[3](1): Characteristics of a Corporation

1. [3](1): Characteristics of a Corporation • Separate Legal Identity • Corporations can own property, make contracts, and BORROW MONEY • Liabilities of shareholders are NOT liabilities for the corporation • Perpetual Existence • Life of the corporation extends beyond the life span of its shareholders • Limited Liability for Shareholders • Shareholders can only lose the purchase price of the stock • Liabilities of the corporation are NOT liabilities for the shareholders • Transferable Ownership • Value of shares depends on the assets and earning power of the corporation, and NOT on the wealth of any shareholder • Stock markets can then evolve because the shares in each corporation are a standardized commodity

2. [3](2): Federal Bankruptcy Act (1978) • Debtor Corporation voluntarily petitions for bankruptcy • Provisions for involuntary petition by creditors are difficult • Liquidation: Chapter 7 • Trustee is appointed to sell the assets of the corporation (Section 704) • Creditors submit claims and Trustee pays the claims based on Priorities • What are the Priorities? • secured creditors receive their collateral or its value • administrative expenses: legal fees and post-petition loans • unsecured creditors receive pro rata distribution of their claims • shareholders typically receive nothing (unless they contribute new money) • Reorganization: Chapter 11 • “Debtor in Possession”: existing management retain control over the corporation, have the powers of the trustee (Section 1106 and 1107), and the right to propose a reorganization plan

3. [3](3): Automatic Stay • (a) All civil actions against the corporation are “stayed” (halted in their tracks) by the petition for bankruptcy • (1) filing a case or continuing a case to recover a claim against the corporation • (2) enforcement of a judgment against the corporation • (3) any act to obtain possession of property of the corporation • (6) any act to collect a claim against the corporation • (7) setoff any debt owed to the corporation • Tort cases and judgments are stayed, just as any case by a creditor • (b) Criminal actions are NOT stayed by the petition • Corporation must discontinue making interest and principal payments to creditors, judgment or settlement payments, etc. • All claims and judgments become bankruptcy claims

4. [3](4): Claims in Bankruptcy • Claims by creditors: balance due on the debt • Debt contracts have “acceleration” clauses which make the balance due immediately upon default of any single payment • Claim from a mortgage would be the unpaid principal • Claim on a bond would be the face value due at the date of maturity • Claims by trade creditors • Amount due from corporation as a result of the sale of good or services • Creditor cannot retain money owed to the corporation in order to setoff the claim • Claims by tort claimants: • If judgment from some court, then the claim is the amount of the judgment • If no judgment, then trustee (debtor on possession) must evaluate the claim • Claims from rejection of leases and collective bargaining contracts • Unsecured claims

5. [3](5): Powers and Duties of Management • Operate the Business (Section 1108) • Accountable for all property of the corporation (Section 704(2)) • Use, sale, or lease of property (Section 363) • Obtaining credit (Section 364) • Assume or Reject Executory Contracts (Section 365) • Recover Property of the Corporation • Void preferences to creditors (Section 547) • Void fraudulent transfers from the corporation (Section 548) • Work with Creditor Classes • Evaluate the claims (Section 704(5)) • File a Reorganization Plan (Section 1123) • Financial Reorganization Plan (Section 1123(a)(1)-(4)) • Business Reorganization Plan (Section 1123(5))

6. [3](6): Financial Reorganization • Section 1123(a)(1): Designate classes of claims (creditors and tort claimants) and classes of interests (shareholders) • Section 1123(a)(3): Specify the treatment of each class • Treatment defines what the class will receive after bankruptcy in return for discharge of their claim • A class is not impaired if its treatment has a value equivalent to the claim • For impaired classes, each creditor in the class must be treated the same • What about tort claimants? • Unsecured claims • But some have judgments and some do not • And those without judgments have different types of injuries and claims • What about future tort claimants who do not know they have been injured at the time the corporation declares bankruptcy?

7. [3](7): Johns-Manville Bankruptcy (1986) • Asbestos Health Trust (1986) • Treatment of all claims by individuals with asbestos-related diseases • Injunction: tort claimants may only settle with the Trust and cannot sue Johns-Manville or its insurance companies • Initial Funding of the Trust • $646.5 million in settlements with insurance companies • $200 million in cash and assets from Johns-Manville • 50% of the common stock of the reorganized Johns-Manville • Long-Term Funding of the Trust • $75 million per year for 22 years, beginning in year 4 (later year 6) • 20% of annual profits for all long as necessary • Preferred stock which can be converted into common stock if necessary • Amendments to Section 524 codify trusts for asbestos cases

8. [3](8): Kane v. Johns-Manville (1988) • Why is Kane challenging this reorganization plan? • Kane is a present tort claimant and is concerned that inclusion of future claimants will reduce the amount of money he will receive from the Trust • So Kane challenges the injunction, the voting, and the confirmation • What is the issue about the Injunction? • Future tort claimants are unknown, and cannot protect their rights • Courts have rejected this challenge to the Trust and Injunction by appointing a legal representative for the future tort claimants • What is the issue about Voting? • Acceptance requires a two-thirds vote of the dollar approved claims • Problem: Court allowed present tort claimants to vote their claims without evaluating their claims or allowing other creditors to challenge the claims • Court rejects this challenge because of the overwhelming vote of the class

9. [3](9): Kane v. Johns-ManvilleConfirmation of the Plan • Key Provisions of Confirmation of a Plan • Section 1129(a)(3): Good Faith by Corporation • Bankruptcy and reorganization is necessary • J-M was not in default on its debts when it petitioned for bankruptcy, but the estimated value of its tort liabilities exceeded its net worth • Section 1129(a)(7): Reorganization under Chapter 11 is better for the creditors than Liquidation under Chapter 7 • Present value of treatment under Chapter 11 is greater than the estimated one-time payment that the creditors would receive under Chapter 7 • Section 1129(a)(11): Business Plan can fund the Financial Plan so that the corporation is not likely to be followed by another bankruptcy • Court discusses the adequacy of the funding of the Trust

10. [3](10): What is Cramdown? • Under Section 1129(a)(8), confirmation requires that each impaired class accept the plan by voting for the plan • What is the problem with this criterion? • Holdout Problem: each class refuses to vote for the plan unless it receives all or most of its claim, but this is not possible for all classes • What is Cramdown: Section 1129(b)(1)? • Bankruptcy Court can confirm a plan even though one or more impaired classes have voted against the plan if the plan is “fair and equitable” to those classes • (b)(2) lists the complicated criterion for “fair and equitable” • But note (b)(2)(B)(ii): ANY treatment for unsecured creditors is fair and equitable if the shareholders receive nothing

11. [3](11): What is Discharge? • Effect of Confirmation (Section 1141) • (a) New debt obligations in the financial reorganization plan • (b) Ownership of the assets is retained by the corporation • (c) Except as provided in the plan, the assets are free and clear of the prior claims and interests • Treatment for secured creditors may result in retaining their collateral • (d) Discharge of the debts arising before the date of confirmation • Section 524: Discharge voids judgments and operates as an injunction against any action such as a lawsuit to recover on the these debts • (d) Terminates the rights and interests of shareholders • Reorganized Corporation has the new debts and stock specified by the treatment of classes creditors, tort claimants, and shareholders

12. [3](12): Continuing Asbestos Litigation • Consolidated Tort Lawsuits • 1991: All federal cases were consolidated the Eastern District Court of Pennsylvania - Philadelphia • 1993: Committee of defendants reaches a settlement agreement with representatives of the present plaintiffs • Schedule of payments for asbestos diseases, includes future plaintiffs • Administrative mechanism to administer the payments • District Court certifies one large class and approves the settlement • But Reversed by Court of Appeals and Supreme Court • Amchem Products v. Windsor (1997) • Consolidated Bankruptcies • Several of the defendants have declared bankruptcy since 1997 • Armstrong, Federal-Mogul, Owens Corning, USB, and W.R. Grace • 2002: Cases consolidated in New Jersey District and Bankruptcy Court

13. [3](13): Rejection of Contracts • In Bankruptcy, the corporation my reject executory contracts or unexpired leases, subject to court approval (Section 365(a)) • Executory contracts are contracts in which one or both sides has not completed the performance promised • The corporation may “assume” and “cure” contracts on which it has defaulted • Outside bankruptcy: if a contract is breached, the other party to the contract could sue for damages as a remedy • Inside bankruptcy: if a contract is rejected, the other party must file a claim for the same damages • Such a claim would be an unsecured claim and only a small percentage would be received by the other party in the financial plan • This provision was used by several airlines in the 1980’s to reject their union contracts and convert their workforce into non-union employees

14. [3](14): Rejection of Collective Bargaining Contracts • Congress added Section 1113 to the Bankruptcy Code • Increase the requirements for rejecting of collective bargaining contracts • (b)(1) the corporation must make a proposal to the union representative of the modifications necessary for a successful reorganization (and provide information) • (b)(2) the corporation must negotiate with the union in good faith • (c) If a new agreement is not reached, the court can approve the rejection of the contract, if the union has refused to accept a proposal without good cause, and the balance of equities favors rejection • (e) After a hearing, the court may authorize interim changes in the collective bargaining contract if it is essential to the continuation of the business

15. [3](15): Rejection of Commercial Leases • Bankruptcy Code was amended in 1984 to add some special provisions for commercial leases • Commercial leases are not loans so that the corporation must continue paying the rent until the lease is rejected (Section 365(d)(3)) • Claims by lessors from rejection of commercial leases are defined and limited so that it is not necessary to calculate the contract damages • Unpaid rent due from the past • Future rent limited by the larger of (1) one year’s rent OR (2) 15% of the rent due over the remaining term of the lease (but no more than three years of rent) • Such a claim would be an unsecured claim • Special protections for shopping center landlords and airport operators • Interesting paper topics for bankruptcies in the retail sector and airline industry

16. [3](16): United Airlines and its Unions • December 9, 2002: United declares bankruptcy • Before Bankruptcy, United renegotiated wage concessions in order to reduce yearly costs by $1.2 billion and obtain a Federal loan guarantee • After Bankruptcy, United renegotiated larger wage concessions in order to reduce yearly costs by $2.4 billion and obtain new post-petition financing from it bank lenders • Union Before Bankruptcy After Bankruptcy • Pilots accepted 18% accepted 29% • Attendants accepted 4% accepted 9% • Machinists rejected 7% court ordered 14% • Other Unions accepted ??% accepted 13% • January 10, 2003: Bankruptcy court orders interim cut for Machinists

17. [3](17): K-Mart and its Landlords • January 22, 2002: K-Mart declares bankruptcy • After Bankruptcy, K-Mart evaluated all its commercial leases for its stores and choose from three different options for each location • (1) Close the Store and Reject the Lease (214 stores) • Landlord recovers the property and has a claim in bankruptcy for rent • These stores were unprofitable AND had lease rates above the local market rate • (2) Close the Store and Assume the Lease (70 stores) • K-Mart can “cure” defaults and nullify lease restrictions on assignment • K-Mart then auctions (assigns) these leases for $46.6 million • These stores are unprofitable but have lease rates below the local market rate • (3) Operate Store, Assume Lease, but Renegotiate Rent (1800 stores) • K-Mart sends letters to landlords requesting lower rent, threatens rejection • These stores are profitable but may have lease rates above the local market rate