Учебный год 2023 / Bhandari_J__Weiss_L_Corporate_Bankruptcy_Economic_and_Legal_Perspectives_1996

Translating assets and liabilities to the bankruptcy forum

cy law and how those rights may be asserted. The relevant inquiry might be conceived this way: Who would be entitled to what if the debtor were to go out of business on the date of the bankruptcy petition? In this inquiry, nonbankruptcy law identifies not only the debtor's assets but also the claimants to them and the extent and contours of their rights.

A. Identification of nonbankruptcy rights in the bankruptcy forum

Consider, first, what types of rights might be considered to be claims cognizable in bankruptcy - the question addressed, in the statute, by section 101(5). The principle behind looking to nonbankruptcy law to determine, in the first instance, who claimants are should be obvious. Bankruptcy law would be an odd place to generate new federal causes of action because each time it is done, strategic incentives are created to use the bankruptcy process for individual gain, even if it comes at the expense of the collective weal. Accordingly, nonbankruptcy law should identify whether a particular claimant has a right to reach the debtor's assets.

In all contexts, the basic program is the same. The central difficulty lies in identifying the structure of the nonbankruptcy claims to be vindicated in the bankruptcy setting, where the focus is always on the substance of the claims and not the labels attached to them under state law. What follows is an examination of some of the more difficult substantive entitlements whose treatment in bankruptcy has generated serious litigation.

B. Nominal valuation of rights in the bankruptcy forum

Assuming that nonbankruptcy law defines the asserted right as a cause of action, how does one place a nominal value on the resultant claim? Sometimes this inquiry is tied to possible nonbankruptcy procedural defenses that reduce to zero the value of a claim recognized in the abstract as a cause of action. Such would be the position of a cause of action barred by an ordinary statute of limitations prior to the date of the filing of the bankruptcy petition. Applying that statutory bar in bankruptcy properly mirrors the zero value of the claim outside bankruptcy.

A slightly more difficult issue is raised by an assertion that a cause of action, although it could conceivably be brought later, cannot be brought on commencement of the bankruptcy proceeding. These causes of action might be allowed in the future, and thus have some existing value under nonbankruptcy law at the time of bankruptcy. The truth of this proposition will be reflected in practice: if they have adequate information, people will pay less to become shareholders of a debtor if they are subject to these unmatured claims.

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Because of their existing value, these "unmatured" causes of action should be recognized in bankruptcy as "claims." The difficult question is how to give them a nominal value within bankruptcy.

1. Acceleration of loan obligations

Consider, first, an asserted claim based on a thirty-year loan of $10,000, made in 1967 at 4 percent interest. This is clearly a "claim," because nonbankruptcy law states that the debtor has the obligation to repay it. The claim "arose" before the filing of the bankruptcy petition, because if the debtor were to cease doing business today, he would be obligated to repay the loan, or to make provisions for its future repayment. The legislative history to section 502 takes this view and states that the nominal value of the claim in bankruptcy is its face amount of $10,000.

Even though the present value of the loan, apart from its acceleration feature, is substantially less than $10,000, accelerating payment of the $10,000 principal is almost surely the correct way of mirroring in bankruptcy the nonbankruptcy nominal value of that claim. The filing of a bankruptcy petition is evidence of the kind of event that would trigger such default and acceleration. Bankruptcy's automatic acceleration rule, therefore, may be thought of as an "off the rack" term that duplicates the near certain contractual outcome in the absence of that rule. Accordingly, the acceleration of a claim in bankruptcy appears accurately to mirror its nonbankruptcy value.

Any attempt to preserve nonbankruptcy attributes in bankruptcy is not without difficulty, particularly when bankruptcy law operates under a fixed rule. With a long-term loan at a below-market interest rate, for example, bankruptcy's provision for automatic acceleration may encourage a lender to force a bankruptcy even when it would be wasteful for the creditors as a group. But this off-focus incentive structure is common both in and out of bankruptcy. Any lender with a below-market loan outstanding has an incentive to precipitate a default in order to accelerate the principal, collect it, and lend the money again.

To minimize the use of bankruptcy for such selfish goals, however, does not require one to do away with things such as automatic acceleration rules in bankruptcy. An alternative solution is to try - as the Bankruptcy Code does1 - to create other devices to limit bankruptcy's use to cases where it is needed.

2. Unmanifested tort injuries

The orientation developed here has direct application to the bankruptcy petitions of such asbestos manufacturers as UNR and Manville, whose legal position has been the source of much academic and public interest. At the core of the debate is the status of the "future" asbestos victims, who under the ap-

1 See not only the statutory limits on involuntary petitions in section 303 but also the more open-ended judicial inquiry promoted by section 305.

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proach taken here are best understood as "creditors" holding existing "claims" because their future causes of action under state law have a present value today under the applicable nonbankruptcy law. These tort claims, moreover, "arose" before the filing of the bankruptcy petition because they are based on the past, completed actions of the debtor.

The mistake that has been made in some of the decided cases, holding that such future asbestos victims cannot participate in the bankruptcy proceeding of the debtor, is to assume that because the Bankruptcy Code uses words such as "claim" or "arose" in describing who participates in the collective proceeding, one must resort to nonbankruptcy law to define those words.2 This view, however, confuses attributes (where nonbankruptcy rules play a crucial role) with labels (where nonbankruptcy rules should play no role). To be sure, courts must resort to nonbankruptcy law to determine who is entitled to participate in the distribution of assets, but nothing in this process suggests that one also must look at what state law calls some asserted claim.

[Subsection 3, dealing with limitations on damage claims by landlords, deleted. Ed.]

4. The process of liquidating liabilities

Another important aspect of the translation problem arises concerning the question of valuation, where the values of claims are not already fixed in the nonbankruptcy forum. Setting the value of these unliquidated claims may be both costly and time consuming.

Does the principle that bankruptcy law derives valuations from nonbankruptcy law require adherence to these nonbankruptcy procedures? Consider the case of a debtor that is liquidating in bankruptcy. It would, of course, be possible to follow nonbankruptcy procedures by deferring disposition of the debtor's assets to any group that would share at or below the level of priority accorded the entity with the unliquidated claim. The claim could then be liquidated in ordinary ways. Such a procedure would be workable, although cumbersome.

This process could even be formalized, to make it easier for liquidated claimants to cash out at any time. All liquidated claimants could, for example, be given "shares" against the pool of assets. These shares, together with those issued to other claimants as their claims became liquidated, would be cashed out after all unliquidated claims had been determined. How much each claimant would ultimately get would depend (1) on the nominal size of his

2 Ibid; see also In reAmatex Corp., 30 Bankr. 309 (Bankr. E.D. Pa.), aff d 37 Bankr. 613 (E.D. Pa. 1983), rev'd 755 F.2d 1034 (1985), Eds.; In re Gladding Corp., 20 Bankr. 566 (Bankr. D. Mass. 1982); but see In re Johns-Manville Corp., 36 Bankr. 743 (Bankr. S.D.N.Y. 1984) (unascertained asbestos victims have claims cognizable in bankruptcy), aff d 700 F.2d 581 (1986).

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claim versus the other claims in the pool, and (2) on the relative priority of those shares vis-a-vis the shares held by other claimants. If any claimant wished to cash out before that ultimate distribution, he could sell his shares in a secondary market.

This solution, however, may give undue deference to nonbankruptcy valuation procedures. These procedures, even if they make sense when claims will be paid in full, may make little sense when the resulting claim will receive only ten cents on the dollar. The relatively fixed costs (such as attorney's fees) associated with nonbankruptcy claim liquidation procedures may loom unduly large when translated into the bankruptcy forum. It may be in the interests of all claimants to expedite the liquidation procedure, thereby scaling down its costs. For that reason, a bankruptcy system might legitimately adopt its own procedures for estimating the expected value of a claim if successful and the probability of its success.3

C. Relative valuation of rights in the bankruptcy forum

Setting nominal values on bankruptcy claims is only the first step in reflecting nonbankruptcy rights in the bankruptcy process. The relative ranking of entitlements - that is, the ordering of claims - is also an integral part of their bankruptcy valuation. A secured creditor with a nominal claim of $10,000 may actually receive $10,000, whereas an unsecured creditor with a nominal claim of $10,000 may actually receive only $1,000. As their nominal claims are the same, the higher priority rights of the secured creditor account for the different amount that each receives in the bankruptcy process.

The concept of relative value is not exhausted by considering creditors alone. Shareholders of a corporation, for example, have a right under nonbankruptcy law to assets of that corporation; the unique nonbankruptcy attribute of that right, however, is its residual nature. That nonbankruptcy attribute is reflected in valuing the shareholders' "claim" against those of competing claimants in the bankruptcy setting. Shareholders get paid if, but only if, the claims of all others have been paid in full first.

More generally, whether the issue is one of ordering secured creditors vis- a-vis unsecured creditors [or] unsecured creditors vis-a-vis shareholders, bankruptcy law has little to say about the relative ordering of claims. That issue is a quintessential nonbankruptcy one of attributes.

1. Contractual specific performance

Nonbankruptcy law sometimes provides a particular claimant with a prior right to some or all of the assets of the debtor. These claimants may be hold-

3 See section 502(c).

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ers of consensual security interests, execution liens, statutory liens, or any one of a number of other interests that have the effect of permitting the holder to assert a prior claim to some or all of the debtor's assets. Because nonbankruptcy law raising this issue comes in myriad forms, however, determining how to characterize the priority of a particular claim in bankruptcy may require sensitive understanding of the nature of the nonbankruptcy right and how it should be recognized in bankruptcy.

How, for example, should a contract that gives the nonbankrupt party a right of specific performance be treated in bankruptcy? Suppose, for example, that a debtor has contracted to sell his Chagall painting to creditor A for $10,000, and his computer to creditor B for $10,000. Under applicable state law, creditor A has a right of specific performance in conjunction with his contract, while creditor B's rights on breach are limited, as with ordinary contract creditors, to monetary damages only. Creditor A and creditor B have both paid the entire sums called for in the contract, and the debtor then files for bankruptcy. Creditor B's claim is that of an unsecured creditor, either in restitution (for his $10,000 back) or in expectancy, for breach of contract (which, for purposes of simplicity, will be presumed to be zero, apart from the claim to recover the $10,000). If, in the debtor's bankruptcy, the unsecured creditors are getting paid ten cents on the dollar, creditor B will receive $1,000.

How should creditor As claim be treated, given his state-law right of specific performance? In recent contract scholarship, the right of specific performance has been illuminatingly analyzed as a property right. If one were to attempt to apply that analysis to bankruptcy, it might seem at first glance that creditor A should receive the painting, effectively satisfying creditor As claim at 100 cents on the dollar. To award specific performance is, however, to respect creditor A's right in full, when it is unlikely that a decision to award specific performance is intended, as a matter of nonbankruptcy law, to alter the relative ordering of claims between creditor A and creditor B dramatically.

The right of specific performance for certain contracts is most often justified on the ground that it secures the party enjoying that right against the undercompensation that would otherwise result from treating the claim as one that could be satisfied by monetary damages. That rationale, however, essentially describes a two-party relationship between the contracting parties. It, therefore, does not mandate giving creditor A $10,000 (in cash or in kind) while leaving creditor B only $1,000. In fact, a further examination of state law is likely to reveal that, considered vis-a-vis the claims of other creditors, the value of the right of specific performance, on the eve of bankruptcy, was nothing close to 100 cents on the dollar. The relevant question for fixing relative values is how state law would treat creditor A versus an execution creditor on the Chagall at the time of the bankruptcy proceeding. It is not how state law would treat creditor A against the debtor. [T]he nonbankruptcy solution is

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almost surely to favor the execution creditor because of the ostensible ownership the buyer created by leaving the Chagall in the debtor's hands following the sale. So, for that reason, allowing specific performance to justify payment in full to creditor A in bankruptcy erroneously promotes a property right - specific performance - into a priority right.

2. Prebankruptcy wage claims

The necessity of first examining the relative nonbankruptcy values of particular rights is further demonstrated by Donovan v. TMC Industries.,4 As TMC Industries slid towards bankruptcy, it ceased paying its workers. Once in bankruptcy, the claims of these workers for those unpaid prepetition wages are prebankruptcy claims. But the rights of workers under nonbankruptcy law may mean that the relative value of their claims is superior to that of ordinary unsecured creditors.

In TMC Industries itself, for example, the workers got the Secretary of Labor to bring a "hot goods" action under the Fair Labor Standards Act (FLSA).6 In that action, the Secretary of Labor sought to enjoin the shipment in interstate commerce of the goods manufactured by TMC Industries during the time when the workers had not been paid, on the ground that the goods were produced in violation of the federal minimum wage requirements. The district court issued the injunction. Although it recognized that the effect of issuing the injunction might be to require the workers to be paid at least the amount of their prebankruptcy claims up to the minimum wage levels, the district court never came to grips with the issue in the case. The court analyzed the question as one of the importance of the policy in the FLSA. For purposes of bankruptcy, however, the question is not one of federal policy or its importance, but the effect of that policy on the relative value of the claims, outside of bankruptcy, being asserted by the workers in bankruptcy.

To answer the key inquiry, one needs to examine the nonbankruptcy consequences of the FLSA on the relative value of the claims and then translate that answer into the bankruptcy forum. At one extreme, the effect of the policy would be to give the workers the equivalent of a lien on the goods that had been manufactured in violation of the statute. Under that construction, the workers' claims are tantamount to those of secured creditors in bankruptcy. It does not necessarily follow, however, that the right itself must be respected in full; nonetheless the value of the right should be preserved. For that reason, although an injunction against the sale of the "hot goods" might not be proper per se, the benefits to the workers should have been much the same, because in protecting the value of their right, the focus of dispute should be whether

420 Bankr. 997 (N.D. Ga. 1982).

5See sections 501, 502.

629 U.S.C. sections 201-19.

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the claims were "adequately protected" within the meaning of section 361. Because of that requirement, the goods could not be sold unless the value of the workers' rights to hold up their sale was recognized in full.

The effect of the FLSAmight, of course, be somewhat less like an ordinary lien, in that it might be construed to prohibit the sale of the goods by the debtor only as long as it remained a going concern, without giving the workers priority either over subsequent secured creditors or over a liquidator's right to sell the goods in winding up the business. The conceptual issues, however, remain exactly the same. What would make it harder to mesh nonbankruptcy policy with what occurs in bankruptcy itself in such a case would derive from the need to translate distinctions made by the FLSA into the bankruptcy forum. Since the nonbankruptcy relative value (under the assumptions described above) would be greater in the case of continuation than in liquidation, one could not simply import the nonbankruptcy relative valuation into bankruptcy. One would first need to decide which nonbankruptcy relative valuation to import. But while the translation problem would make the issue harder to resolve, nothing emanating from bankruptcy policy would help to resolve it.

[Section 3, dealing with successor liability, deleted. Ed.]

III. The Assets Available for Distribution

Both the assets and the liabilities of the debtor must be fixed in order to determine the estate of a debtor available for distribution to particular claimants. The liabilities of the estate reduce what is available to the remaining residual claimants, while the assets increase it. In deciding what counts as an asset, the simple question is: Is the estate more valuable with the thing under consideration than without it? At first blush it looks as though the questions of assets and liabilities are at opposite poles of the bankruptcy process. Nonetheless there is a close, indeed symbiotic, relationship between the two issues. One must focus on who benefits from having something declared an asset.

From the perspective of the class of residual claimants, it is only possible to determine what is an asset in the estate after the property interests of the various claimants are first set out. This point is obviously true when one contemplates the rights of a bailor to have goods returned to him: His property interest is respected in full and the residual claimants get nothing. But it is equally true where the estate can claim for the benefit of unsecured creditors only the equity interest in land or chattels that are subject to either statutory liens or security interests. The point, moreover, also applies to myriad other types of rights. A given party may, for example, have the right to refuse to transfer a certain chattel to a debtor or to decline to renew an existing lease unless and until certain debts are paid. Yet no matter how the rights are described as a matter of

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state law, the substantive consequences are the same: The holder of the right gets to satisfy his claim first; other claimants get only what is left over.

The current tests under bankruptcy law for determining the property of the estate, then, have been needlessly complicated by failure to observe the close linkages between assets and liabilities outside the bankruptcy law that should be preserved within its domain. The proper approach, therefore, is to examine any concrete situation from the vantage point of a creditor attempting to execute on a particular asset or to assert a security interest in it. If such a claimant cannot execute against that property as a matter of state law, then that property has no value to the unsecured creditors and should not be considered to be property of the estate. And if the claimant's execution would take a back seat to some other entity's rights, then only that residual value is an asset for the unsecured creditors.

A. Limited ownership: Assets the debtor may keep or sell only on condition

The above analysis can be extended further. Thus, many assets are of value to a debtor and his general creditors, but only net of some payment to someone else. This was the situation, for example, in the classic Supreme Court case, Chicago Board of Trade v. Johnson? where membership on the Board of Trade could, by its rules, be sold only after all debts to other members of the Board of Trade were paid in full. The Supreme Court correctly identified the inquiry as one of attributes under state law (and not the state-law label, which was that this was not "property"), and that so examined the membership had value to the general unsecured creditors of the debtor only after the debts to the members of the Board of Trade were paid in full. The Court, by respecting the value of the rights of the members, was determining both the ordering of claims and the value of the asset to the residual claimants.

While Chicago Board of Trade is relatively uncontroversial, similar issues arise in numerous other places as well. The continuation or transfer of a number of state privileges or licenses of value are conditioned on making certain payments on specified debts. Cases involving such statutes seem to be decided on an almost ad hoc basis, when more principled solutions are available. Consider the case of a liquor license granted by a state, subject to a requirement that it can be canceled if all state taxes are not kept current. Under the principles of Chicago Board of Trade, the value of the liquor license to the debtor and his unsecured creditors is net of the tax debts to the state. The state, in effect, has the functional equivalent of a security interest or statutory lien in the liquor license.

7 264 U.S. 1 (1924).

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If the case comes up as a question of "property of the estate," courts, although they may fumble over the reason, seem to recognize the attributes conferred on the liquor license under state law.8 But the consequence of recognizing the state attributes is to permit the state to realize on that value in bankruptcy in priority to general claimants. While a state's attempt to cancel the liquor license in a bankruptcy proceeding for nonpayment of debts might appropriately be stayed by the automatic stay of section 362, as are other actions by holders of property rights to remove assets from the estate, the relative value of that right should be protected.

If the state's debts, for some reason, have not been paid in full by the termination of the bankruptcy proceeding, then the relevant state attributes of the state's rights in the liquor license dictate that these rights "pass through" the bankruptcy proceeding, much as a lien passes through bankruptcy if its holder has not been discharged in full. Neither the discharge provisions of section 524 nor the "antidiscrimination" provisions of section 525 should obscure the consequences of recognizing the attributes of the state's interest outside of bankruptcy. Whatever fresh-start policies might dictate a different result in the case of individual debtors, in other cases bankruptcy policy contains no principle that does or should limit the value of those nonbankruptcy rights. These rights are tantamount to having a property (and priority) right in the asset and should be treated like other recognized property rights in bankruptcy.

B. The right to draw under a letter of credit

Determining what is property of the estate requires still greater scrutiny where the underlying fabric of nonbankruptcy rights becomes more complex. One set of cases that illustrates the problem concerns the right to draw on funds under a letter of credit. Thus, in the case of In re Swift Aire Lines, Inc.,10 the question was whether the trustee in bankruptcy could draw on a letter of credit that had named the debtor as the beneficiary. The court said no, seeing an irreconcilable conflict between the trustee's ability to do so and letter-of-credit policy.11 The nature of the conflict, as the court saw it, grew out of the fact that a liquidating debtor under chapter 7 of the Bankruptcy Code was a "new entity" from the prebankruptcy debtor, who could not enforce the letter of credit given that the applicable law on letters of credit prohibited any assignment of the right to draw.

Considering the debtor in bankruptcy as a new entity, however, is a label, when the critical issue in bankruptcy is one of underlying attributes. Letters of

1 See In re Anchorage International Inn, Inc., 718 F.2d 1446 (9th Cir. 1983).

9} This issue depends on whethehr section 362(b)(4) applies. See In re Arnage, Inc., 33 Bankr. 662 (BankrI. E.D. Mich. 1983).

1°30BBankr. 490 (9th Cir. Bankr. App. 1983). ' Ibid.

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credit may be drawn on by presenting documents that comply exactly with those required by the letter of credit.12 In Swift Aire, the letter of credit called for a statement signed by the corporate secretary of Swift Aire. Presumably that requirement would be satisfied by the signature of whomever happened to be the corporate secretary of Swift Aire at the time of the draw. The letter of credit, for example, presumably could have been drawn on by the corporate secretary in a state-law dissolution of Swift Aire. The question then becomes one of how best to mirror those attributes by meshing what occurs in bankruptcy with the relevant nonbankruptcy attributes. Here, the trustee in bankruptcy looks like a surrogate for the officers of Swift Aire. The best way to allow bankruptcy law to mirror state law, accordingly, would be to allow the bankruptcy trustee to draw on the letter of credit. The court's perceived conflict between bankruptcy and nonbankruptcy law was of its own making.

C. Executory contracts in bankruptcy

Swift Aire takes us logically to the subject of executory contracts in bankruptcy. Much of the difficulty caused by executory contracts arises out of the failure to perceive the relationship between assets and liabilities in bankruptcy. Fundamentally, executory contracts are "mixed" assets and liabilities arising out of the same transaction. If the nonbankrupt party has fully performed, then the contract is not executory because the issue is only one of a liability of the debtor - a claim. Bankruptcy treats such contracts as automatically rejected in the sense that the claimant must share according to nonbankruptcy priorities. These claims are, at that time, analytically no different from claims arising out of simple loan transactions where the debtor has not repaid borrowed money. If, on the other hand, the debtor has performed fully, then the contract is not executory for precisely the opposite reason. Since the debtor only has to await a return performance by the other party, the contract is an asset of the estate that, like all assets, is automatically assumed.13

Contracts, however, that remain to be performed to a substantial extent by both parties bear attributes both of assets and of liabilities. The debtor's unperformed obligations are liabilities from the perspective of the debtor's other claimants, while the nonbankrupt party's unperformed obligations are an asset from their perspective. The question how to treat these mixed contracts in bankruptcy would have been aided if bankruptcy law just traced out the consequences of recognizing any such contract as both an asset and a liability. This analysis would really not be different from that raised by cases such as

Chicago Board of Trade or TMC Industries, where an asset was coupled to a particular liability. In those cases, one determines relative values concurrently

12U.C.C. section 5-114 (1978).

13Section 541.

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