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New York Debtor Creditor Law

Prejudgment Attachment
Definitions Attachment the process of creating a lien valid against the debtor Perfection the expansion of a lien so as to make it binding on 3rd parties as well o Sometimes attachment and perfection of a lien happen at the same time; other times, you need 2 separate legal acts o Mortgagtes must be recorded, and article 9 security interests must be perfected. However, the creation of a judicial lien is generally perfect at the moment it is created Levy The Sheriffs seizure or taking control of property pursuant to a writ Execution The enforcement of a judgment by the seizure and sale of property of the debtor CAPITAL VENTURES INTERNATIONAL v. REPUBLIC OF ARGENTINA (5) OVERVIEW: The corporation acquired a beneficial interest in a series of bonds issued by the Argentinian government. When the government defaulted on the bonds, the corporation did not accept the Exchange Offer and instead sued the government for breach of contract based on the default. The district court denied the corporation's motion for attachment. The corporation argued that it was entitled to attach certain portions of the Interest Collateral and the Principal Collateral attributable to the non-tendering bondholders, which was not released pursuant to the Exchange Offer. The appellate court found that the corporation satisfied each of the requirements of N.Y. C.P.L.R. 6201 and 6212 and demonstrated a need for attachment as required by N.Y. C.P.L.R. 6223. That being so, the district court erred to the extent it denied relief because it considered the corporation's chances of realizing on the Principal Collateral to be remote. Given that the corporation met all the statutory requirements and that there now was no threat of confusion since the Exchange Offer was over, the corporation was entitled to attach Argentina's reversionary interest in the remaining Principal Collateral. OUTCOME: The order of the district court was vacated and the case was remanded with instructions to grant the corporation's application for an order of attachment with respect to the remaining Principal Collateral. The corporation's motion to issue the mandate forthwith and to continue the temporary restraining order previously entered was granted to the extent that the clerk was directed to issue the mandate forthwith. Teaching 6201 says that attachment may be granted in any action, but does not have to be granted if the court thinks that probability of success is low. Probable Success on the Merits - Plaintiff must show that he has a good case with a likelihood of success Albany Savings Bank v. All Advantages Limousine Service PROCEDURAL POSTURE: Defendant merchant, a bank customer, challenged a decision from the Supreme Court of Albany County (New York), which denied his motion to vacate an order of attachment against his real property and personal bank accounts that was granted in favor of plaintiff bank, in the bank's action that alleged a conspiracy to defraud and fraud against the bank by use of unauthorized charge slips. OVERVIEW: After the bank declined to process the merchant's charge slips, it began using defendant limousine company's account with the same bank. The bank then terminated the limousine company's account for having breached an agreement to obtain proper customer authorizations from its customers. The bank also froze the merchant's bank and personal assets to satisfy charge-backs to his account, and the bank then obtained an ex parte attachment of his real property and personal bank accounts. On appeal, the court affirmed the order that denied the merchant's motion to vacate the garnishment. Even though the charge-backs had been satisfied, the appeal was not moot because, under N.Y. C.P.L.R. 6212(e) the bank could have been potentially liable if it was not entitled to the order of attachment. However, the court held that the attachment was proper in light of the merchant's statements that he intended to place his property beyond the reach of the bank, thereby frustrating the enforcement of any judgment against him, and because

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the bank had a viable action for intentional interference with the contract between it and the limousine company. OUTCOME: The court affirmed the trial court's order that granted the attachment in favor of the bank. Damages to the Defendant - 6212(e) Plaintiff is liable to the defendant for all costs and damages and attorneys fees sustained because of the plaintiffs attachment if: o Defendant wins the case (and the attachment is clearly wrong) o It becomes clear that the plaintiff was not entitled to an attachment The Birth of a Lien 6203 o The birth of the lien is when the order of attachment is delivered to the Sheriff. There are 2 exceptions where the JC loses to other parties who enter the picture even after JC establishes his lien: After JC delivers the writ to the sheriff, but before the sheriff is able to levy the garnishee / debtor, a 3rd party acquires the property without knowledge of the writ of attachment After the sheriff levies, but before he actually takes the debtors property, a 3rd party acquires the property for fair consideration (a good faith purchaser).

LEBER-KREBS, INC. v. CAPITOL RECORDS (15) OVERVIEW: Plaintiff creditor filed suit in federal court for commissions against the debtor. Plaintiff obtained an ex parte order that attached royalties due the debtor from defendant garnishee. Defendant falsely denied holding any of the debtor's property. As a result, when plaintiff moved within the statutorily mandated five-day period to confirm its attachment, the district court denied the motion. Thereafter, plaintiff filed suit against defendant, claiming that defendant's false failure to reveal the debtor's property in its hands constituted a fraud on the court. Defendant moved to dismiss the suit. The district court granted that motion, agreeing that the unconfirmed attachment order was void and that no remedy could be fashioned on a void order. Plaintiff appealed. On appeal, the court reversed and remanded the matter so that the district court could hold an evidentiary hearing to examine whether defendant's first garnishee statement was fraudulent. Defendant was required under N.Y. C.P.L.R. 6219 to serve a statement in compliance with the attachment order, and it could not assert the order's invalidity, if that invalidity was caused by its fraud. OUTCOME: The court reversed the order dismissing plaintiff creditor's complaint against defendant garnishee in an action alleging that plaintiff's rights to enforce a judgment against the debtor were lost because defendant falsely denied holding any of the debtor's property. Defendant could not profit from its own fraud, and the case was remanded for an evidentiary hearing to determine the issue of fraud

Liens on Real Estate

When is the Judicial Lien on Real Estate born? This Determines PRIORITY AMONG CREDITORS
5203(a) 2 Ways: o Docketing the judgment in the local court. This is an alphabetical list of all the debtors and all the creditors, making the judgment available to and findable by the public, putting everyone else on constructive notice Docketing does NOT occur at moment of entry. o Filing a notice of levy with the clerk Exceptions to General Rule 5203(a)(1-6) o It does not matter which action was commenced first. Whoever dockets first gets priority. o Purchase Money Mortgage a loan from a seller in lieu of cash for the purchase of property. Such mortgages make it possible to sell property when mortgage money is unavailable or when the only buyers are unqualified to borrow from commercial sources. The seller has priority in collecting his mortgage from the buyer over other creditors of the buyer because they wouldnt necessarily know about a Judicial sale. Under NY law,

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mortgage given to seller as collateral for unpaid purchase price will generally enjoy priority over any other contemporaneous mortgage. Also, pmm takes priority over other liens even those that are first in time. If the Judgment was entered after the death of the Debtor, then the creditor has to go to Probate Court. If the debtor is a government entity, liens do not apply in the same way When the debtor is the person representative of a decedent.

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Insulation Plus, Inc v. Thomas F. Higgins (20) o OVERVIEW: The buyer purchased the judgment debtor's properties for $ 1 at a sheriff's sale, conducted in execution of the buyer's judgment against the debtor. After the sale but before the sheriff delivered the deeds, the lienor docketed judgment against the debtor and claimed that its lien survived the sale because the deeds had not yet been delivered. The court affirmed the grant of the buyer's summary judgment motion and the sheriff's cross motion for summary judgment on the second cause of action, and the denial of the lienor's cross motion for summary judgment. The court held that although the sheriff violated N.Y. C.P.L.R. 5236(f) by failing to deliver the deeds within 10 days after the execution sale, that failure did not preserve the lienor's lien against the debtor's properties because Rule 5236 concerned only the sheriff's obligation to execute and deliver certain documents to the purchaser at an execution sale; it did not concern the rights of third parties. The court also noted that the buyer's lien was senior to the lienor's lien and that lienor had no lien when the execution sale took place. Moreover, the buyer was a purchaser for value of the distressed properties. o OUTCOME: In the buyer's action for money damages against the sheriff arising from the failure to timely deliver deeds and seeking declaratory judgment against the lienor, the court affirmed the judgment granting the buyer's summary judgment motion and the sheriff's cross motion for summary judgment on the second cause of action but denying the lienor's cross motion for summary judgment. Dept. of Housing Preservation v. Ferranti (22) o OVERVIEW: The department obtained a judgment against the agent for the agent's failure to comply with a court order to correct housing violations. The property was later acquired at the foreclosure sale by the owner. The department, as a judgment creditor, sought to obtain a judgment of foreclosure and sale of the subject real property. The trial court dismissed the petition, holding that the mortgage foreclosure resulted in a discharge of the department's docketed judgment lien against the subject property. Upon appeal, the court reversed. The court held that the department's judgment lien had priority over all liens created after the judgment was docketed against the property. The court found that the department's judgment became a lien upon the subject real property at the time it was docketed and continued as a charge against the property for a period of 10 years from the date of entry pursuant to N.Y. C.P.L.R. 5017(a) The court found that the department's application to foreclose upon its lien was brought within such period. o OUTCOME: The court reversed the dismissal of the department's petition for a judgment of foreclosure and sale of real property.

Docketing of the Judgment

The winning party prepares a judgment roll containing the important papers and court orders of the case 5018 - In Supreme Court and County Court, the county clerk is to docket a money judgment immediately after filing the judgment roll. CPLR 5018(a). In courts other than the Supreme Court and County Court, the transcript of the docket of the judgment, obtained from the court rendering the judgment, must be filed with the county clerk, who will docket the judgment. The transcript of the docket can then be filed with the clerk of any other county in the state, who in turn dockets the judgment. A judgment docketed by transcript has the ''same effect as a docketed judgment entered in the supreme court within the county where it is docketed.'' CPLR 5018. The issuing clerk functions as a

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clearinghouse for docketed judgments. Thus, one can determine from the issuing clerk's dockets whether the judgment has been docketed in other counties. Docketing vs. Filing of Judgment Roll - The filing of the judgment-roll should not be confused with the entry of judgment or the docketing of judgment. A judgment is entered when it is signed and filed by the clerk. See CPLR 5016(a). At the same time the judgment is entered, the clerk files the judgment-roll, stating the date and time of filing. See CPLR 5017(a). Immediately after filing the judgment-roll, the clerk must docket the judgment in the docket books. See CPLR 5018(a). The judgment lien on the debtor's real property accrues from the time the judgment is docketed with the clerk of the county in which the property is located. See CPLR 5203(a).

Berlin v. United States (24) OVERVIEW: In 1975, the Internal Revenue Service (IRS) filed a notice of federal tax

lien in the amount of $ 5,688 against the interest of a taxpayer in a home he jointly owned with his wife. On June 30, 1976, a loan company obtained a judgment against taxpayer and his wife in the amount of $ 1,268, which was recorded as a judgment lien second in time to the IRS' senior federal tax lien. The loan company subsequently initiated a sheriff's execution sale on the taxpayer's property in 1977, and the purchaser, as the highest bidder, received a deed. The purchaser conveyed title in 1980 to another individual, depositing $ 6,000 as security at the closing to cover the federal tax lien. The IRS served a notice of levy upon the title company's agent, seeking the unpaid balance of the tax assessment in the amount of $ 1,844, and the purchaser filed suit. The court granted the United State's motion to dismiss, holding that the sheriff's execution sale, pursuant to a junior judgment lien, did not extinguish the senior tax lien because 26 U.S.C.S. 7425(b)(2), a portion of the Federal Tax Lien Act of 1966, did not permit state enforcement procedures to extinguish senior government tax liens. OUTCOME: The court granted the United States' motion to dismiss the purchaser's complaint to enjoin the United States from enforcing the tax lien on the property.

Interest in Real Estate acquired by purchaser

Purchaser gets the Debtors Rights in the Property - The purchaser of realty at an execution sale usually acquires whatever rights the judgment debtor had in the property. The purchaser who obtains a deed from the sheriff is in the same position as they would have been if the deed had been executed by the judgment debtor at the time of docketing of the judgment. Purchaser Takes Title over more Senior Lien Creditors - The purchaser of real property at an execution sale takes title free from the liens of all judgment creditors, including those senior to the judgment being levied upon. What do the Senior Lien Creditors get? - CPLR 5236(g) - Rights of senior judgment creditors are limited to the proceeds of the sale The Purchaser and Mortgage Liens - With respect to mortgaged property, the purchaser at an execution sale will take the property subject to mortgage liens which are senior in time to the lien of the levying judgment creditor, but free of mortgage liens which are junior in time to the lien of the levying judgment creditor.

Mortgage Liens vs. Judgment Creditors

Suffolk County Federal Savings and Loan Association v. Geiger (30) o OVERVIEW: The mortgagee brought a mortgage foreclosure action against the debtor. The debtor filed an answer asserting that the claim of the judgment creditor had priority over the mortgage. The mortgagee filed a motion to dismiss the debtor's affirmative defense and for summary judgment. The court determined that the mortgage was made after the judgment was obtained by the judgment creditor but before the judgment was docketed in the office of the clerk of the county where the mortgaged property was located, N.Y. C.P.L.R. 5203. The court determined that the judgment did not become a lien on the premises until the date it was docketed in the county clerk's office, but the mortgage became a lien upon the premises on the date it was made, which was prior in time to the docketing of the judgment. The court ruled that the mortgage was a valid and enforceable legal obligation prior to the lien of the judgment creditor, even though

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the mortgage was not recorded until after the judgment was docketed. The court granted the relief requested in the mortgagee's motion to dismiss the debtor's affirmative defense and for summary judgment.

When Purchaser pays very little for Debtors Property

Wandschneider v. Bekeny o OVERVIEW: On the day after the sheriff's sale, the debtors commenced a special
proceeding to set aside the sale. The debtors sought vacatur solely on the ground that the selling procedure was defective. On reargument, the debtors contended that they were entitled to a credit against the federal judgment for a sum that represented the true, net, fair market value of the property. Alternatively, the debtors renewed their motion to set aside the sale on the new ground that the amount of the purchase price was grossly inadequate. The debtors valued the property at $ 73,000 and contended that the value had increased by $ 7,000 since the appraisal. The creditors valued the property at $ 55,000. Two mortgages amounted to $ 28,252.78. Thus, using the lower figure, the creditors had obtained $ 27,000 equity for $ 500. The court held that when the purchaser of property at a sheriff's sale was the holder of the judgment, the judgment debtor was entitled to a credit against the judgment for the difference between the sale price and the property's fair and reasonable market value. N.Y. C.P.L.R. 5240 and the court's inherent equitable powers provided for regulation of all judgments enforced in New York. o OUTCOME: The court granted the debtors' motion for reargument and referred the matter to Special Term, Part III, for a determination of the fair market value of the property Mikulec v. US o OVERVIEW: Appellant judgment creditor, who held a judgment against her son in the amount of $ 121,008.44, purchased his interest in a factory at a sheriff's sale for $ 50. Appellee, the United States, attempted to redeem the property, on which it had a tax lien, for 50 plus interest. Appellant refused, and filed suit to quiet title in the property, or in the alternative, to set as the redemption price the amount outstanding on her judgment. The district court ruled for appellant. On appeal, the court reversed, and cited 26 U.S.C.S. 7425(d)(1) (1976), which authorized the government to redeem from the purchaser at an execution sale real property subject to federal tax liens, at the actual amount paid by the purchaser. The court explained that where the lien holder purchased the liened property, the amount legally satisfied by the sale did not include the amount for which a deficiency judgment could be obtained, and whether a deficiency judgment could be obtained was a matter of state law. The court held that under New York law, appellant's purchase of her son's property satisfied her judgment only to the amount of her actual bid, where her son made no claim to a setoff.

Guardian Loan v. Early (38) o PROCEDURAL POSTURE: Respondent debtors failed to satisfy a judgment and their

residence was to be sold at a sheriff's sale. The sale was properly noticed and conducted, appellant purchaser bought the residence, and the deed was delivered to the purchaser. The Supreme Court of New York, Appellate Division, granted the debtors' motion to set aside the sheriff's sale upon condition that they repay the purchase price. The purchaser appealed. OVERVIEW: The lower court relied on N.Y. C.P.L.R. 5240. The court reversed. While the statute vested the court with broad discretion to prevent abuse in the use of the enforcement procedures, it furnished no grounds for relief once those procedures had been carried out in accordance with law. The sale was conducted in strict conformity with statutory procedure. While the sale price was less than the debtors' equity in the property, mere inadequacy of price did not furnish sufficient grounds for vacating a sale. To permit the sales to be set aside merely because a beneficial price had not been obtained would discourage participation by third parties at judicial sales, for the title acquired at the sale would never be free from the spectre of judicial invalidation. The record was devoid of any showing warranting intervention by a court of equity. OUTCOME: The court reversed the order in favor of the debtors and denied the motion to set aside the sheriff's sale

6 Reconciling Guardian Loan with Wandschneider

In a normal case, where the purchaser is a 3rd party, as long as procedure is followed, the debtor has no relief if the purchase price is too low. If the purchaser is the judgment creditor himself, we will question the purchase price and deduct the creditors windfall from the property from the amount the debtor owes the creditor

Husband and Wife own Property Together

Seyfarth v. Bi-County Electric Corp. (42) o OVERVIEW: A judgment creditor obtained a lien against a husband arising out of certain business transactions. The husband, who was estranged from his wife, transferred his interest in the marital residence to the wife. The judgment creditor sought to execute its lien on the husband's prior one-half interest in the home through a sheriff's sale. The wife filed a motion under 5240 to stay the execution. The court granted relief to the wife. There was no practical possibility that a commercial creditor or a speculator at a sheriff's sale would obtain immediate co-possession of a home with a woman and her child. If the husband outlived the wife and his survivorship interest came to fruition, the creditor could then enforce its lien against the entire property. If the wife and her child moved out and the property was sold, rented, or became vacant, the creditor could also pursue its remedies against the realty. The wife's economic self-sufficiency was irrelevant to granting equitable relief to the wife under 5240. o OUTCOME: The court granted judgment in favor of a mother and held that a judgment creditor could not execute upon the husband's prior interest in the real property until the house became vacant, was sold, or the wife predeceased the husband.

When the 10 Year Lien is Up.

5235 - Levy Enables JC to Proceed After Expiration of Judgment Lien o Lien is Effective for 10 Years - The lien on a judgment debtor's real property is secured by the docketing of the judgment in the office of the clerk of the county in which the property is located and is effective for a period of 10 years from the date of the filing of the judgment-roll. CPLR 5203(a). During such 10-year period the JC will ordinarily serve an execution on the sheriff who will then proceed to have the realty sold pursuant to the provisions of CPLR 5236 without first having to levy on the realty. o Expiration of Judgment Lien - The end of the 10-year waiting period set forth in CPLR 5235 corresponds to the termination of the judgment lien (see CPLR 5203) which, although effective upon docketing of the judgment in the county in which the realty is located, expires 10 years after the filing of the judgment-roll with the clerk of the court that rendered the judgment. The time differential in most cases will be insignificant except where: (1) the judgment was rendered in one county and the property is in another county; (2) the judgment was rendered in a court other than a supreme, county or family court; or (3) the clerk fails to fulfill his duties promptly. o Problems for JC when 10 Year Period Expires - If, within the 10-year period, the property is not sold to satisfy the judgment, the JC is faced with 2 problems: In the first place, the property cannot be sold if there is no existing lien on the property. See CPLR 5236(a). Secondly, with the lapse of the lien a different judgment creditor or even a transferee of the judgment debtor may obtain rights in the property superior to that of the judgment creditor who has let his lien lapse. o Preventing Lien from Lapsing - The CPLR provides two remedies: Extension of Lien - The first is the provision in CPLR 5203(b) allowing extension of the lien. This is only available prior to the expiration of the lien. Notice of Levy - Once the lien has expired, recourse may be had to CPLR 5235 which allows the sheriff, upon receipt of an execution, to file a notice of levy with the clerk of the county in which the property is located. The filing of the notice of levy creates a lien on the property and allows its sale.

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CPLR 5235 does not prevent the judgment creditor from proceeding against the judgment debtor's real property before the expiration of the judgment lien; actually, the provision extends the judgment creditor's ability to enforce his judgment against the debtor's realty beyond the term of his judgment lien and until the judgment is presumed to have been paid, which is usually at the end of 20 years. Levy not Usually Necessary - No levy is needed to sell real property under an execution when the property is subject to the judgment lien. Delivery of an execution to the sheriff is the only prerequisite to a sale when the judgment lien is in effect. CPLR 5236 continues this longstanding rule by permitting the sale of real property ''which has been levied upon under an execution delivered to the sheriff or which was subject to the lien of the judgment.''

Community Capital Corp. v. Lee (43) o OVERVIEW: The husband and wife held the subject property as tenants by the entirety.

A judgment was recovered by a third party against the husband on January 16, 1956. On January 11, 1966, five days before the automatic lien of the judgment was about to expire, the third party delivered to the Sheriff of Nassau County an execution. On the same date, a notice of levy against the property was filed in the County Clerk's office. A sheriff's sale of the husband's interest in the property was held on April 12, 1966, and was bid in by the bidder. The bidder sought a declaratory judgment putting it into possession of the property jointly with the wife. The court dismissed the bidder's complaint. The court found that N.Y. C.P.L.R. 5236 required publication of at least eight weeks' notice of the sheriff's sale. The court held that the sale was invalid as the third party did not follow the directions of Rule 5236 as the execution was issued too close to the deadline to permit a sale before the lien expired. OUTCOME: The court dismissed the bidder's complaint in its action seeking a declaratory judgment putting the bidder into possession of a private residence jointly with the wife. The court granted the husband's counterclaim canceling the Sheriff's deed of record. Issues Here, the Sheriff has levied right before 10 years of the Judgment Roll. The Court says that 5235 permits the notice of levy only after 10 years. Here, the notice levy was done before the 10 years were up, so the levy was invalid. According to this case, you cant do notice of levy until 10 years after the Judgment Roll. Since thelevy was invalid, the only way to have the sale would be to extend the lien, which was not done. However, 5236(a) implies that in order for the sale of the property to be valid, the lien need only be alive at the time of the writ of execution. It does not matter if the lien is no longer effective (past 10 year limit) at the actual time of sale. The court overlooks the fact that 5236 only requires a lien at the time of execution, not at the sale (it is possible to read 5235 to say that you can levy at any time, that 5235 and 5236 are not contradictory). Federal Court and Notice of Levy Gratton v. Dido Realty A Queens court says that if the lien is created through a federal judgment in Westchester, a federal marshal with a writ of execution should be permitted to file levy in Westchester, even though the 10 year period has not lapsed. This makes sense because in federal court you dont have to docket. Summary Levying permits the sale of real estate after 10 years. Some courts say you can do it before. Some say only after the 10 year lien has expired. Even if a lien is completely dead, file a levy and it rises up again. Kazmeroff v. Ehlinger - JC1 dockets, serves an execution, and purports to levy before all before the 10 years are up (according to Community Capital, this levy would be invalid, since it was before the 10 years were up). JC1 also does not extend the lien under 5203. Then JC2 dockets and serves a writ of execution (within 10 years of his docketing). The court awards the proceeds to JC1. This

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is not consistent with Community Capital, which would have held JC2 to get the proceeds.

Debtor Acquires Property After all of the Liens are Docketed Which Creditor Gets the Property?
Hulbert v. Hulbert (46) (Pre-CPLR Case) o OVERVIEW - A judgment creditor filed an action for partition of the proceeds of a sale of real property acquired by a judgment debtor. The premises were sold in the partition action and the proceeds were paid into the court since such proceeds were insufficient to pay all of the judgment liens in full. One of the creditors claimed a preference for his lien by virtue of the sale of the property to him and the delivery by the sheriff of a sheriff's certificate of sale. The court modified the appellate court's judgment and directed that the funds deposited with the court should be distributed pro rata between the three creditors. The court concluded that the creditors' judgments became liens on the after-acquired property of the debtor at the time of its acquisition by the debtor. The court ruled that the principle of equity favored that diligence had no application when one creditor displayed his diligence in the doing of useless and unnecessary things. The court held the issuing of an execution upon one of the judgments could not affect the relative rank of the liens as between themselves. As such, the sheriff's certificate of sale had no affect on liens of equal rank. o OUTCOME - The court modified the appellate court's judgment and directed that the funds deposited with the court should be distributed pro rata between the three judgment creditors. The court concluded that the liens of all judgments attached when the judgment debtor acquired the property and the issuance of an execution upon one of the judgments could not affect the relative rank of the liens as between themselves. o Rule - When a debtor acquires property after all of the liens have been docketed, all the liens attach simultaneously to the property. It does not matter which creditor quickly runs to the sheriff

5203 - Judgment Creditor Priorities in After-Acquired Real Property

o Docketed Liens Extend to all Property Acquired by Debtor while Lien is Effective Once a judgment is docketed in a particular county, the judgment creditor's lien extends also to realty which the judgment debtor acquires thereafter while the lien remains in effect. The lien will reach any interest that the judgment debtor has in realty located within the county of docketing, whether that interest is vested or contingent. Competing Liens and After Acquired Property - CPLR 5203 does not specifically address the problem of the rights of competing judgment creditors in after-acquired property. The problem arises only when both judgment creditors have already established their liens by docketing the judgments in the county where the realty is located, before the judgment debtor acquires his interest (if the judgment debtor has an interest--whether vested or contingent--at the time of docketing, the normal priorities principles apply). Docketed Lien Defeats Notice of Levy in After Acquired Property - Because a judgment creditor's lien in after-acquired property vests immediately upon the debtor's acquisition, a judgment creditor who has docketed his judgment in the county where the realty is located will automatically defeat a lien acquired by notice of levy filed under CPLR 5235. Thus, a judgment creditor with an expired docket lien who learns that his debtor is about to acquire specific property should hasten to renew his judgment under CPLR 5014(c)(1) and docket the new judgment in the proper county before the acquisition is carried out, rather than utilizing the notice of levy. Pro Rata Division in After Acquired Property (Hulbert v. Hulbert) The principle that competing judgment creditors have pro rata shares in afteracquired property was established by the Court of Appeals in 1916 in Hulbert v. Hulbert. In that famous case, three judgments were entered before the judgment debtor acquired realty. The Court, in a 4-3 decision, reversed the lower court's application of the normal absolute priority rule and held that the liens of the judgment creditors vested simultaneously when the debtor acquired the land. Hulbert - The legal effect of [the statute] is that from the moment a judgment is duly filed and docketed legal rights in the real estate of the debtor attach. In

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the case now under consideration the liens of the three judgments attached simultaneously to the property of Hulbert upon his acquisition of the interest derived from his father. By virtue of the statute they were at that time equal liens entitled to share pro rata in the proceeds of the debtor's property. Understanding Pro Rata Division - The use of the term ''pro rata'' is significant: each of the competing judgment creditors is entitled to share in the proceeds of the sale in proportion to the amount of his judgment: if $ 100,000 is realized, judgment creditors with judgments of $ 200,000 and $ 400,000 would receive $ 33,333 and $ 66,666 respectively, not $ 50,000 each

Execution Liens on Personal Property

5202 - Judgment creditor's rights in personal property An Innocent Transferee May Defeat Lien of Judgment Creditor - The JC establishes his rights
under CPLR 5202 by delivering the property execution to the appropriate sheriff. As a practical matter, however, this delivery, though necessary, is not sufficient in most situations to actually protect his rights in the judgment debtor's assets against a transferee. The reason for the discrepancy are the 2 exceptions in 5202: o 5202(a)(1) - a transferee who acquires personal property of the JD before it is levied upon, and who gives fair consideration, defeats the lien of the judgment creditor. Moreover, the transferee who acquires property before levy defeats the judgment creditor even though he had notice, indeed even actual knowledge, of the existence of the judgment creditor's rights. 5232(b) a levy upon property that is capable of ''delivery'' is accomplished only when the sheriff actually takes possession of the asset in question. Therefore, for personal property, a debtor can easily avoid the JC by selling the property b/4 the sheriff gets his hands on it. o 5202(a)(2) - Even after the sheriff has levied upon particular property, whether by seizure or other device, a transferee who pays fair consideration and who acquires the property without knowledge of the JCs rights will prevail in a dispute over rights in the particular property involved

5232 Levying on Personal Property (NOT Real Estate)

Procedures for Levying - The scheme of CPLR 5232 is relatively simple; a levy is made either by service of a copy of the execution or by seizure, depending upon the nature of the property. There are 2 kinds of Personal Property: o Property Not Capable of Delivery CPLR 5232(a) - provides for service of a copy of the execution for levy upon property ''not capable of delivery'' and upon debts owed to the judgment debtor. Any property not capable of delivery in which the judgment debtor has an interest and any debt owed or owing to the judgment debtor is subject to levy by service of execution if reachable by the sheriff to whom the execution is delivered. Non-Negotiable Instruments - if property is represented by a non-negotiable instrument, it is treated as property not capable of delivery. Thus, pursuant to CPLR 5232(a), it can be levied upon only by service of a copy of the execution on the person indebted to the judgment debtor or on the person holding the property represented by the instrument. o Property Capable of Delivery CPLR 5232(b) - requires that levy by seizure be made upon property ''capable of delivery.'' Negotiable Instruments / Promissory Notes Definition Negotiable Instruments A transferable document (e.g., a bank note, check, or draft) containing an unconditional promise or

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order to pay a specified amount to its holder upon demand or at a specified time. The UCC governs negotiable instruments. CPLR 5201(c)(4) - If property is evidenced by a negotiable instrument, negotiable document of title, or certificate of stock of an association or corporation, it is treated as property capable of delivery. Thus, it can be levied upon by seizure, under CPLR 5232(b). What Property is Capable of Delivery? Since in some cases it is the levy which secures priority for the judgment creditor over other judgment creditors, it is important to distinguish between property capable of delivery and that which is not capable of delivery, so that the proper method of levying will be used. The time within which the levy must be made varies depending upon the nature of the property--60 days after issuance of the execution for property capable of delivery (see CPLR 5230(c) ) and 90 days for property not capable of delivery (see CPLR 5232(a) ). Tangible Property that is Very Difficult to Deliver How to Classify? In some instances tangible property will be overly cumbersome, inaccessible, or in the possession of a pledgee or lessee, and the sheriff will be unable to seize the property. In such cases service of the execution may be sufficient to effect a levy. Knapp v. McFarland Here, the bank against which execution was levied had custody of treasury bills as agent of another bank which had security interest in bills. The sheriff's service of a copy of execution on the custodial bank was sufficient to constitute a valid levy since he was prevented from taking possession of the bills by CPLR 5232(b)'s prohibition against interference with security interests of third persons in property. The Sheriff needs to levy in order to get paid. But tangible property must be seized and here, there was nothing to seize because of the nature of a T-bill. So in reality, no one really has possession of the Tbills (all the bank has are book entries). In this case, even though the treasury bills seem to be capable of delivery, the court rules that levy was enough the sheriff did not actually have to take possession

Garnishing Royalties
6214 Levies on Garnishees (Debts owed to the Debtor) o Property or Money owed to the Debtor can be Levied - The levy upon a garnishee is effective only if he owes a debt to the defendant, or has reason to believe defendant has an interest in property in the garnishee's possession. Plaintiff may specify such debts and property interests in a notice to be served upon the garnishee. All property in which defendant has a current or subsequent interest and all debts owed to defendant currently or in the future are subject to the levy. o Only Service of Execution is Necessary: Sheriff Need not Take Possession Levies on Garnishees vs. Levies on Debtors Personal Property - CPLR 6214 should be compared with CPLR 5232, which governs a levy upon personal property pursuant to an execution. Although the language of the two provisions is substantially identical, and both should be construed in a consistent fashion, CPLR 5232 and CPLR 6214 differ markedly in one respect. Under CPLR 5232, property not capable of delivery is executed upon by service of a copy of the execution; property capable of delivery must be levied upon by seizure. CPLR 6214, on the other hand, permits attachment of any property, whether it is capable or incapable of delivery, by service of a copy of the order of attachment. The sheriff is required to take custody of property capable of delivery only after the levy. Property capable of delivery will be levied upon by seizure only at the plaintiff's direction. 5201 Debts Owed to the Debtor that are Subject to Attachment o Abkco Industries v. Apple Films (60)

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Facts - In ABKCO, the Beatles had a contract through a British corporation with a New York corporation for promotion of the film ''Let It Be.'' The contract called for payment to the British company of 80 percent of the proceeds realized by the New York firm. ABKCO sought to attach funds held by the New York firm and due the British firm under the contract. Issue Money Owed to Beatles was too Contingent to be Considered Debts owed to the Debtor - The Court of Appeals agreed with the defendant's initial contention that the contingencies associated with payments under the licensing agreement were sufficient to preclude their attachment as ''debts'' under CPLR 5201(a). Since the profits are conditional, based on whether people pay to see the movie, the property is not vested and is therefore not considered an attachable debt. Nonetheless, the Property is Attachable While the property can not be considered a debt, it is nonetheless attachable because it was assignable by the Beatles. Essentially, the court held that these royalties were property that was somehow attachable. In re Supreme Merchandise Co v. Chemical Bank (63) Facts - A Japanese firm sold goods to a New York corporation pursuant to an irrevocable letter of credit issued by Chemical Bank and naming the seller as beneficiary. Following an action by the New York buyer against the Japanese seller, wholly unrelated to that particular sale or letter of credit, the buyer as judgment creditor obtained an order of attachment against the Japanese seller's debts and property, including the letter of credit in Chemical's hands. Issue - whether the Japanese company's interest in the letter of credit was a debt or property under 5201. The Court clearly held that such an interest is not a ''debt''. The statute requires that a ''debt'' for this purpose be a fixed obligation. Even if it the sellers interest was a debt, it was plainly contingent and would not be subject to attachment under 5201(a). Teaching You cannot garnish contingent debts Reconciling Abcko and Supreme Everything depends on whether the debt owed to the debtor was a vested, real debt, or a contingent debt. In Abcko, they considered the debt to be real personal property, whereas in Supreme the debt was determined to be contingent and not subject to attachment.

Extension of Levies and Priority of Judicial Creditors who Levy

Levies Last for 90 Days Extension of Levies o Overview - The court may order an extension of the levy beyond the prescribed ninetyday period. The extension must be sought on motion of the plaintiff on notice to all the parties to the action, and if granted, a copy of the order should be served on the garnishee. o Extension After the 90 Day Period Lapses (nunc pro tunc ) - The extension may be requested at any time, even after the ninety-day period has lapsedSince the levy will become void at the expiration of ninety days, an extension should be obtained before the expiration of the original ninety-day period or before the end of an extension period. Nevertheless a court may grant an extension nunc pro tunc after the levy becomes void as long as any rights in the property or debt acquired by a third person are protected. Executions from 2 JCs Delivered to Same Enforcement Officer o Whoever Delivers First to the Sheriff Wins - When two or more executions or orders of attachment against a judgment debtor are delivered to the same enforcement officer, priority is determined strictly in terms of the order in which the executions were delivered. The execution must be appropriately issued and in force at the time of delivery. o If the Junior JC Sells the Property - If the levy is made under a junior execution and the judgment debtor's property is sold, the judgment creditor who first delivered an execution does not lose his priority. If senior execution creditor learns of a prospective distribution of the proceeds of the levy to a junior execution creditor, he may assert his

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right to the proceeds while they are still in the hands of the sheriff, by commencing a special proceeding under CPLR 5239. If he is not given notice until after payment, an action against the distributee would be appropriate. o Faulty Executions - If the execution is so defective that the sheriff cannot levy or if the execution has expired, the issuing creditor will acquire no priority under CPLR 5234(b). Firemans Fund v. DAmbra (68) o Facts - The debtor committed insurance fraud, and deposited the stolen money in a bank. March 19 JC1 gives order of attachment to a federal sheriff, who levies an order of attachment on the bank. However, the levy is only good for 90 days, and expired on June 19th. This means that if the debtor comes to the bank after June 19th, he can actually get his money out of the bank. On June 22, JC1 moves to extend the attachment. The problem is that JC1 did this 3 days late a very big mess up. You can only extend a levy while it is still in effect; now, the levy is dead. So JC1 has the sheriff drop off the same exact levy (the same paper!) on July 2. The Court held that this is valid. JC had a lien and levy as of July 2.

Equity Liens on Personal Property

Equitable Relief
o o 5202(b) The Court only gives a remedy if the legal remedy proves inadequate. The legal remedy for enforcing a Judgment is the Writ of Execution. Princeton Bank & Trust v. Berley (71) Facts - The finance company and bank each held a judgment against the debtor. The finance company attempted to execute the judgment by levy, but being under the mistaken impression that the debtor held the subject property as a tenant in common rather than a partner, improperly directed the sheriff to levy on the real and personal property of the debtor. As the Debtor is a tenant in partnership and therefore, technically, has no interest in real estate he simply has a partnership interest. The finance company then delivered a new execution with proper notice to a partner not the debtor as the garnishee. Holding JC1 wins through equity

Receivership o Definition - A court order whereby all the property subject to dispute in a legal action is placed under the dominion and control of an independent person known as a receiver. Receivership is an extraordinary remedy, the purpose of which is to preserve property during the time needed to prosecute a lawsuit, if a danger is present that such property will be dissipated or removed from the jurisdiction of the court if a receiver is not appointed. Receivership takes place through a court order and is utilized only in exceptional circumstances and with or without the consent of the owner of the property. o Princeton Bank & Trust v. Berley (71) The judgment creditor levied before receivers were appointed and therefore lost o S & H Building Materials Corp v. European-American Bank & Trust C0 (76) Facts Debtor has a rental property and grants a mortgage to A. Later, JC1 gets a Judge and serves a writ and gets a levy. The tenants are then paying rent to the Sheriff (for the JC). Later, A gets a receiver appointed and the issue is, to whom should the tenants pay rent to? As receiver or JC1s S? The Receiver. Issues - Here, the JC levied before receivers were appointed and won (at least until the mortgage holder came in and took the property away). The reason the JC won here is to due to the tenants obligation to pay rent to whoever possesses the reversionary interest. Possession of a reversion means you actually collect the rent. At first, the debtor had that right; then it went to the JC; and finally it went to the mortgagee who had an even better right to the property. The mortgagees appointment of a receiver is equivalent to taking possession.

13 Rent Personal or Real Property?

o S & H Building Materials Corp v. European-American Bank & Trust C0 (76) Status of Rent - The Court held that rents do not qualify as personal property and are not subject to priority provisions of 5234. They are a by-product of realty and should be treated as such. Once a tenant actually pays the rent, something magical happens. The rent is considered real estate at least by mortgage law. Once the tenant pays to the debtor (or whoever possesses the reversionary interest), the rent has been severed and the $$ in the debtors hands becomes personal property. It changes form.

5222 Restraining Orders

5222 - Restraining Orders o Overview - To secure collection of a judgment, it frequently becomes necessary to enjoin a judgment debtor, or someone indebted to or in possession of property belonging to a judgment debtor, from disposing of certain assets. CPLR 5222 provides a method for accomplishing this objective. o Restraining Notice may not be served on Debtor's Employer for Restraint of Wages - The restraining notice may, with one statutory exception, ''be served on any person,'' except that CPLR 5222(a) prohibits the service of a restraining notice upon ''the employer of a judgment debtor where the property sought to be restrained notconsists of wages or salary due or to become due to the judgment debtor.'' o Do Restraining Orders Establish Liens? International Ribbon Mills v. Arjan Ribbons (1975) YES! Holding - The court held that under N.Y. C.P.L.R. 5222, and N.Y. C.P.L.R. 5230, appellant obtained a priority over the judgment debtor's assets by serving a restraining notice on the judgment debtor and issuing a property execution to the local sheriff. The court stated that appellee, sitting as the assignee did not sit in a better position than the judgment debtor, and therefore was burdened with the same priority of appellant. Reasoning - held that a JC who serves a restraining notice on the debtor has superior rights in the debtor's property to those of an assignee for benefit of creditor's to which an assignment was made subsequent to the service of the restraining notice and in the absence of fair consideration. The holding was based, in part, on the proposition that an assignee never stands in any better position than his assignor. The assignee is subject to all the equities and burdens which attach to the property assigned because he receives no more and can do no more than his assignor. The Court observed that it would not serve sound public policy, while subjecting a debtor or garnishee to contempt for disobeying a restraining notice, to allow an assignee without consideration priority over a judgment creditor in property assigned in violation of the restraining notice. Burstein Investors v. KN Investors (1998) NO! Burstein Investors v. KN Investors - The court agreed with the intervenor that the restraining notice served upon it by the corporation was ineffective. The service of a restraining notice pursuant to N.Y. C.P.L.R. 5222 did not confer priority upon the judgment creditor in the form of a lien on the judgment debtor's property, and a judgment creditor ordinarily was required to take further steps in enforcing its judgment, such as an execution or levy upon the judgment debtor's property, in order to prevent the intervening rights of third parties from taking precedence over its claim against the judgment debtor. Statute Implies Restraining Orders do not create Liens - 5202(b) mentions turnover orders and levies, but not restraining orders, so from the statute, we would assume that there is no lien significance for this

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type of ct injunction. Inasmuch as restraining notices are not a matter of public record and are no longer issued by the court, the elimination of lien consequences avoids problems of notice to potential purchasers and encumbrancers. Moreover, the absence of a lien will encourage the judgment creditor to take affirmative steps to satisfy his judgment in order to prevent the debtor from transferring the property ad debts covered by the restraining notice. Reconciling International Ribbon and Burstein There is no way to reconcile apparently, the Court in Burstein simply forgot about Ribbon Mill, or purposely ignored it!!!

Extending Levies
Levy Expires After 90 Days o Overview - The next to the last sentence of CPLR 5232(a) limits the levy's effectiveness to a period of 90 days following the service of the execution. This limit is intended to minimize the burden on the garnishee and to expedite the transfer or payment to the sheriff of property or debts subject to the levy. o When the 90 Days are Up - After 90 days, the levy will become void and without injunctive effect. It remains effective beyond the 90-day period with regard to property or debts already transferred or paid to the sheriff by the garnishee. The levy will also remain in force beyond the 90 days if a special proceeding under CPLR 5225 or CPLR 5227 has been commenced within that period. Furthermore the court may order an extension of the life of a levy. The need for these three exceptions is obvious and none of them impairs the effectiveness of the 90-day provision. Extension of the Levy o Granting the Extension of Levy - CPLR 5232(a) expressly authorizes the court to order an extension of the levy beyond the prescribed 90-day period. An extension is appropriate when the 90-day period is about to expire and the judgment creditor believes that the garnishee is about to receive property belonging to the judgment debtor or to transfer property or pay debts to the sheriff within a short period of time. Although extensions should be freely granted, they should not be granted indiscriminately or without a showing of need. Although extensions are not limited to 90 days, a 90-day limit is not a hardship since the court is free to order more than one extension in an appropriate case. o Kitson and Kitson v. City of Yonkers (81) Facts The Judgment debtor has a valid claim for a civil rights violation against the City of Yonkers, which has to pay the debtor. The debtor made a voluntary assignment of 10% of the Yonkers money to his wife, and 15% to his kids for child support. Kitson, the wifes divorce lawyer, put in a restraining order and then serves multiple writs of executon / levies on the sheriff. The judgment debtors divorce lawyer, Bloom, then puts in a restraining order, and then a writ of execution on the sheriff, creating a lien on the Yonkers payment. Later, the sheriff levies for Bloom. Holding The levy by Debtors attorney, Bloom, had priority over that of Kitson, who represented Debtors ex wife in divorce action. Kitson improperly filed multiple levies, without ever renewing his original levy. Bloom levied only once (after Kitson), but properly extended his levy, so he wins. Extension of the Levy even after it already expired - In Kitson & Kitson v. City of Yonkers, a 2004 decision, the Second Department concluded that the court may order the extension of the levy even after the levy has expired because no CPLR provision prohibited such an extension and because CPLR 5240 would appear to authorize a court to extend a judgment enforcement procedure at any time. In that same decision, the Second Department also concluded that, in a situation in which the levy has expired, the proper procedure for the judgment creditor is to seek an extension of the expired levy rather than serve a second levy on the judgment debtor.

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DO not Serve Multiple Levies! Instead, Extend the First One! - In New York, filing a second levy is worthless; the original levy must be extended. There does not seem to be any source for this rule in the CPLR. When 2nd JC files in between the expiration of the Levy and the Extension Unfortunately, Kitson was not entirely clear on the issue of priority when a previously expired levy is extended, but a third party has served a levy in the time between the serving of the judgment creditor's levy and its extension. The decision simply states that the court should consider the interests of third parties who served an intervening levy in determining whether to grant the extension of the judgment credit's levy. Hence, it is unclear if courts following Kitson can or should condition the extension of the judgment on a denial of priority to the judgment creditor who allowed the levy to lapse in favor of the third party who served a levy prior to the extension

Judicial Liens and Article 9 Security Interests Secured Creditors vs. Unsecured Creditors
Article 9 of the UCC covers consensually created liens. The reason for getting an article 9 security interest is a way to ensure that the creditor will have priority over unsecured creditors (who will later become judicial lien creditors). This becomes a battle between secured lenders like banks and the unsecured parties suing for support 9-102 (Definitions) o Lien Creditor means: A trustee in bankruptcy is a judicial creditor Receivers are judicial lien creditors CPLR 202(b) appointment of a receiver is the birth of a lien A creditor that has acquired a lien on the property involved by attachment, levy or the like. Or the Like means when a person has become a lien creditor CPLR - When the sheriff receives a writ of execution there is a lien on all of the debtors property Attachment and Perfection o Definition of perfection a security interest is perfected if it has attached and some other event has happened. o Perfection requires Attachment First - To understand perfection, we need to understand what attachment means. The moment of attachment is the moment of lien creation. o 9-203(b) there are 3 elements of attachment. 3 things must be true before attachment to be true (Order is unimportant): Value must be given - there must be a loan, or a commitment to lend The debtor has rights in the collateral, so that a lien can attach to it. There must actually be a security agreement/interest. In the case of a pledge, the agreement can be oral. In the case of a hypothecation, the agreement must be in writing Pledge creditor is in possession Hypothecation debtor is in possession; written agreement is required o The Other Event this entails filing as financing statement in the proper office Secured Creditor vs. Judgment Creditor o You Must Perfect before a JC Levies! - If a secured creditor only perfects the loan after the judgment creditor attaches a lien, he is in trouble. o Citibank v. Prime Motor

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Facts - Field owes Citibank money. Later on, he loses judgment and now owes money to Selig. PMI owes Feild money; which creditor will get this cash? executes an instrument assigning all the PMI money to Selig, thereby making Selig a secured party. However, Selig did not perfect his security interest right away by filing the financial papers, and in the meantime, Citibank levied upon Field. Since Citibank levied before Selig perfected, Citibank is considered first in time and gets the money. Bad mistake by Selig!! If Fields and Selig had taken a different approach if Fields had transferred his debt interest from PMI to Selig, thereby canceling the debt Selig would have gotten the money. What actually happened was that the PMI debt to Fields acted as collateral for Selig, meaning it still remained in Fields possession. This allowed Citibank to sneak in and take the money because Selig never perfected. General Motors acceptance Corp. v. Stotsky (89) Facts - The sheriff, pursuant to an execution by a judgment creditor, levied on a car in the possession of the lien creditor and the car was sold at a public sale to the buyer. Shortly thereafter the buyer received a letter from the secured creditor informing him that the secured creditor had a perfected security interest, which was a matter of public record prior to the levy, in the car. The secured creditor was unaware of the sheriff's sale. The buyer returned the car to the sheriff and requested his money back. The finance company requested that the car be turned over to it. The JC for whom the car was levied sought to have his judgment satisfied out of the money received at the sheriff's sale. Holding - The court held that: (1) the rights of the secured creditor, a holder of a perfected security interest, was superior to those of the judgment creditor; (2) the rights of the secured creditor were superior to those of the buyer, third-party purchaser (who should have and could have checked the public record to see that the car was encumbered); but (3) the buyer, as an infant (under 18), could get his money back, though a normal stupid buyer could not do so. The rule A perfected creditor has priority over a lien holder and can take possession of the item (car), unless taking possession will cause a breach of the peace 20 Day Grace Period to File the Financing Statement (Perfection) 9317(e) when you can trace the loan to the collateral, there is a 20-day grace period for the secured creditor to file the financing statement. If JC becomes a lien creditor prior to perfection, JC is senior; however, the secured party (SP) can win back priority by filing for perfection within that 20 day grace period Security Agreement and Financing Statement Enough to Establish Priority 9317(2)(a)&(b) where there is a security agreement (see 9203(b)), and when a financing statement is filed, the secured creditor has priority over JC, even though 2 out of the 3 elements of attachment have not yet occurred (collateral and the payment of the loan) Overview The secured creditor can make additional advances to the debtor, secured by the same financing agreement / collateral, for 45 days after the intial agreement is struck. These advances will be senior to any judicial liens. After this 45 day period, however, any advances given to the debtor by the secured party will be junior to any prior judicial liens. When a person in need of money borrows a lump sum secured by specific collateral, such as real estate, the question of priorities between the lender and any subsequent person who obtains a judgment against the borrower is relatively straightforward: the judgment creditor's interest is subordinate to the lender's, so long as the lender has obtained and perfected a security interest in the borrower's realty before the lien attaches. Under Uniform Commercial Code 9-301(4) (1972), a person who becomes a lien creditor while a security interest is perfected takes subject to the security interest only to the extent that it secures advances made before he becomes a lien creditor or within 45 days thereafter or made without knowledge of the lien or pursuant to a commitment entered into without knowledge of the lien.

o 45 day advance period - 9323(b)

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UCC Beats the CPLR - To the extent that UCC 9-301 is in conflict with C.P.L.R. 5202, the U.C.C. provision prevails Yellin Kenner & Levy v. Simon 9323b this was not considered at the time of this case. Suppose this advance from the Bank to PA is within 45 days, this section might help. The advance is to a third party, but it is an advance nonetheless and if the bank can show that it is in the terms, then the bank could win. Friedlander v. Adelphi Manufacturing (95) Facts - The secured party and the debtor entered into a security agreement covering an indebtedness of $ 24,000, and any other indebtedness or liability of the debtor to the secured party, including all future advances or loans made by the secured party. The agreement provided that the secured party would have the right to immediate possession of the collateral in the event of a default. The secured party filed a financing statement. The secured party and the debtor executed another agreement, which consolidated all the then existing loans and providing for additional advances. Holding - The court held that the security agreement was specifically authorized by N.Y. U.C.C. Law 9-204. The court found that the secured party was entitled to priority with respect to the original loan since his security interest was perfected before the company obtained its judgment against the debtor, and was entitled to immediate possession of the collateral. The court held that the secured party was entitled to priority for the second advance made after the company obtained its judgment against the debtor and issued execution to the sheriff, if it was made in good faith. 45 Day Rule o This case was decided before the Future Advance section was enacted. The court decided that the future advance was senior. Today 9-323b would be used to decide. Uni Imports v. Aparacor (98) Facts The JC sued the lender, seeking to enforce its judgment by writ of execution against assets held on behalf of the judgment debtor, which had been given a revolving line of credit. Citing a security agreement and note for the line of credit, which had been executed a year before plaintiff's judgment, the lender claimed a security interest in the assets that took priority over plaintiff's judgment lien. After being served with the writ of execution, the lender continued to advance money to defendant judgment debtor. The JC petitioned the district court for an order requiring defendant lender to turn over the assets at issue. Holding - The appellate court ruled that the district court had failed to properly determine the parties' priorities under the applicable version of the UCC 9-301(4), which gave a perfected security interest priority over judgment liens for 45 days. 45 Day Rule and Attorneys Fees o To the extent attorneys fees are incurred to advance senior advances (advances during the 45 day advance period), their fees are senior as well. However, attorneys fees incurred to advance junior claims are junior to other claims. It depends which claim the lawyer was working on. While you can't really call attorneys fees advances to the Judgment Debtor, the Court says that if fees were related to protecting senior advances, then they are also protected and senior to the JCs lien. o In Oregon, the attorneys had committed to provide legal services to the secured party; in such a case the attorneys services themselves are considered the advance! As a result,

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the Secured Partys law firm had a 45 day privilege to do legal services to defeat the JC and at the expense of Judgment Creditor. But even beyond this, once the lawyers entered into this commitment, they are no longer restricted by the 45 day rule. The attorneys must make the commitment prior to the lien and once this is done, their good faith doesnt matter

Fraudulent Conveyances
In General
Constructive Fraud 2 Elements: o Debtor does not receive reasonably equivalent value in exchange o The debtor was in a shaky financial situation at the time of the transfer 2 Options for Creditors under Fraudulent Conveyance Law o The Judgment Creditor can have the conveyance from the Judgment Debtor to W set aside o The Judgment Creditor can have the property levied as if the transfer never occurred. Generally o Gifts - Broke people (insolvent) may not make gifts. o Bulk Sale Owner of a store wants to get out of town with some cash to escape creditors. He sells his inventory at a cut rate to another store owner, and runs off to Switzerland, never to be seen again. This is a fraudulent conveyance, because it was done with knowledge to defraud the creditors. o Fraudulent Mortgages if the debtor takes out a mortgage on his property, then runs off with the cash. If the mortgage was granted with knowledge of debtors intentions, this is a fraudulent conveyance. Bonified Purchaser Defense o If the buyer in the bulk sale does not know that the debtor intended to defraud creditors, he will not get in trouble New York Law (Uniform Fraudulent Conveyance Act, Article 10) o Gifts 273 no gifts if the debtor is classically insolvent (when his debts exceed the value of his assets) 273(a) any gift by a defendant in a lawsuit is deemed to be a fraudulent conveyance 274 any conveyance by a business that is undercapitalized is a fraudulent conveyance. Even if the business is technically solvent, if it gives gifts when it has very little capital, that gift is insolvent. 275 gifts made without fair consideration when a person knows he is about to incur a debt that he cannot pay. Some guy commits a tort; he knows hes about to have his pants sued off, so he gives his assets to his mom o Bulk Sale 276 A conveyance made to hinder, delay or defraud creditors is a fraudulent conveyance. 278 The Bonified purchaser defense - Where a conveyance is fraudulent as to a creditor, the creditor can claim title, unless the buyer had purchased without knowledge of the fraud Remedies o Have the conveyance set aside or obligation annulled to the extent necessary to satisfy the creditors claim. This is effectuated by a turnover proceeding

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Disregard the conveyance and attach or levy execution upon the property conveyed As soon as a creditor gets a judgment, the sheriff can simply show up and take the item that was sold. This is extreme the sheriff simply shows up without announcement, without any notice or hearing, and takes the property. Grupo Mexicano v. Alliance Bond Fund (111) Facts - This case involved an action for money damages where the creditor sought a preliminary injunction in federal court to prevent Grupo Mexicano, the defendant, from transferring its assets prior to judgment being entered. Holding - The Supreme Court solidified a property owners right to freely transfer his property prior to judgment subject to subsequent equitable remedies under fraudulent conveyance statutes. The majority opinion pointed out prerequisites for equitable remedies as well as the general availability of injunctive relief against asset transfers depend on common law principles of equity. The Supreme Court stated that, It was well established, however, that, as a general rule, a creditors bill could be brought only by a creditor who had already obtained a judgment establishing the debt. Under common law, a creditor has no property interest in the assets of a debtor prior to the creditor obtaining a judgment, and before judgment, a debtors property is freely alienable. Teaching - that the trial court lacked the authority to issue a preliminary injunction that prevented GMD from disposing of their assets pending adjudication of Alliance's contract claim for money damages because such a remedy was historically unavailable from a court of equity. Writing for the majority, Justice Antonin Scalia said that creditors must first prevail in the case. To allow them to enjoin the transfer of property beforehand ""could radically alter the balance between debtor's and creditor's rights"" and encourage creditors to ""engage in a race to the courthouse,"" Scalia wrote. Neshewat v. Salem (126) Facts - JC had a judgment against the JD obtained in state court in the amount of $ 166,844. After the judgment was entered the debtor transferred his home and a car to his wife, who then sold the home to Paragon, a 3rd party. Paragon was collecting rent from the tenants. JC filed an action seeking to enforce the judgment and to set aside the conveyances, and defendants filed a counterclaim, pursuant to N.Y. C.P.L.R. 5015(a)(3), to set aside the state court judgment. Holding - Summary judgment was entered on the fraudulent conveyance action, pursuant to N.Y. Debt. & Cred. Law 273-a, because at the time of the conveyance, plaintiff's judgment for money damages had been entered, and the conveyances were made without fair consideration. To the extent that the conveyances could not be set aside, defendants were liable for money damages. Plaintiff could garnish past due rent owed to defendants for the home, and there were no grounds for stopping the sheriff's sale of the property. o

Must have Standing as a Creditor to Claim Fraudulent Conveyance

Travelers Insurance Co. v. 633 Third Associates Facts TIC loaned a lot of money to 633 Third Associates to buy an office building; the loan was secured by the building (and limited to the building by the loan agreement). Building profits are bad, and 633 defaults on the loan. Since the building was not in itself worth enough to cover the amount of the loan, TIC sues 633, saying 633 distributed 4 million cash to its partners a fraudulent conveyance! 633 says that TIC has no right to the money, since the loan agreement restricted damages to the building itself. TIC claims that by making the 4 million distribution, 633 lowered the value of the building (the security interest) that money should have gone for building upkeep and local property taxes; since 633 did not make the payments, the buildings value went down, and the IRS has a superior tax lien on the building!

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Holding - The court held that the creditor was precluded from maintaining a suit for damages against the debtors, though it was possible that they could seek equitable relief. Partnerships and Fraudulent Conveyance Law o Non Recourse Mortgages and Partnerships - 633 is a partnership who grants TIC a mortgage. The renters slowly stop paying because of an economic recession. 633 takes whatever income there is and starts divvying up between partners, leaving nothing for TIC. Additionally, they dont pay taxes and they dont maintain building. What can TIC do? If this had been a recourse mortgage, then TIC could sue 633 and sue the partners individually for $$. But TIC does not have this option, so instead TIC sues and claims that each distribution, to each partner, was a fraudulent conveyance. o TIC is not a Creditor in relation to each individual partner - The 2nd Circuit explains that TIC is not a creditor. Therefore TIC has no fraud conveyance theory. This means that when a partnership sees the ship sinking it is invited to loot the remaining $$. o Limitations on Non-Recourse Debtors Ability to Loot - There is, however, a limit on the partnerships ability to loot the property at the expense of the creditor the tort of WASTE. A present partnership is expected to not commit waste on property that means they must make repairs and pay taxes. Because if taxes accrue, the IRS gets seniority over mortgage. Essentially, looting is ok, so long as you dont go too far and prevent the tort of waste.

Fraudulent Transfer Law and Leveraged Buyouts

Leveraged Buyouts o Definition A transaction in which the purchase of shares in a corporation is financed by the corporation itself or secured by the assets of the corporation. In essence, the corporation provides funding to the buyer of its shares. The expectation is that reimbursement of the corporation will come from future profits that the buyer will make from the operation of the corporations business. o How LBOs work there are many ways to structure an LBO, but essentially, they all come down to the same thing the corporation uses its own assets to a secure loans that enable the buyer to raise the money necessary to buy up the corporation. o Dangers of the LBO if the LBO is successful, the new owners of the corporation will make enough profits to pay back the loans and unencumber the corporations assets. However, if the business does not do well, the secured creditors will foreclose on the corporations assets hurting not only the corporation itself, but the corporations other unsecured creditors who no longer have access to the corporations assets (which have been secured by the LBO creditors) o LBOs and Fraudulent Transfer Law When an LBO goes bad, creditors may look to fraudulent transfer law to avoid the transfer made by the corporation in connection with the LBO. The transfer at issue is the corporations grant of a security interest in its assets to the LBO creditors. To avoid the transfer, the unsecured creditors must establish either actual or constructive fraud. o Actual Fraud and LBOs (Rare Case) If the LBO is dishonestly used as a pretext to plunder the corporations assets, this is actual fraud US v. Tabor Court Realty (158) Facts A coal company is bought out by a leveraged buyout. The company soonceases operations and is sold off to its biggest competitor. Essentially, this was na undercover LBO designed to let the LBO shareholder walk away with lots of cash and for the competitor to take over the companys assets a bad faithed LBO! Holding - The district court gave judgment for appellee, and appellants challenged that judgment. The court affirmed the judgment in almost all respects. The court found that appellants did not act in good faith; the district court properly applied fraudulent conveyance law to the leveraged buy-out; appellant realty company was not entitled a superior lien because although it gave a fair equivalent for the mortgages, it did not do so without knowledge of the fraud at the time of the purchase; appellant realty company lacked good faith; the finding that one

21
company was insolvent was not in error; the evidence supported the conclusion that there was an intent to hinder creditors. Finally, the claims of appellant realty company should have been totally invalidated instead of just partially invalidated. Halper v. Halper (192) The corporation offers to redeem its own shares from X. X says yes in exchange for cash equivalent to the value the shares are trading at. But in reality, the corporation was engaged in massive fraud and is insolvent at the time of the stock redemption. Thus, the corporation has fraudulently transferred it remaining money to X. However, X didnt know about all this fraud when he agreed to sell his shares! Nonetheless, the Court says that X has received a fraudulent conveyance. o Constructive Fraud and LBOs (Usual Case) Even when the LBO is done honestly, creditors can sue under constructive fraud - The grant of a security interest in the corporate assets increased the corporations debt over its assets, rendering it insolvent. The corporation (the debtor) did not receive equivalent value in such a situation. Subrogation o Definiton - Subrogation arises when one individual satisfies the debt of another as a result of a contractual agreement that provides that any claims or liens that exist as security for the debt be kept alive for the benefit of the party who pays the debt. It is necessary that the agreement be supported by consideration; however, it does not have to be in writing and can be either express or implied. o When Does Subrogation Apply - The facts of each case determine the issue of whether or not subrogation is applicable. In general, the remedy is broad enough to include every instance in which one party, who is not a mere volunteer, pays a debt for which a second party is primarily liable and which, in equity and good conscience, should have been discharged by the second party. Subrogation is a highly favored remedy that the courts are inclined to extend and apply liberally. o Subrogation Applied to Corporations and Subsidiaries Generally - Typically corporations divide themselves into subsidiaries. There is a lender who lends money to one of the subsidiaries and the lender wants as many guarantees as possible. The parent must guarantee this loan and all of the other subsidiaries must guarantee the loan as well. The trouble with guarantees is that the parent takes on the debt but doesnt get any money. The suspicion is that these guarantees are fraudulent conveyances. Downstream Guarantees In this case, the subsidiary gets the money from the loan, while the parent company guarantees the loan. These arrangements are typically not fraudulent conveyances because even though the parents are not getting $$, the stock is becoming more valuable. Typically in downstream cases, the courts says there is no fraudulent conveyance Upstream Guarantees In this case, the parent company receives the laon, while the subsidiary guarantees the loan. This arrangement is often problematic as it is hard to find consideration that is going to the parent company. However, sometimes a loan to the parent makes the subsidiary stronger. It is possible to locate within the corporate family certain synergies and benefits which can serve as benefits to the subsidiary and therefore qualify as fair consideration. Cross Stream Guarantee The loan goes to one subsidiary and is guaranteed by the other subsidiaries. This is often considered a fraudulent conveyance. Value of Subrogation When a corporation guarantees another persons debt, there is a danger of fraudulent conveyances what is the corporation getting in return? It is imperative for the defendant to show that there was fair consideration. What happens if the subrogation right was worth something when it was created but not now? When do we value it? Carlson says properly, we should value it when it came into existence. Rubin v. Manufacturers Hanover Trust Co (180) - The rule in this case is that you value the subrogation act at the time of creation revolving credit every three days. The timing rule is that every three days, they value.

22
Rubin v. Manufacturers Hanover Trust Co (180) Facts - The bankruptcy trustees of two firms sought to recover from defendant banker the value of certain funds and securities of the bankrupts. Trustees contend that the bank took the assets pursuant to fraudulent conveyances; the sales agents owed money to the bank, but since USN and UMO had guaranteed the loan the bank was able to take their assets when the sales agents defaulted. Issue Did USN and UMO create a fraudulent conveyance when they guaranteed the sales agents loans? Did USN and UMO get fair consideration in return? Holding The court remanded the case to get a better idea as to whenther USN and UMO received fair consideration. The court missed an important piece here the reason USN guaranteed the loans was to make sure the sales agents did not illegally withhold money belonging to USN and thereby deprive USN of the float value of that money

Chapter 7 Liquidation
The Automatic Stay
Citizens Bank v. Strumpf (197) o OVERVIEW: Respondent bankruptcy debtor, who filed a Chapter 13 bankruptcy
petition, had a checking account with petitioner creditor bank. Respondent was in default on a loan from petitioner, and petitioner placed an administrative hold on respondent's account and refused to pay withdrawals that would reduce the balance below the sum claimed due on respondent's loan. Petitioner then filed a motion for relief from the automatic stay and for setoff. Respondent claimed that the administrative hold violated the automatic stay established by 362(a) of Bankruptcy Code, 11 U.S.C.S. 362(a). The bankruptcy court concluded that the hold constituted a setoff in violation of 11 U.S.C.S. 362(a)(7) and sanctioned petitioner. The bankruptcy court subsequently granted petitioner's motion for relief from stay and authorized the setoff. By that time, however, respondent had reduced the account balance to zero. The district court reversed. Respondent appealed. The court of appeals reversed. Petitioner sought a writ of certiorari. The Court granted the petition and reversed, holding that petitioner's administrative hold did not constitute a setoff and did not violate the automatic stay. OUTCOME: The Court granted the creditor bank's petition and reversed, holding that the banks administrative hold did not constitute a setoff and therefore did not violate the automatic stay because petitioner did not purport to permanently reduce respondent's account balance by the amount of the defaulted loan Teaching - The placement of a temporary administrative hold on a bank account while the bank applies for relief from stay is not, in itself, a violation of the automatic stay. (E&E 239)

In Re Archer (199) o OVERVIEW: Creditor bank moved to prohibit debtor's use of cash collateral under the

Bankruptcy Code, 11 U.S.C.S. 363(c)(2) (A) and (B). Creditor claimed it turned over the funds represented by a certificate of deposit to debtor because it believed it was required to do so under the automatic stay. Creditor claimed it had a right of set off against debtor's debt and that such claim was a secured claim under the Bankruptcy Code, 11 U.S.C.S. 506(a). The court rejected debtor's claim that creditor's turnover of the funds constituted waiver of its right to set off. The court found the payment of the funds was not entirely voluntary, and thus no knowing waiver was effected. The court determined the certificate of deposit was cash collateral within the meaning of

23
Bankruptcy Code, 11 U.S.C.S. 363(a). The court determined the funds represented cash collateral against which creditor bank had a secured claim. The court granted creditor's motion to prohibit the use of the cash collateral without a court order or creditor's consent. OUTCOME: The court granted creditor's motion to prohibit use of cash collateral because debtor's certificate of deposit funds represented cash collateral that creditor had a secured claim against when creditor's turnover of funds was not entirely voluntary and its right to set off was not waived.

Brooks v. World Omni (202)

o

o OVERVIEW: The dealership repossessed the debtors' car on June 20, 1996. On June 25,

Issue Is failure to return a repossessed car a violation of the automatic stay?

1996, the debtors filed for Chapter 13 bankruptcy and started an adversary proceeding seeking turnover of the car. That day, their attorney requested the dealership to return the car. The dealership demanded proof of insurance, which was provided on June 28, 1996. That day the dealership told the debtors they could pick up the car from a lot about 40 miles away, but the lot was closed for the weekend. The debtors had their car towed back, and rented a car while the dealership had possession. Granting the motion in part, the court explained that the unsecured creditors should not have been called to pay the cost of transporting the vehicle back to the debtor. By making the car available in 40 miles away, the dealership failed to fulfill its responsibility of returning the car to the debtors' possession. The court held the response time unreasonable, and three days would have been reasonable. The court noted that the dealership's duty was not dependent on proof of insurance. The court found a willful violation, requiring an award of costs. Finding no egregious conduct, the court awarded no punitive damages. OUTCOME: In the adversary proceeding the debtors brought in their Chapter 13 bankruptcy proceeding against the dealership for turnover of their repossessed car, the court awarded costs for a willful violation, but made no award of punitive damages

48th Street Steakhouse v. Rockefeller Group (206) o OVERVIEW: The creditors were the debtor's landlords. The debtor had subleased the

property to another company. The debtor filed for Chapter 11 bankruptcy. The creditors sent a lease termination to the sublessee. The district court held that the creditors had violated the debtor's right to an automatic stay, and it granted the debtor's motion for summary judgment. The creditors appealed, maintaining that they had the right to terminate the lease because the debtor's interest was only that of a sub-lessor. The debtor argued that the assignment of its lease was intended as collateral and that it retained an equitable interest in the lease greater than that of a sub-lessor. The court determined that unexpired leasehold interests, including subleases, were part of a bankrupt estate. Mere possessory interest in real property was sufficient to trigger the protection of the automatic stay. Because the creditors' attempt to terminate the lease would have resulted in the destruction of the sub-tenancy, the creditors' termination notice violated the automatic stay and was void.

Roslyn Savings Bank v. Comcoach Corp. (209) o OVERVIEW: The debtor leased property that was subject to appellant's mortgage. When
the lessor defaulted on its mortgage payments, the mortgage holder instituted a foreclosure proceeding. Debtor, who was neither named as a party-defendant nor served with process in the foreclosure action, subsequently filed a petition under Chapter 11 of the Bankruptcy Code, 11 U.S.C.S. 1101-1174. The mortgage holder commenced an action requesting that the automatic stay be lifted under 11 U.S.C.S. 362(d)(1), (2) to enable it to name the debtor as a party-defendant in the pending state foreclosure action. The bankruptcy court denied the mortgge holders request on the ground that appellant was not a party in interest entitled to seek modification of the stay. The appellate court affirmed the denial and held that appellant was not a party in interest within the meaning of the Bankruptcy Code. Appellant was required to be either a creditor or a debtor to invoke the court's jurisdiction. OUTCOME: The court affirmed the order because appellant was not a party in interest in the bankruptcy proceeding and could not seek to have the automatic stay modified so as to name appellee debtor as a party-defendant in a pending state foreclosure action.

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Creditors Rights to Post Petition Interest

United Savings Association of Texas v. Timbers of Inwood (214) o OVERVIEW: Creditor sought review of an en banc decision holding that Creditor was
not entitled to receive from debtor--undergoing reorganization in bankruptcy--monthly payments for the use value of the loan collateral which bankruptcy stay prevented petitioner from possessing. 11 U.S.C.S. 362(d)(1), protecting "interest in property" and allowing unsecured creditor relief from automatic stay on the grounds of lack of adequate protection, did not include Creditors purported right to an immediate foreclosure proceeding. The 11 U.S.C.S. 506(b) denial of postpetition interest to undersecured creditors merely codified pre-Code bankruptcy law in which that denial was part of an allocation of reorganization's benefits and losses between undersecured and unsecured creditors. Petitioner's interpretation of 11 U.S.C.S. 362(d)(1) was inconsistent with 11 U.S.C.S. 552, which stated a general rule that a prepetition security interest did not reach property acquired postpetition. Petitioner's legislative history arguments were contravened when Congress would not likely have made major change without specific provision in text of the statute. o OUTCOME: The Court affirmed, as the Bankruptcy Code provision protecting "interest in property" and allowing an unsecured creditor relief from an automatic stay on the grounds of lack of adequate protection did not include petitioner's purported right to an immediate foreclosure proceeding. Prepetition security interest did not reach property acquired postpetition. Rules from this Case o Undersecured creditors do not get post-petition interest compensation. Ex. Where the asset is worth 8 and the secured creditors claim is 10, the secured creditor is not entitled to interest on the $8 as a mode of adequate protection (362(d)(2)). o Oversecured creditors will get interest to the extent that the value of the collateral exceeds their claim (under 506(a)). Ex. Where an SP with a sr. claim against D for 6, and the value of the collateral is worth 10, the most the oversecured SP can earn in interest is 4 (the amt he is oversecured by). o Interest itself should not trigger a right to adequate protection payments even if the interest accrual consumes the entire equity in the property. Debtor is required only to protect the value of the property in which the creditor has an interest. The interest entitled to protection under 361 is the value of the property (collateral) securing the creditor's claim and not the value of the creditor's interest in the property. o This decision allows a highly leveraged company to live in ch.11 interest free, where the secured creditors are underwater (undersecured). o Where rent is accruing on property, an undersecured creditor will eventually become an oversecured creditor and be entitled to 506(b) interest. If the roperty earns money each month, those earnings are considered added to the value of the collateral. At a certain point, the value of the collateral will increase to the point that the creditor becomes oversecured. Courts are split as to whether the equity cushion must be preserved. Where it does not have to be preserved, the trustee should take the cushion (making sure there is no cushion to prevent the accruing of interest). o Impact of this Case - This opinion says that no time value for undersecured creditors. This means that there is a bankruptcy tax on undersecured creditors

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undersecured creditors do not get post petition interest.. The Debtor is invited to invest the collateral and expropriate the return. This case represents a direct wealth transfer. There is a wealth transfer from the undersecured debtor to the bankruptcy estate. This had made Chapter 11 a viable business phenomenon. After this case, there was strategic bankruptcy. As a result, a new industry has been invented by Wall Street called: Securitization. Securitization Thisis an industry designed to make sure that even if bankruptcy hits, the cash flow will continue from the debtor to the creditor Basically, the securitization agreement arranges for certain assets of the debtor to be considered outside of the estate, which can then be sold to pay the creditor. These assets will not be covered by Timbers The way this is done is by setting up SPVs to buy accounts receivable from the parent company. The key is to make sure the accounts receivable are not considered part of the parents estate, so that the accounts receivable become bankruptcy remote.

The Bankruptcy Estate

FRESH START What is in the Estate? o General Rule - 541a possessions of the debtor at the commencement of the bankruptcy go to the bankruptcy trustee; anything he comes into after filing escape from the trustee (wages) Exception Inheritances - 541(a)(5) an exception for inheritances received in the first 6 months after filing. Meaning, if an old rich uncle is dying, you cant file just in time to protect the inheritance from creditors. You have to have filed at least 6 months before uncle dies. o Wages - 541c: post petition wages do not go into the estate FRESH START; wages go to the Debtor but everything else goes to the estate. o Burgess v. Sykes Issue - A post-petition bankrupt farmer gets a check from the government that was given to all farmers in the region for difficult conditions. Who gets the check the creditors or the farmer? Precedent for this case was a situation where the court held that a tax attribute held by a debtor was considered property sufficiently rooted in the pre-petition period. Here, the farmer had a loss that generated federal payments through federal legislation that did not exist in the pre-petition period. The Court, by a slight majority, held that the government payments belonged to the farmer alone Facts - A Chapter 7 bankruptcy petition was filed, and the debtor was discharged from bankruptcy. After the discharge, the Agricultural Assistance Act of 2003 was enacted, which provided for crop-disaster relief payments to qualifying farmers for 2001 or 2002 crop losses. Farmers that qualified could begin applying for disaster payments in June 2003, and the debtor did so, after the bankruptcy case was closed. The bankruptcy case was reopened to determine what to do with the check, and the debtor filed a motion for turnover, which was denied by the bankruptcy court. The district court affirmed, and a panel reversed the decision, reasoning the disaster payment was not "property" under 11 U.S.C.S. 541(a)(1) because the legislation providing for the payment was not enacted until after the debtor filed for bankruptcy. The district court ordered rehearing en banc to determine whether the disaster payment at issue constituted property within the meaning of 11 U.S.C.S. 541(a)(1) or proceeds within the meaning of 11 U.S.C.S. 541(a)(6). The appellate court held that the debtor did not obtain a legal interest in the disaster relief payment until the 2003 Act was passed.

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o Severence Pay - Debtor with employment contract that has a severance pay term severance will be 100, but will grow the longer you stay with the company. What if employee goes into bankruptcy on Monday, and is fired on Tuesday, triggering a $1 million severance payment. Is this a pre-petition or post-petition payment? IS this rooted in the pre-bankruptcy past, and therefore considered pre-petition? The 9th circuit held this to be a pre-petition payment. The contract that the employee received is pre-petition property. The only question is whether severance pay is considered wages (which belong to debtors, not creditors). The Court held that severance is considered like earnings, but as pre-petition earnings, as the severance was built up over the course of the employment, the vast majority of which occurred before bankruptcy. The debtor received a miniscule portion of the severance earnings, corresponding to the one day that he worked after bankruptcy.

US v. Whiting Pools (247) o OVERVIEW: Respondent failed to pay its taxes and was assessed a tax lien by the IRS.

o o

The IRS seized respondent's property, and thereafter, respondent filed bankruptcy in a Chapter 11 reorganization. Respondent became a debtor-in-possession and sought to have the property return under 11 U.S.C.S. 542(a). The IRS refused to return the property, arguing that 542(a) did not require it to return the property, and that in any case, it was exempt from the Bankruptcy Code's provision that related to other secured creditors. Respondent sued to enforce the return, and the court held that 542(a) did require a secured creditor to return seized property back to the estate for reorganization. The court also determined that the IRS did not enjoy any special protection from the Bankruptcy Code and had to abide by the law just as any other secured creditor. The court ordered the IRS to return to the estate the property it seized pursuant to its tax lien. There are two views of property: Property is the thing. Does the Debtor own the property? The United States Supreme Court believes this. Therefore, creditors must give back assets that they have repossessed upon bankruptcy. Property is the Debtors interest in the thing (and there/4 debtor has no right to get the chemicals back) this was the IRS view This is important because Repossessed Stuff must be turned back to the Bankruptcy Trustee. Ordinarily turnover by a creditor in possession is NOT a catastrophe, since secured creditors are entitled to adequate protection under 363(e). but the IRS is in a different position. 11 USC 724(b)

Distribution Rule E&E 409

724 Distributions apply to cases where a tax lien is present Example Sec Int. 50 Collateral 130 IRS lien 40 20 10 Jr. Jud Lien 30 Lawyer Exp 20

27
(b)(1) gives senior security interest 50 (b)(2) though 507(a)(1) lawyer gets 20 (b)(3) IRS gets 20 (not all 40) (b)(4) jr. lien gets 30 (b)(5) IRS gets rest of claim paid, but here there is not enough collateral to pay off completely, so they only get 10. Had there been any money left, the IRS would have gotten another opportunity to collect under 726(a)(1) through 507(a)(8). 725 Distribution to secured creditors Permits collateral or its proceeds to be returned to the proper secured creditor when not returned under another section. 726 Distribution of unencumbered assets to unsecured creditors The only place creditors are equals.

o o

Fraudulent Transfers and the Bankruptcy Estate

American National Bank v. Mortgage America Corp (256) OVERVIEW: Creditor brought three claims against the controlling shareholder of a Chapter Seven debtor in state court, two equitable claims on corporate trust fund and denuding the corporation theories, and one under the Texas Fraudulent Transfers Act, Tex. Bus. & Com. Code Ann. 24.02-24.03 (1968). The bankruptcy court had these claims stayed under the automatic stay, 11 U.S.C.S. 362(a). On appeal, the court affirmed both the bankruptcy and the district court, holding that property fraudulently conveyed and recoverable under the Texas Fraudulent Transfers Act remained property of the bankruptcy estate pursuant to 11 U.S.C.S. 541(a)(1), despite its purported transfer. Similarly, an action brought under state trust fund or denuding theories had been an action in the right of the corporation, though for the benefit of creditors and shareholders, and any such claim was also property of the estate and subject to the automatic stay. Automatic Stay applies to Fraudulent Conveyances - Since the conveyance was fraudulent, it is as if the debtor never conveyed the money to anybody else and is still in possession of the money, so the automatic stay applies to the conveyed money. Fraudulent conveyances are in violation of the automatic stay. o Property fraudulently conveyed remains with the debtor, and within the estate, after the conveyance under 541(a)(1). o A dividend payment made by the debtor still belongs to him, and is simply being held in a constructive trust by the transferee. The bank attempting to reach these dividends is considered a violation of the automatic stay. Carlson thinks the gift is final (and that surplus remains with the transferee) and the debtor no longer has an interest and the property is no longer in the estate. o The same result could have been reached through 550 544(b)(1) if the bank were an unsecured creditor Trustee can subrogate himself with the unsecured creditor, which would be the bank, if applicable But the bank IS securedso this is stupid! See notes for 10/29. 548 gives the trustee an independent right to avoid fraudulent conveyances. o Fraudulent conveyance must occur within 1 year of the bankruptcy. 541(a)(4) 551 preserves what the trustee avoids for the unsecured creditors and keeps the property in the estate. o Where D makes a fraudulent transfer to X, then makes a secured transaction with C, and later files for bankruptcy, the transfer to X is not erased (b/c that would give C priority). The trustee works for the unsecured creditors, like X, and just avoids the transfer to X, with 551 preserving it.

Do Bankrupt Debtors Pay Rent?

In Re Szekely (262) Homestead Exemption Case o Facts - The debtors filed for bankruptcy and listed their home as property of the estate. Appellants continued to live in the home. The trustee obtained an order requiring appellants to pay rent from the time they filed bankruptcy until they moved out. The rent

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was to be deducted from appellants' homestead exemption allowed under state law. On appeal, the court reversed and held that under the state homestead exemption, appellants were entitled to live in their home at no charge until they received the cash value of their homestead exemption. The interaction of the bankruptcy laws and the state homestead exemption made appellants and the trustee co-tenants of appellants' home. As a co-tenant, the trustee was not able to charge appellants rent. The trustee was able to obtain sole rights to the property by paying off the homestead exemption, which was in effect a partition of the property. Until the trustee paid the homestead exemption, he had no right to disturb appellants' possession of the home. The court had jurisdiction to hear the appeal because the district court's ruling on the issue was a final, appealable order Holding - The debtor can remain in his home rent-free until the trustee can sell the home and pay the debtor the value of the jurisdictions homestead exemption Reasoning Tenants in Common - The court makes an analogy to property rights, and how the debtor and the trustee are similar to tenants in common (where neither party can charge the other rent but can demand partition). Carlson Disagrees - Carlson disagrees that a homestead exemption is equivalent to a tenancy in common. The same outcome could have been reached by Strong Arm theory, allowing D to remain in the home until sold at aucion: Under 544(a)(1) the trustee is a judicial lien creditor and after the sale the Debtor would be a trespasser. Under 544(a)(3) the trustee obtains the powers of a BFP because of the filing of the petition.

o o

Wages
Litzler v. Sholdra (266) o OVERVIEW: Debtor was an ophthalmologist who conducted his practice through a
professional corporation, organized under Subchapter S of the Internal Revenue Code. As a result of the filing of debtor's Chapter 7 case, the stock of the corporation became property of the estate created pursuant to 11 U.S.C.S. 541. The trustee sought recovery under 11 U.S.C.S. 549 of payments other than his salary made by the corporation since January 1, 1999 to or on behalf of debtor. As plaintiff, it was the trustee's contention that the payments constituted property of the estate as "profits" generated by estate property within the meaning of 541(a)(6). Debtor, on the other hand, argued that the payments fell within the exception provided by 541(a)(6) for earnings from services performed by an individual debtor after the commencement of the case. The court concluded that the trustee presented no evidence that the payments resulted other than from debtor's personal services. Moreover, the debtor produced affidavits stating that his work was the source of the payments.

Earnings and Wages

o o 541(a)(6) - allows a debtor to keep earnings from services performed by an individual debtor after the commencement of the case. Keeping wages is one of the key elements of the fresh start. Burden of Proof - The trustee has the burden of proof to distinguish between wages and other earnings (such as bonuses and dividends). If no proof is present the debtor will be permitted to keep everything. Proof can include overhead costs, past earnings, etc. Assigning Wages - Even where a debtor voluntarily assigns his wages to another and subsequently goes bankrupt, his post filing wages are nevertheless unencumbered and part of the debtors fresh start. Traditionally, the Bankruptcy court upheld this partys lien against the debtor. Competing view points: Right wing (pro-creditor) state law entitlements should be honored and the assignment should be valid.

29
Left wing (pro-debtor) federal law can override state law and allow the fresh start.

541(c)(2) Spendthrift Trusts

o Out of the bankruptcy estate and cannot be garnished by the sheriff.

Claims Against the Bankruptcy Estate

Allowed Claims
Prepetition vs. Post Petition - 502(b) o Prepetition creditors have claims on the estate. o Postpetition creditors have claims on the debtor and are not subject to the automatic stay. o The creditor is barred from going after property of the estate. Administrative Creditors - 503(b). o Creditors that render post petition services to the estate are administrative creditors Proofs of Claim - 502(a) o Proofs of claim are prima facia evidence that the amount of the claim is correct. o Creditor can object to the proof.

Allowed Secured Claims

The Issue If a debt is undersecured at the time of bankruptcy, it bifurcates into secured debt, measured by the current value of the collateral and an unsecured debt for the deficiency. If the value of the collateral rises after the value has been determined by the court, will the increase in value restore the size of the secured debt, or is the secured claim stripped down and fixed, leaving the increased value to the debtor? Dewsnup v. Timm (275) o OVERVIEW: The court affirmed a denial of petitioner debtor's complaint to reduce, pursuant to 11 U.S.C.S. 506(a), the amount of respondent creditors' lien on petitioner's real property to equal the fair market value of the property, and to declare void under 11 U.S.C.S. 506(d) that portion of the lien which exceeded the value of the property. The court held that, because respondent's claim had been "allowed" and was "secured" by a lien, it was not voidable. 11 U.S.C.S. 506(a) provided that a creditor's allowed claim, secured by a lien on property in which the estate had an interest, was a "secured claim" to the extent of the value of the collateral. 11 U.S.C.S. 506(d) provided that to the extent that a lien secured a claim against a debtor that was not an "allowed secured claim," the lien was void. Petitioner argued that the portion of the lien that exceeded the value of the property was not an "allowed secured claim," and hence was void. The court held that the use of the term "allowed secured claim" was ambiguous, and construed 11 U.S.C.S. 506(d) as not to apply to a lien securing a claim that was fully allowed under 11 U.S.C.S. 502.

30 General Rule
o o A chapter 7 debtor cannot use 506(d) to reduce the an under-secured claim to the present value of the collateralas judicially determined in the bankruptcy case Congress intended 506(d) to permit liens to pass through bankruptcy unaffected. The creditor's lien stays with the real property until the foreclosure. Any increase over the judicially determined valuation during bankruptcy rightfully accrues to the benefit of the creditor and not to the benefit of other unsecured creditors. Dewsnup unstops the clock for unsecured creditors so that if the collateral increases, the increase belongs to the creditor (creditor gets wealth transfer). Old rule - the claims were capped, or frozen, at the value of the collateral on bankruptcy day and any increases in value were enjoyed by the trustee and unsecured creditors permitted the stripping down of liens. Bifurcation is never final except where: Trustee sells the collateral free and clear of 363(f). Confirmation of a reorganization plan (default on pan is irrelevant to bifurcation). Bifurcation is out of the question and the entire loan amount may be cured and reinstated Home mortgages have immunity from bifurcation under ch.13. Debtor can (1) cure the default and reinstate the agreement going forward, or (2) get out of the house and hand it over the to the trustee. Nobelman - 1322(b)(2) protects a mortgagee's (creditor) entire right to repayment as defined by the parties' agreement and state law. In this case the debtors ch.13 plan could not be confirmed because it provided only for repayment of the fair market value, which constituted the secured component of the claim under 506(a) and was considerably less than the loan amount. Any interest is on the entire agreement amount. Exception/Loop Hole 1322(b)(2) applies to the debtors residence, but not to personal property. If the mortgage also covered the carpeting in the home, 1322(b) may not apply because the carpeting is personal property. (see note for 11/11) Courts that make this distinction will allow bifurcation, which may allow the debtor to keep his home. Where the personal property is a bank account, some courts will ignore the lien on the account and apply 1322(b) although not solely secured by the residence.

Bifurcation and Chapter 13 Mortgages

o o

Substantive Consolidation
Definition The Court has the power to consolidate cases against separate debtors. Where spouses or other closely related debtors are each placed in bankruptcy, the court can combine their estates so that assets are pooled and creditors of each become creditors of the estate. Impact of Consolidation on the Rights of Creditors - Creditors of the estate with the higher asset to debt ratio will receive less if the estate is consolidated with a poorer one. When will Courts Order Substantive Consolidation? o 2 Criteria: The estates must be hopelessly Commingled the debtors must have acted in a way that has blurred their distinct identities so that their assets are intermingled Balancing of Equities - The equities in favor of treating the debtors as a unit must outweigh those of keeping the estates separate some creditors will lose out if you mix the estates.

In Re Owens Corning (281)

31 o OVERVIEW: The credit was enhanced in part by guarantees made by some subsidiaries

of the debtor. The instant court concluded that no principled reason existed to undo the debtor's and the banks' arms-length negotiation and lending arrangement, especially when to do so punished the very parties that conferred the prepetition benefit--a $ 2,000,000,000 loan unsecured by the debtor and guaranteed by others only in part. To overturn this bargain, set in place by the debtor's own pre-loan choices of organizational form, would have caused chaos in the marketplace. There was no evidence of the prepetition disregard of the borrowing entities' separateness; the debtor negotiated the transaction premised on the separateness of all debtor affiliates. There also was no meaningful evidence postpetition of hopeless commingling of the entities' assets and liabilities; there was no question which entity owned which principal assets and has which material liabilities. Other considerations also counseled strongly against consolidation, e.g., holding out the possibility of later giving priority to the banks on their claims did not cure an improvident grant of substantive consolidation.

Avoidance Powers in Bankruptcy

The Strong Arm Power
Generally o Overview - The trustee is a hypothetical judicial lien creditor on bankruptcy day. Trustee is also a bona fide purchaser. Judicial lien creditors have the power to avoid transfers by the Debtor. The premier one to avoid is the unperfected security interest under Article 9 o 544(a)(1) gives the trustee the state law power of a judicial creditor - to avoid any transfer of Property or any obligation incurred by the debtor that would be avoidable in non bankruptcy law by a creditor who has a judicial lien on all the debtors property as of the date of the petition Basically, if the earlier secured creditors forget to perfect their liens, the trustee can knock out the claim using 544(a), thereby turning the unperfected secured creditor into a general unsecured creditor (much worse!) o 544(a)(3) gives the trustee the avoidance power that would be available in non bankruptcy law to a bona fide purchaser of real property from the debtor who obtained and perfected that status on the date of the petition

32
The Grace Period - 546(b)(1) The Strong arm power is subject to a 20-day grace period at state law. Where there is no perfection and the grace period lapses, SP looses his security interest and becomes an unsecured creditor. McCannon v. Marston (298) o Facts - Mrs. McCannon bought a condo from the debtor, but the agreement was not recorded i.e., it was not perfected o Holding - The district court interpreted the language of 544(a)(3) to permit appellee to avoid an equitable interest in real property, arising from a purchase agreement between appellant and debtor, of appellant whose possession of that property provided constructive notice of her rights under state law. The court held that, under Pennsylvania law, appellant's possession of her apartment, even without record notice, obliged any subsequent purchaser to inquire into the possessor's claimed interests in that property. o Inquiry Notice Landowners have a duty to inquire into their land. Therefore, the trustee, the land owner is charged with inquiry notice to know that Mrs. McCannon was actually living in the condo before they actually come into possession of the land. Therefore, she gets to keep her condo, as the trustee should have known that she was living there. o

REAL ESTATE FRAUD VICTIMS - Belisle v. Plunkett (303)

o Facts - The debtor raises money through limited partnerships with a whole series of people. He uses the money to buy a leasehold estate in the Virgin Islands. But instead of putting the partnerships name on the leasehold, he puts it all in his own name (illegal!). Though the leasehold really belongs to the partners, the law looks at this situation as if the debtor was not being dishonest, and was simply holding this money in trust for the limited partners. This is constructive trust theory, which is used in these illegal cases the debtor has legal title, while the partners have equitable title. The debtor is considered a fiduciary of the partners, who are now considered creditors. Holding - Judge Easterbrook says that the trustee (who has the status of a bona fide purchaser for value) takes the leasehold free and clear of the partners, who are considered unsecured creditors. In real estate fraud cases, we do not help the victims. Constructive Trust Can a bankruptcy trustee take free and clear of a victim defrauded by a debtor? In questions concerning real estate (See above Belisle v. Plunkett), the victim will often lose; with personal property, however, the victim usually does win, through the method of constructive trust law giving the victim a property right that is good against the other creditors. The reasoning behind constructive trusts is that creditors should not receive a windfall simply because the debtor is a thief, at the expense of the defrauded party. In this case, however, the court decides to reject the use of constructive trust. Facts - Trustee in bankruptcy had created a constructive trust for funds (personal property) due by the debtor. The creditor in the underlying action sought to avert regular creditor status via an asserted claim to a full amount it contended was due and payable via a fraud by the debtor. The trustee created the constructive trust in issue for the creditor due to the inequities observed by the actions of the debtor. Holding - On review, the court determined that the trust was improper. The court concluded that, in light of the overall purposes of the bankruptcy code, a trustee may not authorize a constructive trust whenever a creditor asserts that it had been particularly burdened by a debtors fraud. Constructive trusts must be set up before the bankruptcy in order to be valid. Therefore, the decision was reversed. Nobody outside of the 6th circuit agrees with this opinion everyone else accepts the concept of constructive trust. Even the 6th Circuit is now backpedaling from this opinion because there have been some awful cases where people were defrauded and constructive trusts would be helpful.

o PERSONAL PROPERTY FRAUD VICTIMS - XL/Datacomp v. Wilson

o

Fraudulent Conveyances

33 General Rule
o 548(a) The trustee has the right to cancel fraudulent conveyances Statute of Limitations - The bankruptcy Codes fraudulent conveyances section is essentially the same as the UFCA that is used by the states. However, there is an exception: Under state law, there is a 6-year statute of limitations for a fraudulent conveyance. However, the statute of limitations for federal purposes is only 2 years (it used to be 1 year). Durrett v. Washington and Trustee redemption rights Facts - Debtor has real estate worth 120, a mortgage held by A for 80. Debtor defaults, A bids in to collect on his mortgage for 80. A buys fee simple absolute for 80, though the property is worth 120. A gets a windfall of 40. If the debtor had simply given 40 to A, that would be a fraudulent conveyance. Creditors argues that when A gets the 120 property, that is essentially a fraudulent conveyance. This gave the bankruptcy a federalized redemption right, allowing a trustee to redeem the land from A. This was overruled Scalias Dissent Scalia felt that you can never have a fraudulent conveyance in a sale, no matter how big a windfall the buyer gets, if the sale is being conducted by the government itself Durett no Longer Governs - The rule now is that where A bids in and gets a windfall, there is no fraudulent conveyance. BFP establishes this approach.

BFP v Resolution Trust Co. (321) o Facts - Petitioner was a partnership formed by lawyers for the purpose of buying a home.
Petitioner took title to property subject to a first deed of trust in favor of respondent savings association. Respondent savings association entered a notice of default under the first deed of trust and scheduled a properly noticed foreclosure sale. The foreclosure proceeding was completed, and the home was purchased by respondent buyer. Petitioner filed for bankruptcy under Chapter 11 of the Bankruptcy Code and filed a complaint seeking to set aside the conveyance on the grounds that the sale constituted a fraudulent transfer under 11 U.S.C.S. 548 of the Bankruptcy Code. The bankruptcy court denied the petition, and the trial court and the appellate court affirmed the decision. On writ of certiorari, the Supreme Court affirmed the decision. Holding No Fraudulent Conveyance if Property is Sold According to the Standard Procedures - The Court held that the consideration received from the non-collusive real estate mortgage foreclosure sale conducted in conformance with applicable state law satisfied the requirement of 548(a)(2) that transfers of property by insolvent debtors within one year prior to the filing of a bankruptcy petition be in exchange for a reasonably equivalent value.

Exceptions to BFP
o o o Private Foreclosure Sales - There is no fraudulent conveyance specifically where the courts are involved. But private foreclosure sales could be deemed fraudulent conveyances. Sales without Bidding - Even government foreclosures can be problematic if there is no bidding or auction involved to ensure that the government gets the best price possible for the debtors property. If there is collusion in the sale of the property What does collusion mean? Voest Alpine Trading USA Corp v. Vantage Steel Corp A court was involved here, but it was still a fraudulent conveyance because it was a collusive sale. Why is this collusive? The rules were followed! The Issue - What does the trustee do if the fraudulent conveyance happened a little more than 2 years before the bankruptcy and therefore past the statute of limitation? Subrogation Provision - 544(b)(1) If the trustee can locate a real life creditor with an avoidance right under state law, the trustee can step into the shoes of that creditor Example debtor strategically files for bankruptcy 2 years and 1 day after a massive fraudulent conveyance, thereby beating the federal statute of limitations. The trustee can

Subrogation Clause
o o o

34
locate a creditor who has a claim under state law (with a longer statute of limitations), step into his shoes and go after the debtors statute of limitations in that way Moore v. Bay (329) Background The case took place before Article 9 existed; instead there were chattel mortgage statutes railroads wanted to use their railroads as collateral for mortgages without having to actually give the collateral over to the lender. Here, the trustee wanted to get around an earlier creditor through the use of subrogation; the trustee stepped into the shoes of a mini, 5 cent creditor that had priority over the bigger chattel creditor and thereby claimed to have priority over all the debtors assets (not just 5 cents worth). Moore v. Bay Today the rule of subrogation still applies; trustees need only find a creditor that had a claim before the fraudulent conveyance in order to knock out the conveyance. The Bankruptcy Trustee is not limited to the quantity of avoidance that the creditor had he can get the entire amount. The Bankruptcy Trustee can get the entire conveyance.

Voidable Preferences
Voidable Preferences - It requires creditors who have been paid or received transfers right before bankruptcy is filed to return the money they received to the bankruptcy estate so that the money can be distributed more fairly. The creditor must try to get the money as an equal creditor through the bankruptcy proceedings Against State Law - So far, the avoidance powers discussed have been derivative or replicative of state law. But voidable preference is entirely different. According to state law, paying a creditor before bankruptcy is entirely permitted 547(b)

o Step 1 Timing - 547(e)

Timing is very important when did the transfer to the creditor take place? There are 3 timing rules: 547(e)(2)(a) A transfer is made at the time such transfer takes effect between the transferor and the transferee, if the transfer is perfected within 30 days of such time If perfection happens within 30 days of the transfer (attachment) the transfer is considered to have happened at

35 the time it actually takes place. This is the rule that is friendly to creditors. 547(e)(2)(b) If perfection happens more than 30 days after the transfer, we assume the transfer happens at the time of perfection after the transfer actually takes place, putting it closer to the bankruptcy and more likely within the 90 days before bankruptcy when avoidable preference law applies this is very bad for creditors. 547(e)(2)(c) this rule, like (e)(2)(b), is also bad for the creditor. An invalid transfer is made if it is right before the date of filing of the petition for bankruptcy if the transfer is not perfected at all If attachment happens slightly before bankruptcy, there is the grace period of 30 days to perfect. If the secured party perfects after the bankruptcy, which timing rule applies? (e)(2)(a) applies the grace period trumps (e)(2)(c) Does perfection after bankruptcy violate the automatic stay of bankruptcy? No there is an exception for post petition perfection

o Step 2 - Establish the trustees prima facie case Elements of the case 547(b)
Must be a transfer of the debtors property 547(b)(1) - The transfer must be to or for the benefit of the creditor. Even if the transfer is to a 3rd party, if it is for the benefit of the creditor, it can be voided by the bankruptcy trustee 547(b)(2) - The transfer must be on old debt the loan must have happened before the transfer. This excludes contemporaneous exchanges, which are not voidable preferences. If the debtor pays cash for milk, that is not a voidable preference it happens contemporaneously. 547(b)(3) - The debtor was insolvent 547(b)(4) - The transfer must have taken place in the 90 days immediately prior to the bankruptcy; or up to 1 year before the bankruptcy filing if the creditor was an insider. 547(f) if the transfer to the creditor takes place within the 90 days immediately prior to the bankruptcy filing, the trustee has a rebuttable presumption in making the voidable preference the creditor must prove otherwise 547(b)(5) - The Hypothetical Payment Test - The transfer enabled the creditor to get more than he would have received under the debtors bankruptcy.

36 Assuming the creditor will return the money to the bankruptcy estate, what would the creditor get? If the creditor is towards the top of the list and will get the money anyway from the bankruptcy estate, we do not make this voidable preference. Unsecured creditors who get paid right before bankruptcy, however, would certainly fail this hypothetical test. 3 Part Hypothetical Payment Test: o Assume this is a Chapter 7 Case o Imagine that the creditor returns the transfer. Calculate a hypothetical bankruptcy payment. o If the Creditor would get more money in hypothetical life, there is no voidable preference. But if the creditor does better in real life, there is a voidable preference!

o Step 3 - Defenses for the creditors 547(c)

Contemporaneous Exchange Defense 547(c)(1) - the transfer was intended to be contemporaneous and was substantially so. Example - The debtor buys milk with a check. This is not exactly contemporaneous checks take some time to clear. The store has given credit, essentially, to the debtor and should be subject to a voidable preference! But since the check was intended to be used simply as a method of payment for a contemporaneous transaction, its not subject to a voidable preference. Course of Business Defense - 547(c)(2) if the debtor makes the payment in the ordinary course of business or financial affairs of the debtor and transferee Payments - This defense only covers payments by the debtor not mortgages or security interest transferred by the debtor to creditors Ordinary Course of Business what is considered ordinary? o Example - If the debtor gives the creditor a check that bounces, and then has the creditor deposit it again (and it clears), is this ordinary for the debtor? It depends on what the debtor usually does! If his checks always bounce, it is ordinary! o Example if the creditor threatens the debtor, who then pays, that is not the ordinary course of business. However, the question under the 2005 amendments is: if the payment is made ordinarily (by check), is this still a good defense even if the

37 creditor caused the debtor to pay because of a threat, which is certainly not ordinary? Transfers that Create a Security Interest in Property acquired by the Debtor 2 types of purchase money security interest o Conditional Sale - The seller / merchant provides the credit to the buyer. The seller gives the car to the buyer, and the buyer gives the security interest back to the seller contemporaneously o 3rd Party Loan 3rd party lends debtor money to buy from the seller The loan takes place outside the preference period. A financing statement is filed and a security agreement is signed. However, in order for the loan to be perfected, the borrower must have used the money to buy the item i.e., he must have an interest in the collateral of the loan. If the debtor does not use the money to buy the car within 30 days of getting the loan, this is a voidable preference. But as long as its done within 30 days, the lender is safe and can keep the money he has collected from the debtor Give Back Defense - 547(c)(4) - if the creditor is guilty of voidable preference but then replenishes the bankruptcy estate, the creditor has a defense. This give back occurs if the creditor made a second loan to the debtor after the loan at issue, thereby replenishing the estate. However, this second loan must be unsecured (a second secured loan to the debtor would not replenish the estate, since only this creditor would have rights to the secured property, thereby taking it out of the bankruptcy estate). Example - Debtor transfers property to creditor to pay back a loan 2 weeks before bankruptcy. However, one week later, the creditor gives the debtor a second loan. If this second loan is unsecured, the creditor has given back to the bankruptcy estate the amount of that loan. If the second loan is worth as much as the first loan, the creditor can use the give back defense for the entire first transaction. Inventory and accounts receivable - 547(c)(5) - A Debtor will have received inventory within 90 days of bankruptcy. So long as inventory lender or accounts lender has not improved her position

38 over the preference period, then these security interests are not voidable preferences. This is irrespective of fluctuations. The trustee may not avoid a transfer that creates a perfected security interest in inventory or a receivable or the proceeds of either Hypotheticals pg. 335 o 1 What timing rule do we use? Does this transfer need to be perfected? No wire transfers are perfected when they are sent, on February 1st, so 547(e)(2)(a) applies. February 1st is the date of transfer. This transfer is within 90 days of bankruptcy; the debtor was insolvent; it was made to pay off an antecedent loan. Are there any defenses? 547(c)(2) is the only possible defense was this a payment made in the ordinary course of business o 2 This is a voidable preference o 3 If the docketing happens in November, the collection occurs more than 90 days before the bankruptcy, and is therefore not a voidable preference o 4 When the creditor dockets on November 5th, the debtor has not yet inherited real estate 547(e)(3) a transfer is not made until the debtor has acquired rights in the property transferred - The lien can only attach once the debtor inherits. Therefore, the lien is only perfected on the date of the inheritance (Feb.1 ) and not the date of the docketing (which is normally the date of lien creation). After acquired property interests are voidable preferences when the debtor comes into possession of the inheritance within the 90 days before bankruptcy.

Checks and Voidable Preferences

Barnhill v. Johnson (336) o Issue
Debtor writes a check outside the preference period, but the check was honored a couple of hours into the preference period. When did the payment really happen before or after the preference period started? This depends on how we understand what a check is. Since the check was simply an order to the creditors bank to pay the sum stated on the check, the receipt of the check is irrelevant it all depends on when it is deposited, which was after the preference period started. Holding - the United States Supreme Court held that, for purposes of 11 U.S.C.S. 547, the transfer occurred on the date the check was honored. The Court first noted that, under U.C.C. 3-104(1), the check was simply an order to the drawee bank to pay the sum stated, signed by the maker and payable on demand, and accordingly, receipt of the check did not give respondent a right against drawee bank. Thus, the Court ruled, it was not until debtor directed drawee bank to honor the check and drawee bank did so, that debtor implemented a mode of disposing of property or an interest in property under 11 U.S.C.S. 101(54), and a "transfer" took place.

39
o

Is this case a voidable preference? - It may be that the creditor has a defense
the payment of the check could have been the ordinary course of business; we cant know from the facts given.

Hypotheticals (341)
1 o The transfer occurs on January 24th, when the mortgage is perfected. 547(e)(2)(a) should apply, because perfection occurs within 30 days of the mortgage agreement. Therefore, the transfer officially takes place on December 29th, before the preference period begins, and this is not a voidable preference 547(e)(2)(b) applies, because perfection happened more than 30 days after the mortgage agreement. Therefore, the transfer occurs only on February 12th, within the 90 day period. There is a prima facie case of voidable preference here. Determining the timing rule ot apply here dependson whether attachment occur. The first element happens on February 1; the other 2 elements of attachment / perfection happen on February 15th, completing the perfection. Therefore, the transfer occurs on February 15. 547(e)(2)(c) applies because the perfection only occurred on March 20th, after debtor had filed for bankruptcy (and the security interest is considered a pre-petition transfer, transferred just before March 19th) Is there a prima facie case? There was a transfer from a debtor to a creditor. It is a transfer on antecedent debt Is the hypothetical Liquidation test met whenever an unsecured creditor becomes a secured creditor and the - yes. Defenses? Did the parties intend a contemporaneous exchange (even though the transaction was not contemporaneous)? You can certainly make an argument that it was intended to be contemporaneous. Can 547(c)(1) be used to remedy the fact that the lawyer here screwed up and only filed and perfected after the 30-day grace period? Some courts allow you to use 547(c)(1) to correct a grace period screw up; other courts are not so kind to the creditor who messes up and does not perfect within the grace period. The transfer occurs on March 15th, based 547(e)(2)(a) the transfer occurred within 30 days of perfection. Why do we not use 547(e)(2)(c)? The perfection only occurs after bankruptcy! As long as the perfection happens within 30 days of the transfer, we follow (e)(2)(a), which trumps (e)(2)(c) in such a case. There is no prima facie case here, since the transfer occurs at the same date as the loan March 15th and there is no antecedent debt. The only difference between hypos 3 and 4 is that in 4, the perfection occurs within the grace period (even though its after bankruptcy) and can therefore qualify for 547(e)(2)(a) the creditors friend! Here, the lathe is not only collateral for the present loan, but also for all future loans the creditor decides to give the debtor. Are the elements of attachment here? All 3 elements of attachment occur on February 15th. However, the creditor gives a second loan on March 21, creating a second transfer/ security interest. These 2 transfers must be considered separately. 1st transfer Since perfection occurs more than 30 days after the transfer, 547(e)(2)(b) applies, which means the transfer is considered to have taken place at the moment of perfection March 20th

o o

o o 5

o o o

40
Is this a prima facie voidable preference? It is a transfer from a debtor to a creditor, the transfer occurs after the loan (February 15) and so is on an antecedent debt. This is a prima facie voidable preference. Defenses Is the contemporaneous exchange defense available? Most courts say that you cannot use this defense to get around a grace period mistake Give Back Defense - 547(c)(4) Here, the creditor gave new value to the debtor after the transfer (the second loan on March 21). However, in order to qualify for the defense, the second loan must be unsecured 547(c)(4)(A). Here, however, the second loan is also secured, and therefore does not qualify for the give back defense. However, if the second loan (1 million) is worth more than the secured item (the lathe), the creditor will have the give back defense for the difference in value. So if the lathe is worth 800,000, the creditor has a give back defense for 200,000. 2nd Transfer Timing Rule 547(e)(2)(b) - The second is considered to occur on March 21, because that is when perfection of the lien occurs (perfection requires attachment, and attachment only occurs upon the lending of the money. In this case, with attachment comes, simultaneously, perfection). Is there a prima facie case? The second loan occurred on March 21, and the transfer is considered to have occurred on March 21. Therefore, this is considered to be a contemporaneous exchange, and there is no prima facie case! When did the transfer occur? Timing Rule Transfer 1 (the printing press) - 547(e)(2)(a) Since perfection happens on the same day as the security agreement, on December 1, it is within the 30 day rule. Transfer 2 (300,000 check to the creditor) January 10th Prima Facie Case? Transfer 1 o Antecedent Debt? July 1 is the date of the loan, December 1 is the date of the transfer. This is a transfer for an antecedent debt. o Transfer within 90 Days of Bankruptcy? The first transfer is not within the 90-day preference period! Therefore, no voidable preference! Transfer 2 o Antecedent Debt? - July 1 is the date of the loan, this transfer happens on January 10th. o Hypothetical Payment Test - Does this payment allow the creditor to get more than he would have gotten in a hypothetical chapter 7 case? Assume this is a Chapter 7 Case Imagine that the creditor returns the transfer. Calculate a hypothetical bankruptcy payment. Here, since the creditor has the collateral a printing press worth 5 million they would definitely get their million dollars, making their hypothetical payment greater than the real life 300,000 payment! Therefore, as is always the case with an oversecured creditor, the prima facie case fails! Second Transfer

41
Here, the printing press is worth only 500,000, because 4.5 million belongs to an earlier creditor X. The second transfer, on January 10th; is this now a voidable preference? Hypothetical Test In real life, the creditor is getting 500,000 from the printing press plus the 300,000 payment from debtor = a total of 800,000 In hypothetical life, the creditor returns the 300,000 to the bankruptcy estate, and now, once again, has a 1million claim. Under the hypothetical chapter 7, the creditor definitely gets 500,000 from his secured claim on the printing press. But what about the other 500,000 he is owed by the debtor? How much of that will he get? We know that the debtor is insolvent, and that there are other creditors. We dont have other information, but it is clear that he will not get all of the 300,000 other creditors will get a piece of the pie. Therefore, his hypothetical gain will not be as great as his real life gain of 800,000 and there is a prima facie case here for a voidable preference.

Here, since the creditor has agreed to release 300,000 of his secured debt for 300,000 of cash, it seems like this should be a good claim. If the creditor really intended reduce the security interest by 300,000 when he got the debtors payment, this would be a contemporaneous exchange (creditor gives the debtor 300,000 interest in the printing press, gets 300,000 in return). However, here the court found that the creditor did not really intend to reduce his interest in the printing press he wanted the press and the 300,000! Therefore, this is a voidable preference, the creditor must return the 300,000 to the estate, and the creditor must wait for the sale of the printing press in the future to get his money. Waiting for the sale is not optimal for the creditor, because the press might go down in value, and it might take a long time for the press to be sold and for the creditor to get the cash the time value of money. Transfer 3 Creditors new security interest in the 300,000 Why this is a transfer - The moment the debtor receives cash from X on January 5, the creditor gets an Article 9 security interest in this cash. This is yet another transfer is it a voidable preference? Prima Facie Case? Applying the Hypothetical Test - In real life, the creditor would keep the 300,000 he already got from the debtor and get an additional 200,000 (because of the secured 500,000 interest in the printing press). In addition, the creditor has another 500,000 unsecured interest in the estate. In hypothetical life, the creditor would have the same exact 500,000 secured interest, and the same 500,000 unsecured interest in the estate. Therefore, real life is no better than hypothetical life and there is no prima facie case of a voidable preference on this transaction! Transfer 4 Debtors check to the creditor for 300,000 after sale of the secured property 547(e)(2)(a) applies the transfer occurs on January 10th Hypothetical Test In real life, the creditor gets a 300,000 check, and there is a remaining 200,000 in the debtors checking account that belongs to the creditor, and an additional 500,000 unsecured claim. In hypothetical life, the creditor would have the exact same 500,000 secured claim there is no prima facie case here! The creditor already had the security interest on January 10th; the only thing the debtor is giving the creditor is his equity in the printing press. After the check clears, the debtor equity in the money is 0, so there is really no payment to the creditor. Cash Proceeds of Secured Property not a voidable preference! - When the debtor surrenders cash proceeds to the creditor who already owns them, it is

42
never a voidable preference. Simply giving this cash to the creditor is not considered a payment, as it already belongs to the creditor! We must distinguish between payment of unencumbered dollars (usually a voidable preference) and the sale of collateral (never a voidable preference) o Here, there is a commingled bank account, with some of the money encumbered, and some unencumbered. Here, the creditor cannot assume that the money he is receiving is encumbered and therefore ok See the Barash Case

10

Contemporaneous Exchange Defense

Dean v. Davis (343) o Facts - The creditor thinks he is secured, but the notes he has are really forged. The
creditor threatened to go to the police; the debtor was scared, so he got his brother to pay the creditor for him. The brother received a mortgage on debtors property (worth 5 times the loan) to ensure that the debtor would pay him back. Shortly after, the debtor goes bankrupt and the trustee sues the brother for voidable preference. Holding - The court holds this is not a voidable preference because it is a contemporaneous exchange. However, under fraudulent conveyance law, the brother loses anyway. Since he knew the debtor was going bankrupt and made this loan specifically in order to keep the money from the other creditors, he loses This is the birth of Defense 547(c)(1) the transfer was intended to be a contemporaneous exchange.

Hypotheticals
1 Secured refinancing of an unsecured claim o Transfer 1 Wiring Money to the Original Creditor (C1) - Even though the brother (C2) is the one who wires the money to C1, C2 is really just acting as an agent for the debtor, who has already borrowed that money from C2. Therefore, the wiring of money to C1 was a transfer from the debtor to C1. Is there a prima facie voidable preference? The creditor here is getting a benefit due to an antecedent debt, within 90 days of bankruptcy. Also, this is an unsecured creditor who is getting paid, so he is doing better in real life than hypothetical life, and there is a prima facie voidable preference. Defenses? Is this a contemporaneous exchange? 547(c)(1) - It is only a contemporaneous exchange if the debtor receives a new value. Here, the debtor is giving money to Creditor 1, but it also simultaneously receiving money from Creditor 2 (the brother, who immediately sends this money to C1). Therefore, you can argue that there is no voidable preference here. o Transfer 2 - The mortgage given to C2 (the brother in law) This is technically a prima facie voidable preference Defenses? Is this a contemporaneous exchange? there is a 4 day lag here, but the exchange is still basically contemporaneous. Therefore, this is probably protected by 547(c)(1) Creditor 2 loses here while in Dean v. Davis, creditor 2 lost out because of fraudulent transfer law, the bankruptcy code now achieves the same result through fraudulent transfer law. 2 unsecured refinancing of an unsecured claim o Creditor 1 Is there a prima facie case? Yes!

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Has there been a transfer of debtor property, and when did it occur? o Even though creditor 2 directly pays creditor 1, creditor 2 is really acting as the agent of the debtor. Therefore, creditor 1 is really receiving debtor property. Has Creditor 1 received debtor property on antecedent debt? Yes! Defenses for Creditor 1? 547(c)(1) Creditor 2 is giving new value to the debtor. The only issue is was this new value, given to the debtor, contemporaneous with the payment made to creditor 1? Yes; therefore, creditor 1 is off the hook and there is no voidable preference Hypothetical 1 vs. Hypothetical 2 o You are permitted to replace unsecured debt with another source of unsecured debt, as this does not diminish the bankruptcy estate. However, as in hypo 1, if you replace unsecured debt (which goes to the bankruptcy estate) with secured debt (which does not go the bankruptcy estate), the trustee and all the other creditors lose out. Therefore, this will be a voidable preference

Letters of Credit and Voidable Preferences

Kellog v. Blue Quail Energy Inc. (347) o Background Letters of Credit - Letters of credit are said to be subject to the independence doctrine once the bank issues the letter of credit, they are required to pay, regardless of the debtors relationship with person the bank is paying. (This is in contrast to saying that the banks duty to pay the 3rd party receiving the letter of credit is tied to the debtors relationship with the 3rd party). o Facts - A bank extends a line of credit to the debtor in exchange for a security interest. Value includes a commitment to lend. The bank has a perfected security interest that is many years old. The debtor, using its line of credit, has the bank pay off a different unsecured creditor, only a few days before the bankruptcy, by issuing a letter of credit to that creditor. An unsecured creditor gets paid it seems like this must be a voidable preference. o Holding Bank gave New Value - The court held that the bank was protected from preference attack by the trustee because, under the Bankruptcy Code (Code), 11 U.S.C.S. 547(c)(1), bank gave new value for the increased security interest in the debtor's collateral. The bank was protected from preference attack under the relation back provision of the Code, 11 U.S.C.S. 547(e)(2)(A), because the attachment of the bank's interest related back to a previous security agreement, which included a future advances provision, and which was dated prior to the 90-day preference window of the Code, 11 U.S.C.S. 547(b)(4)(A). However, the court held that appellee supplier, as beneficiary of the letter of credit, received an indirect preferential transfer recoverable by appellant trustee. Appellee supplier received a transfer of property for antecedent debt made while debtor was insolvent. o Courts Reasoning - The 5th circuit said that the letter of credit is not debtor property. The creditor, however, receives the benefit of the transfer right before the bankruptcy. The court creates the 2 transfer theory: The security interest was transferred years earlier, but is considered to be transferred again shortly before the bankruptcy when the unsecured 3rd party receives the letter of credit. Carlson says this reasoning is ridiculous; nonetheless, the court reaches the right result. o Carlsons view of how the case should be decided - The letter of credit that the 3rd party receives is really debtor property; the bank is lending money to the debtor and sending it directly to the 3rd party. Therefore, the 3rd party is receiving transfers of debtor property and should be a voidable preference. However, the court does not take this view.

Hypotheticals (357)
1 o 101(10) - Definitions

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Definition of Creditor = an entity that has a claim against the debtor that arose before the bankruptcy petition Definition of Claim = right to payment, even if it is contingent Definition of Insider = a director or officer of the corporation debtor is considered an insider Understanding the Case - S is a creditor of Debtor because it is its guarantor. When S realizes Debtor is insolvent, it causes Debtor to pay Creditor 1 million dollars, as S is concerned that otherwise, S would be liable to make this payment. This is a payment from the debtor to the creditor, but not only the creditor benefits; S does as well, because S is off the hook for making that payment to the creditor instead of D. If Debtor had not made this payment to Creditor, S would have had to make the payment; then, S would have had to try and recover that money in bankruptcy, which was not likely to happen. Essentially, S saved himself 1 million by making this move. Is this a voidable preference? 547(b)(2) Is S an insider? S is a 100% shareholder, and should therefore qualify as an insider Benefit is created on antecedent debt within a year of the bankruptcy therefore, this is a voidable preference. Who can the Trustee Recover From? 550(c) - While the creditor himself is innocent, S is guilty of receiving the benefit of the payment. However, the bankruptcy trustee may not recover against a transferee who is not himself an insider if the transfer is not made within 90 days of bankruptcy. Here, the transfer to creditor was within the year, but not within 90 days, and the creditor was not an insider. Therefore, the trustee cannot get the money back from the creditor he can only go after S. Transfer 1 3 Steps of Attachment Value was given on July 30 (an actual advance) The debtor get property right in the collateral on November 1 The Security Agreement occurs on December 1 Only on December 1 is attachment considered to occur Timing Rule 547(e)(2)(a) Attachment and perfection occur on the same day, so the transfer is considered to occur on December 1st This is not a voidable preference it happened more than 90 days before the bankruptcy Transfer 2 Debtor makes a payment of 300,000 on January 10th Prima Facie Case for Voidable Preference? Here, the creditor is an under-secured creditor; therefore, the hypothetical test is met and there is prima facie case for a voidable preference Defenses? Is this a contemporaneous exchange? There seems to be no new value coming into the debtor. However 547(a)(2) A release of a security interest is considered New Value On January 8th, the debtor is paying down the loan from 1 million to 700,000. At the time, the security interest (the lathe) is worth 800,000. Essentially, then, the creditor is releasing 100,000 of the lathes value from the security interest, since the debtor now only owes him 700,000, while the lathe is worth 800,000. Therefore, the creditor has a partial contemporaneous exchange defense, for 100,000 of the 300,000 payment. Transfer 3

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Debtor sells the lathe on March 19th, receiving in return a cashiers check. C allowed the debtor to sell the lathe; C however, did not release his security interest in the proceeds from the lathe. This is a contemporaneous exchange this is not a voidable preference Transfer 4 Attachment of the security interest to the proceeds on March 19th - Since the check came in return for an attached item (the lathe), the creditor has a security interest in the check itself. Defenses? Is there a 547(c)(4) Giveback defense here? No new value was given in exchange for the release, but in exchange for that, the secured party got an interest in the cash proceeds; 547(c)(4)(b) knocks out this defense This is, however, a contemporaneous exchange the creditor gives up his security interest in exchange for the cash. Suppose the debtor takes the check, cashes it, and spends it all on a party. The proceeds are dissipated and lost to the secured creditor. This would actually support a giveback defense money went back to the debtor (by the fact that he spent it!) from the creditor.

Inventory and Voidable Preferences

547(c)(5) Defense Applies only to Inventory / Receivables o Introduction to the Problem of Inventory - An over-secured creditor has a security interest in inventory. The problem is, the grocery store debtor turns over its inventory constantly. It is possible that, prima facie, in a retail bankruptcy, every piece of inventory is encumbered by a security interest created during the 90 days before bankruptcy. Inventory sitting on the shelves for over 3 months will not be voidable preferences, but inventory that turns over more often probably will. Therefore, whenever you have an inventory security interest, you probably have a prima facie voidable preference. o The defense if there is a perfected security interest in inventory or receivables it is not a voidable preference. This would be a huge and awesome defense. The problem, there is an exception clause which is difficult to understand o The Exception to the Defense If the retailer replenishes its inventory equally, then the creditor will not be diminishing the bankruptcy estate it loses an equal amount of secured inventory to the amount of secured inventory it gains during the preference period. The problem is when the retailer loads up on inventory, increasing its stock (holiday season). This has the effect of often turning an undersecured creditor into an over-secured creditor, because now there is more inventory available to be attached by the creditor. When inventory levels stay the same, the 547(c)(5) defense applies; when inventory levels go up,

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and the creditors security interest improves as a result during the preference period, there is a voidable preference. Formula for Determining how much is Yanked Back X = Loan - Collateral on a certain day (x day). That day will be the 90th day before bankruptcy, or some other day Y = Loan Collateral on the day of bankruptcy Z = the extent to which the exception clause yanks back the defense Restriction 1: L must always be greater than the collateral Restriction 2: Z cannot be a negative number The Formula = X Y = Z o Does the 547(c)(5) Defense Apply? Timing Rule Prima Facie Case? Are there any Defenses Does the Exception Clause yank back the otherwise complete defense? Hypotheticals (375) o 1 On July 1, the creditor is over-secured. On January 1, the beginning of the preference period, the creditor is still oversecured. ON March 1, the secured party makes another loan to the debtor; now the creditor is undersecured. Eventually, debtor realizes bankruptcy is coming, so he starts buying up inventory, which will be secured for the creditor. Timing Rule - To apply the formula, we either use the 90 day before bankruptcy date, or the day on which new value was first given under a security agreement, creating a security interest. Hypothetical Test clearly, the under-secured creditor becomes more secured during the 90-day preference period. There is a prima facie case here for a voidable preference. Does the 547(c)(5) defense apply? Apply the formula: Choosing the day on which to measure L C - To use the formula, we must choose one of 2 dates whichever is later. Either 90 days before bankruptcy (if the value had been given to the debtor more than 90 days before bankruptcy), or the day on which new value is first given to the debtor (this is used if the loan to the debtor only happens after the 90 day preference period has already begun). Here, the transfer took place before the 90 day period, so we use the 90th day Determining X o The Loan on x day is 1 million. The collateral on that day, though it is 1.1 million in real life, is only 1 million for the sake of the problem (because collateral can never be greater than the loan). o X, therefore, equals 0. Determining Y o Y day is bankruptcy day. At bankruptcy, the loan equals 2 million. The collateral is only 1.5 million. o Y = .5 million Determining Z o 0 - .5 million = 0 (no negative numbers allowed). o Therefore, there are no voidable preferences here the entire agreement here is defended by 547(c)(5). o Since, at the time of the bankruptcy, the creditor is less secured than he was 90 days before the bankruptcy, we say there is no voidable preference. Even though a lot happened in between in this case (during the 90 days, the creditor became extremely unsecured, and then got back some security during the preference period to the

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detriment of the other unsecured creditors), the law only looks at these 2 dates not what happens in between. Overview - When the preference period begins, the creditor is very undersecured. He finishes the prefernce period being oversecured. This signals there will probably be a voidable preference. Timing Rule here we again use the 90th day, because the loan happened before the preference period. Determining X Loan = 1 million; Collateral = 200,000 X = 800,000 Determining Y Loan = 1 Million Collateral = 1 million (the debtor has 1.5 million in inventory, but the claim is only for a million, so the collateral is only 1 million) Y=0 Determining Z XY=Z 800,000 0 = 800,000 How much does the Secured Creditor Get? - Out of the 1.5 million in inventory on bankruptcy day, .5 million very clearly belongs to the debtor. Without voidable preference law, the creditor would get the other 1 million. However, the exception to the inventory defense rule tells us that 800,000 is yanked back into the bankruptcy estate, so the secured creditor only gets 200,000 automatically the amount that does not constitute any improvement in condition. Determining X Day - What is X day, the day on which we will determine the value of X? The day on which new value is given to the debtor. In this case, it is July 1, 2001, though the security agreement was not given at this time. Does it matter that the security agreement only came later? No, so January 1, the beginning of the preference period, is X date Determining X Loan Collateral = X Here, there was no collateral on X day, so the equation goes as follows: o 1 million 0 = 1 Million Determining Y Y day is always bankruptcy day Loan Collateral = Y 1 Million 1 Million (Inventory is 1.5 million, but Collateral cannot be greater than the Loan) = 0 Determining Z XY=Z 1 Million 0 = 1 Million Here, the creditor must give back 1 million dollars First Loan Determining X Day For the first loan of 1million, X day is January 1 Determining X o Loan (1 million) Collateral (0) = 1 million Determining Y o Loan (1.5 million) Collateral (1.5 million) = 0 Determining Z o 1 Million 0 = 1 Million Determining X Day January 1

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o 6 Determining X 1 million 200,000 = 800,000 Determining Y 2 Million 1.5 Million = 500,000 Determining Z 800,000 500,000 = 300,000 Determining X day - January 10th is the day on which new value is first given it does not matter that the amount given in 1 dollar Determining X Loan (1 dollar) Collateral (200,000) = 0 Determining Y Loan (500,001) Collateral (500,001) = 0 Determining Z 00=0 Here, the creditor was fully secured on January 10th, for one dollar. On January 11th, the next day, they make a huge loan. From January 10th until the bankruptcy, there is no improvement in position; from January 11th to bankruptcy day, this is a huge improvement in position, but the code doesnt care about that, so the creditor gets away with his scheme. Determining X Day March 1, which is the day new value is first given Determining X Loan (1 million) Collateral (800,000) = 200,000 Determining Y Loan (900,000) Collateral (900,000) = 0 Determining Z XY=Z 200,000 0 = 200,000 On March 10, the debtor paid 100,000 to the creditor. Is this a voidable preference? This is not a voidable preference, since the creditor would do better in hypothetical life than in real life.