Question and Answer for Assignment 2 (Bankruptcy)

1. You said in class that it was OK for a creditor to refuse to sell goods to a debtor in bankruptcy, and that this wouldn't violate the automatic stay. Reading the language of the statute, I'm not sure why this wouldn't be a violation. For example, suppose the Creditor says to the bankrupt Debtor, "I won't sell you any more goods, even if you're willing to pay cash, unless you pay off what you already owe me." Wouldn't that be an act attempting to collect on a prepetition debt in violation of section 362(a)(6)?

If Creditor was that explicit, then a court could hold this was a stay violation. A case with similar facts was In re Sportfame of Ohio, Inc., 40 B.R. 47 (Bankr. N.D. Ohio 1987), where the court held the Creditor in contempt. The court noted that the Creditor could have just refused to sell goods to the Debtor, without explanation, and that would have been OK. But by indicating its willingness to sell to the Debtor if the Debtor repaid the pre-petition debt, the Creditor violated the stay (according to the court).

This is, admittedly, an exceedingly fine line. But the point raised in class is still correct — the stay doesn't force a creditor to continue to provide goods or services to the debtor where the agreement between the debtor and creditor doesn't obligate the creditor to do so. What the stay prohibits is acts to enforce a pre-petition debt. Obviously, in some egregious cases, we may have to depend upon the finder of fact to sort out when a particular refusal to sell is in fact an attempt to collect and thus crosses the line.

2. Can an unsecured creditor obtain relief from the automatic stay?

Keep in mind that an unsecured creditor does not have a security interest in any item of the debtor's property. Thus, the only thing that an unsecured creditor could have done, even outside of bankruptcy, would have been to file a lawsuit to reduce its claim to judgment (or perhaps to have the sheriff levy on the debtor's property if the creditor had already obtained a judgment).

Theoretically, I suppose, an unsecured creditor could move for relief from the automatic stay to permit the unsecured creditor to take these steps (filing a lawsuit or levying upon the debtor's property). The unsecured creditor would have to show "cause" to obtain relief from stay under section 362(d)(1). [Lack of adequate protection would be irrelevant, since the creditor doesn't have a security interest, and section 362(d)(2) would be irrelevant for the same reason.] But I don't ever recall seeing a case where a court did this.

I suppose that the creditor might try to argue that the debtor had filed for bankruptcy in bad faith, and that this justified a finding of "cause" to lift the stay. However, it is more likely in such a scenario that the creditor would instead file a motion to dismiss the bankruptcy case altogether. Obviously, if the case is dismissed, the stay would be dissolved, and so a motion to dismiss the bankruptcy would (if granted) have the same basic effect as a motion to lift the stay.

3. Suppose that Debtor files for bankruptcy, and Bank has a security interest in the Debtor's car. The car is worth $10,000, and the debt is $7,000. Bank moves for relief from stay based on lack of adequate protection, but the court rules that the Bank is adequately protected by the $3,000 equity cushion. Is that ruling final for the rest of the bankruptcy case? Or can the Bank renew its motion later if the car starts to deteriorate faster than originally expected?

If a motion for relief from stay is denied, a secured party can always renew that motion (or file a new motion) later in the case, if circumstances change. The scenario you pose would be one example. Another would be if the court denied the motion as in your hypo, but then six months later, the debtor let insurance on the car lapse. Those changed circumstances would justify granting the secured party's motion, if the secured party renewed the motion or refiled it based upon the lapsed insurance.

4. Suppose Debtor files for bankruptcy, and Bank has a security interest in the Debtor's printing press. After the Debtor has been in bankruptcy for three months, when operation of the printing press has caused it to depreciate in value by $10,000, Bank moves for relief from stay based on lack of adequate protection, and the Bank asks the court to lift the stay unless the Debtor pays Bank $10,000 for the depreciation that occurred over the past three months. Does Debtor have to pay the Bank that $10,000? Or would Debtor only have to pay for depreciation that occurs in the future, AFTER the Bank filed its motion to lift the stay?

The latter. Under section 362(d)(1), the Bank is entitled to receive "adequate protection" of its interest in its collateral, but only if the Bank asks for it. Otherwise, under section 363, the Debtor is entitled to use the collateral, unless the court conditions the Debtor's use as necessary to provide the Bank with adequate protection. Most courts have interpreted this to mean that the Debtor only has to provide adequate protection once the Bank asks for it, and not before.

I don't have much sympathy for the Bank in this hypo. It could have filed a motion to lift the stay as soon as the Debtor filed for bankruptcy, and could have asked the court to condition the Debtor's use of the collateral during bankruptcy upon the Debtor's making adequate protection payments to protect the Bank against depreciation of the collateral during bankruptcy. If the Bank didn't do that, why should the court step in and protect the Bank?

5. Suppose that Creditor A has a security interest in D's equipment. The equipmemt is worth $50,000, and D owes A $40,000, so A is oversecured by $10,000. Now suppose that D goes out and borrows an additional $20,000 from B, and grants B a lien against the same equipment. I understand that this means that B is undersecured.

At this point, if D files for bankruptcy, how does B's lien affect A's lien in terms of the equity cushion? For example, may A still get pendency interest on its claim, due to the fact that it is oversecured? Or does B's security interest "eat up" the equity cushion and preclude A from getting pendency interest? And if A does get pendency interest, does that mean that with each passing day, B's claim gets smaller and smaller?

The correct answer is that A is still entitled to pendency interest because A’s claim is oversecured. D no longer has an equity in the collateral, because the equipment is worth only $50,000 and the two security interests secure debts totaling $60,000. But A is still oversecured, and thus under § 506(b), A is still entitled to pendency interest on its secured claim.

As mentioned in class, during D's bankruptcy, D will either have to pay pendency interest to A, or the amount of A's secured claim will continue to grow, as interest accrues. [Note: On these facts, interest can only accrue up to the point that A's total secured claim becomes $50,000. At that point, A will no longer be oversecured, and from that point on, A will no longer be entitled to pendency interest.]

This does not mean that B’s claim will get smaller. The amount that debtor owes B is still the same ($20,000). But the amount of B's claim that is secured (and the amount that is unsecured) will change. As interest accrues on A's secured claim, the secured portion of B’s claim would get smaller (as the "equity cushion" on A's claim is consumed by the accrual of interest), and the unsecured portion of B's claim would get correspondingly larger.