Deck 15: Creditors Rights and Bankruptcy

Question 1

Answers to the even-numbered questions in this For Review section can be found in Appendix F at the end of this text.
In a bankruptcy proceeding, what constitutes the debtor's estate in property? What property is exempt from the estate under federal bankruptcy law?

Answer 1

In a bankruptcy proceeding, the debtor's estate in property includes:
• Debtor's all legal and equitable interests in property held at present, including community property.
• Property to which the debtor becomes entitled within 180 days after filing bankruptcy.
• Income and profits from the property of the estate.
• Property transferred in a voidable transaction by the trustee.
• Some after-acquired property such as life insurance death proceeds, property settlements, and inheritances.
Property exempted from the estate under federal bankruptcy law includes:
• Debtor's contribution to the employee benefit plan
• Property acquired after filing bankruptcy

Question 2

Discharge. Caroline McAfee loaned $400,000 to Carter Oaks Crossing. Joseph Harman, Carter's president, signed a personal guaranty for the loan. Later, Harman obtained a discharge in bankruptcy under Chapter 7 for his personal debts. His petition did not list the guaranty among the debts. When Carter defaulted on the loan, McAfee sought to collect the unpaid amount from Harman based on the guaranty. Harman argued that the guaranty had been discharged in his bankruptcy. Is Harman correct? Why or why not? [Harman v. McAfee, 302 Ga.App. 698, 691 S.E.2d 586 (2010)] (See pages 441-443.)

Answer 2

Discharge in bankruptcy refers to the permanent order pertaining to which the debtor is released from the person liability from some specific type of debts. It also restricts creditor from taking any kind of action pertaining to the collection of the underlying discharged debts. Creditor possesses the right to enforce the lien pertaining to the recovery of the property.
In this case, JH is not correct because his personal guarantee is not discharged by the bankruptcy. He had signed a personal guarantee on behalf of his company C. He had filed for a personal bankruptcy petition and in the petition he fails to mention regarding the personal guarantee he had offered for C. Thus, his liabilities are not discharged as the personal guarantee as a result of which he is liable to pay the money in case of default of the actual party. Therefore, JH is not correct and is liable to pay.

Question 3

Answers to the even-numbered questions in this For Review section can be found in Appendix F at the end of this text.
What is the difference between an exception to discharge and an objection to discharge?

Answer 3

Difference between an exception to discharge and an objection to discharge:
Under exceptions to discharge, the creditor may deny the debtor of a discharge of his debt. However, he allows discharge of all other debts of the debtor debts so that the creditor has no other creditors to compete to collect his own debt. An exception to discharge takes place when debtor has shown any misconduct towards a particular creditor.
Under objections to discharge, on the other hand, the creditor may deny the debtor of a discharge of his debt. An objection to discharge takes place when debtor has shown misconduct towards all his creditors, in general.
Thus, the main difference between an exception to discharge and an objection to discharge is that the former involves a debtor's misconduct towards a particular creditor while objections to discharge may involve deception in the context of the bankruptcy case.

Question 4

Liens. Autolign Manufacturing Group, Inc., borrowed funds from Wamco 34, Ltd., to operate its auto parts business. The loan was secured by the molds that were used to form the parts. Autolign contracted with Delta Engineered Plastics, LLC, to make the parts and provided Delta with the molds. When Autolign defaulted on its obligations to Wamco and Delta, Delta asserted a "molder's lien" against the molds in its possession. A molder's lien is similar to an artisan's lien. Wamco argued that the molds were its property. Which claim had priority? Explain. [Delta Engineered Plastics, LLC v. Autolign Manufacturing Group, Inc., 286 Mich.App. 115, 777 N.W.2d 502 (2010)] (See page 439.)

Question 5

Answers to the even-numbered questions in this For Review section can be found in Appendix F at the end of this text.
In a Chapter 11 reorganization, what is the role of the debtor in possession?

Question 6

Artisan's Lien. Air Ruidoso, Ltd., operated a commuter airline and air charter service between Ruidoso, New Mexico, and airports in Albuquerque and El Paso. Executive Aviation Center, Inc., provided services for airlines at the Albuquerque International Airport. When Air Ruidoso failed to pay more than $10,000 that it owed for fuel, oil, and oxygen, Executive Aviation took possession of Air Ruidoso's plane. Executive Aviation claimed that it had a lien on the plane and filed a suit in a New Mexico state court to foreclose. Do supplies such as fuel, oil, and oxygen qualify as "materials" for the purpose of creating an artisan's lien? Why or why not? (See page 439.)

Question 7

Guaranty. Majestic Group Korea, Ltd., borrowed $1.5 million from Overseas Private Investment Corp. (OPIC) to finance a Ruby Tuesday's restaurant. Nam Koo Kim, the sole owner of Majestic, and his spouse Hee Sun Kim signed personal guaranties for full payment of the loan. Majestic defaulted. OPIC filed a suit against the Kims to recover. Hee claimed that she did not understand the extent of her liability when she signed the guaranty. Was Hee liable for the debt? Explain. [Overseas Private Investment Corp. v. Kim, 69 A.D.3d 1185, 895 N.Y.S.2d 217 (2010)] (See pages 441-443.)

Question 8

Spotlight on Personal Guaranties
COMPANY PROFILE Tony Riviera founded Tony Maroni's, Inc., to sell Tony Maroni's Famous Gourmet Pizza in Seattle, Washington, in the late 1980s. Tony Maroni's began by offering pizzas, salads, calzones, and lasagna for delivery only. By 1995, the firm had begun franchising its brand (franchising will be discussed in Chapter 19). Two years later, with eleven locations in the Seattle area, including six franchise outlets, and ten more stores in development, the company announced plans to open five hundred locations nationwide before 2002. Despite these plans, by the end of 1997, the firm had yet to turn a profit and was nearly $1 million in debt.
FACTS Tony Maroni's, Inc., agreed to lease retail space owned by Wilson Court Limited Partnership. Tony Riviera, Tony Maroni's president, signed the lease for 1,676 square feet of space for a sixty-month term. When he signed the lease, Riviera also signed a guaranty agreement that was incorporated by reference in the lease.
On the signature line of the guaranty, Riviera wrote "President" after his name. The guaranty did not specifically identify who was bound, referring only to "the undersigned" or "Guarantor." Riviera also signed the lease in a representative capacity, but the lease clearly indicated that only Tony Maroni's was bound by its terms. When Tony Maroni's defaulted on the lease, Wilson filed a suit in a Washington state court against Tony Maroni's, Riviera, and others. Riviera asserted, in part, that he was not personally liable on the guaranty because he signed only in his capacity as a corporate officer. The court issued a summary judgment in favor of Wilson. Riviera appealed to the Washington Supreme Court.
ISSUE Was Riviera personally liable on the guaranty?
DECISION Yes. The Washington Supreme Court affirmed the judgment of the lower court.
REASON The state supreme court reasoned that if Riviera, the president, were not personally liable, the corporation would be the guarantor of its own lease. That conclusion would be commercially unreasonable because a party cannot be the guarantor of its own contract. The court pointed out that "any ambiguity in the Guaranty was created by Riviera" and "such ambiguity will be construed against Riviera as the party who drafted this language." The court noted that the "combination of circumstances" made the guaranty ambiguous. Nevertheless, by referring to three parties, including the "Guarantor," "the language of the Guaranty itself compels the view Riviera is personally liable." The court explained that "[i]f Riviera signed the Guaranty only in his representative capacity, Tony Maroni's would be both Tenant and Guarantor, rendering the Guaranty provisions absurd." Thus, "the very nature of a guaranty is such that Riviera created personal liability by his signature."
CRITICAL THINKING-Ethical Consideration Are there any circumstances in which a collateral document signed by a corporate officer to secure a corporate debt might not create personal liability? Explain.

Question 9

Protection for Debtors. Bill and Betty Ma owned half of a two-unit residential building. Betty lived in the unit, but Bill did not. To collect a judgment against the Mas, Mei-Fang Zhang obtained a writ of execution directing the sheriff to seize and sell the building. State law allowed a $100,000 homestead exemption if the debtor lived in the home and $175,000 if the debtor was also disabled and "unable to engage in gainful employment." Bill argued that he could not work because of "gout and dizziness." How much of an exemption were the Mas allowed? Why? [Zhang v. Tse, __ F.Supp.2d __ (N.D.Cal. 2011)] (See page 444.)

Question 10

ISSUE SPOTTERS
Joe contracts with Larry of Midwest Roofing to fix Joe's roof. Joe pays half of the contract price in advance. Larry and Midwest complete the job, but Joe refuses to pay the rest of the price. What can Larry and Midwest do? (See pages 438-439.)

Question 11

Case Problem with Sample Answer-Automatic Stay. Michelle Gholston leased a Chevy Impala from EZ Auto Van Rentals. In November 2011, Gholston filed for bankruptcy. Around November 21, the bankruptcy court notified EZ Auto of Gholston's bankruptcy and the imposition of an automatic stay. Nevertheless, because Gholston had fallen behind on her payments, EZ Auto repossessed the vehicle on November 28. Gholston's attorney then reminded EZ Auto about the automatic stay, but the company failed to return the car. As a result of the car's repossession, Gholston suffered damages that included emotional distress, lost wages, attorneys' fees, and car rental expenses. Can Gholston recover from EZ Auto? Why or why not? [In re Gholston, ___ Bankr. ___, 2012 WL 639288 (M.D.Fla. 2012)] (See pages 450-451.)

Question 12

Answers to the even-numbered questions in this For Review section can be found in Appendix F at the end of this text.
What is a prejudgment attachment? What is a writ of execution? How does a creditor use these remedies?

Question 13

A Question of Ethics-Guaranty Contracts. 73-75 Main Avenue, LLC, agreed to lease commercial property to PP Door Enterprise, Inc., if its principal officers executed personal guaranties and provided credit information. Nan Zhang signed the lease as manager of PP Door. The principals of PP Door signed the lease and guaranty agreements. When PP Door failed to make monthly payments, the lessor sued PP Door and its owner, Ping Ying Li. Li testified that she was the sole owner of PP Door but denied that Zhang was its manager. She also denied signing the guaranty agreement. She claimed that she had signed the credit authorization form because Zhang had told her he was too young to have good credit. Li claimed to have no knowledge of the lease agreement. She did admit, however, that she had paid the rent because Zhang had been in a car accident and had asked her to help pay his bills, including the rent. [73-75 Main Avenue, LLC v. PP Door Enterprise, Inc., 120 Conn.App. 150, 991 A.2d 650 (2010)]
1. Li argued that she was not liable on the lease agreement because Zhang was not authorized to bind her to the lease. Do the facts support Li? Why or why not? (See page 443.)
2. Li claimed that the guaranty for rent was not enforceable against her. Why might the court agree? (See pages 441-443.)

Question 14

Three months ago, Janet Hart's husband of twenty years died of cancer. Although he had medical insurance, he left Janet with outstanding medical bills of more than $50,000. Janet has worked at the local library for the past ten years, earning $1,500 per month. Since her husband's death, Janet also has received $1,500 in Social Security benefits and $1,100 in life insurance proceeds every month, giving her a monthly income of $4,100. After she pays the mortgage payment of $1,500 and the amounts due on other debts each month, Janet barely has enough left over to buy groceries for her family (she has two teenage daughters at home). She decides to file for Chapter 7 bankruptcy, hoping for a fresh start. Using the information provided in the chapter, answer the following questions.
1. Under the Bankruptcy Code after the reform act, what must Janet do before filing a petition for relief under Chapter 7?
2. How much time does Janet have after filing the bankruptcy petition to submit the required schedules? What happens if Janet does not meet the deadline?
3. Assume that Janet files a petition under Chapter 7. Further assume that the median family income in the state in which Janet lives is $49,300. What steps would a court take to determine whether Janet's petition is presumed to be "substantial abuse" under the means test?
4. Suppose that the court determines that no presumption of substantial abuse applies in Janet's case. Nevertheless, the court finds that Janet does have the ability to pay at least a portion of the medical bills out of her disposable income. What would the court likely order in that situation?
DEBATE THIS Rather than being allowed to file Chapter 7 bankruptcy petitions, individuals and couples should always be forced to make an effort to pay off their debts through Chapter 13.

Question 15

Business Law Writing. Write a few sentences describing the circumstances in which a creditor would resort to each of the following remedies when trying to collect on debt. (See pages 439-440.)
1. Mechanic's lien
2. Artisan's lien
3. Writ of attachment

Question 16

Question with Sample Answer-Perfection. Marsh has a prize horse named Arabian Knight. In need of working capital, Marsh borrows $5,000 from Mendez, who takes possession of Arabian Knight as security for the loan. No written agreement is signed. Discuss whether, in the absence of a written agreement, Mendez has a security interest in Arabian Knight. If Mendez does have a security interest, is it a perfected security interest? Explain. (See pages 436-438.)

Question 17

Business Law Critical Thinking Group Assignment.
Grant owns an older home valued at $45,000. He contracts with Jane's Plumbing to replace the bathtubs and fixtures in both bathrooms. Jane replaces them, and on June 1 she submits her bill of $4,000 to Grant. Because of financial difficulties, Grant does not pay the bill. Grant's only asset is his home, but his state's homestead exemption is $40,000.
1. The first group will determine whether Jane's Plumbing can obtain a lien to pay for the renovations. What type of lien would it be, and how is it created?
2. A second group will determine what would happen if Grant filed for Chapter 7 bankruptcy before Jane took any legal action to collect on her claim. Would Jane be a secured or unsecured creditor? Would Jane's position be different if she had obtained a lien before Grant's petition for bankruptcy? Explain.

Question 18

Ransom v. FIA Card Services, N.A.
FACTS Jason Ransom filed a petition in a federal bankruptcy court to declare bankruptcy under Chapter 13. Among his assets, Ransom reported a Toyota Camry that he owned free of any debt. In listing monthly expenses for the means test, he claimed a deduction of $471 for car ownership and a separate deduction of $388 for car-operating costs. Based on his means-test calculations, Ransom proposed a five-year plan that would repay about 25 percent of his unsecured debt. He listed FIA Card Services, N.A., as an unsecured creditor. FIA objected to Ransom's plan, arguing that he should not have claimed the car-ownership allowance because he did not make payments on his car. The court agreed with FIA and issued a decision in its favor. A Bankruptcy Appellate Panel and the U.S. Court of Appeals for the Ninth Circuit affirmed the decision. Ransom appealed to the United States Supreme Court.
ISSUE Can a debtor in bankruptcy claim the car-ownership deduction even though the debtor owns the car outright and does not make payments on it?
DECISION No. The United States Supreme Court affirmed the lower court's decision.
REASON The Supreme Court referred to tables of standardized expense amounts that a debtor could claim as reasonable living expenses and shield from creditors. The Bankruptcy Code limits a debtor's expense amounts to those that are "applicable," or appropriate. A deduction is appropriate only if the debtor will incur that expense during the life of the Chapter 13 plan. Because Ransom owned the car free and clear, the "Ownership Costs" category was not "applicable" to him, and he could not claim such an expense. The ultimate result was that confirmation of his repayment plan was denied. (Confirmation of repayment plans is discussed below.)
CRITICAL THINKING-Economic Consideration Should debtors with older vehicles be allowed to take an additional deduction for operating expenses? Explain.

Question 19

ISSUE SPOTTERS
Ogden is a vice president of Plumbing Service, Inc. (PSI). On May 1, Ogden loans PSI $10,000. On June 1, the firm repays the loan. On July 1, PSI files for bankruptcy. Quentin is appointed trustee. Can Quentin recover the $10,000 paid to Ogden on June 1? Why or why not? (See pages 452-453.)

Question 20

Answers to the even-numbered questions in this For Review section can be found in Appendix F at the end of this text.
What is garnishment? When might a creditor undertake a garnishment proceeding?

Question 21

Discharge. Caroline McAfee loaned $400,000 to Carter Oaks Crossing. Joseph Harman, Carter's president, signed a personal guaranty for the loan. Later, Harman obtained a discharge in bankruptcy under Chapter 7 for his personal debts. His petition did not list the guaranty among the debts. When Carter defaulted on the loan, McAfee sought to collect the unpaid amount from Harman based on the guaranty. Harman argued that the guaranty had been discharged in his bankruptcy. Is Harman correct? Why or why not? [Harman v. McAfee, 302 Ga.App. 698, 691 S.E.2d 586 (2010)] (See pages 441-443.)

Question 22

United Student Aid Funds, Inc. v. Espinosa
FACTS Francisco Espinosa filed a petition for an individual repayment plan under Chapter 13 of the Bankruptcy Code. His plan proposed to pay only the principal on his student loan and to discharge the interest. United Student Aid Funds, Inc. (the creditor), had notice of the plan and did not object. Without finding that payment of the interest would cause undue hardship (as required under the Code), the court confirmed the plan. Years later, however, United filed a motion under Federal Rule of Civil Procedure 60(b)(4) asking the bankruptcy court to rule that its order confirming the plan was void because the order was issued in violation of the laws and rules governing bankruptcy. The court denied United's petition and ordered the creditor to cease its collection efforts. United appealed, and the case ultimately reached the United States Supreme Court.
ISSUE If a bankruptcy court committed a legal error by confirming a debtor's repayment plan to discharge student loan debt without the required finding of undue hardship, but the creditor did not object, is the court's judgment void?
DECISION No. The United States Supreme Court affirmed the decision of the lower court that the bankruptcy court's order was not void and that the student loan debt was thus discharged.
REASON The Supreme Court pointed out that the bankruptcy court's order confirming Espinosa's proposed plan was a final judgment from which United did not appeal. Federal Rule of Civil Procedure 60(b)(4) authorizes a court to relieve a party from a final judgment if that judgment is void, but a judgment is not void simply because it is or may have been erroneous. Moreover, a motion under this rule is not a substitute for a timely appeal. "The Bankruptcy Court's failure to find undue hardship before confirming Espinosa's plan was a legal error. But the order remains enforceable and binding on United because United had notice of the error and failed to object or timely appeal."
CRITICAL THINKING-Ethical Consideration At one point, United argued that if the Court did not declare the bankruptcy court's order void, dishonest debtors would be encouraged to abuse the Chapter 13 process. How might such abuse occur, and should the possibility of such abuse affect the Court's decision? Discuss your answer.