authorized" under section 364 for the purposes of section\n364(e) mootness but declined to decide whether cross-collateralization was illegal per se under the\nBankruptcy Code.\nWe reject the reasoning of In re Adams Apple because they "put the cart before the horse."\nBy its own terms, section 364(e) is only applicable if the challenged lien or priority was authorized\n131\n\n\x0cunder section 364. We cannot determine if this appeal is moot under section 364(e) until we decide\nthe central issue in this appeal--whether cross-collateralization is authorized under section 364.\nAccordingly, we now turn to that question.\nCross-collateralization is an extremely controversial form of Chapter 11 financing.\nNevertheless, the practice has been approved by several bankruptcy courts. Even the courts that\nhave allowed cross-collateralization, however, were generally reluctant to do so. [The bankruptcy\ncourt in In re Vanguard Diversified, Inc., 31 B.R. 364, 366 (Bankr. E.D.N.Y. 1983)], held that in\norder to obtain a financing order including cross-collateralization the debtor [must] demonstrate\n(1) that its business operations would fail absent the proposed financing, (2) that it is unable to\nobtain alternative financing on acceptable terms, (3) that the proposed lender will not accept less\npreferential terms, and (4) that the proposed financing is in the general creditor body\'s best interest.\nThe issue of whether the Bankruptcy Code authorizes cross-collateralization is a question\nof first impression in this court. Indeed, it is essentially a question of first impression before any\ncourt of appeals. Neither the lenders\' brief nor our own research has produced a single appellate\ndecision which either authorizes or prohibits the practice. [The court noted that the prior appellate\ndecisions ruled that the appeals were moot without deciding whether cross-collateralization is\npermissible].\nThe Second Circuit expressed criticism of cross-collateralization in In re Texlon. The court,\nhowever, stopped short of prohibiting the practice altogether. At issue was the bankruptcy court\'s\nex parte financing order granting the lender a security interest in the debtor\'s property to secure\nboth pre-petition and post-petition debt. The court, in an exercise of judicial restraint, concluded\nthat:\nIn order to decide this case we are not obliged, however, to say that\nunder no conceivable circumstances could "cross-collateralization"\nbe authorized. Here it suffices to hold that ... a financing scheme so\ncontrary to the spirit of the Bankruptcy Act should not have been\ngranted by an ex parte order, where the bankruptcy court relies\nsolely on representations by a debtor in possession that credit\nessential to the maintenance of operations is not otherwise\nobtainable.\nIn re Texlon, 596 F.2d at 1098. Although In re Texlon was decided under the earlier Bankruptcy\nAct, the court also considered whether cross-collateralization was authorized under the Bankruptcy\nCode. "To such limited extent as it is proper to consider the new Bankruptcy Act, which takes\neffect on October 1, 1979, in considering the validity of an order made in 1974, we see nothing in\n\xc2\xa7 364(c) or in other provisions of that section that advances the case in favor of \'crosscollateralization.\' "In re Texlon, 596 F.2d at 1098 (citations omitted).\nCross-collateralization is not specifically mentioned in the Bankruptcy Code. We conclude\nthat cross-collateralization is inconsistent with bankruptcy law for two reasons. First, crosscollateralization is not authorized as a method of post-petition financing under section 364.\nSecond, cross-collateralization is beyond the scope of the bankruptcy court\'s inherent equitable\npower because it is directly contrary to the fundamental priority scheme of the Bankruptcy Code.\nGiven that cross-collateralization is not authorized by section 364, we now turn to the\nlenders\' argument that bankruptcy courts may permit the practice under their general equitable\n132\n\n\x0cpower. Bankruptcy courts are indeed courts of equity, and they have the power to adjust claims to\navoid injustice or unfairness. This equitable power, however, is not unlimited. [T]he bankruptcy\ncourt has the ability to deviate from the rules of priority and distribution set forth in the Code in\nthe interest of justice and equity. The Court cannot use this flexibility, however, merely to establish\na ranking of priorities within priorities. Furthermore, absent the existence of some type of\ninequitable conduct on the part of the claimant, which results in injury to the creditors of the\nbankrupt or an unfair advantage to the claimant, the court cannot subordinate a claim to claims\nwithin the same class.\nSection 507 of the Bankruptcy Code fixes the priority order of claims and expenses against\nthe bankruptcy estate. 11 U.S.C. \xc2\xa7 507. Creditors within a given class are to be treated equally,\nand bankruptcy courts may not create their own rules of superpriority within a single class. Crosscollateralization, however, does exactly that. As a result of this practice, post-petition lenders\'\nunsecured pre-petition claims are given priority over all other unsecured pre-petition claims. The\nNinth Circuit recognized that "[t]here is no ... applicable provision in the Bankruptcy Code\nauthorizing the debtor to pay certain pre-petition unsecured claims in full while others remain\nunpaid. To do so would impermissibly violate the priority scheme of the Bankruptcy Code." The\nfundamental nature of this practice is not changed by the fact that it is sanctioned by the bankruptcy\ncourt. We disagree with the district court\'s conclusion that, while cross-collateralization may\nviolate some policies of bankruptcy law, it is consistent with the general purpose of Chapter 11 to\nhelp businesses reorganize and become profitable. Rehabilitation is certainly the primary purpose\nof Chapter 11. This end, however, does not justify the use of any means. Cross-collateralization is\ndirectly inconsistent with the priority scheme of the Bankruptcy Code. Accordingly, the practice\nmay not be approved by the bankruptcy court under its equitable authority.\nCross-collateralization is not authorized by section 364. Section 364(e), therefore, is not\napplicable and this appeal is not moot. Because Texlon -type cross-collateralization is not explicitly\nauthorized by the Bankruptcy Code and is contrary to the basic priority structure of the Code, we\nhold that it is an impermissible means of obtaining post-petition financing. The judgment of the\ndistrict court is REVERSED and the case is REMANDED for proceedings not inconsistent with\nthis opinion.\n\n7.10.1.2.\n\nREADING v. BROWN, 391 U.S. 471 (1968)\n\nMR. JUSTICE HARLAN delivered the opinion of the Court.\nOn November 16, 1962, I. J. Knight Realty Corporation filed a petition for an arrangement\nunder Chapter XI of the Bankruptcy Act. The same day, the District Court appointed a receiver,\nFrancis Shunk Brown, a respondent here. The receiver was authorized to conduct the debtor\'s\nbusiness, which consisted principally of leasing the debtor\'s only significant asset, an eight-story\nindustrial structure located in Philadelphia.\nOn January 1, 1963, the building was totally destroyed by a fire which spread to adjoining\npremises and destroyed real and personal property of petitioner Reading Company and others. On\nApril 3, 1963, petitioner filed a claim for $559,730.83 in the arrangement, based on the asserted\nnegligence of the receiver. It was styled a claim for "administrative expenses" of the arrangement.\nOther fire loss claimants filed 146 additional claims of a similar nature. The total of all such claims\nwas in excess of $3,500,000, substantially more than the total assets of the debtor.\n133\n\n\x0cOn May 14, 1963, Knight Realty was voluntarily adjudicated a bankrupt, and respondent\nreceiver was subsequently elected trustee in bankruptcy. The claims of petitioner and others thus\nbecame claims for administration expenses in bankruptcy, which are given first priority under \xc2\xa7\n64a(1) of the Bankruptcy Act. The trustee moved to expunge the claims on the ground that they\nwere not for expenses of administration. It was agreed that the decision whether petitioner\'s claim\nis provable as an expense of administration would establish the status of the other 146 claims. It\nwas further agreed that, for purposes of deciding whether the claim is provable, it would be\nassumed that the damage to petitioner\'s property resulted from the negligence of the receiver and\na workman he employed.\nSection 64a of the Bankruptcy Act provides in part as follows: "The debts to have priority,\nin advance of the payment of dividends to creditors, and to be paid in full out of bankrupt estates,\nand the order of payment, shall be (1) the costs and expenses of administration, including the actual\nand necessary costs and expenses of preserving the estate subsequent to filing the petition. . . ."\nThe question in this case is whether the negligence of a receiver administering an estate\nunder a Chapter XI arrangement gives rise to an "actual and necessary" cost of operating the\ndebtor\'s business. The Act does not define "actual and necessary," nor has any case directly in\npoint been brought to our attention. We must, therefore, look to the general purposes of \xc2\xa7 64a,\nChapter XI, and the Bankruptcy Act as a whole.\nThe trustee contends that the relevant statutory objectives are (1) to facilitate rehabilitation\nof insolvent businesses and (2) to preserve a maximum of assets for distribution among the general\ncreditors should the arrangement fail. He therefore argues that first priority as "necessary"\nexpenses should be given only to those expenditures without which the insolvent business could\nnot be carried on. For example, the trustee would allow first priority to contracts entered into by\nthe receiver because suppliers, employees, landlords, and the like would not enter into dealings\nwith a debtor in possession or a receiver of an insolvent business unless priority is allowed. The\ntrustee would exclude all negligence claims, on the theory that first priority for them is not\nnecessary to encourage third parties to deal with an insolvent business, but that first priority would\nreduce the amount available for the general creditors, and that first priority would discourage\ngeneral creditors from accepting arrangements.\nIn our view, the trustee has overlooked one important, and here decisive, statutory\nobjective: fairness to all persons having claims against an insolvent. Petitioner suffered grave\nfinancial injury from what is here agreed to have been the negligence of the receiver and a\nworkman. It is conceded that, in principle, petitioner has a right to recover for that injury from\ntheir "employer," the business under arrangement, upon the rule of respondeat superior.\nRespondents contend. However, that petitioner is in no different position from anyone else injured\nby a person with scant assets: its right to recover exists in theory but is not enforceable in practice.\nThat, however, is not an adequate description of petitioner\'s position. At the moment when\nan arrangement is sought, the debtor is insolvent. Its existing creditors hope that, by partial or\ncomplete postponement of their claims they will through successful rehabilitation, eventually\nrecover from the debtor either in full or in larger proportion than they would in immediate\nbankruptcy. Hence, the present petitioner did not merely suffer injury at the hands of an insolvent\nbusiness: it had an insolvent business thrust upon it by operation of law. That business will, in any\nevent, be unable to pay its fire debts in full. But the question is whether the fire claimants should\n134\n\n\x0cbe subordinated to, should share equally with, or should collect ahead of those creditors for whose\nbenefit the continued operation of the business (which unfortunately led to a fire instead of the\nhoped-for rehabilitation) was allowed.\nIn any event, we see no reason to indulge in a strained construction of the relevant\nprovisions, for we are persuaded that it is theoretically sounder, as well as linguistically more\ncomfortable, to treat tort claims arising during an arrangement as actual and necessary expenses\nof the arrangement, rather than debts of the bankrupt. In the first place, in considering whether\nthose injured by the operation of the business during an arrangement should share equally with, or\nrecover ahead of, those for whose benefit the business is carried on, the latter seems more natural\nand just. Existing creditors are, to be sure, in a dilemma not of their own making, but there is no\nobvious reason why they should be allowed to attempt to escape that dilemma at the risk of\nimposing it on others equally innocent.\nMore directly in point is the possibility of insurance. An arrangement may provide for\nsuitable coverage, and the court below recognized that the cost of insurance against tort claims\narising during an arrangement is an administrative expense payable in full under \xc2\xa7 64a(1) before\ndividends to general creditors. It is, of course, obvious that proper insurance premiums must be\ngiven priority, else insurance could not be obtained, and if a receiver or debtor in possession is to\nbe encouraged to obtain insurance in adequate amounts, the claims against which insurance is\nobtained should be potentially payable in full. In the present case, it is argued, the fire was of such\nincredible magnitude that adequate insurance probably could not have been obtained and, in any\nevent, would have been foolish; this may be true, as it is also true that allowance of a first priority\nto the fire claimants here will still only mean recovery by them of a fraction of their damages. In\nthe usual case where damages are within insurable limits, however, the rule of full recovery for\ntorts is demonstrably sounder.\nAlthough there appear to be no cases dealing with tort claims arising during Chapter XI\nproceedings, decisions in analogous cases suggest that "actual and necessary costs" should include\ncosts ordinarily incident to operation of a business, and not be limited to costs without which\nrehabilitation would be impossible. It has long been the rule of equity receiverships that torts of\nthe receivership create claims against the receivership itself; in those cases, the statutory limitation\nto "actual and necessary costs" is not involved, but the explicit recognition extended to tort claims\nin those cases weighs heavily in favor of considering them within the general category of costs\nand expenses.\nIn some cases arising under Chapter XI, it has been recognized that "actual and necessary\ncosts" are not limited to those claims which the business must be able to pay in full if it is to be\nable to deal at all. For example, state and federal taxes accruing during a receivership have been\nheld to be actual and necessary costs of an arrangement.] The United States, recognizing and\nsupporting these holdings, agrees with petitioner that costs that form "an integral and essential\nelement of the continuation of the business" are necessary expenses even though priority is not\nnecessary to the continuation of the business. Thus, the Government suggests that "an injury to a\nmember of the public -- a business invitee -- who was injured while on the business premises\nduring an arrangement would present a completely different problem [i.e., could qualify for first\npriority]," although it is not suggested that, priority is needed to encourage invitees to enter the\npremises.\n135\n\n\x0cThe United States argues, however, that each tort claim "must be analyzed in its own\ncontext." Apart from the fact that it has been assumed throughout this case that all 147 claimants\nwere on an equal footing and it is not very helpful to suggest here for the first time a rule by which\nlessees, invitees, and neighbors have different rights, we perceive no distinction: no principle of\ntort law of which we are aware offers guidance for distinguishing, within the class of torts\ncommitted by receivers while acting in furtherance of the business, between those "integral" to the\nbusiness and those that are not.\nWe hold that damages resulting from the negligence of a receiver acting within the scope\nof his authority as receiver give rise to "actual and necessary costs" of a Chapter XI arrangement.\n\n7.10.1.3.\nIN RE RESOURCES TECH. CORP., 662 F.3d 472,\n474 (7th Cir. 2011)\nPOSNER, Circuit Judge.\nRoti owned a Holiday Inn in a Chicago suburb. The hotel was adjacent to a landfill owned\nand operated by CDC. Back in 1996 CDC had hired RTC to build a system for preventing the\nmethane, carbon dioxide, hydrogen sulfide, and other gases generated in the landfill from leaking;\nthe system would also extract energy from the gas, which RTC would sell, paying CDC a royalty.\nSo: a gas collection and control system.\nIn 1999 RTC was forced into bankruptcy under Chapter 11 (reorganization). Roti bought\nthe Holiday Inn three years later, and in 2005 it followed RTC into Chapter 11, though for\nunrelated reasons. RTC\'s Chapter 11 bankruptcy was converted to a Chapter 7 bankruptcy\n(liquidation) in September 2005. A trustee was appointed on September 21 to operate the debtor\'s\nbusiness until the liquidation was complete. Four days after the trustee was given operational\ncontrol of RTC\'s business en route to liquidation, RTC\'s gas collection and control system at CDC\'s\nlandfill failed; it had been malfunctioning for years and RTC had lacked the financial wherewithal\nto fix it. The system\'s failure released foul odors that, traveling underground, wafted into the hotel\nthrough electrical outlets and floor cracks. The odors sickened guests and employees, resulting\n(according to Roti) in a disastrous fall off in the hotel\'s business.\nIn September 2006 Roti sold the Holiday Inn for $5 million. He claims that had it not been\nfor the odors, he could have sold it for almost five times as much; his claim against RTC in the\nbankruptcy court is for the difference. (The reason it is his claim, rather than the claim of the LLC\nthat owned the Holiday Inn, is that Roti, the sole member of the LLC, caused the company\'s claim\nto be assigned to him.)\nThe bankrupt estate has other creditors besides Roti. But he contends that his claim is an\nadministrative claim that trumps the claims of the other creditors (with at least one exception, as\nwe\'re about to note). Administrative expenses, which consist of the "actual, necessary costs and\nexpenses of preserving the [bankrupt] estate," receive priority in the distribution of the estate\'s\nassets to creditors. 11 U.S.C. \xc2\xa7\xc2\xa7 503(b)(1)(A), 507(a)(2).\nThe trustee had been operating RTC\'s system for only four days before the failure occurred.\nThe failure resulted from the many years of RTC\'s neglect, and there is no evidence that the trustee\nwas aware of that neglect, did anything to exacerbate it, could have done anything to prevent the\n136\n\n\x0cfailure triggered by that neglect within the few days in which he was in nominal control of the\nsystem before it failed, or could have done anything to mitigate the damage afterward.\nRoti is right to note the oddity of a tort without a suable tortfeasor, but the fact that the\nChapter 11 estate is not suable, nor the trustee in his personal capacity, still leaves the Chapter 7\nestate as the suable party. Roti does have a claim against the bankrupt estate, and that makes him\na creditor, yet he is not asking, as an alternative to the recognition of his administrative claim, that\nhe be dumped in with the general creditors; for him it is administrative claim or nothing, which is\ndoubtless why the district court stopped with ruling that he has no administrative claim.\nThe reason administrative claims are given priority is that they are claims for\nreimbursement by the bankrupt estate of expenses incurred after the declaration of bankruptcy, in\norder to preserve and if possible enhance the value of the bankrupt estate for the benefit of its\ncreditors. A tort victim (Roti) is a creditor, but not a creditor whose actions benefit his debtor, the\ntortfeasor. Yet in Reading v. Brown, 391 U.S. 471 (1968), the Supreme Court held that at least in\na Chapter 11 bankruptcy, tort claims arising from the continued operation of the bankrupt business\nshould be treated as administrative claims, like other post-petition expenses. Tort liability is an\nexpense of doing business, like labor or material costs, and should be treated the same way.\nBusinesses operating in bankruptcy that were excused from tort liability would have an inefficient\ncompetitive advantage over their solvent competitors\xe2\x80\x94and deficient incentives to use due care in\nthe operation of the business. It could indeed be argued that in the interest of safety, insolvent\nfirms, not being deferrable by threat of tort suits, should not be allowed to operate at all. Reading\nstrikes a compromise between the safety interest and the interest in saving bankrupts from\npremature liquidation: the bankrupt that continues to operate (normally under Chapter 11) must\ngive its tort victims priority access to such assets as the bankrupt estate retains.\nRTC was in Chapter 7 bankruptcy when the tort occurred; can the principle of Reading be\nextended to Chapter 7, given that the goal of such a bankruptcy is liquidation of the bankrupt\'s\nassets at the highest possible price rather than the continuation of the bankrupt\'s business?\nSometimes yes; for the dichotomy between operation and liquidation is too stark. There is an\ninterval between the appointment of the trustee and the liquidation of the bankrupt\'s assets under\nhis supervision, and during that interval he may have operating responsibilities. The policy that\nsupports the Reading doctrine\xe2\x80\x94the policy against permitting bankrupt firms to externalize the\ncosts of their torts\xe2\x80\x94depends on whether the bankrupt firm is operating, not which part of the\nBankruptcy Code (that is, whether Chapter 7 or Chapter 11) it is operating under.\nBut at least as far as the gas collection and control system in CDC\'s landfill was concerned,\nthe bankrupt in this case was not operating in any meaningful sense during the brief period in\nwhich the trustee was in charge. It had some minute revenue from energy sales\xe2\x80\x94less than 10\npercent of its normal revenue from such sales\xe2\x80\x94but it is doubtful that this revenue covered its costs,\nor that the continued operation of the system in its diminished state can be attributed to anything\nother than the bankrupt\'s legal duty to minimize further contamination.\nWe thus are far from Reading, where the Chapter 11 receiver (equivalent to a trustee) was\nmanaging a building that was the debtor\'s principal asset, when the building burned down and in\nthe process caused damage to adjacent buildings, triggering tort claims against the bankrupt estate.\nThe receiver was either collecting rents or otherwise obtaining or attempting to obtain income for\nthe estate from the building, and by doing so he was unavoidably running a risk of fire. In this\n137\n\n\x0ccase, in contrast, the trustee took over a bankrupt company at the point of collapse, and the collapse\nwas unrelated to his control of the assets. He had neither the mandate nor the resources to do\nanything with them except liquidate them as quickly as possible, which he proceeded to do. He\ncould and did do nothing with the assets that might (with however low a probability) have\nenhanced their value for the creditors, in which event they would have had to take the bad with the\ngood\xe2\x80\x94the risk of tort liability along with the prospects for successful management of the assets.\nThe trustee operated a losing venture under legal compulsion. There is no basis for applying the\ndoctrine of Reading to such a case.\n\n7.11.\n\nExecutory Contracts and Unexpired Leases \xe2\x80\x93 Assumption and\nRejection\n\nProfessor Vern Countryman defined an executory contract in a famous law review article\nas follows:\n\xe2\x80\x9cA contract under which the obligation of both the bankrupt and the\nother party to the contract are so far unperformed that the failure of\neither to complete performance would constitute a material breach\nexcusing the performance of the other.\xe2\x80\x9d\nEXECUTORY CONTRACTS IN BANKRUPTCY: PART I, 57 Minn. L. Rev. 439, 460 (1973).\nCountryman\xe2\x80\x99s definition has stood the test of time as a touchstone, but has not been accepted by\nall courts. Some courts have used the so-called \xe2\x80\x9cfunctional\xe2\x80\x9d test to define whether a contract is\nexecutory: \xe2\x80\x9cwhether assumption or rejection of the contract in question would benefit the debtor\xe2\x80\x99s\nestate.\xe2\x80\x9d In re Worldcom, 343 B.R. 486 (Bankr. S.D.N.Y. 2006). If assumption or rejection would\nbenefit the estate, then it\xe2\x80\x99s an executory contract, if not it\xe2\x80\x99s not.\nIncomplete contracts pose special problems in bankruptcy. The basic concept underlying\nSection 365 of the Bankruptcy Code is that the trustee should be able to choose whether the estate\nwill assume the contract (and thus be administratively liable for performance \xe2\x80\x93 breach will result\nin an administrative claim), or whether the estate should reject the contract (and thus limit the other\nparty to a general unsecured claim for damages for breach). See 11 U.S.C. \xc2\xa7 365(g) (rejection\nconstitutes breach immediately before bankruptcy, resulting in prepetition claim).\nSection 365 also incorporates the idea that the trustee needs time to decide whether the\nexecutory contract is beneficial to the estate (and thus should be assumed) or burdensome (and\nthus should be rejected). Courts have consistently held that it is a violation of the automatic stay\nfor a counter-party to terminate an executory contract before it has been rejected. See e.g. In re\nLavigne, 114 F.3d 379, 386-88 (2d Cir. 1997); and In re Computer Communications, Inc.,\n[reprinted below].\nBecause the automatic stay requires the other party to the executory contract to continue\nperforming while awaiting the trustee\xe2\x80\x99s decision to assume or reject, the counter-party should be\nentitled to know within a reasonable period of time whether a return performance will be\nforthcoming. Congress has seen fit to protect some executory counter-parties by setting deadlines\nfor assumption or rejection (after which the contract will be deemed rejected), while leaving other\ncounter parties to fend for themselves (by asking the bankruptcy court for protection, to be granted\nin the bankruptcy court\xe2\x80\x99s discretion). See 11 U.S.C. \xc2\xa7 365(d) (setting time periods for assumption\n138\n\n\x0cin certain circumstances), and \xc2\xa7 365(d)(2) (court \xe2\x80\x9cmay order the trustee to determine within a\nspecified period of time whether to assume or reject\xe2\x80\x9d).\nIntertwined with the concept of assumption and rejection is the question of the effect of\nrejection \xe2\x80\x93 does rejection only determine the priority of the executory counter-party\xe2\x80\x99s damage\nclaim, or does rejection terminate the non-debtor party\xe2\x80\x99s substantive rights under the contract?\nThe effect of rejection is a lengthy and complex topic involving many grey areas rather than clearly\ndefined lines. Congress suggested that rejection does terminate the other contracting party\xe2\x80\x99s rights\nby enacting a special exception allowing tenants of a bankrupt landlord (or an installment sale\npurchaser) to retain possessory rights after rejection. See 11 U.S.C. \xc2\xa7\xc2\xa7 365(h), (I). Congress\xe2\x80\x99s\nsuggestion was adopted in the controversial case of Lubrizol Enterprises Inc. v. Richmond\nFinishers Inc., 756 F.2d 1043, 1048 (4th Cir. 1985), where the Fourth Circuit held that the rejection\nof an executory license allowed the debtor to terminate the licensee\xe2\x80\x99s rights. Congress responded\nto Lubrizol by creating additional special exceptions allowing an \xe2\x80\x9cintellectual property\xe2\x80\x9d licensee\nto retain license rights after rejection. See 11 U.S.C. \xc2\xa7 365(n). However, the definition of\n\xe2\x80\x9cintellectual property\xe2\x80\x9d in Section 101(35A) does not cover all intellectual property, including\ntrademarks. Courts have been struggling with whether rejection of a trademark terminates the other\ncontracting-party\xe2\x80\x99s right to use the mark.\nThere is currently great disagreement about whether rejection terminates the other counterparty\xe2\x80\x99s contractual property rights in the absence of a statutory exception. Compare In re Lavigne,\n114 F.3d 379, 386- 88 (2d Cir. 1997); Michael T. Andrew, EXECUTORY CONTRACTS IN\nBANKRUPTCY: UNDERSTANDING "REJECTION," 59 U.Colo.L.Rev. 845 (1988); In re The Drexel\nBurnham Lambert Group, 138 B.R. 687, 703 (Bankr. S.D.N.Y. 1992) ("[r]ejection merely frees\nthe estate from the obligation to perform; it does not make the contract disappear.") with In re\nCentura Software Corp., 281 B.R. 660 (Bankr. N.D. Cal. 2002) (rejection terminates trademark\nlicense). The issue will likely require a decision by the Supreme Court to finally resolve the\nquestion.\nSection 365 deals with both executory contracts and unexpired leases. Not all documents\ncalled leases are subject to Section 365. The law has long recognized that financing transactions\ncan be disguised as leases. If the entire useful life of the property will be used up during the lease\nterm, or if the \xe2\x80\x9clessor\xe2\x80\x9d has the right to buy the property for significantly less than it is expected to\nbe worth at the end of the lease term, then the transaction is really a financed sale and not a true\nlease subject to Section 365. See In re Integrated Health Services, Inc., 260 B.R. 71, 75-76 (Bankr.\nDel. 2001). Only true leases (where the lessee is expected to return the property to the lessor at the\nend of the lease term) are governed by Section 365.\n\n7.12.\n\nPractice Problems: Executory Contracts - Assumption and\nRejection\n\nAnswer the following questions.\nProblem 1. The Trustee wants to assume a prepetition contract of the Debtor to buy goods\nfrom Seller. If the Debtor was in default under the contract prepetition, what must the Trustee do\nand show in order to assume the contract? 11 U.S.C. \xc2\xa7 365(b).\n139\n\n\x0cProblem 2. What must the Trustee do or show to provide \xe2\x80\x9cadequate assurance of future\nperformance? See 11 U.S.C. \xc2\xa7 365(b)(3), and note that this provision only applies to shopping\ncenter leases.\nProblem 3. Assume that the contract in Problem (1) provides as follows: \xe2\x80\x9cSeller has the\nright to terminate the contract without prior notice if the debtor is insolvent, files bankruptcy, or if\na trustee or receiver is appointed over the debtor\xe2\x80\x99s property.\xe2\x80\x9d How could the Trustee possibly cure\nthis default? See 11 U.S.C. \xc2\xa7 365(b)(2); 365(e)(1).\nProblem 4. Shortly before filing bankruptcy, Debtor obtained a $1 million line of credit\nfrom Banko Americo, which can be drawn on at any time within the next three years. Debtor has\nonly drawn $100,000 on the line, leaving $900,000 available. The Trustee would like to use some\nof that money to pay the expenses of administration. May the Trustee assume the loan and draw\ndown on the credit line? 11 U.S.C. \xc2\xa7 365(c)(2).\nProblem 5. How long does a Chapter 7 trustee have to decide whether to assume or reject\nan executory contract or unexpired lease? 11 U.S.C. \xc2\xa7 365(d)(1). How long would a Chapter 11\ntrustee have? In answering this question, does the type of property covered by the agreement\nmatter? What is the consequence of not acting timely? 11 U.S.C. \xc2\xa7 365(d).\nProblem 6. Does the Trustee have to perform the Debtor\xe2\x80\x99s obligations under an executory\ncontract or lease while deciding whether to assume or reject? See 11 U.S.C. \xc2\xa7 365(d)(3) and (d)(5).\nProblem 7. Assume that the Trustee rejects an executory contract, and that the other party\nto the contract would have a $1 million claim for damages under state law if the debtor had\nbreached the contract pre-petition. Is the counter-party\xe2\x80\x99s claim against the estate after rejection\nentitled to priority as a post-petition expense of administration? 11 U.S.C. \xc2\xa7 365(g)(1). What if the\nTrustee assumed the contract and later was unable to perform?\nProblem 8. Debtor owns a shopping center. Tenant has 75 years left on its 100 year lease\non the best location in the center, and is paying a fraction of the fair rental value of the store. Debtor\nhas heard about the rejection of executory contracts and leases in bankruptcy. Debtor would like\nto kick the Tenant out of the premises and re-lease the space for a much higher rent. Debtor\nproposes to file bankruptcy, reject the lease, kick Tenant out, and rent to a new tenant for a much\nhigher rent. What do you think of this strategy? See 11 U.S.C. \xc2\xa7 365(h)(1)(A).\nProblem 9. Assume that Tenant in Problem (8), rather than Landlord, files bankruptcy\nafter falling behind on its rent. The tenancy has a lot of value, and the Trustee wants to assign the\nbelow market lease to another company who will pay a much higher rent to the Trustee than the\nrate under the lease. The lease prohibits Tenant from assigning the lease, and that restriction is\nenforceable outside of bankruptcy under applicable state law. Can Tenant assign the lease in\nbankruptcy even though the lease prohibits assignment? 11 U.S.C. \xc2\xa7 365(f)(2). If so, what must\nTrustee do or show to get the bankruptcy court to approve the assignment? 11 U.S.C. \xc2\xa7 365(b)(1),\n(b)(3), (f).\nProblem 10. What if, during the month before bankruptcy, a shopping center tenant\nstopped operating the store because its store sales were less than its operating costs? Under the\nlease, closing the store is an incurable default allowing Landlord to terminate the lease. Is there\nany way for the Trustee to cure this kind of default? See 11 U.S.C. \xc2\xa7 365(b)(1)(A).\n140\n\n\x0cProblem 11. Assume that the Trustee in Problem (9) is successful in assigning the lease,\nand the Assignee later defaults. Is the Debtor\xe2\x80\x99s estate liable to the landlord for damages (and for\nan administrative claim for damages since the lease was assumed)? 11 U.S.C. \xc2\xa7 365(k).\nProblem 12. Prior to filing bankruptcy, the Debtor leased a fancy laptop computer from\nDull Computers for a three year term. Trustee rejected the lease because the rental value of the\nlaptop was much less than the lease payments. The Debtor wants to keep the computer. What can\nDebtor do? See 11 U.S.C. \xc2\xa7 365(p). What if Dull unreasonably refuses to accept Debtor\xe2\x80\x99s very fair\nproposal to keep the laptop?\nProblem 13. Multi-millionaire fashion designer Bruno agreed to pay $1 million to famous\ngraffiti artist Blankley to paint Bruno\xe2\x80\x99s portrait on the side of a building. Because of unrelated\nfinancial problems, Blankley was forced to file Chapter 11 and seek to reorganize. When Blankley\nsought to assume the contract, Bruno, who no longer wanted his portrait to be painted by a\n\xe2\x80\x9cbankrupt\xe2\x80\x9d artist, objected. Bruno claimed that the contract cannot not be assumed under Section\n365 because it is an unassignable personal services contract under Section 365(c)(1)(A). Blankley\nargues that he should be able to assume because he is the same person with whom the contract was\nmade. Should the personal services prohibition in Section 365(c)(1)(A) only apply to an\nassumption by the trustee or assignment to a third party, or should it apply equally to an assumption\nby the debtor-in-possession? Compare In re Footstar, 323 B.R. 566 (Bankr. S.D.N.Y. 2005)\n(adopting actual test) with In re Catapult Entm\xe2\x80\x99t, Inc., 165 F.3d 747 (9th Cir. 1999) (adopting\nhypothetical test).\nProblem 14. Actress Tia Carrere, who was under contract to perform in a soap opera,\nsought to use bankruptcy to reject her old soap opera contract and enable her to enter into a more\nlucrative contract to appear on a hot new television show called the \xe2\x80\x9cA Team.\xe2\x80\x9d In another case, a\nfranchisee sought to reject a franchise agreement while continuing to operate a similar business in\nthe same location. In both cases, the contracts that the debtors sought to reject contained restrictive\ncovenants preventing the debtors from competing. Does the rejection of a contract containing a\nrestrictive covenant prevent the other contracting party from enforcing the restrictive covenant by\nway of injunction? See In Re Carrere, 64 B.R. 156 (Bankr. C.D. Cal. 1986) (personal services\ncontract not property of the estate that could be assumed or rejected, and therefore restrictive\ncovenant could be enforced); Silk Plants, Etc. Franchise Systems v. Register, 100 B.R. 360 (M.D.\nTenn. 1989) (franchisor could not enforce the restrictive covenant after rejection). To some extent,\nthe correct answer may turn on whether the right to an injunction under state law is a \xe2\x80\x9cclaim\xe2\x80\x9d\nsubject to the Bankruptcy Code\xe2\x80\x99s claim procedures. See 11 U.S.C. \xc2\xa7 101(5)(B); In re Ward, 194\nB.R. 703, 712 (Bankr. D. Mass. 1996).\n\n7.13.\n\nCases on Executory Contracts\n7.13.1.1.\nIN RE JAMESWAY CORP., 201 B.R. 73 (Bankr.\nS.D.N.Y. 1996)\n\nOn October 18, 1995 ("petition date"), [debtor] Jamesway filed petitions for relief under\nChapter 11. At that time, debtors operated discount department stores under the "Jamesway" name.\nAs of the petition date, Jamesway and Mass Mutual were parties to the "Newberry Lease,\xe2\x80\x9d whereby\n141\n\n\x0cJamesway, as tenant, leased certain retail space located in the Newberry Commons shopping center\nin Etters, Pennsylvania. Paragraph 17 of that lease states in relevant part that:\n[I]f Tenant assigns this Lease or sublets all or substantially all of the\ndemised premises . . . and such assignment or subletting commences\nin or extends into the extension periods reserved under Article 3 of\nthis Lease, then during the first twenty (20) years of such extension\nperiods . . . Tenant shall pay Landlord 50% of the "profits" received\nby Tenant from the assignee or sublessee. Thereafter, Tenant shall\npay Landlord 60% of such profits. As used herein, "profits" shall\nmean the amount, if any, paid by the assignee or sublessee to Tenant\nin excess of the fixed rent and additional rent payable by Tenant for\nthe corresponding period of such assignment or sublease, excluding\nthe reasonable costs to Tenant for effectuating such assignment or\nsublease\nNewberry Lease \xc2\xb6 17. On or about February 9, 1996, Jamesway moved under \xc2\xa7 365 of the\nBankruptcy Code to assume and assign the Newberry Lease to Rite Aid for $100,000 (the "Rite\nAid Motion"). Over Mass Mutual\'s objection, we granted the motion. [A] dispute [then arose as to\nwho is entitled to the premium paid by Rite Aid].\nJamesway contends that the subject lease provisions are void and unenforceable under \xc2\xa7\n365(f)(1) because they limit its ability to realize the full economic value of the Leases for the\nbenefit of all unsecured creditors. Mass Mutual argues that \xc2\xa7 365(f)(1) does not empower us to\nnullify the profit sharing provisions in the lease, but merely permits us to authorize the assignment\nover its objection. It argues that our power to invalidate lease provisions is limited by \xc2\xa7 365(f)(3)\nto "ipso facto" or forfeiture provisions and that to hold otherwise will read \xc2\xa7 365(f)(3) out of the\nstatute.\nCourts do not have carte blanche to rewrite leases under \xc2\xa7\xc2\xa7 365(f)(1) and (f)(3) or any\nprovision of the statute. However, \xc2\xa7 365 reflects the clear Congressional policy of assisting the\ndebtor to realize the equity in all of its assets. Toward that end, \xc2\xa7 365(f)(1) permits assignment of\nan unexpired lease despite a clause in the lease prohibiting, conditioning or restricting the\nassignment. Subsection (f)(3) goes beyond the scope of subsection (f)(1) by prohibiting\nenforcement of any clause creating a right to modify or terminate the contract because it is being\nassumed or assigned, "thereby indirectly barring an assignment by the debtor." "The essence of\nSubsections (1) and (3) is that all contractual provisions, not merely those entitled `anti-assignment\nclauses\' are subject to the court\'s scrutiny regarding their anti-assignment effect." While they\noperate in tandem to promote the Congressional policy favoring a debtor\'s ability to maximize the\nvalue of its leasehold assets, subsections (f)(1) and (f)(3) deal with different problems; (f)(1) with\nprovisions that prohibit, restrict or condition assignment, and (f)(3) with provisions that terminate\nor modify the terms of a lease because it has been assumed or assigned. For this reason, construing\nthe former to invalidate provisions that directly or indirectly restrict the debtor\'s ability to assign\nthe subject lease does not render \xc2\xa7 365(f)(3) superfluous.\n[W]e interpret \xc2\xa7 365(f)(1) to invalidate provisions restricting, conditioning or prohibiting\ndebtor\'s right to assign the subject lease. [L]ease provisions conditioning a debtor-in-possession\'s\n142\n\n\x0cright to assignment upon the payment of some portion of the "profit" realized upon such\nassignment are routinely invalidated under \xc2\xa7 365(f)(1).\nThe Landlords cannot, by artful drafting, thwart the fundamental bankruptcy policy\nallowing a debtor to realize maximum value from its assigned leases for the benefit of its estate\nand creditors. We grant debtor\'s request for an order declaring that the profit sharing provisions of\nthe Leases are unenforceable and direct that the $50,000 currently held in escrow from the\nassignment proceeds of the Newberry Lease be released to debtor.\n\n7.13.1.2.\nIN RE GARDINIER, INC., 831 F.2d 974 (11th Cir.\n1987)\nThe issue in this bankruptcy case is whether an agreement to pay a brokerage commission,\ncontained within the same document as a purchase and sale agreement, is a separate and distinct\ncontract from the purchase and sale agreement.\nBefore filing its [bankruptcy] petition, Gardinier had agreed to sell a parcel of land known\nas the Goldstein tract to Boyd Burley [for] $5,117,000. In paragraph eight of the contract, Gardinier\nagreed to pay the broker, Kilgore Real Estate, a 10% commission for its "services in making sale\nof said property ... at the time of closing this transaction.\xe2\x80\x9d\nOn March 22, 1985, pursuant to sections 363(b) and 365 of the Bankruptcy Code, Gardinier\nfiled a motion with the bankruptcy court for entry of orders approving the assumption of the real\nestate contract and approving the sale of the Goldstein tract. The Unsecured Creditors Committee\n(the "Committee") raised an objection to the payment of Kilgore\'s brokerage commission on the\nground that the brokerage agreement, although contained within the same instrument as the\ncontract for the sale of the Goldstein tract, was a distinct, separate and fully executed agreement\nthat could not be assumed post-petition.\nThe bankruptcy court denied payment of the broker\'s commission out of the sales proceeds,\nbut acknowledged Kilgore\'s right to file a proof of claim for its unsecured, non-priority, prepetition claim to the commission.\nWe agree with the bankruptcy court that the brokerage agreement was separate from the\npurchase and sale agreement. [T]he intention of the parties is the governing principle in contract\nconstruction, and, absent ambiguity in the terms of a contract, intent is gleaned from the four\ncorners of the instrument. Furthermore, that the terms of a transaction are set forth in one\ninstrument is not conclusive evidence that the parties intended to make only one contract, but is\nonly a factor in determining intent. Thus, we look to the terms of the "Contract for Sale of Real\nEstate" to determine whether Gardinier, Burley, and Kilgore intended to make one contract or two\nseparate contracts.\nAlthough there is only one document memorializing this transaction, there is otherwise no\nclear indication from the face of the instrument that the parties intended to make only one contract.\nInstead, the terms of the instrument demonstrate that the parties intended to make two separate\ncontracts. In its order, the bankruptcy court noted three aspects of the transaction that we agree are\npersuasive evidence of this intent. First, the nature and purpose of the agreements are different.\nOne agreement addresses the sale of property and the other contemplates an employment contract\nrelated to the sale of the property. Second, the consideration for each agreement is separate and\n143\n\n\x0cdistinct. Burley agreed to pay Gardinier in excess of $5 million in consideration for the Goldstein\ntract. Gardinier separately agreed to pay Kilgore a commission as consideration for services\nrendered in making the sale of the property. There was no consideration flowing between the\nbroker and the buyer. Finally, the obligations of each party to the instrument are not interrelated.\nGardinier obligated itself to deliver the deed to Burley upon payment of the purchase price, and it\nobligated itself to pay a commission to Kilgore upon completion of the broker\'s responsibilities.\nThere are no promises running between the broker and the purchaser; their only relation is that\neach has separate contractual rights with the seller.\nThe issue in other cases cited by the parties was whether numerous promises, each between\nthe same promisor and promisee and contained within one instrument, constituted one or more\ncontracts, and not, as here, whether two promises, each with a different promisor and promisee,\nconstitute one or more contracts. Neither of the courts below nor either party cites any case\nsuggesting that if promises between different parties are dependent or conditioned on one another,\nit is evidence that the parties intended the agreements to actually form one contract. Moreover,\nnone offers any convincing reason why this should be so. Contracts are often conditioned upon the\ncompletion of totally separate agreements. Since the appellee fails to convince us that the\nindependence or interdependence of the agreements is persuasive evidence of intent in this case,\nthe only indication we have that the parties intended one contract is that the agreements appear in\na single document. This by itself is insufficient to overcome the evidence discussed supra that\ndemonstrates the parties\' intent to form two contracts. Because Kilgore has not demonstrated that\nits agreement with Gardinier entitles it to special treatment, it must suffer the consequences of\nGardinier\'s bankruptcy along with the other general creditors.\n\n7.13.1.3.\nIN RE COMPUTER COMMUNICATIONS, INC.,\n824 F.2d 725 (9th Cir. 1987)\nCodex Corporation (Codex) unilaterally terminated its contract to purchase computer\nequipment from CCI after CCI filed a petition for reorganization under Chapter 11. The heart of\nthe Agreement provided that Codex would make minimum quarterly purchases of equipment and\nsoftware from CCI for incorporation in Codex\'s products. The parties executed an Amended\nAgreement on November 4, 1980 for a term of four years commencing April 1979. The value of\nthe purchases under the Agreement aggregated $12.5 million. CCI agreed to provide technical\nsupport, training, and to make spare parts available. Finally, the Agreement stipulated that certain\nevents, including bankruptcy, constituted default; established termination procedures; and stated\nthat Massachusetts law governed the Agreement.\nOn November 6, 1980, two days after the parties executed the Amended Agreement, CCI\nfiled a petition under Chapter 11 of the Bankruptcy Code. On December 30, 1980, Codex notified\nCCI that it was terminating the Agreement pursuant to \xc2\xb6 4.6.4 which provides:\nIn the event of the appointment of a trustee, receiver or liquidator for all or a major portion\nof the property of either party, the commission by either party of any act of bankruptcy as defined\nin the United States Bankruptcy Act, as amended, the filing by either party of any voluntary\npetition in bankruptcy, ... that party shall be in default upon actual notice to the other party of such\nevent, and the other party may terminate this Agreement as provided in paragraph 4.6.2 or 4.6.3,\nas the case may be.\n144\n\n\x0cCodex failed to make its minimum purchase for the quarter ending December 31, 1980,\nand has failed to make its quarterly minimum purchase every quarter since.\nCCI filed suit in bankruptcy court on January 30, 1981 for injunctive relief and damages\nasserting that Codex had wrongfully repudiated the contract and had violated the automatic stay\nprovision of the Bankruptcy Code, 11 U.S.C. \xc2\xa7 362.\nOn February 23, 1981, Codex notified CCI that it was terminating purchases of equipment\nfrom CCI pursuant to \xc2\xb6 4.6.1 of the Agreement. This clause [allows Codex to terminate its\nobligation to make future purchases by giving notice of termination].\nThe bankruptcy court . . . held that 11 U.S.C. \xc2\xa7 365(e)(1) made the bankruptcy default\nclause unenforceable, the automatic stay of 11 U.S.C. \xc2\xa7 362 prohibited Codex from unilaterally\nterminating the Agreement under either \xc2\xb6 4.6.1 or \xc2\xb6 4.6.4, Codex should have applied to the court\nfor relief from the automatic stay, and Codex willfully violated the automatic stay. The court\nawarded general damages of $4,750,000 plus $250,000 in punitive damages.\nCodex appealed to the district court [and the] district court affirmed the general damage\naward and reversed the punitive damage award.\n11 U.S.C. \xc2\xa7 362 provides that the filing of a bankruptcy petition automatically stays "any\nact to obtain possession of property of the estate...." 11 U.S.C. \xc2\xa7 362(a)(3). The courts below held\nthat the automatic stay prohibited Codex from unilaterally terminating the Agreement. We agree.\nEven if Codex had a valid reason for terminating the Agreement, it still was required to petition\nthe court for relief from the automatic stay under \xc2\xa7 362(d).\n11 U.S.C. \xc2\xa7 541 (1982) defines property of the estate. It neither explicitly includes nor\nexcludes contract rights. The definition includes "all legal or equitable interests of the debtor in\nproperty as of the commencement of the case." 11 U.S.C. \xc2\xa7 541(a)(1). The legislative history states\nthat the scope for this paragraph is broad. "It includes all kinds of property, including tangible or\nintangible property [and] causes of action...." H.R.Rep. No. 595 at 367, reprinted in 1978 U.S.Code\nCong. & Admin.News at 6323.\nThe automatic stay does not permanently prohibit a party from retrieving property from the\npossession of the bankrupt estate. Section 362(d) provides [for the bankruptcy court to grant relief\nfrom stay in certain circumstances upon request].\nCodex argues that the trial court erred because the contract was not property of the estate.\nIt asserts that 11 U.S.C. \xc2\xa7 365 (1982), pertaining to executory contracts and unexpired leases,\nsanctioned its termination of the contract. Section 365 provides that a trustee may assume or reject\nany executory contract or unexpired lease of the debtor. The contract, argues Codex, never became\nproperty of the estate because the trustee did not and could not assume it. Section 365(e) generally\nprohibits exercise of bankruptcy termination clauses in such contracts:\nSubparagraph (2), however, creates an exception where "applicable law excuses a party,\nother than the debtor, to such contract or lease from accepting performance from or rendering\nperformance to the trustee or an assignee of such contract or lease...." 11 U.S.C. \xc2\xa7 365(e)(2)(A)(i).\nCodex argues that Massachusetts law excused it from accepting performance from an assignee for\nthree reasons: 1) the Agreement was a personal service contract; 2) even if it was not a personal\nservice contract, it was a contract based on "a relation of personal confidence," and 3) assignment\nof the contract would have revealed Codex\'s trade secrets.\n145\n\n\x0cThe bankruptcy court held that \xc2\xa7 365(e)(2) did not permit Codex to terminate the contract\nunilaterally finding that the Amended Agreement was not a contract for personal services.\nLikewise, the district court concluded that the contract was almost entirely for the sale of goods.\nWe need not reach that question, however, because we hold that even if \xc2\xa7 365(e)(2) allowed Codex\nto terminate the contract, \xc2\xa7 362 automatically stayed termination.\nCodex argues that, since executory contracts do not automatically vest in the bankrupt\nestate, but must be assumed by the executor, they are not automatically stayed. We find this\nargument unavailing. . . . We agree with the analysis of the bankruptcy court in In re Wegner\nFarms Co., 49 B.R. 440 (Bankr. N.D. Iowa 1985), which held that even if, under Section 365(e),\na bonding agreement cannot be assumed by the debtor, it must be terminated pursuant to the terms\nof the automatic stay provision.\nThe legislative history emphasizes that the stay is intended to be broad in scope. Congress\ndesigned it to protect debtors and creditors from piecemeal dismemberment of the debtor\'s estate.\nThe automatic stay statute itself provides a summary procedure for obtaining relief from the stay.\nAll parties benefit from the fair and orderly process contemplated by the automatic stay and\njudicial relief procedure. Judicial toleration of an alternative procedure of self-help and post hoc\njustification would defeat the purpose of the automatic stay. Accordingly, we affirm the\nbankruptcy and district courts on the ground that Codex violated the automatic stay by unilaterally\nterminating the contract and do not reach the question of whether this contract is non-assignable\nunder Massachusetts law.\nWe hold that awarding damages to CCI for Codex\'s violation of the automatic stay was\nwithin the discretion of the bankruptcy court. We find the damage award reasonable.\nAFFIRMED.\n\n7.13.1.4.\nRIESER v. DAYTON COUNTRY CLUB CO., 972\nF.2d 689 (6th Cir 1992)\nIn this case we are asked to review an order barring a trustee in bankruptcy under Chapter\n7 from assuming and assigning a golf membership in a country club as an executory contract,\npursuant to section 365 of the Bankruptcy Code. 11 U.S.C. \xc2\xa7 365.\nThe Dayton Country Club is an organization, in the form of a corporation, consisting of\nseveral hundred individuals who have joined together for recreation and entertainment. Its shares\nof stock may be held only by the members of the club and may not be accumulated in any\nsubstantial amount by one member.\nSince there was only one 18-hole golf course available, the maximum number of members\neligible to play golf needed to be limited in order to make the playing of the game enjoyable to\nthose playing. There was no need to so limit the number of members who could use the tennis\ncourts, the pool, the restaurants, or who could enjoy the social events of the club. The club\ndeveloped within its membership a special membership category for those who had full golfing\nprivileges. This category was limited to 375 members. Detailed rules, procedures, and practices\nwere developed to ensure the fair selection of golfing members. These rules, procedures, and\npractices define how this additional privilege is allocated, how the number of members is\nmaintained at 375, how vacancies occur, how they are filled, and what additional fees are charged.\n146\n\n\x0cIf a member desires to play golf, he or she asks to become a golfing member in one of\nseveral golf membership categories. When he or she makes this request, an additional substantial\nfee is paid to the club and the individual is placed on a waiting list. At the time the record was\nmade in this case, there were about 70 persons on that list. When a vacancy occurs because of a\nfailure to pay dues or a resignation, the first person on the waiting list is given the option to become\na golfing member by paying an additional substantial fee. Upon becoming a golfing member, the\nmonthly dues also increase substantially. If the person at the top of the waiting list declines the\nmembership, then that person is placed at the bottom of the list and the next person on the list is\ngiven the opportunity to become a golfing member. There is no provision for any person to assign\nor sell the golf membership to any other person or for any person to become a golfing member in\nany other way except in two intimate and personal situations dealt with in discrete ways. When\nthe death of a golfing member occurs, a spouse (who had been enjoying the hospitality of the club)\nmay take the deceased member\'s place. If a divorce occurs, the member may designate his or her\nspouse as the golfing member.\nThe nature of the golf membership within the overall club membership is the heart of this\ncase. We are not dealing with the right to be a member of the club and there is nothing in this case\nrelating to laws and social policies against discrimination. The issues in this case relate solely to\nthe rights, duties, and privileges of the club and its members arising from the club\'s effort to\nprovide golfing privileges to some but not all of its members, and the effect of the bankruptcy laws\nupon that effort.\n[Two bankruptcy debtors, Magness and Redman,] were golfing members of the Dayton\nCountry Club. The trustee in bankruptcy sought to assume and assign, through sale, the rights\nunder these memberships to (1) members on the waiting list, (2) other club members, or (3) the\ngeneral public, provided that the purchaser first obtains membership in the Dayton Country Club.\nIn other words, the trustee seeks to increase the value of the bankruptcy estate by taking value for\nand assigning to others a relationship between the bankrupt and the club. The assignment would\nbe to the detriment of other club members who had paid for and acquired the right to become\ngolfing members in due course. The question is whether the trustee has the right to make the\nassignment.\nIt is not inappropriate to think of these contracts as creating a type of property interest. The\nfull golf membership and the rights that come from that relationship with the club can be described\nas a property right of that member, the parameters of which are defined by the rules, procedures,\nand practices of the club. These rules, procedures, and practices, and therefore the extent of the\nmembers\' property interest, do not extend to any right on the members\' part to pass on the\nmembership to others, except in in death or divorce. The persons on the waiting list also can be\ndescribed as having a type of property interest in the relationships described in their contracts with\nthe club. Theirs is a lesser interest than that of the full golfing members, but a real one nonetheless.\nThey have paid the club for the right to be considered in the numbered order on the list to become\nfull golfing members as vacancies occur. They, like the full golfing members, have a status defined\nby the various rules, procedures, and practices pertaining to filling the membership roster.\nThe bankruptcy courts found, and the district court affirmed, that the full golf memberships\nare executory contracts under \xc2\xa7 365 of the Bankruptcy Code. Section 365(f)(1) of the Bankruptcy\nCode provides that executory contracts may be assigned notwithstanding non-assignment\n147\n\n\x0cprovisions in the contract or the law: Section 365(c)(1) contains an exception to Section 365(f)\'s\nbar to enforcement of non-assignment provisions:\n(c) The trustee may not assume or assign any executory contract or\nunexpired lease of the debtor, whether or not such contract or lease prohibits\nor restricts assignment of rights or delegation of duties, if \xe2\x80\x94\n(1)(A) applicable law excuses a party, other than the debtor, to such contract\nor lease from accepting performance from or rendering performance to an\nentity other than the debtor or the debtor in possession, whether or not such\ncontract or lease prohibits or restricts assignment of rights or delegation of\nduties; and\n(B) such party does not consent to such assumption or assignment.\n11 U.S.C. \xc2\xa7 365(c)(1).\nThe bankruptcy courts found that the trustee was barred from assigning the full golf\nmemberships by Ohio law under \xc2\xa7 365(c). The courts concluded that the club\'s rules were, in\neffect, anti-assignment provisions, and that Ohio law excused the club from accepting performance\nby others. The court thus gave effect to the provisions. [The district court affirmed]\nThe trustee then appealed to this court. We conclude that the decision of the district court\nwas correct for two reasons. First, as the district court found, the trustee had no power under \xc2\xa7 365\nof the Code to assign this executory contract. Second, the relationships created by the various\ncontracts between the club and its members create a type of property interest held by the parties to\nthose contracts, the sale of which as proposed by the trustee adversely impacts on the property\ninterests of others such that the sale is prohibited by \xc2\xa7 363(e) of the Code.\nThe trustee asserts that what is involved is simply an executory contract between the\nbankrupt and the club permitting the bankrupt to play golf on the club course. As such, the trustee\nasserts that this executory contract can be sold and assigned, and the estate of the bankrupt is\nentitled to the value that can be realized from such an assignment and sale.\nIn examining the trustee\'s right to assign through sale the full golf membership, we should\nmake clear that we are not dealing with the right to assume the membership with all its baggage,\nthus permitting the debtor to play golf. What is involved here is the right of the trustee to sell and\nassign it to another person without consideration of the rights of others that encumber it. The court\ncannot envision a reason why the trustee would want to continue to pay dues and permit the debtor\nto enjoy the benefits of a full golf membership, but nothing in this case relates to that question. It\nis the claimed right to sell and assign which we address.\nSeveral courts have addressed the scope of \xc2\xa7 365(c), although the decisions are not\npersuasive. A seminal decision was In re Taylor Manufacturing, Inc., 6 B.R. 370, 372 (Bankr.\nN.D. Ga. 1980). That court concluded that \xc2\xa7 365(c) was intended "to be applied narrowly and to\nsuch circumstances as contracts for the performance of non-delegable duties."\nApparently because of an example used by the Taylor court involving an opera singer\'s\ncontract, Taylor was often cited subsequently for the proposition that \xc2\xa7 365(c) applied only to\npersonal service contracts (a construction which, as the Taylor court noted, actually originated\nwith Collier on Bankruptcy).\n148\n\n\x0cThe Court of Appeals for the First Circuit attempted to harmonize Sections 365(f) and (c)\nin the case of In re Pioneer Ford Sales, Inc., 729 F.2d 27 (1st Cir. 1984). That court also held that\nno personal service contract limitation appeared in the language of \xc2\xa7 365(c). In attempting to reach\na rational explanation of the interplay of Sections 365(f) and (c), however, the court proceeded to\nread additional language into \xc2\xa7 365(f):\nAs a matter of logic ... we see no conflict, for (c)(1)(A) refers to state laws\nthat prohibit assignment "whether or not" the contract is silent, while (f)(1)\ncontains no such limitation. Apparently (f)(1) includes state laws that\nprohibit assignment only when the contract is not silent about assignment;\nthat is to say, state laws that enforce contract provisions prohibiting\nassignment.\nId. at 29. There is simply nothing in the language of \xc2\xa7 365(f) which supports the limitation read\ninto it by that court. In addition, it is at least equally as plausible that the phrase "whether or not\nsuch contract ... prohibits ... assignment" in \xc2\xa7 365(c) was intended merely to emphasize that \xc2\xa7\n365(c) should not be construed to apply only to applicable law barring assignment, irrespective of\nthe contract\'s provisions (as opposed to applicable law enforcing anti-assignment provisions in\ncertain contracts), a construction which might otherwise seem logical in light of \xc2\xa7 365(f)\'s explicit\noverride of contractual anti-assignment provisions. Neither Pioneer Ford nor any other decision\nto date provides a defensible explication of the parameters of the \xc2\xa7 365(c) exception.\nWe must read Sections 365(f) and (c) together. At first, it might seem that they are not\nconsistent, but a careful parsing of the provisions suggests that \xc2\xa7 365(f) contains the broad rule\nand \xc2\xa7 365(c) contains a carefully crafted exception to the broad rule made necessary by general\nprinciples of the common law and our constitutions.\nThe parameters of subsections (f) and (c) are revealed through a straightforward reading of\nthose subsections. Subsection (f) states that although the contract or applicable law prohibits\nassignment, these provisions do not diminish the broad power to assume and assign executory\ncontracts granted the trustee by \xc2\xa7 365(a). In other words, a general prohibition against the\nassignment of executory contracts, i.e., by contract or "applicable law," is ineffective against the\ntrustee. In this case the complex nature of the arrangements by the parties for filling vacancies in\nthe full golf membership category is a clear statement that by virtue of these arrangements the\nparties may not assign these memberships. However, subsection (f), by specific reference to\nsubsection (c), allows one specific circumstance in which the power of the trustee may be\ndiminished. Subsection (c) states that if the attempted assignment by the trustee will impact upon\nthe rights of a non-debtor third party, then any applicable law protecting the right of such party to\nrefuse to accept from or render performance to an assignee will prohibit assignment by the trustee.\nWhile subsections (f) and (c) appear contradictory by referring to "applicable law" and\ncommanding opposite results, a careful reading reveals that each subsection recognizes an\n"applicable law" of markedly different scope.\nThus, in application to this case, \xc2\xa7 365(f) permits the executory contract between the\nplaintiffs and the club regarding full golf membership to be assigned by the trustee even though\nthe arrangements between the club and its members clearly do not permit them to assign such\ncontracts, unless there is something in \xc2\xa7 365(c) that indicates to the contrary.\n149\n\n\x0cSection 365(c) requires us to look at the rights and duties of the club as the other party to\nthe contract and the "applicable law" regarding whether the club must accept performance from\nthe assignee member chosen by the trustee or render performance to that member. As required in\n\xc2\xa7 365(c), the applicable law of controlling significance to the solution of this problem addresses\nthe interests of the non-debtor third parties, rather than law relating to general prohibitions or\nrestrictions on assignment of executory contracts covered by \xc2\xa7 365(f).\nThis leads us to a careful examination of Ohio law in light of the nature of the contract. We\nmust determine whether Ohio law excuses the club, as "a party other than the debtor," from\naccepting as a full golfing member a person chosen by the trustee to be that member.\nOhio law does not want the courts involved in the internal workings of associations when\nthose associations have rationally developed rule and procedures.\nThe contracts creating the complex relationships among the parties and others are not in\nany way commercial. They create personal relationships among individuals who play golf, who\nare waiting to play golf, who eat together, swim and play together. They are personal contracts and\nOhio law does not permit the assignment of personal contracts.\nSo-called personal contracts, or contracts in which the personality of one of the parties is\nmaterial, are not assignable. Whether the personality of one or both parties is material depends on\nthe intention of the parties, as shown by the language which they have used, and upon the nature\nof the contract.\nThe claim that the assignment will be made only to those who are already members of the\nclub is not relevant. "Nor would the fact that a particular person it attempted to designate [assign]\nwas personally unexceptionable affect the nature of the contract." Therefore, we believe that the\ntrustee\'s motion to assign the full golf membership should be denied. We reach this conclusion\nbecause the arrangements for filling vacancies proscribe assignment, the club did not consent to\nthe assignment and sale, and applicable law excuses the club from accepting performance from or\nrendering performance to a person other than the debtor.\nA second reason exists for denial of the trustee\'s motion to assume and assign these full\ngolf memberships. Section 363(e) of the Code directs that "use, sale, or lease" of property by the\ntrustee may be "prohibited[ed] or condition[ed]" in light of interests held by others in the subject\nproperty. In this instance, auctioning the full golf membership, although couched in terms of\nassignment, is a sale of a property interest and cannot be reconciled with the rights of persons on\nthe waiting list, the club itself, or other members of the club.\nThe trustee seeks to re-shape that for which the debtor bargained. When the debtor became\na golfing member, he contracted for the right to play golf subject to the rights and privileges of\nthose on the waiting list. The trustee wishes to assume and sell not the limited bundle of rights and\nduties purchased by the debtor but a much larger bundle of rights, including the rights of the\npersons on the waiting list \xe2\x80\x94 the right to be next in line \xe2\x80\x94 and without a redetermination of the\neconomic value of each membership. If allowed, a new contract would be written, creating new\nand different property rights.\nSection 363(e) of the Code directs that when property is to be sold by the trustee,\nnotwithstanding other provisions of \xc2\xa7 363, the court shall prohibit or make conditions necessary\nto protect other persons having an interest in the property to be sold. Since the trustee is attempting\n150\n\n\x0cnot only to sell the debtor\'s right to play golf but also the rights of those on the waiting list to fill\nthe next vacancy, the court was correct in denying the trustee\'s motion. The interest of the persons\npresently involved in this orderly succession cannot adequately be protected in any manner except\nby prohibiting the sale and assignment of the membership.\nIn accordance with our conclusions set forth above, the denial of the trustee\'s motion to\nassign the full golf membership is\nAFFIRMED.\nRALPH B. GUY, JR., Circuit Judge, concurring in result.\nAlthough I agree with the result reached by the court, I arrive at the result by different\nreasoning. . . . I turn instead to the longstanding Ohio rule which excuses a contracting party from\nrendering performance to, or accepting performance from, a third person or entity where the\nidentity of the original contacting party was material. Such contracts are considered non-assignable\nprecisely because of this right of refusal. In my view, this recognition of the right to refuse is the\nvery sort of "applicable law" saved by section 363(c). And, in compliance with section 365(f), I\ndo not rest my analysis on the fact that Ohio law makes such contracts non-assignable, but rather\non the reason behind that legal conclusion.\nOhio courts have long recognized that\n[s]o-called personal contracts, or contracts in which the personality of one\nof the parties is material, are not assignable. Whether the personality of one\nor both parties is material depends upon the intention of the parties, as\nshown by the language which they have used, and upon the nature of the\ncontract.\nGiven that the club is a voluntary association, the identity of its members is surely\n"material" to the membership agreements. The club\'s objection to the proposed assignment is the\nresulting interference with its ability to confer the full golf privileges on those members by the\nmethod of its choice. It makes no difference that the proposed offerees of Mr. Magness\'s full golf\nmembership have already joined the association, or would be required to do so under the club\'s\ntraditional procedures. "[T]he nature of the contract" is not affected by "the fact that the particular\nperson [whom the would-be assignor] attempted to designate was personally unexceptionable." Id.\n\n151\n\n\x0cChapter 8: Enhancing the Estate\n8.1.\n\nFraudulent Transfers (11 U.S.C. \xc2\xa7 548)\n\nThe Bankruptcy Code contains its own provision allowing the trustee to avoid fraudulent\ntransfers made by the debtor prepetition. It is quite similar in its operation to the Uniform\nFraudulent Transfers Act, but gives the recovery to the bankruptcy estate rather than to the creditor\nseeking to avoid the transfer. It also contains a different limitations period, creating the possibility\nthat the state law period for avoiding fraudulent transfers would be longer than the bankruptcy law\nperiod for avoiding fraudulent transfers.\nIn order for the Trustee to avoid a transfer or obligation under Section 548, the transfer\nmust have taken place, or the obligation must have been incurred, within two years before the\nfiling of the petition. 11 U.S.C. \xc2\xa7 548(a)(1).\nThere is one special exception covering transfers to self-settled trusts within 10 years\nbefore bankruptcy. 11 U.S.C. \xc2\xa7 548(e)(1). A self-settled trust is a spendthrift trust funded by the\ndebtor and for the benefit of the debtor for the purpose of shielding assets from the claims of the\ndebtor\xe2\x80\x99s existing or future creditors. Because of the restriction on the debtor\xe2\x80\x99s ability to withdraw\nor transfer the funds in the trust, the corpus would not constitute property of the estate in the\nabsence of avoidance. See 11 U.S.C. \xc2\xa7 541(c)(2). For many years, self-settled spendthrift trusts\nwere invalid under state law, but after Alaska led the states by creating this legal mechanism for\nhiding assets from creditors, other states followed, and it was necessary to add an additional\navoiding power to the trustee\xe2\x80\x99s arsenal.\nThe Bankruptcy Code\xe2\x80\x99s fraudulent conveyance provisions contain the same basic twoground test for fraudulent conveyances: either (1) actual intent to hinder, delay or defraud\ncreditors, or (2) received less than reasonably equivalent value, and was or became insolvent (or\nin an insolvent like condition). 11 U.S.C. \xc2\xa7 548(a)(1)(A) and (B). As under the UFTA, value is\ngiven when an existing creditor\xe2\x80\x99s claim is secured or paid. 11 U.S.C. \xc2\xa7 548(d)(2)(A).\n\n8.2.\n\nThe Trustee\xe2\x80\x99s State Law Powers (11 U.S.C. \xc2\xa7 544(b))\n\nSection 544(b) allows the trustee to step into the shoes of a creditor who could avoid a prepetition transfer under state law. The claim which previously belonged to the creditor now belongs\nto the estate. This rule is commonly used to allow the trustee to avoid fraudulent transfers under\nthe UFTA that would not be avoidable under Section 548 because of the two year limitations\nperiod. It also applies to other state avoidance rules, such as Article 6 of the Uniform Commercial\nCode enacted in only some states that allows the avoidance of bulk transfers made without\nfollowing the notice provisions of the UCC.\nHidden from the statutory language is the doctrine of Moore v. Bay, 284 U.S. 4 (1931),\nwhich allows the trustee to assert the full rights of the estate against the recipient rather than the\nlimited rights of the creditor in whose shoes the trustee has stepped.\nSection 544(b) does not give the trustee the power to assert state law claims directly \xe2\x80\x93 the\ntrustee must find an actual unpaid creditor on the petition date who could have avoided the transfer\n152\n\n\x0cunder state law. Unless there is an existing creditor on the petition date with standing to avoid the\ntransfer, the trustee has no one\xe2\x80\x99s shoes to step into.\n\n8.3.\n\nPractice Problems \xe2\x80\x93 Fraudulent Transfers\n\nProblem 1. When Doctor Debtor was sued for medical malpractice, he immediately\ntransferred title to his only asset \xe2\x80\x93 a house worth $1 million \xe2\x80\x93 to his girlfriend as a gift. The plaintiff\nin the malpractice case knew nothing about the transfer. Two years and one day later, on the eve\nof trial, Doctor Debtor filed a Chapter 7 bankruptcy proceeding. Can the trustee avoid the transfer\nof the house to the girlfriend under Section 548?\nProblem 2. Suppose the plaintiff\xe2\x80\x99s malpractice claim in Problem (1) is determined to be\nworth $400,000. Dr. Debtor also owed other creditors (credit cards, personal loans, investment\nguarantees) $350,000. Assume that only the Plaintiff in Problem (1) could avoid the transfer of the\nhome under the UFTA. If the trustee is able to avoid the transfer, how much of the transfer can the\ntrustee avoid? See 11 U.S.C. \xc2\xa7 544(b), Moore v. Bay, 284 U.S. 4 (1931).\nProblem 3. The day before filing bankruptcy, Dr. Debtor entered into a five year\nemployment contract with his girlfriend, promising to pay her $250,000 per year to work as a\nreceptionist in his medical office. Ignoring any claim limitations that we have yet to study, does\nthe trustee have any way to avoid the girlfriend\xe2\x80\x99s unsecured claim for the present value of\n$1,250,000? See 11 U.S.C. \xc2\xa7 548(a)(1)(B)(ii)(IV).\nProblem 4. One week before the start of the trial in Problem (1), Dr. Debtor gave his last\n$50,000 in cash to his lawyers as a retainer to represent him in the trial. The retainer agreement\nprovided that the $50,000 was a flat fee covering the lawyer\xe2\x80\x99s services through trial regardless of\nthe length or amount of work required in the trial, and was to be deemed earned when paid. Can\nthe trustee recover the $50,000 as a fraudulent transfer?\nProblem 5. Dr. Debtor\xe2\x80\x99s mother loaned him $25,000 one month before bankruptcy. The\nday before bankruptcy, Dr. Debtor secured his mother\xe2\x80\x99s loan with a lien on his medical equipment\nworth $35,000, by signing a security agreement, and filing a UCC-1 financing statement with the\nsecretary of state. Can the trustee avoid the security interest as a fraudulent transfer? See 11 U.S.C.\n\xc2\xa7 548(d)(2)(A).\nProblem 6. Big Corp owns 100% of the stock of Little Corp, as well as 100% of the stock\nof other subsidiary corporations. Big Corp\xe2\x80\x99s bankers require all of Big Corp\xe2\x80\x99s subsidiaries to sign\nguaranties of Big Corp\xe2\x80\x99s $20,000,000 line of credit. This is known as an upstream guaranty.Can\nLittle Corp\xe2\x80\x99s bankruptcy trustee avoid the guaranty as a fraudulent transfer?\nProblem 7. What if Little Corp\xe2\x80\x99s lender required Big Corp to guaranty Little Corp\xe2\x80\x99s line\nof credit, and Big Corp filed bankruptcy. This is known as a downstream guaranty. Could Big\nCorp\xe2\x80\x99s trustee avoid the guaranty as a fraudulent transfer?\n\n153\n\n\x0c8.4.\n\nCases on Fraudulent Transfers\n8.4.1.1.\nBFP v. RESOLUTION TRUST CORP., 511 U.S. 531\n(1994)\n\nJUSTICE SCALIA delivered the opinion of the Court.\nPetitioner BFP is a partnership, formed by Wayne and Marlene Pedersen and Russell\nBarton in 1987, for the purpose of buying a home in Newport Beach, California, from Sheldon and\nAnn Foreman. Petitioner took title subject to a first deed of trust in favor of Imperial Savings\nAssociation (Imperial) to secure payment of a loan of $356,250 made to the Pedersens in\nconnection with petitioner\'s acquisition of the home. Petitioner granted a second deed of trust to\nthe Foremans as security for a $200,000 promissory note. Subsequently, Imperial, whose loan was\nnot being serviced, entered a notice of default under the first deed of trust and scheduled a properly\nnoticed foreclosure sale. The foreclosure proceedings were temporarily delayed by the filing of an\ninvoluntary bankruptcy petition on behalf of petitioner. After the dismissal of that petition in June\n1989, Imperial\'s foreclosure proceeding was completed at a foreclosure sale on July 12, 1989. The\nhome was purchased by respondent Paul Osborne for $433,000.\nIn October 1989, petitioner filed for bankruptcy under Chapter 11 of the Bankruptcy Code.\nActing as a debtor in possession, petitioner filed a complaint in bankruptcy court seeking to set\naside the conveyance of the home to respondent Osborne on the grounds that the foreclosure sale\nconstituted a fraudulent transfer under \xc2\xa7 548 of the Code. Petitioner alleged that the home was\nactually worth over $725,000 at the time of the sale to Osborne.\nThe bankruptcy court found, inter alia, that the foreclosure sale had been conducted in\ncompliance with California law and was neither collusive nor fraudulent. The District Court\naffirmed. A divided bankruptcy appellate panel affirmed. The Court of Appeals for the Ninth\nCircuit affirmed.\nSection 548 of the Bankruptcy Code sets forth the powers of a trustee in bankruptcy (or, in\na Chapter 11 case, a debtor in possession) to avoid fraudulent transfers. It permits to be set aside\nnot only transfers infected by actual fraud but certain other transfers as well--so called\nconstructively fraudulent transfers. The constructive fraud provision at issue in this case applies to\ntransfers by insolvent debtors. It permits avoidance if the trustee can establish (1) that the debtor\nhad an interest in property; (2) that a transfer of that interest occurred within one year of the filing\nof the bankruptcy petition; (3) that the debtor was insolvent at the time of the transfer or became\ninsolvent as a result thereof; and (4) that the debtor received "less than a reasonably equivalent\nvalue in exchange for such transfer." 11 U.S.C. \xc2\xa7 548(a)(2)(A). It is the last of these four elements\nthat presents the issue in the case before us.\nThe question presented here, therefore, is whether the amount of debt (to the first and\nsecond lien holders) satisfied at the foreclosure sale (viz., a total of $433,000) is "reasonably\nequivalent" to the worth of the real estate conveyed.\nThe Courts of Appeals have divided on the meaning of those undefined terms. In Durrett\nv. Washington Nat. Ins. Co., 621 F.2d 201 (1980), the Fifth Circuit, interpreting a provision of the\nold Bankruptcy Act analogous to \xc2\xa7 548(a)(2), held that a foreclosure sale that yielded 57% of the\nproperty\'s fair market value could be set aside, and indicated in dicta that any such sale for less\n154\n\n\x0cthan 70% of fair market value should be invalidated. This \xe2\x80\x9cDurrett rule" has continued to be\napplied by some courts under \xc2\xa7 548 of the new Bankruptcy Code. [In] In re Bundles, the 856 F.\n2d 815, 820 (1988), [the] Seventh Circuit rejected the Durrett rule in favor of a case-by-case, "all\nfacts and circumstances" approach to the question of reasonably equivalent value, with a rebuttable\npresumption that the foreclosure sale price is sufficient to withstand attack under \xc2\xa7 548(a)(2).\nIn this case the Ninth Circuit, agreeing with the Sixth Circuit, adopted the position that the\nconsideration received at a non-collusive, regularly conducted real estate foreclosure sale\nconstitutes a reasonably equivalent value under \xc2\xa7 548(a)(2)(A). The Court of Appeals\nacknowledged that it "necessarily part[ed] from the positions taken by the Fifth [and Seventh]\nCircuits.\nIn contrast to the approach adopted by the Ninth Circuit in the present case Durrett and\nBundles refer to fair market value as the benchmark against which determination of reasonably\nequivalent value is to be measured. In the context of an otherwise lawful mortgage foreclosure sale\nof real estate, such reference is in our opinion not consistent with the text of the Bankruptcy Code.\n[Court notes that Congress uses \xe2\x80\x9cfair market value\xe2\x80\x9d in some places in the code, and \xe2\x80\x9creasonably\nequivalent value\xe2\x80\x9d in Section 548]. One must suspect the language means that fair market value\ncannot--or at least cannot always--be the benchmark.\nThat suspicion becomes a certitude when one considers that market value, as it is\ncommonly understood, has no applicability in the forced sale context: "The market value of . . . a\npiece of property is the price which it might be expected to bring if offered for sale in a fair market;\nnot the price which might be obtained on a sale at public auction or a sale forced by the necessities\nof the owner, but such a price as would be fixed by negotiation and mutual agreement, after ample\ntime to find a purchaser, as between a vendor who is willing (but not compelled) to sell and a\npurchaser who desires to buy but is not compelled to take the particular . . . piece of property."\nBlack\'s Law Dictionary 971 (6th ed. 1990). In short, "fair market value" presumes market\nconditions that, by definition, simply do not obtain in the context of a forced sale.\nNeither petitioner, petitioner\'s amici, nor any federal court adopting the Durrett or the\nBundles analysis has come to grips with this glaring discrepancy between the factors relevant to\nan appraisal of a property\'s market value, on the one hand, and the strictures of the foreclosure\nprocess on the other. Market value cannot be the criterion of equivalence in the foreclosure sale\ncontext. The language of \xc2\xa7 548(a)(2)(A) ("received less than a reasonably equivalent value in\nexchange") requires judicial inquiry into whether the foreclosed property was sold for a price that\napproximated its worth at the time of sale.\nOne might judge there to be such a thing as a "reasonable" or "fair" forced sale price. Such\na conviction must lie behind the Bundles inquiry into whether the state foreclosure proceedings\n"were calculated . . . to return to the debtor mortgagor his equity in the property." And perhaps that\nis what the courts that follow the Durrett rule have in mind when they select 70% of fair market\nvalue as the outer limit of "reasonably equivalent value" for foreclosable property (we have no\nidea where else such an arbitrary percentage could have come from).\nThe history of [both fraudulent conveyance and] foreclosure law begins in England, where\ncourts of chancery developed the "equity of redemption"--the equitable right of a borrower to buy\nback, or redeem, property conveyed as security by paying the secured debt on a later date than\n"law day," the original due date. The courts\' continued expansion of the period of redemption left\n155\n\n\x0clenders in a quandary, since title to forfeited property could remain clouded for years after law\nday. To meet this problem, courts created the equitable remedy of foreclosure: after a certain date\nthe lender would be forever foreclosed from exercising his equity of redemption. This remedy was\ncalled strict foreclosure because the borrower\'s entire interest in the property was forfeited,\nregardless of any accumulated equity. The next major change took place in 19th century America,\nwith the development of foreclosure by sale (with the surplus over the debt refunded to the debtor)\nas a means of avoiding the draconian consequences of strict foreclosure. Since then, the States\nhave created diverse networks of judicially and legislatively crafted rules governing the\nforeclosure process, to achieve what each of them considers the proper balance between the needs\nof lenders and borrowers. All States permit judicial foreclosure, conducted under direct judicial\noversight; about half of the States also permit foreclosure by exercising a private power of sale\nprovided in the mortgage documents. Foreclosure laws typically require notice to the defaulting\nborrower, a substantial lead time before the commencement of foreclosure proceedings,\npublication of a notice of sale, and strict adherence to prescribed bidding rules and auction\nprocedures. Many States require that the auction be conducted by a government official, and some\nforbid the property to be sold for less than a specified fraction of a mandatory presale fair market\nvalue appraisal.\nWhen these procedures have been followed, however, it is "black letter" law that mere\ninadequacy of the foreclosure sale price is no basis for setting the sale aside, though it may be set\naside (under state foreclosure law, rather than fraudulent transfer law) if the price is so low as to\n"shock the conscience or raise a presumption of fraud or unfairness."\nFraudulent transfer law and foreclosure law enjoyed over 400 years of peaceful coexistence\nin Anglo American jurisprudence until the Fifth Circuit\'s unprecedented 1980 decision in Durrett.\nTo our knowledge no prior decision had ever applied the "grossly inadequate price" badge of fraud\nunder fraudulent transfer law to set aside a foreclosure sale. To say that the "reasonably equivalent\nvalue" language in the fraudulent transfer provision of the Bankruptcy Code requires a foreclosure\nsale to yield a certain minimum price beyond what state foreclosure law requires, is to say, in\nessence, that the Code has adopted Durrett or Bundles. Surely Congress has the power pursuant to\nits constitutional grant of authority over bankruptcy, U. S. Const., Art. I, \xc2\xa7 8, cl. 4, to disrupt the\nancient harmony that foreclosure law and fraudulent conveyance law, those two pillars of debtor\ncreditor jurisprudence, have heretofore enjoyed. But absent clearer textual guidance than the\nphrase "reasonably equivalent value"--a phrase entirely compatible with pre-existing practice--we\nwill not presume such a radical departure.\nFederal statutes impinging upon important state interests "cannot . . . be construed without\nregard to the implications of our dual system of government. . . . [W]hen the Federal Government\ntakes over . . . local radiations in the vast network of our national economic enterprise and thereby\nradically readjusts the balance of state and national authority, those charged with the duty of\nlegislating [must be] reasonably explicit." It is beyond question that an essential state interest is at\nissue here: we have said that "the general welfare of society is involved in the security of the titles\nto real estate" and the power to ensure that security "inheres in the very nature of [state]\ngovernment."). Nor is there any doubt that the interpretation urged by petitioner would have a\nprofound effect upon that interest: the title of every piece of realty purchased at foreclosure would\nbe under a federally created cloud. (Already, title insurers have reacted to the Durrett rule by\nincluding specially crafted exceptions from coverage in many policies issued for properties\n156\n\n\x0cpurchased at foreclosure sales. To displace traditional State regulation in such a manner, the federal\nstatutory purpose must be "clear and manifest.\xe2\x80\x9d Otherwise, the Bankruptcy Code will be construed\nto adopt, rather than to displace, pre-existing state law.\nFor the reasons described, we decline to read the phrase "reasonably equivalent value" in\n\xc2\xa7 548(a)(2) to mean, in its application to mortgage foreclosure sales, either "fair market value" or\n"fair foreclosure price" (whether calculated as a percentage of fair market value or otherwise). We\ndeem, as the law has always deemed, that a fair and proper price, or a "reasonably equivalent\nvalue," for foreclosed property, is the price in fact received at the foreclosure sale, so long as all\nthe requirements of the State\'s foreclosure law have been complied with.\nThis conclusion does not render \xc2\xa7 548(a)(2) superfluous, since the "reasonably equivalent\nvalue" criterion will continue to have independent meaning (ordinarily a meaning similar to fair\nmarket value) outside the foreclosure context. Indeed, \xc2\xa7 548(a)(2) will even continue to be an\nexclusive means of invalidating some foreclosure sales. Although collusive foreclosure sales are\nlikely subject to attack under \xc2\xa7 548(a)(1), which authorizes the trustee to avoid transfers "made . .\n. with actual intent to hinder, delay, or defraud" creditors, that provision may not reach foreclosure\nsales that, while not intentionally fraudulent, nevertheless fail to comply with all governing state\nlaws. Any irregularity in the conduct of the sale that would permit judicial invalidation of the sale\nunder applicable state law deprives the sale price of its conclusive force under \xc2\xa7 548(a)(2)(A), and\nthe transfer may be avoided if the price received was not reasonably equivalent to the property\'s\nactual value at the time of the sale (which we think would be the price that would have been\nreceived if the foreclosure sale had proceeded according to law).\n\n8.4.1.2.\nALLARD v. FLAMINGO HILTON, 69 F.3d 769 (6th\nCir. 1995)\nThe debtors, George and Nikki Chomakos, filed a bankruptcy petition on August 2, 1990,\nafter having lost several thousand dollars at a casino operated by Flamingo Hilton Corporation in\nLas Vegas, Nevada. The petition sought relief under Chapter 11 of the Bankruptcy Code, but the\nmatter was soon converted into a Chapter 7 case.\nThe trustee in bankruptcy subsequently commenced an adversary proceeding against\nFlamingo. The trustee\'s complaint alleged that Mr. and Mrs. Chomakos had been insolvent for six\nyears prior to the filing of the petition; that during this time Nikki Chomakos transferred various\nsums to Flamingo for the purpose of gambling; that she made some of these transfers during the\nyear preceding the filing; and that she did not receive a reasonably equivalent value or fair\nconsideration in exchange. The complaint was subsequently amended to allege that George\nChomakos had also made losing bets at the casino while insolvent. Invoking 11 U.S.C. Sec. 548(a),\nthe trustee sought to recover under that section losses incurred during the year preceding the\nbankruptcy filing. Under Michigan\'s version of the Uniform Fraudulent Conveyance Act, the\ntrustee sought to recover losses incurred throughout the entire six-year period in which Mr. and\nMrs. Chomakos were alleged to have been insolvent.\n[T]he bankruptcy court found that the debtors should be deemed to have been insolvent\nfrom and after January of 1988; that at various times in June and September of 1989 Nikki\nChomakos won a total of $9,000 playing slot machines at the Flamingo casino, while losing a total\nof $14,000; and that George Chomakos lost a net amount of $2,710 at the casino after January of\n157\n\n\x0c1988 and before the filing of the petition. The combined net losses of the two debtors during the\nperiod when they were insolvent came to $7,710.\nIn an opinion, the bankruptcy court held that the relief requested by the trustee should be\ndenied because defendant Flamingo gave reasonably equivalent value in exchange for the debtors\'\nmoney. The district court affirmed the decision.\nThe point in time as of which we must determine whether Mr. and Mrs. Chomakos received\nproperty of reasonably equivalent value in exchange for the money they wagered at the casino is\nthe point at which their bets were placed. Where gambling is lawful, as it was in the case at bar,\nthe placing of a bet gives rise to legally enforceable contract rights. These contract rights constitute\n"property," of course, and at the time which Collier identifies as "critical"--a time before anyone\ncan know whether the bet will be successful--the property has economic value. The property is not\nunlike futures contracts purchased on margin. The investor in futures may win big, or his position\nmay be wiped out, but the contractual right to a payoff if the market happens to move the right\nway at the right time constitutes a value reasonably equivalent to the money at risk.\nThe trustee\'s brief takes the bankruptcy court to task for making the suggestion--a\nsuggestion characterized by the trustee as "incredible"--that gambling is arguably "an \'investment\'\nthat can have economic value...." But the trustee looks at the picture only as of the time when Mr.\nand Mrs. Chomakos left the casino "with nothing in exchange for the monies they gambled away."\nThe time that counts is not the time when the bet is won or lost, but the time when the bet is placed.\nThe "investment" may turn out badly, but unless and until it does, the contractual right to receive\npayment in the event that it turns out well is obviously worth something.\nTake blackjack, for instance. The trial record shows that a person who bets $2 at the\nblackjack table where Mr. Chomakos did his gambling will win $3 if he receives a black jack. At\nthe point in time when Mr. Chomakos placed a $2 bet, his chance of winning $3 had an economic\nvalue.\nThe existence of an economic value may be immaterial, however, if the dollar value of the\ngambler\'s chance of winning--augmented, perhaps, by an element of entertainment value--is not\n"reasonably equivalent" to the amount of money wagered. We believe that the evidence presented\nby Flamingo showed a reasonable equivalency here, and the trustee presented no evidence to the\ncontrary.\nThe casino\'s evidence showed, among other things, that the gambling business in Nevada\nis closely regulated by the state; that this regulation extends to payout ratios for both slot machines\nand table games; that casinos depend on repeat business, which is encouraged by customers\nwinning; and that competition among casinos is intense. The evidence further showed that a three\ndollar slot machine bet could produce a jackpot of over a million dollars, which would be paid on\nthe spot; that in a single year, Flamingo slot machine players had more than 9,500 jackpots of\n$1,200 or more, in addition to many lesser jackpots; that for all the dollars deposited in all\nFlamingo slot machines over the course of a year, Flamingo paid out 94 percent in winnings; and\nthat the payout ratio for the particular machines played by Mrs. Chomakos was even higher,\nranging from 95.73 percent to 97.43 percent. The customer enjoys better odds at the blackjack\ntable, moreover. Assuming the blackjack player has a fair knowledge of the game and uses good\nbasic strategy, the evidence showed that the house advantage is only one percent or less.\n158\n\n\x0cThe trustee disputes none of these facts and does not seriously challenge Flamingo\'s good\nfaith. Looking at the situation from the standpoint of creditors, however, the trustee argues that the\nvery existence of a house advantage, coupled with the fact that Mr. and Mrs. Chomakos ultimately\nlost more than they won, means that there was no reasonably equivalent economic benefit. And\nciting In re Young, 148 B.R. 886 (Bankr. D. Minn. 1992), aff\'d 152 B.R. 939 (D. Minn. 1993),\nwhere church contributions made by an insolvent donor were held to be fraudulent conveyances,\nthe trustee maintains that it would be anomalous for gambling losses not to be treated as fraudulent\nconveyances too.\nAs far as church contributions are concerned, the cases are in conflict. While the Young\ndonor was held not to have received reasonably equivalent value, bankruptcy courts reached a\ncontrary result in In re Missionary Baptist Foundation of America, Inc., 24 B.R. 973 (Bankr. N.D.\nTex.1982), and In re Moses, 59 B.R. 815 (Bankr. N.D. Ga.1986). There is no need for us to take\nsides in the church contribution controversy, however. Looking at the matter from the standpoint\nof creditors, as the trustee urges us to do, it seems reasonably clear that the intangible property\nrights accruing to Mr. and Mrs. Chomakos when they placed their bets differed significantly from\nthe benefits accruing to the donors in the church contribution cases.\nA debtor who contributes to a church may receive spiritual and social returns of great value\nto the debtor, but such returns are not likely to be of much benefit to creditors. A debtor who places\na bet in a fair and lawful game of chance, on the other hand, may receive hard cash in return. On\none of the days when Mrs. Chomakos played Flamingo\'s slot machines, for example, she had\nwinnings of $5,000. Suppose she had won a $5,000 jackpot at the start of her visit to the casino\nand had stopped playing as soon as she won; the return on her "investment" would obviously have\nbenefited her creditors.\nIt is true that gambling odds always favor the house, and that Mrs. Chomakos would have\nbeen almost certain to lose her $5,000 jackpot--and more--if she continued playing long enough.\nOn the record before us, however, we cannot say that the existence of a modest house advantage\nmeans that unsuccessful bets are fraudulent conveyances.\nThe trustee argues that Mr. and Mrs. Chomakos did not occupy a bargaining position equal\nto Flamingo\'s, and the gambling transactions were therefore not at arm\'s length. But this argument\noverlooks the governmental and business forces by which Flamingo was constrained. Flamingo\nwas subject to state regulations designed to create a reasonably level playing field, and Flamingo\nhad to compete with nearby casinos to which Mr. and Mrs. Chomakos and all other customers\nwere free to take their business. Without reasonably generous payouts and competitive odds,\nFlamingo could not hope to attract the repeat customers on whom, according to the evidence,\nFlamingo and other casino operators depend for survival. "[T]he quid pro quo," as the bankruptcy\ncourt observed, "was established in the context of a state regulated business, existing in an open\ncompetitive marketplace responding and responsive to desires of legitimate tourists pursuing and\nengaging in a legal and legitimate pursuit."\nAs far as federal law is concerned, moreover, we are not persuaded that we ought to\nevaluate the transactions at issue here solely from the standpoint of creditors. Casino patrons\nreceive what the bankruptcy court called "psychic and other intangible values," just as patrons of\na fine restaurant do, for example. Id. at 593. If, instead of gambling, Mr. and Mrs. Chomakos had\nspent $7,710 on expensive dinners, the creditors would have been no better off than they are now.\n159\n\n\x0cYet the trustee concedes that the restaurateur would not be liable for return of the money--and\nwhen asked at oral argument how money spent at a blackjack table differs from money spent at a\ndinner table, the trustee had no satisfactory answer.\n\n8.5.\n\nIntroduction to Bakersfield Westar\n\nThe following case is very interesting, but also very complex because it requires some\nunderstanding of federal partnership tax law. A corporation that makes an \xe2\x80\x9cS\xe2\x80\x9d election is not a\ntaxable entity. Instead, the shareholders of the \xe2\x80\x9cS corporation\xe2\x80\x9d pay taxes on all of the corporation\xe2\x80\x99s\nactivities. On the other hand, a corporation without an \xe2\x80\x9cS\xe2\x80\x9d election (a so-called \xe2\x80\x9cC\xe2\x80\x9d corporation)\nis taxed on its own activities, with the shareholder paying a second level of taxes on corporate\ndividends.\nBakersfield Westar Corporation took out large loans secured by its assets. The receipt of\nloan proceeds is not taxable income because Bakersfield had an obligation to repay the loan\nproceeds. However, if Bakersfield later does not have to repay the loan proceeds for some reason,\nthen Bakersfield will, at the time of receiving loan foregiveness, have to pay taxes on the original\nloan proceeds that were received without tax because of the obligation to repay. This is known as\n\xe2\x80\x9ccancellation of indebtedness income.\xe2\x80\x9d\nBakersfield Westar also had large tax losses from its operations that passed through to the\nSaunders while the corporation was in S status, allowing the Saunders to use the losses to offset\ntheir income, but not allowing the corporation to use its own tax losses against any future income.\nBy revoking the S election, the Saunders sought to keep the benefit of tax losses that they\ngot from Bakersfield Westar during the S election period, while saddling the bankruptcy estate\nrather than them with the tax liability for not repaying the loans and with the gains from the sale\nor foreclosure of the corporation\xe2\x80\x99s assets due to depreciation deductions passed through to the\nSaunders. If allowed, the revocation of the \xe2\x80\x9cS\xe2\x80\x9d election allowed the Saunders to receive the benefit\nof the corporation\xe2\x80\x99s earlier tax deductions and use of loan proceeds tax free, without having to pay\ntaxes on the gains and cancellation of indebtedness income generated by those tax deductions and\nexclusions, while forcing the creditors of the corporation to bear the burden of the taxes.\n\n8.6.\n\nCases on \xe2\x80\x9cProperty\xe2\x80\x9d and Fraudulent transfers\n8.6.1.1.\nIN RE BAKERSFIELD WESTAR, INC., 226 B.R.\nth\n227 (9 Cir. BAP 1998)\n\nBakersfield Westar provided air and ground ambulance services in Kern County,\nCalifornia. Bakersfield\xe2\x80\x99s president, appellee Craig R. Saunders, and his wife, appellee Jodie K.\nSaunders, co-owned 100% of Bakersfield\xe2\x80\x99s stock as community property.\nOn January 1, 1992, Craig Saunders submitted to the Internal Revenue Service an election\nto have Bakersfield treated as a subchapter S corporation for federal income tax purposes,\nbeginning with tax year 1992. On February 1, 1994, Mr. Saunders submitted to the IRS a statement\nof revocation of Bakersfield\xe2\x80\x99s subchapter S election, together with a statement of the Saunders\xe2\x80\x99\nconsent to the revocation of the election. The legal effect of the statement of revocation, which the\n160\n\n\x0cIRS deemed effective as of February 1, 1994, was to make Bakersfield a \xe2\x80\x9cC\xe2\x80\x9d corporation (i.e., a\nseparate taxable entity) for federal income tax purposes.\nThe Saunders filed a voluntary chapter 7 petition on February 14, 1994. The trustee in the\nSaunders\xe2\x80\x99 bankruptcy case filed a voluntary chapter 7 petition on behalf of Bakersfield (hereinafter\nthe \xe2\x80\x9cdebtor\xe2\x80\x9d) on March 4, 1994. Due to the prepetition revocation of the debtor\xe2\x80\x99s subchapter S\nelection (the \xe2\x80\x9cRevocation\xe2\x80\x9d), the debtor\xe2\x80\x99s bankruptcy estate did not succeed to the debtor\xe2\x80\x99s\nsubchapter S tax attributes because the attributes had already passed through to the Saunders.\nThe trustee in Bakersfield Westar\xe2\x80\x99s bankruptcy case filed an adversary proceeding in\nMarch 1996 against the Saunders, the Saunders\xe2\x80\x99 bankruptcy trustee, and the IRS, seeking to avoid\nthe Revocation as a fraudulent transfer under \xc2\xa7\xc2\xa7 544(b) and 548, and Cal. Civ. Code \xc2\xa7 3439 et seq.\nThe complaint alleged that the Saunders submitted the Revocation to the IRS with the\nintent to shift to the debtor the significant capital gains tax burden that would arise from the future\nsale or other disposition (e.g., foreclosure) of the debtor\xe2\x80\x99s assets, and with the actual intent to\nhinder, delay, and defraud creditors. The complaint alleged in the alternative that the debtor\nreceived less than a reasonably equivalent value in exchange for the Revocation. The Saunders\xe2\x80\x99\nand the IRS\xe2\x80\x99s answers to the complaint denied the material allegations, and the IRS\xe2\x80\x99s answer\ncontended that applicable treasury regulations provided the exclusive means by which a taxpayer\xe2\x80\x99s\nrevocation of a subchapter S election could be rescinded or set aside.\nIn October 1996, the trustee moved for partial summary judgment to avoid the Revocation\nas a fraudulent transfer under \xc2\xa7 548(a)(1) on the grounds that the debtor\xe2\x80\x99s right to make or revoke\nits subchapter S election was \xe2\x80\x9cproperty,\xe2\x80\x9d and the Revocation of that election was a \xe2\x80\x9ctransfer\xe2\x80\x9d\nwithin the meaning of \xc2\xa7 548. The motion included the IRS as a respondent because the trustee\nrequested an order directing the IRS to disregard the Revocation and reinstate the debtor\xe2\x80\x99s\nsubchapter S status, retroactive to the date the Revocation was deemed effective, in order to restore\nthe status quo ante.\nThe trustee analogized the \xe2\x80\x9cproperty\xe2\x80\x9d in this case to a debtor\xe2\x80\x99s right to carry forward a net\noperating loss (\xe2\x80\x9cNOL\xe2\x80\x9d), which he contended has been recognized as \xe2\x80\x9cproperty\xe2\x80\x9d by several courts.\nHe analogized the \xe2\x80\x9ctransfer\xe2\x80\x9d in this case to a debtor\xe2\x80\x99s election to carry forward NOLs, which he\ncontended those courts have recognized as a \xe2\x80\x9ctransfer\xe2\x80\x9d of property.\nThe trustee contended that the debtor\xe2\x80\x99s election to be treated as a subchapter S corporation\nconstituted a valuable property right because its corporate status allowed the debtor to pass its (and\nhence the bankruptcy estate\xe2\x80\x99s) tax liabilities through to its shareholders, the Saunders. He argued\nthat the specific value of the election consisted of the debtor\xe2\x80\x99s ability to pass to the Saunders the\ndebtor\xe2\x80\x99s estate\xe2\x80\x99s capital gains taxes resulting from the sale of over $230,000 in assets and from the\nfuture disposition of approximately $2 million in assets through foreclosure.\nThe trustee asserted that the Revocation constituted a \xe2\x80\x9ctransfer\xe2\x80\x9d because it caused the\ndebtor to \xe2\x80\x9cdispose\xe2\x80\x9d of its right (and thus the estate\xe2\x80\x99s right) to pass its tax liabilities through to the\nSaunders. As a result of the Revocation, the estate\xe2\x80\x99s substantial capital gains tax liabilities\nremained an obligation of the estate and its creditors, rather than an obligation of the Saunders.\nThe trustee also argued that the Revocation was made with the actual intent to hinder,\ndelay, and defraud creditors. He contended that the following \xe2\x80\x9cbadges of fraud\xe2\x80\x9d demonstrated the\nnecessary intent: the debtor\xe2\x80\x99s failure to receive any direct or indirect value or benefit from the\n161\n\n\x0cRevocation; the lack of any consideration received for the Revocation; the fact that the transferee,\nMr. Saunders, was an officer of the debtor; and the debtor\xe2\x80\x99s insolvency (which the trustee inferred\nfrom the timing of the Revocation, i.e., about two weeks before the filing of the Saunders\xe2\x80\x99\nbankruptcy case, and about one month before the filing of the debtor\xe2\x80\x99s bankruptcy case).\nThe IRS\xe2\x80\x99s opposition acknowledged that several courts have recognized the right to\nexercise NOL elections as \xe2\x80\x9cproperty\xe2\x80\x9d within the meaning of the Code, but argued that the right to\nmake or revoke a corporation\xe2\x80\x99s subchapter S election cannot constitute \xe2\x80\x9cproperty\xe2\x80\x9d under \xc2\xa7 548\nbecause it has no present value to a taxpayer, is not referenced in the Code, and has not been\nrecognized by any court to constitute \xe2\x80\x9cproperty.\xe2\x80\x9d The IRS emphasized that a taxpayer\xe2\x80\x99s revocation\nof a subchapter S election has merely the prospective economic impact of changing the tax\nramifications of future corporate transactions, and that the Revocation in this case did not deprive\nthe debtor-corporation (or the bankruptcy estate) of anything of economic value, in contrast to the\nimmediate tax consequences which arise from the exercise of NOL elections. The IRS again\nasserted that the Tax Code provides the exclusive means by which a corporation\xe2\x80\x99s subchapter S\nelection may be revoked.\nThe Saunders\xe2\x80\x99 opposition and counter-motion for summary judgment argued that the\ntrustee could not avoid the Revocation under \xc2\xa7 548(a) because only a corporation\xe2\x80\x99s shareholders\ncould elect or revoke a corporation\xe2\x80\x99s subchapter S status. They also claimed that Mr. Saunders\nlacked the necessary actual fraudulent intent because the Revocation was made on the advice of\nprofessionals.\nThe trustee\xe2\x80\x99s response asserted that the Revocation deprived the bankruptcy estate of tax\nattributes it would have otherwise enjoyed, which he argued was similar in nature to the decision\nto carry forward NOLs, and that the amount of funds available to pay the estate\xe2\x80\x99s creditors would\nbe substantially diminished due to the significant tax liabilities caused by the Revocation.\nAt a hearing on the motion and counter-motion on October 30, 1996, the court concluded\nthat the Revocation was not a voluntary or involuntary transfer by the debtor of property or an\ninterest in property, and the right to make or revoke a subchapter S election was not \xe2\x80\x9cproperty\xe2\x80\x9d or\nan \xe2\x80\x9cinterest in property\xe2\x80\x9d within the meaning of the Code. The court also determined that the trustee\nhad failed to establish the elements of \xc2\xa7 548(a). In support of its conclusions, the court stated:\nSection 548 talks about transfers made by the debtor. This was not a\ntransfer made by the debtor. The debtor is wholly neutral and ineffective\nto do anything at all with regard to subchapter S elections or revocations.\nIt\xe2\x80\x99s purely within the province of the shareholders to do so.\nTranscript of Proceedings October 30, 1996, p. 7.\n[T]here\xe2\x80\x99s no recognition that the corporation has benefited or is subject to\ndetriment because of [the election]. The only thrust of the subchapter S\nelection is what the shareholder wants to do about the shareholder\xe2\x80\x99s tax\nliability.\nTranscript of Proceedings October 30, 1996, p. 11.\nThe corporation had nothing to do with the election, it had nothing to do\nwith the revocation. I cannot find \xe2\x80\x94 and that\xe2\x80\x99s only one element of the\nfinding \xe2\x80\x94 that that could ever be deemed property, apart from any further\n162\n\n\x0cfinding that it was a result \xe2\x80\x94 that there was intent on the part of the \xe2\x80\x94\nthere was a requisite intent.\nBut I think the basic concern, at least with respect to the granting of the\ncountermotion for summary judgment, is that this was not \xe2\x80\x94 that the\ndebtor did not do the transfer, that it was not an involuntary transfer, and\nthat it was not an interest of the debtor.\nTranscript of Proceedings October 30, 1996, pp. 16-17.\nThe [bankruptcy] court denied the trustee\xe2\x80\x99s motion, and granted the Saunders\xe2\x80\x99\ncountermotion. The court sua sponte dismissed the IRS as a defendant, although the IRS had not\nfiled a joinder in the counter-motion, and dismissed the complaint in its entirety. The Saunders\xe2\x80\x99\ncounsel transmitted a proposed judgment and order to the court in November 1996.\nSection 548(a)(1) [9] of the Code, under which the trustee brought his motion for partial\nsummary judgment, allows a trustee to avoid any fraudulent \xe2\x80\x9ctransfer\xe2\x80\x9d of \xe2\x80\x9can interest of the debtor\nin property.\xe2\x80\x9d The IRS acknowledges that the Code does not define \xe2\x80\x9cinterest of the debtor in\nproperty.\xe2\x80\x9d However, the IRS repeats its argument from the proceedings below that a debtor\xe2\x80\x99s\nprepetition right to revoke its election under I.R.C. \xc2\xa7 1362, to be treated as a subchapter S\ncorporation, is not an \xe2\x80\x9cinterest of the debtor in property\xe2\x80\x9d within the meaning of \xc2\xa7 548, because the\nright has no present value to a taxpayer, and has not been recognized by any court as constituting\n\xe2\x80\x9cproperty\nWe disagree. This argument unduly limits the definition of \xe2\x80\x9cproperty\xe2\x80\x9d to those rights which\nhave a quantifiable \xe2\x80\x9cpresent value.\xe2\x80\x9d Even if the definition were limited to this extent, the right in\nquestion has value to a debtor\xe2\x80\x99s estate and is therefore properly characterized as \xe2\x80\x9cproperty.\xe2\x80\x9d In\naddition, the IRS\xe2\x80\x99s assertion that the right has not been recognized as \xe2\x80\x9cproperty\xe2\x80\x9d under the Code\nis incorrect.\nIn the absence of federal law, state law determines whether a debtor possesses an interest\nin property. However, a debtor\xe2\x80\x99s subchapter S status is a creation of I.R.C. \xc2\xa7 1362, and federal law\ntherefore determines whether a debtor holds a \xe2\x80\x9cproperty\xe2\x80\x9d interest in its subchapter S status\nThe United States Supreme Court has defined an \xe2\x80\x9cinterest of the debtor in property\xe2\x80\x9d as\n\xe2\x80\x9cthat property that would have been part of the estate had it not been transferred before the\ncommencement of bankruptcy proceedings.\xe2\x80\x9d\n\xe2\x80\x9cProperty of the debtor\xe2\x80\x9d is also defined broadly under Ninth Circuit case law. \xe2\x80\x9cGenerally,\nproperty belongs to the debtor for purposes of \xc2\xa7 547 if its transfer will deprive the bankruptcy\nestate of something which could otherwise be used to satisfy the claims of creditors.\xe2\x80\x9d See also In\nre Kimura, 969 F.2d 806, 810 (9th Cir. 1992) (defining property as \xe2\x80\x9cgenerally characterized as an\naggregate of rights; `the right to dispose of a thing in every legal way, to possess it, to use it, and\nto exclude everyone else from interfering with it.\'\xe2\x80\x9d)\nA corporation\xe2\x80\x99s right to use, enjoy and dispose of its subchapter S status has been held to\nfall within this broad definition of \xe2\x80\x9cproperty.\xe2\x80\x9d In re Trans-Lines West, Inc., 203 B.R. 653 (Bankr.\nE.D. Tenn.1996). The bankruptcy court in Trans-Lines held on virtually identical facts that a\n163\n\n\x0cdebtor-corporation\xe2\x80\x99s right to revoke its subchapter S status constituted \xe2\x80\x9cproperty\xe2\x80\x9d under the Code.\nId. at 661.\nThe court focused on \xc2\xa7 1362(c) [of the Internal Revenue Code], which provides:\nAn election under subsection (a) shall be effective for the taxable year of\nthe corporation for which it is made and for all succeeding taxable years of\nthe corporation, until such election is terminated under subsection (d).\nThus, the court reasoned, once a corporation elects to be treated as a subchapter S\ncorporation under subsection (a), the right of the corporation to use and enjoy that status is\nguaranteed under subsection (c) until the corporation elects to terminate the status under subsection\n(d). The bankruptcy court held that the debtor therefore possessed a property interest, \xe2\x80\x9ci.e., a\nguaranteed right to use, enjoy and dispose of that interest,\xe2\x80\x9d in its subchapter S status. 203 B.R. at\n661. This holding is consistent with the Ninth Circuit\xe2\x80\x99s definition of \xe2\x80\x9cproperty.\xe2\x80\x9d\nFurthermore, the fact that a right may be prospective in nature does not place it outside the\ndefinition of \xe2\x80\x9cproperty.\xe2\x80\x9d \xe2\x80\x9cThe main thrust of [\xc2\xa7 541\xe2\x80\x99s predecessor under the Act] is to secure for\ncreditors everything of value the [debtor] may possess. . . . To this end the term property has been\nconstrued most generously and an interest is not outside its reach because is it novel or contingent\nor because its enjoyment must be postponed.\xe2\x80\x9d Segal v. Rochelle, 382 U.S. 375, 379, 86 S. Ct. 511,\n15 L.Ed.2d 428 (1966) (declining to exclude the right to NOL carry forwards from definition of\nproperty merely because right was intangible and not yet reduced to a tax refund).\nThe ability to not pay taxes has a value to the debtor-corporation in this case. It is estimated\nthat the debtor passed through to the Saunders approximately $2,359,109.00 in taxable losses from\nits operations during the period between September 30, 1992, and January 1, 1994, while holding\nits subchapter S status. It is further estimated that the debtor\xe2\x80\x99s estate will sustain approximately\n$400,000.00 in capital gains taxes from the sale and other disposition of its assets during\nbankruptcy as a result of the Revocation of that status.\nThe debtor\xe2\x80\x99s estate will be required to pay the capital gains taxes on an administrative\nexpense priority basis, and its payment of the taxes will diminish the amount of monies that would\notherwise be available to satisfy claims of the debtor\xe2\x80\x99s remaining creditors. If the Revocation had\nnot occurred, the Saunders (and thus the creditors of their bankruptcy estate) would have been\nresponsible for payment of these tax liabilities.\nAccordingly, we hold that the debtor\xe2\x80\x99s prepetition right to make or revoke its subchapter S\nstatus constituted \xe2\x80\x9cproperty\xe2\x80\x9d or \xe2\x80\x9can interest of the debtor in property\xe2\x80\x9d within the meaning of the\nCode.\n2. Whether the debtor\xe2\x80\x99s prepetition revocation of its corporate status election constitutes a\n\xe2\x80\x9ctransfer\xe2\x80\x9d that may be avoided by a trustee under \xc2\xa7 548(a)\nThe term transfer, as used throughout the Code, is defined as follows:\n\xe2\x80\x9cTransfer\xe2\x80\x9d means \xe2\x80\x9cevery mode, direct or indirect, absolute or conditional,\nvoluntary or involuntary, of disposing of or parting with property or with\nan interest in property, including retention of title as a security interest and\nforeclosure of the debtor\xe2\x80\x99s equity of redemption;\xe2\x80\x9d\n11 U.S.C. \xc2\xa7 101(54).\n164\n\n\x0cThe fraudulent transfer doctrine prohibits the transfer of a debtor\xe2\x80\x99s property with either the\nintent or effect of placing the property beyond the reach of its creditors. The underlying purpose\nof \xc2\xa7 548 is to preserve assets of the estate for creditors.\nToward that end, Congress has afforded bankruptcy trustees extraordinary powers to avoid\nand recover transfers in order to preserve the bankruptcy estate.\nThe Saunders concede, however, that their decision to revoke the corporation\xe2\x80\x99s subchapter\nS status was based upon the recommendation of their professionals. The Revocation was made\napproximately two weeks prior to their filing personal bankruptcy. It is highly unlikely that the\nSaunders\xe2\x80\x99 professionals would have failed to inform them of the effect of the Revocation on their\npersonal tax obligations and those of the corporation. It is equally difficult to believe that the\nSaunders\xe2\x80\x99s professionals would have failed to discuss with them the possibility that the corporation\nwould also be forced to file bankruptcy and, if that were to happen, that a trustee might sell the\ndebtor\xe2\x80\x99s assets and incur significant capital gains taxes as a result.\nThus, the decision to revoke the debtor\xe2\x80\x99s subchapter S status appears to reflect careful tax\nplanning, and the Revocation appears to represent an effort by the Saunders to manipulate the\nbankruptcy system to their personal advantage under the guise of professional tax planning.\n[T]he trustee in this case has the power to avoid the debtor\xe2\x80\x99s revocation of its subchapter S\nstatus. This result is consistent with the underlying purpose of \xc2\xa7 548.\nThe IRS contends that application of \xc2\xa7 548 would directly conflict with the Tax Code\nprovisions that regulate subchapter S elections. It insists that the general provisions of \xc2\xa7 548 should\nnot be read to override the specific provisions of the Tax Code regarding revocation of subchapter\nS elections, absent some specific statutory provision granting bankruptcy trustees rights that are\nnot otherwise found in the Tax Code. The IRS and the Saunders both contend that courts have\nstrictly construed the Tax Code provisions regarding subchapter S corporations, and rejected all\nefforts to expand their scope and application.\nHowever, courts have long held that Code provisions may override provisions of the Tax\nCode, even absent specific Congressional or statutory authorization to do so. Furthermore, the\ncases cited by the IRS and the Saunders regarding restrictive interpretation of the Tax Code\xe2\x80\x99s\nsubchapter S provisions concern the effect of the subchapter S provisions on shareholders\xe2\x80\x99\nindividual tax obligations outside of bankruptcy. The cases have no relevance to a trustee\xe2\x80\x99s power\nto avoid a revocation under \xc2\xa7 548.\nThe IRS and the Saunders also both argue that revocation of a corporation\xe2\x80\x99s subchapter S\nelection can only be made with the consent of the corporation\xe2\x80\x99s shareholders. They argue that a\ntrustee does not succeed to a corporation\xe2\x80\x99s statutory right to make the revocation when the\ncorporation files bankruptcy and, if the Saunders had not made the revocation in this case, the\ntrustee would not have succeeded to their right to do so. In contrast, a bankruptcy estate is\nspecifically authorized under the Tax Code to succeed to a debtor\xe2\x80\x99s right to waive NOL carry\nbacks.\nThis argument fails to distinguish between \xe2\x80\x9cavoidance\xe2\x80\x9d under the Code in the bankruptcy\ncontext, and \xe2\x80\x9crevocation\xe2\x80\x9d of an otherwise irrevocable election under the Tax Code outside of\nbankruptcy.\n165\n\n\x0cThe IRS also expressed fears that \xe2\x80\x9cadministrative havoc\xe2\x80\x9d will ensue if trustees are allowed\nto avoid revocations of subchapter S elections. In this case, the IRS complains that it might be\nforced to adjust shareholders\xe2\x80\x99 personal income tax returns if trustees are allowed to avoid\notherwise valid subchapter S elections. An S corporation may now have more than 75 shareholders\nin any given year, and the IRS could \xe2\x80\x9cconceivably\xe2\x80\x9d be forced to adjust all of their personal tax\nreturns, regardless of whether they were parties to the \xc2\xa7 548 action or the fraud alleged by the\ntrustee. The IRS contends that the situation would be particularly problematic if avoidance of the\nelection under \xc2\xa7 548 were to conflict with the Tax Code\xe2\x80\x99s statute of limitations for adjustments to\ncorporate and individual tax returns.\nThis argument is unpersuasive. The IRS acknowledges that the concern is speculative. It\nroutinely adjusts individual and corporate tax returns in the ordinary course of its business. The\npossibility that the IRS might be required to amend an unknown (and possibly limited) number of\nadditional tax returns in any given year is not an unusual occurrence and certainly will not create\n\xe2\x80\x9cadministrative havoc.\xe2\x80\x9d\n\n8.7.\n\nThe Strong Arm Power (11 U.S.C. \xc2\xa7 544(a))\n\nThe strong arm power gives the trustee the power to set aside unperfected liens and\ntransfers. As you will recall, under Article 9 of the Uniform Commercial Code a judicial lien\ncreditor has priority over a security interest that is neither \xe2\x80\x9cfiled nor perfected\xe2\x80\x9d at the time the\njudicial lien attaches to the property. Therefore, most security interests that are not perfected as of\nthe petition date can be set aside by the trustee using the trustee\xe2\x80\x99s status as a judicial lien creditor.\n11 U.S.C. \xc2\xa7 544(a)(1).\nWith respect to real estate, the trustee has the power of a bona fide purchaser for value\nwithout notice of a prior lien. 11 U.S.C. \xc2\xa7 544(a)(3). This similarly gives the trustee the power to\navoid mortgages and deeds that have not been perfected prepetition by recording in the county real\nproperty records. When a lien is avoided under the strong arm powers, the creditor is relegated to\nthe status of an unsecured creditor.\nThe problems demonstrate some statutory limitations to the strong arm powers that are not\napparent on the face of the statute. The cases that follow show just how strong the trustee\xe2\x80\x99s\nstatutory strong arm powers are, even in the face of compelling equities.\n\n8.8.\n\nPractice Problems: The Strong Arm Power\n\nAnswer the following Questions:\nProblem 1. Corporate debtor borrows $20,000 from FinanceBank to purchase a new piece\nof business equipment on July 1, signing a promissory note and security agreement. Finance Bank\ndid not file UCC-1 Financing Statement with the Secretary of State. In order to have a purchase\nmoney security interest, Finance Bank paid the $20,000 in loan proceeds directly to the seller of\nthe equipment. On July 15, the equipment was delivered to the debtor. On July 20, the debtor files\na Chapter 11 bankruptcy petition. Can the trustee avoid FinanceBank\xe2\x80\x99s security interest? Can\nFinanceBank perfect its security interest post-petition without getting relief from the automatic\n166\n\n\x0cstay? How much time does FinanceBank have after the debtor files bankruptcy to file its UCC-1\nfinancing statement? Consider UCC \xc2\xa7 9-317(e), 11 U.S.C. \xc2\xa7\xc2\xa7 546(b), 362(b)(3).\nProblem 2. Would your answer to Problem (1) change if the Bank issued the check to the\ndebtor, and the debtor used other money to purchase the equipment.\nProblem 3. Georgio\xe2\x80\x99s Italian Ices entered into a 20 year lease with Beachfront Properties,\nInc., the owner of a strip of retail stores on a popular tourist strip in Malibu, California, and has\nbeen operating the store for several years. The lease was never recorded, however. Can the trustee\nin Beachfront\xe2\x80\x99s bankruptcy case use his or her strong arm powers to avoid Georgio\xe2\x80\x99s lease and\nkick it out of the premises?\n\n8.9.\n\nCases on the Strong Arm Power\n8.9.1.1.\nIN RE PROJECT HOMESTEAD, INC., 374 B.R. 193\n(Bankr. MD NC 2007)\n\nPrior to ceasing operations during the latter part of 2003, the Debtor, a North Carolina nonprofit corporation, was engaged in the business of developing and selling affordable housing to\nlow and moderate income purchasers in North Carolina. Each of these six adversary proceedings\ninvolves a residence that the Debtor purportedly sold to a purchaser in 2003 (the "Properties").\nThe plaintiffs in these proceedings are Commonwealth Land Title Insurance Company\n("Commonwealth") and various lenders who hold promissory notes and deeds of trust from the\nindividuals who purchased the residences from the Debtor (the "Lenders"). Commonwealth issued\nClosing Protection Letters when the residences were purchased. The defendants in these\nproceedings are William P. Miller, the Chapter 7 trustee for the Debtor (the "Trustee"), and the\nindividuals who purchased the residences (the "Purchasers").\nAlthough each of these proceedings arises out of a separate transaction, the fact patterns\ninvolved in the transactions are very similar. In each case, the Purchasers entered into purchase\ncontracts with the Debtor and obtained loans in order to finance the purchase of their homes.\nClosings, or what the parties understood to be closings, were scheduled in early 2003 and held in\neach case in order to consummate the purchases. The closing attorney for each of the closings was\nan attorney named Armina Swittenberg. Prior to the closings, the Lenders who had extended loans\nto the Purchasers wired the loan proceeds to Ms. Swittenberg\'s trust account. At each closing, one\nor more representatives of the Debtor and the respective Purchasers were present. At each closing,\nthe Debtor received the purchase price of the property, including the portion that was paid from\nthe loan proceeds that had been wired to Ms. Swittenberg, and a duly executed deed from the\nDebtor was delivered to the Purchasers that purportedly conveyed the property to the Purchasers.\nAt each closing, the Purchasers executed a promissory note in favor of the Lender, along with a\ndeed of trust purportedly granting the Lender a lien on the property being purchased to secure the\npromissory note. The deed from the Debtor and the deed of trust from the Purchasers were left\nwith Ms. Swittenberg so that she could record the deed and deed of trust. Each of the properties\ninvolved in the six closings was encumbered by a pre-existing deed of trust from the Debtor and\nin each case Ms. Swittenberg retained a sufficient amount of funds at the closing to pay off the\nindebtedness secured by the pre-existing deed of trust. In each instance, Ms. Swittenberg, in fact,\ndid pay off the indebtedness secured by the pre-existing deed of trust. However, Ms. Swittenberg\n167\n\n\x0cfailed to record either the deeds from the Debtor or the deeds of trust from the Purchasers to their\nLender and none of the deeds or the deeds of trust had been recorded when the Debtor filed its\nChapter 7 petition on January 24, 2004.\nThese adversary proceedings were filed on November 4, 2005, The plaintiffs allege a\ncontroversy with the Trustee regarding whether the bankruptcy estate has any beneficial interest\nin the properties and seek declaratory relief that would establish the Purchasers as the owners of\nthe properties in question and establish a first lien in favor of the Lenders securing the indebtedness\ndue under the promissory notes that were executed by the Purchasers. The Trustee denies that the\nplaintiffs are entitled to the relief sought in these proceedings and has asserted a counterclaim\nagainst the plaintiffs and a crossclaim against the Purchasers seeking an adjudication that as\nbankruptcy trustee, he holds title to the properties in question free and clear of all unrecorded\ninterests, including any claims or interests of the plaintiffs or the Purchasers. The plaintiffs and the\nTrustee both assert that there are no material issues of fact and seek summary judgment in their\nfavor.\nThe plaintiffs seek a declaratory judgment that: (a) a constructive trust was created in favor\nof the Purchasers as of dates prior to the petition date; (b) that on the petition date, only the bare\nlegal title to the properties came into the Debtor\'s estate; and (c) that the Trustee be ordered to\ntransfer the legal title to the properties to the Purchasers.\nPlaintiffs base their claim upon state law regarding the imposition of constructive trusts\nand section 541(d) of the Bankruptcy Code. Plaintiffs argue that under applicable North Carolina\nlaw, the Purchasers are entitled to have a constructive trust imposed with respect to the Properties\nand that under North Carolina law such constructive trusts relate back to the conduct giving rise\nto such constructive trusts which, in each case, was prior to the petition date. As a result of the\nconstructive trust, plaintiffs maintain that on the petition date the Purchasers held equitable title,\nthe Debtor held only bare legal title and section 541(d) therefore operates to exclude the properties\nfrom the bankruptcy estate and place the properties beyond the reach of the Trustee\'s powers under\nsection 544(a)(3).\nWhile not conceding that the Purchasers are entitled to a constructive trust, the Trustee\nargues that even if a constructive trust were imposed, the Trustee\'s rights under section 544(a)(3)\nare not subordinate to a constructive trust and that as a bona fide purchaser for value under section\n544(a)(3), he is entitled to prevail over any rights of the Purchasers under a constructive trust.\nThe issue thus presented is whether section 541(d) trumps the Trustee\'s rights and powers\nunder section 544(a)(3). As noted by both parties, there is a split of authority regarding the issue.\nThis court agrees with the reasoning and conclusion of the court in In re Reasonover, 236 B.R.\n219 (Bankr. E.D. Va. 1999), that section 541(d) does not trump the trustee\'s rights and powers\nunder section 544(a)(3).\nAs pointed out in Reasonover, most of the decisions reaching a contrary result do not\ndiscuss or take into account the 1984 amendments to section 541(d). Prior to those amendments,\nsection 541(d) referred to property that became property of the estate under "subsection (a)." The\n1984 amendments significantly modified the language of section 541(d) by deleting "subsection\n(a)" and replacing it with "subsection (a)(1) or (2)." This court agrees with the conclusion that\n"[b]y excluding from the operation of \xc2\xa7 541(d) those portions of \xc2\xa7 541(a) other than subsections\n168\n\n\x0c(a)(1) and (a)(2), Congress clearly signaled its intention that the trustee\'s avoidance powers would\ntrump claims based solely on the debtor\'s lack of equitable title."\nThe decision in Reasonover also supports the Trustee\' argument that under section\n544(a)(3) no transfer is required in order for a bankruptcy trustee to have the rights and powers of\na bona fide purchaser of real property. As pointed out in Reasonover, the text of section 544(a)(3)\nnot only does not limit the trustee\'s avoidance powers to transfers "by" the debtor, it is not even\nlimited to "transfers." This means that in these proceedings, if a bona fide purchaser of the\nProperties from the Debtor would have acquired a superior right and title as against the Purchasers\nor entities claiming through the Purchasers, then so does the Trustee.\nWhile a bankruptcy trustee\'s rights and powers as a bona fide purchaser of real property\nare created or conferred by federal bankruptcy law, the extent of the trustee\'s rights as a bona fide\npurchaser are measured by applicable state law\nThe Trustee argues that under North Carolina law, even if the Purchasers were granted a\nconstructive trust, his rights as a bona fide purchaser of real property are superior to the rights of\nthe Purchasers as the beneficiaries of the constructive trust. The Trustee\'s argument is fully\nsupported by North Carolina law under which the interests of a bona fide purchaser of real property\nwithout notice of the trust are superior to the rights of a beneficiary of an unrecorded equitable\ntrust.\n\n8.9.1.2.\nIN RE LOUISE CARY MORENO, 293 B.R. 777\n(Bankr. D. Col. 2003)\nThe parties raise two major issues in their respective Motions for Summary Judgment:\nA. Whether a defective deed of trust provided constructive notice and/or inquiry notice of\nthe Bank\'s purported lien on the Property to the Trustee \xe2\x80\x94 as a hypothetical lien creditor \xe2\x80\x94 so as\nto trump the Trustee\'s avoidance powers under 11 U.S.C. \xc2\xa7 544.\nB. Whether this Court, by equity, should validate a purported security interest in real\nproperty where the instrument granting the security interest \xe2\x80\x94 a deed of trust \xe2\x80\x94 is executed by an\nentity that does not own the property.\nMs. Moreno was the manager of Hotel Frisco, LLC, which owned and operated the\nbusiness known as The Hotel Frisco, located in Frisco, Colorado. Ms. Moreno, individually, also\nowned certain adjacent real property consisting of vacant lots (\xe2\x80\x9cProperty\xe2\x80\x9d).\nOn December 1, 1999, Hotel Frisco and Ms. Moreno executed and delivered a promissory\nnote ("Note") payable to the Bank in the original principal amount of $140,700.00. The caption on\nthe Note provides that the "Borrower" is/are "HOTEL FRISCO, LLC (TIN: XXXXXXXXX); ET\nAL." The first paragraph of the Note defines the "Borrower" as Hotel Frisco, LLC and Louise C.\nMoreno. On the second page of the Note, there are two signatory lines: one for Hotel Frisco \xe2\x80\x94\nwith Louise Moreno as Manager of Hotel Frisco \xe2\x80\x94 and one for Ms. Moreno, in her individual\ncapacity, and as co-borrower on the Note. The Note is signed, in the two spaces provided, by Ms.\nMoreno, individually, and as manager of Hotel Frisco.\nRepayment of the Note was to be secured by a December 1, 1999 Deed of Trust ("Deed of\nTrust") which was intended to encumber the Property. The first page of the Deed of Trust sets\n169\n\n\x0cforth that it is between the Bank and Hotel Frisco. On the final signatory page of the Deed of Trust,\nhowever, the "Grantor" is identified as Hotel Frisco "by Louise C. Moreno, Manager" and the\nDeed of Trust is signed by Ms. Moreno. That is: although Ms. Moreno owned the Property\npersonally, Ms. Moreno signed the Deed of Trust in her capacity as manager for Hotel Frisco,\nonly, and not in her individual capacity. Moreover, there is no signatory line for Ms. Moreno, in\nher individual capacity and as co-grantor on the Note and Deed of Trust. Further, the Deed of Trust\nsimply defines the "Grantor" as "any and all persons and entities executing this deed of trust,\nincluding without limitation HOTEL FRISCO, L.L.C., A COLORADO LIMITED LIABILITY\nCOMPANY." In the entire "Definitions" section of the Deed of Trust, specific reference is only\nmade to Hotel Frisco.\nThe Deed of Trust was thereafter recorded in the Summit County real estate records.\nOn January 18, 2001, Ms. Moreno and Hotel Frisco filed separate Chapter 11 bankruptcy\ncases. Trustee was appointed to be the Chapter 7 Trustee in both cases.\nOn April 25, 2002, the Bankruptcy Judge entered an Order approving the sale of the\nProperty [and reserving] for resolution at a later date (1) all disputes regarding liens and interests\nin the Property, including disputes regarding validity, priority, and extent of such liens or interests,\nand (2) allocation of the purchase price between estates.\nOn April 30, 2002, the Bank filed the within adversary proceeding seeking [a declaration]\nthat the Trustee may not avoid the Deed of Trust pursuant to 11 U.S.C. \xc2\xa7 544. Moreover, the Bank\nseeks a declaratory judgment that the Bank\'s Deed of Trust constitutes a valid and perfected lien\nupon the Property, junior only to the first lien held by First Commercial.\nA. Trustee\'s Avoidance Powers under 11 U.S.C. \xc2\xa7 544\nThe Trustee is seeking to avoid the lien created by the Deed of Trust under 11 U.S.C. \xc2\xa7\n544(a). As part of the legal fiction created, is the reality that despite any actual knowledge the\ntrustee or the debtor has at the time of the bankruptcy filing, no such actual knowledge will be\nimputed to the trustee in his or her pursuit in avoiding claims under 11 U.S.C. \xc2\xa7 544.\nB. There is No Constructive and/or Inquiry Notice of the Bank\'s Purported Lien on\nthe Property\nThe extent of the trustee\'s rights under 11 U.S.C. \xc2\xa7 544 is measured by the substantive law\nof the jurisdiction governing the property in question. The Bank asserts that under applicable\nColorado state law, the trustee\'s avoidance powers under 11 U.S.C. \xc2\xa7 544 are subject to\nconstructive notice and/or inquiry notice. Here, the Bank contends that under the circumstances,\nsuch constructive notice and/or inquiry notice precludes the Trustee from avoiding its admittedly\ndefective lien on the property.\nA proper execution and recording of the Deed of Trust would have placed the Trustee on\nconstructive notice of the interest affecting title. Here, however, the Deed of Trust is not properly\nexecuted and does not create the intended security interest and, moreover, does not create an\nadequate record in the chain of title. Moreover, this Court believes that in light of the defect in the\nexecution in the Deed of Trust, there are not sufficient facts that were discovered to "excite the\nattention" of a title searcher and place the Trustee on inquiry notice. In In re Bandell Inv., Ltd.,\nJudge Kane noted that the key to determining whether a trustee may use his strong arm avoiding\npowers under \xc2\xa7 544(a) is whether, as a hypothetical purchaser at the time of the filing of the\n170\n\n\x0cbankruptcy, he should be imputed with constructive notice of a deed of trust "as recorded in the\nappropriate fashion." 80 B.R. 210, 212 (D. Colo. 1987). In this case, the Trustee, conducting a title\ninvestigation, as a hypothetical prospective purchaser, would find, with respect to the property in\nquestion, only a transaction between Hotel Frisco, LLC and Alpine Bank. Ms. Moreno,\nindividually, would not appear in the grantor/grantee indices in connection with the property.\nTherefore, no constructive notice can be imputed to the Trustee. A transaction conveying an\ninterest \xe2\x80\x94 any interest \xe2\x80\x94 in the subject property from Ms. Moreno to Alpine Bank simply would\nnot \xe2\x80\x94 and did not \xe2\x80\x94 appear in the chain of title, even if the Deed of Trust was "properly recorded."\nC. No Equitable Reason Exists to Allow the Deed of Trust to Create a Valid Security\nInterest in the Property\nThe Bank admits it made a mistake. Thus, the Bank, as a banking institution, presumably\nwith some experience in the area of securing loans, is "properly charged with the responsibility for\ncompliance with applicable statutes." Id. at 852. It would seem with some minimal due diligence,\nthe Bank could have properly prepared the paperwork to perfect its lien. Moreover, any\nconveyance interest in real property must be signed by the party making that conveyance. It is\nclear that Colorado law intends to mandate that only the owner of real property can encumber or\nconvey the same. Here, while Ms. Moreno did sign the Deed of Trust, she did not sign it in her\nindividual capacity. Instead, she signed only for Hotel Frisco in her capacity as manager of Hotel\nFrisco. Here, the Deed of Trust simply did not pass muster out of the gate. The Deed of Trust,\nmade by the non-owner Hotel Frisco, not the owner, Ms. Moreno, is outside of the chain of title\nvia the grantor-grantee indices. In addition, as noted above, no equitable grounds exist for\nvalidating this defective deed of trust. As a consequence, the Court will permit the Trustee to avoid\nthe purported lien of the Bank pursuant to 11 U.S.C. \xc2\xa7 544 for the benefit of the estate.\n\n8.10.\n\nPreferences (11 U.S.C. \xc2\xa7 547)\n\nEqual distribution to similarly situated creditors is a cornerstone of the bankruptcy process.\nThe preference law was designed to prevent the debtor from favoring certain creditors over others\nshortly before bankruptcy by allowing the trustee to recover the preferential transfer, restoring the\ncreditor\xe2\x80\x99s claim, and thereby permitting equality of distribution.\nBecause of the difficulty of proving intent, the preference law was never limited to\nintentional preferences. And there is no particular logic to the preference time periods. Congress\npicked a bright line period (generally 90 days before bankruptcy), and provided that creditors who\nreceived a preferential benefit during that period must give it back and accept equality of treatment\nwith other similarly situated creditors.\nDespite its logic and fairness, the preference law has always been hated by creditors, and\nthey have successfully lobbied Congress for greater and greater protections from it. Once the most\npowerful of the trustee\xe2\x80\x99s avoiding powers, Congress has created so many exceptions to the law\nthat it is now more holes than cheese. Further, while the preference law was designed as a technical\nstatute without regard to the debtor\xe2\x80\x99s or creditor\xe2\x80\x99s state of mind, the propriety of creditor conduct\nhas become central to some of these exceptions. We start by understanding the definition of a\npreference, then look at an important common law exception, and then focus on the holes in the\ncheese created by the statutory exceptions.\n171\n\n\x0c8.11.\n\nPractice Problems: The Preference Law\n\nAre the following transactions avoidable as preferences under Section 547(b)? Read the elements\nof a preference carefully, and consider whether the elements are met in the following problems.\nDo not consider any preference exceptions, and do not consider who may be liable for the recovery.\nProblem 1. 10 days before bankruptcy, Debtor deeded his house to his mother for no\nconsideration.\nProblem 2. 10 days before bankruptcy, Debtor deeded his house to his mother in full\nsatisfaction of a loan made to him a year earlier. The loan was in the amount of $100,000, and the\nhouse had a fair market value of $300,000, but was subject to a $225,000 first mortgage.\nProblem 3. Same facts as Problem (2), except that Debtor gave the deed to his mother, and\nshe recorded it, 91 days before Debtor filed bankruptcy.\nProblem 4. Same facts as in Problem (2), except that the mother\xe2\x80\x99s loan was secured by a\nmortgage against the house properly recorded when the loan was made.\nProblem 5. 91 days before bankruptcy, Debtor deeded his house to Bank of America in\nfull satisfaction of a loan made to him a year earlier. The loan was in the amount of $100,000. The\nhouse had a fair market value of $300,000, but was subject to a $200,000 first mortgage.\nProblem 6. Same facts as in Problem (5), but in addition Debtor\xe2\x80\x99s mother had guaranteed\nthe Bank of America loan.\nProblem 7. 89 days before bankruptcy, Bank of America foreclosed a mortgage held\nagainst Debtor\xe2\x80\x99s house. The mortgage secured a debt of $200,000 on a house the Debtor believes\nwas worth $250,000. Bank of America bought the house with a credit bid of $200,000 at the\nforeclosure sale.\nProblem 8. Debtor made credit card payments of $1,000 on the 15th of every month, and\nfiled bankruptcy on April 16th.\nProblem 9. Credit card judgment creditor garnished $300 of the debtor\xe2\x80\x99s wages on the first\nand 15th of every month. Debtor filed bankruptcy on April 16.\nProblem 10. Debtor borrowed $100,000 from Bank 100 days before bankruptcy. Debtor\nsigned a promissory note and security agreement covering Debtor\xe2\x80\x99s business equipment before the\nloan was made. Bank filed a UCC-1 financing statement with the Secretary of State 21 days after\nthe loan was made. See 11 U.S.C. \xc2\xa7 547(e)(2).\nProblem 11. Debtor repaid the loan in Problem (10) 10 days before bankruptcy. The\nequipment was worth $250,000.\nProblem 12. Same facts as Problem (11) except that the equipment was worth $75,000.\nProblem 13. Same facts as in Problem (12) except that instead of paying off the loan,\nDebtor made two $10,000 payments to the bank during the 90 day preference period.\nProblem 14. Same facts as Problem (11) except Bank filed the UCC-1 financing statement\nwith the secretary of state 31 days after the loan was made.\n172\n\n\x0cProblem 16. Same facts as Problem (11) except that Bank did not file a UCC-1 financing\nstatement before bankruptcy.\nProblem 17. Debtor\xe2\x80\x99s pizza parlor was having financial problems. Debtor owed his longtime sausage supplier $20,000, and more than $300,000 to other creditors. On January 1, debtor\ngave his sausage supplier a security interest in his equipment to secure the debt, which was\nperfected within 30 days. The Debtor was insolvent at the time the security interest was given.\nDebtor filed bankruptcy on March 2. Can the trustee avoid the security interest?\nProblem 18. What if Debtor in Problem (17) filed bankruptcy on April 4?\nProblem 19. Debtor wrote a check 91 days before bankruptcy to pay an unsecured\ncreditor\xe2\x80\x99s claim. Creditor cashed the check 90 days before bankruptcy, and Debtor\xe2\x80\x99s bank\nprocessed the check 88 days before bankruptcy. Is the payment preferential? Barnhill v. Johnson,\n503 US 393 (1992) (because of debtor\xe2\x80\x99s ability to stop payment, transfer by check \xe2\x80\x9ctakes effect\xe2\x80\x9d\nwithin the meaning of section 547(e)(2) when check is honored by debtor\xe2\x80\x99s bank).\nProblem 20. On the eve of bankruptcy, Debtor paid $150,000 cash for a new house. The\ntransfer of title was recorded immediately. Can the trustee in bankruptcy avoid the $150,000\ntransfer and recover the cash? What if the house had a fair market value of only $75,000?\nProblem 21. 10 days prior to filing bankruptcy, Debtor received a tax refund and used the\nproceeds to pay off a $10,000 loan to Debtor\xe2\x80\x99s mother. If Debtor had not paid his mother before\nbankruptcy, Debtor would have been able to exempt the full $10,000 tax refund under the \xe2\x80\x9cwild\ncard\xe2\x80\x9d exemption. Nevertheless, the trustee seeks to avoid the $10,000 payment to Debtor\xe2\x80\x99s mother\nas a preferential transfer. Should the trustee win? Answer this question after you have read the\nSupreme Court\xe2\x80\x99s decision in Beigier below.\n\n8.12.\n\nCases on Preferences\n8.12.1.1.\n\nBEIGIER v. IRS, 496 U.S. 53 (1990)\n\nJUSTICE MARSHALL delivered the opinion of the Court.\nAmerican International Airways, Inc. (AIA), was a commercial airline. As an employer,\nAIA was required to withhold federal income taxes and to collect Federal Insurance Contributions\nAct (FICA) taxes from its employees\' wages. As an airline, it was required to collect excise taxes\nfrom its customers for payment to the IRS. Because the amount of these taxes is "held to be a\nspecial fund in trust for the United States," they are often called "trust-fund taxes." By early 1984,\nAIA had fallen behind in its payments of its trust-fund taxes to the Government. In February of\nthat year, the IRS ordered AIA to deposit all trust-fund taxes it collected thereafter into a separate\nbank account. AIA established the account, but did not deposit funds sufficient to cover the entire\namount of its trust-fund tax obligations. It nonetheless remained current on these obligations\nthrough June 1984, paying the IRS $695,000 from the separate bank account and $946,434 from\nits general operating funds. AIA and the IRS agreed that all of these payments would be allocated\nto specific trust-fund tax obligations.\nOn July 19, 1984, AIA [filed] under Chapter 11. On September 19, the Bankruptcy Court\nappointed petitioner Harry P. Begier, Jr., trustee, and a plan of liquidation in Chapter 11 was\n173\n\n\x0cconfirmed. Seeking to exercise his avoidance power, Begier filed an adversary action against the\nGovernment to recover the entire amount that AIA had paid the IRS for trust-fund taxes during the\n90 days before the bankruptcy filing.\nEquality of distribution among creditors is a central policy of the Bankruptcy Code.\nAccording to that policy, creditors of equal priority should receive pro rata shares of the debtor\'s\nproperty. Section 547(b) furthers this policy by permitting a trustee in bankruptcy to avoid certain\npreferential payments made before the debtor files for bankruptcy. This mechanism prevents the\ndebtor from favoring one creditor over others by transferring property shortly before filing for\nbankruptcy. Of course, if the debtor transfers property that would not have been available for\ndistribution to his creditors in a bankruptcy proceeding, the policy behind the avoidance power is\nnot implicated. The reach of 547(b)\'s avoidance power is therefore limited to transfers of "property\nof the debtor."\nThe Bankruptcy Code does not define "property of the debtor." Because the purpose of the\navoidance provision is to preserve the property includable within the bankruptcy estate - the\nproperty available for distribution to creditors - "property of the debtor" subject to the preferential\ntransfer provision is best understood as that property that would have been part of the estate had it\nnot been transferred before the commencement of bankruptcy proceedings. For guidance, then, we\nmust turn to 541, which delineates the scope of "property of the estate" and serves as the\npostpetition analog to 547(b)\'s "property of the debtor."\nSection 541(d) provides: "Property in which the debtor holds, as of the commencement of\nthe case, only legal title and not an equitable interest . . . becomes property of the estate under\nsubsection (a) of this section only to the extent of the debtor\'s legal title to such property, but not\nto the extent of any equitable interest in such property that the debtor does not hold." Because the\ndebtor does not own an equitable interest in property he holds in trust for another, that interest is\nnot "property of the estate." Nor is such an equitable interest "property of the debtor" for purposes\nof 547(b). As the parties agree, then, the issue in this case is whether the money AIA transferred\nfrom its general operating accounts to the IRS was property that AIA had held in trust for the IRS.\nWe begin with the language of 26 U.S.C. 7501, the Internal Revenue Code\'s trust-fund tax\nprovision: "Whenever any person is required to collect or withhold any internal revenue tax from\nany other person and to pay over such tax to the United States, the amount of tax so collected or\nwithheld shall be held to be a special fund in trust for the United States." The statutory trust\nextends, then, only to "the amount of tax so collected or withheld." Begier argues that a trust-fund\ntax is not "collected or withheld" until specific funds are either sent to the IRS with the relevant\nreturn or placed in a segregated fund. AIA neither put the funds paid from its general operating\naccounts in a separate account nor paid them to the IRS before the beginning of the preference\nperiod. Begier therefore contends that no trust was ever created with respect to those funds and\nthat the funds paid to the IRS were therefore property of the debtor.\nWe disagree. The Internal Revenue Code directs "every person receiving any payment for\nfacilities or services" subject to excise taxes to "collect the amount of the tax from the person\nmaking such payment." It also requires that an employer "collec[t]" FICA taxes from its employees\n"by deducting the amount of the tax from the wages as and when paid." Both provisions make\nclear that the act of "collecting" occurs at the time of payment - the recipient\'s payment for the\nservice in the case of excise taxes and the employer\'s payment of wages in the case of FICA taxes.\n174\n\n\x0cThe mere fact that AIA neither placed the taxes it collected in a segregated fund nor paid them to\nthe IRS does not somehow mean that AIA never collected the taxes in the first place.\nThe same analysis applies to taxes the Internal Revenue Code requires that employers\n"withhold." Section 3402(a) (1) requires that "every employer making payment of wages shall\ndeduct and withhold upon such wages [the employee\'s federal income tax]." (Emphasis added.)\nWithholding thus occurs at the time of payment to the employee of his net wages.\nWe conclude, therefore, that AIA created a trust within the meaning of 7501 at the moment\nthe relevant payments (from customers to AIA for excise taxes and from AIA to its employees for\nFICA and income taxes) were made.\nOur holding that a trust for the benefit of the IRS existed is not alone sufficient to answer\nthe question presented by this case: whether the particular dollars that AIA paid to the IRS from\nits general operating accounts were "property of the debtor." Only if those particular funds were\nheld in trust for the IRS do they escape characterization as "property of the debtor." [the Court\nthen reviews the legislative history of the bankruptcy Code.] The House Report . . . states:\nA payment of withholding taxes constitutes a payment of money\nheld in trust under Internal Revenue Code 7501(a), and thus will not\nbe a preference because the beneficiary of the trust, the taxing\nauthority, is in a separate class with respect to those taxes, if they\nhave been properly held for payment, as they will have been if the\ndebtor is able to make the payments."\nH. R. Rep. No. 95-595, supra, at 373. Under a literal reading of the above passage, the\nbankruptcy trustee could not avoid any voluntary prepetition payment of trust-fund taxes,\nregardless of the source of the funds. As the House Report expressly states, the limitation that the\nfunds must "have been properly held for payment" is satisfied "if the debtor is able to make the\npayments." The debtor\'s act of voluntarily paying its trust-fund tax obligation therefore is alone\nsufficient to establish the required nexus between the "amount" held in trust and the funds paid.\nWe adopt this literal reading. In the absence of any suggestion in the Bankruptcy Code\nabout what tracing rules to apply, we are relegated to the legislative history. The courts are directed\nto apply "reasonable assumptions" to govern the tracing of funds, and the House Report identifies\none such assumption to be that any voluntary prepetition payment of trust-fund taxes out of the\ndebtor\'s assets is not a transfer of the debtor\'s property. Nothing in the Bankruptcy Code or its\nlegislative history casts doubt on the reasonableness of that assumption. Other rules might be\nreasonable, too, but the only evidence we have suggests that Congress preferred this one. We see\nno reason to disregard that evidence. We hold that AIA\'s payments of trust-fund taxes to the IRS\nfrom its general accounts were not transfers of "property of the debtor," but were instead transfers\nof property held in trust for the Government pursuant to 7501. Such payments therefore cannot be\navoided as preferences.\n\n8.12.1.2.\n\nIN RE CASTILLO, 39 B.R. 45 (Bankr. D. Col. 1984)\n\nThis matter comes before the Court upon the Trustee\'s Complaint for Avoidance of a\nPreferential Transfer and for Turnover.\n175\n\n\x0cThe Debtors contracted for, and obtained, the services of the Defendant, Rivera Funeral\nHome (Rivera). The Debtors executed a note for $2,306.00 in favor of Rivera and paid this amount\ndown until June 29, 1983, at which time there was a balance due of $1,463.25. Rivera then\ndemanded payment of the balance.\nThe Debtors went to Minnequa Bank on June 29, 1983, and borrowed that amount. The\nDebtors executed a note for principal and interest in favor of the Bank for $1,733.28. Rivera\ncosigned this note and also signed a guaranty agreement. The Bank drew a check to the order of\nRivera on the same day, June 29, 1983.\nThe Debtors filed their voluntary Chapter 7 petition on September 12, 1983. When the\nBank received notice of the Debtors\' bankruptcy, they called on the guarantor and co-signer,\nRivera, to pay off the note. Rivera paid the Bank $1,462.07.\nThe Trustee claims that the initial payment by the Bank to Rivera was a preferential transfer\nsince all the elements of section 547(b) of the Bankruptcy Code have been satisfied.\nThe first element of a preferential transfer as set forth in section 547(b) requires that there\nbe a transfer of property of the debtor. As a general rule, when a third person makes a loan to the\ndebtor specifically to enable him to satisfy the claim of a designated creditor, the proceeds never\nbecome part of the debtor\'s assets, and therefore, no preference is created. The rule is the same\nregardless of whether the proceeds of the loan are transferred directly by the lender to the creditor\nor are paid to the debtor with the understanding that they will be paid to the creditor in satisfaction\nof his claim, so long as such proceeds are clearly "earmarked." Because there has been no transfer\nof the debtor\'s property, there has been no diminution of the debtor\'s estate, and consequently,\nthere has been no preference.\nIn this case, it is undisputed that the Bank made Rivera the sole payee on the check. The\ndebtor had no control over the use or disposition of the funds. The money was never available to\nsatisfy the claims of general creditors. There was nothing more than a substitution of one creditor\nfor another and no diminution of the debtor\'s estate resulted. Consequently, the Trustee\'s attempt\nto void the transfer by the Bank to Rivera falters at the very start, as there was no transfer of the\nDebtor\'s property or diminution of the estate.\n\n8.12.1.3.\nPARKS v. FIA CREDIT SERVICES, N.A., 550 F.3d\n1251 (10th Cir. 2008)\nDebtors had two credit card accounts with MBNA. They also had two credit card accounts\nwith Capital One. On July 27, 2005, Debtors directed Capital One to pay MBNA $17,000 on the\nfirst MBNA account through a balance transfer from their first Capital One account. On the same\nday, they directed Capital One to pay MBNA $21,000 on the second MBNA account through a\nbalance transfer from their second Capital One account.\nOn October 13, 2005, Debtors filed a bankruptcy petition under Chapter 7 of the\nBankruptcy Code. Parks was appointed Trustee. Because Debtors\' payments to MBNA were made\nwithin ninety days of the filing of the bankruptcy petition (referred to as the preference period),\nParks filed an adversary complaint against MBNA seeking to avoid these payments as preferential\ntransfers.\n176\n\n\x0cThe bankruptcy court determined Debtors\' payments to MBNA were not preferential\ntransfers because they did not constitute transfers of an interest of Debtors in property as required\nby 11 U.S.C. \xc2\xa7 547(b):\n[T]he funds paid to . . . MBNA were assets of Capital One in which\nthe Debtors did not have an interest for purposes of \xc2\xa7 547. Debtors\nmerely exercised an offer to transfer credit card balances; this offer,\nif not exercised as of the date of filing, would have added no value\nto the estate. The transfer was a mere substitution of creditors which\nhad no impact on either the property of the estate or the value of the\nclaims asserted against the estate.\nParks appealed to the district court, [which] affirmed but analyzed the case under the earmarking\ndoctrine which, in its broadest terms, exempts a debtor\'s use of borrowed funds from the Trustee\'s\navoidance powers when those funds are lent for the purpose of paying a specific debt. In doing so,\nit looked to the amount of control Debtors exercised over the payments to MBNA and whether the\ntransfer of those payments diminished the bankruptcy estate. It thought Debtors lacked the\nrequisite control over the payments for them to constitute interests of Debtors in property:\nIt is undisputed that the debtors never possessed a check or proceeds\nof a loan. Capital One was under no obligation to cooperate with the\ndebtors\' request. The debtor[s] could not compel Capital One to\nmake a payment. Nonetheless, Capital One chose to make a payment\ndirectly and specifically to MBNA on the debtors\' behalf and\nessentially substituted itself as the debtors\' creditor for the MBNA\ndebt under the terms agreed [to] through the balance transfer\nagreement. The Court finds this to be a bank to bank transfer\nresulting in a substitution of the debtors\' creditors.\nThe district court also concluded that because there was never a transfer of assets, only credit, the\nbankruptcy estate was not diminished.\nThe purpose of the [preference] statute is two-fold: (1) "to secure an equal distribution of\nassets among creditors of like class" and (2) "to discourage actions by creditors that might\nprematurely compel the filing of a [bankruptcy] petition."\nOnly the threshold requirement of 11 U.S.C. \xc2\xa7 547(b) is at issue here, i.e., whether the\npayments made to Debtors\' MBNA credit card accounts from their Capital One credit card\naccounts constitute transfers of "an interest of the debtor in property."\nThe Bankruptcy Code does not define "an interest of the debtor in property." However, in\nBegier v. IRS, the Supreme Court said:\nBecause the purpose of the avoidance provision is to preserve the\nproperty includable within the bankruptcy estate\xe2\x80\x94the property\navailable for distribution to creditors\xe2\x80\x94"property of the debtor"\nsubject to the preferential transfer provision is best understood as\nthat property that would have been part of the estate had it not been\ntransferred before the commencement of bankruptcy proceedings.\nFor guidance, then, we must turn to \xc2\xa7 541, which delineates the\n177\n\n\x0cscope of "property of the estate" and serves as the postpetition\nanalog to \xc2\xa7 547(b)\'s "property of the debtor."\n496 U.S. 53\nCourts have used the dominion/control test to determine whether a transfer of property was\na transfer of "an interest of the debtor in property." Under this test, a transfer of property will be a\ntransfer of "an interest of the debtor in property" if the debtor exercised dominion or control over\nthe transferred property.\nOther courts have applied a diminution of the estate test. Under this analysis, a debtor\'s\ntransfer of property constitutes a transfer of "an interest of the debtor in property" if it deprives the\nbankruptcy estate of resources which would otherwise have been used to satisfy the claims of\ncreditors. "[I]f the debtor transfers property that would not have been available for distribution to\nhis creditors in a bankruptcy proceeding, the policy behind the avoidance power is not implicated."\nBegier, 496 U.S. at 58.\nAs both the district court and bankruptcy court acknowledged, their conclusion that the\ncredit card payments in this case were not transfers of "an interest of [Debtors] in property"\nrepresents the minority view. The majority of courts to address the issue have gone the other way.\nThese courts reason that the debtor, even if never in actual possession of the loaned proceeds,\nexercises dominion or control over them as evidenced by an ability to direct their distribution.\nThey also conclude such transactions deplete the bankruptcy estate\xe2\x80\x94when a debtor converts an\noffer of credit into loan proceeds and uses those proceeds to pay another creditor, the debtor\ndeprives the bankruptcy estate of those proceeds.\nWe agree with the majority view. Technology masks the processes involved here.\nSeparating them into constituent elements reveals a sequence of events, not just one: Debtors drew\non their Capital One line of credit; that draw converted available credit into a loan; Debtors directed\nCapital One to use the loan proceeds to pay MBNA; and Capital One complied. It is essentially\nthe same as if Debtors had drawn on their Capital One line of credit, deposited the proceeds into\nan account within their control, and then wrote a check to MBNA. The latter is clearly a preference.\nContrary to the district court\'s conclusion, there is no evidence Capital One could have\nstopped the payments to MBNA once it honored Debtors\' draw. The payments were a debtor\'s\ndiscretionary use of borrowed funds to pay another debt. Such transactions are generally\nconsidered preferential transfers. The only exception to this rule is the earmarking doctrine, which\nthe district court incorrectly applied.\nEarmarking, even if extended beyond the codebtor context, only applies when the lender\nrequires the funds be used to pay a specific debt. Here, Capital One placed no conditions on\nDebtors\' use of the funds, it only honored their instructions. The earmarking doctrine is\ninapplicable.\nAnd Debtors\' exercise of control of the loan proceeds also distinguishes this case from a\nbank-to-bank transfer of consumer debt, in which one bank simply agrees to purchase consumer\ndebt from another bank. A debtor is not directly involved, let alone in control\xe2\x80\x94a notice comes to\nthe debtor redirecting required payments to the acquiring institution. Moreover, there was no\nagreement between Capital One and MBNA for the purchase of Debtors\' paper.\n178\n\n\x0cWe also consider whether Debtors\' transfer of the Capital One loan proceeds to MBNA\ndiminished the bankruptcy estate. It did. The net value of the estate did not change because the\nCapital One infusion of loan proceeds was totally offset by additional debt to Capital One. But that\nis not the relevant test. We must ask whether the loan proceeds "would have been part of the estate\nhad [they] not been transferred before the commencement of bankruptcy proceedings." The Capital\nOne loan proceeds were an asset of the estate for at least an instant before they were preferentially\ntransferred to MBNA. The preferential transfer look back is not time sensitive\xe2\x80\x94the issue is\nwhether any asset, regardless of how fleeting its presence in the bankrupt\'s estate during the\nrelevant period of time, should be ratably apportioned among qualified creditors or permitted to\nbenefit only a preferred creditor. The answer is as clear as the statute itself\xe2\x80\x94all preferential\ntransfers of estate assets during the ninety-day look back are subject to recapture.\nIn reaching the opposite conclusion, the district court and bankruptcy court mistakenly\ncharacterized the transferred property as untapped credit. In their view untapped credit cannot be\nused to satisfy creditors and, thus, no diminution of the estate occurred. But this case does not\ninvolve untapped credit. A transfer of loan proceeds (an asset) diminishes the bankrupt\'s estate.\nTreating the payments to MBNA as avoidable preferential transfers furthers \xc2\xa7 547(b)\'s\npolicy of equality of distribution between similarly situated creditors. Recapture allows all\nqualifying creditors, including Capital One and FIA, to ratably share in a $38,000 estate asset.\n\n8.12.1.4.\nIN RE UNICOM COMPUTER CORP., 13 F.3d 321\nth\n(9 Cir. 1994)\nIn this appeal we are called upon to decide whether a debtor\'s prepetition transfer to a\ncreditor of money belonging to the creditor but mistakenly received by the debtor constitutes a\nvoidable preference because the debtor had temporary possession of the money within ninety days\nof the filing of its petition in bankruptcy. The Bankruptcy Appellate Panel ("BAP") upheld the\nbankruptcy court\'s ruling that, for purposes of bankruptcy law, the debtor\'s prepetition transfer of\nthe payment to its rightful owner constituted a voidable preference. We reverse.\nActing as a computer equipment broker on behalf of its client, Pitney Bowes, Inc.\n("Pitney"), Unicom Computer Corporation ("Unicom") arranged a computer equipment lease in\nearly 1983 between Pitney and Mitsui Manufacturers Bank ("Mitsui"). Under the terms of the\nagreement worked out by Unicom, Mitsui purchased computer equipment, and then leased the\nequipment to Pitney for five years at a monthly rental of $44,197. Pitney made its monthly lease\npayments directly to [Mitsui]\nMidway through the lease term, Pitney told Unicom that it wanted to get out of the fiveyear lease. Although unable to locate a party willing to step into Pitney\'s shoes and re-lease the\nequipment at the $44,197 monthly rental figure, Unicom did find a company, Cincinnati Milacron\n("Cinci"), willing to sublease it for two years at a substantially reduced rent. Pursuant to a deal\nworked out by Unicom, Pitney consented to sublet the equipment directly to Unicom for twentyfour months at a monthly rental of $20,000. Unicom in turn sub-sublet the equipment to Cinci for\nthe same time period (i.e., between January 1986 and December 1987) at a monthly rental of\n$22,000.\n179\n\n\x0cUnicom failed to bill Pitney for the final two payments until late April 1988, nearly two\nmonths after the five-year lease term had expired. Unicom then compounded its error by\ninstructing Pitney to send its payment to Unicom instead of to Mitsui. As a final complication,\nUnicom did not forward Pitney\'s check to Mitsui but deposited it to its own (i.e., Unicom\'s)\naccount.\nUnicom corrected its mistake in August 1988 by remitting the full amount of Pitney\'s\nmisdirected payment to Mitsui; the following month, Unicom filed a Chapter 11 petition in\nbankruptcy.\nNearly two years later Unicom filed the instant adversary proceeding against Mitsui,\narguing that its August 1988 payment constituted a voidable preference because it had been made\nwithin ninety days of the bankruptcy petition\'s filing. Mitsui countered by arguing that the payment\ncould not be viewed as a preference, voidable or otherwise, because the money was never Unicom\'s\nproperty, i.e., Unicom never had any right to the money and was merely holding it in constructive\ntrust for Mitsui.\nThe bankruptcy court rejected Mitsui\'s argument, and the BAP affirmed in a 2-1 decision,\nholding that, while a constructive trust would ordinarily arise under California law in favor of\nMitsui, Mitsui had failed to prove that the equities involved mandated such a result under federal\nbankruptcy law. Judge Russell said in dissent that, once Mitsui had established its right to the\nmoney, the burden of proof shifted to Unicom as the debtor-in-possession to prove that it would\nbe inequitable to impose a constructive trust over the funds belonging to Mitsui. Mitsui has timely\nappealed.\nAlthough the parties have asserted at least three issues on appeal, this case stands or falls\non the answer to one question: Does the fact that Unicom acquired temporary possession of\nPitney\'s final lease payment to Mitsui render that payment Unicom\'s property for bankruptcy\npurposes? For the reasons which follow, we conclude that it does not.\nOne of the ways in which federal bankruptcy law seeks to equalize the positions of\nsimilarly situated creditors is by giving trustees in bankruptcy the power to set aside so-called\npreferential transfers of a debtor\'s property. Thus, a trustee may ordinarily avoid a transfer of a\ndebtor\'s interest in property made to a creditor on account of an antecedent debt if that transfer\noccurred within ninety days of the date of the filing of the debtor\'s bankruptcy petition. 11 U.S.C.\n\xc2\xa7 547(b). Put another way, a transfer may be avoided under section 547(b) if it involves property\nof the debtor and the transfer reduces the amount of the bankruptcy estate available for the payment\nof other creditors.\nThe key, of course, lies with the correct definition of "property". In its simplest terms,\nproperty of the debtor may be said to be that which would have been property of the bankruptcy\nestate had the transfer not taken place. The relevant statute broadly--and somewhat unhelpfully-defines property of a debtor\'s estate as including "all legal or equitable interests of the debtor in\nproperty". 11 U.S.C. Sec. 541(a)(1). However, it does not include "any power that the debtor may\nexercise solely for the benefit" of another, 11 U.S.C. Sec. 541(b)(1), nor does it include "[p]roperty\nin which the debtor holds ... only legal title and not an equitable interest". 11 U.S.C. Sec. 541(d).\nThus, something held in trust by a debtor for another is neither property of the bankruptcy estate\nunder section 541 (d), nor property of the debtor for purposes of section 547 (b).\n180\n\n\x0cIn the instant case, of course, we are dealing with a particular type of trust, viz., a\nconstructive trust that allegedly arose by operation of state law. Although we have never expressly\nheld that the same rule (viz., funds held in trust are property neither of the debtor nor of the\nbankruptcy estate) should apply as well to situations involving funds held by a debtor in\nconstructive trust, the rule would seem to apply with equal force to both situations.\nSituations occasionally arise where property ostensibly belonging to the debtor will\nactually not be property of the debtor, but will be held in trust for another. For example, if the\ndebtor has incurred medical bills that were covered by insurance, and the insurance company had\nsent the payment of the bills to the debtor before the debtor had paid the bill for which the payment\nwas reimbursement, the payment would actually be held in a constructive trust for the person to\nwhom the bill was owed.\nUnicom never had any right to accept Pitney\'s check on behalf of Mitsui. Moreover,\nCalifornia law differs from Arizona law in that, while the latter recognizes only active misconduct\nas a ground for imposing a constructive trust in favor of creditors, California law provides for the\nimposition of a constructive trust in a situation involving simple negligence on the part of a debtor\nwho wrongfully detains another\'s property.\nIt cannot be denied that the money represented by Pitney\'s misdirected check belonged to\nMitsui, not Unicom. Moreover, it is clear that Unicom, having wrongfully and by virtue of its own\nmistake(s) acquired and retained funds properly belonging to Mitsui, had at most only a bare legal\ntitle to those funds. Once Mitsui had established as a matter of state law that grounds properly\nexisted for imposing a constructive trust over those funds, it was up to Unicom as the debtor-inpossession to prove that it would be inequitable as a matter of federal bankruptcy law to impose a\nconstructive trust over those funds. This Unicom has failed to do. Because we find nothing that\nwould warrant overriding the dictates of California law in favor of some unspecified, overarching\nprinciple(s) of federal bankruptcy law, we hold that a constructive trust in favor of Mitsui arose\nover the funds represented by Pitney\'s misdirected check.\n\n8.13.\n\nPreference Defenses \xe2\x80\x93 11 U.S.C. \xc2\xa7 547(c)\n\nSection 547(c) of the Bankruptcy Code now contains nine statutory defenses to preference\nactions. Each will be discussed in order.\nFirst is the contemporaneous exchange for new value defense. 11 U.S.C. \xc2\xa7 547(c)(1).\nThis defense relates to the basic statutory requirement that the payment be made to a creditor (on\naccount of an antecedent debt). A purchase (contemporaneous exchange) does not involve a\npreferential payment to a creditor, and the result should not depend on whether the seller or the\nbuyer tendered first. If the parties intended a contemporaneous sale and not a credit transaction,\nand the resulting transaction was \xe2\x80\x9csubstantially\xe2\x80\x9d contemporaneous, the preference law should not\napply.\nSecond is the ordinary course payment. 11 U.S.C. \xc2\xa7 547(c)(2). This was a very limited\nexception when the Bankruptcy Code was originally enacted, covering only payments made within\n45 days after the debt was incurred. For many years, the payment had to be made both according\nto the ordinary course of business between the parties AND according to ordinary business terms.\nRead Judge Posner\xe2\x80\x99s opinion in Tolana Pizza, below, which was decided when both Section\n181\n\n\x0c547(c)(2)(A) and Section 547(c)(2)(B) had to be met. Now, the payment need only be made\naccording to ordinary terms between the parties OR according to ordinary industry terms. If Judge\nPosner\xe2\x80\x99s liberal test of ordinariness is going to be applied, only a very unusual payment will be\ntrip the statute.\nThird is a special defense for purchase money security interests in Section 547(c)(3) of the\nBankruptcy Code, that will only rarely be needed by creditors. At one time, regular security\ninterests had to be perfected within 10 days of attachment for the perfection not to be treated as\nthe relevant transfer for preference purposes under 547(e)(2). Originally, purchase money security\ninterests got a longer 20 day period. With the expansion of the 547(e)(2) relation-back period to\n30 days for all security interests, the purchase money exception will only rarely be needed. Because\nthe 30 day period in Section 547(c)(3) for purchase money security interests runs from the date the\ndebtor receives possession of the collateral, rather than from the date of attachment under Section\n547(e)(2), the defense will help the purchase money secured creditor by providing a longer\nrelation-back period when the debtor received possession of the collateral after the date that the\nlien attached.\nFourth is the new value exception. 11 U.S.C. \xc2\xa7 547(c)(4). If, after the creditor receives a\npreferential payment, the creditor gives new value to the estate the preference is reduced by the\nnew value because the harm to the estate from the preference is reduced by the benefit to the estate\nof the new value. Timing is everything under this rule. Only new value given AFTER the receipt\nof a preferential transfer reduces the preference. New value given during the preference period but\nBEFORE the preferential payment does not reduce the preference. You cannot simply add up the\npreferential transfers and new value \xe2\x80\x93 you must consider timing. The question is, \xe2\x80\x9cwas the new\nvalue given after the preferential transfer?\xe2\x80\x9d If the new value was given before, rather than after,\nthe preferential transfer, the new value would not reduce the amount of the preference.\nFifth is the so-called \xe2\x80\x9creduction in insufficiency\xe2\x80\x9d test that applies to floating liens on\ninventory and receivables. 11 U.S.C. \xc2\xa7 547(c)(5). This test is very hard to understand on a first\nreading, but is easily mastered. A creditor\xe2\x80\x99s \xe2\x80\x9cinsufficiency\xe2\x80\x9d is the balance that would be owing to\nthe creditor if the collateral were sold and the proceeds paid to the lender. It is the excess of the\ndebt over the value of the collateral, what is normally called the \xe2\x80\x9cdeficiency.\xe2\x80\x9d If a creditor\xe2\x80\x99s $100\nloan is secured by $40 of collateral, the creditor has a $60 insufficiency. If during the preference\nperiod the creditor\xe2\x80\x99s insufficiency is reduced (say from $60 to $50), one of two things must have\nhappened: either the debtor paid down the loan or purchased some additional collateral \xe2\x80\x93 either\nway, the debtor paid money that would otherwise have gone to unsecured creditors to reduce the\nsecured creditor\xe2\x80\x99s insufficiency.2\nThe test measures the insufficiency at only two points in time: (1) the beginning of the\npreference period (or if the loan was first made during the preference period, the date the loan was\nmade) and (2) the bankruptcy filing date. This limits the creditor\xe2\x80\x99s liability for the payment made\n\nOk, technically there is another possibility. It is theoretically possible for the inventory or receivables to increase in\nvalue even though the estate did not purchase additional inventory or generate new receivables. For example, a gold\nbullion dealer\xe2\x80\x99s inventory could go up in value with the rise in the price of gold without any contribution by the\nestate. In this case, the increase in the value of the collateral would not result from a transfer of property, and there\nwould be no underlying preference. A gold bullion dealer would not need a preference exception to keep the\nincrease in the value of the bullion as long as the estate made no transfer of additional collateral to the creditor.\n2\n\n182\n\n\x0cby the debtor to the creditor and purchases of additional collateral during the preference period to\nthose that had a net benefit to the creditor during the entire period. If the insufficiency between the\nbeginning and end of the preference period was not reduced, the purchase of additional inventory\nand the loan payments made during the preference period would not be avoidable as preferences.\nSixth are exceptions for statutory liens. Statutory liens are governed by Section 545, which\nvalidates true statutory liens but invalidates certain statutory liens that are designed to give priority\nto creditors only in bankruptcy. 11 U.S.C. \xc2\xa7 547(c)(6).\nSeventh, newly enacted in 2005, this exception gives a \xe2\x80\x9cget-out-of-preference-liability\xe2\x80\x9d\ncard to domestic support creditors. 11 U.S.C. \xc2\xa7 547(c)(7).\nEighth and Ninth are new floors enacted in 2005 which eliminate most consumer and small\nbusiness preferences. 11 U.S.C. \xc2\xa7 547(c)(8), (c)(9). Preferential payments by consumers debtors\nof less than $600 to any one creditor are no longer avoidable. Preferential payments by businesses\n(non-consumers) of less than $5,850 to any one creditor are not avoidable. Note that if a debtor\npaid $1 over these floor amounts, the full transfer is avoidable as a preference. Only relatively\nlarge transfers are now subject to preference attack.\n\n8.14.\n\nCases on Preference Defenses\n8.14.1.1.\n\nUNION BANK v. WOLAS, 502 U.S. 151 (1991)\n\nJUSTICE STEVENS delivered the opinion of the Court.\nSection 547(b) of the Bankruptcy Code, 11 U.S.C. \xc2\xa7 547(b), authorizes a trustee to avoid\ncertain property transfers made by a debtor within 90 days before bankruptcy. The Code makes an\nexception, however, for transfers made in the ordinary course of business, 11 U.S.C. \xc2\xa7 547(c)(2).\nThe question presented is whether payments on long-term debt may qualify for that exception.\nOn December 17, 1986, ZZZZ Best Co., Inc. (Debtor) borrowed seven million dollars from\npetitioner, Union Bank (Bank). On July 8, 1987, the Debtor filed a voluntary petition under\nChapter 7 of the Bankruptcy Code. During the preceding 90-day period, the Debtor had made two\ninterest payments totaling approximately $100,000, and had paid a loan commitment fee of about\n$2,500 to the Bank. After his appointment as trustee of the Debtor\'s estate, respondent filed a\ncomplaint against the Bank to recover those payments pursuant to 11 U.S.C. \xc2\xa7 547(b).\nThe Bankruptcy Court found that the loans had been made "in the ordinary course of\nbusiness or financial affairs" of both the Debtor and the Bank, and that both interest payments, as\nwell as the payment of the loan commitment fee, had been made according to ordinary business\nterms and in the ordinary course of business. As a matter of law, the Bankruptcy Court concluded\nthat the payments satisfied the requirements of Section 547(c)(2), and therefore were not avoidable\nby the trustee. The District Court affirmed.\nShortly thereafter, in another case, the Court of Appeals held that the ordinary course of\nbusiness exception to avoidance of preferential transfers was not available to long-term creditors.\nIn reaching that conclusion, the Court of Appeals relied primarily on the policies underlying the\nvoidable preference provisions and the state of the law prior to the enactment of the 1978\nBankruptcy Code and its amendment in 1984.\n183\n\n\x0cThe text provides no support for respondent\'s contention that 547(c)(2)\'s coverage is\nlimited to short-term debt, such as commercial paper or trade debt. Given the clarity of the statutory\ntext, respondent\'s burden of persuading us that Congress intended to create or to preserve a special\nrule for long-term debt is exceptionally heavy.\nIn sum, we hold that payments on long-term debt, as well as payments on short-term debt,\nmay qualify for the ordinary course of business exception to the trustee\'s power to avoid\npreferential transfers. We express no opinion, however, on the question whether the Bankruptcy\nCourt correctly concluded that the Debtor\'s payments of interest and the loan commitment fee\nqualify for the ordinary course of business exception, 547(c)(2). In particular, we do not decide\nwhether the loan involved in this case was incurred in the ordinary course of the Debtor\'s business\nand of the Bank\'s business, whether the payments were made in the ordinary course of business,\nor whether the payments were made according to ordinary business terms. These questions remain\nopen for the Court of Appeals on remand.\nJUSTICE SCALIA, concurring.\nI join the opinion of the Court, including Parts II and III, which respond persuasively to\nlegislative history and policy arguments made by respondent. It is regrettable that we have a legal\nculture in which such arguments have to be addressed (and are indeed credited by a Court of\nAppeals), with respect to a statute utterly devoid of language that could remotely be thought to\ndistinguish between long-term and short-term debt. Since there was here no contention of a\n"scrivener\'s error" producing an absurd result, the plain text of the statute should have made this\nlitigation unnecessary and unmaintainable.\nAuthor\xe2\x80\x99s Note. The 2005 amendments changed the relationship between and renumbered\nthe provisions at issue in the following case. Prior to the 2005 amendments, current Section\n547(c)(2)(A) and (B) were numbered as Section 547(c)(2)(B) and (C). More importantly, in\n2005 Congress changed the word connecting the two provisions from \xe2\x80\x9cand\xe2\x80\x9d to \xe2\x80\x9cor.\xe2\x80\x9d\nConsider the effect of this change in light of the decision below regarding the meaning of\ncurrent Section 547(c)(2)(A).\n\n8.14.1.2.\n\nIN RE TOLANA PIZZA, 3 F.3d 1029 (7th Cir. 1993)\n\nPOSNER, Circuit Judge.\nWhen, within 90 days before declaring bankruptcy, the debtor makes a payment to an\nunsecured creditor, the payment is a "preference," and the trustee in bankruptcy can recover it and\nthus make the creditor take pot luck with the rest of the debtor\'s unsecured creditors. 11 U.S.C.\nSec. 547. But there is an exception if the creditor can show that the debt had been incurred in the\nordinary course of the business of both the debtor and the creditor, Sec. 547(c)(2)(A); that the\npayment, too, had been made and received in the ordinary course of their businesses, Sec.\n547(c)(2)(B); and that the payment had been "made according to ordinary business terms." Sec.\n547(c)(2)(C). The first two requirements are easy to understand: of course to defeat the inference\nof preferential treatment the debt must have been incurred in the ordinary course of business of\nboth debtor and creditor and the payment on account of the debt must have been in the ordinary\ncourse as well. But what does the third requirement--that the payment have been "made according\n184\n\n\x0cto ordinary business terms"--add? And in particular does it refer to what is "ordinary" between this\ndebtor and this creditor, or what is ordinary in the market or industry in which they operate? The\ncircuits are divided on this question\nTolona, a maker of pizza, issued eight checks to Rose, its sausage supplier, within 90 days\nbefore being thrown into bankruptcy by its creditors. The checks, which totaled a shade under\n$46,000, cleared and as a result Tolona\'s debts to Rose were paid in full. Tolona\'s other major trade\ncreditors stand to receive only 13 cents on the dollar under the plan approved by the bankruptcy\ncourt, if the preferential treatment of Rose is allowed to stand. Tolona, as debtor in possession,\nbrought an adversary proceeding against Rose to recover the eight payments as voidable\npreferences. The bankruptcy judge entered judgment for Tolona. The district judge reversed. He\nthought that Rose did not, in order to comply with section 547(c)(2)(C), have to prove that the\nterms on which it had extended credit to Tolona were standard terms in the industry, but that if this\nwas wrong the testimony of Rose\'s executive vice-president, Stiehl, did prove it. The parties agree\nthat the other requirements of section 547(c)(2) were satisfied.\nRose\'s invoices recited "net 7 days," meaning that payment was due within seven days. For\nyears preceding the preference period, however, Tolona rarely paid within seven days; nor did\nRose\'s other customers. Most paid within 21 days, and if they paid later than 28 or 30 days Rose\nwould usually withhold future shipments until payment was received. Tolona, however, as an old\nand valued customer (Rose had been selling to it for fifteen years), was permitted to make\npayments beyond the 21-day period and even beyond the 28-day or 30-day period. The eight\npayments at issue were made between 12 and 32 days after Rose had invoiced Tolona, for an\naverage of 22 days; but this actually was an improvement. In the 34 months before the preference\nperiod, the average time for which Rose\'s invoices to Tolona were outstanding was 26 days and\nthe longest time was 46 days. Rose consistently treated Tolona with a degree of leniency that made\nTolona (Stiehl conceded on cross-examination) one of a "sort of exceptional group of customers\nof Rose ... fall[ing] outside the common industry practice and standards."\nIt may seem odd that paying a debt late would ever be regarded as a preference to the\ncreditor thus paid belatedly. But it is all relative. A debtor who has entered the preference period-who is therefore only 90 days, or fewer, away from plunging into bankruptcy--is typically unable\nto pay all his outstanding debts in full as they come due. If he pays one and not the others, as\nhappened here, the payment though late is still a preference to that creditor, and is avoidable unless\nthe conditions of section 547(c)(2) are met. One condition is that payment be in the ordinary course\nof both the debtor\'s and the creditor\'s business. A late payment normally will not be. It will\ntherefore be an avoidable preference.\nThis is not a dryly syllogistic conclusion. The purpose of the preference statute is to prevent\nthe debtor during his slide toward bankruptcy from trying to stave off the evil day by giving\npreferential treatment to his most importunate creditors, who may sometimes be those who have\nbeen waiting longest to be paid. Unless the favoring of particular creditors is outlawed, the mass\nof creditors of a shaky firm will be nervous, fearing that one or a few of their number are going to\nwalk away with all the firm\'s assets; and this fear may precipitate debtors into bankruptcy earlier\nthan is socially desirable.\nFrom this standpoint, however, the most important thing is not that the dealings between\nthe debtor and the allegedly favored creditor conform to some industry norm but that they conform\n185\n\n\x0cto the norm established by the debtor and the creditor in the period before, preferably well before,\nthe preference period. That condition is satisfied here--if anything, Rose treated Tolona more\nfavorably (and hence Tolona treated Rose less preferentially) before the preference period than\nduring it.\nBut if this is all that the third subsection of 547(c)(2) requires, it might seem to add nothing\nto the first two subsections, which require that both the debt and the payment be within the ordinary\ncourse of business of both the debtor and the creditor. For, provided these conditions are fulfilled,\na "late" payment really isn\'t late if the parties have established a practice that deviates from the\nstrict terms of their written contract. But we hesitate to conclude that the third subsection, requiring\nconformity to "ordinary business terms," has no function in the statute. We can think of two\nfunctions that it might have. One is evidentiary. If the debtor and creditor dealt on terms that the\ncreditor testifies were normal for them but that are wholly unknown in the industry, this casts some\ndoubt on his (self-serving) testimony. Preferences are disfavored, and subsection C makes them\nmore difficult to prove. The second possible function of the subsection is to allay the concerns of\ncreditors that one or more of their number may have worked out a special deal with the debtor,\nbefore the preference period, designed to put that creditor ahead of the others in the event of\nbankruptcy. It may seem odd that allowing late payments from a debtor would be a way for a\ncreditor to make himself more rather than less assured of repayment. But such a creditor does have\nan advantage during the preference period, because he can receive late payments then and they\nwill still be in the ordinary course of business for him and his debtor.\nThe functions that we have identified, combined with a natural reluctance to cut out and\nthrow away one-third of an important provision of the Bankruptcy Code, persuade us that the\ncreditor must show that the payment he received was made in accordance with the ordinary\nbusiness terms in the industry. But this does not mean that the creditor must establish the existence\nof some single, uniform set of business terms, as Tolona argues. Not only is it difficult to identify\nthe industry whose norm shall govern (is it, here, the sale of sausages to makers of pizza? The sale\nof sausages to anyone? The sale of anything to makers of pizza?), but there can be great variance\nin billing practices within an industry. Apparently there is in this industry, whatever exactly "this\nindustry" is; for while it is plain that neither Rose nor its competitors enforce payment within seven\ndays, it is unclear that there is a standard outer limit of forbearance. It seems that 21 days is a goal\nbut that payment as late as 30 days is generally tolerated and that for good customers even longer\ndelays are allowed. The average period between Rose\'s invoice and Tolona\'s payment during the\npreference period was only 22 days, which seems well within the industry norm, whatever exactly\nit is. The law should not push businessmen to agree upon a single set of billing practices; antitrust\nobjections to one side, the relevant business and financial considerations vary widely among firms\non both the buying and the selling side of the market.\nWe conclude that "ordinary business terms" refers to the range of terms that encompasses\nthe practices in which firms similar in some general way to the creditor in question engage, and\nthat only dealings so idiosyncratic as to fall outside that broad range should be deemed\nextraordinary and therefore outside the scope of subsection C. Stiehl\'s testimony brought the\ncase within the scope of "ordinary business terms" as just defined. Rose and its competitors pay\nlittle or no attention to the terms stated on their invoices, allow most customers to take up to 30\ndays to pay, and allow certain favored customers to take even more time. There is no single set of\nterms on which the members of the industry have coalesced; instead there is a broad range and the\n186\n\n\x0cdistrict judge plausibly situated the dealings between Rose and Tolona within it. These dealings\nare conceded to have been within the normal course of dealings between the two firms, a course\nestablished long before the preference period, and there is no hint either that the dealings were\ndesigned to put Rose ahead of other creditors of Tolona or that other creditors of Tolona would\nhave been surprised to learn that Rose had been so forbearing in its dealings with Tolona.\nIt is true that Stiehl testified that Tolona was one of an exceptional group of Rose\'s\ncustomers with whom Rose\'s dealings fell outside common industry practice. But the undisputed\nevidence concerning those dealings and the practices of the industry demonstrates that payment\nwithin 30 days is within the outer limits of normal industry practices, and the payments at issue in\nthis case were made on average in a significantly shorter time.\n\n8.15.\n\nPractice Problems: Preference Exceptions\n\nProblem 1: Debtor was a stock broker. Debtor had to pay in cash for securities purchased\nduring the day. In order to have the cash ready for purchases, it had a clearance line of credit with\nNational City Bank. The debtor drew funds from the Bank during the day to pay for securities, and\nprovided cash or securities to the Bank at the end of the day to cover the loan balance. At 10:00\na.m. on January 19, 1910, the Debtor\xe2\x80\x99s assets exceeded its liabilities by half a million dollars. At\nthat time, National City made a $500,000 clearance line of credit available to the Debtor. Shortly\nbefore noon, the stock market crashed, and by noon the firm was suspended. Hearing of the crash,\nNational City demanded that the Debtor immediately provide securities to cover the loan shortfall\n(then $166,000). At 2:00 p.m. the Debtor provided securities to cover its shortfall, but told the\nBank that it would be a preference. At 4:10 p.m. an involuntary bankruptcy petition was filed\nagainst the firm. Would the payment made to the Bank only 4 hours after the loan was made be a\ncontemporaneous exchange under 11 U.S.C. \xc2\xa7 547(c)(1)? National City Bank of NY v. Hotchkiss,\n231 U.S. 50 (1913).\nProblem 2: Debtor\xe2\x80\x99s pizza parlor was having financial problems. On January 1, Debtor\nowed his long-time sausage supplier $20,000, and more than $300,000 to other creditors. On that\ndate debtor gave his sausage supplier a security interest in his equipment (worth $100,000) to\nsecure the sausage supplier\xe2\x80\x99s debt. Sausage supplier perfected the security interest within 30 days.\nThe Debtor was insolvent at the time the security interest was given. On February 10, Sausage\nsupplier delivered $10,000 worth of sausage to the Debtor. Debtor filed bankruptcy on March 10.\nCan the trustee avoid the security interest? See 11 U.S.C. \xc2\xa7 547(c)(3), (e).\nProblem 3: Debtor filed bankruptcy on December 31. Debtor\xe2\x80\x99s ledger card for his\npepperoni and tomato sauce supplier shows the following transactions on the following dates. The\npayment column shows payments from the Debtor to the supplier, and the Deliveries column\nshows deliveries of pepperoni and tomato sauce. Calculate the amount that the trustee can recover\nas a preference assuming that the ordinary course of business exception does not apply. 11 U.S.C.\n\xc2\xa7 547(c)(4).\n\n187\n\n\x0cFile Date\nPref Period\nDeliveries\n20-Sep\n30-Sep\n1-Oct $ 6,000\n4-Oct $ 40,000\n8-Oct\n10-Oct $ 4,000\n12-Oct\n20-Oct $ 2,000\n30-Oct $ 8,000\n10-Nov\n11-Nov $ 2,000\n30-Nov\n1-Dec $ 4,000\n\n31-Dec\n2-Oct\nPayments Balance\n$ 25,000\n$ 5,000 $ 20,000\n$ 26,000\n$ 66,000\n$ 25,000 $ 41,000\n$ 45,000\n$ 5,000 $ 40,000\n$ 42,000\n$ 50,000\n$ 6,000 $ 44,000\n$ 46,000\n$ 2,000 $ 44,000\n$ 48,000\n\nProblem 4: Banco de Pizza gave the Debtor a $100,000 line of credit several years ago to\nstart the pizzeria. At the time the loan was made, the Debtor signed a security agreement giving\nBanco a security interest in his inventory of flour, sauce, cheese, meats and vegetables. The value\nof the Debtor\xe2\x80\x99s inventory was in flux, because he would use ingredients to make pizzas, and then\nbuy additional ingredients as its inventory started to get low. The debt also fluctuated because the\nDebtor\xe2\x80\x99s agreement with Banco required it to pay 80% of its daily collections on account of the\nloan. The following schedule shows the daily values of inventory and debt during the 90 days\nbefore bankruptcy. Calculate the amount of the preference, if any. See 11 U.S.C. \xc2\xa7 547(c)(5).\n\n188\n\n\x0cDate\n\nInventory\n\nDebt\n\nDate\n\nInventory\n\nDebt\n\nDate\n\nInventory\n\nDebt\n\n31-Dec $\n\n86,000\n\n$\n\n84,000\n\n30-Nov $\n\n86,344\n\n$ 87,553\n\n31-Oct $ 86,154\n\n$ 89,500\n\n30-Dec $\n\n84,000\n\n$\n\n90,000\n\n29-Nov $\n\n89,353\n\n$ 86,004\n\n30-Oct $ 87,407\n\n$ 87,055\n\n29-Dec $\n\n83,000\n\n$\n\n90,000\n\n28-Nov $\n\n85,282\n\n$ 89,433\n\n29-Oct $ 89,717\n\n$ 89,977\n\n28-Dec $\n\n82,000\n\n$\n\n89,000\n\n27-Nov $\n\n88,129\n\n$ 85,683\n\n28-Oct $ 85,537\n\n$ 89,895\n\n27-Dec $\n\n87,000\n\n$\n\n88,000\n\n26-Nov $\n\n86,878\n\n$ 89,714\n\n27-Oct $ 89,111\n\n$ 86,962\n\n26-Dec $\n\n81,000\n\n$\n\n87,000\n\n25-Nov $\n\n88,666\n\n$ 85,512\n\n26-Oct $ 89,013\n\n$ 89,982\n\n25-Dec $\n\n92,000\n\n$\n\n89,000\n\n24-Nov $\n\n87,527\n\n$ 86,713\n\n25-Oct $ 86,800\n\n$ 88,205\n\n24-Dec $\n\n99,000\n\n$\n\n90,000\n\n23-Nov $\n\n85,483\n\n$ 88,301\n\n24-Oct $ 88,525\n\n$ 88,332\n\n23-Dec $\n\n73,000\n\n$\n\n79,000\n\n22-Nov $\n\n87,645\n\n$ 89,956\n\n23-Oct $ 86,914\n\n$ 88,864\n\n22-Dec $\n\n82,000\n\n$\n\n82,000\n\n21-Nov $\n\n86,295\n\n$ 85,545\n\n22-Oct $ 87,176\n\n$ 89,800\n\n21-Dec $\n\n85,000\n\n$\n\n88,000\n\n20-Nov $\n\n88,308\n\n$ 88,821\n\n21-Oct $ 85,691\n\n$ 88,920\n\n20-Dec $\n\n86,277\n\n$\n\n85,881\n\n19-Nov $\n\n88,904\n\n$ 89,383\n\n20-Oct $ 88,854\n\n$ 88,422\n\n19-Dec $\n\n86,370\n\n$\n\n88,911\n\n18-Nov $\n\n87,793\n\n$ 87,210\n\n19-Oct $ 89,300\n\n$ 88,442\n\n18-Dec $\n\n88,981\n\n$\n\n89,894\n\n17-Nov $\n\n87,367\n\n$ 88,038\n\n18-Oct $ 86,744\n\n$ 87,054\n\n17-Dec $\n\n87,535\n\n$\n\n86,901\n\n16-Nov $\n\n88,236\n\n$ 89,130\n\n17-Oct $ 87,850\n\n$ 88,896\n\n16-Dec $\n\n85,057\n\n$\n\n85,638\n\n15-Nov $\n\n88,001\n\n$ 89,430\n\n16-Oct $ 85,470\n\n$ 87,413\n\n15-Dec $\n\n86,938\n\n$\n\n87,156\n\n14-Nov $\n\n86,208\n\n$ 86,375\n\n15-Oct $ 88,276\n\n$ 87,504\n\n14-Dec $\n\n88,126\n\n$\n\n86,934\n\n13-Nov $\n\n85,615\n\n$ 87,005\n\n14-Oct $ 87,887\n\n$ 88,633\n\n13-Dec $\n\n87,829\n\n$\n\n89,990\n\n12-Nov $\n\n89,481\n\n$ 86,484\n\n13-Oct $ 87,697\n\n$ 89,330\n\n12-Dec $\n\n85,689\n\n$\n\n87,242\n\n11-Nov $\n\n88,875\n\n$ 86,656\n\n12-Oct $ 89,095\n\n$ 85,158\n\n11-Dec $\n\n89,833\n\n$\n\n89,901\n\n10-Nov $\n\n88,957\n\n$ 88,089\n\n11-Oct $ 88,456\n\n$ 85,831\n\n10-Dec $\n\n86,055\n\n$\n\n85,483\n\n9-Nov $\n\n87,237\n\n$ 88,727\n\n10-Oct $ 89,025\n\n$ 86,765\n\n9-Dec $\n\n89,615\n\n$\n\n88,645\n\n8-Nov $\n\n88,871\n\n$ 86,636\n\n9-Oct $ 89,704\n\n$ 85,567\n\n8-Dec $\n\n86,671\n\n$\n\n86,171\n\n7-Nov $\n\n87,622\n\n$ 89,803\n\n8-Oct $ 89,562\n\n$ 85,058\n\n7-Dec $\n\n88,170\n\n$\n\n89,107\n\n6-Nov $\n\n87,843\n\n$ 86,462\n\n7-Oct $ 87,664\n\n$ 88,113\n\n6-Dec $\n\n86,618\n\n$\n\n88,932\n\n5-Nov $\n\n88,335\n\n$ 87,994\n\n6-Oct $ 86,991\n\n$ 88,814\n\n5-Dec $\n\n88,930\n\n$\n\n89,886\n\n5-Nov $\n\n85,925\n\n$ 85,672\n\n5-Oct $ 88,096\n\n$ 86,015\n\n4-Dec $\n\n89,538\n\n$\n\n87,534\n\n4-Nov $\n\n87,706\n\n$ 87,887\n\n4-Oct $ 89,329\n\n$ 89,004\n\n3-Dec $\n\n85,421\n\n$\n\n87,052\n\n3-Nov $\n\n86,114\n\n$ 89,138\n\n3-Oct $ 81,000\n\n$ 93,000\n\n2-Dec $\n\n85,047\n\n$\n\n86,040\n\n2-Nov $\n\n89,411\n\n$ 87,878\n\n2-Oct $ 81,000\n\n$ 93,000\n\n1-Dec $\n\n89,730\n\n$\n\n89,148\n\n1-Nov $\n\n88,409\n\n$ 88,612\n\nProblem 5: Debtor is a dealer in gold, and maintains an inventory of gold bars for sale to\ncustomers in the ordinary course of business. GoldBank has a perfected security interest in\nDebtor\xe2\x80\x99s inventory. 90 days before bankruptcy, the Debtor\xe2\x80\x99s inventory was worth $1 million and\nthe loan balance was $1.1 million. On the date of bankruptcy, the value of the gold inventory\nincreased to $1.2 million even though no additional inventory was purchased or sold (because the\nprice of gold went up during the 90 days before bankruptcy). The debtor\xe2\x80\x99s loan increased to $1.15\nmillion. Has the creditor received a preference? Consider 11 U.S.C. \xc2\xa7 547(c)(5), 547(b).\n\n8.16.\n\nStatutory Liens. 11 U.S.C. \xc2\xa7 545\n\nStatutory liens are created by state law to benefit certain favored creditors, such as\nmechanics who make improvements to property but are not paid for the improvements. The\n189\n\n\x0cBankruptcy Code respects most statutory liens, but recognizes that states may attempt to upset the\npriority scheme in bankruptcy by creating statutory liens that only apply in bankruptcy. Just as the\nBankruptcy Code invalidates ipso-facto clauses, Section 545(1) invalidates these \xe2\x80\x9cbankruptcyonly\xe2\x80\x9d statutory liens.\nSection 545(2) invalidates unperfected statutory liens \xe2\x80\x93 those not enforceable against a\nbona fide purchaser on the filing date. This is consistent with the trustee\xe2\x80\x99s strong arm powers.\nSection 545(3) invalidates landlord statutory liens. Some states, at least at one time, gave\nlandlords a statutory lien on the tenant\xe2\x80\x99s personal property to sure the obligation to pay rent. These\nliens are invalidated because they are simply too harsh.\n\n8.17.\n\nSetoffs. 11 U.S.C. \xc2\xa7 553\n\nState laws generally allow a party to offset mutual debts with another party. If A owes B\n$100, and B owes A $40, A can offset the debts and satisfy the obligation by paying B $60. Setoffs\navoid the risk of a counter party\xe2\x80\x99s default (A pays B $100, but B doesn\xe2\x80\x99t pay A the $40 that is\nowing back), and avoids unnecessary transaction costs.\nA bank\xe2\x80\x99s right of setoff is well recognized. If a debtor has money on deposit with a bank,\nand owes the bank a debt, the bank may offset the deposit against the debt at any time, so long as\nthe debt is due. While the automatic stay prevents the bank from exercising its right of setoff during\nthe case, 11 U.S.C. \xc2\xa7 362(a)(7), the Supreme Court has recognized that the bank may impose an\nadministrative freeze on deposited funds subject to setoff to prevent losing its setoff rights during\nthe pendency of the automatic stay. Citizens Bank of Maryland v. Strumpf, 516 U.S. 16 (1995).\nWhen the stay terminates or is relieved, the bank may exercise its setoff rights. Setoffs have the\nsame effect as secured claims, granting the party with the setoff right a priority claim against and\ninterest in the property subject to setoff.\nSection 553(a) of the bankruptcy code preserves the right of setoff as long as the two\nreciprocal claims are allowed, of the same class (unsecured), and arise prepetition. A creditor\ncannot offset a prepetition claim against the debtor (that will be paid in depreciated bankruptcy\ndollars) against a post-petition obligation to the debtor (that will be paid in real dollars).\nSection 553(a)(2) contains a mini preference provision preventing the transfer of setoff\nclaims during the preference period to obtain setoff priority. To illustrate the problem, assume the\nDebtor owes $100 to Creditor A, and Creditor B owes $100 to the Debtor. Also assume that the\nDebtor is 50% insolvent. In Bankruptcy, Creditor B would pay $100 to the estate, and Creditor A\nwould get $50. If Creditor A transferred the claim to Creditor B during the preference period, and\nthe setoff were allowed, the estate would get $50 less than it would if the claim had not been\ntransferred. Transferred setoff claims create preferences that can generally be avoided in\nbankruptcy.\nFinally, Section 553(b)(1) of the Bankruptcy Code contains a reduction in insufficiency\ntest designed to catch the use of setoffs that create improvement in position during the preference\nperiod. The test leaves an important gap. The test and the gap are illustrated by the following\nproblems.\n\n190\n\n\x0c8.18.\n\nPractice Problems: Setoff Preferences\n\nProblem 1: Debtor owes Bank $500,000 on a line of credit, and is having severe financial\nproblems. In order to keep good relations with the Bank, Debtor offers to pay the line of credit\nbefore filing bankruptcy. The Bank knows that this will result in a preference. Instead, the Bank\nsuggests that the Debtor deposit $500,000 in a bank account. After the Debtor makes the deposit,\nthe Bank exercises its right of setoff. The Debtor files bankruptcy within 90 days after making the\ndeposit. 11 U.S.C. \xc2\xa7 553(b)(1).\nProblem 2: On the same facts, what if the Bank does not exercise the right of setoff prior\nto bankruptcy and wants relief from stay to do so? 11 U.S.C. \xc2\xa7 553(a)(3).\nProblem 3: Would it make any difference in Problem 2 if the Debtor just deposited\n$500,000 in the Bank without any discussion about paying the Bank a preference?\nProblem 4: Debtor owes money to the IRS, and is owed money on a federal government\ncontract with the US Air Force. Can the federal government claim a right of setoff, or do the claims\nlack mutuality because the IRS and Air Force are separate creditors?\n\n8.19.\n\nCases on Setoffs\n8.19.1.1.\nDURHAM v. SMI INDUS., INC., 882 F.2d 881 (4th\nCir. 1989)\n\nSMI and Continental are scrap metal dealers that until November 1983 engaged in a\nsubstantial amount of business with each other, selling each other materials on open account.\nAlthough the total dollar figures of the open account invoices often grew quite large, the net\nbalance due either party at any one time was relatively small. Periodically, in order to reduce these\naccount debts, SMI and Continental would either make mutual accounting entries cancelling\ncorresponding debts and credits, or they would exchange checks for the outstanding balances. The\ncheck exchanges were carefully coordinated to allow simultaneous deposits in their respective\nbank accounts to ensure that the checks would clear.\nIn late August 1983 SMI and Continental made such a check exchange. Continental sent\nSMI 17 checks totaling $273,137.62 from August 25 to August 26, representing amounts it owed\nSMI for invoiced deliveries from September 3, 1982 to June 28, 1983. On August 29 SMI sent\nContinental its check for $271,967.20 for invoiced deliveries by Continental from February 22,\n1983 through August 16, 1983. Both parties deposited the checks into their bank accounts on\nAugust 30.\nOn November 18, 1983, less than 90 days later, Continental filed a petition in bankruptcy\nunder Chapter 7. In November 1985 Continental\'s Trustee filed an adversary action against SMI\nseeking to recover $273,137.62, which represented the total amount of the checks Continental had\nsent SMI as part of the check exchange. The bankruptcy court held in favor of the Trustee, finding\nthat Continental\'s remittance of the checks to SMI constituted avoidable preferential transfers that\nwere not part of a valid setoff. The district court affirmed.\n\n191\n\n\x0cSection 547(b) provides that a trustee may avoid, and proceed to seek recovery of, any\ntransfer made by a debtor to a creditor within 90 days prior to filing for bankruptcy that has the\neffect of enabling that creditor to receive more than it would in the bankruptcy proceeding had the\ntransfer not been made. However, under section 553(b), a valid setoff executed within 90 days of\nthe date of the filing of a bankruptcy petition is nonetheless protected from avoidance under section\n547, except for any insufficiency. Where a pre-petition setoff is asserted in defense to a proceeding\nbrought by a trustee the court must first determine whether the setoff is valid under section 553.\nOnly if the court finds the setoff invalid, and further concludes that no right of setoff exists in\nbankruptcy, is section 547 applied. We hold that the lower courts erred by attempting to resolve\nthis case under section 547 after SMI asserted that it and Continental had completed a pre-petition\nsetoff of their mutual debts.\nSection 553 does not create a right of setoff or prescribe the means by which a setoff must\nbe executed in order to be effective. It merely preserves any right of setoff accorded by state law,\nsubject to certain limitations. North Carolina has long recognized the right of setoff where mutual\ndebts exist between parties. North Carolina has not, however, prescribed any method by which a\nsetoff must be executed to be valid.\nThe United States Supreme Court, applying the former Bankruptcy Act, recognized that a\npre-petition setoff may be effected where parties with mutual debts have "themselves given checks,\ncharged notes, made book entries, or stated an account whereby the smaller obligation is applied\non the larger." The Trustee concedes that had the parties executed this setoff by corresponding\naccounting entries it would have been valid, but he argues that a setoff may not be effected by\nexchanging checks. We see no reason to distinguish between the two practices. Indeed, the\nexchange of checks, with the resulting endorsements each made on the other\'s checks before\ndepositing them, provided better documentation of satisfaction of the debt than mere book entries.\nWe hold that the check exchange constituted an effective exercise of setoff pursuant to North\nCarolina law and section 553(b).\nThe lower courts used "hypothetical facts" to ignore the intent of the parties at the time of\nthe check exchange and to view each party\'s act of sending a check as the independent payment of\na valid debt.\nHowever, the clear intent of the parties, as expressed through their overt acts, may not be\nso readily ignored. As part of their general and longstanding business practice SMI and Continental\ncustomarily accrued and then set off, sometimes by accounting entries and sometimes by check\nexchange, debts to the other. In the check exchange in question SMI and Continental took every\nstep possible to ensure that their checks would cross in the collection process since neither had\nfunds sufficient to cover their checks. As neither intended a substantial amount of money to change\nhands, there was no need to have sufficient funds on hand, apart from the coordinated deposits of\nthe other\'s check, to ensure that their own check would clear. Although checks were used, in\nessence the exchange constituted an accounting exercise to clear their books of mutual debts.\nSMI would have been entitled to assert its right of setoff under section 553(a) post-petition\nif the check exchange had not been executed before Continental\'s petition was filed since both\ndebts were incurred pre-petition. Where a creditor fails "to exercise its right of setoff prior to the\nfiling of the petition" it does not lose the right, but must "proceed in the bankruptcy court by means\nof a complaint to lift the automatic stay so as to be allowed to exercise its already existing right to\n192\n\n\x0coffset." And, as the Trustee concedes, there is no evidence that the debt SMI extinguished in the\nsetoff was incurred either fraudulently or "\'for the purpose of obtaining a right of setoff against the\ndebtor.\' "11 U.S.C. Sec. 553(a)(3)(C)). It would be inequitable to construe Section 553(b) to\nprevent "the parties from voluntarily doing, before the petition is filed, what the law itself requires\nto be done after proceedings in bankruptcy are instituted."\nSince the debts the two parties eliminated with the setoff were not exactly the same, the\nresulting checks were not equal. The check exchange was a proper setoff only up to the amount\nthat SMI and Continental owed each other equivalent amounts. Since SMI sent Continental\n$271,967.20 while receiving from Continental $273,137.62, an insufficiency of $1,170.42,\nrecoverable from SMI, was created pursuant to sections 553(b)(1) and (b)(2). SMI must return this\ninsufficiency to Continental\'s estate.\n\n8.20.\n\nStatute of Limitations on Avoiding Powers. 11 U.S.C. \xc2\xa7 546(a).\n\nAvoidance actions must generally be brought within two years after the bankruptcy case is\ncommenced. A trustee has at least one year after appointment to exercise avoiding powers. So, for\nexample, if a debtor in possession operated for three years in a Chapter 11 case before conversion\nto Chapter 7 or the appointment of a Chapter 11 trustee, the trustee would still get a year to file\navoidance actions even though the debtor\xe2\x80\x99s time to avoid had expired. A trustee loses the avoidance\npower when a case is closed or dismissed.\n\n8.21.\n\nRelation-back Perfection Rules. 11 U.S.C. \xc2\xa7 546(b)\n\nIf perfection of a lien relates back for priority purposes to an earlier time under state law,\nthe strong arm and other avoidance powers can only be applied after considering that relationback. For example, even though a purchase money security interest was not perfected on the date\nof bankruptcy, if the 20 day relation-back period under state law has not expired (UCC \xc2\xa7\xc2\xa7 9-317(e),\n9-324(a)), the interest can be perfected post-petition (See 11 U.S.C. \xc2\xa7 362(b)(3)), and the trustee\xe2\x80\x99s\nstrong arm powers cannot be used to avoid the security interest on the grounds that the interest\nwas not perfected on the date of bankruptcy.\nFurthermore, if state law requires a suit to be filed or property to be seized in order to\nperfect an interest that relates back, the creditor can perfect post-petition by simply giving notice.\n11 U.S.C. \xc2\xa7 546(b)(2) flush language. This commonly applies to lenders who wish to perfect an\nassignment of rents clause in a mortgage, where state law requires the lender to seize the rents\noutside of bankruptcy (generally by asking for the appointment of a receiver), and to the perfection\nof statutory mechanics liens which often require the commencement of an action against the\nproperty owner within a certain period of time. Since the creditor is automatically stayed from\nseizing or suing, giving notice accomplishes the perfection.\n\n8.22.\n\nReclamation Rights. 11 U.S.C. \xc2\xa7 546(c)\n\nReclamation is a trap for lawyers that is buried deep in the bowels of the Bankruptcy Code.\nOne of my law partners was sued for legal malpractice for failing to advise a client to file a\nreclamation demand, so I am particularly sensitive to the need for caution.\n193\n\n\x0cReclamation is the right of a seller of goods to stop the goods in transit and recover them,\nor demand the return of the goods delivered to a buyer, upon learning of the buyer\xe2\x80\x99s insolvency.\nSection 2-702 of the Uniform Commercial code allows a seller who discovers that the buyer is\ninsolvent to stop delivery and demand cash for prior and current shipments. Of more importance\nis the seller\xe2\x80\x99s right to reclaim goods upon learning of the buyer\xe2\x80\x99s insolvency after delivery. Section\n2-702 of the Uniform Commercial Code (standard version) provides\n(2) Where the seller discovers that the buyer has received goods on\ncredit while insolvent he may reclaim the goods upon demand made\nwithin ten days after the receipt, but if misrepresentation of solvency\nhas been made to the particular seller in writing within three months\nbefore delivery the ten day limitation does not apply.\n***\n(3) The seller\'s right to reclaim under subsection (2) is subject to the\nrights of a buyer in ordinary course or other good faith purchaser\nunder this Article.\nThe revised version of UCC 2-207 eliminates the 10 day rule entirely, allowing a reclamation\ndemand to be made within \xe2\x80\x9ca reasonable time after the buyer\xe2\x80\x99s receipt of the goods.\xe2\x80\x9d\nSection 546(c) of the Bankruptcy Code does not by its terms create a special reclamation\nright, but merely provides that the trustee\xe2\x80\x99s avoiding powers are limited by the rights of a\nreclaiming seller for goods received by the debtor within 45 days before the bankruptcy filing. The\nseller must make the demand within 45 days after the debtor\xe2\x80\x99s receipt of the goods, or within 20\ndays after bankruptcy if the 45 day period has not expired by the petition date.\nAs an alternative to reclamation, the Bankruptcy Code since 2005 has given an\nadministrative claim to the seller of goods delivered to the debtor within 20 days before\nbankruptcy. 11 U.S.C. \xc2\xa7 503(b)(9). Prior to 2005, this section gave the bankruptcy court the\nalternate power to grant the reclaiming creditor an administrative claim in lieu of returning the\ngoods. The creditor can now elect between an administrative claim or reclamation.\nBoth the Bankruptcy Code and the UCC recognize that the reclamation demand may be\nsubordinate to the rights of buyers and other good faith \xe2\x80\x9cpurchasers,\xe2\x80\x9d a definition which includes\nsecured creditors. UCC 2-702(3); 11 U.S.C. \xc2\xa7 546(c)(1) (\xe2\x80\x9csubject to the prior rights of a holder of\na security interest in such goods.\xe2\x80\x9d) The relative rights of reclaiming sellers and secured creditors\n(who are \xe2\x80\x9cpurchasers\xe2\x80\x9d under the UCC) are explored in the cases that follow.\n\n8.23.\n\nCases on Reclamation Rights\n8.23.1.1.\nIN RE ARLCO, INC., 239 B.R. 261 (Bankr. S.D.N.Y.\n1999)\n\nOn June 6, 1997, Arley Corporation and Home Fashions each filed a petition under chapter\n11 of the Bankruptcy Code. Arley [manufactured and sold home furnishings to retailers,] one of\nwhich was Home Fashions, Arley\'s wholly-owned subsidiary.\n194\n\n\x0cOn September 15, 1997, pursuant to 11 U.S.C. \xc2\xa7 363, the Court approved an asset purchase\nagreement for the sale of substantially all of the Debtors\' assets as a going concern. On August 6,\n1998, the Debtors chapter 11 cases were converted to chapter 7.\nGaley is a fabric manufacturer that sold textile goods on credit to Arley. On May 16, 1997,\nGaley sent a letter to Arley by fax, overnight courier, and certified mail (the "May 16th Letter")\ndemanding that Arley return the merchandise it "received during the applicable periods referred to\nin [\xc2\xa7 2-702 of the Uniform Commercial Code]" and notifying Arley that "all goods subject to\n[Galey\'s] right of reclamation should be protected and segregated by [Arley] and are not to be used\nfor any purpose whatsoever." Subsequently, on May 21, 1997, Galey sent the Debtor an additional\nnotice detailing each invoice issued to Arley within the 10-day period prior to May 16, 1997 for\nthe goods allegedly subject to reclamation.\nSince early 1995, CIT Group/Business Credit Inc. ("CIT") has held a perfected security\ninterest in substantially all Arley\'s assets, including accounts receivable and inventory.\nOn June 9, 1997, prior to the sale of the Debtors\' assets, Galey commenced an adversary\nproceeding against Arley seeking reclamation of the textile goods referred to in the May 16th\nLetter. Currently before the Court are motions for summary judgment filed by Galey and by the\nTrustee, respectively.\nIn its summary judgment motion, Galey maintains that it has complied with all the statutory\nrequirements for establishing a valid claim for reclamation. The Trustee refutes Galey\'s contention\nand opposes entry of summary judgment in favor of Galey. Rather, the Trustee maintains that his\narguments support entry of summary judgment in Arley\'s favor. The three principal reasons\nadvanced by the Trustee in opposition to Galey\'s motion and in support of his own motion are that\n. . . 3) Galey\'s right to reclamation is subject to CIT\'s perfected security interest.\nThe purpose of 11 U.S.C. \xc2\xa7 546(c)[1] is to recognize any right to reclamation that a seller\nmay have under applicable nonbankruptcy law. Section 546(c) does not create a new, independent\nright to reclamation but merely affords the seller an opportunity, with certain limitations, to avail\nitself of any reclamation right it may have under nonbankruptcy law. Pursuant to \xc2\xa7 546(c), a seller\nmay reclaim goods it has sold to an insolvent debtor if it establishes:\n(1) that it has a statutory or common law right to reclaim the goods;\n(2) that the goods were sold in the ordinary course of the seller\'s business;\n(3) that the debtor was insolvent at the time the goods were received; and\n(4) that it made a written demand for reclamation within the statutory time limit after the\ndebtor received the goods.\nIn addition, to be subject to reclamation, goods must be identifiable and cannot have been\nprocessed into other products. It has also been noted that "an implicit requirement of a \xc2\xa7 546(c)\nreclamation claim is that the debtor must possess the goods when the reclamation demand is\nmade." However, it is not clear "whether possession is an element under \xc2\xa7 546(c) of the Bankruptcy\nCode or in establishing an independent right of reclamation under nonbankruptcy law to be\nrecognized under \xc2\xa7 546(c)." Logic dictates that, if not possession, the debtor should at least have\ncontrol over the goods if it is to be required to return them. For the same reason, if the goods are\nnot identifiable, the debtor could not identify or extract the goods to return them to the reclaiming\n195\n\n\x0cseller. The issue concerning control of the goods or the identifiable nature of the goods would be\nrelevant whether or not the reclaiming seller is seeking the goods in a bankruptcy context. Thus, it\nappears that these elements are requirements under the "independent right of reclamation under\nnonbankruptcy law."\nSection 546(c) also affords the bankruptcy court broad discretion to substitute an\nadministrative claim or lien in place of the right to reclaim. This discretion gives the court needed\nflexibility and permits it to recognize the reclaiming creditor\'s rights while allowing the debtor the\nopportunity to retain the goods in order to facilitate the reorganization effort.\nUniform Commercial Code ("U.C.C.") \xc2\xa7 2-702[(2)] as enacted in various jurisdictions,\nordinarily forms the statutory right upon which sellers base their reclamation demand. Pursuant to\nU.C.C. \xc2\xa7 2-702(3), the seller\'s right to reclamation is "subject to" the rights of a good faith\npurchaser from the buyer. That the right of a reclaiming creditor is subordinate to that of a good\nfaith purchaser does not automatically extinguish the reclamation right. Rather, the reclaiming\ncreditor is "relegated to some less commanding station."\nMost courts have treated "a holder of a prior perfected, floating lien on inventory . . . as a\ngood faith purchaser with rights superior to those of a reclaiming seller." A "purchaser" is defined\nas one "who takes by purchase," U.C.C. \xc2\xa7 1-201(33), and "purchase" is defined to include "taking\nby sale, discount, negotiation, mortgage, pledge, lien, issue or re-issue, gift or any other voluntary\ntransaction creating an interest in property." U.C.C. \xc2\xa7 1-201(32). Thus, the definition of purchaser\nis broad enough to include an Article 9 secured party, which then qualifies as a purchaser under\nU.C.C. \xc2\xa7 2-403. Thus, in the instant case, if CIT qualifies as a good faith purchaser then even if\nArley had voidable title to the goods, it could transfer good title under Article 2 to CIT. Further, if\nCIT obtained the goods in this manner, the demand of a reclaiming seller is subject to CIT\'s\ninterest. [The Court then concludes that Galey has failed to allege facts to show that CIT is not a\ngood faith purchaser].\nAs previously noted, while a seller\'s right to reclamation is subject to the rights of a good\nfaith purchaser, the reclamation right is not automatically extinguished. Relying on this principle,\nGaley argues that, pursuant to \xc2\xa7 546, it is entitled to either an administrative claim or lien in lieu\nof its right to reclamation. . . . Galey contends that because there will be surplus collateral once\nCIT has been paid in full, that collateral should be used to pay Galey\'s reclamation claim and it\nshould get its administrative claim or lien on that surplus.\n[T]he Trustee argues that when the goods subject to a reclamation demand are liquidated\nand the proceeds are used to pay the secured creditor\'s claim, the reclaiming seller\'s subordinated\nright is rendered valueless. The Trustee maintains that once the secured creditor is paid in full, the\nreclaiming seller is only entitled to reclamation when the surplus collateral remaining consists of\nthe very goods sold by the reclaiming seller or the traceable proceeds from those goods.\nCourts differ on the treatment to be afforded reclaiming sellers subject to the superior rights\nof good faith purchasers. Some courts have awarded a reclaiming seller, who otherwise meets the\ncriteria to qualify as a reclaiming seller but is subject to a superior claim, an administrative claim\nor replacement lien for the full amount of the goods sought to be reclaimed. However, the majority\nview appears to be some method of assuring that the reclaiming seller only receive what it would\nhave received outside of the bankruptcy context after the superior claim was satisfied. Thus, it is\nonly when the reclaiming seller\'s goods or traceable proceeds from those goods are in excess\n196\n\n\x0cof the value of the superior claimant\'s claim that the reclaiming seller will be allowed either\nto reclaim the goods or receive an administrative claim or lien in an amount equal to the\ngoods that remain after the superior claim has been paid. Allowing the reclaiming seller to\nrecover only that to which it would be entitled absent the bankruptcy is in keeping with the\npurpose \xc2\xa7 546(c) which is to preserve any common law or statutory rights to reclamation,\nnot to enhance those rights. It therefore follows that any administrative claim or lien\nsubstituted for the right to reclamation pursuant to \xc2\xa7 546(c) should be "allowed only to the\nextent of the value of the lost right of reclamation." If the right to reclamation would be\nworthless absent the bankruptcy filing, it is also worthless in bankruptcy. Indeed, granting an\nadministrative claim or lien when the secured creditors have paid their claims out of the goods to\nbe reclaimed "would afford the reclamation seller something it does not have under the UCC\xe2\x80\x94a\npriority interest in the buyer\'s assets other than the goods to be reclaimed."\nThus, while the reclaiming seller\'s claim is not automatically extinguished, the reclaiming\nseller is also not automatically granted an administrative claim or lien in the full amount sought\nwhen it is subject to the rights of the good faith purchaser. Rather, the reclaiming seller\'s right to\nreclaim depends on the value of the excess goods remaining once the secured creditor\'s claim is\npaid or released.\nAs the bankruptcy filing does not enhance the reclaiming seller\'s rights, the Court should\ndetermine what would have happened to the reclaiming seller\'s claim in a nonbankruptcy context.\nThe parties concede that under state law the secured creditor would have the option of proceeding\nagainst any of its collateral. Therefore, the secured creditor may choose to foreclose on the goods\nsold by the reclaiming seller if these goods can be readily liquidated. When the secured claim, or\na portion of it, is paid out of the goods sought to be reclaimed, the right to reclaim is rendered\nvalueless. Thus, "in the non-bankruptcy context, the secured creditor\'s decision with respect to its\nsecurity interest in the goods will determine the value of the seller\'s right to reclaim." Here,\nfollowing the Debtors\' filing, CIT decided not to seek relief from the Court to pursue those\nremedies available to it to secure the immediate liquidation of all the Debtors\' assets. Rather, it\nsupported the Debtors\' efforts to sell its inventory including any Galey goods in the ordinary course\nof its business. As a result, all of the goods which Galey sought to reclaim were sold and the\nproceeds used to pay CIT. Moreover, even after CIT received payment from the sale of the goods,\nthere was still a balance due it. Thus, Galey\'s reclamation claim was rendered valueless.\nGaley concedes that CIT\'s security interest is of a greater value than the value of the goods\nupon which Galey bases its reclamation claim. Nevertheless, inasmuch as it now appears that CIT\'s\nsecurity interest will ultimately be satisfied through the continued liquidation of its remaining\ncollateral, Galey argues that the Court should use its equitable power and afford it relief based\nupon a marshaling theory.\nThe equitable principle of marshaling of assets applies when a senior secured creditor can\ncollect on its debt against more than one property or fund held by the debtor but a junior secured\ncreditor can only proceed against one of those sources. The principle benefits the junior secured\ncreditor by requiring the senior secured creditor to first attempt to collect amounts owed it from\nthe property or fund in which the junior secured creditor has no interest, thereby producing a\ngreater possibility that there will be remaining value in the only fund from which the junior secured\ncreditor can be paid to allow for a payment to it.\n197\n\n\x0cTo apply marshaling, three elements must be established by clear and convincing evidence\n(1) the existence of two secured creditors with a common debtor, (2) the existence of two funds\nbelonging to the debtor, and (3) the right of the senior secured creditor to receive payment from\nmore than one fund while the junior secured creditor can only resort to one fund. These three\nrequirements have been strictly construed in the bankruptcy context. "An unsecured creditor has\nno standing to invoke the doctrine." Moreover, marshaling is not applied if either a senior secured\ncreditor or other parties are prejudiced. Thus, it is not applied when the senior secured creditor\nwould be delayed or inconvenienced in the collection of the debt owed it. A secured creditor may\nproperly proceed first to collect against "readily available collateral." The senior secured creditor\nwill not be required to proceed first against a fund that requires more rigorous procedures to collect\nupon if it has a fund "more directly available" to it that can be "easily reduced to money."\nAs a threshold matter, marshaling is not applicable in this case because the first requirement\nfor its application is not met in that Galey is not a secured creditor. Although Galey argues that its\nclaim has a higher priority than general unsecured claims and that its claim is akin to a secured\nclaim, Galey, nevertheless, does not have a secured claim. Further, with respect to Galey\'s assertion\nthat a reclaiming creditor\'s rights are superior to those of a general unsecured creditor, the Court\nnotes that the reclaiming creditor\'s claim is only superior to that of an unsecured creditor to the\nextent its reclamation claim is found to have value, however, with respect to that portion of the\nreclaiming creditor\'s claim in excess of that value, the reclaiming seller is an unsecured creditor.\nIn the case before this Court, CIT could have sought Court approval to foreclose on all its\ncollateral, including the Galey goods, immediately. However, CIT chose to consent to the Debtor\'s\ndecision to continue in business with the expectation that as a going concern the return on CIT\'s\ncollateral would increase. . . . It is clear that whatever Galey goods may have been present on the\ndate of the demand \xe2\x80\x94all of which goods were subject to CIT\'s rights\xe2\x80\x94were sold or processed into\nfinished products and sold. . . . Thus, all of the traceable proceeds from any Galey goods were used\nto pay CIT.\nIn summary, in the context of a secured creditor that qualifies as a good faith purchaser,\nthe value of the reclaiming seller\'s reclamation claim will depend on whether the goods or the\nproceeds from those goods have been used to satisfy the secured creditor\'s claim. Once the goods\nor the proceeds from the sale of those goods have been "paid" to the secured creditor, the\nreclaiming seller\'s claim in those goods is valued at zero, regardless of whether the secured creditor\nis ultimately paid in full and its lien is released as to other collateral.\nFinally, because this Court finds that Galey is not entitled to an administrative claim or\nreplacement lien inasmuch as any right to reclamation it might have was subject to CIT\'s security\ninterest and was rendered valueless by CIT\'s interest, it is unnecessary for the Court to reach the\nissue of whether Galey otherwise complied with all the requirements for a right to reclamation.\n\n8.23.1.2.\nPHAR-MOR v. McKESSON CORP., 534 F.3d 502\n(6th Cir. 2008)\nAt issue in this bankruptcy case is whether a vendor\'s administrative-expense priority on\nits reclamation claim is effectively extinguished when the goods subject to reclamation are sold\nand the proceeds used to satisfy a secured creditor\'s superior claim. Because we hold that it is not,\nwe AFFIRM the district court\'s decision.\n198\n\n\x0cPhar-Mor filed Chapter 11 bankruptcy on September 24, 2001, but continued to operate as\na debtor in possession. In response, several vendors, including McKesson Corporation, filed timely\n"reclamation claims," pursuant to 11 U.S.C. \xc2\xa7 546(c) and UCC \xc2\xa7 2-702, seeking to recover goods\nthey had delivered to Phar-Mor on credit. On October 5, 2001, Phar-Mor proposed "that each\nVendor be granted an administrative expense priority claim under Section 503(b) in the amount\n(if any) of its allowed reclamation claim," and reported reclamation claims from 141 vendors\ntotaling $18 million. All but McKesson have since settled.\nOn the petition date, Phar-Mor owed its secured creditors $103 million. The bankruptcy\ncourt authorized Phar-Mor to borrow up to $135 million to repay these pre-petition secured\ncreditors. Phar-Mor did so and those security interests were extinguished. Phar-Mor gave the new\ncreditors (i.e., "DIP Lenders") super-priority status over the remaining security interests, which\nalso meant that their claims had priority over any administrative expense claims, such as\nMcKesson\'s.\nUpon entering bankruptcy, Phar-Mor closed 65 stores and held going-out-of-business\nsales, which generated $30 million. Phar-Mor continued to lose money, continued to close stores,\nand eventually had a final going-out-of-business-liquidation sale, which generated $103 million.\nPhar-Mor was able to pay off the $135 million post-petition loan from the DIP Lenders and was\nleft with $64.5 million. After expenses, fees, and the money allotted to payment of the reclamation\nclaims, $30 million was left towards payment of $185.5 million in general unsecured claims.\nOn February 13, 2003, Phar-Mor moved the bankruptcy court to reclassify the reclamation\nclaims as general unsecured claims. Phar-Mor argued that the vendors\' administrative-expense\npriority was extinguished when the goods subject to reclamation were sold and the proceeds used\nto pay off the DIP Lenders. The court denied the motion and held that, even though the reclamation\nclaims were rendered "subject to" the DIP Lenders\' super-priority, the vendors\' properly filed\nreclamation claims still had administrative-expense priority over the general claims.\nPhar-Mor moved the bankruptcy court for reconsideration (twice), and was denied (twice);\nappealed to the district court, which affirmed the bankruptcy court; and now appeals to this court\n\xe2\x80\x94 each time asserting the same arguments that it had asserted to the bankruptcy court in the first\ninstance. Because we find that the bankruptcy court properly granted McKesson an administrative\nexpense priority in lieu of its reclamation claim, we affirm the bankruptcy court\'s decision.\nThere is no question that McKesson sold goods to Phar-Mor in the ordinary course of its\nbusiness, that Phar-Mor received the goods while insolvent, or that McKesson, upon discovering\nPhar-Mor\'s insolvency, made a timely, written demand for reclamation. The immediate question\nis whether McKesson had a statutory or common-law right, pursuant to Ohio law, to reclaim those\ngoods. If so, then the court, having denied reclamation, was obligated to grant McKesson either an\nadministrative-expense priority in the amount of the goods (as it did) or a lien on the proceeds\nresulting from the use of those goods by the debtor. But if not, then the court was not so obliged\nand McKesson\'s claim for the value of those goods may be properly regarded as merely a general\nunsecured claim.\nPhar-Mor argues, however, that McKesson did not have a right to reclaim the goods\nbecause McKesson did not have the ability to reclaim those goods, inasmuch as [the UCC] renders\na seller\'s right to reclaim "subject to the rights of a buyer in ordinary course or other good faith\npurchaser or lien creditor." Phar-Mor contends that the DIP Lenders, who held a security interest\n199\n\n\x0cin all of Phar-Mor\'s inventory, via an after-acquired-property clause in their security agreement\nwere "good faith purchasers." Thus, Phar-Mor surmises that, because McKesson\'s reclamation\nrights are "subject to" the DIP Lenders\' security interest and because Phar-Mor sold McKesson\'s\n"reclamation goods" to satisfy the DIP Lenders\' claim, McKesson is unable to reclaim the goods\nand, hence, is left without any right to reclaim the goods. . . .\n[The court then discusses various cases, specifically rejecting the Galey opinion, and\nquoting with approval from In re Am. Food Purveyors, Inc., 17 UCC Rep. Serv. 436, 1974 WL\n21665 (Bankr. N.D. Ga.1974):\nThe issues of good faith, notice and knowledge are important here\nbecause the after-acquired-property secured creditor is attempting to\nacquire rights over goods which were essentially being held in trust\nby the debtor/buyer for the seller, because of their acquisition by\nfraud. It was as if the debtor/buyer never had obtained title, and the\nseller is essentially trying to retake his own property. For these\nreasons, and because this is a court of equity and guided by equitable\ndoctrines and principles, it was essential that the creditor\ndemonstrate that it was in good faith and had no knowledge or notice\nof the debtor/buyer\'s financial plight, in order to prevail.\nFor the reason that the property was still the seller\'s even after it was\ndelivered, at least for the ten day period provided for in \xc2\xa7 2-702, the\ncourt finds further that the creditor acquired no `rights in the\ncollateral\' as required under UCC \xc2\xa7 9-204, in regard to the goods. .\n. . [A] secured party\'s rights, generally speaking, against the debtor\'s\nvendor are no greater than the debtor himself.\nThe court finds that rights under \xc2\xa7 9-204 of the UCC means an\nownership claim paramount to that of the seller and capable of\nspecific enforcement in equity. Consequently, for the ten day period\nin question, the debtor/buyer could not have sustained an action in\nequity to keep these goods. All of the rights during this period were\nwith the defrauded seller.\nThis reasoning is persuasive.\nWe find that UCC 2-207(2) grants a properly reclaiming vendor, such as McKesson, a right\nto reclaim its goods and that UCC 2-207(3) does not allow a secured creditor\'s claim to defeat that\nright. But, correspondingly, we find that 11 U.S.C. \xc2\xa7 546(c)(2) (1998) grants the bankruptcy court\nthe power to deny a properly reclaiming vendor, such as McKesson, its right to reclaim the goods,\nbut only by granting the denied vendor either an administrative-expense priority in the amount of\nthe goods or a lien on the proceeds resulting from the use of those goods by the debtor. In this\ncase, the bankruptcy court granted McKesson an administrative-expense priority, and we have no\nbasis to overturn its decision in this matter.\n\n200\n\n\x0c8.24.\n\nRecovering Avoided Transfers. 11 U.S.C. \xc2\xa7 550\n\nSection 550 puts important additional limits on the ability to recover avoided transfers. Not\nall avoided transfers need to be recovered. There is no need for a recovery if the granting of a lien\nis avoided \xe2\x80\x93 the creditor is simply made unsecured. But if after avoiding a transfer the trustee wants\nto recover money or the property from someone then the strictures of Section 550 come into play.\nSection 550 provides protection for (1) innocent secondary transferees (11 U.S.C. \xc2\xa7\n550(b)); (2) non-insider transferees outside of the 90 day period (11 U.S.C. \xc2\xa7 550(c)); and (3) good\nfaith transferees who gave value (11 U.S.C. \xc2\xa7 550(d)). It also adds a one year statute of limitations\non recovery following avoidance of the transfer. 11 U.S.C. \xc2\xa7 550(f).\n\n8.25.\n\nPractice Problems: Recovering Avoided Transfers\n\nProblem 1: Bank lends $100,000 to the debtor, unsecured, guaranteed by the debtor\xe2\x80\x99s rich\nmother. Debtor repays the loan 91 days before filing bankruptcy. Can the trustee recover the\n$100,000 from the Bank?\n[This is a simplified example of the problem identified in In re Deprizio Constr. Co.,\n874 F.2d 1186, 1200-1201 (7th Cir. 1989), decided before Congress attempted to fix\nthe problem by enacting 11 U.S.C. \xc2\xa7 550(c). Since the transfer benefitted an insider it\nwas subject to the one year avoidance period even though the transfer was not made to\nan insider.]\nProblem 2: Bank lends $100,000 to the debtor, unsecured, guaranteed by the debtor\xe2\x80\x99s rich\nmother. Debtor grants a security interest to the Bank to secure the loan 91 days before filing\nbankruptcy. Can the trustee avoid the security interest?\n[NOTE: Because Section 550 (c) did not completely fix this problem (where no\nrecovery is required), Congress again amended the Bankruptcy Code by adding\n11 U.S.C. \xc2\xa7 547(i).]\n\n8.26.\n\nCases on Recovering Avoided Transfers\n8.26.1.1.\nBONDED FIN. SERV., INC., v. EUROPEAN\nAMERICAN BANK, 838 F.2d 890 (7th Cir. 1988)\n\nEASTERBROOK, Circuit Judge.\nMichael Ryan controlled a number of currency exchanges in Illinois. He also owned quite\na few horses, doing business as Shamrock Hill Farm. Ryan had borrowed $655,000 from European\nAmerican Bank to run this business. One of the currency exchanges, Bonded Financial Services,\nput $200,000 at Ryan\'s disposal in January 1983. Bonded sent the Bank a check payable to the\nBank\'s order on January 21 with a note directing the Bank to "deposit this check into Mike [Ryan]\'s\naccount." The Bank did this. On January 31 Ryan instructed the Bank to debit the account $200,000\nin order to reduce the outstanding balance of the Shamrock loan. The Bank did this. Ryan paid off\nthe loan in two more installments, on February 11 and 14, 1983. The Bank released its security\ninterest in the horses.\n201\n\n\x0cThe currency exchanges and Ryan paid visits to the judicial system. Bonded filed a petition\nin bankruptcy on February 10, 1983, along with about 65 other entities that Ryan controlled.\nCreditors later filed involuntary proceedings against Ryan. Ryan was convicted of mail fraud on\naccount of his irregular administration of the currency exchanges (Bonded was not, for starters)\nand is in prison. The transfer of $200,000 out of Bonded on January 21, 1983, was a fraudulent\nconveyance and the trustee may recover for the benefit of creditors the value of such a conveyance.\nThe trustee seeks to recover from the Bank, which unlike Ryan is solvent.\nBonded\'s trustee contends in this adversary proceeding that the Bank is the "initial\ntransferee" under Sec. 550(a)(1) because it was the payee of the check it received on January 21;\nthat the Bank is in any event the "entity for whose benefit such transfer was made" because Ryan\nintended to pay off the loan when he caused Bonded to write the check; that if the Bank is a\nsubsequent transferee under Sec. 550(a)(2) it did not give "value" under Sec. 550(b)(1) because\nBonded received nothing; and that the Bank loses even if it gave value because it should have\nknown that something was amiss, given the substantial sum Bonded was transferring to a corporate\nofficer. The bankruptcy court granted summary judgment to the Bank without explicitly discussing\nSec. 550. The district court affirmed on appeal under 28 U.S.C. Sec. 158(a). It held that the Bank\nhandled the check of January 21 as a "mere conduit" and so was not the initial transferee; that Ryan\nwas the person "for whose benefit the transfer was made" because he got the benefit of the\nreduction in the balance of the loan; that the Bank\'s giving value to Ryan satisfied Sec. 550(b)(1);\nand that because the trustee presented no evidence that the Bank knew or should have known of\nBonded\'s impending collapse, the Bank took in good faith.\nIf the note accompanying Bonded\'s check had said: "use this check to reduce Ryan\'s loan"\ninstead of "deposit this check into [Ryan]\'s account", Sec. 550(a)(1) would provide a ready answer.\nThe Bank would be the "initial transferee" and Ryan would be the "entity for whose benefit [the]\ntransfer was made". The trustee could recover the $200,000 from the Bank, Ryan, or both, subject\nto the rule of Sec. 550(c) that there may be but one recovery. The trustee contends that the\napparently formal difference--depositing the check in Ryan\'s account and then debiting that\naccount--should not affect the outcome. In either case the Bank is the payee of the check and ends\nup with the money, while Ryan gets the horses free of liens and Bonded is left holding the bag.\nFrom a larger perspective, however, the two cases are different.\nFraudulent conveyance law protects creditors from last-minute diminutions of the pool of\nassets in which they have interests. They accordingly need not monitor debtors so closely, and the\nsavings in monitoring costs make businesses more productive. The original rule, in 13 Eliz. ch. 5\n(1571), dealt with debtors who transferred property to their relatives, while the debtors themselves\nsought sanctuary from creditors. The family enjoyed the value of the assets, which the debtor might\nreclaim if the creditors stopped pursuing him. In the last 400 years the principle has been\ngeneralized to address transfers without either sufficient consideration or bad intent, for they, no\nless than gifts, reduce the value of the debtor\'s estate and thus the net return to creditors as a group.\nThe trustee reverses, for the benefit of all creditors, un- or under-compensated conveyances within\na specified period before the bankruptcy.\nThere have always been limits on the pursuit of transfers. If the recipient of a fraudulent\nconveyance uses the money to buy a Rolls Royce, the auto dealer need not return the money to the\nbankrupt even if the trustee can identify the serial numbers on the bills. The misfortune of the\nfirm\'s creditors is not a good reason to mulct the dealer, who gave value for the money and was in\n202\n\n\x0cno position to monitor the debtor. Some monitoring is both inevitable and desirable, and the\ncreditors are in a better position to carry out this task than are auto dealers and the many others\nwith whom the firm\'s transferees may deal. . . . Sec. 550(b) leaves with the initial transferee the\nburden of inquiry and the risk if the conveyance is fraudulent. The initial transferee is the best\nmonitor; subsequent transferees usually do not know where the assets came from and would be\nineffectual monitors if they did.\nThe potential costs of monitoring and residual risk are evident when the transferees include\nbanks and other financial intermediaries. The check-clearing system processes more than 100\nmillion instruments every day; most pass through several banks as part of the collection process;\neach bank may be an owner of the instrument or agent for purposes of collecting at a given\nmoment. Some of these instruments represent funds fraudulently conveyed out of bankrupts, yet\nthe cost of checking back on the earlier transferors would be staggering. Bonded\'s trustee dismisses\nfinancial intermediaries on the ground that they obviously are not initial transferees, but this is not\nso clear. Hundreds of thousands of wire transfers occur every day. The sender of money on a wire\ntransfer tells its bank to send instructions to the Federal Reserve System (for a Fedwire transfer)\nor to a correspondent bank to make money or credit available through still another bank. The Fed\nor the receiving bank could be called the "initial transferee" of the funds if we disregarded the\nfunction of fraudulent conveyance law. Similarly, an armored car company might be called the\n"initial transferee" if the bankrupt gave it valuables or specie to carry. Exposing financial\nintermediaries and couriers to the risk of disgorging a "fraudulent conveyance" in such\ncircumstances would lead them to take precautions, the costs of which would fall on solvent\ncustomers without significantly increasing the protection of creditors.\nThe functions of fraudulent conveyance law lead us to conclude that the Bank was not the\n"initial transferee" of Bonded\'s check even though it was the payee. The Bank acted as a financial\nintermediary. It received no benefit. Ryan\'s loan was fully secured and not in arrears, so the Bank\ndid not even acquire a valuable right to offset its loan against the funds in Ryan\'s account. Under\nthe law of contracts, the Bank had to follow the instructions that came with the check. The Uniform\nCommercial Code treats such instructions as binding to the extent any contract binds (see UCC\nSec. 3-119). The Bank therefore was no different from a courier or an intermediary on a wire\ntransfer; it held the check only for the purpose of fulfilling an instruction to make the funds\navailable to someone else.\nAlthough the Bankruptcy Code does not define "transferee", and there is no legislative\nhistory on the point, we think the minimum requirement of status as a "transferee" is dominion\nover the money or other asset, the right to put the money to one\'s own purposes. When A gives a\ncheck to B as agent for C, then C is the "initial transferee"; the agent may be disregarded.\nAs the Bank saw the transaction on January 21, it was Ryan\'s agent for the purpose of\ncollecting a check from Bonded\'s bank. It received nothing from Bonded that it could call its own;\nthe Bank was not Bonded\'s creditor, and Ryan owed the Bank as much as ever. The Bank had no\ndominion over the $200,000 until January 31, when Ryan instructed the Bank to debit the account\nto reduce the loan; in the interim, so far as the Bank was concerned, Ryan was free to invest the\nwhole $200,000 in lottery tickets or uranium stocks. As the Bank saw things on January 31, it was\ngetting Ryan\'s money. It would be at risk if Ryan were defrauding his other creditors or preferring\nthe Bank, but the Bank would perceive no reason to investigate Bonded or sequester the money\n203\n\n\x0cfor the benefit of Bonded\'s creditors. So the two-step transaction is indeed different from the onestep transaction we hypothesized at the beginning of this discussion.\nWe are aware that some courts say that an agent (or a bank in a case like ours) is an "initial\ntransferee" but that courts may excuse the transferee from repaying using equitable powers. This\nis misleading. "Transferee" is not a self-defining term; it must mean something different from\n"possessor" or "holder" or "agent". To treat "transferee" as "anyone who touches the money" and\nthen to escape the absurd results that follow is to introduce useless steps; we slice these off with\nOccam\'s Razor and leave a more functional rule.\nIf the Bank is not the "initial transferee", the trustee insists, it is at least the "entity for\nwhose benefit such transfer was made". The Bank ultimately was paid and therefore, one might\nthink, it got the "benefit" of the transfer--though the Bank cancelled the note and gave up a security\ninterest in horses that, the trustee concedes, was sufficient to cover the balance. Kenneth Kortas,\nBonded\'s day-to-day manager, filed an affidavit stating that he prepared the check in question at\nRyan\'s request as part of Ryan\'s program "to put the horse business in a position where it could\nfunction and sustain itself for at least several months even if his other business ventures ran into\nfinancial difficulty.... At the request of Ryan, I routinely prepared checks payable to banks where\nRyan had personal accounts and loan accounts to finance his horse business." This may show that\nRyan intended all along to wash the $200,000 through his personal account and pay the Bank; at\na minimum, the argument would run, questions of intent prevent summary judgment.\nThe Bank responds that it did not "intend" to be the beneficiary of the transfer; it was not\nin cahoots with Ryan or Bonded and did not know of their plans. Moreover, the Bank insists that\nit did not receive a "benefit" because it gave value for the $200,000. The only beneficiary on this\nview was Ryan, who increased his equity position in Shamrock Hill Farm and obtained clear title\nto the horses. As both initial transferee and ultimate beneficiary, Ryan is the only person covered\nby Sec. 550(a)(1), the Bank insists. The distinction is important, because entities covered by Sec.\n550(a)(1) cannot use the value-and-good-faith defense provided by Sec. 550(b).\nThis exchange seems to raise difficult questions. To what extent does "intent" matter under\nSec. 550(a)(1)? If intent matters, whose? To what extent must courts find the true economic\nbenefits of a transaction? If the Bank were undersecured, would the transfer make the Bank the\nbeneficiary by the amount of the difference between the loan and the security? Suppose Ryan\nplanned to, and did, buy a Rolls Royce with the money; would the dealer be the beneficiary by the\ndifference between the wholesale and retail price of the car? How are bankruptcy courts to\ndetermine "intent" and compute the benefit in transactions of this nature?\nThese questions need not be answered, because a subsequent transferee cannot be the\n"entity for whose benefit" the initial transfer was made. The structure of the statute separates initial\ntransferees and beneficiaries, on the one hand, from "immediate or mediate transferee[s]", on the\nother. The implication is that the "entity for whose benefit" is different from a transferee,\n"immediate" or otherwise. The paradigm "entity for whose benefit such transfer was made" is a\nguarantor or debtor--someone who receives the benefit but not the money. In the Firm-GuarantorLender example at the end of Part I, when Firm pays the loan, Lender is the initial transferee and\nGuarantor, which no longer is exposed to liability, is the "entity for whose benefit". If Bonded had\nsent a check to the Bank with instructions to reduce Ryan\'s loan, the Bank would have been the\ninitial transferee and Ryan the "entity for whose benefit. Section 550(a)(1) recognizes that debtors\n204\n\n\x0coften pay money to A for the benefit of B; that B may indeed have arranged for the payment (likely\nso if B is an insider of the payor); that but for the payment B may have had to make good on the\nguarantee or pay off his own debt; and accordingly that B should be treated the same way initial\nrecipients are treated. If B gave value to the bankrupt for the benefit, B will receive credit in the\nbankruptcy, and if not, B should be subject to recovery to the same extent as A--sometimes ahead\nof A, although Sec. 550 does not make this distinction. Someone who receives the money later on\nis not an "entity for whose benefit such transfer was made"; only a person who receives a benefit\nfrom the initial transfer is within this language.\nTo say that the categories "transferee" and "entity for whose benefit such transfer was\nmade" are mutually exclusive does not necessarily make it easy to determine in which category a\ngiven entity falls. The method we employed in Part I of this opinion to decide that the Bank was\nnot an "initial" transferee governs the question whether entities are subsequent transferees, too.\nThe answer is not difficult in this case, however. The Bank did not obtain a benefit from the transfer\nto Ryan on January 21; it obtained dominion over the funds on January 31. The Bank is a\ntransferee.\nA trustee may not recover from a subsequent transferee who "takes for value, including\nsatisfaction ... of a present or antecedent debt, in good faith, and without knowledge of the\nvoidability of the transfer avoided", Sec. 550(b)(1). The Bank took for value on January 31. It had\nextended $655,000 in credit to Ryan, and the payment satisfied $200,000 of this debt; the Bank\nalso released a share of its security interest. Bonded\'s trustee contends, however, that a subsequent\ntransferee must give value to the debtor; the Bank gave value only to Ryan.\nThe statute does not say "value to the debtor"; it says "value". A natural reading looks to\nwhat the transferee gave up rather than what the debtor received. Other portions of the Code require\nvalue to the debtor. Section 548(c), for example, gives the initial recipient of a fraudulent\nconveyance a lien against any assets it hands back, "to the extent that such transferee ... gave value\nto the debtor in exchange for such transfer". The difference between "value" in Sec. 550(b)(1) and\n"value to the debtor" in Sec. 548(c) makes sense. Sec. 550(b)(1) implements a system well known\nin commercial law, in which a transferee of commercial paper or chattels acquires an interest to\nthe extent he purchased the items without knowledge of a defect in the chain. These recipients\nreceive protection because monitoring of earlier stages is impractical, and exposing them to risk\non account of earlier delicts would make commerce harder to conduct. Benefits to the commercial\neconomy, and not to the initial transferors (who may be victims of fraud), justify this approach.\nTransferees and other purchasers generally deal only with the previous person in line; they\ngive value, if at all, to their transferors (or the transferors\' designees). The statute emulates the\npattern of other rules protecting good faith purchasers. All of the courts that have considered this\nquestion have held or implied that value to the transferor is sufficient.\nThe final question is whether the Bank received the $200,000 "in good faith, and without\nknowledge of the voidability of the transfer avoided". The trustee does not contend that the Bank\nknew of Bonded\'s precarious condition or Ryan\'s plan to use Bonded\'s money to pay his personal\ndebts. He does not say that the Bank acted in bad faith--or even that there is a difference between\n"good faith" and "without knowledge of the voidability of the transfer".\nThe phrase "good faith" in [Sec. 550(b)] is intended to prevent a transferee from whom the\ntrustee could recover from transferring the recoverable property to an innocent transferee, and\n205\n\n\x0creceiving a transfer from him, that is, "washing" the transaction through an innocent third party.\nIn order for the transferee to be excepted from liability ... he himself must be a good faith\ntransferee.\nThe trustee contends, instead, that the Bank should have known about Bonded\'s distress\nand Ryan\'s chicanery; had it investigated the deposit on January 21, it would have found out; and\nbecause it should have known, this is as good as knowledge.\nImputed knowledge is an old idea, employed even in the criminal law. Venerable authority\nhas it that the recipient of a voidable transfer may lack good faith if he possessed enough\nknowledge of the events to induce a reasonable person to investigate. No one supposes that\n"knowledge of voidability" means complete understanding of the facts and receipt of a lawyer\'s\nopinion that such a transfer is voidable; some lesser knowledge will do. Some facts strongly\nsuggest the presence of others; a recipient that closes its eyes to the remaining facts may not deny\nknowledge. But this is not the same as a duty to investigate, to be a monitor for creditors\' benefit\nwhen nothing known so far suggests that there is a fraudulent conveyance in the chain.\n"Knowledge" is a stronger term than "notice". A transferee that lacks the information necessary to\nsupport an inference of knowledge need not start investigating on his own.\nNothing in the record of this case suggests that the Bank knew of Bonded\'s financial peril\nor Ryan\'s plan. Bonded was not the Bank\'s customer. The transfer from Ryan to the Bank on\nJanuary 31 was innocuous. The Bank thought it got Ryan\'s money; its loan was fully secured; it\nperceived Ryan as a well-heeled horse breeder, with a balance sheet in the millions, current on his\nloan payments.\nThe transfer from Bonded to Ryan on January 21 was only slightly more problematic from\nthe Bank\'s perspective. A corporation was transferring $200,000 to one of its executives. This does\nnot hint at a fraudulent conveyance by a firm on the brink of insolvency; for all the Bank knew,\nBonded had plenty more where the $200,000 came from. Banks frequently receive large checks\nfrom corporations to their officers; think of the annual bonus checks General Motors issues, or the\ncheck to repurchase a bloc of shares. A $200,000 check is not a plausible bonus for a currency\nexchange, however. It could hint at embezzlement. Several Illinois cases say that a bank should\ninquire when a firm\'s employee signs a large check with himself as payee.\nSince those cases were decided, Illinois adopted the Uniform Fiduciaries Act, which\nrelieves banks of such a duty to inquire into the authority of the fiduciary signing the check on the\nmaker\'s behalf. At all events, the Bank had no reason to think Ryan an embezzler. The check was\naccompanied by a memorandum from Kenneth Kortas, Bonded\'s manager, demonstrating that\nRyan was not keeping other corporate officers in the dark. The Kortas memorandum would have\nled a reasonable bank to conclude that Bonded as a corporate entity wanted to make the transfer-and a bank drawing that inference here would have been right. Had the Bank called Kortas (or\nanyone else at Bonded) to inquire about the check, the Bank would have learned that the instrument\nwas authorized by the appropriate corporate officials. Since the inquiry would have turned up\nnothing pertinent to voidability, the Bank\'s failure to make it does not permit a court to attribute to\nit the necessary knowledge.\nThe Bank is a subsequent transferee covered by Sec. 550(b)(1). It took for value and\nwithout knowledge of the voidability of the initial transaction.\n206\n\n\x0c8.26.1.2.\nKELLOGG v. BLUE QUAIL ENERGY, 831 F.2d 586\n(5th Cir. 1987)\nIn March 1982, Blue Quail Energy, Inc., delivered a shipment of oil to debtor Compton\nCorporation. Payment of $585,443.85 for this shipment of oil was due on or about April 20, 1982.\nCompton failed to make timely payment. Compton induced MBank-Abilene National Bank to\nissue an irrevocable standby letter of credit in Blue Quail\'s favor on May 6, 1982. Under the terms\nof the letter of credit, payment of up to $585,443.85 was due Blue Quail if Compton failed to pay\nBlue Quail this amount by June 22, 1982. Compton paid MBank $1,463.61 to issue the letter of\ncredit. MBank also received a promissory note payable on demand for $585,443.85. MBank did\nnot need a security agreement to cover the letter of credit transaction because a prior 1980 security\nagreement between the bank and Compton had a future advances provision. This 1980 security\nagreement had been perfected as to a variety of Compton\'s assets through the filing of several\nfinancing statements. The most recent financing statement had been filed a year before, May 7,\n1981. The letter of credit on its face noted that it was for an antecedent debt due Blue Quail.\nOn May 7, 1982, the day after MBank issued the letter of credit in Blue Quail\'s favor,\nseveral of Compton\'s creditors filed an involuntary bankruptcy petition against Compton. On June\n22, 1982, MBank paid Blue Quail $569,932.03 on the letter of credit after Compton failed to pay\nBlue Quail.\nIn the ensuing bankruptcy proceeding, MBank\'s aggregate secured claims against\nCompton, including the letter of credit payment to Blue Quail, were paid in full from the\nliquidation of Compton\'s assets which served as the bank\'s collateral. Walter Kellogg, bankruptcy\ntrustee for Compton, did not contest the validity of MBank\'s secured claim against Compton\'s\nassets for the amount drawn under the letter of credit by Blue Quail. Instead, on June 14, 1983,\ntrustee Kellogg filed a complaint in the bankruptcy court against Blue Quail asserting that Blue\nQuail had received a preferential transfer under 11 U.S.C. Sec. 547 through the letter of credit\ntransaction. The trustee sought to recover $585,443.85 from Blue Quail pursuant to 11 U.S.C. Sec.\n550.\nBlue Quail answered and filed a third party complaint against MBank. [The Bankruptcy\nCourt granted Blue Quail\xe2\x80\x99s] motion for summary judgment, [holding] that the trustee could not\nrecover any preference from Blue Quail because Blue Quail had been paid from MBank\'s funds\nunder the letter of credit and therefore had not received any of Compton\'s property. The district\ncourt affirmed, [holding] that the transfer of the increased security interest to MBank was a transfer\nof the debtor\'s property for the sole benefit of the bank and in no way benefitted Blue Quail.\nIt is well established that a letter of credit and the proceeds therefrom are not property of\nthe debtor\'s estate under 11 U.S.C. Sec. 541. When the issuer honors a proper draft under a letter\nof credit, it does so from its own assets and not from the assets of its customer who caused the\nletter of credit to be issued. As a result, a bankruptcy trustee is not entitled to enjoin a post petition\npayment of funds under a letter of credit from the issuer to the beneficiary, because such a payment\nis not a transfer of debtor\'s property (a threshold requirement under 11 U.S.C. Sec. 547(b)). A case\napparently holding otherwise, In re Twist Cap., Inc., 1 B.R. 284 (Bankr. Fla. 1979), has been\nroundly criticized and otherwise ignored by courts and commentators alike.\n207\n\n\x0cRecognizing these characteristics of a letter of credit in a bankruptcy case is necessary in\norder to maintain the independence principle, the cornerstone of letter of credit law. Under the\nindependence principle, an issuer\'s obligation to the letter of credit\'s beneficiary is independent\nfrom any obligation between the beneficiary and the issuer\'s customer. All a beneficiary has to do\nto receive payment under a letter of credit is to show that it has performed all the duties required\nby the letter of credit. Any disputes between the beneficiary and the customer do not affect the\nissuer\'s obligation to the beneficiary to pay under the letter of credit.\nLetters of credit are most commonly arranged by a party who benefits from the provision\nof goods or services. The party will request a bank to issue a letter of credit which names the\nprovider of the goods or services as the beneficiary. Under a standby letter of credit, the bank\nbecomes primarily liable to the beneficiary upon the default of the bank\'s customer to pay for the\ngoods or services. The bank charges a fee to issue a letter of credit and to undertake this liability.\nThe shifting of liability to the bank rather than to the services or goods provider is the main purpose\nof the letter of credit. After all, the bank is in a much better position to assess the risk of its\ncustomer\'s insolvency than is the service or goods provider. It should be noted, however, that it is\nthe risk of the debtor\'s insolvency and not the risk of a preference attack that a bank assumes under\na letter of credit transaction. Overall, the independence principle is necessary to insure "the\ncertainty of payments for services or goods rendered regardless of any intervening misfortune\nwhich may befall the other contracting party."\nThe trustee in this case accepts this analysis and does not ask us to upset it. The trustee is\nnot attempting to set aside the postpetition payments by MBank to Blue Quail under the letter of\ncredit as a preference; nor does the trustee claim the letter of credit itself constitutes debtor\'s\nproperty. The trustee is instead challenging the earlier transfer in which Compton granted\nMBank an increased security interest in its assets to obtain the letter of credit for the benefit\nof Blue Quail. Collateral which has been pledged by a debtor as security for a letter of credit is\nproperty of the debtor\'s estate. The trustee claims that the direct transfer to MBank of the increased\nsecurity interest on May 6, 1982, also constituted an indirect transfer to Blue Quail which\noccurred one day prior to the filing of the involuntary bankruptcy petition and is voidable as a\npreference under 11 U.S.C. Sec. 547.\nIt is important to note that the irrevocable standby letter of credit in the case at bar was not\narranged in connection with Blue Quail\'s initial decision to sell oil to Compton on credit. Compton\narranged for the letter of credit after Blue Quail had shipped the oil and after Compton had\ndefaulted in payment. The letter of credit in this case did not serve its usual function of backing up\na contemporaneous credit decision, but instead served as a backup payment guarantee on an\nextension of credit already in jeopardy. The letter of credit was issued to pay off an antecedent\nunsecured debt. This fact was clearly noted on the face of the letter of credit. Blue Quail, the\nbeneficiary of the letter of credit, did not give new value for the issuance of the letter of credit by\nMBank on May 6, 1982, or for the resulting increased security interest held by MBank. MBank,\nhowever, did give new value for the increased security interest it obtained in Compton\'s collateral:\nthe bank issued the letter of credit.\nWhen a debtor pledges its assets to secure a letter of credit, a transfer of debtor\'s property\nhas occurred under the provisions of 11 U.S.C. Sec. 547. By subjecting its assets to MBank\'s\nreimbursement claim in the event MBank had to pay on the letter of credit, Compton made a\ntransfer of its property. The broad definition of "transfer" under 11 U.S.C. Sec. 101(50) is clearly\n208\n\n\x0cdesigned to cover such a transfer. Overall, the letter of credit itself and the payments thereunder\nmay not be property of debtor, but the collateral pledged as a security interest for the letter of credit\nis.\nFurthermore, in a secured letter of credit transaction, the transfer of debtor\'s property takes\nplace at the time the letter of credit is issued (when the security interest is granted) and received\nby the beneficiary, not at the time the issuer pays on the letter of credit.\nThe transfer to MBank of the increased security interest was a direct transfer which\noccurred on May 6, 1982, when the bank issued the letter of credit. Under 11 U.S.C. Sec.\n547(e)(2)(A), however, such a transfer is deemed to have taken place for purposes of 11 U.S.C.\nSec. 547 at the time such transfer "takes effect" between the transferor and transferee if such\ntransfer is perfected within 10 days [note now 30 days]. The phrase "takes effect" is undefined in\nthe Bankruptcy Code, but under Uniform Commercial Code Article 9 law, a transfer of a security\ninterest "takes effect" when the security interest attaches. Because of the future advances clause in\nMBank\'s 1980 security agreement with Compton, the attachment of the MBank\'s security interest\nrelates back to May 9, 1980, the date the security agreement went into effect. The bottom line is\nthat the direct transfer of the increased security interest to MBank is artificially deemed to have\noccurred at least by May 7, 1981, the date MBank filed its final financing statement, for purposes\nof a preference attack against the bank. This date is well before the 90 day window of 11 U.S.C.\nSec. 547(b)(4)(A). This would protect the bank from a preference attack by the trustee even if the\nbank had not given new value at the time it received the increased security interest. MBank is\ntherefore protected from a preference attack by the trustee for the increased security interest\ntransfer under either of two theories: under 11 U.S.C. Sec. 547(c)(1) because it gave new value\nand under the operation of the relation back provision of 11 U.S.C. Sec. 547(e)(2)(A). The bank is\nalso protected from any claims of reimbursement by Blue Quail because the bank received no\nvoidable preference.\nThe relation back provision of 11 U.S.C. Sec. 547(e)(2)(A), however, applies only to the\ndirect transfer of the increased security interest to MBank. The indirect transfer to Blue Quail that\nallegedly resulted from the direct transfer to MBank occurred on May 6, 1982, the date of issuance\nof the letter of credit. The relation back principle of 11 U.S.C. Sec. 547(e)(2)(A) does not apply to\nthis indirect transfer to Blue Quail. Blue Quail was not a party to the security agreement between\nMBank and Compton. So it will not be able to utilize the relation back provision if it is deemed to\nhave received an indirect transfer resulting from the direct transfer of the increased security interest\nto MBank. Blue Quail, therefore, cannot assert either of the two defenses to a preference attack\nwhich MBank can claim. Blue Quail did not give new value under sec. 547 (c)(1), and it received\na transfer within 90 days of the filing of Compton\'s bankruptcy petition.\nThe federal courts have long recognized that "[t]o constitute a preference, it is not necessary\nthat the transfer be made directly to the creditor. If the bankrupt has made a transfer of his property,\nthe effect of which is to enable one of his creditors to obtain a greater percentage of his debt than\nanother creditor of the same class, circuity of arrangement will not avail to save it." To combat\nsuch circuity, the courts have broken down certain transfers into two transfers, one direct and one\nindirect. The direct transfer to the third party may be valid and not subject to a preference attack.\nThe indirect transfer, arising from the same action by the debtor, however, may constitute a\nvoidable preference as to the creditor who indirectly benefitted from the direct transfer to the third\nparty.\n209\n\n\x0cThis is the situation presented in the case before us. The term "transfer" as used in the\nvarious bankruptcy statutes through the years has always been broad enough to cover such indirect\ntransfers and to catch various circuitous arrangements. The new Bankruptcy Code implicitly\nadopts this doctrine through its broad definition of "transfer." [The Court then reviews other cases\ninvolving indirect transfers.]\nBlue Quail\'s attempt to otherwise distinguish the case from the direct/indirect transfer cases\ndoes not withstand scrutiny. [In other letter of credit cases], the letters of credit were issued\ncontemporaneously with the initial extension of credit by the beneficiaries of the letters. In those\ncases the letters of credit effectively served as security devices for the benefit of the creditor\nbeneficiaries and took the place of formal security interests. The courts in those cases properly\nfound there had been no voidable transfers, direct or indirect, in the letter of credit transactions\ninvolved. New value was given contemporaneously with the issuance of the letters of credit\nin the form of the extensions of credit by the beneficiaries of the letters. As a result, the 11\nU.S.C. Sec. 547(c)(1) preference exception was applicable.\nThe case at bar differs from these other letter of credit cases by one very important fact:\nthe letter of credit in this case was issued to secure an antecedent unsecured debt due the\nbeneficiary of the letter of credit. The unsecured creditor beneficiary gave no new value upon the\nissuance of the letter of credit. When the issuer paid off the letter of credit and foreclosed on the\ncollateral securing the letter of credit, a preferential transfer had occurred. An unsecured creditor\nwas paid in full and a secured creditor was substituted in its place.\nThe district court upheld the bankruptcy court in maintaining the validity of the letter of\ncredit issued to cover the antecedent debt. The district court held that MBank, the issuer of the\nletter of credit, could pay off the letter of credit and foreclose on the collateral securing it. We are\nin full agreement. But we also look to the impact of the transaction as it affects the situation of\nBlue Quail in the bankrupt estate. We hold that the bankruptcy trustee can recover from Blue Quail,\nthe beneficiary of the letter of credit, because Blue Quail received an indirect preference. This\nresult preserves the sanctity of letter of credit and carries out the purposes of the Bankruptcy Code\nby avoiding a preferential transfer. MBank, the issuer of the letter of credit, being just the\nintermediary through which the preferential transfer was accomplished, completely falls out of the\npicture and is not involved in this particular legal proceeding.\nMBank did not receive any preferential transfer--it gave new value for the security interest.\nFurthermore, because the direct and indirect transfers are separate and independent, the trustee\ndoes not even need to challenge the direct transfer of the increased security interest to MBank, or\nseek any relief at all from MBank, in order to attack the indirect transfer and recover under 11\nU.S.C. Sec. 550 from the indirect transferee Blue Quail.\nWe hold that a creditor cannot secure payment of an unsecured antecedent debt through a\nletter of credit transaction when it could not do so through any other type of transaction. The\npurpose of the letter of credit transaction in this case was to secure payment of an unsecured\nantecedent debt for the benefit of an unsecured creditor. This is the only proper way to look at such\nletters of credit in the bankruptcy context. The promised transfer of pledged collateral induced the\nbank to issue the letter of credit in favor of the creditor. The increased security interest held by the\nbank clearly benefitted the creditor because the bank would not have issued the letter of credit\n210\n\n\x0cwithout this security. A secured creditor was substituted for an unsecured creditor to the detriment\nof the other unsecured creditors.\nWe also hold, therefore, that the trustee can recover under 11 U.S.C. Sec. 550(a)(1) the\nvalue of the transferred property from "the entity for whose benefit such transfer was made." In\nthe case at bar, this entity was the creditor beneficiary, not the issuer, of the letter of credit even\nthough the issuer received the direct transfer from the debtor. The entire purpose of the\ndirect/indirect doctrine is to look through the form of a transaction and determine which entity\nactually benefitted from the transfer.\nThe fact that there was a prior security agreement between the issuing bank and the debtor\ncontaining the future advances clause does not alter this conclusion. As we pointed out in Part II\nsupra, this prior security agreement gave MBank an additional shield from preferential attack\nbecause of the relation back mechanism of 11 U.S.C. Sec. 547(e)(2)(A). 11 U.S.C. Sec.\n547(e)(2)(A), however, does not avail Blue Quail to shield it from a preferential attack for the\nindirect transfer. The indirect transfer to Blue Quail occurred on May 6, 1982, when the letter of\ncredit was issued and the increased security interest was pledged. This was the day before the\ninvoluntary bankruptcy petition was filed. For purposes of 11 U.S.C. Sec. 547, a transfer of\nCompton\'s property for the benefit of Blue Quail did occur within 90 days of the bankruptcy filing.\nThe bankruptcy and district courts erred in failing to analyze properly the transfer of debtor\'s\nproperty that occurred when Compton pledged its assets to obtain the letter of credit. This transfer\nconsisted of two aspects: the direct transfer to MBank which is not a voidable preference for\nvarious reasons and the indirect transfer to Blue Quail which is a voidable preference.\nThe precise holding in this case needs to be emphasized. We do not hold that payment\nunder a letter of credit, or even a letter of credit itself, constitute preferential transfers under 11\nU.S.C. Sec. 547(b) or property of a debtor under 11 U.S.C. Sec. 541. The holding of this case fully\nallows the letter of credit to function. We preserve its sanctity and the underlying independence\ndoctrine. We do not, however, allow an unsecured creditor to avoid a preference attack by utilizing\na letter of credit to secure payment of an antecedent debt. Otherwise the unsecured creditor would\nreceive an indirect preferential transfer from the granting of the security for the letter of credit to\nthe extent of the value of that security. Our holding does not affect the strength of or the proper\nuse of letters of credit. When a letter of credit is issued contemporaneously with a new extension\nof credit, the creditor beneficiary will not be subject to a preferential attack under the direct/indirect\ndoctrine elaborated in this case because the creditor will have given new value in exchange for the\nindirect benefit of the secured letter of credit. Only when a creditor receives a secured letter of\ncredit to cover an unsecured antecedent debt will it be subject to a preferential attack under 11\nU.S.C. Sec. 547(b).\nBlue Quail has no valid claim against MBank for reimbursement for any amounts Blue\nQuail has to pay the trustee under the trustee\'s preference claim, just as the trustee has no preference\nchallenge against MBank. Blue Quail received the preferential transfer, not MBank. MBank gave\nnew value in exchange for the increased security interest in its favor. Thus, it is insulated from any\nassertion of a voidable preference. The bank in no way assumed the risk of a preference attack by\nissuing the letter of credit. For these reasons, we affirm the district court\'s dismissal of Blue Quail\'s\nrequest to proceed against MBank for reimbursement.\n\n211\n\n\x0cIn addition, the trustee may not set aside the $1,463.61 fee Compton paid MBank to issue\nthe letter of credit. This payment is not a preferential transfer. MBank has fully performed its duties\nunder the terms of the letter of credit and has earned this fee. The services MBank rendered in\nissuing and executing the letter of credit constitute new value under the 11 U.S.C. Sec. 547(c)(1)\npreference exception.\n\n8.27.\n\nPractice Problems: The Debtor\xe2\x80\x99s Avoiding Powers\n\nProblem 1: Debtor repays a $10,000 loan ten days before filing bankruptcy. The trustee\navoids the transfer as a preference under Section 547 and recovers $10,000 from the creditor under\nSection 550. The Debtor has not used $15,000 of her wild card exemption. Can the Debtor exempt\nthe trustee\xe2\x80\x99s recovery and keep the $10,000? 11 U.S.C. \xc2\xa7 522(g).\nProblem 2: Creditor garnishes $10,000 of the Debtor\xe2\x80\x99s wages during the 90 day period\nprior to bankruptcy. The trustee brings a preference action under Section 547 to avoid the $10,000\ntransfer, and recovers $10,000 from the creditor under Section 550. The debtor has not used\n$20,000 of her wild card exemption. Can the Debtor exempt the trustee\xe2\x80\x99s recovery and keep the\n$10,000? 11 U.S.C. \xc2\xa7 522(g).\nProblem 3: Suppose that the Trustee in Problem 2, recognizing the futility of seeking to\navoid and recover the $10,000 decides not to bring a preference action. Can the Debtor bring the\naction? 11 U.S.C. \xc2\xa7 522(h).\n\n212\n\n\x0cChapter 9: Secured Claims in Bankruptcy\n9.1.\n\nThe Section 506(a) Split\n\nSection 506 is an extremely important provision of the Bankruptcy Code and should be\nread with great care. It begins with a fundamental concept: a creditor whose collateral is worth less\nthan the debt is partially secured, and partially unsecured. 11 U.S.C. \xc2\xa7 506(a). The undersecured\ncreditor thus has two claims in bankruptcy that are treated very differently: a secured claim to the\nextent of the value of the collateral, and an unsecured claim for the potential deficiency.\nSection 506(a) also discusses how the collateral should be valued for purposes of the split.\nOriginally, the value was governed by the last sentence of Section 506(a) \xe2\x80\x93 the collateral should\nbe valued \xe2\x80\x9cin light of the purpose of the valuation and proposed disposition and use of the\nproperty.\xe2\x80\x9d Thus, the valuation could change throughout the case depending on why the collateral\nwas being valued. In Associates Commercial Corp. v. Rash, 520 U.S. 953 (1997), reprinted below,\nthe Supreme Court established a replacement value standard for reorganization cases where the\ndebtor sought to keep the collateral. It is important to note the famous footnote 4 from the Rash\ndecision, which remains a correct and important consideration in the valuation process.\nIn 2005, Congress added Section 506(a)(2) to the Bankruptcy Code. The general rule of\nSection 506(a)(2) follows Rash, but the new statute differs from Rash in the case of consumer\ngoods by requiring the use of retail value. The statute thus makes it more difficult for debtors to\nkeep their consumer goods even though the creditor will not be able to recover retail value after\nrepossession.\nThe creditors who pushed for Section 506(a)(2)\xe2\x80\x99s overvaluation may not have fully thought\nthe situation through. If the rule makes it more difficult for debtors to keep their property by\nrequiring the use of a high retail value, what happens when the debtors throw up their hands and\nsurrender the collateral back to the secured creditor? The case that follows Rash in the materials,\nIn re Brown, proves the old adage: \xe2\x80\x9cwhat is sauce for the goose is sauce for the gander.\xe2\x80\x9d\n\n9.2.\n\nCases on Valuation and the Section 506(a) Split\n9.2.1.1.\nASSOCIATES COMMERCIAL v. RASH, 520 U.S.\n953 (1997)\n\nJUSTICE GINSBURG\nIn 1989, respondent Elray Rash purchased for $73,700 a Kenworth tractor truck for use in\nhis freight-hauling business. Rash made a down payment on the truck, agreed to pay the seller the\nremainder in 60 monthly installments, and pledged the truck as collateral on the unpaid balance.\nThe seller assigned the loan, and its lien on the truck, to petitioner Associates Commercial\nCorporation (ACC).\nIn March 1992, Elray and Jean Rash filed a joint petition and a repayment plan under\nChapter 13. At the time of the bankruptcy filing, the balance owed to ACC on the truck loan was\n$41,171. Because it held a valid lien on the truck, ACC was listed in the bankruptcy petition as a\n213\n\n\x0ccreditor holding a secured claim. Under the Code, ACC\'s claim for the balance owed on the truck\nwas secured only to the extent of the value of the collateral; its claim over and above the value of\nthe truck was unsecured.\nThe Rashes\' Chapter 13 plan invoked the cram down power. It proposed that the Rashes\nretain the truck for use in the freight-hauling business and pay ACC, over 58 months, an amount\nequal to the present value of the truck. That value, the Rashes\' petition alleged, was $28,500. ACC\nobjected to the plan and asked the Bankruptcy Court to lift the automatic stay so ACC could\nrepossess the truck. ACC also filed a proof of claim alleging that its claim was fully secured in the\namount of $41,171. The Rashes filed an objection to ACC\'s claim.\nThe Bankruptcy Court held an evidentiary hearing to resolve the dispute over the truck\'s\nvalue. At the hearing, ACC and the Rashes urged different valuation benchmarks. ACC maintained\nthat the proper valuation was the price the Rashes would have to pay to purchase a like vehicle, an\namount ACC\'s expert estimated to be $41,000. The Rashes, however, maintained that the proper\nvaluation was the net amount ACC would realize upon foreclosure and sale of the collateral, an\namount their expert estimated to be $31,875.\nCourts of Appeals have adopted three different standards for valuing a security interest in\na bankruptcy proceeding when the debtor invokes the cram down power to retain the collateral\nover the creditor\'s objection. In contrast to the Fifth Circuit\'s foreclosure-value standard, a number\nof Circuits have followed a replacement-value approach. Other courts have settled on the midpoint\nbetween foreclosure value and replacement value. We granted certiorari to resolve this conflict.\nOver ACC\'s objection, the Rashes\' repayment plan proposed, pursuant to \xc2\xa7 1325(a)(5)(B),\ncontinued use of the property in question, i. e., the truck, in the debtor\'s trade or business. In such\na "cram down" case, we hold, the value of the property (and thus the amount of the secured claim\nunder \xc2\xa7 506(a)) is the price a willing buyer in the debtor\'s trade, business, or situation would pay\nto obtain like property from a willing seller. . . .\nThe second sentence of \xc2\xa7 506(a) does speak to the how question. "Such value," that\nsentence provides, "shall be determined in light of the purpose of the valuation and of the proposed\ndisposition or use of such property." \xc2\xa7 506(a). By deriving a foreclosure-value standard from \xc2\xa7\n506(a)\'s first sentence, the Fifth Circuit rendered inconsequential the sentence that expressly\naddresses how "value shall be determined."\nAs we comprehend \xc2\xa7 506(a), the "proposed disposition or use" of the collateral is of\nparamount importance to the valuation question. If a secured creditor does not accept a debtor\'s\nChapter 13 plan, the debtor has two options for handling allowed secured claims: surrender the\ncollateral to the creditor, or, under the cram down option, keep the collateral over the creditor\'s\nobjection and provide the creditor, over the life of the plan, with the equivalent of the present value\nof the collateral. The "disposition or use" of the collateral thus turns on the alternative the debtor\nchooses - in one case the collateral will be surrendered to the creditor, and in the other, the\ncollateral will be retained and used by the debtor. Applying a foreclosure-value standard when the\ncram down option is invoked attributes no significance to the different consequences of the debtor\'s\nchoice to surrender the property or retain it. A replacement-value standard, on the other hand,\ndistinguishes retention from surrender and renders meaningful the key words "disposition or use."\nTying valuation to the actual "disposition or use" of the property points away from a\nforeclosure-value standard when a Chapter 13 debtor, invoking cram down power, retains and uses\n214\n\n\x0cthe property. Under that option, foreclosure is averted by the debtor\'s choice and over the creditor\'s\nobjection. From the creditor\'s perspective as well as the debtor\'s, surrender and retention are not\nequivalent acts.\nWhen a debtor surrenders the property, a creditor obtains it immediately, and is free to sell\nit and reinvest the proceeds. We recall here that ACC sought that very advantage. If a debtor keeps\nthe property and continues to use it, the creditor obtains at once neither the property nor its value\nand is exposed to double risks: The debtor may again default and the property may deteriorate\nfrom extended use. Adjustments in the interest rate and secured creditor demands for more\n"adequate protection" do not fully offset these risks.\nOf prime significance, the replacement-value standard accurately gauges the debtor\'s "use"\nof the property. It values "the creditor\'s interest in the collateral in light of the proposed [repayment\nplan] reality: no foreclosure sale and economic benefit for the debtor derived from the collateral\nequal to ... its [replacement] value." The debtor in this case elected to use the collateral to generate\nan income stream. That actual use, rather than a foreclosure sale that will not take place, is the\nproper guide under a prescription hinged to the property\'s "disposition or use."\nAs our reading of \xc2\xa7 506(a) makes plain, we also reject a ruleless approach allowing use of\ndifferent valuation standards based on the facts and circumstances of individual cases. We agree\nwith the Seventh Circuit that "a simple rule of valuation is needed" to serve the interests of\npredictability and uniformity. We conclude, however, that \xc2\xa7 506(a) supplies a governing\ninstruction less complex than the Seventh Circuit\'s "make two valuations, then split the difference"\nformulation.\nIn sum, under \xc2\xa7 506(a), the value of property retained because the debtor has exercised the\n\xc2\xa7 1325(a)(5)(B) "cram down" option is the cost the debtor would incur to obtain a like asset for\nthe same "proposed ... use."3\n\n9.2.1.2.\n\nIN RE BROWN, 746 F.3d 1236 (11th Cir. 2014)\n\nThe issue before this Court is whether \xc2\xa7 506(a)(2)\'s valuation standard applies when a\nChapter 13 debtor surrenders his vehicle under \xc2\xa7 1325(a)(5)(C). We hold that it does, and we\naffirm.\nIn July 2007, Brown purchased a 37-foot 2006 Keystone Challenger recreational vehicle.\nBrown entered into a loan agreement secured by the recreational vehicle. In July 2012, Brown\nOur recognition that the replacement-value standard, not the foreclosure-value standard, governs in cram down cases\nleaves to bankruptcy courts, as triers of fact, identification of the best way of ascertaining replacement value on the\nbasis of the evidence presented. Whether replacement value is the equivalent of retail value, wholesale value, or some\nother value will depend on the type of debtor and the nature of the property. We note, however, that replacement value,\nin this context, should not include certain items. For example, where the proper measure of the replacement value of\na vehicle is its retail value, an adjustment to that value may be necessary: A creditor should not receive portions of the\nretail price, if any, that reflect the value of items the debtor does not receive when he retains his vehicle, items such\nas warranties, inventory storage, and reconditioning. Cf. 90 F.3d, at 1051-1052. Nor should the creditor gain from\nmodifications to the property-e. g., the addition of accessories to a vehicle-to which a creditor\'s lien would not extend\nunder state law.\n3\n\n215\n\n\x0cfiled for Chapter 13 bankruptcy. Santander, the owner of the loan agreement, filed a proof of\nsecured claim in the bankruptcy court for $36,587.53, the outstanding payoff balance due at the\npetition date. Brown\'s modified Chapter 13 plan proposed surrendering the vehicle in full\nsatisfaction of Santander\'s claim. Santander objected to the confirmation of the plan.\nAt the confirmation hearing on September 27, 2012, the parties disagreed on the method\nfor valuing Brown\'s vehicle. Brown argued that \xc2\xa7 506(a)(2)\'s replacement value standard governed\nhis vehicle\'s valuation, which in turn determined the amount of Santander\'s secured claim. Brown\ncontended that if his vehicle\'s replacement value exceeded his debt, surrendering his vehicle would\nsatisfy Santander\'s entire claim (and his debt). Santander argued that a surrendered vehicle\'s value\nshould be based on its foreclosure value, not replacement value.\nThe bankruptcy court found that while the Supreme Court\'s 1997 decision in Associates\nCommercial Corp. v. Rash, 520 U.S. 953 (1997), supported applying a foreclosure value standard\nto Brown\'s surrendered vehicle, Rash preceded the Bankruptcy Abuse Prevention and Consumer\nProtection Act of 2005\'s ("BAPCPA") addition of \xc2\xa7 506(a)(2), which required the replacement\nvalue standard. The court concluded Santander would have a secured claim to the extent of the\nvehicle\'s replacement value, and that Brown\'s surrender of the vehicle would satisfy that claim\nunder \xc2\xa7 1325(a)(5)(C).\nFollowing a valuation and confirmation hearing, the bankruptcy court determined that the\nvehicle\'s replacement value at least equaled the debt and confirmed Brown\'s Chapter 13 plan.[\nIn Rash, the debtor proposed to retain the collateral under \xc2\xa7 1325(a)(5)(B), while valuing\nthe collateral based on its foreclosure value. However, the Supreme Court interpreted "disposition\nor use" as requiring different valuation standards depending on whether the collateral was\nsurrendered or retained. Rash held that the proper standard was replacement value, not foreclosure\nvalue, in the retention context.\nAfter Rash, BAPCPA added \xc2\xa7 506(a)(2). Like \xc2\xa7 506(a)(1)\'s last sentence, \xc2\xa7 506(a)(2) refers\nto \xc2\xa7 506(a)(1)\'s bifurcation provision and addresses how to determine value. Unlike \xc2\xa7 506(a)(1), \xc2\xa7\n506(a)(2)\'s scope is limited to certain cases and expressly mandates a replacement value standard.\n. . . Thus, when \xc2\xa7 506(a)(1) and (a)(2) both apply, a creditor holding an undersecured claim would\nhave a secured claim equal to the collateral\'s judicially-determined replacement value and an\nunsecured claim to the extent the debt exceeds the collateral\'s replacement value.\nThe parties do not dispute that Brown is an individual in a Chapter 13 case with property\nfalling within the scope of \xc2\xa7 506(a)(2). Nevertheless, they dispute whether \xc2\xa7 506(a)(2) applies.\nSantander contends \xc2\xa7 506(a)(2)\'s replacement value standard does not apply where, as here, the\ndebtor exercises the surrender option under \xc2\xa7 1325(a)(5)(C). Brown contends it does.\nWe begin with the text of the Bankruptcy Code. . . .\nWe disagree with Santander\'s textual arguments. Santander argues that applying \xc2\xa7\n506(a)(2)\'s replacement value standard when a debtor surrenders property under \xc2\xa7 1325(a)(5)(C)\nwould misapply Rash and violate \xc2\xa7 506(a)(1)\'s "disposition and use" language. Specifically,\nSantander contends that applying a replacement value standard would ignore Rash\'s holding that\ndifferent valuation standards should apply depending on the collateral\'s "disposition or use," with\nforeclosure value governing surrender and replacement value governing retention.\n216\n\n\x0cBut Santander fails to acknowledge that Rash preceded BAPCPA\'s addition of \xc2\xa7 506(a)(2),\nwhich expressly requires applying the replacement value standard in this case. And while \xc2\xa7\n506(a)(2)\'s replacement value standard mandate seemingly contradicts \xc2\xa7 506(a)(1)\'s broader\n"disposition and use" valuation language, a well-established canon "of statutory construction [is]\nthat the specific governs the general."\nHere, \xc2\xa7 506(a)(2) specifies how to value certain property in Chapter 7 and 13 cases, while\n\xc2\xa7 506(a)(1) is more broadly worded and says nothing about Chapter 7 and 13 cases. When a case\nfalls within \xc2\xa7 506(a)(2)\'s ambit, its specific requirements control.\nSantander\'s corollary argument is that \xc2\xa7 506(a)(2) only applies to cases where the debtor\nexercises the retention option under \xc2\xa7 1325(a)(5)(B). But this requires us to read a limitation into\nthe statute that does not exist in the plain text. Congress expressly limited \xc2\xa7 506(a)(2) to certain\nChapter 7 and 13 cases; it could have also limited \xc2\xa7 506(a)(2) to cases where the debtor retains or\n"uses" the collateral. Congress did not, and neither will we.\nSantander also asserts that \xc2\xa7 506(a)(2) only applies to retained property under \xc2\xa7\n1325(a)(5)(B), because BAPCPA only added \xc2\xa7 506(a)(2) to codify Rash\'s holding that replacement\nvalue should govern in the retention context. We acknowledge that cases have described \xc2\xa7\n506(a)(2) as a codification of Rash, but they do not hold that \xc2\xa7 506(a)(2) is limited to the facts of\nRash. Nor does the text of \xc2\xa7 506(a)(2) support that conclusion.\nSantander also suggests that it is improper to conduct any valuation at all, because Rash\n"does not state that the court is to pre-determine the value of surrendered vehicles under \xc2\xa7 506(a)\nbased on foreclosure value, or any other value standard." However, as Santander concedes, \xc2\xa7\n506(a)(1) bifurcation applies. Because bifurcation is premised on the collateral\'s valuation, "[i]t\nwas permissible for [Brown] to seek a valuation in proposing [his] Chapter 13 plan."\nNor are we persuaded by Santander\'s arguments that applying \xc2\xa7 506(a)(2) in the surrender\ncontext would be absurd. Santander argues that it would be absurd because it allows debtors to\nsurrender collateral in full satisfaction of the debt. This overstates the effect of \xc2\xa7 506(a)(2).\nSurrender would satisfy the creditor\'s secured claim, not the entire debt. If a creditor holds an\nundersecured claim, the creditor would still have an unsecured claim to the extent the debt exceeds\nthe collateral\'s judicially-determined replacement value.\nSantander also argues that applying \xc2\xa7 506(a)(2) would be absurd because it eliminates\ncreditors\' contract and state law rights to liquidate and pursue an unsecured claim for any\ndeficiency. But state law does not govern if the Bankruptcy Code requires a different result. Here,\nthe Bankruptcy Code is contrary to state law, as an unsecured claim under \xc2\xa7 506(a)(1) and (a)(2)\nequals the amount that the debt exceeds the property\'s replacement value \xe2\x80\x94 not the amount of\npost-sale deficiency. Thus, state law cannot apply.\nThe district court\'s order affirming the bankruptcy court is AFFIRMED.\n\n9.3.\n\nPractice Problems: The \xc2\xa7 506(a) Split\n\nProblem 1: Debtor bought a new car for $25,000 last year, financing 100% of the purchase\nprice at an 18% annual interest rate. The Debtor does not use the car for business, but uses it to get\nto work. The Debtor currently owes $24,500 on the car. The car has a liquidation value of $8,000,\n217\n\n\x0ca replacement value of $12,000, and would be sold by a dealer for $18,000 with the standard 30\nday warranty required by New York law for retail sales. What claims should the lender have?\nDoes it make any difference for valuation whether the Debtor wants to keep or surrender the car?\nProblem 2: Would your answer change if the Debtor used the car in his business as a\ntraveling salesperson?\nProblem 3: What if the Debtor that owned the car was a corporation?\nProblem 4: Debtor owns a home that is subject to a first lien for unpaid property taxes of\n$12,000, a first mortgage of $100,000, and a second mortgage of $20,000. What claims do the\ncreditors have if the property is worth $85,000, $113,000, or $150,000? Does it matter whether\nthe debtor is keeping or surrendering the home?\nProblem 5: Creditor made a $1 million loan to the debtor prepetition secured by the\nDebtor\xe2\x80\x99s office building. After a hearing, the bankruptcy court determined that the office building\nhad a fair market value of $600,000, and therefore that the Creditor had a $600,000 secured claim\nand a $400,000 unsecured claim. Thereafter, the trustee received an offer of $800,000 for the\nproperty. Can the trustee sell the property for $800,000, pay off the secured claim of $600,000,\nand keep the $200,000 balance for unsecured creditors?\nProblem 6: If creditor in Problem 5 believes that the property is worth $900,000, is there\nanything that creditor can do in connection with the proposed sale to preserve its rights as a secured\ncreditor? See 11 U.S.C. \xc2\xa7 363(k).\n\n9.4.\n\nPractice Problems: Post-Petition Interest, Fees, Costs and\nCharges (11 U.S.C. \xc2\xa7 506(b))\n\nRead Section 506(b) carefully and answer the following problems:\nProblem 1. On the petition date, Debtor owns a house worth $210,000, and owes $200,000\nin principal on a first mortgage. The mortgage carries a simple interest rate of 1% per month. The\npromissory note also provides for late fees of an additional 1% of the loan balance per month\nduring any period of default. The debtor does not have the money to make mortgage payments.\nAssume that the debtor files bankruptcy exactly one month after the last payment was made. What\nclaims does the lender have on the petition date, and what claims will the lender have three months\nlater? 12 months later?\nProblem 2. Same as Problem (1) except the Debtor owns a house worth 200,000, and the\nprincipal balance on the first mortgage is $210,000 on the petition date. What claims does the\nlender have on the petition date, and what claims will the lender have three months later? 12\nmonths later?\nProblem 3. Can the interest rate on a loan be challenged on the grounds that the rate is\nunreasonably high? Can the late charge provision be challenged in bankruptcy?\n\n218\n\n\x0c9.5.\n\nCases on Post-Petition Interest under Section 506(b)\n9.5.1.1.\nIN RE RESIDENTIAL CAPITAL, INC., 508 B.R. 851\n(Bankr. S.D.N.Y. 2014)\n\nThe Bankruptcy Code entitles oversecured creditors to postpetition interest, but the Code\ndoes not describe how to calculate it. As an oversecured creditor, Citibank seeks postpetition\ninterest at the default rate governed by its contract (the \xe2\x80\x9cAgreement\xe2\x80\x9d) with two Debtor entities.\nThe ResCap Liquidating Trust (the \xe2\x80\x9cTrust\xe2\x80\x9d) opposes the contract default rate, arguing that\nit is inequitable because it would harm unsecured creditors and because Citibank was protected in\nthe bankruptcy and was adequately compensated both before and during the bankruptcy. The\nparties agree that the right to postpetition interest does not arise from the contract itself; the right\narises from the Bankruptcy Code. The parties have stipulated to the facts and seek a decision\nwithout the necessity of an evidentiary hearing.\nIn determining the interest to be awarded to an oversecured creditor, two guiding principles\napply: (1) courts in this circuit apply a rebuttable presumption that the contract default rate applies;\nand (2) a court has only limited discretion\xe2\x80\x94which it should exercise \xe2\x80\x9csparingly\xe2\x80\x9d\xe2\x80\x94 to modify the\ncontract interest rate. Case law has identified non-exclusive factors to consider in exercising this\ndiscretion. The factors do not all point in one direction here. For the reasons explained below, the\nCourt concludes that Citibank should recover postpetition interest at the contract default rate, but\nonly after the loan\xe2\x80\x99s maturity date. For the period between the Debtors\xe2\x80\x99 bankruptcy filings and the\nloan\xe2\x80\x99s maturity date, interest at the contract non-default interest rate\xe2\x80\x94already paid to Citibank\xe2\x80\x94\nis appropriate.\nCitibank also seeks to recover the unpaid portion of its legal fees and expenses in pursuing\ndefault interest at the contract rate. The Agreement provides that Citibank is entitled to recover its\nfees and expenses, most of which were paid by the Debtors during the case; at some point the\nDebtors stopped paying, so Citibank now seeks to recover the unpaid balance. Because Citibank\xe2\x80\x99s\nMotion was pursued in good faith, its request to recover attorneys\xe2\x80\x99 fees and expenses that were not\npreviously reimbursed is GRANTED, subject to the Trust having an opportunity to review and\nchallenge the reasonableness of the requested fees and expenses.\nOn May 14, 2012 (the \xe2\x80\x9cPetition Date\xe2\x80\x9d), each of the Debtors filed a voluntary petition for\nrelief under chapter 11 of the Bankruptcy Code. Before the Petition Date, Citibank entered into a\nrevolving credit facility with GMAC Mortgage, LLC (\xe2\x80\x9cGMACM\xe2\x80\x9d) as borrower and Residential\nCapital, LLC (\xe2\x80\x9cResCap\xe2\x80\x9d) as guarantor. That MSR Loan Facility allowed GMACM to borrow up\nto $700 million, secured by mortgage servicing rights (\xe2\x80\x9cMSRs\xe2\x80\x9d) for loans in Fannie Mae and\nFreddie Mac securitization pools.\nOriginally, the MSR Loan Facility had a maturity date of August 31, 2010 (id. \xc2\xb6 7), but the\nparties amended the Agreement ten times, [the last time in contemplation of bankruptcy]. If, as the\nparties contemplated, bankruptcy petitions were filed, they understood the loans would probably\nnot be repaid at maturity, but agreed that any order approving the sale of the collateral \xe2\x80\x9cshall\nprovide for the repayment of Loans with proceeds of Collateral received by the Borrower from\nsuch sale . . . .\xe2\x80\x9d (Id.) The substantial extension fee for Amendment Ten no doubt recognized that\nthe loans in all likelihood were going to remain outstanding for more than two months while the\n219\n\n\x0cDebtors marketed their assets and obtained necessary approvals for the sales (including from the\nCourt).\nThe original Agreement established a non-default interest rate of LIBOR plus six percent,\nand a default rate that was four percent higher.\nOn the Petition Date, the outstanding principal balance under the MSR Loan Facility was\napproximately $152 million. Despite the many amendments to the Agreement, one provision\nrelevant to this Motion never changed (including in Amendment Ten): the filing of a bankruptcy\npetition always constituted an event of default. Therefore, filing the bankruptcy petitions was an\nevent of default. Additionally, Citibank was not repaid on the May 30, 2012 maturity date, and\nthat was also an event of default.\nAfter the Petition Date, Citibank entered into an agreement allowing the Debtors to use\nCitibank\xe2\x80\x99s cash collateral. The [cash collateral order] included a finding that \xe2\x80\x9cCitibank is\noversecured and, accordingly, is entitled to interest and fees with respect to the Prepetition\n[Agreement].\xe2\x80\x9d No party challenged that finding within the 120-day challenge period. The Citibank\nOrder required the Debtors to pay (1) interest on the prepetition MSR Loan Facility obligations at\nthe non-default rate, (2) fees required by the Agreement at the times specified in the Agreement,\nand (3) Citibank\xe2\x80\x99s reasonable fees and costs, including fees and expenses for Citibank\xe2\x80\x99s\nprofessionals.\nOn November 21, 2012, the Court entered an order approving the sale of the Debtors\xe2\x80\x99\nmortgage origination and servicing platform to Ocwen Loan Servicing LLC. That Sale Order\nrequired the Debtors to obtain the consent of Fannie Mae and Freddie Mac, both of which had\nobjected to the sale. The parties settled those objections in January 2013. As required by\nAmendment Ten, the Sale Order authorized the Debtors to apply a portion of the sale proceeds to\nsatisfy the Debtors\xe2\x80\x99 \xe2\x80\x9cobligations under the [Agreement].\xe2\x80\x9d On January 31, 2013, the date the sale\nclosed, the Debtors paid Citibank the outstanding principal of $152 million plus interest at the\ncontractual non-default rate.\nCitibank argued that the Sale Order required the Debtors to pay Citibank accrued interest\nat the contract default rate. The Debtors disagreed and refused to pay interest at the contract default\nrate. The parties agreed the default interest issue would remain open for later resolution.\nOn December 11, 2013, the Court entered an order confirming the joint chapter 11 plan in\nthese cases. Under the Plan, unsecured creditors will receive recoveries between nine percent and\njust over thirty-six percent of their claims. The Disclosure Statement described the dispute between\nCitibank and the Debtors and explained that if Citibank prevails and obtains postpetition interest\nat the contract default rate, \xe2\x80\x9cit would be entitled to an Allowed Other Secured Claim of\napproximately $4.5 million in addition to the amounts already paid.\xe2\x80\x9d With the passage of time\nsince the Motion was filed, Citibank now calculates the differential between the non-default\ninterest which it received and the default interest it claims as $5.04 million.\nCitibank also argues that the Debtors wrongly stopped paying Citibank\xe2\x80\x99s legal fees. In its\nObjection, the Trust asserts that the Debtors paid approximately $1.21 million in Citibank\xe2\x80\x99s legal\nfees before repayment of the MSR Loan Facility, and an additional $136,000 after repayment.\nUnpaid fees claimed by Citibank allegedly total $351,935.20, plus $5,233.34 as of January 31,\n2014. The Trust opposes any further payment of legal fees, stating at the March 26, 2014 hearing\n220\n\n\x0con the Motion that \xe2\x80\x9cunder these circumstances, which . . . are really rather extreme . . . it was\ninequitable to pursue the default interest.\xe2\x80\x9d\nBankruptcy Code section 506(b) provides that an oversecured creditor is entitled to interest\non its secured claim, \xe2\x80\x9cand any reasonable fees, costs or charges provided under the agreement\nunder which such claim arose.\xe2\x80\x9d The oversecured creditor may receive postpetition interest up to\nthe value of its equity cushion, i.e., the difference between the value of the allowed claim and the\nvalue of the collateral securing the claim. Section 506(b) governs a court\xe2\x80\x99s determination of\npostpetition interest; state law governs a creditor\xe2\x80\x99s claim for prepetition interest.\nWhile the Bankruptcy Code governs postpetition interest, there is a rebuttable presumption\nthat the parties\xe2\x80\x99 contract rate should apply. (\xe2\x80\x9c[A] debtor bears the burden of rebutting the\npresumption that the contract rate of interest applies post-petition.\xe2\x80\x9d)\n[The Court in a prior case (Travelers) awarded default rate interest]. The Trust argues that\nTravelers does not control here because post-Travelers courts have denied postpetition interest at\nthe contract default rate on equitable grounds.\nTrying to seize on this factor, the Trust argues that the rebuttable presumption is overcome\nhere because the Debtors are insolvent, meaning that unsecured creditors will be harmed by an\naward of the contract rate for Citibank. The Trust notes that no Second Circuit cases involving\ninsolvent debtors have awarded oversecured creditors contractual default interest.\nWhether the debtor is insolvent is certainly an important factor courts consider in deciding\nwhether to award an oversecured creditor postpetition interest at the contract default rate. But no\ncourt has adopted a bright line rule that the contract default rate should be refused in all insolvent\ndebtor cases. As the court noted in Madison 92nd St. Assocs., the presumptive contract default\nrate should not necessarily be adjusted downward in insolvent debtor cases even though the\nunsecured creditors will not be paid in full: \xe2\x80\x9cMost chapter 11 cases involve insolvent debtors, and\nsuch an exception would swallow up the rule that the oversecured creditor is presumptively entitled\nto the \xe2\x80\x98contract rate.\xe2\x80\x99\xe2\x80\x9d 472 B.R. at 200 n.7. The precise issue in Madison 92nd St. Assocs. was\nwhether the state law statutory judgment interest rate (9%) or the federal judgment rate (0.2%)\nshould apply in awarding postpetition interest. The court explained that \xe2\x80\x9c[t]he great majority of\ncourts have concluded that the appropriate rate should be the one provided in the parties\xe2\x80\x99\nagreement or the applicable law under which the claim arose, the so-called \xe2\x80\x98contract rate\xe2\x80\x99 of\ninterest.\xe2\x80\x9d While the parties in Madison disputed whether the debtor was insolvent (indeed,\npossibly, administratively insolvent), the court concluded that the contract rate or state law rate\nshould apply. Solvency vel non is an important factor, but not the determinative factor.\nAdopting a bright-line rule refusing to enforce contract default interest for oversecured\ncreditors of insolvent debtors would likely increase the cost of credit for all high-risk borrowers if\nthe creditor cannot protect itself from \xe2\x80\x9cunforeseeable costs involved with collecting from debtors\nin default.\xe2\x80\x9d\nWhere prepetition interest is in question, the answer is clear: state law controls and contract\ndefault interest is awarded so long as state law permits it. When it comes to postpetition interest,\nthough, the Bankruptcy Code controls payment of default interest to oversecured creditors, but the\npotential economic consequences in the credit markets remain. Refusing to enforce bargained-for\ndefault interest for oversecured creditors raises the risk that lenders will demand higher interest\n221\n\n\x0crates from all high risk borrowers to compensate for the potentially higher costs of collection and\ngreater risk of loss once bankruptcy begins.\nThat doesn\xe2\x80\x99t mean that the contract default rate should be awarded to all oversecured\ncreditors in insolvent debtor cases. The Supreme Court in the seminal case of Vanston Bondholders\nProtective Committee v. Green, 329 U.S. 156 (1947), applied equitable considerations based on\nthe purpose of bankruptcy favoring \xe2\x80\x9cratable distribution of assets among the bankrupt\xe2\x80\x99s creditors.\xe2\x80\x9d\nWhile the creditor in that case was oversecured, and the contract entitled the creditor to interest on\ninterest, the Court rejected awarding that relief: \xe2\x80\x9cThe general rule in bankruptcy and in equity\nreceivership has been that interest on the debtors\xe2\x80\x99 obligations ceases to accrue at the beginning of\nthe proceedings.\xe2\x80\x9d If all creditors are to be repaid in full, equitable considerations permit payment\nof the additional interest to the secured creditor rather than to the debtor. \xe2\x80\x9cIt is manifest that the\ntouchstone of each decision on allowance of interest in bankruptcy, receivership and\nreorganization has been the balance of equities between creditor and creditor or between creditors\nand the debtor.\xe2\x80\x9d\nThe issue then is the balance of the equities. In many or even most cases involving insolvent\ndebtors, the balance may well fall on the side of the junior secured or unsecured creditors\xe2\x80\x94they\nare the ones that will have their distributions reduced when the oversecured creditor is awarded\npostpetition interest at the contract default rate.\nWhile the issue is a close one here, the Court concludes in the exercise of discretion that\nthe balance of equities favors the award to Citibank of contract default interest, except for the\nperiod between the Petition Date of May 14, 2012 and Amendment Ten\xe2\x80\x99s Maturity Date of May\n30, 2012, which will be discussed below.\nThe Trust argues that the Court should not grant Citibank default interest at the contract\nrate because that award would diminish recovery to unsecured creditors. Citing the Disclosure\nStatement, the Trust notes that general unsecured creditor recoveries will range from nine percent\nto just over thirty-six percent. Awarding Citibank the contract default rate further diminishes\nunsecured creditor recoveries. Harm to unsecured creditors is unquestionably a factor counseling\nagainst the award of default contract interest. But, as explained below, if Amendment Ten is\nviewed as one piece of the Debtors\xe2\x80\x99 postpetition financing that enabled the Debtors to continue\noperating as a going concern, it is not clear that unsecured creditor recoveries were diminished\nfrom what they would have been if the Debtors had been forced to liquidate soon after the cases\nwere filed if they had been unable to obtain sufficient postpetition financing. While it is easy to\nconclude that every dollar paid to Citibank today is one dollar less for unsecured creditors, what\nis more difficult to say is that this result today is inequitable. All creditors benefited as a result of\nthe Debtors\xe2\x80\x99 ability to continue to operate as a going concern\xe2\x80\x94a result that was only possible\nwhen the Debtors obtained sufficient financing to conduct their business. Citibank argues that,\nwhen put in context, granting the contract rate here would only have a \xe2\x80\x9cminiscule\xe2\x80\x9d impact on\nrecovery by unsecured creditors because on the whole, those creditors are recovering from a $2.462\nbillion pool. (Motion \xc2\xb6 27; Stip. \xc2\xb6 23.) To be sure, the Court rejects Citibank\xe2\x80\x99s argument that $5\nmillion is \xe2\x80\x9cminiscule.\xe2\x80\x9d Nevertheless, because this is an equitable inquiry, the Court must consider\nthe impact that awarding the contract default rate has on unsecured creditors. It would diminish\nthe pool of distributable assets by roughly two-tenths of a percent. That reduction in distributable\nassets is not\xe2\x80\x94on its own\xe2\x80\x94sufficient to overcome the rebuttable presumption in favor of the\ncontractual default rate.\n222\n\n\x0cIn this case, Amendment Ten\xe2\x80\x94entered in contemplation of bankruptcy\xe2\x80\x94already hiked the\nnon-default interest rate from LIBOR plus six percent to LIBOR plus eight and one-half percent,\nwith the default rate set four percent higher. If an oversecured lender knew that the contract default\nrate would not be enforced postpetition, it could have demanded a higher non-default interest\nrate\xe2\x80\x94for example, LIBOR plus twelve and one-half percent from the date of the amendment. That\nwould have been a steep rate, particularly when all of the fees associated with the extension were\nadded, but not unenforceable under state law. The risk of higher rates across the board for\ndistressed borrowers does not mean that the default rate should be enforced in all cases, but a court\nshould pause before barring collection of default interest, even when it reduces recoveries for\nunsecured creditors. All of the facts and circumstances of the case should be examined. . . .\nThe Trust argues that additional equitable factors also weigh against default interest here.\nEven after the Petition Date, Citibank received timely payments of interest at the non-default rate.\nEven though Citibank did not receive the proceeds of the Walter Sale until seven months past the\nloan maturity date, the Trust argues that Citibank knowingly accepted this risk by negotiating\nAmendment Ten understanding that the Obligors would file for bankruptcy. The Trust also argues\nthat repayment was never seriously at risk due to the stalking horse contracts that the Debtors\nsecured before filing for bankruptcy.\nAll of this is true, but the bargain that Citibank struck for assuming these risks, whether\nreal or exaggerated, included interest at the contract default rate. The Debtors agreed, and not in a\nvacuum, but in the context of negotiations with many sophisticated parties aimed at helping the\nDebtors proceed into bankruptcy with a semblance of order, to the benefit of secured and unsecured\ncreditors.\nOffering another reason to deny the Motion, the Trust argues that this case involves only a\ntechnical default. According to the Trust, the bankruptcy filing did not prejudice Citibank since\nCitibank continued to receive timely payments and was adequately protected. The Trust likens the\ndefault event clause to an ipso facto clause. Such clauses are generally disfavored, although not\nper se invalid in this circuit.\nThe Court concludes that solely as it relates to the sixteen day period in May 2012 between\nthe Petition Date and the loan maturity date, granting the contract default rate would be inequitable.\nDuring that time, the Debtors were current on the loan, and assuming that Citibank was\noversecured, it was entitled to recover its costs, fees and expenses. While the contract provision\nmaking the filing of a bankruptcy petition an event of default is not invalid as an impermissible\nipso facto clause, bankruptcy policy should not penalize a debtor for filing by awarding default\ninterest when the only default was the filing itself. Other courts have rejected default interest where\nthe only event of default was a bankruptcy filing.\nBut the Debtors defaulted in a more meaningful sense later by failing to pay Citibank at\nthe maturity date, so Citibank is entitled to recover postpetition interest at the contract default rate\nfor the period after the maturity date.\nHaving found that Citibank is entitled to recover interest at the contract default rate, the\nCourt easily concludes that Citibank should be awarded its legal fees in pursuing that relief. Even\nif the Court ruled against Citibank with respect to default interest, the Court would nevertheless\nconclude that Citibank pursued the Motion in good faith and is entitled to recover its legal fees as\n223\n\n\x0cprovided for in the Agreement. Citibank\xe2\x80\x99s request for legal fees incurred in pursuing postpetition\ninterest at the contractual default rate is GRANTED.\n\n9.6.\n\nThe Section 506(c) Surcharge\n\nSection 506(c) allows the court to surcharge a secured creditor\xe2\x80\x99s collateral for the direct\nbenefits received by the secured creditor in preserving or selling the collateral. Trustees in\nadministratively insolvent cases look longingly at the security creditor\xe2\x80\x99s collateral when seeking\nto recover funds to pay bankruptcy administrative expenses. But secured creditor generally do not\nseek the aid of bankruptcy, and its accompanying administrative expenses, but rather are delayed\nfrom foreclosing by the filing of the bankruptcy case. Only when the secured creditor directly\nbenefitted from the estate\xe2\x80\x99s services (such as saving the cost of foreclosure) do courts consider a\nsurcharge, and only when the secured creditor would not have been paid in full in foreclosure\n(oversecured creditors generally cannot be surcharged). In re Compton Impressions Ltd., 217 F.3d\n1256 (9th Cir. 2000) (denying surcharge where creditor would have been paid in full); In re West\nPost Road Props. Corp., 44 B.R. 244, 246 (Bankr. S.D.N.Y. 1984) (same).\nSimilarly, in Hartford v. Union Planters, 530 U.S. 1 (2000), the Supreme Court considered\nwhether an administrative unsecured creditor could seek to surcharge a secured creditor\xe2\x80\x99s claim\nunder Section 506(c). Hartford had provided workers compensation insurance to the debtor postpetition, without receiving payment. Hartford claimed that the insurance allowed the\nreorganization to continue, which benefitted secured creditor Union Planters. Hartford sought to\nsurcharge Union Planters for the cost of the insurance. The Supreme Court rejected Hartford\xe2\x80\x99s\nclaim, holding that the plain language of Section 506(c) allows only the trustee (or possibly a\ndebtor in possession who stands in the shoes of the trustee) to seek a Section 506(c) surcharge.\n\n9.7.\n\nSection 506(d) and Striping-down or Striping-Off Liens\n\nOne reading Section 506(d) in the context of the code section would surely think that the\nundersecured creditor\xe2\x80\x99s secured claim would set a limit. Take a simple example. Debtor owns a\nhouse worth $100,000, subject to a $125,000 mortgage. We\xe2\x80\x99ve already seen that the mortgagee\nhas a $100,000 secured claim and a $25,000 unsecured claim in bankruptcy, and is entitled to no\npost-petition interest, fees, costs or charges. Section 506(d) then suggests that the unsecured\nportion would no longer be secured by the property, could be discharged, leaving only the\n$100,000 secured claim as a lien against the property. This would be strip down \xe2\x80\x93 the lien would\nbe stripped down to the value of the collateral, and the unsecured portion would no longer be part\nof the secured claim in the future.\nIn what was at the time a surprising decision to many, the Supreme Court in the Dewsnup\ncase that follows in the materials rejected the notion that Section 506(d) allows \xe2\x80\x9cstrip down\xe2\x80\x9d in\nChapter 7. Ever since, Courts have struggled to give Section 506(d) meaning. More recently in the\nCaulkett decision discussed below, the Supreme Court appeared to double-down on its decision in\nDewsnup, holding that liens wholly unsecured by collateral value could also not be stripped off. A\nclose reading of Caulkett suggests that Section 506(d) may have new life as voting majorities on\nthe Supreme Court shift.\n224\n\n\x0cThese decisions only address the \xe2\x80\x9cstrip down\xe2\x80\x9d and \xe2\x80\x9cstrip off\xe2\x80\x9d of liens in Chapter 7 under\nSection 506(d). They do not address the ability to restructure debts under the reorganization\nchapters \xe2\x80\x93 a topic that will await further consideration in our orderly review of the chapter\nproceedings.\n\n9.8.\n\nCases on Stripping Liens under Section 506(d)\n9.8.1.1.\n\nDEWSNUP v. TIMM, 502 U.S. 410 (1992)\n\nWe are confronted in this case with an issue concerning \xc2\xa7 506(d) of the Bankruptcy Code,\n11 U.S.C. \xc2\xa7 506(d). May a debtor "strip down" a creditor\'s lien on real property to the value of the\ncollateral, as judicially determined, when that value is less than the amount of the claim secured\nby the lien?\nOn June 1, 1978, respondents loaned $119,000 to petitioner Aletha Dewsnup and her\nhusband, T. LaMar Dewsnup, since deceased. The loan was accompanied by a Deed of Trust\ngranting a lien on two parcels of Utah farmland owned by the Dewsnups.\nPetitioner defaulted the following year. Under the terms of the Deed of Trust, respondents\nat that point could have proceeded against the real property collateral by accelerating the maturity\nof the loan, issuing a notice of default, and selling the land at a public foreclosure sale to satisfy\nthe debt.\nRespondents did issue a notice of default in 1981. Before the foreclosure sale took place,\nhowever, petitioner sought reorganization under Chapter 11 of the Bankruptcy Code. That\nbankruptcy petition was dismissed, as was a subsequent Chapter 11 petition. In June 1984,\npetitioner filed a petition seeking liquidation under Chapter 7 of the Code. Because of the pendency\nof these bankruptcy proceedings, respondents were not able to proceed to the foreclosure sale.\nIn 1987, petitioner filed the present adversary proceeding in the Bankruptcy Court for the\nDistrict of Utah seeking, pursuant to \xc2\xa7 506, to "avoid" a portion of respondents\' lien. Petitioner\nrepresented that the debt of approximately $120,000 then owed to respondents exceeded the fair\nmarket value of the land and that, therefore, the Bankruptcy Court should reduce the lien to that\nvalue. According to petitioner, this was compelled by the interrelationship of the security-reducing\nprovision of \xc2\xa7 506(a) and the lien-voiding provision of \xc2\xa7 506(d).\nThe Bankruptcy Court refused to grant this relief. After a trial, it determined that the then\nvalue of the land subject to the Deed of Trust was $39,000. It indulged in the assumption that the\nproperty had been abandoned by the trustee pursuant to \xc2\xa7 554, and reasoned that once property\nwas abandoned it no longer fell within the reach of \xc2\xa7 506(a), which applies only to "property in\nwhich the estate has an interest," and therefore was not covered by \xc2\xa7 506(d). The United States\nDistrict Court [and] the Court of Appeals for the Tenth Circuit, affirmed.\nAs we read their several submissions, the parties and their amici are not in agreement in\ntheir respective approaches to the problem of statutory interpretation that confronts us. Petitionerdebtor takes the position that \xc2\xa7\xc2\xa7 506(a) and 506(d) are complementary and to be read together.\nBecause, under \xc2\xa7 506(a), a claim is secured only to the extent of the judicially determined value\nof the real property on which the lien is fixed, a debtor can void a lien on the property pursuant to\n\xc2\xa7 506(d) to the extent the claim is no longer secured and thus is not "an allowed secured claim."\n225\n\n\x0cIn other words, \xc2\xa7 506(a) bifurcates classes of claims allowed under \xc2\xa7 502 into secured claims and\nunsecured claims; any portion of an allowed claim deemed to be unsecured under \xc2\xa7 506(a) is not\nan "allowed secured claim" within the lien-voiding scope of \xc2\xa7 506(d). Petitioner argues that there\nis no exception for unsecured property abandoned by the trustee.\nPetitioner\'s amicus argues that the plain language of \xc2\xa7 506(d) dictates that the proper\nportion of an undersecured lien on property in a Chapter 7 case is void whether or not the property\nis abandoned by the trustee. It further argues that the rationale of the Court of Appeals would lead\nto evisceration of the debtor\'s right of redemption and the elimination of an undersecured creditor\'s\nability to participate in the distribution of the estate\'s assets.\nRespondents primarily assert that \xc2\xa7 506(d) is not, as petitioner would have it, "rigidly tied"\nto \xc2\xa7 506(a). They argue that \xc2\xa7 506(a) performs the function of classifying claims by true secured\nstatus at the time of distribution of the estate to ensure fairness to unsecured claimants. In contrast,\nthe lien-voiding \xc2\xa7 506(d) is directed to the time at which foreclosure is to take place, and, where\nthe trustee has abandoned the property, no bankruptcy distributional purpose is served by voiding\nthe lien.\nIn the alternative, respondents, joined by the United States as amicus curiae, argue more\nbroadly that the words "allowed secured claim" in \xc2\xa7 506(d) need not be read as an indivisible term\nof art defined by reference to \xc2\xa7 506(a), which by its terms is not a definitional provision. Rather,\nthe words should be read term-by-term to refer to any claim that is, first, allowed, and, second,\nsecured. Because there is no question that the claim at issue here has been "allowed" pursuant to \xc2\xa7\n502 of the Code and is secured by a lien with recourse to the underlying collateral, it does not come\nwithin the scope of \xc2\xa7 506(d), which voids only liens corresponding to claims that have not been\nallowed and secured. This reading of \xc2\xa7 506(d), according to respondents and the United States,\ngives the provision the simple and sensible function of voiding a lien whenever a claim secured by\nthe lien itself has not been allowed. It ensures that the Code\'s determination not to allow the\nunderlying claim against the debtor personally is given full effect by preventing its assertion\nagainst the debtor\'s property.\nRespondents point out that pre-Code bankruptcy law preserved liens like respondents\' and\nthat there is nothing in the Code\'s legislative history that reflects any intent to alter that law.\nMoreover, according to respondents, the "fresh start" policy cannot justify an impairment of\nrespondents\' property rights, for the fresh start does not extend to an in rem claim against property\nbut is limited to a discharge of personal liability.\nThe foregoing recital of the contrasting positions of the respective parties and their amici\ndemonstrates that \xc2\xa7 506 of the Bankruptcy Code and its relationship to other provisions of that\nCode do embrace some ambiguities. Hypothetical applications that come to mind and those\nadvanced at oral argument illustrate the difficulty of interpreting the statute in a single opinion that\nwould apply to all possible fact situations. We therefore focus upon the case before us and allow\nother facts to await their legal resolution on another day.\nWe conclude that respondents\' alternative position, espoused also by the United States,\nalthough not without its difficulty, generally is the better of the several approaches. Therefore, we\nhold that \xc2\xa7 506(d) does not allow petitioner to "strip down" respondents\' lien, because respondents\'\nclaim is secured by a lien and has been fully allowed pursuant to \xc2\xa7 502. Were we writing on a\nclean slate, we might be inclined to agree with petitioner that the words "allowed secured claim"\n226\n\n\x0cmust take the same meaning in \xc2\xa7 506(d) as in \xc2\xa7 506(a). But, given the ambiguity in the text, we\nare not convinced that Congress intended to depart from the pre-Code rule that liens pass through\nbankruptcy unaffected.\nThe practical effect of petitioner\'s argument is to freeze the creditor\'s secured interest at the\njudicially determined valuation. By this approach, the creditor would lose the benefit of any\nincrease in the value of the property by the time of the foreclosure sale. The increase would accrue\nto the benefit of the debtor, a result some of the parties describe as a "windfall."\nWe think, however, that the creditor\'s lien stays with the real property until the\nforeclosure. That is what was bargained for by the mortgagor and the mortgagee. The voidness\nlanguage sensibly applies only to the security aspect of the lien and then only to the real deficiency\nin the security. Any increase over the judicially determined valuation during bankruptcy rightly\naccrues to the benefit of the creditor, not to the benefit of the debtor and not to the benefit of other\nunsecured creditors whose claims have been allowed and who had nothing to do with the\nmortgagor-mortgagee bargain.\nIt is true that [the lienholder\xe2\x80\x99s] participation in the bankruptcy results in his having the\nbenefit of an allowed unsecured claim as well as his allowed secured claim, but that does not strike\nus as proper recompense for what petitioner proposes by way of the elimination of the remainder\nof the lien. This result appears to have been clearly established before the passage of the 1978 Act.\n...\nWhen Congress amends the bankruptcy laws, it does not write "on a clean slate."\nFurthermore, this Court has been reluctant to accept arguments that would interpret the Code,\nhowever vague the particular language under consideration might be, to effect a major change in\npre-Code practice that is not the subject of at least some discussion in the legislative history. Of\ncourse, where the language is unambiguous, silence in the legislative history cannot be controlling.\nBut, given the ambiguity here, to attribute to Congress the intention to grant a debtor the broad\nnew remedy against allowed claims to the extent that they become "unsecured" for purposes of \xc2\xa7\n506(a) without the new remedy\'s being mentioned somewhere in the Code itself or in the annals\nof Congress is not plausible, in our view, and is contrary to basic bankruptcy principles.\nJustice Scalia, with whom Justice Souter joins, dissenting.\nRead naturally and in accordance with other provisions of the statute, [506(d)]\nautomatically voids a lien to the extent the claim it secures is not both an "allowed claim" and a\n"secured claim" under the Code. In holding otherwise, the Court replaces what Congress said with\nwhat it thinks Congress ought to have said\xe2\x80\x94and in the process disregards, and hence impairs for\nfuture use, well established principles of statutory construction. I respectfully dissent.\nThe Court makes no attempt to establish a textual or structural basis for overriding the plain\nmeaning of \xc2\xa7 506(d), but rests its decision upon policy intuitions of a legislative character, and\nupon the principle that a text which is "ambiguous" (a status apparently achieved by being the\nsubject of disagreement between self-interested litigants) cannot change pre-Code law without the\nimprimatur of "legislative history." Thus abandoning the normal and sensible principle that a term\n(and especially an artfully defined term such as "allowed secured claim") bears the same meaning\nthroughout the statute, the Court adopts instead what might be called the one-subsection-at-a-time\napproach to statutory exegesis. "[W]e express no opinion," the Court amazingly says, "as to\nwhether the words `allowed secured claim\' have different meaning in other provisions of the\n227\n\n\x0cBankruptcy Code." "We . . . focus upon the case before us and allow other facts to await their legal\nresolution on another day."\n***\nMoreover, the practical consequences of the United States\' interpretation would be absurd.\nA secured creditor holding a lien on property that is completely worthless would not face lien\navoidance under \xc2\xa7 506(d), even if the claim secured by that lien were disallowed entirely.\nThe principal harm caused by today\'s decision is not the misinterpretation of \xc2\xa7 506(d) of\nthe Bankruptcy Code. The disposition that misinterpretation produces brings the Code closer to\nprior practice and is, as the Court irrelevantly observes, probably fairer from the standpoint of\nnatural justice. (I say irrelevantly, because a bankruptcy law has little to do with natural justice.)\nThe greater and more enduring damage of today\'s opinion consists in its destruction of\npredictability, in the Bankruptcy Code and elsewhere. By disregarding well-established and oftrepeated principles of statutory construction, it renders those principles less secure and the\ncertainty they are designed to achieve less attainable. When a seemingly clear provision can be\npronounced "ambiguous" sans textual and structural analysis, and when the assumption of uniform\nmeaning is replaced by "one-subsection-at-a-time" interpretation, innumerable statutory texts\nbecome worth litigating. In the bankruptcy field alone, for example, unfortunate future litigants\nwill have to pay the price for our expressed neutrality "as to whether the words `allowed secured\nclaim\' have different meaning in other provisions of the Bankruptcy Code." Having taken this case\nto resolve uncertainty regarding one provision, we end by spawning confusion regarding scores of\nothers. I respectfully dissent.\n\n9.9.\n\nStripping Wholly Unsecured Liens in Chapter 7\n\nIn 2012, the Court of Appeals for the 11th Circuit created a split among the circuits by\nholding that a wholly unsecured junior lien could be stripped off in Chapter 7. The property was\nworth $141,416, and was encumbered by a first mortgage of $176,413 and a second mortgage of\n$44,444. The 11th Circuit allowed the debtor to strip off the second mortgage under 506(d), since\nthere was no value in the property to support any part of the second mortgage debt. McNeal v\nGMAC Mortgage, 735 F.3d 1263 (11th Cir. 2012). Note that the first mortgage could not be\nstripped-down under Dewsnup.\nIn Bank of America v. Caulkett, 135 S. Ct. 1995 (2015), a unanimous Supreme Court\nexpanded Dewsnup by rejecting any form of lien stripping in Chapter 7. Ironically, Justice Thomas,\nwho took no position in Dewsnup, previously raised questions about Dewsnup\xe2\x80\x99s validity, stating\n"[t]he methodological confusion created by Dewsnup has enshrouded both the Courts of Appeals\nand . . . Bankruptcy Courts." Bank of America Nat. Trust and Sav. Assn. v. 203 North LaSalle\nStreet Partnership, 526 U.S. 434, 463, and n. 3 (1999) (THOMAS, J., concurring in judgment)\nBy concurring in Caulkett, had Justice Thomas changed his mind on Dewsnup? It appears\nnot. In a footnote, Justice Thomas emphasized that the Court was applying Dewsnup as written\nbecause \xe2\x80\x9cthe debtors have repeatedly insisted that they are not asking us to overrule Dewsnup.\xe2\x80\x9d\nThree judges did not join in the footnote, indicating a split on the court between those who think\nDewsnup was correctly decided, and those who do not. It is pretty clear that two of the judges in\nCaulkett (Scalia and Thomas) continued to believe that Dewsnup was wrongly decided. The three\n228\n\n\x0cjudges who refused to join in Thomas\xe2\x80\x99s footnote (Kennedy, Breyer and Sotomayor) support\nDewsnup. That left four judges (Roberts, Ginsburg, Alito and Kagen) who did not commit to either\nside, but were willing to join in a footnote raising questions about Dewsnup\xe2\x80\x99s validity. Allowing\nliens to be stripped in Chapter 7 to the value of the collateral would certainly be a major change in\nthe law. But the decision in Dewsnup, as a matter of statutory construction, was far from\nconvincing.\n\n9.10.\n\nRedemption. 11 U.S.C. \xc2\xa7 722.\n\nStrip-down remains a viable option for the Chapter 7 debtor only if the debtor can afford\nto redeem the property from the lien by paying the full \xe2\x80\x9callowed secured claim\xe2\x80\x9d determined under\nSection 506(a). Redemption is only available to individual debtors seeking to redeem tangible\nconsumer goods; only if the property is exempt or abandoned by the trustee; and only if the debtor\ncan somehow afford to pay the full redemption price in cash. Redemption would often be a great\ndeal for many consumer debtors for things like personal use cars, rent-to-own furniture, and\nfinanced computers \xe2\x80\x93 property that may be worth far less than the loan balance because of\nexcessive sales prices and rapid depreciation - but few debtors have access to sufficient sources of\ncash to redeem.\n\n9.11.\n\nDebtor\xe2\x80\x99s Treatment of Secured Claims in Chapter 7: Surrender,\nRedeem or Reinstate \xe2\x80\x93 or Maybe \xe2\x80\x9cRide Through.\xe2\x80\x9d\n\nOne of the more draconian provisions added by Congress in the 2005 BAPCPA\namendments is the requirement for individual debtors holding personal property subject to a\npurchase money security interest to redeem, reaffirm or surrender the property. Section 521(a)(2)\nrequires the debtor to file a statement of intention within 30 days after filing bankruptcy, and to\nperform the intention within 30 days after the original date for the first meeting of creditors. Next,\nSection 521(a)(6) specifies that the debtor may \xe2\x80\x9cnot retain possession of\xe2\x80\x9d the collateral\n[presumably must surrender the collateral to the lender], unless within 45 days after bankruptcy\nthe debtor has entered into an agreement with the creditor to reaffirm the loan, or the debtor has\nredeemed the property. 11 U.S.C. \xc2\xa7 521 (a)(6). The timing of Section 521(a)(6) conflicts with the\ntiming of Section 521(a)(2).\nSection 521(d) in turn adds teeth to the reaffirm, redeem or surrender requirement by\neliminating the bankruptcy rule that ipso facto clauses are unenforceable in bankruptcy. The\nlanguage does not exactly validate ipso facto clauses; rather the language provides that bankruptcy\ndoes not impair whatever right the creditor has under state law to enforce the ipso facto clause if\nthe debtor fails to timely reaffirm or redeem. If the ipso facto clause is valid under state law, the\nfailure to timely redeem or reaffirm will likely trigger a non-curable default because so many form\nloan and lease contracts contain ipso facto clauses. A corollary provision in Section 362(h)\nterminates the automatic stay with respect to all security interests in, or leases of, personal property\nif the debtor does not timely file a statement of intention to surrender, reaffirm or redeem, and then\ntimely perform the stated action. 11 U.S.C. \xc2\xa7 362(h). Based on Sections 521(d) and 362(h), it\nwould appear that the lender could promptly repossess the collateral and proceed with its nonbankruptcy remedies (foreclosure) if the collateral is not redeemed or reaffirmed \xe2\x80\x93 even if the loan\nis current - if the lender has an ipso facto clause in its loan documents. Because most debtors lack\n229\n\n\x0cthe ability to redeem, the debtor who needs the collateral (often a car) is left with the difficult\nchoice under the Bankruptcy Code between reaffirmation and the possibility of repossession. One\nuncertainty remains, however. Would it be legal under state law for a lender to repossess the\ncollateral based on an ipso facto bankruptcy default if the loan is current?\nReaffirmation, which will be covered in a later chapter, means that the debtor\xe2\x80\x99s personal\nobligation to repay the loan or lease will not be discharged. If the debtor later defaults, the debtor\nwill not only lose the collateral but will be liable for any deficiency between the debt and the\nforeclosure sale price. In order to reaffirm, the debtor\xe2\x80\x99s lawyer must certify under penalty of\nperjury (or, if the debtor is pro se, the court must find) that reaffirmation will not impose an undue\nhardship on the debtor \xe2\x80\x93 a difficult thing for a lawyer in good conscience to do if the loan balance\nexceeds the value of the property, or the payments impose a substantial burden. See 11 U.S.C. \xc2\xa7\n524(c)(3).\nAn unwritten third alternative in some jurisdictions is known as \xe2\x80\x9cride through.\xe2\x80\x9d The debtor\nsimply continues to make payments in the hope that the creditor will not elect to declare an ipso\nfacto default and repossess the collateral. By not reaffirming, the debtor is able to walk away from\nthe debt at a later time without liability for a deficiency.\nPrior to the 2005 amendments, there was a circuit split about the availability of ride\nthrough. Compare In re Belanger, 962 F.2d 345, 347-348 (4th Cir. 1992) and cases cited therein\nallowing ride through, with In re Burr, 160 F.3d 843 (1st Cir. 1998) and cases cited therein not\nallowing ride through.\nFollowing the 2005 amendments to Section 521 and 362, virtually all of the courts to\nconsider the issue have rejected ride through as a legally enforceable alternative to reaffirmation\nor redemption. See e.g., In re Dumont, 383 B.R. 481 (9th Cir. BAP 2007), and numerous cases\ncited therein.\nAlthough ride through (simply remaining current on the loan or lease without\nreaffirmation) cannot prevent the lender from declaring a default under an ipso facto clause and\nrepossessing the collateral, nothing requires a lender to repossess the collateral. Thus, many\ndebtors ride through without statutory authority and simply bear the risk of repossession.\nA few courts have allowed what has become known as \xe2\x80\x9cback door ride-through.\xe2\x80\x9d In order\nto accomplish back door ride-through, the debtor must sign the reaffirmation agreement and then\nseek court approval for the reaffirmation. Because the debtor\xe2\x80\x99s attorney refuses to sign off on the\nreaffirmation, the debtor must appear before the judge to seek approval for the reaffirmation. The\ndebtor\xe2\x80\x99s hope is to have the reaffirmation denied by the court on the grounds that reaffirmation is\nnot in the debtor\xe2\x80\x99s best interests. Since the statutory language only requires the debtor to agree to\nreaffirm \xe2\x80\x93 and does not technically require that the court approve the reaffirmation \xe2\x80\x93 some courts\nachieve the ride-through remedy by denying the debtor\xe2\x80\x99s request to approve the reaffirmation. See\ne.g. In re Husain, 364 B.R. 211 (Bankr. E.D. Va.2007); In re Blakeley, 363 B.R. 225, 232 (Bankr.\nD. Utah 2007); In re Moustafi, 371 B.R. 434 (Bkrtcy. Ariz. 2007); In re Henderson, 492 B.R. 537\n(Bankr. D. Nev. 2013). These courts have held that the debtor\xe2\x80\x99s effort at reaffirmation \xe2\x80\x93 even if\ndenied by the court \xe2\x80\x93 is all that is required to avoid ipso facto default.\nAs a last resort, debtors who are current on their loan or lease payments can always look\nto state law for protection. If the secured creditor accepts payments after bankruptcy, the debtor\ncan argue that the secured creditor has thereby waived the ipso facto default. Alternatively, the\n230\n\n\x0cdebtor can argue that it is unconscionable under state law to allow the secured creditor to enforce\nthe ipso facto default when the loan is current, even though the ipso facto default has not been\ninvalidated by the bankruptcy law.\nThe fact is, most lenders will be better off accepting performance on a current loan or lease\nrather than repossessing the collateral and incurring a certain loss. But some lenders seem to think\ntheir \xe2\x80\x9ctough-guy\xe2\x80\x9d reputation is worth the individual losses because their reputation will encourage\nother borrowers to reaffirm. Consumer advocates disdain these rules for creating perverse\nincentives on lenders to repossess collateral even though everyone (lender and borrower) will be\nworse off by repossession.\n\n9.12.\n\nPost-Petition Effect of Security Interests: Section 552\n\nOutside of bankruptcy the composition of a secured creditor\xe2\x80\x99s collateral can change. For\nexample, a creditor who has a security interest in the inventory of a grocery store will see the\ncollateral increase when new inventory is purchased, and decrease when inventory is sold. The\nlien will \xe2\x80\x9cfloat\xe2\x80\x9d with the change in the identity of the debtor\xe2\x80\x99s inventory.\nUnder the general rule in Section 552(a), a secured creditor\xe2\x80\x99s floating lien will be cut off\non the date of bankruptcy. Any additional inventory purchased by the estate will not be subject to\nsecured creditor\xe2\x80\x99s prepetition security interest.\nHowever, Section 552(b) creates an important exception to this general rule. If the secured\ncreditor\xe2\x80\x99s security interest extends to proceeds and other things that grow out of the creditor\xe2\x80\x99s\ncollateral (products, offspring, rents or profits), then the prepetition security interest will extend to\nthe proceeds and other growth of the collateral occurring post-petition. For example, if the\ncreditor\xe2\x80\x99s security interest in the grocery store\xe2\x80\x99s inventory extends to proceeds, then the lien will\nattach to any money received post-petition from the sale of inventory (the money will be \xe2\x80\x9ccash\ncollateral\xe2\x80\x9d under Section 363(a)). If that cash collateral is then used to purchase new inventory,\nthat new inventory will also be subject to the secured creditor\xe2\x80\x99s security interest as well, because\nit too will be proceeds of the secured creditor\xe2\x80\x99s cash collateral. Section 552(b) requires tracing the\nsale of the old inventory into the purchase of new inventory.\nOn the other hand, if the estate buys inventory post-petition using other money not subject\nto the creditor\xe2\x80\x99s security interest, that new inventory will not be subject to the secured creditor\xe2\x80\x99s\nafter acquired property clause. Since the new money used to buy inventory cannot be traced to the\nsecured creditor\xe2\x80\x99s collateral, any post-petition benefit from honoring the secured creditor\xe2\x80\x99s floating\nlien would come at the expense of the unsecured creditors who funded the purchase of the new\ninventory.\nThe rule recognizes that if the creditor\xe2\x80\x99s collateral enables new collateral, then the new\ncollateral should continue to be subject to the secured creditor\xe2\x80\x99s security interest, while if\nunsecured creditors enable to creation of new collateral the secured creditor should not receive the\nbenefit of the new collateral.\nUnder Section 552, tracing is thus very important, and the secured creditor should require\na proper segregation of post-petition collateral and non-collateral in order to protect its interests.\n\n231\n\n\x0c9.13.\n\nPractice Problems: Floating Liens in Bankruptcy\n\nProblem 1: Fresh Foods, Inc., operates a chain of grocery stores. BigBank has a perfected\nfirst priority security interest in all of Fresh Foods\xe2\x80\x99 inventory to secure a $1 million loan. Fresh\nFoods filed a Chapter 11 petition one year ago. During its post-petition operations over the past\nyear, Fresh Foods purchased $400,000 of additional inventory. Fresh Foods\xe2\x80\x99 reorganization failed,\nand its bankruptcy case was converted to Chapter 7. The Chapter 7 trustee sold the remaining\ninventory for $700,000. BigBank claims to have a lien on all of the proceeds; the trustee on behalf\nof unsecured creditors\xe2\x80\x99 claims that $400,000 of the inventory was purchased post-petition and\nbelongs to the unsecured creditors. Who is right?\nProblem 2: Debtor is a farmer. Prior to bankruptcy, Debtor borrowed $100,000 from\nCropFinance to purchase seed, fertilizer, pesticides, and other materials for planting her crops.\nCropFinance has a first priority lien against the crop to secure repayment of the loan. The Debtor\nfiled bankruptcy shortly after planting the crop. During the following six months, the trustee paid\nfor water and labor to maintain and harvest the crop, which grew due to the passage of time. The\ncrop was sold for $95,000. CropFinance claims entitlement to all of the proceeds from the crop on\naccount of its security interest. The trustee says that the crop would have been worthless but for\nthe water and labor incurred by the estate to allow the crop to grow, and therefore the proceeds of\nthe crop should belong to the estate. Who is right?\n\n9.14.\n\nRelief from Stay and Adequate Protection\n\nThe rights of creditors collide with the rights of the debtor and the estate under Section\n362(d) of the Bankruptcy Code. Relief from stay is the main battleground for secured creditor\ndisputes. The statute contains two primary grounds for relief from stay: (1) cause, including the\nlack of adequate protection (\xc2\xa7 362(d)(1)), and (2) lack of equity and necessity for a reorganization\n(\xc2\xa7 362(d)(2)). Read the statute carefully along with the following comments.\nNeither \xe2\x80\x9ccause\xe2\x80\x9d nor \xe2\x80\x9cadequate protection\xe2\x80\x9d are defined in the Bankruptcy Code in any\nmeaningful way. Section 361 of the Bankruptcy Code suggests some ways of providing adequate\nprotection when required, but does not say when or to what extent adequate protection is required.\nThe concept of adequate protection recognizes that the debtor\xe2\x80\x99s and trustee\xe2\x80\x99s rights (to\nreorganize or obtain maximize value for creditors, respectively), cannot unfairly harm the rights\nof secured creditors to have their collateral protected from harm. If the secured creditor\xe2\x80\x99s collateral\nis at risk of harm during the bankruptcy case, and the creditor requests protection, the estate must\neither provide the necessary protection or the creditor must be allowed to proceed with its state\nlaw remedies. Is the property insured against casualty loss? Is the trustee\xe2\x80\x99s use of the property\nwearing it out to the point that the decline in value threatens the secured creditor\xe2\x80\x99s interest? Is the\nproperty subject to a foreseeable decline in market value as time passes that will put the creditor\xe2\x80\x99s\nsecured claim at risk of loss during the bankruptcy case?\nThe more controversial problem has been defining the creditor\xe2\x80\x99s interest that must be\nprotected. Take the case of the undersecured creditor holding a $100,000 claim secured by $60,000\nof collateral. If the creditor were allowed to foreclose now, the creditor could realize $60,000, and\nreinvest the money at interest to earn a return. The secured creditor is being prevented by the\n232\n\n\x0cautomatic stay from foreclosing and reinvesting, and thus suffers an opportunity loss during the\npendency of the automatic stay. Must the trustee compensate the creditor for this opportunity loss\neven though Section 506(b) of the Bankruptcy Code denies the undersecured creditor post-petition\ninterest on its claim? This question vexed the courts until the Supreme Court settled the issue in\nthe Timbers case reprinted below.\nThe Bankruptcy Code allows the oversecured creditor to recover post-petition interest (and\nreasonable fees, costs and charges) under Section 506(b) of the Bankruptcy Code to the extent of\nan equity cushion, but that right to post-petition interest and any charges stops once the equity\ncushion is depleted. This rule puts the oversecured creditor at risk of loss as the equity cushion is\ndepleted by the rising debt. Must the trustee adequately protect the equity cushion from decline?\nOnce again, this question was settled in the Bank of Alyucan case reprinted below.\nSection 362(d)(2) contains an alternative basis for relief from stay. If there is no value for\nthe estate in keeping the property (the debtor lacks equity in the property), and the property is not\nnecessary for the debtor\xe2\x80\x99s reorganization, there is no good reason to prevent the creditor from\nforeclosing its interest in the property. But when is property \xe2\x80\x9cnecessary for an effective\nreorganization\xe2\x80\x9d? Is it enough for the debtor/trustee to show that the property would be needed for\nany reorganization to occur? Can the secured creditor be stalled for years while the court waits to\nsee if a reorganization plan can be confirmed? The Supreme Court addressed this question too in\nthe Timbers case with some very important and influential dicta.\nWhile the legal questions raised by the statutory language have been largely resolved by\nthe Supreme Court in the Timbers decision, there remain difficult factual questions for the\nbankruptcy courts to resolve in individual cases. First, determining the fair market value of the\ncollateral, in order to determine whether the Debtor has equity in the collateral, is an art, not a\nscience. Without a market mechanism to match buyers and sellers, the courts are left to settle a\ncounter-factual question: how much would the property sell for if it were offered for sale? The\nparties hire appraisers to write lengthy reports estimating value. There are usually three approaches\nto value used in the reports: (1) the cost approach estimates the cost of duplicating the property.\n(2) The income approach estimates the present value of the income stream generated from the\nproperty using uncertain discount rates, uncertain assumptions about future income and expenses,\nand uncertain terminal values. (3) The report compare market sales of different properties, making\ndiscretionary adjustments for differences between the comparable and the subject property, to\npredict what a sale of the subject property would bring. Paid experts can justify widely varying\nappraisals by making different assumptions and adjustments, and bankruptcy judges, who are\ngenerally well trained in law but often not so well trained in evaluating financial projections \xe2\x80\x93\nmust determine which experts to believe. The battle of experts is expensive for all concerned, and\nhas often led with the benefit of hindsight to incorrect decisions by the courts.\nWhat happens when the bankruptcy court gets the valuation wrong? If the court is wrong\non the high side, the creditor is denied adequate protection and relief from stay, and may ultimately\nsuffer a significant loss. On the low side, the debtor may prematurely lose the property to\nforeclosure, and with it a prospect for reorganization or profit for the unsecured creditors. The\nBankruptcy Code seems to provide some relief when the court\xe2\x80\x99s adequate protection determination\nturns out to be inadequate, in the form of a super-administrative claim under Section 507(b) of the\nBankruptcy Code, but as seen in the Dobbins case reprinted below, some courts have interpreted\nSection 507(b) in a surprisingly limited way.\n233\n\n\x0c9.15.\n\nCases on Relief from Stay\n\n9.15.1.1. UNITED SAVINGS v. TIMBERS OF INWOOD FOREST,\n484 U.S. 365 (1988)\nJUSTICE SCALIA delivered the opinion of the Court.\n[Debtor Timbers borrowed $4.1 million from United Savings in 1982. The loan was\nsecured by a lien against an apartment project owned by the Debtor. The loan contained an\nassignment of rents. After the Debtor filed bankruptcy, United Savings moved for relief from stay.]\nAt a hearing before the Bankruptcy Court, it was established that respondent [the Debtor] owed\npetitioner [United Savings] $4,366,388.77, and evidence was presented that the value of the\ncollateral was somewhere between $2,650,000 and $4,250,000. The collateral was appreciating in\nvalue, but only very slightly. It was therefore undisputed that petitioner was an undersecured\ncreditor.\nRespondent had agreed to pay petitioner the postpetition rents from the apartment project\n(covered by the after-acquired property clause in the security agreement), minus operating\nexpenses. Petitioner contended, however, that it was entitled to additional compensation. The\nBankruptcy Court agreed and conditioned continuance of the stay on monthly payments by\nrespondent, at the market rate of 12% per annum, on the estimated amount realizable on\nforeclosure, $4,250,000\xe2\x80\x94commencing six months after the filing of the bankruptcy petition, to\nreflect the normal foreclosure delays. The District Court affirmed but the Fifth Circuit en banc\nreversed.\nWe granted certiorari to determine whether undersecured creditors are entitled to\ncompensation under 11 U.S.C. 362(d)(1) for the delay caused by the automatic stay in foreclosing\non their collateral.\nIt is common ground that the "interest in property" referred to by \xc2\xa7 362(d)(1) includes the\nright of a secured creditor to have the security applied in payment of the debt upon completion of\nthe reorganization; and that that interest is not adequately protected if the security is depreciating\nduring the term of the stay. Thus, it is agreed that if the apartment project in this case had been\ndeclining in value petitioner would have been entitled, under \xc2\xa7 362(d)(1), to cash payments or\nadditional security in the amount of the decline, as \xc2\xa7 361 describes. The crux of the present dispute\nis that petitioner asserts, and respondent denies, that the phrase "interest in property" also includes\nthe secured party\'s right (suspended by the stay) to take immediate possession of the defaulted\nsecurity, and apply it in payment of the debt. If that right is embraced by the term, it is obviously\nnot adequately protected unless the secured party is reimbursed for the use of the proceeds he is\ndeprived of during the term of the stay.\nThe term "interest in property" certainly summons up such concepts as "fee ownership,"\n"life estate," "co-ownership," and "security interest" more readily than it does the notion of "right\nto immediate foreclosure." Nonetheless, viewed in the isolated context of \xc2\xa7 362(d)(1), the phrase\ncould reasonably be given the meaning petitioner asserts. Statutory construction, however, is a\nholistic endeavor. A provision that may seem ambiguous in isolation is often clarified by the\nremainder of the statutory scheme\xe2\x80\x94because the same terminology is used elsewhere in a context\nthat makes its meaning clear, or because only one of the permissible meanings produces a\n234\n\n\x0csubstantive effect that is compatible with the rest of the law. That is the case here. Section\n362(d)(1) is only one of a series of provisions in the Bankruptcy Code dealing with the rights of\nsecured creditors. The language in those other provisions, and the substantive dispositions that\nthey effect, persuade us that the "interest in property" protected by \xc2\xa7 362(d)(1) does not include a\nsecured party\'s right to immediate foreclosure.\nSection 506 of the Code defines the amount of the secured creditor\'s allowed secured claim\nand the conditions of his receiving postpetition interest. . . . In subsection (a) of this provision the\ncreditor\'s "interest in property" obviously means his security interest without taking account of his\nright to immediate possession of the collateral on default. If the latter were included, the "value of\nsuch creditor\'s interest" would increase, and the proportions of the claim that are secured and\nunsecured would alter, as the stay continues\xe2\x80\x94since the value of the entitlement to use the collateral\nfrom the date of bankruptcy would rise with the passage of time. No one suggests this was\nintended. The phrase "value of such creditor\'s interest" in \xc2\xa7 506(a) means "the value of the\ncollateral." H.R.Rep. No. 95-595, pp. 181, 356 (1977); We think the phrase "value of such entity\'s\ninterest" in \xc2\xa7 361(1) and (2), when applied to secured creditors, means the same.\nEven more important for our purposes than \xc2\xa7 506\'s use of terminology is its substantive\neffect of denying undersecured creditors postpetition interest on their claims\xe2\x80\x94just as it denies over\nsecured creditors postpetition interest to the extent that such interest, when added to the principal\namount of the claim, will exceed the value of the collateral. Section 506(b) . . . permits postpetition\ninterest to be paid only out of the "security cushion," the undersecured creditor, who has no such\ncushion, falls within the general rule disallowing postpetition interest. If the Code had meant to\ngive the undersecured creditor, who is thus denied interest on his claim, interest on the value of\nhis collateral, surely this is where that disposition would have been set forth, and not obscured\nwithin the "adequate protection" provision of \xc2\xa7 362(d)(1). Instead of the intricate phraseology set\nforth above, \xc2\xa7 506(b) would simply have said that the secured creditor is entitled to interest "on\nhis allowed claim, or on the value of the property securing his allowed claim, whichever is lesser."\nPetitioner\'s interpretation of \xc2\xa7 362(d)(1) must be regarded as contradicting the carefully drawn\ndisposition of \xc2\xa7 506(b).\nPetitioner seeks to avoid this conclusion by characterizing \xc2\xa7 506(b) as merely an alternative\nmethod for compensating oversecured creditors, which does not imply that no compensation is\navailable to undersecured creditors. This theory of duplicate protection for oversecured creditors\nis implausible even in the abstract, but even more so in light of the historical principles of\nbankruptcy law. Section 506(b)\'s denial of postpetition interest to undersecured creditors merely\ncodified pre-Code bankruptcy law, in which that denial was part of the conscious allocation of\nreorganization benefits and losses between undersecured and unsecured creditors. "To allow a\nsecured creditor interest where his security was worth less than the value of his debt was thought\nto be inequitable to unsecured creditors." Vanston Bondholders Protective Committee v. Green,\n329 U.S. 156, 164 (1946). It was considered unfair to allow an undersecured creditor to recover\ninterest from the estate\'s unencumbered assets before unsecured creditors had recovered any\nprincipal. We think it unlikely that \xc2\xa7 506(b) codified the pre-Code rule with the intent, not of\nachieving the principal purpose and function of that rule, but of providing over-secured creditors\nan alternative method of compensation. Moreover, it is incomprehensible why Congress would\nwant to favor undersecured creditors with interest if they move for it under \xc2\xa7 362(d)(1) at the\n235\n\n\x0cinception of the reorganization process\xe2\x80\x94thereby probably pushing the estate into liquidation\xe2\x80\x94\nbut not if they forbear and seek it only at the completion of the reorganization.\nSecond, petitioner\'s interpretation of \xc2\xa7 362(d)(1) is structurally inconsistent with 11 U.S.C.\n\xc2\xa7 552. Section 552(a) states the general rule that a prepetition security interest does not reach\nproperty acquired by the estate or debtor postpetition. Section 552(b) sets forth an exception,\nallowing postpetition "proceeds, product, offspring, rents, or profits" of the collateral to be covered\nonly if the security agreement expressly provides for an interest in such property, and the interest\nhas been perfected under "applicable nonbankruptcy law." Section 552(b) therefore makes\npossession of a perfected security interest in postpetition rents or profits from collateral a condition\nof having them applied to satisfying the claim of the secured creditor ahead of the claims of\nunsecured creditors. Under petitioner\'s interpretation, however, the undersecured creditor who\nlacks such a perfected security interest in effect achieves the same result by demanding the "use\nvalue" of his collateral under \xc2\xa7 362. It is true that \xc2\xa7 506(b) gives the over secured creditor, despite\nlack of compliance with the conditions of \xc2\xa7 552, a similar priority over unsecured creditors; but\nthat does not compromise the principle of \xc2\xa7 552, since the interest payments come only out of the\n"cushion" in which the oversecured creditor does have a perfected security interest.\nThird, petitioner\'s interpretation of \xc2\xa7 362(d)(1) makes nonsense of \xc2\xa7 362(d)(2). On\npetitioner\'s theory, the undersecured creditor\'s inability to take immediate possession of his\ncollateral is always "cause" for conditioning the stay (upon the payment of market rate interest)\nunder \xc2\xa7 362(d)(1), since there is, within the meaning of that paragraph, "lack of adequate protection\nof an interest in property." But \xc2\xa7 362(d)(2) expressly provides a different standard for relief from\na stay "of an act against property," which of course includes taking possession of collateral. By\napplying the "adequate protection of an interest in property" provision of \xc2\xa7 362(d)(1) to the alleged\n"interest" in the earning power of collateral, petitioner creates the strange consequence that \xc2\xa7 362\nentitles the secured creditor to relief from the stay (1) if he is undersecured (and thus not eligible\nfor interest under \xc2\xa7 506(b)), or (2) if he is undersecured and his collateral "is not necessary to an\neffective reorganization." This renders \xc2\xa7 362(d)(2) a practical nullity and a theoretical absurdity.\nIf \xc2\xa7 362(d)(1) is interpreted in this fashion, an undersecured creditor would seek relief under \xc2\xa7\n362(d)(2) only if his collateral was not depreciating (or he was being compensated for\ndepreciation) and it was receiving market rate interest on his collateral, but nonetheless wanted to\nforeclose. Petitioner offers no reason why Congress would want to provide relief for such an\nobstreperous and thoroughly unharmed creditor.\nSection 362(d)(2) also belies petitioner\'s contention that undersecured creditors will face\ninordinate and extortionate delay if they are denied compensation for interest lost during the stay\nas part of "adequate protection" under \xc2\xa7 362(d)(1). Once the movant under \xc2\xa7 362(d)(2) establishes\nthat he is an undersecured creditor, it is the burden of the debtor to establish that the collateral at\nissue is "necessary to an effective reorganization." See \xc2\xa7 362(g). What this requires is not merely\na showing that if there is conceivably to be an effective reorganization, this property will be\nneeded for it; but that the property is essential for an effective reorganization that is in\nprospect. This means, as many lower courts, including the en banc court in this case, have properly\nsaid, that there must be "a reasonable possibility of a successful reorganization within a\nreasonable time." The cases are numerous in which \xc2\xa7 362(d)(2) relief has been provided within\nless than a year from the filing of the bankruptcy petition. And while the bankruptcy courts demand\nless detailed showings during the four months in which the debtor is given the exclusive right to\n236\n\n\x0cput together a plan, see 11 U.S.C. 1121(b), (c)(2), even within that period lack of any realistic\nprospect of effective reorganization will require \xc2\xa7 362(d)(2) relief.\nThe Fifth Circuit correctly held that the undersecured petitioner is not entitled to interest\non its collateral during the stay to assure adequate protection under 11 U.S.C. 362(d)(1). Petitioner\nhas never sought relief from the stay under \xc2\xa7 362(d)(2) or on any ground other than lack of\nadequate protection. Accordingly, the judgment of the Fifth Circuit is affirmed.\n\n9.15.1.2.\nBANKERS LIFE INS. CO., v. ALYUCAN\nINTERSTATE CORP., 12 B.R. 803 (Bankr. D. Utah 1981)\nThis case raises the question whether an "equity cushion" is necessary to provide adequate\nprotection under 11 U.S.C. Section 362(d)(1). This Court concludes that it is not.\nOn January 14, 1981, debtor, a construction and real estate development firm, filed a\npetition under Chapter 11 of the Code. On May 4, Bankers Life, holder of a trust deed on realty\nowned by debtor, brought this action for relief from the automatic stay under Section 362(d). The\ncomplaint alleges that the realty secures a debt in the principal amount of $1,220,000 and that\nBankers Life is not adequately protected. On May 20, the preliminary hearing contemplated by\nSection 362(e) was held. After receiving evidence, the Court fixed the value of the realty on the\ndate of the petition at $1,425,000 and found that there had been no erosion in that value as of the\nhearing. The debt owing was $1,297,226 as of the petition, and with interest accruing at roughly\n$8,000 per month, had increased to $1,330,761 as of the hearing. Thus, there was an "equity\ncushion" of $127,774 or approximately nine percent of the value of the collateral, as of the petition,\nwhich had decreased to $94,239, or approximately six and one half percent of the value of the\ncollateral, as of the hearing. As interest accumulates, and if no payments are made, this cushion\nwill dissipate within a year.\n[T]here is a trend toward defining adequate protection in terms of an "equity cushion": the\ndifference between outstanding debt and the value of the property against which the creditor\ndesires to act. Where the difference is substantial, a cushion is said to exist, adequately protecting\nthe creditor. As interest accrues, or depreciation advances, and the margin declines, the cushion\nweakens and the stay may be lifted. Naturally, courts disagree on what is an acceptable margin.\nThe emerging view, however, may be that the stay should be terminated when the cushion will be\nabsorbed through interest, commissions, and other costs of resale. The cushion analysis enjoys\npractical appeal and ease of application.\nThis Court rejects a cushion analysis. . . . Under Section 362(d)(2) a lack of equity, absent\na further showing that the property is unnecessary to an effective reorganization, does not warrant\nrelief from the stay. This statutory provision expresses a legislative judgment, first, that it is the\nabsence of equity rather than any particular cushion which is the criterion for relief from stay, and\nsecond, that the absence of equity is not alone dispositive \xe2\x80\x94 the court must still weigh the necessity\nof the property to an effective reorganization. The cushion analysis is inconsistent with this\njudgment. It makes surplusage out of Section 362(d)(2) which speaks in terms of equity and\nreorganization. Indeed, this dual requirement emphasizes the role of equity, when present, not as\na cushion, but to underwrite, through sale or credit, the rehabilitation of debtors. . . .\n237\n\n\x0cAlthough the "idea of equity" became "something of a totem for courts," it was equity in\nthe sense contemplated under Section 362(d)(2), not an equity cushion. Thus, it was acknowledged\nthat "deciding whether to continue or vacate the stay solely on the ground of the debtor\'s equity in\nthe property may produce an unjust result," for example where "the encumbered property is so\nvital to the operation of debtor\'s business that foreclosure will simply not be allowed."\nSimilarly, another commentator describes the "operative equities" which are weighed in\nrelief from stay actions, to include the debtor\'s need for the property, harm to the creditor, stage of\nthe proceedings, and "how persuasive the indications are that the debtor can fabricate a plan\nsusceptible of confirmation," but warns against "red herrings." "One of these is the oft mentioned\nconcern as to how much equity the debtor has in property sought by a secured creditor. If the equity\nis large, that is the reason for granting relief [to the debtor] which might be denied if it were not.\nYet, that judgment ought to be largely immaterial, since the equity can presumably be salvaged\nfor the debtor in liquidation of the property as part of the administration of the estate or upon its\nsurrender to the secured creditor, particularly where the court exercises its discretion to control the\ntime and manner of liquidation. It is submitted that the real determinants should be and probably\nare the factors just suggested. For example, if a debtor badly needs the property and its vital signs\nare strong, the size of its equity shouldn\'t have much bearing on the situation, although a large\nequity does make a decision favorable to the debtor more palatable for all concerned."\nAdequate protection is a concept designed to balance the rights of creditors and debtors in\nthe preliminary stages of reorganization. It is, in each case, ad hoc. For this reason the cushion\nanalysis, which may be helpful in general, falls short in the particular. It is not fully alert to the\nlegislative directive that "the facts," in each hearing under Section 362(d), "will determine whether\nrelief is appropriate under the circumstances." H.R.Rep.No.95-595, 95th Cong., 1st Sess. 344\n(1977). The facts of each case, thoughtfully weighed, not formularized, define adequate protection.\n\n9.15.1.3.\nFORD MOTOR CREDIT CO. v. DOBBINS, 35 F.3d\n860 (4th Cir. 1994)\nFrom 1970 until 1980 Dobbins operated a car dealership in Roanoke, Virginia. In 1980, as\na result of financial problems, the Dealership ceased operating. On March 3, 1981, the Dealership\nfiled a petition under Chapter 11 of the Bankruptcy Code. That same day the Dobbinses filed their\nown Chapter 11 petition.\nFMCC provided financing to the dealership. The loans were secured by certain personal\nproperty of the dealership, including parts and equipment. The Dobbinses personally guaranteed\npayment of the Dealership\'s debt to FMCC. The Dobbinses\' guaranty was secured by a deed of\ntrust on their Melrose Avenue property, which was where the Dealership was located.\nOn April 7, 1982, FMCC moved for relief from the automatic stay in the Dobbinses\'\nbankruptcy case to foreclose on the Melrose Avenue property. FMCC asserted that the value of its\nclaim was $697,720.54. FMCC and the Dobbinses presented expert testimony on the value of the\nsecured collateral. FMCC\'s experts valued the Melrose Avenue property at $425,000 and the\nremaining personal property of the Dealership at $47,731. The Dobbinses\' and the Dealership\'s\nexperts valued the Melrose Avenue property at $898,000 and the remaining personal property at\n$190,000.\n238\n\n\x0cOn March 31, 1983, the bankruptcy court entered an order finding that "[FMCC\'s] interest\n[was] adequately protected by the equity in the subject property." Accordingly, the court denied\nFMCC\'s motion for relief from the stay pending a hearing on the reorganization plans of both the\nDealership and the Dobbinses.\nOn November 29, 1983, the bankruptcy court issued orders confirming the plans in both\ncases. The Dealership\'s plan provided for the sale of property. The plan said that if the Melrose\nAvenue Property was not sold by November 30, 1984, the Dobbinses would be in default and\nFMCC could take possession [and foreclose].\nThe Dobbinses were unable to sell the Melrose Avenue property. On February 10, 1986,\nthe bankruptcy court lifted the stay so that FMCC could sell the property. FMCC listed the property\nwith a realty agency that specialized in marketing commercial property. On January 30, 1987,\nabout one year after the court lifted the stay, FMCC finally sold the Melrose Avenue property for\n$375,000 at a private sale. The court approved the sale over the Dobbinses\' objection that the price\nwas too low. After sale-related costs and expenses were deducted, the net sale proceeds\n($301,123.83) were applied to FMCC\'s claim.\nFollowing the sale, FMCC filed a Second Amended Proof of Claim in the Dobbinses\'\nbankruptcy case for its deficiency in the amount of $545,639.41, which included postpetition\ninterest, legal fees and expenses. Significantly, in its Second Amended Proof of Claim FMCC\nsought a superpriority administrative expense under 11 U.S.C. \xc2\xa7 507(b) for the alleged decrease in\nthe value of the Melrose Avenue property from the date of the adequate protection order to the\ndate of the sale. The Dobbinses objected.\nThe bankruptcy court ruled that FMCC was not entitled to a \xc2\xa7 507(b) superpriority [or\npostpetition interest]. The district court reversed. The district court held that FMCC was entitled\nto a \xc2\xa7 507(b) superpriority in the amount of $322,720.54 because the "adequate protection" proved\nto be inadequate [and to post-petition interest]. . . .\n[Superpriority under 507(b).]\nFMCC contends that it is entitled to a superpriority administrative expense under \xc2\xa7 507(b)\nbecause the value of the Melrose Avenue property declined after the adequate protection order,\nwith the property eventually selling for less than the amount of FMCC\'s claim. In short, adequate\nprotection proved to be inadequate.\nIt is apparent from the language of \xc2\xa7 507(b) that a creditor must satisfy several requirements\nin order to trigger the superpriority. First, adequate protection must have been provided previously,\nand the protection ultimately must prove to be inadequate. Second, the creditor must have a claim\nallowable under \xc2\xa7 507(a)(1) (which in turn requires that the creditor have an administrative\nexpense claim under \xc2\xa7 503(b)). And third, the claim must have arisen from either the automatic\nstay under \xc2\xa7 362; or the use, sale or lease of the collateral under \xc2\xa7 363; or the granting of a lien\nunder \xc2\xa7 364(d). For the reasons that follow, we conclude that FMCC is not entitled to a \xc2\xa7 507(b)\nsuperpriority because it does not meet the second requirement above, i.e., it does not have a claim\nallowable under \xc2\xa7 507(a)(1).\n"The presumption in bankruptcy cases is that the debtor\'s limited resources will be equally\ndistributed among the creditors. Thus, statutory priorities must be narrowly construed." Heeding\nthis principle, we begin with the language of \xc2\xa7 507(b), which allows a superpriority only to a claim\n239\n\n\x0cotherwise allowable under \xc2\xa7 507(a)(1). Section 507(a)(1), in turn, allows a claim for\n"administrative expenses allowable under \xc2\xa7 503(b)...." For our purposes, the administrative\nexpenses allowable under \xc2\xa7 503(b) are "the actual, necessary costs and expenses of preserving the\nestate...." Thus, FMCC cannot receive a \xc2\xa7 507(b) superpriority unless it can demonstrate that it has\nincurred postpetition an actual and necessary cost or expense of preserving the Dobbinses\' estate.\n"The modifiers `actual\' and `necessary\' must be observed with scrupulous care[,]"because\n[o]ne of the goals of Chapter 11 is to keep administrative costs to a minimum in order to preserve\nthe debtor\'s scarce resources and thus encourage rehabilitation. In keeping with this goal, \xc2\xa7\n503(b)(1)(A) was not intended to "saddle debtors with special post-petition obligations lightly or\ngive preferential treatment to certain select creditors by creating a broad category of administrative\nexpenses." This ... narrow interpretation requires actual use of the creditor\'s property by the debtor,\nthereby conferring a concrete benefit on the estate before a claim is allowable as an administrative\nexpense. Accordingly, the mere potential of benefit to the estate is insufficient for the claim to\nacquire status as an administrative expense. The court\'s administrative expense inquiry centers\nupon whether the estate has received an actual benefit, as opposed to the loss a creditor might\nexperience by virtue of the debtor\'s possession of its property.\nWith this background in mind, we examine FMCC\'s argument, which essentially boils\ndown to this: The Dobbinses used, and the Dobbinses\' estate received a benefit from, the Melrose\nAvenue property in that the Dobbinses had the opportunity to market the property. We are\npresented with a close question here, but we do not believe that the mere opportunity to market\ncollateral is the type of concrete, actual benefit contemplated by \xc2\xa7 503(b)(1)(A).\nIn sum, there is a critical distinction between an actual benefit to the estate resulting from\nthe actual postpetition use of collateral and a potential benefit to the estate resulting from a debtor\'s\nmere possession of collateral.\nFMCC\'s theory is that a debtor\'s opportunity to benefit from the continued possession\npostpetition of collateral constitutes an actual and necessary cost of preserving the estate for\npurposes of \xc2\xa7 503(b)(1)(A). But every time a bankruptcy court denies a secured creditor\'s motion\nto lift the stay the debtor is given some "opportunity" to benefit from the continued possession of\nthe collateral (e.g., to use, lease or sell it). Thus, were we to adopt FMCC\'s theory, we would be\nhard pressed to find a case where a creditor would not be entitled to a superpriority after adequate\nprotection proved inadequate. In effect, FMCC would have us read out of \xc2\xa7 507(b) Congress\'\nrequirement (in its cross-reference to \xc2\xa7 503(b)) that the creditor must have incurred an actual and\nnecessary cost of preserving the estate. Because a literal application of \xc2\xa7 507(b) would not produce\na result demonstrably at odds with Congressional intent, we must reject FMCC\'s broad conception\nof "use" and "benefit."\nWe appreciate that FMCC wants to be compensated for the delay and related opportunity\nloss occasioned by the Dobbinses\' continued possession of its collateral. And we agree that in\nmany cases "it would be inequitable to tax the creditor with the burden of the court\'s error if the\njudicially determined adequate protection later proves to be `inadequate.\'" However, it also strikes\nus as inequitable to tax unsecured creditors for a decline in the value of collateral when the decline\ndoes not result from a use that actually benefits the estate: "To prioritize ... claims where they are\nnot clearly entitled to such treatment, is not only inconsistent with the policy of equality of\n240\n\n\x0cdistribution but it also dilutes the value of the priority for the claims of creditors Congress in fact\nintended to prefer."\nPostpetition Interest Under \xc2\xa7 506(b)\nFMCC says it is entitled to postpetition interest on its various loans to the Dealership. The\ngeneral rule is that interest stops accruing when the bankruptcy petition is filed. See 11 U.S.C. \xc2\xa7\n502(b)(2). However, in \xc2\xa7 506(b) Congress carved out an exception for oversecured creditors.\n"Section 506(b)\'s denial of postpetition interest to undersecured creditors merely codified preCode bankruptcy law, in which that denial was part of the conscious allocation of reorganization\nbenefits and losses between undersecured and unsecured creditors."\nThe first and critical inquiry under \xc2\xa7 506(b) is whether FMCC is oversecured. The\nDobbinses argue, and the bankruptcy court found, that FMCC is undersecured for purposes of \xc2\xa7\n506(b) because the Melrose Avenue property ultimately sold for an amount less than FMCC\'s\nsecured claim. FMCC concedes that, if we use the sale price to determine the value of the collateral\nfor purposes of \xc2\xa7 506(b), then it is undersecured. But, FMCC urges, although it was undersecured\nat the time of sale, it was oversecured earlier in the bankruptcy proceedings \xe2\x80\x94 the value of the\nMelrose Avenue property simply declined between the filing of the petition and the time the\nproperty was sold. FMCC contends that so long as a creditor is oversecured at some point\npostpetition, the creditor should be treated as an oversecured creditor for purposes of \xc2\xa7 506(b),\neven if the creditor ultimately ends up undersecured when the collateral is sold. The district court\nagreed with FMCC and reversed the bankruptcy court.\nWe hold that when secured collateral has been sold, so long as the sale price is fair and is\nthe result of an arm\'s-length transaction, courts should use the sale price, not some earlier\nhypothetical valuation, to determine whether a creditor is oversecured and thus entitled to\npostpetition interest under \xc2\xa7 506(b).\nUsing the sale price thus makes practical sense because it is "conclusive evidence of the\nproperty\'s value," Alpine Group, 151 B.R. at 935, and it is the amount of money the collateral\nactually was able to bring into the estate for distribution.\nIf, as FMCC urges, we value the collateral on the basis of a hypothetical valuation made\nearlier in the proceedings, and if that earlier valuation is higher than the sale price, then every\ndollar of postpetition interest awarded above the sale price is a dollar usurped from the estate\'s\nunencumbered assets, a dollar that would otherwise be available for distribution to unsecured\ncreditors. By using sale price, we avoid this inequitable result. Of course, secured creditors may\nbenefit by a \xc2\xa7 506(b) valuation based on sale price if the collateral appreciates postpetition and the\nproperty is sold for more than it was appraised earlier in the proceedings.\nIn sum, when valuing secured collateral to determine whether a creditor is oversecured and\nthus entitled to postpetition interest pursuant to \xc2\xa7 506(b), if the collateral has been sold, the value\nof the collateral should be based on the consideration received by the estate in connection with the\nsale, provided that the sale price is both fair and the result of an arm\'s-length transaction. Here,\nbecause the net consideration received in connection with the sale of the Melrose Avenue property\nis less than the amount of FMCC\'s claim, FMCC is an undersecured creditor for purposes of \xc2\xa7\n506(b) and thus is not entitled to any postpetition interest.\n241\n\n\x0c9.16.\n\nPractice Problems: Relief from Stay\n\nProblem 1. You represent a plaintiff bringing a class action lawsuit against 100 defendants.\nYou are set for trial in three weeks. One of the defendants files bankruptcy. You do not want to\ndelay the trial. What should you do?\nProblem 2. Bank made a $100,000 loan secured by the debtor\xe2\x80\x99s real property. According\nto the loan documents, interest accrues at the rate of 1% per month, but interest is not compounded\n(no interest on unpaid interest). The Bank filed a motion for relief from stay asserting that it was\nowed $100,000 of principal, $5,000 of interest, and $2,000 in legal fees as of the date the\nbankruptcy petition was filed, and will be owed an additional $4,000 in post-petition interest and\n$3,000 in post-petition legal fees as of the date of the hearing. If the court determines that the\nproperty is worth $120,000, what claims will the Bank have, what will the Bank have to show to\nget relief from stay, and what will the debtor have to show to avoid relief from stay?\nProblem 3. What difference would it make, if any, in the last problem if the property was\nworth $123,000, but was also encumbered by a second lien in the amount of $10,000?\nProblem 4. What if the second lienholder in Problem (3) sought relief from stay?\nProblem 5. Suppose the property in problem (2) is worth $115,000, and is encumbered by\na second mortgage of $25,000. Can the second mortgage be stripped down to the secured claim of\n$1,000?\nProblem 6. What would the claims be in Problem (5) if the property was worth only\n$110,000 on the hearing date? Could the second mortgage be stripped off as an unsecured claim?\nProblem 7. The debtor purchased a car two years ago, borrowing $25,000 at 28% interest\non a five year loan. The debtor\xe2\x80\x99s monthly payments are $778.40, and the current loan balance is\n$18,818.38. The \xe2\x80\x9cblue book\xe2\x80\x9d lists the car as having a $10,000 trade-in value, an $11,000 private\nsale value, and a $12,000 retail value. The debtor needs the car to get to work. The debtor has\nasked you to sign off on a reaffirmation of the loan. What do you say?\nProblem 8. The Debtor owns a Dull brand laptop computer that the debtor needs for his\njob. He owes Dull $1,200, and the laptop is worth $400. He bought the laptop from Dull Computer\nCorporation 7 months ago, and Dull\xe2\x80\x99s interest rate on the loan is 35%. The contract payments are\n$55 per month, and there are three years left on the term. What options does the debtor have?\n\n242\n\n\x0cChapter 10: Unsecured Claims in Bankruptcy\n10.1.\n\nWhat is a \xe2\x80\x9cClaim\xe2\x80\x9d?\n\nThe drafters of the Bankruptcy Code adopted an extremely broad definition of a \xe2\x80\x9cclaim\xe2\x80\x9d\nto resolve all of the debtor\xe2\x80\x99s liabilities as part of the bankruptcy process. Section 101(5) of the\nBankruptcy Code defines a claim as either a \xe2\x80\x9cright to payment,\xe2\x80\x9d or the \xe2\x80\x9cright to an equitable\nremedy\xe2\x80\x9d if the breach \xe2\x80\x9cgives rise to a right to payment.\xe2\x80\x9d Under the definition, one has a claim in\nbankruptcy whether or not the claim is reduced to judgment, is liquidated or unliquidated, is fixed\nor contingent, is matured or unmatured, is legal or equitable, or is secured or unsecured. Under the\nstatute, if a right to payment from the debtor exists in any fashion, it is a claim that will be subject\nto the process of bankruptcy.\nDespite the broad statutory definition, there is one fundamental limitation on the definition\nof a claim \xe2\x80\x93 the constitutional requirement of due process mandated by the 5th Amendment. The\ncases that follow attempt to draw the line between the policy of bankruptcy to resolve all of the\ndebtor\xe2\x80\x99s liabilities at once, and the policies of due process and fundamental fairness that are so\nfundamental to our system of justice.\n\n10.2.\n\nCases on Claims and Due Process\n10.2.1.1.\nMULLANE v. CENTRAL HANOVER BANK &\nTRUST CO., 339 U.S. 306 (1950)\n\nMr. JUSTICE JACKSON delivered the opinion of the Court.\nThis controversy questions the constitutional sufficiency of notice to beneficiaries on\njudicial settlement of accounts by the trustee of a common trust fund established under the New\nYork Banking Law. The New York Court of Appeals considered and overruled objections that the\nstatutory notice contravenes requirements of the Fourteenth Amendment, and that, by allowance\nof the account, beneficiaries were deprived of property without due process of law. Common trust\nfund legislation is addressed to a problem appropriate for state action. Mounting overheads have\nmade administration of small trusts undesirable to corporate trustees. In order that donors and\ntestators of moderately sized trusts may not be denied the service of corporate fiduciaries, the\nDistrict of Columbia and some thirty states other than New York have permitted pooling small\ntrust estates into one fund for investment administration. The income, capital gains, losses and\nexpenses of the collective trust are shared by the constituent trusts in proportion to their\ncontribution. By this plan, diversification of risk and economy of management can be extended to\nthose whose capital standing alone would not obtain such advantage.\nUnder [New York Banking Law, the assets of small trusts may be pooled. The Court can\nissue a decree settling the accounts by publishing notice]. The decree, in each such judicial\nsettlement of accounts, is made binding and conclusive as to any matter set forth in the account\nupon everyone having any interest in the common fund or in any participating estate, trust or fund.\nIn January, 1946, Central Hanover Bank and Trust Company established a common trust\nfund in accordance with these provisions, and, in March, 1947, it petitioned the Surrogate\'s Court\n243\n\n\x0cfor settlement of its first account as common trustee. During the accounting period, a total of 113\ntrusts, approximately half inter vivos and half testamentary, participated in the common trust fund,\nthe gross capital of which was nearly three million dollars. The record does not show the number\nor residence of the beneficiaries, but they were many, and it is clear that some of them were not\nresidents of the State of New York.\nThe only notice given beneficiaries of this specific application was by publication in a local\nnewspaper in strict compliance with [New York Banking Law]. Thus, the only notice required,\nand the only one given, was by newspaper publication setting forth merely the name and address\nof the trust company, the name and the date of establishment of the common trust fund, and a list\nof all participating estates, trusts or funds.\nAt the time the first investment in the common fund was made on behalf of each\nparticipating estate; however, the trust company had notified by mail each person of full age and\nsound mind whose name and address was then known to it and who was [a beneficiary of the trust].\nIncluded in the notice was a copy of those provisions of the Act relating to the sending of the notice\nitself and to the judicial settlement of common trust fund accounts.\nUpon the filing of the petition for the settlement of accounts, appellant was, by order of the\ncourt appointed special guardian and attorney for all persons known or unknown not otherwise\nappearing who had or might thereafter have any interest in the income of the common trust fund,\nand appellee Vaughan was appointed to represent those similarly interested in the principal. There\nwere no other appearances on behalf of anyone interested in either interest or principal.\nAppellant appeared specially, objecting that notice and the statutory provisions for notice\nto beneficiaries were inadequate to afford due process under the Fourteenth Amendment, and\ntherefore that the court was without jurisdiction to render a final and binding decree. Appellant\'s\nobjections were entertained and overruled, the Surrogate holding that the notice required and given\nwas sufficient. A final decree accepting the accounts has been entered [and affirmed by the lower\ncourts]. The effect of this decree, as held below, is to settle "all questions respecting the\nmanagement of the common fund." We understand that every right which beneficiaries would\notherwise have against the trust company, either as trustee of the common fund or as trustee of any\nindividual trust, for improper management of the common trust fund during the period covered by\nthe accounting is sealed and wholly terminated by the decree. [The Court then recognizes New\nYork\xe2\x80\x99s power to discharge trustees even if the beneficiaries live out of state]\nQuite different from the question of a state\'s power to discharge trustees is that of the\nopportunity it must give beneficiaries to contest. Many controversies have raged about the cryptic\nand abstract words of the Due Process Clause, but there can be no doubt that, at a minimum, they\nrequire that deprivation of life, liberty or property by adjudication be preceded by notice and\nopportunity for hearing appropriate to the nature of the case.\nIn two ways, this proceeding does or may deprive beneficiaries of property. It may cut off\ntheir rights to have the trustee answer for negligent or illegal impairments of their interests. Also,\ntheir interests are presumably subject to diminution in the proceeding by allowance of fees and\nexpenses to one who, in their names but without their knowledge, may conduct a fruitless or\nuncompensatory contest. Certainly the proceeding is one in which they may be deprived of\nproperty rights and hence notice and hearing must measure up to the standards of due process.\n244\n\n\x0cPersonal service of written notice within the jurisdiction is the classic form of notice always\nadequate in any type of proceeding. But the vital interest of the State in bringing any issues as to\nits fiduciaries to a final settlement can be served only if interests or claims of individuals who are\noutside of the State can somehow be determined. A construction of the Due Process Clause which\nwould place impossible or impractical obstacles in the way could not be justified.\nAgainst this interest of the State, we must balance the individual interest sought to be\nprotected by the Fourteenth Amendment. This is defined by our holding that "[t]he fundamental\nrequisite of due process of law is the opportunity to be heard." This right to be heard has little\nreality or worth unless one is informed that the matter is pending and can choose for himself\nwhether to appear or default, acquiesce or contest.\nThe Court has not committed itself to any formula achieving a balance between these\ninterests in a particular proceeding or determining when constructive notice may be utilized, or\nwhat test it must meet. Personal service has not, in all circumstances, been regarded as\nindispensable to the process due to residents, and it has more often been held unnecessary as to\nnonresidents. We disturb none of the established rules on these subjects. No decision constitutes a\ncontrolling, or even a very illuminating, precedent for the case before us. But a few general\nprinciples stand out in the books.\nAn elementary and fundamental requirement of due process in any proceeding which is to\nbe accorded finality is notice reasonably calculated, under all the circumstances, to apprise\ninterested parties of the pendency of the action and afford them an opportunity to present their\nobjections. The notice must be of such nature as reasonably to convey the required information,\nand it must afford a reasonable time for those interested to make their appearance. But if, with due\nregard for the practicalities and peculiarities of the case, these conditions are reasonably met, the\nconstitutional requirements are satisfied.\nBut when notice is a person\'s due, process which is a mere gesture is not due process. The\nmeans employed must be such as one desirous of actually informing the absentee might reasonably\nadopt to accomplish it. The reasonableness, and hence the constitutional validity of, any chosen\nmethod may be defended on the ground that it is, in itself, reasonably certain to inform those\naffected, or, where conditions do not reasonably permit such notice, that the form chosen is not\nsubstantially less likely to bring home notice than other of the feasible and customary substitutes.\nIt would be idle to pretend that publication alone, as prescribed here, is a reliable means of\nacquainting interested parties of the fact that their rights are before the courts. It is not an accident\nthat the greater number of cases reaching this Court on the question of adequacy of notice have\nbeen concerned with actions founded on process constructively served through local newspapers.\nChance alone brings to the attention of even a local resident an advertisement in small type inserted\nin the back pages of a newspaper, and, if he makes his home outside the area of the newspaper\'s\nnormal circulation, the odds that the information will never reach him are large indeed. The chance\nof actual notice is further reduced when, as here, the notice required does not even name those\nwhose attention it is supposed to attract, and does not inform acquaintances who might call it to\nattention. In weighing its sufficiency on the basis of equivalence with actual notice, we are unable\nto regard this as more than a feint.\nNor is publication here reinforced by steps likely to attract the parties\' attention to the\nproceeding. It is true that publication traditionally has been acceptable as notification supplemental\n245\n\n\x0cto other action which, in itself, may reasonably be expected to convey a warning. The ways of an\nowner with tangible property are such that he usually arranges means to learn of any direct attack\nupon his possessory or proprietary rights. Hence, libel of a ship, attachment of a chattel or entry\nupon real estate in the name of law may reasonably be expected to come promptly to the owner\'s\nattention. When the state within which the owner has located such property seizes it for some\nreason, publication or posting affords an additional measure of notification. A state may indulge\nthe assumption that one who has left tangible property in the state either has abandoned it, in which\ncase proceedings against it deprive him of nothing, or that he has left some caretaker under a duty\nto let him know that it is being jeopardized.\nIn the case before us, there is, of course, no abandonment. On the other hand, these\nbeneficiaries do have a resident fiduciary as caretaker of their interest in this property. But it is\ntheir caretaker who, in the accounting, becomes their adversary. Their trustee is released from\ngiving notice of jeopardy, and no one else is expected to do so. Not even the special guardian is\nrequired or apparently expected to communicate with his ward and client, and, of course, if such a\nduty were merely transferred from the trustee to the guardian, economy would not be served and\nmore likely the cost would be increased.\nThis Court has not hesitated to approve of resort to publication as a customary substitute\nin another class of cases where it is not reasonably possible or practicable to give more adequate\nwarning. Thus, it has been recognized that, in the case of persons missing or unknown,\nemployment of an indirect, and even a probably futile, means of notification is all that the situation\npermits, and creates no constitutional bar to a final decree foreclosing their rights.\nThose beneficiaries represented by appellant whose interests or whereabouts could not,\nwith due diligence, be ascertained come clearly within this category. As to them, the statutory\nnotice is sufficient. However great the odds that publication will never reach the eyes of such\nunknown parties, it is not in the typical case, much more likely to fail than any of the choices open\nto legislators endeavoring to prescribe the best notice practicable.\nNor do we consider it unreasonable for the State to dispense with more certain notice to\nthose beneficiaries whose interests are either conjectural or future or, although they could be\ndiscovered upon investigation, do not, in due course of business, come to knowledge of the\ncommon trustee. Whatever searches might be required in another situation under ordinary\nstandards of diligence, in view of the character of the proceedings and the nature of the interests\nhere involved, we think them unnecessary. We recognize the practical difficulties and costs that\nwould be attendant on frequent investigations into the status of great numbers of beneficiaries,\nmany of whose interests in the common fund are so remote as to be ephemeral, and we have no\ndoubt that such impracticable and extended searches are not required in the name of due process.\nThe expense of keeping informed from day to day of substitutions among even current income\nbeneficiaries and presumptive remaindermen, to say nothing of the far greater number of\ncontingent beneficiaries, would impose a severe burden on the plan, and would likely dissipate its\nadvantages. These are practical matters in which we should be reluctant to disturb the judgment of\nthe state authorities. Accordingly we overrule appellant\'s constitutional objections to published\nnotice insofar as they are urged on behalf of any beneficiaries whose interests or addresses are\nunknown to the trustee.\n\n246\n\n\x0cAs to known present beneficiaries of known place of residence, however, notice by\npublication stands on a different footing. Exceptions in the name of necessity do not sweep away\nthe rule that, within the limits of practicability, notice must be such as is reasonably calculated to\nreach interested parties. Where the names and post office addresses of those affected by a\nproceeding are at hand, the reasons disappear for resort to means less likely than the mails to\napprise them of its pendency.\nThe trustee has on its books the names and addresses of the income beneficiaries\nrepresented by appellant, and we find no tenable ground for dispensing with a serious effort to\ninform them personally of the accounting, at least by ordinary mail to the record addresses.\nCertainly sending them a copy of the statute months, and perhaps years, in advance does not answer\nthis purpose. The trustee periodically remits their income to them, and we think that they might\nreasonably expect that, with or apart from their remittances, word might come to them personally\nthat steps were being taken affecting their interests.\nWe need not weigh contentions that a requirement of personal service of citation on even\nthe large number of known resident or nonresident beneficiaries would, by reasons of delay, if not\nof expense, seriously interfere with the proper administration of the fund. Of course, personal\nservice, even without the jurisdiction of the issuing authority, serves the end of actual and personal\nnotice, whatever power of compulsion it might lack. However, no such service is required under\nthe circumstances. This type of trust presupposes a large number of small interests. The individual\ninterest does not stand alone, but is identical with that of a class. The rights of each in the integrity\nof the fund, and the fidelity of the trustee, are shared by many other beneficiaries. Therefore, notice\nreasonably certain to reach most of those interested in objecting is likely to safeguard the interests\nof all, since any objections sustained would inure to the benefit of all. We think that, under such\ncircumstances, reasonable risks that notice might not actually reach every beneficiary are\njustifiable.\nThe statutory notice to known beneficiaries is inadequate not because, in fact, it fails to\nreach everyone, but because, under the circumstances, it is not reasonably calculated to reach those\nwho could easily be informed by other means at hand. However it may have been in former times,\nthe mails today are recognized as an efficient and inexpensive means of communication.\nMoreover, the fact that the trust company has been able to give mailed notice to known\nbeneficiaries at the time the common trust fund was established is persuasive that postal\nnotification at the time of accounting would not seriously burden the plan.\nIn some situations, the law requires greater precautions in its proceedings than the business\nworld accepts for its own purposes. In few, if any, will it be satisfied with less. Certainly it is\ninstructive, in determining the reasonableness of the impersonal broadcast notification here used,\nto ask whether it would satisfy a prudent man of business, counting his pennies but finding it in\nhis interest to convey information to many persons whose names and addresses are in his files. We\nare not satisfied that it would. Publication may theoretically be available for all the world to see,\nbut it is too much, in our day, to suppose that each or any individual beneficiary does or could\nexamine all that is published to see if something may be tucked away in it that affects his property\ninterests. We have before indicated, in reference to notice by publication that "Great caution should\nbe used not to let fiction deny the fair play that can be secured only by a pretty close adhesion to\nfact."\n247\n\n\x0cWe hold the notice of judicial settlement of accounts required by the New York Banking\nLaw is incompatible with the requirements of the Fourteenth Amendment as a basis for\nadjudication depriving known persons whose whereabouts are also known of substantial property\nrights. Accordingly, the judgment is reversed, and the cause remanded for further proceedings not\ninconsistent with this opinion.\n\n10.2.1.2.\nA.H. ROBINS CO. v. GRADY, 839 F.2d 198 (4th Cir.\n1988)\n[A.H.] Robins, a pharmaceutical company, was the manufacturer and marketer of the\nDalkon Shield, an interuterine contraceptive device, from 1971 to 1974. Production was\ndiscontinued in 1974 because of mounting concerns about the device\'s safety. Because of the\noverwhelming number of claims filed against it because of the Dalkon Shield, Robins filed a\npetition for reorganization under Chapter 11 of the Bankruptcy Code on August 21, 1985.\nMrs. Grady had inserted a Dalkon Shield some years before but thought that the device had\nfallen out. On August 21, 1985, she was admitted to Salinas Valley Memorial Hospital, Salinas,\nCalifornia, complaining of abdominal pain, fever and chills. X-rays and sonograms revealed the\npresence of the Dalkon Shield. On August 28, 1985, the Dalkon Shield was surgically removed.\nMrs. Grady was discharged from the hospital but not long after returned to her physician,\ncomplaining of persistent pain, fever and chills. She was again admitted to the hospital on\nNovember 14, 1985, on which admission she was diagnosed as having pelvic inflammatory\ndisease, and underwent a hysterectomy. She blames the Dalkon Shield for those injuries.\nOn October 15, 1985 (almost two months after Robins filed its petition for reorganization),\nMrs. Grady filed a civil action against Robins.\nMrs. Grady then filed a motion in the bankruptcy court, seeking a decision that her claim\ndid not arise before the filing of the petition so that it would not be stayed by the automatic stay\nprovision of the Code. If the claim arose when the Dalkon Shield was inserted into her, the district\ncourt reasoned, then it would be considered a claim under the Bankruptcy Code and its prosecution\nwould be stayed. If, however, the claim was found to arise when the injuries became apparent,\nthen it might not be a claim for bankruptcy purposes and the automatic stay provision would be\ninapplicable.\nThe bankruptcy court determined that Mrs. Grady\'s claim against Robins arose when the\nacts giving rise to Robins\' liability were performed, not when the harm caused by those acts\nwas manifested. The court rejected Mrs. Grady\'s contention that the court must look to state law\nto determine when her cause of action accrued and equate that with a right to payment. It concluded\nthat the court must follow federal law in determining when the claim arose. It held that the right to\npayment under 11 U.S.C. Sec. 101(4)(A) of Mrs. Grady\'s claim arose when the acts giving rise to\nthe liability were performed and thus the claim was pre-petition.\nWe affirm, although our reasoning may vary somewhat from that of the [lower] court(s).\nCongress intended that the definition of claim in the Code be as broad as possible, noting\nthat "the bill contemplates that all legal obligations of the debtor, no matter how remote or\ncontingent, will be able to be dealt with in the bankruptcy. It permits the broadest possible relief\nin the bankruptcy court."\n248\n\n\x0cWhile the parties agree that the term claim is broadly defined under the Bankruptcy Code,\nthey disagree over whether Mrs. Grady\'s suit falls within that definition\nMrs. Grady argues that her cause of action against Robins did not accrue until after Robins\nhad filed its reorganization petition and therefore the stay provision is inapplicable. Under\nCalifornia law, she argues that she could not have sued Robins until she knew the nature of her\ninjuries. The argument goes that because she had no right to payment from Robins under state law\nuntil she was injured, and since that injury occurred after the reorganization petition was filed, the\nstay provision of Sec. 362 should not bar her case from its prosecution. While not agreeing that\nstate law necessarily controls, the Future Tort Claimants agree that Mrs. Grady had no pre-petition\nright of payment from Robins and therefore no claim under the Bankruptcy Code.\nRobins argues that Mrs. Grady\'s claim falls within the definition set out in Sec 101(4)(A)\nbecause the tortious conduct occurred prior to the filing of the petition, and conclude that claim\naccrual for bankruptcy purposes must be determined in light of bankruptcy law and not state law.\nWe commence with the proposition that "... except where federal law, fully apart from\nbankruptcy, has created obligations by the exercise of power granted to the federal government, a\nclaim implies the existence of an obligation created by State law\xe2\x80\x9d and that "[b]ankruptcy\nlegislation is superimposed upon rights and obligations created by the laws of the States." So, the\nbankruptcy Code is superimposed upon the law of the State which has created the obligation.\nCongress has the undoubted power under the bankruptcy article, U.S. Const. Art. I, Sec. 8 cl. 4, to\ndefine and classify claims against the estate of a bankrupt. In the case of a claim as noted above,\nthe legislative history shows that Congress intended that all legal obligations of the debtor, no\nmatter how remote or contingent, will be able to be dealt with in bankruptcy.\nWith those thoughts in mind, we turn to the pertinent parts of the statutes at hand. Section\n362(a)(1) provides for an automatic stay of, among other things, judicial action against the debtor\n"... to recover a claim against the debtor that arose before the commencement of the case under\nthis title." Section 101(4)(A) defines a claim to be a "right to payment whether or not such right is\nreduced to judgment, liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed,\nundisputed, legal, equitable, secured or unsecured."\nCode Sec 101(4)(A) provides for a "right to payment" whether or not "such right" is\n"contingent." BLACK\'S LAW DICTIONARY, 5th Ed., 1979, defines "contingent" as follows,\nand we adopt this definition, there being no indication that Congress meant to use the word in any\nother sense:\nContingent. Possible, but not assured; doubtful or uncertain; conditioned\nupon the occurrence of some future event which is itself uncertain, or\nquestionable. Synonymous with provisional. This term, when applied to a\nuse, remainder, devise, bequest, or other legal right or interest, implies that\nno present interest exists, and that whether such interest or right ever will\nexist depends upon a future uncertain event.\nMrs. Grady\'s claim, as well as whatever rights the other Future Tort Claimants have, is\nundoubtedly "contingent." It depends upon a future uncertain event, that event being the\nmanifestation of injury from use of the Dalkon Shield. We do not believe that there must be a right\nto the immediate payment of money in the case of a tort or allied breach of warranty or like claim,\nas present here, when the acts constituting the tort or breach of warranty have occurred prior to the\n249\n\n\x0cfiling of the petition, to constitute a claim under Sec. 362(a)(1). It is at once apparent that there\ncan be no right to the immediate payment of money on account of a claim, the existence of which\ndepends upon a future uncertain event. But it is also apparent that Congress has created a\ncontingent right to payment as it has the power to create a contingent tort or like claim within the\nprotection of Sec. 362(a)(1). We are of opinion that it has done so.\nNot only do we think that a literal reading of the statute requires the result we have reached,\nour reading is fortified by other considerations. The broad reading of the word "claim" required by\nthe legislative history and the cases is considerable support. That the legislative history\ncontemplates "the broadest possible relief in the bankruptcy court" also enters our reasoning. If\nMrs. Grady and the Future Tort Claimants, who had no right to the immediate payment of money\nat the time of the filing of the petition, were participants in a Chapter 7 proceeding, the chances\nare that they would receive nothing, for no compensable result had manifested itself prior to the\nfiling of the petition.\nWe also find persuasive the fact that the district court probably had authority to achieve\nthe same result by staying Mrs. Grady\'s suit under 11 U.S.C. Sec. 105(a) in the use of its equitable\npowers to assure the orderly conduct of reorganization proceedings.\nWe emphasize, as did the district court, that we do not decide whether or not Mrs. Grady\'s\nclaim or those of the Future Tort Claimants are dischargeable in this case. Neither do we decide\nwhether or not post-petition claims constitute an administrative expense. We hold only that the\nDalkon Shield claim in the case before us, when the Dalkon Shield was inserted in the claimant\nprior to the time of filing of the petition, constitutes a "claim" "that arose before the commencement\nof the case" within the meaning of 11 U.S.C. Sec. 362(a)(1).\n\n10.2.1.3.\nIN RE JOHNS-MANVILLE CORP., 36 B.R. 743\n(Bankr. S.D.N.Y. 1984)\nKeene Corp. has put before this Court a motion to appoint a legal representative for\nasbestos-exposed future claimants in the Manville reorganization case. It is abundantly clear that\nthe Manville reorganization will have to be accountable to future asbestos claimants whose\ncompelling interest must be safeguarded in order to leave a residue of assets sufficient to\naccommodate a meaningful resolution of the Manville asbestos-related health problem. The term\n"future asbestos claimants" is defined for these purposes to include all persons and entities who,\non or before August 26, 1982, came into contact with asbestos or asbestos-containing products\nmined, fabricated, manufactured, supplied or sold by Manville and who have not yet filed claims\nagainst Manville for personal injuries or property damage. These claimants may be unaware of\ntheir entitlement to recourse against Manville due to the latency period of many years\ncharacterizing manifestation of all asbestos related diseases.\nExposure to asbestos dust may result in one of three diseases: asbestosis, a chronic disease\nof the lungs causing shortness of breath similar to emphysema; mesothelioma, a fatal cancer of the\nlining of the chest, abdomen or lung, and lung or other cancers. However, it is contended by\nManville that it was not until recently that the full extent of the dangers due to asbestos exposure\nwas clarified. Thus, the enhanced safety programs which eventuated because of the new\ndiscoveries regarding the damages of asbestos were too late to have any effect on those who had\n250\n\n\x0cpreviously been exposed. Accordingly, Manville expects a proliferation of claims in the next 30\nyears by those previously exposed who will manifest these diseases in this period.\nAn excursus into the various factors supporting this Court\'s conclusion that these future\nclaimants possess at the very least a cognizable interest in this reorganization case follows. These\nfactors include the applicability of Code Section 1109(b) regarding parties in interest and those\ninsurance cases holding that a proper trigger for insurance coverage for claims liability is exposure\nto asbestos. Analysis also focuses on the statistical data relating to the proliferation of future\nasbestos claims submitted by Manville in support of its petition as well as facts known and agreed\nto by all parties which dictate a finding that these claimants are parties in interest entitled to\nrepresentation in this case. This excursus will conclude by exploring the kinds of entities which\nmay be utilized to represent future claimants in these proceedings.\nFrom the inception of this case, it has been obvious to all concerned that the very purpose\nof the initiation of these proceedings is to deal in some fashion with claimants exposed to the\nravages of asbestos dust who have not as of the filing date manifested symptoms of asbestos\ndisease. Indeed, but for this continually evolving albeit amorphous constituency, it is clear that an\notherwise economically robust Manville would not have commenced these reorganization\nproceedings. It is the spectre of proliferating, overburdening litigation to be commenced in the\nnext 20-30 years, which litigation would be beyond the company\'s ability to manage, control, and\npay for, which has prompted this filing.\n[The court then reviews statistical estimates of Manville\xe2\x80\x99s future asbestos liability]\nAccordingly, a resolution of the interests of future claimants is a central focus of these\nreorganization proceedings. Any plan emerging from this case which ignores these claimants\nwould serve the interests of neither the debtor nor any of its other creditor constituencies in that\nthe central short and long-term economic drain on the debtor would not have been eliminated.\nManville might indeed be forced to file again and again if this eventuated. Each filing would leave\nattenuated assets available to deal with interests of emerging future claimants. Manville could also\nbe forced into liquidation. The liquidation of this substantial corporation would be economically\ninefficient in not only leaving many asbestos claimants uncompensated, but also in eliminating\nneeded jobs and the productivity emanating from an ongoing concern. It fosters the key aims of\nChapter 11 to avoid liquidation at all reasonable costs.\nIndeed, in the final stages of preparation of this opinion, the Seventh Circuit issued its\ndecision in In re UNR Industries, Inc., 725 F.2d 1111, (7th Cir.1984), concerning a decision below\ndenying the appointment of a legal representative for future asbestos claimants. Although the\nSeventh Circuit held that the issue was not ripe for appellate review, it did declare in dicta the\nimportance of future claimants to any plan emerging from this kind of reorganization. The Seventh\nCircuit stated: "If future claims cannot be discharged before they ripen, UNR may not be able to\nemerge from bankruptcy with reasonable prospects for continued existence as a going concern."\n[The Court concludes that future claimants are \xe2\x80\x9cparties in interest\xe2\x80\x9d because their prepetition\nexposure to asbestos would trigger insurance coverage under Manville\xe2\x80\x99s insurance policies.]\nMuch of the opposition expressed by the constituencies in this case is concerned with the\nmechanical difficulties of appointment, i.e., the fairness of a single representative, or the lack of a\nspecifically defined role. The Unsecured Creditors Committee argues that if a representative can\nbe appointed, it should not be a solitary representative, but rather a committee of persons\n251\n\n\x0crepresenting this group. The Equity Committee takes the position that if future claims are to be\ndealt with, the appointment of a legal representative at this time would serve no tangible objective\nbecause it is only when Manville seeks an inevitable injunction prohibiting future claimants from\nasserting their claims against an asset-shielded post-confirmation entity that this representative\'s\nfunction is no longer amorphous. This statement exhibits the Equity Committee\'s basic belief that\na legal representative for future claimants is appropriate to the reorganization process. The\nCommittee only differs from Keene and Manville on the timing of such appointment.\nThe concept of the appointment of some kind of representative for parties in interest whose\nidentities are yet unknown is not unprecedented. The power to appoint such a representative is\ninherent in every court.\nFor the reasons set forth at length herein and in Decision No. 1 on correlated Manville\nmatters, Keene\'s motion for the appointment of a legal representative is granted.\n\n10.2.1.4.\n\nKANE v. MANVILLE, 843 F.2d 636 (2d Cir. 1988)\n\nThis appeal challenges the lawfulness of the reorganization plan of the Johns-Manville\nCorporation ("Manville"), a debtor in one of the nation\'s most significant Chapter 11 bankruptcy\nproceedings. Lawrence Kane, on behalf of himself and a group of other personal injury claimants,\nappeals from an order [confirming Manville\xe2\x80\x99s] Second Amended Plan of Reorganization (the\n"Plan").\nKane and the group of 765 individuals he represents (collectively "Kane") are persons with\nasbestos-related disease who had filed personal injury suits against Manville prior to Manville\'s\nChapter 11 petition. The suits were stayed, and Kane and other claimants presently afflicted with\nasbestos-related disease were designated as Class-4 creditors in the reorganization proceedings.\nKane now objects to confirmation of the reorganization Plan on several grounds: it\ndischarges the rights of future asbestos victims who do not have "claims" within the meaning of\n11 U.S.C. \xc2\xa7 101(4) (1982), it was adopted without constitutionally adequate notice to various\ninterested parties, [and] the voting procedures used in approving the Plan violated the Bankruptcy\nCode and due process requirements. We determine that Kane lacks standing to challenge the Plan\non the grounds that it violates the rights of future claimants and other third parties, and we reject\non the merits his remaining claims that the Plan violates his rights regarding voting.\nPrior to its filing for reorganization in 1982, Manville was the world\'s largest miner of\nasbestos and a major manufacturer of insulating materials and other asbestos products. Beginning\nin the 1960\'s, scientific studies began to confirm that exposure to asbestos fibers over time could\ncause a variety of respiratory diseases, including certain forms of lung cancer. A significant\ncharacteristic of these asbestos-related diseases is their unusually long latency period. An\nindividual might not become ill from an asbestos-related disease until as long as forty years after\ninitial exposure. Hence, many asbestos victims remain unknown, most of whom were exposed in\nthe 1950\'s and 1960\'s before the dangers of asbestos were widely recognized. These persons might\nnot develop clinically observable symptoms until the 1990\'s or even later.\nAs a result of the studies linking respiratory disease with asbestos, Manville became the\ntarget in the 1960\'s and 1970\'s of a growing number of products liability lawsuits. By the early\n1980\'s, Manville had been named in approximately 12,500 such suits brought on behalf of over\n252\n\n\x0c16,000 claimants. New suits were being filed at the rate of 425 per month. Epidemiological studies\nundertaken by Manville revealed that approximately 50,000 to 100,000 additional suits could be\nexpected from persons who had already been exposed to Manville asbestos. On the basis of these\nstudies and the costs Manville had already experienced in disposing of prior claims, Manville\nestimated its potential liability at approximately $2 billion. On August 26, 1982, Manville filed a\nvoluntary petition in bankruptcy under Chapter 11. From the outset of the reorganization, all\nconcerned recognized that the impetus for Manville\'s action was not a present inability to meet\ndebts but rather the anticipation of massive personal injury liability in the future.\nBecause future asbestos-related liability was the raison d\'etre of the Manville\nreorganization, an important question at the initial stages of the proceedings concerned the\nrepresentation and treatment of what were termed "future asbestos health claimants" ("future\nclaimants"). The future claimants were persons who had been exposed to Manville\'s asbestos prior\nto the August 1982 petition date but had not yet shown any signs of disease at that time. Since the\nfuture claimants were not yet ill at the time the Chapter 11 proceedings were commenced, none\nhad filed claims against Manville, and their identities were unknown. An Asbestos Health\nCommittee was appointed to represent all personal injury claimants, but the Committee took the\nposition that it represented the interests only of "present claimants," persons who, prior to the\npetition date, had been exposed to Manville asbestos and had already developed an asbestosrelated disease. The Committee declined to represent the future claimants. Other parties in the\nproceedings, recognizing that an effective reorganization would have to account for the future\nasbestos victims as well as the present ones, moved the Bankruptcy Court to appoint a legal\nguardian for the future claimants. The Bankruptcy Court granted the motion, reasoning that\nregardless of whether the future claimants technically had "claims" cognizable in bankruptcy\nproceedings, see 11 U.S.C. \xc2\xa7 101(4), they were at least "parties in interest" under section 1109(b)\nof the Code and were therefore entitled to a voice in the proceedings. The Court appointed a Legal\nRepresentative to participate on behalf of the future claimants. Additionally, the Court invited any\nperson who had been exposed to Manville\'s asbestos but had not developed an illness to participate\nin the proceedings, and two such persons appeared.\nThe Second Amended Plan of Reorganization resulted from more than four years of\nnegotiations among Manville, the Asbestos Health Committee, the Legal Representative, the\nEquity Security Holders\' Committee, and other groups interested in the estate. The cornerstone of\nthe Plan is the Asbestos Health Trust (the "Trust"), a mechanism designed to satisfy the claims of\nall asbestos health victims, both present and future. The Trust is funded with the proceeds from\nManville\'s settlements with its insurers; certain cash, receivables, and stock of the reorganized\nManville Corporation; long term notes; and the right to receive up to 20% of Manville\'s yearly\nprofits for as long as it takes to satisfy all health claims. According to the terms of the Trust,\nindividuals with asbestos-related disease must first try to settle their claims by a mandatory\nexchange of settlement offers with Trust representatives. If a settlement cannot be reached, the\nclaimant may elect mediation, binding arbitration, or traditional tort litigation. The claimant may\ncollect from the Trust the full amount of whatever compensatory damages he is awarded. The only\nrestriction on recovery is that the claimant may not obtain punitive damages.\nThe purpose of the Trust is to provide a means of satisfying Manville\'s ongoing personal\ninjury liability while allowing Manville to maximize its value by continuing as an ongoing\nconcern. To fulfill this purpose, the Plan seeks to ensure that health claims can be asserted only\n253\n\n\x0cagainst the Trust and that Manville\'s operating entities will be protected from an onslaught of\ncrippling lawsuits that could jeopardize the entire reorganization effort. To this end, the parties\nagreed that as a condition precedent to confirmation of the Plan, the Bankruptcy Court would issue\nan injunction channeling all asbestos-related personal injury claims to the Trust (the "Injunction").\nThe Injunction provides that asbestos health claimants may proceed only against the Trust to\nsatisfy their claims and may not sue Manville, its other operating entities, and certain other\nspecified parties, including Manville\'s insurers. Significantly, the Injunction applies to all health\nclaimants, both present and future, regardless of whether they technically have dischargeable\n"claims" under the Code. The Injunction applies to any suit to recover "on or with respect to any\nClaim, Interest or Other Asbestos Obligation." "Claim" covers the present claimants, who are\ncategorized as Class-4 unsecured creditors under the Plan and who have dischargeable "claims"\nwithin the meaning of 11 U.S.C. \xc2\xa7 101(4). The future claimants are subject to the Injunction under\nthe rubric of "Other Asbestos Obligation," which is defined by the Plan as asbestos-related health\nliability caused by pre-petition exposure to Manville asbestos, regardless of when the individual\ndevelops clinically observable symptoms. Thus, while the future claimants are not given creditor\nstatus under the Plan, they are nevertheless treated identically to the present claimants by virtue of\nthe Injunction, which channels all claims to the Trust.\nThe Plan was submitted to the Bankruptcy Court for voting in June of 1986. At that time\nrelatively few present asbestos health claimants had appeared in the reorganization proceedings.\nApproximately 6,400 proofs of claims had been filed for personal injuries, which accounted for\nless than half of the more than 16,000 persons who had filed pre-petition personal injury suits\nagainst Manville. Moreover, Manville estimated that there were tens of thousands of additional\npresent asbestos victims who had neither filed suits nor presented proofs of claims. Manville and\nthe creditor constituencies agreed that as many present claimants as possible should be brought\ninto the proceedings so that they could vote on the Plan. However, the parties were reluctant to\nembark on the standard Code procedure of establishing a bar date, soliciting proofs of claims,\nresolving all disputed claims on notice and hearing, and then weighting the votes by the amounts\nof the claims, as such a process could delay the reorganization for many years. To avoid this delay,\nthe Bankruptcy Court adopted special voting procedures for Class 4. Manville was directed to\nundertake a comprehensive multi-media notice campaign to inform persons with present health\nclaims of the pendency of the reorganization and their opportunity to participate. Potential health\nclaimants who responded to the campaign were given a combined proof-of-claim-and-voting form\nin which each could present a medical diagnosis of his asbestos-related disease and vote to accept\nor reject the Plan. For voting purposes only, each claim was valued in the amount of one dollar.\nClaimants were informed that the proof-of-claim-and-voting form would be used only for voting\nand that to collect from the Trust, they would have to execute an additional proof of claim\nestablishing the actual value of their damages.\nThe notice campaign produced a large number of present asbestos claimants. In all, 52,440\nsuch claimants submitted proof-of-claim-and-voting forms. Of these, 50,275 or 95.8% approved\nthe Plan, while 2,165 or 4.2% opposed it. In addition to these Class-4 claimants, all other classes\nof creditors also approved the Plan. Class 8, the common stockholders, opposed the Plan.\nA confirmation hearing was held on December 16, 1986, at which Manville presented\nevidence regarding the feasibility and fairness of the Plan. Objections to confirmation were filed\nby several parties, including Kane. On December 18, 1986, the Bankruptcy Court issued a\n254\n\n\x0cDetermination of Confirmation Issues in which it rejected all objections to confirmation. With\nrespect to Kane\'s challenge to the Injunction and the voting procedures, the Court relied primarily\non its broad equitable powers to achieve reorganizations. Furthermore, the Court found that, based\non an extensive liquidation and feasibility analysis presented by Manville at the hearing, the Plan\nwas workable, in the best interests of the creditors, and otherwise in conformity with the\nrequirements of 11 U.S.C. \xc2\xa7 1129(a) and (b). The Court entered an order confirming the Plan on\nDecember 22, 1986.\nA. Standing\nThe Legal Representative of the future claimants challenges Kane\'s standing to bring this\nappeal. The Legal Representative contends that Kane is not directly and adversely affected by the\nconfirmation order and that his appeal improperly asserts the rights of third parties, namely the\nfuture claimants. We conclude that Kane is sufficiently harmed by confirmation of the Plan to\nchallenge it on appeal but that his appeal must be limited to those contentions that assert a\ndeprivation of his own rights.\nIn the present case, Kane, a creditor, has economic interests that are directly impaired by\nthe Plan. His recourse to the courts to pursue damages for his injuries is limited by the settlement\nprocedures mandated by the Trust, he is not entitled to punitive damages, and, ultimately, his\nrecovery is subject to the Trust\'s being sufficiently funded. Kane might receive more under this\nPlan than he would receive in a liquidation. However, he might do better still under alternative\nplans. Since the Second Amended Plan gives Kane less than what he might have received, he is\ndirectly and adversely affected pecuniarily by it, and he therefore has standing to challenge it on\nappeal.\nHaving determined that Kane may appeal the Bankruptcy Court\'s confirmation order, we\nmust now decide whose rights Kane will be permitted to assert. It is clear that some of Kane\'s\nclaims are based exclusively on the rights of third parties. He asserts five claims:\n(1) The Injunction violates the Bankruptcy Code because it affects the rights of future\nasbestos victims who do not have "claims" within the meaning of 11 U.S.C. \xc2\xa7 101(4).[4]\n(2) The Injunction violates due process because future claimants were given inadequate\nnotice of the discharge of their rights.\n(3) The special voting procedures for Class 4 violate due process because present claimants\nwere given inadequate notice of the hearing at which the voting procedures were adopted.\n(4) The Class-4 voting procedures violate the Code because persons were permitted to vote\nbefore their claims were "allowed" pursuant to 11 U.S.C. \xc2\xa7 502 (1982 & Supp. IV 1986), claims\nwere arbitrarily assigned a value of one dollar each for voting purposes, and creditors were denied\nthe opportunity to object to claims.\n(5) The Plan fails to meet the requirements of 11 U.S.C. \xc2\xa7 1129(a) and (b) because it was\nnot proposed in good faith, it is not in the best interests of all creditors, it is not feasible, and it is\nnot fair and equitable with respect to dissenting classes.\nKane does not dispute that his challenges to the Injunction (claims (1) and (2)) assert the\nconstitutional and statutory rights only of the future claimants. Additionally, we note that claim\n(3) regarding notice of the voting procedures asserts only third-party rights. Kane was present at\n255\n\n\x0cthe June 23, 1986, hearing at which the voting procedures were adopted and had an opportunity to\nobject, which he concedes that he exercised. Kane\'s claim with respect to notice of voting\nprocedures is that notice was inadequate only as to present health claimants (other than himself)\nwho were not informed of the special voting procedures and might have wanted to object. The\nquestion we must consider is whether on this appeal of the confirmation order, Kane may assert\nclaims of these third parties. We conclude that he may not.\nGenerally, litigants in federal court are barred from asserting the constitutional and\nstatutory rights of others in an effort to obtain relief for injury to themselves. Though this limitation\nis not dictated by the Article III case or controversy requirement, the third-party standing doctrine\nhas been considered a valuable prudential limitation, self-imposed by the federal courts.\nThe prudential concerns limiting third-party standing are particularly relevant in the\nbankruptcy context. Bankruptcy proceedings regularly involve numerous parties, each of whom\nmight find it personally expedient to assert the rights of another party even though that other party\nis present in the proceedings and is capable of representing himself. Third-party standing is of\nspecial concern in the bankruptcy context where, as here, one constituency before the court seeks\nto disturb a plan of reorganization based on the rights of third parties who apparently favor the\nplan. In this context, the courts have been understandably skeptical of the litigant\'s motives and\nhave often denied standing as to any claim that asserts only third-party rights.\nPrudential concerns weigh heavily against permitting Kane to assert the rights of the future\nclaimants in attacking the Plan. First, Kane\'s interest in these proceedings is potentially opposed\nto that of the future claimants. Both Kane and the future claimants wish to recover from the debtor\nfor personal injuries. To the extent that Kane is successful in obtaining more of the debtor\'s assets\nto satisfy his own claims, less will be available for other parties, with the distinct risk that the\nfuture claimants will suffer. Thus, we cannot depend on Kane sincerely to advance the interests of\nthe future claimants. Second, the third parties whose rights Kane seeks to assert are already\nrepresented in the proceedings. Though it is true, as Kane points out, that the future claimants\nthemselves are not before the Court, they are ably represented by the appointed Legal\nRepresentative. Therefore, it is not necessary to allow Kane to raise the future claimants\' rights on\nthe theory that these rights will be otherwise ignored. The Bankruptcy Court appointed the Legal\nRepresentative specifically for the purpose of ensuring that the rights of the future claimants would\nbe asserted where necessary. Certainly as between Kane and the Legal Representative, there is no\nquestion that the latter is the more reliable advocate of the future claimants\' rights, and we may\nconfidently leave that task entirely to him. Finally, and significantly, the Legal Representative has\nexpressly stated in this appeal that he does not want Kane to assert the future claimants\' rights.\nThis is precisely the situation where the third-party standing limitation should apply.\nFor similar reasons, Kane may not assert the rights of present claimants who he contends\nwere given inadequate notice of the June 1986 hearing at which the special Class-4 voting\nprocedures were adopted. Those Class-4 creditors are in the proceedings and could have objected\nto the Plan if they had wanted to, but they did not. In fact, the overwhelming majority of Class 4\nvoted in favor of the Plan. It is not for Kane to insist that other Class-4 members should have\nreceived more notice than what apparently satisfies them.\nKane argues that he ought to be permitted at least to challenge the Injunction because his\nclaim is "inextricably bound up with" the rights of the future claimants. Kane reasons that his own\n256\n\n\x0crecovery from the Trust depends upon Manville\'s financial stability, which in turn could be\njeopardized by a future claimant\'s successful challenge to the Injunction. If future claimants are\nnot bound by the Injunction, then, Kane predicts, they will sue Manville\'s operating entities\ndirectly, Manville will be unable to meet its funding commitments to the Trust, and Kane will lose\nhis rights to compensation under the Plan. Kane therefore contends that he should be able to test\nthe validity of the Injunction as to the future claimants now so as to avoid a successful challenge\ndetrimental to him in the future.\nThough we recognize that future claimants may at some later point attempt to challenge\nthe Injunction, we do not believe that Kane\'s interests are so "inextricably bound up with" those of\nthe future claimants in such a suit as to warrant third-party standing. Even if we assume that future\nclaimants would at some later time be permitted to advance a position contrary to that taken by the\nLegal Representative in this litigation and assume further that the future claimants\' objections to\nthe Injunction are upheld, matters upon which we express no opinion, Kane has failed to show a\nsufficient likelihood that he would be harmed by such a successful challenge. The flaw in Kane\'s\nanalysis is that it assumes that an onslaught of future victims\' suits could impair the Trust before\nKane is paid. Such is not the case. Kane and the other present claimants are, by definition, currently\nafflicted with asbestos disease. They may all initiate claims against the Trust immediately after\nconfirmation. Resolution and payment of these claims is expected to take approximately ten years.\nThe bulk of the future victims, in contrast, are not presently afflicted with disease. Many of them\nwill not become ill until well into the 1990\'s or later. While some of the last of the present claimants\nmay overlap with the first of the future claimants in presenting their damage claims, the claims of\nthese groups will be presented essentially consecutively. By the time enough future claimants\ndevelop asbestos-related disease, challenge the Injunction, and, if successful, collect damages\ndirectly from Manville to an extent sufficient to impair the long-term funding of the Trust, Kane\nwill have had years to enforce his own claims. Kane\'s concern that he will be precluded from\ncollecting from the Trust because of future claimants\' suits against Manville is therefore too\nspeculative a basis on which to grant third-party standing.\n[The Court then rejects Kane\xe2\x80\x99s own claims regarding voting procedures and compliance\nwith the confirmation requirements of the Bankruptcy Code.]\nThe order of the District Court affirming the Bankruptcy Court\'s confirmation order is\naffirmed.\n\n10.2.1.5.\nEPSTEIN v. PIPER AIRCRAFT, 58 F.3d 1573 (11th\nCir. 1995)\nThis is an appeal by David G. Epstein, as the Legal Representative for the Piper future\nclaimants (Future Claimants). The sole issue on appeal is whether the class of Future Claimants,\nas defined by the bankruptcy court, holds claims against the estate of Piper Aircraft Corporation\n(Piper), within the meaning of \xc2\xa7 101(5) of the Bankruptcy Code. After review of the relevant\nprovisions, policies and goals of the Bankruptcy Code and the applicable case law, we hold that\nthe Future Claimants do not have claims as defined by \xc2\xa7 101(5) and thus affirm the opinion of the\ndistrict court.\nPiper has been manufacturing and distributing general aviation aircraft and spare parts\nthroughout the United States and abroad since 1937. Approximately 50,000 to 60,000 Piper aircraft\n257\n\n\x0cstill are operational in the United States. Although Piper has been a named defendant in several\nlawsuits based on its manufacture, design, sale, distribution and support of its aircraft and parts, it\nhas never acknowledged that its products are harmful or defective.\nOn July 1, 1991, Piper filed a voluntary petition under Chapter 11. Piper\'s plan of\nreorganization contemplated finding a purchaser of substantially all of its assets or obtaining\ninvestments from outside sources, with the proceeds of such transactions serving to fund\ndistributions to creditors. On April 8, 1993, Piper and Pilatus Aircraft Limited signed a letter of\nintent pursuant to which Pilatus would purchase Piper\'s assets. The letter of intent required Piper\nto seek the appointment of a legal representative to represent the interests of future claimants by\narranging a set-aside of monies generated by the sale to pay off future product liability claims.\nOn May 19, 1993, the bankruptcy court appointed Appellant Epstein as the legal\nrepresentative for the Future Claimants. This Order expressly stated that the court was making no\nfinding on whether the Future Claimants could hold claims against Piper under \xc2\xa7 101(5) of the\nCode.\nOn July 12, 1993, Epstein filed a proof of claim on behalf of the Future Claimants in the\napproximate amount of $100,000,000. The claim was based on statistical assumptions regarding\nthe number of persons likely to suffer, after the confirmation of a reorganization plan, personal\ninjury or property damage caused by Piper\'s pre-confirmation manufacture, sale, design,\ndistribution or support of aircraft and spare parts. The Official Committee of Unsecured Creditors\n(Official Committee), and later Piper, objected to the claim on the ground that the Future Claimants\ndo not hold \xc2\xa7 101(5) claims against Piper. After a hearing on the objection, the bankruptcy court\nagreed that the Future Claimants did not hold \xc2\xa7 101(5) claims, and, on December 6, 1993, entered\nan Order Sustaining the Committee\'s Objection and Disallowing the Legal Representative\'s Proof\nof Claim\nThe sole issue on appeal, whether any of the Future Claimants hold claims against Piper as\ndefined in \xc2\xa7 101(5) of the Bankruptcy Code, is one of first impression in this Circuit. Interpretation\nand application of the Bankruptcy Code is a question of law, to which this Court will apply a de\nnovo standard of review.\nUnder the Bankruptcy Code, only parties that hold pre-confirmation claims have a legal\nright to participate in a Chapter 11 bankruptcy case and share in payments pursuant to a Chapter\n11 plan.\nThe legislative history of the Code suggests that Congress intended to define the term claim\nvery broadly under \xc2\xa7 101(5), so that "all legal obligations of the debtor, no matter how remote or\ncontingent, will be able to be dealt with in the bankruptcy case."\nSince the enactment of \xc2\xa7 101(5), courts have developed several tests to determine whether\ncertain parties hold claims pursuant to that section: the accrued state law claim test, the conduct\ntest, and the prepetition relationship test. The bankruptcy court and district court adopted the\nprepetition relationship test in determining that the Future Claimants did not hold claims pursuant\nto \xc2\xa7 101(5).\nEpstein primarily challenges the district court\'s application of the prepetition relationship\ntest. He argues that the conduct test, which some courts have adopted in mass tort cases, is more\nconsistent with the text, history, and policies of the Code. Under the conduct test, a right to\n258\n\n\x0cpayment arises when the conduct giving rise to the alleged liability occurred. Epstein\'s position is\nthat any right to payment arising out of the prepetition conduct of Piper, no matter how remote,\nshould be deemed a claim and provided for, pursuant to \xc2\xa7 101(5), in this case. He argues that the\nrelevant conduct giving rise to the alleged liability was Piper\'s prepetition manufacture, design,\nsale and distribution of allegedly defective aircraft. Specifically, he contends that, because Piper\nperformed these acts prepetition, the potential victims, although not yet identifiable, hold claims\nunder \xc2\xa7 101(5) of the Code.\nThe Official Committee and Piper dispute the breadth of the definition of claim asserted\nby Epstein, arguing that the scope of claim cannot extend so far as to include unidentified, and\npresently unidentifiable, individuals with no discernible prepetition relationship to Piper.\nRecognizing, as Appellees do, that the conduct test may define claim too broadly in certain\ncircumstances, several courts have recognized "claims" only for those individuals with some type\nof prepetition relationship with the debtor. The prepetition relationship test, as adopted by the\nbankruptcy court and district court, requires "some prepetition relationship, such as contact,\nexposure, impact, or privity, between the debtor\'s prepetition conduct and the claimant" in order\nfor the claimant to hold a \xc2\xa7 101(5) claim.\nUpon examination of the various theories, we agree with Appellees that the district court\nutilized the proper test in deciding that the Future Claimants did not hold a claim under \xc2\xa7 101(5).\nEpstein\'s interpretation of "claim" and application of the conduct test would enable anyone to hold\na claim against Piper by virtue of their potential future exposure to any aircraft in the existing fleet.\nEven the conduct test cases, on which Epstein relies, do not compel the result he seeks. In fact, the\nconduct test cases recognize that focusing solely on prepetition conduct, as Epstein espouses,\nwould stretch the scope of \xc2\xa7 101(5). Accordingly, the courts applying the conduct test also presume\nsome prepetition relationship between the debtor\'s conduct and the claimant.\nWhile acknowledging that the district court\'s test is more consistent with the purposes of\nthe Bankruptcy Code than is the conduct test supported by Epstein, we find that the test as set forth\nby the district court unnecessarily restricts the class of claimants to those who could be identified\nprior to the filing of the petition. Those claimants having contact with the debtor\'s product postpetition but prior to confirmation also could be identified, during the course of the bankruptcy\nproceeding, as potential victims, who might have claims arising out of debtor\'s prepetition conduct.\nWe therefore modify the test used by the district court and adopt what we will call the\n"Piper test" in determining the scope of the term claim under \xc2\xa7 101(5): an individual has a \xc2\xa7 101(5)\nclaim against a debtor manufacturer if (i) events occurring before confirmation create a\nrelationship, such as contact, exposure, impact, or privity, between the claimant and the debtor\'s\nproduct; and (ii) the basis for liability is the debtor\'s pre-petition conduct in designing,\nmanufacturing and selling the allegedly defective or dangerous product. The debtor\'s prepetition\nconduct gives rise to a claim to be administered in a case only if there is a relationship established\nbefore confirmation between an identifiable claimant or group of claimants and that prepetition\nconduct.\nIn the instant case, it is clear that the Future Claimants fail the minimum requirements of\nthe Piper test. There is no pre-confirmation exposure to a specific identifiable defective product or\nany other pre-confirmation relationship between Piper and the broadly defined class of Future\nClaimants. As there is no pre-confirmation connection established between Piper and the Future\n259\n\n\x0cClaimants, the Future Claimants do not hold a \xc2\xa7 101(5) claim arising out of Piper\'s prepetition\ndesign, manufacture, sale, and distribution of allegedly defective aircraft.\nFor the foregoing reasons, we hold that the Future Claimants do not meet the threshold\nrequirements of the Piper test and, as a result, do not hold claims as defined in \xc2\xa7 101(5) of the\nBankruptcy Code.\n\n10.2.1.6.\nIN RE FAIRCHILD AIRCRAFT CORP., 184 B.R.\n910 (Bankr. W.D. Tex. 1995)\nFairchild Aircraft Incorporated ("FAI") filed its Complaint for Declaratory and Injunctive\nRelief in the bankruptcy case of Fairchild Aircraft Corporation ("FAC"). [FAI and defendants have\nfiled] cross-motions for summary judgment.\nThe issue of future claims in bankruptcy has bedeviled the federal courts for many years\nnow. What happens after a bankruptcy plan disposes of all the assets of a debtor and, years later,\nsomeone suffers an injury alleged to have arisen from a defective product produced by the\nprepetition debtor? Does the injured party have a claim against the successor entity for damages,\nunaffected by the bankruptcy process? Or may bankruptcy alter or even eliminate those claims\nbefore they even mature into an injury? That is the issue with which this decision struggles and\nattempts to resolve.\nThe facts surrounding this matter span over a decade. Fairchild Aircraft Corporation\nmanufactured and sold commuter aircraft, one a 19-seat passenger aircraft sold to civilians as a\nMetro III and to the military as the C-26, and the other a smaller aircraft sold as the Merlin II and\nIII or the Fairchild 300. This case concerns the crash of one these smaller aircraft, a Fairchild 300.\nFAC stopped production of the Fairchild 300 in 1982. FAC continued to sell the aircraft as late as\n1985, because it held several of the airframes in inventory. It is undisputed that the aircraft in\nquestion in this case was manufactured no later than 1982 and sold no later than 1985 \xe2\x80\x94 five years\nbefore FAC\'s later chapter 11 bankruptcy.\nFAC filed for chapter 11 relief on February 11, 1990. Shortly after the filing, a chapter 11\ntrustee was appointed (the "Trustee"), with full authority to operate the debtor\'s business. The\nTrustee, Bettina M. Whyte, decided that reorganization was not a viable option for the estate, and\nsolicited a buyer for the company\'s assets, which she proposed to sell as a going concern. On\nAugust 14, 1990, the Trustee entered into an asset purchase agreement with a group of investors\nwho formed a corporation for the purpose of the acquisition, called appropriately enough Fairchild\nAcquisition, Inc. FAI was to pay $5 million in cash and was to assume liability for FAC\'s secured\ndebt to Sanwa Business Credit, in the range of $36 million. The estate was to retain some cash, its\nestate causes of action (including preference actions), and a share of an anticipated tax refund. The\nasset purchase agreement also contained the following provision, which the acquiring entity\nmaintains was an essential element of the bargain and induced the seller to purchase the assets for\nas much as it did:\nPurchaser shall not assume, have any liability for, or in any manner\nbe responsible for any liabilities or obligations of any nature of\nSeller or the Trustee, including without limiting the generality of the\nforegoing: ... (ii) any occurrence or event at any time which results\n260\n\n\x0cor is alleged to have resulted in injury or death to any person or\ndamage to or destruction of property (including loss of use) or any\nother damage (regardless of when such injury, death or damage\ntakes place) which was caused by or allegedly caused by (A) any\nhazard or alleged hazard or defect or alleged defect in manufacture,\ndesign, materials or workmanship...\nThe sale took place as part of the confirmation of the Trustee\'s First Amended Plan of\nReorganization and was of course subject to the approval of the bankruptcy court. On September\n17, 1990, the court confirmed the Trustee\'s Plan and the asset sale agreement which was its central\nfeature. The confirmation order expressly stated that the assets were sold "free and clear of all\nliens, claims, and encumbrances," except for those liens and encumbrances assumed by the buyer\nunder the plan. The order further stated that the purchaser would not "assume, have any liability\nfor, or in any manner be responsible for any liabilities or obligations of any nature of Debtor,\nReorganized Debtor, the Trustee or the Fiscal Agent." Finally, the order enjoined and stayed "all\ncreditors, claimants against, and persons claiming or having any interest of any nature whatsoever"\nfrom "pursuing or attempting to pursue, or commencing any suits or proceedings at law, in equity\nor otherwise, against the property of the Debtor\'s estate ... the proceeds of the sale ... or any other\nperson or persons claiming, directly or indirectly, including the Purchaser under the Asset Purchase\nAgreement ..."\nThe court found that the consideration to be paid by FAI (the cash and the assumption of\nsecured debt) was "fair and adequate and fully representative of the maximum value that can be\nrealized at this time for Debtor\'s Property." The court also made a finding that the notice provided\nconcerning the plan and disclosure statement was reasonable under the circumstances. The Trustee\nhad published notice of the disclosure statement, plan of reorganization and confirmation hearing\nin the Weekly News of Business Aviation, and in two local newspapers, the San Antonio Light\nand the San Antonio Express-News.\nThe Trustee made no provision in her plan for claimants in the position of these defendants.\nIndeed, the debtor had not even listed any of the owners or operators of FAC aircraft in its\nbankruptcy schedules, though their identities were available and ascertainable from the records of\nFAC. The Trustee made no particular effort to reach these persons in the plan process, and the plan\nitself made no particular provision for these persons.\nOn April 1, 1993, a Fairchild 300 aircraft, originally sold and manufactured by FAC\ncrashed near Blountville, Tennessee. Four individuals lost their lives. Multiple lawsuits were of\ncourse filed on the heels of this crash, in both federal and state courts in Georgia, Tennessee and\nSouth Carolina. Three of the plaintiffs were persons suing both individually and on behalf of\nestates of the individuals killed in the aircraft crash. The plaintiffs also included Eastern Foods,\nInc. and Hooters of America, Inc., the owners of the airplane, as well as Insurance Company of\nNorth America, the owner\'s insurance carrier.\nThe plaintiffs named FAI as one of the defendants, alleging that the aircraft was defectively\nmanufactured by FAC, and that FAI is now liable for the manufacture and sale of a defective\nproduct on a successor liability theory. FAI filed this adversary proceeding as a preemptive strike,\nseeking an order for declaratory and injunctive relief premised on the provisions of the plan, the\n261\n\n\x0casset purchase agreement, and the court\'s order confirming the plan. As such, the plaintiffs in the\nproducts liability lawsuits find themselves as defendants in this action for declaratory relief.\nThe legal issues presented can be stated simply. FAI claims that the provisions of the asset\npurchase agreement and order confirming the plan "cleansed" the property acquired of any liability\nfor the acts of FAC, including any successor liability growing out of the sale of those assets to FAI\nby the trustee of FAC\'s bankruptcy. FAI says that the sale was free and clear of this sort of liability,\nand that the bankruptcy court should here so declare. FAI also contends that any lawsuit to force\nliability on FAI based upon its acquisition of assets would violate the bankruptcy court\'s injunction\ncontained in the confirmation order, and asks the court to enforce that injunction.\nFAI would like to stop the defendants in their tracks without ever having to defend against\na successor liability lawsuit. It is not hard to understand why. Even if FAI believes the successor\nliability allegation to have little merit (and that is its position), it must still incur the cost of defense\nand risk the uncertainty of litigation. Moreover, there are still other FAC aircraft out there, and if\nanother one crashes, an adverse outcome in this litigation could all but assure an adverse outcome\nin other litigation as well. Rather than endure these risks, FAI would like to rely on what it believes\nto have been the effective protections built into the court-supervised sale process, protections for\nwhich it believes it bargained. If those protections prove to be worthless, then it will not have\nreceived the benefit of its bargain, a result with consequences reaching far beyond this litigation\nnot only for FAI but also for bankruptcy estates in general.\n[W]e must first be sure to understand the nature of the particular claim with which we are\nhere presented. Then we must next determine whether it is in fact a "bankruptcy claim" within the\nmeaning of section 101(5) of the Code. If it is, then we must determine whether the bankruptcy\nprocess could have affected this claim. Finally, we must decide whether the bankruptcy process\nemployed in this case did in fact affect this claim in a manner such as to cut off the ability of these\ndefendants to maintain their action against FAI. We turn to the first question, an understanding of\nthe nature of this claim.\nSuccessor liability has its antecedents in corporate law. In corporate law, the general rule\nhas always been that the transfer of assets from one company to another does not pass on the debts\nor liabilities of the transferor, including liability for torts or products liability actions. The general\nrule is not absolute, and four exceptions have been traditionally recognized. A successor by\npurchase may be held liable for the debts or liabilities of its predecessor where: (1) there is an\nexpress or implied assumption of liability; (2) the transaction amounts to a consolidation, merger\nor similar restructuring of the two corporations; (3) the purchasing corporation is a "mere\ncontinuation" of the seller; or (4) the transfer of assets to the purchaser is for the fraudulent purpose\nof escaping liability for the seller\'s debts. In recent years, a few courts have recognized a fifth\nexception, springing essentially from the nature of the defect and the product in question.\nRegardless the exception, successor liability does not create a new cause of action against\nthe purchaser so much as it transfers the liability of the predecessor to the purchaser. The nature\nof the liability itself does not change. Thus, while successor liability may give a party an alternative\nentity from whom to recover, the doctrine does not convert the claim to an in rem action running\nagainst the property being sold. Nor does the claim have an existence independent of the\nunderlying liability of the entity that sold the assets.\n262\n\n\x0cIf this "claim" is in fact one properly characterized as a "claim" within the meaning of the\nBankruptcy Code (i.e., a "bankruptcy claim"), then the sale of assets via the bankruptcy process\ncould certainly transfer the assets free of any such in personam bankruptcy claims against the\nestate. What is more, we know from the nature of successor liability itself that a successor cannot\nlegitimately be presumed to have "assumed" claims that were already being handled in the\nbankruptcy process when the successor purchased assets out of a bankruptcy estate. For this\nreason, we must turn our focus to what sort of claim, if any, the defendants can be said to have had\nagainst FAC, the predecessor entity. Here, importantly, we are speaking of claim in the bankruptcy\nsense, for it is only if the claims of the defendants can properly be said to have been the subject of\nthe bankruptcy process that we can maintain that the bankruptcy court had any authority to issue\norders affecting their rights.\nCourts have struggled to give content to the extraordinarily broad definition of claim found\nin the Code, with an eye on the impact that bankruptcy now has on a given creditor who is held to\nhave a "claim" in the bankruptcy case. On the one hand, all recognize that Congress fully intended\nto move away from the relatively restricted definition in the Act, toward a concept that would\npermit the bankruptcy process to accord broad and complete relief to debtors. After all, what\'s the\npoint in having a remedy for financial restructuring that leaves a substantial portion of the debt\noutside the process? By the same token, however, more and more courts and commentators also\nrecognize that the concept must have some limits. Due process, fundamental fairness, and the\nlimits of subject matter jurisdiction all seem to mark the outer boundaries of the concept. Courts\nare still struggling with a formulation that reconciles these competing considerations.\nWith provability eliminated from the Code\'s definition of claim, and with even contingent,\nunliquidated, unmatured claims now swept into the bankruptcy process, courts have quickly\ndiscovered that "future claims" of a kind that never would have passed muster under [the\nBankruptcy Act] could conceivably be treated in bankruptcy today. Certainly claims arising from\ninjuries that manifest themselves any time before confirmation come within the scope of the\ndefinition, even if both liability and damages are contested and unresolved. And claims that hinge\non a contingency are also included, even if the contingency has yet to occur. Courts have also\nfound that claims that arise from some prepetition conduct of the debtor causing injury to the\nclaimant, but which do not even manifest themselves until after the bankruptcy, may be claims\ntreatable in the bankruptcy process. [citing Johns-Manville Corp. and Grady v. A.H. Robins]. Each\ntime courts revisit the issue, they find themselves having to reconfront the competing concerns of\nevincing Congress\' intentions that the definition be given broad scope to assure that bankruptcy is\nan effective remedy, on the one hand, and of assuring that the entire process is fair (to say nothing\nof constitutional), on the other. The broader the reach, the greater the impact on notions of\nfundamental fairness. The more circumscribed by court-erected limitations, the greater the risk of\ndoing violence to congressional intent.\n[The court reviews prior decisions on what constitutes a \xe2\x80\x9cclaim\xe2\x80\x9d \xe2\x80\x93 (1) the \xe2\x80\x9caccrual\xe2\x80\x9d test,\nwhich looks at whether the claim \xe2\x80\x9caccrued\xe2\x80\x9d for statute of limitations purposes prepetition or postpetition; (2) the \xe2\x80\x9cconduct\xe2\x80\x9d test, which asks whether the debtor\xe2\x80\x99s pre-petition or post-petition\nconduct caused the injury; and (3) the \xe2\x80\x9crelationship\xe2\x80\x9d test, which is described below.]\nConcerned about the broad sweep of the "conduct" test and its adverse impact on notions\nof fundamental fairness, several courts have devised yet a third approach, characterized as the\n"relationship" or "conduct plus" test. The "relationship" test looks not merely to the conduct of the\n263\n\n\x0cdebtor, but to whether the purported claimant had a specific and identifiable relationship with the\ndebtor prepetition. It is not enough that the claimant\'s injury can be traced to the debtor\'s prebankruptcy conduct. The court must also inquire into the relationship of the debtor and the alleged\nclaimant. A claim for bankruptcy purposes will exist only where "some prepetition relationship,\nsuch as contact, exposure, impact, or privity, between the debtor\'s prepetition conduct and the\nclaimant" is established.\n[T]he Fifth Circuit recently adopted a version of the "relationship" test in Lemelle v.\nUniversal Mfg. Corp., 18 F.3d 1268 (5th Cir.1994). In Lemelle, the plaintiff brought a wrongful\ndeath suit against Universal Manufacturing Corporation, an entity ultimately determined to be a\nsuccessor to Winston Industries, Inc., the debtor. The suit was based upon Winston\'s defective\ndesign and manufacturing of a mobile home in 1970, twelve years prior to the debtor\'s bankruptcy.\nUniversal moved for summary judgment on grounds that it was not the successor in interest and\nthat the liability had been "discharged" in Winston\'s bankruptcy. [T]he Fifth Circuit [adopted a]\nvariant of the relationship test. Though Lemelle clearly requires as a threshold a showing of\nprepetition "relationship," the court declined to flesh out the contours of that concept. In fact, a\nrelationship established might nonetheless not be enough to make the claim a bankruptcy claim.\nThe Fifth Circuit thus accurately senses that honoring the tension between fundamental fairness\nand congressional intent is far from mechanical.\nIn leaving many doors still open, the Fifth Circuit has also left at least some hints about\nwhich direction it might take in a future case. Clearly, the court recognized the need, positively\nexpressed in the Code\'s definition of "claim" that the process be as all-encompassing as possible\nin order to achieve a meaningful result. Especially in the reorganization context, the more loose\nends left unattended by the process, the less likely the process is to achieve an effective result.\nThat is precisely why the drafters employed such far-reaching language in section 101(5).\nYet it is precisely that phrase, "the broadest possible relief" that suggests where the outer\nboundaries might be. We are limited to the possible. That may not sound like much of a limitation\nat first blush, but in fact it is a very effective, very practical statement of parameters. For what is\npossible is defined at least in part by what is fair. And Lemelle gives a sign or two that the Fifth\nCircuit senses that this is how we go about finding the limitations on the concept of bankruptcy\nclaim. Specifically addressing the scenario in which both the injury and the manifestation of the\ninjury take place simultaneously at a time after the confirmation of the debtor\'s plan, even though\narising out of prepetition conduct, the court said:\nat a minimum, there must be evidence that would permit the debtor\nto identify, during the course of the bankruptcy proceedings,\npotential victims and thereby permit notice to these potential victims\nof the pendency of the proceedings.\nWhat kinds of claims can be bankruptcy claims, then? Perhaps whatever claims that it is\npossible to handle fairly in the bankruptcy process.\nThis is an entirely new and different approach to the problem of future claims. It starts, true\nenough, by looking at the events that give rise to the claim, but it finishes by focusing less on the\nclaim and more on the claimant. At the beginning of the inquiry, we are attentive to the clearly\nexpressed intentions of the statute that the bankruptcy process sweep broadly and completely, to\nmaximize the possibility of achieving an effective result. But by the end of the inquiry, we find\n264\n\n\x0courselves most attentive to the other side of the dialectic, that of assuring that the process, whatever\nelse it be, be fair.\nWe ought to be able to first give effect to the broadest definition of what might be a claim,\nthen focus on what is possible in order to determine what is in fact a bankruptcy claim in any given\ncase.\nWe ought here to retrace our steps a bit, then. On the one hand, bankruptcy claims\nencompass the "broadest" relief for the estate. On the other, bankruptcy claims can go no further\nthan what is "possible." Placed side by side, thesis and antithesis, we struggle Hegelian-style\ntoward a synthesis. We turn first to how "broad" ought to be the concept of claim.\nTaken at its word, the definition of claim implies the inclusion of every type of liability\nwhich could be traced to prepetition conduct. The definition includes all legal obligations no matter\nhow remote or contingent. These modifying terms will operate to sweep up virtually every liability\nwhich could be traced to the debtor\'s prepetition past. The legal obligation need only be slight, and\nneed not be a present interest. It might merely be not assured and doubtful or uncertain. The\ndefinition easily includes liabilities which are afar off and conditioned upon future events. And the\nstatute\'s legislative history instructs that the definition of claim include all legal obligations, no\nmatter how remote or contingent. The term could thus encompass not only the types of liabilities\nin question here, or even those discussed in Lemelle, but even claims one could only imagine\nhappening. What is more, they might not even be "legal" obligations as of the date of the filing.\nThe only natural limit is that "bankruptcy claim" by definition can extend no further than\nthe confirmation of a debtor\'s plan (in a chapter 11 case). Claims that have their origin after that\nartificial date are deemed to be the post-confirmation debtor\'s problem. The conduct formulation\nof the test found in the case law helps to remind us that the intended target of the reorganization\nprocess are those claims that have something to do with the debtor\'s pre-bankruptcy existence (or\nits in-bankruptcy experience). But the scope of the concept remains extraordinarily broad\nnonetheless, thanks to the qualifying terms in the statute, and the further explanations contained in\nthe legislative history. What is swept up by the "broadest" aspect of the dialectic are simply\nwhatever kinds of liabilities that have their antecedents in the debtor\'s pre-bankruptcy history.\nIn the case of a company such as Fairchild Aircraft Corporation, one of the many kinds of\nremote or contingent liabilities that of necessity arose out of its pre-bankruptcy activities was that\nassociated with the possibility that at least one of the planes that it manufactured might fall out of\nthe sky, for reasons ultimately attributable to something FAC did. Cigarette manufacturers face\nthe same potential when they sell people tobacco products. Asbestos manufacturers "incurred"\nliability in the bankruptcy sense just by making products out of asbestos. In this analysis, it does\nnot much matter whether the injury "occurs" before the bankruptcy filing or after confirmation.\nThe definition of claim draws no such distinction and, for purposes of this aspect of the dialectic,\nwe need not either. About all that we need do is to locate the source, the cause, the responsibility\nin the debtor\'s pre-bankruptcy past.\nThat establishes the thesis. Now for the antithesis. What sort of relief is "possible" in the\nbankruptcy context? Or to state it in a fashion more consistent with the tenor of the case law, what\nsort of relief is "not possible?"\n"Claim" ought not to do what is "not possible" in a court of law \xe2\x80\x94 it may not authorize\ncourts to ride roughshod over due process and notions of fundamental fairness, for example. The\n265\n\n\x0cbankruptcy process, after all, has its antecedents in equity. Courts have an affirmative duty to\nassure that the process, within the confines of the law, achieve a fair and equitable result.\nThe immediate limitation this suggests is that, of necessity, no treatment which violates the\ndue process rights of a claimant can be permitted to stand, regardless the purported breadth of the\ndefinition of bankruptcy claim (to say nothing of the breadth of provisions such as section 1141(c)).\nEven more important for our analysis, in addition to these constitutional constraints (which\nwould be applicable regardless of the dialectic), the bankruptcy process ought to be fair in the\nbroader, equitable sense. Not every conceivable obligation finding its source in the debtor\'s prebankruptcy past is necessarily an obligation that can be fairly handled by the bankruptcy process.\nThe Lemelle court cautioned that a debtor in a given case will have to be able to sufficiently identify\ncontingent liabilities such that the holders of such claims could be afforded some degree of\nprocedural fairness before a court will call the claim a bankruptcy claim, i.e., one which not only\nhas its antecedents in the debtor\'s pre-bankruptcy past but which also can be dealt with fairly by\nthe bankruptcy process.\nThis brings us to the critical question left unanswered by Lemelle. Just what is capable of\nresolution in the bankruptcy process? The answer lies in the extent to which it is possible to deal\nwith a given category of claims in a fashion that assures fundamental fairness in treatment.\nNotions of fundamental fairness will not normally tolerate a potential claimant\'s rights\nbeing affected without its having had any way of participating in or being involved in the process.\nYet, we also know, from looking at other kinds of proceedings outside of bankruptcy that courts\ncan and do affect the rights of parties not before the court.\nClass actions provide us with the most telling parallel. [The court discusses class action\ncases binding future parties through the appointment of a class representative]. Bankruptcy too\nseeks to achieve an "efficient and fair resolution" of what often parallels large-scale litigation,\nespecially in the mass tort bankruptcies. That resolution might indeed "outweigh" the gains that\nmight be obtained by some form of individualized noticing \xe2\x80\x94 precisely because the benefits in\nthe bankruptcy context are conjectural. The alternative, after all, in the bankruptcy context, would\nbe the liquidation of the enterprise, resulting in no compensation at all to any of the victims. The\nrights of such claimants might be "better served" by assuring that "fair and just recovery procedures\n[are] made available to these claimants." And if such procedures can be crafted in the class action\ncontext, they ought to be capable of implementation in bankruptcy as well.\nTo be sure, some sort of notice is indicated \xe2\x80\x94mandated, in fact \xe2\x80\x94 by the case law in class\nactions. Publication notice of the broadest sort feasible is certainly a common feature in many\nbankruptcy cases, as well, especially those involving mass tort victims. In our particular case, one\nmight even imagine notices posted at the door of every Fairchild aircraft, advising that any claims\narising out of the manufacture of the aircraft are to be (have been?) dealt with in bankruptcy. But\nthat the notice might not in fact reach a given claimant in time for that claimant to do anything\nabout it was not, of itself, decisive in the [class action] case. That "defect" might be offset by other\nsocietal needs, especially where it was clear that such notice, if given, "would probably do no\ngood." Further, the "defect" might be counterbalanced by "vigorous and faithful vicarious\nrepresentation." For persons whose injuries have yet to "manifest" themselves, such notice would\nbe far from perfect. But under the circumstances, and given the countervailing social policy of\n266\n\n\x0cassuring at least some payment for the broadest range of persons, that might be all the notice\nrequired. The same can be said of bankruptcy cases.\nThe more important consideration is whether it is possible to design "fair and just recovery\nprocedures" in the bankruptcy process, as it was evidently possible to do in the class action context.\nMany of the mass tort bankruptcy cases have given heed to the class action model, employing a\n"class representative" for the members of the class, including those members who might not even\nknow they are members. Such a representative was appointed in both Johns-Manville and A.H.\nRobins. A similar representative was appointed in the [Agent Orange class action] litigation, and\nthe employment of that device was a critical factor in the court\'s ultimate conclusion that the\nprocess employed was fundamentally fair and did not violate the due process rights of the\nclaimants there.\nBankruptcy shares common features with this sort of class action. Here too the law permits\nthe putatively liable party to come down quickly to the bottom line, estimate the total liability,\nmake appropriate provision for it, and thereby be permitted to move on with its economic life.\nHere too, the interests of some creditors may well have to be handled not directly (because practical\nrealities make that impossible) but indirectly, via a representative.\nBankruptcy almost always involves at least some creditors whose individual identities\nmight not be known to the debtor, even though the debtor can identify a known group of likely\nclaimants who, within a statistical certainty, will be (or already have been) injured by the debtor\'s\nprepetition conduct. The critical question always for such types of claimants is affording them a\nmeaningful opportunity to participate in the process, such that the process can actually effectuate\nmeaningful relief for the debtor. The debtor in restructuring its financial affairs will want to take\naccount of these anticipated liabilities along with its other, more quantifiable liabilities lest the\nprocess be doomed to failure from the start, for the anticipated liabilities are no less real for being\nless quantifiable. But meaningful relief for the debtor must of necessity affect the collection rights\nof future claimants. So long as those rights are affected in a manner that comports with notions of\nfundamental fairness, the debtor ought to be able to bind those claimants, in much the same way\nas members of a class in a class action may be bound. If the debtor can achieve this end, then the\nclaims ought to be thought of as "bankruptcy claims," and ought to be bound by the bankruptcy\nprocess.\nWe have posited the "legal representative" as one device for assuring fundamental fairness\nfor future claimants. It may not be the only way, of course. Each case will turn on its own facts.\nWe know, for example, that a non-party could be bound to a prior judgment, where the non-party\'s\ninterests have been represented in the proceeding by a person with similar rights or interests. A\nnon-party may also be bound to the issues resolved in a prior suit where the non-party\'s interests\nwere "so closely aligned with the interests" of a party that the non-party\'s interests can be held to\nbe "virtually represented." The point is not that one or another method is guaranteed to achieve\nfundamental fairness, but rather that whatever method is chosen to meet the peculiar circumstances\nmust, in the process, achieve fundamental fairness in the manner in which it deals with remote\nclaims such as these.\nWe thus reach the denouement of our dialectic. It is indeed possible to synthesize the\nantipodal notions of broad scope and fair treatment to arrive at a sensible and workable definition\nof bankruptcy claim. Congress was not, after all, posing an impossible conundrum. Instead,\n267\n\n\x0cCongress sought and succeeded in devising a definition of claim that would both assure an\neffective mechanism for reorganization and a fair treatment of creditor interests. But the selfsame\ndefinition is also restricted to those claims to which it is also possible to accord fair representation\nof their interests in the course of the case. The debtor must demonstrate to the bankruptcy court\nthat it had sufficient knowledge of the nature and scope of the claims to be obligated to fairly\nanticipate having to provide for them as part of its financial restructuring, that these types of claims\nwere indeed bankruptcy claims because it was practically and equitably possible to deal with such\nliabilities as claims, and that such claims were in fact dealt with fairly and responsibly. This is\nwhat we take the Fifth Circuit to have meant when it insisted that the debtor demonstrate a\nprepetition "relationship" with the potential victims such that it was possible for the court to\npractically deal with the claimants in the bankruptcy.\nThere can be no doubt that the general policy of assuring a debtor\'s "fresh start," as well as\nthe reorganizational policy of "saving going concern value" are furthered by the broadest definition\nof the term claim. Bankruptcy is meant to separate the past and the future of an enterprise for those\npurposes. Claims attributable to yesterday\'s activities ought to be satisfied out of existing assets,\nwhich will in turn enable a business with positive value to move onward without the burden of its\nprior blunders. By the same token, as it is the debtor that is the intended beneficiary of this policy,\nit is also appropriate that substantial responsibility be imposed on the debtor to assure fair and\nequitable treatment of the creditors whose interests will necessarily be affected.\nWe now turn to that critical inquiry. In the present case, there is no dispute that the injuries\nalleged arose out of the prepetition conduct of FAC. The basis for successor liability is the debtor\'s\nmanufacture and sale of allegedly defective aircraft, which must have occurred at least five years\nprior to the bankruptcy (if it occurred at all). Nor is there any dispute that the injuries occurred\npost confirmation and that the manifestation of those injuries occurred simultaneously with the\ninjury. The undisputed facts also show that the debtor (actually in this case, the trustee) did not\ntake the necessary steps to establish these liabilities as claims in the bankruptcy proceeding either\ndirectly or indirectly (though perhaps they could have been included). No claims were ever filed\non behalf of these persons, and at no time did any party attempt to have a legal representative\nappointed. These claimants could have been claimants in the bankruptcy sense, for the debtor\ncertainly had enough information to know that some of its planes might fall out of the sky, and\nthat people injured or killed in those crashes would likely attempt (perhaps justifiably) to hold\nFAC responsible. The debtor could have, with a fair amount of precision, even estimated the\nnumber of such aircraft likely to crash, and the number of persons likely to be injured as a result.\nAnd the trustee could have then taken the steps that were taken in A.H. Robins and Johns-Manville\nto appoint a legal representative for these interests whose task it would have been to assure that\nappropriate steps were taken to protect or provide for those interests.\nBecause these steps were not taken, though they could have been, these alleged claims\ncannot, at the end of the day, be treated as "bankruptcy claims." To reiterate our dialectic, while\nthe claims fit the thesis, they falter on the antithesis.\nThe court\'s conclusion that the defendants did not have bankruptcy claims leads to the\nfurther conclusion that the bankruptcy court\'s order confirming the plan could not have affected\nthese liabilities. Sections 1141(a), 1141(c) and 1141(d) could have provided the relief suggested\nby FAI, but those sections all have one limiting characteristic in common. Before one can be bound\nby a plan, have property transferred free and clear or their interest or be subject to the debtor\'s\n268\n\n\x0cdischarge, the person must hold a "bankruptcy claim." Since, these liabilities cannot properly be\nconsidered claims, these sections have no effect on the liabilities.\nThe order of sale did not insulate FAI, and this court lacked the jurisdiction to enjoin these\nclaimants, because they did not hold "bankruptcy claims" as defined in this decision. Summary\njudgment must be denied to plaintiffs, and entered in favor of defendants. An order will be entered\nconsistent with this decision.\n\n10.2.1.7.\nIN RE GROSSMAN\xe2\x80\x99S INC., 607 F.3d 114 (3d Cir.\n2010)\nThis Court\'s Internal Operating Procedure provides:\nIt is the tradition of this court that the holding of a panel in a\nprecedential opinion is binding on subsequent panels. Thus, no\nsubsequent panel overrules the holding in a precedential opinion of\na previous panel. Court en banc consideration is required to do so.\nWe adhere strictly to that tradition. It is only on a rare occasion that we overrule a prior precedential\nopinion. We assemble en banc to consider whether this is such an occasion.\nIn 1977, Appellee Mary Van Brunt, who was remodeling her home, purchased products\nthat allegedly contained asbestos from Grossman\'s, a home improvement and lumber retailer. In\nApril 1997, Grossman\'s filed petitions under Chapter 11 of the Bankruptcy Code.\nAt the time of the [bankruptcy], \xe2\x80\x9cGrossman\'s had actual knowledge that it had previously\nsold asbestos containing products such as gypsum board and joint compound; Grossman\'s knew\nof the adverse health risks associated with exposure to asbestos; it was aware that asbestos\nmanufacturers had been or were being sued by asbestos personal-injury claimants; it was aware\nthat producers of both gypsum board and joint compound were being sued for asbestos-related\ninjuries; and it was not aware of any product liability lawsuits based upon alleged exposure to\nasbestos-containing products that had been filed against [it]."\nGrossman\'s proceeded to provide notice by publication of the deadline for filing proofs of\nclaim. There was no suggestion in the publication notice that Grossman\'s might have future\nasbestos liability. Grossman\'s Chapter 11 Plan of Reorganization purported to discharge all claims\nthat arose before the Plan\'s effective date. The Bankruptcy Court confirmed the Plan of\nReorganization in December 1997.\nMs. Van Brunt did not file a proof of claim before confirmation of the Plan of\nReorganization because, at the time, she was unaware of any "claim" as she manifested no\nsymptoms related to asbestos exposure. It was only in 2006, almost ten years later, that Ms. Van\nBrunt began to manifest symptoms of mesothelioma, a cancer linked to asbestos exposure. She\nwas diagnosed with the disease in March 2007.\nShortly after her diagnosis, the Van Brunts filed an action for tort and breach of warranty\nin a New York state court against JELD-WEN, the successor-in-interest to Grossman\'s, and fiftyseven other companies who allegedly manufactured the products that Ms. Van Brunt purchased\nfrom Grossman\'s in 1977. Ms. Van Brunt conceded that she did not know the manufacturer of any\nof the products that she acquired from Grossman\'s for her remodeling projects in 1977. After the\n269\n\n\x0cVan Brunts filed their suit, JELD-WEN moved to reopen the Chapter 11 case, seeking a\ndetermination that their claims were discharged by the Plan. Ms. Van Brunt died in 2008 while the\ncase was pending. Gordon Van Brunt has been substituted in her stead as the representative of her\nestate.\nThe Bankruptcy Court concluded that the 1997 Plan of Reorganization did not discharge\nthe Van Brunts\' asbestos-related claims because they arose after the effective date of the Plan. In\nso holding, the Bankruptcy Court relied on our decisions in [Matter of M. Frenville Co., 744 F.2d\n332 (3d Cir. 1984) ("Frenville")].\nIn 1980, M. Frenville Co. [and its two principals filed bankruptcy] Later that year, four\nbanks filed a lawsuit in a New York state court against the company\'s former accountants, Avellino\n& Bienes ("A & B"), alleging that A & B negligently and recklessly prepared the company\'s prepetition financial statements and seeking damages for their alleged losses exceeding five million\ndollars. A & B filed a complaint in the bankruptcy court seeking relief from the automatic stay in\norder to implead Frenville as a third-party defendant in order to obtain indemnification or\ncontribution under New York law. The bankruptcy court, affirmed by the district court, held that\nthe automatic stay barred A & B\'s action.\nWe reversed, holding that because the automatic stay applied only to claims that arose prepetition, under New York law A & B did not have a right to payment for its claim for\nindemnification or contribution from Frenville until after the banks filed their suit against A & B.\nIt followed that A & B\'s claim against Frenville arose post-petition even though the conduct upon\nwhich A & B\'s liability was predicated (negligent preparation of Frenville\'s financial statements)\noccurred pre-petition. It followed that the automatic stay was inapplicable. We emphasized that\nthe "crucial issue" was when the "right to payment" arose as determined by reference to the New\nYork law that governed the indemnification claim.\nThis court subsequently summarized Frenville as holding that "the existence of a valid\nclaim depends on: (1) whether the claimant possessed a right to payment; and (2) when that right\narose" as determined by reference to the relevant non-bankruptcy law. The Frenville test for\ndetermining when a claim arises has been referred to as the "accrual test."\nThe applicable New York law provides that a cause of action for asbestos-related injury\ndoes not accrue until the injury manifests itself. The Bankruptcy Court therefore reasoned that the\nVan Brunts had no "claim" subject to discharge in 1997 because Ms. Van Brunt did not manifest\nsymptoms of mesothelioma\xe2\x80\x94and thus the New York cause of action did not accrue\xe2\x80\x94until 2006.\nIn the case before us, the District Court and Bankruptcy Court correctly applied the accrual\ntest in holding that the Van Brunts\' tort claims were not discharged by the Plan of Reorganization.\nAccording to Frenville, the claims arose for bankruptcy purposes when the underlying state law\ncause of action accrued. The New York tort cause of action accrued in 2006 when Ms. Van Brunt\nmanifested symptoms of mesothelioma. The claims were therefore post-petition under Frenville.\nThe question remains, however, whether we should continue to follow Frenville and its\naccrual test. We have recognized that "[s]ignificant authority [contrary to Frenville] exists in other\ncircuits...." A sister circuit has described our approach in Frenville as "universally rejected." The\ncourts of appeals that have considered Frenville have uniformly declined to follow it. At least one\nbankruptcy court has stated that Frenville "may be fairly characterized as one of the most criticized\nand least followed precedents decided under the current Bankruptcy Code." In addition to the cases\n270\n\n\x0ccited above, JELD-WEN cites numerous district court and bankruptcy court decisions that have\ndeclined to follow Frenville. The criticism has been echoed by commentators.\nNotwithstanding what appears to be universal disapproval, we decide cases before us based\non our own examination of the issue, not on the views of other jurisdictions. Nevertheless, those\nwidely held views impel us to consider whether the reasoning applied by our colleagues elsewhere\nis persuasive.\nCourts have declined to follow Frenville because of its apparent conflict with the\nBankruptcy Code\'s expansive treatment of the term "claim." [the court then reviews the statute,\nthe legislative history, and prior Supreme Court precedent on the broad sweep of the term \xe2\x80\x9cclaim.\xe2\x80\x9d]\nThe Frenville court focused on the "right to payment" language in \xc2\xa7 101(5) and, according\nto some courts, "impos[ed] too narrow an interpretation on the term claim," by failing to give\nsufficient weight to the words modifying it: "contingent," "unmatured," and "unliquidated." The\naccrual test in Frenville does not account for the fact that a "claim" can exist under the Code before\na right to payment exists under state law.\nWe are persuaded that the widespread criticism of Frenville\'s accrual test is justified, as it\nimposes too narrow an interpretation of a "claim" under the Bankruptcy Code. Accordingly, the\nFrenville accrual test should be and now is overruled.\nOur decision to overrule Frenville leaves a void in our jurisprudence as to when a claim\narises. That decision has various implications. One such implication involves the application of\nthe automatic stay provided in \xc2\xa7 362 of the Bankruptcy Code which operates to stay the\ncommencement or continuation of any "action or proceeding" that was or could have been\ncommenced against the debtor.\nPrincipal among the effects of the determination when a claim arises is the effect on the\ndischargeability of a claim. Under 11 U.S.C. \xc2\xa7 1141(d)(1)(A) of the Code, the confirmation of a\nplan of reorganization "discharges the debtor from any debt that arose before the date of such\nconfirmation ...." A "debt" is defined as liability on a "claim," which in turn is defined as a "right\nto payment.\xe2\x80\x9d This is consistent with Congress\' intent to provide debtors with a fresh start, an\nobjective, noted the Second Circuit, "made more feasible by maximizing the scope of a discharge."\nUnited States v. LTV Corp. (In re Chateaugay), 944 F.2d 997, 1002 (2d Cir. 1991). On the other\nhand, a broad discharge may disadvantage potential claimants, such as tort claimants, whose\ninjuries were allegedly caused by the debtor but which have not yet manifested and who therefore\nhad no reason to file claims in the bankruptcy. These competing considerations have not been\nresolved consistently by the cases decided to date.\nMoreover, the determination when a claim arises has significant due process implications.\nIf potential future tort claimants have not filed claims because they are unaware of their injuries,\nthey might challenge the effectiveness of any purported notice of the claims bar date. Discharge\nof such claims without providing adequate notice raises questions under the Fourteenth\nAmendment. See Mullane v. Cent. Hanover Bank & Trust Co., 339 U.S. 306, 314 (1950).\nThe courts have generally divided into two groups on the decision as to when a claim arises\nfor purposes of the Code, with numerous variations. One group has applied the conduct test [citing\nGrady v. A.H. Robins] and the other has applied what has been termed the pre-petition relationship\ntest.\n271\n\n\x0cIn contrast, the Eleventh Circuit criticized a conduct test that would enable individuals to\nhold a claim against a debtor by virtue of their potential future exposure to "the debtor\'s product,"\nregardless of whether the claimant had any relationship or contact with the debtor. [citing In re\nPiper]. It stated that approach would define a "claim" too broadly in certain circumstances and\nwould "stretch the scope of \xc2\xa7 101(5)" too far. Similarly, a commentator observed that under the\nconduct test, "[c]laimants who did not use or have any exposure to the dangerous product until\nlong after the bankruptcy case has concluded would nonetheless be subject to the terms of a\npreexisting confirmed Chapter 11 plan." "These claimants may be unidentifiable because of their\nlack of contact with the debtor or the product and, accordingly, may not have had the benefit of\nnotice and an opportunity to participate in the bankruptcy case."\nSome of the courts concerned that the conduct test may be too broad have adopted what\nhas been referred to as a pre-petition relationship test. Under this test, a claim arises from a debtor\'s\npre-petition tortious conduct where there is also some pre-petition relationship between the debtor\nand the claimant, such as a purchase, use, operation of, or exposure to the debtor\'s product. [The\nCourt then discusses the Lemelle case]\nThe Second Circuit followed a similar approach in an environmental regulatory context. In\nIn re Chateaugay, 944 F.2d at 1004-05, the court held that the EPA\'s post-confirmation costs of\nresponding to a release of hazardous waste, even if not yet incurred at the time of bankruptcy,\ninvolved "claims" under \xc2\xa7 101(5). The court reasoned that "[t]he relationship between\nenvironmental regulating agencies and those subject to regulation provides sufficient\n`contemplation\' of contingencies to bring most ultimately maturing payment obligations based on\npre-petition conduct within the definition of `claims\' [under the Bankruptcy Code]."\nA somewhat modified approach was taken by the Eleventh Circuit in a case involving the\nbankruptcy of Piper Aircraft, Inc. . . . The court of appeals agreed that the pre-petition relationship\ntest was generally superior to either our test in Frenville, or the "conduct test" adopted by other\ncourts of appeals. It also held that claimants having contact with the debtor\'s product post-petition,\nbut prior to confirmation, also could be identified during the course of the bankruptcy procedure.\nIt thus framed what it chose to denominate as the "Piper" test as follows:\n[A]n individual has a \xc2\xa7 101(5) claim against a debtor manufacturer\nif (i) events occurring before confirmation create a relationship, such\nas contact, exposure, impact, or privity, between the claimant and\nthe debtor\'s product; and (ii) the basis for liability is the debtor\'s\nprepetition conduct in designing, manufacturing and selling the\nallegedly defective or dangerous product.\nThe court stated that "[t]he debtor\'s prepetition conduct gives rise to a claim to be administered in\na case only if there is a relationship established before confirmation between an identifiable\nclaimant or group of claimants and that prepetition conduct."\nThe pre-petition relationship test in Piper has been criticized for narrowing the definition\nof "claim" under 11 U.S.C. \xc2\xa7 101(5).\nIn addition, various bankruptcy courts have followed a form of the conduct test when\nconsidering the existence of an asbestos-related claim.\n272\n\n\x0cIrrespective of the title used, there seems to be something approaching a consensus among\nthe courts that a prerequisite for recognizing a "claim" is that the claimant\'s exposure to a product\ngiving rise to the "claim" occurred pre-petition, even though the injury manifested after the\nreorganization. We agree and hold that a "claim" arises when an individual is exposed prepetition to a product or other conduct giving rise to an injury, which underlies a "right to\npayment" under the Bankruptcy Code. Applied to the Van Brunts, it means that their claims arose\nsometime in 1977, the date Mary Van Brunt alleged that Grossman\'s product exposed her to\nasbestos.\nThat does not necessarily mean that the Van Brunts\' claims were discharged by the Plan of\nReorganization. Any application of the test to be applied cannot be divorced from fundamental\nprinciples of due process. Notice is "[a]n elementary and fundamental requirement of due process\nin any proceeding which is to be accorded finality...." Mullane, 339 U.S. at 314. Without notice of\na bankruptcy claim, the claimant will not have a meaningful opportunity to protect his or her claim.\nInadequate notice therefore "precludes discharge of a claim in bankruptcy." This issue has arisen\nstarkly in the situation presented by persons with asbestos injuries that are not manifested until\nyears or even decades after exposure.\nThe most innovative approach yet to the asbestos problem was adopted by the New York\nbankruptcy court as part of the Manville plan of reorganization. In an effort "to grapple with a\nsocial, economic and legal crisis of national importance within the statutory framework of\n[C]hapter 11," the bankruptcy court oversaw the "largely consensual plan" leading to the\nestablishment of a trust out of which all asbestos health-related claims were to be paid. The trust\nwas "designed to satisfy the claims of all victims, whenever their disease manifest[ed]," (the\n"Manville Trust"). Manville agreed to fund the trust in an amount that, over time, was "in excess\nof approximately $2.5 billion." The Manville Trust was the basis for Congress\' effort to deal with\nthe problem of asbestos claims on a national basis, which it did by enacting \xc2\xa7 524(g) of the\nBankruptcy Code as part of the Bankruptcy Reform Act of 1994. Section 524(g) authorizes courts\n"to enjoin entities from taking legal action for the purpose of ... collecting, recovering, or receiving\npayment or recovery with respect to any [asbestos-related] claim or demand" through the\nestablishment of a trust from which asbestos-related claims and demands are paid.\nIt is apparent from the legislative history of \xc2\xa7 524(g) that Congress was concerned that\nfuture claims by presently unknown claimants could cripple the debtor\'s reorganization. By\nenacting \xc2\xa7 524(g), Congress took account of the due process implications of discharging future\nclaims of individuals whose injuries were not manifest at the time of the bankruptcy petition.\nThe due process safeguards in \xc2\xa7 524(g) are of no help to the Van Brunts as Grossman\'s\nPlan of Reorganization did not provide for a channeling injunction or trust under that provision. A\ncourt therefore must decide whether discharge of the Van Brunts\' claims would comport with due\nprocess, which may invite inquiry into the adequacy of the notice of the claims bar date. The only\nopen matter before the District Court is JELD-WEN\'s request for a declaration that the Van Brunts\'\nclaims had been discharged.\nWhether a particular claim has been discharged by a plan of reorganization depends on\nfactors applicable to the particular case and is best determined by the appropriate bankruptcy court\nor the district court. In determining whether an asbestos claim has been discharged, the court may\nwish to consider, inter alia, the circumstances of the initial exposure to asbestos, whether and/or\n273\n\n\x0cwhen the claimants were aware of their vulnerability to asbestos, whether the notice of the\nclaims bar date came to their attention, whether the claimants were known or unknown\ncreditors, whether the claimants had a colorable claim at the time of the bar date, and other\ncircumstances specific to the parties, including whether it was reasonable or possible for the\ndebtor to establish a trust for future claimants as provided by \xc2\xa7 524(g). These are not factors\nfor consideration in the first instance by this court sitting en banc. Accordingly, we will reverse\nthe decision of the District Court and remand this case to the District Court for further proceedings\nconsistent with this opinion.\n\n10.2.1.8.\nMAIDS INT\xe2\x80\x99L., INC., v. Ward, 194 B.R. 703 (Bankr.\nD. Mass. 1996)\nSeeking to enforce a noncompetition clause in its franchise agreement, The Maids\nInternational, Inc. ("Maids") has brought this complaint to enjoin Michael E. Ward and Angela L.\nWard (the "Debtors") from owning or operating a maintenance and cleaning service within a fifty\nmile radius of the franchised territory.\nMaids contends neither the Debtors\' bankruptcy filing nor rejection of their covenant not\nto compete affects its right to an injunction against the Debtors\' competition.\nI am thus faced with the question of whether Maids\' right to injunctive relief is a "claim"\nwithin the meaning of the Bankruptcy Code and hence subject to being discharged.\nAt the hearing on Maids\' motion for a temporary restraining order, I ruled its right to an\ninjunction is a claim. I therefore dismissed the complaint and ordered Maids to file a proof of\nclaim, reserving jurisdiction to issue the present opinion. Set forth here are my findings of fact and\nconclusions of law in support of the order of dismissal.\nMaids has developed a system for establishing and operating a household maintenance and\ncleaning service.\nOn April 10, 1989, Maids signed a franchise agreement with a corporation owned and\noperated by the Debtors named Award Services, Inc. ("Award"). In addition to signing on behalf\nof Award, the Debtors signed the agreement personally as guarantors of Award\'s performance\nthereunder. The agreement also includes the Debtors within the meaning of the term "Franchise",\nthereby making them jointly responsible with Award.\nUnder the agreement, Maids gave Award the exclusive right to use its system and the name\n"Maids" in Concord, Massachusetts and in several nearby towns. In return, Award paid Maids\n$15,900 and obligated itself (and the Debtors) to pay Maids a royalty based on a percentage of its\ngross sales at rates which range from 4.5% to 7%, depending upon the amount of weekly gross\nsales. The agreement was for an initial term of five years.\nThe following provisions of the franchise agreement are of relevance to the present\nproceeding:\nFRANCHISEE further covenants that for a period of two (2) years\nafter the termination or nonrenewal of the franchise, regardless of\nthe cause of termination, it shall not, either directly or indirectly,\nfor itself, or on behalf of or in conjunction with any other person,\n274\n\n\x0cpersons, partnership or corporation, own, maintain, engage in, or\nparticipate in the operation of a maintenance and cleaning\nservice system within a radius of fifty (50) miles of the area\ndesignated hereunder or any then existing The Maids Unit\nFranchise.\nFRANCHISEE acknowledges that a violation of any covenant in\nthis Paragraph will cause irreparable damage to FRANCHISOR, the\nexact amount of which may not be subject to reasonable or accurate\nascertainment, and therefore, FRANCHISEE does hereby consent\nthat in the event of such violation, FRANCHISOR shall as a\nmatter of right be entitled to injunctive relief to restrain\nFRANCHISEE, or anyone acting for or on behalf (sic), from\nviolating said covenants, or any of them. Such remedies, however,\nshall be cumulative and in addition to any other remedies to which\nFRANCHISOR may then be entitled.\n[A]ny controversy or claim arising out of or relating to this\nAgreement, or the breach thereof, shall be settled by arbitration\nconducted in Omaha, Nebraska in accordance with the commercial\nArbitration Rules of the American Arbitration Association\nIn the event of any default on the part of either party hereto, in\naddition to any other remedies of the aggrieved party, the party in\ndefault shall pay to the aggrieved party all amounts due and all\ndamages, costs and expenses, including reasonable attorney\xe2\x80\x99s fees,\nincurred by the aggrieved party as a result of any such default.\nThis Agreement was accepted in the State of Nebraska and shall be\ninterpreted and construed under the laws thereof.\nNothing herein contained shall bar the right of either party to\nobtain injunction relief against threatened conduct that will cause\nloss or damages under the usual equity rules, including the\napplicable rules for obtaining preliminary injunctions, provided an\nappropriate bond against damages be provided.\nThe franchisee agreement expired on April 9, 1994, the end of its five year term. Thereafter,\nthe Debtors commenced operation of a cleaning service within the franchised territory. They\noperate the business under the name "Mops" and do not hold themselves out as operating a\nfranchise of Maids.\nMaids responded to this competition with a series of legal actions. It first commenced an\narbitration proceeding in Omaha with the American Arbitration Association. This was uncontested\nby the Debtors. On March 31, 1995, the arbitrator awarded Maids damages (including interest) of\n$29,232. He also ordered the Debtors to cease and desist the ownership or operation of a\nmaintenance and cleaning service until April 9, 1996, within a radius of fifty miles from the\nfranchised area or within a radius of fifty miles from any Maids franchise existing on April 9,\n1994. Maids then brought suit in the District Court of Douglas County, Nebraska. On July 20,\n1995, that court entered a default judgment against the Debtors in the sum of $61,056. Apparently\n275\n\n\x0cthis was in part a confirmation of the arbitration award. At no time has any court entered an\ninjunction against the Debtors competing, in confirmation of the arbitration award or otherwise.\nMaids next brought its attack closer to home. On November 1, 1995, it filed suit on the judgment\nin the District Court of Concord, Massachusetts. That court authorized attachments of the Debtors\'\nresidence and bank accounts.\nShortly thereafter, on November 13, 1995, the Debtors filed a petition with this court\nrequesting entry of an order for relief under chapter 7 of the Bankruptcy Code. Undeterred, Maids\non January 25, 1996 filed its complaint commencing the present adversary proceeding. In its\ncomplaint Maids requested an injunction against the Debtors owning or operating a\nmaintenance and cleaning establishment within a fifty mile radius of the franchised territory.\nAt the same time, Maids filed a motion for a temporary restraining order and asked for an\nemergency hearing. At the hearing on February 5, 1996, I denied the motion, dismissed the\ncomplaint and ordered Maids to file a proof of claim. Maids thereafter filed a proof of claim within\nthe permissible filing period.\nCovenants not to compete are often made by sellers of small businesses, key employees,\nfranchisees and partners. The covenant is generally valid under state law so long as its time period,\ngeographic area and covered activities go no further than what is reasonably necessary to protect\nthe other\'s business and goodwill. For this reason, the wording of the covenant is usually restricted\nin time and area, and sometimes in scope of activity. The Debtors\' covenant was so restricted. It is\nvalid and enforceable.\nThe Debtors are clearly in breach of their covenant not to compete. Breach of the ordinary\ncontract gives rise only to a claim for damages. Maids, however, has the additional right under\nstate law to obtain an injunction against the Debtors\' competition, without regard to the provision\nin the agreement permitting such relief. Although many of the decisions do not reach the issue,\nengaging instead in what is often a mechanical search for "executoriness," breach of a covenant\nnot to compete presents a question which has proven difficult for the courts: Do the nondebtor\'s\ninjunctive rights constitute a "claim" so as to be subject to discharge? The Debtors\' discharge\nhinges upon this issue. A discharge in bankruptcy releases a debtor only as to liability on a "debt,"\nwhich is defined as "liability on a claim." [the Court then quotes the definition of a \xe2\x80\x9cclaim\xe2\x80\x9d in\nSection 101(5)]\nMaids unquestionably has a "right to an equitable remedy" for breach of the Debtors\'\ncovenant. But does the breach also give rise to a "right to payment" within the meaning of the\nstatute? That question is not answered by Maids having obtained a damage judgment. As shall be\nexplained, the damages available for breach of the covenant must be an alternative to an\nequitable remedy if "a right to payment" is to be present. For all we know, the arbitration\naward and default judgment Maids obtained were only for damages accrued to the date of the\nhearings, and did not include the future damages that are an alternative to equitable relief.\nThe only order issued against the Debtors competing is the arbitrator\'s cease and desist\norder. No court has entered an injunction against the competition. Even if one had, it would make\nno difference on the claim issue. The inclusion of an equitable remedy within the definition of\n"claim" applies "whether or not such right to an equitable remedy is reduced to judgment. . . .\xe2\x80\x9d\nThe Supreme Court\'s decision in Ohio v. Kovacs, [469 U.S. 274 (1985),] did not involve a\ncovenant not to compete, but it deals with the meaning of the phrase "right to payment" in the\n276\n\n\x0ccontext of paragraph (B) of the claim definition. Kovacs has been influential in cases involving\ncovenants not to compete. The debtor was the chief executive officer and stockholder of a\ncorporation owning a hazardous waste site located next to a river. Prior to the bankruptcy filing,\nthe State of Ohio had gone into state court and obtained a $75,000 judgment against the debtor and\nothers for damage from fish kills and an injunction ordering a cleanup of the property by removal\nof specified wastes. When the defendants failed to comply with the cleanup order, the state court\nappointed a receiver, who was directed to take possession of the property and commence the\ncleanup. Before the receiver had completed his assignment, the debtor filed a bankruptcy petition.\nOhio countered by instituting a proceeding in state court to discover the debtor\'s current income\nand assets, in preparation for making a reimbursement claim against him. The bankruptcy court\nstayed that proceeding. The State also filed a complaint in bankruptcy court seeking a declaration\nthat its rights under the cleanup order were not a "claim" within the meaning of the Bankruptcy\nCode. The courts below ruled against it on this issue.\nThe Court in Kovacs examined the rulings of the lower courts at some length. The lower\ncourts had stressed various considerations: the necessity that the debtor spend money to comply\nwith his cleanup obligations, the debtor\'s inability to perform the cleanup, the State\'s possession\nof the site through the receiver, and the State\'s conduct indicating its intention to seek\nreimbursement from the debtor for the cleanup costs. In light of all these circumstances, the Court\nconcluded that as a practical matter the State\'s claim was a monetary one falling within the\ndefinition of "claim." It stated: "[W]e cannot fault the Court of Appeals for concluding that the\ncleanup order had been converted into an obligation to pay money, an obligation that was\ndischargeable in bankruptcy."\nKovacs bears close study. The Court made no attempt to analyze the statutory definition of\nclaim, except to note that the phrases "equitable remedy," "breach of performance" and "right to\npayment" are undefined. For an equitable remedy to be a claim, the definition requires only\nthat the breach giving rise to the equitable remedy also give rise to a "right" to payment. It\nimposes no requirement that the claimant exercise his right to payment or show an intent to\nexercise it. Yet, without pointing to statutory language, the Court saw significance in the State\'s\nintention to seek reimbursement for cleanup costs. Nor does the statute say compliance with a\ncourt decree granting the equitable remedy must involve an expenditure of money. The Court\nnevertheless quotes with apparent approval from the opinion of the bankruptcy court requiring\nsuch linkage. Indeed, the Court took pains to tie its opinion to all the various views of the lower\ncourts. This makes the decision vague. The Court also seemed intent on confining its rationale to\nthe particular facts before it. It apparently took this approach because of the inherent difficulty in\nmeshing the compelling environmental concerns before it with a Bankruptcy Code which promotes\na fresh start and gives no priority to prepetition environmental claims. The reasoning employed in\nKovacs should therefore not be binding in cases involving covenants not to compete.\nSome courts nevertheless rely upon Kovacs or its progeny in cases dealing with covenants.\nThey hold that a right to injunctive relief against the debtor\'s competition is not a claim, and hence\nis not dischargeable, because compliance with the injunction involves no monetary expenditure.\nThere is also case law rejecting application of the Kovacs reasoning to these covenants. In\nIn re Kilpatrick, before the bankruptcy filing a state court had enjoined the debtor from breaching\nhis covenant not to compete. In discussing Kovacs, the court observed that the statutory definition\nof "claim" speaks only of a "right" to payment, without imposing any requirement that the claimant\n277\n\n\x0cpursue that right or disavow the equitable remedy. Because under state law the beneficiary of a\ncovenant can elect to receive either damages or an injunction, the court held injunctive rights\nare a claim.\nAnother line of cases holds the other party\'s right to an injunction against the debtor\'s\ncompetition is not a claim because only monetary rights fall within the statutory definition. These\ndecisions contain no statutory analysis. Some seem largely motivated by facts which evoke no\nsympathy for the debtor.\nFocusing more on the statutory definition, some courts hold the nondebtor party\'s\ninjunctive right is not a claim because it is present only if the remedy at law is "inadequate", or\nonly if the threatened harm is "irreparable," concluding from this that the nondebtor has no right\nto payment within the meaning of the statutory definition. Although these courts are correct in\nruling a right to payment must exist under nonbankruptcy law, their holding that there is no right\nto payment for breach of a covenant not to compete conflicts with the damage rights of the\nbeneficiary of a covenant as well as with the general standard employed by courts in determining\nwhether a party\'s remedy at law is adequate. This requires some explanation.\nAn injunction against breach of the covenant is a grant of specific performance. As a result\nof the historical separation of courts of law and equity, such an equitable remedy is available only\nif the remedy at law, typically damages, is "inadequate." Courts take into account a number of\nfactors in determining whether damages are inadequate. Principal among them are difficulty in\nproving the existence and amount of damages with reasonable certainty, difficulty in collecting a\nmonetary judgment, and uncertainty that the benefits of a monetary judgment would be equivalent\nto the promised performance. The rule has been stated as follows: "The adequate remedy at law,\nwhich will preclude the grant of specific performance of a contract by a court of equity, must be\nas certain, prompt, complete, and efficient to attain the ends of justice as a decree of specific\nperformance. Put another way, "the remedy at law, in order to exclude a concurrent remedy at\nequity, must be as complete, as practical and as efficient to the ends of justice and its prompt\nadministration, as the remedy at equity."\nCourts thus compare the remedies at law and equity to see which is more effective in\nserving the ends of justice. Difficulty in fixing damages is only one factor in that equation. In any\nevent, damages need only be difficult, not impossible, to prove for equitable relief to be\navailable. Comparison of the two remedies usually leads to the grant of equitable relief. Doubts\nas to the adequacy of the remedy at law are resolved in favor of granting equitable relief. In sum,\ncourts look quite favorably upon equitable relief. This has led one author to conclude that the\nadequate remedy rule is essentially dead.\nLoss of future profits is typically a principal element of damages for breach of a covenant\nnot to compete. The evidentiary problems here for Maids and other covenant beneficiaries are\nobvious. The proof involves futuristic projections which are especially subject to contest. Courts\ntherefore readily grant an injunction for breach of a covenant not to compete. Indeed, the injured\nparty invariably requests injunctive relief because an injunction gives strong assurance he will\nreceive precisely what was bargained for. This avoids the trauma of future injury, the need to prove\ndamages, and problems in collecting a money judgment. The request for equitable relief has\nhistorically been regarded as the election of a preferred remedy.\n278\n\n\x0cIf the beneficiary of a covenant not to compete elects to receive damages for loss of future\nprofits, he gets the lost profits. Lost profits are a proper element of damages for any breach of\ncontract so long as at the time of the contract the breaching party had reason to know they would\nbe the probable result of breach. The Debtors certainly had that knowledge. The purpose of their\ncovenant was to protect Maids\' business. Although damages must be established with reasonable\ncertainty, an approximation rather than mathematical accuracy is all that is required. The perceived\ndifficulty in proving lost profits is less present today because of the receptive attitude of modern\ncourts toward proof of sophisticated financial data through expert testimony. The award of\ndamages for lost future profits is now a commonplace remedy for breach of all kinds of contracts.\nMaids therefore has the right to obtain either damages for the Debtors\' future\ncompetition or an injunction against the competition. As a result, in the words of the statute,\nMaids has a "right to an equitable remedy for breach of performance . . . [which] breach\ngives rise to a right to payment. . . . As an alternative remedy, this right to payment permits a\ndollar sign to be placed on the equitable remedy, as is done with other claims. Including equitable\nremedies within the statute\'s definition of "claim" is therefore supported by a strong bankruptcy\npolicy \xe2\x80\x94 equal treatment of similar rights. And because a "claim" is subject to discharge, another\nimportant bankruptcy policy is promoted \xe2\x80\x94 the policy favoring a debtor\'s fresh start,\nunencumbered by past commitments.\nIn In re Udell, [18 F.3d 403 (1994)], the Seventh Circuit came to the opposite conclusion,\nand in the process added greatly to the confusion in this troubled area of the law. The Seventh\nCircuit in Udell held Carpetland\'s injunctive rights were not a "claim" and hence were not\ndischargeable in bankruptcy. Although not finding the statutory definition of claim ambiguous, the\ncourt nevertheless looked to the [following] legislative history:\nSection 101(4)(B) [now \xc2\xa7 101(5)(B)] represents a modification of\nthe House-passed bill to include [sic] the definition of "claim" a right\nto an equitable remedy for breach of performance if such breach\ngives rise to a right to payment. This is intended to cause the\nliquidation or estimation of contingent rights of payment for which\nthere may be an alternative equitable remedy with the result that the\nequitable remedy will be susceptible to being discharged in\nbankruptcy. For example, in some States, a judgment for specific\nperformance may be satisfied by an alternative right to\npayment, in the event performance is refused; in that event the\ncreditor entitled to specific performance would have a "claim"\nfor purposes of proceeding under title 11.\nOn the other hand, rights to an equitable remedy for breach of\nperformance with respect to which such breach does not give rise to\na right to payment are not "claims" and would therefore not be\nsusceptible to discharge in bankruptcy.[46]\nThe Udell court constructed a confusing alternative test from this floor statement. It seized\non the awkward phrase "with respect to which such breach does not give rise to a right to payment"\nappearing in the last sentence. Because the phrase arguably modifies "equitable remedy" rather\nthan "breach of performance," the court concluded equitable rights are a claim if payment arises\n279\n\n\x0cfrom their exercise. This is opposed to the wording of the statute, which clearly requires that the\nbreach, not the equitable remedy, give rise to a right to payment. And the test makes no sense\nbecause equitable remedies are typically designed to provide nonmonetary relief. Having thus\ncreated a virtually unpassable test, the court ruled it was flunked by the facts before it because the\nright to obtain liquidated damages arose from the contract, not from an equitable remedy under it.\nThe Udell court also fashioned another test which, if passed, would make an equitable\nremedy a claim. It here focused on the reference in the floor statement to a right to payment being\nan "alternative" to the equitable remedy. From this the court concluded all right to payment must\nbe an alternative to the equitable remedy. Because state courts would enforce the parties\' agreement\nby granting both damages and an injunction, the court ruled an alternative right to payment was\nnot present, so Carpetland\'s rights failed this test as well. This reasoning ignores Carpetland\'s right\nto damages for future loss, which is an alternative to its equitable remedy. The floor statement\'s\nreference to a right to payment being an alternative to equitable relief is understandable because\nthe claim for future loss is the monetary equivalent to the right to an injunction against further\ncompetition. Nor is there any reason to believe Congress intended that this alternative right to\npayment be the only right to payment. The statute does not say so. The injured party is obviously\nentitled to compensation for damages already incurred by the time of trial, as well as to an\ninjunction against future competition. The liquidated damage clause before the court was\npresumably designed to provide this compensation because the parties also agreed upon an\ninjunction to prevent future loss. Udell thus commits the double sin of elevating legislative history\nabove the statute\'s plain wording and then misunderstanding the legislative history.\nThe real basis for the Udell court\'s holding emerges from the concurring opinion of Judge\nRaum. He thought the majority opinion "dodges this statute\'s plain language in an effort to reach\na sensible result." To Judge Raum, and one suspects to the other panel members, discharge in\nbankruptcy of an injunction against competition is like a bankruptcy discharge of an injunction\nagainst trespassing, polluting, stalking or battering. Because he thought the debtor\'s discharge\nwould have similar "patently absurd consequences," Judge Raum believed the plain language of\nthe statute should not be followed.\nJudge Raum\'s reasoning leaves much to be desired as well, quite apart from his willingness\nto elide what he admits to be the statute\'s plain wording. The case concerned breach of contract,\nnot trespass, pollution, stalking or battery. Moreover, trespass and the like is prohibited by law,\nwithout regard to the existence of an injunction. So a bankruptcy discharge does not terminate the\nobligation to refrain from such conduct. In the final analysis, the decision in Udell comes down to\nthis: The court could not bring itself to equate an injunction against breach of contract with a\nmonetary judgment for breach of contract which is routinely discharged in bankruptcy.\nIn summary, although the decisions are in disarray, Maids\' alternative right to damages\nfrom the Debtors\' future competition in breach of their covenant not to compete is a "right\nto payment" within the meaning of the statutory definition of an equitable claim. Hence, under\nthe definition, Maids\' injunctive rights constitute a claim. That state courts consider damages\ninadequate when compared to the equitable remedy of an injunction is beside the point. Although\ndamages for breach of the covenant, particularly damages for lost future profits, are difficult to fix,\ncourts are perfectly capable of doing so. This alternative right to damages fits into the statutory\ndefinition of an equitable claim very well. The same breach, a debtor\'s competition and threat\nof further competition, "gives rise" to both a damage claim and injunctive rights. The\n280\n\n\x0cdefinition imposes no requirement that the claimant elect to receive a monetary payment,\nthat compliance with the injunction require an expenditure of funds, or that the equitable remedy,\nas opposed to the breach, give rise to a right to payment. Following the statute\'s plain meaning\npromotes two fundamental policies of the Bankruptcy Code \xe2\x80\x94 the policy favoring a debtor\'s fresh\nstart and the policy favoring equality among holders of similar rights.\n\n10.3.\n\nClaim Procedures\n\nNow that we know what a \xe2\x80\x9cclaim\xe2\x80\x9d is, we have to consider how it will be dealt with in\nbankruptcy. Under most chapters, a creditor must file a \xe2\x80\x9cproof of claim,\xe2\x80\x9d which is an official form\nlisting the basis for and amount of the claim sought by the creditor, and whether the creditor claims\nany priority or security interests. If the claim is based on a writing, the writing should be attached\nto the proof of claim. Bankruptcy Rule 3001(c)(1). Courts have adopted liberal rules for amending\ntimely filed claims, so the most important thing is to get the claim form filed timely, even if the\nfiling is imperfect.\nUnder Chapters 7, 12 and 13, with some exceptions, the claim must be filed within 90 days\nafter the first date set for the meeting of creditors. Bankruptcy Rule 3002(c). One important\nexception is for no asset cases. The court\xe2\x80\x99s notice to creditors will request that claims in apparently\nno-asset cases not be filed until the trustee determines that distributions will be available. At that\ntime, the court will send out a second notice setting a deadline for filing proofs of claim.\nBankruptcy Rule 3002(c)(5).\nIn Chapter 11 cases, creditors whose claims are listed in the schedules properly (and as\nundisputed, non-contingent and liquidated), need not file a proof of claim; others must file by the\nclaims bar date set by the court (often by court rule the first date set for hearing on a disclosure\nstatement). See Bankruptcy Rule 3003(c)(3).\nA creditor who fails to timely file a proof of claim will not participate in distributions from\nthe bankruptcy estate (unless the court allows a late filed claim).\nProofs of claim are deemed to be allowed as filed, unless a party in interest objects. 11\nU.S.C. \xc2\xa7 502(a). Section 502(b) provides that if an objection is filed, the claim is to be determined\n(estimated by the court if unliquidated, unmatured or contingent), and allowed in the amount owing\nunder applicable non-bankruptcy law as of the petition date unless one of the exceptions in\nSection 502(b) applies. Id.; 11 U.S.C. \xc2\xa7 502(c)(1). Claims under Section 502 do not accrue postpetition interest. Section 506(b) allows over-secured claimants to recover post-petition interest and\nreasonable charges to the extent of their equity cushion. Otherwise, any amounts owing for\nunmatured interest accruing after the petition date are specifically disallowed. 11 U.S.C. \xc2\xa7\n502(b)(2). If an objection to a claim is filed, the court will determine the present discounted value\nof the claim as of the petition date.\nSection 502 contains two important claim limitations. First, the claims of a landlord against\na debtor tenant for breach (rejection) of a long term real property lease, and second the claims of\nan employee under a long term employment contract with an employer debtor, are limited by\nformulas set forth in Sections 502(b)(6) and (7). The structure of these statutory claim limitations\nwill be examined in the following problems.\n281\n\n\x0cFurthermore, the statute specifically disallows entirely contingent claims for\nreimbursement or contribution. This prevents two creditors from recovering on the same single\ndebt. 11 U.S.C. \xc2\xa7 502(e)(1)(B). This too will be illustrated in the following problems.\n\n10.4.\n\nPractice Problems: Landlord, Employer and Certain Contingent\nClaims\n\nProblem 1. On January 1, Year 1, creditor lent $100,000 to the debtor. Debtor promised\nto repay the loan together with interest at the rate of 12% per annum, compounded monthly.\nMonthly compounding means that any unpaid interest each month is to be added to the principal\nbalance to bear interest the next month. Debtor filed a Chapter 7 bankruptcy petition on April 1,\nYear 1, without ever making any payments on the loan. Creditor has asked you to prepare a proof\nof claim for filing with the bankruptcy court by the July 30, Year 1, the deadline set by the\nbankruptcy court. In what amount should the claim be filed?\nProblem 2. Charles Swindle has made a business of filing proofs of claim in numerous\nbankruptcy cases, even though he is owed nothing by the debtors. Is Swindle entitled to a\ndistribution on his false claims if no one files a claim objection? 11 U.S.C. \xc2\xa7 502(a). Is there\nanything stopping mountebanks like Swindle from filing baseless proofs of claim in the hope that\nno one will notice or have the incentive to object? (The Official Proof of Claim form reads, above\nthe signature line, \xe2\x80\x9cI have examined the information in this Proof of Claim and have a reasonable\nbelief that the information is true and correct. I declare under penalty of perjury that the foregoing\nis true and correct.\xe2\x80\x9d).\nProblem 3. Debtor owes $10,000 in federally insured student loans. Both debtor and\nstudent loan creditor know that this debt will not be discharged in bankruptcy. Is there any reason\nfor the student loan lender to file a proof of claim anyway? If the student loan lender does not file\na proof of claim, might the debtor want to file a proof of claim for the creditor? See 11 U.S.C. \xc2\xa7\n501(c).\nProblem 4. Several years ago, Radio Shacke, Inc. entered into a long term 30 year lease\nfor a store on Erie Boulevard owned by Robert Conjail. The monthly rent is $10,000. The store\nwas never profitable, and Radio Shacke decided to close the store. On February 1, Radio Shacke\nstopped paying rent. On June 1, Radio Shacke moved out of the store and sent Conjail the keys.\nOn September 1, Radio Shacke filed a Chapter 7 bankruptcy petition. At the time of bankruptcy\n25 years and 3 months remained on the lease. Conjail has been trying to re-rent the store, but the\nonly tenant he has been able to find is willing to pay only $5,000 per month in rent for the\nremaining lease term. Conjail has filed a claim for all unpaid rent through the end of the lease term,\nand the trustee has objected to the claim. The judge has asked you to determine how much of the\nclaim to allow. Review 11 U.S.C. \xc2\xa7 502(b)(6) carefully and calculate the claim amount.\nProblem 5. Recalculate Problem (4) assuming that the lease term expired 15 months after\nthe bankruptcy was filed.\nProblem 6. When Radio Shacke opened the store in Problem (4), it entered into a 30 year\nemployment contract with Walter Sales to run the store. The contract required Radio Shacke to\npay wages of $4,000 per month. When Radio Shacke moved out of the Store on June 1, it also\nstopped paying Sales under the employment contract. At the time of bankruptcy, 25 years and 3\n282\n\n\x0cmonths remained on the employment contract. Sales has filed a claim for $4,000 per month for the\nremaining term of the contract, and Radio Shacke has objected. The Judge has asked you to\ndetermine how much of the claim to allow. Review 11 U.S.C. \xc2\xa7 502(b)(7) carefully and calculate\nthe amount of Sales\xe2\x80\x99 claim.\nProblem 7. Assume that Charles Shacke, the owner of Radio Shacke, Inc., had personally\nguaranteed the lease in Problem (4). When Radio Shacke stopped paying rent, Conjail demanded\nthat Charles personally make the missed payments. Charles paid $80,000 so far, and has filed a\nproof of claim against Radio Shacke for the amount paid in the past plus the amount that he will\nowe in the future under the terms of the lease. Note that both Conjail and Charles seek to recover\nthe future rent from Radio Shacke. The trustee has objected to Charles\xe2\x80\x99s claim. How much of a\nclaim should Charles be allowed in the bankruptcy case? Review 11 U.S.C. \xc2\xa7 502(e)(1)(B)\ncarefully to answer this question.\n\n10.5.\n\nCases on Claim Estimation and Limitations\n10.5.1.1.\nIN RE RADIO-KEITH-ORPHEUM CORP., 106 F.2d\n22 (2d Cir. 1939)\n\nRadio-Keith-Orpheum Corporation is a holding company, organized in 1928. Some of the\nsubsidiary companies are engaged in producing and distributing motion picture films, others in\noperating motion picture and vaudeville theatres. Heavy losses were encountered in 1931 and\n1932, and in 1933 the company went into equity receivership. In 1934 it filed petition for\nreorganization as a debtor under section 77B of the Bankruptcy Act, 11 U.S.C.A. \xc2\xa7 207. The\npetition was approved, and the business has since been conducted by a trustee.\nThe appeal of Copia Realty Corporation and Fabian Operating Corporation brings up the\nfairness of the treatment given to contingent claims in the plan. These appellants are landlords who\nleased theatres to one of the debtor\'s subsidiaries on the debtor\'s guaranties that the subsidiary\nwould pay the rent reserved. There are no defaults under the leases, and there has never been\noccasion for resort to the guaranties given by the debtor. For contingent or indeterminable claims,\nof which there were a number in addition to those of the appellants, the proposed plan provided in\neffect that in the event of a claim becoming fixed after confirmation, the claimant might assert it\nat such later time, any recovery to be limited to the amount that would have been allowed if default\nhad occurred prior to confirmation and the debtor to have the right to satisfy the claim either in\ncash or in common stock of the same amount that the claimant would have received if he had\nestablished his claim as an unsecured claim prior to confirmation, that is to say, ten shares for each\n$100 of the claim.\nThe appellants objected to this in the district court, partly on the ground that they had no\nprotection against later decline in value of the shares. The district judge approved of the provision\nin general, but sought to meet the objection of the appellants by requiring that the number of shares\nof common stock to be delivered in satisfaction should be determined according to the market\nprice current at the time of default by the debtor. The plan was modified to include such a\nprovision.\n\n283\n\n\x0cThe appellants insist that even with this change the plan is prejudicial to contingent\nclaimants in their position and unduly favorable to unsecured creditors with accrued claims and to\nstockholders. They ask for either a continuance of the guaranties or a security deposit in cash of at\nleast three years\' rent.\nThe claims based on the debtor\'s guaranties were wholly contingent and indeterminate in\namount, there having been no default under the leases and no predictable prospect of a default. In\nordinary bankruptcy [under the old Bankruptcy Act] such claims would not be provable or\ndischargeable to any extent. In a proceeding under section 77B, however, they are claims subject\nto reorganization. The section provides in paragraph (b) that "`creditors\' shall include . . . all\nholders of claims of whatever character against the debtor or its property . . . whether or not such\nclaims would otherwise constitute provable claims under this title." The appellants therefore were\nnot as matter of law entitled to stand aloof and obtain a continuance of the guaranties unaffected\nby reorganization, the equivalent of a preference for them over unsecured creditors with accrued\nor determinable claims. What they were entitled to was treatment as nearly like that accorded to\nordinary unsecured creditors as the circumstances permitted, and we are of opinion that the plan\nextends that sort of treatment to them.\nThe demand for a cash deposit of the maximum amount of their claims is a call for better\ntreatment, a demand which would render it impossible in many cases to effect a reorganization.\nThe plan as it stands is fair to these parties, and their appeal fails.\n\n10.5.1.2.\nIN RE EL TORO MATERIALS CO., INC., 504 F.3d\n978 (9th Cir. 2007)\nKOZINSKI, Circuit Judge:\nBankruptcy presents a unique challenge: How should a paucity of resources be allocated\nto cover a multiplicity of claims? Distributing money to satisfy claims is, in most cases, a zerosum game: Every dollar given to one creditor is a dollar unavailable to satisfy the debt owed to\nothers. For Paul to be paid in full, Peter must be short-changed. Congress sought to balance the\ninterests of competing creditors through an extensive set of rules organizing, prioritizing and\nstructuring claims against the estate.\nThe bankruptcy estate of mining company El Toro Materials hopes to use one of these\nrules\xe2\x80\x94a cap on damages "resulting from the termination of a lease of real property," id. \xc2\xa7\n502(b)(6)\xe2\x80\x94to limit its liability for allegedly leaving one million tons of its wet clay "goo," mining\nequipment and other materials on Saddleback Community Church\'s property after rejecting its\nlease.\nSaddleback brought an adversary proceeding against El Toro claiming $23 million in\ndamages for the alleged cost of removing the mess, under theories of waste, nuisance, trespass and\nbreach of contract. The bankruptcy court, on a motion for partial summary judgment, found that\nSaddleback\'s recovery would not be limited by the section 502(b)(6) cap. On certified cross-appeal\nthe Bankruptcy Appellate Panel (BAP) reversed, holding that any damages would be capped.\nSaddleback appeals.\nClaims made by landlords against their bankrupt tenants for lost rent have always been\ntreated differently than other unsecured claims. Prior to 1934, landlords could not recover at all\n284\n\n\x0cfor the loss of rental income they suffered when a bankrupt tenant rejected a long-term lease\nagreement; future lease payments were considered contingent and thus not provable debts in\nbankruptcy.\nThe Great Depression created pressure to reform the system: A wave of bankruptcies left\nmany landlords with broken long-term leases, buildings sitting empty and no way to recover from\nthe estates of their former tenants. On the one hand, allowing landlords to make a claim for lost\nrental income would reduce the harm done to them by a tenant\'s breach of a long-term lease,\nespecially in a down market when it was difficult or impossible to re-lease the premises. On the\nother hand, "extravagant claims for . . . unearned rent" could quickly deplete the estate, to the\ndetriment of other creditors. The solution was a compromise in the Bankruptcy Act of 1934\nallowing a claim against the bankruptcy estate for back rent to the date of abandonment, plus\ndamages no greater than one year of future rent.\nCongress dramatically overhauled bankruptcy law when it passed the Bankruptcy Reform\nAct of 1978. However, section 502(b)(6) of the 1978 Act was intended to carry forward existing\nlaw allowing limited damages for lost rental income. Only the method of calculating the cap was\nchanged. Under the current Act, the cap limits damages "resulting from the termination of a lease\nof real property" to "the greater of one year, or 15 percent, not to exceed three years, of the\nremaining term of such lease." 11 U.S.C. \xc2\xa7 502(b)(6). The damages cap was "designed to\ncompensate the landlord for his loss while not permitting a claim so large (based on a long-term\nlease) as to prevent other general unsecured creditors from recovering a dividend from the estate."\nThe structure of the cap\xe2\x80\x94measured as a fraction of the remaining term\xe2\x80\x94suggests that\ndamages other than those based on a loss of future rental income are not subject to the cap. It\nmakes sense to cap damages for lost rental income based on the amount of expected rent: Landlords\nmay have the ability to mitigate their damages by re-leasing or selling the premises, but will suffer\ninjury in proportion to the value of their lost rent in the meantime. In contrast, collateral damages\nare likely to bear only a weak correlation to the amount of rent: A tenant may cause a lot of damage\nto a premises leased cheaply, or cause little damage to premises underlying an expensive leasehold.\nOne major purpose of bankruptcy law is to allow creditors to receive an aliquot share of\nthe estate to settle their debts. Metering these collateral damages by the amount of the rent would\nbe inconsistent with the goal of providing compensation to each creditor in proportion with what\nit is owed. Landlords in future cases may have significant claims for both lost rental income and\nfor breach of other provisions of the lease. To limit their recovery for collateral damages only to a\nportion of their lost rent would leave landlords in a materially worse position than other creditors.\nIn contrast, capping rent claims but allowing uncapped claims for collateral damage to the rented\npremises will follow congressional intent by preventing a potentially overwhelming claim for lost\nrent from draining the estate, while putting landlords on equal footing with other creditors for their\ncollateral claims.\nThe statutory language supports this interpretation. The cap applies to damages "resulting\nfrom" the rejection of the lease. 11 U.S.C. \xc2\xa7 502(b)(6). Saddleback\'s claims for waste, nuisance\nand trespass do not result from the rejection of the lease - they result from the pile of dirt allegedly\nleft on the property. Rejection of the lease may or may not have triggered Saddleback\'s ability to\nsue for the alleged damages. But the harm to Saddleback\'s property existed whether or not the\nlease was rejected. A simple test reveals whether the damages result from the rejection of the lease:\n285\n\n\x0cAssuming all other conditions remain constant, would the landlord have the same claim against\nthe tenant if the tenant were to assume the lease rather than rejecting it? Here, Saddleback would\nstill have the same claim it brings today had El Toro accepted the lease and committed to finish its\nterm: The pile of dirt would still be allegedly trespassing on Saddleback\'s land and Saddleback\nstill would have the same basis for its theories of nuisance, waste and breach of contract. The\nmillion-ton heap of dirt was not put there by the rejection of the lease\xe2\x80\x94it was put there by the\nactions and inactions of El Toro in preparing to turn over the site.\nInterpreting the section 502(b)(6) cap to include damage collateral to the lease would also\ncreate a perverse incentive for tenants to reject their lease in bankruptcy instead of running it out:\nRejecting the lease would allow the tenant to cap its liability for any collateral damage to the\npremises and thus reduce its overall liability, even if staying on the property would otherwise be\ndesirable and preserve the operating value of the business. Bankrupt tenants\xe2\x80\x94especially those who\nhave damaged the property and thus may face liability upon expiration of the lease\xe2\x80\x94would pack\nup their wares and reject otherwise desirable leases in order to gain the benefit of capping unrelated\ndamages. This would both reduce the operating value of the business and deny recovery to a\ncreditor\xe2\x80\x94a lose-lose situation counter to bankruptcy policy. An incentive to sacrifice efficiency\nin order to exploit a loophole in the liability-capping provisions would be plainly counter to\ncongressional intent to maximize the value of the estate to creditors.\nFurther, extending the cap to cover any collateral damage to the premises would allow a\npost-petition but pre-rejection tenant to cause any amount of damage to the premises\xe2\x80\x94either\nnegligently or intentionally\xe2\x80\x94without fear of liability beyond the cap. If the tenant\'s debt to the\nlandlord already exceeded the cap then there would be no deterrence against even the most flagrant\nacts in violation of the lease, possibly even to the point of the tenant burning down the property in\na fit of pique. Absent clear statutory language supporting such an absurd result, we cannot suppose\nthat Congress intended it.\nThe BAP reached a contrary conclusion because it considered itself bound by its precedent\nin In re McSheridan, 184 B.R. 91 (B.A.P. 9th Cir. 1995), and therefore held that Saddleback\'s\nrecovery against El Toro would be capped under section 502(b)(6). To the extent that McSheridan\nholds section 502(b)(6) to be a limit on tort claims other than those based on lost rent, rent-like\npayments or other damages directly arising from a tenant\'s failure to complete a lease term, it is\noverruled.\nSaddleback\'s argument that section 502(b)(6) does not cap its claim for damages is properly\nraised before us; Saddleback did not waive the argument by failing to question the breadth of the\nsection 502(b)(6) cap in its cross-appeal from the bankruptcy court to the BAP, as the ruling of the\nbankruptcy court on this issue was entirely favorable to Saddleback. Saddleback had no reason to\nchallenge a favorable decision.\nWe remand for a determination on the merits of Saddleback\'s claim.\n\n10.6.\n\nPriority Claims \xe2\x80\x93 11 U.S.C. \xc2\xa7 507\n\nCongress decided to favor certain creditors over others in the bankruptcy distribution by\ncreating priorities for favored creditors. Note that section 507 states the order of priorities. 11\nU.S.C. \xc2\xa7 507 (\xe2\x80\x9cthe following expenses and claims have priority in the following order\xe2\x80\x9d). Under\n286\n\n\x0cthe absolute priority rule, higher priority creditors must be paid in full before lower priority\ncreditors receive any distribution.\nWe have already studied one important priority \xe2\x80\x93 the priority for administrative claims \xe2\x80\x93\nprimarily professionals and creditors who provide post-petition benefits to the estate. 11 U.S.C. \xc2\xa7\n507(a)(2); 503.\nPrior to 2005, administrative creditors were at the top of the unsecured creditor food chain,\nhaving first priority. But in 2005, Congress subordinated administrative creditors to a new super\ncreditor \xe2\x80\x93 the domestic support creditor. 11 U.S.C. \xc2\xa7 507(a)(1). However, the administrative claims\nof the trustee are pushed back to the top of the heap if the trustee\xe2\x80\x99s administration enables the fund\nfrom which domestic support creditors are paid. 11 U.S.C. \xc2\xa7 507(a)(1)(C).\nPriorities are given to the Debtor\xe2\x80\x99s employees for unpaid wages (11 U.S.C. \xc2\xa7 507(a)(4))\nand certain employee benefits (11 U.S.C. \xc2\xa7 507(a)(5)) earned within 180 days before bankruptcy\nup to a limit of $12,475 as of 2015 per employee.\nDeposits given to the debtor for consumer goods or services are given a priority up to\n$2,775 as of 2015 per deposit. 11 U.S.C. \xc2\xa7 507(a)(7).\nThe most complex priority is given for certain tax obligations. 11 U.S.C. \xc2\xa7 507 (a)(8). As\nwe will see later in the course, priority taxes are also not dischargeable, so the determination of\npriority is particularly important for many debtors. See 11 U.S.C. \xc2\xa7 523(a)(1)(A). The priority\nrules are different for different kinds of taxes.\nThe most commonly owed taxes are income taxes, and they also have the most complex\npriority rule. There are three separate rules \xe2\x80\x93 any one of which can provide a priority.\nThe first rule is known as the \xe2\x80\x9clook-back rule.\xe2\x80\x9d If the tax return for the applicable period\nwas first due (including any extensions) within 3 years before the bankruptcy filing, then the taxes\nare subject to a priority. 11 U.S.C. \xc2\xa7 507(a)(8)(A)(i). Thus, for each tax year in which the debtor\nowes taxes, you must determine: (1) when the return for the tax year was due (usually April 15 of\nthe following year if no extension, or October 15 if an extension was granted), and (2) whether\nthat date was within 3 years of the bankruptcy filing. Only old taxes \xe2\x80\x93 generally for tax years three\nto four years before bankruptcy \xe2\x80\x93 have the possibility of being non-priority.\nThe second rule depends on when the taxes were assessed. Assessment is the process by\nwhich the IRS records the taxes as owing on its records. The taxes shown as owing on a filed return\nare assessed when the return is filed. However, if the IRS claims that the debtor owes additional\ntaxes not shown on the return, the IRS can follow a procedure to assess the additional taxes. Any\ntaxes assessed within 240 days before bankruptcy are also entitled to a priority. 11 U.S.C. \xc2\xa7\n507(a)(8)(a)(ii). Further, that 240 day period is extended if the debtor files an offer in compromise\nor obtains a stay of collection during the 240 day period. 11 U.S.C. \xc2\xa7 507(a)(8)(a)(ii)(I) and (II).\nFinally, taxes that have not been assessed but are assessable after bankruptcy are entitled\nto priority. 11 U.S.C. \xc2\xa7 507(a)(8)(A)(iii). Normally, the IRS has three years from the time the\ndebtor files an income tax return to assess a deficiency. See 18 U.S.C. \xc2\xa7 6501(a). Although the\nlanguage is somewhat confusing, Congress intended not to provide a priority for older taxes that\ncan be assessed post-petition only because the debtor failed to file a return, filed a late return, or\ncommitted tax fraud. 11 U.S.C. \xc2\xa7 507(a)(8)(A)(iii) (see reference to Section 523(a)(1)(B) and (C)).\n287\n\n\x0cWithholding taxes (most sales taxes, and employee withholding taxes) are always given a\npriority, no matter how old. 11 U.S.C. \xc2\xa7 507(a)(8)(C). Property taxes due without penalty within\na year before bankruptcy are given a priority. 11 U.S.C. \xc2\xa7 507(a)(8)(B). A three year look-back\nrule similar to the one for income taxes applies to non-withheld employment taxes and excise\ntaxes. 11 U.S.C. \xc2\xa7 507(a)(8)(D) and (E).\nTax penalties owing on priority claims and in compensation for actual pecuniary loss are\ngiven a priority. 11 U.S.C. \xc2\xa7 507(a)(8)(G). This language is rather curious because penalties, by\ndefinition, are designed to punish not to compensate, but the section has been interpreted to apply\nto amounts designated as penalties but designed to compensate.\n\n10.7.\n\nPractice Problems: Priority Claims.\n\nProblem 1. Assume that the Debtor did not obtain an extension, and that the Debtor\xe2\x80\x99s tax\nreturns were due on April 15 of each year. If the Debtor files bankruptcy on February 10, 2015,\nwhich years\xe2\x80\x99 taxes will be entitled to priority under the look-back rule. 11 U.S.C. \xc2\xa7 507(a)(8)\nProblem 2. Same question as Problem 1 except the Debtor filed bankruptcy on September\n21, 2015.\nProblem 3. Bob Servant worked for Radio Shacke for many years. He received his last\n$2,000 paycheck on March 20. On the way home from work, he stopped at Wedgeman\xe2\x80\x99s grocery\nstore to pick up food. Wedgeman\xe2\x80\x99s always cashed Servant\xe2\x80\x99s paychecks. Radio Shacke filed\nbankruptcy on March 21, and the check was dishonored by Radio Shacke\xe2\x80\x99s bank. Can\nWedgeman\xe2\x80\x99s grocery store assert that the unpaid check was entitled to a wage priority under 11\nU.S.C. \xc2\xa7 507(a)(4)? See 11 U.S.C. \xc2\xa7 507(d). Is Wedgeman\xe2\x80\x99s a subrogee or an assignee? See In\nre Missionary Baptist Foundation of America, 667 F.2d 1244 (5th Cir.1982); In re All American\nManufacturing Corp., 185 B.R. 79 (Bankr. S.D. Fla.1995) (subrogee has pre-existing duty to pay,\nassignee does not).\n\n10.8.\n\nSubordination: 11 U.S.C. \xc2\xa7 510\n\nSection 510(a) of the Bankruptcy Code validates private subordination agreements. If one\ncreditor contractually agrees to be subordinate to another, the bankruptcy court will enforce the\nsubordination. Contractual subordination is common in sophisticated secured and unsecured\nfinancing arrangements, such as corporate bonds and debentures.\nSection 510(b) provides for automatic subordination of a rescission claim by a purchaser\nof securities. This prevents a buyer of stock, for example, from attempting to obtain priority over\nother stockholders by seeking rescission of the stock purchase (which, absent this provision, would\nmake the buyer a creditor rather than a stockholder). The provision subordinates the claim to the\nsame priority as the security.\nSection 510(c) gives the bankruptcy court the power to equitably subordinate claims. This\nis known as the \xe2\x80\x9cDeep Rock Doctrine,\xe2\x80\x9d after one of the early equitable subordination cases, Taylor\nv. Standard Gas and Electric Company, 306 U.S. 307 (1939), where the claims of insider equity\ninvestors were subordinated to those of regular creditors. The doctrine has traditionally been used\nagainst insiders who have taken advantage of their position to benefit themselves at the expense\n288\n\n\x0cof creditors. Courts generally use the three factors from In re Mobile Steel Co., 563 F.2d 692, 699700 (5th Cir. 1977), in deciding whether to equitably subordinate a claim or interest:\n(i) the claimant must have engaged in some type of inequitable\nconduct; (ii) the misconduct must have resulted in injury to the\ncreditors of the bankrupt or conferred an unfair advantage on the\nclaimant; and (iii) equitable subordination of the claim must not\nbe inconsistent with bankruptcy law.\nBecause of the broad nature of the power, courts have not been entirely consistent in deciding what\ntype of conduct qualifies for equitable subordination.\n\n10.9.\n\nAbandonment: 11 U.S.C. \xc2\xa7 554\n\nSection 554 allows the trustee to abandon property that is burdensome or of inconsequential\nvalue to the estate. The Supreme Court held that the power to abandon is not without limits,\nhowever, in Midlantic Nat\xe2\x80\x99l Bank v. NJDEP, 474 U.S. 494 (1986), reprinted below, and the courts\nhave been trying to figure out the limits of the abandonment power ever since. If the trustee cannot\nabandon burdensome property, the estate must incur expenses relating to that property. The cost\nof cleaning up prepetition contamination essentially becomes a prepetition claim.\n\n10.10. Cases on Abandonment of Property in Bankruptcy\n10.10.1.1. MIDLANTIC NAT\xe2\x80\x99L BANK v. NJDEP, 474 U.S. 494\n(1986)\nJUSTICE POWELL delivered the opinion of the Court.\nThese petitions for certiorari, arising out of the same bankruptcy proceeding, present the\nquestion whether \xc2\xa7 554(a) of the Bankruptcy Code authorizes a trustee in bankruptcy to abandon\nproperty in contravention of state laws or regulations that are reasonably designed to protect the\npublic\'s health or safety.\nQuanta Resources Corporation (Quanta) processed waste oil at two facilities, one in Long\nIsland City, New York, and the other in Edgewater, New Jersey. At the Edgewater facility, Quanta\nhandled the oil pursuant to a temporary operating permit issued by the New Jersey Department of\nEnvironmental Protection (NJDEP). In June, 1981, Midlantic National Bank provided Quanta with\na $600,000 loan secured by Quanta\'s inventory, accounts receivable, and certain equipment. The\nsame month, NJDEP discovered that Quanta had violated a specific prohibition in its operating\npermit by accepting more than 400,000 gallons of oil contaminated with PCB, a highly toxic\ncarcinogen. NJDEP ordered Quanta to cease operations at Edgewater, and the two began\nnegotiations concerning the cleanup of the Edgewater site. But on October 6, 1981, before the\nconclusion of negotiations, Quanta filed a petition for reorganization under Chapter 11 of the\nBankruptcy Code. The next day, NJDEP issued an administrative order requiring Quanta to clean\nup the site. Quanta\'s financial condition remained perilous, however, and, the following month, it\nconverted the action to a liquidation proceeding under Chapter 7. Thomas J. O\'Neill was appointed\ntrustee in bankruptcy, and subsequently oversaw abandonment of both facilities.\n289\n\n\x0cAfter Quanta filed for bankruptcy, an investigation of the Long Island City facility revealed\nthat Quanta had accepted and stored there over 70,000 gallons of toxic, PCB-contaminated oil in\ndeteriorating and leaking containers. Since the mortgages on that facility\'s real property exceeded\nthe property\'s value, the estimated cost of disposing of the waste oil plainly rendered the property\na net burden to the estate. After trying without success to sell the Long Island City property for the\nbenefit of Quanta\'s creditors, the trustee notified the creditors and the Bankruptcy Court for the\nDistrict of New Jersey that he intended to abandon the property pursuant to \xc2\xa7 554(a). No party to\nthe bankruptcy proceeding disputed the trustee\'s allegation that the site was "burdensome" and of\n"inconsequential value to the estate" within the meaning of \xc2\xa7 554.\nThe City and the State of New York (collectively, New York) nevertheless objected,\ncontending that abandonment would threaten the public\'s health and safety, and would violate state\nand federal environmental law. New York rested its objection on "public policy" considerations\nreflected in applicable local laws, and on the requirement of 28 U.S.C. \xc2\xa7 959(b) that a trustee\n"manage and operate" the property of the estate "according to the requirements of the valid laws\nof the State in which such property is situated." New York asked the Bankruptcy Court to order\nthat the assets of the estate be used to bring the facility into compliance with applicable law. [The\nbankruptcy court approved abandonment\nUpon abandonment, the trustee removed the 24-hour guard service and shut down the firesuppression system. It became necessary for New York to decontaminate the facility, with the\nexception of the polluted subsoil, at a cost of about $2.5 million.\nOn April 23, 1983, shortly after the District Court had approved abandonment of the New\nYork site, the trustee gave notice of his intention to abandon the personal property at the Edgewater\nsite, consisting principally of the contaminated oil. The Bankruptcy Court approved the\nabandonment on May 20, over NJDEP\'s objection that the estate had sufficient funds to protect the\npublic from the dangers posed by the hazardous waste.\nA divided panel of the Court of Appeals for the Third Circuit reversed. Although the court\nfound little guidance in the legislative history of \xc2\xa7 554, it concluded that Congress had intended to\ncodify the judge-made abandonment practice developed under the previous Bankruptcy Act.\nUnder that law, where state law or general equitable principles protected certain public interests,\nthose interests were not overridden by the judge-made abandonment power. The court also found\nevidence in other provisions of the Bankruptcy Code that Congress did not intend to preempt all\nstate regulation, but only that grounded on policies outweighed by the relevant federal interests.\nAccordingly, the Court of Appeals held that the Bankruptcy Court erred in permitting\nabandonment, and remanded both cases for further proceedings.\nWe granted certiorari and consolidated these cases to determine whether the Court of\nAppeals properly construed \xc2\xa7 554, 469 U.S. 1207 (1985). We now affirm.\nBefore the 1978 revisions of the Bankruptcy Code, the trustee\'s abandonment power had\nbeen limited by a judicially developed doctrine intended to protect legitimate state or federal\ninterests. [Court reviews historical cases]. Thus, when Congress enacted \xc2\xa7 554, there were wellrecognized restrictions on a trustee\'s abandonment power. In codifying the judicially developed\nrule of abandonment, Congress also presumably included the established corollary that a trustee\ncould not exercise his abandonment power in violation of certain state and federal laws. The\n290\n\n\x0cnormal rule of statutory construction is that, if Congress intends for legislation to change the\ninterpretation of a judicially created concept, it makes that intent specific.\nNeither the Court nor Congress has granted a trustee in bankruptcy powers that would lend\nsupport to a right to abandon property in contravention of state or local laws designed to protect\npublic health or safety. As we held last Term when the State of Ohio sought compensation for\ncleaning the toxic waste site of a bankrupt corporation:\n"Finally, we do not question that anyone in possession of the site -whether it is [the debtor] or another in the event the receivership is\nliquidated and the trustee abandons the property, or a vendee from\nthe receiver or the bankruptcy trustee -- must comply with the\nenvironmental laws of the State of Ohio. Plainly, that person or firm\nmay not maintain a nuisance, pollute the waters of the State, or\nrefuse to remove the source of such conditions."\nOhio v. Kovacs, 469 U.S. 274, 285 (1985) (emphasis added).\nCongress has repeatedly expressed its legislative determination that the trustee is not to\nhave carte blanche to ignore nonbankruptcy law. Where the Bankruptcy Code has conferred\nspecial powers upon the trustee and where there was no common law limitation on that power,\nCongress has expressly provided that the efforts of the trustee to marshal and distribute the assets\nof the estate must yield to governmental interest in public health and safety. For example, \xc2\xa7\n362(b)(5) permits the Government to enforce "nonmonetary" judgments against a debtor\'s estate.\nIt is clear from the legislative history that one of the purposes of this exception is to protect public\nhealth and safety:\nPetitioners have suggested that the existence of an express exception to the automatic stay\nundermines the inference of a similar exception to the abandonment power: had Congress sought\nto restrict similarly the scope of \xc2\xa7 554, it would have enacted similar limiting provisions. This\nargument, however, fails to acknowledge the differences between the predecessors of \xc2\xa7\xc2\xa7 554 and\n362. As we have noted, the exceptions to the judicially created abandonment power were firmly\nestablished. But in enacting \xc2\xa7 362 in 1978, Congress significantly broadened the scope of the\nautomatic stay, an expansion that had begun only five years earlier with the adoption of the\nBankruptcy Rules in 1973. Between 1973 and 1978, some courts had stretched the expanded\nautomatic stay to foreclose States\' efforts to enforce their antipollution laws, and Congress wanted\nto overrule these interpretations in its 1978 revision.\n28 U.S.C. \xc2\xa7 959(b) provides additional evidence that Congress did not intend for the\nBankruptcy Code to preempt all state laws. Section 959(b) commands the trustee to "manage and\noperate the property in his possession . . . according to the requirements of the valid laws of the\nState." Petitioners have contended that \xc2\xa7 959(b) is relevant only when the trustee is actually\noperating the business of the debtor, and not when he is liquidating it. Even though \xc2\xa7 959(b) does\nnot directly apply to an abandonment under \xc2\xa7 554(a) of the Bankruptcy Code -- and therefore does\nnot delimit the precise conditions on an abandonment -- the section nevertheless supports our\nconclusion that Congress did not intend for the Bankruptcy Code to preempt all state laws that\notherwise constrain the exercise of a trustee\'s powers.\nAlthough the reasons elaborated above suffice for us to conclude that Congress did not\nintend for the abandonment power to abrogate certain state and local laws, we find additional\n291\n\n\x0csupport for restricting that power in repeated congressional emphasis on its "goal of protecting the\nenvironment against toxic pollution." [The Court discusses various environmental laws. The Court\nnoted that CERCLA] \xe2\x80\x9calso empowers the Federal Government to secure such relief as may be\nnecessary to avert \xe2\x80\x98imminent and substantial endangerment to the public health or welfare or the\nenvironment because of an actual or threatened release of a hazardous substance.\xe2\x80\x99\xe2\x80\x9d 42 U.S.C. \xc2\xa7\n9606. In the face of Congress\' undisputed concern over the risks of the improper storage and\ndisposal of hazardous and toxic substances, we are unwilling to presume that, by enactment of \xc2\xa7\n554(a), Congress implicitly overturned longstanding restrictions on the common law abandonment\npower.\n[W]e conclude that Congress did not intend for \xc2\xa7 554(a) to preempt all state and local laws.\nThe Bankruptcy Court does not have the power to authorize an abandonment without formulating\nconditions that will adequately protect the public\'s health and safety. Accordingly, without\nreaching the question whether certain state laws imposing conditions on abandonment may be so\nonerous as to interfere with the bankruptcy adjudication itself, we hold that a trustee may not\nabandon property in contravention of a state statute or regulation that is reasonably\ndesigned to protect the public health or safety from identified hazards.9\n9\n\nThis exception to the abandonment power vested in the trustee by \xc2\xa7 554 is a narrow one. It does\nnot encompass a speculative or indeterminate future violation of such laws that may stem from\nabandonment. The abandonment power is not to be fettered by laws or regulations not reasonably\ncalculated to protect the public health or safety from imminent and identifiable harm.\n[Editor\xe2\x80\x99s Note: Three judges dissented, pointing out that their disagreement was somewhat\nmitigated by the conclusion that only certain \xe2\x80\x9cidentified hazards\xe2\x80\x9d that posted an \xe2\x80\x9cimminent\nand identifiable harm\xe2\x80\x9d limited the trustee\xe2\x80\x99s abandonment power. Most of the cases decided\nafter Midlantic have tried to address which \xe2\x80\x9cidentified hazards\xe2\x80\x9d limit the abandonment\npower and which do not.]\n\n10.11. Distribution to Creditors: 11 U.S.C. \xc2\xa7 726\nAfter the trustee sells off all of the debtor\xe2\x80\x99s non-exempt assets and recovers avoided\ntransfers, and after all claims are filed, allowed or disputed and determined, all that\xe2\x80\x99s left is\ndistributing the money to creditors in accordance with the absolute priority rule. Section 726 of\nthe Bankruptcy Code provides for that distribution. First, priority claims are paid in the order\nspecified in Section 507. 11 U.S.C. \xc2\xa7 726(a)(1). Then timely filed and late filed unsecured claims\nare paid. 11 U.S.C. \xc2\xa7\xc2\xa7 726(a)(2); (a)(3). Fines, penalties and forfeitures not in compensation for\nactual pecuniary loss are paid after general unsecured creditors. 11 U.S.C. \xc2\xa7 726(a)(4).\nIf there is money left over after all unsecured claims are paid in full, then all unsecured\ncreditors are entitled to post-petition interest on their claims (from the petition date until the date\nof payment) at the legal rate. 11 U.S.C. \xc2\xa7 726(a)(5). Only after all creditors are paid in full with\ninterest is any distribution made to the debtor. 11 U.S.C. \xc2\xa7 726(a)(6).\nIf the trustee does not have enough money to pay all of the claims in any class in full, the\nclaims in that last class share pro rata, and no one junior receives any distribution. See 11 U.S.C.\n\xc2\xa7 726(b).\n292\n\n\x0cA recent circuit split has developed over the meaning of the \xe2\x80\x9clegal rate\xe2\x80\x9d of interest that\nmust be paid by a solvent estate. In In re Cardelucci, 285 F.3d 1231, 1234 (9th Cir. 2002), the court\nheld that \xe2\x80\x9clegal rate\xe2\x80\x9d means the federal judgment rate of interest, which at the time of this writing\nis a very low 0.63%. More recently, in In re Dvorkin Holdings, LLC, 547 B.R. 880 (N.D. Ill. 2016),\nthe district court rejected Cardelucci, holding that the solvent debtor must pay the parties\xe2\x80\x99\nprepetition contract rate.\nThe next section deals with what happens to the claims of creditors who are not paid in full\nfrom the bankruptcy estate.\n\n293\n\n\x0cChapter 11: The Discharge\n11.1.\n\nThe Discharge Order\n\nThe primary benefit of Chapter 7 bankruptcy to most individual debtors is the discharge.\nThe discharge gives the debtor a fresh start free from the obligation to pay his or her prepetition\ndebts. Unless the debtor is denied a discharge or the debt is not discharged, the claims that remain\nunpaid after the Chapter 7 distribution from the bankruptcy estate are discharged.\nSection 524 of the Bankruptcy Code takes over after discharge where the automatic stay\nleft off during the bankruptcy case. The automatic stay terminates upon the grant of a discharge.\n11 U.S.C. \xc2\xa7 362(c)(2)(C). Section 524 imposes an injunction against filing or continuing a suit to\ncollect a discharged debt, or taking any other act to collect a discharged debt from the debtor or\nfrom the debtor\xe2\x80\x99s property on account of the debtor\xe2\x80\x99s personal liability for the debt. Note that\nSection 524 does not enjoin actions to foreclose prepetition liens that pass through bankruptcy \xe2\x80\x93\nonly the debtor\xe2\x80\x99s \xe2\x80\x9cpersonal liability\xe2\x80\x9d for the debt is discharged. Only the debtor who filed the\nbankruptcy is discharged. Third parties (such as co-debtors and guarantors) who are jointly,\nseverally or partially liable for the debt with the debtor remain liable. 11 U.S.C. \xc2\xa7 524(e).\nViolation of the post-discharge injunction is prosecuted in the same way as violations of\nthe automatic stay. A creditor who violates the post discharge injunction is in contempt of court.\nIn a state court lawsuit, the debtor must raise the discharge as an affirmative defense under state\nlaw or it is deemed waived. Alternatively, Debtors can reopen their bankruptcy cases (if they have\nbeen closed) and seek to hold the creditor in contempt of court for violating the post-discharge\ninjunction.\n\n11.2.\n\nCases on Violation of the Discharge Order\n11.2.1.1.\n\nIN RE ANDRUS, 189 B.R. 413 (N.D. Ill. 1995)\n\nStanley Stann appeals an order of the bankruptcy court finding him in civil contempt and\ndirecting him to pay remedial and compensatory damages. We affirm the decision of the\nbankruptcy court.\nThe debtors obtained an Order of Discharge on June 24, 1993. In February or March of\n1995 Stann decided to post a large sign near the debtors house reading, "GENE ANDRUS,\nWHERE\'S MY MONEY?" The debtors immediately filed a motion for contempt before the\nbankruptcy court, and Stann agreed to take down the sign. The parties subsequently entered an\nagreed Order for Injunctive Relief and Dismissal of Proceedings, which specifically enjoined "the\ncommencement or continuation of any action, the employment of any process, or an act, to collect,\nrecover or offset" the discharged debt. The order also specifically referred to the injunction\nimposed by 11 U.S.C. \xc2\xa7 524 against attempts to collect a discharged debt.\nStann apparently was not deterred by this order or the statutory injunction. Soon after\nresolving the dispute over the first sign, Stann posted a second sign on his property \xe2\x80\x94 which is\ntwo doors down from the debtors\' house \xe2\x80\x94 declaring, "GENE ANDRUS WENT BANKRUPT!\nHE DIDN\'T PAY HIS BILLS. HE IS A DEADBEAT! THIS IS A PUBLIC SERVICE\n294\n\n\x0cANNOUNCEMENT." The signs were not the only evidence of Stann\'s disappointment with the\ndebtors; indeed, the bankruptcy court found them to be merely part of a larger pattern of\nmisconduct intended to pressure the debtors into paying the discharged debt. On February 9, 1995,\nStann left a harassing and vulgar message on the Andrus\'s answering machine, in which Stann\nthreatened to ruin Eugene Andrus\'s reputation in the community unless he repaid the debt.4\nOn June 8, 1995, Stann approached the debtors in their car and repeatedly asked them to\nrepay the money they owed him.5 On July 3, 1995, Stann shouted to Ms. Andrus from his yard:\nWho do you think you are? Your husband is a deadbeat. I\'ve told the\nwhole Ukrainian community about you. You\'re just off the boat.\nYou think that that attorney of yours is going to protect you? Your\nattorney knows nothing. Get yourself a better attorney. No court is\ngoing to protect you. You get that deadbeat husband of yours. I want\nmy money. I want Gene. I want my money.\nThe following day Stann approached the Andruses and offered to fight Gene Andrus for\nthe money:\nYou\'re a deadbeat. I want my money. Let\'s go. I\'ll beat it out of you.\nLet\'s go fight over it. I\'m going to beat the shit out of you. And if\nyou win, Gene \xe2\x80\x94 because you\'re such a faggot you\'re not going to\nwin \xe2\x80\x94 but if you win, I\'ll drop the $20,000.\nThe Andruses brought a civil contempt action against Stann pursuant to Fed. R.Bankr.P.\n9020, alleging that he violated the injunction in the Discharge Order, as well as 11 U.S.C. \xc2\xa7\n524(a)(2). After an evidentiary hearing, during which Stann corroborated most of the testimony\noffered by Ms. Andrus, Judge Schmetterer found that Stann had willfully violated the injunction\nimposed by \xc2\xa7 524(a)(2) by engaging a course of conduct intended to force the payment of a\ndischarged debt. The bankruptcy court also found that the signs posted by Stann did not constitute\nprotected speech under the First Amendment, and thus could provide the basis for a finding of\ncontempt. The court ordered Stann to pay remedial and compensatory damages, and directed him\nto remove the sign posted on his property, although it did not prohibit Stann from engaging in\nprotected speech in the future.\nStann raises a single issue in this appeal: Did the bankruptcy court\'s interpretation of \xc2\xa7\n524(a)(2) and its finding of contempt "abridg[e] the freedom of speech" guaranteed by the First\nAmendment to the United States Constitution? Although wary of injunctions restricting speech,\n4\n\n\xe2\x80\x9cStan Stann here (parts inaudible) to return my call so now we\'re going to have to get real embarrassing. Once I start\nthe ball rolling on these things, Gene, I ain\'t going to f____g talk to you anymore. I would appreciate the courtesy of\n... a call back, otherwise we\'re going to start making your life real interesting. And, hey, you\'re bringing this all on\nyourself, but we\'re going to let the whole world know what a cheap son of a bitch you are. So I suggest that you get\nin touch with me; otherwise, once I start the moving this time on it, banners and the whole thing, the whole shot, you\'re\ngoing to be ashamed to even come home because everyone on this lake is going to know what a f____g deadbeat you\nare. So you\'d better make peace with me fairly quickly, guy.\xe2\x80\x9d\nMs. Andrus testified that Stann said: \xe2\x80\x9cI want my f___ing money, I want my money. Why do you f___ with me? ...\nI\'m going to get my money. Your faggot husband. No one is going to protect you. Wait until you throw another party.\nYou think you\'re going to have another party in your house? You just wait and see.\xe2\x80\x9d\n5\n\n295\n\n\x0cand mindful of the importance of the First Amendment in civic life, we nonetheless conclude that\nthe contempt order issued in this case did not run afoul of the First Amendment.\nAt the outset we observe that the injunction and contempt order were directed at conduct\n\xe2\x80\x94 that is, attempting to collect a discharged debt. The fact that Stann\'s conduct contained a\n"communicative element" does not necessarily render it protected speech under the First\nAmendment. . . . Proper enforcement of the Bankruptcy Code would be seriously undermined if\ncourts could not enjoin efforts at collecting discharged debts and punish those who ignored court\norders.\nHowever, even assuming arguendo that the injunction and contempt order issued by the\nbankruptcy court were directed at pure speech, we still do not find them violative of the First\nAmendment. When evaluating a content-neutral injunction \xe2\x80\x94 such as the one embodied in \xc2\xa7 524\nand the Discharge Order[7] \xe2\x80\x94 we ask "whether the challenged provisions of the injunction burden\nno more than necessary to serve a significant government interest." We discern two significant\ngovernmental interests implicated by Stann\'s conduct: the power of the courts to enforce and\nprotect their judicial process, and the ability of the Bankruptcy Code to protect debtors. The former\nhas long been recognized as significant component in the effective administration of justice, and\ncan justify the fashioning of effective remedies that incidentally implicate speech.\nIn sum, we believe that the contempt order and injunction satisfied the requirements of\nO\'Brien and were therefore constitutional. Alternatively, even if these restrictions implicated pure\nspeech, we find that they did not burden more speech than necessary to serve the significant\ngovernment interests at risk. Accordingly, we affirm the contempt order of the bankruptcy court.\nIt is so ordered.\n\n11.3.\n\nDenial of Discharge\n\nThere are 5 ways in which the debtor can be denied a discharge entirely.\nBad Acts. First, as we have already seen in connection with debtors who convert excessive\namounts of non-exempt to exempt property, the debtor can be denied a discharge for bad\nprepetition or post-petition conduct. 11 U.S.C. \xc2\xa7\xc2\xa7 727(a)(2) \xe2\x80\x93 (a)(7). These rules apply to actual\nintent fraudulent transfers before or after bankruptcy, destroying or falsifying records, making a\nfalse oath, failing to explain satisfactorily the loss of assets, and failing to obey court orders. Courts\nhave substantial discretion when bad acts are shown to determine whether the acts justify denial\nof discharge, and generally impose a high standard of proof for denial. Creditors seeking denial of\ndischarge must file a complaint for denial of discharge within 60 days after the first meeting of\ncreditors. Bankruptcy Rule 4004(a).\nNon-Individuals. Second, only individuals \xe2\x80\x93 non-entities \xe2\x80\x93 are entitled to a Chapter 7\ndischarge. 11 U.S.C. \xc2\xa7 707(a)(1). This is because entities are non-functioning shells after\nbankruptcy (all assets have been liquidated and business operations have been terminated). There\nis no need for a non-functioning shell to receive a discharge because it is, for all intents and\npurposes, dead. The proprietors of the non-functioning shell should follow the dictates of state law\nto terminate the entity. An individual has a life after bankruptcy, and freed from the burden of\nexcessive debt can begin life with a financial fresh start due to the discharge. Entities do receive a\n296\n\n\x0cdischarge of debts under the reorganization provisions of Chapters 9, 11 and 12. See 11 U.S.C. \xc2\xa7\xc2\xa7\n944(b), 1141(d), 1228(a).\nPrior Bankruptcy Cases. Third, a discharge is denied for debtors who obtained a\ndischarge in a prior bankruptcy case filed within certain prescribed time periods before the current\ncase. The rule compares the filing date of the previous case to the filing date of the new case, and\nrequires 8 years between a previous Chapter 7 or 11 case and a new Chapter 7 case, six years\nbetween a previous Chapter 12 or 13 case and a new Chapter 7 case. 11 U.S.C. \xc2\xa7\xc2\xa7 727(a)(8), (a)(9).\nIn order for the restriction on filing a new case to apply, the debtor must have received a discharge\nin the prior case. Id. The date that the prior discharge was granted does not matter.\nPrior Case Dismissals within 180 Days for \xe2\x80\x9cBad Acts\xe2\x80\x9d. Individual debtors may not be\neligible to obtain a discharge in a new case if the previous bankruptcy case was dismissed for\ncertain enumerated reasons within 180 days before the filing of the new case. This rule only applies\nif the prior case was dismissed because:\n(1) the debtor \xe2\x80\x9cwillfully failed to abide by orders of the court,\xe2\x80\x9d\n(2) the debtor failed \xe2\x80\x9cto appear before the court in proper\nprosecution of the case,\xe2\x80\x9d or\n(3) \xe2\x80\x9cwhere the debtor requested and obtained voluntary dismissal\n. . . following the filing of a request for relief from the automatic\nstay.\xe2\x80\x9d\n11 U.S.C. \xc2\xa7 109(g). The third ground in Section 109(g) is troubling, because it is terribly\noverbroad. The provision was intended to prevent debtors from gaming the system by dismissing\none case in response to a relief from stay motion that the debtor knew would be granted, and then\nrefiling a new case to further stall the creditor. Unfortunately, the rule is so broad that it punishes\ndebtors who were not abusing the system. For example, the debtor may have voluntarily dismissed\nthe case after the relief from stay motion was denied. Or the debtor may have dismissed the case\nafter the creditor obtained relief from stay, and did not file the new case until the creditor completed\na foreclosure. A number of courts have interpreted the provision narrowly to prevent unfairness\nwhere the dismissal had nothing to do with the request for relief from stay. See In re Luna, 122\nB.R. 575 (B.A.P. 9th Cir. Cal. 1991) (denying dismissal when result would be illogical, unintended\nand unjust); In re Santana, 110 B.R. 819 (Bankr. W.D. Mich. 1990) (same). Some courts have\nread the word \xe2\x80\x9cfollowing\xe2\x80\x9d to mean that the request for dismissal must be prompted by the relief\nfrom stay motion, In re Duncan, 182 B.R. 156 (Bankr. W.D. Va. 1995), and most courts require\nthat a proper motion for relief from stay be pending at the time the debtor requests and obtains the\nvoluntary dismissal. See In re Jones, 99 B.R. 412 (Bankr. E.D. Ark. 1989); In re Milton, 82 B.R.\n637 (Bankr. S.D. Ga. 1988).\nBad Act Revocations. Finally, a discharge may also be revoked, generally within one year\nafter it is granted, for bad acts discovered after discharge. 11 U.S.C. \xc2\xa7 727(d) and (e).\n\n297\n\n\x0c11.4.\n\nCases on Denial of Discharge\n11.4.1.1.\n\nDAVIS v. DAVIS, 911 F.2d 560 (11th Cir. 1990)\n\nIn 1983, the Appellee, Roe Davis, and the Debtor/Appellant, Don Davis, opened a\npharmacy business. Roe Davis owned fifty-one percent of the stock, while Don Davis owned the\nremaining forty-nine percent. Both Roe and Don Davis, who are unrelated, individually signed\npromissory notes for the money they borrowed to operate the business. The business failed and\nwas closed in October 1985. The final bank loan used to finance the pharmacy was payable in\nOctober 1986. Two days after the due date, the Debtor discussed with his attorney his inability to\npay this note and his concern about possibly losing his home. At the suggestion of his attorney,\nthe Debtor deeded his one-half interest in his home to his wife. Shortly thereafter, in November\n1986, Appellee Roe Davis paid off the outstanding balance on the bank note, amounting to\n$118,395.24.\nAppellee Roe Davis sued the Debtor for contribution and obtained a default judgment for\n$58,694.24. Two days after obtaining this judgment, the Appellee filed a fraudulent conveyance\naction against the Debtor seeking to set aside the transfer of the Debtor\'s interest in his home to\nhis wife. Upon service of this complaint, the Debtor consulted his attorney, who advised him to\nsee a bankruptcy lawyer. The Debtor did so, and was advised to reverse the transfer of his home\nto his wife. The necessary deed was prepared, executed and recorded. The day following\nrecordation, the Debtor filed for bankruptcy protection under Chapter 7 of the Bankruptcy Code.\nIn his bankruptcy schedules, the Debtor/Appellant disclosed the existence of these\ntransfers, which had taken place within one year of the bankruptcy filing. In April 1987, the\nAppellee filed an adversary proceeding seeking to deny the Debtor discharge under section\n727(a)(2)(A) of the Code.\nThe matter was tried in December 1987. The bankruptcy court found that the transfer of\nproperty of the Debtor to his wife was made with the intent to hinder, delay or defraud a creditor\nas proscribed by section 727(a)(2)(A), notwithstanding retransfer of the property completed the\nday before the petition was filed.\nThe Debtor contended that discharge should not be denied under section 727(a)(2)(A),\nsince the transfer in question did not in fact diminish the assets available to creditors. In a\nsubsequent memorandum opinion, the bankruptcy court rejected this argument, and denied the\nDebtor a discharge.\nIn his appeal to this court, the Debtor identifies two issues. First, the Debtor argues the\ndistrict court erred in affirming the denial of discharge in light of the fact that the Debtor\'s transfer\nof property to his wife did not in fact reduce the assets available to creditors. We disagree in light\nof Future Time [where the court] reasoned:\nWhen appellant transferred his interest in the residence to his wife,\nhe obviously intended to shield what he thought was valuable\nproperty from the claims of his creditors. To hold now that there\noccurred no transfer of property with the intent to hinder creditors\nmerely because the debts on the residence exceeded its estimated\n298\n\n\x0cfair market value would be to reward appellant for his wrongdoing,\nwhich the court refuses to do.\nThe Debtor next argues the district court erred in affirming the denial of the Debtor\ndischarge under section 727(a)(2)(A) since the property fraudulently conveyed to his wife was\nrecovered prior to his filing bankruptcy. The Debtor relies principally on In re Adeeb, 787 F.2d\n1339 (9th Cir. 1986), for the proposition that, as used in section 727(a)(2)(A), the word\n"transferred" should be read to mean "transferred and remained transferred" at the time a debtor\nfiles his bankruptcy petition. Despite the clear, unambiguous language used in the statute, the\nAdeeb court reasoned that its reading of "transferred" was "most consistent with the legislative\npurpose of the section." The court wrote that such a reading would "encourage honest debtors to\nrecover property they have transferred during the year preceding bankruptcy" and serve to facilitate\n"the equitable distribution of assets among creditors by ensuring that the trustee has possession of\nall of the debtor\'s assets." The court added that this readily allowed the "honest debtor to undo his\nmistakes and receive his discharge." Finally, the court noted its reliance on the practical aspects of\nsuch a situation:\nIt is not uncommon for an uncounseled or poorly counseled debtor\nfaced with mounting debts and pressure from his creditors to attempt\nto protect his property by transferring it to others. Upon later\nreflection or upon obtaining advice from experienced bankruptcy\ncounsel, the debtor may realize that his original transfer of the\nproperty was a mistake. If the debtor is informed that his mistake\nbars him from a discharge in bankruptcy, he will have no incentive\nto attempt to recover the property or to reveal its existence to his\ncreditors. Rather, he will have a strong incentive to continue to hide\nhis assets.\nNormally, a court should interpret a statute in a manner consistent with the plain meaning\nof the language used in the statute. The statutory language of section 727(a)(2)(A) is plain and\nunambiguous. Congress certainly was capable of drafting a statute which would deny a discharge\nonly when assets were fraudulently transferred and remained transferred at the time of filing of\nbankruptcy proceedings, but it did not. We are a court and not a legislative body; therefore, we are\nnot free to create by interpretation an exception in a statute which is plain on its face. We therefore\nreject the approach initiated by the Ninth Circuit in Adeeb. We recognize that our holding may\nwork hardship in some cases, perhaps this one, but we are compelled to apply statutory law as\nenacted by Congress.\n\n11.4.1.2.\n\nIN RE BAJGAR, 104 F.3d 495 (1st Cir. 1997)\n\nBajgar and his wife jointly owned a vacant parcel of land in Port St. Lucie, Florida ("the\nFlorida property"). On November 10, 1993, Bajgar conveyed his interest in the land to his wife,\npurportedly as a belated engagement gift, delayed twenty-three years. In return, Bajgar received\n"love and affection." The conveyance was recorded on December 2, 1993. At the time of the\nconveyance, Bajgar faced a collection action and several foreclosures. He conceded at trial that\nthe transfer was fraudulent within the meaning of the Bankruptcy Code, admitting that the transfer\nwas completed with actual intent to hinder, delay, or defraud his creditors.\n299\n\n\x0cOn May 16, 1994, less than one year after the conveyance of the Florida property, Bajgar\nfiled a petition for relief under Chapter 7 of the Bankruptcy Code. In his petition, Bajgar disclosed\nthe fraudulent transfer by attaching a copy of the deed to the statement of affairs. At the mandatory\ncreditors meeting, Bajgar and his wife volunteered to reconvey the Florida property.\nOn August 19, 1994, Martin, one of Bajgar\'s creditors, filed a complaint [alleging] a\nviolation of 11 U.S.C. \xc2\xa7 727(a)(2)(A). On September 30, 1994, at Bajgar\'s request and on the\nadvice of counsel, Bajgar\'s wife reconveyed the Florida property to herself and Bajgar jointly by\nquitclaim deed. Bajgar\'s wife completed the retransfer more than four months after Bajgar filed\nhis voluntary bankruptcy petition, more than three months after the meeting with creditors, and\nmore than one month after Martin first objected to discharge.\nThe bankruptcy court (Hillman, J.) held that the conveyance of the Florida property did not\nconstitute grounds to deny Bajgar\'s discharge under Section 727(a)(2)(A). The district court\naffirmed.\nThis case presents this Circuit with an issue of first impression: whether an admittedly\nfraudulent transfer of a debtor\'s property within one year before the filing of a voluntary petition\nfor relief under Chapter 7 of the Bankruptcy Code is cured for purposes of dischargeability\npursuant to Section 727(a)(2)(A) by its re-transfer to the debtor after the debtor files his petition.\nWe hold that retransfer subsequent to filing a voluntary bankruptcy petition does not cure the\nfraudulent transfer, and, thus, does not avail the debtor discharge under Section 727.\nThe statutory language of Section 727(a)(2)(A) is sufficiently plain. The statute specifically\nauthorizes denial of discharge if the debtor "transferred" property within one year prior to the date\nof filing the bankruptcy petition; it does not qualify this provision with a clause to the effect that\ntransferred property must remain transferred. See 11 U.S.C. \xc2\xa7 727(a)(2)(A).\nWithout delving into the murky realm of legislative purpose and equitable principles, the\nEleventh Circuit, one of the two other courts of appeals to address this issue, reached the same\nconclusion we reach today. See Davis v. Davis, 911 F.2d 560 (11th Cir. 1990) (per curiam).\nAccording to the Eleventh Circuit, therefore, if a debtor fraudulently transfers property\nwithin one year before the filing of a bankruptcy petition, he will not receive a discharge.\nWhile the plain language of Section 727(a)(2)(A) and the applicable legislative history\npoint to the conclusion that, upon proper objection, any debtor who fraudulently transfers property\nwithin one year before the filing of a bankruptcy petition is not entitled to receive a discharge\npursuant to Section 727, irrespective of the timing of a reconveyance, this case presents us with a\ndebtor who reconveyed property several months subsequent to filing a voluntary bankruptcy\npetition. We need not decide now either the effect of a reconveyance made prior to the filing of a\nvoluntary bankruptcy petition or the question of a retransfer effected immediately following the\nfiling of an involuntary petition.\nBajgar seeks solace in a Ninth Circuit case, In re Adeeb, 787 F.2d 1339, 1344 (9th Cir.\n1986), which interpreted the term "transferred" to mean "transferred and remained transferred" in\nthe context of Section 727(a)(2)(A). Both the bankruptcy court and the district court found Adeeb\npersuasive in this case. We do not.\n[The Court reviews Adeeb]. Treating Adeeb as the subject of an involuntary petition\nbecause "[t]he involuntary petition in this case began the bankruptcy process," the court discharged\n300\n\n\x0cAdeeb. The court held that "a debtor who has disclosed his previous transfers to his creditors and\nis making a good faith effort to recover the property transferred at the time an involuntary\nbankruptcy petition is filed is entitled to a discharge of his debts if he is otherwise qualified."\nThe Adeeb court, however, enunciated a different rule with respect to a debtor who files\na voluntary bankruptcy petition: "[A] debtor who transfers property within one year of bankruptcy\nwith the intent penalized by section 727(a)(2)(A) may not be denied discharge of his debts if he\nreveals the transfers to his creditors, recovers substantially all of the property before he files\nhis bankruptcy petition, and is otherwise qualified for a discharge." As the Adeeb court\nexplained, this rule demanding recovery prior to the filing of a petition "assumes the filing of a\nvoluntary petition by the debtor. In that situation, the debtor controls the time of filing the petition.\nHe is therefore able to time the filing to allow recovery of substantially all of his property."\nEven were we to adopt Adeeb, its application to the instant case would result in denial of\ndischarge. Bajgar did not recover any of the transferred property until well after he filed his\nvoluntary bankruptcy petition. In the case of a voluntary bankruptcy petition, such as Bajgar filed,\nhowever, "[t]he Ninth Circuit requires actual reconveyance of the fraudulently transferred property\nbefore the bankruptcy filing."\nWe recognize that reading the term "transferred" to mean "transferred and remained\ntransferred," could be construed, in certain instances, to advance the "purpose of the Bankruptcy\nAct to [distribute] the assets of the bankrupt ... among creditors and then to relieve the honest\ndebtor from the weight of oppressive indebtedness and permit him to start afresh free from the\nobligations and responsibilities consequent upon business misfortunes. This purpose affords the\n"honest but unfortunate debtor who surrenders for distribution the property which he owns at the\ntime of bankruptcy, a new opportunity in life and a clear field for future effort, unhampered by the\npressure and discouragement of preexisting debt."\nIn this case, however, Bajgar did not reveal his initial fraudulent transfer until he filed his\nbankruptcy petition. In addition, Bajgar consulted with an experienced bankruptcy attorney at the\ntime he executed the initial fraudulent transfer. It was not until he faced the prospect of being\ndenied discharge pursuant to Section 727(a)(2)(A) that Bajgar actually reconveyed the property.\nWe are not presented with an "honest but unfortunate debtor" that the Bankruptcy Code\nenvisions as the deserving recipient of a fresh start. Denying Bajgar discharge actually comports\nwith the "purpose" of the Bankruptcy Act.\n\n11.5.\n\nExceptions to Discharge: 11 U.S.C. \xc2\xa7 523\n\nThe Bankruptcy Code after 2005 contains 19 kinds of debts that are excepted from\ndischarge. These debts can then be divided into automatically non-dischargeable debts that simply\npass through bankruptcy unimpaired by the debtor\xe2\x80\x99s discharge, and debts that will be discharged\nunless the creditor timely files a complaint to determine that the debt is not dischargeable and\nultimately obtains a non-dischargeability determination from the Bankruptcy Court. For those\ndebts that are dischargeable unless the creditor obtains a non-dischargeability determination, the\ncreditor must file a non-dischargeability complaint within 60 days after the first date set for the\nSection 341 meeting of creditors. See 11 U.S.C. \xc2\xa7 523(c); Bankruptcy Rule 4007(c).\n301\n\n\x0c11.5.1.1.\n\nAutomatically Non-Dischargeable Debts\n\nTaxes \xe2\x80\x93 11 U.S.C. \xc2\xa7 523(a)(1).\nBy far the most complex exception to non-dischargeability is for taxes owed to a\ngovernmental unit (federal, state or local). The exception starts with those taxes that are entitled to\npriority under Section 507(a)(8) of the Bankruptcy Code. 11 U.S.C. \xc2\xa7 523(a)(1)(A). This part of\nthe rule makes non-dischargeable income taxes for which a return was first due within 3 years\nbefore the bankruptcy filing (3 Year Look-back Rule), or were assessed within 240 day (plus\ntolling period) before bankruptcy (240 Day Assessment Rule), or were not assessed before but are\nassessable after bankruptcy (Post-Petition Assessability Rule). 11 U.S.C. \xc2\xa7 507(a)(8)(A). The rule\nalso incorporates the complete denial of discharge for withholding taxes (\xc2\xa7 507(a)(8)(C)), the one\nyear rule for property taxes (\xc2\xa7 507(a)(8)(B), and a 3 year look-back rule for employment and excise\ntaxes (\xc2\xa7 507(a)(8)(D) and (E).\nBut even debtors who are able to jump over the priority hurdles do not necessarily pass the\ntax discharge test. Most importantly, taxes for which a return was due and not filed by the date\nof bankruptcy are not dischargeable under any circumstances, nor are any taxes if the debtor filed\na fraudulent return, or willfully attempted to evade or defeat such taxes. 11 U.S.C. \xc2\xa7\n523(a)(1)(B)(i), (a)(1)(C).\nThis leaves taxes owing on late filed returns, an area of particular complexity and\nconfusing court decisions. First, the statute boldly and clearly states that taxes owing on late returns\nfiled more than two (2) years before bankruptcy are eligible for discharge. 11 U.S.C. \xc2\xa7\n523(a)(1)(B)(ii). Nevertheless, courts have generally denied discharge for late returns if the IRS\nhad taken action against a non-filing debtor to collect taxes before the filing of the late return. See\ndiscussion in In re Moroney, 352 F.3d 902, 905-06 (4th Cir. 2003).\nMore recently, several courts have read flush language added in 2005 after Section\n523(a)(19) to all but bar the discharge of taxes owing under a late filed return \xe2\x80\x93 even one filed one\nday late. The added language defines a \xe2\x80\x9creturn\xe2\x80\x9d as one filed in compliance with non-bankruptcy\nlaw \xe2\x80\x9cincluding applicable filing requirements.\xe2\x80\x9d One of the cases reprinted below interprets this\napparently innocent definition to virtually eliminate the ability to discharge taxes owing on late\nfiled returns, despite the main statute\xe2\x80\x99s clear two year rule.\nUnscheduled Debts \xe2\x80\x93 11 U.S.C. \xc2\xa7 523(a)(3).\nDebts of known creditors that are not scheduled by the debtor in time for the creditor to\nfile a proof of claim or object to discharge are not discharged. However, these rules are not applied\nto creditors who receive actual knowledge of the bankruptcy case in time to file a claim or object\nto discharge. Furthermore, the majority of courts have held that the claims of omitted creditors are\ndischarged in no asset cases, where the creditor was not harmed by the lack of notice. See e.g. In\nre Anderson, 72 B.R. 783, 787 (Bankr. D. Minn. 1987) (adopting \xe2\x80\x9cno harm no foul\xe2\x80\x9d approach); In\nre Beezley, 994 F.2d 1433 (9th Cir. 1993); Stone v. Caplan, 10 F.3d 285 (5th Cir. 1994); Judd v.\nWolfe, 78 F.3d 110 (3d Cir. 1996); In re Madaj, 149 F.3d 467 (6th Cir. 1998); In re Tucker, 143\nB.R. 330 (Bankr. W.D.N.Y. 1992).\nA minority of courts have held that unscheduled debts are not discharged even in no asset\ncases. See In re Stark, 717 F.2d 322 (7th Cir. 1983) (decision on whether to discharge omitted\n302\n\n\x0ccreditor based on equitable considerations); Colonial Surety v. Weitzman, 564 F.3d 526 (1st Cir.\n2009) (holding unscheduled debts excepted to discharge even in no asset cases).\nFamily Law Claims \xe2\x80\x93 11 U.S.C. \xc2\xa7\xc2\xa7 523(a)(5), (a)(15).\nPrior to 2005, the Court made a distinction between claims \xe2\x80\x9cin the nature of alimony,\nmaintenance or support,\xe2\x80\x9d and claims in the nature of a property division: the former were not\ndischargeable, while the latter were. Because federal law governs the determination of whether a\nclaim agreed to as part of a separation or divorce agreement, or awarded by a court in connection\nwith a divorce, was \xe2\x80\x9cin the nature of alimony, maintenance or support,\xe2\x80\x9d the language used in the\nagreement or order is relevant but not determinative.\nWith the addition of Section 523(a)(15) in 2005, property settlements are now also nondischargeable in Chapter 7. However, Congress did not add a cross reference to (a)(15) in the\nChapter 13 discharge provisions. See 11 U.S.C. \xc2\xa7\xc2\xa7 1328(a)(2). Therefore, the distinction between\nsupport and non-support remains relevant in Chapter 13 cases.\nGovernment Fines and Penalties \xe2\x80\x93 11 U.S.C. \xc2\xa7 523(a)(7).\nFines and penalties not in compensation for actual pecuniary loss are excepted from\ndischarge. This commonly covers things like parking tickets and traffic tickets.\nStudent Loans and Debts \xe2\x80\x93 11 U.S.C. \xc2\xa7 523(a)(8).\nStudent loans and debts are automatically non-dischargeable, unless the debtor obtains an\n\xe2\x80\x9cundue hardship\xe2\x80\x9d determination from the Court. There are two competing standards for undue\nhardship, both focusing primarily on the possibility (or probability) of the debtor being able to pay\nin the future. The major decisions are attached below. The Court of Appeals for the Seventh Circuit\nheld in In re Roberson, 999 F.2d 1132 (7th Cir. 1993), that dischargeability requires a \xe2\x80\x9ccertainty of\nhopelessness.\xe2\x80\x9d More recent courts have been a bit more liberal. Still, as a general rule, healthy\nyoung debtors cannot discharge student loans or debts.\nThe definition of a \xe2\x80\x9cStudent Loan\xe2\x80\x9d or debt is very broad. It covers both federal and state\ninsured student loans, as well as private student loans and obligations to repay educational benefits,\nscholarships or stipends.\nDrunk Driving. 11 U.S.C. \xc2\xa7 523(a)(9).\nA debtor who causes death or personal injury by driving a vehicle while intoxicated\n(alcohol or drugs beyond the legal limit) cannot discharge the debt. Property damage caused by\ndrunk driving remains dischargeable.\nFederal Criminal Restitution. 11 U.S.C. \xc2\xa7 523(a)(13).\nThe Supreme Court held that criminal restitution, even though owing to private parties and\npartially compensatory, is flatly non-dischargeable. Kelly v. Robinson, 479 U.S. 36 (1986).\n\n11.5.1.2.\nDebts Non-Dischargeable Only On Timely Request of\nthe Creditor\nSection 523(c) provides that the exceptions to discharge in Section 523(a)(2), (4) and (6)\nonly apply if the creditors timely requests a non-dischargeability determination \xe2\x80\x93 otherwise the\n303\n\n\x0cdebts will be discharged. Bankruptcy Rule 4007(c) requires the creditor to file a complaint\nobjecting to the dischargeability of a debt within 60 days after the first date set for the meeting of\ncreditors under Section 341. These rules apply to the following grounds for non-dischargeability:\nFraud. 11 U.S.C. \xc2\xa7 523(a)(2).\nThe fraud exception covers two types of fraudulent conduct: financial condition fraud, and\nnon-financial condition fraud. Misrepresentations of financial condition are only excepted from\ndischarge if (1) in writing, (2) materially false, and (3) relied on by the creditor. Other kinds of\nfraudulent conduct need not be in writing, although materiality and reliance generally must be\nshown under non-bankruptcy law to establish any kind of fraud. Section 523(a)(2)(C) presumes\nfraud in two kinds of transactions incurred a short time before bankruptcy:\n(1) Debts for luxury goods (not reasonably necessary for support) exceeding $600 to a\nsingle creditor within 90 days of bankruptcy;\n(2) Debts for cash advances exceeding $875 within 70 days of bankruptcy.\nEven outside the presumption, debtors who run up debts in anticipation of discharging the\ndebts in bankruptcy (known as \xe2\x80\x9cloading up\xe2\x80\x9d) have committed fraud and may face dischargeability\ncomplaints.\nFiduciary Fraud. 11 U.S.C. \xc2\xa7 523(a)(4).\nDebts for embezzlement, larceny and other defalcations by a fiduciary are not\ndischargeable. The issue in these cases often turns on whether the money was obtained with\nconsent (a loan) or was obtained without consent (stolen). The Supreme Court\xe2\x80\x99s recent opinion on\nthe requirements for fiduciary fraud are reprinted below.\nWillful and Malicious Injury to Persons or Property. 11 U.S.C. \xc2\xa7 523(a)(6).\nAnother recent opinion, reprinted below, requires the creditor to meet a high standard of\nproof in establishing maliciousness.\n\n11.6.\n\nCases on Exceptions to Discharge\n11.6.1.1.\nFAHEY v. MASS. DEP\xe2\x80\x99T OF REVENUE, 2015 BL\n41157 (1st Cir. 2015)\n\nThe four bankruptcy appeals before us pose a single question of statutory interpretation:\nwhether a Massachusetts state income tax return filed after the date by which Massachusetts\nrequires such returns to be filed constitutes a \xe2\x80\x9creturn\xe2\x80\x9d under 11 U.S.C. \xc2\xa7 523(a) such that unpaid\ntaxes due under the return can be discharged in bankruptcy. For the reasons set forth below, we\nconclude that it does not.\nThe facts in each of the four cases now on appeal are undisputed. John Brown, Brian Fahey,\nAnthony Gonzalez, and Timothy Perkins (the \xe2\x80\x9cdebtors\xe2\x80\x9d) all failed to timely file their\nMassachusetts income tax returns for multiple years in a row. This failure would not be a problem\nfor them in these bankruptcy proceedings, but for the fact that they also failed to pay (either timely\nor otherwise) their taxes to the Massachusetts Department of Revenue. Eventually, each debtor\n304\n\n\x0cfiled his late tax returns, but still failed to pay all taxes, interest, and penalties that were due. More\nthan two years later, they filed for Chapter 7 bankruptcy. The debtors seek a ruling that their\nobligation to pay the taxes they failed to pay is dischargeable. The Department argues for the\nopposite result; it contends unpaid taxes for which no return was timely filed by the\nCommonwealth\'s statutory deadline fit within an exception to discharge under 11 U.S.C. \xc2\xa7\n523(a)(1)(B)(i).\n[Under 11 U.S.C. \xc2\xa7 523(a)(1)] a tax is not dischargeable if the debtor failed to file a return,\nor if\xe2\x80\x94perhaps anticipating bankruptcy\xe2\x80\x94he filed the return late and within two years of his\nbankruptcy petition. Looking solely at the foregoing language, and using a common notion of what\na \xe2\x80\x9creturn\xe2\x80\x9d is, one could easily conclude that any return filed after the due date but more than two\nyears before a bankruptcy filing would place the tax due under that return outside the section\n523(a)(1) exception, and thus within the broad category of dischargeable debts. Prior to 2005,\ncourts nevertheless attempted to fashion a definition of \xe2\x80\x9creturn\xe2\x80\x9d that prevented debtors from\nrelying on \xe2\x80\x9cbad faith\xe2\x80\x9d returns, or returns filed only after the taxing authority actually issued an\nassessment for taxes due in the absence of a tax return. See generally Moroney v. United States (In\nre Moroney), 352 F.3d 902, 905-06 (4th Cir. 2003) (providing examples of courts that determined\nlate tax returns \xe2\x80\x9cfiled after an involuntary assessment do not serve the purposes of the tax system,\nand thus rarely, if ever, qualify as honest and reasonable attempts to comply with the tax laws\xe2\x80\x9d).\nIn 2005, Congress decided to define \xe2\x80\x9creturn\xe2\x80\x9d on its own when it passed the Bankruptcy\nAbuse Prevention and Consumer Protection Act (\xe2\x80\x9cBAPCPA\xe2\x80\x9d), making numerous revisions to\nsection 523. Among the BAPCPA\'s changes was the insertion of a \xe2\x80\x9changing paragraph,\xe2\x80\x9d denoted\nas section 523(a)(*), at the end of section 523(a). It provides:\nFor purposes of this subsection, the term \xe2\x80\x9creturn\xe2\x80\x9d means a return\nthat satisfies the requirements of applicable nonbankruptcy law\n(including applicable filing requirements). Such term includes a\nreturn prepared pursuant to section 6020(a) of the Internal Revenue\nCode of 1986, or similar State or local law, or a written stipulation\nto a judgment or a final order entered by a nonbankruptcy tribunal,\nbut does not include a return made pursuant to section 6020(b) of\nthe Internal Revenue Code of 1986, or a similar State or local law.\nSection 6020(a) returns are allowed only at the I.R.S.\xe2\x80\x99s request and require the taxpayer\'s\ncooperation, while returns filed under section 6020(b) do not involve assistance by the taxpayer\nand may involve willful fraud.\nSo the question now presented is a question of statutory interpretation: Is a Massachusetts\ntax return filed after the due date for such returns a \xe2\x80\x9creturn\xe2\x80\x9d as defined in section 523(a) so that\nthe tax due under that return remains dischargeable\nRead together, the hanging paragraph\'s definitional language and the \xe2\x80\x9capplicable\xe2\x80\x9d\nMassachusetts law control our decision. Under the hanging paragraph, for a document, whatever\nit may be called, to be a \xe2\x80\x9creturn,\xe2\x80\x9d it must \xe2\x80\x9csatisf[y] the requirements of applicable nonbankruptcy\nlaw (including applicable filing requirements).\xe2\x80\x9d So the question is whether timely filing is a \xe2\x80\x9cfiling\nrequirement\xe2\x80\x9d under Massachusetts law. The answer is plainly yes.\nThe two other circuits to have decided this issue, albeit construing other jurisdictions\xe2\x80\x99\n\xe2\x80\x9capplicable\xe2\x80\x9d filing deadlines, reached the same conclusion. The Tenth Circuit recently found\n305\n\n\x0creturns filed late under the Internal Revenue Code not to be returns within the meaning of the\nhanging paragraph. Mallo v. Internal Revenue Service, 2014 WL 7360130, at *6 [774 F.3d 1313]\n(10th Cir. 2014) (explaining, in reference to the I.R.C.\xe2\x80\x99s deadline for income tax returns, that \xe2\x80\x9cthe\nphrase \xe2\x80\x98shall be filed on or before\xe2\x80\x99 a particular date is a classic example of something that must be\ndone with respect to filing a tax return and therefore, is an \xe2\x80\x98applicable filing requirement\xe2\x80\x99\xe2\x80\x9d).\nSimilarly, the Fifth Circuit determined that a debtor\'s failure to comply with a Mississippi law\nstating that returns \xe2\x80\x9cshall be filed on or before April 15th\xe2\x80\x9d meant that the returns did not satisfy\napplicable filing requirements under the hanging paragraph\'s definition. In re McCoy, 666 F.3d\n924, 928, 932 (5th Cir. 2012). And at least one other circuit court judge, in dictum, predicted such\na result. In re Payne, 431 F.3d 1055, 1060 (7th Cir. 2005) (Easterbrook, J., dissenting) (\xe2\x80\x9cAfter the\n2005 legislation, an untimely return cannot lead to a discharge\xe2\x80\x94recall that the new language refers\nto \xe2\x80\x98applicable nonbankruptcy law (including applicable filing requirements).\xe2\x80\x99\xe2\x80\x9d).\nThe debtors nevertheless argue that the hanging paragraph\'s language is not quite so clear\nas to dictate our holding. Perhaps the term \xe2\x80\x9capplicable filing requirement\xe2\x80\x9d may acquire vagueness\nat the outer boundaries of its possible application. For example, is an instruction on an official\nform that the filer not staple the return together, or staple the check to the return, an \xe2\x80\x9capplicable\nfiling requirement\xe2\x80\x9d? However one might answer that question, we do not see how there is any\nroom for reasonable argument that, as a matter of plain language, a Massachusetts law setting the\ndate when a tax return \xe2\x80\x9cis required to be filed\xe2\x80\x9d is somehow not a \xe2\x80\x9cfiling requirement.\xe2\x80\x9d\nWidening the scope slightly, debtors point to the language of section 523(a)(1)(B)(ii) (\xe2\x80\x9cthe\ntwo-year provision\xe2\x80\x9d), which clearly implies that there can be a \xe2\x80\x9creturn\xe2\x80\x9d that is filed within two\nyears \xe2\x80\x9cafter the date on which such return\xe2\x80\xa6 was last due.\xe2\x80\x9d So the hanging paragraph cannot be\nread as entirely excluding the possibility that a late return can also be a \xe2\x80\x9creturn.\xe2\x80\x9d Grasping onto\nthis point, the debtors contend (and the BAP agreed) that our interpretation would \xe2\x80\x9cvitiat[e] in its\nentirety\xe2\x80\x9d the two-year provision, rendering it \xe2\x80\x9csuperfluous.\xe2\x80\x9d\nThe defect in this argument is that the hanging paragraph itself carves out an exception\nfrom its general rule, deeming one type of late return to be a return. It specifies that \xe2\x80\x9ca return\nprepared pursuant to section 6020(a)\xe2\x80\xa6 or similar State or local law\xe2\x80\x9d qualifies as a \xe2\x80\x9creturn,\xe2\x80\x9d while\nthose prepared pursuant to section 6020(b) do not. Section 6020(a) and (b) can both be invoked\nwhen a taxpayer \xe2\x80\x9cfails to make\xe2\x80\x9d a proper return, including situations where the taxpayer is late in\nfiling a return to the I.R.S. Therefore, a late tax return, if prepared in compliance with section\n6020(a) and filed within two years of the bankruptcy petition, is still a return (and the tax due thus\ndischargeable), notwithstanding its failure to meet the otherwise \xe2\x80\x9capplicable filing requirement\xe2\x80\x9d\nof a mandatory deadline. While section 6020(a) may only apply in a small minority of cases, the\nfact that a late filed section 6020(a) return can still qualify as a \xe2\x80\x9creturn\xe2\x80\x9d for section 523(a) purposes\nmeans that the two-year provision still has a role to play if the hanging paragraph\'s plain meaning\ncontrols.\nThe I.R.S.\xe2\x80\x99s Chief Counsel has referred to the number of section 6020(a) returns as\n\xe2\x80\x9cminute\xe2\x80\x9d and in 2010 took the position that the safe harbor created by it was \xe2\x80\x9cillusory\xe2\x80\x9d because\ntaxpayers have no right to demand a return under the provision. I.R.S. Chief Couns. Notice CC2010-016 at 2-3 (Sept. 2, 2010). We accept the claim that such returns are rare, and are allowed\nonly at the I.R.S.\xe2\x80\x99s behest. It hardly follows, though, that the safe harbor expressly created for such\nreturns is illusory. In fact, this \xe2\x80\x9cnarrow safe harbor,\xe2\x80\x9d was utilized by a debtor in a recent bankruptcy\n306\n\n\x0ccase where the bankruptcy court was bound by the reading of section 523(a)(*) that the Department\nurges here. See In re Kemendo, 516 B.R. 434, 438 (Bankr. S.D. Tex. 2014).\nBut, say the debtors, our reading of the hanging paragraph still renders unnecessary its last\nclause, stating that the term \xe2\x80\x9creturn\xe2\x80\x9d does not include \xe2\x80\x9ca return made pursuant to [section 6020(b)]\nor a similar State or local law.\xe2\x80\x9d The debtors are correct on this point. Nevertheless, we do not see\nthis as the type of redundancy that invokes any effective application of the doctrine that we try to\nread statutes so that no section is superfluous. Here, in context, it simply appears that in creating\nan exception for section 6020(a), the drafters made clear (desiring a belt and suspenders) that they\nwere not including its companion section 6020(b). Whatever one thinks of this redundancy, it\noffers too little to parry the force of the observation that a requirement to file on time is a filing\nrequirement.\nMoreover, were we to adopt the debtors\xe2\x80\x99 position that a law requiring compliance with a\nfiling deadline is not a filing requirement, we would be left without any textual basis for\ndistinguishing those filing requirements that count from those that do not. Instead\xe2\x80\x94and debtors\nand the dissent are frank about this\xe2\x80\x94we would be back to tinkering with subjective and conflicting\njudge-made rules. In that respect, we would render the principal thrust of the hanging paragraph\nto be largely of no effect. Of course, the debtors say that this is what Congress wanted, simply\nseeking to \xe2\x80\x9cconfirm\xe2\x80\x9d pre-existing case law. But there was no such uniform rule in the case law to\nwhich the language in the hanging paragraph could be read as referring.\nSensibly anticipating weak support in the statutory and regulatory language, the debtors\nrely with much emphasis on three other rules of statutory construction.\nFirst, they (and the amicus curiae) implore us to find instructive the notion that exceptions\nto discharge should be narrowly construed in the debtor\'s favor, and that the Bankruptcy Code\nshould be read in light of its purpose to provide a fresh start to the \xe2\x80\x9chonest but unfortunate debtor.\xe2\x80\x9d\nSecond, the debtors attempt to frame our interpretation\xe2\x80\x94 particularly with respect to the\nlimitations it imposes on the two-year provision\'s applicability\xe2\x80\x94as representing a significant\nchange to the pre-2005 Bankruptcy Code. Third, the debtors and amicus curiae call the result we\nreach here\xe2\x80\x94that all late filed returns in Massachusetts are not subject to discharge in bankruptcy\xe2\x80\x94\n\xe2\x80\x9cunfathomable\xe2\x80\x9d and its consequences \xe2\x80\x9cdraconian\xe2\x80\x9d and \xe2\x80\x9cabsurd.\xe2\x80\x9d\nOur response to the debtors\xe2\x80\x99 reliance on these rules of statutory construction is fourfold.\nFirst, and most importantly, where the question is whether a Massachusetts law setting a\ndate by which a tax return \xe2\x80\x9cis required to be filed\xe2\x80\x9d is a \xe2\x80\x9cfiling requirement\xe2\x80\x9d under Massachusetts\nlaw, we find little need\xe2\x80\x94or justification\xe2\x80\x94for turning to secondary principles of statutory\nconstruction. Second, while the result we reach may be unfavorable towards delinquent taxpayers\nwho are also bankrupt, there is hardly anything \xe2\x80\x9cunfathomable,\xe2\x80\x9d \xe2\x80\x9cdraconian,\xe2\x80\x9d or \xe2\x80\x9cabsurd\xe2\x80\x9d in the\nnotion that Congress might disfavor debtors who both fail to pay their taxes and also fail to timely\nfile the returns that would alert the taxing authority to the failure to pay. Finally, we acknowledge\nthat straightforward application of Congress\'s language changes presumed practice in some\nbankruptcy courts (including those that ruled for three of the debtors below). That being said, the\njudge-made law surrounding the meaning of a \xe2\x80\x9creturn\xe2\x80\x9d in section 523(a) was far from settled.\nFor the foregoing reasons, we affirm the district court\'s judgment in favor of the\nDepartment. Summary judgment shall be entered in favor of the Department for the tax years at\nissue because the debtors\xe2\x80\x99 tax liabilities were not discharged in bankruptcy as a matter of law.\n307\n\n\x0c11.6.1.2.\nBRUNNER v. NEW YORK STATE HIGHER EDUC.\nSERV. CORP., 831 F.2d 395 (2d Cir. 1987)\nMarie Brunner, pro se, appeals from a decision of the District Court which held that it was\nerror for the bankruptcy court to discharge her student loans based on "undue hardship," 46 B.R.\n752 (Bankr.D.C.N.Y.1985). We affirm.\nWhether not discharging Brunner\'s student loans would impose on her "undue hardship"\nunder 11 U.S.C. \xc2\xa7 523(a)(8)(B) requires a conclusion regarding the legal effect of the bankruptcy\ncourt\'s findings as to her circumstances.\n[T]here is very little appellate authority on the definition of "undue hardship" in the context\nof 11 U.S.C. \xc2\xa7 523(a)(8)(B). Based on legislative history and the decisions of other district and\nbankruptcy courts, the district court adopted a standard for "undue hardship" requiring a three-part\nshowing: (1) that the debtor cannot maintain, based on current income and expenses, a "minimal"\nstandard of living for herself and her dependents if forced to repay the loans; (2) that additional\ncircumstances exist indicating that this state of affairs is likely to persist for a significant portion\nof the repayment period of the student loans; and (3) that the debtor has made good faith efforts to\nrepay the loans. [W]e adopt this analysis.\nThe first part of this test has been applied frequently as the minimum necessary to establish\n"undue hardship." Requiring such a showing comports with common sense as well.\nThe further showing required by part two of the test is also reasonable in light of the clear\ncongressional intent exhibited in section 523(a)(8) to make the discharge of student loans more\ndifficult than that of other nonexcepted debt. Predicting future income is, as the district court noted,\nproblematic. Requiring evidence not only of current inability to pay but also of additional,\nexceptional circumstances, strongly suggestive of continuing inability to repay over an extended\nperiod of time, more reliably guarantees that the hardship presented is "undue."\nUnder the test proposed by the district court, Brunner has not established her eligibility for\na discharge of her student loans based on "undue hardship." The record demonstrates no\n"additional circumstances" indicating a likelihood that her current inability to find any work will\nextend for a significant portion of the loan repayment period. She is not disabled, nor elderly, and\nshe has \xe2\x80\x94 so far as the record discloses \xe2\x80\x94 no dependents. No evidence was presented indicating\na total foreclosure of job prospects in her area of training. In fact, at the time of the hearing, only\nten months had elapsed since Brunner\'s graduation from her Master\'s program. Finally, as noted\nby the district court, Brunner filed for the discharge within a month of the date the first payment\nof her loans came due. Moreover, she did so without first requesting a deferment of payment, a\nless drastic remedy available to those unable to pay because of prolonged unemployment. Such\nconduct does not evidence a good faith attempt to repay her student loans.\nJudgment affirmed.\n\n308\n\n\x0c11.6.1.3.\nELLINGSWORTH v. AT&T UNIVERSAL CARD\nSERV., 212 B.R. 326 (Bankr. W.D. Mo. 1997)\nMs. Ellingsworth and her husband filed their joint bankruptcy petition on November 25,\n1996. According to their bankruptcy schedules Ms. Ellingsworth was indebted to AT&T Universal\nCard Services (UCS) for the sum of $4,038.11 at the time of filing. UCS issued a pre-approved\ncredit card to Ms. Ellingsworth on October 19, 1995, with a credit limit of $4,000. Ms.\nEllingsworth did not use the card from the time it was issued until September 11, 1996. Between\nSeptember 11, 1996, and October 15, 1996, she took 16 cash advances totaling $3,411, and she\nmade 8 purchases totaling $500.91. She made no payments to UCS before she and her husband\nfiled their bankruptcy petition. Ten cash advances, totaling $2,058, excluding finance charges,\nwere taken within 60 days of the bankruptcy filing. According to Mr. and Mrs. Ellingsworth\'s\nbankruptcy schedules, they had a total of $70,445 in unsecured debt at the time of filing. The vast\nmajority of that debt is from 18 different credit cards.\n[UCS filed a complaint claiming that the debt was non-dischargeable for fraud under\nSection 523(a)(2) of the Bankruptcy Code]. A trial was held on July 28, 1997. At the trial Ms.\nEllingsworth testified that she is employed as a special education teacher, and has been so\nemployed for 18 years. Her net monthly income is $2,111.48. She stated that she and Mr.\nEllingsworth began to depend on their credit cards to make ends meet six years ago, prior to the\nbirth of their third child. They had always been able to make the minimum payments on the credit\ncard accounts, but eventually they began to max-out one card and shift to another. She claims they\nalways believed they would be able to get out of debt, and they had never contemplated\nbankruptcy. They believed Mr. Ellingsworth was being groomed for a job promotion, but in\nAugust of 1996 he was demoted from a buyer to an assistant manager. While his salary declined\nby approximately $200 a month, the real decrease was in benefits. The company had supplied him\nwith a car, insurance, and a gas allowance when he was a buyer. There was also the potential for\na bonus each year as a buyer. As an assistant manager, Mr. Ellingsworth had to provide his own\ntransportation necessitating the purchase of an automobile. His net monthly income is $1,186.69.\nThe Ellingsworths apparently began to use the UCS credit card when they encountered\nthese additional expenses. Ms. Ellingsworth also testified that the cash advances she made with\nthe credit card were to pay for food, medicines, and clothing. She referred to medical expenses for\nthree children, but she admitted she had health insurance, and offered no documentation for money\nshe claimed was paid for doctor\'s visits and medications. She said that at the time she began using\nthe UCS card all of her other credit cards were at their limit. She also said that on October 15,\n1996, after the last cash advance, she stopped using the card and made an appointment with Credit\nCounseling Services in order to develop a plan to get out of debt. I note that she was over her credit\nlimit on the UCS card at the time she claims she voluntarily stopped using it. She stated that until\nshe and Mr. Ellingsworth met with a counselor at Credit Counseling Services she had never\ncontemplated filing for bankruptcy. They only filed their petition when they were told that they\nwere in too much debt to benefit from counseling.\nDon Carter, an employee, testified on behalf of UCS. He admitted that UCS contacted Ms.\nEllingsworth in 1995 and informed her that she had been pre-approved for a card. She responded\nby telephone and was sent a credit card and a Universal Bank Credit Agreement (the Agreement).\nShe never filled out an application for the card. Apparently she only verified by phone her income\n309\n\n\x0cand employment. She was not asked about other liabilities. According to her bankruptcy schedules\nand the credit bureau report admitted at the trial, Ms. Ellingsworth and her husband already\npossessed at least 16 credit cards when she was offered the UCS card. Mr. Carter stated that UCS\npre-approved Ms. Ellingsworth for its card based upon a credit score it obtained from a credit\nbureau. He stated that UCS obtained a Fair, Issacs Credit Bureau Score (a FICO score) of 759 on\nMs. Ellingsworth prior to issuing her the card, and that any score above 680 merits consideration\nfor a pre-approved card. He stated that UCS has developed some internal indicators that it uses in\naddition to the FICO score, but he was not certain of how the internal analysis is performed. And,\nother than the FICO score and the information provided by the customer as to her income and\nemployment, it appears UCS had no other information available to it prior to issuing the card.\nAccording to Mr. Carter, once a card is issued to a customer, it is UCS policy to obtain a FICO\nscore not less than every quarter, and to consider raising or lowering the credit limit or revoking\nthe card, based on any changes. He said full credit bureau reports are not obtained prior to issuing\ncards because analyzing the credit bureau report itself would be too time consuming.\nMr. Carter testified that a full credit bureau report was generated on Ms. Ellingsworth on\nJuly 2, 1997, in preparation for this trial. That report showed her various obligations in detail. A\ncasual reading of the report indicates that Ms. Ellingsworth is insolvent and unable to meet her\nobligations. UCS did not present any evidence that a quarterly credit score had been obtained on\nMs. Ellingsworth between October of 1995, when she received the card, and July 2, 1997, when\nthe credit bureau report was obtained.\nUCS claims that Ms. Ellingsworth represented with each purchase and cash advance that\nshe had the ability and the intent to repay her obligation to UCS. It also claims that any cash\nadvances she took within 60 days of the bankruptcy filing aggregating more than $1,000 are\npresumed nondischargeable.\nThe dischargeability of credit card debt is but one small piece in the puzzle that represents\nunsecured lending today because the use of credit cards is, in fact, a form of unsecured lending.\nThe following scenario illustrates this point. Assume you are a loan officer for a large metropolitan\nbank. A woman walks in one day and says she wants to borrow $60,000 on her signature. She\nwillingly fills out a financial statement which shows that she already has $300,000 in unsecured\ndebt, but she needs these additional funds for a business trip. She also shows one asset, a heavily\nencumbered apartment building that is being foreclosed. Of course, she promises to repay the loan\nif one is made to her. Would a bank that makes such a loan be found to have justifiably relied on\nher promise? Of course not.\nBut, what if, instead, the bank made the loan without bothering to ask her basic information\nabout assets, liabilities, and income? And what if she did not make an express promise to repay\nthe loan? Should this bank be allowed to claim that it justifiably relied on her implied promises to\npay? One would think not. However, those are the very facts of a recent bankruptcy opinion, except\nthat rather than a face to face encounter with a bank officer, the debt was incurred through use of\na credit card. In In re Hashemi, [104 F.3d 1122 (9th Cir. 1996),] the debtor used his American\nExpress Card to run up over $60,000 in debt while vacationing in France with his family. Dr.\nHashemi then came home and filed for bankruptcy protection. The Ninth Circuit held that the debt\nwas nondischargeable. The opinion pays scant attention to whether American Express acted\njustifiably in relying on debtor\'s promise to pay, whether express or implied. The Court found only\nthat when Dr. Hashemi began his spending spree his account balance was $227.00, and that he had\n310\n\n\x0coften repaid balances in excess of $60,000 in the past. Nonetheless, surely if American Express\nhad been aware of Dr. Hashemi\'s current situation, it would not have extended the credit. And, if\nit was not aware that Dr. Hashemi was insolvent, then it should have taken some steps to find out\nbefore extending such a large amount of credit. If no lender would have made that loan in a face\nto face transaction, why are American Express\' unreasonable lending practices afforded special\nprotection under the Bankruptcy Code? Is there something in the Bankruptcy Code that treats\ncredit card loans differently from face to face loans?\nCongress has created certain presumptions of nondischargeability as to credit card debt. To\nthe extent those presumptions are applicable, a portion of Ms. Ellingsworth\'s debt is\nnondischargeable. However, to the extent there is not a presumption of nondischargeability, the\nconduct of UCS in making credit available to her is a significant factor, which renders that portion\nof her debt dischargeable.\nI begin with some background regarding the explosive growth of pre-approved credit cards.\nI then find that UCS cannot justifiably rely on any representation made by Ms. Ellingsworth when\nUCS issued a pre-approved card to her unless UCS first obtained information as to her assets,\nliabilities, income, and expenses, and periodically updated that information. However, I also find\nthat Ms. Ellingsworth did not intend to repay her obligation to UCS at the time she made the\ncharges and took cash advances on the card. Finally, I find that Congress did intend to treat credit\ncard cash advances differently from other credit card transactions if taken within the presumption\nperiod of 60 days prior to the bankruptcy filing. Therefore, to the extent any cash advances fall\nwithin the presumption period, I find that these debts are nondischargeable even though UCS did\nnot prove justifiable reliance. To the extent the charges and cash advances were taken outside the\npresumption period, the lack of justifiable reliance requires a finding of dischargeability.\nB. The Growth of Credit Card Use\nIn 1995 2.7 billion unrequested solicitations for credit cards were mailed to American\nconsumers. That amounts to about 17 offers per adult. The average card has a spending limit of\n$6,007, therefore, if a consumer accepted every offer, she would end up with a potential credit line\nof $102,119. And, while the industry average for charging off credit card debt is 6 percent, bank\nprofits have hit the highest levels in more than half a century, thanks primarily to the profits from\ncredit cards. The average household carries about $4,000 a month in card debt, a total of $367\nbillion, and banks earned approximately $35 billion in interest on this total in 1995.\nSince credit cards are so profitable, and the profits derive from having a very large customer\nbase, issuers such as UCS may choose to ignore the usual standards of credit worthiness.\nAdditionally, the creditors actively seek out undisciplined spenders who carry large unpaid\nbalances from month to month. They dangle large credit lines in front of these consumers, and\noffer come-ons like lower interest rates for the first few months, as well as pre-printed cash\nadvance checks. Some banks have even started to penalize consumers who pay their accounts in\nfull each month. In their eagerness to capture market share, banks spend little time gathering\nfinancial information about their potential credit card customers. Prior to a mass mailing, creditors\nsuch as UCS obtain lists from credit bureaus with the names of candidates and a "credit score" for\neach person on the list. These scores relate generally to past card use, whether the candidate pays\nthe minimum monthly balance on current cards, and whether there are any delinquencies or\n311\n\n\x0cbankruptcies on record. Car loans, medical bills, and mortgages are not included in the credit score,\nnor are income, job history, marital status, and assets.\nThe credit score, which can range from 450 to 850, is a supposedly scientific way of\nassessing the likelihood that a debtor will repay a loan. The computer credit model upon which\nmost lenders rely today was developed by Fair, Issacs, and Company in California. The score is\nbased on all credit-related data in a credit bureau report, but it is not a measure of a borrower\'s\nincome, assets, or bank accounts. Fair Issacs, which is the service that UCS uses, identifies credit\npatterns, each of which corresponds to the probability that a lender [ed-borrower?] will make\npayments. The items are updated monthly, so the scores will change with new information.\nBy Mr. Carter\'s own admission it is more efficient for UCS to rely on a credit score than\nto acquire specific information about a potential customer prior to offering that customer a credit\ncard. In other words, as long as you use a credit card instead of a financial statement to obtain an\nunsecured loan, you do not have to indicate any form of credit-worthiness, other than the fact that,\nuntil now, you have paid your bills on time. Unfortunately, this tactic guarantees that borrowers\nwho are encouraged to use credit cards until they acquire unsecured debt that far exceeds their\nincome will ultimately not be able to pay their bills on time.\nBanks use other techniques as well to encourage consumers to keep large balances on their\ncredit cards. For example, VISA and MASTERCARD issuer Citibank offer credit cards that give\na 2 percent interest rate break to customers who keep a balance of more than $2,500. UCS, the\nplaintiff here, rewards customers with bonus points if they carry a large balance. More disturbing,\ncredit card companies flood college campuses with sign-up tables to hook customers early in\nadulthood. It is not unusual for college students with no income at all to accumulate 10 to 15 cards\nwhile in college. Why do the credit card companies solicit college students who have no regular\njob, little income, and no credit history? Because market research indicates that consumers are\nlikely to hang onto the first credit card they obtain and use it long after graduation. Moreover, they\nwill make 77 percent of their monthly purchases with that card.\nWith this background, I turn now to how vast numbers of consumers are coping with such\neasy access to credit cards. Between April 1, 1996, and March 31, 1997, 830,921 consumers filed\nChapter 7 bankruptcy petitions asking for the discharge of a total of $30 billion dollars in debt. Of\nthat $30 billion dollars, $6 billion represented credit card debt.\nThe credit card issuers are lobbying Congress to tighten bankruptcy laws to deal with the\nmassive amount of debt that is discharged each year. This approach, however, will not address the\nunderlying problem. Credit card debt represents on average about 15 percent of a debtor\'s debt at\nthe time of the bankruptcy filing. But this is rarely recently-acquired debt in anticipation of the\nfiling. At least 25 percent of discharged debt is from consumers whose accounts had been current\njust prior to the filing.\nOne scholar has demonstrated that credit card operations are so much more profitable than\nother banking areas that lenders can relax their usual lending requirements, suffer a higher default\nrate, and still be money ahead. Which leads to the question in this case. Can UCS sustain its\nburden to prove that Ms. Ellingsworth misrepresented her intent to repay its debt, and that\nit justifiably relied on that representation?\n\n312\n\n\x0cC. Section 523(a)(2)(A)\nSection 523(a)(2)(A) of the Bankruptcy Code (the Code) excepts from discharge a debt for\n"false pretenses, a false representation, or actual fraud, other than a statement respecting the\ndebtor\'s or an insider\'s financial condition."\nThe United States Supreme Court recently held that section 523(a)(2)(A) encompasses\ncommon law misrepresentation or actual fraud. To prove actual or common law fraud, a creditor\nmust prove the following:\n(1) the debtor made a false representation;\n(2) at the time the representation was made the debtor knew it was false;\n(3) debtor subjectively intended to deceive the creditor at the time he made the\nrepresentation;\n(4) the creditor justifiably relied upon the representation; and\n(5) creditor was damaged.[39]\nWhile case law makes much of these five elements, most cases turn on whether debtor\'s\nuse of a credit card is an actual representation that she intends to repay the money borrowed,\nand whether the creditor justifiably relied on debtor\'s representation that she intended to repay.\nIt is rarely disputed that the debtor used the card, that the debt is being discharged because the\ndebtor cannot pay the debt, and that the creditor is harmed.\nIn making its determination, the Court must, therefore, make a factual analysis of both the\ndebtor and the creditor\'s conduct. In this case I will first look to Ms. Ellingsworth\'s conduct to\ndiscern her intent.\nIn the past, courts have held that a debtor makes an implied representation with each\nuse of a credit card that she has both the ability and intent to repay the debt. The implied\nrepresentation theory developed due to the unique nature of credit card transactions. Since a debtor\npresents a credit card to a third party merchant when making a purchase, not the issuer, Courts\nheld that there could be no direct representation or contemporaneous reliance with each use of the\ncard. Courts, therefore, held that with each use of the card, a debtor made an implied representation\nthat she had the ability and intent to repay the debt.\nWith the advent of electronic transmission of credit card transactions, creditors are now\ninstantly aware when a debtor uses its card. Therefore, debtors make an express representation to\nthe issuer each time they use the card that they intend to repay the debt.\nIt is not clear if debtors ever made a representation of an ability to repay. However, as was\nrecently pointed out by the Honorable Leif M. Clark, in the real world very few people who use\ncredit cards represent a present ability to pay. They are using a credit card instead of cash precisely\nbecause they do not have the present ability to pay. It is this condition that allows card issuers to\ncharge the interest and finance charges that make the credit card business so profitable. Judge\nClark noted, ironically, that "an ability to repay is inferred to protect an industry that purposefully\nsolicits customers who generally lack such ability.\xe2\x80\x9d\nA minority of Courts hold that the credit card company assumes the risk of nonpayment\nwith the use of the card, unless the issuer told the debtor to stop using its card. Both the assumption\n313\n\n\x0cof the risk theory and the implied representation theory were developed at a time when there was\na significant lag between the time the card was used and the transaction was actually recorded with\nthe issuer. Neither theory is as relevant today when most credit transactions are automatically\nrecorded electronically at the instant the card is used. The issuer has the technology to refuse to\naccept the transaction before the merchant completes the sale. In fact, most merchants today will\nnot complete the sale until they receive a code accepting the card. Likewise, if an issuer wishes to\nterminate the use of a card it can do so automatically. It does not have to inform the debtor to stop\nusing the card, and then wait for it to be mailed back. I, therefore, find that debtors make express\nrepresentation that they intend to repay the obligation each time they use a credit card.\nWith these fictional theories removed from the analysis, I must decide two things. Did Ms.\nEllingsworth falsely represent to UCS that she intended to repay her obligation to UCS at the time\nshe used the credit card, and did UCS justifiably rely on that representation.\nHere, the Ellingsworths filed their Chapter 7 petition within 75 days of using the credit\ncard for the first time. The majority of the cash advances were taken within 60 days of the filing.\nBetween September 11, 1996, and October 15, 1996, Ms. Ellingsworth made 16 cash advances\nand 8 purchases totaling approximately $4,000. According to the bankruptcy schedules, the debtors\nhad over $70,000 in unsecured debt at the time of filing. Ms. Ellingsworth testified that all of the\nother credit cards were "maxed out" when she began to use the UCS card, therefore, she and her\nhusband had at least $65,000 in debt when the charges were made. Ms. Ellingsworth testified that\nshe did not contact an attorney until she stopped using the UCS card. She did, however, state that\nshe realized on October 15, 1996, that they could not go on using credit cards to meet their\nexpenses, and that they needed credit counseling. She stated she and Mr. Ellingsworth made an\nappointment with Consumer Credit Counseling on October 18, 1996. The counselor at Consumer\nCredit Counseling told the debtors that they could not cut their expenses enough to service their\ndebt, and that they should consider filing bankruptcy. According to the worksheet prepared by\ndebtors and the counselor, debtors had net income of $4,180 and minimum living expenses of\n$3,383 leaving disposable income of $797. They needed $1465 a month to pay the minimum on\ntheir credit cards.\nMs. Ellingsworth testified that she voluntarily ceased using the UCS card before she went\nto credit counseling. I note, however, that she stopped using the card when she reached the credit\nlimit. I also note that Mr. Ellingsworth testified that he contacted Consumer Credit Counseling\nlong enough before their appointment to allow debtors to fill out all the financial information and\nreturn it to the counselor five days before their appointment. It appears, therefore, that debtors had\ndetermined they at least needed professional advice before they ceased using the UCS card.\nThey both insisted at trial that all of the charges were made for necessities. But, Ms.\nEllingsworth could not explain a charge in the amount of $63.46 at Dave\'s Guns in Pataskala, Ohio,\nnor could she explain a charge in the amount of $217.23 at Golf Discount Campbell in Springfield,\nMissouri. Ms. Ellingsworth attempted to explain the medical expenses she encounters with three\nchildren, but she again failed to document these expenses. She admitted that they have health\ninsurance that pays 80 percent of their health costs, and she did not refer to any specific illness that\naccounted for some of the funds she obtained with the UCS card.\nFinally, I note that the debtors are intelligent and articulate people. They were not\nconvincing when they said that, even though they had over $70,000 in unsecured debt, a second\n314\n\n\x0cmortgage on their home, and had been using credit cards for six years to make ends meet, they\ndidn\'t realize the extent of their financial difficulty until they went to client counseling. I especially\nnote that the charges on the UCS card were made over a very short period of time and debtors\nstopped using the card as soon as the limit was reached. I, therefore, find that when Ms.\nEllingsworth used the UCS card she knew that she would be unable to ever repay the debt, and\nshe, therefore, did not intend to repay the debt.\nA determination of intent, however, deals only with the debtor\'s conduct. I turn next to\nwhether UCS proved that it justifiably relied upon Ms. Ellingsworth\'s representation of her\nintent to repay. The Supreme Court attempted to distinguish reasonable and justifiable reliance:\nReliance may be justifiable even if it does not conform to the standard of a reasonable man. For\nexample, a creditor may justifiably rely on a debtor\'s statement that his house is free and clear of\nliens, without going to the recorder of deeds office to check for itself. On the other hand, a creditor\nis "required to use his senses, and cannot recover if he blindly relies upon a misrepresentation the\nfalsity of which would be patent to him if he had utilized his opportunity to make a cursory\nexamination or investigation." For example, the Supreme Court stated, if a seller represents that a\nhorse is sound when it is apparent that it has one eye, the buyer cannot be said to have justifiably\nrelied upon the representation. This clarification is not always apparent in the credit card context.\nThe Restatement (Second) of Torts does instruct, however, that "justification is a matter of the\nqualities and characteristics of a particular plaintiff, and the circumstances of a particular case,\nrather than of the application of a community standard of conduct in all cases."\nIt becomes clear that UCS had access to much of the same information that is now available\nto this Court. Credit card issuers have come to rely on these factors when determining whether to\nobject to the discharge of their debt after someone files for bankruptcy relief. Interestingly, rarely\ndo creditors consider these factors prior issuing a card. Mr. Carter testified that UCS relied solely\non these factors in determining whether to object to the discharge of Ms. Ellingsworth\'s debt. UCS,\ntherefore, did not attend the section 341 meeting and it did not conduct a 2004 examination prior\nto filing the adversary proceeding.\nCredit card issuers are very sophisticated creditors. They have instant electronic access\neach time a credit card is used now. They know the number of charges made in a given day, they\nknow the amount of those charges, and they know when a customer exceeds his credit limit. While\nthey do not know with each use whether a debtor is employed, the issuers could, and often choose\nnot to, obtain updated information about debtor\'s employment status. Moreover, the issuers elect\nnot to obtain any other financial information, including assets and liabilities, about potential\ncustomers at the time a pre-approved card is issued. Often the reaction of a creditor at the time a\nuser exceeds the credit limit on his account is to increase the limit. Mr. Carter testified that on\nmany accounts, UCS grants a gap over the limit, ostensibly to prevent embarrassing a customer by\nrefusing to accept a charge if the limit has been exceeded. In First USA Bank v. Hunter, the Court\nnoted that First USA extended an invitation to Mr. Hunter to accept its Platinum Card one week\nbefore the trial was to begin on its Complaint objecting to the discharge of its debt in Mr. Hunter\'s\nbankruptcy case. I also note that, while UCS has not offered Ms. Ellingsworth another preapproved card, according to the Credit Bureau Report, she has obtained four new credit cards\nsince the bankruptcy filing.\n\n315\n\n\x0cThus, in order to determine if UCS justifiably relied on any representation of intent to repay\nMs. Ellingsworth made before UCS extended her credit, I must first focus on the common sense\nactions of UCS while considering the qualities and characteristics of this creditor.\nMs. Ellingsworth did not request UCS\'s credit card. UCS, with all of the sophisticated tools\nof the credit scoring industry at its disposal, made a calculated decision to offer Ms. Ellingsworth\nits credit card with a $4,000 limit. Mr. Carter testified that UCS does not pull a credit bureau report\non potential customers, because that would be too time consuming and costly. In other words, UCS\nnever required so much as a signature from Ms. Ellingsworth acknowledging that she accepted all\nof the terms contained in the Agreement. Moreover, the Agreement authorizes UCS or its\nsubsidiaries and affiliates "to make or have made any credit, employment, and investigative\ninquiries we deem appropriate related to this extension of credit, or the collection of amounts owed\non your account." And, in preparation for this dischargeability proceeding, UCS did authorize a\nfull Credit Bureau report.\nCredit card issuers are sophisticated lenders. They make their decisions to offer customers\ncredit cards not out of some altruistic notion of helping society, but because credit cards are very\nprofitable. They carefully solicit customers who are most likely to use their services in a manner\nthat increases those profits. They don\'t seek out or want customers who demonstrate an ability to\npay by paying their other accounts in full each month. Judge Clark noted in In re Hernandez that\none large credit card company makes $318 a year on the typical customer who carries a balance,\nwhile it loses $30 a year on customers who pay their monthly balance each month. A credit score\ndemonstrates a likelihood a debtor will not default. It is not based upon an analysis of one\'s assets,\nsecured liabilities, and living expenses. Mr. Carter admitted that credit scoring will not eliminate\npotential customers who are insolvent. In fact, Ms. Ellingsworth received a credit score, which\nwas acceptable to UCS, at a time when, according to her bankruptcy schedules, the credit bureau\nreport, and the information sheet from Consumer Client Counseling, her expenses exceeded her\nincome by at least $500.00 a month.\nCredit scoring reflects the practice of targeting individuals who use many credit cards and\npay the minimum amount each month, rather than paying off their balance. Mr. Carter testified\nthat a minimum payment on UCS\'s card is 2.1 percent of the outstanding balance each month.\nSurely UCS understands that customers with excess disposable income would not choose to make\nminimum payments leaving balances that incur interest in excess of 15 percent per annum.\nOffering this customer a pre-approved card, without making any individual inquiry into her\nfinancial status, is the equivalent of buying a horse with one eye. If the credit card issuers choose\nto continue this profitable technique to increase their customer base, they cannot claim that they\njustifiably relied upon any representation the customer made at the time the card was issued. In\nother words, a creditor cannot justifiably rely on any representation, or the absence thereof, made\nby a card holder if the card was pre-approved, and no direct financial information was obtained by\nthe issuer.\nMoreover, if UCS did not justifiably rely upon Ms. Ellingsworth\'s representations at the\ntime the card was issued, reliance cannot then attach when the card is used. I find, therefore, that\nthe credit in this case was extended to Ms. Ellingsworth without justifiable consideration of her\nability to repay. If UCS did not consider her ability to repay, it certainly cannot now claim that it\nrelied on her intent. Indeed, to hold otherwise only encourages creditors to continue to act\nirresponsibly. At the time debtor used the card, the only information UCS had obtained was\n316\n\n\x0cdebtor\'s credit score as of a year before, her income, and her employment. Thus, UCS made the\nloan to debtor without consideration of her assets, her secured debt, or her other living expenses.\nSurely a bank that made an unsecured loan to a customer without obtaining such basic information\ncould not be said to have justifiably relied on the debtor\'s representation that she intended to repay\nthe debt. The issue, then, is whether a credit card company is entitled to more favorable treatment\nthan a lender in a face to face transaction with a debtor. Which brings me to the presumption of\nnondischargeability in section 523(a)(2)(C).\nD. Section 523(a)(2)(C)\nSection 523(a)(2)(C) presumes the nondischargeability of cash advances exceeding a total\nof $1,000 taken within 60 days of filing:\nThe presumption is rebuttable. Congress adopted this provision to address what it\nconsidered an especially egregious form of behavior referred to as "loading up." Loading up is\ndefined as "going on a buying spree in contemplation of bankruptcy." The Court in In re Cox found\nthat the presumption in section 523(a)(2)(C) is the exclusive remedy against loading up. Only debt\nincurred within the 60 day period is subject to the presumption, but it can be rebutted if the debtor\ncan demonstrate that the debt was not incurred in anticipation of a bankruptcy discharge.\nFurthermore, "debts incurred for expenses reasonably necessary for support of the debtor and the\ndebtor\'s dependents" are not covered by the presumption.\nBefore discussing the issue of whether Ms. Ellingsworth and her husband successfully\nrebutted the presumption, I will discuss the effect of the presumption. The legislative history\nindicates that the presumption shifts the burden to the debtor to prove the dischargeability of a\ndebt, as opposed to the burden resting squarely on the creditor to prove the nondischageability of\na debt incurred outside the presumption period. This shift of the burden means "the reliance\nelement inherent in section 523(a)(2)(A) is not relevant in the context of subsection\n523(a)(2)(C)."Thus, if the debt is subject to the presumption, Congress has determined that it is\nthe debtor\'s intent alone, and not the creditor\'s conduct, which determines dischargeability.\nI note that Ms. Ellingsworth used her UCS card to make two purchases within 60 days of\nthe filing, but the aggregate sum of those purchases was $61.94. Further, UCS did not claim the\npurchases were for luxury items. I, therefore, find the purchases do not fall within the ambit of\nsection 523(a)(2)(C).\nThe cash advances, on the other hand, taken after September 25, 1996, total $2,058 (not\nincluding finance charges of $74.76),[91] and they, therefore, do represent debt that is presumed\nnondischargeable.\nIn attempting to rebut this presumption, Mr. and Mrs. Ellingsworth both testified that the\ncash advances were taken to pay reasonably necessary living and medical expenses for themselves\nand their three children. As discussed above, I have already found that Ms. Ellingsworth used her\nUCS card at a time when she could not have intended to repay the obligation.\nThe fact that the debt in this case resulted from cash advances also increases the sufficiency\nof the evidence necessary to rebut the presumption. [G]iven Congress\' obvious abhorrence of\n"loading up," and the difficulty of proving what cash was used for, Congress may have intended\ncash advances to be nondischargeable if taken within the presumption period, regardless of how\nthe money was used. I need not decide here whether the cash advance presumption can ever be\n317\n\n\x0crebutted, since Ms. Ellingsworth did not offer sufficient evidence tracing the funds acquired by\ncash advance to reasonable living expenses. And, even if she had, I have found that she incurred\nthe debt to UCS with the knowledge that she would not be able to repay it at some future time,\nand, therefore, with the intent not to repay.\nE. Attorney\'s Fees\nMr. Carter testified that the cost to UCS of collecting this debt to date is $1,937.50.\nIt is not disputed that Ms. Ellingsworth defaulted under the terms of the Agreement, and\nthat the Agreement provides for recovery of fees for any legal action. Therefore, any reasonable\nfees incurred in pursuing this adversary proceeding will be allowed. Ms. Ellingsworth did not\nobject to the reasonableness of UCS\'s fees, therefore, UCS is allowed its attorney\'s fees in the\namount of $1,937.50.\nIn sum, I find that the debt incurred for cash advances during the presumption period, in\nthe amount of $2,058 is nondischargeable. The remainder is dischargeable. I further find that UCS\nis entitled to its attorney\'s fees and costs of collection in the amount of $1,937.50.\n\n11.6.1.4.\nIN RE SHARPE, 351 B.R. 409 (Bankr. N.D. Tex.\n2006)\n[This] Adversary Complaint Objecting to Dischargeability of Debt [was] brought by Susan\nBaker. [It is] essentially a dispute between two parties, former friends, regarding various loans in\nthe aggregate sum of $150,000 made by Ms. Baker to Mr. Sharpe in 2005. It was the undisputed\ntestimony of the parties that Ms. Baker and Mr. Sharpe met sometime in December of 2004, shortly\nafter Ms. Baker\'s divorce had become final, and that they became fast friends. Both parties, in fact,\nagreed that at one point their relationship could be fairly characterized as that of "best friends."\nDuring the period of their friendship, Ms. Baker and Mr. Sharpe spent a large amount of time\ntogether and spoke to each other most every day on the telephone.\nMs. Baker is, generally, a sophisticated woman. She testified that she has a high school\ndegree, an undergraduate degree and a Master\'s degree. Ms. Baker had been married for 25 years\nupon her divorce and is the mother of three adult children. Her divorce from her one-and-only\nhusband left her in a comfortable financial position, although she testified that she never informed\nMr. Sharpe that she was well-off.\nMr. Sharpe\'s educational background was not defined at trial, but it is clear from his\ntestimony that he had been involved for some time in various types of business speculation. Mr.\nSharpe did testify on cross that, during the time frame in question, he had had drug and alcohol\nabuse problems and that he had not, as of the time of trial, been able to overcome such problems.\nDuring the first part of 2005, Ms. Baker made two loans to Mr. Sharpe evidenced by\npromissory notes, and made several other loans not so documented. All of such loans, the parties\nagree, aggregate to $150,000. The loans were made starting late 2004 through August or\nSeptember of 2005. Mr. Sharpe does not dispute that he took such loans and, in fact, scheduled\nMs. Baker as an unsecured creditor in the amount of $175,000 describing the nature of her debt as\na "personal loan." Ms. Baker is also listed on Mr. Sharpe\'s Schedule D as the holder of a purchase\nmoney security interest in the amount of $13,500 in a 2.87 carat diamond ring.\n318\n\n\x0cThere was also testimony that Mr. Sharpe had, for some months, been preparing to file for\nbankruptcy protection. Mr. Sharpe\'s former office assistant, Eileen Wolkowitz, testified that Mr.\nSharpe maintained a file into which bills were placed, which at her deposition she had referred to\nas a "bankruptcy file." She testified that Mr. Sharpe would instruct her not to pay certain bills as\nthey came due. Ms. Wolkowitz also testified that there were times when she wanted to pay bills,\nbut Mr. Sharpe would not let her. Ms. Wolkowitz testified that she and Mr. Sharpe did discuss the\npossibility that he might file for bankruptcy protection and further testified that the bankruptcy\nfiling seemed like an inevitability to her. But she also testified that Mr. Sharpe never said that he\nwas definitely going to file bankruptcy. An e-mail from Steve Smith to Mr. Sharpe, Plaintiffs\nExhibit 8, reflects that at least as of September 6, 2005, Mr. Sharpe had been planning to file\nbankruptcy.\nThe parties agree that Mr. Sharpe dressed expensively at the time the loans were made,\nwearing custom-made suits and designer label clothes and accessories, and that he continues to so\nclothe himself today. Mr. Sharpe characterized his manner of dress as "dressing for success." Ms.\nBaker testified that Mr. Sharpe\'s manner of dress led her to believe that he was a wealthy man. She\nalso testified that based upon his demeanor and appearance she thought he had money. Ms.\nWolkowitz also testified that Mr. Sharpe led a lifestyle that led her to believe that he was a\nsuccessful, wealthy person and that she believed Mr. Sharpe intended to lead people to believe that\nhe was a wealthy person. There was testimony that Mr. Sharpe utilized an American Express card,\nwhich had his name on it, but was to an account belonging to a Johnny Vaughn, a friend of Mr.\nSharpe, to make many extravagant purchases. Mr. Sharpe stipulated to the fact that high-dollar\ncharges reflected on an American Express bill, Plaintiffs Exhibit 7, were his charges.\nNext, Ms. Wolkowitz testified that, over the 11 years that she has known Mr. Sharpe, she\nhas known him to make a lot of money and to have lost a lot of money. She also testified that his\ndisposition is such that he often attempts and genuinely desires to do more than he is financially\ncapable of doing. And, indeed, what is remarkable about Mr. Sharpe\'s testimony throughout the\ntrial, though convoluted and often confused, is the sense of a desperate, "pie-in-the-sky" optimism\non his part that maybe, someday things will work out his way and he will be as rich as he aspires\nto be.\nThe parties also agree that, in addition to dressing extravagantly, Mr. Sharpe lived\nextravagantly, flying on a business associate\'s Lear jet, dining in expensive restaurants (often with\nMs. Baker in tow), drinking expensive wines, and shopping in designer boutiques and expensive\nstores, such as Cartier. Ms. Baker also presented photographs to the court one showing Mr. Sharpe\nbeside a Lear jet and one of a mansion, as evidence that Mr. Sharpe wished to portray himself as\na man of significant means. The photo of Mr. Sharp beside the Lear jet was captioned, "If you\nhaven\'t had the opportunity to fly on a private jet I encourage you to make enough money to do\nso! No matter how good you think financial freedom is..... it\'s better!" There is no evidence as to\nthe author of the caption, but Mr. Sharpe acknowledges that the photo appeared on his website and\nasserted that the photo was one of several photos that many people\' took on that day in order to\npromote their business ventures and to generate leads for people interested in home-based\nbusinesses. He emphatically asserts that the photo was not used to defraud Ms. Baker of $150,000,\nbut for business purposes in order to project an image that he is a mover and a shaker who could\nget deals done.\n319\n\n\x0cFinally, there was also undisputed testimony that Mr. Sharpe described himself on\nMySpace.com, at some point during 2006, as "Funny guy with killer body and money to burn\nseeks classy woman who doesn\'t believe everything she reads!" Ms. Baker emphasizes the phrase\n"money to burn;" Mr. Sharpe emphasizes the phrase "doesn\'t believe everything she reads!"\nMs. Baker also recounted, as evidence of Mr. Sharpe\'s extravagant bent, a particular\nevening out with Mr. Sharpe and other friends or associates at one of the Dallas/Fort Worth area\'s\nfiner steakhouses, Del Frisco\'s Double Eagle Steak House (Del Frisco\'s). Ms. Baker testified that\nshe became familiar with Mr. Sharpe\'s spending habits by watching him spend money, and that\nshe knew that he would spend hundreds and hundreds of dollars on his frequent trips to Del\nFrisco\'s. Indeed, during the evening in question, Ms. Baker testified that Mr. Sharpe had ordered\nthe most expensive bottle of wine the restaurant offered, a bottle priced at $15,000, and that Ms.\nBaker took it upon herself to approach the owner or manager of the restaurant to request that a less\nexpensive bottle of wine be served instead. Upon Ms. Baker\'s request, a $5,000 bottle of wine was\ndelivered for the evening\'s consumption.\nMs. Baker asserts that all of this evidence aggregates to show that Mr. Sharpe devised a\nscheme to portray himself as a wealthy man in order to con her into loaning him monies he knew\nhe could not possibly repay. Ms. Baker represents that the clothing, the lifestyle, and all the\ntrappings were part and parcel to Mr. Sharpe\'s having obtained money from her by false pretenses,\nfalse representations, or actual fraud. The lifestyle and all that went with it, Ms. Baker asserts,\nwere designed to fool her into believing that Mr. Sharpe was a rich fellow who could easily take\nout loans and repay them. Ms. Baker asserts that Mr. Sharpe knew he was not financially secure,\nbut held himself out, in word and deed, as if he were financially secure in order to obtain loans\nfrom her.\nMr. Sharpe, on the other hand, asserts that the extravagant purchases about which he and\nMs. Baker testified, were not done in order to impress Ms. Baker so that he could obtain money\nfrom her, but were simply the way he had lived his life for many, many years. He acknowledged\nthat he lived a very extravagant lifestyle, but it was never intended to defraud people.\nFurther to the allegations of false representations on the part of Mr. Sharpe is Ms. Baker\'s\ntestimony that Mr. Sharpe had represented to her at the time the loans were made that he was able\nto repay the loans because he was essentially hiding assets from his second wife, Jennifer Sharpe,\nin order to prevent her from obtaining her share of those assets as part of the then-pending divorce\nsettlement. Ms. Baker asserts that Mr. Sharpe told her that he had the funds to repay the loans at\nthe time the loans were made and that he would repay Ms. Baker from such funds as soon as the\ndivorce from Jennifer Sharpe was final.\nMs. Baker presented the court with no writing from Mr. Sharpe regarding this arrangement\nor these representations concerning his financial wherewithal to repay the loans. In connection\nwith these allegations, the Plaintiff also elicited testimony from Ms. Wolkowitz that Mr. Sharpe\nput a business in Ms. Wolkowitz\'s name and generally wanted to avoid having things like credit\ncards in his name in connection with his pending divorce from Jennifer Sharpe. To the extent Mr.\nSharpe represented that he had the funds to repay Ms. Baker hidden, and to the extent such\narrangement to repay the loan upon the Sharpe divorce being final was made, it appears to the\ncourt that such representations and arrangements were oral and were never evidenced by a\nwriting.\n320\n\n\x0cMr. Sharpe has a very different story. While Ms. Baker asserts that Mr. Sharpe\'s dress,\nlifestyle, and demeanor were part of a scheme to defraud her (and, presumably, others), Mr. Sharpe\nasserts that the dress and the lifestyle were just how he lived his life and not part of some elaborate\nscheme. Mr. Sharpe absolutely disputes Ms. Baker\'s assertion that he represented to her that he\nwas hiding funds in order to keep them out of his divorce settlement with Jennifer Sharpe. He\ndenies ever making such a representation.\nThe court finds Ms. Baker\'s testimony concerning the proposed plan to repay the loans to\nbe the most credible.\nThis court must determine whether, based upon the foregoing facts, the $150,000 debt\nowed by Mr. Sharpe to Ms. Baker is nondischargeable pursuant to section 523(a)(2)(A) of the\nBankruptcy Code. Do the trappings of wealth, demeanor and an extravagant lifestyle, together with\nan oral representation by the Debtor that he has sufficient funds to repay a debt, rise to the level of\nfalse pretenses, false representation or actual fraud such that the debt is nondischargeable pursuant\nto 11 U.S.C. \xc2\xa7 523(a)(2)(A)?\nMs. Baker is hamstrung by the last clause of this provision, which \xe2\x80\x94 when read in\nconjunction with section 523(a)(2)(B) \xe2\x80\x94 requires that a statement respecting the debtor\'s\nfinancial condition be in writing in order to result in nondischargeability. Ms. Baker, by her own\nadmission, relied upon Mr. Sharpe\'s oral representations that he had hidden away funds which\nwere sufficient to repay Ms. Baker upon his divorce from Jennifer Sharpe. Ms. Baker, therefore,\ncould not move under section 523(a)(2)(B) to seek nondischargeability of her debt \xe2\x80\x94 it requires a\nwriting \xe2\x80\x94 and must move under section 523(a)(2)(A) and attempt to show this court that Mr.\nSharpe\'s oral representations, together with his demeanor, lifestyle and the trappings of wealth,\nrise to the level of false pretenses, false representation, or actual fraud under section 523(a)(2)(A)\nin order that this court may find her debt nondischargeable.\nIn order to show a debt is nondischargeable under section 523(a)(2)(A), the creditor must\nshow (1) that the debtor made representations other than a statement concerning his financial\ncondition, (2) that at the time the debtor made the representations he or she knew they were false,\n(3) that the debtor made the representations with the intention and purpose to deceive the creditor,\n(4) that the creditor justifiably relied on such representations, and (5) that the creditor sustained\nlosses as a proximate result of the false representations. [T]he court must determine that the\nplaintiff \xe2\x80\x94 in this case, Ms. Baker \xe2\x80\x94 justifiably relied upon the representations made to her by\nthe defendant (Mr. Sharpe, herein). A plaintiff may not blindly rely upon a misrepresentation, the\nfalsity of which would be obvious to the plaintiff had he or she used her senses to make a cursory\nexamination or investigation.\nThis court finds that, during 2005, Mr. Sharpe lived a lifestyle and put forth a demeanor\nthat suggested wealth. The expensive clothes, the expensive dinners, the extravagant spending,\nand all the rest were calculated by Mr. Sharpe to portray himself as a successful man of means.\nMr. Sharpe characterizes this as "dressing for success" \xe2\x80\x94 and the court, having spent many years\nin private legal practice, certainly understands this maxim well. Ms. Baker sees a more sinister\nmotive, one designed to dupe her (and, one presumes, others like her) into giving him large sums\nof money. The court also finds that Mr. Sharpe\'s concealment of his dire financial condition during\n2005, and his, at least, vague intention to file bankruptcy \xe2\x80\x94 as reflected by the so-called\n321\n\n\x0c"bankruptcy file" \xe2\x80\x94 are also misrepresentations of his financial wherewithal to repay the loans to\nMs. Baker.\nBut there is a problem with Ms. Baker\'s argument: the clothes, food, spending habits, et\ncetera are all false representations concerning Mr. Sharpe\'s financial condition. Patently,\nthese do not fall within the ambit of section 523(a)(2)(A), which specifically excludes from it\nstatements concerning a debtor\'s financial condition.\nThese representations pale, however, in comparison to the admitted linchpin representation\nto Ms. Baker: in obtaining from Ms. Baker, at least, the two large loans aggregating $95,000 in\nprincipal, Mr. Sharpe represented to her that he had the funds available to repay her hidden\naway pending his divorce from Jennifer Sharpe. In other words, the key misrepresentation that\ninduced Ms. Baker to make the loans was Mr. Sharpe\'s oral representation to her that he had the\nfunds to repay the loans, which he was hiding from his second wife pending their divorce, and that\nhe would repay Ms. Baker\'s loans from such hidden funds upon the divorce becoming final.\nRegardless of all of the other testimony regarding extravagant lifestyle, clothing, and demeanor,\nMs. Baker\'s unequivocal testimony is that the key inducement to her making the loans was Mr.\nSharpe\'s oral representations to her that he had the funds to repay her and that he would repay\nher from such funds.\nEvery representation made by Mr. Sharpe to Ms. Baker in inducement of the loans was\neither explicitly or implicitly a representation concerning his financial condition. As such, they\ncannot form the basis of a cause of action under section 523(a)(2)(A).\nFor these reasons, the court concludes that it cannot provide relief to Ms. Baker under\nsection 523(a)(2)(A). Mr. Sharpe\'s representations, though false, all concerned his financial\ncondition, which fall under section 523(a)(2)(B), and which requires a writing to accord relief. For\nthe foregoing reasons, Plaintiffs $150,000 debt is found to be dischargeable pursuant to section\n523(a)(2)(A) and 523(a)(6) of the Bankruptcy Code.\n\n11.6.1.5.\n\nARCHER v. WARNER, 538 U.S. 314 (2003)\n\nIn late 1991, Leonard and Arlene Warner bought the Warner Manufacturing Company for\n$250,000. About six months later they sold the company to Elliott and Carol Archer for $610,000.\nA few months after that the Archers sued the Warners in North Carolina state court for (among\nother things) fraud connected with the sale.\nIn May 1995, the parties settled the lawsuit. The settlement agreement specified that the\nWarners would pay the Archers "$300,000.00 less legal and accounting expenses" "as\ncompensation for emotional distress/personal injury type damages." It added that the Archers\nwould "execute releases to any and all claims ... arising out of this litigation, except as to amounts\nset forth in [the] Settlement Agreement."\nThe Warners paid the Archers $200,000 and executed a promissory note for the remaining\n$100,000. The Archers executed releases "discharg[ing]" the Warners "from any and every right,\nclaim, or demand" that the Archers "now have or might otherwise hereafter have against" them,\n"excepting only obligations under" the promissory note and related instruments.\n\n322\n\n\x0cThe releases, signed by all parties, added that the parties did not "admi[t] any liability or\nwrongdoing," that the settlement was "the compromise of disputed claims, and that payment [was]\nnot to be construed as an admission of liability. A few days later the Archers voluntarily dismissed\nthe state-court lawsuit with prejudice.\nIn November 1995, the Warners failed to make the first payment on the $100,000\npromissory note. The Archers sued for the payment in state court. The Warners filed for\nbankruptcy. The Bankruptcy Court ordered liquidation under Chapter 7 of the Bankruptcy Code.\nAnd the Archers brought the present claim, asking the Bankruptcy Court to find the\n$100,000 debt nondischargeable, and to order the Warners to pay the $100,000. Leonard Warner\nagreed to a consent order holding his debt nondischargeable. Arlene Warner contested\nnondischargeability. The Archers argued that Arlene Warner\'s promissory note debt was\nnondischargeable because it was for "money ... obtained by ... fraud."\nThe Fourth Circuit, dividing two to one, [found the debt dischargeable]. The majority\nreasoned that the settlement agreement, releases, and promissory note had worked a kind of\n"novation." This novation replaced (1) an original potential debt to the Archers for money obtained\nby fraud with (2) a new debt. The new debt was not for money obtained by fraud. It was for money\npromised in a settlement contract. And it was consequently dischargeable in bankruptcy.\nWe agree with the Court of Appeals and the dissent that "[t]he settlement agreement and\npromissory note here, coupled with the broad language of the release, completely addressed and\nreleased each and every underlying state law claim." That agreement left only one relevant debt: a\ndebt for money promised in the settlement agreement itself. To recognize that fact, however, does\nnot end our inquiry. We must decide whether that same debt can also amount to a debt for money\nobtained by fraud, within the terms of the nondischargeability statute. Given this Court\'s precedent,\nwe believe that it can.\nBrown v. Felsen, 442 U.S. 127 (1979), governs the outcome here. [In that case, the parties\nto an action for fraud entered into a consent decree for the repayment of money. Instead of\nrepaying, the debtor filed bankruptcy. The creditor Brown sought to except the debt from discharge\ndue to the Debtor Felson\xe2\x80\x99s underlying fraud.]\nThis Court . . . conceded that the state law of claim preclusion would bar Brown from\nmaking any claim based on the same cause of action\'" that Brown had brought in state court. But\nall this, the Court held, was beside the point. Claim preclusion did not prevent the Bankruptcy\nCourt from looking beyond the record of the state-court proceeding and the documents that\nterminated that proceeding (the stipulation and consent judgment) in order to decide whether the\ndebt at issue (namely, the debt embodied in the consent decree and stipulation) was a debt for\nmoney obtained by fraud.\nAs a matter of logic, Brown\'s holding means that the Fourth Circuit\'s novation theory\ncannot be right. The reduction of Brown\'s state-court fraud claim to a stipulation (embodied in a\nconsent decree) worked the same kind of novation as the "novation" at issue here. Yet, in Brown,\nthis Court held that the Bankruptcy Court should look behind that stipulation to determine whether\nit reflected settlement of a valid claim for fraud. If the Fourth Circuit\'s view were correct \xe2\x80\x94 if\nreducing a fraud claim to settlement definitively changed the nature of the debt for dischargeability\npurposes \xe2\x80\x94 the nature of the debt in Brown would have changed similarly, thereby rendering the\ndebt dischargeable. This Court\'s instruction that the Bankruptcy Court could "weigh all the\n323\n\n\x0cevidence," would have been pointless. There would have been nothing for the Bankruptcy Court\nto examine.\nMoreover, the Court\'s language in Brown strongly favors the Archers\' position here. The\nCourt said that "the mere fact that a conscientious creditor has previously reduced his claim to\njudgment should not bar further inquiry into the true nature of the debt." If we substitute the word\n"settlement" for the word "judgment," the Court\'s statement describes this case.\nFinally, the Court\'s basic reasoning in Brown applies here. The Court pointed out that the\nBankruptcy Code\'s nondischargeability provision had originally covered "only `judgments\'\nsounding in fraud." Congress later changed the language so that it covered all such "`liabilities.\'"\nThis change indicated that "Congress intended the fullest possible inquiry" to ensure that "all debts\narising out of" fraud are "excepted from discharge," no matter what their form. Congress also\nintended to allow the relevant determination (whether a debt arises out of fraud) to take place in\nbankruptcy court, not to force it to occur earlier in state court at a time when nondischargeability\nconcerns "are not directly in issue and neither party has a full incentive to litigate them."\nThe only difference we can find between Brown and the present case consists of the fact\nthat the relevant debt here is embodied in a settlement, not in a stipulation and consent judgment.\nBut we do not see how that difference could prove determinative. The dischargeability provision\napplies to all debts that "aris[e] out of" fraud. A debt embodied in the settlement of a fraud case\n"arises" no less "out of" the underlying fraud than a debt embodied in a stipulation and consent\ndecree. Policies that favor the settlement of disputes, like those that favor "repose," are neither any\nmore nor any less at issue here than in Brown. In Brown, the doctrine of res judicata itself ensured\n"a blanket release" of the underlying claim of fraud, just as the contractual releases did here.\nDespite the dissent\'s protests to the contrary, what has not been established here, as in Brown, is\nthat the parties meant to resolve the issue of fraud or, more narrowly, to resolve that issue for\npurposes of a later claim of nondischargeability in bankruptcy. In a word, we can find no\nsignificant difference between Brown and the case now before us.\nArlene Warner argues that we should affirm the Court of Appeals\' decision on alternative\ngrounds. She says that the settlement agreement and releases not only worked a novation by\nconverting potential tort liabilities into a contract debt, but also included a promise that the\nArchers would not make the present claim of nondischargeability for fraud. She adds that, in\nany event, because the Archers dismissed the original fraud action with prejudice, North Carolina\nlaw treats the fraud issue as having been litigated and determined in her favor, thereby barring the\nArchers from making their present claim on grounds of collateral estoppel.\nWithout suggesting that these additional arguments are meritorious, we note that the Court\nof Appeals did not determine the merits of either argument, both of which are, in any event, outside\nthe scope of the question presented and insufficiently addressed below. We choose to leave initial\nevaluation of these arguments to "[t]he federal judges who deal regularly with questions of state\nlaw in their respective districts and circuits," and who "are in a better position than we," to\ndetermine, for example, whether the parties intended their agreement and dismissal to have issuepreclusive, as well as claim-preclusive, effect, and to what extent such preclusion applies to\nenforcement of a debt specifically excepted from the releases. The Court of Appeals remains free,\non remand, to determine whether such questions were properly raised or preserved, and, if so, to\ndecide them.\n324\n\n\x0cWe conclude that the Archers\' settlement agreement and releases may have worked a kind\nof novation, but that fact does not bar the Archers from showing that the settlement debt arose out\nof "false pretenses, a false representation, or actual fraud," and consequently is nondischargeable.\nJUSTICE THOMAS, with whom JUSTICE STEVENS joins, dissenting.\nRemarkably the Court fails to address the critical difference between this case and Brown:\nThe parties here executed a blanket release, rather than entered into a consent judgment. And, in\nmy view, "if it is shown that [a] note was given and received as payment or waiver of the original\ndebt and the parties agreed that the note was to substitute a new obligation for the old, the note\nfully discharges the original debt, and the nondischargeability of the original debt does not affect\nthe dischargeability of the obligation under the note." In re West, 22 F.3d 775, 778 (7th Cir. 1994).\nThat is the case before us, and, accordingly, Brown does not control our disposition of this matter.\nBased on the sweeping language of the general release, it is inaccurate for the Court to say\nthat the parties did not "resolve the issue of fraud." To be sure, as in Brown, there is no legally\ncontrolling document stating that respondent did (or did not) commit fraud. But, unlike in Brown,\nwhere it was not clear which claims were being resolved by the consent judgment, the release in\nthis case clearly demonstrates that the parties intended to resolve conclusively not only the issue\nof fraud, but also any other "right[s], claim[s], or demand[s]" related to the state-court litigation,\n"excepting only obligations under [the] Note and deeds of trust." The fact that the parties intended,\nby the language of the general release, to replace an "old" fraud debt with a "new" contract debt is\nan important distinction from Brown, for the text of the Bankruptcy Code prohibits discharge of\nany debt "to the extent obtained by" fraud.\nThe Court today ignores the plain intent of the parties, as evidenced by a properly executed\nsettlement agreement and general release, holding that a debt owed by respondent under a contract\nwas "obtained by" fraud. Because I find no support for the Court\'s conclusion in the text of the\nBankruptcy Code, or in the agreements of the parties, I respectfully dissent.\n\n11.6.1.6.\n\nKAWAAUHAU v. GEIGER, 523 U.S. 57 (1998)\n\nThe question before us is whether a debt arising from a medical malpractice judgment,\nattributable to negligent or reckless conduct, falls within this statutory exception. We hold that it\ndoes not and that the debt is dischargeable.\nIn January 1983, petitioner Margaret Kawaauhau sought treatment from respondent Dr.\nPaul Geiger for a foot injury. Geiger examined Kawaauhau and admitted her to the hospital to\nattend to the risk of infection resulting from the injury. Although Geiger knew that intravenous\npenicillin would have been more effective, he prescribed oral penicillin, explaining in his\ntestimony that he understood his patient wished to minimize the cost of her treatment.\nGeiger then departed on a business trip, leaving Kawaauhau in the care of other physicians,\nwho decided she should be transferred to an infectious disease specialist. When Geiger returned,\nhe canceled the transfer and discontinued all antibiotics because he believed the infection had\nsubsided. Kawaauhau\'s condition deteriorated over the next few days, requiring the amputation of\nher right leg below the knee.\n\n325\n\n\x0cKawaauhau, joined by her husband Solomon, sued Geiger for malpractice. After a trial, the\njury found Geiger liable and awarded the Kawaauhaus approximately $355,000 in damages.\nGeiger, who carried no malpractice insurance, moved to Missouri, where his wages were garnished\nby the Kawaauhaus. Geiger then petitioned for bankruptcy. The Kawaauhaus requested the\nBankruptcy Court to hold the malpractice judgment nondischargeable on the ground that it was a\ndebt "for willful and malicious injury" excepted from discharge by 11 U.S.C. \xc2\xa7 523 (a)(6).\nThe Bankruptcy Court concluded that Geiger\'s treatment fell far below the appropriate\nstandard of care and therefore ranked as "willful and malicious."\nSection 523(a)(6) of the Bankruptcy Code [excepts any debt] "(6) for willful and malicious\ninjury by the debtor to another entity or to the property of another entity."\nThe Kawaauhaus urge that the malpractice award fits within this exception because Dr.\nGeiger intentionally rendered inadequate medical care to Margaret Kawaauhau that necessarily led\nto her injury. According to the Kawaauhaus, Geiger deliberately chose less effective treatment\nbecause he wanted to cut costs, all the while knowing that he was providing substandard care. Such\nconduct, the Kawaauhaus assert, meets the "willful and malicious" specification of \xc2\xa7 523(a)(6).\nWe confront this pivotal question concerning the scope of the "willful and malicious\ninjury" exception: Does \xc2\xa7 523(a)(6)\'s compass cover acts, done intentionally, that cause injury (as\nthe Kawaauhaus urge), or only acts done with the actual intent to cause injury?\nThe word "willful" in (a)(6) modifies the word "injury," indicating that nondischargeability\ntakes a deliberate or intentional injury, not merely a deliberate or intentional act that leads to\ninjury. Had Congress meant to exempt debts resulting from unintentionally inflicted injuries, it\nmight have described instead "willful acts that cause injury." Or, Congress might have selected an\nadditional word or words, i. e., "reckless" or "negligent," to modify "injury." Moreover, as the\nEighth Circuit observed, the (a)(6) formulation triggers in the lawyer\'s mind the category\n"intentional torts," as distinguished from negligent or reckless torts. Intentional torts generally\nrequire that the actor intend "the consequences of an act," not simply "the act itself."\nThe Kawaauhaus\' more encompassing interpretation could place within the excepted\ncategory a wide range of situations in which an act is intentional, but injury is unintended, i. e.,\nneither desired nor in fact anticipated by the debtor. Every traffic accident stemming from an initial\nintentional act\xe2\x80\x94for example, intentionally rotating the wheel of an automobile to make a left-hand\nturn without first checking oncoming traffic\xe2\x80\x94could fit the description. A "knowing breach of\ncontract" could also qualify. A construction so broad would be incompatible with the "wellknown" guide that exceptions to discharge "should be confined to those plainly expressed."\nFinally, the Kawaauhaus maintain that, as a policy matter, malpractice judgments should\nbe excepted from discharge, at least when the debtor acted recklessly or carried no malpractice\ninsurance. Congress, of course, may so decide. But unless and until Congress makes such a\ndecision, we must follow the current direction \xc2\xa7 523(a)(6) provides.\n\n326\n\n\x0c11.6.1.7.\nBULLOCK V. BANKCHAMPAIGN, 133 S. Ct. 1754\n(2013)\nJUSTICE BREYER delivered the opinion of the Court.\nSection 523(a)(4) of the Federal Bankruptcy Code provides that an individual cannot obtain\na bankruptcy discharge from a debt "for fraud or defalcation while acting in a fiduciary capacity,\nembezzlement, or larceny." 11 U.S.C. \xc2\xa7 523(a)(4). We here consider the scope of the term\n"defalcation." We hold that it includes a culpable state of mind requirement akin to that which\naccompanies application of the other terms in the same statutory phrase. We describe that state of\nmind as one involving knowledge of, or gross recklessness in respect to, the improper nature of\nthe relevant fiduciary behavior.\nIn 1978, the father of petitioner Randy Bullock established a trust for the benefit of his five\nchildren. He made petitioner the (nonprofessional) trustee; and he transferred to the trust a single\nasset, an insurance policy on his life. The trust instrument permitted the trustee to borrow funds\nfrom the insurer against the policy\'s value (which, in practice, was available at an insurancecompany-determined 6% interest rate).\nIn 1981, petitioner, at his father\'s request, borrowed money from the trust, paying the funds\nto his mother who used them to repay a debt to the father\'s business. In 1984, petitioner again\nborrowed funds from the trust, this time using the funds to pay for certificates of deposit, which\nhe and his mother used to buy a mill. In 1990, petitioner once again borrowed funds, this time\nusing the money to buy real property for himself and his mother. Petitioner saw that all of the\nborrowed funds were repaid to the trust along with 6% interest.\nIn 1999, petitioner\'s brothers sued petitioner in Illinois state court. The state court held that\npetitioner had committed a breach of fiduciary duty. It explained that petitioner "does not appear\nto have had a malicious motive in borrowing funds from the trust" but nonetheless "was clearly\ninvolved in self-dealing." It ordered petitioner to pay the trust "the benefits he received from his\nbreaches" (along with costs and attorney\'s fees). The court imposed constructive trusts on\npetitioner\'s interests in the mill and the original trust, in order to secure petitioner\'s payment of its\njudgment, with respondent BankChampaign serving as trustee for all of the trusts. After petitioner\ntried unsuccessfully to liquidate his interests in the mill and other constructive trust assets to obtain\nfunds to make the court-ordered payment, petitioner filed for bankruptcy in federal court.\nBankChampaign opposed petitioner\'s efforts to obtain a bankruptcy discharge of his statecourt-imposed debts to the trust. And the Bankruptcy Court granted summary judgment in the\nbank\'s favor.\nPetitioner in effect has asked us to decide whether the bankruptcy term "defalcation"\napplies "in the absence of any specific finding of ill intent or evidence of an ultimate loss of trust\nprincipal."\nThe lower courts have long disagreed about whether "defalcation" includes a scienter\nrequirement and, if so, what kind of scienter it requires. In light of that disagreement, we granted\nthe petition.\n[In an omitted part of the opinion, the Court reviewed the historical use of \xe2\x80\x9cdefalcation\nbeginning with the 1867 Bankruptcy Act]. We base our approach and our answer upon one of this\n327\n\n\x0cCourt\'s precedents. In 1878, this Court interpreted the related statutory term "fraud" in the portion\nof the Bankruptcy Code laying out exceptions to discharge. Justice Harlan wrote for the Court:\n"[D]ebts created by `fraud\' are associated directly with debts created by `embezzlement.\'\nSuch association justifies, if it does not imperatively require, the conclusion that the `fraud\' referred\nto in that section means positive fraud, or fraud in fact, involving moral turpitude or intentional\nwrong, as does embezzlement; and not implied fraud, or fraud in law, which may exist without\nthe imputation of bad faith or immorality." Neal v. Clark, 95 U.S. 704, 709 (1878). We believe\nthat the statutory term "defalcation" should be treated similarly.\nThus, where the conduct at issue does not involve bad faith, moral turpitude, or other\nimmoral conduct, the term requires an intentional wrong. We include as intentional not only\nconduct that the fiduciary knows is improper but also reckless conduct of the kind that the\ncriminal law often treats as the equivalent. Thus, we include reckless conduct of the kind set\nforth in the Model Penal Code. Where actual knowledge of wrongdoing is lacking, we consider\nconduct as equivalent if the fiduciary "consciously disregards" (or is willfully blind to) "a\nsubstantial and unjustifiable risk" that his conduct will turn out to violate a fiduciary duty\n[wilful blindness\']. That risk "must be of such a nature and degree that, considering the nature and\npurpose of the actor\'s conduct and the circumstances known to him, its disregard involves a gross\ndeviation from the standard of conduct that a law-abiding person would observe in the actor\'s\nsituation.\xe2\x80\x9d\nSecond, this interpretation does not make the word identical to its statutory neighbors. Nor\nare embezzlement, larceny, and fiduciary fraud simply special cases of defalcation as so defined.\nThe statutory provision makes clear that the first two terms apply outside of the fiduciary context;\nand "defalcation," unlike "fraud," may be used to refer to nonfraudulent breaches of fiduciary duty.\nThird, the interpretation is consistent with the longstanding principle that "exceptions to\ndischarge `should be confined to those plainly expressed.\'" In the absence of fault, it is difficult to\nfind strong policy reasons favoring a broader exception here, at least in respect to those whom a\nscienter requirement will most likely help, namely nonprofessional trustees, perhaps administering\nsmall family trusts potentially immersed in intrafamily arguments that are difficult to evaluate in\nterms of comparative fault.\nFinally, it is important to have a uniform interpretation of federal law, the choices are\nlimited, and neither the parties nor the Government has presented us with strong considerations\nfavoring a different interpretation.\nIn this case the Court of Appeals applied a standard of "objectiv[e] reckless[ness]" to facts\npresented at summary judgment. We consequently remand the case to permit the court to determine\nwhether further proceedings are needed and, if so, to apply the heightened standard that we have\nset forth.\n\n11.7.\n\nReaffirmation: 11 U.S.C. \xc2\xa7 524(c)\n\nThe discharge prevents a creditor from seeking to collect a discharged debt, but it does not\nprevent a debtor from voluntarily repaying a discharged debt. Debtors are free to voluntarily repay\ndebts if they wish to do so. 11 U.S.C. \xc2\xa7 524(f).\n328\n\n\x0cCreditors, of course, do not wish to rely on the debtor\xe2\x80\x99s good graces to collect debts, and\nwould like to retain the ability to enforce collection. Before 1978, debtors could bind themselves\nby agreements made after discharge to reaffirm a debt, and thereby became obligated to repay the\ndebt. One of the main reforms made in the Bankruptcy Code was to eliminate the debtor\xe2\x80\x99s\nunilateral ability to reaffirm a discharged debt.\nThe Bankruptcy Code requires reaffirmation agreements to be filed with the Court before\nthe discharge is entered, after very substantial disclosures to the debtor about the risks of\nreaffirmation, and the approval of either the debtor\xe2\x80\x99s lawyer or the bankruptcy judge. 11 U.S.C. \xc2\xa7\n524(c) et seq. Absent the filing of a formal pre-discharge reaffirmation agreement, approved by\nthe debtor\xe2\x80\x99s lawyer or the bankruptcy court, the debt is discharged and the obligation cannot be\nreinstated (although it can be voluntarily paid) by the debtor. Creditors who seek to enforce a postdischarge private reaffirmation agreement are in violation of the post-discharge injunction in 11\nU.S.C. \xc2\xa7 524(a).\nThe process of reaffirmation is cumbersome. Several pages of written disclosures must be\ngiven to the debtor in the form required by the Bankruptcy Code. 11 U.S.C. \xc2\xa7 524(k). If the debtor\nis represented by counsel in the bankruptcy case, the debtor\xe2\x80\x99s counsel must sign a declaration or\naffidavit stating that (1) the debtor was fully informed of and voluntarily agreed to the terms\n(including the effect and consequences of default), and (2) the agreement does not impose an undue\nhardship on the debtor). 11 U.S.C. \xc2\xa7\xc2\xa7 524(c)(3), 524(k)(4).\nThese reaffirmation rules often put the debtor and the debtor\xe2\x80\x99s lawyer in conflict, especially\nover reaffirming cars. Debtors often want to keep cars even though the debt exceeds the value of\nthe car, and the debtor\xe2\x80\x99s lawyer has the unhappy burden of refusing to sign off. Some lawyers\nprovide in their engagement agreements that they will not represent the debtor in connection with\nreaffirmations, so that the debtor can seek the approval or disapproval of the court (and possibly\nthereby limit the risk of an ipso-facto default and repossession under Section 521(a)(6) and 521(d)\nof the Bankruptcy Code.\nDebtors who are not represented by counsel must obtain court approval for the\nreaffirmation agreement, with the bankruptcy court determining that the reaffirmation does not\nimpose an \xe2\x80\x9cundue hardship\xe2\x80\x9d and is in the best interests of the debtor. 11 U.S.C. \xc2\xa7 523(d). There is\na presumption of undue hardship if the debtor\xe2\x80\x99s estimated future income does not exceed the\ndebtor\xe2\x80\x99s future expenses by the amount of the required reaffirmed payments. 11 U.S.C. \xc2\xa7\n524(m)(1). The Debtor must rebut this presumption by explaining the additional source of funds\nthat will be used to make the payments.\n\n11.8.\n\nPractice Problems: Protecting the Discharge.\n\nRead Section 525 of the Bankruptcy Code and answer the following problems:\nProblem 1. The local bar association has a policy of refusing to grant law licenses to\napplicants who have filed bankruptcy or have failed to repay discharged debts. Is that lawful? 11\nU.S.C. \xc2\xa7 525(a).\nProblem 2. New York State has passed a law providing for the revocation of driving\nlicense privilege to any taxpayer who has failed to pay more than $10,000 in state income taxes.\n329\n\n\x0cMay the state revoke the driver\xe2\x80\x99s license of a debtor who has filed bankruptcy and discharged the\nobligation to pay $12,000 in state income taxes? 11 U.S.C. \xc2\xa7 525(a).\nProblem 3. Last week, a former Chapter 7 debtor was offered a job at an insurance\ncompany. This week, the insurance company called the debtor and revoked the offer, saying that\nthey discovered that the debtor had filed bankruptcy, and they have a policy against hiring\nbankrupts. Was it legal to withdraw the offer? See 11 U.S.C. \xc2\xa7 525(b). Compare Burnett v. Stewart\nTitle, Inc., 635 F.3d 169 (5th Cir. 2011) (protections under \xc2\xa7 525(b) apply only for existing\nemployees, not job applicants); Leary v. Warnaco, Inc., 251 B.R. 656 (S.D.N.Y. 2000) (statute\nprevents discrimination against job applicants).\nProblem 4. Credit union employee tells credit union that he intends to file bankruptcy next\nweek. Credit union promptly fires the employee. Can employee sue for violation of Section 525(b)\nof the Bankruptcy Code? In re Majewski, 310 F.3d 653 (9th Cir. 2002) (may fire employees for\nthreatening to file bankruptcy; cannot fire employees for filing bankruptcy).\nProblem 5. Debtor files bankruptcy owing $100,000 to creditors. Several creditors\nobtained guaranties from an insider of the debtor when the original loans were made. Can the\ncreditors sue the insider on the guaranty after the debtor has filed bankruptcy? If the court\ndetermines that the suits against the insider will harm the debtor\xe2\x80\x99s reorganization effort, is there\nanything the court can do about the suits? See 11 U.S.C. \xc2\xa7 105; AH Robins Co., Inc. v. Piccinin,\n788 F.2d 994 (4th Cir. 1986) (the Court may issue or extend stays to enjoin a variety of proceedings\n[including discovery against the debtor or its officers and employees] which will have an adverse\nimpact on the Debtor\'s ability to formulate a Chapter 11 plan.\xe2\x80\x9d).\nProblem 6. Debtor filed a Chapter 7 bankruptcy case on January 1, year 1, received a\ndischarge on May 1, Year 1, and filed a new Chapter 7 case on January 2, Year 9. Is the debtor\neligible for a discharge in the new case? 11 U.S.C. \xc2\xa7 727(a)(8).\nProblem 7. Debtor filed a Chapter 13 bankruptcy case on January 1, Year 1, and received\na discharge on January 1, Year 5. Can the Debtor receive a discharge in a Chapter 7 case filed on\nJanuary 2, Year 7? 11 U.S.C. \xc2\xa7 727(a)(9).\nProblem 8. Debtor filed a Chapter 7 case on January 1, Year 1, and received a discharge\non May 1, Year 1. When would the debtor be eligible to receive a Chapter 13 discharge? 11 U.S.C.\n\xc2\xa7 1328(f).\n\n330\n\n\x0cChapter 12: Wage Earner Reorganizations under Chapter 13\n12.1.\n\nIntroduction\n\nIndividual debtors can technically file under either Chapter 11 or Chapter 13 (and Chapter\n12 if they are small farmers or fisherman), but Chapter 11 is appropriate only for individual debtors\nwho have substantial property and business holdings. Chapter 11 is expensive and complicated,\nand is suitable only for operating businesses that need more flexibility than Chapter 13 can provide\n(or for entities or larger businesses that are not eligible for Chapter 13). Chapter 13 is a simplified\nreorganization procedure for individuals (entities are not eligible) designed to be cost effective.\nThis chapter will therefore focus on consumer reorganizations under Chapter 13 \xe2\x80\x93 with an\nemphasis on how Chapter 13 works, and who should consider Chapter 13 over Chapter 7. The next\nchapter will focus on business reorganization under Chapter 11.\n\n12.2.\n\nReasons for Filing under Chapter 13\n\nThere are three main benefits of Chapter 13 over Chapter 7.\nRestructuring Secured Debts. First, debtors in Chapter 13 may restructure secured debts.\nIn Chapter 7, debtors can only restructure secured debts with the creditor\xe2\x80\x99s agreement. In Chapter\n7, the debtor must either surrender the collateral, redeem consumer goods by paying the secured\nclaim in full, or live with the existing terms by reaffirmation or ride-through. With the exception\nof home mortgages and certain purchase money security interests, secured debts in Chapter 13 can\nbe stripped down, the maturity date can be changed to coincide with the plan term, and the interest\nrate can be modified.\nKeeping Non-Exempt Property. Second, debtors in Chapter 13 may keep their nonexempt property. In Chapter 7, the debtor must turn over non-exempt property to the trustee for\nliquidation and distribution to creditors. But debtors must pay a price for keeping all of their nonexempt property \xe2\x80\x93 debtors must pay unsecured creditors more than they would receive in a\nhypothetical Chapter 7 liquidation, and must pay unsecured creditors all of their \xe2\x80\x9cprojected\ndisposable income\xe2\x80\x9d during the term of the plan. The \xe2\x80\x9cprojected disposable income\xe2\x80\x9d test is\ncomplicated by rules incorporating the dreaded Chapter 7 means test into the calculation.\nEligibility for a Discharge. Some debtors who would not qualify for Chapter 7 or a\nChapter 7 discharge (due to the means test or the longer applicable period between discharges)\nmay qualify for Chapter 13 and a Chapter 13 discharge.\n\n12.3.\n\nThe Chapter 13 Process\n\nThe process of Chapter 13 is very similar to the Chapter 7 process, except that the debtor\xe2\x80\x99s\nnon-exempt property is not liquidated by a trustee. The debtor must file a petition and schedules\ncontaining the same basic information as required in Chapter 7. In addition, the debtor must file a\nplan of reorganization in compliance with Chapter 13\xe2\x80\x99s requirements. The plan must describe the\ntreatment of secured and unsecured claims during the plan period. Most jurisdictions require the\n331\n\n\x0cuse of a form plan of reorganization, making it easy for experienced local practitioners to locate\nthe relevant terms added by the particular debtor.\nThe Court must hold a hearing to confirm the plan of reorganization. These hearings are\noften unopposed and perfunctory. Once the plan of reorganization is confirmed, the debtor will\nmake the required play payments to the trustee, who will distribute the payments to the creditors\nwho have timely filed proofs of claim. In some jurisdictions, the regular post-petition payments\nowing on secured claims are paid directly by the debtor to creditors outside of the plan (and thereby\navoid being \xe2\x80\x9ctaxed\xe2\x80\x9d by the Chapter 13 trustee\xe2\x80\x99s administrative fees). In other jurisdictions all\npayments to creditors during the plan flow through the trustee. Jurisdictions that impose trustee\nfees on all payments have a lower payment rate, which may actually benefit unsecured creditors.\nIn all jurisdictions, if secured claims are restructured by the plan, the cure or restructured plan\npayments will go through the Chapter 13 trustee.\nThe debtor receives a discharge only after completing the payments required under the plan\n(or in some cases after failing to complete the plan if the requirements for a \xe2\x80\x9chardship discharge\xe2\x80\x9d\nare met). What is discharged is the difference between the original debt and the payments called\nfor by the plan during the term of the plan. In most cases, debtors who fail to complete the plan\nwill either convert their cases to Chapter 7 or end up without a discharge.\n\n12.4.\n\nThe Chapter 13 Plan Term (and \xe2\x80\x9cCommitment Period\xe2\x80\x9d).\n\nThe permitted plan \xe2\x80\x9ccommitment period\xe2\x80\x9d is between 3 and 5 years, unless the debtor can\npay all claims in full in less than 3 years. See 11 U.S.C. \xc2\xa7 1325(b)(4)(B). Technically, below\nmedian debtors must ask the court for permission to propose a plan longer than 3 years, but this\nrequest is perfunctory and routinely granted. 11 U.S.C. \xc2\xa7 1322(d)(2). Above median debtors must\npropose a five year plan. 11 U.S.C. \xc2\xa7 1325(b)(4)(A)(ii).\n\n12.5.\n\nRestructuring Secured Claims in a Chapter 13 Plan\n\nChapter 13 has different rules for restructuring different kinds of secured claims.\nRestructuring home mortgages is the most restrictive, followed by purchase money security\ninterests in personal use property that was purchased within certain periods before bankruptcy. We\nwill start with the general rules for restructuring secured claims and then look at the restrictions.\n(a) General Restructuring Rules.\nThe basic rules for restructuring secured claims in Chapter 13 are set forth in Section\n1325(a)(5) of the Bankruptcy Code. Unless the secured creditor consents (and of course anything\ncan be done to the secured creditor with the secured creditor\xe2\x80\x99s consent), the debtor has three\nchoices:\n(1) Restructure.\nPay the \xe2\x80\x9cvalue as of the effective date of the plan\xe2\x80\x9d of the \xe2\x80\x9callowed secured claim\xe2\x80\x9d in equal\nmonthly installments, in full, over the plan term (11 U.S.C. \xc2\xa7 1325(a)(5)(B)). Here, the section\n506(a) split takes on real meaning. The restructuring option allows the debtor to strip down an\nundersecured creditor\xe2\x80\x99s claim to the value of the collateral.\n332\n\n\x0cThe Supreme Court in Till v. SCS Credit, reprinted below, determined that the \xe2\x80\x9cvalue as of\nthe effective date of the plan\xe2\x80\x9d language in the statute requires the debtor to pay post-confirmation\ninterest on that secured claim, but also set a post-confirmation interest rate that many consider to\nbe beneficial to debtors. The debtor must be able to pay off the entire secured claim during the 3\nto 5 year plan term.\n(2) Surrender.\nSurrender the collateral to the secured creditor (11 U.S.C. \xc2\xa7 1325(a)(5)(C); or\n(3) Cure and Reinstate.\nCure the default over the plan term, and reinstate the original loan terms (11 U.S.C. \xc2\xa7\xc2\xa7\n1322(b)(3); 1322(b)(5)). This last option requires the debtor to pay off the arrearage plus make\nany current payments that are due during the life of the plan, so at the end of the plan term the loan\nis current. In all jurisdictions the cure payments are made through the Chapter 13 trustee. In some\njurisdictions to regular post-petition payments may be made outside the plan to avoid the Chapter\n13 Trustee\xe2\x80\x99s distribution fees.\nWhether or not the debtor must pay interest on the cure amount depends on a number of\nfactors. In Rake v. Wade, 508 U.S. 464 (1993), the Supreme Court ruled that post-confirmation\ninterest had to be paid on the cure amount under the \xe2\x80\x9cvalue as of the effective date of the plan\xe2\x80\x9d\nlanguage in Section 1325(a)(5), even though the home mortgage was not subject to modification\nunder Section 1325(a)(5).\nThen, in 1994, Congress enacted Section 1322(e), which is only applicable to loan\nagreements made after the date of enactment. Loans made prior to 1994 are still governed by Rake\nv. Wade. Section 1322(e) was intended to overrule Rake v. Wade, by allowing the creditor to collect\ninterest on the cure amount only if the agreement AND applicable law require the payment of\ninterest on cure amounts. In many cases, neither the loan documents nor state law provide\nspecifically for interest to be paid on any missed payments in order to cure a default. Some courts\nhave determined that no interest need be paid over the 3 to 5 year term on the arrearage that is\nbeing cured. See In re Hoover, 254 B.R. 492 (Bankr. N.D. Okla. 2000) (agreement did not permit\ninterest on arrears, except for interest on insurance advance).\nCuring property tax arrearages poses a special problem because of Section 511 of the\nBankruptcy Code, which requires interest to be paid at the applicable non-bankruptcy rate on\nproperty tax claims whenever the code requires interest to be paid. Some courts have determined\nthat interest must be paid on the tax arrearage being cured even through there is no contractual\nagreement to pay interest on cure amounts. In re Meyhoefer, 459 B.R. 167 (Bankr. N.D.N.Y.\n2011).\n(b) Limitation on Restructuring Home Mortgages\nSection 1322(b)(2) prohibits the debtor from restructuring \xe2\x80\x9ca claim secured only by a\nsecurity interest in real property that is the debtor\xe2\x80\x99s principal residence.\xe2\x80\x9d This has proven to be a\nsignificant limitation on the use of Chapter 13. Homeowners cannot strip undersecured mortgages,\nand cannot change the interest rate or term of the loan. Chapter 13 debtors can only force the\n333\n\n\x0cmortgagee to accept a cure and reinstatement of a home mortgage \xe2\x80\x93 the debt cannot be stripped\nunder Section 506(a), and the terms cannot otherwise be changed. However, if the debt is secured\nby both the debtor\xe2\x80\x99s principal residence and other property, it can be restructured because it is not\nsecured \xe2\x80\x9conly\xe2\x80\x9d by the principal residence. The courts are not in agreement on whether a mortgage\ncovering a legal multiplex in which one of the units is occupied as a principal residence by the\nowner/debtor can be modified. Some courts have held that the mortgage is secured by both a\nprincipal residence and rental property, and therefore it may be modified. Other courts have held\nthat the mortgage secures a single parcel that is occupied as a principal residence, and therefore\ncannot be modified. Compare In re Scarborough, 461 F.3d 406 (3d Cir. 2006) (multi-family\nproperty occupied in part may be modified in Chapter 13); In re Macaluso, 254 B.R. 799, 800\n(Bankr. W.D.N.Y. 2000) (multi-family property partially occupied as a principal residence may\nnot be modified in Chapter 13).\nThe limitation on restructuring home mortgages does not prevent the debtor from avoiding\njudicial liens that impair the debtor\xe2\x80\x99s exemption under Section 522(f). Moreover, as exemplified\nby In re Pond reprinted below, many courts have allowed \xe2\x80\x9cstripping off\xe2\x80\x9d wholly underwater junior\nmortgages in Chapter 13 on the grounds that they are not secured by an interest in the real property.\nCreditors who are in arrears on a home mortgage, may cure the arrearages over time. This\nrequires sufficient income to cure the default over the plan term (at most 5 years) in addition to\nmaking the regular required monthly payments. Restructured debts must be paid in full during the\nplan term, which because of the five year limitation poses significant problems for many debtors\nif the secured debts are large.\nThere is one exception to the rule that home mortgages cannot be modified. Section\n1322(c)(2) allows modification of a home mortgage that matures by its own terms during the plan\nterm. See In re Paschen, 296 F.3d 1203 (11th Cir. 2002). Despite the clear wording of the statute,\none circuit has held that a maturing home loan cannot be stripped down under 506(a), but can only\nhave its payment schedule modified. In re Witt, 113 F.3d 508 (4th Cir. 1997).\n(c) Limitation on Restructuring Purchase Money Security Interests\nThe so-called un-numbered \xe2\x80\x9changing paragraph\xe2\x80\x9d at the end of Section 1325(a) of the\nBankruptcy Code (below Section 1325(a)(9)), contains important limitations on the restructuring\nof secured claims. The hanging paragraph applies to two kinds of purchase money secured claims:\n(1) Motor vehicle loans, where the debt was incurred within 910 days before bankruptcy,\nand the vehicle was acquired for the personal use of the debtor; and\n(2) Other property where the debt was incurred within 1 year of bankruptcy.\nIf the purchase money loan was incurred more than 910 days or 1 year, respectively, from\nthe bankruptcy filing, the loan can be restructured under the general rule.\nConsumer purchase money car loans incurred within 910 days, and other purchase money\nloans incurred within 1 year, before bankruptcy cannot be stripped down under Section 506(a).\nHowever, these loans may be restructured in other ways \xe2\x80\x93 the interest rate can be changed under\nTill, reprinted below, the maturity date can be changed to comport with the plan term, or the default\ncan be cured under the plan.\n334\n\n\x0c12.6.\n\nCases on Restructuring Secured Claims in Chapter 13\n12.6.1.1.\n\nTILL v. SCS CREDIT CORP., 541 U.S. 465 (2004)\n\nOn October 2, 1998, petitioners Lee and Amy Till, residents of Kokomo, Indiana,\npurchased a used truck from Instant Auto Finance for $6,395 plus $330.75 in fees and taxes. They\nmade a $300 down payment and financed the balance of the purchase price by entering into a retail\ninstallment contract that Instant Auto immediately assigned to respondent, SCS Credit\nCorporation. Petitioners\' initial indebtedness amounted to $8,285.24 \xe2\x80\x94 the $6,425.75 balance of\nthe truck purchase plus a finance charge of 21% per year for 136 weeks, or $1,859.49. Under the\ncontract, petitioners agreed to make 68 biweekly payments to cover this debt; Instant Auto \xe2\x80\x94 and\nsubsequently respondent \xe2\x80\x94 retained a purchase money security interest that gave it the right to\nrepossess the truck if petitioners defaulted under the contract.\nOn October 25, 1999, petitioners, by then in default on their payments to respondent, filed\na joint petition for relief under Chapter 13 of the Bankruptcy Code. At the time of the filing,\nrespondent\'s outstanding claim amounted to $4,894.89, but the parties agreed that the truck\nsecuring the claim was worth only $4,000. In accordance with the Bankruptcy Code, therefore,\nrespondent\'s secured claim was limited to $4,000, and the $894.89 balance was unsecured.\nPetitioners\' proposed debt adjustment plan called for them to submit their future earnings\nto the supervision and control of the Bankruptcy Court for three years, and to assign $740 of their\nwages to the trustee each month.\nThe proposed plan also provided that petitioners would pay interest on the secured portion\nof respondent\'s claim at a rate of 9.5% per year. Petitioners arrived at this "prime-plus" or "formula\nrate" by augmenting the national prime rate of approximately 8% (applied by banks when making\nlow-risk loans) to account for the risk of nonpayment posed by borrowers in their financial\nposition. Respondent objected to the proposed rate, contending that the company was "entitled to\ninterest at the rate of 21%, which is the rate . . . it would obtain if it could foreclose on the vehicle\nand reinvest the proceeds in loans of equivalent duration and risk as the loan" originally made to\npetitioners.\nAt the hearing on its objection, respondent presented expert testimony establishing that it\nuniformly charges 21% interest on so-called "subprime" loans, or loans to borrowers with poor\ncredit ratings, and that other lenders in the subprime market also charge that rate. Petitioners\ncountered with the testimony of an economics professor, who acknowledged that he had only\nlimited familiarity with the subprime auto lending market, but described the 9.5% formula rate as\n"very reasonable" given that Chapter 13 plans are "supposed to be financially feasible."\nThe Seventh Circuit majority held that the original contract rate should "serve as a\npresumptive [cramdown] rate," which either the creditor or the debtor could challenge with\nevidence that a higher or lower rate should apply.\nThe Bankruptcy Code provides little guidance as to which of the rates of interest advocated\nby the four opinions in this case\xe2\x80\x94the formula rate, the coerced loan rate, the presumptive contract\nrate, or the cost of funds rate\xe2\x80\x94Congress had in mind when it adopted the cramdown provision.\nThat provision, 11 U.S.C. \xc2\xa7 1325(a)(5)(B), does not mention the term "discount rate" or the word\n"interest." Rather, it simply requires bankruptcy courts to ensure that the property to be distributed\n335\n\n\x0cto a particular secured creditor over the life of a bankruptcy plan has a total "value, as of the\neffective date of the plan," that equals or exceeds the value of the creditor\'s allowed secured\nclaim\xe2\x80\x94in this case, $4,000. \xc2\xa7 1325(a)(5)(B)(ii). A debtor\'s promise of future payments is worth\nless than an immediate payment of the same total amount because the creditor cannot use the\nmoney right away, inflation may cause the value of the dollar to decline before the debtor pays,\nand there is always some risk of nonpayment. The challenge for bankruptcy courts reviewing such\nrepayment schemes, therefore, is to choose an interest rate sufficient to compensate the creditor\nfor these concerns.\n[We] reject the coerced loan, presumptive contract rate, and cost of funds approaches. Each\nof these approaches is complicated, imposes significant evidentiary costs, and aims to make each\nindividual creditor whole rather than to ensure the debtor\'s payments have the required present\nvalue. [Court discusses problems with each of the rejected approaches]\nThe formula approach has none of these defects. Taking its cue from ordinary lending\npractices, the approach begins by looking to the national prime rate, reported daily in the press,\nwhich reflects the financial market\'s estimate of the amount a commercial bank should charge a\ncreditworthy commercial borrower to compensate for the opportunity costs of the loan, the risk of\ninflation, and the relatively slight risk of default. Because bankrupt debtors typically pose a greater\nrisk of nonpayment than solvent commercial borrowers, the approach then requires a bankruptcy\ncourt to adjust the prime rate accordingly. The appropriate size of that risk adjustment depends, of\ncourse, on such factors as the circumstances of the estate, the nature of the security, and the\nduration and feasibility of the reorganization plan. The court must therefore hold a hearing at which\nthe debtor and any creditors may present evidence about the appropriate risk adjustment. Some of\nthis evidence will be included in the debtor\'s bankruptcy filings, however, so the debtor and\ncreditors may not incur significant additional expense. Moreover, starting from a concededly low\nestimate and adjusting upward places the evidentiary burden squarely on the creditors, who are\nlikely to have readier access to any information absent from the debtor\'s filing (such as evidence\nabout the "liquidity of the collateral market." Finally, many of the factors relevant to the adjustment\nfall squarely within the bankruptcy court\'s area of expertise. For these reasons, the prime-plus or\nformula rate best comports with the purposes of the Bankruptcy Code.\nWe do not decide the proper scale for the risk adjustment, as the issue is not before us. The\nBankruptcy Court in this case approved a risk adjustment of 1.5%, and other courts have generally\napproved adjustments of 1% to 3%. Respondent\'s core argument is that a risk adjustment in this\nrange is entirely inadequate to compensate a creditor for the real risk that the plan will fail. There\nis some dispute about the true scale of that risk\xe2\x80\x94respondent claims that more than 60% of Chapter\n13 plans fail, but petitioners argue that the failure rate for approved Chapter 13 plans is much\nlower. We need not resolve that dispute. It is sufficient for our purposes to note that, under 11\nU.S.C. \xc2\xa7 1325(a)(6), a court may not approve a plan unless, after considering all creditors\'\nobjections and receiving the advice of the trustee, the judge is persuaded that "the debtor will be\nable to make all payments under the plan and to comply with the plan." Together with the\ncramdown provision, this requirement obligates the court to select a rate high enough to\ncompensate the creditor for its risk but not so high as to doom the plan. If the court determines that\nthe likelihood of default is so high as to necessitate an "eye-popping" interest rate, the plan\nprobably should not be confirmed.\n336\n\n\x0c[The plurality then criticizes the dissent.] [I]n theory the formula and presumptive contract\nrate approaches would yield the same final interest rate. Thus, we principally differ with the dissent\nnot over what final rate courts should adopt but over which party (creditor or debtor) should bear\nthe burden of rebutting the presumptive rate (prime or contract, respectively).\nJUSTICE SCALIA, with whom THE CHIEF JUSTICE, JUSTICE O\'CONNOR, and\nJUSTICE KENNEDY join, dissenting.\nMy areas of agreement with the plurality are substantial. We agree that, although all\nconfirmed Chapter 13 plans have been deemed feasible by a bankruptcy judge, some nevertheless\nfail. We agree that any deferred payments to a secured creditor must fully compensate it for the\nrisk that such a failure will occur. Finally, we agree that adequate compensation may sometimes\nrequire an "`eye-popping\'" interest rate, and that, if the rate is too high for the plan to succeed, the\nappropriate course is not to reduce it to a more palatable level, but to refuse to confirm the plan.\nOur only disagreement is over what procedure will more often produce accurate estimates\nof the appropriate interest rate. The plurality would use the prime lending rate\xe2\x80\x94a rate we know is\ntoo low\xe2\x80\x94and require the judge in every case to determine an amount by which to increase it. I\nbelieve that, in practice, this approach will systematically undercompensate secured creditors for\nthe true risks of default. I would instead adopt the contract rate\xe2\x80\x94i. e., the rate at which the creditor\nactually loaned funds to the debtor\xe2\x80\x94as a presumption that the bankruptcy judge could revise on\nmotion of either party. Since that rate is generally a good indicator of actual risk, disputes should\nbe infrequent, and it will provide a quick and reasonably accurate standard.\nThe prime rate becomes the objective tail wagging a dog of unknown size.\nThere is no better demonstration of the inadequacies of the formula approach than the\nproceedings in this case. Petitioners\' economics expert testified that the 1.5% risk premium was\n"very reasonable" because Chapter 13 plans are "supposed to be financially feasible" and "the\nborrowers are under the supervision of the court." Nothing in the record shows how these two\nplatitudes were somehow manipulated to arrive at a figure of 1.5%. It bears repeating that\nfeasibility determinations and trustee oversight do not prevent at least 37% of confirmed Chapter\n13 plans from failing. On cross-examination, the expert admitted that he had only limited\nfamiliarity with the subprime auto lending market and that he was not familiar with the default\nrates or the costs of collection in that market. In light of these devastating concessions, it is\nimpossible to view the 1.5% figure as anything other than a smallish number picked out of a hat.\nBased on even a rudimentary financial analysis of the facts of this case, the 1.5% figure is\nobviously wrong\xe2\x80\x94not just off by a couple percent, but probably by roughly an order of magnitude.\nThe first cost of default involves depreciation. The second cost of default involves liquidation. The\nthird cost of default consists of the administrative expenses of foreclosure. I have omitted several\nother costs of default, but the point is already adequately made. The three figures above total\n$1,600. Even accepting petitioners\' low estimate of the plan failure rate, a creditor choosing the\nstream of future payments instead of the immediate lump sum would be selecting an alternative\nwith an expected cost of about $590 ($1,600 multiplied by 37%, the chance of failure) and an\nexpected benefit of about $100 (as computed above). No rational creditor would make such a\nchoice. In sum, the 1.5% premium adopted in this case is far below anything approaching fair\ncompensation.\n337\n\n\x0cGiven the inherent uncertainty of the enterprise, what heartless bankruptcy judge can be\nexpected to demand that the unfortunate debtor pay triple the prime rate as a condition of keeping\nhis sole means of transportation? It challenges human nature.\n\n12.6.1.2.\nNOBELMAN v. AMERICAN SAVINGS BANK, 508\nU.S. 324 (1993)\n\nThis case focuses on the interplay between two provisions of the Bankruptcy Code. The\nquestion is whether \xc2\xa7 1322(b)(2) prohibits a Chapter 13 debtor from relying on \xc2\xa7 506(a) to reduce\nan undersecured homestead mortgage to the fair market value of the mortgaged residence. We\nconclude that it does and therefore affirm the judgment of the Court of Appeals.\nIn 1984, respondent American Savings Bank loaned petitioners Leonard and Harriet\nNobelman $68,250 for the purchase of their principal residence, a condominium in Dallas, Texas.\nIn exchange, petitioners executed an adjustable rate note payable to the bank and secured by a deed\nof trust on the residence. In 1990, after falling behind in their mortgage payments, petitioners\nsought relief under Chapter 13 of the Bankruptcy Code. The bank filed a proof of claim with the\nBankruptcy Court for $71,335 in principal, interest, and fees owed on the note. Petitioners\'\nmodified Chapter 13 plan valued the residence at a mere $23,500 \xe2\x80\x94 an uncontroverted valuation\n\xe2\x80\x94 and proposed to make payments pursuant to the mortgage contract only up to that amount (plus\nprepetition arrearages). Relying on \xc2\xa7 506(a) of the Bankruptcy Code, petitioners proposed to treat\nthe remainder of the bank\'s claim as unsecured. Under the plan, unsecured creditors would receive\nnothing.\nThe bank and the Chapter 13 trustee, also a respondent here, objected to petitioners\' plan.\nThey argued that the proposed bifurcation of the bank\'s claim into a secured claim for $23,500 and\nan effectively worthless unsecured claim modified the bank\'s rights as a homestead mortgagee, in\nviolation of 11 U.S.C. \xc2\xa7 1322(b)(2). The Bankruptcy Court agreed with respondents and denied\nconfirmation of the plan. The District Court affirmed, as did the Court of Appeals.\nSection 1322(b)(2), the provision at issue here, allows modification of the rights of both\nsecured and unsecured creditors, subject to special protection for creditors whose claims are\nsecured only by a lien on the debtor\'s home.\nThe parties agree that the "other than" exception in \xc2\xa7 1322(b)(2) proscribes modification\nof the rights of a homestead mortgagee. Petitioners maintain, however, that their Chapter 13 plan\nproposes no such modification. They argue that the protection of \xc2\xa7 1322(b)(2) applies only to the\nextent the mortgagee holds a "secured claim" in the debtor\'s residence and that we must look first\nto \xc2\xa7 506(a) to determine the value of the mortgagee\'s "secured claim." Petitioners contend that the\nvaluation provided for in \xc2\xa7 506(a) operates automatically to adjust downward the amount of a\nlender\'s undersecured home mortgage before any disposition proposed in the debtor\'s Chapter 13\nplan. Under this view, the bank is the holder of a "secured claim" only in the amount of $23,500\n\xe2\x80\x94 the value of the collateral property. Because the plan proposes to make $23,500 worth of\npayments pursuant to the monthly payment terms of the mortgage contract, petitioners argue, the\n338\n\n\x0cplan effects no alteration of the bank\'s rights as the holder of that claim. Section 1322(b)(2), they\nassert, allows unconditional modification of the bank\'s leftover "unsecured claim."\nThis interpretation fails to take adequate account of \xc2\xa7 1322(b)(2)\'s focus on "rights." That\nprovision does not state that a plan may modify "claims" or that the plan may not modify "a claim\nsecured only by" a home mortgage. Rather, it focuses on the modification of the "rights of holders"\nof such claims. By virtue of its mortgage contract with petitioners, the bank is indisputably the\nholder of a claim secured by a lien on petitioners\' home. The term "rights" is nowhere defined in\nthe Bankruptcy Code. In the absence of a controlling federal rule, we generally assume that\nCongress has "left the determination of property rights in the assets of a bankrupt\'s estate to state\nlaw," since such "[p]roperty interests are created and defined by state law. The bank\'s "rights,"\ntherefore, are reflected in the relevant mortgage instruments, which are enforceable under Texas\nlaw. They include the right to repayment of the principal in monthly installments over a fixed term\nat specified adjustable rates of interest, the right to retain the lien until the debt is paid off, the right\nto accelerate the loan upon default and to proceed against petitioners\' residence by foreclosure and\npublic sale, and the right to bring an action to recover any deficiency remaining after foreclosure.\nThese are the rights that were "bargained for by the mortgagor and the mortgagee," and are rights\nprotected from modification by \xc2\xa7 1322(b)(2).\nThis is not to say, of course, that the contractual rights of a home mortgage lender are\nunaffected by the mortgagor\'s Chapter 13 bankruptcy. The lender\'s power to enforce its rights \xe2\x80\x94\nand, in particular, its right to foreclose on the property in the event of default \xe2\x80\x94 is checked by the\nBankruptcy Code\'s automatic stay provision. 11 U.S.C. \xc2\xa7 362. In addition, \xc2\xa7 1322(b)(5) permits\nthe debtor to cure prepetition defaults on a home mortgage by paying off arrearages over the life\nof the plan "notwithstanding" the exception in \xc2\xa7 1322(b)(2). These statutory limitations on the\nlender\'s rights, however, are independent of the debtor\'s plan or otherwise outside \xc2\xa7 1322(b)(2)\'s\nprohibition.\n[T]o give effect to \xc2\xa7 506(a)\'s valuation and bifurcation of secured claims through a Chapter\n13 plan in the manner petitioners propose would require a modification of the rights of the holder\nof the security interest. Section 1322(b)(2) prohibits such a modification where, as here, the\nlender\'s claim is secured only by a lien on the debtor\'s principal residence.\n\n12.6.1.3.\n\nIN RE POND, 252 F.3d 122 (2d Cir. 2001)\n\nWe are asked to decide whether, under 11 U.S.C. \xc2\xa7 1322(b)(2), Chapter 13 debtors can\nvoid a lien on their residential property if there is insufficient equity in the residence to cover any\nportion of that lien.\nDefendants Charles Livingston, Jr. and Farm Specialist Realty hold a valid, duly recorded,\nmortgage lien for $10,630.58 on the principal residential property of plaintiffs Richard J. Pond and\nLorrie A. Pond. On January 1, 1996, plaintiffs filed for bankruptcy under Chapter 13 of the\nBankruptcy Code.\nThe Bankruptcy Court valued plaintiffs\' residential property at $69,000. In addition, the\nBankruptcy Court determined that there were four liens on the property, which had to be\ndischarged in the following order of priority: (1) $1,505.18 for real property taxes; (2) $48,995.63\nfor the mortgage of the Farmers Home Administration; (3) $20,000 for the mortgage of the New\n339\n\n\x0cYork State Affordable Housing Corporation; and (4) $10,630.58 for defendants\' mortgage. The\nfirst three liens amounted to an encumbrance of $70,500.81; accordingly, plaintiffs\' property,\nvalued at $69,000, had insufficient equity to cover any portion of defendants\' lien.\nIn August 1996, plaintiffs commenced this action to dissolve defendants\' lien under 11\nU.S.C. \xc2\xa7 1322(b)(2). Plaintiffs argued that defendants\' lien was wholly unsecured under 11 U.S.C.\n\xc2\xa7 506 and, therefore, not entitled to the protection against modification under 11 U.S.C. \xc2\xa7\n1322(b)(2) accorded to claims "secured" solely by a debtor\'s principal residence. The Bankruptcy\nCourt rejected this argument. It held that defendants\' lien could not be modified under 11 U.S.C.\n\xc2\xa7 1322(b)(2). The District Court reversed. It held that the statutory prohibition against modification\ndoes not apply to a holder of a wholly unsecured lien under 11 U.S.C. \xc2\xa7 506, because such a lien\nis not "secured" by a residential property within the meaning of 11 U.S.C. \xc2\xa7 1322(b)(2).\nThe question presented here is whether defendants\' lien falls within the antimodification\nexception of 11 U.S.C. \xc2\xa7 1322(b)(2) for claims "secured only by a security interest in ... the debtor\'s\nprincipal residence," because it is wholly "unsecured" under Section 506(a).\nThe Supreme Court in Nobelman held that, as long as some portion of the lien was secured\nby the residence, the creditor was a holder of "a claim secured only by ... the debtor\'s principal\nresidence," and its rights in the entire lien were protected under the antimodification exception.\nAccordingly, the debtors\' Chapter 13 plan could not void the unsecured component of the creditor\'s\nmortgage lien.\nThe Nobelman Court, however, left open the issue before us\xe2\x80\x94namely, whether its holding\nextends to a holder of a wholly unsecured homestead lien. This issue has sharply divided\nbankruptcy and district courts, as well as bankruptcy scholars.\nThe majority view, which the District Court in the instant case adopted, is that the\nantimodification exception is triggered only where there is sufficient value in the underlying\ncollateral to cover some portion of a creditor\'s claim. The courts that have espoused this position\nnote, inter alia, that the Supreme Court in Nobelman first looked to Section 506(a) to determine\nwhether any part of the creditor\'s claim was secured. Once the Court determined that the creditor\'s\nclaim was at least partially secured under this provision, it held that the antimodification exception\nof Section 1322(b)(2) protected the creditor\'s rights in the entire claim. According to the majority\nview, therefore, the antimodification exception applies only where a creditor\'s claim is at least\npartially secured under Section 506(a).\nA sizeable minority of courts, however, interprets Nobelman differently. According to\nthese courts, Nobelman stands for the proposition that the value of the collateral underlying a lien\nis irrelevant to whether that lien is modifiable by a Chapter plan. Under this view, as long as the\ncollateral underlying a lien is the debtor\'s principal residential property, the lien cannot be voided\nunder Section 1322(b)(2) because to do so would modify the "rights of holders of ... a claim\nsecured only by a security interest in ... the debtor\'s principal residence," 11 U.S.C. \xc2\xa7 1322(b)(2).\nUpon a review of the relevant statutory language, as well as the Supreme Court\'s decision\nin Nobelman, we agree with the majority view on this issue and therefore adopt it here. We\nconclude from [the Supreme Court\xe2\x80\x99s language in Nobelman], as well as the language of the statute,\nthat the antimodification exception of Section 1322(b)(2) protects a creditor\'s rights in a mortgage\nlien only where the debtor\'s residence retains enough value \xe2\x80\x94 after accounting for other\nencumbrances that have priority over the lien \xe2\x80\x94 so that the lien is at least partially secured under\n340\n\n\x0cSection 506(a). We therefore join the Third, Fifth, and Eleventh Circuits, as well as the Bankruptcy\nAppellate Panels of the First and Ninth Circuits, in holding that a wholly unsecured claim, as\ndefined under Section 506(a), is not protected under the antimodification exception of Section\n1322(b)(2).\n\n12.7.\n\nQuestion: Is In re Pond Still Good Law?\n\nConsider the effect of the Supreme Court\xe2\x80\x99s recent decision in Bank of America v. Caulkett,\n135 S. Ct. 1995 (2015), on the Court\xe2\x80\x99s reasoning in In re Pond. If wholly unsecured junior home\nmortgages cannot be stripped in Chapter 7 under Section 506(d) under the reasoning in Caulkett,\ncan they be modified over the antimodification rule in Section 1322(b)(2) as interpreted in\nNobelman?\n\n12.8.\n\nUnsecured Claims in Chapter 13\n\nThe debtor must surmount the following hurdles in order to confirm a Chapter 13 plan if\nany creditor objects:\n(1) Priority Claims Paid in Full.\nClaims entitled to priority, with the exception of support claims that have been assigned to\nthe government for collection, must be paid in full by the plan. 11 U.S.C. \xc2\xa7 1322(a)(2). Assigned\nsupport claims must be paid in full unless the debtor has insufficient projected disposable income\nover a five year plan term to do so. 11 U.S.C. \xc2\xa7 1322(a)(3). These provisions do not require the\npayment of interest on priority claims, but if the priority claims are not dischargeable in Chapter\n13, the debtor will likely owe accruing interest at the end of the plan term under applicable nonbankruptcy law, and thus on the non-dischargeable claim. Also, interest on priority claims may be\nrequired in order to meet the \xe2\x80\x9cBest Interests of Creditors Test.\xe2\x80\x9d\n(2) Best Interests of Creditors Test.\nThe debtor must show that creditors are receiving more in present value under the plan\nthan they would receive from the estate in a Chapter 7 liquidation case that occurred on the\nconfirmation date. 11 U.S.C. \xc2\xa7 1325(a)(4). This requires the debtor to perform a hypothetical\nliquidation to compare a Chapter 7 liquidation with the distribution under the plan. The plan\ndistribution must be discounted to present value, presumably at the interest rate suggested in Till\nv. SCS.\nExemptions, which are normally irrelevant in Chapter 13 because the debtor may keep all\nproperty, exempt or not, become relevant when performing hypothetical liquidation analysis\nbecause you must calculate what creditors would have received in the hypothetical Chapter 7\nliquidation occurring on the effective date of the plan. Exempt property would not have been\ndistributed to creditors.\n\n341\n\n\x0c(3) Projected Disposable Income Test.\nIf any creditor objects to the plan, the court cannot confirm the plan unless it either pays\nunsecured creditors in full, or proposes to use all of the debtor\xe2\x80\x99s \xe2\x80\x9cprojected disposable income\xe2\x80\x9d\nduring the plan term to pay unsecured creditors. 11 U.S.C. \xc2\xa7 1325(b)(1).\n\xe2\x80\x9cDisposable income\xe2\x80\x9d starts with the debtor\xe2\x80\x99s \xe2\x80\x9ccurrent monthly income\xe2\x80\x9d (which you will\nrecall is the average prior six months of gross income used in the Chapter 7 means test \xe2\x80\x93 11 U.S.C.\n\xc2\xa7 101(10A)). Current monthly income is then reduced by either (1) reasonable living and business\nexpenses for a below median debtor (11 U.S.C. \xc2\xa7 1325(b)(2)), or (2) means test living and\nbusiness expenses for an above-median debtor (11 U.S.C. \xc2\xa7 1325(b)(3), which references 11\nU.S.C. \xc2\xa7 707(b)(2)(A) and (B)). The formula results in a hypothetical net monthly income which\nthe debtor must pay to the trustee for unsecured creditor claims. The bankruptcy court has broad\ndiscretion to determine whether the below median debtor needs to incur all of the living expenses\nthat the debtor proposes to pay after bankruptcy, which amounts are deducted by the formula above\nfrom the distribution that must be made to unsecured creditors during the plan term. The rigid\nmeans test in large measure replaces the judge\xe2\x80\x99s discretion for above-median debtors. Abovemedian debtors may ultimately be better off than below median debtors in proposing to pay secured\nclaims after bankruptcy from money that could be used to make a larger distribution to creditors.\nWhat if the debtor\xe2\x80\x99s current income is significantly different than it was during the six full\nmonths before bankruptcy? Given the specificity with which Congress defined \xe2\x80\x9cdisposable\nincome,\xe2\x80\x9d one would assume changed circumstances for the better would result in a windfall for\nthe debtor (allowing the debtor to keep the extra income rather than paying it to creditors), while\nchanged circumstances for the worse may make it impossible for the debtor to make the required\npayments under the plan. The Supreme Court\xe2\x80\x99s decision in Hamilton v. Lanning, reprinted below,\nmay surprise you as it did many of us in the bankruptcy community.\n(4) Equal Treatment and Co-Debtor Exception.\nAs a general matter, similar priority claims must be treated the same way. There may be\nsome small leeway for a debtor to separately classifying non-priority unsecured claims through the\nreference in Section 1322(b)(1) to the Chapter 11 classification rule in Section 1122, but for the\nmost part the debtor must treat general unsecured claims the same way. One explicit exception\nburied in the last phrase of Section 1322(b)(2) allows the debtor to prefer a consumer debt for\nwhich a co-debtor is also liable. This would allow, say, a consumer debt guaranteed by a family\nmember to be paid in preference to other unsecured claims.\n(5) Feasibility, Good Faith, and Post-petition Tax Returns.\nThe debtor must show that the plan is feasible (the debtor will be able to make the payments\nrequired by the plan) (11 U.S.C. \xc2\xa7 1325(a)(6)); that the plan has been filed in good faith (11 U.S.C.\n\xc2\xa7 1325(a)(7)); and that all post-petition tax returns that are due have been filed (11 U.S.C. \xc2\xa7\n1325(a)(8)).\n\n342\n\n\x0c12.9.\n\nCases on Unsecured Claims in Chapter 13\n12.9.1.1.\n\nHAMILTON v. LANNING, 560 U.S. 505 (2010)\n\nRespondent had $36,793.36 in unsecured debt when she filed for Chapter 13 bankruptcy\nprotection in October 2006. In the six months before her filing, she received a one-time buyout\nfrom her former employer, and this payment greatly inflated her gross income for April 2006 (to\n$11,990.03) and for May 2006 (to $15,356.42). As a result of these payments, respondent\'s current\nmonthly income, as averaged from April through October 2006, was $5,343.70\xe2\x80\x94a figure that\nexceeds the median income for a family of one in Kansas. Respondent\'s monthly expenses,\ncalculated pursuant to \xc2\xa7 707(b)(2), were $4,228.71. She reported a monthly "disposable income"\nof $1,114.98 on Form 22C.\nOn the form used for reporting monthly income (Schedule I), she reported income from\nher new job of $1,922 per month\xe2\x80\x94 which is below the state median. On the form used for reporting\nmonthly expenses (Schedule J), she reported actual monthly expenses of $1,772.97. Subtracting\nthe Schedule J figure from the Schedule I figure resulted in monthly disposable income of $149.03.\nRespondent filed a plan that would have required her to pay $144 per month for 36 months.\nPetitioner, a private Chapter 13 trustee, objected to confirmation of the plan because the amount\nrespondent proposed to pay was less than the full amount of the claims against her, see \xc2\xa7\n1325(b)(1)(A), and because, in petitioner\'s view, respondent was not committing all of her\n"projected disposable income" to the repayment of creditors, see \xc2\xa7 1325(b)(1)(B). According to\npetitioner, the proper way to calculate projected disposable income was simply to multiply\ndisposable income, as calculated on Form 22C, by the number of months in the commitment\nperiod. Employing this mechanical approach, petitioner calculated that creditors would be paid in\nfull if respondent made monthly payments of $756 for a period of 60 months. There is no dispute\nthat respondent\'s actual income was insufficient to make payments in that amount.\nThe parties differ sharply in their interpretation of \xc2\xa7 1325\'s reference to "projected\ndisposable income." Petitioner, advocating the mechanical approach, contends that "projected\ndisposable income" means past average monthly disposable income multiplied by the number of\nmonths in a debtor\'s plan. Respondent, who favors the forward-looking approach, agrees that the\nmethod outlined by petitioner should be determinative in most cases, but she argues that in\nexceptional cases, where significant changes in a debtor\'s financial circumstances are known or\nvirtually certain, a bankruptcy court has discretion to make an appropriate adjustment. Respondent\nhas the stronger argument.\nFirst, respondent\'s argument is supported by the ordinary meaning of the term "projected."\nHere, the term "projected" is not defined, and in ordinary usage future occurrences are not\n"projected" based on the assumption that the past will necessarily repeat itself. . . . While a\nprojection takes past events into account, adjustments are often made based on other factors that\nmay affect the final outcome. See In re Kibbe, 361 B.R. 302, 312, n. 9 (1st Cir. BAP 2007)\n(contrasting "multiplied," which "requires only mathematical acumen," with "projected," which\nrequires "mathematic acumen adjusted by deliberation and discretion").\nSecond, the word "projected" appears in many federal statutes, yet Congress rarely has\nused it to mean simple multiplication.\n343\n\n\x0cBy contrast, we need look no further than the Bankruptcy Code to see that when Congress\nwishes to mandate simple multiplication, it does so unambiguously\xe2\x80\x94 most commonly by using\nthe term "multiplied."\nThird, pre-BAPCPA case law points in favor of the "forward-looking" approach. Prior to\nBAPCPA, the general rule was that courts would multiply a debtor\'s current monthly income by\nthe number of months in the commitment period as the first step in determining projected\ndisposable income. But courts also had discretion to account for known or virtually certain changes\nin the debtor\'s income.\nPre-BAPCPA bankruptcy practice is telling because we "`will not read the Bankruptcy\nCode to erode past bankruptcy practice absent a clear indication that Congress intended such a\ndeparture.\'" Congress did not amend the term "projected disposable income" in 2005, and preBAPCPA bankruptcy practice reflected a widely acknowledged and well-documented view that\ncourts may take into account known or virtually certain changes to debtors\' income or expenses\nwhen projecting disposable income. In light of this historical practice, we would expect that, had\nCongress intended for "projected" to carry a specialized\xe2\x80\x94and indeed, unusual\xe2\x80\x94meaning in\nChapter 13, Congress would have said so expressly.\nThe mechanical approach also clashes repeatedly with the terms of 11 U.S.C. \xc2\xa7 1325.\nFirst, \xc2\xa7 1325(b)(1)(B)\'s reference to projected disposable income "to be received in the\napplicable commitment period" strongly favors the forward-looking approach. There is no dispute\nthat respondent would in fact receive far less than $756 per month in disposable income during the\nplan period, so petitioner\'s projection does not accurately reflect "income to be received" during\nthat period. The mechanical approach effectively reads this phrase out of the statute when a\ndebtor\'s current disposable income is substantially higher than the income that the debtor\npredictably will receive during the plan period.\nSecond, \xc2\xa7 1325(b)(1) directs courts to determine projected disposable income "as of the\neffective date of the plan," which is the date on which the plan is confirmed and becomes binding,\nsee \xc2\xa7 1327(a). Had Congress intended for projected disposable income to be nothing more than a\nmultiple of disposable income in all cases, we see no reason why Congress would not have required\ncourts to determine that value as of the filing date of the plan.\nThird, the requirement that projected disposable income "will be applied to make\npayments" is most naturally read to contemplate that the debtor will actually pay creditors in the\ncalculated monthly amounts. \xc2\xa7 1325(b)(1)(B). But when, as of the effective date of a plan, the\ndebtor lacks the means to do so, this language is rendered a hollow command.\nThe arguments advanced in favor of the mechanical approach are unpersuasive. Noting\nthat the Code now provides a detailed and precise definition of "disposable income," proponents\nof the mechanical approach maintain that any departure from this method leaves that definition\n"`with no apparent purpose.\'" This argument overlooks the important role that the statutory formula\nfor calculating "disposable income" plays under the forward-looking approach. As the Tenth\nCircuit recognized in this case, a court taking the forward-looking approach should begin by\ncalculating disposable income, and in most cases, nothing more is required. It is only in\nunusual cases that a court may go further and take into account other known or virtually certain\ninformation about the debtor\'s future income or expenses.\n344\n\n\x0cIn cases in which a debtor\'s disposable income during the 6-month look-back period is\neither substantially lower or higher than the debtor\'s disposable income during the plan period, the\nmechanical approach would produce senseless results that we do not think Congress intended. In\ncases in which the debtor\'s disposable income is higher during the plan period, the mechanical\napproach would deny creditors payments that the debtor could easily make. And where, as in the\npresent case, the debtor\'s disposable income during the plan period is substantially lower, the\nmechanical approach would deny the protection of Chapter 13 to debtors who meet the chapter\'s\nmain eligibility requirements. Here, for example, respondent is an "individual whose income is\nsufficiently stable and regular" to allow her "to make payments under a plan," \xc2\xa7 101(30), and her\ndebts fall below the limits set out in \xc2\xa7 109(e). But if the mechanical approach were used, she could\nnot file a confirmable plan. Under \xc2\xa7 1325(a)(6), a plan cannot be confirmed unless "the debtor will\nbe able to make all payments under the plan and comply with the plan." And as petitioner concedes,\nrespondent could not possibly make the payments that the mechanical approach prescribes.\nConsistent with the text of \xc2\xa7 1325 and pre-BAPCPA practice, we hold that when a\nbankruptcy court calculates a debtor\'s projected disposable income, the court may account for\nchanges in the debtor\'s income or expenses that are known or virtually certain at the time of\nconfirmation. We therefore affirm the decision of the Court of Appeals.\nJUSTICE SCALIA, dissenting.\nThe Bankruptcy Code requires a debtor seeking relief under Chapter 13, unless he will\nrepay his unsecured creditors in full, to pay them all of his "projected disposable income" over the\nlife of his repayment plan. 11 U.S.C. \xc2\xa7 1325(b)(1)(B). The Code provides a formula for\n"project[ing]" what a debtor\'s "disposable income" will be, which so far as his earnings are\nconcerned turns only on his past income. The Court concludes that this formula should not apply\nin "exceptional cases" where "known or virtually certain" changes in the debtor\'s circumstances\nmake it a poor predictor. Ante, at 2471. Because that conclusion is contrary to the Code\'s text, I\nrespectfully dissent.\nThe puzzle is what to make of the word "projected." In the Court\'s view, this modifier\nmakes all the difference. Projections, it explains, ordinarily account for later developments, not\njust past data.\nThat interpretation runs aground because it either renders superfluous text Congress\nincluded or requires adding text Congress did not. It would be pointless to define disposable\nincome in such detail, based on data during a specific 6-month period, if a court were free to set\nthe resulting figure aside whenever it appears to be a poor predictor. And since "disposable\nincome" appears nowhere else in \xc2\xa7 1325(b), then unless \xc2\xa7 1325(b)(2)\'s definition applies to\n"projected disposable income" in \xc2\xa7 1325(b)(1)(B), it does not apply at all.\nThe Court insists its interpretation does not render \xc2\xa7 1325(b)(2)\'s incorporation of "current\nmonthly income" a nullity: A bankruptcy court must still begin with that figure, but is simply free\nto fiddle with it if a "significant" change in the debtor\'s circumstances is "known or virtually\ncertain." That construction conveniently avoids superfluity, but only by utterly abandoning the\ntext the Court purports to construe. Nothing in the text supports treating the definition of disposable\nincome Congress supplied as a suggestion. And even if the word "projected" did allow (or direct)\na court to disregard \xc2\xa7 1325(b)(2)\'s fixed formula and to consider other data, there would be no\nbasis in the text for the restrictions the Court reads in, regarding when and to what extent a court\n345\n\n\x0cmay (or must) do so. If the statute authorizes estimations, it authorizes them in every case, not just\nthose where changes to the debtor\'s income are both "significant" and either "known or virtually\ncertain." If the evidence indicates it is merely more likely than not that the debtor\'s income will\nincrease by some minimal amount, there is no reading of the word "projected" that permits (or\nrequires) a court to ignore that change. The Court, in short, can arrive at its compromise\nconstruction only by rewriting the statute.\nPerhaps Congress concluded that other information a bankruptcy court might consider is\ntoo uncertain or too easily manipulated. Or perhaps it thought the cost of considering such\ninformation outweighed the benefits. In all events, neither the reasons for nor the wisdom of the\nprojection method Congress chose has any bearing on what the statute means.\nUnable to assemble a compelling case based on what the statute says, the Court falls back\non the "senseless results" it would produce\xe2\x80\x94results the Court "do[es] not think Congress\nintended." Even if it were true that a "mechanical" reading resulted in undesirable outcomes, that\nwould make no difference. For even assuming (though I do not believe it) that we could know\nwhich results Congress thought it was achieving (or avoiding) apart from the only congressional\nexpression of its thoughts, the text, those results would be entirely irrelevant to what the statute\nmeans.\n[I]t requires little imagination to see why Congress might want to withhold relief from\ndebtors whose situations have suddenly deteriorated (after or even toward the end of the 6-month\nwindow), or who in the midst of dire straits have been blessed (within the 6-month window) by an\ninflux of unusually high income. Bankruptcy protection is not a birthright, and Congress could\nreasonably conclude that those who have just hit the skids do not yet need a reprieve from repaying\ntheir debts; perhaps they will recover. And perhaps the debtor who has received a one-time bonus\nwill thereby be enabled to stay afloat. How long to wait before throwing the debtor a lifeline is\ninherently a policy choice.\nUnderlying the Court\'s interpretation is an understandable urge: Sometimes the best\nreading of a text yields results that one thinks must be a mistake, and bending that reading just a\nlittle bit will allow all the pieces to fit together. But taking liberties with text in light of outcome\nmakes sense only if we assume that we know better than Congress which outcomes are mistaken.\nAnd by refusing to hold that Congress meant what it said, we deprive it of the ability to say what\nit means in the future. It may be that no interpretation of \xc2\xa7 1325(b)(1)(B) is entirely satisfying. But\nit is in the hard cases, even more than the easy ones, that we should faithfully apply our settled\ninterpretive principles, and trust that Congress will correct the law if what it previously prescribed\nis wrong.\n12.9.1.2.\n\nIN RE GAMBOA, 538 B.R. 53 (Bankr. S.D. Cal. 2013)\n\nThe Chapter 13 Trustee has objected to confirmation of Debtors Chapter 13 plan and\nmoved to dismiss their case. The central issue is whether Debtors may retain an income-producing\nproperty and cure the mortgage arrears on it through their plan. The court finds that they may not,\nand so sustains the Trustee\'s objection but denies his motion to dismiss.\nDebtors\' plan provides for four initial payments of $1,342.29 and then $975.29 per month\nfor the remaining 56 months. This yields a 1.01 percent dividend to general unsecured claims.\n346\n\n\x0cDebtors propose to retain an income-producing property located at 9092 Libra Drive, San Diego,\nCalifornia (the "Libra property"). The Libra property is a single-family residence encumbered by\na mortgage with $49,811.15 in arrears. [The Debtors have no equity in the property]. They propose\nto pay all of the arrears through their plan. The mortgage payment on the rental property is\n$2,197.13 [and they receive monthly rent of] $2,250.00, creating a monthly positive cash flow of\n$52.87 by the property.\nDebtors disregard the Trustee\'s central argument that retaining the rental property results\nin a net loss because they are paying both arrears on this mortgage through the plan as well as the\nmortgage outside the plan. The difference between the rent received ($2,250.00) and the sum of\nthe monthly mortgage payment ($2,197.13) together with the arrears ($873.88 per month) leaves\nan $821.01 monthly deficiency \xe2\x80\x94 without accounting for maintenance costs or potential\nvacancies. Thus, Debtors would maintain ownership of the Libra property throughout the plan\'s\nlife at a significant loss. Debtors\' cash flow computation also overlooks likely future costs\nassociated with maintaining the property. Further, Debtors\' variable interest rate on their mortgage\ncould well rise, given that current rates are near historic lows. Any one of these additional costs\nwould easily absorb the rental\'s minimal revenue surplus. The court therefore finds that the\nproperty operates at a net loss.\nAlthough Debtors focus on feasibility, the Trustee primarily objects to Debtors\' retaining\nthe Libra property on the theory that they are not applying all projected disposable income to the\nplan. A less than 100-percent plan is not confirmable unless a debtor applies all projected\ndisposable income to it. 11 U.S.C. \xc2\xa7 1325(b). Disposable income "means current monthly income\nreceived by the debtor . . . less amounts reasonably necessary to be expended for the maintenance\nor support of the debtor . . ." 11 U.S.C. \xc2\xa7\xc2\xa7 1325(b)(2) and (3). Thus, a debtor has not applied all\nprojected disposable income to the plan if he proposes a less than 100-percent plan and wishes to\nretain an unnecessary expense.\n[For above-median debtors] Section 1325 provides that "amounts reasonably\nnecessary to be expended... shall be determined in accordance with subparagraphs (A) and\n(B) of section 707(b)(2)." 11 U.S.C. \xc2\xa7 1325(b)(3). The statute envisions a "two-step inquiry."\nFirst, "if an expense is not reasonably necessary for the debtor\'s and/or dependents\'\nmaintenance and support, the inquiry ends at section 1325(b)(2) as there is no "amount" to\ndetermine."Id. But "[i]f the expense is reasonably necessary for the debtor\'s and/or\ndependents\' maintenance and support, then section 1325(b)(3) requires the court to\ndetermine the amount in accordance with section 707(b)(2)." Id.\nOrdinarily, a debtor who is current on a secured obligation may continue to make\ncontractually scheduled payments and deduct them from current monthly income "regardless of\nwhether the collateral is necessary." 11 U.S.C. \xc2\xa7 707(b)(2)(A)(iii)(I). That same rule does not\napply, however, to curing arrears on secured claims. 11 U.S.C. \xc2\xa7 707(b)(2)(A)(iii)(II). Rather,\nsection 707(b)(2)(A)(iii)(II) limits "allowable cure payments to cure payments on necessary\nproperty." Debtors propose to pay both contractual payments and arrearages on the Libra property\nmortgage. The court must therefore determine whether maintaining the Libra Property is a\nreasonably necessary expense.\nThe Trustee draws an analogy between Debtors\' effort to retain this property and a debtor\nproposing to fund a retirement account during a Chapter 13 plan. Courts generally hold that\n347\n\n\x0cvoluntary contributions to a pension fund or 401(k) account are not reasonably necessary expenses.\nThe problem with such an investment is that while it may "enhance an individual\'s financial\nsecurity," it does so impermissibly at the "expense of unpaid creditors."\nThe reasoning in these cases likewise applies to Debtors\' proposal to retain this property\nand pay the arrears through their plan. They assert that the property is necessary to "permit them\nto live in modest comfort" after their case is over. And, they suggest, "holding onto this property\n... in an improving market, could be ... a way of helping them make a fresh start." Prudent as this\ncourse may be, the Code does not allow debtors "to acquire financial security for the future at the\nexpense of [their] unsecured creditors." Debtors\' attempt to retain their investment would consume\nvirtually all of their projected disposable income and excluded funds that they would otherwise\ncontribute to their plan.\nThis results in a de minimis return to their creditors. It would be inequitable to allow\nDebtors to saddle their creditors with the burden of Debtors\' financial investment while they obtain\nthe benefits of a bankruptcy discharge. Retaining the Libra property is not a reasonably necessary\nexpense since Debtors operate it at a loss and it is not their primary residence. As such, Debtors\nmay not deduct the property\'s costs from their disposable income. The court sustains the Trustee\'s\nobjection because Debtors have not applied all of their projected disposable income toward the\nplan. [Court denied dismissal of the case, allowing the debtor to propose another plan.]\n\n12.10. Modification.\nConfirmation of a Chapter 13 plan does not give the debtor a safe harbor against improving\ncircumstances, nor does it protect creditors against declining circumstances. The debtor, the\nChapter 13 Trustee or any unsecured creditor may ask the court to modify the plan to increase or\ndecrease payments or make other changes that are appropriate in the light of changed\ncircumstances. See 11 U.S.C. \xc2\xa7 1329(a). The debtor remains under the scrutiny of the Chapter 13\ntrustee and the court until the plan is completed.\n\n12.11. Practice Problems: Developing a Chapter 13 Plan\nThe following questions concern Abraham and Mary Lincoln, who have been married for\nmany years, and have filed a joint Chapter 13 petition on January 1, 2015. Assume that the prime\nrate is 3.25%, and the Till rate in the local jurisdiction is 2% over prime (5.25%). Also assume that\nthe Lincolns\xe2\x80\x99 \xe2\x80\x9ccurrent monthly income\xe2\x80\x9d is above the median in the state. Note that all payoff\namounts below include the arrearages.\nHome. Lincolns jointly own and reside in a home worth $109,000, which is subject to the\ntwo mortgages and the unpaid property taxes listed below. The mortgages mature in 15\nyears. The Lincolns want to keep their home. What is the least amount they will be required\nto pay each month to secured creditors as part of a Chapter 13 plan to keep their home?\n\na) Property Taxes: Interest accrues at 1% per month. Their annual property taxes are\n\n$3,500, and they are one year in arrears. Note that under 11 U.S.C. \xc2\xa7 511, the statutory\ninterest rate applies to cure payments for property tax claims.\n348\n\n\x0cb) First Mortgage (HSBC): $110,000 payoff, $12,000 arrears, 9% contract rate, contract\npayments of $622/month. The loan documents do not say whether interest must be paid\non arrearages to cure the default.\n\nc) Second Mortgage (Beneficial): $34,568 payoff, $5,000 arrears, 9.75% contract rate,\n\ncontract payments of $344/month. The loan documents require interest to be paid on\narrearages to cure a default.\nKeep in mind the limitation in 11 U.S.C. \xc2\xa7 1322(b)(2), and the remaining rights under\n11 U.S.C. \xc2\xa7 1322(c)(1). You will need to calculate the amount of the monthly\npayments.\n\nRental Property. The Lincolns also jointly own a rental property currently worth $60,000.\nGreentree Financial holds a first mortgage to secure a debt of $129,000. The promissory\nnote requires payment of $1,202.82 per month and carries a 9.75% interest rate. The\nLincolns are $15,000 in arrears. The home generates rental income of $800 per month. The\nLincolns think the value of the property has bottomed and will be worth a lot more in the\nfuture, and would like to keep the property. How could the loan be restructured in Chapter\n13 to minimize the total payoff cost, and what amount would they be required to pay each\nmonth to achieve that goal? 11 U.S.C. \xc2\xa7 1325(a)(5)(B).\nCars. The Lincolns own two cars, both used for personal, family or household purposes.\n\na) Abraham has a 2011 Ford Ranger purchased in September 2013, valued at $16,000.\n\nFord Motor Credit holds a purchase money security interest (\xe2\x80\x9cPMSI\xe2\x80\x9d) to secure a loan\nbalance of $20,000. The Lincolns are $2,500 in arrears, and the contract interest rate is\n17.5%, resulting in original payments of $519 per month.\n\nb) Mary has a 2009 Hyundai Elantra purchased 8/10/2009. The current value is $3,000,\nand the car is subject to a PMSI from Ally Financial with a loan balance of $5,000. The\nLincolns are $750 in arrears, and the contract interest rate was 16.5%, resulting in\nmonthly contract payments of $225.00 per month.\nThe Lincolns would like to keep their cars. What can you do for them in Chapter 13, and\nhow much will their payments be on each of the cars? You will need to consider both the\nrestructuring rules in 11 U.S.C. \xc2\xa7 1325(a)(5)(B), and the limitation on restructuring in the\nflush language above 11 U.S.C. \xc2\xa7 1325(b)(1).\nPersonal Property. The Lincolns have furnished their home with living room and dining\nroom furniture sets that they purchased from Rent-A-Center. They purchased the furniture\n14 months ago for $9,000, paying $1,000 down and financing the $8,000 balance over 7\nyears at an interest rate of 22% per year, resulting in monthly payments of $187.41. The\ncurrent loan balance is $7,356.41. The retail value of the used furniture is no more than\n$1,500. How much would they have to pay each month to keep the furniture? Again,\nconsider the restructuring rules in 11 U.S.C. \xc2\xa7 1325(a)(5)(B), and whether the limitation\non restructuring in the flush language above 11 U.S.C. \xc2\xa7 1325(b)(1) applies.\nProjected Disposable Income. 11 U.S.C. \xc2\xa7 1325(b)(1)(B) requires the Debtors to pay all\nof their \xe2\x80\x9cprojected disposable income\xe2\x80\x9d during the 5 year plan term to unsecured creditors.\nDisposable income is defined in 11 U.S.C. \xc2\xa7 1325(b)(2) as \xe2\x80\x9ccurrent monthly income\xe2\x80\x9d less allowed\n349\n\n\x0cexpenses. \xe2\x80\x9cCurrent monthly income\xe2\x80\x9d is in turn defined in 11 U.S.C. \xc2\xa7 101(10A). Recall that the\nCourt in Hamilton v. Lanning, provides for the use of actual projected income rather than \xe2\x80\x9ccurrent\nmonthly income\xe2\x80\x9d if the Debtors\xe2\x80\x99 income has changed substantially.\nCalculation of Current Monthly Income. During the six month period before\nbankruptcy, Abraham slipped while shoveling snow from his driveway and broke several of his\nribs. As a result, Abraham was out of work on disability during three of the six full months\npreceding the bankruptcy filing. As a result of Abraham\xe2\x80\x99s reduced income while on disability, the\nDebtors had average gross income during the six full months before bankruptcy (Currently\nMonthly Income as defined in 11 U.S.C. \xc2\xa7 101((10A) of $4,000 per month, which includes the\n$800 per month in rental income that they received from the rental property. Abraham is now back\nat work, and the Lincolns now have gross wage income of $5,100 per month, plus the $800 per\nmonth in rental income.\nDeductible Living Expenses. After calculating current monthly income or Hamilton v.\nLanning income, you have to deduct the allowed living expenses to arrive at Projected Disposable\nIncome. 11 U.S.C. \xc2\xa7 1325(b)(2)(A). For a below median debtor, you would simply itemize the\nDebtor\xe2\x80\x99s expected living expenses, and the bankrutpcy court would have the power to strike any\nexpenses that the court did not deem \xe2\x80\x9creasonably necessary.\xe2\x80\x9d However, with above-median\ndebtors like the Lincolns, you have to use the expenses allowed in 11 U.S.C. \xc2\xa7 1325(b)(3) which\nhas three elements: (1) expenses allowed under the IRS\xe2\x80\x99s National Standards and Local Standards\nunder 11 U.S.C. \xc2\xa7707(b)(2)(A)(ii)(I), (2) payments to Chapter 13 priority creditors under 11\nU.S.C. \xc2\xa7707(b)(2)(A)(ii)(III), and (3) additional expenses allowed under 11 U.S.C.\n\xc2\xa7707(b)(2)(A)(iii) for the debt service payments on secured claims that you calculated above. Note\nthat no interest has to be paid to priority creditors under 11 U.S.C. 1322(a)(2).\n\na) National and Local Standards. The Lincoln\xe2\x80\x99s allowed expenses under the IRS National\nStandards and Local Standards (Section 707(b)(2)(A)(ii)(I) are $2,000 per month.\n\nb) The Lincolns will have Chapter 13 priority expenses for attorneys fees and Chapter 13\ntrustee Fees.\n\xef\x82\xb7\n\nAttorney Fees. Assume that the Lincolns will have to pay $3,500 to their\nbankruptcy attorney in monthly installments for Chapter 13 legal services.\nThese fees are entitled to priority under 11 U.S.C. \xc2\xa7 503(b)(1)(A).\n\n\xef\x82\xb7\n\nChapter 13 Trustee Fees. Each Chapter 13 Trustee charges a commission rate,\nset by the United States Trustee, on all money that is distributed to creditors by\nthe Chapter 13 Trustee. In some jurisdictions, all payments (secured and\nunsecured) go through the Chapter 13 trustee. In other jurisdictions, the debtor\npays directly the debtor\xe2\x80\x99s regular post-petition secured debt payments, while\ncure payments, restructured loan payments and unsecured distributions go\nthrough the Chapter 13 trustee. For the purpose of calculating the actual\ndistribution to creditors, and meeting the best-interests-of-creditors test, assume\nthat the Chapter 13 Trustee\xe2\x80\x99s commission rate is 10% on any distributions paid\nby the Chapter 13 trustee to creditors, and that the local jurisdiction allows\nordinary debt service payments (but not cure and restructuring payments) to be\npaid directly to the creditors, bypassing the Chapter 13 trustee. The fees will\nalso be entitled to priority under 11 U.S.C. \xc2\xa7 503(b)(1)(A).\n350\n\n\x0cProblem 1: Calculate the payments to secured creditors, and the amount of projected\ndisposable income that the Lincolns must pay under a plan of reorganization.\nProblem 2: If the trustee or a creditor objects to the plan on the grounds that keeping the\nrental property is unfair to unsecured creditors, can you make an argument under 11 U.S.C.\n\xc2\xa7707(b)(2)(A)(iii) that the statute would permit keeping the property? Would the standard for\nconsidering this issue be different if the Lindolns were below median debtors? Compare 11 U.S.C.\n\xc2\xa7 1325(b)(2) and 11 U.S.C. \xc2\xa7 1325(b)(3).\nProblem 3: Calculate the distribution to unsecured creditors under the Chapter 13 plan\nthat you have developed. Assume that the Debtors have general unsecured debts totaling $100,000,\nnot counting any of the secured or priority debts listed above.\nProblem 4: Explain how the monthly payment would change if Abraham used the Ford\nRanger primarily as a work vehicle. You do not need to change all of your calculations for the\nplan.\nProblem 5. In addition to the above facts, assume that the Lincolns own a 20 acre parcel\nof undeveloped land in Onondaga County that is free and clear of liens. The Lincolns believe that\nthe land may have great value when the western United States runs out of water and those residents\nmigrate back to the Syracuse area. The Lincolns claim that the land could be liquidated for $39,000\nafter sales commissions. A creditor has objected to the plan claiming that the property could be\nliquidated for $42,000. Explain whether confirmation depends on the value of the property? See\n11 U.S.C. \xc2\xa7 1325(a)(4).\n\n351\n\n\x0cChapter 13: Business Reorganizations under Chapter 11\n13.1.\n\nIntroduction to Chapter 11 of the Bankruptcy Code\n\nChapter 11 is a very flexible chapter for reorganizing businesses. Because of the chapter\xe2\x80\x99s\nflexibility, it is also very expensive. Chapter 11 is designed to be a negotiated plan with the\ncreditors. It provides for negotiating the plan terms with the relevant class of creditors, and for a\nvoting mechanism to bind minority creditors who are not willing to go along with the will of the\nmajority. Chapter 11\xe2\x80\x99s fundamental purpose is to address the holdout problem \xe2\x80\x93 the problem that\nsome minority creditors will always hold out for a better deal \xe2\x80\x93 that often prevents an out-of-court\nworkout from proceeding.\nWe begin by understanding the plan process: what provisions must be contained in a\ndisclosure statement and plan, how the plan is negotiated, and how does the voting process work.\nWe will then look at the requirements for confirming the plan, including the so-called \xe2\x80\x9ccramdown\xe2\x80\x9d\nfor confirming a plan over the objection of an impaired class of creditors. Finally, we will consider\na popular method of reorganization that avoids the strictures of Chapter 11 \xe2\x80\x93 the pre-plan\nbankruptcy sale of the debtor\xe2\x80\x99s entire business to a new entity. This procedure was recently\nemployed by giant corporations like General Motors and Chrysler at the federal government\xe2\x80\x99s\nbehest. We will consider whether such sales are consistent with the purposes of Chapter 11.\n\n13.2.\n\nThe Chapter 11 Process\n\nThe Chapter 11 process generally begins very much like a Chapter 7 case. The Debtor files\na petition and schedules closely mirroring the ones the debtor would file in Chapter 7. Unlike\nChapter 7, however, a trustee is not automatically appointed to take control of and liquidate the\ndebtor\xe2\x80\x99s assets. Instead, the individual debtor in an individual case, or the prepetition management\nof the debtor in an entity case, continue to operate the business in Chapter 11 as a \xe2\x80\x9cdebtor in\npossession.\xe2\x80\x9d Except for the right to compensation, the debtor in possession has the powers under\nthe Bankruptcy Code given to a trustee. 11 U.S.C. \xc2\xa7 1107(a). The court retains the power to appoint\na Chapter 11 trustee for \xe2\x80\x9ccause\xe2\x80\x9d or in the best interests of the estate (11 U.S.C. \xc2\xa7 1104(a)), but\nChapter 11 trustees are the exception not the rule.\nThe official committee of unsecured creditors, consisting of the seven creditors holding the\nlargest claims who are willing to serve, is organized by the United States Trustee, and serves to\nbalance and operate as a check on the powers of the debtor in possession. 11 U.S.C. \xc2\xa7 1102(b)(1).\nThe members of the official committee are fiduciaries acting on behalf of all unsecured creditors,\nand will generally retain counsel at the expense of the debtor\xe2\x80\x99s estate to review and monitor the\ndebtor in possession\xe2\x80\x99s activities. The creditors\xe2\x80\x99 committee can seek the appointment of a Chapter\n11 trustee if the committee loses confidence in the debtor in possession\xe2\x80\x99s management, and the\ncommittee plays an important role in the plan negotiation process.\nIn an appropriate case, the Court can appoint additional official committees who are\nentitled to administrative claims against the bankruptcy estate for their costs and attorney fees \xe2\x80\x93 to\nrepresent other constituents in the case (such as stockholders, bondholders, secured creditors, etc.).\nUnofficial committees are often formed by interested groups to act jointly in the case to protect\n352\n\n\x0ctheir own interests. Unofficial committees must show that they have rendered benefit to the estate\nin order to recover their costs and fees from the bankruptcy estate as an administrative expense.\nIf there are doubts about the debtor in possession\xe2\x80\x99s honesty or competence, the Court can\nupon request appoint an examiner \xe2\x80\x93 a professional (usually lawyer, business expert or accountant)\n\xe2\x80\x93 to review a particular issue or more broadly consider whether to recommend the appointment of\na Chapter 11 trustee. 11 U.S.C. \xc2\xa7 1104(c).\nOne can imagine that the costs of multiple sets of professionals reviewing each other\xe2\x80\x99s\nwork can quickly skyrocket, which is one reason that large Chapter 11 cases are so expensive. The\nbankruptcy court has to carefully consider the size and complexity of the case in deciding whether\nmultiple official committees are appropriate.\n\n13.3.\n\nThe Exclusivity Period\n\nOnly the debtor in possession can file a plan of reorganization during the exclusivity period.\nThis gives the debtor in possession a great deal of power in the Chapter 11 process by requiring\nall creditors and equity security holders to negotiate with the debtor in possession for a\nreorganization plan. Once the exclusivity period ends, any party in interest can file a plan\n(including a liquidating plan), which can promptly doom the reorganization.\nThe initial exclusivity period is 120 days from the filing of the case for the debtor to\npropose a plan, and 180 days from the filing of the case to confirm a plan. 11 U.S.C. \xc2\xa7 1121(b)\nand (c).\nIn the early days of the Bankruptcy Code, the bankruptcy court could extend the exclusivity\nperiod indefinitely, and in large cases often did so right at the beginning of the case to center\nnegotiating authority with the debtor in possession. However, in 2005 Congress amended the\nBankruptcy Code to put real limits on the bankruptcy court\xe2\x80\x99s power to extend the exclusivity\nperiod: the 120 day period to propose a plan cannot be extended beyond 18 months from the filing\ndate, and the 180 day period to confirm a plan timely filed cannot be extended beyond 20 months\nfrom the filing date. 11 U.S.C. \xc2\xa7 1121(d)(2).\nThe exclusivity period also ends automatically if a Chapter 11 trustee is appointed. 11\nU.S.C. \xc2\xa7 1121(c)(1).\n\n13.4.\n\nNegotiating a Plan and the Disclosure Statement\n\nThe Bankruptcy Code prohibits a plan proponent from soliciting acceptance or rejection of\na plan unless the proponent provides the solicitee with a copy of the plan and a bankruptcy-courtapproved disclosure statement. 11 U.S.C. \xc2\xa7 1125(b). Strict adherence to this rule would put the\ncart before the horse, because one would have to complete the plan and obtain court approval for\nthe disclosure statement before negotiating the plan terms with creditors. As long as a formal vote\nis not being solicited, a plan proponent may have general discussions about plan terms with\ncreditors without violating the rule. Care must be taken during planning stages not to seek formal\nvoting commitments during the negotiations.\nAfter some general negotiations, the plan proponent must draft a plan of reorganization\nand disclosure statement. The disclosure statement is like a security prospectus \xe2\x80\x93 it must contain\n353\n\n\x0c\xe2\x80\x9cadequate information\xe2\x80\x9d which is defined in the Bankruptcy Code as all information that a\nreasonable investor typical of holders of claims and interests would require to make an informed\njudgment in voting on the plan. Unlike security offerings outside of bankruptcy, however, the\nproponent does not have to make a guess about what information need be disclosed and then bear\nthe risk of a lawsuit if the information is deficient. Instead, the proponent must obtain the\nbankruptcy court\xe2\x80\x99s approval for the disclosure statement, and is protected from later claims of\ndeficiency as long as the disclosure statement was submitted in good faith. See 11 U.S.C. \xc2\xa7 1125\n(e).\nThe process of seeking approval of a disclosure statement is rather convoluted because of\nthe prohibition against seeking acceptances before the disclosure statement has been approved by\nthe bankruptcy court. The plan proponent files the proposed plan and disclosure statement with\nthe bankruptcy court, and sets a date for the hearing on the disclosure statement. The disclosure\nstatement and plan can only be mailed out to the debtor, trustee, the committees and the SEC.\nCreditors and other parties in interest just get a notice stating the hearing date, the deadline for\nfiling objections to the proposed disclosure statement, and that the proposed disclosure statement\nis available from the court or will be sent to anyone else who in writing requests a copy. Only\nthose who request a copy of the proposed disclosure statement will receive one. See Bankruptcy\nRule 3017.\nProper objections at the disclosure statement stage are only to the adequacy of disclosure,\nnot the merits of the plan itself. Parties in interest who believe that the disclosure statement\ncontains insufficient disclosure or is confusing can ask for additional disclosure or clarification\nbefore the statement is approved by the Court. Courts are liberal in requiring additional disclosure\nor clarification. Some courts will consider the merits at the disclosure statement stage if, under a\nsummary judgment type standard, the plan is not confirmable on its face. Arguments about\nconfirmation that depend on the result of the votes, of course, are not proper at the disclosure\nstatement stage and should be held for the confirmation hearing after the voting has occurred.\nIt is common for additional modifications to be made to the disclosure statement both\nbefore the disclosure statement hearing, and after in response to the bankruptcy court\xe2\x80\x99s\nrequirements.\nAfter the bankruptcy court approves the proposed disclosure statement, an order approving\nthe disclosure statement, setting the date for the confirmation hearing, the deadline for filing\nobjections to confirmation, and the deadline for submitting a ballot, along with the approved\ndisclosure statement, plan of reorganization, ballot and voting instructions is mailed to all creditors\nand parties in interest. The plan proponent then receives and tabulates the ballots. If sufficient\nvotes are obtained for confirmation, the case proceeds to confirmation. If not, the proponent can\nstart over.\nThe confirmation hearing can be a full blown trial on whether the requirements for\nconfirmation can be met, or can be a rather simple affair if there are no major contests. Some\njudges accept an offer of proof and confirm the plan if the requirements are met and there is no\nmaterial opposition. Other judges require the proponent to call witnesses and prove each of the\nrequirements for confirmation even in the absence of a material objection. Confirmation is\ngoverned by Section 1129 of the Bankruptcy Code, which we will review in some detail.\n354\n\n\x0cAfter confirmation, the plan goes into effect. Entities receive an immediate discharge of all\ndebts not provided for by the plan. 11 U.S.C. \xc2\xa7 1141(d)(1). As in Chapter 13, individuals receive\na discharge only upon completing the plan. See 11 U.S.C. \xc2\xa7 1141(d)(5).\nThe normal process of confirmation is very time consuming. The proponent must give at\nleast 28 days\xe2\x80\x99 notice of the hearing on the disclosure statement, and an additional 28 days\xe2\x80\x99 notice\nfor the hearing on confirmation. Bankruptcy Rule 2002(b). Objections and modifications slow the\nprocess down even further.\nMany companies believe that the stigma of being in bankruptcy will harm their ability to\ndo business, and want to be in and out of bankruptcy as quickly as possible. One popular method\nfor minimizing the time in bankruptcy is the pre-packaged plan of reorganization, permitted by\nSection 1125(g) of the Bankruptcy Code\nThe idea of a pre-pak is to negotiate the plan terms before filing bankruptcy, obtain\nsufficient consents from creditors to meet the confirmation requirements before filing bankruptcy,\nand then file the petition with the consents and proceed immediately to confirmation avoiding the\ndisclosure statement process entirely. See 11 U.S.C. \xc2\xa7 1125(g). The difficulty is that the\nbankruptcy court must find in hindsight that the pre-bankruptcy disclosure and solicitation\ncomplied with the Bankruptcy Code\xe2\x80\x99s disclosure statement requirements (and complied with\napplicable non-bankruptcy law \xe2\x80\x93 law that generally does not exist) \xe2\x80\x93 otherwise the solicitation\nmust start over under the bankruptcy court\xe2\x80\x99s supervision. Id.\n\n13.5.\n\nClassification\n\nAt the core of Chapter 11 is the classification and voting process. The plan must put\ncreditors in classes, provide for the treatment of the claims in each class, solicit votes from the\ncreditors in each class, and obtain the votes of the requisite class majorities to obtain class\nacceptance. The plan can be confirmed only if all classes accept with the requisite majorities, or\nthe debtor can satisfy the \xe2\x80\x9ccramdown\xe2\x80\x9d requirements with respect to each class that does not accept\nby the requisite majorities. See 11 U.S.C. \xc2\xa7 1129(a)(8), (b)(1).\nSection 1122 contains the main rule on classification. It requires claims that are not\n\xe2\x80\x9csubstantially similar\xe2\x80\x9d to be placed in separate classes. Secured claims are not \xe2\x80\x9csubstantially\nsimilar\xe2\x80\x9d to unsecured claims. First priority secured claims are not \xe2\x80\x9csubstantially similar\xe2\x80\x9d to second\npriority secured claims. Secured claims against one property are not substantially similar to\nsecured claims against another property. Thus, secured claims must be put in their own separate\nclasses, unless they are secured by the same property and in the same priority (like bonds).\nPriority claims must be separately classified according to their priority, except for some\nunexplained reason administrative claims, gap claims, and tax claims which cannot be classified\nat all. See 11 U.S.C. \xc2\xa7 1123(a)(1). Often plans will list these claims in \xe2\x80\x9cnon-classified classes.\xe2\x80\x9d\nThe Bankruptcy Code allows the creation of a small claims class for administrative\nconvenience. 11 U.S.C. \xc2\xa7 1122(b). These claims can be treated better than other general unsecured\nclaims.\nThe main area of classification dispute concerns whether general unsecured claims can be\nseparately classified for strategic reasons. Section 1122 of the Bankruptcy Code requires separate\n355\n\n\x0cclassification for different claims, but it does not prohibit separate classification for similar claims.\nThe common law has restricted the separate classification of similar claims made for strategic\npurposes (usually to meet the confirmation requirement in Section 1129(a)(10) of the Bankruptcy\nCode that one impaired class vote for the plan). The rules on separately classifying similar claims\nare set forth below in the US Truck and Bernard Steiner cases. The main classification controversy\ndiscussed in the Greystone and SM 103 cases concerns whether the huge unsecured deficiency\nclaim of a secured creditor under section 506(a) can or must be separately classified from the\nclaims of other general unsecured creditors. In large real estate cases, the answer to the question\nmay dictate whether the debtor can reorganize under Chapter 11 or not.\n\n13.6.\n\nVoting and Impairment\n\nA class of creditors accepts the plan if at least 2/3 in amount of claims and more than 1/2\nin number of creditors in the class, who vote, vote to accept the plan. Only those who vote count\nin the denominator \xe2\x80\x93 non-voters are ignored. 11 U.S.C. \xc2\xa7 1126(c). Both the amount and number\nrequirements must be met for acceptance. Only the 2/3 in amount requirement applies to interest\nholders (2/3rds of shares, for example). 11 U.S.C. \xc2\xa7 1126(d). The court can exclude the vote of\nanyone who did not vote in good faith, or whose votes were not solicited or procured in good faith.\n11 U.S.C. \xc2\xa7 1126(e).\nTwo other rules are important. Classes who are unimpaired are deemed to accept the plan,\nand classes who receive or retain nothing under the plan are deemed to reject the plan. 11 U.S.C.\n\xc2\xa7 1126(f), (g). The concept of impairment is a technical one. With one exception, any change in\nthe claimant\xe2\x80\x99s (or interest holders) legal, equitable or contractual rights \xe2\x80\x93 whether for the better or\nworse \xe2\x80\x93 is an impairment. 11 U.S.C. \xc2\xa7 1124(1). The one exception is that the curing of a default\ncan leave the creditor unimpaired if the creditor is both cured and compensated for the default, and\nthe creditor\xe2\x80\x99s legal, equitable and contractual rights are not otherwise affected. 11 U.S.C. \xc2\xa7\n1124(2).\n\n13.7.\n\nNon-Recourse Debt and the Section 1111(b) Election\n\nNon-recourse debt is debt that is secured only by property and not by the debtor\xe2\x80\x99s personal\npromise to pay. In essence, the creditor has agreed to look only to the property for payment and\nhas waived the right to recover a deficiency judgment against the borrower if the collateral is\ninsufficient to satisfy the debt. Non-recourse debt is commonly used in large business transactions,\nand in some states certain kinds of consumer debts are statutorily non-recourse. It is very rare to\nsee consensually non-recourse debts in consumer transactions.\nOne of the most strategically complex bankruptcy provisions is contained in Section 1111\nof the Bankruptcy Code.\nSection 1111(b)(1) of the Bankruptcy Code automatically turns non-recourse debt into\nrecourse debt in Chapter 11 if the debtor is keeping the collateral, unless the debtor makes the\nSection 1111(b)(2) election. Thus, even though the loan is non-recourse, if the debtor proposes to\nstrip the claim down under Section 506(a), the nonrecourse creditor gets an unsecured claim for\nthe deficiency (unless the creditor makes the Section 1111(b)(2) election, discussed below). On\n356\n\n\x0cthe other hand, if the debtor proposes to sell the collateral, the creditor must live with the nonrecourse deal that was originally made.\nSection 1111(b)(2) of the Bankruptcy Code allows a secured creditor to elect to be treated\nas fully secured by giving up its Section 506(a) unsecured deficiency claim. However, two types\nof creditors cannot elect under Section 1111(b)(2): (1) a secured creditor whose lien is of\ninconsequential value (junior lienholder who has very little or no equity in the property, for\nexample), and (2) a recourse creditor whose collateral is being sold under Section 363 or in the\nplan. There is no reason for recourse creditors to make the election if their property is being sold,\nsince they can credit bid at the sale up to the full amount of the debt. See 11 U.S.C. \xc2\xa7 363(k).\nRecourse creditors who elect under Section 1111(b)(2) when property is being sold would be\ngiving up their deficiency claims without receiving any economic benefit in return.\nAt first blush, the creditor\xe2\x80\x99s ability to prevent the debtor from stripping down a secured\nclaim by making the Section 1111(b)(2) election would seem like a tremendous secured creditor\nbenefit, but as we will see creditors who make the Section 1111(b)(2) election do not really have\nfully secured claims. Under the cramdown rules, these creditors are not entitled to full payment in\npresent value terms. Except in unusual situations where the election may provide a strategic benefit\ndue to the language used in the proposed plan of reorganization, or where the creditor expects the\ndebtor to default after confirmation, undersecured creditors will be better off not making the\nSection 1111(b)(2) election.\n\n13.8.\n\nCases on Classifying Claims in Chapter 11 Reorganizations\n13.8.1.1.\n\nIN RE US TRUCK CO., 800 F.2d 581 (6th Cir. 1986)\n\nThe Teamsters Negotiating Committee (the Teamsters Committee), a creditor of [Chapter\n11 debtor] U.S. Truck \xe2\x80\x94appeals the District Court\'s order confirming U.S. Truck\'s Fifth Amended\nPlan of Reorganization. The District Court held that the requirements of section 1129 had been\nsatisfied. We agree.\nAfter filing its petition for relief under Chapter 11, U.S. Truck rejected the collective\nbargaining agreement [with the Union]. New agreements have been negotiated to the satisfaction\nof each participating local union. Such agreements have been implemented over the lone dissent\nof the Teamsters Joint Area Rider Committee. [After rejection] U.S. Truck was able to record\nmonthly profits in the range of $125,000 to $250,000. These new agreements achieved such results\nby reducing wages and requiring employees to buy their own trucking equipment, which the\nemployees then leased to the company.\nThe Teamsters Committee\'s first objection is that the plan does not meet the requirement\nthat at least one class of impaired claims accept the plan, see 11 U.S.C. \xc2\xa7 1129(a)(10), because\nU.S. Truck impermissibly gerrymandered the classes in order to neutralize the Teamsters\nCommittee\'s dissenting vote. The Teamsters Committee argues that Class XI should have included\nClass IX [the Teamster\xe2\x80\x99s class], and hence was an improperly constructed class.\nThe issue raised by the Teamsters Committee\'s challenge is under what circumstances does\nthe Bankruptcy Code permit a debtor to keep a creditor out of a class of impaired claims which are\nof a similar legal nature as those of the "isolated" creditor. The District Court held that the Code\n357\n\n\x0cpermits such action here because of the following circumstances: (1) the employees represented\nby the Teamsters Committee have a unique continued interest in the ongoing business of the\ndebtor; (2) the mechanics of the Teamsters Committee\'s claim differ substantially from those of\nthe Class XI claims; and (3) the Teamsters Committee\'s claim is likely to become part of the agenda\nof future collective bargaining sessions between the union and the reorganized company. Thus,\naccording to the court, the interests of the Teamsters Committee are substantially dissimilar from\nthose of the creditors in Class XI. Congress has sent mixed signals on the issue that we must decide.\nOur starting point is 11 U.S.C. \xc2\xa7 1122. The statute, by its express language, only addresses the\nproblem of dissimilar claims being included in the same class. It does not address the correlative\nproblem \xe2\x80\x94 the one we face here \xe2\x80\x94 of similar claims being put in different classes. Some courts\nhave seized upon this omission, and have held that the Code does not require a debtor to put similar\nclaims in the same class.\nU.S. Truck is using its classification powers to segregate dissenting (impaired) creditors\nfrom assenting (impaired) creditors (by putting the dissenters into a class or classes by themselves)\nand, thus, it is assured that at least one class of impaired creditors will vote for the plan and make\nit eligible for cram down consideration by the court. We agree with the Teamsters Committee that\nthere must be some limit on a debtor\'s power to classify creditors in such a manner. The potential\nfor abuse would be significant otherwise. Unless there is some requirement of keeping similar\nclaims together, nothing would stand in the way of a debtor seeking out a few impaired creditors\n(or even one such creditor) who will vote for the plan and placing them in their own class.\nThe District Court noted three important ways in which the interests of the Teamsters\nCommittee differ substantially from those of the other impaired creditors. Because of these\ndifferences, the Teamsters Committee has a different stake in the future viability of the reorganized\ncompany and has alternative means at its disposal for protecting its claim. The Teamsters\nCommittee\'s claim is connected with the collective bargaining process. In the words of the\nCommittee\'s counsel, the union employees have a "virtually unique interest." These differences\nput the Teamsters Committee\'s claim in a different posture than the Class XI claims. The Teamsters\nCommittee may choose to reject the plan not because the plan is less than optimal to it as a creditor,\nbut because the Teamsters Committee has a noncreditor interest \xe2\x80\x94 e.g., rejection will benefit its\nmembers in the ongoing employment relationship. Although the Teamsters Committee certainly\nis not intimately connected with the debtor, to allow the Committee to vote with the other impaired\ncreditors would be to allow it to prevent a court from considering confirmation of a plan that a\nsignificant group of creditors with similar interests have accepted. Permitting separate\nclassification of the Teamsters Committee\'s claim does not automatically result in adoption of the\nplan. The Teamsters Committee is still protected by the provisions of subsections (a) and (b),\nparticularly the requirements of subsection (b) that the plan not discriminate unfairly and that it be\nfair and equitable with respect to the Teamsters Committee\'s claim. In fact, the Teamsters\nCommittee invokes those requirements, but as we note in the following sections, the plan does not\nviolate them.\nThe District Court\'s judgment is affirmed.\n\n358\n\n\x0c13.8.1.2.\nIN RE BERNHARD STEINER PIANOS USA, INC.,\n292 B.R. 109 (Bankr. N.D. Tex. 2002)\nThis opinion addresses [an] issue which appears frequently in contested confirmation\nhearings: classification of claims. Although this case is not of national importance, it is very\nimportant to the parties involved.\nBernhard Steiner Pianos was established in Europe in 1886. In 1903, the company moved\noperations to South Africa. Bernhard Steiner Pianos was a part of the Kahn Pianos Group, a family\nbusiness owned by the Kahn family. The Kahn family enjoys an international reputation in the\npiano industry, with Ivan Kahn being the fourth generation of piano makers in the family.\nIn 1976, Ivan Kahn and members of his family relocated to the United States and\nestablished Bernhard Steiner Pianos USA, Inc. ("Debtor") in North Dallas. The company deals in\nthe sale and service of new and used pianos of all descriptions. The company sells new pianos,\nconsigns used pianos, and repairs and refurbishes pianos. By 2001, annual sales had reached over\n$3.3 million.\nUnfortunately, the Kahn family also entered into other areas of commerce in Africa. Ivan\nKahn\'s father and mother contracted with the Nigerian government relating to certain construction.\nThe Kahn family was to provide services and the Nigerian government would then submit payment\nfor those services. Ivan Kahn was told that some $30 million had been set aside for payment of his\nfamily\'s debt. The Kahn family eventually depleted their funds in this pursuit. Mr. Kahn began\nassisting his family in recovering the Nigerian funds through his financial support. Kahn\neventually depleted his own funds.\nIn order to free up some capital to pursue the Nigerian funds, the Debtor began to finance\nsome of its pianos. The Debtor found financing through the Objecting Creditors, who provided\npianos to the company on a floor plan basis, i.e., the pianos were brought into the store and once a\npiano was sold, the funds received were used to pay the floor planner for that particular piano.\nKahn provided individual guarantees to these lenders.\nIn a self-described "misguided" attempt to aid his family, Kahn began borrowing funds\nfrom the Debtor without repaying on a timely basis, if at all. To further compound the situation,\nthe events of September 11, 2001 were far-reaching and even impacted negatively a piano store in\nDallas, Texas. After the terrorist attacks, piano sales fell dramatically for Mr. Kahn. In late 2001\nand early 2002, sales were also dismal. Due to the Debtor\'s cash crunch, funds were not turned\nover to the Objecting Creditors providing the floor plan financing. The collateral was exceeded by\nthe debt owed to those entities. Debtor, and Kahn, found themselves out of trust with the Objecting\nCreditors.\nDebtor filed this bankruptcy proceeding on March 14, 2002. Debtor remained open for\nbusiness during the pendency of this bankruptcy. Early in the case, the Objecting Creditors\nobtained relief from the automatic stay, and repossessed their remaining collateral.\nDuring this bankruptcy case, Debtor entered into a Court-approved agreement with a third\nparty whereby the third party would provide pianos to Debtor and would also pay for the cost of\noperations for a 90 day period. In return, Debtor and the third party split the profits from the sale.\nDuring this 90 day period, Debtor sold $1 million worth of pianos and netted $45,000. Thereafter,\n359\n\n\x0cDebtor entered into another Court-approved agreement with another third party who presently\nprovides pianos to Debtor for sale.\nDebtor filed its Debtor\'s Plan of Reorganization dated September 13, 2002 (the "Plan").\nThe Plan contemplates repayment of Debtor\'s creditors on a 100% basis. Kahn testified that in\norder for Debtor to repay its creditors, Debtor must maintain a successful operation. Kahn further\ntestified that Debtor\'s ability to continue successfully in business will require that the Debtor attract\ngood consignment pianos; the sale of new pianos alone will not suffice.\nTypically, consignment pianos come from individual owners. Most of the consignment\nbusiness is by word of mouth. In the piano industry, if a consignee gets the reputation that it is\nunwilling or unable to pay consignors, the consignee won\'t be able to attract good consignment\npianos. Kahn testified that it would be very difficult to supplement any lost consignment income\nthrough other operations. Kahn testified that the quicker the Debtor repays the consignment class,\nthe quicker they will get new consignment pianos.\nKahn testified that he will remain the president of the company after confirmation. Largely\nspeaking, Mr. Kahn is all that is left of the Debtor. The company\'s only tangible assets are some\ndesks and some old wood. At the confirmation hearing, the parties were complimentary of Mr.\nKahn\'s heroic efforts at keeping the Debtor in operation. Through his management during the\npendency of the bankruptcy, Kahn singlehandedly managed to keep the Debtor\'s doors open. The\nBernhard Steiner Pianos name is closely associated with Kahn and the Kahn family in the minds\nof the piano-buying public. The public identifies the Debtor and Mr. Kahn as one and the same.\nThe Plan was ultimately approved by all the impaired classes except for Class 6, of which the\nObjecting Creditors, the floor plan lenders, are members.\nThe Plan separately classifies creditors whose claims arose from consigned goods and\ngeneral unsecured claims, including the claims of the floor plan Objecting Creditors.\nThe consignment creditors, Class 4, will be repaid over a term of 10 months beginning on\nthe effective date of the plan. The floor plan lenders are part of the allowed general unsecured\nclass, Class 6. Under the Plan, as originally drafted, their scheduled payments begin after full\npayment to Class 4, approximately one year after the effective date. Under an agreed modification\nmade in Court after the effective date, the Class 6 creditors will also begin to receive a portion of\nexcess cash flow. Based on the record, the excess cash flow payments should begin before the\nClass 4 consignment claims are paid in full. Despite the favorable change in the payment schedule,\nthe Objecting Creditors still object and argue that both Class 4 and Class 6 should be placed in the\nsame class.\nAll unsecured claims outstanding as of the commencement of the case, and claims arising\nfrom the rejection of executory contracts or unexpired leases, may be classified together as general\nunsecured claims. However, the Code does not require that all such claims be placed within a\nsingle class. See also In re U.S. Truck Co., Inc., 800 F.2d 581 (6th Cir. 1986). Separate classification\nof some unsecured claims is allowed if the classification scheme is reasonable.\nThe Fifth Circuit has taught that, as a general premise, substantially similar claims, or those\nwhich share common priority and rights against the debtor\'s estate, should be placed in the same\nclass. Matter of Greystone, 995 F.2d 1274 (5th Cir. 1992). Substantially similar claims are not\npermitted to be separately classified "in order to gerrymander an affirmative vote on a\nreorganization plan."\n360\n\n\x0cNevertheless, in this Circuit, separate classification is permitted for "good business\nreasons." In the present case, the Debtor has met the good business reason test. Selling consigned\npianos has historically been an important part of the Debtor\'s business and is contemplated to be\nan integral part of the Debtor\'s future. Debtor presented evidence, which was not rebutted, that its\nconsignment business had suffered significantly since word had leaked out that Debtor did not\nremit the proceeds from the sale of consigned pianos. Kahn testified that the consignment market\nis local and small, and adverse local community opinion affected whether pianos would be\nconsigned to the Debtor or to its competitors. Kahn also testified that competitors were informing\npotential consignors that Debtor had failed to remit the sale proceeds to its past consignors. The\nundisputed testimony is that the Class 4 consignment creditors were separately classified so as to\naccelerate repayment to them so Debtor could begin expeditiously to repair its tarnished\nconsignment name in a small market. Improving the consignment public\'s perception of this\nDebtor and restoring trust in the Debtor among potential consignors as soon as possible is\nimportant to the success of the reorganization overall.\nNo evidence of gerrymandering was offered at the confirmation hearing. Debtor\'s\nprincipal, Mr. Kahn, testified that the development of future consignment business was necessary\nto its successful reorganization and accordingly, for the repayment of its creditors. Further, the\nPlan, on its face, treats the consignment class and the general unsecured class differently. The\nDebtor has presented a good business reason for the separate classification and treatment of\nconsignment creditors in Class 4 from the claims of the general unsecured creditors; therefore, the\nCourt overrules the classification objection.\n\n13.8.1.3.\nPHOENIX MUT. LIFE v. GREYSTONE III JOINT\nVENTURE, 995 F.2d 1274 (5th Cir. 1991)\nEDITH H. JONES, Circuit Judge:\nThis appeal pits a debtor whose only significant asset is an office building in the troubled\nAustin, Texas real estate market against a lender who possesses a multi-million dollar lien on the\nproperty. After obtaining bankruptcy relief under Chapter 11, Greystone III proposed a\n"cramdown" plan of reorganization, hoping to force a writedown of over $3,000,000 on the secured\nlender\'s note and to retain possession and full ownership of the property. Over the secured lender\'s\nstrenuous objections, the bankruptcy court confirmed the debtor\'s plan.\nAppellant Phoenix Mutual Life Insurance Corporation lent $8,800,000, evidenced by a\nnon-recourse promissory note secured by a first lien, to Greystone to purchase the venture\'s office\nbuilding. When Greystone defaulted on the loan, missing four payments, Phoenix posted the\nproperty for foreclosure. Greystone retaliated by filing a Chapter 11 bankruptcy reorganization\npetition.\nAt the date of bankruptcy Greystone owed Phoenix approximately $9,325,000, trade\ncreditors approximately $10,000, and taxing authorities approximately $145,000. The bankruptcy\ncourt valued Phoenix\'s secured claim at $5,825,000, the appraised value of the office building,\nleaving Phoenix an unsecured deficiency of approximately $3,500,000 \xe2\x80\x94the difference between\nthe aggregate owed Phoenix and its secured claim.\n361\n\n\x0cAs filed, Greystone\'s Plan of Reorganization, the confirmation of which is challenged in\nthis appeal, separately classified the Code-created unsecured deficiency claim of Phoenix Mutual\nand the unsecured claims of the trade creditors. The Plan proposed to pay Phoenix and the trade\ncreditors slightly less than four cents on the dollar for their unsecured claims, but it also provided\nthat Greystone\'s general partner would satisfy the balance of the trade creditors\' claims after\nconfirmation of the Plan.\nIn a separate class, the Plan further provided for security deposit "claims" held by existing\ntenants of the office building. These claimants were promised, notwithstanding the debtor\'s\neventual assumption of their leases, 11 U.S.C. \xc2\xa7 365, 25% of their deposits upon approval of the\nPlan and 50% of their deposits at the expiration of their respective leases. The Plan stipulated that\nthe general partner would "retain its legal obligations and ... pay the [tenant] ... creditors the\nbalance of their claims upon confirmation."\nFinally, Greystone\'s Plan contemplated a $500,000 capital infusion by the debtor\'s partners,\nfor which they would reacquire 100% of the equity interest in the reorganized Greystone.\nUnsurprisingly, Phoenix rejected this Plan, while the trade creditors and the class of holders\nof tenant security deposits voted to accept it. On January 27, 1989, the bankruptcy court held a\nconfirmation hearing at which the Debtor orally modified its Plan to delete the statements that\nthe general partner would pay the balance of trade debt and tenant security deposit claims\nafter confirmation. A Phoenix representative testified that the insurance company was willing to\nfund its own plan of reorganization by paying off all unsecured creditors in cash in full after\nconfirmation. The bankruptcy court refused to consider this proposal and then confirmed\nGreystone\'s modified Plan. The district court upheld the confirmation.\nPhoenix attacks Greystone\'s classification of its unsecured deficiency claim in a separate\nclass from that of the other unsecured claims against the debtor. This issue benefits from some\nbackground explanation.\n[The court then discusses the requirement that one impaired class of creditors vote for the\nplan under \xc2\xa7 1129(a)(10)]. Classification of claims thus affects the integrity of the voting process,\nfor, if claims could be arbitrarily placed in separate classes, it would almost always be possible for\nthe debtor to manipulate "acceptance" by artful classification.\nIn this case, Greystone\'s plan classified the Phoenix claim in separate secured and\nunsecured classes, a dual status afforded by 11 U.S.C. \xc2\xa7 1111(b) despite the nonrecourse nature of\nPhoenix\'s debt. Because of Phoenix\'s opposition to a reorganization, Greystone knew that its only\nhope for confirmation lay in the Bankruptcy Code\'s cramdown provision. Procedurally, Greystone\nfaced a dilemma in deciding how to obtain the approval of its cramdown plan by at least one class\nof "impaired" claims, as the Code requires. Greystone anticipated an adverse vote of Phoenix\'s\nsecured claim. If the Phoenix $3.5 million unsecured deficiency claim shared the same class as\nGreystone\'s other unsecured trade claims, it would swamp their $10,000 value in voting against\nconfirmation. The only other arguably impaired class consisted of tenant security deposit claims,\nwhich, the bankruptcy court found, were not impaired at all.\nGreystone surmounted the hurdle by classifying Phoenix\'s unsecured deficiency claim\nseparately from the trade claims, although both classes were to be treated alike under the plan and\nwould receive a cash payment equal to 3.42% of each creditor\'s claim. Greystone then achieved\nthe required favorable vote of the trade claims class.\n362\n\n\x0cPhoenix contends that Greystone misapplied \xc2\xa7 1122 by classifying its unsecured claim\nseparately from those of trade creditors. The lower courts rejected Phoenix\'s argument in three\nsteps. First, they held that \xc2\xa7 1122 of the Code does not unambiguously prevent classification of\nlike claims in separate classes. The only question is what types of class differentiations among like\nclaims are acceptable. Second, Greystone\'s unsecured deficiency claim is "legally different" from\nthat of the trade claims because it arises statutorily, pursuant to \xc2\xa7 1111(b). Third, "good business\nreasons" justify the separate classification of these unsecured claims. We must address each of\nthese arguments.\nWe observe from this language that the lower courts\' suggestion that \xc2\xa7 1122 does not\nprevent classification of like claims in separate classes is oversimplified. It is true that \xc2\xa7 1122(a)\nin terms only governs permissible inclusions of claims in a class rather requiring that all similar\nclaims be grouped together. One cannot conclude categorically that \xc2\xa7 1122(a) prohibits the\nformation of different classes from similar types of claims. But if \xc2\xa7 1122(a) is wholly permissive\nregarding the creation of such classes, there would be no need for \xc2\xa7 1122(b) specifically to\nauthorize a class of smaller unsecured claims, a common feature of plans in reorganization cases\npast and present. The broad interpretation of \xc2\xa7 1122(a) adopted by the lower courts would render\n\xc2\xa7 1122(b) superfluous, a result that is anathema to elementary principles of statutory construction.\nSection 1122 consequently must contemplate some limits on classification of claims of\nsimilar priority. A fair reading of both subsections suggests that ordinarily "substantially similar\nclaims," those which share common priority and rights against the debtor\'s estate, should be placed\nin the same class. Section 1122(b) expressly creates one exception to this rule by permitting small\nunsecured claims to be classified separately from their larger counterparts if the court so approves\nfor administrative convenience. The lower courts acknowledged the force of this narrow rather\nthan totally permissive construction of \xc2\xa7 1122 by going on to justify Greystone\'s segregation of\nthe Phoenix claim. Put otherwise, the lower courts essentially found that Phoenix\'s unsecured\ndeficiency claim is not "substantially similar" to those of the trade creditors.\nThose courts did not, however, adhere to the one clear rule that emerges from otherwise\nmuddled case law on \xc2\xa7 1122 claims classification: thou shalt not classify similar claims\ndifferently in order to gerrymander an affirmative vote on a reorganization plan. We agree\nwith this rule, and if Greystone\'s proffered "reasons" for separately classifying the Phoenix\ndeficiency claim simply mask the intent to gerrymander the voting process, that classification\nscheme should not have been approved.\nGreystone contends that the "legal difference" between Phoenix\'s deficiency claim and the\ntrade creditors\' claims is sufficient to sustain its classification scheme. The alleged distinction\nbetween the legal attributes of the unsecured claims is that under state law Phoenix has no recourse\nagainst the debtor personally. However, state law is irrelevant where, as here, the Code has\neliminated the legal distinction between non-recourse deficiency claims and other unsecured\nclaims.\nThe purpose of \xc2\xa7 1111(b) is to provide an undersecured creditor an election with respect to\nthe treatment of its deficiency claim. Generally, the creditor may elect recourse status and obtain\nthe right to vote in the unsecured class, or it may elect to forego recourse to gain an allowed secured\nclaim for the entire amount of the debt. If separate classification of unsecured deficiency claims\narising from non-recourse debt were permitted solely on the ground that the claim is non-recourse\n363\n\n\x0cunder state law, the right to vote in the unsecured class would be meaningless. Plan proponents\ncould effectively disenfranchise the holders of such claims by placing them in a separate class and\nconfirming the plan over their objection by cramdown. With its unsecured voting rights effectively\neliminated, the electing creditor\'s ability to negotiate a satisfactory settlement of either its secured\nor unsecured claims would be seriously undercut. It seems likely that the creditor would often have\nto "elect" to take an allowed secured claim under \xc2\xa7 1111(b)(2) in the hope that the value of the\ncollateral would increase after the case is closed. Thus, the election under \xc2\xa7 1111(b) would be\nessentially meaningless. We believe Congress did not intend this result.\nAs the bankruptcy court viewed this issue, the debtor\'s ability to achieve a cramdown plan\nshould be preferred over the creditor\'s \xc2\xa7 1111(b) election rights because of the Code\'s policy of\nfacilitating reorganization. The bankruptcy court resorted to policy considerations because it\nbelieved Congress did not foresee the potential impact of an electing creditor\'s deficiency claim\non the debtor\'s aspiration to cramdown a plan. We disagree with this approach for three reasons.\nFirst, it results here in violating \xc2\xa7 1122, by gerrymandering the plan vote, for the sake of allegedly\neffectuating a \xc2\xa7 1129(b) cramdown. "Policy" considerations do not justify preferring one section\nof the Code, much less elevating its implicit "policies" over other sections, where the statutory\nlanguage draws no such distinctions. Second, as shown, it virtually eliminates the \xc2\xa7 1111(b)\nelection for secured creditors in this type of case. Third, the bankruptcy court\'s concern for the\nviability of cramdown plans is overstated. If Phoenix\'s unsecured claim were lower and the trade\ndebt were higher, or if there were other impaired classes that favored the plan, a cramdown plan\nwould be more realistic. That Greystone\'s cramdown plan may not succeed on the facts before us\ndoes not disprove the utility of the cramdown provision. The state law distinction between Codecreated unsecured deficiency claims and other unsecured claims does not alone warrant separate\nclassification.\nGreystone next argues that separate classification was justified for "good business\nreasons." The bankruptcy court found that the debtor "need[s] trade to maintain good will for future\noperations." The court further reasoned:\n[I]f the expectation of trade creditors is frustrated ... [they] have little\nrecourse but to refrain from doing business with the enterprise. The\nresulting negative reputation quickly spreads in the trade\ncommunity, making it difficult to obtain services in the future on\nany but the most onerous terms.\nGreystone argues that the "realities of business" more than justify separate classification of the\ntrade debt from Phoenix\'s deficiency claim. This argument is specious, for it fails to distinguish\nbetween the classification of claims and the treatment of claims. Greystone\'s justification for\nseparate classification of the trade claims might be valid if the trade creditors were to receive\ndifferent treatment from Phoenix. Indeed, Greystone initially created a separate class of unsecured\ncreditors that could be wooed to vote for the plan by the promise to pay their remaining claims in\nfull outside the plan. Greystone then changed course and eliminated its promise. Because there is\nno separate treatment of the trade creditors in this case, we reject Greystone\'s "realities of business"\nargument.\nEven if Greystone\'s Plan had treated the trade creditors differently from Phoenix, the\nclassification scheme here is still improper. At the confirmation hearing, none of the Debtor\'s\n364\n\n\x0cwitnesses offered any reason for classifying the trade debt separately from Phoenix\'s unsecured\ndeficiency claim. There is no evidence in the record of a limited market in Austin for trade\ngoods and services. Nor is there any evidence that Greystone would be unable to obtain any of\nthe trade services if the trade creditors did not receive preferential treatment under the Plan. Thus,\nthe bankruptcy court\'s finding that there were good business reasons for separate classification is\nwithout support in the record and must be set aside as clearly erroneous.\nPhoenix\'s unsecured deficiency claim approximates $3,500,000, while the claims of the\nunsecured trade creditors who voted to accept the Plan total less than $10,000. Greystone\'s\nclassification scheme, which effectively disenfranchised Phoenix\'s Code-created deficiency claim,\nis sanctioned neither by the Code nor by caselaw. The lower courts erred in approving it.\n\n13.8.1.4.\nIN RE SM 104 LTD., 160 B.R. 202 (Bankr. S.D. Fla.\n1993)\nThe Debtor is a limited partnership which owns and operates an office complex called\nCypress Creek Executive Court in Fort Lauderdale, Florida. The office complex is situated on land\nleased from the City of Fort Lauderdale. The Debtor acquired the leasehold in 1984 and,\nsubsequently, built the office complex on it. Construction financing was provided by South Florida\nSavings Bank.\nOn September 18, 1992, the Debtor filed a proposed plan of reorganization. The Debtor\'s\nplan divides the claims against the Debtor into 7 classes. Class 1 is EquiVest\'s disputed\nnonrecourse secured claim. Class 2 is the claim of Capital Bank, which has a nonrecourse junior\nmortgage on the Cypress Creek property as a result of a loan it made to SM 108. Capital Bank\'s\nclaim and mortgage is worthless, because the Cypress Creek property is fully encumbered by\nEquiVest\'s senior claim, leaving no equity for Capital Bank\'s mortgage, and Capital Bank\'s loan is\nnonrecourse. Class 3 is EquiVest\'s unsecured deficiency claim. Class 4 is the claim of Fort\nLauderdale for rent arrearages and the past-due 1991 property taxes. That claim has been paid in\nfull. Class 5 is the claims of the Debtor\'s trade creditors, totaling approximately $175,000. Class 6\nis the unsecured claims of Murphy. Finally, Class 7 is the interests of the Debtor\'s equity security\nholders.\nBasically, the Debtor\'s plan proposes to pay EquiVest\'s secured claim over 10 years, with\ninterest at 8%, based on a twenty year amortization. The plan also proposes to pay Capital Bank\'s\nclaim, EquiVest\'s unsecured deficiency claim, and the general unsecured claims an equal dividend\non the effective date, with any balance owed to be paid in equal quarterly installments over the\nnext two years. The plan does not provide for Class 4, which has already been paid in full.\nFurthermore, the plan waives the Class 6 inside claims. Finally, the plan proposes to wipe out, in\neffect, the existing equity interests. Under the plan, the equity interests in the reorganized Debtor\nwill go to Murphy in exchange for a one-time payment of $200,000 from Murphy to the Debtor\non the effective date of the plan. Murphy intends to distribute the new equity interests to the old\nequity holders.\nClass 1, EquiVest\'s secured claim, voted to reject the plan. Class 2, the claim of Capital\nBank, originally voted to reject the plan, but, subsequent to the ballot deadline, was permitted to\nchange its ballot to accept the plan. Class 3, EquiVest\'s unsecured deficiency claim, voted to reject\nthe plan. Class 4, the City of Fort Lauderdale, is unimpaired by the plan, and, therefore, does not\n365\n\n\x0cvote. Class 5, the trade creditors\' claims, voted to accept the plan. Classes 6 and 7, the claims of\ninsider creditors and interests of existing equity holders, are wiped out by the plan and thus are\ndeemed to reject it. See 11 U.S.C. \xc2\xa7 1126(g).\nOn March 1, 1993, EquiVest filed its objections to the confirmation of the Debtor\'s plan.\nThere is no doubt that EquiVest\'s claim is undersecured. EquiVest\'s total claim is\napproximately $5.5 million. The parties agree that the value of EquiVest\'s collateral, the Cypress\nCreek property, does not exceed $2.7 million. Section 506 (a) provides that an undersecured claim\nis to be bifurcated into two claims, secured and unsecured. In determining the amount of an\nundersecured creditor\'s secured claim under \xc2\xa7 506(a), property is to be valued "in light of the\npurpose of the valuation and of the proposed disposition or use of such property." 11 U.S.C. \xc2\xa7\n506(a). Where a debtor\'s plan proposes to retain and use the property, it is appropriate to value the\nproperty at its fair market value.\nIn this case, we have the usual battle of the appraisers. EquiVest\'s appraiser, John Danner,\nvalues the property at $2.7 million. The Debtor\'s appraiser, Fred Roe, values the property at $2.15\nmillion. [After evaluating the appraisals, the Court concludes that] the value of EquiVest\'s\ncollateral is $2.27 million. Under \xc2\xa7 506(a), EquiVest\'s secured claim is fixed at that amount.\nEquiVest\'s unsecured claim is equal to the difference between its total claim of approximately $5.5\nmillion and its secured claim, $3.23 million.\nEquiVest objects to the classification of its unsecured deficiency claim separately from\nother unsecured claims. EquiVest\'s argument in this regard is erroneous.\nSection 1129(a)(10) of the Bankruptcy Code provides that before a plan can be crammed\ndown over the objections of a creditor class, at least one impaired class of creditor claims must\nvote to accept the plan, without regard to any insider votes. 11 U.S.C. \xc2\xa7 1129(a)(10). Thus, the\nDebtor, to get its plan confirmed over EquiVest\'s objections, must come up with one impaired\ncreditor class that accepts the plan, without regard to any insider votes in that class.\nThe Debtor has placed EquiVest\'s \xc2\xa7 1111(b) \xe2\x80\x94 created deficiency claim in a separate class\nby itself, Class 3. This court has previously held EquiVest\'s unsecured claim is $3.23 million. The\nother unsecured creditors\' claims are placed by the Debtor\'s plan in Class 5, and total $175,000.\nGiven the size of EquiVest\'s \xc2\xa7 1111(b) unsecured deficiency claim relative to the other unsecured\nclaims and EquiVest\'s opposition to the plan, it is obvious the reason the Debtor seeks to separately\nclassify EquiVest\'s \xc2\xa7 1111(b) deficiency claim from the claims of other unsecured creditors is to\nsatisfy the requirements of \xc2\xa7 1129(a)(10); i.e., to get one impaired class to accept the plan.\nEquiVest claims that the Debtor\'s apparently manipulative motive is improper, and that\nEquiVest\'s unsecured deficiency claim should be placed in the same class as the claims of the\ngeneral unsecured creditors. If the court accepts EquiVest\'s argument that it should be classified\nwith the other general unsecured creditors in a single class and EquiVest\'s argument that the Class\n5 unsecured creditors were the only impaired class to accept the plan, such a joint classification\nwould be the death knell for the Debtor\'s plan because the Debtor could no longer satisfy the\nrequirements of \xc2\xa7 1129(a)(10). The Debtor also argues that such separate classification, whether\nor not done solely to gerrymander to create an accepting impaired class, is perfectly consistent\nwith the Bankruptcy Code.\n366\n\n\x0cIn general, the proponent of a Chapter 11 plan has broad discretion to classify claims and\ninterests in the plan according to the particular facts and circumstances of each case. Section\n1122(a) expressly provides that only substantially similar claims may be placed in the same class.\nIt does not expressly require that all substantially similar claims be placed in the same class, nor\ndoes it expressly prohibit substantially similar claims from being classified separately.\nNevertheless, many courts, including five circuit courts of appeal, while recognizing that \xc2\xa7 1122\ndoes not explicitly forbid a plan proponent from placing similar claims in separate classes, have\nimposed significant limits on the ability of a plan proponent to do so. The majority of lower courts\nhave followed suit. In Greystone, the Fifth Circuit held that "one clear rule" has emerged from the\notherwise muddled \xc2\xa7 1122 case law: "thou shalt not classify similar claims differently in order to\ngerrymander an affirmative vote on a reorganization plan."\nHowever, while Greystone and the other cases have paid lip service to principles of\nstatutory construction and the language of \xc2\xa7 1122, they have turned more on notions of basic\nfairness and good faith. Indeed, most courts seem to base their rulings less on the language of \xc2\xa7\n1122 than on their view that separate classification is usually done to manipulate the voting to\ninsure that at least one impaired class of creditors accepts the plan, and thus that the plan meets\nthe requirements of \xc2\xa7 1129(a)(10). Courts subscribing to this view have rejected any plan where\nthe classification scheme "is designed to manipulate class voting, or violates basic priority rights."\nObviously, one premise for the rulings in Greystone [and other cases following it] has\nbeen that unsecured deficiency claims created by \xc2\xa7 1111(b) are substantially similar to general\nunsecured claims. Indeed, if the claims are not substantially similar, \xc2\xa7 1122(a) would bar them\nfrom being put in the same class. However, a few lower courts have rejected this conclusion and\nheld that unsecured deficiency claims created by \xc2\xa7 1111(b) are not substantially similar to other\nunsecured claims, and thus that separate classification of those claims is not only permissible, but\nmandatory. These latter courts rely on two lines of reasoning to support their conclusion. First,\nsome of these courts believe that general unsecured claims and unsecured deficiency claims\ncreated by \xc2\xa7 1111(b) are legally distinct because the former are recourse claims cognizable under\nstate law, while the latter exist only within the Chapter 11 bankruptcy case and are not cognizable\nunder state law. The circuit courts have largely rejected this argument, holding that \xc2\xa7 1111(b) has\nlargely eliminated the legal distinction between non-recourse deficiency claims for purposes of\nChapter 11.\nIn addition, the minority of courts supporting the proposition that the separate classification\nof unsecured deficiency claims created by \xc2\xa7 1111(b) is either proper or required often argue that\nseparate classification is permissible on the grounds that the vote of such claims will be uniquely\naffected by the plan\'s proposed treatment of the secured claim held by the creditor. Thus, for\nexample, the court in Aztec [107 B.R. 585 (Bankr. MD Tenn. 1989)] reasoned that the\nundersecured mortgagee would have "every incentive to vote its large deficiency claim to affect\nthe treatment of its secured claim by defeating confirmation of any plan" if classified with other\nunsecured creditors. Aztec, at 587. Such a rationale is highly persuasive when viewed in light of\nthe logic underlying \xc2\xa7 1129(a)(10). Section 1129(a)(10) was intended not to give the real estate\nlobby a veto power, but merely to require "some indicia of creditor support" for confirmation of a\nproposed Chapter 11 plan.\xe2\x80\x9d\n[T]his court believes that the lines of reasoning articulated by the circuit courts and the\nmajority of district and bankruptcy courts have missed the forests for the trees. Section 1122(a)\n367\n\n\x0callows joint classification of claims only if the claims are substantially similar in terms of their\nlegal rights. There are, however, significant differences between the legal rights of a general\nunsecured claim and an unsecured deficiency claim created for the nonrecourse lender by \xc2\xa7\n1111(b). Thus, an unsecured deficiency claim created by \xc2\xa7 1111(b) is not substantially similar to\ngeneral unsecured claims, and, under \xc2\xa7 1122(a), the two types of claims cannot be classified\ntogether.\nOne area in which the distinction between the rights of holders of general unsecured claims\nand the rights of \xc2\xa7 1111(b) deficiency claimants can be seen clearly is in the application of the\n"best interests" test of \xc2\xa7 1129(a)(7). [T]he majority in a class can never force the minority in that\nclass to take less in present value terms than the minority would receive in a Chapter 7 liquidation\ncase involving the debtor.\nThe application of this standard to a class consisting of both general unsecured claims and\n\xc2\xa7 1111(b) deficiency claims can lead to anomalous results. A simple example shows why. Suppose\nthat an unsecured deficiency claim created by \xc2\xa7 1111(b) is placed in the same class as the general\nunsecured claims, and that the plan provides for that class to receive a 25% payment of claims on\nthe effective date of the plan. Suppose further that, in a Chapter 7 liquidation, the holders of general\nunsecured claims would be paid a 35% dividend. The plan would fail the best interests of the\ncreditors test as to the general unsecured creditors, and the plan could not be confirmed unless\neach general unsecured claim voted for the plan. This would be true even if a majority in number\nand two-thirds in amount of the claims in the class that voted on the plan voted to accept. On the\nother hand, the plan would propose to give the unsecured deficiency claim created by \xc2\xa7 1111(b)\nmore than it would receive in a hypothetical Chapter 7 liquidation: in a Chapter 7 case, the\nunsecured deficiency claim created by \xc2\xa7 1111(b) would not exist and would not be paid at all.\nAll that is ever required to satisfy the best interests test as to a \xc2\xa7 1111(b) nonrecourse\ndeficiency claim is for the claimholder to receive the present value of the collateral. Nevertheless,\nas long as joint classification is utilized, the holder of a \xc2\xa7 1111(b) deficiency claim can hold out\nfor a dividend equal to what the general unsecured claims are being paid to satisfy the best interests\nof the creditors test as to such creditors, even though the undersecured nonrecourse claim is never\nentitled to any payment in a Chapter 7 case for the amount by which the value of its collateral is\nless than it is owed. This is because \xc2\xa7 1123(a)(4) requires a plan to provide for the same treatment\nof all claims in a class, unless the holder of a claim agrees to less favorable treatment. 11 U.S.C. \xc2\xa7\n1123(a)(4). Thus, in the hypothetical above, if the plan were amended to satisfy the best interests\nof the creditors test by giving the holders of general unsecured claims a 35% dividend, the holder\nof the \xc2\xa7 1111(b) nonrecourse deficiency claim could, as long as the claims are jointly classified,\ninsist on the same 35% dividend, or block confirmation of the plan. It would be hard to believe\nthat the drafters of the Bankruptcy Code intended such an absurd result.\nThere are other significant disparities between the legal rights of the holder of a general\nunsecured claim and the holder of a \xc2\xa7 1111(b) nonrecourse deficiency claim. For example, if the\ndebtor is a partnership, the general partners are liable for the debts of the partnership in the event\nthe case converts to one under Chapter 7. See 11 U.S.C. \xc2\xa7 723. If the Chapter 11 case shows signs\nof possible failure, the general unsecured creditors could seek equitable relief to prevent\ndissipation of the assets of the general partners pending resolution of the Chapter 11 case. It is\nunlikely that the holder of a \xc2\xa7 1111(b) nonrecourse deficiency claim could pursue such relief, since\n368\n\n\x0cthe nonrecourse lender is confined to its collateral as a source of payment in Chapter 7. It has no\ndeficiency claim against either the estate or the general partners.\nIt is clear that the legal rights of creditors holding unsecured deficiency claims created by\n\xc2\xa7 1111(b) and general unsecured creditors are, for classification purposes, substantially dissimilar.\nTherefore, separate classification of unsecured deficiency claims created by \xc2\xa7 1111(b) and general\nunsecured claims is not only permissible, but mandatory. Thus, this court rules that the Debtor\'s\nseparate classification of EquiVest\'s Class 3 unsecured deficiency claim and the claims of the Class\n5 general unsecured creditors is permissible. Indeed, such separate classification is required by \xc2\xa7\n1122(a).\n\n13.9.\n\nPractice Problems: Classification, Voting and Impairment\n\nAnswer the following questions:\nProblem 1. Debtors have five classes of creditors who have voted on a Chapter 11 plan of\nreorganization. Determine which of the classes have accepted and which have rejected the plan.\nClass 1\nTotal Creditors in Class\nTotal Claims in Class\nCreditors Voting Yes\nClaims Voting Yes\nCreditors Voting No\nClaims Voting No\n\nClass 2\n\nClass 3\n\nClass 4\n\nClass 5\n\n100\n2,000\n12\n150,000\n352,687\n$ 1,000,000 $ 3,000,000 $ 450,000 $ 25,000,258 $ 12,569,854\n31\n700\n5\n90,000\n152,365\n$ 600,000 $ 1,525,000 $ 250,000 $ 14,256,897 $ 4,000,365\n29\n700\n4\n45,000\n152,536\n$ 300,000 $ 1,016,666 $ 100,000 $ 7,425,698 $ 1,998,562\n\nProblem 2. Debtor owes a secured loan that matures next year. Debtor has proposed a\nChapter 11 plan that pays the claim in cash in full on the effective date of the plan. Is the creditor\nentitled to vote on the plan? 11 U.S.C. \xc2\xa7\xc2\xa7 1124, 1126(f).\nProblem 3. Debtor owes $1 million on a loan secured by its sole asset \xe2\x80\x93 an office building.\nDebtor missed 5 prepetition monthly payments and 3 post-petition monthly payments. Debtor\nproposes a plan to pay the 8 months of arrearages over the 10 year term of the plan with postpetition interest at the Till rate (prime +2%), together with the regular installments coming due in\nthe future. Is the creditor impaired? 11 U.S.C. \xc2\xa7 1124.\nProblem 4. Debtor was forced to close its store for 10 days prepetition when the debtor\nran out of funds to pay employees. Debtor\xe2\x80\x99s lease contains a \xe2\x80\x9cgoing dark\xe2\x80\x9d clause that provides that\nthe tenant who ceases to operate the store at any time during the shopping center\xe2\x80\x99s business hours\nis in default. Debtor wants to re-open the store, and has proposed to pay all back rent in cash and\nreopen. Is the landlord entitled to vote against the plan? To avoid the landlord\xe2\x80\x99s vote, must Debtor\ncompensate the landlord for lost percentage rent during the days that the store was closed? 11\nU.S.C. \xc2\xa7 1124.\n\n369\n\n\x0cProblem 5. Debtor needs one class of creditors to vote for the plan. 11 U.S.C. \xc2\xa7\n1129(a)(10). Debtor proposes to separately classify and pay a friendly creditor $99,999.99 on a\n$100,000 unsecured claim. Does this work? 11 U.S.C. \xc2\xa7 1122, 1124.\nProblem 6. In order to confirm its plan of reorganization, Debtor must classify the Section\n506(a) unsecured portion of its lender\xe2\x80\x99s undersecured claim separately from the claims of trade\ncreditors, because the lender will vote no, and the lender\xe2\x80\x99s unsecured claim will swamp the claims\nof the other unsecured creditors who will vote yes. Is Debtor allowed to separately classify the\nlender\xe2\x80\x99s unsecured claim? Does it matter whether the original loan was with recourse or without\nrecourse?\n\n13.10. Confirmation Requirements under 11 U.S.C. \xc2\xa7 1129(a)\nSection 1129(a) contains a long string of confirmation requirements. With one exception\ndescribed later, known as the \xe2\x80\x9ccramdown,\xe2\x80\x9d all of the requirements of Section 1129(a) must be met\nbefore the bankruptcy court may confirm the plan. The most important requirements are as follows:\n(a) The Best Interests of Creditors Test. 11 U.S.C. \xc2\xa7 1129(a)(7).\nThe plan proponent must show that any creditor who did not vote for the plan will receive\npresent value at least equal to the amount they would receive in an instant Chapter 7 liquidation\noccurring on the date of confirmation.\n(b) Acceptance by Every class. 11 U.S.C. \xc2\xa7 1129(a)(8).\nEach class must either accept the plan or be unimpaired (and thereby deemed to accept the\nplan). This is the only Section 1129(a) requirement that is not always required for confirmation. If\none or more classes do not accept, the plan may still be confirmed if the plan meets the cramdown\nrequirements of Section 1129(b).\n(c) Priority Claim Treatment. 11 U.S.C. \xc2\xa7 1129(a)(8).\nUnless a particular creditor agrees to accept different treatment, administrative and gap\npriority claims must be paid in cash and in full (11 U.S.C. \xc2\xa7 1129(a)(9)(A)); Tax priority claims\nmust be paid in full with interest over a period not exceeding five years and in a manner not less\nfavorable to the treatment of non-priority claims (11 U.S.C. \xc2\xa7 1129(a)(9)(C)); and most other\npriority claims must be paid in cash on the effective date unless the class votes to accept full\npayments over time with interest.\n(d) One Accepting Impaired Class. 11 U.S.C. \xc2\xa7 1129(a)(10)\nIf any class is impaired, at least one impair class votes to accept the plan.\n(e) Feasibility. 11 U.S.C. \xc2\xa7 1129(a)(11).\nThe Debtor must show that the plan can be completed without the need for further financial\nreorganization.\n\n370\n\n\x0c(f) Projected Disposable Income Test for Individual Debtors. 11 U.S.C. \xc2\xa7 1129(a)(15).\nThis is the same test as in Chapter 13 (11 U.S.C. \xc2\xa7 1325(b)(2)), except it requires a five\nyear plan even for below median debtors.\n\n13.11. The Cramdown: 11 U.S.C. \xc2\xa7 1129(b).\nA debtor who meets all of the requirements for confirmation except section 1129(a)(8) (the\nrequirement that all classes have accepted the plan), may still be able to confirm the plan under the\ncramdown rules in section 1129(b). Section 1129(b) allows for confirmation over the rejection of\none or more class(es) of claims or interests if the plan is fair and equitable and does not discriminate\nunfairly against the creditors. The discriminate unfairly requirement is not defined in the\nBankruptcy Code and is rarely discussed in the case law. The primary focus is on the \xe2\x80\x9cfair and\nequitable requirement\xe2\x80\x9d which is defined to include three sets of rules: (1) Section 1129(b)(2)(A)\nfor cramming down secured classes, (2) Section 1129(b)(2)(B) for cramming down unsecured\nclasses, and (3) Section 1129(b)(2)(C) for cramming down equity interest classes.\n\n13.11.1.1.\n\nCramdown of Secured Claims.\n\nSecured claims can be restructured under Section 1129(b)(2)(A)(i), the collateral can be\nsold and the creditor paid the proceeds of sale (with the right to credit bid) under Section\n1129(b)(2)(A)(ii), or the plan can provide the secured creditors in the non-accepting class with the\n\xe2\x80\x9cindubitable equivalent\xe2\x80\x9d of their claims, under Section 1129(b)(2)(A)(iii). The main focus must\nbe on the restructuring provisions. The creditor must retain its lien, and receive deferred cash\npayments TOTALLING the allowed amount of the claim, but having a PRESENT VALUE equal\nto the value of the creditor\xe2\x80\x99s interest in the property. Thus, the arithmetic sum of the payments\nmust exceed the total claim, but the present value of the stream need only equal the \xc2\xa7 506(a)\nsecured claim. To maintain present value, the payment stream must include interest at the \xe2\x80\x9cTill\xe2\x80\x9d\nrate on the value of the property, but not on the claim amount. Indeed, the claim amount can be\npaid without any interest at all, if the present value of the stream will exceed the value of the\nproperty.\nWhat is the relationship between the Section 1111(b)(2) election and the cramdown\nformula? Suppose the creditor\xe2\x80\x99s total claim is $100,000, secured by property worth $60,000.\nUnder Section 506(a), the creditor would have a $60,000 secured claim and a $40,000 unsecured\nclaim. But if the creditor made the Section 1111(b)(2) election, the creditor would be treated as\nhaving a $100,000 secured claim even though the property is worth only $60,000. The debtor\nwould have to make TOTAL payments of $100,000 to the creditor (the amount of the claim), but\nthe present value of the payment stream would have to be only $60,000 (the value of the creditor\xe2\x80\x99s\nlien). If prevailing interest rates are 10%, the debtor could propose to pay $10,000 per year for 10\nyears, equaling total payments of $100,000. But the discounted present value of those payments\nwould be only $61,445.67. If the creditor makes the Section 1111(b)(2) election, the debtor may\nsimply propose pay the claim without interest (or with below market rate interest if necessary to\nmaintain the present value of the collateral). Under the statutory test, the real value that the creditor\nreceives may be no more than the value of the creditor\xe2\x80\x99s lien. The receipt of the total secured claim,\nwithout (or with below market) interest, will not generally be of importance to a financially\n371\n\n\x0csophisticated creditor. If the debtor makes the proposed payments, the creditor is worse off in real\npresent value terms than if the creditor did not make the election, because the non-electing creditor\nwould receive the same present value of its secured claim, plus would receive some distribution\non its unsecured claim. The creditor may receive no \xe2\x80\x9cvalue\xe2\x80\x9d to in return for giving up its unsecured\nclaim.\nThe alternative \xe2\x80\x9cindubitable equivalent\xe2\x80\x9d provision has come under scrutiny in the \xe2\x80\x9cdirt for\ndebt\xe2\x80\x9d cases, where a debtor proposes in a plan to paydown the creditor\xe2\x80\x99s secured claim by returning\na portion of the collateral to the secured creditor, based on the bankruptcy court\xe2\x80\x99s valuation of the\nproperty. The Ninth Circuit Court of Appeals considers such a plan, and the meaning of\n\xe2\x80\x9cindubitable equivalence,\xe2\x80\x9d in the Arnold & Baker case reprinted below.\n\n13.11.1.2.\n\nCramdown of Unsecured Claims.\n\nThe cramdown rule for unsecured creditors is simple: the claims of senior classes must be\npaid in full with post-confirmation interest, or no junior creditor or equity security classes can\nreceive or retain any property on account of their claims or interests. This is the absolute priority\nrule, and prevents the equity owners from keeping their interests unless all non-consenting\nunsecured creditor classes are paid in full. For example, corporate business plans can easily be\ncrammed down on objecting existing shareholders if management is willing to sacrifice the\nshareholder interests by distributing all of the stock to the creditors.\nLike alchemists trying to turn cheap iron into gold, debtors have been searching for a way\naround the absolute priority rule since its inception. The most promising gambit has been the so\ncalled \xe2\x80\x9cnew value corollary,\xe2\x80\x9d under which the equity holders would retain their stock or other\ninterests in the reorganized debtor not on account of their prior equity interests but on account of\ntheir new contributions of money, property or services under the plan.\nIn Norwest Bank Worthington v. Ahlers, 485 U.S. 197 (1988), a debtor farmer sought to\nkeep the equity in his farm under a plan that did not pay unsecured creditors in full, by giving the\nestate his employment contract, under which he promised to render his labor to work the farm in\nreturn for the new equity. The Supreme Court refused to decide whether a new value corollary\nexists or not, but ruled that, if it exists, the new value must be \xe2\x80\x9cmoney or money\xe2\x80\x99s worth,\xe2\x80\x9d not the\npromise of future services.\nWhile not answering the ultimate question of whether the new value corollary exists, the\nCourt in BofA v. 203 North LaSalle case reprinted below, made clear that it is, at best, a very\nnarrow exception to the absolute priority rule. The Court left the door open slightly for debtors to\nmaintain their equity interests without paying dissenting creditors in full, but in most cases and for\nall practical purposes the door will be closed.\n\n372\n\n\x0c13.12. Cases on Cramming Down Secured Claims in a Chapter 11 Plan\nof Reorganization\n13.12.1.1. IN RE ARNOLD & BAKER FARMS, 85 F.3d 1415\n(9th Cir. 1996)\nWILLIAM A. NORRIS, Circuit Judge:\nDebtor Arnold and Baker Farms petitioned for relief under Chapter 11 and filed a plan of\nreorganization which proposed to satisfy the claims of the creditors by transferring real property\nto them\xe2\x80\x94colloquially known as a "dirt for debt" plan. When Arnold and Baker\'s largest creditor,\nthe Farmers Home Administration (FmHA), objected to the plan, Arnold and Baker invoked the\n"cram down" provision of the Bankruptcy Code, 11 U.S.C. \xc2\xa7 1129(b). The question presented is\nwhether the plan\'s proposal to transfer to FmHA a portion of the collateral securing FmHA\'s claim\nwill provide FmHA with the "indubitable equivalent" of its secured claim, as required by the "cram\ndown" provision. See 11 U.S.C. \xc2\xa7 1129(b)(2)(A)(iii).\nThe debtor Arnold and Baker Farms is an Arizona general partnership. Arnold and Baker\npurchased 1120 acres in 1975 and an additional 320 acres in 1979. In 1977, the farm began to\nexperience financial difficulties. [The sellers carried back first deeds of trust to secure repayment\nof the purchase price.]\n[FmHA and Western Cotton] financed certain crops for the years 1978 through 1981, and\nFmHA lent Arnold and Baker sufficient funds to make the annual payments on the installments\ndue to the [sellers] in the years 1979, 1980, and 1983. In return, FmHA held a second deed of trust\non Arnold and Baker\'s real property, and Western Cotton held a third deed of trust.\nArnold and Baker\xe2\x80\x99s plan proposed to pay FmHA\'s $3,837,618 note and Western Cotton\'s\n$565,044 note in full. The plan proposed to transfer a proportionate fee simple interest in the 635\nacre parcel of real property to FmHA and Western Cotton. FmHA was earmarked to receive 515\nacres of real property and Western Cotton was earmarked to receive 77 acres. Arnold and Baker\nwas earmarked to retain ownership of 48 of the 640 acres scheduled for distribution. Arnold and\nBaker proposed to sell the adjoining 360 acre parcel of real property in order to pay the\nadministrative claims, United States Trustee\'s fees, attorney fees, accountant fees, postpetition\ntaxes, the real estate commission due and owing to Walter Arnold, and use the remainder to pay\nthe unsecured creditors. Arnold and Baker retained an interest in the property remaining after\ndistribution and sale.\nBoth FmHA and Western Cotton initially objected to confirmation of Arnold and Baker\'s\nsecond amended plan. However, during the course of the confirmation hearing, Western Cotton\nreached a settlement with Arnold and Baker pursuant to which Western Cotton agreed to accept\n130 acres of real property in full satisfaction of its debt. Western subsequently withdrew its\nobjection to confirmation and voted to accept the plan.\nThe principal factual issue concentrated on the fair market value of Arnold and Baker\'s\n1320 acres of land. Arnold and Baker estimated the per acre value to be $7,322 for the 640 acre\nlot, $8,300 for the 360 acre lot, and $8,631 for the 320 acre lot. FmHA estimated the per acre value\nfor the entire 1320 acres at $1,381.\n373\n\n\x0cOn May 5, 1993, the bankruptcy court confirmed the plan finding that the property had an\nestimated value of $7,300 per acre. However, the bankruptcy court modified the transfer to FmHA\nin the plan by ordering an additional 10% transfer to FmHA in order to compensate it for the costs\nassociated with a sale [resulting in a total of 566.5 acres]. [The Bankruptcy Appellate Panel (BAP)\nreversed.]\nAppellant Arnold and Baker argues that the BAP erred in reversing the confirmation of the\nplan on the ground that the proposed transfer of 566.5 acres to FmHA would not provide "for the\nrealization by [FmHA] of the indubitable equivalent" of its secured claim, as required by \xc2\xa7\n1129(b)(2)(A)(iii).[5]\nBecause FmHA objected to confirmation of the plan, Arnold and Baker invoked the "cram\ndown" provision of Chapter 11\nThe bankruptcy court confirmed the plan on the ground that the plan satisfied the third\n[indubitable equivalent] requirement. After an evidentiary hearing on the issue of valuation, the\ncourt found that the property was worth $7,300 per acre. It then concluded that the receipt of 566.5\nacres at $7,300 per acre would provide for FmHA to realize the indubitable equivalent of its\nsecured claim.\nAs an initial matter, we must address the appropriate standard of review of such a\ndetermination. Arnold and Baker argues that the question of indubitable equivalence is a question\nof fact to be reviewed under the clearly erroneous standard. We disagree. Although the value of\nthe land is a finding of fact which we review for clear error, the ultimate conclusion of indubitable\nequivalence is a question of law which we review de novo because it requires analysis of the\nmeaning of the statutory language in the context of the Bankruptcy Code\'s "cram down" scheme.\nThe BAP reviewed de novo the bankruptcy court\'s determination that the proposed transfer\nwould provide FmHA with the indubitable equivalent of its secured claim, and reversed. Stressing\nthat "[t]he determination of whether a partial dirt for debt distribution will provide the creditor\nwith the indubitable equivalence of its secured claim must be made on a case-by-case basis," the\nBAP reasoned that the bankruptcy court\'s valuation of the property was an insufficient basis on\nwhich to conclude that the property was the indubitable equivalent of FmHA\'s secured claim.\nThe finding of a trial court of a particular value of real property ... will not necessarily\ndetermine whether the creditor will receive the indubitable equivalent of its secured claim.\nExperience has taught us that determining the value of real property at any given time is not an\nexact science. Because each parcel of real property is unique, the precise value of land is difficult,\nif not impossible, to determine until it is actually sold. Nevertheless, bankruptcy courts have\ntraditionally been requested, out of necessity, to determine the value of various types of property,\nincluding real property, and yet courts have recognized the difficulty of being able to determine\naccurately the value of land. For instance, in In re Walat Farms Inc., 70 B.R. 330 (Bankr. E.D.\nMich. 1987), the court stated:\nSimilarly, we concede to doubts about our ability to fix the "value"\nof the land in question. We need not make a pronouncement that no\nplan proposing the surrender of a portion of mortgaged land to a\nmortgagee in return for a compelled release of the lien on the\nremainder of the property will ever be confirmed. Suffice it to say,\nhowever, that no matter how hot the market for real estate may\n374\n\n\x0cbecome in the future, the market for farm real estate here and now\nis not such which would permit us to hold that the value of the land\nbeing offered is the indubitable equivalent of [the mortgagee]\'s\nclaim. "Indubitable" means "too evident to be doubted." Webster\'s\nNinth New Collegiate Dictionary (1985). We profess doubt on the\nfacts of this case.\n[T]he determination of whether a dirt for debt distribution provides a secured creditor with\nthe indubitable equivalent of its secured claim must be made on a case-by-case basis, and we must\ndecide whether the bankruptcy court\'s finding with respect to the value of the real property for the\npurpose of determining the amount of the creditor\'s secured claim provided the secured creditor\nwith the indubitable equivalent of its claim. In addition, we conclude that in order for a partial\ndistribution to constitute the most "indubitable equivalence," the partial distribution must insure\nthe safety of or prevent jeopardy to the principal.\nAlthough we conclude that the bankruptcy court\'s valuation in this case is not clearly\nerroneous, we are not convinced that its finding regarding the value of the real property provided\nthe indubitable equivalence of the particular secured claim in question, nor are we convinced that\nthe partial distribution of 566.5 acres to FmHA will insure the safety of or prevent jeopardy to the\nprincipal.\nThe evidence at trial demonstrated that the value of the real property was far from certain.\nThe Arnold and Baker appraisal admitted that due to unfavorable market conditions, including the\nfact that the [Resolution Trust Company had acquired 19,000 acres near Arnold and Baker\'s\nproperty and was considering bulk sale offers at no more than $2,105 per acre], the normal one\nyear marketing period for the property would be extended by another two years [by which time\nthe appraisal estimated that the Resolution Trust Company\'s activities would have ceased affecting\nthe market].\nThe bankruptcy court agreed with Arnold and Baker\'s valuation of $7,300 per acre. FmHA,\nhowever, proffered a valuation of $1,381 per acre. The large disparity in the parties\' valuation of\nthe same property illustrates the obvious uncertainty in attempting to forecast the price at which\nreal property will sell at some uncertain future date.\nThe bankruptcy court found the value of each acre to be $7,300, and thus the value of the\n566.5 acres to be transferred to FmHA to be $4,135,450 ($7,300 \xc3\x97 566.5). We must decide,\ntherefore, whether a distribution of land with an estimated value of $4,135,450 constitutes the\nindubitable equivalent of a $3,837,618 claim secured by 1,320 acres. Under the circumstances of\nthis case, we conclude that it does not.\nThe partial distribution of 566.5 acres to FmHA will not insure the safety of or prevent\njeopardy to the principal. FmHA originally lent funds to Arnold and Baker secured by 1320 acres\nof land. If Arnold and Baker defaulted on the terms of the note, FmHA bargained for the right to\nforeclose on the entire 1320 acres of land in order to satisfy the outstanding obligation. In this\nsituation, the principal is protected to the extent of the entire 1320 acres held as security.\nIf FmHA subsequently sells the property for less than the value calculated by the\nbankruptcy court, FmHA has no recourse to the remaining collateral to satisfy the deficiency. As\na result, the distribution to FmHA may not be "completely compensatory." FmHA is forced to\n375\n\n\x0cassume the risk of receiving less on the sale without being able to look to the remaining\nundistributed collateral for security.\nArnold and Baker challenges the BAP\'s decision on the ground that it conflicts with Matter\nof Sandy Ridge Development Corp., 881 F.2d 1346 (5th Cir. 1989), in which the Fifth Circuit held\nthat a "dirt for debt" plan satisfied the indubitable equivalence standard. The BAP distinguished\nSandy Ridge on the ground that the plan in that case provided for the transfer of all of the secured\ncreditor\'s collateral, rather than only a portion of the collateral as in the present case. Arnold and\nBaker argues that even in the Sandy Ridge situation, the court\'s valuation of the collateral is critical\nto the creditor\'s substantive rights because the valuation directly impacts the creditor\'s rights\nregarding an unsecured deficiency claim, as was the case in Sandy Ridge.\nHowever, this argument misapprehends the indubitable equivalence analysis. Section\n1129(b)(2)(A)(iii) does not require that a creditor receive the indubitable equivalent of its entire\nclaim, but only of its secured claim. [T]he value of the secured portion of an undersecured creditor\'s\ntotal claim is by definition equal to the value of the collateral securing it. Therefore, a creditor\nnecessarily receives the indubitable equivalent of its secured claim when it receives the collateral\nsecuring that claim, regardless of how the court values the collateral. For this reason, the Sandy\nRidge court did not need a judicial determination of value, explaining that "for the present analysis,\nthe exact value of [the collateral] is unimportant." The court\'s valuation of the collateral does, as\nArnold and Baker observes, determine the amount of any remaining unsecured claim, but the Code\nrequires only that the creditor receive the indubitable equivalent of its secured claim.\nIn this case, in contrast, the amount of collateral deemed to be the indubitable equivalent\nof FmHA\'s secured claim depends entirely on the court\'s valuation of the collateral. If the court\nhad found that the land was worth more than $7,300 per acre, FmHA would receive\ncorrespondingly less land, and if the court had found that the land was worth less, FmHA would\nreceive correspondingly more. Our holding that this plan does not satisfy the indubitable\nequivalent requirement is therefore entirely consistent with Sandy Ridge\'s holding that the plan in\nthat case did.\nIn conclusion, while we do not hold that the indubitable equivalent standard can never as\na matter of law be satisfied when a creditor receives less than the full amount of the collateral\noriginally bargained for, we do hold, as did the BAP, that the Arnold and Baker plan does not\nprovide FmHA with the indubitable equivalent of its secured claim as required by the Bankruptcy\nCode.\n\n13.12.1.2. BANK OF AMERICA v. 203 N. LaSALLE STREET\nP\xe2\x80\x99SHIP, 526 U.S. 434 (1999)\nJUSTICE SOUTER, delivered the opinion of the Court.\nPetitioner, Bank of America is the major creditor of the [Debtor], 203 North LaSalle Street\nPartnership. The Bank lent the Debtor some $93 million, secured by a nonrecourse first mortgage\non the Debtor\'s principal asset, 15 floors of an office building in downtown Chicago. In January\n1995, the Debtor defaulted, and the Bank began foreclosure in a state court.\nIn March, the Debtor responded with a voluntary petition for relief under Chapter 11 of the\nBankruptcy Code, which automatically stayed the foreclosure proceedings. The Debtor\'s principal\n376\n\n\x0cobjective was to ensure that its partners retained title to the property so as to avoid roughly $20\nmillion in personal tax liabilities, which would fall due if the Bank foreclosed. The Debtor\nproceeded to propose a reorganization plan during the 120-day period when it alone had the right\nto do so. The Bankruptcy Court rejected the Bank\'s motion to terminate the period of exclusivity\nto make way for a plan of its own to liquidate the property, and instead extended the exclusivity\nperiod for cause shown, under \xc2\xa7 1121(d).\nThe value of the mortgaged property was less than the balance due the Bank, which elected\nto divide its undersecured claim into secured and unsecured deficiency claims under \xc2\xa7 506(a) and\n\xc2\xa7 1111(b). Under the plan, the Debtor separately classified the Bank\'s secured claim, its unsecured\ndeficiency claim, and unsecured trade debt owed to other creditors. The Bankruptcy Court found\nthat the Debtor\'s available assets were prepetition rents in a cash account of $3.1 million and the\n15 floors of rental property worth $54.5 million. The secured claim was valued at the latter figure,\nleaving the Bank with an unsecured deficiency of $38.5 million.\nSo far as we need be concerned here, the Debtor\'s plan had these further features:\n(1) The Bank\'s $54.5 million secured claim would be paid in full between 7 and 10 years\nafter the original 1995 repayment date.\n(2) The Bank\'s $38.5 million unsecured deficiency claim would be discharged for an\nestimated 16% of its present value.\n(3) The remaining unsecured claims of $90,000, held by the outside trade creditors, would\nbe paid in full, without interest, on the effective date of the plan.\n(4) Certain former partners of the Debtor would contribute $6.125 million in new capital\nover the course of five years (the contribution being worth some $4.1 million in present value), in\nexchange for the Partnership\'s entire ownership of the reorganized debtor.\nThe last condition was an exclusive eligibility provision: the old equity holders were the\nonly ones who could contribute new capital.\nThe Bank objected and, being the sole member of an impaired class of creditors, thereby\nblocked confirmation of the plan on a consensual basis. The Debtor, however, took the alternate\nroute to confirmation of a reorganization plan, forthrightly known as the judicial "cramdown"\nprocess for imposing a plan on a dissenting class. \xc2\xa7 1129(b).\n[The Court reviewed the statutory requirements for cramdown]. As to a dissenting class of\nimpaired unsecured creditors, such a plan may be found to be "fair and equitable" only if the\nallowed value of the claim is to be paid in full, \xc2\xa7 1129(b)(2)(B)(i), or, in the alternative, if "the\nholder of any claim or interest that is junior to the claims of such [impaired unsecured] class will\nnot receive or retain under the plan on account of such junior claim or interest any property," \xc2\xa7\n1129(b)(2)(B)(ii). That latter condition is the core of what is known as the "absolute priority rule."\nThe absolute priority rule was the basis for the Bank\'s position that the plan could not be\nconfirmed as a cramdown. As the Bank read the rule, the plan was open to objection simply\nbecause certain old equity holders in the Debtor Partnership would receive property even though\nthe Bank\'s unsecured deficiency claim would not be paid in full. The Bankruptcy Court approved\nthe plan nonetheless, and the District Court affirmed, as did the Court of Appeals.\n377\n\n\x0cThe majority of the Seventh Circuit\'s divided panel found ambiguity in the language of the\nstatutory absolute priority rule, and looked beyond the text to interpret the phrase "on account of"\nas permitting recognition of a "new value corollary" to the rule. According to the panel, the\ncorollary, as stated by this Court in Case v. Los Angeles Lumber Products Co., 308 U.S. 106, 118\n(1939), provides that the objection of an impaired senior class does not bar junior claim holders\nfrom receiving or retaining property interests in the debtor after reorganization, if they contribute\nnew capital in money or money\'s worth, reasonably equivalent to the property\'s value, and\nnecessary for successful reorganization of the restructured enterprise.\n[The Court reviewed the history of reorganizations under the Bankruptcy Act, in which\ncourts adopted the absolute priority rule as a rule of fairness and equity] The second interpretive\nrule addressed the first. Its classic formulation occurred in Case v. Los Angeles Lumber Products\nCo., in which the Court spoke through Justice Douglas in this dictum:\nIt is, of course, clear that there are circumstances under which\nstockholders may participate in a plan of reorganization of an\ninsolvent debtor. . . . Where th[e] necessity [for new capital] exists\nand the old stockholders make a fresh contribution and receive in\nreturn a participation reasonably equivalent to their contribution, no\nobjection can be made. . . . [W]e believe that to accord `the creditor\nhis full right of priority against the corporate assets\' where the debtor\nis insolvent, the stockholder\'s participation must be based on a\ncontribution in money or in money\'s worth, reasonably equivalent\nin view of all the circumstances to the participation of the\nstockholder.\nAlthough counsel for one of the parties here has described the Case observation as "`blackletter\' principle," it never rose above the technical level of dictum in any opinion of this Court,\nwhich last addressed it in Norwest Bank Worthington v. Ahlers, 485 U.S. 197 (1988), holding that\na contribution of "`labor, experience, and expertise\' " by a junior interest holder was not in the\n"`money\'s worth\' " that the Case observation required. Nor, prior to the enactment of the current\nBankruptcy Code, did any court rely on the Case dictum to approve a plan that gave old equity a\nproperty right after reorganization. Hence the controversy over how weighty the Case dictum had\nbecome.\nEnactment of the Bankruptcy Code in place of the prior Act might have resolved the status\nof new value by a provision bearing its name or at least unmistakably couched in its terms, but the\nCongress chose not to avail itself of that opportunity. In 1973, Congress had considered proposals\nby the Bankruptcy Commission that included a recommendation to make the absolute priority rule\nmore supple by allowing nonmonetary new value contributions. Although Congress took no action\non any of the ensuing bills containing language that would have enacted such an expanded new\nvalue concept, each of them was reintroduced in the next congressional session. After extensive\nhearings, a substantially revised House bill emerged, but without any provision for nonmonetary\nnew value contributions. [The final bill that became law] had no explicit new value language,\nexpansive or otherwise, but did codify the absolute priority rule in nearly its present form.\nFor the purpose of plumbing the meaning of subsection (b)(2)(B)(ii) in search of a possible\nstatutory new value exception, the lesson of this drafting history is equivocal. Although hornbook\n378\n\n\x0claw has it that "`Congress does not intend sub silentio to enact statutory language that it has earlier\ndiscarded,\' " the phrase "on account of" is not silentium, and the language passed by in this instance\nhad never been in the bill finally enacted, but only in predecessors that died on the vine. None of\nthese contained an explicit codification of the absolute priority rule, and even in these earlier bills\nthe language in question stated an expansive new value concept, not the rule as limited in the Case\ndictum.\nThe equivocal note of this drafting history is amplified by another feature of the legislative\nadvance toward the current law. Any argument from drafting history has to account for the fact\nthat the Code does not codify any authoritative pre-Code version of the absolute priority rule.\nThe upshot is that this history does nothing to disparage the possibility apparent in the\nstatutory text, that the absolute priority rule now on the books as subsection (b)(2)(B)(ii) may carry\na new value corollary. Although there is no literal reference to "new value" in the phrase "on\naccount of such junior claim," the phrase could arguably carry such an implication in modifying\nthe prohibition against receipt by junior claimants of any interest under a plan while a senior class\nof unconsenting creditors goes less than fully paid.\nThree basic interpretations have been suggested for the "on account of" modifier. The first\nreading is proposed by the Partnership, that "on account of" harks back to accounting practice and\nmeans something like "in exchange for," or "in satisfaction of," On this view, a plan would not\nviolate the absolute priority rule unless the old equity holders received or retained property in\nexchange for the prior interest, without any significant new contribution; if substantial money\npassed from them as part of the deal, the prohibition of subsection (b)(2)(B)(ii) would not stand in\nthe way, and whatever issues of fairness and equity there might otherwise be would not implicate\nthe "on account of" modifier.\nThis position is beset with troubles, the first one being textual. Subsection (b)(2)(B)(ii)\nforbids not only receipt of property on account of the prior interest but its retention as well. The\nsecond difficulty is practical: the unlikelihood that Congress meant to impose a condition as\nmanipulable as subsection (b)(2)(B)(ii) would be if "on account of" meant to prohibit merely an\nexchange unaccompanied by a substantial infusion of new funds but permit one whenever\nsubstantial funds changed hands. "Substantial" or "significant" or "considerable" or like\ncharacterizations of a monetary contribution would measure it by the Lord Chancellor\'s foot, and\nan absolute priority rule so variable would not be much of an absolute.\nSince the "in exchange for" reading merits rejection, the way is open to recognize the more\ncommon understanding of "on account of" to mean "because of." This is certainly the usage meant\nfor the phrase at other places in the statute. . . . So, under the commonsense rule that a given phrase\nis meant to carry a given concept in a single statute, the better reading of subsection (b)(2)(B)(ii)\nrecognizes that a causal relationship between holding the prior claim or interest and receiving or\nretaining property is what activates the absolute priority rule.\nThe degree of causation is the final bone of contention. We understand the Government, as\namicus curiae, to take the starchy position not only that any degree of causation between earlier\ninterests and retained property will activate the bar to a plan providing for later property, but also\nthat whenever the holders of equity in the Debtor end up with some property there will be some\ncausation; when old equity, and not someone on the street, gets property the reason is res ipsa\n379\n\n\x0cloquitur. An old equity holder simply cannot take property under a plan if creditors are not paid in\nfull.\nThere are, however, reasons counting against such a reading. If, as is likely, the drafters\nwere treating junior claimants or interest holders as a class at this point then the simple way to\nhave prohibited the old interest holders from receiving anything over objection would have been\nto omit the "on account of" phrase entirely from subsection (b)(2)(B)(ii). On this assumption,\nreading the provision as a blanket prohibition would leave "on account of" as a redundancy,\ncontrary to the interpretive obligation to try to give meaning to all the statutory language. One\nwould also have to ask why Congress would have desired to exclude prior equity categorically\nfrom the class of potential owners following a cramdown. Although we have some doubt about\nthe Court of Appeals\xe2\x80\x99 assumption that prior equity is often the only source of significant capital\nfor reorganizations, old equity may well be in the best position to make a go of the reorganized\nenterprise and so may be the party most likely to work out an equity-for-value reorganization.\nA less absolute statutory prohibition would follow from reading the "on account of"\nlanguage as intended to reconcile the two recognized policies underlying Chapter 11, of preserving\ngoing concerns and maximizing property available to satisfy creditors. Causation between the old\nequity\'s holdings and subsequent property substantial enough to disqualify a plan would\npresumably occur on this view of things whenever old equity\'s later property would come at a\nprice that failed to provide the greatest possible addition to the bankruptcy estate, and it\nwould always come at a price too low when the equity holders obtained or preserved an\nownership interest for less than someone else would have paid. A truly full value transaction,\non the other hand, would pose no threat to the bankruptcy estate not posed by any reorganization,\nprovided of course that the contribution be in cash or be realizable money\'s worth, just as Ahlers\nrequired for application of Case`s new value rule.\nWhich of these positions is ultimately entitled to prevail is not to be decided here, however,\nfor even on the latter view the Bank\'s objection would require rejection of the plan at issue in this\ncase. It is doomed, we can say without necessarily exhausting its flaws, by its provision for\nvesting equity in the reorganized business in the Debtor\'s partners without extending an\nopportunity to anyone else either to compete for that equity or to propose a competing\nreorganization plan. Although the Debtor\'s exclusive opportunity to propose a plan under \xc2\xa7\n1121(b) is not itself "property" within the meaning of subsection (b)(2)(B)(ii), the respondent\npartnership in this case has taken advantage of this opportunity by proposing a plan under which\nthe benefit of equity ownership may be obtained by no one but old equity partners. Upon the\ncourt\'s approval of that plan, the partners were in the same position that they would have enjoyed\nhad they exercised an exclusive option under the plan to buy the equity in the reorganized entity,\nor contracted to purchase it from a seller who had first agreed to deal with no one else. It is quite\ntrue that the escrow of the partners\' proposed investment eliminated any formal need to set out an\nexpress option or exclusive dealing provision in the plan itself, since the court\'s approval that\ncreated the opportunity and the partners\' action to obtain its advantage were simultaneous. But\nbefore the Debtor\'s plan was accepted no one else could propose an alternative one, and after its\nacceptance no one else could obtain equity in the reorganized entity. At the moment of the plan\'s\napproval the Debtor\'s partners necessarily enjoyed an exclusive opportunity that was in no\neconomic sense distinguishable from the advantage of the exclusively entitled offeror or option\nholder. This opportunity should, first of all, be treated as an item of property in its own right. While\n380\n\n\x0cit may be argued that the opportunity has no market value, being significant only to old equity\nholders owing to their potential tax liability, such an argument avails the Debtor nothing, for\nseveral reasons. It is to avoid just such arguments that the law is settled that any otherwise\ncognizable property interest must be treated as sufficiently valuable to be recognized under the\nBankruptcy Code. Even aside from that rule, the assumption that no one but the Debtor\'s partners\nmight pay for such an opportunity would obviously support no inference that it is valueless, let\nalone that it should not be treated as property. And, finally, the source in the tax law of the\nopportunity\'s value to the partners implies in no way that it lacks value to others. It might, indeed,\nbe valuable to another precisely as a way to keep the Debtor from implementing a plan that would\navoid a Chapter 7 liquidation.\nGiven that the opportunity is property of some value, the question arises why old equity\nalone should obtain it, not to mention at no cost whatever. The closest thing to an answer favorable\nto the Debtor is that the old equity partners would be given the opportunity in the expectation that\nin taking advantage of it they would add the stated purchase price to the estate. But this just begs\nthe question why the opportunity should be exclusive to the old equity holders. If the price to be\npaid for the equity interest is the best obtainable, old equity does not need the protection of\nexclusiveness (unless to trump an equal offer from someone else); if it is not the best, there is no\napparent reason for giving old equity a bargain. There is no reason, that is, unless the very purpose\nof the whole transaction is, at least in part, to do old equity a favor. And that, of course, is to say\nthat old equity would obtain its opportunity, and the resulting benefit, because of old equity\'s\nprior interest within the meaning of subsection (b)(2)(B)(ii). Hence it is that the exclusiveness\nof the opportunity, with its protection against the market\'s scrutiny of the purchase price by means\nof competing bids or even competing plan proposals, renders the partners\' right a property interest\nextended "on account of" the old equity position and therefore subject to an unpaid senior creditor\nclass\'s objection.\n[E]ven if we assume that old equity\'s plan would not be confirmed without satisfying the\njudge that the purchase price was top dollar, there is a further reason here not to treat property\nconsisting of an exclusive opportunity as subsumed within the total transaction proposed. On the\ninterpretation assumed here, it would, of course, be a fatal flaw if old equity acquired or retained\nthe property interest without paying full value. It would thus be necessary for old equity to\ndemonstrate its payment of top dollar, but this it could not satisfactorily do when it would receive\nor retain its property under a plan giving it exclusive rights and in the absence of a competing plan\nof any sort. Under a plan granting an exclusive right, making no provision for competing bids or\ncompeting plans, any determination that the price was top dollar would necessarily be made\nby a judge in bankruptcy court, whereas the best way to determine value is exposure to a\nmarket.\nWhether a market test would require an opportunity to offer competing plans or would be\nsatisfied by a right to bid for the same interest sought by old equity is a question we do not decide\nhere. It is enough to say, assuming a new value corollary, that plans providing junior interest\nholders with exclusive opportunities free from competition and without benefit of market valuation\nfall within the prohibition of \xc2\xa7 1129(b)(2)(B)(ii).\n\n13.13. Practice Problems: Confirmation and Cramdown under Chapter\n11 (11 U.S.C. \xc2\xa7 1129)\n381\n\n\x0cProblem 1. Is there a new value exception/corollary to the absolute priority rule? If so,\nhow must the plan be structured to qualify under the exception/corollary? See BofA v. 203 North\nLaSalle reprinted above\nProblem 2. Debtor wishes to propose a Chapter 11 plan that pays unsecured creditors in\nfull over 5 years with post-confirmation interest at the Till rate. Debtor expects unsecured creditors\nto vote against the plan. Assuming that unsecured creditors would be paid in full right away in a\nChapter 7 liquidation, can the plan be confirmed over the unsecured creditors\xe2\x80\x99 objections if the\nequity holders are keeping their stock? See 11 U.S.C. \xc2\xa7 1129(b)(2)(B)(1).\nProblem 3. Debtor owes BigBank a total of $12 million. The loan is secured by a first\npriority mortgage on the Debtor\xe2\x80\x99s 10-story office building. The Court has determined that the\ncurrent fair market value of the office building is $9 million. The prime rate is currently 7%, and\nthe Court will require the payment of 3% over prime under Till. The Court will also not permit a\nplan term to exceed 20 years. Calculate a monthly payment to be made over a 20 year term that\nwill allow the Debtor to confirm the plan over BigBank\xe2\x80\x99s objection if BigBank makes the election\nunder 11 U.S.C. \xc2\xa7 1111(b)(2) to be treated as a fully secured creditor. Read carefully the\nrequirement for confirmation in 11 U.S.C. \xc2\xa7 1129(b)(2)(A)(i)(II). Note that the courts have\ninterpreted the Bankruptcy Code to require equal monthly payments over the term.\nProblem 4. Could the Debtor in Problem (3) confirm the plan while making a lower\nmonthly payment for the same term if BigBank did not make the Section 1111(b)(2) election?\nProblem 5. Given your analysis in Problems (3) and (4), when would it be advisable for\nan undersecured creditor make the Section 1111(b)(2) election?\n\n13.14. The Chapter 11 Discharge - 11 U.S.C. \xc2\xa7 1141\nSection 1141 contains two discharges \xe2\x80\x93 one for entities and one for individuals. Entities\nare discharged from all debts not provided for in the plan upon confirmation. 11 U.S.C. \xc2\xa7\n1141(d)(1). Individuals do not receive a discharge until the plan is completed (11 U.S.C. \xc2\xa7\n1141(d)(5)(A)), and are not discharged from those debts excepted from discharge under Section\n523 (11 U.S.C. \xc2\xa7 1141(d)(2)). Note that there are no exceptions to discharge for entities \xe2\x80\x93 entities\nare discharged from all debts other than those provided by the plan, even if they committed terrible\nacts like fraud, breach of fiduciary duty, and the like. Finally, as in Chapter 13, individuals in\nChapter 11 may be eligible for a hardship discharge if they cannot complete the plan but have paid\nmore in present value to creditors than the creditors would have received in Chapter 7. 11 U.S.C.\n\xc2\xa7 1141(d)(5)(B).\n\n13.15. Protecting the Integrity of the Bankruptcy Process\nThe Bankruptcy Code contains a great deal of flexibility for a debtor seeking to operate a\nbusiness. Just about anything can be done with the approval of the bankruptcy court, after notice\nand an opportunity for a hearing, including the use, sale or lease of the debtor\xe2\x80\x99s money or property\nout of the ordinary course of business under Section 363(b)(1) of the Bankruptcy Code. This preconfirmation flexibility can come into conflict with the plan process, and the fundamental\nbankruptcy principle that requires equal distribution in bankruptcy to similarly situated creditors.\n382\n\n\x0cWould an early proposal by the debtor to sell all of the debtor\xe2\x80\x99s assets under Section 363 to a newly\nformed corporation in return for stock in the newly formed corporation subvert the plan process\nby bypassing the voting and other confirmation protections of the Bankruptcy Code? Would an\norder allowing the debtor to pay in full certain favored unsecured claims while other unsecured\ncreditors in the same class go largely unpaid violate the Bankruptcy Code\xe2\x80\x99s equality of distribution\nprinciple? The cases that follow, which were shocking to the bankruptcy community when issued,\nemphasize that the bankruptcy judge must carefully consider and justify the decision to allow a\ndebtor or trustee to act outside of a plan when fundamental bankruptcy principles are at stake.\n\n13.16. Cases on Protecting the Integrity of the Bankruptcy Process\n13.16.1.1.\n\nIN RE LIONEL CORP., 722 F.2d 1063 (2d Cir. 1983)\n\nThis expedited appeal is from [lower court orders authorizing] the sale by Lionel\nCorporation, a Chapter 11 debtor in possession, of its 82% common stock holding in Dale\nElectronics, Inc. to Peabody International Corporation for $50 million.\nOn February 19, 1982 the Lionel Corporation--toy train manufacturer of childhood\nmemory-- filed petitions for reorganization under Chapter 11 of the Bankruptcy Code. Resort to\nChapter 11 was precipitated by losses totaling $22.5 million that Lionel incurred in its toy retailing\noperation during the two year period ending December 1982. Lionel continues to operate its\nbusinesses and manage its properties.\nLionel\'s most important asset and the subject of this proceeding is its ownership of 82% of\nthe common stock of Dale, a corporation engaged in the manufacture of electronic components.\nDale is not a party to the Lionel bankruptcy proceeding. Public investors own the remaining 18\npercent of Dale\'s common stock, which is listed on the American Stock Exchange. Lionel\'s\ninvestment in Dale is Lionel\'s most valuable single asset. Unlike Lionel\'s toy retailing operation,\nDale is profitable. For the same two-year period ending in December 1982 during which Lionel\nhad incurred its substantial losses, Dale had an aggregate operating profit of $18.8 million.\nOn June 14, 1983 Lionel filed an application under section 363(b) seeking bankruptcy court\nauthorization to sell its 82% interest in Dale to Acme-Cleveland Corporation for $43 million in\ncash. Four days later the debtor filed a plan of reorganization conditioned upon a sale of Dale with\nthe proceeds to be distributed to creditors. Bankruptcy Judge Ryan held a hearing on Lionel\'s\napplication. At the hearing, Peabody emerged as the successful of three bidders with an offer of\n$50 million for Lionel\'s interest in Dale.\nThe Chief Executive Officer of Lionel and a Vice-President of Salomon Brothers were the\nonly witnesses produced and both testified in support of the application. Their testimony\nestablished that while the price paid for the stock was "fair," Dale is not an asset "that is wasting\naway in any sense." Lionel\'s Chief Executive Officer stated that there was no reason why the sale\nof Dale stock could not be accomplished as part of the reorganization plan, and that the sole reason\nfor Lionel\'s application to sell was the Creditors\' Committee\'s insistence upon it. The creditors\nwanted to turn this asset of Lionel into a "pot of cash," to provide the bulk of the $70 million\nrequired to repay creditors under the proposed plan of reorganization.\n383\n\n\x0cIn confirming the sale, Judge Ryan made no formal findings of fact. He simply noted that\ncause to sell was sufficiently shown by the Creditors\' Committee\'s insistence upon it.\nThe Committee of Equity Security Holders, statutory representatives of the 10,000 public\nshareholders of Lionel, appealed this order claiming that the sale, prior to approval of a\nreorganization plan, deprives the equity holders of the Bankruptcy Code\'s safeguards of disclosure,\nsolicitation and acceptance and divests the debtor of a dominant and profitable asset which could\nserve as a cornerstone for a sound plan. The SEC also appeared and objected to the sale in the\nbankruptcy court and supports the Equity Committee\'s appeal, claiming that approval of the sale\nside-steps the Code\'s requirement for informed suffrage which is at the heart of Chapter 11.\nFrom the oral arguments and briefs we gather that the Equity Committee believes that\nChapter 11 has cleared the reorganization field of major pre-plan sales--somewhat like the way\nMinerva routed Mars--relegating Sec. 363(b) to be used only in emergencies. The Creditors\'\nCommittee counters that a bankruptcy judge should have absolute freedom under Sec. 363(b) to\ndo as he thinks best. Neither of these arguments is wholly persuasive. Here, as in so many similar\ncases, we must avoid the extremes, for the policies underlying the Bankruptcy Reform Act of 1978\nsupport a middle ground--one which gives the bankruptcy judge considerable discretion yet\nrequires him to articulate sound business justifications for his decisions.\nOn its face, section 363(b) appears to permit disposition of any property of the estate of a\ncorporate debtor without resort to the statutory safeguards embodied in Chapter 11 of the\nBankruptcy Code. Yet, analysis of the statute\'s history and over seven decades of case law\nconvinces us that such a literal reading of section 363(b) would unnecessarily violate the\ncongressional scheme for corporate reorganizations.\nA. Prior bankruptcy Acts --the "Perishable" Standard\nThe 1867 Act did not provide for reorganizations; nevertheless, the requirements that the\nproperty be of a perishable nature or liable to deteriorate in value and that there be loss if the same\nis not sold immediately were also found in General Bankruptcy Order No. XVIII(3), adopted by\nthe Supreme Court in 1898.\nFrom 1898 through 1937, the Bankruptcy Act did not contain a specific provision\npermitting pre-adjudication sales of a debtor\'s property. But, pursuant to General Order XVIII, this\nCircuit over fifty years ago upheld an order that approved a private, pre-adjudication sale of a\nbankrupt\'s stock of handkerchiefs. Not only was merchandise sold at a price above its appraised\nvalue, but Christmas sales had commenced and the sale of handkerchiefs would decline greatly\nafter the holidays. Our court held that the concept of "perishable" was not limited to its physical\nmeaning, but also included property liable to deteriorate in price and value.\nB. Chandler Act of 1938--The "Upon Cause Shown" Standard\nWhen reorganization became part of the bankruptcy law, the long established\nadministrative powers of the court to sell a debtor\'s property prior to adjudication were extended\nto cover reorganizations. The Rules of Bankruptcy Procedure provided for a sale of all or part of\na bankrupt\'s property after application to the court and "upon cause shown." Despite the provisions\nof this Rule, the "perishable" concept, expressed in the view that a pre-confirmation or preadjudication sale was the exception and not the rule, persisted. As one commentator stated,\n384\n\n\x0c"[o]rdinarily, in the absence of perishable goods, or depreciation of assets, or actual jeopardy of\nthe estate, a sale will not be ordered, particularly prior to adjudication."\n[Later] in Frank v. Drinc-O-Matic, Inc., 136 F.2d 906 (2d Cir.1943), we upheld the sale of\na debtor\'s 19 vending machines that were subject to a vendor\'s lien and in the possession of their\nmanufacturer. We noted that the trustee had no funds with which to redeem the machines and that\nsix months had passed from the filing of the petition without proposal of a reorganization plan.\nCiting Sec. 116(3) of the Act, we next affirmed an order of a sale of vats, kettles and other brewing\nmachinery which, with "\'the approach of warm weather ... will, because of lack of use and\nrefrigeration, deteriorate rapidly and lose substantially all their value.\'" In re V. Loewer\'s\nGambrinus Brewery Co., 141 F.2d 747, 748 (2d Cir. 1944). While the court acknowledged the\nviability of the "perishable" property concept, it upheld the sale even though virtually all of the\nincome producing assets of the debtor were involved. The same proceeding, then entitled Patent\nCereals v. Flynn, 149 F.2d 711 (2d Cir. 1945), came before us the following year. We said it made\nno difference whether sale of a debtor\'s property preceded or was made part of a plan of\nreorganization. Nothing, we continued, in former section 216 (providing for the sale of a\nreorganizing debtor\'s property pursuant to a plan) precluded approval of a plan after a sale of all\nor a substantial part of the debtor\'s property. Section 216 merely permitted a plan providing for\nsuch sale and did not forbid a plan after such a sale has already taken place.\nJudge Ryan, in authorizing the sale of the Dale stock cited Patent Cereals as his authority.\nAppellees here cite Patent Cereals for the proposition that this court has abandoned the perishable\nproperty or emergency concept. We reject such a broad reading of Patent Cereals for several\nreasons. First, the decision involved an appeal from a denial of confirmation of a plan of\nreorganization, i.e., the sale in that case was a fait accompli, it was not as here an appeal from an\nauthorization of sale. Second, the earlier decision in Loewer\'s Gambrinus Brewery, indicates that\nthe court did view the original sale as involving perishable property. Third, subsequent cases in\nthis Circuit confirm the misapprehension in appellees\' and Judge Ryan\'s broad interpretation.\nThe Third Circuit took an even stricter view in In re Solar Mfg. Corp., 176 F.2d 493 (3d\nCir. 1949). [T]he court concluded that pre-confirmation sales should be "confined to emergencies\nwhere there is imminent danger that the assets of the ailing business will be lost if prompt action\nis not taken." This "emergency" approach was so appealing that our court cited Solar Mfg. Corp.\nwith approval and held in In re Pure Penn Petroleum Co., 188 F.2d 851 (2d Cir. 1951), that the\ndebtor must plead and prove "the existence of an emergency involving imminent danger of loss of\nthe assets if they were not promptly sold."\nFinally, in In re Sire Plan, Inc., 332 F.2d 497 (2d Cir. 1964), corporate owners of a sevenstory skeletal building then under construction filed for reorganization under Chapter X of the Act.\nBecause of the site\'s close proximity to the impending 1964 World\'s Fair, Holiday Inns felt it was\na favorable location for a hotel and accordingly offered to purchase it. The sale to Holiday Inns\nwas affirmed under the Patent Cereal rationale. The Court stated that there is no re quirement that\nthe sale be in aid of a reorganization; but we further noted, as in Pure Penn, that the evidence\ndemonstrated that in its exposed state a "partially constructed building is a \'wasting asset\' [that]\ncan only deteriorate in value the longer it remains uncompleted."\n\n385\n\n\x0cMore recently, other circuits have upheld sales prior to plan approval under the Bankruptcy\nAct where the bankruptcy court outlined the circumstances in its findings of fact indicating why\nthe sale was in the best interest of the estate.\nC. The Bankruptcy Reform Act of 1978\nSection 363(b) of the Code seems on its face to confer upon the bankruptcy judge virtually\nunfettered discretion to authorize the use, sale or lease, other than in the ordinary course of\nbusiness, of property of the estate. Of course, the statute requires that notice be given and a hearing\nconducted, but no reference is made to an "emergency" or "perishability" requirement nor is there\nan indication that a debtor in possession or trustee contemplating sale must show "cause." Thus,\nthe language of Sec. 363(b) clearly is different from the terms of its statutory predecessors. And,\nwhile Congress never expressly stated why it abandoned the "upon cause shown" terminology of\nSec. 116(3), arguably that omission permits easier access to Sec. 363(b). Various policy\nconsiderations lend some support to this view.\nFirst and foremost is the notion that a bankruptcy judge must not be shackled with\nunnecessarily rigid rules when exercising the undoubtedly broad administrative power granted him\nunder the Code.\nSupport for this policy is found in the rationale underlying a number of earlier cases that\nhad applied Sec. 116(3) of the Act. In particular, this Court\'s decision in Sire Plan was not hinged\non an "emergency" or "perishability" concept. Lip service was paid to the argument that a partially\nconstructed building is a "wasting asset;" but the real justification for authorizing the sale was the\nbelief that the property\'s value depended on whether a hotel could be built in time for the World\'s\nFair and that an advantageous sale after the opening of the World\'s Fair seemed unlikely. Thus,\nthe reason was not solely that a steel skeleton was deteriorating, but rather that a good business\nopportunity was presently available, so long as the parties could act quickly. In such cases therefore\nthe bankruptcy machinery should not straightjacket the bankruptcy judge so as to prevent him from\ndoing what is best for the estate.\nJust as we reject the requirement that only an emergency permits the use of Sec. 363(b),\nwe also reject the view that Sec. 363(b) grants the bankruptcy judge carte blanche.\nThe history surrounding the enactment in 1978 of current Chapter 11 and the logic\nunderlying it buttress our conclusion that there must be some articulated business justification,\nother than appeasement of major creditors, for using, selling or leasing property out of the ordinary\ncourse of business before the bankruptcy judge may order such disposition under Section 363(b).\nThe case law under section 363\'s statutory predecessors used terms like "perishable,"\n"deteriorating," and "emergency" as guides in deciding whether a debtor\'s property could be sold\noutside the ordinary course of business. The use of such words persisted long after their omission\nfrom newer statutes and rules. The administrative power to sell or lease property in a reorganization\ncontinued to be the exception, not the rule. In enacting the 1978 Code Congress was aware of\nexisting case law and clearly indicated as one of its purposes that equity interests have a greater\nvoice in reorganization plans--hence, the safeguards of disclosure, voting, acceptance and\nconfirmation in present Chapter 11.\nResolving the apparent conflict between Chapter 11 and Sec. 363(b) does not require an\nall or nothing approach. Every sale under Sec. 363(b) does not automatically short-circuit or side386\n\n\x0cstep Chapter 11; nor are these two statutory provisions to be read as mutually exclusive. Instead,\nif a bankruptcy judge is to administer a business reorganization successfully under the Code, then-like the related yet independent tasks performed in modern production techniques to ensure good\nresults--some play for the operation of both Sec. 363(b) and Chapter 11 must be allowed for.\nThe rule we adopt requires that a judge determining a Sec. 363(b) application expressly\nfind from the evidence presented before him at the hearing a good business reason to grant such\nan application. In this case the only reason advanced for granting the request to sell Lionel\'s 82\npercent stock interest in Dale was the Creditors\' Committee\'s insistence on it. Such is insufficient\nas a matter of fact because it is not a sound business reason and insufficient as a matter of law\nbecause it ignores the equity interests required to be weighed and considered under Chapter 11.\nThe court also expressed its concern that a present failure to approve the sale would result in a\nlong delay. As the Supreme Court has noted, it is easy to sympathize with the desire of a\nbankruptcy court to expedite bankruptcy reorganization proceedings for they are frequently\nprotracted. "The need for expedition, however, is not a justification for abandoning proper\nstandards."\nAccordingly, the order appealed from is reversed and the matter remanded to the district\ncourt with directions to remand to the bankruptcy court for further proceedings consistent with this\nopinion.\n\n13.16.1.2.\n\nIN RE CHRYSLER, 576 F.3d 108 (2d Cir. 2009)\n\n[Secured Creditors] (collectively, the "Indiana Pensioners" or "Pensioners"), along with\nvarious tort claimants and others, appeal from an order entered in the United States Bankruptcy\nCourt for the Southern District of New York, Arthur J. Gonzalez, Bankruptcy Judge, dated June\n1, 2009 (the "Sale Order"), authorizing the sale of substantially all of the debtor\'s assets to New\nCarCo Acquisition LLC ("New Chrysler"). On June 2, 2009 we granted the Indiana Pensioners\'\nmotion for a stay and for expedited appeal directly to this Court, pursuant to 28 U.S.C. \xc2\xa7 158(d)(2).\nOn June 5, 2009 we heard oral argument, and ruled from the bench and by written order, affirming\nthe Sale Order "for the reasons stated in the opinions of Bankruptcy Judge Gonzalez," stating that\nan opinion or opinions would follow. This is the opinion.\nIn a nutshell, Chrysler and its related companies filed a prepackaged bankruptcy petition\nunder Chapter 11 on April 30, 2009. The filing followed months in which Chrysler experienced\ndeepening losses, received billions in bailout funds from the Federal Government, searched for a\nmerger partner, unsuccessfully sought additional government bailout funds for a stand-alone\nrestructuring, and ultimately settled on an asset-sale transaction pursuant to 11 U.S.C. \xc2\xa7 363 (the\n"Sale"), which was approved by the Sale Order. The key elements of the Sale were: substantially\nall of Chrysler\'s operating assets (including manufacturing plants, brand names, certain dealer and\nsupplier relationships, and much else) would be transferred to New Chrysler in exchange for New\nChrysler\'s assumption of certain liabilities and $2 billion in cash. Fiat S.p.A agreed to provide New\nChrysler with certain fuel-efficient vehicle platforms, access to its worldwide distribution system,\nand new management that is experienced in turning around a failing auto company. Financing for\nthe sale transaction\xe2\x80\x94$6 billion in senior secured financing, and debtor in possession financing for\n60 days in the amount of $4.96 billion\xe2\x80\x94would come from the United States Treasury and from\nExport Development Canada. Ownership of New Chrysler was to be distributed by membership\n387\n\n\x0cinterests, 55% of which go to an employee benefit entity created by the United Auto Workers\nunion, 8% to the United States Treasury and 2% to Export Development Canada. Fiat, for its\ncontributions, would immediately own 20% of the equity with rights to acquire more (up to 51%),\ncontingent on payment in full of the debts owed to the United States Treasury and Export\nDevelopment Canada.\n[The bankruptcy court allowed other bids. After no other bids were forthcoming], the\nbankruptcy court approved the Sale by order dated June 1, 2009.\nAfter briefing and oral argument, we affirmed the bankruptcy court\'s order on June 5, but\nwe entered a short stay pending Supreme Court review. The Supreme Court, after an extension of\nthe stay, declined a further extension. The Sale closed on June 10, 2009.\n[I]t is contended that the sale of Chrysler\'s auto-manufacturing assets, considered together\nwith the associated intellectual property and (selected) dealership contractual rights, so closely\napproximates a final plan of reorganization that it constitutes an impermissible "sub rosa plan,"\nand therefore cannot be accomplished under \xc2\xa7 363(b).\nDISCUSSION\nThe Indiana Pensioners characterize the Sale as an impermissible, sub rosa plan of\nreorganization. As the Indiana Pensioners characterize it, the Sale transaction "is a `Sale\' in name\nonly; upon consummation, new Chrysler will be old Chrysler in essentially every respect. It will\nbe called `Chrysler.\' Its employees, including most management, will be retained.... It will\nmanufacture and sell Chrysler and Dodge cars and minivans, Jeeps and Dodge Trucks.... The real\nsubstance of the transaction is the underlying reorganization it implements."\nSection 363(b) of the Bankruptcy Code authorizes a Chapter 11 debtor in possession to\nuse, sell, or lease estate property outside the ordinary course of business, requiring in most\ncircumstances only that a movant provide notice and a hearing. 11 U.S.C. \xc2\xa7 363(b). We have\nidentified an "apparent conflict" between the expedient of a \xc2\xa7 363(b) sale and the otherwise\napplicable features and safeguards of Chapter 11. In re Lionel Corp., 722 F.2d 1063, 1071 (2d Cir.\n1983).\nIn Lionel, we consulted the history and purpose of \xc2\xa7 363(b) to situate \xc2\xa7 363(b) transactions\nwithin the overall structure of Chapter 11. The origin of \xc2\xa7 363(b) is the Bankruptcy Act of 1867,\nwhich permitted a sale of a debtor\'s assets when the estate or any part thereof was "of a perishable\nnature or liable to deteriorate in value." Typically, courts have approved \xc2\xa7 363(b) sales to preserve\n"`wasting asset[s].\'" Most early transactions concerned perishable commodities; but the same\npractical necessity has been recognized in contexts other than fruits and vegetables. "[T]here are\ntimes when it is more advantageous for the debtor to begin to sell as many assets as quickly as\npossible in order to insure that the assets do not lose value." Thus, an automobile manufacturing\nbusiness can be within the ambit of the "melting ice cube" theory of \xc2\xa7 363(b). As Lionel\nrecognized, the text of \xc2\xa7 363(b) requires no "emergency" to justify approval. For example, if "a\ngood business opportunity [is] presently available," which might soon disappear, quick action may\nbe justified in order to increase (or maintain) the value of an asset to the estate, by means of a lease\nor sale of the assets. Accordingly, Lionel rejected the requirement that only an emergency permits\nthe use of \xc2\xa7 363(b). If a bankruptcy judge is to administer a business reorganization successfully\nunder the Code, then ... some play for the operation of both \xc2\xa7 363(b) and Chapter 11 must be\nallowed for.\n388\n\n\x0cAt the same time, Lionel reject[ed] the view that \xc2\xa7 363(b) grants the bankruptcy judge carte\nblanche. The concern was that a quick, plenary sale of assets outside the ordinary course of\nbusiness risked circumventing key features of the Chapter 11 process, which afford debt and equity\nholders the opportunity to vote on a proposed plan of reorganization after receiving meaningful\ninformation. Pushed by a bullying creditor, a \xc2\xa7 363(b) sale might evade such requirements as\ndisclosure, solicitation, acceptance, and confirmation of a plan. "[T]he natural tendency of a debtor\nin distress," as a Senate Judiciary Committee Report observed, is "to pacify large creditors with\nwhom the debtor would expect to do business, at the expense of small and scattered public\ninvestors." Lionel, 722 F.2d at 1070 (quoting S.Rep. No. 95-989, 2d Sess., at 10 (1978)).\nTo balance the competing concerns of efficiency against the safeguards of the Chapter 11\nprocess, Lionel required a "good business reason" for a \xc2\xa7 363(b) transaction.\nIn the twenty-five years since Lionel, \xc2\xa7 363(b) asset sales have become common practice\nin large-scale corporate bankruptcies. In the current economic crisis of 2008-09, \xc2\xa7 363(b) sales\nhave become even more useful and customary. The "side door" of \xc2\xa7 363(b) may well "replace the\nmain route of Chapter 11 reorganization plans."\nResort to \xc2\xa7 363(b) has been driven by efficiency, from the perspectives of sellers and buyers\nalike. The speed of the process can maximize asset value by sale of the debtor\'s business as a going\nconcern. Moreover, the assets are typically burnished (or "cleansed") because (with certain limited\nexceptions) they are sold free and clear of liens, claims and liabilities. A \xc2\xa7 363 sale can often yield\nthe highest price for the assets because the buyer can select the liabilities it will assume and\npurchase a business with cash flow (or the near prospect of it). Often, a secured creditor can "credit\nbid," or take an ownership interest in the company by bidding a reduction in the debt the company\nowes. See 11 U.S.C. \xc2\xa7 363(k).\nThis tendency has its critics. The objections are not to the quantity or percentage of assets\nbeing sold: it has long been understood by the drafters of the Code, and the Supreme Court that \xc2\xa7\n363(b) sales may encompass all or substantially all of a debtor\'s assets. Rather, the thrust of\ncriticism remains what it was in Lionel: fear that one class of creditors may strong-arm the debtor\nin possession, and bypass the requirements of Chapter 11 to cash out quickly at the expense of\nother stakeholders, in a proceeding that amounts to a reorganization in all but name, achieved by\nstealth and momentum.\nAs \xc2\xa7 363(b) sales proliferate, the competing concerns identified in Lionel have become\nharder to manage. Debtors need flexibility and speed to preserve going concern value; yet one or\nmore classes of creditors should not be able to nullify Chapter 11\'s requirements. A balance is not\neasy to achieve, and is not aided by rigid rules and prescriptions. Lionel\'s multi-factor analysis\nremains the proper, most comprehensive framework for judging the validity of \xc2\xa7 363(b)\ntransactions.\nAdopting the Fifth Circuit\'s wording in In re Braniff Airways, Inc., 700 F.2d 935, 940 (5th\nCir. 1983), commentators and courts\xe2\x80\x94including ours\xe2\x80\x94have sometimes referred to improper \xc2\xa7\n363(b) transactions as "sub rosa plans of reorganization." Braniff rejected a proposed transfer\nagreement in large part because the terms of the agreement specifically attempted to "dictat[e]\nsome of the terms of any future reorganization plan. The [subsequent] reorganization plan would\nhave to allocate the [proceeds of the sale] according to the terms of the [transfer] agreement or\nforfeit a valuable asset." 700 F.2d at 940. As the Fifth Circuit concluded, "[t]he debtor and the\n389\n\n\x0cBankruptcy Court should not be able to short circuit the requirements of Chapter 11 for\nconfirmation of a reorganization plan by establishing the terms of the plan sub rosa in connection\nwith a sale of assets." Id.\nThe term "sub rosa" is something of a misnomer. It bespeaks a covert or secret activity,\nwhereas secrecy has nothing to do with a \xc2\xa7 363 transaction. Transactions blessed by the bankruptcy\ncourts are openly presented, considered, approved, and implemented. Braniff seems to have used\n"sub rosa" to describe transactions that treat the requirements of the Bankruptcy Code as\nsomething to be evaded or subverted. But even in that sense, the term is unhelpful. The sale of\nassets is permissible under \xc2\xa7 363(b); and it is elementary that the more assets sold that way, the\nless will be left for a plan of reorganization, or for liquidation. But the size of the transaction, and\nthe residuum of corporate assets, is, under our precedent, just one consideration for the exercise of\ndiscretion by the bankruptcy judge(s), along with an open-ended list of other salient factors.\nBraniff\'s holding did not support the argument that a \xc2\xa7 363(b) asset sale must be rejected\nsimply because it is a sale of all or substantially all of a debtor\'s assets. Thus a \xc2\xa7 363(b) sale may\nwell be a reorganization in effect without being the kind of plan rejected in Braniff. Although\nLionel did not involve a contention that the proposed sale was a sub rosa or de facto reorganization,\na bankruptcy court confronted with that allegation may approve or disapprove a \xc2\xa7 363(b) transfer\nthat is a sale of all or substantially all of a debtor\'s assets, using the analysis set forth in Lionel in\norder to determine whether there was a good business reason for the sale.\nThe Indiana Pensioners argue that the Sale is a sub rosa plan chiefly because it gives value\nto unsecured creditors (i.e., in the form of the ownership interest in New Chrysler provided to the\nunion benefit funds) without paying off secured debt in full, and without complying with the\nprocedural requirements of Chapter 11. However, Bankruptcy Judge Gonzalez demonstrated\nproper solicitude for the priority between creditors and deemed it essential that the Sale in no way\nupset that priority. The lien holders\' security interests would attach to all proceeds of the Sale: "Not\none penny of value of the Debtors\' assets is going to anyone other than the First-Lien Lenders."\nSale Opinion at 18. As Bankruptcy Judge Gonzalez found, all the equity stakes in New Chrysler\nwere entirely attributable to new value\xe2\x80\x94including governmental loans, new technology, and new\nmanagement\xe2\x80\x94which were not assets of the debtor\'s estate. Id. at 22-23.\nThe Indiana Pensioners\' arguments boil down to the complaint that the Sale does not pass\nthe discretionary, multifarious Lionel test. The bankruptcy court\'s findings constitute an adequate\nrebuttal. Applying the Lionel factors, Bankruptcy Judge Gonzalez found good business reasons for\nthe Sale. The linchpin of his analysis was that the only possible alternative to the Sale was an\nimmediate liquidation that would yield far less for the estate\xe2\x80\x94and for the objectors. The court\nfound that, notwithstanding Chrysler\'s prolonged and well-publicized efforts to find a strategic\npartner or buyer, no other proposals were forthcoming. In the months leading up to Chrysler\'s\nbankruptcy filing, and during the bankruptcy process itself, Chrysler executives circled the globe\nin search of a deal. But the Fiat transaction was the only offer available. [Judge Gonzalez found\nthat] \xe2\x80\x9cthe only other alternative is the immediate liquidation of the company.").\nThe Sale would yield $2 billion. According to expert testimony\xe2\x80\x94not refuted by the\nobjectors\xe2\x80\x94an immediate liquidation of Chrysler as of May 20, 2009 would yield in the range of\nnothing to $800 million. Crucially, Fiat had conditioned its commitment on the Sale being\ncompleted by June 15, 2009. While this deadline was tight and seemingly arbitrary, there was little\n390\n\n\x0cleverage to force an extension. To preserve resources, Chrysler factories had been shuttered, and\nthe business was hemorrhaging cash. According to the bankruptcy court, Chrysler was losing going\nconcern value of nearly $100 million each day.\nOn this record, and in light of the arguments made by the parties, the bankruptcy court\'s\napproval of the Sale was no abuse of discretion. With its revenues sinking, its factories dark, and\nits massive debts growing, Chrysler fit the paradigm of the melting ice cube. Going concern value\nwas being reduced each passing day that it produced no cars, yet was obliged to pay rents,\noverhead, and salaries. Consistent with an underlying purpose of the Bankruptcy Code\xe2\x80\x94\nmaximizing the value of the bankrupt estate\xe2\x80\x94it was no abuse of discretion to determine that the\nSale prevented further, unnecessary losses.\nThe Indiana Pensioners exaggerate the extent to which New Chrysler will emerge from the\nSale as the twin of Old Chrysler. New Chrysler may manufacture the same lines of cars but it will\nalso make newer, smaller vehicles using Fiat technology that will become available as a result of\nthe Sale\xe2\x80\x94moreover, at the time of the proceedings, Old Chrysler was manufacturing no cars at\nall. New Chrysler will be run by a new Chief Executive Officer, who has experience in turning\naround failing auto companies. It may retain many of the same employees, but they will be working\nunder new union contracts that contain a six-year no-strike provision. New Chrysler will still sell\ncars in some of its old dealerships in the United States, but it will also have new access to Fiat\ndealerships in the European market. Such transformative use of old and new assets is precisely\nwhat one would expect from the \xc2\xa7 363(b) sale of a going concern.\nAffirmed.\n[Editor\xe2\x80\x99s Note: In the full opinion, the Chrysler court rejected a number of other\narguments made by the appellants. The Court held that the Indiana Pensioners, who were\nparticipants with others in a secured loan, ceded to a joint trustee the power to consent to\nthe sale. Since the trustee consented, the Indiana Pensioners were bound by that consent.\nThe Court also held that the Indiana Pensioners lacked standing to challenge the use of the\nFederal Government\xe2\x80\x99s TARP money to fund the plan. The court validated the terms which\ngave New Chrysler the assets free and clear of existing product liability claims, rejecting the\nIndiana Pensioners\xe2\x80\x99 argument that Section 363(f) only allows the sale of assets \xe2\x80\x9cfree and clear\nof interests\xe2\x80\x9d and not \xe2\x80\x9cfree and clear of all claims and interests\xe2\x80\x9d which would be permitted\nonly under a confirmed Chapter 11 plan under Section 1141(c). The court rejected the\nargument that the language of Section 363(f) is narrower than the language of Section\n1141(c). Instead, the Court held that the two provisions should be \xe2\x80\x9charmonized.\xe2\x80\x9d Finally,\nlike the court in Manville, the Chrysler court held that the Indiana Pensioners lacked\nstanding to challenge the scope of the release on behalf of future creditors.\nThe Chrysler court left Lionel\xe2\x80\x99s analytical framework in place, but with a very\ndifferent emphasis. It is difficult to know if that pro-sale emphasis was due to the national\nemergency of the Great Recession, with the federal government and proponents of the sale\nclaiming that the American economy\xe2\x80\x99s recovery depended on a favorable decision approving\nthe sale, or whether the courts will generally defer to the \xe2\x80\x9cmelting ice cube\xe2\x80\x9d arguments of\nthe sale proponents in cases where the stakes are not so momentous. Since Lehman Brothers,\nChrysler, and GM, early Section 363 sales have continued to be the predominant method of\n391\n\n\x0creorganization in large corporate cases. But the pendulum may one day swing back against\nearly sales that have the effect of bypassing the reorganization structure of Chapter 11.]\n\n13.16.1.3. IN THE MATTER OF KMART CORP., 359 F.3d 866\n(7th Cir. 2004)\nOn the first day of its bankruptcy, Kmart sought permission to pay immediately, and in\nfull, the pre-petition claims of all "critical vendors." The theory behind the request is that some\nsuppliers may be unwilling to do business with a customer that is behind in payment, and, if it\ncannot obtain the merchandise that its own customers have come to expect, a firm such as Kmart\nmay be unable to carry on, injuring all of its creditors. Full payment to critical vendors thus could\nin principle make even the disfavored creditors better off: they may not be paid in full, but they\nwill receive a greater portion of their claims than they would if the critical vendors cut off supplies\nand the business shut down. Putting the proposition in this way implies, however, that the debtor\nmust prove, and not just allege, two things: that, but for immediate full payment, vendors would\ncease dealing; and that the business will gain enough from continued transactions with the favored\nvendors to provide some residual benefit to the remaining, disfavored creditors, or at least leave\nthem no worse off.\nBankruptcy Judge Sonderby entered a critical-vendors order just as Kmart proposed it,\nwithout notifying any disfavored creditors, without receiving any pertinent evidence, and without\nmaking any finding of fact that the disfavored creditors would gain or come out even. The\nbankruptcy court\'s order declared that the relief Kmart requested \xe2\x80\x94 open-ended permission to pay\nany debt to any vendor it deemed "critical" in the exercise of unilateral discretion, provided that\nthe vendor agreed to furnish goods on "customary trade terms" for the next two years \xe2\x80\x94 was "in\nthe best interests of the Debtors, their estates and their creditors".\nKmart used its authority to pay in full the pre-petition debts to 2,330 suppliers, which\ncollectively received about $300 million. This came from the $2 billion in new credit (debtor in\npossession or DIP financing) that the bankruptcy judge authorized, granting the lenders superpriority in post-petition assets and revenues. Another 2,000 or so vendors were not deemed\n"critical" and were not paid. They and 43,000 additional unsecured creditors eventually received\nabout 10\xc2\xa2 on the dollar, mostly in stock of the reorganized Kmart.\nCapital Factors, Inc., appealed the critical-vendors order immediately after its entry on\nJanuary 25, 2002. A little more than 14 months later, after all of the critical vendors had been paid\nand as Kmart\'s plan of reorganization was on the verge of approval, District Judge Grady reversed\nthe order authorizing payment. He concluded that neither \xc2\xa7 105(a) nor a "doctrine of necessity"\nsupports the orders.\nAppellants insist that, by the time Judge Grady acted, it was too late. Money had changed\nhands and, we are told, cannot be refunded. But why not? Reversing preferential transfers is an\nordinary feature of bankruptcy practice, often continuing under a confirmed plan of reorganization.\nIf the orders in question are invalid, then the critical vendors have received preferences that Kmart\nis entitled to recoup for the benefit of all creditors.\nAppellants say that we should recognize their reliance interests: after the order, they\ncontinued selling goods and services to Kmart (doing this was a condition of payment for pre392\n\n\x0cpetition debts). Continued business relations may or may not be a form of reliance (that depends\non whether the vendors otherwise would have stopped selling), but they are not detrimental\nreliance. The vendors have been paid in full for post-petition goods and services. If Kmart had\nbecome administratively insolvent, and unable to compensate the vendors for post-petition\ntransactions, then it might make sense to permit vendors to retain payments under the criticalvendors order, at least to the extent of the post-petition deficiency. Because Kmart emerged as an\noperating business, however, no such question arises.\nThus we arrive at the merits. Section 105(a) allows a bankruptcy court to "issue any order,\nprocess, or judgment that is necessary or appropriate to carry out the provisions of" the Code. This\ndoes not create discretion to set aside the Code\'s rules about priority and distribution; the power\nconferred by \xc2\xa7 105(a) is one to implement rather than override. Every circuit that has considered\nthe question has held that this statute does not allow a bankruptcy judge to authorize full payment\nof any unsecured debt, unless all unsecured creditors in the class are paid in full.\nA "doctrine of necessity" is just a fancy name for a power to depart from the Code.\nAlthough courts in the days before bankruptcy law was codified wielded power to reorder priorities\nand pay particular creditors in the name of "necessity," today it is the Code rather than the norms\nof nineteenth century railroad reorganizations that must prevail. Older doctrines may survive as\nglosses on ambiguous language enacted in 1978 or later, but not as freestanding entitlements to\ntrump the text.\nSo does the Code contain any grant of authority for debtors to prefer some vendors over\nothers? Many sections require equal treatment or specify the details of priority when assets are\ninsufficient to satisfy all claims. Pre-filing debts are not administrative expenses; they are the\nantithesis of administrative expenses. Filing a petition for bankruptcy effectively creates two firms:\nthe debts of the pre-filing entity may be written down so that the post-filing entity may reorganize\nand continue in business if it has a positive cash flow. Treating pre-filing debts as "administrative"\nclaims against the post-filing entity would impair the ability of bankruptcy law to prevent old debts\nfrom sinking a viable firm.\nThat leaves \xc2\xa7 363(b)(1): "The trustee [or debtor in possession], after notice and a hearing,\nmay use, sell, or lease, other than in the ordinary course of business, property of the estate." This\nis more promising, for satisfaction of a pre-petition debt in order to keep "critical" supplies flowing\nis a use of property other than in the ordinary course of administering an estate in bankruptcy. We\nneed not decide whether \xc2\xa7 363(b)(1) could support payment of some pre-petition debts, because\nthis order was unsound no matter how one reads \xc2\xa7 363(b)(1).\nThe foundation of a critical-vendors order is the belief that vendors not paid for prior\ndeliveries will refuse to make new ones. Without merchandise to sell, a retailer such as Kmart will\nfold. If paying the critical vendors would enable a successful reorganization and make even the\ndisfavored creditors better off, then all creditors favor payment whether or not they are designated\nas "critical." This suggests a use of \xc2\xa7 363(b)(1) similar to the theory underlying a plan crammed\ndown the throats of an impaired class of creditors: if the impaired class does at least as well as it\nwould have under a Chapter 7 liquidation, then it has no legitimate objection and cannot block the\nreorganization. For the premise to hold true, however, it is necessary to show not only that the\ndisfavored creditors will be as well off with reorganization as with liquidation \xe2\x80\x94 a demonstration\nnever attempted in this proceeding \xe2\x80\x94 but also that the supposedly critical vendors would have\n393\n\n\x0cceased deliveries if old debts were left unpaid while the litigation continued. If vendors will deliver\nagainst a promise of current payment, then a reorganization can be achieved, and all unsecured\ncreditors will obtain its benefit, without preferring any of the unsecured creditors.\nSome supposedly critical vendors will continue to do business with the debtor because they\nmust. They may, for example, have long term contracts, and the automatic stay prevents these\nvendors from walking away as long as the debtor pays for new deliveries. Fleming Companies,\nwhich received the largest critical-vendors payment because it sold Kmart between $70 million\nand $100 million of groceries and related goods weekly, was one of these. No matter how much\nFleming would have liked to dump Kmart, it had no right to do so. It was unnecessary to\ncompensate Fleming for continuing to make deliveries that it was legally required to make. Nor\nwas Fleming likely to walk away even if it had a legal right to do so. Each new delivery produced\na profit; as long as Kmart continued to pay for new product, why would any vendor drop the\naccount? That would be a self-inflicted wound. To abjure new profits because of old debts would\nbe to commit the sunk-cost fallacy; well-managed businesses are unlikely to do this. Firms that\ndisdain current profits because of old losses are unlikely to stay in business. They might as well\nburn money or drop it into the ocean. Again Fleming illustrates the point. When Kmart stopped\nbuying its products after the contract expired, Fleming collapsed (Kmart had accounted for more\nthan 50% of its business) and filed its own bankruptcy petition. Fleming was hardly likely to have\nquit selling of its own volition, only to expire the sooner.\nDoubtless many suppliers fear the prospect of throwing good money after bad. It therefore\nmay be vital to assure them that a debtor will pay for new deliveries on a current basis. Providing\nthat assurance need not, however, entail payment for pre-petition transactions. Kmart could have\npaid cash or its equivalent.\nYet the bankruptcy court did not explore [other methods] to assure vendors of payment.\nThe court did not find that any firm would have ceased doing business with Kmart if not paid for\npre-petition deliveries, and the scant record would not have supported such a finding had one been\nmade. The court did not find that discrimination among unsecured creditors was the only way to\nfacilitate a reorganization. It did not find that the disfavored creditors were at least as well off as\nthey would have been had the critical-vendors order not been entered. Even if \xc2\xa7 362(b)(1) allows\ncritical-vendors orders in principle, preferential payments to a class of creditors are proper only if\nthe record shows the prospect of benefit to the other creditors. This record does not, so the criticalvendors order cannot stand.\n\n394\n\n\x0cAPPENDIX A: The Fair Debt Collection Practices Act\n15 U.S.C. \xc2\xa7 1601 et seq\n[Note: bolding has been added to the original text.]\n[T]he Consumer Credit Protection Act (15 U.S.C. \xc2\xa7 1601 et seq.) is amended by adding at the end\nthereof the following new title:\n\xc2\xa7 801. Short Title [15 USC 1601 note] This title may be cited as the "Fair Debt Collection Practices\nAct."\n\xc2\xa7 802. Congressional findings and declarations of purpose [15 USC \xc2\xa7 1692] [omitted]\n\xc2\xa7 803. Definitions [15 USC \xc2\xa7 1692a]. As used in this title -(1) The term "Commission" means the Federal Trade Commission.\n(2) The term "communication" means the conveying of information regarding a debt directly\nor indirectly to any person through any medium.\n(3) The term "consumer" means any natural person obligated or allegedly obligated to pay\nany debt.\n(4) The term "creditor" means any person who offers or extends credit creating a debt or to\nwhom a debt is owed, but such term does not include any person to the extent that he receives\nan assignment or transfer of a debt in default solely for the purpose of facilitating collection\nof such debt for another.\n(5) The term "debt" means any obligation or alleged obligation of a consumer to pay money\narising out of a transaction in which the money, property, insurance or services which are the\nsubject of the transaction are primarily for personal, family, or household purposes,\nwhether or not such obligation has been reduced to judgment.\n(6) The term "debt collector" means any person who uses any instrumentality of interstate\ncommerce or the mails in any business the principal purpose of which is the collection of any\ndebts, or who regularly collects or attempts to collect, directly or indirectly, debts owed or due\nor asserted to be owed or due another. Notwithstanding the exclusion provided by clause (F)\nof the last sentence of this paragraph, the term includes any creditor who, in the process of\ncollecting his own debts, uses any name other than his own which would indicate that a third\nperson is collecting or attempting to collect such debts. For the purpose of section 808(6),\nsuch term also includes any person who uses any instrumentality of interstate commerce or\nthe mails in any business the principal purpose of which is the enforcement of security\ninterests. The term does not include -(A) any officer or employee of a creditor while, in the name of the creditor, collecting\ndebts for such creditor;\n[Omitted captive debt collectors, government collectors, process servers; credit\ncounselors, escrow agents and secured parties, and debts assigned when not in default]\n(7) The term "location information" means a consumer\'s place of abode and his telephone\nnumber at such place, or his place of employment.\n395\n\n\x0c\xc2\xa7 804. Acquisition of location information [15 USC \xc2\xa7 1692b]. Any debt collector communicating\nwith any person other than the consumer for the purpose of acquiring location information\nabout the consumer shall -(1) identify himself, state that he is confirming or correcting location information concerning\nthe consumer, and, only if expressly requested, identify his employer;\n(2) not state that such consumer owes any debt;\n[other limitations on communications that would lead the contacted person to believe the\ncommunication is from a debt collector]\n(6) after the debt collector knows the consumer is represented by an attorney with regard\nto the subject debt and has knowledge of, or can readily ascertain, such attorney\'s name and\naddress, not communicate with any person other than that attorney, unless the attorney fails\nto respond within a reasonable period of time to the communication from the debt collector.\n\xc2\xa7 805. Communication in connection with debt collection [15 USC \xc2\xa7 1692c]\n(a) COMMUNICATION WITH THE CONSUMER GENERALLY. Without the prior\nconsent of the consumer given directly to the debt collector or the express permission of a\ncourt of competent jurisdiction, a debt collector may not communicate with a consumer in\nconnection with the collection of any debt -(1) at any unusual time or place or a time or place known or which should be known to\nbe inconvenient to the consumer. In the absence of knowledge of circumstances to the\ncontrary, a debt collector shall assume that the convenient time for communicating with\na consumer is after 8 o\'clock antemeridian and before 9 o\'clock postmeridian, local time\nat the consumer\'s location;\n(2) if the debt collector knows the consumer is represented by an attorney with respect\nto such debt and has knowledge of, or can readily ascertain, such attorney\'s name and\naddress, unless the attorney fails to respond within a reasonable period of time to a\ncommunication from the debt collector or unless the attorney consents to direct\ncommunication with the consumer; or\n(3) at the consumer\'s place of employment if the debt collector knows or has reason to\nknow that the consumer\'s employer prohibits the consumer from receiving such\ncommunication.\n(b) COMMUNICATION WITH THIRD PARTIES. Except as provided in section 804,\nwithout the prior consent of the consumer given directly to the debt collector, or the express\npermission of a court of competent jurisdiction, or as reasonably necessary to effectuate a post\njudgment judicial remedy, a debt collector may not communicate, in connection with the\ncollection of any debt, with any person other than a consumer, his attorney, a consumer\nreporting agency if otherwise permitted by law, the creditor, the attorney of the creditor, or\nthe attorney of the debt collector.\n(c) CEASING COMMUNICATION. If a consumer notifies a debt collector in writing that\nthe consumer refuses to pay a debt or that the consumer wishes the debt collector to cease\nfurther communication with the consumer, the debt collector shall not communicate further\nwith the consumer with respect to such debt, except-396\n\n\x0c(1) to advise the consumer that the debt collector\'s further efforts are being terminated;\n(2) to notify the consumer that the debt collector or creditor may invoke specified\nremedies which are ordinarily invoked by such debt collector or creditor; or\n(3) where applicable, to notify the consumer that the debt collector or creditor intends to\ninvoke a specified remedy.\nIf such notice from the consumer is made by mail, notification shall be complete upon\nreceipt.\n(d) For the purpose of this section, the term "consumer" includes the consumer\'s spouse, parent\n(if the consumer is a minor), guardian, executor, or administrator.\n\xc2\xa7 806. Harassment or abuse [15 USC \xc2\xa7 1692d]. A debt collector may not engage in any conduct\nthe natural consequence of which is to harass, oppress, or abuse any person in connection with\nthe collection of a debt. Without limiting the general application of the foregoing, the following\nconduct is a violation of this section:\n(1) The use or threat of use of violence or other criminal means to harm the physical person,\nreputation, or property of any person.\n(2) The use of obscene or profane language or language the natural consequence of which is\nto abuse the hearer or reader.\n(3) The publication of a list of consumers who allegedly refuse to pay debts, except to a\nconsumer reporting agency or to persons meeting the requirements of section 603(f) or\n604(3)1 of this Act.\n(4) The advertisement for sale of any debt to coerce payment of the debt.\n(5) Causing a telephone to ring or engaging any person in telephone conversation repeatedly\nor continuously with intent to annoy, abuse, or harass any person at the called number.\n(6) Except as provided in section 804, the placement of telephone calls without meaningful\ndisclosure of the caller\'s identity.\n\xc2\xa7 807. False or misleading representations [15 USC \xc2\xa7 1692e]. A debt collector may not use any\nfalse, deceptive, or misleading representation or means in connection with the collection of any\ndebt. Without limiting the general application of the foregoing, the following conduct is a violation\nof this section:\n(1) The false representation or implication that the debt collector is vouched for, bonded by,\nor affiliated with the United States or any State, including the use of any badge, uniform, or\nfacsimile thereof.\n(2) The false representation of -(A) the character, amount, or legal status of any debt; or\n(B) any services rendered or compensation which may be lawfully received by any debt\ncollector for the collection of a debt.\n(3) The false representation or implication that any individual is an attorney or that any\ncommunication is from an attorney.\n397\n\n\x0c(4) The representation or implication that nonpayment of any debt will result in the arrest\nor imprisonment of any person or the seizure, garnishment, attachment, or sale of any\nproperty or wages of any person unless such action is lawful and the debt collector or creditor\nintends to take such action.\n(5) The threat to take any action that cannot legally be taken or that is not intended to be taken.\n(6) The false representation or implication that a sale, referral, or other transfer of any interest\nin a debt shall cause the consumer to -(A) lose any claim or defense to payment of the debt; or\n(B) become subject to any practice prohibited by this title.\n(7) The false representation or implication that the consumer committed any crime or other\nconduct in order to disgrace the consumer.\n(8) Communicating or threatening to communicate to any person credit information which\nis known or which should be known to be false, including the failure to communicate that a\ndisputed debt is disputed.\n(9) The use or distribution of any written communication which simulates or is falsely\nrepresented to be a document authorized, issued, or approved by any court, official, or agency\nof the United States or any State, or which creates a false impression as to its source,\nauthorization, or approval.\n(10) The use of any false representation or deceptive means to collect or attempt to collect any\ndebt or to obtain information concerning a consumer.\n(11) The failure to disclose in the initial written communication with the consumer and, in\naddition, if the initial communication with the consumer is oral, in that initial oral\ncommunication, that the debt collector is attempting to collect a debt and that any\ninformation obtained will be used for that purpose, and the failure to disclose in subsequent\ncommunications that the communication is from a debt collector, except that this paragraph\nshall not apply to a formal pleading made in connection with a legal action.\n(12) The false representation or implication that accounts have been turned over to innocent\npurchasers for value.\n(13) The false representation or implication that documents are legal process.\n(14) The use of any business, company, or organization name other than the true name of the\ndebt collector\'s business, company, or organization.\n(15) The false representation or implication that documents are not legal process forms or do\nnot require action by the consumer.\n(16) The false representation or implication that a debt collector operates or is employed by a\nconsumer reporting agency as defined by section 603(f) of this Act.\n\xc2\xa7 808. Unfair practices [15 USC \xc2\xa7 1692f]. A debt collector may not use unfair or unconscionable\nmeans to collect or attempt to collect any debt. Without limiting the general application of the\nforegoing, the following conduct is a violation of this section:\n398\n\n\x0c(1) The collection of any amount (including any interest, fee, charge, or expense incidental\nto the principal obligation) unless such amount is expressly authorized by the agreement\ncreating the debt or permitted by law.\n(2) The acceptance by a debt collector from any person of a check or other payment instrument\npostdated by more than five days unless such person is notified in writing of the debt\ncollector\'s intent to deposit such check or instrument not more than ten nor less than three\nbusiness days prior to such deposit.\n(3) The solicitation by a debt collector of any postdated check or other postdated payment\ninstrument for the purpose of threatening or instituting criminal prosecution.\n(4) Depositing or threatening to deposit any postdated check or other postdated payment\ninstrument prior to the date on such check or instrument.\n(5) Causing charges to be made to any person for communications by concealment of the true\npurpose of the communication. Such charges include, but are not limited to, collect telephone\ncalls and telegram fees.\n(6) Taking or threatening to take any non-judicial action to effect dispossession or disablement\nof property if -(A) there is no present right to possession of the property claimed as collateral through\nan enforceable security interest;\n(B) there is no present intention to take possession of the property; or\n(C) the property is exempt by law from such dispossession or disablement.\n(7) Communicating with a consumer regarding a debt by post card.\n(8) Using any language or symbol, other than the debt collector\'s address, on any envelope\nwhen communicating with a consumer by use of the mails or by telegram, except that a debt\ncollector may use his business name if such name does not indicate that he is in the debt\ncollection business.\n\xc2\xa7 809. Validation of debts [15 USC \xc2\xa7 1692g]\n(a) Within five days after the initial communication with a consumer in connection with\nthe collection of any debt, a debt collector shall, unless the following information is contained\nin the initial communication or the consumer has paid the debt, send the consumer a written\nnotice containing -(1) the amount of the debt;\n(2) the name of the creditor to whom the debt is owed;\n(3) a statement that unless the consumer, within thirty days after receipt of the notice,\ndisputes the validity of the debt, or any portion thereof, the debt will be assumed to be\nvalid by the debt collector;\n(4) a statement that if the consumer notifies the debt collector in writing within the thirtyday period that the debt, or any portion thereof, is disputed, the debt collector will obtain\nverification of the debt or a copy of a judgment against the consumer and a copy of such\nverification or judgment will be mailed to the consumer by the debt collector; and\n399\n\n\x0c(5) a statement that, upon the consumer\'s written request within the thirty-day period, the\ndebt collector will provide the consumer with the name and address of the original\ncreditor, if different from the current creditor.\n(b) If the consumer notifies the debt collector in writing within the thirty-day period described\nin subsection (a) that the debt, or any portion thereof, is disputed, or that the consumer requests\nthe name and address of the original creditor, the debt collector shall cease collection of the\ndebt, or any disputed portion thereof, until the debt collector obtains verification of the debt\nor any copy of a judgment, or the name and address of the original creditor, and a copy of\nsuch verification or judgment, or name and address of the original creditor, is mailed to\nthe consumer by the debt collector.\n(c) The failure of a consumer to dispute the validity of a debt under this section may not be\nconstrued by any court as an admission of liability by the consumer.\n\xc2\xa7 810. Multiple debts [15 USC \xc2\xa7 1692h]. If any consumer owes multiple debts and makes any\nsingle payment to any debt collector with respect to such debts, such debt collector may not apply\nsuch payment to any debt which is disputed by the consumer and, where applicable, shall apply\nsuch payment in accordance with the consumer\'s directions.\n\xc2\xa7 811. Legal actions by debt collectors [15 USC \xc2\xa7 1692i]\n(a) Any debt collector who brings any legal action on a debt against any consumer shall -(1) in the case of an action to enforce an interest in real property securing the consumer\'s\nobligation, bring such action only in a judicial district or similar legal entity in which such\nreal property is located; or\n(2) in the case of an action not described in paragraph (1), bring such action only in the\njudicial district or similar legal entity -(A) in which such consumer signed the contract sued upon; or\n(B) in which such consumer resides at the commencement of the action.\n(b) Nothing in this title shall be construed to authorize the bringing of legal actions by debt\ncollectors.\n\xc2\xa7 812. Furnishing certain deceptive forms [15 USC \xc2\xa7 1692j]\n(a) It is unlawful to design, compile, and furnish any form knowing that such form would be\nused to create the false belief in a consumer that a person other than the creditor of such\nconsumer is participating in the collection of or in an attempt to collect a debt such consumer\nallegedly owes such creditor, when in fact such person is not so participating.\n(b) Any person who violates this section shall be liable to the same extent and in the same\nmanner as a debt collector is liable under section 813 for failure to comply with a provision\nof this title.\n\xc2\xa7 813. Civil liability [15 USC \xc2\xa7 1692k]\n(a) Except as otherwise provided by this section, any debt collector who fails to comply with\nany provision of this title with respect to any person is liable to such person in an amount\nequal to the sum of -400\n\n\x0c(1) any actual damage sustained by such person as a result of such failure;\n(2)\n(A) in the case of any action by an individual, such additional damages as the court\nmay allow, but not exceeding $1,000; or\n(B) in the case of a class action, (i) such amount for each named plaintiff as could be\nrecovered under subparagraph (A), and (ii) such amount as the court may allow for\nall other class members, without regard to a minimum individual recovery, not to\nexceed the lesser of $500,000 or 1 per centum of the net worth of the debt collector;\nand\n(3) in the case of any successful action to enforce the foregoing liability, the costs of the\naction, together with a reasonable attorney\'s fee as determined by the court. On a\nfinding by the court that an action under this section was brought in bad faith and for the\npurpose of harassment, the court may award to the defendant attorney\'s fees reasonable\nin relation to the work expended and costs.\n(b) In determining the amount of liability in any action under subsection (a), the court shall\nconsider, among other relevant factors -(1) in any individual action under subsection (a)(2)(A), the frequency and persistence of\nnoncompliance by the debt collector, the nature of such noncompliance, and the extent to\nwhich such noncompliance was intentional; or\n(2) in any class action under subsection (a)(2)(B), the frequency and persistence of\nnoncompliance by the debt collector, the nature of such noncompliance, the resources of\nthe debt collector, the number of persons adversely affected, and the extent to which the\ndebt collector\'s noncompliance was intentional.\n(c) A debt collector may not be held liable in any action brought under this title if the debt\ncollector shows by a preponderance of evidence that the violation was not intentional and\nresulted from a bona fide error notwithstanding the maintenance of procedures\nreasonably adapted to avoid any such error.\n(d) An action to enforce any liability created by this title may be brought in any appropriate\nUnited States district court without regard to the amount in controversy, or in any other court\nof competent jurisdiction, within one year from the date on which the violation occurs.\n(e) No provision of this section imposing any liability shall apply to any act done or omitted\nin good faith in conformity with any advisory opinion of the Commission, notwithstanding\nthat after such act or omission has occurred, such opinion is amended, rescinded, or\ndetermined by judicial or other authority to be invalid for any reason.\n\xc2\xa7 814. Administrative enforcement [15 USC \xc2\xa7 1692l] [omitted]\n\xc2\xa7 815. Reports to Congress by the Commission [15 USC \xc2\xa7 1692m] [omitted]\n\xc2\xa7 816. Relation to State laws [15 USC 1692n]. This title does not annul, alter, or affect, or exempt\nany person subject to the provisions of this title from complying with the laws of any State with\nrespect to debt collection practices, except to the extent that those laws are inconsistent with any\nprovision of this title, and then only to the extent of the inconsistency. For purposes of this section,\n401\n\n\x0ca State law is not inconsistent with this title if the protection such law affords any consumer\nis greater than the protection provided by this title.\n\xc2\xa7 817. Exemption for State regulation [15 USC \xc2\xa7 1692o]. The Commission shall by regulation\nexempt from the requirements of this title any class of debt collection practices within any State if\nthe Commission determines that under the law of that State that class of debt collection practices\nis subject to requirements substantially similar to those imposed by this title, and that there is\nadequate provision for enforcement.\n\n402\n\n\x0cAPPENDIX B: Federal Wage Garnishment Limits\n15 U.S.C. \xc2\xa7 1672. Definitions. For the purposes of this subchapter:\n(a) The term \xe2\x80\x9cearnings\xe2\x80\x9d means compensation paid or payable for personal services, whether\ndenominated as wages, salary, commission, bonus, or otherwise, and includes periodic\npayments pursuant to a pension or retirement program.\n(b) The term \xe2\x80\x9cdisposable earnings\xe2\x80\x9d means that part of the earnings of any individual remaining\nafter the deduction from those earnings of any amounts required by law to be withheld.\n(c) The term \xe2\x80\x9cgarnishment\xe2\x80\x9d means any legal or equitable procedure through which the\nearnings of any individual are required to be withheld for payment of any debt.\n15 U.S.C. 1673. Restriction on garnishment\n(a) Maximum allowable garnishment. Except as provided in subsection (b) of this section and\nin section 1675 of this title, the maximum part of the aggregate disposable earnings of an\nindividual for any workweek which is subjected to garnishment may not exceed\n(1) 25 per centum of his disposable earnings for that week, or\n(2) the amount by which his disposable earnings for that week exceed thirty times the\nFederal minimum hourly wage prescribed by section 206 (a)(1) of title 29 in effect at the\ntime the earnings are payable,\nwhichever is less. In the case of earnings for any pay period other than a week, the Secretary\nof Labor shall by regulation prescribe a multiple of the Federal minimum hourly wage\nequivalent in effect to that set forth in paragraph (2).\n(b) Exceptions\n(1) The restrictions of subsection (a) of this section do not apply in the case of\n(A) any order for the support of any person issued by a court of competent\njurisdiction or in accordance with an administrative procedure, which is established\nby State law, which affords substantial due process, and which is subject to judicial\nreview.\n(B) any order of any court of the United States having jurisdiction over cases under\nchapter 13 of title 11.\n(C) any debt due for any State or Federal tax.\n(2) The maximum part of the aggregate disposable earnings of an individual for any\nworkweek which is subject to garnishment to enforce any order for the support of any\nperson shall not exceed\xe2\x80\x94\n(A) where such individual is supporting his spouse or dependent child (other than a\nspouse or child with respect to whose support such order is used), 50 per centum of\nsuch individual\xe2\x80\x99s disposable earnings for that week; and\n(B) where such individual is not supporting such a spouse or dependent child\ndescribed in clause (A), 60 per centum of such individual\xe2\x80\x99s disposable earnings for\nthat week;\n403\n\n\x0cexcept that, with respect to the disposable earnings of any individual for any workweek,\nthe 50 per centum specified in clause (A) shall be deemed to be 55 per centum and the 60\nper centum specified in clause (B) shall be deemed to be 65 per centum, if and to the\nextent that such earnings are subject to garnishment to enforce a support order with\nrespect to a period which is prior to the twelve-week period which ends with the\nbeginning of such workweek.\n(c) Execution or enforcement of garnishment order or process prohibited. No court\nof the United States or any State, and no State (or officer or agency thereof), may\nmake, execute, or enforce any order or process in violation of this section.\n15 U.S. Code \xc2\xa7 1674 - Restriction on discharge from employment by reason of garnishment\n(a) Termination of employment. No employer may discharge any employee by reason of the\nfact that his earnings have been subjected to garnishment for any one indebtedness.\n(b) Penalties. Whoever willfully violates subsection (a) of this section shall be fined not more\nthan $1,000, or imprisoned not more than one year, or both.\n15 U.S. Code \xc2\xa7 1677 - Effect on State laws. This subchapter does not annul, alter, or affect, or\nexempt any person from complying with, the laws of any State\n(1) prohibiting garnishments or providing for more limited garnishment than are allowed\nunder this subchapter, or\n(2) prohibiting the discharge of any employee by reason of the fact that his earnings have been\nsubjected to garnishment for more than one indebtedness.\n\n404\n\n\x0cAPPENDIX C: New York Exemptions\nC.1.\n\nCPLR \xc2\xa7 5205. Personal property exempt from application to the\nsatisfaction of money judgments.\n\n(a) Exemption for personal property. The following personal property when owned by any person\nis exempt from application to the satisfaction of a money judgment except where the judgment is\nfor the purchase price of the exempt property or was recovered by a domestic, laboring person or\nmechanic for work performed by that person in such capacity:\n1. all stoves and home heating equipment kept for use in the judgment debtor\'s dwelling house\nand necessary fuel therefor for one hundred twenty days; one sewing machine with its\nappurtenances;\n2. religious texts, family pictures and portraits, and school books used by the judgment debtor\nor in the family; and other books, not exceeding five hundred dollars in value, kept and used\nas part of the family or judgment debtor\'s library;\n3. a seat or pew occupied by the judgment debtor or the family in a place of public worship;\n4. domestic animals with the necessary food for those animals for one hundred twenty days,\nprovided that the total value of such animals and food does not exceed one thousand dollars;\nall necessary food actually provided for the use of the judgment debtor or his family for one\nhundred twenty days;\n5. all wearing apparel, household furniture, one mechanical, gas or electric refrigerator, one\nradio receiver, one television set, one computer and associated equipment, one cellphone,\ncrockery, tableware and cooking utensils necessary for the judgment debtor and the family;\nall prescribed health aids;\n6. a wedding ring; a watch, jewelry and art not exceeding one thousand dollars in value;\n7. tools of trade, necessary working tools and implements, including those of a mechanic, farm\nmachinery, team, professional instruments, furniture and library, not exceeding three thousand\ndollars in value, together with the necessary food for the team for one hundred twenty days,\nprovided, however, that the articles specified in this paragraph are necessary to the carrying\non of the judgment debtor\'s profession or calling;\n8. one motor vehicle not exceeding four thousand dollars in value above liens and\nencumbrances of the debtor; if such vehicle has been equipped for use by a disabled debtor,\nthen ten thousand dollars in value above liens and encumbrances of the debtor; provided,\nhowever, that this exemption for one motor vehicle shall not apply if the debt enforced is for\nchild support, spousal support, maintenance, alimony or equitable distribution; and\n9. if no homestead exemption is claimed, then one thousand dollars in personal property, bank\naccount or cash.\n***\n(g) Security deposit exemption. Money deposited as security for the rental of real property to be\nused as the residence of the judgment debtor or the judgment debtor\'s family; and money deposited\n405\n\n\x0cas security with a gas, electric, water, steam, telegraph or telephone corporation, or a municipality\nrendering equivalent utility services, for services to judgment debtor\'s residence or the residence\nof judgment debtor\'s family, are exempt from application to the satisfaction of a money judgment\n\nC.2.\n\nCPLR \xc2\xa7 5206. Real property exempt from application to the\nsatisfaction of money judgments.\n\n(a) Exemption of homestead. Property of one of the following types, not exceeding [$150,000 in\nNYC counties, $125,000 in certain other expensive counties, and $75,000 in the remaining\ncounties like Onondaga] in value above liens and encumbrances, owned and occupied as a\nprincipal residence, is exempt from application to the satisfaction of a money judgment, unless the\njudgment was recovered wholly for the purchase price thereof:\n1. a lot of land with a dwelling thereon,\n2. shares of stock in a cooperative apartment corporation,\n3. units of a condominium apartment, or\n4. a mobile home.\nBut no exempt homestead shall be exempt from taxation or from sale for non-payment of taxes or\nassessments.\n(b) Homestead exemption after owner\'s death. The homestead exemption continues after the death\nof the person in whose favor the property was exempted for the benefit of the surviving spouse\nand surviving children until the majority of the youngest surviving child and until the death of the\nsurviving spouse.\n(c) Suspension of occupation as affecting homestead. The homestead exemption ceases if the\nproperty ceases to be occupied as a residence by a person for whose benefit it may so continue,\nexcept where the suspension of occupation is for a period not exceeding one year, and occurs in\nconsequence of injury to, or destruction of, the dwelling house upon the premises.\n(d) Exemption of homestead exceeding [exempt amounts by county listed above]. The exemption\nof a homestead is not void because the value of the property exceeds [the exempt amount by\ncounty] but the lien of a judgment attaches to the surplus.\n(e) Sale of homestead exceeding [exempt amounts by county listed above]. A judgment creditor\nmay commence a special proceeding in the county in which the homestead is located against the\njudgment debtor for the sale, by a sheriff or receiver, of a homestead exceeding [exempt amount\nby county]. The court may direct that the notice of petition be served upon any other person. The\ncourt, if it directs such a sale, shall so marshal the proceeds of the sale that the right and interest\nof each person in the proceeds shall correspond as nearly as may be to his right and interest in the\nproperty sold. Money, not exceeding [exempt amounts by county] paid to a judgment debtor, as\nrepresenting his interest in the proceeds, is exempt for one year after the payment, unless, before\nthe expiration of the year, he acquires an exempt homestead, in which case, the exemption ceases\nwith respect to so much of the money as was not expended for the purchase of that property; and\nthe exemption of the property so acquired extends to every debt against which the property sold\nwas exempt. Where the exemption of property sold as prescribed in this subdivision has been\n406\n\n\x0ccontinued after the judgment debtor\'s death, or where he dies after the sale and before payment to\nhim of his portion of the proceeds of the sale, the court may direct that portion of the proceeds\nwhich represents his interest be invested for the benefit of the person or persons entitled to the\nbenefit of the exemption, or be otherwise disposed of as justice requires.\n(f) Exemption of burying ground. Land, set apart as a family or private burying ground, is exempt\nfrom application to the satisfaction of a money judgment, upon the following conditions only:\n1. a portion of it must have been actually used for that purpose;\n2. it must not exceed in extent one-fourth of an acre; and\n3. it must not contain any building or structure, except one or more vaults or other places of\ndeposit for the dead, or mortuary monuments.\n\nC.3.\n\nNew York Debtor Creditor Law, Art. 10A, \xc2\xa7 282.\n\nPermissible exemptions in bankruptcy.\nUnder section five hundred twenty-two of title eleven of the United States Code, entitled\n"Bankruptcy", an individual debtor domiciled in this state may exempt from the\nproperty of the estate, to the extent permitted by subsection (b) thereof, only\n(i) personal and real property exempt from application to the satisfaction of\nmoney judgments under sections fifty-two hundred five and fifty-two hundred six\nof the civil practice law and rules,\n(ii) insurance policies and annuity contracts and the proceeds and avails thereof\nas provided in section three thousand two hundred twelve of the insurance law\nand (iii) the following property:\n1. Bankruptcy exemption of a motor vehicle. One motor vehicle not\nexceeding four thousand dollars in value above liens and encumbrances of\nthe debtor; provided, however, if such vehicle has been equipped for use\nby a disabled debtor, then ten thousand dollars in value above liens and\nencumbrances of the debtor.\n2. Bankruptcy exemption for right to receive benefits. The debtor\'s right to\nreceive or the debtor\'s interest in:\n(a) a social security benefit, unemployment compensation or a\nlocal public assistance benefit;\n(b) a veterans\' benefit;\n(c) a disability, illness, or unemployment benefit;\n(d) alimony support, or separate maintenance, to the extent\nreasonably necessary for the support of the debtor and any\ndependent of the debtor; and\n\n407\n\n\x0c(e) all payments under a stock bonus, pension, profit sharing, or\nsimilar plan or contract on account of illness, disability, death,\nage, or length of service unless\n(i) such plan or contract, except those qualified under\nsection 401, 408 or 408A of the United States Internal\nRevenue Code of 1986, as amended, was established by the\ndebtor or under the auspices of an insider that employed the\ndebtor at the time the debtor\'s rights under such plan or\ncontract arose,\n(ii) such plan is on account of age or length of service, and\n(iii) such plan or contract does not qualify under section\nfour hundred one (a), four hundred three (a), four\nhundred three (b), four hundred eight, four hundred eight\nA, four hundred nine or four hundred fifty-seven of the\nInternal Revenue Code of nineteen hundred eighty-six, as\namended.\n3. Bankruptcy exemption for right to receive certain property. The\ndebtor\'s right to receive, or property that is traceable to:\n(i) an award under a crime victim\'s reparation law;\n(ii) a payment on account of the wrongful death of an individual\nof whom the debtor was a dependent to the extent reasonably\nnecessary for the support of the debtor and any dependent of the\ndebtor;\n(iii) a payment, not to exceed seventy-five hundred dollars on\naccount of personal bodily injury, not including pain and suffering\nor compensation for actual pecuniary loss, of the debtor or an\nindividual of whom the debtor is a dependent; and (iv) a payment\nin compensation of loss of future earnings of the debtor or an\nindividual of whom the debtor is or was a dependent, to the extent\nreasonably necessary for the support of the debtor and any\ndependent of the debtor.\n\nC.4.\n\nNew York Debtor Creditor Law, Art. 10A, \xc2\xa7 283.\n\nAggregate individual bankruptcy exemption for certain annuities and personal\nproperty.\n1. General application. The aggregate amount the debtor may exempt from the property\nof the estate for personal property exempt from application to the satisfaction of a\nmoney judgment under subdivision (a) of section fifty-two hundred five of the civil\npractice law and rules and for benefits, rights, privileges, and options of annuity\ncontracts described in the following sentence shall not exceed ten thousand dollars.\nAnnuity contracts subject to the foregoing limitation are those that are: (a) initially\n408\n\n\x0cpurchased by the debtor within six months of the debtor\'s filing a petition in\nbankruptcy, (b) not described in any paragraph of section eight hundred five (d) of the\nInternal Revenue Code of nineteen hundred fifty-four, and (c) not purchased by\napplication of proceeds under settlement options of annuity contracts purchased more\nthan six months before the debtor\'s filing a petition in bankruptcy or under settlement\noptions of life insurance policies.\n2. Contingent alternative bankruptcy exemption. Notwithstanding section two hundred\neighty-two of this article, a debtor, who (a) does not elect, claim, or otherwise avail\nhimself of an exemption described in section fifty-two hundred six of the civil practice\nlaw and rules; (b) utilizes to the fullest extent permitted by law as applied to said\ndebtor\'s property, the exemptions referred to in subdivision one of this section which are\nsubject to the ten thousand dollar aggregate limit; and (c) does not reach such aggregate\nlimit, may exempt cash in the amount by which ten thousand dollars exceeds the\naggregate of his or her exemptions referred to in subdivision one of this section or in\nthe amount of five thousand dollars, whichever amount is less. For purposes of this\nsubdivision, cash means currency of the United States at face value, savings bonds of the\nUnited States at face value, the right to receive a refund of federal, state and local\nincome taxes, and deposit accounts in any state or federally chartered depository\ninstitution.\n\nC.5.\n\nNew York Debtor Creditor Law, Art. 10A, \xc2\xa7 284 [OLD].\n\nExclusivity of exemptions.\nIn accordance with the provisions of section five hundred twenty-two (b) of title eleven\nof the United States Code, debtors domiciled in this state are not authorized to exempt\nfrom the estate property that is specified under subsection (d) of such section.\n\nC.6.\n\nNew York Debtor Creditor Law, Art. 10A, \xc2\xa7 285 [NEW].\n\nAlternative federal exemptions.\nNotwithstanding any inconsistent provision of law, an individual debtor may opt to\nexempt from property of the estate such property as is permitted to be exempted\npursuant to section five hundred twenty-two of title eleven of the United States Code\nin lieu of such property as is permitted to be exempted pursuant to the applicable\nprovisions of this article.\n\n409\n\n\x0cAPPENDIX D: Social Security Act \xc2\xa7 207, 42 U.S.C. \xc2\xa7 407\n(a) The right of any person to any future payment under this title shall not be transferable or\nassignable, at law or in equity, and none of the moneys paid or payable or rights existing under\nthis title shall be subject to execution, levy, attachment, garnishment, or other legal process, or to\nthe operation of any bankruptcy or insolvency law.\n(b) No other provision of law, enacted before, on, or after the date of the enactment of this\nsection, may be construed to limit, supersede, or otherwise modify the provisions of this section\nexcept to the extent that it does so by express reference to this section.\n(c) Nothing in this section shall be construed to prohibit withholding taxes from any benefit\nunder this title, if such withholding is done pursuant to a request made in accordance with\nsection 3402(p)(1) of the Internal Revenue Code of 1986 by the person entitled to such benefit or\nsuch person\xe2\x80\x99s representative payee\n\n410\n\n\x0cAPPENDIX E: Uniform Fraudulent Transfer Act, 740 ILCS 160/1\n(Illinois)\nSec. 1. This Act shall be known and may be cited as the Uniform Fraudulent Transfer Act.\nSec. 2. As used in this Act:\n(a) "Affiliate" means:\n(1) a person who directly or indirectly owns, controls, or holds with power to vote, 20%\nor more of the outstanding voting securities of the debtor, other than a person who holds\nthe securities,\n(A) as a fiduciary or agent without sole discretionary power to vote the securities; or\n(B) solely to secure a debt, if the person has not exercised the power to vote;\n(2) a corporation with 20% or more outstanding voting securities which are directly or\nindirectly owned, controlled, or held with power to vote, by the debtor or a person who\ndirectly or indirectly owns, controls, or holds with power to vote, 20% or more of the\noutstanding voting securities of the debtor, other than a person who holds the securities,\n(A) as a fiduciary or agent without sole power to vote the securities; or\n(B) solely to secure a debt, if the person has not in fact exercised the power to vote;\n(3) a person whose business is operated by the debtor under a lease or other agreement,\nor a person substantially all of whose assets are controlled by the debtor; or\n(4) a person who operates the debtor\'s business under a lease or other agreement or\ncontrols substantially all of the debtor\'s assets.\n(b) "Asset" means property of a debtor, but the term does not include:\n(1) property to the extent it is encumbered by a valid lien;\n(2) property to the extent it is generally exempt under laws of this State; or\n(3) an interest in property held in tenancy by the entireties to the extent it is not subject\nto process by a creditor holding a claim against only one tenant.\n(c) "Claim" means a right to payment, whether or not the right is reduced to judgment,\nliquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal,\nequitable, secured, or unsecured.\n(d) "Creditor" means a person who has a claim, including a claim for past-due child support.\n(e) "Debt" means liability on a claim.\n(f) "Debtor" means a person who is liable on a claim.\n(g) "Insider" includes:\n(1) if the debtor is an individual,\n(A) a relative of the debtor or of a general partner of the debtor;\n(B) a partnership in which the debtor is a general partner;\n411\n\n\x0c(C) a general partner in a partnership described in clause (B); or\n(D) a corporation of which the debtor is a director, officer, or person in control;\n(2) if the debtor is a corporation,\n(A) a director of the debtor;\n(B) an officer of the debtor;\n(C) a person in control of the debtor;\n(D) a partnership in which the debtor is a general partner;\n(E) a general partner in a partnership described in clause (D); or\n(F) a relative of a general partner, director, officer, or person in control of the debtor;\n(3) if the debtor is a partnership,\n(A) a general partner in the debtor;\n(B) a relative of a general partner in, a general partner of, or a person in control of\nthe debtor;\n(C) another partnership in which the debtor is a general partner;\n(D) a general partner in a partnership described in clause (C); or\n(E) a person in control of the debtor;\n(4) an affiliate, or an insider of an affiliate as if the affiliate were the debtor; and\n(5) a managing agent of the debtor.\n(h) "Lien" means a charge against or an interest in property to secure payment of a debt or\nperformance of an obligation, and includes a security interest created by agreement, a judicial\nlien obtained by legal or equitable process or proceedings, a common-law lien, or a statutory\nlien.\n(i) "Person" means an individual, partnership, corporation, association, organization,\ngovernment or governmental subdivision or agency, business trust, estate, trust, or any other\nlegal or commercial entity.\n(j) "Property" means anything that may be the subject of ownership.\n(k) "Relative" means an individual related by consanguinity within the third degree as\ndetermined by the common law, a spouse, or an individual related to a spouse within the third\ndegree as so determined, and includes an individual in an adoptive relationship within the\nthird degree.\n(l) "Transfer" means every mode, direct or indirect, absolute or conditional, voluntary or\ninvoluntary, of disposing of or parting with an asset or an interest in an asset, and includes\npayment of money, release, lease, and creation of a lien or other encumbrance.\n(m) "Valid lien" means a lien that is effective against the holder of a judicial lien subsequently\nobtained by legal or equitable process or proceedings.\nSec. 3.\n412\n\n\x0c(a) A debtor is insolvent if the sum of the debtor\'s debts is greater than all of the debtor\'s assets\nat a fair valuation.\n(b) A debtor who is generally not paying his debts as they become due is presumed to be\ninsolvent.\n(c) A partnership is insolvent under subsection (a) if the sum of the partnership\'s debts is\ngreater than the aggregate, at a fair valuation, of all of the partnership\'s assets and the sum of\nthe excess of the value of each general partner\'s non-partnership assets over the partner\'s nonpartnership debts.\n(d) Assets under this Section do not include property that has been transferred, concealed, or\nremoved with intent to hinder, delay, or defraud creditors or that has been transferred in a\nmanner making the transfer voidable under this Act.\n(e) Debts under this Section do not include an obligation to the extent it is secured by a valid\nlien on property of the debtor not included as an asset.\nSec. 4.\n(a) Value is given for a transfer or an obligation if, in exchange for the transfer or obligation,\nproperty is transferred or an antecedent debt is secured or satisfied, but value does not include\nan unperformed promise made otherwise than in the ordinary course of the promisor\'s business\nto furnish support to the debtor or another person.\n(b) For the purposes of paragraph (2) of subsection (a) of Section 5 and Section 6, a person\ngives a reasonably equivalent value if the person acquires an interest of the debtor in an asset\npursuant to a regularly conducted, non-collusive foreclosure sale or execution of a power of\nsale for the acquisition or disposition of the interest of the debtor upon default under a\nmortgage, deed of trust, or security agreement.\n(c) A transfer is made for present value if the exchange between the debtor and the transferee\nis intended by them to be contemporaneous and is in fact substantially contemporaneous.\nSec. 5.\n(a) A transfer made or obligation incurred by a debtor is fraudulent as to a creditor, whether\nthe creditor\'s claim arose before or after the transfer was made or the obligation was incurred,\nif the debtor made the transfer or incurred the obligation:\n(1) with actual intent to hinder, delay, or defraud any creditor of the debtor; or\n(2) without receiving a reasonably equivalent value in exchange for the transfer or\nobligation, and the debtor:\n(A) was engaged or was about to engage in a business or a transaction for which the\nremaining assets of the debtor were unreasonably small in relation to the business or\ntransaction; or\n(B) intended to incur, or believed or reasonably should have believed that he would\nincur, debts beyond his ability to pay as they became due.\n(b) In determining actual intent under paragraph (1) of subsection (a), consideration may be\ngiven, among other factors, to whether:\n413\n\n\x0c(1) the transfer or obligation was to an insider;\n(2) the debtor retained possession or control of the property transferred after the transfer;\n(3) the transfer or obligation was disclosed or concealed;\n(4) before the transfer was made or obligation was incurred, the debtor had been sued or\nthreatened with suit;\n(5) the transfer was of substantially all the debtor\'s assets;\n(6) the debtor absconded;\n(7) the debtor removed or concealed assets;\n(8) the value of the consideration received by the debtor was reasonably equivalent to the\nvalue of the asset transferred or the amount of the obligation incurred;\n(9) the debtor was insolvent or became insolvent shortly after the transfer was made or\nthe obligation was incurred;\n(10) the transfer occurred shortly before or shortly after a substantial debt was incurred;\nand\n(11) the debtor transferred the essential assets of the business to a lienor who transferred\nthe assets to an insider of the debtor.\nSec. 6.\n(a) A transfer made or obligation incurred by a debtor is fraudulent as to a creditor whose\nclaim arose before the transfer was made or the obligation was incurred if the debtor made the\ntransfer or incurred the obligation without receiving a reasonably equivalent value in exchange\nfor the transfer or obligation and the debtor was insolvent at that time or the debtor became\ninsolvent as a result of the transfer or obligation.\n(b) A transfer made by a debtor is fraudulent as to a creditor whose claim arose before the\ntransfer was made if the transfer was made to an insider for an antecedent debt, the debtor was\ninsolvent at that time, and the insider had reasonable cause to believe that the debtor was\ninsolvent.\nSec. 7. For the purposes of this Act:\n(a) a transfer is made:\n(1) with respect to an asset that is real property other than a fixture, but including the\ninterest of a seller or purchaser under a contract for the sale of the asset, when the transfer\nis so far perfected that a good-faith purchaser of the asset from the debtor against whom\napplicable law permits the transfer to be perfected cannot acquire an interest in the asset\nthat is superior to the interest of the transferee; and\n(2) with respect to an asset that is not real property or that is a fixture, when the transfer\nis so far perfected that a creditor on a simple contract cannot acquire a judicial lien\notherwise than under this Act that is superior to the interest of the transferee;\n\n414\n\n\x0c(b) if applicable law permits the transfer to be perfected as provided in subsection (a) and the\ntransfer is not so perfected before the commencement of an action for relief under this Act,\nthe transfer is deemed made immediately before the commencement of the action;\n(c) if applicable law does not permit the transfer to be perfected as provided in subsection (a),\nthe transfer is made when it becomes effective between the debtor and the transferee;\n(d) a transfer is not made until the debtor has acquired rights in the asset transferred;\n(e) an obligation is incurred:\n(1) if oral, when it becomes effective between the parties; or\n(2) if evidenced by a writing, when the writing executed by the obligor is delivered to or\nfor the benefit of the obligee.\nSec. 8.\n(a) In an action for relief against a transfer or obligation under this Act, a creditor, subject to\nthe limitations in Section 9, may obtain:\n(1) avoidance of the transfer or obligation to the extent necessary to satisfy the creditor\'s\nclaim;\n(2) an attachment or other provisional remedy against the asset transferred or other\nproperty of the transferee in accordance with the procedure prescribed by the Code of\nCivil Procedure;\n(3) subject to applicable principles of equity and in accordance with applicable rules of\ncivil procedure,\n(A) an injunction against further disposition by the debtor or a transferee, or both, of\nthe asset transferred or of other property;\n(B) appointment of a receiver to take charge of the asset transferred or of other\nproperty of the transferee; or\n(C) any other relief the circumstances may require.\n(b) If a creditor has obtained a judgment on a claim against the debtor, the creditor, if the court\nso orders, may levy execution on the asset transferred or its proceeds.\nSec. 9.\n(a) A transfer or obligation is not voidable under paragraph (1) of subsection (a) of Section 5\nagainst a person who took in good faith and for a reasonably equivalent value or against any\nsubsequent transferee or obligee.\n(b) Except as otherwise provided in this Section, to the extent a transfer is voidable in an\naction by a creditor under paragraph (1) of subsection (a) of Section 8, the creditor may\nrecover judgement for the value of the asset transferred, as adjusted under subsection (c), or\nthe amount necessary to satisfy the creditor\'s claim, whichever is less. The judgment may be\nentered against:\n(1) the first transferee of the asset or the person for whose benefit the transfer was made;\nor\n415\n\n\x0c(2) any subsequent transferee other than a good-faith transferee who took for value or\nfrom any subsequent transferee.\n(c) If the judgment under subsection (b) is based upon the value of the asset transferred,\nthe judgment must be for an amount equal to the value of the asset at the time of the\ntransfer, subject to adjustment as the equities may require.\n(d) Notwithstanding voidability of a transfer or an obligation under this Act, a good-faith\ntransferee or obligee is entitled, to the extent of the value given the debtor for the transfer or\nobligation, to\n(1) a lien on or a right to retain any interest in the asset transferred;\n(2) enforcement of any obligation incurred; or\n(3) a reduction in the amount of the liability on the judgment.\n(e) A transfer is not voidable under paragraph (2) of subsection (a) of Section 5 or Section 6\nif the transfer results from:\n(1) termination of a lease upon default by the debtor when the termination is pursuant to\nthe lease and applicable law; or\n(2) enforcement of a security interest in compliance with Article 9 of the Uniform\nCommercial Code.\n(f) A transfer is not voidable under subsection (b) of Section 6:\n(1) to the extent the insider gave new value to or for the benefit of the debtor after the\ntransfer was made unless the new value was secured by a valid lien;\n(2) if made in the ordinary course of business or financial affairs of the debtor and the\ninsider; or\n(3) if made pursuant to a good-faith effort to rehabilitate the debtor and the transfer\nsecured present value given for that purpose as well as an antecedent debt of the debtor.\nSec. 10. A cause of action with respect to a fraudulent transfer or obligation under this Act is\nextinguished unless action is brought:\n(a) under paragraph (1) of subsection (a) of Section 5, within 4 years after the transfer was\nmade or the obligation was incurred or, if later, within one year after the transfer or obligation\nwas or could reasonably have been discovered by the claimant;\n(b) under paragraph (2) of subsection (a) of Section 5 or subsection (a) of Section 6, within 4\nyears after the transfer was made or the obligation was incurred; or\n(c) under subsection (b) of Section 6, within one year after the transfer was made or the\nobligation was incurred.\nSec. 11. Unless displaced by the provisions of this Act, the principles of law and equity, including\nthe law merchant and the law relating to principal and agent, estoppel, laches, fraud,\nmisrepresentation, duress, coercion, mistake, insolvency, or other validating or invalidating cause,\nsupplement its provisions.\n416\n\n\x0cSec. 12. This Act shall be applied and construed to effectuate its general purpose to make\nuniform the law with respect to the subject of this Act among states enacting it.\n\n417\n\n\x0cAPPENDIX F: Article 9 of the New York Uniform Commercial\nCode\nReprinted from this link maintained by the New York State Legislature\n\nF.1.\n\nIndex\n\nArticle 9 - SECURED TRANSACTIONS\nPart 1 - GENERAL PROVISIONS\nSubPart 1 - SHORT TITLE, DEFINITIONS, AND GENERAL CONCEPTS\nSection 9-101 Short Title\nSection 9-102 Definitions And Index of Definitions\nSection 9-103 Purchase-money Security Interest; Application of Payments; Burden of\nEstablishing\nSection 9-104 Control of Deposit Account\nSection 9-105 Control of Electronic Chattel Paper\nSection 9-106 Control of Investment Property\nSection 9-107 Control of Letter-of-credit Right\nSection 9-108 Sufficiency of Description\nSubPart 2 - APPLICABILITY OF ARTICLE\nSection 9-109 Scope\nSection 9-110 Security Interests Arising Under Article 2 or 2-A\nPart 2 - EFFECTIVENESS OF SECURITY AGREEMENT; ATTACHMENT OF SECURITY\nINTEREST; RIGHTS OF PARTIES TO SECURITY AGREEMENT\nSubPart 1 - EFFECTIVENESS AND ATTACHMENT\nSection 9-201General Effectiveness of Security Agreement\nSection 9-202 Section 9-202 Title to Collateral Immaterial\nSection 9-203 Attachment and Enforceability of Security Interest; Proceeds; Supporting\nObligations; Formal Requisites\nSection 9-204 After-acquired Property; Future Advances\nSection 9-205 Use or Disposition of Collateral Permissible\nSection 9-206 Security Interest Arising in Purchase or Delivery of Financial Asset\n418\n\n\x0cSubPart 2 - RIGHTS AND DUTIES\nSection 9-207 Rights and Duties of Secured Party Having Possession or Control of\nCollateral\nSection 9-208 Additional Duties of Secured Party Having Control of Collateral\nSection 9-209 Section 9-209 Duties of Secured Party If Account Debtor Has Been\nNotified of Assignment\nSection 9-210 Section 9-210 Request for Accounting; Request Regarding List of\nCollateral or Statement of Account\nPart 3 PERFECTION AND PRIORITY\nSubPart 1 LAW GOVERNING PERFECTION AND PRIORITY\nSection 9-301 Law Governing Perfection and Priority of Security Interests\nSection 9-302 Law Governing Perfection and Priority of Agricultural Liens\nSection 9-303 Law Governing Perfection and Priority of Security Interests in Goods\nCovered by a Certificate of Title\nSection 9-304 Law Governing Perfection and Priority of Security Interests in Deposit\nAccounts\nSection 9-305 Law Governing Perfection and Priority of Security Interests in Investment\nProperty\nSection 9-306 Law Governing Perfection and Priority of Security Interests in Letter-ofcredit Rights\nSection 9-307Location of Debtor\nSubPart 2 PERFECTION\nSection 9-308 When Security Interest or Agricultural Lien Is Perfected; Continuity of\nPerfection\nSection 9-301 Security Interest Perfected upon Attachment\nSection 9-310 When Filing Required to Perfect Security Interest or Agricultural Lien;\nSecurity Interests and Agricultural Liens to Which Filing Provisions Do Not Apply\nSection 9-311 Perfection of Security Interests in Property Subject to Certain Statutes,\nRegulations, and Treaties\nSection 9-312 Perfection of Security Interests in Chattel Paper, Deposit Accounts,\nDocuments, Goods Covered by Documents, Instruments, Investment Property, Letter419\n\n\x0cof-credit Rights, and Money; Perfection by Permissive Filing; Temporary Perfection\nWithout Filing or Transfer of Possession\nSection 9-313 When Possession by or Delivery to Secured Party Perfects Security\nInterest Without Filing\nSection 9-314 Perfection by Control\nSection 9-315 Secured Party\'s Rights on Disposition of Collateral and in Proceeds\nSection 9-316 Continued Perfection of Security Interest Following Change in Governing\nLaw\nSubPart 3 - PRIORITY\nSection 9-317 Interests That Take Priority over or Take Free of Security Interest or\nAgricultural Lien\nSection 9-318 No Interest Retained in Right to Payment That Is Sold; Rights and Title of\nSeller of Account or Chattel Paper with Respect to Creditors and Purchasers\nSection 9-319 Rights and Title of Consignee with Respect to Creditors and Purchasers\nSection 9-320 Buyer of Goods\nSection 9-321 Licensee of General Intangible and Lessee of Goods in Ordinary Course of\nBusiness\nSection 9-322 Priorities among Conflicting Security Interests in and Agricultural Liens\non Same Collateral\nSection 9-323 Future Advances\nSection 9-324 Priority of Purchase-money Security Interests\nSection 9-325 Priority of Security Interests in Transferred Collateral\nSection 9-326 Priority of Security Interests Created by New Debtor\nSection 9-327 Priority of Security Interests in Deposit Account\nSection 9-328 Priority of Security Interests in Investment Property\nSection 9-329 Priority of Security Interests in Letter-of-credit Right\nSection 9-330 Priority of Purchaser of Chattel Paper or Instrument\nSection 9-331 Priority of Rights of Purchasers of Instruments, Documents, and Securities\nunder Other Articles; Priority of Interests in Financial Assets and Security\nEntitlements under Article 8\nSection 9-332 Transfer of Money; Transfer of Funds from Deposit Account\nSection 9-333 Priority of Certain Liens Arising by Operation of Law\nSection 9-334 Priority of Security Interests in Fixtures and Crops\nSection 9-335 Accessions\n420\n\n\x0cSection 9-336 Commingled Goods\nSection 9-337 Priority of Security Interests in Goods Covered by Certificate of Title\nSection 9-338 Priority of Security Interest or Agricultural Lien Perfected by Filed\nFinancing Statement Providing Certain Incorrect Information\nSection 9-339 Priority Subject to Subordination\nSubPart 4 - RIGHTS OF BANK\nSection 9-340 Effectiveness of Right of Recoupment or Set-off Against Deposit Account\nSection 9-341 Bank\'s Rights and Duties with Respect to Deposit Account\nSection 9-342 Bank\'s Right to Refuse to Enter into or Disclose Existence of Control\nAgreement\nPart 4 RIGHTS OF THIRD PARTIES\nSection 9-401 Alienability of Debtor\'s Rights\nSection 9-402 Secured Party Not Obligated on Contract of Debtor or in Tort\nSection 9-403 Agreement Not to Assert Defenses Against Assignee\nSection 9-404 Rights Acquired by Assignee; Claims and Defenses Against Assignee\nSection 9-405 Modification of Assigned Contract\nSection 9-406 Discharge of Account Debtor; Notification of Assignment; Identification\nand Proof of Assignment; Restrictions on Assignment of Accounts, Chattel Paper,\nPayment Intangibles, and Promissory Notes Ineffective\nSection 9-407 Restrictions on Creation or Enforcement of Security Interest in Leasehold\nInterest or in Lessor\'s Residual Interest\nSection 9-408 Restrictions on Assignment of Promissory Notes, Health-care-insurance\nReceivables, and Certain General Intangibles Ineffective\nSection 9-409 Restrictions on Assignment of Letter-of-credit Rights Ineffective\nPart 5 FILING\nSubPart 1 FILING OFFICE; CONTENTS AND EFFECTIVENESS OF FINANCING\nSTATEMENT\nSection 9-501 Filing Office\n\n421\n\n\x0cSection 9-502 Contents of Financing Statement; Record of Mortgage as Financing\nStatement; Time of Filing Financing Statement; Contents of Cooperative Addendum\nSection 9-503 Name of Debtor and Secured Party\nSection 9-504 Indication of Collateral\nSection 9-505 Filing and Compliance with Other Statutes and Treaties for Consignments,\nLeases, Other Bailments, and Other Transactions\nSection 9-506 Effect of Errors or Omissions\nSection 9-507 Effect of Certain Events on Effectiveness of Financing Statement\nSection 9-508 Effectiveness of Financing Statement If New Debtor Becomes Bound by\nSecurity Agreement\nSection 9-509 Persons Entitled to File a Record\nSection 9-510 Effectiveness of Filed Record\nSection 9-511 Secured Party of Record\nSection 9-512 Amendment of Financing Statement\nSection 9-513 Termination Statement\nSection 9-514 Assignment of Powers of Secured Party of Record\nSection 9-515 Duration and Effectiveness of Financing Statement; Effect of Lapsed\nFinancing Statement\nSection 9-516 What Constitutes Filing; Effectiveness of Filing\nSection 9-517 Effect of Indexing Errors\nSection 9-518 Claim Concerning Inaccurate or Wrongfully Filed Record\nSubPart 2 - DUTIES AND OPERATION OF FILING OFFICE\nSection 9-519 Numbering, Maintaining, and Indexing Records; Communicating\nInformation Provided in Records\nSection 9-520 Acceptance and Refusal to Accept Record\nSection 9-521 Uniform Form of Written Financing Statement; Amendment; and\nCooperative Addendum\nSection 9-522 Maintenance and Destruction of Records\nSection 9-523 Information from Filing Office; Sale or License of Records\nSection 9-524 Delay by Filing Office\nSection 9-525 Fees\nSection 9-526 Filing-office Rules\nSection 9-527 Duty to Report\n422\n\n\x0cPart 6 - DEFAULT\nSubPart 1 - DEFAULT AND ENFORCEMENT OF SECURITY INTEREST\nSection 9-601 Rights after Default; Judicial Enforcement; Consignor or Buyer of\nAccounts, Chattel Paper, Payment Intangibles, or Promissory Notes\nSection 9-602 Waiver and Variance of Rights and Duties\nSection 9-603 Agreement on Standards Concerning Rights and Duties\nSection 9-604 Procedure If Security Agreement Covers Real Property, Fixtures, or\nCooperative Interests\nSection 9-605 Unknown Debtor or Secondary Obligor\nSection 9-606 Time of Default for Agricultural Lien\nSection 9-607 Collection and Enforcement by Secured Party\nSection 9-608 Application of Proceeds of Collection or Enforcement; Liability for\nDeficiency and Right to Surplus\nSection 9-609 Secured Party\'s Right to Take Possession after Default\nSection 9-610 Disposition of Collateral after Default\nSection 9-611 Notification Before Disposition of Collateral\nSection 9-612 Timeliness of Notification Before Disposition of Collateral\nSection 9-613 Contents and Form of Notification Before Disposition of Collateral:\nGeneral\nSection 9-614 Contents and Form of Notification Before Disposition of Collateral:\nConsumer-goods Transaction\nSection 9-615 Application of Proceeds of Disposition; Liability for Deficiency and Right\nto Surplus\nSection 9-616 Explanation of Calculation of Surplus or Deficiency\nSection 9-617 Rights of Transferee of Collateral\nSection 9-618 Rights and Duties of Certain Secondary Obligors\nSection 9-619 Transfer of Record or Legal Title\nSection 9-620 Acceptance of Collateral in Full or Partial Satisfaction of Obligation;\nCompulsory Disposition of Collateral\nSection 9-621 Notification of Proposal to Accept Collateral\nSection 9-622 Effect of Acceptance of Collateral\nSection 9-623 Right to Redeem Collateral\n423\n\n\x0cSection 9-624 Waiver\nSubPart 2 - NONCOMPLIANCE WITH ARTICLE\nSection 9-625 Remedies for Secured Party\'s Failure to Comply with Article\nSection 9-626 Action in Which Deficiency or Surplus is in Issue\nSection 9-627 Determination of Whether Conduct Was Commercially Reasonable\nSection 9-628 Nonliability and Limitation on Liability of Secured Party; Liability of\nSecondary Obligor\nPart 7 TRANSITION\nSection 9-700 Definitions\nSection 9-701 Effective Date\nSection 9-702 Savings Clause\nSection 9-703 Security Interest Perfected Before Effective Date\nSection 9-704 Security Interest Unperfected Before Effective Date\nSection 9-705 Effectiveness of Action Taken Before Effective Date\nSection 9-706 When Initial Financing Statement Suffices to Continue Effectiveness of\nFinancing Statement\nSection 9-707 Amendment of Pre-effective-date Financing Statement\nSection 9-708 Persons Entitled to File Initial Financing Statement or Continuation\nStatement\nSection 9-709 Priority\nSection 9-710 Transitional Provision for Maintaining and Searching Local-Filing Office\nRecords\n\nF.2.\n\nStatutory Provisions\nNew York Article 9 \xe2\x80\x93 SECURED TRANSACTIONS\nPart 1 \xe2\x80\x93 GENERAL PROVISIONS\nSubPart 1 - SHORT TITLE, DEFINITIONS, AND GENERAL CONCEPTS\n\nSection 9-101. Short Title.\nThis article may be cited as Uniform Commercial Code\xe2\x80\x94Secured Transactions.\nSection 9-102. Definitions and Index of Definitions.\n424\n\n\x0c(a) Article 9 definitions. In this article:\n(1) "Accession" means goods that are physically united with other goods in such a\nmanner that the identity of the original goods is not lost.\n(2) "Account", except as used in "account for", means a right to payment of a monetary\nobligation, whether or not earned by performance,\n(i) for property that has been or is to be sold, leased, licensed, assigned, or otherwise\ndisposed of,\n(ii) for services rendered or to be rendered,\n(iii) for a policy of insurance issued or to be issued,\n(iv) for a secondary obligation incurred or to be incurred,\n(v) for energy provided or to be provided,\n(vi) for the use or hire of a vessel under a charter or other contract,\n(vii) arising out of the use of a credit or charge card or information contained on or for\nuse with the card, or\n(viii) as winnings in a lottery or other game of chance operated or sponsored by a state,\ngovernmental unit of a State, or person licensed or authorized to operate the game by a\nState or governmental unit of a State. The term includes health-care-insurance\nreceivables.\nThe term does not include\n(i) rights to payment evidenced by chattel paper or an instrument,\n(ii) commercial tort claims,\n(iii) deposit accounts,\n(iv) investment property,\n(v) letter-of-credit rights or letters of credit, or\n(vi) rights to payment for money or funds advanced or sold, other than rights arising out\nof the use of a credit or charge card or information contained on or for use with the\ncard.\n(3) "Account debtor" means a person obligated on an account, chattel paper, or general\nintangible. The term does not include persons obligated to pay a negotiable instrument,\neven if the instrument constitutes part of chattel paper.\n(4) "Accounting", except as used in "accounting for", means a record:\n(A) authenticated by a secured party;\n(B) indicating the aggregate unpaid secured obligations as of a date not more than 35\ndays earlier or 35 days later than the date of the record; and\n(C) identifying the components of the obligations in reasonable detail.\n(5) "Agricultural lien" means an interest in farm products:\n425\n\n\x0c(A) which secures payment or performance of an obligation for:\n(i) goods or services furnished in connection with a debtor\'s farming operation; or\n(ii) rent on real property leased by a debtor in connection with its farming\noperation; and\n(B) which is created by statute in favor of a person that:\n(i) in the ordinary course of its business furnished goods or services to a debtor in\nconnection with a debtor\'s farming operation; or\n(ii) leased real property to a debtor in connection with the debtor\'s farming\noperation; and\n(C) whose effectiveness does not depend on the person\'s possession of the personal\nproperty.\n(6) "As-extracted collateral" means:\n(A) oil, gas, or other minerals that are subject to a security interest that:\n(i) is created by a debtor having an interest in the minerals before extraction; and\n(ii) attaches to the minerals as extracted; or\n(B) accounts arising out of the sale at the wellhead or minehead of oil, gas, or other\nminerals in which the debtor had an interest before extraction.\n(7) "Authenticate" means:\n(A) to sign; or\n(B) with present intent to adopt or accept a record, to attach to or logically associate\nwith the record an electronic sound, symbol, or process.\n(8) "Bank" means an organization that is engaged in the business of banking. The term\nincludes savings banks, savings and loan associations, credit unions, and trust companies.\n(9) "Cash proceeds" means proceeds that are money, checks, deposit accounts, or the like.\n(10) "Certificate of title" means a certificate of title with respect to which a statute\nprovides for the security interest in question to be indicated on the certificate as a\ncondition or result of the security interest\'s obtaining priority over the rights of a lien\ncreditor with respect to the collateral. Such term includes another record maintained as an\nalternative to a certificate of title by the governmental unit that issues certificates of title\nif a statute permits the security interest in question to be indicated on the record as a\ncondition or result of the security interest\'s obtaining priority over the rights of a lien\ncreditor with respect to the collateral.\n(11) "Chattel paper" means a record or records that evidence both a monetary obligation\nand a security interest in specific goods, a security interest in specific goods and software\nused in the goods, a security interest in specific goods and license of software used in the\ngoods, a lease of specific goods, or a lease of specific goods and license of software used\nin the goods. In this paragraph, "monetary obligation" means a monetary obligation\n426\n\n\x0csecured by the goods or owed under a lease of the goods and includes a monetary\nobligation with respect to software used in the goods. The term does not include\n(i) charters or other contracts involving the use or hire of a vessel or\n(ii) records that evidence a right to payment arising out of the use of a credit or charge\ncard or information contained on or for use with the card. If a transaction is evidenced\nby records that include an instrument or series of instruments, the group of records\ntaken together constitutes chattel paper.\n(11-a) "Check" means\n(i) a draft, other than a documentary draft, payable on demand and drawn on a bank or\n(ii) a cashier\'s check or a teller\'s check. An instrument may be a check even though it is\ndescribed on its face by another term, such as "money order". An instrument that\n(i) meets all of the requirements stated in Article 3 of this chapter to be a negotiable\ninstrument other than stating that it is payable to order or bearer and\n(ii) otherwise qualifies as a check is a negotiable instrument and a check.\n(12) "Collateral" means the property subject to a security interest or agricultural lien. The\nterm includes:\n(A) proceeds to which a security interest attaches;\n(B) accounts, chattel paper, payment intangibles, and promissory notes that have been\nsold; and\n(C) goods that are the subject of a consignment.\n(13) "Commercial tort claim" means a claim arising in tort with respect to which:\n(A) the claimant is an organization; or\n(B) the claimant is an individual and the claim: (i) arose in the course of the claimant\'s\nbusiness or profession; and (ii) does not include damages arising out of personal injury\nto or the death of an individual.\n(14) "Commodity account" means an account maintained by a commodity intermediary\nin which a commodity contract is carried for a commodity customer.\n(15) "Commodity contract" means a commodity futures contract, an option on a\ncommodity futures contract, a commodity option, or another contract if the contract or\noption is:\n(A) traded on or subject to the rules of a board of trade that has been designated as a\ncontract market for such a contract pursuant to federal commodities laws; or\n(B) traded on a foreign commodity board of trade, exchange, or market, and is carried\non the books of a commodity intermediary for a commodity customer.\n(16) "Commodity customer" means a person for which a commodity intermediary carries\na commodity contract on its books.\n(17) "Commodity intermediary" means a person that:\n427\n\n\x0c(A) is registered as a futures commission merchant under federal commodities law; or\n(B) in the ordinary course of its business provides clearance or settlement services for a\nboard of trade that has been designated as a contract market pursuant to federal\ncommodities law.\n(18) "Communicate" means:\n(A) to send a written or other tangible record;\n(B) to transmit a record by any means agreed upon by the persons sending and\nreceiving the record; or\n(C) in the case of transmission of a record to or by a filing office, to transmit a record\nby any means prescribed by filing-office rule.\n(19) "Consignee" means a merchant to which goods are delivered in a consignment.\n(20) "Consignment" means a transaction, regardless of its form, in which a person\ndelivers goods to a merchant for the purpose of sale and:\n(A) the merchant:\n(i) deals in goods of that kind under a name other than the name of the person\nmaking delivery;\n(ii) is not an auctioneer; and\n(iii) is not generally known by its creditors to be substantially engaged in selling\nthe goods of others;\n(B) with respect to each delivery, the aggregate value of the goods is $1,000 or more at\nthe time of delivery;\n(C) the goods are not consumer goods immediately before delivery; and\n(D) the transaction does not create a security interest that secures an obligation.\n(21) "Consignor" means a person that delivers goods to a consignee in a consignment.\n(22) "Consumer debtor" means a debtor in a consumer transaction.\n(23) "Consumer goods" means goods that are used or bought for use primarily for\npersonal, family, or household purposes.\n(24) "Consumer-goods transaction" means a consumer transaction in which:\n(A) an individual incurs an obligation primarily for personal, family, or household\npurposes; and\n(B) a security interest in consumer goods secures the obligation.\n(25) "Consumer obligor" means an obligor who is an individual and who incurred the\nobligation as part of a transaction entered into primarily for personal, family, or\nhousehold purposes.\n(26) "Consumer transaction" means a transaction in which\n428\n\n\x0c(i) an individual incurs an obligation primarily for personal, family, or household\npurposes,\n(ii) a security interest secures the obligation, and\n(iii) the collateral is held or acquired primarily for personal, family, or household\npurposes. The term includes consumer-goods transactions.\n(27) "Continuation statement" means an amendment of a financing statement which:\n(A) identifies, by its file number, the initial financing statement to which it relates; and\n(B) indicates that it is a continuation statement for, or that it is filed to continue the\neffectiveness of, the identified financing statement.\n(27-a) "Cooperative addendum" means a record that satisfies Section 9-502(e).\n(27-b) "Cooperative interest" means an ownership interest in a cooperative organization,\nwhich interest, when created, is coupled with possessory rights of a proprietary nature in\nidentified physical space belonging to the cooperative organization. A subsequent\ntermination of the possessory rights shall not cause an ownership interest to cease being a\ncooperative interest.\n(27-c) "Cooperative organization" means an organization which has as its principal asset\nan interest in real property in this state and in which organization all ownership interests\nare cooperative interests.\n(27-d) "Cooperative organization security interest" means a security interest which is in a\ncooperative interest, is in favor of the cooperative organization, is created by the\ncooperative record, and secures only obligations incident to ownership of that cooperative\ninterest.\n(27-e) "Cooperative record" means those records which, as a whole, evidence cooperative\ninterests and define the mutual rights and obligations of the owners of the cooperative\ninterests and the cooperative organization.\n(27-f) "Cooperative unit" means the physical space associated with a cooperative interest.\n(28) "Debtor" means:\n(A) a person having an interest, other than a security interest or other lien, in the\ncollateral, whether or not the person is an obligor;\n(B) a seller of accounts, chattel paper, payment intangibles, or promissory notes; or\n(C) a consignee.\n(29) "Deposit account" means a demand, time, savings, passbook, or similar account\nmaintained with a bank. The term does not include investment property or accounts\nevidenced by an instrument.\n(30) "Document" means a document of title or a receipt of the type described in Section\n7-201(b).\n(31) "Electronic chattel paper" means chattel paper evidenced by a record or records\nconsisting of information stored in an electronic medium.\n429\n\n\x0c(32) "Encumbrance" means a right, other than an ownership interest, in real property. The\nterm includes mortgages and other liens on real property.\n(33) "Equipment" means goods other than inventory, farm products, or consumer goods.\n(34) "Farm products" means goods, other than standing timber, with respect to which the\ndebtor is engaged in a farming operation and which are:\n(A) crops grown, growing, or to be grown, including:\n(i) crops produced on trees, vines, and bushes; and\n(ii) aquatic goods produced in aquacultural operations;\n(B) livestock, born or unborn, including aquatic goods produced in aquacultural\noperations;\n(C) supplies used or produced in a farming operation; or\n(D) products of crops or livestock in their unmanufactured states.\n(35) "Farming operation" means raising, cultivating, propagating, fattening, grazing, or\nany other farming, livestock, or aquacultural operation.\n(36) "File number" means the number assigned to an initial financing statement pursuant\nto Section 9-519(a).\n(37) "Filing office" means an office designated in Section 9-501 as the place to file a\nfinancing statement.\n(38) "Filing-office rule" means a rule adopted pursuant to Section 9-526.\n(39) "Financing statement" means a record or records composed of an initial financing\nstatement and any filed record relating to the initial financing statement.\n(40) "Fixture filing" means the filing of a financing statement covering goods that are or\nare to become fixtures and satisfying Section 9-502(a) and (b). The term includes the\nfiling of a financing statement covering goods of a transmitting utility which are or are to\nbecome fixtures.\n(41) "Fixtures" means goods that have become so related to particular real property that\nan interest in them arises under real property law.\n(42) "General intangible" means any personal property, including things in action, other\nthan accounts, chattel paper, commercial tort claims, deposit accounts, documents, goods,\ninstruments, investment property, letter-of-credit rights, letters of credit, money, and oil,\ngas, or other minerals before extraction. The term includes payment intangibles and\nsoftware.\n(43) "Good faith" means honesty in fact and the observance of reasonable commercial\nstandards of fair dealing.\n(44) "Goods" means all things that are movable when a security interest attaches. The\nterm includes\n(i) fixtures,\n430\n\n\x0c(ii) standing timber that is to be cut and removed under a conveyance or contract for\nsale,\n(iii) the unborn young of animals,\n(iv) crops grown, growing, or to be grown, even if the crops are produced on trees,\nvines, or bushes, and\n(v) manufactured homes.\nThe term also includes a computer program embedded in goods and any supporting\ninformation provided in connection with a transaction relating to the program if\n(i) the program is associated with the goods in such a manner that it customarily is\nconsidered part of the goods, or\n(ii) by becoming the owner of the goods, a person acquires a right to use the program in\nconnection with the goods. The term does not include a computer program embedded in\ngoods that consists solely of the medium in which the program is embedded. The term\nalso does not include accounts, chattel paper, commercial tort claims, deposit accounts,\ndocuments, general intangibles, instruments, investment property, letter-of-credit rights,\nletters of credit, money, or oil, gas, or other minerals before extraction.\n(45) "Governmental unit" means a subdivision, agency, department, county, parish,\nmunicipality, or other unit of the government of the United States, a state, or a foreign\ncountry. The term includes an organization having a separate corporate existence if the\norganization is eligible to issue debt on which interest is exempt from income taxation\nunder the laws of the United States.\n(46) "Health-care-insurance receivable" means an interest in or claim under a policy of\ninsurance which is a right to payment of a monetary obligation for health-care goods or\nservices provided or to be provided.\n(47) "Instrument" means a negotiable instrument or any other writing that evidences a\nright to the payment of a monetary obligation, is not itself a security agreement or lease,\nand is of a type that in ordinary course of business is transferred by delivery with any\nnecessary indorsement or assignment. The term does not include\n(i) investment property,\n(ii) letters of credit, or\n(iii) writings that evidence a right to payment arising out of the use of a credit or charge\ncard or information contained on or for use with the card.\n(48) "Inventory" means goods, other than farm products, which:\n(A) are leased by a person as lessor;\n(B) are held by a person for sale or lease or to be furnished under a contract of service;\n(C) are furnished by a person under a contract of service; or\n(D) consist of raw materials, work in process, or materials used or consumed in a\nbusiness.\n431\n\n\x0c(49) "Investment property" means a security, whether certificated or uncertificated,\nsecurity entitlement, securities account, commodity contract, or commodity account.\n(50) "Jurisdiction of organization", with respect to a registered organization, means the\njurisdiction under whose law the organization is formed or organized.\n(51) "Letter-of-credit right" means a right to payment or performance under a letter of\ncredit, whether or not the beneficiary has demanded or is at the time entitled to demand\npayment or performance. The term does not include the right of a beneficiary to demand\npayment or performance under a letter of credit.\n(52) "Lien creditor" means:\n(A) a creditor that has acquired a lien on the property involved by attachment, levy, or\nthe like;\n(B) an assignee for benefit of creditors from the time of assignment;\n(C) a trustee in bankruptcy from the date of the filing of the petition; or\n(D) a receiver in equity from the time of appointment.\n(53) "Manufactured home" means a structure, transportable in one or more sections,\nwhich, in the traveling mode, is eight body feet or more in width or 40 body feet or more\nin length, or, when erected on site, is 320 or more square feet, and which is built on a\npermanent chassis and designed to be used as a dwelling with or without a permanent\nfoundation when connected to the required utilities, and includes the plumbing, heating,\nair-conditioning, and electrical systems contained therein. The term includes any\nstructure that meets all of the requirements of this paragraph except the size requirements\nand with respect to which the manufacturer voluntarily files a certification required by\nthe United States Secretary of Housing and Urban Development and complies with the\nstandards established under Title 42 of the United States Code.\n(54) "Manufactured-home transaction" means a secured transaction:\n(A) that creates a purchase-money security interest in a manufactured home, other than\na manufactured home held as inventory; or\n(B) in which a manufactured home, other than a manufactured home held as inventory,\nis the primary collateral.\n(55) "Mortgage" means a consensual interest in real property, including fixtures, which\nsecures payment or performance of an obligation.\n(56) "New debtor" means a person that becomes bound as debtor under Section 9-203(d)\nby a security agreement previously entered into by another person.\n(57) "New value" means\n(i) money,\n(ii) money\'s worth in property, services, or new credit, or\n(iii) release by a transferee of an interest in property previously transferred to the\ntransferee. The term does not include an obligation substituted for another obligation.\n432\n\n\x0c(58) "Noncash proceeds" means proceeds other than cash proceeds.\n(59) "Obligor" means a person that, with respect to an obligation secured by a security\ninterest in or an agricultural lien on the collateral,\n(i) owes payment or other performance of the obligation,\n(ii) has provided property other than the collateral to secure payment or other\nperformance of the obligation, or\n(iii) is otherwise accountable in whole or in part for payment or other performance of\nthe obligation. The term does not include issuers or nominated persons under a letter of\ncredit.\n(60) "Original debtor", except as used in Section 9-310(c), means a person that, as debtor,\nentered into a security agreement to which a new debtor has become bound under Section\n9-203(d).\n(61) "Payment intangible" means a general intangible under which the account debtor\'s\nprincipal obligation is a monetary obligation.\n(62) "Person related to", with respect to an individual, means:\n(A) the spouse of the individual;\n(B) a brother, brother-in-law, sister, or sister-in-law of the individual;\n(C) an ancestor or lineal descendant of the individual or the individual\'s spouse; or\n(D) any other relative, by blood or marriage, of the individual or the individual\'s spouse\nwho shares the same home with the individual.\n(63) "Person related to", with respect to an organization, means:\n(A) a person directly or indirectly controlling, controlled by, or under common control\nwith the organization;\n(B) an officer or director of, or a person performing similar functions with respect to,\nthe organization;\n(C) an officer or director of, or a person performing similar functions with respect to, a\nperson described in subparagraph (A);\n(D) the spouse of an individual described in subparagraph (A), (B), or (C); or (E) an\nindividual who is related by blood or marriage to an individual described in\nsubparagraph (A), (B), (C), or (D) and shares the same home with the individual.\n(64) "Proceeds", except as used in Section 9-609(b), means the following property:\n(A) Whatever is acquired upon the sale, lease, license, exchange, or other disposition of\ncollateral;\n(B) whatever is collected on, or distributed on account of, collateral;\n(C) rights arising out of collateral;\n\n433\n\n\x0c(D) to the extent of the value of collateral, claims arising out of the loss,\nnonconformity, or interference with the use of, defects or infringement of rights in, or\ndamage to, the collateral; or\n(E) to the extent of the value of collateral and to the extent payable to the debtor or the\nsecured party, insurance payable by reason of the loss or nonconformity of, defects or\ninfringement of rights in, or damage to, the collateral.\n(65) "Promissory note" means an instrument that evidences a promise to pay a monetary\nobligation, does not evidence an order to pay, and does not contain an acknowledgment\nby a bank that the bank has received for deposit a sum of money or funds.\n(66) "Proposal" means a record authenticated by a secured party which includes the terms\non which the secured party is willing to accept collateral in full or partial satisfaction of\nthe obligation it secures pursuant to Sections 9-620, 9-621, and 9-622.\n(66-a) "Prove" with respect to a fact means to meet the burden of establishing the fact\n(Section 1-201(8)).\n(67) "Public-finance transaction" means a secured transaction in connection with which:\n(A) debt securities are issued;\n(B) all or a portion of the securities issued have an initial stated maturity of at least 20\nyears; and\n(C) the debtor, obligor, secured party, account debtor or other person obligated on\ncollateral, assignor or assignee of a secured obligation, or assignor or assignee of a\nsecurity interest is a state or a governmental unit of a state.\n(68) "Public organic record" means a record that is available to the public for inspection\nand is:\n(A) a record consisting of the record initially filed with or issued by a state or the\nUnited States to form or organize an organization and any record filed with or issued by\nthe state or the United States which amends or restates the initial record;\n(B) an organic record of a business trust consisting of the record initially filed with a\nstate and any record filed with the state which amends or restates the initial record, if a\nstatute of the state governing business trusts requires that the record be filed with the\nstate; or\n(C) a record consisting of legislation enacted by the legislature of a state or the\nCongress of the United States which forms or organizes an organization, any record\namending the legislation, and any record filed with or issued by the state or the United\nStates which amends or restates the name of the organization.\n(69) "Pursuant to commitment", with respect to an advance made or other value given by\na secured party, means pursuant to the secured party\'s obligation, whether or not a\nsubsequent event of default or other event not within the secured party\'s control has\nrelieved or may relieve the secured party from its obligation.\n\n434\n\n\x0c(70) "Record", except as used in "for record", "of record", "record or legal title", and\n"record owner", means information that is inscribed on a tangible medium or which is\nstored in an electronic or other medium and is retrievable in perceivable form.\n(71) "Registered organization" means an organization formed or organized solely under\nthe law of a single state or the United States by the filing of a public organic record with,\nthe issuance of a public organic record by, or the enactment of legislation by the state or\nthe United States. The term includes a business trust that is formed or organized under the\nlaw of a single state if a statute of the state governing business trusts requires that the\nbusiness trust\'s organic record be filed with the state.\n(72) "Secondary obligor" means an obligor to the extent that:\n(A) the obligor\'s obligation is secondary; or\n(B) the obligor has a right of recourse with respect to an obligation secured by collateral\nagainst the debtor, another obligor, or property of either.\n(73) "Secured party" means:\n(A) a person in whose favor a security interest is created or provided for under a\nsecurity agreement, whether or not any obligation to be secured is outstanding;\n(B) a person that holds an agricultural lien;\n(C) a consignor;\n(D) a person to which accounts, chattel paper, payment intangibles, or promissory notes\nhave been sold;\n(E) a trustee, indenture trustee, agent, collateral agent, or other representative in whose\nfavor a security interest or agricultural lien is created or provided for; or (F) a person\nthat holds a security interest arising under Section 2-401, 2-505, 2-711(3), 2-A-508(5),\n4-210, or 5-118.\n(74) "Security agreement" means an agreement that creates or provides for a security\ninterest. A cooperative record that provides that the owner of a cooperative interest has an\nobligation to pay amounts to the cooperative organization incident to ownership of that\ncooperative interest and which states that the cooperative organization has a direct\nremedy against that cooperative interest if such amounts are not paid is a security\nagreement creating a cooperative organization security interest.\n(75) "Send", in connection with a record or notification, means:\n(A) to deposit in the mail, deliver for transmission, or transmit by any other usual\nmeans of communication, with postage or cost of transmission provided for, addressed\nto any address reasonable under the circumstances; or\n(B) to cause the record or notification to be received within the time that it would have\nbeen received if properly sent under subparagraph (A).\n(76) "Software" means a computer program and any supporting information provided in\nconnection with a transaction relating to the program. The term does not include a\ncomputer program that is included in the definition of goods.\n435\n\n\x0c(77) "State" means a state of the United States, the District of Columbia, Puerto Rico, the\nUnited States Virgin Islands, or any territory or insular possession subject to the\njurisdiction of the United States.\n(78) "Supporting obligation" means a letter-of-credit right or secondary obligation that\nsupports the payment or performance of an account, chattel paper, a document, a general\nintangible, an instrument, or investment property.\n(79) "Tangible chattel paper" means chattel paper evidenced by a record or records\nconsisting of information that is inscribed on a tangible medium.\n(80) "Termination statement" means an amendment of a financing statement which:\n(A) identifies, by its file number, the initial financing statement to which it relates; and\n(B) indicates either that it is a termination statement or that the identified financing\nstatement is no longer effective.\n(81) "Transmitting utility" means a person primarily engaged in the business of:\n(A) operating a railroad, subway, street railway, or trolley bus;\n(B) transmitting communications electrically, electromagnetically, or by light;\n(C) transmitting goods by pipeline or sewer; or\n(D) transmitting or producing and transmitting electricity, steam, gas, or water.\n(b) Definitions in other articles. The following definitions in other articles apply to this\narticle:\n"Applicant" Section 5-102.\n"Beneficiary" Section 5-102.\n"Broker" Section 8-102.\n"Certificated security" Section 8-102.\n"Clearing corporation" Section 8-102.\n"Contract for sale" Section 2-106.\n"Control" (with respect to a document Section 7-106. of title)\n"Customer" Section 4-104.\n"Entitlement holder" Section 8-102.\n"Financial asset" Section 8-102.\n"Holder in due course" Section 3-302.\n"Issuer" (with respect to a letter of credit or letter-of-credit right) Section 5-102.\n"Issuer" (with respect to a security) Section 8-201.\n"Issuer" (with respect to document of title) Section 7-102.\n"Lease" Section 2-A-103.\n436\n\n\x0c"Lease agreement" Section 2-A-103.\n"Lease contract" Section 2-A-103.\n"Leasehold interest" Section 2-A-103.\n"Lessee" Section 2-A-103.\n"Lessee in ordinary course of business" Section 2-A-103.\n"Lessor" Section 2-A-103.\n"Lessor\'s residual interest" Section 2-A-103.\n\xe2\x80\x9cLetter of credit" Section 5-102.\n"Merchant" Section 2-104.\n"Negotiable instrument" Section 3-104.\n"Nominated person" Section 5-102.\n"Note" Section 3-104.\n"Proceeds of a letter of credit" Section 5-114.\n"Prove" Section 4-A-105.\n"Sale" Section 2-106.\n"Securities account" Section 8-501.\n"Securities intermediary" Section 8-102.\n"Security" Section 8-102.\n"Security certificate" Section 8-102.\n"Security entitlement" Section 8-102.\n"Uncertificated security" Section 8-102.\n(c) Article 1 definitions and principles. Article 1 contains general definitions and\nprinciples of construction and interpretation applicable throughout this article.\nSection 9-103: Purchase-money Security Interest; Application of Payments; Burden of\nEstablishing\n(a) Definitions. In this section:\n(1) "purchase-money collateral" means goods or software that secures a purchase-money\nobligation incurred with respect to that collateral; and\n(2) "purchase-money obligation" means an obligation of an obligor incurred as all or part\nof the price of the collateral or for value given to enable the debtor to acquire rights in or\nthe use of the collateral if the value is in fact so used.\n(b) Purchase-money security interest in goods. A security interest in goods is a purchasemoney security interest:\n437\n\n\x0c(1) to the extent that the goods are purchase-money collateral with respect to that security\ninterest;\n(2) if the security interest is in inventory that is or was purchase-money collateral, also to\nthe extent that the security interest secures a purchase-money obligation incurred with\nrespect to other inventory in which the secured party holds or held a purchase-money\nsecurity interest; and\n(3) also to the extent that the security interest secures a purchase-money obligation\nincurred with respect to software in which the secured party holds or held a purchasemoney security interest.\n(c) Purchase-money security interest in software. A security interest in software is a\npurchase-money security interest to the extent that the security interest also secures a\npurchase-money obligation incurred with respect to goods in which the secured party holds\nor held a purchase-money security interest if:\n(1) the debtor acquired its interest in the software in an integrated transaction in which it\nacquired an interest in the goods; and\n(2) the debtor acquired its interest in the software for the principal purpose of using the\nsoftware in the goods.\n(d) Consignor\'s inventory purchase-money security interest. The security interest of a\nconsignor in goods that are the subject of a consignment is a purchase-money security\ninterest in inventory.\n(e) Application of payment in non-consumer-goods transaction. In a transaction other than a\nconsumer-goods transaction, if the extent to which a security interest is a purchase-money\nsecurity interest depends on the application of a payment to a particular obligation, the\npayment must be applied:\n(1) in accordance with any reasonable method of application to which the parties agree;\n(2) in the absence of the parties\' agreement to a reasonable method, in accordance with\nany intention of the obligor manifested at or before the time of payment; or\n(3) in the absence of an agreement to a reasonable method and a timely manifestation of\nthe obligor\'s intention, in the following order: (A) to obligations that are not secured; and\n(B) if more than one obligation is secured, to obligations secured by purchase-money\nsecurity interests in the order in which those obligations were incurred.\n(f) No loss of status of purchase-money security interest in non-consumer-goods transaction.\nIn a transaction other than a consumer-goods transaction, a purchase-money security interest\ndoes not lose its status as such, even if:\n(1) the purchase-money collateral also secures an obligation that is not a purchase-money\nobligation;\n(2) collateral that is not purchase-money collateral also secures the purchase-money\nobligation; or\n\n438\n\n\x0c(3) the purchase-money obligation has been renewed, refinanced, consolidated, or\nrestructured.\n(g) Burden of proof in non-consumer-goods transaction. In a transaction other than a\nconsumer-goods transaction, a secured party claiming a purchase-money security interest has\nthe burden of establishing the extent to which the security interest is a purchase-money\nsecurity interest.\n(h) Non-consumer-goods transactions; no inference. The limitation of the rules in subsections\n(e), (f), and (g) to transactions other than consumer-goods transactions is intended to leave to\nthe court the termination of the proper rules in consumer-goods transactions. The court may\nnot infer from that limitation the nature of the proper rule in consumer-goods transactions\nand may continue to apply established approaches.\nSection 9-104: Control of Deposit Account\n(a) Requirements for control. A secured party has control of a deposit account if:\n(1) the secured party is the bank with which the deposit account is maintained;\n(2) the debtor, secured party, and bank have agreed in an authenticated record that the\nbank will comply with instructions originated by the secured party directing disposition\nof the funds in the deposit account without further consent by the debtor; or\n(3) the secured party becomes the bank\'s customer with respect to the deposit account.\n(b) Debtor\'s right to direct disposition. A secured party that has satisfied subsection (a) has\ncontrol, even if the debtor retains the right to direct the disposition of funds from the\ndeposit account.\nSection 9-105: Control of Electronic Chattel Paper\nA secured party has control of electronic chattel paper if the record or records comprising the\nchattel paper are created, stored, and assigned in such a manner that:\n(1) a single authoritative copy of the record or records exists which is unique, identifiable\nand, except as otherwise provided in paragraphs (4), (5), and (6), unalterable;\n(2) the authoritative copy identifies the secured party as the assignee of the record or\nrecords;\n(3) the authoritative copy is communicated to and maintained by the secured party or its\ndesignated custodian;\n(4) copies or revisions that add or change an identified assignee of the authoritative copy\ncan be made only with the participation of the secured party;\n(5) each copy of the authoritative copy and any copy of a copy is readily identifiable as a\ncopy that is not the authoritative copy; and\n(6) any revision of the authoritative copy is readily identifiable as an authorized or\nunauthorized revision.\n439\n\n\x0cSection 9-106: Control of Investment Property\n(a) Control under Section 8-106. A person has control of a certificated security,\nuncertificated security, or security entitlement as provided in Section 8-106.\n(b) Control of commodity contract. A secured party has control of a commodity contract if:\n(1) the secured party is the commodity intermediary with which the commodity contract\nis carried; or\n(2) the commodity customer, secured party, and commodity intermediary have agreed\nthat the commodity intermediary will apply any value distributed on account of the\ncommodity contract as directed by the secured party without further consent by the\ncommodity customer.\n(c) Effect of control of securities account or commodity account. A secured party having\ncontrol of all security entitlements or commodity contracts carried in a securities account or\ncommodity account has control over the securities account or commodity account.\nSection 9-107: Control of Letter-of-credit Right\nA secured party has control of a letter-of-credit right to the extent of any right to payment or\nperformance by the issuer or any nominated person if the issuer or nominated person has\nconsented to an assignment of proceeds of the letter of credit under Section 5-114(c) or\notherwise applicable law or practice.\nSection 9-108: Sufficiency of Description\n(a) Sufficiency of description. Except as otherwise provided in subsections (c), (d), and (e), a\ndescription of personal or real property is sufficient, whether or not it is specific, if it\nreasonably identifies what is described.\n(b) Examples of reasonable identification. Except as otherwise provided in Section 9-502 and\nsubsection (d), a description of collateral reasonably identifies the collateral if it identifies the\ncollateral by:\n(1) specific listing;\n(2) category;\n(3) except as otherwise provided in subsection (e), a type of collateral defined in this\nchapter;\n(4) quantity;\n(5) computational or allocational formula or procedure; or\n(6) except as otherwise provided in subsection (c), any other method, if the identity of the\ncollateral is objectively determinable.\n440\n\n\x0c(c) Supergeneric description not sufficient. A description of collateral as "all the debtor\'s\nassets" or "all the debtor\'s personal property" or using words of similar import does not\nreasonably identify the collateral.\n(d) Investment property. Except as otherwise provided in subsection (e), a description of a\nsecurity entitlement, securities account, or commodity account is sufficient if it describes:\n(1) the collateral by those terms or as investment property; or\n(2) the underlying financial asset or commodity contract.\n(e) When description by type insufficient. A description only by type of collateral defined in\nthis chapter is an insufficient description of:\n(1) a commercial tort claim;\n(2) in a consumer transaction, consumer goods, a security entitlement, a securities\naccount, or a commodity account; or\n(3) a cooperative interest.\nSubPart 2- APPLICABILITY OF ARTICLE\nSection 9-109. Scope.\n(a) General scope of article. Except as otherwise provided in subsections (c) and (d), this\narticle applies to:\n(1) a transaction, regardless of its form, that creates a security interest in personal\nproperty or fixtures by contract;\n(2) an agricultural lien;\n(3) a sale of accounts, chattel paper, payment intangibles, or promissory notes;\n(4) a consignment;\n(5) a security interest arising under Section 2-401, 2-505, 2-711(3), or 2-A-508(5), as\nprovided in Section 9-110;\n(6) a security interest arising under Section 4-210 or 5-118; and\n(7) a security interest in a cooperative interest.\n(b) Security interest in secured obligation. The application of this article to a security interest\nin a secured obligation is not affected by the fact that the obligation is itself secured by a\ntransaction or interest to which this article does not apply.\n(c) Extent to which article does not apply. This article does not apply to the extent that:\n(1) a statute, regulation, or treaty of the United States preempts this article;\n(2) another statute of this State expressly governs the creation, perfection, priority, or\nenforcement of a security interest created by this state or a governmental unit of this\nstate;\n441\n\n\x0c(3) a statute of another state, a foreign country, or a governmental unit of another state or\na foreign country, other than a statute generally applicable to security interests, expressly\ngoverns creation, perfection, priority, or enforcement of a security interest created by the\nstate, country, or governmental unit; or\n(4) the rights of a transferee beneficiary or nominated person under a letter of credit are\nindependent and superior under Section 5-114.\n(d) Inapplicability of article. This article does not apply to:\n(1) a landlord\'s lien, other than an agricultural lien, or a security interest in a cooperative\ninterest;\n(2) a lien, other than an agricultural lien, given by statute or other rule of law for services\nor materials, but Section 9-333 applies with respect to priority of the lien;\n(3) an assignment of a claim for wages, salary, or other compensation of an employee;\n(4) a sale of accounts, chattel paper, payment intangibles, or promissory notes as part of a\nsale of the business out of which they arose;\n(5) an assignment of accounts, chattel paper, payment intangibles, or promissory notes\nwhich is for the purpose of collection only;\n(6) an assignment of a right to payment under a contract to an assignee that is also\nobligated to perform under the contract;\n(7) an assignment of a single account, payment intangible, or promissory note to an\nassignee in full or partial satisfaction of a preexisting indebtedness;\n(8) a transfer of an interest in or an assignment of a claim under a policy of insurance or\ncontract for an annuity including a variable annuity other than an assignment by or to a\nhealth-care provider of a health-care-insurance receivable and any subsequent assignment\nof the right to payment, but Sections 9-315 and 9-322 apply with respect to proceeds and\npriorities in proceeds;\n(9) an assignment of a right represented by a judgment, other than a judgment taken on a\nright to payment that was collateral;\n(10) a right of recoupment or set-off, but:\n(A) Section 9-340 applies with respect to the effectiveness of rights of recoupment or\nset-off against deposit accounts; and\n(B) Section 9-404 applies with respect to defenses or claims of an account debtor;\n(11) the creation or transfer of an interest in or lien on real property, including a lease or\nrents thereunder, except to the extent that provision is made for:\n(A) liens on real property in Section 9-203 and 9-308;\n(B) fixtures in Section 9-334;\n(C) fixture filings in Sections 9-501, 9-502, 9-512, 9-516, and 9-519;\n(D) security agreements covering personal and real property in Section 9-604; and\n442\n\n\x0c(E) security interests in cooperative interests;\n(12) an assignment of a claim arising in tort, other than a commercial tort claim, but\nSections 9-315 and 9-322 apply with respect to proceeds and priorities in proceeds; or\n(13) an assignment of a deposit account in a consumer transaction, but Sections 9-315\nand 9-322 apply with respect to proceeds and priorities in proceeds.\nSection 9-110. Security Interests Arising Under Article 2 or 2-A.\nA security interest arising under Section 2-401, 2-505, 2-711(3), or 2-A-508(5) is subject to\nthis article. However, until the debtor obtains possession of the goods:\n(1) the security interest is enforceable, even if Section 9-203(b)(3) has not been satisfied;\n(2) filing is not required to perfect the security interest;\n(3) the rights of the secured party after default by the debtor are governed by Article 2 or\n2-A; and\n(4) the security interest has priority over a conflicting security interest created by the\ndebtor.\nPart 2- EFFECTIVENESS OF SECURITY AGREEMENT; ATTACHMENT OF SECURITY\nINTEREST; RIGHTS OF PARTIES TO SECURITY AGREEMENT\nSubPart 1 - EFFECTIVENESS AND ATTACHMENT\nSection 9-201. General Effectiveness of Security Agreement.\n(a) General effectiveness. Except as otherwise provided in this chapter, a security agreement\nis effective according to its terms between the parties, against purchasers of the collateral,\nand against creditors.\n(b) Applicable consumer laws and other law. A transaction subject to this article is subject to:\n(1) any applicable rule of law which establishes a different rule for consumers;\n(2) any other statute or regulation of this state which regulates the rates, charges,\nagreements and practices for loans, credit sales or other extensions of credit;\n(3) any consumer protection statute or regulation of this state.\n(c) Other applicable law controls. In case of conflict between this article and a rule of law,\nstatute, or regulation described in subsection (b), the rule of law, statute, or regulation\ncontrols. Failure to comply with a statute or regulation described in subsection (b) has only\nthe effect the statute or regulation specifies.\n(d) Further deference to other applicable law. This article does not:\n443\n\n\x0c(1) validate any rate, charge, agreement, or practice that violates a rule of law, statute, or\nregulation described in subsection (b); or\n(2) extend the application of the rule of law, statute, or regulation to a transaction not\notherwise subject to it.\nSection 9-202. Title to Collateral Immaterial.\nExcept as otherwise provided with respect to consignments or sales of accounts, chattel\npaper, payment intangibles, or promissory notes, the provisions of this article with regard to\nrights and obligations apply whether title to collateral is in the secured party or the debtor.\nSection 9-203. Attachment and Enforceability of Security Interest; Proceeds; Supporting\nObligations; Formal Requisites.\n(a) Attachment. A security interest attaches to collateral when it becomes enforceable against\nthe debtor with respect to the collateral, unless an agreement expressly postpones the time of\nattachment.\n(b) Enforceability. Except as otherwise provided in subsections (c) through (i), a security\ninterest is enforceable against the debtor and third parties with respect to the collateral only\nif:\n(1) value has been given;\n(2) the debtor has rights in the collateral or the power to transfer rights in the collateral to\na secured party; and\n(3) one of the following conditions is met:\n(A) the debtor has authenticated a security agreement that provides a description of the\ncollateral and, if the security interest covers timber to be cut, a description of the land\nconcerned;\n(B) the collateral is not a certificated security and is in the possession of the secured\nparty under Section 9\xe2\x80\x94313 pursuant to the debtor\'s security agreement;\n(C) the collateral is a certificated security in registered form and the security certificate\nhas been delivered to the secured party under Section 8-301 pursuant to the debtor\'s\nsecurity agreement; or\n(D) the collateral is deposit accounts, electronic chattel paper, investment property,\nletter-of-credit rights, or electronic documents, and the secured party has control under\nSection 7-106, 9-104, 9-105, 9-106, or 9\xe2\x80\x94107 pursuant to the debtor\'s security\nagreement.\n(c) Other UCC provisions. Subsection (b) is subject to Section 4\xe2\x80\x94210 on the security\ninterest of a collecting bank, Section 5-118 on the security interest of a letter-of-credit issuer\nor nominated person, Section 9-110 on a security interest arising under Article 2 or 2-A, and\nSection 9-206 on security interests in investment property.\n444\n\n\x0c(d) When a person becomes bound by another person\'s security agreement. A person\nbecomes bound as debtor by a security agreement entered into by another person if, by\noperation of law other than this article or by contract:\n(1) the security agreement becomes effective to create a security interest in the person\'s\nproperty; or\n(2) the person becomes generally obligated for the obligations of the other person,\nincluding the obligation secured under the security agreement, and acquires or succeeds\nto all or substantially all of the assets of the other person.\n(e) Effect of new debtor becoming bound. If a new debtor becomes bound as debtor by a\nsecurity agreement entered into by another person:\n(1) the agreement satisfies subsection (b)(3) with respect to existing or after-acquired\nproperty of the new debtor to the extent the property is described in the agreement; and\n(2) another agreement is not necessary to make a security interest in the property\nenforceable.\n(f) Proceeds and supporting obligations. The attachment of a security interest in collateral\ngives the secured party the rights to proceeds provided by Section 9-315 and is also\nattachment of a security interest in a supporting obligation for the collateral.\n(g) Lien securing right to payment. The attachment of a security interest in a right to payment\nor performance secured by a security interest or other lien on personal or real property is also\nattachment of a security interest in the security interest, mortgage, or other lien.\n(h) Security entitlement carried in securities account. The attachment of a security interest in\na securities account is also attachment of a security interest in the security entitlements\ncarried in the securities account.\n(i) Commodity contracts carried in commodity account. The attachment of a security interest\nin a commodity account is also attachment of a security interest in the commodity contracts\ncarried in the commodity account.\nSection 9-204. After-acquired Property; Future Advances.\n(a) After-acquired collateral. Except as otherwise provided in subsection (b), a security\nagreement may create or provide for a security interest in after-acquired collateral.\n(b) When after-acquired property clause not effective. A security interest does not attach\nunder a term constituting an after-acquired property clause to:\n(1) consumer goods, other than an accession when given as additional security, unless the\ndebtor acquires rights in them within 10 days after the secured party gives value; or\n(2) a commercial tort claim.\n(c) Future advances and other value. A security agreement may provide that collateral\nsecures, or that accounts, chattel paper, payment intangibles, or promissory notes are sold in\nconnection with, future advances or other value, whether or not the advances or value are\ngiven pursuant to commitment.\n445\n\n\x0cSection 9-205. Use or Disposition of Collateral Permissible.\n(a) When security interest not invalid or fraudulent. A security interest is not invalid or\nfraudulent against creditors solely because:\n(1) the debtor has the right or ability to:\n(A) use, commingle, or dispose of all or part of the collateral, including returned or\nrepossessed goods;\n(B) collect, compromise, enforce, or otherwise deal with collateral;\n(C) accept the return of collateral or make repossessions; or\n(D) use, commingle, or dispose of proceeds; or\n(2) the secured party fails to require the debtor to account for proceeds or replace\ncollateral.\n(b) Requirements of possession not relaxed. This section does not relax the requirements of\npossession if attachment, perfection, or enforcement of a security interest depends upon\npossession of the collateral by the secured party.\nSection 9-206. Security Interest Arising in Purchase or Delivery of Financial Asset.\n(a) Security interest when person buys through securities intermediary. A security interest in\nfavor of a securities intermediary attaches to a person\'s security entitlement if:\n(1) the person buys a financial asset through the securities intermediary in a transaction in\nwhich the person is obligated to pay the purchase price to the securities intermediary at\nthe time of the purchase; and\n(2) the securities intermediary credits the financial asset to the buyer\'s securities account\nbefore the buyer pays the securities intermediary.\n(b) Security interest secures obligation to pay for financial asset. The security interest\ndescribed in subsection (a) secures the person\'s obligation to pay for the financial asset.\n(c) Security interest in payment against delivery transaction. A security interest in favor of a\nperson that delivers a certificated security or other financial asset represented by a writing\nattaches to the security or other financial asset if:\n(1) the security or other financial asset:\n(A) in the ordinary course of business is transferred by delivery with any necessary\nindorsement or assignment; and\n(B) is delivered under an agreement between persons in the business of dealing with\nsuch securities or financial assets; and\n(2) the agreement calls for delivery against payment.\n\n446\n\n\x0c(d) Security interest secures obligation to pay for delivery. The security interest described in\nsubsection (c) secures the obligation to make payment for the delivery.\nSubPart 2- RIGHTS AND DUTIES\nSection 9-207: Rights and Duties of Secured Party Having Possession or Control of Collateral\n(a) Duty of care when secured party in possession. Except as otherwise provided in\nsubsection (d), a secured party shall use reasonable care in the custody and preservation of\ncollateral in the secured party\'s possession. In the case of chattel paper or an instrument,\nreasonable care includes taking necessary steps to preserve rights against prior parties unless\notherwise agreed.\n(b) Expenses, risks, duties, and rights when secured party in possession. Except as otherwise\nprovided in subsection (d), if a secured party has possession of collateral:\n(1) reasonable expenses, including the cost of insurance and payment of taxes or other\ncharges, incurred in the custody, preservation, use, or operation of the collateral are\nchargeable to the debtor and are secured by the collateral;\n(2) the risk of accidental loss or damage is on the debtor to the extent of a deficiency in\nany effective insurance coverage;\n(3) the secured party shall keep the collateral identifiable, but fungible collateral may be\ncommingled; and\n(4) the secured party may use or operate the collateral:\n(A) for the purpose of preserving the collateral or its value;\n(B) as permitted by an order of a court having competent jurisdiction; or\n(C) except in the case of consumer goods, in the manner and to the extent agreed by the\ndebtor.\n(c) Duties and rights when secured party in possession or control. Except as otherwise\nprovided in subsection (d), a secured party having possession of collateral or control of\ncollateral under Section 9-104, 9-105, 9-106, or 9-107:\n(1) may hold as additional security any proceeds, except money or funds, received from\nthe collateral;\n(2) shall apply money or funds received from the collateral to reduce the secured\nobligation, unless remitted to the debtor; and\n(3) may create a security interest in the collateral.\n(d) Buyer of certain rights to payment. If the secured party is a buyer of accounts, chattel\npaper, payment intangibles, or promissory notes or a consignor:\n(1) subsection (a) does not apply unless the secured party is entitled under an agreement:\n(A) to charge back uncollected collateral; or\n447\n\n\x0c(B) otherwise to full or limited recourse against the debtor or a secondary obligor based\non the nonpayment or other default of an account debtor or other obligor on the\ncollateral; and (2) subsections (b) and (c) do not apply.\nSection 9-208: Additional Duties of Secured Party Having Control of Collateral\n(a) Applicability of section. This section applies to cases in which there is no outstanding\nsecured obligation and the secured party is not committed to make advances, incur\nobligations, or otherwise give value.\n(b) Duties of secured party after receiving demand from debtor. Within 10 days after\nreceiving an authenticated demand by the debtor:\n(1) a secured party having control of a deposit account under\nSection 9-209: Duties of Secured Party If Account Debtor Has Been Notified of Assignment\n(a) Applicability of section. Except as otherwise provided in subsection (c), this section\napplies if:\n(1) there is no outstanding secured obligation; and\n(2) the secured party is not committed to make advances, incur obligations, or otherwise\ngive value.\n(b) Duties of secured party after receiving demand from debtor. Within 10 days after\nreceiving an authenticated demand by the debtor, a secured party shall send to an account\ndebtor that has received notification of an assignment to the secured party as assignee under\nSection 9-406(a) an authenticated record that releases the account debtor from any further\nobligation to the secured party.\n(c) Inapplicability to sales. This section does not apply to an assignment constituting the sale\nof an account, chattel paper, or payment intangible.\nSection 9-210: Request for Accounting; Request Regarding List of Collateral or Statement of\nAccount\n(a) Definitions in this section:\n(1) "Request" means a record of a type described in paragraph (2), (3), or (4).\n(2) "Request for an accounting" means a record authenticated by a debtor requesting that\nthe recipient provide an accounting of the unpaid obligations secured by collateral and\nreasonably identifying the transaction or relationship that is the subject of the request.\n(3) "Request regarding a list of collateral" means a record authenticated by a debtor\nrequesting that the recipient approve or correct a list of what the debtor believes to be the\ncollateral securing an obligation and reasonably identifying the transaction or relationship\nthat is the subject of the request.\n448\n\n\x0c(4) "Request regarding a statement of account" means a record authenticated by a debtor\nrequesting that the recipient approve or correct a statement indicating what the debtor\nbelieves to be the aggregate amount of unpaid obligations secured by collateral as of a\nspecified date and reasonably identifying the transaction or relationship that is the subject\nof the request.\n(b) Duty to respond to requests. Subject to subsections (c), (d), (e), and (f), a secured party,\nother than a buyer of accounts, chattel paper, payment intangibles, or promissory notes or a\nconsignor, shall comply with a request within 14 days after receipt:\n(1) in the case of a request for an accounting, by authenticating and sending to the debtor\nan accounting; and\n(2) in the case of a request regarding a list of collateral or a request regarding a statement\nof account, by authenticating and sending to the debtor an approval or correction.\n(c) Request regarding list of collateral; statement concerning type of collateral. A secured\nparty that claims a security interest in all of a particular type of collateral owned by the\ndebtor may comply with a request regarding a list of collateral by sending to the debtor an\nauthenticated record including a statement to that effect within 14 days after receipt.\n(d) Request regarding list of collateral; no interest claimed. A person that receives a request\nregarding a list of collateral, claims no interest in the collateral when it receives the request,\nand claimed an interest in the collateral at an earlier time shall comply with the request\nwithin 14 days after receipt by sending to the debtor an authenticated record:\n(1) disclaiming any interest in the collateral; and\n(2) if known to the recipient, providing the name and mailing address of any assignee of\nor successor to the recipient\'s interest in the collateral.\n(e) Request for accounting or regarding statement of account; no interest in obligation\nclaimed. A person that receives a request for an accounting or a request regarding a statement\nof account, claims no interest in the obligations when it receives the request, and claimed an\ninterest in the obligations at an earlier time shall comply with the request within 14 days after\nreceipt by sending to the debtor an authenticated record:\n(1) disclaiming any interest in the obligations; and\n(2) if known to the recipient, providing the name and mailing address of any assignee of\nor successor to the recipient\'s interest in the obligations.\n(f) Charges for responses. A debtor is entitled without charge to one response to a request\nunder this section during any six-month period. The secured party may require payment of a\ncharge not exceeding $25 for each additional response.\nPart 3 \xe2\x80\x93 PERFECTION AND PRIORITY\nSubPart 1 - LAW GOVERNING PERFECTION AND PRIORITY\nSection 9-301: Law Governing Perfection and Priority of Security Interests\n449\n\n\x0cExcept as otherwise provided in Sections 9-303 through 9-306, the following rules determine\nthe law governing perfection, the effect of perfection or nonperfection, and the priority of a\nsecurity interest in collateral:\n(a) Except as otherwise provided in this section, while a debtor is located in a\njurisdiction, the local law of that jurisdiction governs perfection, the effect of perfection\nor nonperfection, and the priority of a security interest in collateral.\n(b) While collateral is located in a jurisdiction, the local law of that jurisdiction governs\nperfection, the effect of perfection or nonperfection, and the priority of a possessory\nsecurity interest in that collateral.\n(c) Except as otherwise provided in paragraph (d), while negotiable documents, goods,\ninstruments, money, or tangible chattel paper is located in a jurisdiction, the local law of\nthat jurisdiction governs:\n(1) perfection of a security interest in the goods by filing a fixture filing;\n(2) perfection of a security interest in timber to be cut; and\n(3) the effect of perfection or nonperfection and the priority of a nonpossessory security\ninterest in the collateral.\n(d) The local law of the jurisdiction in which the wellhead or minehead is located governs\nperfection, the effect of perfection or nonperfection, and the priority of a security interest\nin as-extracted collateral.\n(e) When collateral is a cooperative interest, the law of this state governs perfection, the\neffect of perfection or nonperfection, and the priority of the security interest in such\ncollateral.\nSection 9-302: Law Governing Perfection and Priority of Agricultural Liens\nWhile farm products are located in a jurisdiction, the local law of that jurisdiction governs\nperfection, the effect of perfection or nonperfection, and the priority of an agricultural lien on\nthe farm products.\nSection 9-303: Law Governing Perfection and Priority of Security Interests in Goods Covered by\na Certificate of Title\n(a) Applicability of section. This section applies to goods covered by a certificate of title,\neven if there is no other relationship between the jurisdiction under whose certificate of title\nthe goods are covered and the goods or the debtor.\n(b) When goods covered by certificate of title. Goods become covered by a certificate of title\nwhen a valid application for the certificate of title and the applicable fee are delivered to the\nappropriate authority. Goods cease to be covered by a certificate of title at the earlier of the\ntime the certificate of title ceases to be effective under the law of the issuing jurisdiction or\nthe time the goods become covered subsequently by a certificate of title issued by another\njurisdiction.\n450\n\n\x0c(c) Applicable law. The local law of the jurisdiction under whose certificate of title the goods\nare covered governs perfection, the effect of perfection or nonperfection, and the priority of a\nsecurity interest in goods covered by a certificate of title from the time the goods become\ncovered by the certificate of title until the goods cease to be covered by the certificate of title.\nSection 9-304: Law Governing Perfection and Priority of Security Interests in Deposit Accounts\n(a) Law of bank\'s jurisdiction governs. The local law of a bank\'s jurisdiction governs\nperfection, the effect of perfection or nonperfection, and the priority of a security interest in a\ndeposit account maintained with that bank.\n(b) Bank\'s jurisdiction. The following rules determine a bank\'s jurisdiction for purposes of\nthis part:\n(1) If an agreement between the bank and the debtor governing the deposit account\nexpressly provides that a particular jurisdiction is the bank\'s jurisdiction for purposes of\nthis part, this article, or this chapter, that jurisdiction is the bank\'s jurisdiction.\n(2) If paragraph (1) does not apply and an agreement between the bank and its customer\ngoverning the deposit account expressly provides that the agreement is governed by the\nlaw of a particular jurisdiction, that jurisdiction is the bank\'s jurisdiction.\n(3) If neither paragraph (1) nor paragraph (2) applies and an agreement between the bank\nand its customer governing the deposit account expressly provides that the deposit\naccount is maintained at an office in a particular jurisdiction, that jurisdiction is the\nbank\'s jurisdiction.\n(4) If none of the preceding paragraphs apply, the bank\'s jurisdiction is the jurisdiction in\nwhich the office identified in an account statement as the office serving the customer\'s\naccount is located.\n(5) If none of the preceding paragraphs apply, the bank\'s jurisdiction is the jurisdiction in\nwhich the chief executive office of the bank is located.\nSection 9-305. Law Governing Perfection and Priority of Security Interests in Investment\nProperty.\n(a) Governing law: general rules. Except as otherwise provided in subsections (c) and (d), the\nfollowing rules apply:\n(1) While a security certificate is located in a jurisdiction, the local law of that\njurisdiction governs perfection, the effect of perfection or nonperfection, and the priority\nof a security interest in the certificated security represented thereby.\n(2) The local law of the issuer\'s jurisdiction as specified in Section 8-110(d) governs\nperfection, the effect of perfection or nonperfection, and the priority of a security interest\nin an uncertificated security.\n\n451\n\n\x0c(3) The local law of the securities intermediary\'s jurisdiction as specified in Section 8110(e) governs perfection, the effect of perfection or nonperfection, and the priority of a\nsecurity interest in a security entitlement or securities account.\n(4) The local law of the commodity intermediary\'s jurisdiction governs perfection, the\neffect of perfection or nonperfection, and the priority of a security interest in a\ncommodity contract or commodity account.\n(b) Commodity intermediary\'s jurisdiction. The following rules determine a commodity\nintermediary\'s jurisdiction for purposes of this part:\n(1) If an agreement between the commodity intermediary and commodity customer\ngoverning the commodity account expressly provides that a particular jurisdiction is the\ncommodity intermediary\'s jurisdiction for purposes of this part, this article, or this\nchapter, that jurisdiction is the commodity intermediary\'s jurisdiction.\n(2) If paragraph (1) does not apply and an agreement between the commodity\nintermediary and commodity customer governing the commodity account expressly\nprovides that the agreement is governed by the law of a particular jurisdiction, that\njurisdiction is the commodity intermediary\'s jurisdiction.\n(3) If neither paragraph (1) nor paragraph (2) applies and an agreement between the\ncommodity intermediary and commodity customer governing the commodity account\nexpressly provides that the commodity account is maintained at an office in a particular\njurisdiction, that jurisdiction is the commodity intermediary\'s jurisdiction.\n(4) If none of the preceding paragraphs apply, the commodity intermediary\'s jurisdiction\nis the jurisdiction in which the office identified in an account statement as the office\nserving the commodity customer\'s account is located.\n(5) If none of the preceding paragraphs apply, the commodity intermediary\'s jurisdiction\nis the jurisdiction in which the chief executive office of the commodity intermediary is\nlocated.\n(c) When perfection governed by law of jurisdiction where debtor located. The local law of\nthe jurisdiction in which the debtor is located governs:\n(1) perfection of a security interest in investment property by filing;\n(2) automatic perfection of a security interest in investment property created by a broker\nor securities intermediary; and\n(3) automatic perfection of a security interest in a commodity contract or commodity\naccount created by a commodity intermediary.\n(d) Cooperative interests. Subsections (a) through (c) do not apply to cooperative interests.\nSection 9-306. Law Governing Perfection and Priority of Security Interests in Letter-of-credit\nRights.\n(a) Governing law: issuer\'s or nominated person\'s jurisdiction. Subject to subsection (c), the\nlocal law of the issuer\'s jurisdiction or a nominated person\'s jurisdiction governs perfection,\n452\n\n\x0cthe effect of perfection or nonperfection, and the priority of a security interest in a letter-ofcredit right if the issuer\'s jurisdiction or nominated person\'s jurisdiction is a state.\n(b) Issuer\'s or nominated person\'s jurisdiction. For purposes of this part, an issuer\'s\njurisdiction or nominated person\'s jurisdiction is the jurisdiction whose law governs the\nliability of the issuer or nominated person with respect to the letter-of-credit right as provided\nin Section 5-116.\n(c) When section not applicable. This section does not apply to a security interest that is\nperfected only under Section 9-308(d).\nSection 9-307. Location of Debtor.\n(a) "Place of business." In this section, "place of business" means a place where a debtor\nconducts its affairs. (b) Debtor\'s location: general rules. Except as otherwise provided in this\nsection, the following rules determine a debtor\'s location:\n(1) A debtor who is an individual is located at the individual\'s principal residence.\n(2) A debtor that is an organization and has only one place of business is located at its\nplace of business.\n(3) A debtor that is an organization and has more than one place of business is located at\nits chief executive office.\n(c) Limitation of applicability of subsection (b). Subsection (b) applies only if a debtor\'s\nresidence, place of business, or chief executive office, as applicable, is located in a\njurisdiction whose law generally requires information concerning the existence of a\nnonpossessory security interest to be made generally available in a filing, recording, or\nregistration system as a condition or result of the security interest\'s obtaining priority over the\nrights of a lien creditor with respect to the collateral. If subsection (b) does not apply, the\ndebtor is located in the District of Columbia.\n(d) Continuation of location: cessation of existence, etc. A person that ceases to exist, have a\nresidence, or have a place of business continues to be located in the jurisdiction specified by\nsubsections (b) and (c).\n(e) Location of registered organization organized under state law. A registered organization\nthat is organized under the law of a state is located in that state.\n(f) Location of registered organization organized under federal law; bank branches and\nagencies. Except as otherwise provided in subsection (i), a registered organization that is\norganized under the law of the United States and a branch or agency of a bank that is not\norganized under the law of the United States or a state are located:\n(1) in the state that the law of the United States designates, if the law designates a state of\nlocation;\n(2) in the state that the registered organization, branch, or agency designates, if the law of\nthe United States authorizes the registered organization, branch, or agency to designate its\n453\n\n\x0cstate of location, including by designating its main office, home office, or other\ncomparable office; or\n(3) in the District of Columbia, if neither paragraph (1) nor paragraph (2) applies.\n(g) Continuation of location: change in status of registered organization. A registered\norganization continues to be located in the jurisdiction specified by subsection (e) or (f)\nnotwithstanding:\n(1) the suspension, revocation, forfeiture, or lapse of the registered organization\'s status\nas such in its jurisdiction of organization; or\n(2) the dissolution, winding up, or cancellation of the existence of the registered\norganization.\n(h) Location of United States. The United States is located in the District of Columbia.\n(i) Location of foreign bank branch or agency if licensed in only one state. A branch or\nagency of a bank that is not organized under the law of the United States or a state is located\nin the state in which the branch or agency is licensed, if all branches and agencies of the bank\nare licensed in only one state.\n(j) Location of foreign air carrier. A foreign air carrier under the Federal Aviation Act of\n1958, as amended, is located at the designated office of the agent upon which service of\nprocess may be made on behalf of the carrier.\n(k) Section applies only to this part. This section applies only for purposes of this part.\nSubPart 2- PERFECTION\nSection 9-308. When Security Interest or Agricultural Lien Is Perfected; Continuity of\nPerfection.\n(a) Perfection of security interest. Except as otherwise provided in this section and Section 9309, a security interest is perfected if it has attached and all of the applicable requirements\nfor perfection in Sections 9-310 through 9-316 have been satisfied. A security interest is\nperfected when it attaches if the applicable requirements are satisfied before the security\ninterest attaches.\n(b) Perfection of agricultural lien. An agricultural lien is perfected if it has become effective\nand all of the applicable requirements for perfection in Section 9-310 have been satisfied. An\nagricultural lien is perfected when it becomes effective if the applicable requirements are\nsatisfied before the agricultural lien becomes effective.\n(c) Continuous perfection; perfection by different methods. A security interest or agricultural\nlien is perfected continuously if it is originally perfected by one method under this article and\nis later perfected by another method under this article, without an intermediate period when it\nwas unperfected.\n(d) Supporting obligation. Perfection of a security interest in collateral also perfects a\nsecurity interest in a supporting obligation for the collateral.\n454\n\n\x0c(e) Lien securing right to payment. Perfection of a security interest in a right to payment or\nperformance also perfects a security interest in a security interest, mortgage, or other lien on\npersonal or real property securing the right.\n(f) Security entitlement carried in securities account. Perfection of a security interest in a\nsecurities account also perfects a security interest in the security entitlements carried in the\nsecurities account.\n(g) Commodity contract carried in commodity account. Perfection of a security interest in a\ncommodity account also perfects a security interest in the commodity contracts carried in the\ncommodity account.\n(h) Cooperative organization security interest. A cooperative organization security interest\nbecomes perfected when the cooperative interest first comes into existence and remains\nperfected so long as the cooperative interest exists.\nSection 9-309. Security Interest Perfected upon Attachment.\nThe following security interests are perfected when they attach:\n(1) a purchase-money security interest in consumer goods, except as otherwise provided\nin Section 9-311(b) with respect to consumer goods that are subject to a statute or treaty\ndescribed in Section 9-311(a);\n(2) an assignment of accounts or payment intangibles which does not by itself or in\nconjunction with other assignments to the same assignee transfer a significant part of the\nassignor\'s outstanding accounts or payment intangibles;\n(3) a sale of a payment intangible;\n(4) a sale of a promissory note;\n(5) a security interest created by the assignment of a health-care-insurance receivable to\nthe provider of the health-care goods or services;\n(6) a security interest arising under Section 2-401, 2-505, 2-711(3), or 2-A-508(5), until\nthe debtor obtains possession of the collateral;\n(7) a security interest of a collecting bank arising under Section 4-210;\n(8) a security interest of an issuer or nominated person arising under Section 5-118;\n(9) a security interest arising in the delivery of a financial asset under Section 9-206(c);\n(10) a security interest in investment property created by a broker or securities\nintermediary;\n(11) a security interest in a commodity contract or a commodity account created by a\ncommodity intermediary;\n(12) an assignment for the benefit of all creditors of the transferor and subsequent\ntransfers by the assignee thereunder;\n\n455\n\n\x0c(13) a security interest created by an assignment of a beneficial interest in a decedent\'s\nestate; and\n(14) a sale by an individual of an account that is a right to payment of winnings in a\nlottery or other game of chance.\nSection 9-310. When Filing Required to Perfect Security Interest or Agricultural Lien; Security\nInterests and Agricultural Liens to Which Filing Provisions Do Not Apply.\n(a) General rule: perfection by filing. Except as otherwise provided in subsection (b) and\nSection 9-312(b), a financing statement must be filed to perfect all security interests and\nagricultural liens.\n(b) Exceptions: filing not necessary. Except as provided in subsection (d), the filing of a\nfinancing statement is not necessary to perfect a security interest:\n(1) that is perfected under Section 9-308(d), (e), (f), or (g);\n(2) that is perfected under Section 9-309 when it attaches;\n(3) in property subject to a statute, regulation, or treaty described in Section 9-311(a);\n(4) in goods in possession of a bailee which is perfected under Section 9-312(d)(1) or (2);\n(5) in certificated securities, documents, goods, or instruments which is perfected without\nfiling, control, or possession under Section 9-312(e), (f), or (g);\n(6) in collateral in the secured party\'s possession under Section 9-313;\n(7) in a certificated security which is perfected by delivery of the security certificate to\nthe secured party under Section 9-313;\n(8) in deposit accounts, electronic chattel paper, electronic documents, investment\nproperty, or letter-of-credit rights which is perfected by control under Section 9-314;\n(9) in proceeds which is perfected under Section 9-315;\n(10) that is perfected under Section 9-316; or\n(11) that is a cooperative organization security interest.\n(c) Assignment of perfected security interest. If a secured party assigns a perfected security\ninterest or agricultural lien, a filing under this article is not required to continue the perfected\nstatus of the security interest against creditors of and transferees from the original debtor.\n(d) Special rule for cooperative interests. Except for a cooperative organization security\ninterest, a security interest in a cooperative interest may be perfected only by filing a\nfinancing statement.\nSection 9-311. Perfection of Security Interests in Property Subject to Certain Statutes,\nRegulations, and Treaties.\n\n456\n\n\x0c(a) Security interest subject to other law. Except as otherwise provided in subsection (d), the\nfiling of a financing statement is not necessary or effective to perfect a security interest in\nproperty subject to:\n(1) a statute, regulation, or treaty of the United States whose requirements for a security\ninterest\'s obtaining priority over the rights of a lien creditor with respect to the property\npreempt Section 9-310(a);\n(2) a certificate-of-title statute of this state or regulations promulgated thereunder, to the\nextent such statute or regulations provide for a security interest to be indicated on the\ncertificate as a condition or result of perfection; or\n(3) a statute of another jurisdiction which provides for a security interest to be indicated\non a certificate of title as a condition or result of the security interest\'s obtaining priority\nover the rights of a lien creditor with respect to the property.\n(b) Compliance with other law. Compliance with the requirements of a statute, regulation, or\ntreaty described in subsection (a) for obtaining priority over the rights of a lien creditor is\nequivalent to the filing of a financing statement under this article. Except as\notherwise provided in subsection (d) and Sections 9-313 and 9-316(d) and (e) for goods\ncovered by a certificate of title, a security interest in property subject to a statute, regulation,\nor treaty described in subsection (a) may be perfected only by compliance with those\nrequirements, and a security interest so perfected remains perfected notwithstanding a change\nin the use or transfer of possession of the collateral.\n(c) Duration and renewal of perfection. Except as otherwise provided in subsection (d) and\nSection 9-316(d) and (e), duration and renewal of perfection of a security interest perfected\nby compliance with the requirements prescribed by a statute, regulation, or treaty described\nin subsection (a) are governed by the statute, regulation, or treaty. In other respects, the\nsecurity interest is subject to this article.\n(d) Inapplicability to certain inventory. During any period in which collateral subject to a\nstatute specified in subsection (a)(2) is inventory held for sale or lease by a person or leased\nby that person as lessor and that person is in the business of selling goods of that kind, this\nsection does not apply to a security interest in that collateral created by that person.\nSection 9-312. Perfection of Security Interests in Chattel Paper, Deposit Accounts, Documents,\nGoods Covered by Documents, Instruments, Investment Property, Letter-of-credit Rights, and\nMoney; Perfection by Permissive Filing; Temporary Perfection Without Filing or Transfer of\nPossession.\n(a) Perfection by filing permitted. A security interest in chattel paper, negotiable documents,\ninstruments, or investment property may be perfected by filing.\n(b) Control or possession of certain collateral. Except as otherwise provided in Section 9315(c) and (d) for proceeds:\n(1) a security interest in a deposit account may be perfected only by control under Section\n9-314;\n457\n\n\x0c(2) and except as otherwise provided in Section 9-308(d), a security interest in a letter-ofcredit right may be perfected only by control under Section 9-314; and\n(3) a security interest in money may be perfected only by the secured party\'s taking\npossession under Section 9-313.\n(c) Goods covered by negotiable document. While goods are in the possession of a bailee that\nhas issued a negotiable document covering the goods:\n(1) a security interest in the goods may be perfected by perfecting a security interest in\nthe document; and\n(2) a security interest perfected in the document has priority over any security interest\nthat becomes perfected in the goods by another method during that time.\n(d) Goods covered by nonnegotiable document. While goods are in the possession of a bailee\nthat has issued a non-negotiable document covering the goods, a security interest in the\ngoods may be perfected by:\n(1) issuance of a document in the name of the secured party;\n(2) the bailee\'s receipt of notification of the secured party\'s interest; or\n(3) filing as to the goods.\n(e) Temporary perfection: new value. A security interest in certificated securities, negotiable\ndocuments, or instruments is perfected without filing or the taking of possession or control\nfor a period of 20 days from the time it attaches to the extent that it arises for new value\ngiven under an authenticated security agreement.\n(f) Temporary perfection: goods or documents made available to debtor. A perfected security\ninterest in a negotiable document or goods in possession of a bailee, other than one that has\nissued a negotiable document for the goods, remains perfected for 20 days without filing if\nthe secured party makes available to the debtor the goods or documents representing the\ngoods for the purpose of:\n(1) ultimate sale or exchange; or\n(2) loading, unloading, storing, shipping, transshipping, manufacturing, processing, or\notherwise dealing with them in a manner preliminary to their sale or exchange.\n(g) Temporary perfection: delivery of security certificate or instrument to debtor. A perfected\nsecurity interest in a certificated security or instrument remains perfected for 20 days without\nfiling if the secured party delivers the security certificate or instrument to the debtor for the\npurpose of:\n(1) ultimate sale or exchange; or\n(2) presentation, collection, enforcement, renewal, or registration of transfer.\n(h) Expiration of temporary perfection. After the 20-day period specified in subsection (e),\n(f), or (g) expires, perfection depends upon compliance with this article.\n(i) Cooperative interests. Subsections (a) through (h) do not apply to cooperative interests.\n458\n\n\x0cSection 9-313. When Possession by or Delivery to Secured Party Perfects Security Interest\nWithout Filing.\n(a) Perfection by possession or delivery. Except as otherwise provided in subsection (b), a\nsecured party may perfect a security interest in tangible negotiable documents, goods,\ninstruments, money, or tangible chattel paper by taking possession of the collateral. A\nsecured party may perfect a security interest in certificated securities by taking delivery of\nthe certificated securities under Section 8-301.\n(b) Goods covered by certificate of title. With respect to goods covered by a certificate of\ntitle issued by this state, a secured party may perfect a security interest in the goods by taking\npossession of the goods only in the circumstances described in Section 9-316(d).\n(c) Collateral in possession of person other than debtor. With respect to collateral other than\ncertificated securities and goods covered by a document, a secured party takes possession of\ncollateral in the possession of a person other than the debtor, the secured party, or a lessee of\nthe collateral from the debtor in the ordinary course of the debtor\'s business, when:\n(1) the person in possession authenticates a record acknowledging that it holds possession\nof the collateral for the secured party\'s benefit; or\n(2) the person takes possession of the collateral after having authenticated a record\nacknowledging that it will hold possession of collateral for the secured party\'s benefit.\n(d) Time of perfection by possession; continuation of perfection. If perfection of a security\ninterest depends upon possession of the collateral by a secured party, perfection occurs no\nearlier than the time the secured party takes possession and continues only while the secured\nparty retains possession.\n(e) Time of perfection by delivery; continuation of perfection. A security interest in a\ncertificated security in registered form is perfected by delivery when delivery of the\ncertificated security occurs under Section 8-301 and remains perfected by delivery until the\ndebtor obtains possession of the security certificate.\n(f) Acknowledgment not required. A person in possession of collateral is not required to\nacknowledge that it holds possession for a secured party\'s benefit.\n(g) Effectiveness of acknowledgment; no duties or confirmation. If a person acknowledges\nthat it holds possession for the secured party\'s benefit:\n(1) the acknowledgment is effective under subsection (c) or Section 8-301(a), even if the\nacknowledgment violates the rights of a debtor; and\n(2) unless the person otherwise agrees or law other than this article otherwise provides,\nthe person does not owe any duty to the secured party and is not required to confirm the\nacknowledgment to another person.\n(h) Secured party\'s delivery to person other than debtor. A secured party having possession of\ncollateral does not relinquish possession by delivering the collateral to a person other than the\ndebtor or a lessee of the collateral from the debtor in the ordinary course of the debtor\'s\nbusiness if the person was instructed before the delivery or is instructed contemporaneously\nwith the delivery:\n459\n\n\x0c(1) to hold possession of the collateral for the secured party\'s benefit; or\n(2) to redeliver the collateral to the secured party.\n(i) Effect of delivery under subsection (h); no duties or confirmation. A secured party does\nnot relinquish possession, even if a delivery under subsection (h) violates the rights of a\ndebtor. A person to which collateral is delivered under subsection (h) does not owe any duty\nto the secured party and is not required to confirm the delivery to another person unless the\nperson otherwise agrees or law other than this article otherwise provides.\n(j) Cooperative interests. Subsections (a) through (i) do not apply to cooperative interests.\nSection 9-314. Perfection by Control.\n(a) Perfection by control. A security interest in investment property, deposit accounts, letterof-credit rights, electronic chattel paper, or electronic documents may be perfected by control\nof the collateral under Section 7-106, 9-104, 9-105, 9-106, or 9-107.\n(b) Specified collateral: time of perfection by control; continuation of perfection. A security\ninterest in deposit accounts, electronic chattel paper, letter-of-credit rights, or electronic\ndocuments is perfected by control under Section 7-106, 9-104, 9-105, or 9\xe2\x80\x94107 when the\nsecured party obtains control and remains perfected by control only while the secured party\nretains control.\n(c) Investment property: time of perfection by control; continuation of perfection. A security\ninterest in investment property is perfected by control under Section 9-106 from the time the\nsecured party obtains control and remains perfected by control until:\n(1) the secured party does not have control; and\n(2) one of the following occurs:\n(A) if the collateral is a certificated security, the debtor has or acquires possession of\nthe security certificate;\n(B) if the collateral is an uncertificated security, the issuer has registered or registers the\ndebtor as the registered owner; or\n(C) if the collateral is a security entitlement, the debtor is or becomes the entitlement\nholder.\n(d) Cooperative interests. Subsections (a) through (c) do not apply to cooperative interests\nSection 9-315. Secured Party\'s Rights on Disposition of Collateral and in Proceeds.\n(a) Disposition of collateral: continuation of security interest or agricultural lien; proceeds.\nExcept as otherwise provided in this article and in Section 2-403(2):\n(1) a security interest or agricultural lien continues in collateral notwithstanding sale,\nlease, license, exchange, or other disposition thereof unless the secured party authorized\nthe disposition free of the security interest or agricultural lien; and\n460\n\n\x0c(2) a security interest attaches to any identifiable proceeds of collateral.\n(b) When commingled proceeds identifiable. Proceeds that are commingled with other\nproperty are identifiable proceeds:\n(1) if the proceeds are goods, to the extent provided by Section 9-336; and\n(2) if the proceeds are not goods, to the extent that the secured party identifies the\nproceeds by a method of tracing, including application of equitable principles, that is\npermitted under law other than this article with respect to commingled property of the\ntype involved.\n(c) Perfection of security interest in proceeds. A security interest in proceeds is a perfected\nsecurity interest if the security interest in the original collateral was perfected.\n(d) Continuation of perfection. A perfected security interest in proceeds becomes unperfected\non the 21st day after the security interest attaches to the proceeds unless:\n(1) the following conditions are satisfied:\n(A) a filed financing statement covers the original collateral;\n(B) the proceeds are collateral in which a security interest may be perfected by filing in\nthe office in which the financing statement has been filed; and\n(C) the proceeds are not acquired with cash proceeds;\n(2) the proceeds are identifiable cash proceeds; or\n(3) the security interest in the proceeds is perfected other than under subsection (c) when\nthe security interest attaches to the proceeds or within 20 days thereafter.\n(e) When perfected security interest in proceeds becomes unperfected. If a filed financing\nstatement covers the original collateral, a security interest in proceeds which remains\nperfected under subsection (d)(1) becomes unperfected at the later of:\n(1) when the effectiveness of the filed financing statement lapses under Section 9-515 or\nis terminated under Section 9-513; or\n(2) the 21st day after the security interest attaches to the proceeds.\nSection 9-316. Effect of Change in Governing Law.\n(a) General rule: effect on perfection of change in governing law. A security interest\nperfected pursuant to the law of the jurisdiction designated in Section 9-301(a) or 9-305(c)\nremains perfected until the earliest of:\n(1) the time perfection would have ceased under the law of that jurisdiction;\n(2) the expiration of four months after a change of the debtor\'s location to another\njurisdiction; or\n(3) the expiration of one year after a transfer of collateral to a person that thereby\nbecomes a debtor and is located in another jurisdiction.\n461\n\n\x0c(b) Security interest perfected or unperfected under law of new jurisdiction. If a security\ninterest described in subsection (a) becomes perfected under the law of the other jurisdiction\nbefore the earliest time or event described in that subsection, it remains perfected thereafter.\nIf the security interest does not become perfected under the law of the other jurisdiction\nbefore the earliest time or event, it becomes unperfected and is deemed never to have been\nperfected as against a purchaser of the collateral for value.\n(c) Possessory security interest in collateral moved to new jurisdiction. A possessory security\ninterest in collateral, other than goods covered by a certificate of title and as-extracted\ncollateral consisting of goods, remains continuously perfected if:\n(1) the collateral is located in one jurisdiction and subject to a security interest perfected\nunder the law of that jurisdiction;\n(2) thereafter the collateral is brought into another jurisdiction; and\n(3) upon entry into the other jurisdiction, the security interest is perfected under the law\nof the other jurisdiction.\n(d) Goods covered by certificate of title from this state. Except as otherwise provided in\nsubsection (e), a security interest in goods covered by a certificate of title which is perfected\nby any method under the law of another jurisdiction when the goods become covered by a\ncertificate of title from this state remains perfected until the security interest would have\nbecome unperfected under the law of the other jurisdiction had the goods not become so\ncovered.\n(e) When subsection (d) security interest becomes unperfected against purchasers. A security\ninterest described in subsection (d) becomes unperfected as against a purchaser of the goods\nfor value and is deemed never to have been perfected as against a purchaser of the goods for\nvalue if the applicable requirements for perfection under Section 9-311(b) or 9-313 are not\nsatisfied before the earlier of:\n(1) the time the security interest would have become unperfected under the law of the\nother jurisdiction had the goods not become covered by a certificate of title from this\nstate; or\n(2) the expiration of four months after the goods had become so covered.\n(f) Change in jurisdiction of bank, issuer, nominated person, securities intermediary, or\ncommodity intermediary. A security interest in deposit accounts, letter-of-credit rights, or\ninvestment property which is perfected under the law of the bank\'s jurisdiction, the issuer\'s\njurisdiction, a nominated person\'s jurisdiction, the securities intermediary\'s jurisdiction, or\nthe commodity intermediary\'s jurisdiction, as applicable, remains perfected until the earlier\nof:\n(1) the time the security interest would have become unperfected under the law of that\njurisdiction; or\n(2) the expiration of four months after a change of the applicable jurisdiction to another\njurisdiction.\n\n462\n\n\x0c(g) Subsection (f) security interest perfected or unperfected under law of new jurisdiction. If\na security interest described in subsection (f) becomes perfected under the law of the other\njurisdiction before the earlier of the time or the end of the period described in that subsection,\nit remains perfected thereafter. If the security interest does not become perfected under the\nlaw of the other jurisdiction before the earlier of that time or the end of that period, it\nbecomes unperfected and is deemed never to have been perfected as against a purchaser of\nthe collateral for value.\n(h) Effect on filed financing statement of change in governing law. The following rules apply\nto collateral to which a security interest attaches within four months after the debtor changes\nits location to another jurisdiction:\n(1) A financing statement filed before the change pursuant to the law of the jurisdiction\ndesignated in Section 9-301(a) or 9-305(c) is effective to perfect a security interest in the\ncollateral if the financing statement would have been effective to perfect a security\ninterest in the collateral had the debtor not changed its location.\n(2) If a security interest perfected by a financing statement that is effective under\nparagraph (1) becomes perfected under the law of the other jurisdiction before the earlier\nof the time the financing statement would have become ineffective under the law of the\njurisdiction designated in Section 9-301(a) or 9-305(c) or the expiration of the fourmonth period, it remains perfected thereafter. If the security interest does not become\nperfected under the law of the other jurisdiction before the earlier time or event, it\nbecomes unperfected and is deemed never to have been perfected as against a purchaser\nof the collateral for value.\n(i) Effect of change in governing law on financing statement filed against original debtor. If a\nfinancing statement naming an original debtor is filed pursuant to the law of the jurisdiction\ndesignated in Section 9-301(a) or 9-305(c) and the new debtor is located in another\njurisdiction, the following rules apply:\n(1) The financing statement is effective to perfect a security interest in collateral in which\nthe new debtor has or acquires rights before or within four months after the new debtor\nbecomes bound under Section 9-203(d), if the financing statement would have been\neffective to perfect a security interest in the collateral had the collateral been acquired by\nthe original debtor.\n(2) A security interest that is perfected by the financing statement and which becomes\nperfected under the law of the other jurisdiction before the earlier of the expiration of the\nfour month period or the time the financing statement would have become ineffective\nunder the law of the jurisdiction designated in Section 9-301(a) or 9-305(c) remains\nperfected thereafter. A security interest that is perfected by the financing statement but\nwhich does not become perfected under the law of the other jurisdiction before the earlier\ntime or event becomes unperfected and is deemed never to have been perfected as against\na purchaser of the collateral for value.\nSubPart 3- PRIORITY\n463\n\n\x0cSection 9-317. Interests That Take Priority over or Take Free of Security Interest or Agricultural\nLien.\n(a) Conflicting security interests and rights of lien creditors. A security interest or agricultural\nlien is subordinate to the rights of:\n(1) a person entitled to priority under Section 9-322; and\n(2) except as otherwise provided in subsection (e), a person that becomes a lien creditor\nbefore the earlier of the time:\n(A) the security interest or agricultural lien is perfected; or\n(B) one of the conditions specified in Section 9-203(b)(3) is met and a financing\nstatement covering the collateral is filed.\n(b) Buyers that receive delivery. Except as otherwise provided in subsection (e), a buyer,\nother than a secured party, of tangible chattel paper, tangible documents, goods, instruments,\nor a certificated security takes free of a security interest or agricultural lien if the buyer gives\nvalue and receives delivery of the collateral without knowledge of the security interest or\nagricultural lien and before it is perfected.\n(c) Lessees that receive delivery. Except as otherwise provided in subsection (e), a lessee of\ngoods takes free of a security interest or agricultural lien if the lessee gives value and\nreceives delivery of the collateral without knowledge of the security interest or agricultural\nlien and before it is perfected.\n(d) Licensees and buyers of certain collateral. A licensee of a general intangible or a buyer,\nother than a secured party, of accounts, electronic chattel paper, electronic documents,\ngeneral intangibles, or investment property other than a certificated security takes free of a\nsecurity interest if the licensee or buyer gives value without knowledge of the security\ninterest and before it is perfected.\n(e) Purchase-money security interest. Except as otherwise provided in Sections 9-320 and 9321, if a person files a financing statement with respect to a purchase-money security interest\nbefore or within 20 days after the debtor receives delivery of the collateral, the security\ninterest takes priority over the rights of a buyer, lessee, or lien creditor which arise between\nthe time the security interest attaches and the time of filing. The preceding sentence does not\napply to cooperative interests.\nSection 9-318. No Interest Retained in Right to Payment That Is Sold; Rights and Title of Seller\nof Account or Chattel Paper with Respect to Creditors and Purchasers.\n(a) Seller retains no interest. A debtor that has sold an account, chattel paper, payment\nintangible, or promissory note does not retain a legal or equitable interest in the collateral\nsold.\n(b) Deemed rights of debtor if buyer\'s security interest unperfected. For purposes of\ndetermining the rights of creditors of, and purchasers for value of an account or chattel paper\nfrom, a debtor that has sold an account or chattel paper, while the buyer\'s security interest is\n464\n\n\x0cunperfected, the debtor is deemed to have rights and title to the account or chattel paper\nidentical to those the debtor sold.\nSection 9-319. Rights and Title of Consignee with Respect to Creditors and Purchasers.\n(a) Consignee has consignor\'s rights. Except as otherwise provided in subsection (b), for\npurposes of determining the rights of creditors of, and purchasers for value of goods from, a\nconsignee, while the goods are in the possession of the consignee, the consignee is deemed to\nhave rights and title to the goods identical to those the consignor had or had power to\ntransfer.\n(b) Applicability of other law. For purposes of determining the rights of a creditor of a\nconsignee, law other than this article determines the rights and title of a consignee while\ngoods are in the consignee\'s possession if, under this part, a perfected security interest held\nby the consignor would have priority over the rights of the creditor.\nSection 9-320. Buyer of Goods.\n(a) Buyer in ordinary course of business. Except as otherwise provided in subsection (e), a\nbuyer in ordinary course of business, other than a person buying farm products from a person\nengaged in farming operations, takes free of a security interest created by the buyer\'s seller,\neven if the security interest is perfected and the buyer knows of its existence.\n(b) Buyer of consumer goods. Except as otherwise provided in subsection (e), a buyer of\ngoods from a person who used or bought the goods for use primarily for personal, family, or\nhousehold purposes takes free of a security interest, even if perfected, if the buyer buys:\n(1) without knowledge of the security interest;\n(2) for value;\n(3) primarily for the buyer\'s personal, family, or household purposes; and\n(4) before the filing of a financing statement covering the goods.\n(c) Effectiveness of filing for subsection (b). To the extent that it affects the priority of a\nsecurity interest over a buyer of goods under subsection (b), the period of effectiveness of a\nfiling made in the jurisdiction in which the seller is located is governed by Section 9-316(a)\nand (b).\n(d) Buyer in ordinary course of business at wellhead or minehead. A buyer in ordinary course\nof business buying oil, gas, or other minerals at the wellhead or minehead or after extraction\ntakes free of an interest arising out of an encumbrance.\n(e) Possessory security interest not affected. Subsections (a) and (b) do not affect a security\ninterest in goods in the possession of the secured party under Section 9-313.\nSection 9-321. Licensee of General Intangible and Lessee of Goods in Ordinary Course of\nBusiness.\n465\n\n\x0c(a) "Licensee in ordinary course of business." In this section, "licensee in ordinary course of\nbusiness" means a person that becomes a licensee of a general intangible in good faith,\nwithout knowledge that the license violates the rights of another person in the general\nintangible, and in the ordinary course from a person in the business of licensing general\nintangibles of that kind. A person becomes a licensee in the ordinary course if the license to\nthe person comports with the usual or customary practices in the kind of business in which\nthe licensor is engaged or with the licensor\'s own usual or customary practices.\n(b) Rights of licensee in ordinary course of business. A licensee in ordinary course of\nbusiness takes its rights under a nonexclusive license free of a security interest in the general\nintangible created by the licensor, even if the security interest is perfected and the licensee\nknows of its existence.\n(c) Rights of lessee in ordinary course of business. A lessee in ordinary course of business\ntakes its leasehold interest free of a security interest in the goods created by the lessor, even if\nthe security interest is perfected and the lessee knows of its existence.\nSection 9-322. Priorities among Conflicting Security Interests in and Agricultural Liens on Same\nCollateral.\n(a) General priority rules. Except as otherwise provided in this section, priority among\nconflicting security interests and agricultural liens in the same collateral is determined\naccording to the following rules:\n(1) Conflicting perfected security interests and agricultural liens rank according to\npriority in time of filing or perfection. Priority dates from the earlier of the time a filing\ncovering the collateral is first made or the security interest or agricultural lien is first\nperfected, if there is no period thereafter when there is neither filing nor perfection.\n(2) A perfected security interest or agricultural lien has priority over a conflicting\nunperfected security interest or agricultural lien.\n(3) The first security interest or agricultural lien to attach or become effective has priority\nif conflicting security interests and agricultural liens are unperfected.\n(b) Time of perfection: proceeds and supporting obligations. For the purposes of subsection\n(a)(1):\n(1) the time of filing or perfection as to a security interest in collateral is also the time of\nfiling or perfection as to a security interest in proceeds; and\n(2) the time of filing or perfection as to a security interest in collateral supported by a\nsupporting obligation is also the time of filing or perfection as to a security interest in the\nsupporting obligation.\n(c) Special priority rules: proceeds and supporting obligations. Except as otherwise provided\nin subsection (f), a security interest in collateral which qualifies for priority over a conflicting\nsecurity interest under Section 9-327, 9-328, 9-329, 9-330, or 9-331 also has priority over a\nconflicting security interest in:\n(1) any supporting obligation for the collateral; and\n466\n\n\x0c(2) proceeds of the collateral if:\n(A) the security interest in proceeds is perfected;\n(B) the proceeds are cash proceeds or of the same type as the collateral; and\n(C) in the case of proceeds that are proceeds of proceeds, all intervening proceeds are\ncash proceeds, proceeds of the same type as the collateral, or an account relating to the\ncollateral.\n(d) First-to-file priority rule for certain collateral. Subject to subsection (e) and except as\notherwise provided in subsection (f), if a security interest in chattel paper, deposit accounts,\nnegotiable documents, instruments, investment property, or letter-of-credit rights is perfected\nby a method other than filing, conflicting perfected security interests in proceeds of the\ncollateral rank according to priority in time of filing.\n(e) Applicability of subsection (d). Subsection (d) applies only if the proceeds of the\ncollateral are not cash proceeds, chattel paper, negotiable documents, instruments, investment\nproperty, or letter-of-credit rights.\n(f) Limitations on subsections (a) through (e). Subsections (a) through (e) are subject to:\n(1) subsection (g) and the other provisions of this part;\n(2) Section 4-210 with respect to a security interest of a collecting bank;\n(3) Section 5-118 with respect to a security interest of an issuer or nominated person; and\n(4) Section 9-110 with respect to a security interest arising under Article 2 or 2-A.\n(g) Priority under agricultural lien statute. A perfected agricultural lien on collateral has\npriority over a conflicting security interest in or agricultural lien on the same collateral if the\nstatute creating the agricultural lien so provides.\n(h) Special priority rules: cooperative interests.\n(1) With respect to all amounts secured, a cooperative organization security interest has\npriority over all other security interests in a cooperative interest.\n(2) As to security interests in cooperative interests other than cooperative organization\nsecurity interests, Section 9-323(h) provides special rules for future advances.\nSection 9-323. Future Advances.\n(a) When priority based on time of advance. Except as otherwise provided in subsection (c),\nfor purposes of determining the priority of a perfected security interest under Section 9322(a)(1), perfection of the security interest dates from the time an advance is made to the\nextent that the security interest secures an advance that:\n(1) is made while the security interest is perfected only:\n(A) under Section 9-309 when it attaches; or\n(B) temporarily under Section 9-312(e), (f), or (g); and\n467\n\n\x0c(2) is not made pursuant to a commitment entered into before or while the security\ninterest is perfected by a method other than under Section 9-309 or 9-312(e), (f), or (g).\n(b) Lien creditor. Except as otherwise provided in subsections (c) and (h), a security interest\nis subordinate to the rights of a person that becomes a lien creditor to the extent that the\nsecurity interest secures an advance made more than 45 days after the person becomes a lien\ncreditor unless the advance is made:\n(1) without knowledge of the lien; or\n(2) pursuant to a commitment entered into without knowledge of the lien.\n(c) Buyer of receivables. Subsections (a) and (b) do not apply to a security interest held by a\nsecured party that is a buyer of accounts, chattel paper, payment intangibles, or promissory\nnotes or a consignor.\n(d) Buyer of goods. Except as otherwise provided in subsection (e), a buyer of goods other\nthan a buyer in ordinary course of business takes free of a security interest to the extent that it\nsecures advances made after the earlier of:\n(1) the time the secured party acquires knowledge of the buyer\'s purchase; or\n(2) 45 days after the purchase.\n(e) Advances made pursuant to commitment: priority of buyer of goods. Subsection (d) does\nnot apply if the advance is made pursuant to a commitment entered into without knowledge\nof the buyer\'s purchase and before the expiration of the 45 day period.\n(f) Lessee of goods. Except as otherwise provided in subsection (g), a lessee of goods, other\nthan a lessee in ordinary course of business, takes the leasehold interest free of a security\ninterest to the extent that it secures advances made after the earlier of:\n(1) the time the secured party acquires knowledge of the lease; or\n(2) 45 days after the lease contract becomes enforceable.\n(g) Advances made pursuant to commitment: priority of lessee of goods. Subsection (f) does\nnot apply if the advance is made pursuant to a commitment entered into without knowledge\nof the lease and before the expiration of the 45 day period. (h) Priority with respect to\ncooperative interests. The following rules apply for purposes of determining under Section 9322(a)(1) the priority of a perfected security interest in a cooperative interest:\n(1) Perfection of the security interest with respect to a future advance dates from the time\nof the filing under Section 9-310(d) if all of the following are true:\n(A) The security agreement states the maximum amount to be advanced pursuant to\ncommitment;\n(B) The future advance is made pursuant to that commitment;\n(C) The future advance plus the outstanding sum of any prior advances is not more than\nthe stated maximum amount; and\n(D) The filed financing statement includes a cooperative addendum disclosing that the\nsecurity agreement contains a commitment to make future advances.\n468\n\n\x0c(2) Except as provided in paragraph (1), perfection of the security interest with respect to\na future advance dates from the time the advance is made.\n(3) For purposes of paragraph (1), no amendment of a security agreement shall adversely\naffect the priority of any other security interest in the same cooperative interest that was\nperfected prior to the amendment.\n(4) This subsection applies only to advances made subsequent to an initial advance.\nSection 9-324. Priority of Purchase-money Security Interests.\n(a) General rule: purchase-money priority. Except as otherwise provided in subsection (g), a\nperfected purchase-money security interest in goods other than inventory or livestock has\npriority over a conflicting security interest in the same goods, and, except as otherwise\nprovided in Section 9-327, a perfected security interest in its identifiable proceeds also has\npriority, if the purchase-money security interest is perfected when the debtor receives\npossession of the collateral or within 20 days thereafter.\n(b) Inventory purchase-money priority. Subject to subsection (c) and except as otherwise\nprovided in subsection (g), a perfected purchase-money security interest in inventory has\npriority over a conflicting security interest in the same inventory, has priority over a\nconflicting security interest in chattel paper or an instrument constituting proceeds of the\ninventory and in proceeds of the chattel paper, if so provided in Section 9-330, and, except as\notherwise provided in Section 9-327, also has priority in identifiable cash proceeds of the\ninventory to the extent the identifiable cash proceeds are received on or before the delivery of\nthe inventory to a buyer, if:\n(1) the purchase-money security interest is perfected when the debtor receives possession\nof the inventory;\n(2) the purchase-money secured party sends an authenticated notification to the holder of\nthe conflicting security interest;\n(3) the holder of the conflicting security interest receives the notification within five\nyears before the debtor receives possession of the inventory; and\n(4) the notification states that the person sending the notification has or expects to acquire\na purchase-money security interest in inventory of the debtor and describes the inventory.\n(c) Holders of conflicting inventory security interests to be notified. Subsections (b)(2)\nthrough (4) apply only if the holder of the conflicting security interest had filed a financing\nstatement covering the same types of inventory:\n(1) if the purchase-money security interest is perfected by filing, before the date of the\nfiling; or\n(2) if the purchase-money security interest is temporarily perfected without filing or\npossession under Section 9-312(f), before the beginning of the 20-day period thereunder.\n(d) Livestock purchase-money priority. Subject to subsection (e) and except as otherwise\nprovided in subsection (g), a perfected purchase-money security interest in livestock that are\n469\n\n\x0cfarm products has priority over a conflicting security interest in the same livestock, and,\nexcept as otherwise provided in Section 9-327, a perfected security interest in their\nidentifiable proceeds and identifiable products in their unmanufactured states also has\npriority, if:\n(1) the purchase-money security interest is perfected when the debtor receives possession\nof the livestock;\n(2) the purchase-money secured party sends an authenticated notification to the holder of\nthe conflicting security interest;\n(3) the holder of the conflicting security interest receives the notification within six\nmonths before the debtor receives possession of the livestock; and\n(4) the notification states that the person sending the notification has or expects to acquire\na purchase-money security interest in livestock of the debtor and describes the livestock.\n(e) Holders of conflicting livestock security interests to be notified. Subsections (d)(2)\nthrough (4) apply only if the holder of the conflicting security interest had filed a financing\nstatement covering the same types of livestock:\n(1) if the purchase-money security interest is perfected by filing, before the date of the\nfiling; or\n(2) if the purchase-money security interest is temporarily perfected without filing or\npossession under Section 9-312(f), before the beginning of the 20-day period thereunder.\n(f) Software purchase-money priority. Except as otherwise provided in subsection (g), a\nperfected purchase-money security interest in software has priority over a conflicting security\ninterest in the same collateral, and, except as otherwise provided in Section 9-327, a\nperfected security interest in its identifiable proceeds also has priority, to the extent that the\npurchase-money security interest in the goods in which the software was acquired for use has\npriority in the goods and proceeds of the goods under this section.\n(g) Conflicting purchase-money security interests. If more than one security interest qualifies\nfor priority in the same collateral under subsection (a), (b), (d), or (f):\n(1) a security interest securing an obligation incurred as all or part of the price of the\ncollateral has priority over a security interest securing an obligation incurred for value\ngiven to enable the debtor to acquire rights in or the use of collateral; and\n(2) in all other cases, Section 9-322(a) applies to the qualifying security interests.\nSection 9-325. Priority of Security Interests in Transferred Collateral.\n(a) Subordination of security interest in transferred collateral. Except as otherwise provided\nin subsection (b), a security interest created by a debtor is subordinate to a security interest in\nthe same collateral created by another person if:\n(1) the debtor acquired the collateral subject to the security interest created by the other\nperson;\n470\n\n\x0c(2) the security interest created by the other person was perfected when the debtor\nacquired the collateral; and\n(3) there is no period thereafter when the security interest is unperfected.\n(b) Limitation of subsection (a) subordination. Subsection (a) subordinates a security interest\nonly if the security interest:\n(1) otherwise would have priority solely under Section 9-322(a) or 9-324; or\n(2) arose solely under Section 2-711(3) or 2-A-508(5).\nSection 9-326. Priority of Security Interests Created by New Debtor.\n(a) Subordination of security interest created by new debtor. Subject to subsection (b), a\nsecurity interest that is created by a new debtor in collateral in which the new debtor has or\nacquires rights and is perfected solely by a filed financing statement that would be ineffective\nto perfect the security interest but for the application of Section 9-316(i)(1) or 9-508 is\nsubordinate to a security interest in the same collateral which is perfected other than by such\na filed financing statement.\n(b) Priority under other provisions; multiple original debtors. The other provisions of this part\ndetermine the priority among conflicting security interests in the same collateral perfected by\nfiled financing statements described in subsection (a). However, if the security agreements to\nwhich a new debtor became bound as debtor were not entered into by the same original\ndebtor, the conflicting security interests rank according to priority in time of the new debtor\'s\nhaving become bound.\nSection 9-327. Priority of Security Interests in Deposit Account.\nThe following rules govern priority among conflicting security interests in the same deposit\naccount:\n(a) A security interest held by a secured party having control of the deposit account under\nSection 9-104 has priority over a conflicting security interest held by a secured party that\ndoes not have control.\n(b) Except as otherwise provided in subsections (c) and (d), security interests perfected\nby control under Section 9-314 rank according to priority in time of obtaining control.\n(c) Except as otherwise provided in subsection (d), a security interest held by the bank\nwith which the deposit account is maintained has priority over a conflicting security\ninterest held by another secured party.\n(d) A security interest perfected by control under Section 9-104(a)(3) has priority over a\nsecurity interest held by the bank with which the deposit account is maintained.\nSection 9-328. Priority of Security Interests in Investment Property.\n471\n\n\x0cThe following rules govern priority among conflicting security interests in the same\ninvestment property:\n(a) A security interest held by a secured party having control of investment property\nunder Section 9-106 has priority over a security interest held by a secured party that does\nnot have control of the investment property.\n(b) Except as otherwise provided in paragraphs (c) and (d), conflicting security interests\nheld by secured parties each of which has control under Section 9-106 rank according to\npriority in time of:\n(1) if the collateral is a security, obtaining control;\n(2) if the collateral is a security entitlement carried in a securities account and:\n(A) if the secured party obtained control under Section 8-106 (d) (1), the secured\nparty\'s becoming the person for which the securities account is maintained;\n(B) if the secured party obtained control under Section 8-106 (d) (2), the securities\nintermediary\'s agreement to comply with the secured party\'s entitlement orders\nwith respect to security entitlements carried or to be carried in the securities\naccount; or\n(C) if the secured party obtained control through another person under Section 8106 (d) (3), the time on which priority would be based under this paragraph if the\nother person were the secured party; or\n(3) if the collateral is a commodity contract carried with a commodity intermediary, the\nsatisfaction of the requirement for control specified in Section 9-106 (b) (2) with\nrespect to commodity contracts carried or to be carried with the commodity\nintermediary.\n(c) A security interest held by a securities intermediary in a security entitlement or a\nsecurities account maintained with the securities intermediary has priority over a\nconflicting security interest held by another secured party.\n(d) A security interest held by a commodity intermediary in a commodity contract or a\ncommodity account maintained with the commodity intermediary has priority over a\nconflicting security interest held by another secured party.\n(e) A security interest in a certificated security in registered form which is perfected by\ntaking delivery under Section 9-313 (a) and not by control under Section 9-314 has\npriority over a conflicting security interest perfected by a method other than control.\n(f) Conflicting security interests created by a broker, securities intermediary, or\ncommodity intermediary which are perfected without control under Section 9-106 rank\nequally.\n(g) In all other cases, priority among conflicting security interests in investment property\nis governed by Sections 9-322 and 9-323.\n(h) Subsections (a) through (g) do not apply to cooperative interests.\n472\n\n\x0cSection 9-329. Priority of Security Interests in Letter-of-credit Right.\nThe following rules govern priority among conflicting security interests in the same letter-ofcredit right:\n(a) A security interest held by a secured party having control of the letter-of-credit right\nunder Section 9-107 has priority to the extent of its control over a conflicting security\ninterest held by a secured party that does not have control.\n(b) Security interests perfected by control under Section 9-314 rank according to priority\nin time of obtaining control.\nSection 9-330. Priority of Purchaser of Chattel Paper or Instrument.\n(a) Purchaser\'s priority: security interest claimed merely as proceeds. A purchaser of chattel\npaper has priority over a security interest in the chattel paper which is claimed merely as\nproceeds of inventory subject to a security interest if:\n(1) in good faith and in the ordinary course of the purchaser\'s business, the purchaser\ngives new value and takes possession of the chattel paper or obtains control of the chattel\npaper under Section 9-105; and\n(2) the chattel paper does not indicate that it has been assigned to an identified assignee\nother than the purchaser.\n(b) Purchaser\'s priority: other security interests. A purchaser of chattel paper has priority over\na security interest in the chattel paper which is claimed other than merely as proceeds of\ninventory subject to a security interest if the purchaser gives new value and takes possession\nof the chattel paper or obtains control of the chattel paper under Section 9-105 in good faith,\nin the ordinary course of the purchaser\'s business, and without knowledge that the purchase\nviolates the rights of the secured party.\n(c) Chattel paper purchaser\'s priority in proceeds. Except as otherwise provided in Section 9327, a purchaser having priority in chattel paper under subsection (a) or (b) also has priority\nin proceeds of the chattel paper to the extent that:\n(1) Section 9-322 provides for priority in the proceeds; or\n(2) the proceeds consist of the specific goods covered by the chattel paper or cash\nproceeds of the specific goods, even if the purchaser\'s security interest in the proceeds is\nunperfected.\n(d) Instrument purchaser\'s priority. Except as otherwise provided in Section 9-331(a), a\npurchaser of an instrument has priority over a security interest in the instrument perfected by\na method other than possession if the purchaser gives value and takes possession of the\ninstrument in good faith and without knowledge that the purchase violates the rights of the\nsecured party.\n(e) Holder of purchase-money security interest gives new value. For purposes of subsections\n(a) and (b), the holder of a purchase-money security interest in inventory gives new value for\nchattel paper constituting proceeds of the inventory.\n473\n\n\x0c(f) Indication of assignment gives knowledge. For purposes of subsections (b) and (d), if\nchattel paper or an instrument indicates that it has been assigned to an identified secured\nparty other than the purchaser, a purchaser of the chattel paper or instrument has knowledge\nthat the purchase violates the rights of the secured party.\nSection 9-331. Priority of Rights of Purchasers of Instruments, Documents, and Securities under\nOther Articles; Priority of Interests in Financial Assets and Security Entitlements under Article 8.\n(a) Rights under Articles 3, 7, and 8 not limited. This article does not limit the rights of a\nholder in due course of a negotiable instrument, a holder to which a negotiable document of\ntitle has been duly negotiated, or a protected purchaser of a security. These holders or\npurchasers take priority over an earlier security interest, even if perfected, to the extent\nprovided in Articles 3, 7, and 8.\n(b) Protection under Article 8. This article does not limit the rights of or impose liability on a\nperson to the extent that the person is protected against the assertion of a claim under Article\n8.\n(c) Filing not notice. Filing under this article does not constitute notice of a claim or defense\nto the holders, or purchasers, or persons described in subsections (a) and (b).\n(d) Section not applicable to cooperative interests. Subsections (a), (b), and (c) do not apply\nto cooperative interests.\nSection 9-332. Transfer of Money; Transfer of Funds from Deposit Account.\n(a) Transferee of money. A transferee of money takes the money free of a security interest\nunless the transferee acts in collusion with the debtor in violating the rights of the secured\nparty.\n(b) Transferee of funds from deposit account. A transferee of funds from a deposit account\ntakes the funds free of a security interest in the deposit account unless the transferee acts in\ncollusion with the debtor in violating the rights of the secured party.\nSection 9-333. Priority of Certain Liens Arising by Operation of Law.\n(a) "Possessory lien." In this section, "possessory lien" means an interest, other than a\nsecurity interest or an agricultural lien:\n(1) which secures payment or performance of an obligation for services or materials\nfurnished with respect to goods by a person in the ordinary course of the person\'s\nbusiness;\n(2) which is created by statute or rule of law in favor of the person; and\n(3) whose effectiveness depends on the person\'s possession of the goods.\n(b) Priority of possessory lien. A possessory lien on goods has priority over a security interest\nin the goods unless the lien is created by a statute that expressly provides otherwise.\n474\n\n\x0cSection 9-334. Priority of Security Interests in Fixtures and Crops.\n(a) Security interest in fixtures under this article. A security interest under this article may be\ncreated in goods that are fixtures or may continue in goods that become fixtures. A security\ninterest does not exist under this article in ordinary building materials incorporated into an\nimprovement on land.\n(b) Security interest in fixtures under real property law. This article does not prevent creation\nof an encumbrance upon fixtures under real property law.\n(c) General rule: subordination of security interest in fixtures. In cases not governed by\nsubsections (d) through (h), a security interest in fixtures is subordinate to a conflicting\ninterest of an encumbrancer or owner of the related real property other than the debtor.\n(d) Fixtures purchase-money priority. Except as otherwise provided in subsection (h), a\nperfected security interest in fixtures has priority over a conflicting interest of an\nencumbrancer or owner of the real property if the debtor has an interest of record in or is in\npossession of the real property and:\n(1) the security interest is a purchase-money security interest;\n(2) the interest of the encumbrancer or owner arises before the goods become fixtures;\nand\n(3) the security interest is perfected by a fixture filing before the goods become fixtures\nor within 20 days thereafter.\n(e) Priority of security interest in fixtures over interests in real property. A perfected security\ninterest in fixtures has priority over a conflicting interest of an encumbrancer or owner of the\nreal property if:\n(1) the debtor has an interest of record in the real property or is in possession of the real\nproperty and the security interest:\n(A) is perfected by a fixture filing before the interest of the encumbrancer or owner is\nof record; and\n(B) has priority over any conflicting interest of a predecessor in title of the\nencumbrancer or owner;\n(2) before the goods become fixtures, the security interest is perfected by any method\npermitted by this article and the fixtures are readily removable:\n(A) factory or office machines;\n(B) equipment that is not primarily used or leased for use in the operation of the real\nproperty; or\n(C) replacements of domestic appliances that are consumer goods;\n(3) the conflicting interest is a lien on the real property obtained by legal or equitable\nproceedings after the security interest was perfected by any method permitted by this\narticle; or\n475\n\n\x0c(4) the security interest is:\n(A) created in a manufactured home in a manufactured-home transaction; and\n(B) perfected pursuant to a statute described in Section 9-311(a)(2).\n(f) Priority based on consent, disclaimer, or right to remove. A security interest in fixtures,\nwhether or not perfected, has priority over a conflicting interest of an encumbrancer or owner\nof the real property if:\n(1) the encumbrancer or owner has, in an authenticated record, consented to the security\ninterest or disclaimed an interest in the goods as fixtures; or\n(2) the debtor has a right to remove the goods as against the encumbrancer or owner.\n(g) Continuation of paragraph (f)(2) priority. The priority of the security interest under\nparagraph (f)(2) continues for a reasonable time if the debtor\'s right to remove the goods as\nagainst the encumbrancer or owner terminates.\n(h) Priority of construction mortgage. A mortgage is a construction mortgage to the extent\nthat it secures an obligation incurred for the construction of an improvement on land,\nincluding the acquisition cost of the land, if a recorded record of the mortgage so indicates.\nExcept as otherwise provided in subsections (e) and (f), a security interest in fixtures is\nsubordinate to a construction mortgage if a record of the mortgage is recorded before the\ngoods become fixtures and the goods become fixtures before the completion of the\nconstruction. A mortgage has this priority to the same extent as a construction mortgage to\nthe extent that it is given to refinance a construction mortgage.\n(i) Priority of security interest in crops. A perfected security interest in crops growing on real\nproperty has priority over a conflicting interest of an encumbrancer or owner of the real\nproperty if the debtor has an interest of record in or is in possession of the real property.\n(j) Subsection (i) prevails. Subsection (i) prevails over any inconsistent provisions with this\narticle or any other chapter of law.\nSection 9-335. Accessions.\n(a) Creation of security interest in accession. A security interest may be created in an\naccession and continues in collateral that becomes an accession.\n(b) Perfection of security interest. If a security interest is perfected when the collateral\nbecomes an accession, the security interest remains perfected in the collateral.\n(c) Priority of security interest. Except as otherwise provided in subsection (d), the other\nprovisions of this part determine the priority of a security interest in an accession.\n(d) Compliance with certificate-of-title statute. A security interest in an accession is\nsubordinate to a security interest in the whole which is perfected by compliance with the\nrequirements of a certificate-of-title statute under Section 9-311 (b).\n(e) Removal of accession after default. After default, subject to Part 6, a secured party may\nremove an accession from other goods if the security interest in the accession has priority\nover the claims of every person having an interest in the whole.\n476\n\n\x0c(f) Reimbursement following removal. A secured party that removes an accession from other\ngoods under subsection (e) shall promptly reimburse any holder of a security interest or other\nlien on, or owner of, the whole or of the other goods, other than the debtor, for the cost of\nrepair of any physical injury to the whole or the other goods. The secured party need not\nreimburse the holder or owner for any diminution in value of the whole or the other goods\ncaused by the absence of the accession removed or by any necessity for replacing it. A\nperson entitled to reimbursement may refuse permission to remove until the secured party\ngives adequate assurance for the performance of the obligation to reimburse.\nSection 9-336. Commingled Goods.\n(a) "Commingled goods." In this section, "commingled goods" means goods that are\nphysically united with other goods in such a manner that their identity is lost in a product or\nmass.\n(b) No security interest in commingled goods as such. A security interest does not exist in\ncommingled goods as such. However, a security interest may attach to a product or mass that\nresults when goods become commingled goods.\n(c) Attachment of security interest to product or mass. If collateral becomes commingled\ngoods, a security interest attaches to the product or mass.\n(d) Perfection of security interest. If a security interest in collateral is perfected before the\ncollateral becomes commingled goods, the security interest that attaches to the product or\nmass under subsection (c) is perfected.\n(e) Priority of security interest Except as otherwise provided in subsection (f), the other\nprovisions of this part determine the priority of a security interest that attaches to the product\nor mass under subsection (c).\n(f) Conflicting security interests in product or mass If more than one security interest attaches\nto the product or mass under subsection (c), the following rules determine priority:\n(1) A security interest that is perfected under subsection (d) has priority over a security\ninterest that is unperfected at the time the collateral becomes commingled goods.\n(2) If more than one security interest is perfected under subsection (d), the security\ninterests rank equally in proportion to the value of the collateral at the time it became\ncommingled goods.\nSection 9-337. Priority of Security Interests in Goods Covered by Certificate of Title.\nIf, while a security interest in goods is perfected by any method under the law of another\njurisdiction, this state issues a certificate of title that does not show that the goods are subject\nto the security interest or contain a statement that they may be subject to security interests not\nshown on the certificate:\n\n477\n\n\x0c(a) a buyer of the goods, other than a person in the business of selling goods of that kind,\ntakes free of the security interest if the buyer gives value and receives delivery of the\ngoods after issuance of the certificate and without knowledge of the security interest; and\n(b) the security interest is subordinate to a conflicting security interest in the goods that\nattaches, and is perfected under Section 9-311 (b), after issuance of the certificate and\nwithout the conflicting secured party\'s knowledge of the security interest.\nSection 9-338. Priority of Security Interest or Agricultural Lien Perfected by Filed Financing\nStatement Providing Certain Incorrect Information.\nIf a security interest or agricultural lien is perfected by a filed financing statement providing\ninformation described in Section 9-516(b)(5) which is incorrect at the time the financing\nstatement is filed:\n(1) the security interest or agricultural lien is subordinate to a conflicting perfected\nsecurity interest in the collateral to the extent that the holder of the conflicting security\ninterest gives value in reasonable reliance upon the incorrect information; and\n(2) a purchaser, other than a secured party, of the collateral takes free of the security\ninterest or agricultural lien to the extent that, in reasonable reliance upon the incorrect\ninformation, the purchaser gives value and, in the case of tangible chattel paper, tangible\ndocuments, goods, instruments, or a security certificate, receives delivery of the\ncollateral.\nSection 9-339. Priority Subject to Subordination.\nThis article does not preclude subordination by agreement by a person entitled to priority.\nSubPart 4- RIGHTS OF BANK\nSection 9-340. Effectiveness of Right of Recoupment or Set-off Against Deposit Account.\n(a) Exercise of recoupment or set-off. Except as otherwise provided in subsection (c), a bank\nwith which a deposit account is maintained may exercise any right of recoupment or set-off\nagainst a secured party that holds a security interest in the deposit account.\n(b) Recoupment or set-off not affected by security interest. Except as otherwise provided in\nsubsection (c), the application of this article to a security interest in a deposit account does\nnot affect a right of recoupment or set-off of the secured party as to a deposit account\nmaintained with the secured party.\n(c) When set-off ineffective. The exercise by a bank of a set-off against a deposit account is\nineffective against a secured party that holds a security interest in the deposit account which\nis perfected by control under Section 9-104(a)(3), if the set-off is based on a claim against the\ndebtor.\n478\n\n\x0cSection 9-341. Bank\'s Rights and Duties with Respect to Deposit Account.\nExcept as otherwise provided in Section 9-340 (c), and unless the bank otherwise agrees in\nan authenticated record, a bank\'s rights and duties with respect to a deposit account\nmaintained with the bank are not terminated, suspended, or modified by:\n(a) the creation, attachment, or perfection of a security interest in the deposit account;\n(b) the bank\'s knowledge of the security interest; or\n(c) the bank\'s receipt of instructions from the secured party.\nSection 9-342. Bank\'s Right to Refuse to Enter into or Disclose Existence of Control Agreement.\nThis article does not require a bank to enter into an agreement of the kind described in\nSection 9-104(a)(2), even if its customer so requests or directs. A bank that has entered into\nsuch an agreement is not required to confirm the existence of the agreement to another\nperson unless requested to do so by its customer.\nPart 4 - RIGHTS OF THIRD PARTIES\nSection 9-401. Alienability of Debtor\'s Rights.\n(a) Other law governs alienability; exceptions. Except as otherwise provided in subsection\n(b) and Sections 9-406, 9-407, 9-408, and 9-409, whether a debtor\'s rights in collateral may\nbe voluntarily or involuntarily transferred is governed by law other than this article.\n(b) Agreement does not prevent transfer. An agreement between the debtor and secured party\nwhich prohibits a transfer of the debtor\'s rights in collateral or makes the transfer a default\ndoes not prevent the transfer from taking effect.\nSection 9-402. Secured Party Not Obligated on Contract of Debtor or in Tort.\nThe existence of a security interest, agricultural lien, or authority given to a debtor to dispose\nof or use collateral, without more, does not subject a secured party to liability in contract or\ntort for the debtor\'s acts or omissions.\nSection 9-403. Agreement Not to Assert Defenses Against Assignee.\n(a) "Value." In this section, "value" has the meaning provided in Section 3-303. In this\nsection the meaning of "obligor" is not limited to the meaning given it in Section 9102(a)(59). In this section the term "person entitled to enforce the instrument" means (i) the\nholder of the instrument, (ii) a nonholder in possession of the instrument who has the rights\nof a holder, or (iii) a person not in possession of the instrument who is entitled to enforce the\ninstrument pursuant to Article 3 of this chapter. A person may be a person entitled to enforce\n479\n\n\x0cthe instrument even though the person is not the owner of the instrument or is in wrongful\npossession of the instrument.\n(b) Agreement not to assert claim or defense. Except as otherwise provided in this section, an\nagreement between an account debtor and an assignor not to assert against an assignee any\nclaim or defense that the account debtor may have against the assignor is enforceable by an\nassignee that takes an assignment:\n(1) for value;\n(2) in good faith;\n(3) without notice of a claim of a property or possessory right to the property assigned;\nand\n(4) without notice of:\n(A) a defense of the obligor based on (i) infancy of the obligor to the extent it is a\ndefense to a simple contract, (ii) duress, lack of legal capacity, or illegality of the\ntransaction which, under other law, nullifies the obligation of the obligor, (iii) fraud that\ninduced the obligor to sign the instrument with neither knowledge nor reasonable\nopportunity to learn of its character or its essential terms, or (iv) discharge of the\nobligor in solving proceedings;\n(B) a defense of the obligor stated anywhere in Article 3 of this chapter or a defense of\nthe obligor that would be available if the person entitled to enforce the instrument were\nenforcing a right to payment under a simple contract; and\n(C) a claim in recoupment of the obligor against the assignor if the claim arose from the\ntransaction that gave rise to the assigned obligation, but the claim of the obligor may be\nasserted against an assignee only to reduce the amount owing on the assigned\nobligation at the time the action is brought.\n(c) When subsection (b) not applicable. An assignee takes subject to the defenses listed in\nparagraph (b)(4)(A), but is not subject to defenses of the obligor stated in paragraph (b)(4)(B)\nor claims in recoupment stated in paragraph (b)(4)(C) against a person other than the\nenforcing assignee.\n(d) Omission of required statement in consumer transaction. In a consumer transaction, if a\nrecord evidences the account debtor\'s obligation, law other than this article requires that the\nrecord include a statement to the effect that the rights of an assignee are subject to claims or\ndefenses that the account debtor could assert against the original obligee, and the record does\nnot include such a statement:\n(1) the record has the same effect as if the record included such a statement; and\n(2) the account debtor may assert against an assignee those claims and defenses that\nwould have been available if the record included such a statement.\n(e) Rule for individual under other law. This section is subject to law other than this article\nwhich establishes a different rule for an account debtor who is an individual and who\nincurred the obligation primarily for personal, family, or household purposes.\n480\n\n\x0c(f) Other law not displaced. Except as otherwise provided in subsection (d), this section does\nnot displace law other than this article which gives effect to an agreement by an account\ndebtor not to assert a claim or defense against an assignee.\nSection 9-404. Rights Acquired by Assignee; Claims and Defenses Against Assignee.\n(a) Assignee\'s rights subject to terms, claims, and defenses; exceptions. Unless an account\ndebtor has made an enforceable agreement not to assert defenses or claims, and subject to\nsubsections (b) through (e), the rights of an assignee are subject to:\n(1) all terms of the agreement between the account debtor and assignor and any defense\nor claim in recoupment arising from the transaction that gave rise to the contract; and (2)\nany other defense or claim of the account debtor against the assignor which accrues\nbefore the account debtor receives a notification of the assignment authenticated by the\nassignor or the assignee.\n(b) Account debtor\'s claim reduces amount owed to assignee. Subject to subsection (c) and\nexcept as otherwise provided in subsection (d), the claim of an account debtor against an\nassignor may be asserted against an assignee under subsection (a) only to reduce the amount\nthe account debtor owes.\n(c) Rule for individual under other law. This section is subject to law other than this article\nwhich establishes a different rule for an account debtor who is an individual and who\nincurred the obligation primarily for personal, family, or household purposes.\n(d) Omission of required statement in consumer transaction. In a consumer transaction, if a\nrecord evidences the account debtor\'s obligation, law other than this article requires that the\nrecord include a statement to the effect that the account debtor\'s recovery against an assignee\nwith respect to claims and defenses against the assignor may not exceed amounts paid by the\naccount debtor under the record, and the record does not include such a statement, the extent\nto which a claim of an account debtor against the assignor may be asserted against an\nassignee is determined as if the record included such a statement. (e) Inapplicability to\nhealth-care-insurance receivable. This section does not apply to an assignment of a healthcare-insurance receivable.\nSection 9-405. Modification of Assigned Contract.\n(a) Effect of modification on assignee. A modification of or substitution for an assigned\ncontract is effective against an assignee if made in good faith. The assignee acquires\ncorresponding rights under the modified or substituted contract. The assignment may provide\nthat the modification or substitution is a breach of contract by the assignor. This subsection is\nsubject to subsections (b) through (d).\n(b) Applicability of subsection (a). Subsection (a) applies to the extent that:\n(1) the right to payment or a part thereof under an assigned contract has not been fully\nearned by performance; or\n481\n\n\x0c(2) the right to payment or a part thereof has been fully earned by performance and the\naccount debtor has not received notification of the assignment under Section 9-406(a).\n(c) Rule for individual under other law. This section is subject to law other than this article\nwhich establishes a different rule for an account debtor who is an individual and who\nincurred the obligation primarily for personal, family, or household purposes.\n(d) Inapplicability to health-care-insurance receivable. This section does not apply to an\nassignment of a health-care-insurance receivable.\nSection 9-406. Discharge of Account Debtor; Notification of Assignment; Identification and\nProof of Assignment; Restrictions on Assignment of Accounts, Chattel Paper, Payment\nIntangibles, and Promissory Notes Ineffective.\n(a) Discharge of account debtor; effect of notification. Subject to subsections (b) through (h),\nan account debtor on an account, chattel paper, or a payment intangible may discharge its\nobligation by paying the assignor until, but not after, the account debtor receives a\nnotification, authenticated by the assignor or the assignee, that the amount due or to become\ndue has been assigned and that payment is to be made to the assignee. After receipt of the\nnotification, the account debtor may discharge its obligation by paying the assignee and may\nnot discharge the obligation by paying the assignor.\n(b) When notification ineffective. Subject to subsection (g), notification is ineffective under\nsubsection (a):\n(1) if it does not reasonably identify the rights assigned;\n(2) to the extent that an agreement between an account debtor and a seller of a payment\nintangible limits the account debtor\'s duty to pay a person other than the seller and the\nlimitation is effective under law other than this article; or\n(3) at the option of an account debtor, if the notification notifies the account debtor to\nmake less than the full amount of any installment or other periodic payment to the\nassignee, even if:\n(A) only a portion of the account, chattel paper, or payment intangible has been\nassigned to that assignee; (B) a portion has been assigned to another assignee; or\n(C) the account debtor knows that the assignment to that assignee is limited.\n(c) Proof of assignment. Subject to subsection (g), if requested by the account debtor, an\nassignee shall seasonably furnish reasonable proof that the assignment has been made.\nUnless the assignee complies, the account debtor may discharge its obligation by paying the\nassignor, even if the account debtor has received a notification under subsection (a).\n(d) Term restricting assignment generally ineffective. Except as otherwise provided in\nsubsection (e) and Sections 2-A-303 and 9-407, and subject to subsection (g), a term in an\nagreement between an account debtor and an assignor or in a promissory note is ineffective\nto the extent that it:\n\n482\n\n\x0c(1) prohibits, restricts, or requires the consent of the account debtor or person obligated\non the promissory note to the assignment or transfer of, or the creation, attachment,\nperfection, or enforcement of a security interest in, the account, chattel paper, payment\nintangible, or promissory note; or\n(2) provides that the assignment or transfer or the creation, attachment, perfection, or\nenforcement of the security interest may give rise to a default, breach, right of\nrecoupment, claim, defense, termination, right of termination, or remedy under the\naccount, chattel paper, payment intangible, or promissory note.\n(e) Inapplicability of subsection (d) to certain sales. Subsection (d) does not apply to the sale\nof a payment intangible or promissory note.\n(f) Subsection (b)(3) not waivable. Subject to subsection (g), an account debtor may not\nwaive or vary its option under subsection (b)(3).\n(g) Rule for individual under other law. This section is subject to a rule of law, statute, rule or\nregulation other than this article which establishes a different rule for an account debtor who\nis an individual and who incurred the obligation primarily for personal, family, or household\npurposes.\n(h) Inapplicability. This section does not apply to:\n(1) an assignment of a health care insurance receivable to the extent such assignment\nconflicts with other law or the parties have otherwise agreed in writing that such\nreceivable is non-assignable,\n(2) a claim or right to receive compensation for injuries or sickness as described in 26\nU.S.C. \xc2\xa7 104(a)(1) and (2), as amended from time to time, or\n(3) a claim or right to receive benefits under a special needs trust as described in 42\nU.S.C. \xc2\xa7 1396p (d)(4), as amended from time to time.\nSection 9-407. Restrictions on Creation or Enforcement of Security Interest in Leasehold Interest\nor in Lessor\'s Residual Interest.\n(a) Term restricting assignment generally ineffective. Except as otherwise provided in\nsubsection (b), a term in a lease agreement is ineffective to the extent that it:\n(1) prohibits, restricts, or requires the consent of a party to the lease to the assignment or\ntransfer of, or the creation, attachment, perfection, or enforcement of a security interest\nin, an interest of a party under the lease contract or in the lessor\'s residual interest in the\ngoods; or\n(2) provides that the assignment or transfer or the creation, attachment, perfection, or\nenforcement of the security interest may give rise to a default, breach, right of\nrecoupment, claim, defense, termination, right of termination, or remedy under the lease.\n(b) Effectiveness of certain terms. Except as otherwise provided in Section 2-A-303(7), a\nterm described in subsection (a)(2) is effective to the extent that there is:\n483\n\n\x0c(1) a transfer by the lessee of the lessee\'s right of possession or use of the goods in\nviolation of the term; or\n(2) a delegation of a material performance of either party to the lease contract in violation\nof the term.\n(c) Security interest not material impairment. The creation, attachment, perfection, or\nenforcement of a security interest in the lessor\'s interest under the lease contract or the\nlessor\'s residual interest in the goods is not a transfer that materially impairs the lessee\'s\nprospect of obtaining return performance or materially changes the duty of or materially\nincreases the burden or risk imposed on the lessee within the purview of Section 2-A-303(4)\nunless, and then only to the extent that, enforcement actually results in a delegation of\nmaterial performance of the lessor.\nSection 9-408. Restrictions on Assignment of Promissory Notes, Health-care-insurance\nReceivables, and Certain General Intangibles Ineffective.\n(a) Term restricting assignment generally ineffective. Except as otherwise provided in\nsubsection (b), a term in a promissory note or in an agreement between an account debtor and\na debtor which relates to a health-care-insurance receivable or a general intangible, including\na contract, permit, license, or franchise, and which term prohibits, restricts, or requires the\nconsent of the person obligated on the promissory note or the account debtor to, the\nassignment or transfer of, or creation, attachment, or perfection of a security interest in, the\npromissory note, health-care-insurance receivable, or general intangible, is ineffective to the\nextent that the term:\n(1) would impair the creation, attachment, or perfection of a security interest; or\n(2) provides that the assignment or transfer or the creation, attachment, or perfection of\nthe security interest may give rise to a default, breach, right of recoupment, claim,\ndefense, termination, right of termination, or remedy under the promissory note, healthcare-insurance receivable, or general intangible.\n(b) Applicability of subsection (a) to sales of certain rights to payment. Subsection (a) applies\nto a security interest in a payment intangible or promissory note only if the security interest\narises out of a sale of the payment intangible or promissory note.\n(c) Limitation on ineffectiveness under subsection (a). To the extent that a term in a\npromissory note or in an agreement between an account debtor and a debtor which relates to\na health-care-insurance receivable or general intangible would be effective under law other\nthan this article but is ineffective under subsection (a), the creation, attachment, or perfection\nof a security interest in the promissory note, health-care-insurance receivable, or general\nintangible:\n(1) is not enforceable against the person obligated on the promissory note or the account\ndebtor;\n(2) does not impose a duty or obligation on the person obligated on the promissory note\nor the account debtor;\n484\n\n\x0c(3) does not require the person obligated on the promissory note or the account debtor to\nrecognize the security interest, pay or render performance to the secured party, or accept\npayment or performance from the secured party;\n(4) does not entitle the secured party to use or assign the debtor\'s rights under the\npromissory note, health-care-insurance receivable, or general intangible, including any\nrelated information or materials furnished to the debtor in the transaction giving rise to\nthe promissory note, health-care-insurance receivable, or general intangible;\n(5) does not entitle the secured party to use, assign, possess, or have access to any trade\nsecrets or confidential information of the person obligated on the promissory note or the\naccount debtor; and\n(6) does not entitle the secured party to enforce the security interest in the promissory\nnote, health-care-insurance receivable, or general intangible.\n(d) Inapplicability. This section does not apply to:\n(1) a claim or right to receive compensation for injuries or sickness as described in 26\nU.S.C. \xc2\xa7 104(a)(1) and (2), as amended from time to time, or\n(2) a claim or right to receive benefits under a special needs trust as described in 42\nU.S.C. \xc2\xa7 1396p (d)(4), as amended from time to time.\nSection 9-409. Restrictions on Assignment of Letter-of-credit Rights Ineffective.\n(a) Term or law restricting assignment generally ineffective. A term in a letter-of-credit or a\nrule of law, statute, regulation, custom, or practice applicable to the letter of credit which\nprohibits, restricts, or requires the consent of an applicant, issuer, or nominated person to a\nbeneficiary\'s assignment of or creation of a security interest in a letter-of-credit right is\nineffective to the extent that the term or rule of law, statute, regulation, custom, or practice:\n(1) would impair the creation, attachment, or perfection of a security interest in the letterof-credit right; or\n(2) provides that the assignment or the creation, attachment, or perfection of the security\ninterest may give rise to a default, breach, right of recoupment, claim, defense,\ntermination, right of termination, or remedy under the letter-of-credit right.\n(b) Limitation on ineffectiveness under subsection (a). To the extent that a term in a letter-ofcredit is ineffective under subsection (a) but would be effective under law other than this\narticle or a custom or practice applicable to the letter-of-credit, to the transfer of a right to\ndraw or otherwise demand performance under the letter-of-credit, or to the assignment of a\nright to proceeds of the letter-of-credit, the creation, attachment, or perfection of a security\ninterest in the letter-of-credit right:\n(1) is not enforceable against the applicant, issuer, nominated person, or transferee\nbeneficiary;\n(2) imposes no duties or obligations on the applicant, issuer, nominated person, or\ntransferee beneficiary; and\n485\n\n\x0c(3) does not require the applicant, issuer, nominated person, or transferee beneficiary to\nrecognize the security interest, pay or render performance to the secured party, or accept\npayment or other performance from the secured party.\nPart 5- FILING\nSubPart 1 - FILING OFFICE; CONTENTS AND EFFECTIVENESS OF FINANCING\nSTATEMENT\nSection 9-501. Filing Office.\n(a) Filing offices. Except as otherwise provided in subsection (b), if the law of this state\ngoverns perfection of a security interest or agricultural lien, the office in which to file a\nfinancing statement to perfect the security interest or agricultural lien is:\n(1) the office designated for the filing or recording of a record of a mortgage on the\nrelated real property, if:\n(A) the collateral is as-extracted collateral or timber to be cut; or\n(B) the financing statement is filed as a fixture filing and the collateral is goods that are\nor are to become fixtures; or\n(C) the collateral is a cooperative interest; or\n(2) the office of the secretary of state, in all other cases, including a case in which the\ncollateral is goods that are or are to become fixtures and the financing statement is not\nfiled as a fixture filing.\n(b) Filing office for transmitting utilities. The office in which to file a financing statement to\nperfect a security interest in collateral, including fixtures, of a transmitting utility is the office\nof the secretary of state. The financing statement also constitutes a fixture filing as to the\ncollateral indicated in the financing statement which is or is to become fixtures.\n(c) The term "filing officer" or "recording officer" means the county clerk of the county,\nexcept in the counties of Bronx, Kings, New York, and Queens where it means the city\nregister in the county; and the term "filing officer" includes the secretary of state where a\nfiling is made in the department of state.\nSection 9-502. Contents of Financing Statement; Record of Mortgage as Financing Statement;\nTime of Filing Financing Statement; Contents of Cooperative Addendum.\n(a) Sufficiency of financing statement. Subject to subsection (b), a financing statement is\nsufficient only if it:\n(1) provides the name of the debtor;\n(2) provides the name of the secured party or a representative of the secured party;\n(3) indicates the collateral covered by the financing statement; and\n486\n\n\x0c(4) in the case of a cooperative interest, indicates the number or other designation and the\nstreet address of the cooperative unit.\n(b) Real-property-related financing statements. Except as otherwise provided in Section 9501(b), to be sufficient, a financing statement that covers as-extracted collateral or timber to\nbe cut, or which is filed as a fixture filing and covers goods that are or are to become fixtures,\nor, unless a cooperative addendum is filed, which covers a cooperative interest, must satisfy\nsubsection (a) and also:\n(1) indicate that it covers this type of collateral;\n(2) indicate that it is to be filed in the real property records;\n(3) provide a description of the real property to which the collateral is related, including\nthe location of the real estate by reference to a book and page number in a deed or\nmortgage index maintained in the county clerk\'s office in the county where the property\nis situate or by street and number and town or city, or, if the real estate is in the city of\nNew York, by county, except that if the real estate is in the city of New York or counties\nof Nassau or Onondaga, where the block system of recording or registering and indexing\nconveyances is in use, the statement must also specify the block and lot number in which\nthe real estate is situated; and\n(4) if the debtor does not have an interest of record in the real property, provide the name\nof a record owner.\n(c) Record of mortgage as financing statement. A record of a mortgage is effective, from the\ndate of recording, as a financing statement filed as a fixture filing or as a financing statement\ncovering as-extracted collateral or timber to be cut only if:\n(1) the record indicates the goods or accounts that it covers;\n(2) the goods are or are to become fixtures related to the real property described in the\nrecord or the collateral is related to the real property described in the record and is asextracted collateral or timber to be cut;\n(3) the record satisfies the requirements for a financing statement in this section, but: (A)\nthe record need not indicate that it is to be filed in the real property records; and (B) the\nrecord sufficiently provides the name of a debtor who is an individual if it provides the\nindividual name of the debtor or the surname and first personal name of the debtor, even\nif the debtor is an individual to whom Section 9-503(a)(4) applies; and\n(4) the record is duly recorded.\n(d) Filing before security agreement or attachment. A financing statement may be filed\nbefore a security agreement is made or a security interest otherwise attaches. (e) Contents of\ncooperative addendum. A cooperative addendum is sufficient only if it satisfies subsection\n(a) and also:\n(1) if not filed simultaneously with the initial financing statement, identifies, by its file\nnumber, the initial financing statement to which the addendum relates;\n(2) indicates the street address of the cooperative unit;\n487\n\n\x0c(3) indicates the county in which the cooperative unit is located;\n(4) indicates the city, town, or village in which the cooperative unit is located;\n(5) indicates the real property tax designation associated with the real property in which\nthe cooperative unit is located as assigned by the local real property tax assessing\nauthority; and\n(6) indicates the name of the cooperative organization.\nSection 9-503. Name of Debtor and Secured Party.\n(a) Sufficiency of debtor\'s name. A financing statement sufficiently provides the name of the\ndebtor:\n(1) except as otherwise provided in paragraph (3), if the debtor is a registered\norganization or the collateral is held in a trust that is a registered organization, only if the\nfinancing statement provides the name that is stated to be the registered organization\'s\nname on the public organic record most recently filed with or issued or enacted by the\nregistered organization\'s jurisdiction of organization which purports to state, amend, or\nrestate the registered organization\'s name;\n(2) subject to subsection (f), if the collateral is being administered by the personal\nrepresentative of a decedent, only if the financing statement provides, as the name of the\ndebtor, the name of the decedent and, in a separate part of the financing statement,\nindicates that the collateral is being administered by a personal representative;\n(3) if the collateral is held in a trust that is not a registered organization, only if the\nfinancing statement:\n(A) provides, as the name of the debtor:\n(i) if the organic record of the trust specifies a name for the trust, the name\nspecified; or\n(ii) if the organic record of the trust does not specify a name for the trust, the\nname of the settlor or testator; and\n(B) in a separate part of the financing statement:\n(i) if the name is provided in accordance with subparagraph (A)(i), indicates that\nthe collateral is held in a trust; or\n(ii) if the name is provided in accordance with subparagraph (A)(ii), provides\nadditional information sufficient to distinguish the trust from other trusts having\none or more of the same settlors or the same testator and indicates that the\ncollateral is held in a trust, unless the additional information so indicates;\n(4) subject to subsection (g), if the debtor is an individual to whom this State has issued a\ndriver\'s license or non-driver photo identification card that has not expired, only if the\nfinancing statement provides the name of the individual which is indicated on the driver\'s\nlicense or non-driver photo identification card;\n488\n\n\x0c(5) if the debtor is an individual to whom paragraph (4) does not apply, only if the\nfinancing statement provides the individual name of the debtor or the surname and first\npersonal name of the debtor; and\n(6) in other cases:\n(A) if the debtor has a name, only if the financing statement provides the organizational\nname of the debtor; and\n(B) if the debtor does not have a name, only if it provides the names of the partners,\nmembers, associates, or other persons comprising the debtor, in a manner that each\nname provided would be sufficient if the person named were the debtor.\n(b) Additional debtor-related information. A financing statement that provides the name of\nthe debtor in accordance with subsection (a) is not rendered ineffective by the absence of:\n(1) a trade name or other name of the debtor; or\n(2) unless required under subsection (a)(6)(B), names of partners, members, associates, or\nother persons comprising the debtor.\n(c) Debtor\'s trade name insufficient. A financing statement that provides only the debtor\'s\ntrade name does not sufficiently provide the name of the debtor.\n(d) Representative capacity. Failure to indicate the representative capacity of a secured party\nor representative of a secured party does not affect the sufficiency of a financing statement.\n(e) Multiple debtors and secured parties. A financing statement may provide the name of\nmore than one debtor and the name of more than one secured party.\n(f) Name of decedent. The name of the decedent indicated on the order appointing the\npersonal representative of the decedent issued by the court having jurisdiction over the\ncollateral is sufficient as the "name of the decedent" under subsection (a)(2).\n(g) Multiple driver\'s licenses. If this State has issued to an individual more than one driver\'s\nlicense or non-driver photo identification card of a kind described in subsection (a)(4), the\none that was issued most recently is the one to which subsection (a)(4) refers.\n(h) Definition. In this section, the "name of the settlor or testator" means:\n(1) if the settlor is a registered organization, the name that is stated to be the settlor\'s\nname on the public organic record most recently filed with or issued or enacted by the\nsettlor\'s jurisdiction of organization which purports to state, amend, or restate the settlor\'s\nname; or\n(2) in other cases, the name of the settlor or testator indicated in the trust\'s organic record.\nSection 9-504. Indication of Collateral.\nA financing statement sufficiently indicates the collateral that it covers if the financing\nstatement provides: (1) a description of the collateral pursuant to Section 9-108; or (2) an\nindication that the financing statement covers all assets or all personal property.\n489\n\n\x0cSection 9-505. Filing and Compliance with Other Statutes and Treaties for Consignments,\nLeases, Other Bailments, and Other Transactions.\n(a) Use of terms other than "debtor" and "secured party." A consignor, lessor, or other bailor\nof goods, a licensor, or a buyer of a payment intangible or promissory note may file a\nfinancing statement, or may comply with a statute or treaty described in Section 9-311(a),\nusing the terms "consignor", "consignee", "lessor", "lessee", "bailor", "bailee", "licensor",\n"licensee", "owner", "registered owner", "buyer", "seller", or words of similar import, instead\nof the terms "secured party" and "debtor".\n(b) Effect of financing statement under subsection (a). This part applies to the filing of a\nfinancing statement under subsection (a) and, as appropriate, to compliance that is equivalent\nto filing a financing statement under Section 9-311(b), but the filing or compliance is not of\nitself a factor in determining whether the collateral secures an obligation. If it is determined\nfor another reason that the collateral secures an obligation, a security interest held by the\nconsignor, lessor, bailor, licensor, owner, or buyer which attaches to the collateral is\nperfected by the filing or compliance.\nSection 9-506. Effect of Errors or Omissions.\n(a) Minor errors and omissions. A financing statement substantially satisfying the\nrequirements of this part is effective, even if it has minor errors or omissions, unless the\nerrors or omissions make the financing statement seriously misleading.\n(b) Financing statement seriously misleading. Except as otherwise provided in subsection (c),\na financing statement that fails sufficiently to provide the name of the debtor in accordance\nwith Section 9-503(a) is seriously misleading.\n(c) Financing statement not seriously misleading. If a search of the records of the filing office\nunder the debtor\'s correct name, using the filing office\'s standard search logic, if any, would\ndisclose a financing statement that fails sufficiently to provide the name of the debtor in\naccordance with Section 9-503(a), the name provided does not make the financing statement\nseriously misleading.\n(d) "Debtor\'s correct name." For purposes of Section 9-508(b), the "debtor\'s correct name" in\nsubsection (c) means the correct name of the new debtor.\nSection 9-507. Effect of Certain Events on Effectiveness of Financing Statement.\n(a) Disposition. A filed financing statement remains effective with respect to collateral that is\nsold, exchanged, leased, licensed, or otherwise disposed of and in which a security interest or\nagricultural lien continues, even if the secured party knows of or consents to the disposition.\n(b) Information becoming seriously misleading. Except as otherwise provided in subsection\n(c) and Section 9-508, a financing statement is not rendered ineffective if, after the financing\nstatement is filed, the information provided in the financing statement becomes seriously\nmisleading under Section 9-506.\n490\n\n\x0c(c) Change in debtor\'s name. If the name that a filed financing statement provides for a\ndebtor becomes insufficient as the name of the debtor under Section 9-503(a) so that the\nfinancing statement becomes seriously misleading under Section 9-506:\n(1) the financing statement is effective to perfect a security interest in collateral acquired\nby the debtor before, or within four months after, the filed financing statement becomes\nseriously misleading; and\n(2) the financing statement is not effective to perfect a security interest in collateral\nacquired by the debtor more than four months after the filed financing statement becomes\nseriously misleading, unless an amendment to the financing statement which renders the\nfinancing statement not seriously misleading is filed within four months after the\nfinancing statement became seriously misleading.\nSection 9-508. Effectiveness of Financing Statement If New Debtor Becomes Bound by Security\nAgreement.\n(a) Financing statement naming original debtor. Except as otherwise provided in this section,\na filed financing statement naming an original debtor is effective to perfect a security interest\nin collateral in which a new debtor has or acquires rights to the extent that the financing\nstatement would have been effective had the original debtor acquired rights in the collateral.\n(b) Financing statement becoming seriously misleading. If the difference between the name\nof the original debtor and that of the new debtor causes a filed financing statement that is\neffective under subsection (a) to be seriously misleading under Section 9-506:\n(1) the financing statement is effective to perfect a security interest in collateral acquired\nby the new debtor before, and within four months after, the new debtor becomes bound\nunder Section 9-203(d); and\n(2) the financing statement is not effective to perfect a security interest in collateral\nacquired by the new debtor more than four months after the new debtor becomes bound\nunder Section 9-203(d) unless an initial financing statement providing the name of the\nnew debtor is filed before the expiration of that time. (c) When section not applicable.\nThis section does not apply to collateral as to which a filed financing statement remains\neffective against the new debtor under Section 9-507(a).\nSection 9-509. Persons Entitled to File a Record.\n(a) Person entitled to file record. A person may file an initial financing statement, amendment\nthat adds collateral covered by a financing statement, or amendment that adds a debtor to a\nfinancing statement only if:\n(1) the debtor authorizes the filing in an authenticated record or pursuant to subsection (b)\nor (c); or\n(2) the person holds an agricultural lien that has become effective at the time of filing and\nthe financing statement covers only collateral in which the person holds an agricultural\nlien.\n491\n\n\x0c(b) Security agreement as authorization. By authenticating or becoming bound as debtor by a\nsecurity agreement, a debtor or new debtor authorizes the filing of an initial financing\nstatement, and an amendment, covering:\n(1) the collateral described in the security agreement; and\n(2) property that becomes collateral under Section 9-315(a)(2), whether or not the\nsecurity agreement expressly covers proceeds.\n(c) Acquisition of collateral as authorization. By acquiring collateral in which a security\ninterest or agricultural lien continues under Section 9-315(a)(1), a debtor authorizes the filing\nof an initial financing statement, and an amendment, covering the collateral and property that\nbecomes collateral under Section 9-315(a)(2).\n(d) Person entitled to file certain amendments. A person may file an amendment other than\nan amendment that adds collateral covered by a financing statement or an amendment that\nadds a debtor to a financing statement only if:\n(1) the secured party of record authorizes the filing; or\n(2) the amendment is a termination statement for a financing statement as to which the\nsecured party of record has failed to file or send a termination statement as required by\nSection 9-513(a) or (c), the debtor authorizes the filing, and the termination statement\nindicates that the debtor authorized it to be filed.\n(e) Multiple secured parties of record. If there is more than one secured party of record for a\nfinancing statement, each secured party of record may authorize the filing of an amendment\nunder subsection (d).\nSection 9-510. Effectiveness of Filed Record.\n(a) Filed record effective if authorized. A filed record is effective only to the extent that it\nwas filed by a person that may file it under Section 9-509.\n(b) Authorization by one secured party of record. A record authorized by one secured party\nof record does not affect the financing statement with respect to another secured party of\nrecord.\n(c) Continuation statement not timely filed. A continuation statement that is not filed within\nthe six-month period prescribed by Section 9-515(d) is ineffective.\nSection 9-511. Secured Party of Record.\n(a) Secured party of record. A secured party of record with respect to a financing statement is\na person whose name is provided as the name of the secured party or a representative of the\nsecured party in an initial financing statement that has been filed. If an initial financing\nstatement is filed under Section 9-514(a), the assignee named in the initial financing\nstatement is the secured party of record with respect to the financing statement.\n(b) Amendment naming secured party of record. If an amendment of a financing statement\nwhich provides the name of a person as a secured party or a representative of a secured party\n492\n\n\x0cis filed, the person named in the amendment is a secured party of record. If an amendment is\nfiled under Section 9-514(b), the assignee named in the amendment is a secured party of\nrecord.\n(c) Amendment deleting secured party of record. A person remains a secured party of record\nuntil the filing of an amendment of the financing statement which deletes the person.\nSection 9-512. Amendment of Financing Statement.\n(a) Amendment of information in financing statement. Subject to Section 9-509, a person\nmay add or delete collateral covered by, continue or terminate the effectiveness of, or,\nsubject to subsection (e), otherwise amend the information provided in, a financing statement\nby filing an amendment that:\n(1) identifies, by its file number, the initial financing statement to which the amendment\nrelates; and\n(2) if the amendment relates to an initial financing statement filed in a filing office\ndescribed in Section 9-501(a)(1), provides the date and time that the initial financing\nstatement was filed and the information specified in Section 9-502(b).\n(b) Period of effectiveness not affected. Except as otherwise provided in Section 9-515, the\nfiling of an amendment does not extend the period of effectiveness of the financing\nstatement.\n(c) Effectiveness of amendment adding collateral. A financing statement that is amended by\nan amendment that adds collateral is effective as to the added collateral only from the date of\nthe filing of the amendment.\n(d) Effectiveness of amendment adding debtor. A financing statement that is amended by an\namendment that adds a debtor is effective as to the added debtor only from the date of the\nfiling of the amendment.\n(e) Certain amendments ineffective. An amendment is ineffective to the extent it:\n(1) purports to delete all debtors and fails to provide the name of a debtor to be covered\nby the financing statement; or\n(2) purports to delete all secured parties of record and fails to provide the name of a new\nsecured party of record.\nSection 9-513. Termination Statement.\n(a) Consumer goods. A secured party shall cause the secured party of record for a financing\nstatement to file a termination statement for the financing statement if the financing\nstatement covers consumer goods and:\n(1) there is no obligation secured by the collateral covered by the financing statement and\nno commitment to make an advance, incur an obligation, or otherwise give value; or\n(2) the debtor did not authorize the filing of the initial financing statement.\n493\n\n\x0c(b) Time for compliance with subsection (a). To comply with subsection (a), a secured party\nshall cause the secured party of record to file the termination statement:\n(1) within one month after there is no obligation secured by the collateral covered by the\nfinancing statement and no commitment to make an advance, incur an obligation, or\notherwise give value; or\n(2) if earlier, within 20 days after the secured party receives an authenticated demand\nfrom a debtor.\n(c) Other collateral. In cases not governed by subsection (a), within 20 days after a secured\nparty receives an authenticated demand from a debtor, the secured party shall cause the\nsecured party of record for a financing statement to send to the debtor a termination\nstatement for the financing statement or file the termination statement in the filing office if:\n(1) except in the case of a financing statement covering accounts or chattel paper that has\nbeen sold or goods that are the subject of a consignment, there is no obligation secured by\nthe collateral covered by the financing statement and no commitment to make an\nadvance, incur an obligation, or otherwise give value;\n(2) the financing statement covers accounts or chattel paper that has been sold but as to\nwhich the account debtor or other person obligated has discharged its obligation;\n(3) the financing statement covers goods that were the subject of a consignment to the\ndebtor but are not in the debtor\'s possession; or\n(4) the debtor did not authorize the filing of the initial financing statement.\n(d) Effect of filing termination statement. Except as otherwise provided in Section 9-510,\nupon the filing of a termination statement with the filing office, the financing statement to\nwhich the termination statement relates ceases to be effective. Except as otherwise provided\nin Section 9-510, for purposes of Section 9-519(g), 9-522(a), and 9-523(c), the filing with the\nfiling office of a termination statement relating to a financing statement that indicates that the\ndebtor is a transmitting utility also causes the effectiveness of the financing statement to\nlapse.\n(e) Cooperative Interests.\n(1) "Cooperative Interest Settlement" means the time and place at which an owner of a\ncooperative interest transfers the cooperative interest, or refinances or pays off the debt\nsecured by the cooperative interest.\n(2) Upon an authenticated demand with sufficient notice by a debtor, the secured party\nshall deliver to a cooperative interest settlement a termination statement or partial release\nand any component of the cooperative record of which it took possession, which shall be\nreleased to the debtor upon payment of the debt secured by the cooperative interest and\nthe discharge of any obligation of the secured party to make further advances. Unless the\nsecured party has agreed otherwise or the cooperative interest settlement takes place at\nthe offices of the secured party, the secured party or its agent shall be entitled to a\nreasonable fee for attendance at the cooperative interest settlement.\n\n494\n\n\x0c(3) Upon payment of the debt secured by a cooperative interest other than at a\ncooperative interest settlement and the discharge of any obligation of the secured party to\nmake further advances, the secured party shall arrange for a termination statement or\npartial release to be filed within one month of receipt of the payment or discharge of the\nobligation to make further advances, whichever is later, and shall send to the debtor any\ncomponent of the cooperative record of which it took possession.\nSection 9-514. Assignment of Powers of Secured Party of Record.\n(a) Assignment reflected on initial financing statement. Except as otherwise provided in\nsubsection (c), an initial financing statement may reflect an assignment of all of the secured\nparty\'s power to authorize an amendment to the financing statement by providing the name\nand mailing address of the assignee as the name and address of the secured party.\n(b) Assignment of filed financing statement. Except as otherwise provided in subsection (c),\na secured party of record may assign of record all or part of its power to authorize an\namendment to a financing statement by filing in the filing office an amendment of the\nfinancing statement which:\n(1) identifies, by its file number, the initial financing statement to which it relates;\n(2) provides the name of the assignor; and\n(3) provides the name and mailing address of the assignee.\n(c) Assignment of record of mortgage. An assignment of record of a security interest in a\nfixture covered by a record of a mortgage which is effective as a financing statement filed as\na fixture filing under Section 9-502(c) may be made only by an assignment of record of the\nmortgage in the manner provided by law of this state other than this chapter.\nSection 9-515. Duration and Effectiveness of Financing Statement; Effect of Lapsed Financing\nStatement.\n(a) Five-year effectiveness. Except as otherwise provided in subsections (b), (e), (f), (g), and\n(h), a filed financing statement is effective for a period of five years after the date of filing.\n(b) Public-financed or manufactured-home transaction. Except as otherwise provided in\nsubsections (e), (f), (g), and (h), an initial financing statement filed in connection with a\npublic-financed transaction or manufactured-home transaction is effective for a period of 30\nyears after the date of filing if it indicates that it is filed in connection with a public-financed\ntransaction or manufactured-home transaction.\n(c) Lapse and continuation of financing statement. The effectiveness of a filed financing\nstatement lapses on the expiration of the period of its effectiveness unless before the lapse a\ncontinuation statement is filed pursuant to subsection (d). Upon lapse, a financing statement\nceases to be effective and any security interest or agricultural lien that was perfected by the\nfinancing statement becomes unperfected, unless the security interest is perfected otherwise.\nIf the security interest or agricultural lien becomes unperfected upon lapse, it is deemed\nnever to have been perfected as against a purchaser of the collateral for value.\n495\n\n\x0c(d) When continuation statement may be filed. A continuation statement may be filed only\nwithin six months before the expiration of the five-year period specified in subsection (a) or\nthe thirty-year period specified in subsection (b) or the fifty-year period specified in\nsubsection (h), whichever is applicable.\n(e) Effect of filing continuation statement. Except as otherwise provided in Section 9-510,\nupon timely filing of a continuation statement, the effectiveness of the initial financing\nstatement continues for a period of five years commencing on the day on which the financing\nstatement would have become ineffective in the absence of the filing. Upon the expiration of\nthe five-year period, the financing statement lapses in the same manner as provided in\nsubsection (c), unless, before the lapse, another continuation statement is filed pursuant to\nsubsection (d). Succeeding continuation statements may be filed in the same manner to\ncontinue the effectiveness of the initial financing statement.\n(f) Transmitting utility financing statement. If a debtor is a transmitting utility and a filed\ninitial financing statement so indicates, the financing statement is effective until a\ntermination statement is filed.\n(g) Record of mortgage as financing statement. A record of a mortgage that is effective as a\nfinancing statement filed as a fixture filing under Section 9-502(c) remains effective as a\nfinancing statement filed as a fixture filing until the mortgage is released or satisfied of\nrecord or its effectiveness otherwise terminates as to the real property.\n(h) Cooperative interest transaction. An initial financing statement covering a cooperative\ninterest is effective for a period of 50 years after the date of the filing of the initial financing\nstatement if a cooperative addendum is filed simultaneously with the initial financing\nstatement or is filed before the financing statement lapses.\nSection 9-516. What Constitutes Filing; Effectiveness of Filing.\n(a) What constitutes filing. Except as otherwise provided in subsection (b), communication of\na record to a filing office and tender of the filing fee or acceptance of the record by the filing\noffice constitutes filing.\n(b) Refusal to accept record; filing does not occur. Filing does not occur with respect to a\nrecord that a filing office refuses to accept because:\n(1) the record is not communicated by a method or medium of communication authorized\nby the filing office;\n(2) an amount equal to or greater than the applicable filing fee is not tendered;\n(3) the filing office is unable to index the record because:\n(A) in the case of an initial financing statement, the record does not provide a name for\nthe debtor;\n(B) in the case of an amendment or correction statement, the record:\n(i) does not identify the initial financing statement as required by Section 9-512 or\n9-518, as applicable; or\n496\n\n\x0c(ii) identifies an initial financing statement whose effectiveness has lapsed under\nSection 9-515;\n(C) in the case of an initial financing statement that provides the name of a debtor\nidentified as an individual or an amendment that provides a name of a debtor identified\nas an individual which was not previously provided in the financing statement to which\nthe record relates, the record does not identify the debtor\'s last name; or (\nD) in the case of a record filed in the filing office described in Section 9-501 (a) (1), the\nrecord does not provide a sufficient description of the real property to which it relates;\n(4) in the case of an initial financing statement or an amendment that adds a secured party\nof record, the record does not provide a name and mailing address for the secured party\nof record;\n(5) in the case of an initial financing statement or an amendment that provides a name of\na debtor which was not previously provided in the financing statement to which the\namendment relates, the record does not:\n(A) provide a mailing address for the debtor; or\n(B) indicate whether the debtor is an individual or an organization;\n(C) if the financing statement indicates that the debtor is an organization, provide:\n(i) a type of organization for the debtor, or\n(ii) a jurisdiction of organization for the debtor; or\n(6) in the case of an assignment reflected in an initial financing statement under Section\n9-514(a) or an amendment filed under Section 9-514(b), the record does not provide a\nname and mailing address for the assignee; or\n(7) in the case of a continuation statement, the record is not filed within the six-month\nperiod prescribed by Section 9-515(d).\n(c) Rules applicable to subsection (b). For purposes of subsection (b):\n(1) a record does not provide information if the filing office is unable to read or decipher\nthe information; and\n(2) a record that does not indicate that it is an amendment or identify an initial financing\nstatement to which it relates, as required by Section 9-512, 9-514, or 9-518, is an initial\nfinancing statement.\n(d) Refusal to accept record; record effective as filed record. A record that is communicated\nto the filing office with tender of the filing fee, but which the filing office refuses to accept\nfor a reason other than one set forth in subsection (b), is effective as a filed record except as\nagainst a purchaser of the collateral which gives value in reasonable reliance upon the\nabsence of the record from the files.\n(e) Special rule for cooperative interests; record effective as notice. A filing that includes a\ncooperative addendum covering a cooperative interest constitutes notice of the existence of\nthe security interest in the cooperative interest as of the date of the filing of the cooperative\n497\n\n\x0caddendum, except as against a purchaser of the collateral which gives value in reasonable\nreliance upon the absence of the record from the files.\nSection 9-517. Effect of Indexing Errors.\nThe failure of the filing office to index a record correctly does not affect the effectiveness of\nthe filed record.\nSection 9-518. Claim Concerning Inaccurate or Wrongfully Filed Record.\n(a) Correction statement. A person may file in the filing office a correction statement with\nrespect to a record indexed there under the person\'s name if the person believes that the\nrecord is inaccurate or was wrongfully filed.\n(b) Sufficiency of correction statement. A correction statement must:\n(1) identify the record to which it relates by:\n(A) the file number assigned to the initial financing statement to which the record\nrelates; and\n(B) if the correction statement relates to a record filed in a filing office described in\nSection 9-501(a)(1), the date and time that the initial financing statement was filed and\nthe information specified in Section 9-502(b);\n(2) indicate that it is a correction statement; and\n(3) provide the basis for the person\'s belief that the record is inaccurate and indicate the\nmanner in which the person believes the record should be amended to cure any\ninaccuracy or provide the basis for the person\'s belief that the record was wrongfully\nfiled.\n(c) Record not affected by correction statement. The filing of a correction statement does not\naffect the effectiveness of an initial financing statement or other filed record.\n(d) Special proceeding to redact or expunge a falsely filed or amended financing statement.\n(1) Provided he or she is an employee of the state or a political subdivision thereof, a\nperson identified as a debtor in a financing statement filed pursuant to this subpart may\nbring a special proceeding against the named filer of such statement or any amendment\nthereof to invalidate the filing or amendment thereof where such statement was falsely\nfiled or amended; except that an attorney who is not an employee of the state or a\npolitical subdivision thereof may also bring a special proceeding hereunder where he or\nshe represents or has represented the respondent therein in a criminal court. Such special\nproceeding shall be governed by article four of the civil practice law and rules, and shall\nbe commenced in the supreme court of Albany county, the county of the petitioner\'s\nresidence or a county within the judicial district in which any property covered by the\nfinancing statement is located. No fee pursuant to article eighty of the civil practice law\nand rules shall be collected in such special proceeding.\n(2) The petition in a special proceeding hereunder shall plead that:\n498\n\n\x0c(A) the financing statement filed or amended by the respondent pursuant to section 9509 was falsely filed or amended to retaliate for:\n(i) the performance of the petitioner\'s official duties in his or her capacity as an\nemployee of the state or a political subdivision thereof, or\n(ii) in the case of a special proceeding brought by an attorney who is not an\nemployee of the state or a political subdivision thereof, to retaliate for the\nperformance of the petitioner\'s duties in his or her capacity as an attorney for the\nrespondent in a criminal court; and\n(B) such financing statement does not relate to an interest in a consumer-goods\ntransaction, a commercial transaction, or any other actual transaction between the\npetitioner and the respondent; and\n(C) the collateral covered in such financing statement is the property of the petitioner;\nand\n(D) prompt redaction or invalidation of the financing statement is necessary to avert or\nmitigate prejudice to the petitioner.\n(3) If the court makes a written finding that the allegations in paragraph two of this\nsubsection are established, the court shall order the expungement of such statement or its\nredaction in the public records in the office in which the financing statement is filed, as\nappropriate, and may grant any additional relief authorized by section 9-625. In such\ncase, the court shall cause a copy of its order to be filed with the secretary of state or\nother appropriate filing office pursuant to this chapter. Upon a finding that the respondent\nhas engaged in a repeated pattern of false filings as found under this subsection, the court\nalso may enjoin the respondent from filing or amending any further financing statement\npursuant to this article without leave of the court. If the respondent is incarcerated at the\ntime the court issues an order containing such an injunction, the court shall cause the\nhead of the correctional facility in which the respondent is incarcerated to receive a copy\nof such determination. The head of such a facility shall cause a copy of such order to be\nprovided to the respondent. In any instances of the issuance of such an injunction where\nthe respondent has defaulted, the court shall direct service of such injunction upon the\nrespondent.\nSubPart 2- DUTIES AND OPERATION OF FILING OFFICE\nSection 9-519. Numbering, Maintaining, and Indexing Records; Communicating Information\nProvided in Records.\n(a) Filing office duties. For each record filed in a filing office, the filing office shall:\n(1) assign a unique number to the filed record;\n(2) create a record that bears the number assigned to the filed record and the date and\ntime of filing;\n499\n\n\x0c(3) maintain the filed record for public inspection; and\n(4) index the filed record in accordance with subsections (c), (d), and (e).\n(b) File number. A file number must include a digit that:\n(1) is mathematically derived from or related to the other digits of the file number; and\n(2) aids the filing office in determining whether a number communicated as the file\nnumber includes a single-digit or transpositional error.\n(c) Indexing: general. Except as otherwise provided in subsections (d) and (e), the filing\noffice shall:\n(1) index an initial financing statement according to the name of the debtor and index all\nfiled records relating to the initial financing statement in a manner that associates with\none another an initial financing statement and all filed records relating to the initial\nfinancing statement; and\n(2) index a record that provides a name of a debtor which was not previously provided in\nthe financing statement to which the record relates also according to the name that was\nnot previously provided.\n(d) Indexing: real-property-related financing statement. If a financing statement is filed as a\nfixture filing or covers as-extracted collateral, or timber to be cut, or a cooperative interest,\nthe filing office shall index it:\n(1) under the names of the debtor and of each owner of record shown on the financing\nstatement as if they were the mortgagors under a mortgage of the real property described;\nand\n(2) to the extent that the law of this state provides for indexing of records of mortgages\nunder the name of the mortgagee, under the name of the secured party as if the secured\nparty were the mortgagee thereunder, and;\n(3) if the real estate is in the City of New York or in Nassau, Onondaga, or any other\ncounty where the block system of recording or registering and indexing conveyances is in\nuse, according to the block in which the real estate is situated; the filing officer may\nindex such statements according to the names of the record owners of the real estate in a\nsingle consolidated index installed and maintained by him pursuant to section five\nhundred twenty-nine of the county law.\n(e) Indexing: real-property-related assignment. If a financing statement is filed as a fixture\nfiling or covers as-extracted collateral, timber to be cut or a cooperative interest, the filing\noffice shall index an assignment filed under Section 9-514(a) or an amendment filed under\nSection 9-514(b):\n(1) under the name of the assignor as grantor; and\n(2) to the extent that the law of this state provides for indexing a record of the assignment\nof a mortgage under the name of the assignee, under the name of the assignee; and\n(3) if the real estate is in the City of New York or in Nassau, Onondaga, or any other\ncounty where the block system of recording or registering and indexing conveyances is in\n500\n\n\x0cuse, according to the block in which the real estate is situated; the filing officer may\nindex such assignments according to the names of the record owners of the real estate in a\nsingle consolidated index installed and maintained by him pursuant to section five\nhundred twenty-nine of the county law.\n(f) Retrieval and association capability. The filing office shall maintain a capability:\n(1) to retrieve a record by the name of the debtor and: (A) if the filing office is described\nin Section 9-501(a)(1), by the file number assigned to the initial financing statement to\nwhich the record relates and the date and time that the record was filed or recorded; or\n(B) if the filing office is described in Section 9-501(a)(2), by the file number assigned to\nthe initial financing statement to which the record relates; and\n(2) to associate and retrieve with one another an initial financing statement and each filed\nrecord relating to the initial financing statement; and\n(3) if the real estate is in the City of New York or in Nassau, Onondaga, or any other\ncounty where the block system of recording or registering and indexing conveyances is in\nuse, to retrieve a record according to the block in which the real estate is situated.\n(g) Removal of debtor\'s name. The filing office may not remove a debtor\'s name from the\nindex until one year after the effectiveness of a financing statement naming the debtor lapses\nunder Section 9-515 with respect to all secured parties of record.\n(h) Timeliness of filing office performance. The filing office shall perform the acts required\nby subsections (a) through (e) at the time and in the manner prescribed by filing-office rule,\nbut not later than two business days after the filing office receives the record in question.\n(i) Inapplicability to real-property-related filing office. Subsections (b) and (h) do not apply\nto a filing office described in Section 9-501(a)(1).\nSection 9-520. Acceptance and Refusal to Accept Record.\n(a) Mandatory refusal to accept record. A filing office shall refuse to accept a record for\nfiling for a reason set forth in Section 9-516(b) and may refuse to accept a record for filing\nonly for a reason set forth in Section 9-516(b).\n(b) Communication concerning refusal. If a filing office refuses to accept a record for filing,\nit shall communicate to the person that presented the record the fact of and reason for the\nrefusal and the date and time the record would have been filed had the filing office accepted\nit. The communication must be made at the time and in the manner prescribed by filingoffice rule but, in the case of a filing office described in Section 9-501(a)(2), in no event\nmore than two business days after the filing office receives the record.\n(c) When filed financing statement effective. A filed financing statement satisfying Section\n9-502(a) and (b) is effective, even if the filing office is required to refuse to accept it for\nfiling under subsection (a). However, Section 9-338 applies to a filed financing statement\nproviding information described in Section 9-516(b)(5) which is incorrect at the time the\nfinancing statement is filed.\n501\n\n\x0cSection 9-521. Uniform Form of Written Financing Statement; Amendment; and Cooperative\nAddendum.\n(a) Initial financing statement form. A filing office that accepts written records may not\nrefuse to accept a written initial financing statement in the form promulgated by the\ndepartment of state except for a reason as set forth in Section 9-516(b).\n(b) Amendment form. A filing office that accepts written records may not refuse to accept a\nwritten financing statement amendment in the form promulgated by the department of state\nexcept for a reason as set forth in Section 9-516 (b).\n(c) Cooperative addendum form. A filing office that accepts written records may not refuse\nto accept a written cooperative addendum in the form promulgated by the department of state\nexcept for a reason as set forth in Section 9-516 (b).\nSection 9-522. Maintenance and Destruction of Records.\n(a) Post-lapse maintenance and retrieval of information. The filing office shall maintain a\nrecord of the information provided in a filed financing statement for at least one year after the\neffectiveness of the financing statement has lapsed under Section 9-515 with respect to all\nsecured parties of record. The record must be retrievable by using the name of the debtor\nand:\n(1) if the record was filed in the filing office described in Section 9-501(a)(1), by using:\n(A) the file number assigned to the initial financing statement to which the record relates\nand the date and time that the record was filed; and (B) in the case of collateral which is a\ncooperative interest, the real property tax designation associated with the real property in\nwhich the cooperative unit is located as assigned by the local real property tax assessing\nauthority; or\n(2) if the record was filed in the filing office described in Section 9-501(a)(2), by using\nthe file number assigned to the initial financing statement to which the record relates.\n(b) Destruction of written records. Except to the extent that a statute governing disposition of\npublic records provides otherwise, the filing office immediately may destroy any written\nrecord evidencing a financing statement. However, if the filing office destroys a written\nrecord, it shall maintain another record of the financing statement which complies with\nsubsection (a).\nSection 9-523. Information from Filing Office; Sale or License of Records.\n(a) Acknowledgment of filing written record. If a person that files a written record requests\nan acknowledgment of the filing, the filing office shall send to the person an image of the\nrecord showing the number assigned to the record pursuant to Section 9-519(a)(1) and the\ndate and time of the filing of the record. However, if the person furnishes a copy of the\nrecord to the filing office, the filing office may instead:\n(1) note upon the copy the number assigned to the record pursuant to Section 9-519 (a)\n(1) and the date and time of the filing of the record; and\n502\n\n\x0c(2) send the copy to the person.\n(b) Acknowledgment of filing other record. If a person files a record other than a written\nrecord, the filing office shall communicate to the person an acknowledgment that provides:\n(1) the information in the record;\n(2) the number assigned to the record pursuant to Section 9-519(a)(1); and\n(3) the date and time of the filing of the record.\n(c) Communication of requested information. The filing office shall communicate or\notherwise make available in a record the following information to any person that requests it:\n(1) whether there is on file on a date and time specified by the filing office, but not a date\nearlier than three business days before the filing office receives the request, any financing\nstatement that:\n(A) designates a particular debtor or, if the request so states, designates a particular\ndebtor at the address specified in the request;\n(B) has not lapsed under Section 9-515 with respect to all secured parties of record; and\n(C) if the request so states, has lapsed under Section 9-515 and a record of which is\nmaintained by the filing office under Section 9-522(a);\n(D) is filed in the filing office described in Section 9-501(a)(1), if the request indicates\nthe real property tax designation associated with the real property as assigned by the\nlocal real property tax assessing authority.\n(2) the date and time of filing of each financing statement,\n(3) the information provided in each financing statement,\n(4) whether there is on file any notice of federal tax lien, or a certificate or notice\naffecting such lien, on the date and time specified in such record naming a particular\ndebtor; and\n(5) the date and time of filing of each such notice or certificate of or affecting a federal\ntax lien.\n(d) Medium for communicating information. In complying with its duty under subsection (c),\nthe filing office may communicate information in any medium. However, if requested, the\nfiling office shall communicate information by issuing its written certificate.\n(e) Timeliness of filing office performance. The filing office, except by a filing office\ndescribed in Section 9-501 (a) (1), shall perform the acts required by subsections (a) through\n(d) at the time and in the manner prescribed by filing-office rule, but not later than two\nbusiness days after the filing office receives the request.\n(f) Public availability of records. At least weekly, the secretary of state shall offer to sell or\nlicense to the public on a nonexclusive basis, in bulk, copies of all records filed in it under\nthis part, in every medium from time to time available to the filing office.\n\n503\n\n\x0cSection 9-524. Delay by Filing Office.\nDelay by the filing office beyond a time limit prescribed by this part is excused if:\n(a) the delay is caused by interruption of communication or computer facilities, war,\nemergency conditions, failure of equipment, or other circumstances beyond control of the\nfiling office; and\n(b) the filing office exercises reasonable diligence under the circumstances.\nSection 9-525. Fees.\nFees for filing and services under this chapter shall be determined in accordance with section\nninety-six-a of the executive law.\nSection 9-526. Filing-office Rules.\n(a) Adoption of filing-office rules. The secretary of state shall adopt and publish rules to\nimplement this article. The filing-office rules must be consistent with this article.\n(b) Harmonization of rules. To keep the filing-office rules and practices of the filing office in\nharmony with the rules and practices of filing offices in other jurisdictions that enact\nsubstantially this part, and to keep the technology used by the filing office compatible with\nthe technology used by filing offices in other jurisdictions that enact substantially this part,\nthe secretary of state, so far as is consistent with the purposes, policies, and provisions of this\narticle, in adopting, amending, and repealing filing-office rules, shall:\n(1) consult with filing offices in other jurisdictions that enact substantially this part; and\n(2) consult the most recent version of the Model Rules promulgated by the International\nAssociation of Corporate Administrators or any successor organization; and\n(3) take into consideration the rules and practices of, and the technology used by, filing\noffices in other jurisdictions that enact substantially this part.\nSection 9-527. Duty to Report.\nThe secretary of state shall report to the governor, the temporary president of the senate and\nthe speaker of the assembly on the first day of July, two thousand two, on the first day of\nJuly, two thousand three and biennially on the first day of July thereafter, on the operation of\nthe filing office. In addition to a statement on the operation of the filing office, the report\nshall contain a statement of the extent to which:\n(a) the filing office rules are not in harmony with the rules of the filing offices in other\njurisdictions that enact substantially this part and the reasons for such variation; and\n(b) the filing office rules are not in harmony with the most recent version of the Model\nRules promulgated by the International Association of Corporate Administrators, or any\nsuccessor organization, and the reasons for these variations.\n504\n\n\x0cPart 6- DEFAULT\nSubPart 1 - DEFAULT AND ENFORCEMENT OF SECURITY INTEREST\nSection 9-601. Rights after Default; Judicial Enforcement; Consignor or Buyer of Accounts,\nChattel Paper, Payment Intangibles, or Promissory Notes.\n(a) Rights of secured party after default. After default, a secured party has the rights provided\nin this part and, except as otherwise provided in Section 9-602, those provided by agreement\nof the parties. A secured party:\n(1) may reduce a claim to judgment, foreclose, or otherwise enforce the claim, security\ninterest, or agricultural lien by any available judicial procedure; and\n(2) if the collateral is documents, may proceed either as to the documents or as to the\ngoods they cover.\n(b) Rights and duties of secured party in possession or control. A secured party in possession\nof collateral or control of collateral under Section 7-106, 9-104, 9-105, 9-106, or 9-107 has\nthe rights and duties provided in Section 9-207.\n(c) Rights cumulative; simultaneous exercise. The rights under subsections (a) and (b) are\ncumulative and may be exercised simultaneously.\n(d) Rights of debtor and obligor. Except as otherwise provided in subsection (g) and Section\n9-605, after default, a debtor and an obligor have the rights provided in this part and by\nagreement of the parties.\n(e) Lien of levy after judgment. If a secured party has reduced its claim to judgment, the lien\nof any levy that may be made upon the collateral by virtue of an execution based upon the\njudgment relates back to the earliest of:\n(1) the date of perfection of the security interest or agricultural lien in the collateral;\n(2) the date of filing a financing statement covering the collateral; or\n(3) any date specified in a statute under which the agricultural lien was created.\n(f) Execution sale. A sale pursuant to an execution is a foreclosure of the security interest or\nagricultural lien by judicial procedure within the meaning of this section. A secured party\nmay purchase at the sale and thereafter hold the collateral free of any other requirements of\nthis article.\n(g) Consignor or buyer of certain rights to payment. Except as otherwise provided in Section\n9-607(c), this part imposes no duties upon a secured party that is a consignor or is a buyer of\naccounts, chattel paper, payment intangibles, or promissory notes.\nSection 9-602. Waiver and Variance of Rights and Duties.\n\n505\n\n\x0cExcept as otherwise provided in Section 9-624, to the extent that they give rights to a debtor\nor obligor and impose duties on a secured party, the debtor or obligor may not waive or vary\nthe rules stated in the following listed sections:\n(a) Section 9-207 (b) (4) (C), which deals with use and operation of the collateral by the\nsecured party;\n(b) Section 9-210, which deals with requests for an accounting and requests concerning a\nlist of collateral and statement of account; (c) Section 9-607\n(c), which deals with collection and enforcement of collateral;\n(d) Sections 9-608 (a) and 9-615 (c) to the extent that they deal with application or\npayment of noncash proceeds of collection, enforcement, or disposition;\n(e) Sections 9-608 (a) and 9-615 (d) to the extent that they require accounting for or\npayment of surplus proceeds of collateral;\n(f) Section 9-609 to the extent that it imposes upon a secured party that takes possession\nof collateral without judicial process the duty to do so without breach of the peace;\n(g) Sections 9-610 (b), 9-611, 9-613, and 9-614, which deal with disposition of collateral;\n(h) Section 9-615 (f), which deals with calculation of a deficiency or surplus when a\ndisposition is made to the secured party, a person related to the secured party, or a\nsecondary obligor;\n(i) Section 9-616, which deals with explanation of the calculation of a surplus or\ndeficiency;\n(j) Sections 9-620, 9-621, and 9-622, which deal with acceptance of collateral in\nsatisfaction of obligation;\n(k) Section 9-623, which deals with redemption of collateral;\n(l) Section 9-624, which deals with permissible waivers; and\n(m) Sections 9-625 and 9-626, which deal with the secured party\'s liability for failure to\ncomply with this article.\nSection 9-603. Agreement on Standards Concerning Rights and Duties.\n(a) Agreed standards. The parties may determine by agreement the standards measuring the\nfulfillment of the rights of a debtor or obligor and the duties of a secured party under a rule\nstated in Section 9-602 if the standards are not manifestly unreasonable.\n(b) Agreed standards inapplicable to breach of peace. Subsection (a) does not apply to the\nduty under Section 9-609 to refrain from breaching the peace.\nSection 9-604. Procedure If Security Agreement Covers Real Property, Fixtures, or Cooperative\nInterests.\n506\n\n\x0c(a) Enforcement: personal and real property. If a security agreement covers both personal and\nreal property, a secured party may proceed:\n(1) under this part as to the personal property without prejudicing any rights with respect\nto the real property; or\n(2) as to both the personal property and the real property in accordance with the rights\nwith respect to the real property, in which case the other provisions of this part do not\napply.\n(b) Enforcement: fixtures. Subject to subsection (c), if a security agreement covers goods that\nare or become fixtures, a secured party may proceed:\n(1) under this part; or\n(2) in accordance with the rights with respect to real property, in which case the other\nprovisions of this part do not apply.\n(c) Removal of fixtures. Subject to the other provisions of this part, if a secured party holding\na security interest in fixtures has priority over all owners and encumbrancers of the real\nproperty, the secured party, after default, may remove the collateral from the real property.\n(d) Injury caused by removal. A secured party that removes collateral shall promptly\nreimburse any encumbrancer or owner of the real property, other than the debtor, for the cost\nof repair of any physical injury caused by the removal. The secured party need not reimburse\nthe encumbrancer or owner for any diminution in value of the real property caused by the\nabsence of the goods removed or by any necessity of replacing them. A person entitled to\nreimbursement may refuse permission to remove until the secured party gives adequate\nassurance for the performance of the obligation to reimburse.\n(e) Enforcement: cooperative interests. A security interest in a cooperative interest may be\nenforced only as provided in Section 9-601(a).\nSection 9-605. Unknown Debtor or Secondary Obligor. A secured party does not owe a duty\nbased on its status as secured party:\n(a) to a person that is a debtor or obligor, unless the secured party knows:\n(1) that the person is a debtor or obligor;\n(2) the identity of the person; and\n(3) how to communicate with the person; or\n(b) to a secured party or lienholder that has filed a financing statement against a person,\nunless the secured party knows:\n(1) that the person is a debtor; and\n(2) the identity of the person.\nSection 9-606. Time of Default for Agricultural Lien.\n507\n\n\x0cFor purposes of this part, a default occurs in connection with an agricultural lien at the time\nthe secured party becomes entitled to enforce the lien in accordance with the statute under\nwhich it was created.\nSection 9-607. Collection and Enforcement by Secured Party.\n(a) Collection and enforcement generally. If so agreed, and in any event after default, a\nsecured party:\n(1) may notify an account debtor or other person obligated on collateral to make payment\nor otherwise render performance to or for the benefit of the secured party;\n(2) may take any proceeds to which the secured party is entitled under Section 9-315;\n(3) may enforce the obligations of an account debtor or other person obligated on\ncollateral and exercise the rights of the debtor with respect to the obligation of the\naccount debtor or other person obligated on collateral to make payment or otherwise\nrender performance to the debtor, and with respect to any property that secures the\nobligations of the account debtor or other person obligated on the collateral;\n(4) if it holds a security interest in a deposit account perfected by control under Section 9104 (a) (1), may apply the balance of the deposit account to the obligation secured by the\ndeposit account; and\n(5) if it holds a security interest in a deposit account perfected by control under Section 9104 (a) (2) or (3), may instruct the bank to pay the balance of the deposit account to or for\nthe benefit of the secured party.\n(b) Nonjudicial enforcement of mortgage. If necessary to enable a secured party to exercise\nunder subsection (a) (3) the right of a debtor to enforce a mortgage nonjudicially, the secured\nparty may record in the office in which a record of the mortgage is recorded:\n(1) a copy of the security agreement that creates or provides for a security interest in the\nobligation secured by the mortgage; and\n(2) the secured party\'s sworn affidavit in recordable form stating that: (A) a default has\noccurred with respect to the obligation secured by the mortgage; and (B) the secured\nparty is entitled to enforce the mortgage nonjudicially.\n(c) Commercially reasonable collection and enforcement. A secured party shall proceed in a\ncommercially reasonable manner if the secured party:\n(1) undertakes to collect from or enforce an obligation of an account debtor or other\nperson obligated on collateral; and\n(2) is entitled to charge back uncollected collateral or otherwise to full or limited recourse\nagainst the debtor or a secondary obligor.\n(d) Expenses of collection and enforcement. A secured party may deduct from the collections\nmade pursuant to subsection (c) reasonable expenses of collection and enforcement,\nincluding reasonable attorney\'s fees and legal expenses incurred by the secured party.\n508\n\n\x0c(e) Duties to secured party not affected. This section does not determine whether an account\ndebtor, bank, or other person obligated on collateral owes a duty to a secured party.\nSection 9-608. Application of Proceeds of Collection or Enforcement; Liability for Deficiency\nand Right to Surplus.\n(a) Application of proceeds, surplus, and deficiency if obligation secured. If a security\ninterest or agricultural lien secures payment or performance of an obligation, the following\nrules apply:\n(1) A secured party shall apply or pay over for application the cash proceeds of collection\nor enforcement under Section 9-607 in the following order to:\n(A) the reasonable expenses of collection and enforcement and, to the extent provided\nfor by agreement and not prohibited by law, reasonable attorney\'s fees and legal\nexpenses incurred by the secured party;\n(B) the satisfaction of obligations secured by the security interest or agricultural lien\nunder which the collection or enforcement is made; and\n(C) the satisfaction of obligations secured by any subordinate security interest in or\nother lien on the collateral subject to the security interest or agricultural lien under\nwhich the collection or enforcement is made if the secured party receives an\nauthenticated demand for proceeds before distribution of the proceeds is completed.\n(2) If requested by a secured party, a holder of a subordinate security interest or other lien\nshall furnish reasonable proof of the interest or lien within a reasonable time. Unless the\nholder complies, the secured party need not comply with the holder\'s demand under\nparagraph (1)(C).\n(3) A secured party need not apply or pay over for application noncash proceeds of\ncollection and enforcement under Section 9-607 unless the failure to do so would be\ncommercially unreasonable. A secured party that applies or pays over for application\nnoncash proceeds shall do so in a commercially reasonable manner.\n(4) A secured party shall account to and pay a debtor for any surplus, and the obligor is\nliable for any deficiency.\n(b) No surplus or deficiency in sales of certain rights to payment. If the underlying\ntransaction is a sale of accounts, chattel paper, payment intangibles, or promissory notes, the\ndebtor is not entitled to any surplus, and the obligor is not liable for any deficiency.\nSection 9-609. Secured Party\'s Right to Take Possession after Default.\n(a) Possession; rendering equipment unusable; disposition on debtor\'s premises. After\ndefault, a secured party:\n(1) may take possession of the collateral; and\n(2) without removal, may render equipment unusable and dispose of collateral on a\ndebtor\'s premises under Section 9-610.\n509\n\n\x0c(b) Judicial and nonjudicial process. A secured party may proceed under subsection (a):\n(1) pursuant to judicial process; or\n(2) without judicial process, if it proceeds without breach of the peace.\n(c) Assembly of collateral. If so agreed, and in any event after default, a secured party may\nrequire the debtor to assemble the collateral and make it available to the secured party at a\nplace to be designated by the secured party which is reasonably convenient to both parties.\nSection 9-610. Disposition of Collateral after Default.\n(a) Disposition after default. After default, a secured party may sell, lease, license, or\notherwise dispose of any or all of the collateral in its present condition or following any\ncommercially reasonable preparation or processing.\n(b) Commercially reasonable disposition. Every aspect of a disposition of collateral,\nincluding the method, manner, time, place, and other terms, must be commercially\nreasonable. If commercially reasonable, a secured party may dispose of collateral by public\nor private proceedings, by one or more contracts, as a unit or in parcels, and at any time and\nplace and on any terms.\n(c) Purchase by secured party. A secured party may purchase collateral:\n(1) at a public disposition; or\n(2) at a private disposition only if the collateral is of a kind that is customarily sold on a\nrecognized market or the subject of widely distributed standard price quotations.\n(d) Warranties on disposition. A contract for sale, lease, license, or other disposition includes\nthe warranties relating to title, possession, quiet enjoyment, and the like which by operation\nof law accompany a voluntary disposition of property of the kind subject to the contract.\n(e) Disclaimer of warranties. A secured party may disclaim or modify warranties under\nsubsection (d):\n(1) in a manner that would be effective to disclaim or modify the warranties in a\nvoluntary disposition of property of the kind subject to the contract of disposition; or\n(2) by communicating to the purchaser a record evidencing the contract for disposition\nand including an express disclaimer or modification of the warranties.\n(f) Record sufficient to disclaim warranties. A record is sufficient to disclaim warranties\nunder subsection (e) if it indicates "There is no warranty relating to title, possession, quiet\nenjoyment, or the like in this disposition" or uses words of similar import.\nSection 9-611. Notification Before Disposition of Collateral.\n(a) "Notification date." In this section, "notification date" means the earlier of the date on\nwhich:\n\n510\n\n\x0c(1) a secured party sends to the debtor and any secondary obligor an authenticated\nnotification of disposition; or\n(2) the debtor and any secondary obligor waive the right to notification.\n(b) Notification of disposition required. Except as otherwise provided in subsection (d), a\nsecured party that disposes of collateral under Section 9-610 shall send to the persons\nspecified in subsection (c) a reasonable authenticated notification of disposition.\n(c) Persons to be notified. To comply with subsection (b), the secured party shall send an\nauthenticated notification of disposition to:\n(1) the debtor;\n(2) any secondary obligor; and\n(3) if the collateral is other than consumer goods:\n(A) any other person from which the secured party has received, before the notification\ndate, an authenticated notification of a claim of an interest in the collateral;\n(B) any other secured party or lienholder that, 10 days before the notification date, held\na security interest in or other lien on the collateral perfected by the filing of a financing\nstatement that:\n(i) identified the collateral;\n(ii) was indexed under the debtor\'s name as of that date; and\n(iii) was filed in the office in which to file a financing statement against the debtor\ncovering the collateral as of that date; and\n(C) any other secured party that, 10 days before the notification date, held a security\ninterest in the collateral perfected by compliance with a statute, regulation, or treaty\ndescribed in Section 9-311(a).\n(d) Subsection (b) inapplicable: perishable collateral; recognized market. Subsection (b) does\nnot apply if the collateral is perishable or threatens to decline speedily in value or is of a type\ncustomarily sold on a recognized market.\n(e) Compliance with subsection (c) (3) (B). A secured party complies with the requirement\nfor notification prescribed by subsection (c) (3) (B) if:\n(1) not later than twenty days or earlier than thirty days before the notification date, the\nsecured party requests, in a commercially reasonable manner, information concerning\nfinancing statements indexed under the debtor\'s name in the office indicated in subsection\n(c) (3) (B); and\n(2) before the notification date, the secured party: (A) did not receive a response to the\nrequest for information; or (B) received a response to the request for information and sent\nan authenticated notification of disposition to each secured party or other lienholder\nnamed in that response whose financing statement covered the collateral.\n(f) Additional pre-disposition notice for cooperative interests.\n511\n\n\x0c(1) In addition to such other notification as may be required pursuant to subsection (b) of\nthis section and section 9-613 of this article, a secured party whose collateral consists of a\nresidential cooperative interest used by the debtor and whose security interest in such\ncollateral secures an obligation incurred in connection with financing or refinancing of\nthe acquisition of such cooperative interest and who proposes to dispose of such\ncollateral after a default with respect to such obligation, shall send to the debtor, not less\nthan ninety days prior to the date of the disposition of the cooperative interest, an\nadditional pre-disposition notice as provided herein.\n(2) The notice required by this subsection shall be in bold, fourteen-point type and shall\nbe printed on colored paper that is other than the color of the notice required by\nsubsection (b) of this section, and the title of the notice shall be in bold, twenty-point\ntype. The notice shall be on its own page.\n(3) The notice required by this subsection shall appear as follows: Help for Homeowners\nat Risk of Foreclosure New York State Law requires that we send you this information\nabout the foreclosure process. Please read it carefully. Notice You are in danger of losing\nyour home. You are in default of your obligations under the loan secured by your rights\nto your cooperative apartment. It is important that you take action, if you wish to avoid\nlosing your home. Sources of Information and Assistance The State encourages you to\nbecome informed about your options, by seeking assistance from an attorney, a legal aid\noffice, or a government agency or non-profit organization that provides counseling with\nrespect to home foreclosures. To locate a housing counselor near you, you may call the\ntoll-free helpline maintained by the New York State Department of Financial Services at\n(enter number) or visit the Department\'s website at (enter web address). One of these\npersons or organizations may be able to help you, including trying to work with your\nlender to modify the loan to make it more affordable. Foreclosure rescue scams Be\ncareful of people who approach you with offers to "save" your home. There are\nindividuals who watch for notices of foreclosure actions or collateral sales in order to\nunfairly profit from a homeowner\'s distress. You should be extremely careful about any\nsuch promises and any suggestions that you pay them a fee or sign any papers that\ntransfer rights of any kind to your cooperative apartment. State law requires anyone\noffering such services for profit to enter into a contract which fully describes the services\nthey will perform and fees they will charge, and which prohibits them from taking any\nmoney from you until they have completed all such promised services.\n(4) The department of financial services shall prescribe the telephone number and web\naddress to be included in the notice.\n(5) The department of financial services shall post on its website or otherwise make\nreadily available the name and contact information of government agencies or non-profit\norganizations that may be contacted for information about the foreclosure process,\nincluding maintaining a toll-free helpline to disseminate the information required by this\nsubsection.\n\n512\n\n\x0cSection 9-612. Timeliness of Notification Before Disposition of Collateral.\n(a) Reasonable time is question of fact. Except as otherwise provided in subsection (b),\nwhether a notification is sent within a reasonable time is a question of fact.\n(b) 10-day period sufficient in non-consumer transaction. In a transaction other than a\nconsumer transaction, a notification of disposition sent after default and 10 days or more\nbefore the earliest time of disposition set forth in the notification is sent within a reasonable\ntime before the disposition.\nSection 9-613. Contents and Form of Notification Before Disposition of Collateral: General.\nExcept in a consumer-goods transaction, the following rules apply:\n(a) The contents of a notification of disposition are sufficient if the notification:\n(1) describes the debtor and the secured party;\n(2) describes the collateral that is the subject of the intended disposition;\n(3) states the method of intended disposition;\n(4) states that the debtor is entitled to an accounting of the unpaid indebtedness and\nstates the charge, if any, for an accounting; and\n(5) states the time and place of a public disposition or the time after which any other\ndisposition is to be made.\n(b) Whether the contents of a notification that lacks any of the information specified in\nsubsection (a) are nevertheless sufficient is a question of fact.\n(c) The contents of a notification providing substantially the information specified in\nsubsection (a) are sufficient, even if the notification includes:\n(1) information not specified by subsection (a); or\n(2) minor errors that are not seriously misleading.\n(d) A particular phrasing of the notification is not required.\n(e) The following form of notification and the form appearing in Section 9-614(c), when\ncompleted, each provides sufficient information:\nNOTIFICATION OF DISPOSITION OF COLLATERAL To: (Name of debtor,\nobligor, or other person to which the notification is sent) From: (Name, address, and\ntelephone number of secured party) Name of Debtor(s): (Include only if debtor(s) are\nnot an addressee) (For a public disposition:) We will sell (or lease or license, as\napplicable) the (describe collateral) (to the highest qualified bidder) in public as\nfollows: Day and Date: ____________________ Time: ____________________ Place:\n____________________ (For a private disposition:) We will sell (or lease or license, as\napplicable) the (describe collateral) privately sometime after (day and date). You are\nentitled to an accounting of the unpaid indebtedness secured by the property that we\nintend to sell (or lease or license, as applicable) (for a charge of $ ). You may request\nan accounting by calling us at (telephone number).\n513\n\n\x0cSection 9-614. Contents and Form of Notification Before Disposition of Collateral: Consumergoods Transaction.\nIn a consumer-goods transaction, the following rules apply:\n(a) A notification of disposition must provide the following information:\n(1) the information specified in Section 9-613(a);\n(2) a description of any liability for a deficiency of the person to which the notification\nis sent;\n(3) a telephone number from which the amount that must be paid to the secured party to\nredeem the collateral under Section 9-623 is available; and\n(4) a telephone number or mailing address from which additional information\nconcerning the disposition and the obligation secured is available.\n(b) A particular phrasing of the notification is not required.\n(c) The following form of notification, when completed, provides sufficient information:\n(Name and address of secured party) (Date) NOTICE OF OUR PLAN TO SELL\nPROPERTY (Name and address of any obligor who is also a debtor) Subject:\n(Identification of Transaction) We have your (describe collateral), because you broke\npromises in our agreement. (For a public disposition:) We will sell (describe collateral)\nat public sale. A sale could include a lease or license. The sale will be held as follows:\nDate: ____________________ Time: ____________________ Place:\n____________________ You may attend the sale and bring bidders if you want. (For a\nprivate disposition:) We will sell (describe collateral) at private sale sometime after\n(date). A sale could include a lease or license. The money that we get from the sale\n(after paying our costs) will reduce the amount you owe. If we get less money than you\nowe, you (will or will not, as applicable) still owe us the difference. If we get more\nmoney than you owe, you will get the extra money, unless we must pay it to someone\nelse. You can get the property back at any time before we sell it by paying us the full\namount you owe (not just the past due payments), including our expenses. To learn the\nexact amount you must pay, call us at (telephone number). If you want us to explain to\nyou in writing how we have figured the amount that you owe us, you may call us at\n(telephone number) (or write us at (secured party\'s address)) and request a written\nexplanation. (We will charge you $ for the explanation if we sent you another written\nexplanation of the amount you owe us within the last six months.) If you need more\ninformation about the sale call us at (telephone number) (or write us at (secured party\'s\naddress) ). We are sending this notice to the following other people who have an\ninterest in (describe collateral) or who owe money under your agreement: (Names of all\nother debtors and obligors, if any)\n(d) A notification in the form of subsection (c) is sufficient, even if additional\ninformation appears at the end of the form.\n\n514\n\n\x0c(e) A notification in the form of subsection (c) is sufficient, even if it includes errors in\ninformation not required by subsection (a), unless the error is misleading with respect to\nrights arising under this article.\n(f) If a notification under this section is not in the form of subsection (c), law other than\nthis article determines the effect of including information not required by subsection (a).\nSection 9-615. Application of Proceeds of Disposition; Liability for Deficiency and Right to\nSurplus.\n(a) Application of proceeds. A secured party shall apply or pay over for application the cash\nproceeds of disposition under Section 9-610 in the following order to:\n(1) the reasonable expenses of retaking, holding, preparing for disposition, processing,\nand disposing, and, to the extent provided for by agreement and not prohibited by law,\nreasonable attorney\'s fees and legal expenses incurred by the secured party;\n(1-a) in the case of a cooperative organization security interest, the holder thereof in the\namount secured thereby;\n(2) the satisfaction of obligations secured by the security interest or agricultural lien\nunder which the disposition is made;\n(3) the satisfaction of obligations secured by any subordinate security interest in or other\nsubordinate lien on the collateral if:\n(A) the secured party receives from the holder of the subordinate security interest or\nother lien an authenticated demand for proceeds before distribution of the proceeds is\ncompleted; and\n(B) in a case in which a consignor has an interest in the collateral, the subordinate\nsecurity interest or other lien is senior to the interest of the consignor; and\n(4) a secured party that is a consignor of the collateral if the secured party receives from\nthe consignor an authenticated demand for proceeds before distribution of the proceeds is\ncompleted.\n(b) Proof of subordinate interest. If requested by a secured party, a holder of a subordinate\nsecurity interest or other lien shall furnish reasonable proof of the interest or lien within a\nreasonable time. Unless the holder does so, the secured party need not comply with the\nholder\'s demand under subsection (a) (3).\n(c) Application of noncash proceeds. A secured party need not apply or pay over for\napplication noncash proceeds of disposition under Section 9-610 unless the failure to do so\nwould be commercially unreasonable. A secured party that applies or pays over for\napplication noncash proceeds shall do so in a commercially reasonable manner.\n(d) Surplus or deficiency if obligation secured. If the security interest under which a\ndisposition is made secures payment or performance of an obligation, after making the\npayments and applications required by subsection (a) and permitted by subsection (c):\n515\n\n\x0c(1) unless subsection (a)(4) requires the secured party to apply or pay over cash proceeds\nto a consignor, the secured party shall account to and pay a debtor for any surplus; and\n(2) the obligor is liable for any deficiency.\n(e) No surplus or deficiency in sales of certain rights to payment. If the underlying\ntransaction is a sale of accounts, chattel paper, payment intangibles, or promissory notes:\n(1) the debtor is not entitled to any surplus; and\n(2) the obligor is not liable for any deficiency.\n(f) Calculation of surplus or deficiency in disposition to person related to secured party. The\nsurplus or deficiency following a disposition is calculated based on the amount of proceeds\nthat would have been realized in a disposition complying with this part to a transferee other\nthan the secured party, a person related to the secured party, or a secondary obligor if:\n(1) the transferee in the disposition is the secured party, a person related to the secured\nparty, or a secondary obligor; and\n(2) the amount of proceeds of the disposition is significantly below the range of proceeds\nthat a complying disposition to a person other than the secured party, a person related to\nthe secured party, or a secondary obligor would have brought.\n(g) Cash proceeds received by junior secured party. A secured party that receives cash\nproceeds of a disposition in good faith and without knowledge that the receipt violates the\nrights of the holder of a security interest or other lien that is not subordinate to the security\ninterest or agricultural lien under which the disposition is made:\n(1) takes the cash proceeds free of the security interest or other lien;\n(2) is not obligated to apply the proceeds of the disposition to the satisfaction of\nobligations secured by the security interest or other lien; and\n(3) is not obligated to account to or pay the holder of the security interest or other lien for\nany surplus.\nSection 9-616. Explanation of Calculation of Surplus or Deficiency.\n(a) Definitions. In this section:\n(1) "Explanation" means a writing that:\n(A) states the amount of the surplus or deficiency;\n(B) provides an explanation in accordance with subsection (c) of how the secured party\ncalculated the surplus or deficiency;\n(C) states, if applicable, that future debits, credits, charges, including additional credit\nservice charges or interest, rebates, and expenses may affect the amount of the surplus\nor deficiency; and\n(D) provides a telephone number or mailing address from which additional information\nconcerning the transaction is available.\n516\n\n\x0c(2) "Request" means a record:\n(A) authenticated by a debtor or consumer obligor;\n(B) requesting that the recipient provide an explanation; and\n(C) sent after disposition of the collateral under Section 9-610.\n(b) Explanation of calculation. In a consumer-goods transaction in which the debtor is\nentitled to a surplus or a consumer obligor is liable for a deficiency under Section 9-615, the\nsecured party shall:\n(1) send an explanation to the debtor or consumer obligor, as applicable, after the\ndisposition and: (A) before or when the secured party accounts to the debtor and pays any\nsurplus or first makes written demand on the consumer obligor after the disposition for\npayment of the deficiency; and (B) within fourteen days after receipt of a request; or\n(2) in the case of a consumer obligor who is liable for a deficiency, within fourteen days\nafter receipt of a request, send to the consumer obligor a record waiving the secured\nparty\'s right to a deficiency.\n(c) Required information. To comply with subsection (a)(1)(B), a writing must provide the\nfollowing information in the following order:\n(1) the aggregate amount of obligations secured by the security interest under which the\ndisposition was made, and, if the amount reflects a rebate of unearned interest or credit\nservice charge, an indication of that fact, calculated as of a specified date:\n(A) if the secured party takes or receives possession of the collateral after default, not\nmore than thirty-five days before the secured party takes or receives possession; or\n(B) if the secured party takes or receives possession of the collateral before default or\ndoes not take possession of the collateral, not more than thirty-five days before the\ndisposition;\n(2) the amount of proceeds of the disposition;\n(3) the aggregate amount of the obligations after deducting the amount of proceeds;\n(4) the amount, in the aggregate or by type, and types of expenses, including expenses of\nretaking, holding, preparing for disposition, processing, and disposing of the collateral,\nand attorney\'s fees secured by the collateral which are known to the secured party and\nrelate to the current disposition;\n(5) the amount, in the aggregate or by type, and types of credits, including rebates of\ninterest or credit service charges, to which the obligor is known to be entitled and which\nare not reflected in the amount in paragraph (1); and\n(6) the amount of the surplus or deficiency.\n(d) Substantial compliance. A particular phrasing of the explanation is not required. An\nexplanation complying substantially with the requirements of subsection (a) is sufficient,\neven if it includes minor errors that are not seriously misleading.\n517\n\n\x0c(e) Charges for responses. A debtor or consumer obligor is entitled without charge to one\nresponse to a request under this section during any six-month period in which the secured\nparty did not send to the debtor or consumer obligor an explanation pursuant to subsection\n(b)(1). The secured party may require payment of a charge not exceeding 25 dollars for each\nadditional response.\nSection 9-617. Rights of Transferee of Collateral.\n(a) Effects of disposition. A secured party\'s disposition of collateral after default:\n(1) transfers to a transferee for value all of the debtor\'s rights in the collateral;\n(2) discharges the security interest under which the disposition is made; and\n(3) discharges any subordinate security interest or other subordinate lien other than liens\ncreated under any law of this state that are not to be discharged.\n(b) Rights of good-faith transferee. A transferee that acts in good faith takes free of the rights\nand interests described in subsection (a), even if the secured party fails to comply with this\narticle or the requirements of any judicial proceeding.\n(c) Rights of other transferee. If a transferee does not take free of the rights and interests\ndescribed in subsection (a), the transferee takes the collateral subject to:\n(1) the debtor\'s rights in the collateral;\n(2) the security interest or agricultural lien under which the disposition is made; and\n(3) any other security interest or other lien.\nSection 9-618. Rights and Duties of Certain Secondary Obligors.\n(a) Rights and duties of secondary obligor. A secondary obligor acquires the rights and\nbecomes obligated to perform the duties of the secured party after the secondary obligor:\n(1) receives an assignment of a secured obligation from the secured party;\n(2) receives a transfer of collateral from the secured party and agrees to accept the rights\nand assume the duties of the secured party; or\n(3) is subrogated to the rights of a secured party with respect to collateral.\n(b) Effect of assignment, transfer, or subrogation. An assignment, transfer, or subrogation\ndescribed in subsection (a):\n(1) is not a disposition of collateral under Section 9-610; and\n(2) relieves the secured party of further duties under this article.\nSection 9-619. Transfer of Record or Legal Title.\n(a) "Transfer statement." In this section, "transfer statement" means a record authenticated by\na secured party stating:\n518\n\n\x0c(1) that the debtor has defaulted in connection with an obligation secured by specified\ncollateral;\n(2) that the secured party has exercised its post-default remedies with respect to the\ncollateral;\n(3) that, by reason of the exercise, a transferee has acquired the rights of the debtor in the\ncollateral; and\n(4) the name and mailing address of the secured party, debtor, and transferee.\n(b) Effect of transfer statement. A transfer statement entitles the transferee to the transfer of\nrecord of all rights of the debtor in the collateral specified in the statement in any official\nfiling, recording, registration, or certificate-of-title system covering the collateral. If a\ntransfer statement is presented with the applicable fee and request form to the official or\noffice responsible for maintaining the system, the official or office shall:\n(1) accept the transfer statement;\n(2) promptly amend its records to reflect the transfer; and\n(3) if applicable, issue a new appropriate certificate of title in the name of the transferee.\n(c) Transfer not a disposition; no relief of secured party\'s duties. A transfer of the record or\nlegal title to collateral to a secured party under subsection (b) or otherwise is not of itself a\ndisposition of collateral under this article and does not of itself relieve the secured party of its\nduties under this article.\nSection 9-620. Acceptance of Collateral in Full or Partial Satisfaction of Obligation; Compulsory\nDisposition of Collateral.\n(a) Conditions to acceptance in satisfaction. Except as otherwise provided in subsections (g)\nand (h), a secured party may accept collateral in full or partial satisfaction of the obligation it\nsecures only if:\n(1) the debtor consents to the acceptance under subsection (c);\n(2) the secured party does not receive, within the time set forth in subsection (d), a\nnotification of objection to the proposal authenticated by: (A) a person to which the\nsecured party was required to send a proposal under Section 9-621; or (B) any other\nperson, other than the debtor, holding an interest in the collateral subordinate to the\nsecurity interest that is the subject of the proposal;\n(3) if the collateral is consumer goods, the collateral is not in the possession of the debtor\nwhen the debtor consents to the acceptance; and\n(4) subsection (e) does not require the secured party to dispose of the collateral or the\ndebtor waives the requirement pursuant to Section 9-624.\n(b) Purported acceptance ineffective. A purported or apparent acceptance of collateral under\nthis section is ineffective unless:\n519\n\n\x0c(1) the secured party consents to the acceptance in an authenticated record or sends a\nproposal to the debtor; and\n(2) the conditions of subsection (a) are met.\n(c) Debtor\'s consent. For purposes of this section:\n(1) a debtor consents to an acceptance of collateral in partial satisfaction of the obligation\nit secures only if the debtor agrees to the terms of the acceptance in a record authenticated\nafter default; and\n(2) a debtor consents to an acceptance of collateral in full satisfaction of the obligation it\nsecures only if the debtor agrees to the terms of the acceptance in a record authenticated\nafter default or the secured party:\n(A) sends to the debtor after default a proposal that is unconditional or subject only to a\ncondition that collateral not in the possession of the secured party be preserved or\nmaintained;\n(B) in the proposal, proposes to accept collateral in full satisfaction of the obligation it\nsecures; and\n(C) does not receive a notification of objection authenticated by the debtor within\ntwenty days after the proposal is sent.\n(d) Effectiveness of notification. To be effective under subsection (a)(2), a notification of\nobjection must be received by the secured party:\n(1) in the case of a person to which the proposal was sent pursuant to Section 9-621,\nwithin 20 days after notification was sent to that person; and\n(2) in other cases:\n(A) within 20 days after the last notification was sent pursuant to Section 9-621; or\n(B) if a notification was not sent, before the debtor consents to the acceptance under\nsubsection (c).\n(e) Mandatory disposition of consumer goods. A secured party that has taken possession of\ncollateral shall dispose of the collateral pursuant to Section 9-610 within the time specified in\nsubsection (f) if:\n(1) sixty percent of the cash price has been paid in the case of a purchase-money security\ninterest in consumer goods; or\n(2) sixty percent of the principal amount of the obligation secured has been paid in the\ncase of a non-purchase-money security interest in consumer goods.\n(f) Compliance with mandatory disposition requirement. To comply with subsection (e), the\nsecured party shall dispose of the collateral:\n(1) within 90 days after taking possession; or\n(2) within any longer period to which the debtor and all secondary obligors have agreed\nin an agreement to that effect entered into and authenticated after default.\n520\n\n\x0c(g) No partial satisfaction in consumer transaction. In a consumer transaction, a secured party\nmay not accept collateral in partial satisfaction of the obligation it secures.\n(h) Special provisions for cooperative interests. A secured party whose collateral consists of a\nresidential cooperative interest used by the debtor and whose security interest in such\ncollateral secures an obligation incurred in connection with financing or refinancing of the\nacquisition of such cooperative interest and who chooses to accept that cooperative interest in\nfull satisfaction of the debtor\'s obligation may do so.\n(1) If the secured party sends a proposal to take the cooperative interest in full\nsatisfaction of the debtor\'s obligation, the proposal shall be accompanied by a notice in\nthe form and manner prescribed in subsection (f) of section 9-611 of this subpart, unless\nthe secured party has previously sent the debtor such notice. A debtor consents to an\nacceptance of a cooperative interest in full satisfaction of the obligation it secures only if\nthe debtor agrees to the terms of the proposal in a record authenticated after default.\n(2) A debtor may propose to the secured party that it take the cooperative interest in full\nsatisfaction of the obligation it secures. The proposal shall be ineffective unless the\nsecured party consents to the proposal in an authenticated record.\nSection 9-621. Notification of Proposal to Accept Collateral.\n(a) Persons to which proposal to be sent. A secured party that desires to accept collateral in\nfull or partial satisfaction of the obligation it secures shall send its proposal to:\n(1) any person from which the secured party has received, before the debtor consented to\nthe acceptance, an authenticated notification of a claim of an interest in the collateral;\n(2) any other secured party or lienholder that, 10 days before the debtor consented to the\nacceptance, held a security interest in or other lien on the collateral perfected by the filing\nof a financing statement that: (A) identified the collateral; (B) was indexed under the\ndebtor\'s name as of that date; and (C) was filed in the office or offices in which to file a\nfinancing statement against the debtor covering the collateral as of that date; and\n(3) any other secured party that, 10 days before the debtor consented to the acceptance,\nheld a security interest in the collateral perfected by compliance with a statute, regulation,\nor treaty described in Section 9-311(a).\n(b) Proposal to be sent to secondary obligor in partial satisfaction. A secured party that\ndesires to accept collateral in partial satisfaction of the obligation it secures shall send its\nproposal to any secondary obligor in addition to the persons described in subsection (a).\nSection 9-622. Effect of Acceptance of Collateral.\n(a) Effect of acceptance. A secured party\'s acceptance of collateral in full or partial\nsatisfaction of the obligation it secures:\n(1) discharges the obligation to the extent consented to by the debtor;\n(2) transfers to the secured party all of a debtor\'s rights in the collateral;\n521\n\n\x0c(3) discharges the security interest or agricultural lien that is the subject of the debtor\'s\nconsent and any subordinate security interest or other subordinate lien; and\n(4) terminates any other subordinate interest.\n(b) Discharge of subordinate interest notwithstanding noncompliance. A subordinate interest\nis discharged or terminated under subsection (a), even if the secured party fails to comply\nwith this article.\nSection 9-623. Right to Redeem Collateral.\n(a) Persons that may redeem. A debtor, any secondary obligor, or any other secured party or\nlienholder may redeem collateral.\n(b) Requirements for redemption. To redeem collateral, a person shall tender:\n(1) fulfillment of all obligations secured by the collateral; and\n(2) the reasonable expenses and attorney\'s fees described in Section 9-615(a)(1).\n(c) When redemption may occur. A redemption may occur at any time before a secured\nparty:\n(1) has collected collateral under Section 9-607;\n(2) has disposed of collateral or entered into a contract for its disposition under Section 9610; or\n(3) has accepted collateral in full or partial satisfaction of the obligation it secures under\nSection 9-622.\nSection 9-624. Waiver.\n(a) Waiver of disposition notification. A debtor or secondary obligor may waive the right to\nnotification of disposition of collateral under Section 9-611 only by an agreement to that\neffect entered into and authenticated after default.\n(b) Waiver of mandatory disposition. A debtor may waive the right to require disposition of\ncollateral under Section 9-620 (e) only by an agreement to that effect entered into and\nauthenticated after default.\n(c) Waiver of redemption right. Except in a consumer-goods transaction, a debtor or\nsecondary obligor may waive the right to redeem collateral under Section 9-623 only by an\nagreement to that effect entered into and authenticated after default.\nSubPart 2- NONCOMPLIANCE WITH ARTICLE\nSection 9-625. Remedies for Secured Party\'s Failure to Comply with Article.\n522\n\n\x0c(a) Judicial orders concerning noncompliance. If it is established that a secured party is not\nproceeding in accordance with this article, a court may order or restrain collection,\nenforcement, or disposition of collateral on appropriate terms and conditions.\n(b) Damages for noncompliance. Subject to subsections (c), (d), and (f), a person is liable for\ndamages in the amount of any loss caused by a failure to comply with this article. Loss\ncaused by a failure to comply may include loss resulting from the debtor\'s inability to obtain,\nor increased costs of, alternative financing.\n(c) Persons entitled to recover damages; statutory damages if collateral is consumer goods.\nExcept as otherwise provided in Section 9-628:\n(1) a person that, at the time of the failure, was a debtor, was an obligor, or held a\nsecurity interest in or other lien on the collateral may recover damages under subsection\n(b) for its loss; and\n(2) if the collateral is consumer goods, a person that was a debtor or a secondary obligor\nat the time a secured party failed to comply with this part may recover for that failure in\nany event an amount not less than the credit service charge plus 10 percent of the\nprincipal amount of the obligation or the time-price differential plus 10 percent of the\ncash price.\n(d) Recovery when deficiency eliminated or reduced. A debtor whose deficiency is\neliminated under Section 9-626 may recover damages for the loss of any surplus. However, a\ndebtor or secondary obligor whose deficiency is eliminated or reduced under Section 9-626\nmay not otherwise recover under subsection (b) for noncompliance with the provisions of\nthis part relating to collection, enforcement, disposition, or acceptance.\n(e) Statutory damages: noncompliance with specified provisions. In addition to any damages\nrecoverable under subsection (b), the debtor, consumer obligor, or person named as a debtor\nin a filed record, as applicable, may recover five hundred dollars in each case from a person\nthat:\n(1) fails to comply with Section 9-208;\n(2) fails to comply with Section 9-209;\n(3) files a record that the person is not entitled to file under Section 9-509 (a);\n(4) fails to cause the secured party of record to file or send a termination statement as\nrequired by Section 9-513 (a), (c), or (e);\n(5) fails to comply with Section 9-616 (b) (1) and whose failure is part of a pattern, or\nconsistent with a practice, of noncompliance; or\n(6) fails to comply with Section 9-616 (b) (2).\n(f) Statutory damages: noncompliance with Section 9-210. A debtor or consumer obligor\nmay recover damages under subsection (b) and, in addition, five hundred dollars in each case\nfrom a person that, without reasonable cause, fails to comply with a request under Section 9210. A recipient of a request under Section 9-210 which never claimed an interest in the\ncollateral or obligations that are the subject of a request under that section has a reasonable\nexcuse for failure to comply with the request within the meaning of this subsection.\n523\n\n\x0c(g) Limitation of security interest: noncompliance with Section 9-210. If a secured party fails\nto comply with a request regarding a list of collateral or a statement of account under Section\n9-210, the secured party may claim a security interest only as shown in the list or statement\nincluded in the request as against a person that is reasonably misled by the failure.\nSection 9-626. Action in Which Deficiency or Surplus is in Issue.\n(a) Applicable rules if amount of deficiency or surplus is in issue. In an action arising from a\ntransaction, other than a consumer transaction, in which the amount of a deficiency or surplus\nis in issue, the following rules apply:\n(1) A secured party need not prove compliance with the provisions of this part relating to\ncollection, enforcement, disposition, or acceptance unless the debtor or a secondary\nobligor places the secured party\'s compliance in issue.\n(2) If the secured party\'s compliance is placed in issue, the secured party has the burden\nof establishing that the collection, enforcement, disposition, or acceptance was conducted\nin accordance with this part.\n(3) Except as otherwise provided in Section 9-628, if a secured party fails to prove that\nthe collection, enforcement, disposition, or acceptance was conducted in accordance with\nthe provisions of this part relating to collection, enforcement, disposition, or acceptance,\nthe liability of a debtor or a secondary obligor for a deficiency is limited to an amount by\nwhich the sum of the secured obligation, expenses, and attorney\'s fees exceeds the greater\nof:\n(A) the proceeds of the collection, enforcement, disposition, or acceptance; or\n(B) the amount of proceeds that would have been realized had the noncomplying\nsecured party proceeded in accordance with the provisions of this part relating to\ncollection, enforcement, disposition, or acceptance.\n(4) For purposes of paragraph (3)(B), the amount of proceeds that would have been\nrealized is equal to the sum of the secured obligation, expenses, and attorney\'s fees unless\nthe secured party proves that the amount is less than that sum.\n(5) If a deficiency or surplus is calculated under Section 9-615(f), the debtor or obligor\nhas the burden of establishing that the amount of proceeds of the disposition is\nsignificantly below the range of prices that a complying disposition to a person other than\nthe secured party, a person related to the secured party, or a secondary obligor would\nhave brought.\n(b) Non-consumer transactions; no inference. The limitation of the rules in subsection (a) to\ntransactions other than consumer transactions is intended to leave to the court the\ndetermination of the proper rules in consumer transactions. The court may not infer from that\nlimitation the nature of the proper rule in consumer transactions and may continue to apply\nestablished approaches.\nSection 9-627. Determination of Whether Conduct Was Commercially Reasonable.\n524\n\n\x0c(a) Greater amount obtainable under other circumstances; no preclusion of commercial\nreasonableness. The fact that a greater amount could have been obtained by a collection,\nenforcement, disposition, or acceptance at a different time or in a different method from that\nselected by the secured party is not of itself sufficient to preclude the secured party from\nestablishing that the collection, enforcement, disposition, or acceptance was made in a\ncommercially reasonable manner.\n(b) Dispositions that are commercially reasonable. A disposition of collateral is made in a\ncommercially reasonable manner if the disposition is made:\n(1) in the usual manner on any recognized market;\n(2) at the price current in any recognized market at the time of the disposition; or\n(3) otherwise in conformity with reasonable commercial practices among dealers in the\ntype of property that was the subject of the disposition.\n(c) Approval by court or on behalf of creditors. A collection, enforcement, disposition, or\nacceptance is commercially reasonable if it has been approved:\n(1) in a judicial proceeding;\n(2) by a bona fide creditors\' committee;\n(3) by a representative of creditors; or\n(4) by an assignee for the benefit of creditors.\n(d) Approval under subsection (c) not necessary; absence of approval has no effect. Approval\nunder subsection (c) need not be obtained, and lack of approval does not mean that the\ncollection, enforcement, disposition, or acceptance is not commercially reasonable.\nSection 9-628. Nonliability and Limitation on Liability of Secured Party; Liability of Secondary\nObligor.\n(a) Limitation of liability of secured party for noncompliance with article. Unless a secured\nparty knows that a person is a debtor or obligor, knows the identity of the person, and knows\nhow to communicate with the person:\n(1) the secured party is not liable to the person, or to a secured party or lienholder that has\nfiled a financing statement against the person, for failure to comply with this article; and\n(2) the secured party\'s failure to comply with this article does not affect the liability of the\nperson for a deficiency.\n(b) Limitation of liability based on status as secured party. A secured party is not liable\nbecause of its status as secured party:\n(1) to a person that is a debtor or obligor, unless the secured party knows:\n(A) that the person is a debtor or obligor;\n(B) the identity of the person; and\n(C) how to communicate with the person; or\n525\n\n\x0c(2) to a secured party or lienholder that has filed a financing statement against a person,\nunless the secured party knows:\n(A) that the person is a debtor; and\n(B) the identity of the person.\n(c) Limitation of liability if reasonable belief that transaction not a consumer-goods\ntransaction or consumer transaction. A secured party is not liable to any person, and a\nperson\'s liability for a deficiency is not affected, because of any act or omission arising out of\nthe secured party\'s reasonable belief that a transaction is not a consumer-goods transaction or\na consumer transaction or that goods are not consumer goods, if the secured party\'s belief is\nbased on its reasonable reliance on:\n(1) a debtor\'s representation concerning the purpose for which collateral was to be used,\nacquired, or held; or\n(2) an obligor\'s representation concerning the purpose for which a secured obligation was\nincurred.\n(d) Limitation of liability for statutory damages. A secured party is not liable to any person\nunder Section 9-625 (c) (2) for its failure to comply with Section 9-616.\n(e) Limitation of multiple liability for statutory damages. A secured party is not liable under\nSection 9-625 (c) (2) more than once with respect to any one secured obligation.\nPart 7 \xe2\x80\x93 TRANSITION\nSection 9-700. Definitions.\nThe following words and terms when used in this part 7 shall have the following meanings:\n"Former Article 9." The provisions of article 9 of the Uniform Commercial Code of this\nstate as in effect before the effective date of Revised Article 9.\n"Revised Article 9." The provisions of article 9 of the Uniform Commercial Code of this\nstate, as amended by the chapter of the laws of 2001 which added these words and as they\nmay be further amended.\nSection 9-701. Effective Date.\nRevised Article 9 takes effect on July 1, 2001.\nSection 9-702. Savings Clause.\n(a) Pre-effective-date transactions or liens. Except as otherwise provided in this part, Revised\nArticle 9 applies to a transaction or lien within its scope, even if the transaction or lien was\nentered into or created before Revised Article 9 takes effect.\n526\n\n\x0c(b) Continuing validity. Except as otherwise provided in subsection (c) and Sections 9-703\nthrough 9-709:\n(1) transactions and liens that were not governed by Former Article 9, were validly\nentered into or created before Revised Article 9 takes effect, and would be subject to\nRevised Article 9 if they had been entered into or created after Revised Article 9 takes\neffect, and the rights, duties, and interests flowing from those transactions and liens\nremain valid after Revised Article 9 takes effect; and\n(2) the transactions and liens may be terminated, completed, consummated, and enforced\nas required or permitted by Revised Article 9 or by the law that otherwise would apply if\nRevised Article 9 had not taken effect.\n(c) Pre-effective-date proceedings. Revised Article 9 does not affect an action, case, or\nproceeding commenced before Revised Article 9 takes effect.\nSection 9-703. Security Interest Perfected Before Effective Date.\n(a) Continuing priority over lien creditor: perfection requirements satisfied. A security\ninterest that is enforceable immediately before Revised Article 9 takes effect and would have\npriority over the rights of a person that becomes a lien creditor at that time is a perfected\nsecurity interest under Revised Article 9 if, when Revised Article 9 takes effect, the\napplicable requirements for enforceability and perfection under Revised Article 9 are\nsatisfied without further action.\n(b) Continuing priority over lien creditor: perfection requirements not satisfied. Except as\notherwise provided in Section 9-705 and subsection (c), if, immediately before this article\ntakes effect, a security interest is enforceable and would have priority over the rights of a\nperson that becomes a lien creditor at that time, but the applicable requirements for\nenforceability or perfection under this article are not satisfied when this article takes effect,\nthe security interest:\n(1) is a perfected security interest for one year after this article takes effect;\n(2) remains enforceable thereafter only if the security interest becomes enforceable under\nSection 9-203 before the year expires; and\n(3) remains perfected thereafter only if the applicable requirements for perfection under\nthis article are satisfied before the year expires.\n(c) Special rule for cooperative interests: perfection requirements not satisfied. If,\nimmediately before Revised Article 9 takes effect, a security interest in a cooperative interest\nis enforceable and would have priority over the rights of a person that becomes a lien creditor\nat that time, but the applicable requirements for perfection under Revised Article 9 are not\nsatisfied when Revised Article 9 takes effect, the security interest:\n(1) is a perfected security interest for 5 years after Revised Article 9 takes effect; and\n(2) remains perfected thereafter only if the applicable requirements for perfection under\nRevised Article 9 are satisfied before the 5 years expire.\n527\n\n\x0cSection 9-704. Security Interest Unperfected Before Effective Date.\nA security interest that is enforceable immediately before Revised Article 9 takes effect but\nwhich would be subordinate to the rights of a person that becomes a lien creditor at that time:\n(a) remains an enforceable security interest for one year after Revised Article 9 takes\neffect;\n(b) remains enforceable thereafter if the security interest becomes enforceable under\nSection 9-203 when Revised Article 9 takes effect or within one year thereafter; and\n(c) becomes perfected:\n(1) without further action, when Revised Article 9 takes effect if the applicable\nrequirements for perfection under Revised Article 9 are satisfied before or at that time;\nor\n(2) when the applicable requirements for perfection are satisfied if the requirements are\nsatisfied after that time.\nSection 9-705. Effectiveness of Action Taken Before Effective Date.\n(a) Pre-effective-date action; one-year perfection period unless reperfected. If action, other\nthan the filing of a financing statement, is taken before Revised Article 9 takes effect and the\naction would have resulted in priority of a security interest over the rights of a person that\nbecomes a lien creditor had the security interest become enforceable before Revised Article 9\ntakes effect, the action is effective to perfect a security interest that attaches under Revised\nArticle 9 within one year after Revised Article 9 takes effect. An attached security interest\nbecomes unperfected one year after Revised Article 9 takes effect unless the security interest\nbecomes a perfected security interest under Revised Article 9 before the expiration of that\nperiod.\n(b) Pre-effective-date filing. The filing of a financing statement before Revised Article 9\ntakes effect is effective to perfect a security interest to the extent the filing would satisfy the\napplicable requirements for perfection under Revised Article 9.\n(c) Pre-effective-date filing in jurisdiction formerly governing perfection. Revised Article 9\ndoes not render ineffective an effective financing statement that, before Revised Article 9\ntakes effect, is filed and satisfies the applicable requirements for perfection under the law of\nthe jurisdiction governing perfection as provided in Former Section 9-103. However, except\nas otherwise provided in subsections (d) and (e) and Section 9-706, the financing statement\nceases to be effective at the earlier of:\n(1) the time the financing statement would have ceased to be effective under the law of\nthe jurisdiction in which it is filed; or\n(2) June thirtieth, 2006.\n(d) Continuation statement. The filing of a continuation statement after Revised Article 9\ntakes effect does not continue the effectiveness of the financing statement filed before\n528\n\n\x0cRevised Article 9 takes effect. However, upon the timely filing of a continuation statement\nafter Revised Article 9 takes effect and in accordance with the law of the jurisdiction\ngoverning perfection as provided in Part 3, the effectiveness of a financing statement filed in\nthe same office in that jurisdiction before Revised Article 9 takes effect continues for the\nperiod provided by the law of that jurisdiction.\n(e) Application of subsection (c) (2) to transmitting utility financing statement. Subsection\n(c) (2) applies to a financing statement that, before Revised Article 9 takes effect, is filed\nagainst a transmitting utility and satisfies the applicable requirements for perfection under the\nlaw of the jurisdiction governing perfection as provided in Former Section 9-103 only to the\nextent that Part 3 provides that the law of a jurisdiction other than the jurisdiction in which\nthe financing statement is filed governs perfection of a security interest in collateral covered\nby the financing statement.\n(f) Application of Part 5. A financing statement that includes a financing statement filed\nbefore Revised Article 9 takes effect and a continuation statement filed after Revised Article\n9 takes effect is effective only to the extent that it satisfies the requirements of Part 5 for an\ninitial financing statement.\nSection 9-706. When Initial Financing Statement Suffices to Continue Effectiveness of\nFinancing Statement.\n(a) Initial financing statement in lieu of continuation statement. The filing of an initial\nfinancing statement in the office specified in Section 9-501 continues the effectiveness of a\nfinancing statement filed before Revised Article 9 takes effect if:\n(1) the filing of an initial financing statement in that office would be effective to perfect a\nsecurity interest under Revised Article 9;\n(2) the pre-effective-date financing statement was filed in an office in another state or\nanother office in this state; and\n(3) the initial financing statement satisfies subsection (c).\n(b) Period of continued effectiveness. The filing of an initial financing statement under\nsubsection (a) continues the effectiveness of the pre-effective-date financing statement:\n(1) if the initial financing statement is filed before Revised Article 9 takes effect, for the\nperiod provided in Former Section 9-403 with respect to a financing statement; and\n(2) if the initial financing statement is filed after Revised Article 9 takes effect, for the\nperiod provided in Section 9-515 with respect to an initial financing statement.\n(c) Requirements for initial financing statement under subsection (a). To be effective for\npurposes of subsection (a), an initial financing statement must:\n(1) satisfy the requirements of Part 5 for an initial financing statement;\n(2) identify the pre-effective-date financing statement by indicating the office in which\nthe financing statement was filed and providing the dates of filing and file numbers, if\n529\n\n\x0cany, of the financing statement and of the most recent continuation statement filed with\nrespect to the financing statement; and\n(3) indicate that the pre-effective-date financing statement remains effective.\nSection 9-707. Amendment of Pre-effective-date Financing Statement.\n(a) "Pre-effective-date financing statement". In this section, "pre-effective-date financing\nstatement" means a financing statement filed before Revised Article 9 takes effect.\n(b) Applicable law. After Revised Article 9 takes effect, a person may add or delete collateral\ncovered by, continue or terminate the effectiveness of, or otherwise amend the information\nprovided in, a pre-effective-date financing statement only in accordance with the law of the\njurisdiction governing perfection as provided in Part 3. However, the effectiveness of a preeffective-date financing statement also may be terminated in accordance with the law of the\njurisdiction in which the financing statement is filed.\n(c) Method of amending: general rule. Except as otherwise provided in subsection (d), if the\nlaw of this state governs perfection of a security interest, the information in a pre-effectivedate financing statement may be amended after Revised Article 9 takes effect only if:\n(1) the pre-effective-date financing statement and an amendment are filed in the office\nspecified in Section 9-501;\n(2) an amendment is filed in the office specified in Section 9-501 concurrently with, or\nafter the filing in that office of, an initial financing statement that satisfies Section 9-706\n(c); or\n(3) an initial financing statement that provides the information as amended and satisfies\nSection 9-706 (c) is filed in the office specified in Section 9-501.\n(d) Method of amending: continuation. If the law of this state governs perfection of a security\ninterest, the effectiveness of a pre-effective-date financing statement may be continued only\nunder Section 9-705 (d) and (f) or 9-706.\n(e) Method of amending: additional termination rule. Whether or not the law of this state\ngoverns perfection of a security interest, the effectiveness of a pre-effective-date financing\nstatement filed in this state may be terminated after Revised Article 9 takes effect by filing a\ntermination statement in the office in which the pre-effective-date financing statement is\nfiled, unless an initial financing statement that satisfies Section 9-706 (c) has been filed in the\noffice specified by the law of the jurisdiction governing perfection as provided in Part 3 as\nthe office in which to file a financing statement.\nSection 9-708. Persons Entitled to File Initial Financing Statement or Continuation Statement.\nA person may file an initial financing statement or a continuation statement under this part if:\n(a) the secured party of record authorizes the filing; and (b) the filing is necessary under\nthis part:\n530\n\n\x0c(1) to continue the effectiveness of a financing statement filed before Revised Article 9\ntakes effect; or\n(2) to perfect or continue the perfection of a security interest.\nSection 9-709. Priority.\n(a) Law governing priority. Revised Article 9 determines the priority of conflicting claims to\ncollateral. However, if the relative priorities of the claims were established before Revised\nArticle 9 takes effect, Former Article 9 determines priority.\n(b) Priority if security interest becomes enforceable under Section 9-203. For purposes of\nSection 9-322(a), the priority of a security interest that becomes enforceable under Section 9203 of Revised Article 9 dates from the time Revised Article 9 takes effect if the security\ninterest is perfected under Revised Article 9 by the filing of a financing statement before\nRevised Article 9 takes effect which would not have been effective to perfect the security\ninterest under Former Article 9. This subsection does not apply to conflicting security\ninterests each of which is perfected by the filing of such a financing statement.\nSection 9-710. Transitional Provision for Maintaining and Searching Local-Filing Office\nRecords.\n(a) In this Section:\n(1) "Local-filing office" means a filing office, other than the department of state, that is\ndesignated as the proper place to file a financing statement under Section 9-401 of\nFormer Article 9. The term applies only with respect to a record that covers a type of\ncollateral as to which the filing office is designated in that section as the proper place to\nfile.\n(2) "Former-Article-9 records" means:\n(A) financing statements and other records that have been filed in a local-filing office\nbefore the effective date of this Article, and that are, or upon processing and indexing\nwill be, reflected in the index maintained, as of the effective date of this Article, by the\nlocal-filing office for financing statements and other records filed in the local-filing\noffice before the effective date of this Article, and\n(B) the index as of the day before the effective date of this Article. The term does not\ninclude records presented to a local-filing office for filing after the effective date of this\nArticle, whether or not the records relate to financing statements filed in the local-filing\noffice before the effective date of this Article.\n(3) "Cooperative interest", "mortgage", "as-extracted collateral", "fixture filing", "goods"\nand "fixtures" have the meanings set forth in this Article.\n(b) A local-filing office must not accept for filing a record presented on or after the effective\ndate of this Article, whether or not the record relates to a financing statement filed in the\nlocal-filing office before the effective date of this Article.\n531\n\n\x0c(c) Until at least seven years after the effective date of this Article, each local-filing office\nshall maintain all former-Article-9 records in accordance with Former Article 9. A formerArticle-9 record that is not reflected on the index maintained on the day before the effective\ndate of this Article by the local-filing office must be processed and indexed as soon as\npracticable but in any event no later than thirty days after the effective date of this Article.\n(d) Until at least seven years after the effective date of this Article, each local-filing office\nshall respond to requests for information with respect to former-Article-9 records relating to\na debtor and issue certificates, in accordance with Former Article 9. The fees charged for\nresponding to requests for information relating to a debtor and issuing certificates with\nrespect to former-Article-9 records shall be the fees in effect under Former Article 9 on the\nday before the effective date of this Article, unless a different fee is later determined in\naccordance with section ninety-six-a of the executive law.\n(e) Subsequent to seven years after the effective date of this Article, each local-filing office\nmay remove and destroy, in accordance with any then applicable record retention law of this\nstate, all former-Article-9 records, including the related index.\n(f) This section shall not apply, with respect to financing statements and other records, to a\nfiling office in which mortgages or records of mortgages on real property are required to be\nfiled or recorded, if:\n(1) the collateral is timber to be cut or as-extracted collateral; or\n(2) the record is or relates to a financing statement filed as a fixture filing and the\ncollateral is goods that are or are to become fixtures; or\n(3) the collateral is a cooperative interest.\n\n532\n\n\x0cAPPENDIX G: Example of Promissory Note\nPROMISSORY NOTE\n$5,000,000.00\nFor value received, JOE SCHMOE, an individual with a principal place of business at E.I.\nWhite Hall, Suite 144(i), Syracuse, New York 13244-1030 (the \xe2\x80\x9cMaker\xe2\x80\x9d), by this Promissory Note\nunconditionally promises to pay to BIG HEARTED BANK, a New York Corporation having its\nprincipal place of business at 1 Erie Street, Syracuse, New York 10030 (the \xe2\x80\x9cHolder\xe2\x80\x9d) the principal\nsum of FIVE MILLION DOLLARS ($5,000,000.00) plus interest thereon, at a rate per annum\nequal to TWENTY FIVE PERCENT per cent (25%) per annum, all as further specified below.\nMaker shall pay One Million annual installments of interest and principal of $25.00 per\nyear, payable on the first day of each year, until all principal and interest have been paid in full.\nIf Maker fails to make payment of any part of principal or interest when due, at the sole\noption of Holder and without notice, the whole sum of principal and interest shall become\nimmediately due and payable.\nMaker hereby waives diligence, demand, protest, presentment, notice of dishonor or any\nother notice or demand whatsoever.\nIf the indebtedness evidenced by this Promissory Note is collected by or through an\nattorney, the Holder shall be entitled to recover reasonable attorney\'s fees to the extent permitted\nby applicable law.\nThis Promissory Note shall be governed by, and construed in accordance with, the laws of\nthe State of New York, United States of America.\nIN WITNESS WHEREOF, the Maker has duly executed this Promissory Note as of\nJanuary 12, 2015.\n___________________________\nJoe Schmoe\n\n533\n\n\x0cAPPENDIX H:\n\nExample of Security Agreement\nSECURITY AGREEMENT\n\n1. Grant. On this 12th day of January, 2012, JOE SCHMOE, with his principal place of business\nat EI White Hall, Suite 144(i), Syracuse, New York 13244-1030 (hereinafter called "Debtor"),\nfor valuable consideration, receipt whereof is acknowledged, hereby grants to BIG HEARTED\nBANK, a New York corporation with its principal place of business at 1 Erie Street, Syracuse,\nNew York 10030 (hereinafter called "Secured Party") a security interest in, and mortgages to\nSecured Party, the following described property and interests in property of Debtor (hereinafter\ncalled the "Collateral"):\nALL INVENTORY AND EQUIPMENT, INCLUDING LAW\nBOOKS\nto secure payment of the following obligations of Debtor to Secured Party (all hereinafter called\nthe "Obligations"):\nAll obligations and liabilities of Debtor to Secured Party\n(including without limitation all debts, claims and indebtedness)\nwhether primary, secondary, direct, contingent, fixed or\notherwise, heretofore, now and/or from time to time hereafter\nowing, due or payable, however evidenced, created, incurred,\nacquired or owing and however arising, or by oral agreement or\noperation of law or otherwise.\n2. Warranties and Covenants of Debtor. Debtor warrants and covenants that:\n2.1. Debtor is the owner of the Collateral free from any adverse lien, security interest or\nencumbrance; and Debtor will defend the Collateral against all claims and demands of all\npersons at any time claiming the same or any interest therein.\n2.2. No Financing Statement covering any of the Collateral or any proceeds thereof is on file\nin any public office. The Debtor shall immediately notify the Secured Party in writing of\nany change in name, address, identity or corporate structure from that shown in this\nAgreement and shall also upon demand furnish to the Secured Party such further\ninformation and shall execute and deliver to Secured Party such financing statements and\nother documents in form satisfactory to Secured Party and shall do all such acts and things\nas Secured Party may at any time or from time to time reasonably request or as may be\nnecessary or appropriate to establish and maintain a perfected security interest in the\nCollateral as security for the Obligations, subject to no adverse liens or encumbrances;\nand Debtor will pay the cost of filing the same or filing or recording this agreement in all\npublic offices wherever filing or recording is deemed by Secured Party to be necessary or\ndesirable. A carbon, photographic or other reproduction of this agreement is sufficient as\na financing statement.\n2.3. Debtor will not sell or offer to sell, assign, pledge, lease or otherwise transfer or encumber\nthe Collateral or any interest therein, without the prior written consent of Secured Party.\n534\n\n\x0c2.4. Debtor shall keep the Collateral at all times insured against risks of loss or damage by fire\n(including so-called extended coverage), theft and such other casualties as Secured Party\nmay reasonably require, including collision in the case of any motor vehicles, all in such\namounts, under such forms of policies, upon such terms, for such periods and written by\nsuch companies or underwriters as Secured Party may approve, losses in all cases to be\npayable to Secured Party and Debtor as their interests may appear. All policies of\ninsurance shall provide that Secured Party\'s interest therein shall not be invalidated by the\nact, omission or neglect of anyone other than Secured Party and for at least ten days\' prior\nwritten notice of cancellation to Secured Party. Debtor shall furnish Secured Party with\ncertificates of such insurance or other evidence satisfactory to Secured Party as to\ncompliance with the provisions of this paragraph. Secured Party may act as attorney for\nDebtor in making, adjusting and settling claims under and cancelling such insurance and\nendorsing Debtor\'s name on any drafts drawn by insurers of the Collateral.\n2.5. Debtor will keep the Collateral free from any adverse lien, security interest or\nencumbrance and in good order and repair, shall not waste or destroy the Collateral or any\npart thereof, and shall not use the Collateral in violation of any statute, ordinance or policy\nof insurance thereon.\n2.6. Secured Party may examine and inspect the Collateral at any reasonable time or times,\nwherever located.\n2.7. Debtor will pay promptly when due all taxes and assessments upon the Collateral or for\nits use or operation or upon this Agreement or upon any note or notes evidencing the\nObligations.\n3. Additional Rights of Parties. At its option, Secured Party may discharge taxes, liens or\nsecurity interests or other encumbrances at any time levied or placed on the Collateral, may\nplace and pay for insurance on the Collateral upon failure by the Debtor, after having been\nrequested to do so, to provide insurance satisfactory to the Secured Party, and may pay for the\nmaintenance, repair, and preservation of the Collateral. To the extent permitted by applicable\nlaw, Debtor agrees to reimburse Secured Party on demand for any payment made, or any\nexpense incurred by Secured Party pursuant to the foregoing authorization. Until default\nDebtor may have possession of the Collateral and use it in any lawful manner not inconsistent\nwith this agreement and not inconsistent with any policy of insurance thereon.\n4. Events of Default. Debtor shall be in default under this agreement upon the occurrence of any\nof the following events or conditions, namely: (a) default in the payment or performance of\nany of the Obligations or of any covenants or liabilities contained or referred to herein or in\nany of the Obligations; (b) any warranty, representation or statement made or furnished to\nSecured Party by or on behalf of Debtor proving to have been false in any material respect\nwhen made or furnished; (c) loss, theft, substantial damage, destruction, sale or encumbrance\nto or any of the Collateral, or the making of any levy, seizure or attachment thereof or thereon;\n(d) dissolution, termination of existence, filing by Debtor or by any third party against Debtor\nof any petition under any Federal bankruptcy statute, insolvency, business failure, appointment\nof a receiver of any part of the property of, or assignment for the benefit of creditors by, Debtor;\nor (e) the occurrence of an event of default in any agreement between Debtor and/or Secured\nParty.\n5. Remedies. UPON DEFAULT AND AT ANY TIME THEREAFTER, SECURED PARTY\nMAY DECLARE ALL OBLIGATIONS SECURED HEREBY IMMEDIATELY DUE AND\nPAYABLE AND SHALL HAVE THE REMEDIES OF A SECURED PARTY UNDER THE\n535\n\n\x0cUNIFORM COMMERCIAL CODE OF NEW YORK, including without limitation the right\nto take immediate and exclusive possession of the Collateral, or any part thereof, and for that\npurpose may, so far as Debtor can give authority therefor, with or without judicial process,\nenter (if this can be done without breach of the peace), upon any premises on which the\nCollateral or any part thereof may be situated and remove the same therefrom (provided that if\nthe Collateral is affixed to real estate, such removal shall be subject to the conditions stated in\nthe Uniform Commercial Code of New York); and the Secured Party shall be entitled to hold,\nmaintain, preserve and prepare the Collateral for sale, until disposed of, or may propose to\nretain the Collateral subject to Debtor\'s right of redemption in satisfaction of the Debtor\'s\nObligations as provided in the Uniform Commercial Code of New York. Secured Party without\nremoval may render the Collateral unusable and dispose of the Collateral on the Debtor\'s\npremises. Secured Party may require Debtor to assemble the Collateral and make it available\nto Secured Party for possession at a place to be designated by Secured Party which is\nreasonably convenient to both parties. Unless the Collateral is perishable or threatens to decline\nspeedily in value or is of a type customarily sold on a recognized market, Secured Party will\ngive Debtor at least 5 days\' notice of the time and place of any public sale thereof or of the\ntime after which any private sale or any other intended disposition thereof is to be made. The\nrequirements of reasonable notice shall be met if such notice is mailed, postage prepaid, to the\naddress of Debtor shown at the beginning of this agreement at least ten days before the time of\nthe sale or disposition. Secured Party may buy at any public sale. The net proceeds realized\nupon any such disposition, after deduction for the expenses of retaking, holding, preparing for\nsale or lease, selling, leasing and the like and the reasonable attorney\'s fees and legal expenses\nincurred by Secured Party, shall be applied in satisfaction of the Obligations secured hereby.\nThe Secured Party will account to the Debtor for any surplus realized on such disposition and\nthe Debtor shall remain liable for any deficiency.\nThe remedies of the Secured Party hereunder are cumulative and the exercise of any one or\nmore of the remedies provided for herein or under the Uniform Commercial Code of New York\nshall not be construed as a waiver of any of the other remedies of the Secured Party so long as\nany part of the Debtor\'s Obligation remains unsatisfied.\n6. General. No waiver by Secured Party of any default shall operate as a waiver of any other\ndefault or of the same default on a future occasion. All rights of Secured Party hereunder shall\ninure to the benefit of its successors and assigns; and all obligations of Debtor shall bind its\nsuccessors or assigns. If there be more than one Debtor, their obligations hereunder shall be\njoint and several. This agreement shall become effective when it is signed by Debtor.\nAll rights of the Secured Party in, to and under this agreement and in and to the Collateral shall\npass to and may be exercised by any assignee thereof. The Debtor agrees that if the Secured\nParty gives notice to the Debtor of an assignment of said rights, upon such notice the liability\nof the Debtor to the assignee shall be immediate and absolute. The Debtor will not set up any\nclaim against the Secured Party as a defense, counterclaim or set-off to any action brought by\nany such assignee for the unpaid balance owed hereunder or for the possession of the\nCollateral, provided that Debtor shall not waive hereby any right of action to the extent that\nwaiver thereof is expressly made unenforceable under applicable law.\n536\n\n\x0cIf any provision of this agreement shall be prohibited by or invalid under applicable law, such\nprovision shall be ineffective to the extent of such prohibition or invalidity, without\ninvalidating the remainder of such provision or the remaining provisions of this agreement.\nSECURED PARTY:\n\nDEBTOR:\n\nBIG HEARTED BANK,\n\n________________________________\n\nA New York Corporation\n\nJOE SCHMOE\n\nBy_____________________\nJoe Heart\nIts President and Chief Executive\nOfficer\n\n537\n\n\x0cAPPENDIX I:\n\nExample of UCC-1 Financing Statement\n\n538\n\n\x0c539\n\n\x0cAPPENDIX K: Bankruptcy Code & Selected Provisions of Federal\nLaw\n\nTable of Contents\nTITLE 11\xe2\x80\x94BANKRUPTCY ................................................................................553\n\xc2\xa7101. Definitions ....................................................................................................553\n\xc2\xa7102. Rules of construction ...................................................................................573\n\xc2\xa7103. Applicability of chapters ..............................................................................573\n\xc2\xa7104. Adjustment of dollar amounts......................................................................574\n\xc2\xa7105. Power of court ..............................................................................................574\n\xc2\xa7106. Waiver of sovereign immunity ....................................................................575\n\xc2\xa7107. Public access to papers.................................................................................576\n\xc2\xa7108. Extension of time .........................................................................................577\n\xc2\xa7109. Who may be a debtor ...................................................................................578\n\xc2\xa7110. Penalty for persons who negligently or fraudulently prepare bankruptcy\npetitions .....................................................................................................580\n\xc2\xa7111. Nonprofit budget and credit counseling agencies; financial management\ninstructional courses ..................................................................................585\n\xc2\xa7112. Prohibition on disclosure of name of minor children ..................................588\nCHAPTER 3\xe2\x80\x94CASE ADMINISTRATION ........................................................589\nSUBCHAPTER I\xe2\x80\x94COMMENCEMENT OF A CASE .......................................590\n\xc2\xa7301. Voluntary cases ............................................................................................590\n\xc2\xa7302. Joint cases ....................................................................................................590\n\xc2\xa7303. Involuntary cases..........................................................................................590\n\xc2\xa7304 [Repealed] .....................................................................................................593\n\xc2\xa7305. Abstention ....................................................................................................593\n\xc2\xa7306. Limited appearance ......................................................................................593\n\xc2\xa7307. United States trustee ....................................................................................593\n540\n\n\x0c\xc2\xa7308. Debtor reporting requirements .....................................................................593\nSUBCHAPTER II\xe2\x80\x94OFFICERS ...........................................................................594\n\xc2\xa7321. Eligibility to serve as trustee ........................................................................594\n\xc2\xa7322. Qualification of trustee ................................................................................594\n\xc2\xa7323. Role and capacity of trustee .........................................................................595\n\xc2\xa7324. Removal of trustee or examiner ...................................................................595\n\xc2\xa7325. Effect of vacancy .........................................................................................595\n\xc2\xa7326. Limitation on compensation of trustee ........................................................595\n\xc2\xa7327. Employment of professional persons ...........................................................596\n\xc2\xa7328. Limitation on compensation of professional persons ..................................596\n\xc2\xa7329. Debtor\'s transactions with attorneys ............................................................597\n\xc2\xa7330. Compensation of officers .............................................................................597\n\xc2\xa7331. Interim compensation...................................................................................599\n\xc2\xa7332. Consumer privacy ombudsman....................................................................599\n\xc2\xa7333. Appointment of patient care ombudsman ....................................................600\nSUBCHAPTER III\xe2\x80\x94ADMINISTRATION ..........................................................601\n\xc2\xa7341. Meetings of creditors and equity security holders .......................................601\n\xc2\xa7342. Notice ...........................................................................................................602\n\xc2\xa7343. Examination of the debtor ............................................................................603\n\xc2\xa7344. Self-incrimination; immunity.......................................................................604\n\xc2\xa7345. Money of estates ..........................................................................................604\n\xc2\xa7346. Special provisions related to the treatment of State and local taxes ............604\n\xc2\xa7347. Unclaimed property .....................................................................................606\n\xc2\xa7348. Effect of conversion .....................................................................................607\n\xc2\xa7349. Effect of dismissal........................................................................................608\n\xc2\xa7350. Closing and reopening cases ........................................................................608\n\xc2\xa7351. Disposal of patient records...........................................................................608\nSUBCHAPTER IV\xe2\x80\x94ADMINISTRATIVE POWERS .........................................609\n\xc2\xa7361. Adequate protection .....................................................................................609\n\xc2\xa7362. Automatic stay .............................................................................................609\n541\n\n\x0c\xc2\xa7363. Use, sale, or lease of property ......................................................................623\n\xc2\xa7364. Obtaining credit............................................................................................627\n\xc2\xa7365. Executory contracts and unexpired leases ...................................................628\n\xc2\xa7366. Utility service ...............................................................................................636\nCHAPTER 5\xe2\x80\x94CREDITORS, THE DEBTOR, AND THE ESTATE ..................637\nSUBCHAPTER I\xe2\x80\x94CREDITORS AND CLAIMS ...............................................639\n\xc2\xa7501. Filing of proofs of claims or interests ..........................................................639\n\xc2\xa7502. Allowance of claims or interests ..................................................................639\n\xc2\xa7503. Allowance of administrative expenses ........................................................643\n\xc2\xa7504. Sharing of compensation..............................................................................646\n\xc2\xa7505. Determination of tax liability .......................................................................646\n\xc2\xa7506. Determination of secured status ...................................................................647\n\xc2\xa7507. Priorities .......................................................................................................648\n\xc2\xa7508. Effect of distribution other than under this title...........................................652\n\xc2\xa7509. Claims of codebtors .....................................................................................652\n\xc2\xa7510. Subordination ...............................................................................................652\n\xc2\xa7511. Rate of interest on tax claims .......................................................................653\nSUBCHAPTER II\xe2\x80\x94DEBTOR\'S DUTIES AND BENEFITS ..............................653\n\xc2\xa7521. Debtor\'s duties ..............................................................................................653\n\xc2\xa7522. Exemptions...................................................................................................658\n\xc2\xa7523. Exceptions to discharge ...............................................................................667\n\xc2\xa7524. Effect of discharge .......................................................................................672\n\xc2\xa7525. Protection against discriminatory treatment ................................................686\n\xc2\xa7526. Restrictions on debt relief agencies .............................................................687\n\xc2\xa7527. Disclosures ...................................................................................................689\n\xc2\xa7528. Requirements for debt relief agencies .........................................................691\nSUBCHAPTER III\xe2\x80\x94THE ESTATE .....................................................................692\n\xc2\xa7541. Property of the estate ...................................................................................692\n\xc2\xa7542. Turnover of property to the estate................................................................697\n\xc2\xa7543. Turnover of property by a custodian............................................................697\n542\n\n\x0c\xc2\xa7544. Trustee as lien creditor and as successor to certain creditors and purchasers\n...................................................................................................................698\n\xc2\xa7545. Statutory liens ..............................................................................................699\n\xc2\xa7546. Limitations on avoiding powers ..................................................................699\n\xc2\xa7547. Preferences ...................................................................................................702\n\xc2\xa7548. Fraudulent transfers and obligations ............................................................705\n\xc2\xa7549. Postpetition transactions ..............................................................................708\n\xc2\xa7550. Liability of transferee of avoided transfer ...................................................709\n\xc2\xa7551. Automatic preservation of avoided transfer ................................................710\n\xc2\xa7552. Postpetition effect of security interest .........................................................710\n\xc2\xa7553. Setoff ............................................................................................................710\n\xc2\xa7554. Abandonment of property of the estate........................................................711\n\xc2\xa7555. Contractual right to liquidate, terminate, or accelerate a securities contract\n...................................................................................................................712\n\xc2\xa7556. Contractual right to liquidate, terminate, or accelerate a commodities\ncontract or forward contract ......................................................................712\n\xc2\xa7557. Expedited determination of interests in, and abandonment or other\ndisposition of grain assets .........................................................................712\n\xc2\xa7558. Defenses of the estate...................................................................................715\n\xc2\xa7559. Contractual right to liquidate, terminate, or accelerate a repurchase\nagreement ..................................................................................................715\n\xc2\xa7560. Contractual right to liquidate, terminate, or accelerate a swap agreement ..716\n\xc2\xa7561. Contractual right to terminate, liquidate, accelerate, or offset under a master\nnetting agreement and across contracts; proceedings under chapter 15 ...716\n\xc2\xa7562. Timing of damage measurement in connection with swap agreements,\nsecurities contracts, forward contracts, commodity contracts, repurchase\nagreements, and master netting agreements..............................................718\nCHAPTER 7\xe2\x80\x94LIQUIDATION ............................................................................718\nSUBCHAPTER I\xe2\x80\x94OFFICERS AND ADMINISTRATION ...............................718\n\xc2\xa7701. Interim trustee ..............................................................................................720\n\xc2\xa7702. Election of trustee ........................................................................................720\n\xc2\xa7703. Successor trustee ..........................................................................................721\n543\n\n\x0c\xc2\xa7704. Duties of trustee ...........................................................................................721\n\xc2\xa7705. Creditors\xe2\x80\x99 committee ...................................................................................724\n\xc2\xa7706. Conversion ...................................................................................................724\n\xc2\xa7707. Dismissal of a case or conversion to a case under chapter 11 or 13 ............724\nSUBCHAPTER II\xe2\x80\x94COLLECTION, LIQUIDATION, AND DISTRIBUTION OF\nTHE ESTATE ...........................................................................................731\n\xc2\xa7721. Authorization to operate business ................................................................731\n\xc2\xa7722. Redemption ..................................................................................................731\n\xc2\xa7723. Rights of partnership trustee against general partners .................................732\n\xc2\xa7724. Treatment of certain liens ............................................................................732\n\xc2\xa7725. Disposition of certain property ....................................................................733\n\xc2\xa7726. Distribution of property of the estate ...........................................................733\n\xc2\xa7727. Discharge .....................................................................................................735\n\xc2\xa7728 Repealed ........................................................................................................738\nSUBCHAPTER III\xe2\x80\x94STOCKBROKER LIQUIDATION ....................................738\n\xc2\xa7741. Definitions for this subchapter .....................................................................738\n\xc2\xa7742. Effect of section 362 of this title in this subchapter ....................................741\n\xc2\xa7743. Notice ...........................................................................................................741\n\xc2\xa7744. Executory contracts ......................................................................................741\n\xc2\xa7745. Treatment of accounts ..................................................................................741\n\xc2\xa7746. Extent of customer claims ............................................................................742\n\xc2\xa7747. Subordination of certain customer claims ...................................................742\n\xc2\xa7748. Reduction of securities to money.................................................................742\n\xc2\xa7749. Voidable transfers ........................................................................................742\n\xc2\xa7750. Distribution of securities ..............................................................................743\n\xc2\xa7751. Customer name securities ............................................................................743\n\xc2\xa7752. Customer property........................................................................................743\n\xc2\xa7753. Stockbroker liquidation and forward contract merchants, commodity\nbrokers, stockbrokers, financial institutions, financial participants,\nsecurities clearing agencies, swap participants, repo participants, and\nmaster netting agreement participants ......................................................744\n544\n\n\x0cSUBCHAPTER IV\xe2\x80\x94COMMODITY BROKER LIQUIDATION ......................744\n\xc2\xa7761. Definitions for this subchapter .....................................................................744\n\xc2\xa7762. Notice to the Commission and right to be heard .........................................749\n\xc2\xa7763. Treatment of accounts ..................................................................................749\n\xc2\xa7764. Voidable transfers ........................................................................................749\n\xc2\xa7765. Customer instructions ..................................................................................749\n\xc2\xa7766. Treatment of customer property...................................................................750\n\xc2\xa7767. Commodity broker liquidation and forward contract merchants, commodity\nbrokers, stockbrokers, financial institutions, financial participants,\nsecurities clearing agencies, swap participants, repo participants, and\nmaster netting agreement participants ......................................................752\nSUBCHAPTER V\xe2\x80\x94CLEARING BANK LIQUIDATION..................................752\n\xc2\xa7781. Definitions ....................................................................................................752\n\xc2\xa7782. Selection of trustee .......................................................................................752\n\xc2\xa7783. Additional powers of trustee ........................................................................752\n\xc2\xa7784. Right to be heard ..........................................................................................753\nCHAPTER 9\xe2\x80\x94ADJUSTMENT OF DEBTS OF A MUNICIPALITY ................753\nSUBCHAPTER I\xe2\x80\x94GENERAL PROVISIONS ....................................................753\n\xc2\xa7901. Applicability of other sections of this title ..................................................754\n\xc2\xa7902. Definitions for this chapter ..........................................................................754\n\xc2\xa7903. Reservation of State power to control municipalities ..................................755\n\xc2\xa7904. Limitation on jurisdiction and powers of court ...........................................755\nSUBCHAPTER II\xe2\x80\x94ADMINISTRATION ...........................................................755\n\xc2\xa7921. Petition and proceedings relating to petition ...............................................755\n\xc2\xa7922. Automatic stay of enforcement of claims against the debtor ......................756\n\xc2\xa7923. Notice ...........................................................................................................756\n\xc2\xa7924. List of creditors ............................................................................................757\n\xc2\xa7925. Effect of list of claims ..................................................................................757\n\xc2\xa7926. Avoiding powers ..........................................................................................757\n\xc2\xa7927. Limitation on recourse .................................................................................757\n\xc2\xa7928. Post petition effect of security interest ........................................................757\n545\n\n\x0c\xc2\xa7929. Municipal leases...........................................................................................757\n\xc2\xa7930. Dismissal ......................................................................................................757\nSUBCHAPTER III\xe2\x80\x94THE PLAN .........................................................................758\n\xc2\xa7941. Filing of plan ................................................................................................758\n\xc2\xa7942. Modification of plan ....................................................................................758\n\xc2\xa7943. Confirmation ................................................................................................758\n\xc2\xa7944. Effect of confirmation ..................................................................................759\n\xc2\xa7945. Continuing jurisdiction and closing of the case ...........................................759\n\xc2\xa7946. Effect of exchange of securities before the date of the filing of the petition\n...................................................................................................................759\nCHAPTER 11\xe2\x80\x94REORGANIZATION .................................................................759\nSUBCHAPTER I\xe2\x80\x94OFFICERS AND ADMINISTRATION ...............................759\n\xc2\xa71101. Definitions for this chapter ........................................................................761\n\xc2\xa71102. Creditors\xe2\x80\x99 and equity security holders\xe2\x80\x99 committees ..................................761\n\xc2\xa71103. Powers and duties of committees...............................................................762\n\xc2\xa71104. Appointment of trustee or examiner ..........................................................763\n\xc2\xa71105. Termination of trustee\'s appointment ........................................................764\n\xc2\xa71106. Duties of trustee and examiner ..................................................................765\n\xc2\xa71107. Rights, powers, and duties of debtor in possession ...................................766\n\xc2\xa71108. Authorization to operate business ..............................................................767\n\xc2\xa71109. Right to be heard ........................................................................................767\n\xc2\xa71110. Aircraft equipment and vessels ..................................................................767\n\xc2\xa71111. Claims and interests ...................................................................................769\n\xc2\xa71112. Conversion or dismissal .............................................................................769\n\xc2\xa71113. Rejection of collective bargaining agreements ..........................................771\n\xc2\xa71114. Payment of insurance benefits to retired employees .................................773\n\xc2\xa71115. Property of the estate .................................................................................776\n\xc2\xa71116. Duties of trustee or debtor in possession in small business cases .............777\nSUBCHAPTER II\xe2\x80\x94THE PLAN ...........................................................................778\n\xc2\xa71121. Who may file a plan ...................................................................................778\n546\n\n\x0c\xc2\xa71122. Classification of claims or interests ...........................................................779\n\xc2\xa71123. Contents of plan .........................................................................................779\n\xc2\xa71124. Impairment of claims or interests ..............................................................781\n\xc2\xa71125. Postpetition disclosure and solicitation......................................................781\n\xc2\xa71126. Acceptance of plan .....................................................................................783\n\xc2\xa71127. Modification of plan ..................................................................................784\n\xc2\xa71128. Confirmation hearing .................................................................................785\n\xc2\xa71129. Confirmation of plan ..................................................................................785\nSUBCHAPTER III\xe2\x80\x94POSTCONFIRMATION MATTERS ................................789\n\xc2\xa71141. Effect of confirmation ................................................................................789\n\xc2\xa71142. Implementation of plan ..............................................................................791\n\xc2\xa71143. Distribution ................................................................................................791\n\xc2\xa71144. Revocation of an order of confirmation .....................................................791\n\xc2\xa71145. Exemption from securities laws .................................................................791\n\xc2\xa71146. Special tax provisions ................................................................................793\nSUBCHAPTER IV\xe2\x80\x94RAILROAD REORGANIZATION ...................................793\n\xc2\xa71161. Inapplicability of other sections .................................................................793\n\xc2\xa71162. Definition ...................................................................................................793\n\xc2\xa71163. Appointment of trustee ..............................................................................794\n\xc2\xa71164. Right to be heard ........................................................................................794\n\xc2\xa71165. Protection of the public interest .................................................................794\n\xc2\xa71166. Effect of subtitle IV of title 49 and of Federal, State, or local regulations794\n\xc2\xa71167. Collective bargaining agreements ..............................................................794\n\xc2\xa71168. Rolling stock equipment ............................................................................794\n\xc2\xa71169. Effect of rejection of lease of railroad line ................................................796\n\xc2\xa71170. Abandonment of railroad line ....................................................................796\n\xc2\xa71171. Priority claims ............................................................................................797\n\xc2\xa71172. Contents of plan .........................................................................................797\n\xc2\xa71173. Confirmation of plan ..................................................................................798\n\xc2\xa71174. Liquidation .................................................................................................799\n547\n\n\x0cCHAPTER 12\xe2\x80\x94ADJUSTMENT OF DEBTS OF A FAMILY FARMER OR\nFISHERMAN WITH REGULAR ANNUAL INCOME .........................799\nSUBCHAPTER I\xe2\x80\x94OFFICERS, ADMINISTRATION, AND THE ESTATE ....799\n\xc2\xa71201. Stay of action against codebtor ..................................................................800\n\xc2\xa71202. Trustee ........................................................................................................800\n\xc2\xa71203. Rights and powers of debtor ......................................................................802\n\xc2\xa71204. Removal of debtor as debtor in possession................................................802\n\xc2\xa71205. Adequate protection ...................................................................................802\n\xc2\xa71206. Sales free of interests .................................................................................803\n\xc2\xa71207. Property of the estate .................................................................................803\n\xc2\xa71208. Conversion or dismissal .............................................................................803\nSUBCHAPTER II\xe2\x80\x94THE PLAN ...........................................................................804\n\xc2\xa71221. Filing of plan ..............................................................................................804\n\xc2\xa71222. Contents of plan .........................................................................................804\n\xc2\xa71223. Modification of plan before confirmation .................................................805\n\xc2\xa71224. Confirmation hearing .................................................................................806\n\xc2\xa71225. Confirmation of plan ..................................................................................806\n\xc2\xa71226. Payments ....................................................................................................807\n\xc2\xa71227. Effect of confirmation ................................................................................808\n\xc2\xa71228. Discharge ...................................................................................................808\n\xc2\xa71229. Modification of plan after confirmation ....................................................809\n\xc2\xa71230. Revocation of an order of confirmation .....................................................810\n\xc2\xa71231. Special tax provisions ................................................................................810\nCHAPTER 13\xe2\x80\x94ADJUSTMENT OF DEBTS OF AN INDIVIDUAL WITH\nREGULAR INCOME ...............................................................................810\nSUBCHAPTER I\xe2\x80\x94OFFICERS, ADMINISTRATION, AND THE ESTATE ....811\n\xc2\xa71301. Stay of action against codebtor ..................................................................811\n\xc2\xa71302. Trustee ........................................................................................................812\n\xc2\xa71303. Rights and powers of debtor ......................................................................813\n\xc2\xa71304. Debtor engaged in business .......................................................................813\n548\n\n\x0c\xc2\xa71305. Filing and allowance of postpetition claims ..............................................814\n\xc2\xa71306. Property of the estate .................................................................................814\n\xc2\xa71307. Conversion or dismissal .............................................................................814\n\xc2\xa71308. Filing of prepetition tax returns .................................................................815\nSUBCHAPTER II\xe2\x80\x94THE PLAN ...........................................................................816\n\xc2\xa71321. Filing of plan ..............................................................................................816\n\xc2\xa71322. Contents of plan .........................................................................................816\n\xc2\xa71323. Modification of plan before confirmation .................................................819\n\xc2\xa71324. Confirmation hearing .................................................................................819\n\xc2\xa71325. Confirmation of plan ..................................................................................819\n\xc2\xa71326. Payments ....................................................................................................822\n\xc2\xa71327. Effect of confirmation ................................................................................823\n\xc2\xa71328. Discharge ...................................................................................................824\n\xc2\xa71329. Modification of plan after confirmation ....................................................825\n\xc2\xa71330. Revocation of an order of confirmation .....................................................826\nCHAPTER 15\xe2\x80\x94ANCILLARY AND OTHER CROSS-BORDER CASES ........827\n\xc2\xa71501. Purpose and scope of application...............................................................828\nSUBCHAPTER I\xe2\x80\x94GENERAL PROVISIONS ....................................................829\n\xc2\xa71502. Definitions ..................................................................................................829\n\xc2\xa71503. International obligations of the United States ...........................................830\n\xc2\xa71504. Commencement of ancillary case ..............................................................830\n\xc2\xa71505. Authorization to act in a foreign country ...................................................830\n\xc2\xa71506. Public policy exception ..............................................................................830\n\xc2\xa71507. Additional assistance .................................................................................830\n\xc2\xa71508. Interpretation ..............................................................................................830\nSUBCHAPTER II\xe2\x80\x94ACCESS OF FOREIGN REPRESENTATIVES AND\nCREDITORS TO THE COURT ...............................................................831\n\xc2\xa71509. Right of direct access .................................................................................831\n\xc2\xa71510. Limited jurisdiction ....................................................................................831\n\xc2\xa71511. Commencement of case under section 301, 302, or 303 ...........................831\n549\n\n\x0c\xc2\xa71512. Participation of a foreign representative in a case under this title .............832\n\xc2\xa71513. Access of foreign creditors to a case under this title .................................832\n\xc2\xa71514. Notification to foreign creditors concerning a case under this title ...........832\nSUBCHAPTER III\xe2\x80\x94RECOGNITION OF A FOREIGN PROCEEDING AND\nRELIEF .....................................................................................................833\n\xc2\xa71515. Application for recognition ........................................................................833\n\xc2\xa71516. Presumptions concerning recognition ........................................................833\n\xc2\xa71517. Order granting recognition .........................................................................833\n\xc2\xa71518. Subsequent information .............................................................................834\n\xc2\xa71519. Relief that may be granted upon filing petition for recognition ................834\n\xc2\xa71520. Effects of recognition of a foreign main proceeding .................................835\n\xc2\xa71521. Relief that may be granted upon recognition .............................................835\n\xc2\xa71522. Protection of creditors and other interested persons ..................................836\n\xc2\xa71523. Actions to avoid acts detrimental to creditors ...........................................836\n\xc2\xa71524. Intervention by a foreign representative ....................................................836\nSUBCHAPTER IV\xe2\x80\x94COOPERATION WITH FOREIGN COURTS AND\nFOREIGN REPRESENTATIVES............................................................837\n\xc2\xa71525. Cooperation and direct communication between the court and foreign\ncourts or foreign representatives ...............................................................837\n\xc2\xa71526. Cooperation and direct communication between the trustee and foreign\ncourts or foreign representatives ...............................................................837\n\xc2\xa71527. Forms of cooperation .................................................................................837\nSUBCHAPTER V\xe2\x80\x94CONCURRENT PROCEEDINGS ......................................837\n\xc2\xa71528. Commencement of a case under this title after recognition of a foreign main\nproceeding .................................................................................................837\n\xc2\xa71529. Coordination of a case under this title and a foreign proceeding ..............838\n\xc2\xa71530. Coordination of more than 1 foreign proceeding ......................................838\n\xc2\xa71531. Presumption of insolvency based on recognition of a foreign main\nproceeding .................................................................................................839\n\xc2\xa71532. Rule of payment in concurrent proceedings ..............................................839\nSELECTED UNITED STATES CODE PROVISIONS .......................................839\n550\n\n\x0cTITLE 18 - CRIMES AND CRIMINAL PROCEDURE ......................................839\n\xc2\xa7 151 \xe2\x80\x93 Definition ..................................................................................................839\n\xc2\xa7 152 - Concealment of assets; false oaths and claims; bribery ............................839\n\xc2\xa7 153 - Embezzlement against estate .....................................................................840\n\xc2\xa7 154 - Adverse interest and conduct of officers ...................................................841\n\xc2\xa7 155 - Fee agreements in cases under title 11 and receiverships .........................841\n\xc2\xa7 156 - Knowing disregard of bankruptcy law or rule...........................................841\n\xc2\xa7 157 - Bankruptcy fraud .......................................................................................842\n\xc2\xa7 158 - Designation of United States attorneys and agents of the Federal Bureau of\nInvestigation to address abusive reaffirmations of debt and materially\nfraudulent statements in bankruptcy schedules ........................................842\n\xc2\xa7 1519 - Destruction, alteration, or falsification of records in Federal investigations\nand bankruptcy ..........................................................................................842\n\xc2\xa7 3284 - Concealment of bankrupt\xe2\x80\x99s assets ...........................................................843\nTITLE 26 \xe2\x80\x93 INTERNAL REVENUE CODE ........................................................843\n\xc2\xa7 6321 - Lien for taxes ...........................................................................................843\n\xc2\xa7 6322 - Period of lien............................................................................................843\n\xc2\xa7 6323 - Validity and priority against certain persons ...........................................843\n\xc2\xa7 6334 - Property exempt from levy ......................................................................853\n\xc2\xa7 7425 - Discharge of liens ....................................................................................858\nTITLE 28 \xe2\x80\x93 JUDICIARY AND JUDICIAL PROCEDURE .................................860\n\xc2\xa7 157 \xe2\x80\x93 Procedures .................................................................................................860\n\xc2\xa7 158 \xe2\x80\x93 Appeals......................................................................................................862\n\xc2\xa7 959 - Trustees and receivers suable; management; State laws ...........................865\n\xc2\xa7 1334 - Bankruptcy cases and proceedings ..........................................................865\n\xc2\xa7 1408 - Venue of cases under title 11...................................................................866\n\xc2\xa7 1409 - Venue of proceedings arising under title 11 or arising in or related to\ncases under title 11 ....................................................................................866\n\xc2\xa7 1410 - Venue of cases ancillary to foreign proceedings .....................................867\n\xc2\xa7 1411 - Jury trials .................................................................................................867\n\xc2\xa7 1412 - Change of venue ......................................................................................867\n551\n\n\x0c\xc2\xa7 1452 - Removal of claims related to bankruptcy cases ......................................867\n\n552\n\n\x0cTITLE 11\xe2\x80\x94BANKRUPTCY\nThis title was enacted by Pub. L. 95\xe2\x80\x93598, title I, \xc2\xa7101, Nov. 6, 1978, 92 Stat. 2549\n\nTITLE 11\xe2\x80\x94BANKRUPTCY ................................................................................553\nCHAPTER 1\n\xc2\xa7101. Definitions ....................................................................................................553\n\xc2\xa7102. Rules of construction ...................................................................................573\n\xc2\xa7103. Applicability of chapters ..............................................................................573\n\xc2\xa7104. Adjustment of dollar amounts......................................................................574\n\xc2\xa7105. Power of court ..............................................................................................574\n\xc2\xa7106. Waiver of sovereign immunity ....................................................................575\n\xc2\xa7107. Public access to papers.................................................................................576\n\xc2\xa7108. Extension of time .........................................................................................577\n\xc2\xa7109. Who may be a debtor ...................................................................................578\n\xc2\xa7110. Penalty for persons who negligently or fraudulently prepare bankruptcy\npetitions .....................................................................................................580\n\xc2\xa7111. Nonprofit budget and credit counseling agencies; financial management\ninstructional courses ..................................................................................585\n\xc2\xa7112. Prohibition on disclosure of name of minor children ..................................588\n\xc2\xa7101. Definitions\nIn this title the following definitions shall apply:\n(1) The term "accountant" means accountant authorized under applicable law to practice\npublic accounting, and includes professional accounting association, corporation, or\npartnership, if so authorized.\n(2) The term "affiliate" means\xe2\x80\x94\n(A) entity that directly or indirectly owns, controls, or holds with power to vote, 20\npercent or more of the outstanding voting securities of the debtor, other than an entity\nthat holds such securities\xe2\x80\x94\n(i) in a fiduciary or agency capacity without sole discretionary power to vote\nsuch securities; or\n(ii) solely to secure a debt, if such entity has not in fact exercised such power to\nvote;\n553\n\n\x0c(B) corporation 20 percent or more of whose outstanding voting securities are directly\nor indirectly owned, controlled, or held with power to vote, by the debtor, or by an\nentity that directly or indirectly owns, controls, or holds with power to vote, 20 percent\nor more of the outstanding voting securities of the debtor, other than an entity that\nholds such securities\xe2\x80\x94\n(i) in a fiduciary or agency capacity without sole discretionary power to vote\nsuch securities; or\n(ii) solely to secure a debt, if such entity has not in fact exercised such power to\nvote;\n(C) person whose business is operated under a lease or operating agreement by a\ndebtor, or person substantially all of whose property is operated under an operating\nagreement with the debtor; or\n(D) entity that operates the business or substantially all of the property of the debtor\nunder a lease or operating agreement.\n(3) The term "assisted person" means any person whose debts consist primarily of consumer\ndebts and the value of whose nonexempt property is less than $150,000 [$192,450 as of April\n1, 2016].\n(4) The term "attorney" means attorney, professional law association, corporation, or\npartnership, authorized under applicable law to practice law.\n(4A) The term "bankruptcy assistance" means any goods or services sold or otherwise\nprovided to an assisted person with the express or implied purpose of providing information,\nadvice, counsel, document preparation, or filing, or attendance at a creditors\xe2\x80\x99 meeting or\nappearing in a case or proceeding on behalf of another or providing legal representation with\nrespect to a case or proceeding under this title.\n(5) The term "claim" means\xe2\x80\x94\n(A) right to payment, whether or not such right is reduced to judgment, liquidated,\nunliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal,\nequitable, secured, or unsecured; or\n(B) right to an equitable remedy for breach of performance if such breach gives rise to\na right to payment, whether or not such right to an equitable remedy is reduced to\njudgment, fixed, contingent, matured, unmatured, disputed, undisputed, secured, or\nunsecured.\n(6) The term "commodity broker" means futures commission merchant, foreign futures\ncommission merchant, clearing organization, leverage transaction merchant, or commodity\noptions dealer, as defined in section 761 of this title, with respect to which there is a\ncustomer, as defined in section 761 of this title.\n(7) The term "community claim" means claim that arose before the commencement of the\ncase concerning the debtor for which property of the kind specified in section 541(a)(2) of\nthis title is liable, whether or not there is any such property at the time of the commencement\nof the case.\n554\n\n\x0c(7A) The term "commercial fishing operation" means\xe2\x80\x94\n(A) the catching or harvesting of fish, shrimp, lobsters, urchins, seaweed, shellfish, or\nother aquatic species or products of such species; or\n(B) for purposes of section 109 and chapter 12, aquaculture activities consisting of\nraising for market any species or product described in subparagraph (A).\n(7B) The term "commercial fishing vessel" means a vessel used by a family fisherman to\ncarry out a commercial fishing operation.\n(8) The term "consumer debt" means debt incurred by an individual primarily for a\npersonal, family, or household purpose.\n(9) The term "corporation"\xe2\x80\x94\n(A) includes\xe2\x80\x94\n(i) association having a power or privilege that a private corporation, but not an\nindividual or a partnership, possesses;\n(ii) partnership association organized under a law that makes only the capital\nsubscribed responsible for the debts of such association;\n(iii) joint-stock company;\n(iv) unincorporated company or association; or\n(v) business trust; but\n(B) does not include limited partnership.\n(10) The term "creditor" means\xe2\x80\x94\n(A) entity that has a claim against the debtor that arose at the time of or before the\norder for relief concerning the debtor;\n(B) entity that has a claim against the estate of a kind specified in section 348(d),\n502(f), 502(g), 502(h) or 502(i) of this title; or\n(C) entity that has a community claim.\n(10A) The term "current monthly income"\xe2\x80\x94\n(A) means the average monthly income from all sources that the debtor receives (or in\na joint case the debtor and the debtor\'s spouse receive) without regard to whether such\nincome is taxable income, derived during the 6-month period ending on\xe2\x80\x94\n(i) the last day of the calendar month immediately preceding the date of the\ncommencement of the case if the debtor files the schedule of current income\nrequired by section 521(a)(1)(B)(ii); or\n(ii) the date on which current income is determined by the court for purposes of\nthis title if the debtor does not file the schedule of current income required by\nsection 521(a)(1)(B)(ii); and\n555\n\n\x0c(B) includes any amount paid by any entity other than the debtor (or in a joint case the\ndebtor and the debtor\'s spouse), on a regular basis for the household expenses of the\ndebtor or the debtor\'s dependents (and in a joint case the debtor\'s spouse if not\notherwise a dependent), but excludes benefits received under the Social Security Act,\npayments to victims of war crimes or crimes against humanity on account of their\nstatus as victims of such crimes, and payments to victims of international terrorism (as\ndefined in section 2331 of title 18) or domestic terrorism (as defined in section 2331 of\ntitle 18) on account of their status as victims of such terrorism.\n(11) The term "custodian" means\xe2\x80\x94\n(A) receiver or trustee of any of the property of the debtor, appointed in a case or\nproceeding not under this title;\n(B) assignee under a general assignment for the benefit of the debtor\'s creditors; or\n(C) trustee, receiver, or agent under applicable law, or under a contract, that is\nappointed or authorized to take charge of property of the debtor for the purpose of\nenforcing a lien against such property, or for the purpose of general administration of\nsuch property for the benefit of the debtor\'s creditors.\n(12) The term "debt" means liability on a claim.\n(12A) The term "debt relief agency" means any person who provides any bankruptcy\nassistance to an assisted person in return for the payment of money or other valuable\nconsideration, or who is a bankruptcy petition preparer under section 110, but does not\ninclude\xe2\x80\x94\n(A) any person who is an officer, director, employee, or agent of a person who\nprovides such assistance or of the bankruptcy petition preparer;\n(B) a nonprofit organization that is exempt from taxation under section 501(c)(3) of\nthe Internal Revenue Code of 1986;\n(C) a creditor of such assisted person, to the extent that the creditor is assisting such\nassisted person to restructure any debt owed by such assisted person to the creditor;\n(D) a depository institution (as defined in section 3 of the Federal Deposit Insurance\nAct) or any Federal credit union or State credit union (as those terms are defined in\nsection 101 of the Federal Credit Union Act), or any affiliate or subsidiary of such\ndepository institution or credit union; or\n(E) an author, publisher, distributor, or seller of works subject to copyright protection\nunder title 17, when acting in such capacity.\n(13) The term "debtor" means person or municipality concerning which a case under this\ntitle has been commenced.\n(13A) The term "debtor\'s principal residence"\xe2\x80\x94\n(A) means a residential structure if used as the principal residence by the debtor,\nincluding incidental property, without regard to whether that structure is attached to\nreal property; and\n556\n\n\x0c(B) includes an individual condominium or cooperative unit, a mobile or manufactured\nhome, or trailer if used as the principal residence by the debtor.\n(14) The term "disinterested person" means a person that\xe2\x80\x94\n(A) is not a creditor, an equity security holder, or an insider;\n(B) is not and was not, within 2 years before the date of the filing of the petition, a\ndirector, officer, or employee of the debtor; and\n(C) does not have an interest materially adverse to the interest of the estate or of any\nclass of creditors or equity security holders, by reason of any direct or indirect\nrelationship to, connection with, or interest in, the debtor, or for any other reason.\n(14A) The term "domestic support obligation" means a debt that accrues before, on, or after\nthe date of the order for relief in a case under this title, including interest that accrues on that\ndebt as provided under applicable nonbankruptcy law notwithstanding any other provision of\nthis title, that is\xe2\x80\x94\n(A) owed to or recoverable by\xe2\x80\x94\n(i) a spouse, former spouse, or child of the debtor or such child\'s parent, legal\nguardian, or responsible relative; or\n(ii) a governmental unit;\n(B) in the nature of alimony, maintenance, or support (including assistance provided\nby a governmental unit) of such spouse, former spouse, or child of the debtor or such\nchild\'s parent, without regard to whether such debt is expressly so designated;\n(C) established or subject to establishment before, on, or after the date of the order for\nrelief in a case under this title, by reason of applicable provisions of\xe2\x80\x94\n(i) a separation agreement, divorce decree, or property settlement agreement;\n(ii) an order of a court of record; or\n(iii) a determination made in accordance with applicable nonbankruptcy law by a\ngovernmental unit; and\n(D) not assigned to a nongovernmental entity, unless that obligation is assigned\nvoluntarily by the spouse, former spouse, child of the debtor, or such child\'s parent,\nlegal guardian, or responsible relative for the purpose of collecting the debt.\n(15) The term "entity" includes person, estate, trust, governmental unit, and United States\ntrustee.\n(16) The term "equity security" means\xe2\x80\x94\n(A) share in a corporation, whether or not transferable or denominated "stock", or\nsimilar security;\n(B) interest of a limited partner in a limited partnership; or\n\n557\n\n\x0c(C) warrant or right, other than a right to convert, to purchase, sell, or subscribe to a\nshare, security, or interest of a kind specified in subparagraph (A) or (B) of this\nparagraph.\n(17) The term "equity security holder" means holder of an equity security of the debtor.\n(18) The term "family farmer" means\xe2\x80\x94\n(A) individual or individual and spouse engaged in a farming operation whose\naggregate debts do not exceed $3,237,000 [$4,153,150 as of April 1, 2016] and not\nless than 50 percent of whose aggregate noncontingent, liquidated debts (excluding a\ndebt for the principal residence of such individual or such individual and spouse unless\nsuch debt arises out of a farming operation), on the date the case is filed, arise out of a\nfarming operation owned or operated by such individual or such individual and\nspouse, and such individual or such individual and spouse receive from such farming\noperation more than 50 percent of such individual\'s or such individual and spouse\'s\ngross income for\xe2\x80\x94\n(i) the taxable year preceding; or\n(ii) each of the 2d and 3d taxable years preceding;\nthe taxable year in which the case concerning such individual or such individual and\nspouse was filed; or\n(B) corporation or partnership in which more than 50 percent of the outstanding stock\nor equity is held by one family, or by one family and the relatives of the members of\nsuch family, and such family or such relatives conduct the farming operation, and\n(i) more than 80 percent of the value of its assets consists of assets related to the\nfarming operation;\n(ii) its aggregate debts do not exceed $3,237,000 [$4,153,150 as of April 1,\n2016] and not less than 50 percent of its aggregate noncontingent, liquidated\ndebts (excluding a debt for one dwelling which is owned by such corporation or\npartnership and which a shareholder or partner maintains as a principal\nresidence, unless such debt arises out of a farming operation), on the date the\ncase is filed, arise out of the farming operation owned or operated by such\ncorporation or such partnership; and\n(iii) if such corporation issues stock, such stock is not publicly traded.\n(19) The term "family farmer with regular annual income" means family farmer whose\nannual income is sufficiently stable and regular to enable such family farmer to make\npayments under a plan under chapter 12 of this title.\n(19A) The term "family fisherman" means\xe2\x80\x94\n(A) an individual or individual and spouse engaged in a commercial fishing\noperation\xe2\x80\x94\n(i) whose aggregate debts do not exceed $1,500,000 [$1,924,550 as of April 1,\n2016] and not less than 80 percent of whose aggregate noncontingent, liquidated\n558\n\n\x0cdebts (excluding a debt for the principal residence of such individual or such\nindividual and spouse, unless such debt arises out of a commercial fishing\noperation), on the date the case is filed, arise out of a commercial fishing\noperation owned or operated by such individual or such individual and spouse;\nand\n(ii) who receive from such commercial fishing operation more than 50 percent of\nsuch individual\'s or such individual\'s and spouse\'s gross income for the taxable\nyear preceding the taxable year in which the case concerning such individual or\nsuch individual and spouse was filed; or\n(B) a corporation or partnership\xe2\x80\x94\n(i) in which more than 50 percent of the outstanding stock or equity is held by\xe2\x80\x94\n(I) 1 family that conducts the commercial fishing operation; or\n(II) 1 family and the relatives of the members of such family, and such family\nor such relatives conduct the commercial fishing operation; and\n(ii)\n(I) more than 80 percent of the value of its assets consists of assets related to\nthe commercial fishing operation;\n(II) its aggregate debts do not exceed $1,500,000 [$1,924,550 as of April 1,\n2016] and not less than 80 percent of its aggregate noncontingent, liquidated\ndebts (excluding a debt for 1 dwelling which is owned by such corporation or\npartnership and which a shareholder or partner maintains as a principal\nresidence, unless such debt arises out of a commercial fishing operation), on\nthe date the case is filed, arise out of a commercial fishing operation owned or\noperated by such corporation or such partnership; and\n(III) if such corporation issues stock, such stock is not publicly traded.\n(19B) The term "family fisherman with regular annual income" means a family fisherman\nwhose annual income is sufficiently stable and regular to enable such family fisherman to\nmake payments under a plan under chapter 12 of this title.\n(20) The term "farmer" means (except when such term appears in the term "family farmer")\nperson that received more than 80 percent of such person\'s gross income during the taxable\nyear of such person immediately preceding the taxable year of such person during which the\ncase under this title concerning such person was commenced from a farming operation\nowned or operated by such person.\n(21) The term "farming operation" includes farming, tillage of the soil, dairy farming,\nranching, production or raising of crops, poultry, or livestock, and production of poultry or\nlivestock products in an unmanufactured state.\n(21A) The term "farmout agreement" means a written agreement in which\xe2\x80\x94\n\n559\n\n\x0c(A) the owner of a right to drill, produce, or operate liquid or gaseous hydrocarbons on\nproperty agrees or has agreed to transfer or assign all or a part of such right to another\nentity; and\n(B) such other entity (either directly or through its agents or its assigns), as\nconsideration, agrees to perform drilling, reworking, recompleting, testing, or similar\nor related operations, to develop or produce liquid or gaseous hydrocarbons on the\nproperty.\n(21B) The term "Federal depository institutions regulatory agency" means\xe2\x80\x94\n(A) with respect to an insured depository institution (as defined in section 3(c)(2) of\nthe Federal Deposit Insurance Act) for which no conservator or receiver has been\nappointed, the appropriate Federal banking agency (as defined in section 3(q) of such\nAct);\n(B) with respect to an insured credit union (including an insured credit union for which\nthe National Credit Union Administration has been appointed conservator or\nliquidating agent), the National Credit Union Administration;\n(C) with respect to any insured depository institution for which the Resolution Trust\nCorporation has been appointed conservator or receiver, the Resolution Trust\nCorporation; and\n(D) with respect to any insured depository institution for which the Federal Deposit\nInsurance Corporation has been appointed conservator or receiver, the Federal Deposit\nInsurance Corporation.\n(22) The term "financial institution" means\xe2\x80\x94\n(A) a Federal reserve bank, or an entity that is a commercial or savings bank, industrial\nsavings bank, savings and loan association, trust company, federally-insured credit\nunion, or receiver, liquidating agent, or conservator for such entity and, when any such\nFederal reserve bank, receiver, liquidating agent, conservator or entity is acting as\nagent or custodian for a customer (whether or not a "customer", as defined in section\n741) in connection with a securities contract (as defined in section 741) such customer;\nor\n(B) in connection with a securities contract (as defined in section 741) an investment\ncompany registered under the Investment Company Act of 1940.\n(22A) The term "financial participant" means\xe2\x80\x94\n(A) an entity that, at the time it enters into a securities contract, commodity contract,\nswap agreement, repurchase agreement, or forward contract, or at the time of the date\nof the filing of the petition, has one or more agreements or transactions described in\nparagraph (1), (2), (3), (4), (5), or (6) of section 561(a) with the debtor or any other\nentity (other than an affiliate) of a total gross dollar value of not less than\n$1,000,000,000 in notional or actual principal amount outstanding (aggregated across\ncounterparties) at such time or on any day during the 15-month period preceding the\ndate of the filing of the petition, or has gross mark-to-market positions of not less than\n$100,000,000 (aggregated across counterparties) in one or more such agreements or\n560\n\n\x0ctransactions with the debtor or any other entity (other than an affiliate) at such time or\non any day during the 15-month period preceding the date of the filing of the petition;\nor\n(B) a clearing organization (as defined in section 402 of the Federal Deposit Insurance\nCorporation Improvement Act of 1991).\n(23) The term "foreign proceeding" means a collective judicial or administrative proceeding\nin a foreign country, including an interim proceeding, under a law relating to insolvency or\nadjustment of debt in which proceeding the assets and affairs of the debtor are subject to\ncontrol or supervision by a foreign court, for the purpose of reorganization or liquidation.\n(24) The term "foreign representative" means a person or body, including a person or body\nappointed on an interim basis, authorized in a foreign proceeding to administer the\nreorganization or the liquidation of the debtor\'s assets or affairs or to act as a representative\nof such foreign proceeding.\n(25) The term "forward contract" means\xe2\x80\x94\n(A) a contract (other than a commodity contract, as defined in section 761) for the\npurchase, sale, or transfer of a commodity, as defined in section 761(8) of this title, or\nany similar good, article, service, right, or interest which is presently or in the future\nbecomes the subject of dealing in the forward contract trade, or product or byproduct\nthereof, with a maturity date more than two days after the date the contract is entered\ninto, including, but not limited to, a repurchase or reverse repurchase transaction\n(whether or not such repurchase or reverse repurchase transaction is a "repurchase\nagreement", as defined in this section) 1 consignment, lease, swap, hedge transaction,\ndeposit, loan, option, allocated transaction, unallocated transaction, or any other\nsimilar agreement;\n(B) any combination of agreements or transactions referred to in subparagraphs (A)\nand (C);\n(C) any option to enter into an agreement or transaction referred to in subparagraph\n(A) or (B);\n(D) a master agreement that provides for an agreement or transaction referred to in\nsubparagraph (A), (B), or (C), together with all supplements to any such master\nagreement, without regard to whether such master agreement provides for an\nagreement or transaction that is not a forward contract under this paragraph, except\nthat such master agreement shall be considered to be a forward contract under this\nparagraph only with respect to each agreement or transaction under such master\nagreement that is referred to in subparagraph (A), (B), or (C); or\n(E) any security agreement or arrangement, or other credit enhancement related to any\nagreement or transaction referred to in subparagraph (A), (B), (C), or (D), including\nany guarantee or reimbursement obligation by or to a forward contract merchant or\nfinancial participant in connection with any agreement or transaction referred to in any\nsuch subparagraph, but not to exceed the damages in connection with any such\nagreement or transaction, measured in accordance with section 562.\n561\n\n\x0c(26) The term "forward contract merchant" means a Federal reserve bank, or an entity the\nbusiness of which consists in whole or in part of entering into forward contracts as or with\nmerchants in a commodity (as defined in section 761) or any similar good, article, service,\nright, or interest which is presently or in the future becomes the subject of dealing in the\nforward contract trade.\n(27) The term "governmental unit" means United States; State; Commonwealth; District;\nTerritory; municipality; foreign state; department, agency, or instrumentality of the United\nStates (but not a United States trustee while serving as a trustee in a case under this title), a\nState, a Commonwealth, a District, a Territory, a municipality, or a foreign state; or other\nforeign or domestic government.\n(27A) The term "health care business"\xe2\x80\x94\n(A) means any public or private entity (without regard to whether that entity is\norganized for profit or not for profit) that is primarily engaged in offering to the\ngeneral public facilities and services for\xe2\x80\x94\n(i) the diagnosis or treatment of injury, deformity, or disease; and\n(ii) surgical, drug treatment, psychiatric, or obstetric care; and\n(B) includes\xe2\x80\x94\n(i) any\xe2\x80\x94\n(I) general or specialized hospital;\n(II) ancillary ambulatory, emergency, or surgical treatment facility;\n(III) hospice;\n(IV) home health agency; and\n(V) other health care institution that is similar to an entity referred to in\nsubclause (I), (II), (III), or (IV); and\n(ii) any long-term care facility, including any\xe2\x80\x94\n(I) skilled nursing facility;\n(II) intermediate care facility;\n(III) assisted living facility;\n(IV) home for the aged;\n(V) domiciliary care facility; and\n(VI) health care institution that is related to a facility referred to in subclause\n(I), (II), (III), (IV), or (V), if that institution is primarily engaged in offering\nroom, board, laundry, or personal assistance with activities of daily living and\nincidentals to activities of daily living.\n(27B) The term "incidental property" means, with respect to a debtor\'s principal\nresidence\xe2\x80\x94\n562\n\n\x0c(A) property commonly conveyed with a principal residence in the area where the real\nproperty is located;\n(B) all easements, rights, appurtenances, fixtures, rents, royalties, mineral rights, oil or\ngas rights or profits, water rights, escrow funds, or insurance proceeds; and\n(C) all replacements or additions.\n(28) The term "indenture" means mortgage, deed of trust, or indenture, under which there is\noutstanding a security, other than a voting-trust certificate, constituting a claim against the\ndebtor, a claim secured by a lien on any of the debtor\'s property, or an equity security of the\ndebtor.\n(29) The term "indenture trustee" means trustee under an indenture.\n(30) The term "individual with regular income" means individual whose income is\nsufficiently stable and regular to enable such individual to make payments under a plan under\nchapter 13 of this title, other than a stockbroker or a commodity broker.\n(31) The term "insider" includes\xe2\x80\x94\n(A) if the debtor is an individual\xe2\x80\x94\n(i) relative of the debtor or of a general partner of the debtor;\n(ii) partnership in which the debtor is a general partner;\n(iii) general partner of the debtor; or\n(iv) corporation of which the debtor is a director, officer, or person in control;\n(B) if the debtor is a corporation\xe2\x80\x94\n(i) director of the debtor;\n(ii) officer of the debtor;\n(iii) person in control of the debtor;\n(iv) partnership in which the debtor is a general partner;\n(v) general partner of the debtor; or\n(vi) relative of a general partner, director, officer, or person in control of the\ndebtor;\n(C) if the debtor is a partnership\xe2\x80\x94\n(i) general partner in the debtor;\n(ii) relative of a general partner in, general partner of, or person in control of the\ndebtor;\n(iii) partnership in which the debtor is a general partner;\n(iv) general partner of the debtor; or\n(v) person in control of the debtor;\n563\n\n\x0c(D) if the debtor is a municipality, elected official of the debtor or relative of an\nelected official of the debtor;\n(E) affiliate, or insider of an affiliate as if such affiliate were the debtor; and\n(F) managing agent of the debtor.\n(32) The term "insolvent" means\xe2\x80\x94\n(A) with reference to an entity other than a partnership and a municipality, financial\ncondition such that the sum of such entity\'s debts is greater than all of such entity\'s\nproperty, at a fair valuation, exclusive of\xe2\x80\x94\n(i) property transferred, concealed, or removed with intent to hinder, delay, or\ndefraud such entity\'s creditors; and\n(ii) property that may be exempted from property of the estate under section 522\nof this title;\n(B) with reference to a partnership, financial condition such that the sum of such\npartnership\'s debts is greater than the aggregate of, at a fair valuation\xe2\x80\x94\n(i) all of such partnership\'s property, exclusive of property of the kind specified\nin subparagraph (A)(i) of this paragraph; and\n(ii) the sum of the excess of the value of each general partner\'s nonpartnership\nproperty, exclusive of property of the kind specified in subparagraph (A) of this\nparagraph, over such partner\'s nonpartnership debts; and\n(C) with reference to a municipality, financial condition such that the municipality\nis\xe2\x80\x94\n(i) generally not paying its debts as they become due unless such debts are the\nsubject of a bona fide dispute; or\n(ii) unable to pay its debts as they become due.\n(33) The term "institution-affiliated party"\xe2\x80\x94\n(A) with respect to an insured depository institution (as defined in section 3(c)(2) of\nthe Federal Deposit Insurance Act), has the meaning given it in section 3(u) of the\nFederal Deposit Insurance Act; and\n(B) with respect to an insured credit union, has the meaning given it in section 206(r)\nof the Federal Credit Union Act.\n(34) The term "insured credit union" has the meaning given it in section 101(7) of the\nFederal Credit Union Act.\n(35) The term "insured depository institution"\xe2\x80\x94\n(A) has the meaning given it in section 3(c)(2) of the Federal Deposit Insurance Act;\nand\n(B) includes an insured credit union (except in the case of paragraphs (21B) and\n(33)(A) of this subsection).\n564\n\n\x0c(35A) The term "intellectual property" means\xe2\x80\x94\n(A) trade secret;\n(B) invention, process, design, or plant protected under title 35;\n(C) patent application;\n(D) plant variety;\n(E) work of authorship protected under title 17; or\n(F) mask work protected under chapter 9 of title 17;\nto the extent protected by applicable nonbankruptcy law.\n(36) The term "judicial lien" means lien obtained by judgment, levy, sequestration, or other\nlegal or equitable process or proceeding.\n(37) The term "lien" means charge against or interest in property to secure payment of a debt\nor performance of an obligation.\n(38) The term "margin payment" means, for purposes of the forward contract provisions of\nthis title, payment or deposit of cash, a security or other property, that is commonly known in\nthe forward contract trade as original margin, initial margin, maintenance margin, or\nvariation margin, including mark-to-market payments, or variation payments.\n(38A) The term "master netting agreement"\xe2\x80\x94\n(A) means an agreement providing for the exercise of rights, including rights of\nnetting, setoff, liquidation, termination, acceleration, or close out, under or in\nconnection with one or more contracts that are described in any one or more of\nparagraphs (1) through (5) of section 561(a), or any security agreement or arrangement\nor other credit enhancement related to one or more of the foregoing, including any\nguarantee or reimbursement obligation related to 1 or more of the foregoing; and\n(B) if the agreement contains provisions relating to agreements or transactions that are\nnot contracts described in paragraphs (1) through (5) of section 561(a), shall be\ndeemed to be a master netting agreement only with respect to those agreements or\ntransactions that are described in any one or more of paragraphs (1) through (5) of\nsection 561(a).\n(38B) The term "master netting agreement participant" means an entity that, at any time\nbefore the date of the filing of the petition, is a party to an outstanding master netting\nagreement with the debtor.\n(39) The term "mask work" has the meaning given it in section 901(a)(2) of title 17.\n(39A) The term "median family income" means for any year\xe2\x80\x94\n(A) the median family income both calculated and reported by the Bureau of the\nCensus in the then most recent year; and\n(B) if not so calculated and reported in the then current year, adjusted annually after\nsuch most recent year until the next year in which median family income is both\ncalculated and reported by the Bureau of the Census, to reflect the percentage change\n565\n\n\x0cin the Consumer Price Index for All Urban Consumers during the period of years\noccurring after such most recent year and before such current year.\n(40) The term "municipality" means political subdivision or public agency or\ninstrumentality of a State.\n(40A) The term "patient" means any individual who obtains or receives services from a\nhealth care business.\n(40B) The term "patient records" means any record relating to a patient, including a written\ndocument or a record recorded in a magnetic, optical, or other form of electronic medium.\n(41) The term "person" includes individual, partnership, and corporation, but does not\ninclude governmental unit, except that a governmental unit that\xe2\x80\x94\n(A) acquires an asset from a person\xe2\x80\x94\n(i) as a result of the operation of a loan guarantee agreement; or\n(ii) as receiver or liquidating agent of a person;\n(B) is a guarantor of a pension benefit payable by or on behalf of the debtor or an\naffiliate of the debtor; or\n(C) is the legal or beneficial owner of an asset of\xe2\x80\x94\n(i) an employee pension benefit plan that is a governmental plan, as defined in\nsection 414(d) of the Internal Revenue Code of 1986; or\n(ii) an eligible deferred compensation plan, as defined in section 457(b) of the\nInternal Revenue Code of 1986;\nshall be considered, for purposes of section 1102 of this title, to be a person with\nrespect to such asset or such benefit.\n(41A) The term "personally identifiable information" means\xe2\x80\x94\n(A) if provided by an individual to the debtor in connection with obtaining a product\nor a service from the debtor primarily for personal, family, or household purposes\xe2\x80\x94\n(i) the first name (or initial) and last name of such individual, whether given at\nbirth or time of adoption, or resulting from a lawful change of name;\n(ii) the geographical address of a physical place of residence of such individual;\n(iii) an electronic address (including an e-mail address) of such individual;\n(iv) a telephone number dedicated to contacting such individual at such physical\nplace of residence;\n(v) a social security account number issued to such individual; or\n(vi) the account number of a credit card issued to such individual; or\n(B) if identified in connection with 1 or more of the items of information specified in\nsubparagraph (A)\xe2\x80\x94\n566\n\n\x0c(i) a birth date, the number of a certificate of birth or adoption, or a place of\nbirth; or\n(ii) any other information concerning an identified individual that, if disclosed,\nwill result in contacting or identifying such individual physically or\nelectronically.\n(42) The term "petition" means petition filed under section 301, 302, 303 and 2 1504 of this\ntitle, as the case may be, commencing a case under this title.\n(42A) The term "production payment" means a term overriding royalty satisfiable in cash\nor in kind\xe2\x80\x94\n(A) contingent on the production of a liquid or gaseous hydrocarbon from particular\nreal property; and\n(B) from a specified volume, or a specified value, from the liquid or gaseous\nhydrocarbon produced from such property, and determined without regard to\nproduction costs.\n(43) The term "purchaser" means transferee of a voluntary transfer, and includes immediate\nor mediate transferee of such a transferee.\n(44) The term "railroad" means common carrier by railroad engaged in the transportation of\nindividuals or property or owner of trackage facilities leased by such a common carrier.\n(45) The term "relative" means individual related by affinity or consanguinity within the\nthird degree as determined by the common law, or individual in a step or adoptive\nrelationship within such third degree.\n(46) The term "repo participant" means an entity that, at any time before the filing of the\npetition, has an outstanding repurchase agreement with the debtor.\n(47) The term "repurchase agreement" (which definition also applies to a reverse\nrepurchase agreement)\xe2\x80\x94\n(A) means\xe2\x80\x94\n(i) an agreement, including related terms, which provides for the transfer of one\nor more certificates of deposit, mortgage related securities (as defined in section\n3 of the Securities Exchange Act of 1934), mortgage loans, interests in mortgage\nrelated securities or mortgage loans, eligible bankers\xe2\x80\x99 acceptances, qualified\nforeign government securities (defined as a security that is a direct obligation of,\nor that is fully guaranteed by, the central government of a member of the\nOrganization for Economic Cooperation and Development), or securities that are\ndirect obligations of, or that are fully guaranteed by, the United States or any\nagency of the United States against the transfer of funds by the transferee of such\ncertificates of deposit, eligible bankers\xe2\x80\x99 acceptances, securities, mortgage loans,\nor interests, with a simultaneous agreement by such transferee to transfer to the\ntransferor thereof certificates of deposit, eligible bankers\xe2\x80\x99 acceptance, securities,\nmortgage loans, or interests of the kind described in this clause, at a date certain\n567\n\n\x0cnot later than 1 year after such transfer or on demand, against the transfer of\nfunds;\n(ii) any combination of agreements or transactions referred to in clauses (i) and\n(iii);\n(iii) an option to enter into an agreement or transaction referred to in clause (i) or\n(ii);\n(iv) a master agreement that provides for an agreement or transaction referred to\nin clause (i), (ii), or (iii), together with all supplements to any such master\nagreement, without regard to whether such master agreement provides for an\nagreement or transaction that is not a repurchase agreement under this paragraph,\nexcept that such master agreement shall be considered to be a repurchase\nagreement under this paragraph only with respect to each agreement or\ntransaction under the master agreement that is referred to in clause (i), (ii), or\n(iii); or\n(v) any security agreement or arrangement or other credit enhancement related to\nany agreement or transaction referred to in clause (i), (ii), (iii), or (iv), including\nany guarantee or reimbursement obligation by or to a repo participant or\nfinancial participant in connection with any agreement or transaction referred to\nin any such clause, but not to exceed the damages in connection with any such\nagreement or transaction, measured in accordance with section 562 of this title;\nand\n(B) does not include a repurchase obligation under a participation in a commercial\nmortgage loan.\n(48) The term "securities clearing agency" means person that is registered as a clearing\nagency under section 17A of the Securities Exchange Act of 1934, or exempt from such\nregistration under such section pursuant to an order of the Securities and Exchange\nCommission, or whose business is confined to the performance of functions of a clearing\nagency with respect to exempted securities, as defined in section 3(a)(12) of such Act for the\npurposes of such section 17A.\n(48A) The term "securities self regulatory organization" means either a securities\nassociation registered with the Securities and Exchange Commission under section 15A of\nthe Securities Exchange Act of 1934 or a national securities exchange registered with the\nSecurities and Exchange Commission under section 6 of the Securities Exchange Act of\n1934.\n(49) The term "security"\xe2\x80\x94\n(A) includes\xe2\x80\x94\n(i) note;\n(ii) stock;\n(iii) treasury stock;\n568\n\n\x0c(iv) bond;\n(v) debenture;\n(vi) collateral trust certificate;\n(vii) pre-organization certificate or subscription;\n(viii) transferable share;\n(ix) voting-trust certificate;\n(x) certificate of deposit;\n(xi) certificate of deposit for security;\n(xii) investment contract or certificate of interest or participation in a profitsharing agreement or in an oil, gas, or mineral royalty or lease, if such contract or\ninterest is required to be the subject of a registration statement filed with the\nSecurities and Exchange Commission under the provisions of the Securities Act\nof 1933, or is exempt under section 3(b) of such Act from the requirement to file\nsuch a statement;\n(xiii) interest of a limited partner in a limited partnership;\n(xiv) other claim or interest commonly known as "security"; and\n(xv) certificate of interest or participation in, temporary or interim certificate for,\nreceipt for, or warrant or right to subscribe to or purchase or sell, a security; but\n(B) does not include\xe2\x80\x94\n(i) currency, check, draft, bill of exchange, or bank letter of credit;\n(ii) leverage transaction, as defined in section 761 of this title;\n(iii) commodity futures contract or forward contract;\n(iv) option, warrant, or right to subscribe to or purchase or sell a commodity\nfutures contract;\n(v) option to purchase or sell a commodity;\n(vi) contract or certificate of a kind specified in subparagraph (A)(xii) of this\nparagraph that is not required to be the subject of a registration statement filed\nwith the Securities and Exchange Commission and is not exempt under section\n3(b) of the Securities Act of 1933 from the requirement to file such a statement;\nor\n(vii) debt or evidence of indebtedness for goods sold and delivered or services\nrendered.\n(50) The term "security agreement" means agreement that creates or provides for a security\ninterest.\n569\n\n\x0c(51) The term "security interest" means lien created by an agreement.\n(51A) The term "settlement payment" means, for purposes of the forward contract\nprovisions of this title, a preliminary settlement payment, a partial settlement payment, an\ninterim settlement payment, a settlement payment on account, a final settlement payment, a\nnet settlement payment, or any other similar payment commonly used in the forward contract\ntrade.\n(51B) The term "single asset real estate" means real property constituting a single property\nor project, other than residential real property with fewer than 4 residential units, which\ngenerates substantially all of the gross income of a debtor who is not a family farmer and on\nwhich no substantial business is being conducted by a debtor other than the business of\noperating the real property and activities incidental thereto.\n(51C) The term "small business case" means a case filed under chapter 11 of this title in\nwhich the debtor is a small business debtor.\n(51D) The term "small business debtor"\xe2\x80\x94\n(A) subject to subparagraph (B), means a person engaged in commercial or business\nactivities (including any affiliate of such person that is also a debtor under this title and\nexcluding a person whose primary activity is the business of owning or operating real\nproperty or activities incidental thereto) that has aggregate noncontingent liquidated\nsecured and unsecured debts as of the date of the filing of the petition or the date of the\norder for relief in an amount not more than $2,000,000 [$2,566,050 as of April 1,\n2016] (excluding debts owed to 1 or more affiliates or insiders) for a case in which the\nUnited States trustee has not appointed under section 1102(a)(1) a committee of\nunsecured creditors or where the court has determined that the committee of unsecured\ncreditors is not sufficiently active and representative to provide effective oversight of\nthe debtor; and\n(B) does not include any member of a group of affiliated debtors that has aggregate\nnoncontingent liquidated secured and unsecured debts in an amount greater than\n$2,000,000 [$2,566,050 as of April 1, 2016] (excluding debt owed to 1 or more\naffiliates or insiders).\n(52) The term "State" includes the District of Columbia and Puerto Rico, except for the\npurpose of defining who may be a debtor under chapter 9 of this title.\n(53) The term "statutory lien" means lien arising solely by force of a statute on specified\ncircumstances or conditions, or lien of distress for rent, whether or not statutory, but does not\ninclude security interest or judicial lien, whether or not such interest or lien is provided by or\nis dependent on a statute and whether or not such interest or lien is made fully effective by\nstatute.\n(53A) The term "stockbroker" means person\xe2\x80\x94\n(A) with respect to which there is a customer, as defined in section 741 of this title;\nand\n(B) that is engaged in the business of effecting transactions in securities\xe2\x80\x94\n570\n\n\x0c(i) for the account of others; or\n(ii) with members of the general public, from or for such person\'s own account.\n(53B) The term "swap agreement"\xe2\x80\x94\n(A) means\xe2\x80\x94\n(i) any agreement, including the terms and conditions incorporated by reference\nin such agreement, which is\xe2\x80\x94\n(I) an interest rate swap, option, future, or forward agreement, including a rate\nfloor, rate cap, rate collar, cross-currency rate swap, and basis swap;\n(II) a spot, same day-tomorrow, tomorrow-next, forward, or other foreign\nexchange, precious metals, or other commodity agreement;\n(III) a currency swap, option, future, or forward agreement;\n(IV) an equity index or equity swap, option, future, or forward agreement;\n(V) a debt index or debt swap, option, future, or forward agreement;\n(VI) a total return, credit spread or credit swap, option, future, or forward\nagreement;\n(VII) a commodity index or a commodity swap, option, future, or forward\nagreement;\n(VIII) a weather swap, option, future, or forward agreement;\n(IX) an emissions swap, option, future, or forward agreement; or\n(X) an inflation swap, option, future, or forward agreement;\n(ii) any agreement or transaction that is similar to any other agreement or\ntransaction referred to in this paragraph and that\xe2\x80\x94\n(I) is of a type that has been, is presently, or in the future becomes, the subject\nof recurrent dealings in the swap or other derivatives markets (including terms\nand conditions incorporated by reference therein); and\n(II) is a forward, swap, future, option, or spot transaction on one or more rates,\ncurrencies, commodities, equity securities, or other equity instruments, debt\nsecurities or other debt instruments, quantitative measures associated with an\noccurrence, extent of an occurrence, or contingency associated with a\nfinancial, commercial, or economic consequence, or economic or financial\nindices or measures of economic or financial risk or value;\n(iii) any combination of agreements or transactions referred to in this\nsubparagraph;\n(iv) any option to enter into an agreement or transaction referred to in this\nsubparagraph;\n\n571\n\n\x0c(v) a master agreement that provides for an agreement or transaction referred to\nin clause (i), (ii), (iii), or (iv), together with all supplements to any such master\nagreement, and without regard to whether the master agreement contains an\nagreement or transaction that is not a swap agreement under this paragraph,\nexcept that the master agreement shall be considered to be a swap agreement\nunder this paragraph only with respect to each agreement or transaction under the\nmaster agreement that is referred to in clause (i), (ii), (iii), or (iv); or\n(vi) any security agreement or arrangement or other credit enhancement related\nto any agreements or transactions referred to in clause (i) through (v), including\nany guarantee or reimbursement obligation by or to a swap participant or\nfinancial participant in connection with any agreement or transaction referred to\nin any such clause, but not to exceed the damages in connection with any such\nagreement or transaction, measured in accordance with section 562; and\n(B) is applicable for purposes of this title only, and shall not be construed or applied so\nas to challenge or affect the characterization, definition, or treatment of any swap\nagreement under any other statute, regulation, or rule, including the Gramm-LeachBliley Act, the Legal Certainty for Bank Products Act of 2000, the securities laws (as\nsuch term is defined in section 3(a)(47) of the Securities Exchange Act of 1934) and\nthe Commodity Exchange Act.\n(53C) The term "swap participant" means an entity that, at any time before the filing of the\npetition, has an outstanding swap agreement with the debtor.\n(56A) The term "term overriding royalty" means an interest in liquid or gaseous\nhydrocarbons in place or to be produced from particular real property that entitles the owner\nthereof to a share of production, or the value thereof, for a term limited by time, quantity, or\nvalue realized.\n(53D) The term "timeshare plan" means and shall include that interest purchased in any\narrangement, plan, scheme, or similar device, but not including exchange programs, whether\nby membership, agreement, tenancy in common, sale, lease, deed, rental agreement, license,\nright to use agreement, or by any other means, whereby a purchaser, in exchange for\nconsideration, receives a right to use accommodations, facilities, or recreational sites,\nwhether improved or unimproved, for a specific period of time less than a full year during\nany given year, but not necessarily for consecutive years, and which extends for a period of\nmore than three years. A "timeshare interest" is that interest purchased in a timeshare plan\nwhich grants the purchaser the right to use and occupy accommodations, facilities, or\nrecreational sites, whether improved or unimproved, pursuant to a timeshare plan.\n(54) The term "transfer" means\xe2\x80\x94\n(A) the creation of a lien;\n(B) the retention of title as a security interest;\n(C) the foreclosure of a debtor\'s equity of redemption; or\n(D) each mode, direct or indirect, absolute or conditional, voluntary or involuntary, of\ndisposing of or parting with\xe2\x80\x94\n572\n\n\x0c(i) property; or\n(ii) an interest in property.\n(54A) The term "uninsured State member bank" means a State member bank (as defined in\nsection 3 of the Federal Deposit Insurance Act) the deposits of which are not insured by the\nFederal Deposit Insurance Corporation.\n(55) The term "United States", when used in a geographical sense, includes all locations\nwhere the judicial jurisdiction of the United States extends, including territories and\npossessions of the United States.\n\xc2\xa7102. Rules of construction\nIn this title\xe2\x80\x94\n(1) "after notice and a hearing", or a similar phrase\xe2\x80\x94\n(A) means after such notice as is appropriate in the particular circumstances, and such\nopportunity for a hearing as is appropriate in the particular circumstances; but\n(B) authorizes an act without an actual hearing if such notice is given properly and\nif\xe2\x80\x94\n(i) such a hearing is not requested timely by a party in interest; or\n(ii) there is insufficient time for a hearing to be commenced before such act must\nbe done, and the court authorizes such act;\n(2) "claim against the debtor" includes claim against property of the debtor;\n(3) "includes" and "including" are not limiting;\n(4) "may not" is prohibitive, and not permissive;\n(5) "or" is not exclusive;\n(6) "order for relief" means entry of an order for relief;\n(7) the singular includes the plural;\n(8) a definition, contained in a section of this title that refers to another section of this title,\ndoes not, for the purpose of such reference, affect the meaning of a term used in such other\nsection; and\n(9) "United States trustee" includes a designee of the United States trustee.\n\xc2\xa7103. Applicability of chapters\n(a) Except as provided in section 1161 of this title, chapters 1, 3, and 5 of this title apply in a\ncase under chapter 7, 11, 12, or 13 of this title, and this chapter, sections 307, 362(o), 555\nthrough 557, and 559 through 562 apply in a case under chapter 15.\n(b) Subchapters I and II of chapter 7 of this title apply only in a case under such chapter.\n(c) Subchapter III of chapter 7 of this title applies only in a case under such chapter\nconcerning a stockbroker.\n573\n\n\x0c(d) Subchapter IV of chapter 7 of this title applies only in a case under such chapter\nconcerning a commodity broker.\n(e) Scope of Application.\xe2\x80\x94Subchapter V of chapter 7 of this title shall apply only in a case\nunder such chapter concerning the liquidation of an uninsured State member bank, or a\ncorporation organized under section 25A of the Federal Reserve Act, which operates, or\noperates as, a multilateral clearing organization pursuant to section 409 of the Federal\nDeposit Insurance Corporation Improvement Act of 1991.\n(f) Except as provided in section 901 of this title, only chapters 1 and 9 of this title apply in a\ncase under such chapter 9.\n(g) Except as provided in section 901 of this title, subchapters I, II, and III of chapter 11 of\nthis title apply only in a case under such chapter.\n(h) Subchapter IV of chapter 11 of this title applies only in a case under such chapter\nconcerning a railroad.\n(i) Chapter 13 of this title applies only in a case under such chapter.\n(j) Chapter 12 of this title applies only in a case under such chapter.\n(k) Chapter 15 applies only in a case under such chapter, except that\xe2\x80\x94\n(1) sections 1505, 1513, and 1514 apply in all cases under this title; and\n(2) section 1509 applies whether or not a case under this title is pending.\n\xc2\xa7104. Adjustment of dollar amounts\n(a) On April 1, 1998, and at each 3-year interval ending on April 1 thereafter, each dollar\namount in effect under sections 101(3), 101(18), 101(19A), 101(51D), 109(e), 303(b),\n507(a), 522(d), 522(f)(3) and 522(f)(4), 522(n), 522(p), 522(q), 523(a)(2)(C), 541(b),\n547(c)(9), 707(b), 1322(d), 1325(b), and 1326(b)(3) of this title and section 1409(b) of title\n28 immediately before such April 1 shall be adjusted\xe2\x80\x94\n(1) to reflect the change in the Consumer Price Index for All Urban Consumers,\npublished by the Department of Labor, for the most recent 3-year period ending\nimmediately before January 1 preceding such April 1, and\n(2) to round to the nearest $25 the dollar amount that represents such change.\n(b) Not later than March 1, 1998, and at each 3-year interval ending on March 1 thereafter,\nthe Judicial Conference of the United States shall publish in the Federal Register the dollar\namounts that will become effective on such April 1 under sections 101(3), 101(18),\n101(19A), 101(51D), 109(e), 303(b), 507(a), 522(d), 522(f)(3) and 522(f)(4), 522(n), 522(p),\n522(q), 523(a)(2)(C), 541(b), 547(c)(9), 707(b), 1322(d), 1325(b), and 1326(b)(3) of this title\nand section 1409(b) of title 28.\n(c) Adjustments made in accordance with subsection (a) shall not apply with respect to cases\ncommenced before the date of such adjustments.\n\xc2\xa7105. Power of court\n574\n\n\x0c(a) The court may issue any order, process, or judgment that is necessary or appropriate to\ncarry out the provisions of this title. No provision of this title providing for the raising of an\nissue by a party in interest shall be construed to preclude the court from, sua sponte, taking\nany action or making any determination necessary or appropriate to enforce or implement\ncourt orders or rules, or to prevent an abuse of process.\n(b) Notwithstanding subsection (a) of this section, a court may not appoint a receiver\nin a case under this title.\n(c) The ability of any district judge or other officer or employee of a district court to\nexercise any of the authority or responsibilities conferred upon the court under this\ntitle shall be determined by reference to the provisions relating to such judge, officer,\nor employee set forth in title 28. This subsection shall not be interpreted to exclude\nbankruptcy judges and other officers or employees appointed pursuant to chapter 6 of\ntitle 28 from its operation.\n(d) The court, on its own motion or on the request of a party in interest\xe2\x80\x94\n(1) shall hold such status conferences as are necessary to further the expeditious\nand economical resolution of the case; and\n(2) unless inconsistent with another provision of this title or with applicable\nFederal Rules of Bankruptcy Procedure, may issue an order at any such\nconference prescribing such limitations and conditions as the court deems\nappropriate to ensure that the case is handled expeditiously and economically,\nincluding an order that\xe2\x80\x94\n(A) sets the date by which the trustee must assume or reject an executory\ncontract or unexpired lease; or\n(B) in a case under chapter 11 of this title\xe2\x80\x94\n(i) sets a date by which the debtor, or trustee if one has been appointed,\nshall file a disclosure statement and plan;\n(ii) sets a date by which the debtor, or trustee if one has been appointed,\nshall solicit acceptances of a plan;\n(iii) sets the date by which a party in interest other than a debtor may file\na plan;\n(iv) sets a date by which a proponent of a plan, other than the debtor,\nshall solicit acceptances of such plan;\n(v) fixes the scope and format of the notice to be provided regarding the\nhearing on approval of the disclosure statement; or\n(vi) provides that the hearing on approval of the disclosure statement\nmay be combined with the hearing on confirmation of the plan.\n\xc2\xa7106. Waiver of sovereign immunity\n(a) Notwithstanding an assertion of sovereign immunity, sovereign immunity is abrogated as\nto a governmental unit to the extent set forth in this section with respect to the following:\n575\n\n\x0c(1) Sections 105, 106, 107, 108, 303, 346, 362, 363, 364, 365, 366, 502, 503, 505, 506,\n510, 522, 523, 524, 525, 542, 543, 544, 545, 546, 547, 548, 549, 550, 551, 552, 553,\n722, 724, 726, 744, 749, 764, 901, 922, 926, 928, 929, 944, 1107, 1141, 1142, 1143,\n1146, 1201, 1203, 1205, 1206, 1227, 1231, 1301, 1303, 1305, and 1327 of this title.\n(2) The court may hear and determine any issue arising with respect to the application\nof such sections to governmental units.\n(3) The court may issue against a governmental unit an order, process, or judgment\nunder such sections or the Federal Rules of Bankruptcy Procedure, including an order\nor judgment awarding a money recovery, but not including an award of punitive\ndamages. Such order or judgment for costs or fees under this title or the Federal Rules\nof Bankruptcy Procedure against any governmental unit shall be consistent with the\nprovisions and limitations of section 2412(d)(2)(A) of title 28.\n(4) The enforcement of any such order, process, or judgment against any governmental\nunit shall be consistent with appropriate nonbankruptcy law applicable to such\ngovernmental unit and, in the case of a money judgment against the United States,\nshall be paid as if it is a judgment rendered by a district court of the United States.\n(5) Nothing in this section shall create any substantive claim for relief or cause of\naction not otherwise existing under this title, the Federal Rules of Bankruptcy\nProcedure, or nonbankruptcy law.\n(b) A governmental unit that has filed a proof of claim in the case is deemed to have waived\nsovereign immunity with respect to a claim against such governmental unit that is property of\nthe estate and that arose out of the same transaction or occurrence out of which the claim of\nsuch governmental unit arose.\n(c) Notwithstanding any assertion of sovereign immunity by a governmental unit, there shall\nbe offset against a claim or interest of a governmental unit any claim against such\ngovernmental unit that is property of the estate.\n\xc2\xa7107. Public access to papers\n(a) Except as provided in subsections (b) and (c) and subject to section 112, a paper filed in a\ncase under this title and the dockets of a bankruptcy court are public records and open to\nexamination by an entity at reasonable times without charge.\n(b) On request of a party in interest, the bankruptcy court shall, and on the bankruptcy court\'s\nown motion, the bankruptcy court may\xe2\x80\x94\n(1) protect an entity with respect to a trade secret or confidential research,\ndevelopment, or commercial information; or\n(2) protect a person with respect to scandalous or defamatory matter contained in a\npaper filed in a case under this title.\n(c)\n(1) The bankruptcy court, for cause, may protect an individual, with respect to the\nfollowing types of information to the extent the court finds that disclosure of such\n576\n\n\x0cinformation would create undue risk of identity theft or other unlawful injury to the\nindividual or the individual\'s property:\n(A) Any means of identification (as defined in section 1028(d) of title 18)\ncontained in a paper filed, or to be filed, in a case under this title.\n(B) Other information contained in a paper described in subparagraph (A).\n(2) Upon ex parte application demonstrating cause, the court shall provide access to\ninformation protected pursuant to paragraph (1) to an entity acting pursuant to the\npolice or regulatory power of a domestic governmental unit.\n(3) The United States trustee, bankruptcy administrator, trustee, and any auditor\nserving under section 586(f) of title 28\xe2\x80\x94\n(A) shall have full access to all information contained in any paper filed or\nsubmitted in a case under this title; and\n(B) shall not disclose information specifically protected by the court under this\ntitle.\n\xc2\xa7108. Extension of time\n(a) If applicable nonbankruptcy law, an order entered in a nonbankruptcy proceeding, or an\nagreement fixes a period within which the debtor may commence an action, and such period\nhas not expired before the date of the filing of the petition, the trustee may commence such\naction only before the later of\xe2\x80\x94\n(1) the end of such period, including any suspension of such period occurring on or\nafter the commencement of the case; or\n(2) two years after the order for relief.\n(b) Except as provided in subsection (a) of this section, if applicable nonbankruptcy law, an\norder entered in a nonbankruptcy proceeding, or an agreement fixes a period within which\nthe debtor or an individual protected under section 1201 or 1301 of this title may file any\npleading, demand, notice, or proof of claim or loss, cure a default, or perform any other\nsimilar act, and such period has not expired before the date of the filing of the petition, the\ntrustee may only file, cure, or perform, as the case may be, before the later of\xe2\x80\x94\n(1) the end of such period, including any suspension of such period occurring on or\nafter the commencement of the case; or\n(2) 60 days after the order for relief.\n(c) Except as provided in section 524 of this title, if applicable nonbankruptcy law, an order\nentered in a nonbankruptcy proceeding, or an agreement fixes a period for commencing or\ncontinuing a civil action in a court other than a bankruptcy court on a claim against the\ndebtor, or against an individual with respect to which such individual is protected under\nsection 1201 or 1301 of this title, and such period has not expired before the date of the filing\nof the petition, then such period does not expire until the later of\xe2\x80\x94\n(1) the end of such period, including any suspension of such period occurring on or\nafter the commencement of the case; or\n577\n\n\x0c(2) 30 days after notice of the termination or expiration of the stay under section 362,\n922, 1201, or 1301 of this title, as the case may be, with respect to such claim.\n\xc2\xa7109. Who may be a debtor\n(a) Notwithstanding any other provision of this section, only a person that resides or has a\ndomicile, a place of business, or property in the United States, or a municipality, may be a\ndebtor under this title.\n(b) A person may be a debtor under chapter 7 of this title only if such person is not\xe2\x80\x94\n(1) a railroad;\n(2) a domestic insurance company, bank, savings bank, cooperative bank, savings and\nloan association, building and loan association, homestead association, a New Markets\nVenture Capital company as defined in section 351 of the Small Business Investment\nAct of 1958, a small business investment company licensed by the Small Business\nAdministration under section 301 of the Small Business Investment Act of 1958, credit\nunion, or industrial bank or similar institution which is an insured bank as defined in\nsection 3(h) of the Federal Deposit Insurance Act, except that an uninsured State\nmember bank, or a corporation organized under section 25A of the Federal Reserve\nAct, which operates, or operates as, a multilateral clearing organization pursuant to\nsection 409 of the Federal Deposit Insurance Corporation Improvement Act of 1991\nmay be a debtor if a petition is filed at the direction of the Board of Governors of the\nFederal Reserve System; or\n(3)\n(A) a foreign insurance company, engaged in such business in the United States;\nor\n(B) a foreign bank, savings bank, cooperative bank, savings and loan association,\nbuilding and loan association, or credit union, that has a branch or agency (as\ndefined in section 1(b) of the International Banking Act of 1978) in the United\nStates.\n(c) An entity may be a debtor under chapter 9 of this title if and only if such entity\xe2\x80\x94\n(1) is a municipality;\n(2) is specifically authorized, in its capacity as a municipality or by name, to be a\ndebtor under such chapter by State law, or by a governmental officer or organization\nempowered by State law to authorize such entity to be a debtor under such chapter;\n(3) is insolvent;\n(4) desires to effect a plan to adjust such debts; and\n(5)\n(A) has obtained the agreement of creditors holding at least a majority in amount\nof the claims of each class that such entity intends to impair under a plan in a\ncase under such chapter;\n578\n\n\x0c(B) has negotiated in good faith with creditors and has failed to obtain the\nagreement of creditors holding at least a majority in amount of the claims of each\nclass that such entity intends to impair under a plan in a case under such chapter;\n(C) is unable to negotiate with creditors because such negotiation is\nimpracticable; or\n(D) reasonably believes that a creditor may attempt to obtain a transfer that is\navoidable under section 547 of this title.\n(d) Only a railroad, a person that may be a debtor under chapter 7 of this title (except a\nstockbroker or a commodity broker), and an uninsured State member bank, or a corporation\norganized under section 25A of the Federal Reserve Act, which operates, or operates as, a\nmultilateral clearing organization pursuant to section 409 of the Federal Deposit Insurance\nCorporation Improvement Act of 1991 may be a debtor under chapter 11 of this title.\n(e) Only an individual with regular income that owes, on the date of the filing of the petition,\nnoncontingent, liquidated, unsecured debts of less than $250,000 [$394,725 as of April 1,\n2016] and noncontingent, liquidated, secured debts of less than $750,000 [$1,184,200 as of\nApril 1, 2016], or an individual with regular income and such individual\'s spouse, except a\nstockbroker or a commodity broker, that owe, on the date of the filing of the petition,\nnoncontingent, liquidated, unsecured debts that aggregate less than $250,000 [$394,725 as of\nApril 1, 2016] and noncontingent, liquidated, secured debts of less than $750,000\n[$1,184,200 as of April 1, 2016] may be a debtor under chapter 13 of this title.\n(f) Only a family farmer or family fisherman with regular annual income may be a debtor\nunder chapter 12 of this title.\n(g) Notwithstanding any other provision of this section, no individual or family farmer may\nbe a debtor under this title who has been a debtor in a case pending under this title at any\ntime in the preceding 180 days if\xe2\x80\x94\n(1) the case was dismissed by the court for willful failure of the debtor to abide by\norders of the court, or to appear before the court in proper prosecution of the case; or\n(2) the debtor requested and obtained the voluntary dismissal of the case following the\nfiling of a request for relief from the automatic stay provided by section 362 of this\ntitle.\n(h)\n(1) Subject to paragraphs (2) and (3), and notwithstanding any other provision of this\nsection other than paragraph (4) of this subsection, an individual may not be a debtor\nunder this title unless such individual has, during the 180-day period ending on the\ndate of filing of the petition by such individual, received from an approved nonprofit\nbudget and credit counseling agency described in section 111(a) an individual or group\nbriefing (including a briefing conducted by telephone or on the Internet) that outlined\nthe opportunities for available credit counseling and assisted such individual in\nperforming a related budget analysis.\n(2)\n579\n\n\x0c(A) Paragraph (1) shall not apply with respect to a debtor who resides in a\ndistrict for which the United States trustee (or the bankruptcy administrator, if\nany) determines that the approved nonprofit budget and credit counseling\nagencies for such district are not reasonably able to provide adequate services to\nthe additional individuals who would otherwise seek credit counseling from such\nagencies by reason of the requirements of paragraph (1).\n(B) The United States trustee (or the bankruptcy administrator, if any) who\nmakes a determination described in subparagraph (A) shall review such\ndetermination not later than 1 year after the date of such determination, and not\nless frequently than annually thereafter. Notwithstanding the preceding sentence,\na nonprofit budget and credit counseling agency may be disapproved by the\nUnited States trustee (or the bankruptcy administrator, if any) at any time.\n(3)\n(A) Subject to subparagraph (B), the requirements of paragraph (1) shall not\napply with respect to a debtor who submits to the court a certification that\xe2\x80\x94\n(i) describes exigent circumstances that merit a waiver of the\nrequirements of paragraph (1);\n(ii) states that the debtor requested credit counseling services from an\napproved nonprofit budget and credit counseling agency, but was unable\nto obtain the services referred to in paragraph (1) during the 7-day\nperiod beginning on the date on which the debtor made that request; and\n(iii) is satisfactory to the court.\n(B) With respect to a debtor, an exemption under subparagraph (A) shall cease\nto apply to that debtor on the date on which the debtor meets the requirements\nof paragraph (1), but in no case may the exemption apply to that debtor after\nthe date that is 30 days after the debtor files a petition, except that the court,\nfor cause, may order an additional 15 days.\n(4) The requirements of paragraph (1) shall not apply with respect to a debtor\nwhom the court determines, after notice and hearing, is unable to complete those\nrequirements because of incapacity, disability, or active military duty in a\nmilitary combat zone. For the purposes of this paragraph, incapacity means that\nthe debtor is impaired by reason of mental illness or mental deficiency so that he\nis incapable of realizing and making rational decisions with respect to his\nfinancial responsibilities; and "disability" means that the debtor is so physically\nimpaired as to be unable, after reasonable effort, to participate in an in person,\ntelephone, or Internet briefing required under paragraph (1).\n\xc2\xa7110. Penalty for persons who negligently or fraudulently prepare bankruptcy petitions\n(a) In this section\xe2\x80\x94\n\n580\n\n\x0c(1) "bankruptcy petition preparer" means a person, other than an attorney for the\ndebtor or an employee of such attorney under the direct supervision of such attorney,\nwho prepares for compensation a document for filing; and\n(2) "document for filing" means a petition or any other document prepared for filing\nby a debtor in a United States bankruptcy court or a United States district court in\nconnection with a case under this title.\n(b)\n(1) A bankruptcy petition preparer who prepares a document for filing shall sign the\ndocument and print on the document the preparer\'s name and address. If a bankruptcy\npetition preparer is not an individual, then an officer, principal, responsible person, or\npartner of the bankruptcy petition preparer shall be required to\xe2\x80\x94\n(A) sign the document for filing; and\n(B) print on the document the name and address of that officer, principal,\nresponsible person, or partner.\n(2)\n(A) Before preparing any document for filing or accepting any fees from or on\nbehalf of a debtor, the bankruptcy petition preparer shall provide to the debtor a\nwritten notice which shall be on an official form prescribed by the Judicial\nConference of the United States in accordance with rule 9009 of the Federal\nRules of Bankruptcy Procedure.\n(B) The notice under subparagraph (A)\xe2\x80\x94\n(i) shall inform the debtor in simple language that a bankruptcy petition\npreparer is not an attorney and may not practice law or give legal advice;\n(ii) may contain a description of examples of legal advice that a bankruptcy\npetition preparer is not authorized to give, in addition to any advice that the\npreparer may not give by reason of subsection (e)(2); and\n(iii) shall\xe2\x80\x94\n(I) be signed by the debtor and, under penalty of perjury, by the\nbankruptcy petition preparer; and\n(II) be filed with any document for filing.\n(c)\n(1) A bankruptcy petition preparer who prepares a document for filing shall place on\nthe document, after the preparer\'s signature, an identifying number that identifies\nindividuals who prepared the document.\n(2)\n(A) Subject to subparagraph (B), for purposes of this section, the identifying\nnumber of a bankruptcy petition preparer shall be the Social Security account\n581\n\n\x0cnumber of each individual who prepared the document or assisted in its\npreparation.\n(B) If a bankruptcy petition preparer is not an individual, the identifying number\nof the bankruptcy petition preparer shall be the Social Security account number\nof the officer, principal, responsible person, or partner of the bankruptcy petition\npreparer.\n(d) A bankruptcy petition preparer shall, not later than the time at which a document for\nfiling is presented for the debtor\'s signature, furnish to the debtor a copy of the document.\n(e)\n(1) A bankruptcy petition preparer shall not execute any document on behalf of a\ndebtor.\n(2)\n(A) A bankruptcy petition preparer may not offer a potential bankruptcy debtor\nany legal advice, including any legal advice described in subparagraph (B).\n(B) The legal advice referred to in subparagraph (A) includes advising the\ndebtor\xe2\x80\x94\n(i) whether\xe2\x80\x94\n(I) to file a petition under this title; or\n(II) commencing a case under chapter 7, 11, 12, or 13 is appropriate;\n(ii) whether the debtor\'s debts will be discharged in a case under this title;\n(iii) whether the debtor will be able to retain the debtor\'s home, car, or other\nproperty after commencing a case under this title;\n(iv) concerning\xe2\x80\x94\n(I) the tax consequences of a case brought under this title; or\n(II) the dischargeability of tax claims;\n(v) whether the debtor may or should promise to repay debts to a creditor or\nenter into a reaffirmation agreement with a creditor to reaffirm a debt;\n(vi) concerning how to characterize the nature of the debtor\'s interests in\nproperty or the debtor\'s debts; or\n(vii) concerning bankruptcy procedures and rights.\n(f) A bankruptcy petition preparer shall not use the word "legal" or any similar term in any\nadvertisements, or advertise under any category that includes the word "legal" or any similar\nterm.\n(g) A bankruptcy petition preparer shall not collect or receive any payment from the debtor\nor on behalf of the debtor for the court fees in connection with filing the petition.\n(h)\n582\n\n\x0c(1) The Supreme Court may promulgate rules under section 2075 of title 28, or the\nJudicial Conference of the United States may prescribe guidelines, for setting a\nmaximum allowable fee chargeable by a bankruptcy petition preparer. A bankruptcy\npetition preparer shall notify the debtor of any such maximum amount before\npreparing any document for filing for the debtor or accepting any fee from or on behalf\nof the debtor.\n(2) A declaration under penalty of perjury by the bankruptcy petition preparer shall be\nfiled together with the petition, disclosing any fee received from or on behalf of the\ndebtor within 12 months immediately prior to the filing of the case, and any unpaid fee\ncharged to the debtor. If rules or guidelines setting a maximum fee for services have\nbeen promulgated or prescribed under paragraph (1), the declaration under this\nparagraph shall include a certification that the bankruptcy petition preparer complied\nwith the notification requirement under paragraph (1).\n(3)\n(A) The court shall disallow and order the immediate turnover to the bankruptcy\ntrustee any fee referred to in paragraph (2)\xe2\x80\x94\n(i) found to be in excess of the value of any services rendered by the\nbankruptcy petition preparer during the 12-month period immediately\npreceding the date of the filing of the petition; or\n(ii) found to be in violation of any rule or guideline promulgated or prescribed\nunder paragraph (1).\n(B) All fees charged by a bankruptcy petition preparer may be forfeited in any\ncase in which the bankruptcy petition preparer fails to comply with this\nsubsection or subsection (b), (c), (d), (e), (f), or (g).\n(C) An individual may exempt any funds recovered under this paragraph under\nsection 522(b).\n(4) The debtor, the trustee, a creditor, the United States trustee (or the bankruptcy\nadministrator, if any) or the court, on the initiative of the court, may file a motion for\nan order under paragraph (3).\n(5) A bankruptcy petition preparer shall be fined not more than $500 for each failure to\ncomply with a court order to turn over funds within 30 days of service of such order.\n(i)\n(1) If a bankruptcy petition preparer violates this section or commits any act that the\ncourt finds to be fraudulent, unfair, or deceptive, on the motion of the debtor, trustee,\nUnited States trustee (or the bankruptcy administrator, if any), and after notice and a\nhearing, the court shall order the bankruptcy petition preparer to pay to the debtor\xe2\x80\x94\n(A) the debtor\'s actual damages;\n(B) the greater of\xe2\x80\x94\n(i) $2,000; or\n583\n\n\x0c(ii) twice the amount paid by the debtor to the bankruptcy petition preparer for\nthe preparer\'s services; and\n(C) reasonable attorneys\xe2\x80\x99 fees and costs in moving for damages under this\nsubsection.\n(2) If the trustee or creditor moves for damages on behalf of the debtor under this\nsubsection, the bankruptcy petition preparer shall be ordered to pay the movant the\nadditional amount of $1,000 plus reasonable attorneys\xe2\x80\x99 fees and costs incurred.\n(j)\n(1) A debtor for whom a bankruptcy petition preparer has prepared a document for\nfiling, the trustee, a creditor, or the United States trustee in the district in which the\nbankruptcy petition preparer resides, has conducted business, or the United States\ntrustee in any other district in which the debtor resides may bring a civil action to\nenjoin a bankruptcy petition preparer from engaging in any conduct in violation of this\nsection or from further acting as a bankruptcy petition preparer.\n(2)\n(A) In an action under paragraph (1), if the court finds that\xe2\x80\x94\n(i) a bankruptcy petition preparer has\xe2\x80\x94\n(I) engaged in conduct in violation of this section or of any provision of\nthis title;\n(II) misrepresented the preparer\'s experience or education as a\nbankruptcy petition preparer; or\n(III) engaged in any other fraudulent, unfair, or deceptive conduct; and\n(ii) injunctive relief is appropriate to prevent the recurrence of such conduct,\nthe court may enjoin the bankruptcy petition preparer from engaging in such\nconduct.\n(B) If the court finds that a bankruptcy petition preparer has continually engaged\nin conduct described in subclause (I), (II), or (III) of clause (i) and that an\ninjunction prohibiting such conduct would not be sufficient to prevent such\nperson\'s interference with the proper administration of this title, has not paid a\npenalty imposed under this section, or failed to disgorge all fees ordered by the\ncourt the court may enjoin the person from acting as a bankruptcy petition\npreparer.\n(3) The court, as part of its contempt power, may enjoin a bankruptcy petition preparer\nthat has failed to comply with a previous order issued under this section. The\ninjunction under this paragraph may be issued on the motion of the court, the trustee,\nor the United States trustee (or the bankruptcy administrator, if any).\n(4) The court shall award to a debtor, trustee, or creditor that brings a successful action\nunder this subsection reasonable attorneys\xe2\x80\x99 fees and costs of the action, to be paid by\nthe bankruptcy petition preparer.\n584\n\n\x0c(k) Nothing in this section shall be construed to permit activities that are otherwise prohibited\nby law, including rules and laws that prohibit the unauthorized practice of law.\n(l)\n(1) A bankruptcy petition preparer who fails to comply with any provision of\nsubsection (b), (c), (d), (e), (f), (g), or (h) may be fined not more than $500 for each\nsuch failure.\n(2) The court shall triple the amount of a fine assessed under paragraph (1) in any case\nin which the court finds that a bankruptcy petition preparer\xe2\x80\x94\n(A) advised the debtor to exclude assets or income that should have been\nincluded on applicable schedules;\n(B) advised the debtor to use a false Social Security account number;\n(C) failed to inform the debtor that the debtor was filing for relief under this title;\nor\n(D) prepared a document for filing in a manner that failed to disclose the identity\nof the bankruptcy petition preparer.\n(3) A debtor, trustee, creditor, or United States trustee (or the bankruptcy\nadministrator, if any) may file a motion for an order imposing a fine on the bankruptcy\npetition preparer for any violation of this section.\n(4)\n(A) Fines imposed under this subsection in judicial districts served by United\nStates trustees shall be paid to the United States trustees, who shall deposit an\namount equal to such fines in the United States Trustee Fund.\n(B) Fines imposed under this subsection in judicial districts served by\nbankruptcy administrators shall be deposited as offsetting receipts to the fund\nestablished under section 1931 of title 28, and shall remain available until\nexpended to reimburse any appropriation for the amount paid out of such\nappropriation for expenses of the operation and maintenance of the courts of the\nUnited States.\n\xc2\xa7111. Nonprofit budget and credit counseling agencies; financial management instructional\ncourses\n(a) The clerk shall maintain a publicly available list of\xe2\x80\x94\n(1) nonprofit budget and credit counseling agencies that provide 1 or more services\ndescribed in section 109(h) currently approved by the United States trustee (or the\nbankruptcy administrator, if any); and\n(2) instructional courses concerning personal financial management currently\napproved by the United States trustee (or the bankruptcy administrator, if any), as\napplicable.\n585\n\n\x0c(b) The United States trustee (or bankruptcy administrator, if any) shall only approve a\nnonprofit budget and credit counseling agency or an instructional course concerning personal\nfinancial management as follows:\n(1) The United States trustee (or bankruptcy administrator, if any) shall have\nthoroughly reviewed the qualifications of the nonprofit budget and credit counseling\nagency or of the provider of the instructional course under the standards set forth in\nthis section, and the services or instructional courses that will be offered by such\nagency or such provider, and may require such agency or such provider that has sought\napproval to provide information with respect to such review.\n(2) The United States trustee (or bankruptcy administrator, if any) shall have\ndetermined that such agency or such instructional course fully satisfies the applicable\nstandards set forth in this section.\n(3) If a nonprofit budget and credit counseling agency or instructional course did not\nappear on the approved list for the district under subsection (a) immediately before\napproval under this section, approval under this subsection of such agency or such\ninstructional course shall be for a probationary period not to exceed 6 months.\n(4) At the conclusion of the applicable probationary period under paragraph (3), the\nUnited States trustee (or bankruptcy administrator, if any) may only approve for an\nadditional 1-year period, and for successive 1-year periods thereafter, an agency or\ninstructional course that has demonstrated during the probationary or applicable\nsubsequent period of approval that such agency or instructional course\xe2\x80\x94\n(A) has met the standards set forth under this section during such period; and\n(B) can satisfy such standards in the future.\n(5) Not later than 30 days after any final decision under paragraph (4), an interested\nperson may seek judicial review of such decision in the appropriate district court of the\nUnited States.\n(c)\n(1) The United States trustee (or the bankruptcy administrator, if any) shall only\napprove a nonprofit budget and credit counseling agency that demonstrates that it will\nprovide qualified counselors, maintain adequate provision for safekeeping and\npayment of client funds, provide adequate counseling with respect to client credit\nproblems, and deal responsibly and effectively with other matters relating to the\nquality, effectiveness, and financial security of the services it provides.\n(2) To be approved by the United States trustee (or the bankruptcy administrator, if\nany), a nonprofit budget and credit counseling agency shall, at a minimum\xe2\x80\x94\n(A) have a board of directors the majority of which\xe2\x80\x94\n(i) are not employed by such agency; and\n(ii) will not directly or indirectly benefit financially from the outcome of the\ncounseling services provided by such agency;\n586\n\n\x0c(B) if a fee is charged for counseling services, charge a reasonable fee, and\nprovide services without regard to ability to pay the fee;\n(C) provide for safekeeping and payment of client funds, including an annual\naudit of the trust accounts and appropriate employee bonding;\n(D) provide full disclosures to a client, including funding sources, counselor\nqualifications, possible impact on credit reports, and any costs of such program\nthat will be paid by such client and how such costs will be paid;\n(E) provide adequate counseling with respect to a client\'s credit problems that\nincludes an analysis of such client\'s current financial condition, factors that\ncaused such financial condition, and how such client can develop a plan to\nrespond to the problems without incurring negative amortization of debt;\n(F) provide trained counselors who receive no commissions or bonuses based on\nthe outcome of the counseling services provided by such agency, and who have\nadequate experience, and have been adequately trained to provide counseling\nservices to individuals in financial difficulty, including the matters described in\nsubparagraph (E);\n(G) demonstrate adequate experience and background in providing credit\ncounseling; and\n(H) have adequate financial resources to provide continuing support services for\nbudgeting plans over the life of any repayment plan.\n(d) The United States trustee (or the bankruptcy administrator, if any) shall only approve an\ninstructional course concerning personal financial management\xe2\x80\x94\n(1) for an initial probationary period under subsection (b)(3) if the course will provide\nat a minimum\xe2\x80\x94\n(A) trained personnel with adequate experience and training in providing\neffective instruction and services;\n(B) learning materials and teaching methodologies designed to assist debtors in\nunderstanding personal financial management and that are consistent with stated\nobjectives directly related to the goals of such instructional course;\n(C) adequate facilities situated in reasonably convenient locations at which such\ninstructional course is offered, except that such facilities may include the\nprovision of such instructional course by telephone or through the Internet, if\nsuch instructional course is effective;\n(D) the preparation and retention of reasonable records (which shall include the\ndebtor\'s bankruptcy case number) to permit evaluation of the effectiveness of\nsuch instructional course, including any evaluation of satisfaction of instructional\ncourse requirements for each debtor attending such instructional course, which\nshall be available for inspection and evaluation by the Executive Office for\nUnited States Trustees, the United States trustee (or the bankruptcy\n587\n\n\x0cadministrator, if any), or the chief bankruptcy judge for the district in which such\ninstructional course is offered; and\n(E) if a fee is charged for the instructional course, charge a reasonable fee, and\nprovide services without regard to ability to pay the fee; and\n(2) for any 1-year period if the provider thereof has demonstrated that the course meets\nthe standards of paragraph (1) and, in addition\xe2\x80\x94\n(A) has been effective in assisting a substantial number of debtors to understand\npersonal financial management; and\n(B) is otherwise likely to increase substantially the debtor\'s understanding of\npersonal financial management.\n(e) The district court may, at any time, investigate the qualifications of a nonprofit budget\nand credit counseling agency referred to in subsection (a), and request production of\ndocuments to ensure the integrity and effectiveness of such agency. The district court may, at\nany time, remove from the approved list under subsection (a) a nonprofit budget and credit\ncounseling agency upon finding such agency does not meet the qualifications of subsection\n(b).\n(f) The United States trustee (or the bankruptcy administrator, if any) shall notify the clerk\nthat a nonprofit budget and credit counseling agency or an instructional course is no longer\napproved, in which case the clerk shall remove it from the list maintained under subsection\n(a).\n(g)\n(1) No nonprofit budget and credit counseling agency may provide to a credit\nreporting agency information concerning whether a debtor has received or sought\ninstruction concerning personal financial management from such agency.\n(2) A nonprofit budget and credit counseling agency that willfully or negligently fails\nto comply with any requirement under this title with respect to a debtor shall be liable\nfor damages in an amount equal to the sum of\xe2\x80\x94\n(A) any actual damages sustained by the debtor as a result of the violation; and\n(B) any court costs or reasonable attorneys\xe2\x80\x99 fees (as determined by the court)\nincurred in an action to recover those damages.\n\xc2\xa7112. Prohibition on disclosure of name of minor children\nThe debtor may be required to provide information regarding a minor child involved in\nmatters under this title but may not be required to disclose in the public records in the case\nthe name of such minor child. The debtor may be required to disclose the name of such minor\nchild in a nonpublic record that is maintained by the court and made available by the court\nfor examination by the United States trustee, the trustee, and the auditor (if any) serving\nunder section 586(f) of title 28, in the case. The court, the United States trustee, the trustee,\nand such auditor shall not disclose the name of such minor child maintained in such\nnonpublic record.\n588\n\n\x0cCHAPTER 3\xe2\x80\x94CASE ADMINISTRATION\n\xc2\xa7301. Voluntary cases ............................................................................................590\n\xc2\xa7302. Joint cases ....................................................................................................590\n\xc2\xa7303. Involuntary cases..........................................................................................590\n\xc2\xa7304 [Repealed] .....................................................................................................593\n\xc2\xa7305. Abstention ....................................................................................................593\n\xc2\xa7306. Limited appearance ......................................................................................593\n\xc2\xa7307. United States trustee ....................................................................................593\n\xc2\xa7308. Debtor reporting requirements .....................................................................593\nSUBCHAPTER II\xe2\x80\x94OFFICERS ...........................................................................594\n\xc2\xa7321. Eligibility to serve as trustee ........................................................................594\n\xc2\xa7322. Qualification of trustee ................................................................................594\n\xc2\xa7323. Role and capacity of trustee .........................................................................595\n\xc2\xa7324. Removal of trustee or examiner ...................................................................595\n\xc2\xa7325. Effect of vacancy .........................................................................................595\n\xc2\xa7326. Limitation on compensation of trustee ........................................................595\n\xc2\xa7327. Employment of professional persons ...........................................................596\n\xc2\xa7328. Limitation on compensation of professional persons ..................................596\n\xc2\xa7329. Debtor\'s transactions with attorneys ............................................................597\n\xc2\xa7330. Compensation of officers .............................................................................597\n\xc2\xa7331. Interim compensation...................................................................................599\n\xc2\xa7332. Consumer privacy ombudsman....................................................................599\n\xc2\xa7333. Appointment of patient care ombudsman ....................................................600\nSUBCHAPTER III\xe2\x80\x94ADMINISTRATION ..........................................................601\n\xc2\xa7341. Meetings of creditors and equity security holders .......................................601\n\xc2\xa7342. Notice ...........................................................................................................602\n\xc2\xa7343. Examination of the debtor ............................................................................603\n\xc2\xa7344. Self-incrimination; immunity.......................................................................604\n\xc2\xa7345. Money of estates ..........................................................................................604\n589\n\n\x0c\xc2\xa7346. Special provisions related to the treatment of State and local taxes ............604\n\xc2\xa7347. Unclaimed property .....................................................................................606\n\xc2\xa7348. Effect of conversion .....................................................................................607\n\xc2\xa7349. Effect of dismissal........................................................................................608\n\xc2\xa7350. Closing and reopening cases ........................................................................608\n\xc2\xa7351. Disposal of patient records...........................................................................608\nSUBCHAPTER IV\xe2\x80\x94ADMINISTRATIVE POWERS .........................................609\n\xc2\xa7361. Adequate protection .....................................................................................609\n\xc2\xa7362. Automatic stay .............................................................................................609\n\xc2\xa7363. Use, sale, or lease of property ......................................................................623\n\xc2\xa7364. Obtaining credit............................................................................................627\n\xc2\xa7365. Executory contracts and unexpired leases ...................................................628\n\xc2\xa7366. Utility service ...............................................................................................636\nSUBCHAPTER I\xe2\x80\x94COMMENCEMENT OF A CASE\n\xc2\xa7301. Voluntary cases\n(a) A voluntary case under a chapter of this title is commenced by the filing with the\nbankruptcy court of a petition under such chapter by an entity that may be a debtor under\nsuch chapter.\n(b) The commencement of a voluntary case under a chapter of this title constitutes an order\nfor relief under such chapter.\n\xc2\xa7302. Joint cases\n(a) A joint case under a chapter of this title is commenced by the filing with the bankruptcy\ncourt of a single petition under such chapter by an individual that may be a debtor under such\nchapter and such individual\'s spouse. The commencement of a joint case under a chapter of\nthis title constitutes an order for relief under such chapter.\n(b) After the commencement of a joint case, the court shall determine the extent, if any, to\nwhich the debtors\xe2\x80\x99 estates shall be consolidated.\n\xc2\xa7303. Involuntary cases\n(a) An involuntary case may be commenced only under chapter 7 or 11 of this title, and only\nagainst a person, except a farmer, family farmer, or a corporation that is not a moneyed,\nbusiness, or commercial corporation, that may be a debtor under the chapter under which\nsuch case is commenced.\n\n590\n\n\x0c(b) An involuntary case against a person is commenced by the filing with the bankruptcy\ncourt of a petition under chapter 7 or 11 of this title\xe2\x80\x94\n(1) by three or more entities, each of which is either a holder of a claim against such\nperson that is not contingent as to liability or the subject of a bona fide dispute as to\nliability or amount, or an indenture trustee representing such a holder, if such\nnoncontingent, undisputed claims aggregate at least $10,000 [$15,775 as of April 1,\n2016] more than the value of any lien on property of the debtor securing such claims\nheld by the holders of such claims;\n(2) if there are fewer than 12 such holders, excluding any employee or insider of such\nperson and any transferee of a transfer that is voidable under section 544, 545, 547,\n548, 549, or 724(a) of this title, by one or more of such holders that hold in the\naggregate at least $10,000 [$15,775 as of April 1, 2016] of such claims;\n(3) if such person is a partnership\xe2\x80\x94\n(A) by fewer than all of the general partners in such partnership; or\n(B) if relief has been ordered under this title with respect to all of the general\npartners in such partnership, by a general partner in such partnership, the trustee\nof such a general partner, or a holder of a claim against such partnership; or\n(4) by a foreign representative of the estate in a foreign proceeding concerning such\nperson.\n(c) After the filing of a petition under this section but before the case is dismissed or relief is\nordered, a creditor holding an unsecured claim that is not contingent, other than a creditor\nfiling under subsection (b) of this section, may join in the petition with the same effect as if\nsuch joining creditor were a petitioning creditor under subsection (b) of this section.\n(d) The debtor, or a general partner in a partnership debtor that did not join in the petition,\nmay file an answer to a petition under this section.\n(e) After notice and a hearing, and for cause, the court may require the petitioners under this\nsection to file a bond to indemnify the debtor for such amounts as the court may later allow\nunder subsection (i) of this section.\n(f) Notwithstanding section 363 of this title, except to the extent that the court orders\notherwise, and until an order for relief in the case, any business of the debtor may continue to\noperate, and the debtor may continue to use, acquire, or dispose of property as if an\ninvoluntary case concerning the debtor had not been commenced.\n(g) At any time after the commencement of an involuntary case under chapter 7 of this title\nbut before an order for relief in the case, the court, on request of a party in interest, after\nnotice to the debtor and a hearing, and if necessary to preserve the property of the estate or to\nprevent loss to the estate, may order the United States trustee to appoint an interim trustee\nunder section 701 of this title to take possession of the property of the estate and to operate\nany business of the debtor. Before an order for relief, the debtor may regain possession of\nproperty in the possession of a trustee ordered appointed under this subsection if the debtor\nfiles such bond as the court requires, conditioned on the debtor\'s accounting for and\n591\n\n\x0cdelivering to the trustee, if there is an order for relief in the case, such property, or the value,\nas of the date the debtor regains possession, of such property.\n(h) If the petition is not timely controverted, the court shall order relief against the debtor in\nan involuntary case under the chapter under which the petition was filed. Otherwise, after\ntrial, the court shall order relief against the debtor in an involuntary case under the chapter\nunder which the petition was filed, only if\xe2\x80\x94\n(1) the debtor is generally not paying such debtor\'s debts as such debts become due\nunless such debts are the subject of a bona fide dispute as to liability or amount; or\n(2) within 120 days before the date of the filing of the petition, a custodian, other than\na trustee, receiver, or agent appointed or authorized to take charge of less than\nsubstantially all of the property of the debtor for the purpose of enforcing a lien against\nsuch property, was appointed or took possession.\n(i) If the court dismisses a petition under this section other than on consent of all petitioners\nand the debtor, and if the debtor does not waive the right to judgment under this subsection,\nthe court may grant judgment\xe2\x80\x94\n(1) against the petitioners and in favor of the debtor for\xe2\x80\x94\n(A) costs; or\n(B) a reasonable attorney\'s fee; or\n(2) against any petitioner that filed the petition in bad faith, for\xe2\x80\x94\n(A) any damages proximately caused by such filing; or\n(B) punitive damages.\n(j) Only after notice to all creditors and a hearing may the court dismiss a petition filed under\nthis section\xe2\x80\x94\n(1) on the motion of a petitioner;\n(2) on consent of all petitioners and the debtor; or\n(3) for want of prosecution.\n(k)\n(1) If\xe2\x80\x94\n(A) the petition under this section is false or contains any materially false,\nfictitious, or fraudulent statement;\n(B) the debtor is an individual; and\n(C) the court dismisses such petition,\nthe court, upon the motion of the debtor, shall seal all the records of the court relating\nto such petition, and all references to such petition.\n(2) If the debtor is an individual and the court dismisses a petition under this section,\nthe court may enter an order prohibiting all consumer reporting agencies (as defined in\n592\n\n\x0csection 603(f) of the Fair Credit Reporting Act (15 U.S.C. 1681a(f))) from making any\nconsumer report (as defined in section 603(d) of that Act) that contains any\ninformation relating to such petition or to the case commenced by the filing of such\npetition.\n(3) Upon the expiration of the statute of limitations described in section 3282 of title\n18, for a violation of section 152 or 157 of such title, the court, upon the motion of the\ndebtor and for good cause, may expunge any records relating to a petition filed under\nthis section.\n\xc2\xa7304 [Repealed]\n\xc2\xa7305. Abstention\n(a) The court, after notice and a hearing, may dismiss a case under this title, or may suspend\nall proceedings in a case under this title, at any time if\xe2\x80\x94\n(1) the interests of creditors and the debtor would be better served by such dismissal or\nsuspension; or\n(2)\n(A) a petition under section 1515 for recognition of a foreign proceeding has\nbeen granted; and\n(B) the purposes of chapter 15 of this title would be best served by such\ndismissal or suspension.\n(b) A foreign representative may seek dismissal or suspension under subsection (a)(2) of this\nsection.\n(c) An order under subsection (a) of this section dismissing a case or suspending all\nproceedings in a case, or a decision not so to dismiss or suspend, is not reviewable by appeal\nor otherwise by the court of appeals under section 158(d), 1291, or 1292 of title 28 or by the\nSupreme Court of the United States under section 1254 of title 28.\n\xc2\xa7306. Limited appearance\nAn appearance in a bankruptcy court by a foreign representative in connection with a petition\nor request under section 303 or 305 of this title does not submit such foreign representative to\nthe jurisdiction of any court in the United States for any other purpose, but the bankruptcy\ncourt may condition any order under section 303 or 305 of this title on compliance by such\nforeign representative with the orders of such bankruptcy court.\n\xc2\xa7307. United States trustee\nThe United States trustee may raise and may appear and be heard on any issue in any case or\nproceeding under this title but may not file a plan pursuant to section 1121(c) of this title.\n\xc2\xa7308. Debtor reporting requirements\n(a) For purposes of this section, the term "profitability" means, with respect to a debtor, the\namount of money that the debtor has earned or lost during current and recent fiscal periods.\n593\n\n\x0c(b) A debtor in a small business case shall file periodic financial and other reports containing\ninformation including\xe2\x80\x94\n(1) the debtor\'s profitability;\n(2) reasonable approximations of the debtor\'s projected cash receipts and cash\ndisbursements over a reasonable period;\n(3) comparisons of actual cash receipts and disbursements with projections in prior\nreports;\n(4) whether the debtor is\xe2\x80\x94\n(A) in compliance in all material respects with postpetition requirements imposed by\nthis title and the Federal Rules of Bankruptcy Procedure; and\n(B) timely filing tax returns and other required government filings and paying taxes\nand other administrative expenses when due;\n(5) if the debtor is not in compliance with the requirements referred to in paragraph\n(4)(A) or filing tax returns and other required government filings and making the\npayments referred to in paragraph (4)(B), what the failures are and how, at what cost,\nand when the debtor intends to remedy such failures; and\n(6) such other matters as are in the best interests of the debtor and creditors, and in the\npublic interest in fair and efficient procedures under chapter 11 of this title.\nSUBCHAPTER II\xe2\x80\x94OFFICERS\n\xc2\xa7321. Eligibility to serve as trustee\n(a) A person may serve as trustee in a case under this title only if such person is\xe2\x80\x94\n(1) an individual that is competent to perform the duties of trustee and, in a case under\nchapter 7, 12, or 13 of this title, reside
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