ESSAY QUESTIONS
B1. Real Estate Sales Corporation (RESC) orders office equipment from Standard Goods, Inc., which has an unperfected security interest in the equipment until it is paid for. Meanwhile, RESC takes out a loan from Trend Credit, Inc., subject to a security interest in RESC’s building and equip¬ment, which Trend perfects. RESC files a petition in bankruptcy for relief in a liquidation proceeding. If the petition is granted, in what or¬der will RESC’s creditors be paid?
ANSWER: The order of the priority of the creditors in this problem is (1) Trend, which has a perfected security interest in RESC’s building and equipment, and (2) Standard, which has only an unper¬fected security in¬terest in RESC’s office equipment. This is because, un¬der the priority es¬tablished by the Bankruptcy Code, and between the creditors listed in this question, those with perfected security interests have the highest priority. In almost cases, including this one, the claims of unsecured credi¬tors are paid last, if at all.
PAGES: 544–545 TYPE: =
NAT: AACSB Reflective AICPA Decision Modeling
B2. First State Bank is a secured party on a $5,000 loan to Geoff, who owns Happy Hours, a nightclub. When Geoff experiences financial difficulty, creditors other than First State Bank petition him into involuntary bankruptcy. The value of the secured collateral has substantially decreased in value. On its sale, the debt to First State Bank is reduced to $2,500. Geoff’s estate consists of $100,000 in exempt assets and $2,000 in nonexempt assets. After the bankruptcy costs and back wages to Geoff’s employees are paid, nothing is left for unsecured creditors. Geoff receives a discharge in bankruptcy. Later he decides to go back into business. By selling a few exempt assets and getting a small loan, he is able to buy the Idle Inn, a small, but profitable, restaurant. Geoff goes to First State Bank for the loan. The bank claims that the balance of its secured debt was not discharged in Geoff’s bankruptcy. He signs an agreement to pay First State Bank the $2,500, and the bank makes a new unsecured loan to him. Is First State Bank correct that the balance of its secured debt was not discharged in bankruptcy? What is the legal effect of Geoff’s agreement to pay the bank $2,500 after the discharge in bankruptcy?
ANSWER: A secured creditor is entitled to priority to the proceeds from the dis¬posal of the secured collateral of the bankrupt debtor up to the amount of the debt owed. Should the proceeds not cover the secured debt, the secured party be¬comes an unsecured creditor for the balance. Unless the debtor is denied a dis¬charge in bankruptcy, all debts of the debtor are rendered void upon the grant¬ing of the discharge. In this case, First State Bank is incor¬rect. First State Bank became an unsecured creditor to the balance of $2,500 owed. Geoff’s discharge in bankruptcy discharged his obligation to pay the debt.
The Bankruptcy Code restricts the legality of reaffirma¬tions—agreements to pay debts discharged in bankruptcy. For these agree-ments to be binding, they must be executed before the discharge in bankruptcy is granted. All reaf¬firmation agreements must be filed with the court. Unless the debtor (Geoff) is repre¬sented by an attorney, court approval is required. The court will only approve the reaf¬firmation if the agreement will not cause her a hardship and is in the best interests of Geoff. If Geoff is represented by an attor¬ney, the attorney must file a declaration or affidavit stat¬ing that Geoff was fully informed of the consequences, the agreement was voluntarily made, and the agreement does not impose a hardship on Geoff or her de¬pendents. Geoff has a right to rescind this agreement. Because the reaffirma¬tion agreement in this case was made after Geoff’s discharge in bankruptcy, she is not le¬gally obligated to pay the $2,500 debt previously discharged in bankruptcy.
ESSAY QUESTIONS
A1. Current City (CC) is a retail seller of television sets. CC sells Dhani a $5,000 large-screen, high-definition, plasma set on a retail installment security agreement in which he pays $100 down and agrees to pay the balance in equal installments. CC retains a security interest in the set, and perfects that interest by filing a financing statement centrally. Two months later, Dhani is in default on the payments to CC and is involun-tarily petitioned into bankruptcy by other creditors. Discuss CC’s right to repossess the TV set and whether CC has priority over the trustee in bankruptcy to any proceeds from the disposal of the set.
ANSWER: CC will not be able to repossess the set. The filing of the in¬voluntary petition in bank¬ruptcy operates as an automatic stay of any creditor’s action against the debtor or the property of the debtor. If CC knowingly violates the automatic stay, CC could be liable to any injured party for actual damages suffered, all costs, reasonable attorneys’ fees, and even possibly punitive damages. Therefore, CC’s right of reposses¬sion is cut off by the bankruptcy proceeding. Because Dhani is a con¬sumer debtor, within thirty days of the filing of the peti-tion or before the first creditor’s meeting (whichever is first) Dhani must file with the clerk his intent as to the disposition of the TV set—is, whether he in¬tends to retain the set, surrender the set to CC, claim the set as exempt, or reaffirm the debt. The trustee must carry out this intent within forty five days of this filing. As a secured party, however, CC may at¬tempt to get relief from the stay by claim¬ing it needs adequate protection to preserve its security interest in the set. If, for exam¬ple, the set is still in Dhani’s possession and is being used by him, the bankruptcy court could require Dhani or the trustee to make periodic cash payments or even a single, one time payment to protect against depreciation of the value of the set. If adequate pro¬tection cannot be pro¬vided, the court may vacate the stay and allow CC to repossess the set by pur¬su¬ing its rights under Article 9 of the UCC. CC does have a right of priority over the trustee. A trustee occupies the same position as a lien creditor, but a lien credi¬tor’s priority is secondary to a previously perfected secured party. CC is a perfected se-cured party, and on sale of the television set it is entitled to the proceeds up to the amount of balance of the debt and any costs incurred because of Dhani’s default.
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NAT: AACSB Reflective AICPA Decision Modeling
A2. Job Service, Inc., needs funds to meet its payroll, to make other cur¬rent operating expenses, and to pay its creditors. Kelly, Job Service’s only shareholder, loans the company $10,000 and accepts a promissory note signed on behalf of Job Service by Luna, the firm’s accountant. Job Service’s fi¬nancial problems continue, however, and the firm’s creditors file an in¬voluntary petition to force it into bankruptcy. Is Kelly entitled to repay¬ment of the loan to Job Service? If so, what is the priority of the claim?
ANSWER: Kelly is entitled to be repaid the amount loaned to Job Service. The priority is that of any other general creditor, however, which is at the bottom of the list of the classes of unsecured creditors. Because Luna signed the promissory note, Kelly can prove the claim. The claim is not superior or inferior to other claims because Kelly is the debtor’s only shareholder, nor is it worthless for that same reason. Kelly is a not a se¬cured creditor because she did not ask for, and did not get, collateral to se¬cure the loan. Thus, she is a general unsecured creditor who can share, on a proportionate basis, whatever proceeds are available to other mem¬bers of the class of general unsecured creditors after those with higher prior¬ity are paid in full.
