II. Business Law-Debtor-Creditor Relationships

Question 1

II. Business Law-Debtor-Creditor Relationships

Answer 1

1. Rights, Duties and Liabilities of Debtors, Creditors, Sureties, and Guarantors
2. Article 9 UCC Secured Transactions
3. Bankruptcy and Insolvency

Question 2

II. Business Law-Debtor-Creditor Relationships

1. Rights, Duties and Liabilities of Debtors, Creditors, Sureties, and Guarantors
2. Suretyship: Introduction, Creation, and Types

Answer 2

Introduction: The parties(Creditor/ Principal debtor/ Surety or guarantor)

Creation: 1) must be in writing and signed by the surety (guarantor)

2) consideration is Not Required

Question 3

II. Business Law-Debtor-Creditor Relationships

1. Rights, Duties and Liabilities of Debtors, Creditors, Sureties, and Guarantors
2. Suretyship: Introduction, Creation, and Types

Edwards Corp. lent Lark $200,000. At Edwards’s request, Lark entered into an agreement with Owen and Ward for them to act as compensated co-sureties on the loan in the amount of $200,000 each.

If Edwards releases Ward without Owen’s or Lark’s consent, and Lark later defaults, which of the following statements is correct?

Answer 3

1. Lark will be released for 50% of the loan balance.
2. Owen will be liable for the entire loan balance.
3. Owen will be liable for 50% of the loan balance.
4. Edwards’s release of Ward will have no effect on Lark’s and Owen’s liability to Edwards.

Since Edwards released one of the two sureties, the remaining surety is liable for only half of the entire debt. Until the release, Edwards could have collected the entire debt from either surety, and then that surety could have sued the other surety for half of that amount under the right of contribution. However, now Edwards can only collect 50% of the debt from Owen, because he has eliminated Owen’s ability to collect anything from Ward. Lark is still liable for the entire amount.

C

Question 4

II. Business Law-Debtor-Creditor Relationships

1. Rights, Duties and Liabilities of Debtors, Creditors, Sureties, and Guarantors
2. Suretyship: Introduction, Creation, and Types

AICPA.921126REG-BL

Ivor borrowed $420,000 from Lear Bank. At Lear’s request, Ivor entered into an agreement with Ash, Kane, and Queen for them to act as co-sureties on the loan. The agreement between Ivor and the co-sureties provided that the maximum liability of each co-surety was: Ash, $84,000; Kane, $126,000; and Queen, $210,000. After making several payments, Ivor defaulted on the loan. The balance was $280,000.

If Queen pays $210,000 and Ivor subsequently pays $70,000, what amounts may Queen recover from Ash and Kane?

Answer 4

1. $0 from Ash and $0 from Kane.
2. $42,000 from Ash and $63,000 from Kane.
3. $70,000 from Ash and $70,000 from Kane.
4. $56,000 from Ash and $84,000 from Kane.

2.

The total maximum amount that the sureties stand to lose is $84,000 + $126,000 + $210,000 = $420,000. If the loss is below the maximums, each co-surety is ultimately liable for a proportionate share of the total debt based on their maximum liability. For example, Queen will bear 50% of any loss because Queen is liable for $210,000 of the $420,000 total maximum, or 50%.

Here, after Ivor has paid in $70,000 toward his loan balance of $280,000, the loan balance stands at $210,000. The exact order of payments is not important; what is important is that at the end of the day all co-sureties pay their fair share. Since the debt balance is $210,000, and the maximum total the sureties stand to lose is $420,000, each surety will pay exactly 1/2 of their personal maximum liability. Since Queen paid the entire debt to begin with, Queen is able to recover half of Ash’s maximum, or $42,000, and half of Kane’s maximum, or $63,000.

Question 5

II. Business Law-Debtor-Creditor Relationships

1. Rights, Duties and Liabilities of Debtors, Creditors, Sureties, and Guarantors
2. Suretyship: Rights of Parties

II. Rights of the Surety or Guarantor

Answer 5

1. Exoneration—This equitable right permits a surety to petition the court to order the creditor by court decree to exhaust recovery against the principal debtor before holding the surety liable.
2. Reimbursement and Indemnity
3. Subrogation—Upon payment, the surety succeeds to any rights the creditor has (stands in the shoes of the creditor). These include the following.
4. Right of Contribution—Applies when two or more sureties are liable on the same obligation to the same creditor and, upon debtor’s default, one cosurety pays more than his or her proportionate share of the obligation. The right of contribution entitles this cosurety to recover the amount paid above his or her share owed from the other cosurety.

Question 6

II. Business Law-Debtor-Creditor Relationships

1. Rights, Duties and Liabilities of Debtors, Creditors, Sureties, and Guarantors
2. Suretyship: Rights of Parties

III. Defenses of the Parties—Events that Do Not Release or Discharge the Surety from Liability

Answer 6

1. Insolvency of the Principal Debtor
2. Bankruptcy of the Principal Debtor
3. Fraud or Misrepresentation by the Debtor
4. Principal Debtor’s Incapacity
5. Death of the Principal Debtor
6. Release—Release by the creditor of the principal debtor, without the surety’s consent and with the creditor reserving rights against the surety, does not result in a release of the surety.
7. Changes or Modification

Question 7

II. Business Law-Debtor-Creditor Relationships

1. Rights, Duties and Liabilities of Debtors, Creditors, Sureties, and Guarantors
2. Suretyship: Rights of Parties

IV. Defenses of the Parties—Events that Do Result in the Release of the Surety

Answer 7

1. Principal Debt Paid
2. Surety’s Incapacity
3. Guarantor’s Discharge Decree in Bankruptcy
4. Statute of Limitations Expires
5. Fraud or Misrepresentation by the Creditor
6. Release—Release of the principal debtor without the surety’s consent is also a release from liability of the surety. Collateral of the principal debtor held by either the creditor or the guarantor can still be used by the creditor to satisfy the debt.
7. Refusal of Principal Debtor’s Tender—If the principal debtor tenders payment to the creditor under a surety contract, and the creditor refuses the proper tender, the surety is completely discharged from liability.
8. Material Alteration by Creditor
9. Creditor’s Failure to Disclose
10. Changes and Modifications where There Is an Uncompensated Surety
11. Surrender or Impairment of Debtor’s Collateral
12. Special Release for Guaranty of Collections
13. Statute of Frauds—Surety contracts must be in writing. A surety is always released from liability under an oral suretyship agreement.

Question 8

II. Business Law-Debtor-Creditor Relationships

1. Rights, Duties and Liabilities of Debtors, Creditors, Sureties, and Guarantors
2. Suretyship: Rights of Parties

Modifications

Answer 8

1. Evans is a gratuitous guarantor on a loan made to her daughter by West Bank. The loan is due in one month. Without Evans’ consent, her daughter and West Bank agree to extend the loan period for one month without interest or other fees charged. After the one month, the daughter goes into default. Can Evans be held liable on her surety contract? TRUE
2. Gail is a gratuitous guarantor on a loan West Bank made to her son. It is an absolute guaranty. One month before the loan is due, Gail’s son and West Bank enter into a written agreement, without Gail’s consent, to extend the loan with a 2% increase in the interest rate for two years. This modification completely discharges Gail’s surety liability. TRUE

Question 9

II. Business Law-Debtor-Creditor Relationships

2. Article 9 UCC secured Transactions
3. Introduction and Creation of Security Interests

C. Article 9 security interests apply to personal property or fixtures including goods, documents, instruments, general intangibles, chattel paper, and accounts, agricultural liens, sales of accounts, and promissory notes, and commercial consignments of $1,000 or more—UCC 9-109.

1. Transactions excluded from secured transactions law (other laws apply):

Answer 9

1. Landlord’s liens
2. Mechanic’s liens
3. Artisan’s liens
4. Assignment of wage
5. Tort claims (see discussion of commercial tort claims below)
6. Insurance (except proceeds from policies covering covered collateral)
7. Judgments
8. Leases
9. Real estate mortgages

Question 10

II. Business Law-Debtor-Creditor Relationships

2. Article 9 UCC secured Transactions
3. Introduction and Creation of Security Interests

To create a security interest

Answer 10

1. the creditor must give value,
2. the debtor must have rights in the collateral,
3. the creditor must take possession of the collateral or obtain the agreement in a signed or authenticated writing by the debtor.

Filing is not necessary to create an interest, it is only necessary to perfect an interest that has already been created.

Question 11

II. Business Law-Debtor-Creditor Relationships

2. Article 9 UCC secured Transactions
3. Perfection of Security Interests

A filing is effective even if filing officer refuses it unless, generally—UCC 9–516(d):

Answer 11

1. The proper filing fee is not tendered.
2. The name of the debtor is not provided (which would prevent indexing).
3. The record filing is communicated in an unauthorized (as set by the filing offices) medium.
4. Where required, there is not a sufficient description of the realty—UCC 9–516(b).

Question 12

II. Business Law-Debtor-Creditor Relationships

2. Article 9 UCC secured Transactions
3. Perfection of Security Interests

V. Automatic Perfection
PMSI

Answer 12

• A purchase money security interest (PMSI) in consumer goods
  Ex1)
  Beyer wants to purchase a large-screen TV from Sallor TV Inc. for $1,500. Beyer pays $200 down and signs a security agreement giving Sallor TV a security interest in the set being purchased until the balance of $1,300 is paid. Sallor has a PMSI.
  Ex2)
  Beyer wants to buy a large-screen TV from Sallor TV Inc. Beyer goes to West Bank seeking a loan to buy the set. West Bank loans Beyer the money and Beyer signs a security agreement giving West Bank a security interest in the to-be-purchased TV set. If Beyer does purchase the set, West Bank has a PMSI in the set. (Note: If Beyer purchases a large refrigeratorfreezer instead of the TV, West Bank would be an unsecured creditor.)
• A sale of payment intangibles;
• A sale of promissory notes

Question 13

II. Business Law-Debtor-Creditor Relationships

2. Article 9 UCC secured Transactions
3. Perfection of Security Interests

V. Automatic Perfection
Temporary Perfection

Answer 13

1. There is temporary perfection without filing or possession for certificated securities, negotiable documents, and instruments if new value is given
   
   1. For 20 days from creation of the security interest by authenticated security agreement;
   2. Applicable only to certificated securities, negotiable documents, and instruments if new value is given.
2. If perfected by possession—Remains perfected for 20 days without a filing:
   
   1. For goods in possession of a bailee or a negotiable document where the secured party makes the goods or documents available to the debtor for sale, exchange, loading, shipping, etc.
   2. For a certificated security or an instrument where the secured party delivers the security certificate or instrument to the debtor for sale, exchange, collection, presentation, etc.
   3. Need to take action for post-20-day period in order to retain perfection.
3. When a debtor moves out of state—(debtor moved to a new jurisdiction)—UCC 9-316.
   
   1. If collateral is perfected in one jurisdiction (e.g., in state A) and the debtor moves into another jurisdiction (state B), the perfected secured party (state A) has priority over a subsequent perfected secured party in the new jurisdiction (state B) for a period of four months (or for the period of time remaining under the original perfection, whichever is earlier) from the date the debtor changes his/her location into the new jurisdiction (state B).

Question 14

II. Business Law-Debtor-Creditor Relationships

2. Article 9 UCC secured Transactions
3. Priorities in Security Interests

Answer 14

When a perfected secured party’s interest has priority over:

1. Unsecured creditors—Perfected secured creditor vs. unsecured creditor: Perfected secured creditor has priority.
2. Unperfected secured parties—Perfected secured party vs. unperfected secured party: Perfected secured creditor has priority.
3. Lien creditors—Perfected secured creditor vs. lien creditor —First to attach has priority. If the perfected secured party perfected before the lien attached, the perfected secured party has priority. If the lien attached prior to perfection, the lien creditor has priority.
4. Judgment creditors—Perfected secured creditor vs. judgment creditor —First to attach has priority. If the perfected secured party perfected before the judgment lien attached, the perfected secured party has priority. If the judgment lien attached prior to perfection, the lien creditor has priority.
5. Trustees in bankruptcy.

Question 15

II. Business Law-Debtor-Creditor Relationships

2. Article 9 UCC secured Transactions
3. Priorities in Security Interests

II. Priority of Perfected Secured Parties over Buyers

Answer 15

1. Buyers in the Ordinary Course of Business—Perfected secured creditor vs. buyer in the ordinary course of business:Buyer in the ordinary course of business wins and gets the goods/collateral.
2. Buyer Not in the Ordinary Course of Business (perfected secured creditor)—Perfected secured party vs. buyer not in the ordinary course of business: Perfected secured party takes priority because buyers not in the ordinary course of business need to check for creditors’ interests before buying in less-than-ordinary transactions.
3. Buyer Not in the Ordinary Course of (secured creditor only)—Secured creditor vs. buyer not in the ordinary course of business: Buyer will have priority unless the buyer is aware of the creditor’s secured interest.
4. Buyer Not in the Ordinary Course of Business of Consumer Goods—A buyer not in the ordinary course of business of consumer goods will prevail over a previously perfected secured party by attachment (automatically)

​If the buyer cannot establish all four of these requirements, the perfected secured party has priority.

• Buyer must give value to the seller-debtor;
• Buyer must not know of secured party’s security interest;
• Buyer must buy for personal use (as consumer goods); and
• Buyer must buy before the secured party perfects by filing a financing statement.

Question 16

II. Business Law-Debtor-Creditor Relationships

2. Article 9 UCC secured Transactions
3. Rights of Secured Parties and Debtors

I. Creditor’s Options upon Debtor Default

F. Creditor’s Rights on Disposal of the Repossessed Collateral

Answer 16

1. When the creditor must sell the collateral—If the collateral is consumer goods and 60% or more of the purchase price (or debt if the collateral was not fully financed by the creditor) has been paid, the creditor must sell it
2. Time requirement for sale—If objection is received or the secured party must sell, the secured party must dispose of the collateral within 90 days after taking possession.

Question 17

II. Business Law-Debtor-Creditor Relationships

3. Bankruptcy and Insolvency
4. Prebankruptcy Options, and Introduction to and Declaration of Bankruptcy

I. When the Debtor Does Not Pay—Options for Creditors

Answer 17

1. Creditors may execute rights under common law or statutory lien rights,
2. under Article 9 secured transactions and/or suretyship agreements, or
   
   1. Repossess the collateral from the debtor, or
   2. Bring suit for collection of the amount due.
3. under the Fair Debt Collections Practice Act (FDCPA) to try to collect the debt.
   the creditor may:
   
   1. Not talk to the debtor once the debtor has a lawyer.
   2. Contact third parties to obtain information about the debtor.
   3. File suit for collection.
   4. Not harass the debtor or call during certain time periods.

Question 18

II. Business Law-Debtor-Creditor Relationships

3. Bankruptcy and Insolvency
4. Prebankruptcy Options, and Introduction to and Declaration of Bankruptcy

III. Types of Bankruptcy

1. Chapter 7—Referred to as “straight bankruptcy” or liquidation

Answer 18

1. Permits voluntary and involuntary petitions
2. Permits individuals and businesses to file
   
   1. Consumers generally cannot go directly to a Chapter 7 liquidation bankruptcy.
   2. >> means test
      
      1. examines the debtor’s monthly income
      2. not include income tax refunds SS retirement benefits
      3. If the debtor’s income is at or below the state median income, the bankruptcy can proceed
      4. If above >> examines expenses >> If there is sufficient income after the coverage for reasonable expenses to pay off debts, then the debtor is required to go through Chapter 13 bankruptcy.
3. Trustee is appointed.
4. Not eligible for Chapter 7:
   
   1. Railroads
   2. Domestic insurance companies
   3. Credit unions
   4. Savings and loans
   5. Banks and cooperative banks
   6. Certain SBA entities

Question 19

II. Business Law-Debtor-Creditor Relationships

3. Bankruptcy and Insolvency
4. Prebankruptcy Options, and Introduction to and Declaration of Bankruptcy

III. Types of Bankruptcy

2. Chapter 9—Allows for the adjustment of debts of an insolvent municipality

Answer 19

1. Permits voluntary petitions only by the municipality.
2. This chapter is rarely addressed on the exam.
3. Liquidation of the municipality’s assets is not permitted.
4. Automatic stay, but there are limitations on the stay.

Question 20

II. Business Law-Debtor-Creditor Relationships

3. Bankruptcy and Insolvency
4. Prebankruptcy Options, and Introduction to and Declaration of Bankruptcy

III. Types of Bankruptcy

3. Chapter 11—Allows for the reorganization of a business debtor to pay debts—a rehabilitation of a debtor.

Answer 20

1. Permits voluntary and involuntary petitions.
2. Allows companies to restructure and be discharged from certain debts.
3. Generally, no trustee.
4. Reorganization plan approved by half of the creditors with two-thirds of the total claims (includes shareholders).
5. Court must approve.
6. Savings and loans, banks, insurance companies are not eligible for Chapter 11.

Question 21

II. Business Law-Debtor-Creditor Relationships

3. Bankruptcy and Insolvency
4. Prebankruptcy Options, and Introduction to and Declaration of Bankruptcy

III. Types of Bankruptcy

4. Chapter 12—Allows for the adjustment of debts of a family farmer and family fisherman—a rehabilitation of a person (including a corporation or a partnership) who meets the definition of a family farmer or fisherman (rarely tested on the exam).

Answer 21

1. Permits only voluntary petitions by the family farmer or family fisherman.
2. Chapter 12 is a more streamlined process than Chapter 11, which is used for other types of businesses.
3. Automatic stay upon filing.
4. Court appoints an interim trustee.
5. Debt adjustment plan is established at a meeting of the creditors.

Question 22

II. Business Law-Debtor-Creditor Relationships

3. Bankruptcy and Insolvency
4. Prebankruptcy Options, and Introduction to and Declaration of Bankruptcy

III. Types of Bankruptcy

5. Chapter 13 (also called a wage earner’s plan)—Allows for the adjustment of debts of an individual with regular income—a rehabilitation of only individuals (not partnerships or corporations) with limited total secured and unsecured debt amounts.

Answer 22

1. Permits only voluntary petitions
2. Less than $394,725/$419,275 in unsecured and less than $1,184,200/$1,257,850 in secured debt
3. Always has a trustee
4. Applies only to individuals (debt limits)
5. Debtor’s plan
6. Court confirmation
7. Three to five years for plan—discharged if payment is made
8. The debtor(s) must have undergone credit/debt counseling within the 180 days preceding the filing of Chapter 13 petition.
   
   1. The credit counseling must be from an agency approved by the U.S Trustee’s office.
   2. The agency gives debtors a certificate of completion that must be filed no later than 15 days after the bankruptcy is filed. date. The counseling service also provides a repayment plan that must then be approved by the court.

Question 23

II. Business Law-Debtor-Creditor Relationships

3. Bankruptcy and Insolvency
4. Prebankruptcy Options, and Introduction to and Declaration of Bankruptcy

IV. Commencement of Bankruptcy

Answer 23

1. Chapter 7—Involuntarily petition into a Chapter 7 bankruptcy
   
   1. Same persons eligible as under voluntary Chapter 7 declaration except:
      
      1. All of the above exclusions from a voluntary Chapter 7 petition
      2. Nonprofit (not for profit) corporations
      3. Farmers (those that receive 80% or more of gross income from a farming operation and family farmers who meet that definition under a Chapter 12 bankruptcy—see detailed discussion below of Chapter 12 bankruptcies).
   2. Requirements for creditors’ involuntary petitions of a debtor into bankruptcy
      
      1. If the debtor has 12 or more unsecured creditors with noncontingent claims, the petition must be signed by three or more of these creditors whose aggregate claims are $15,775/$16,750 or more;
      2. If the debtor has less than 12 unsecured creditors with noncontingent claims, the petition requires only one (more can sign) of these creditors with an aggregate debt of $15,775/$16,750 or more to sign the involuntary petition.
2. Chapter 11 Bankruptcy
   
   1. Debt adjustment plan for businesses.
   2. If the business bankruptcy is filed by an individual (sole proprietorship), the same requirements for debt counseling within 180 days of the declaration of bankruptcy apply.
   3. same amounts and number of creditor requirements for Chapter 7 apply under Chapter 11. The same debt requirements apply for voluntary petitions.
   4. No trustee is appointed
3. Chapter 13 Bankruptcy Consumer Debt Adjustment Plan
   1. Individuals and married couples with regular income who have been through credit counseling and have a proposed plan qualify if they have less than $394,725/$419,275 in unsecured debts and less than $1,184,200/$1,257,850 in secured debts. The court also applies the means test, which is an evaluation of whether the debtors have sufficient means to pay their debts.
   2. Corporations and partnerships do not qualify for Chapter 13 bankruptcy.

Question 24

II. Business Law-Debtor-Creditor Relationships

3. Bankruptcy and Insolvency
4. Prebankruptcy Options, and Introduction to and Declaration of Bankruptcy

F. Effect of Bankruptcy Petition

Answer 24

1. Upon the filing of a voluntary petition or the filing or granting of an involuntary petition, the court will grant an order for relief or a stay.
2. Order for relief or stay means that creditors must stop collection and all pending credit proceedings (lien foreclosure; judicial liens, etc., as discussed in the earlier sections of this lesson) are stayed (stopped), and the debts and payments will be handled through the bankruptcy court.
3. This stay sets in motion proceedings that lead to the discharge of the debtor’s debts.
4. Some proceedings are not affected by the order for relief or stay including:
   
   1. Criminal prosecution of the debtor
   2. Collection of child support and/or alimony
   3. Tax audits
   4. Department of Housing and Urban Development (HUD) foreclosures
   5. Investigations by a securities regulatory agency (Securities Exchange Commission)
   6. Driver’s license suspensions

EX) If bridal store files for Chapter 7 bankruptcy, once the petition is filed, the owner of the bridal store no longer has access to the inventory (the dresses) and the trustee is in possession of those dresses.

NOTE: Under Chapter 11, there is no trustee, and the owner of the bridal store would continue to be in possession of the inventory (the dresses) and could continue to operate, including selling the dresses.

Question 25

II. Business Law-Debtor-Creditor Relationships 3. Bankruptcy and Insolvency 44. Prebankruptcy Process A company that has filed a Chapter 11 bankruptcy petition intends to pay an insider key employee an inducement to remain with the company. The average amount of similar payments made to nonmanagement employees will be $35,000 in the same calendar year. Which of the following annual monetary incentives can be paid to this employee? 1. $335,000 2. $355,000 3. $375,000 4. $395,000

Answer 25

1. KERP (key employee retention plan) payments are made to nonmanagement and management employees. Those paid to management cannot be more than 10 times the average amount of retention payments made to nonmanagement employees.

Question 26

II. Business Law-Debtor-Creditor Relationships 3. Bankruptcy and Insolvency 44. Prebankruptcy Process Which of the following transfers by a debtor within 90 days of filing for bankruptcy could be set aside as a preferential payment? 1. Making a gift to charity 2. Paying a business utility bill 3. Borrowing money from a bank secured by giving a mortgage on business property 4. Prepaying an installment loan on inventory

Answer 26

1. Incorrect. It may not be the best idea to make charitable donations just before bankruptcy, but it is not a voidable preference. 2. Incorrect. This is ordinary course of business. 3. Incorrect. The debtor can continue to make contemporaneous transactions. This transaction is not giving an existing creditor an advantage—it is a new transaction, contemporaneous for present value. 4. Correct! Any action by a debtor that gives a creditor an advantage over other creditors who would have priority in bankruptcy can be set aside as a voidable preference.

Question 27

II. Business Law-Debtor-Creditor Relationships 3. Bankruptcy and Insolvency 44. Prebankruptcy Process On February 28, year 1, Master, Inc. has total assets with a fair market value of $1.2mn and total liabilities of $990,000. On January 15, year 1, Master makes a monthly installment-note payment to Acme Distributors Corp., a creditor holding a properly perfected security interest in equipment having a fair market value greater than the balance due on the note. On March 15, year 1, Master voluntarily files a petition in bankruptcy under the liquidation provisions of Chapter 7 instead of a Chapter 11 reorganization under the Federal Bankruptcy Code. One year later, the equipment is sold to Acme for less than the balance due on the note. If Master's voluntary petition is filed properly, 1. Master will be entitled to conduct its business as a debtor-in-possession, unless the court appoints a trustee. 2. A trustee must be immediately appointed by the creditors. 3. Lawsuits by Master's creditors will be stayed by the Federal Bankruptcy Code. 4. The unsecured creditors must elect a creditors' committee of 3-11 members to consult with the trustee.

Answer 27

1. Chapter 11 relief allows a debtor to retain control of their business, because the business will ultimately be reorganized and will continue. Under Chapter 7, however, the business will be liquidated and terminated. It is immediately turned over to a trustee, and there is no debtor-in-possession allowance 2. In a Chapter 7 bankruptcy, the U.S. Trustee appoints an interim trustee after the order for relief is entered. Under a Chapter 11 bankruptcy, the debtor in possession generally becomes the trustee. Although in a Chapter 7 bankruptcy the creditors can select a permanent trustee, it rarely happens. 3. Once a petition is filed, there is an automatic stay under both Chapter 7 and 11, which ends almost any proceeding against the debtor. The creditors will then have to seek relief from the bankruptcy court and not through independent legal action. 4. A creditor's committee is formed under a Chapter 11 bankruptcy proceeding for reorganization and not under a Chapter 7 proceeding. C.

Question 28

II. Business Law-Debtor-Creditor Relationships 3. Bankruptcy and Insolvency 44. Prebankruptcy Process On August 1, 2004, Hall files a voluntary petition under Chapter 7 of the Federal Bankruptcy Code. Hall's assets are sufficient to pay general creditors 40% of their claims. The following transactions occurred before the filing: - On May 15, 2004, Hall gave a mortgage on Hall's home to National Bank to secure payment of a loan National had given Hall two years earlier. When the loan was made, Hall's twin was a National employee. - On June 1, 2004, Hall purchased a boat from Olsen for $10,000 cash. - On July 1, 2004, Hall paid off an outstanding credit card balance of $500. The original debt had been $2,500. The National mortgage was 1. Preferential, because National would be considered an insider. 2. Preferential, because the mortgage was given to secure an antecedent debt. 3. Not preferential, because Hall is presumed insolvent when the mortgage was given. 4. Not preferential, because the mortgage was a security interest.

Answer 28

2. A debtor who declares bankruptcy may not give one creditor better treatment than others. Any payment or security interest made to a particular creditor within 90 days of declaring bankruptcy is a preferential payment if the payment is made on an antecedent debt. An antecedent debt is one that existed at the time bankruptcy was declared.

Question 29

II. Business Law-Debtor-Creditor Relationships 3. Bankruptcy and Insolvency 44. Prebankruptcy Process On August 1, 20XX, Hall files a voluntary petition under Chapter 7 of the Federal Bankruptcy Code. Hall's assets are sufficient to pay general creditors 40% of their claims. The following transactions occurred before the filing: - On May 15, 20XX, Hall gave a mortgage on Hall's home to National Bank to secure payment of a loan National had given Hall two years earlier. When the loan was made, Hall's twin was a National employee. - On June 1, 20XX, Hall purchased a boat from Olsen for $10,000 cash. - On July 1, 20XX, Hall paid off an outstanding credit card balance of $500. The original debt had been $2,500. The credit card payment was 1. Preferential, because the payment was made within 90 days of the filing of the petition. 2. Preferential, because the payment was on account of an antecedent debt. 3. Not preferential, because the payment was for a consumer debt of less than $6,425. 4. Not preferential, because the payment was less than 40% of the original debt.

Answer 29

3. This looks like a preferential payment, but is not, because it falls within an exception to the general rule. Consumer debts of up to $6,425 may be made without showing a preference, as can alimony and child support payments. If the payment were more than $6,425, then the 90-day rule would make the payment preferential, because the credit card balance was an antecedent debt, or one that existed when the bankruptcy was filed.

Question 30

II. Business Law-Debtor-Creditor Relationships 3. Bankruptcy and Insolvency 44. Prebankruptcy Process The filing of an involuntary bankruptcy petition under the Federal Bankruptcy Code 1. Terminates liens on exempt property. 2. Terminates all security interests in property in the bankruptcy estate. 3. Stops the debtor from incurring new debts. 4. Stops the enforcement of judgment liens against property in the bankruptcy estate.

Answer 30

1. Exempt property is, by definition, beyond the reach of a bankruptcy proceeding. Liens on such property are therefore unaffected. 2. A security interest is essentially a right to repossess collateral if a loan is not repaid. For example, when taking out a mortgage loan from a bank, the house is normally the collateral and may be seized by the lender if mortgage payments are not made. This interest is generally not terminated by the filing of an involuntary bankruptcy petition. 3. Bankruptcy courts do not prohibit a person from buying new things. If a creditor wishes to extend credit to someone who has just declared bankruptcy, then the debtor may certainly run up new debt. 4. Once a bankruptcy petition is filed, the enforcement of any lien against this property is stopped pending a resolution through bankruptcy proceedings. D.

Question 31

II. Business Law-Debtor-Creditor Relationships 3. Bankruptcy and Insolvency 45. Distribution of Debtor’s Estate 1. Time for Filing: Must be filed within 90 days from first meeting of creditors, Taxing and governmental units have 180 days 2. Distribution of Estate

Answer 31

Example West Bank is a perfected secured party on a loan balance of $10,000 with a security interest in $14,000 of the debtor's equipment. The debtor is in default. West Bank has repossessed the equipment and stored it for $500 pending its sale. West Bank also has $1,000 in attorney fees due to debtor's default. If the equipment is sold for $11,000 by either the debtor or trustee, assuming West Bank's security agreement also covers default costs and attorney fees, West Bank would receive the entire $11,000 and would have to file a claim as a general creditor for $500. * Employee Wages—Employee claims for back wages, salaries, or commissions (including vacation, severance, sick leave, and other benefits) but limited to those earned within 180 days of the filing of the petition or cessation of business (whichever is first) to a maximum amount of $12,850/$13,650. * IMPORTANT—Any amount of back wages, etc., owed, regardless of when owed or amount owed above the $12,850/$13,650 during the 180–day period, is still a claim but for priority purposes goes to the last category—general creditors. * Consumer Creditors—Consumers who deposit or prepay for the purchase, lease, or rental of goods or services for personal, family, or household use up to an amount of $2,850/$3,025 per creditor. Any amount above $2,850/$3,025 is treated as a general creditor claim.

Question 32

II. Business Law-Debtor-Creditor Relationships 3. Bankruptcy and Insolvency 45. Distribution of Debtor’s Estate Example

Answer 32

Knox operates an electronics store as a sole proprietor. On April 5, year 1, Knox was involuntarily petitioned into bankruptcy under the liquidation provisions of the Bankruptcy Code. On April 20, a trustee in bankruptcy was appointed and an order for relief was entered. Knox's nonexempt property has been converted to cash, which is available to satisfy the following claims and expenses as may be appropriate: Claims and Expenses Claims by Dart Corp. (one of Knox's suppliers) for computers ordered on April 6, year 1, and delivered on credit to Knox on April 10, year 1$20,000 Fee earned by the bankruptcy trustee$15,000 Claim by Boyd for a deposit given to Knox on April 1, year 1, for a computer Boyd purchased for personal use but that had not yet been received by Boyd$1,500 Claim by Noll Co. for the delivery of stereos to Knox on credit. The stereos were delivered on March 4, year 1, and a financing statement was properly filed on March 5, year 1. These stereos were sold by the trustee with Noll's consent for $7,500 for their fair market value$5,000 Fees earned by the attorneys for the bankruptcy estate$10,000 Claims by unsecured general creditor$1,000 The cash available for distribution includes the proceeds from the sale of the stereos. What amount will be distributed to the trustee as a fee if the cash available for distribution is $15,000? 1. $6,000 2. $9,000 3. $10,000 4. $15,000 Secured creditors go first with the $5,000. Then you have $25,000 TOTAL administrative expenses for lawyers and trustees, and the trustees are $15,000 of that, so you take the $15,000/25,000 × the $10,000 remaining and 3/5 of $10,000, which is $6,000.

Question 33

II. Business Law-Debtor-Creditor Relationships 3. Bankruptcy and Insolvency 45. Distribution of Debtor’s Estate In a voluntary bankruptcy proceeding under Chapter 7 of the Federal Bankruptcy Code, which of the following claims, filed within 90 days of the filing for bankruptcy, will be paid first? 1. Unsecured federal taxes. 2. Utility bills up to $1,000. 3. Voluntary contributions to employee benefit plans. 4. Employee vacation and sick pay up to $2,000 per employee.

Answer 33

4. The bankruptcy establishes an order of priority for claims like these. 1. After **_administrative_** expenses are paid, 2. **_unpaid wages earned_** for 180 days prior to filing of the petition, up to $12,850/$13,650 per employee, are paid; then, 3. **_unpaid contributions to employee benefit plans_**, up to $12,850/$13,650 per employee, are paid; then, 4. **_taxes_** are paid; lastly, **_utility bills_** with the **_general creditors_** are paid.

Question 34

II. Business Law-Debtor-Creditor Relationships 3. Bankruptcy and Insolvency 45. Distribution of Debtor’s Estate Which of the following claims would have the highest priority in the distribution of a bankruptcy estate under the liquidation provisions of Chapter 7 of the Federal Bankruptcy Code if the petition was filed June 1, 20XX? 1. Federal tax lien filed May 15, 20XX. 2. A secured debt properly perfected on February 10, 20XX. 3. Trustee's administration cost filed September 30, 20XX. 4. Employee wages due March 30, 20XX.

Answer 34

2. A secured creditor with a perfected interest will generally have top priority. 1. After secured creditors are paid, 2. unsecured creditors. 3. administrative expenses would come first among the unsecured claims, 4. followed by the wages, and 5. the tax lien would come last.

Question 35

II. Business Law-Debtor-Creditor Relationships 3. Bankruptcy and Insolvency 46. Discharge and Reaffirmation Agreements II. Conditions under which Discharge May Be Denied

Answer 35

1. A partnership or corporation cannot get a discharge decree under Chapter 7 (can under other chapters), only individuals can. 2. A debtor will be denied a discharge if he or she received a discharge within eight years before the filing of the current petition. 3. Consumer Debts (can be rebutted by debtor) 1. Any consumer debt incurred within 90 days of filing of petition (order of relief) of more than $675/$725 to a single creditor for luxury goods or services; 2. Any cash advance more than $950/$1,000 by the debtor using a credit card or other open-ended consumer credit if incurred within 70 days of the filing of the petition (order of relief).

Question 36

II. Business Law-Debtor-Creditor Relationships 3. Bankruptcy and Insolvency 46. Discharge and Reaffirmation Agreements Chapter 7 of the Federal Bankruptcy Code will deny a debtor a discharge when the debtor 1. Makes a preferential transfer to a creditor. 2. Accidentally destroys information relevant to the bankruptcy proceeding. 3. Obtains a Chapter 7 discharge ten years previously. 4. Is a corporation or a partnership.

Answer 36

4. Corporations and partnerships may go through a Chapter 7 liquidation, but do not qualify for a general discharge from all remaining debts as natural persons do.

Question 37

II. Business Law-Debtor-Creditor Relationships 3. Bankruptcy and Insolvency 46. Discharge and Reaffirmation Agreements Which of the following acts by a debtor could result in a bankruptcy court revoking the debtor's discharge? I. Failure to list one creditor. II. Failure to answer correctly material questions on the bankruptcy petition. 1. I only. 2. II only. 3. Both I and II. 4. Neither I nor II.

Answer 37

2. A discharge is usually final. It will be revoked only if later evidence suggests that the debtor acted fraudulently or intentionally misled the bankruptcy court. Failure to list one creditor is probably not a fraudulent action, particularly if there are many creditors. Failing to answer important questions honestly and accurately may well indicate fraud. Give feedback

Question 38

II. Business Law-Debtor-Creditor Relationships 3. Bankruptcy and Insolvency 46. Discharge and Reaffirmation Agreements Under the liquidation provisions of Chapter 7 of the Federal Bankruptcy Code, a debtor will be denied a discharge in bankruptcy if the debtor 1. Fails to list a creditor. 2. Owes alimony and child support payments. 3. Cannot pay administration expenses. 4. Refuses satisfactorily to explain a loss of assets.

Answer 38

4. Generally, a bankrupt debtor, at the end of bankruptcy proceedings, will receive a discharge decree. Unless the debtor has committed an act such as fraud, intentional concealment of assets, refusal to explain the loss of assets, and the like, is a partnership or corporation, or the debtor has received a discharge decree within eight years of the current filing petition, the discharge decree will be granted. Here, the debtor has committed an act, has refused satisfactorily to explain a loss of assets, and as such will be denied a discharge decree in bankruptcy.