Corporate Bankruptcy and Reorganization

1. Corporate Bankruptcy and Reorganization Prof. Jesse M. Fried U.C. Berkeley School of Law

2. Course Details • Contents • -- Chapter 7 and Chapter 11 of US Bankruptcy Code • -- other statutory and non-statutory law relating to bankruptcy • Materials • Reading Packages (based on material of Prof. Mark Roe) • Statutory Appendix (“Appendix B”) • 3. Exam – (24-hour) Take-home exam • -- questions in English • -- (typed) answers in English or Hebrew • 4. Office Hours: after class • appointment by email: • friedj@law.berkeley.edu

3. Course Outline Introduction I. A World Without Bankruptcy (Non-bankruptcy law) II. Chapter 7: Liquidation Bankruptcy III. Valuation in the Absence of a Cash Sale IV. Chapter 11: Overview and Plan Requirements V. Recovering Funds and Reranking Claims (other topics if time permits)

4. Introduction 1. Sources of Business Financing 2. The Bankruptcy Code 3. Financial Claims on the Corporation 4. Basic Balance Sheet

5. Internal Financing 2% • Retained Earnings Debt Financing 38% • Equity Financing • Common Stock • Preferred Stock • IPOs & Secondary • Offerings 60% Sources of Business Financing in the U.S.

6. Bankruptcy Code Chapter 1: Definitions, Power of Court Chapter 3: Administration of Bankruptcy Estate Chapter 5: What is in the Bankruptcy Estate Chapter 7: Liquidation Provisions Chapter 11: Reorganization Provisions

7. Financial Claims on the Corporation • Creditors • Banks • Finance companies, insurance companies, etc. • Public bondholders (including “debentureholders”) • Trade Creditors (suppliers) • Employees • Contract breach creditors • Tort Victims (sometimes) • Government (tax, regulatory claims) 2. Equityholders --- Preferred stockholders --- Common stockholders

8. Basic Balance Sheet $Assets = $Debt + $Equity

9. I. A World Without Bankruptcy A. Individual creditor remedies 1. Unsecured 2. Secured B. Priorities Outside Bankruptcy C. Common Pool Problem – loss of going concern

10. Creditors’ remedies outside bankruptcyWhat happens when the borrower (debtor) does not pay? • Unsecured creditor • -- goes to court to get judgment • -- if gets judgment, then gets “judgment (or judicial) lien” – right to payment • -- if debtor does not pay, creditor asks “sheriff” to seize property • 2. Secured creditor: loan secured by “collateral” • -- can seize collateral (but only peacefully)

11. Article 9 in a Nutshell – Creation and enforcement of security interests (“SI”) in personal property. Similar rules for real property – Two rights 1. Property right – right to repossess collateral from defaulting debtor 2. Priority right – over third parties (other creditors, purchasers)

12. Two steps to creating effective SI • I. Attachment • written security agreement • lender gives value, debtor owns asset • II. Perfection • for rights against 3rd parties • must “perfect” SI by taking possession of collateral or public filling • judicial lien has priority over unperfected SI

13. What happens when there is “intercreditor conflict” – 2 or more creditors attempting to seize asset? • Unsecured vs. unsecured • “grab law” – first come, first served • (first to get judgment or first to seize assets) • Unsecured vs secured • secured wins • Secured vs. Secured • first to “perfect” (file) wins

14. Common Pool Problem – Loss of Going Concern Value -- • Business ABC • 2 machines (“A”, “B”) each worth $20,000 • “going concern value” of ABC: $50,000 = • $10,000 more than liquidation value of $40,000 • 3 creditors (“1”, “2”, “3”), each owed $20,000 • ABC cannot pay its loans. • *All creditors are unsecured. What does Creditor #1 do? • #2? #3? How much do they recover in total? • **Creditor #1’s loan secured by machine A. What does #1 do? • #2? #3? How much do they recover in total?

15. Purposes of Bankruptcy • Preserve going concern value (if there is any) • (bankruptcy overrides “grab law”, which makes preservation of going concern value impossible outside bankruptcy) • a. Automatic Stay (Part II) • b. Recovery of assets (Part V) • Divide the “pie” among creditors, equityholders • a. Liquidation – sale of entire business or asset-by-asset for cash – cash divided according to Chapter 7 (Part II) • b. Reorganization – parties get equity, debt in reorganized firm -- Chapter 11 (Part IV)

16. II. Chapter 7: Liquidation Bankruptcy • Automatic Stay • B. Overview of Distribution in Chapter 7 (with exercises) • C. Statutory Priority in Chapter 7 • D. Priority Unsecured Creditors

17. Automatic Stay Stops individual collection efforts against debtor --- cannot sue --- cannot impose lien --- cannot take property Necessary to preserve going concern value Section 362 of the Bankruptcy Code (p. 612)

18. Overview of Distribution in Chapter 7 (1 of 5) General rule: all debt has equal priority – debt is paid pro rata 3 creditors owed $6000 A. owed $1000 B. owed $2000 C. owed $3000 Debtor has $3000 in cash >> Each creditor is paid ($3000/$6000) per $1 owed >>>>> A. receives $500 B. receives $1000 C. receives $1500

19. Overview of Distribution in Chapter 7 (1 of 5) 3 important exceptions 1. Secured debt 2. Subordinated debt 3. Priority unsecured debt (Section 507)

20. Overview of Distribution in Chapter 7 (3 of 5) Secured debt: (debt secured by collateral) paid the amount of collateral, up to amount owed if there is a “deficiency”, gets unsecured claim for that amount Owed Value of Collateral Receives $100 V > $100 $100 $100 V = $100 $100 $100 V < $100 V + unsecured claim for ($100 - $V)

21. Overview of Distribution in Chapter 7 (4 of 5) Subordinated debt X is subordinated to Y = X must give all of its share to Y until Y is paid in full Pro rata Subordination X owed $5000 $2500 $1000 Y owed $3000 $1500 $3000 $4000 of assets

22. 1. Administrative expenses Overview of Distribution in Chapter 7 (5 of 5) 2. “Gap Claims” 3,4. Wage claims, up to ~ $4K per person earned within 90 days of filing, employee benefit contributions Section 507 (a) Priority Unsecured Creditors 5. Fishermen/farmers 6. Customer deposits 7. Unsecured tax claims (income, excise, property, etc.)