C H A P T E R 2 3
Debtor-Creditor Relations and Bankruptcy
TRUE-FALSE QUESTIONS
1. The UCC requires that a precise form be followed in order to create a security interest.
2. Commercial paper is a term that describes short-term corporate indebtedness.
3. A revolving loan is based upon the continuous extension of credit of an unlimited amount.
4. A commitment fee is an amount a lender requires as consideration for its promise to keep a
commitment to loan available.
5. Agreements for term or revolving loans may call for mandatory prepayment when certain events
occur.
6. In order to reflect the greater risk to the lender, secured loans are priced at a higher rate than
unsecured loans.
7. If a borrower fails to repay a secured loan, the lender may foreclose on the collateral.
8. Under a guaranty of collection, the guarantor becomes obliged to pay only after the lender has
attempted unsuccessfully to collect the amount due from the primary debtor.
9. National banks acting as lenders are subject to state usury laws.
10. After-acquired property is property that the debtor acquires after the repayment of a loan under a
security agreement.
11. The UCC provides that, unless otherwise agreed, a security agreement gives the secured party a
security interest in the proceeds if collateral is sold, exchanged, collected, or otherwise disposed of.
12. A debtor does not have to show it is insolvent to file for bankruptcy.
13. A creditor’s claim in bankruptcy may be involuntarily postponed through application of the doctrine
of equitable subordination.
14. Chapter 13 does not provide a bankruptcy discharge for corporations.
15. A repayment plan under a Chapter 11 bankruptcy must either be accepted unanimously or pass the
“best interests of creditors” test.
16. Payments in the ordinary course of business made within 90 days prior to a Chapter 11 bankruptcy
filing are voidable as a preference.
17. The debtor–in-possession must honor all prebankruptcy executory contracts.
18. A purchase-money security interest in consumer goods is automatically perfected.
19. While state restrictions may apply, there are no federal restrictions on lenders and borrowers
entering into transactions whereby secured credit will be sued to acquire stock.
20. A number of states have enacted legislation providing that loan commitments must be in writing to
be enforceable.
MULTIPLE-CHOICE QUESTIONS
1. Congress is given the power to enact bankruptcy laws by
A. a delegation of authority by the President.
B. the U. S. Constitution.
C. rulings of the Supreme Court.
D. inherent powers under federalism.
2. A ________ interest rate fluctuates throughout the life of the loan according to the interest rate that
the lender would pay if it borrowed the funds in order to relend them.
A. fixed
366 MANAGERS AND THE LEGAL ENVIRONMENT
B. principal
C. base
D. floating
3. Requirements that must be met under the loan agreement before the lender’s obligations arise are
known as ________.
A. conditions precedent
B. conditions concurrent
C. conditions subsequent
D. loan qualifiers
4. In a(n)________ loan, more than one lender enters into concurrent direct obligations with the
borrower to make the loan.
A. participation
B. term sheet
C. syndicated
D. illegal
5. ________ a security interest involves making it valid as against other creditors of the debtor.
A. Finalizing
B. Perfecting
C. Organizing
D. Signing
6. An equipment lease that serves the purpose of financing is known as a(n) ________ lease.
A. finance
B. temporary
C. lending
D. debtor’s
7. A provision in a loan agreement that the borrower cannot incur additional debt beyond a certain
amount is an example of a(n) _______ covenant.
A. absolute
B. prohibitive
C. negative
D. affirmative
8. A ________ loan is one in which the original lender sells shares to other parties.
A. master
B. syndicated
C. participation
D. attached
9. A loan agreement may be preceded by a(n) _______ which is a letter outlining the terms and
conditions on which the lender will lend.
A. term sheet
B. advance notification
C. contract addendum
D. attachment
10. A(n) ________ clause in a loan document provides that any breach by the borrower under any other
loan agreement constitutes an event of default.
A. attached
B. dragnet
C. cross-default
D. cross collateralization
11. Which of the following makes a security interest created under Article 9 a floating lien?
A. The provision that, unless otherwise agreed, a security agreement gives the secured party a
security interest in the proceeds if the collateral is sold, exchanged, collected, or otherwise disposed
of.
B. The provision that, unless otherwise agreed, a security agreement fails to give the secured party a
security interest in the proceeds if the collateral is sold, exchanged, collected, or otherwise disposed
of.
C. The provision that, unless otherwise agreed, interest rates will vary depending on the prime rate
of interest.
368 MANAGERS AND THE LEGAL ENVIRONMENT
D. The provision that, unless otherwise agreed, the parties will not sell, exchange, collect, or
otherwise dispose of property and that if such an action is taken, all sums owed become immediately
due.
12. A(n) ________ guaranty is enforceable only with respect to a specified transaction or series of
transactions.
A. attached
B. upstream
C. restricted
D. payment
13. A ________ is an agreement whereby one or more creditors of a common debtor agree to defer
payment of their claims until another creditor of the same debtor is fully paid.
A. participation loan
B. cross-collateralization
C. debt subordination
D. lien subordination
14. Which of the following is false regarding remedies for default of a security agreement?
A. After default, the secured party has the right to take possession of the collateral so long as
judicial process is followed.
B. After properly taking possession of the property, the secured party may then dispose of the
collateral at a public or private sale.
C. If there is a surplus from the sale of collateral, the secured parry is required to return it to the
debtor.
D. If there is a deficiency from the sale of collateral, the debtor remains liable for that amount
15. Which of the following is false regarding methods of perfection?
A. A security interest in a deposit account may be perfected only by taking control of the collateral.
B. A security interest in a letter–of-credit right may be perfected only by taking control of the
collateral.
C. A security interest in money may be perfected either through possession or through filing a
financing statement.
D. For a limited period, a purchase-money security interest in consumer goods is automatically
perfected.
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16. An equipment lease that serves the purpose of financing is known as a(n) _______ lease.
A. credit
B. finance
C. unterminal
D. revokable
17. A bank’s ________ rate is the lowest published rate of interest at which the bank lends to its best
and most creditworthy commercial customers.
A. lien
B. term
C. prime
D. secured
18. In order to arrive at an actual interest rate, a ________ is an amount added to the bank’s theoretical
cost of obtaining funds to lend.
A. spread
B. base
C. reference
D. security
19. The ________ interest rate is based on the cost of borrowing offshore U.S. dollars in the global
interbank market.
A. International Rate Exchange
B. Frankfurt International Trade Rate
C. London Interbank Offered Rate
D. New York Exchange Rate
20. Interest is generally computed on a ________ basis.
A. yearly
B. monthly
C. weekly
D. daily
370 MANAGERS AND THE LEGAL ENVIRONMENT
21. A state law that limits the maximum rate of interest that may be charged is called a(n) ________
law.
A. interest
B. usury
C. rate
D. term
22. A guaranty that covers all future obligations of the primary debtor to a lender is referred to as a
_______ guaranty.
A. continuing
B. restricted
C. primary
D. performance
23. With a(n) _______ guaranty, subsidiaries guarantee, or pledge their assets as security for, the
parent’s debt.
A. downstream
B. upstream
C. leveraged
D. subordination
24. A(n) _______ subordination is an agreement between two secured creditors by which the
subordinating party agrees that the lien of the other creditor will have priority notwithstanding the
relative priorities that the parties’ liens would otherwise have under applicable law.
A. unenforceable
B. debt
C. lien
D. equitable
25. Which of the following was the result in In re Bryan Road, the case in the text involving the issue of
whether a prebankruptcy waiver of the automatic stay in a prepetition workout was enforceable?
A. After considering a number of factors, the court concluded that the waiver of the automatic stay
would be enforced.
B. The court ruled as a matter of law that such agreements are contrary to the principles set forth in
the federal bankruptcy statutes and that such agreements are, therefore, unenforceable.
C. The court ruled as a matter of law that such agreements are enforceable.
D. The court ruled that such agreements are enforceable only if all other creditors are paid in full.
26. A Chapter 7 discharge is not available to a debtor who has received a discharge in a bankruptcy filed
in the preceding _______ years or in a Chapter 13 case filed in the preceding _______ years.
A. two, four
B. six, seven
C. eight, six
D. seven, six
27. Which of the following was the result before the U.S. Supreme Court in Stern v. Marshall, the case
in the text involving whether a counterclaim for tortuous interference with an expected gift, filed in
response to a bankruptcy claim for defamation, was a core matter subject to the jurisdiction of the
bankruptcy court; and, if so, whether conferring that authority on the bankruptcy court violated
Article III of the U.S. Constitution?
A. The Court ruled that the tortuous interference counterclaim was a core proceeding but that the
bankruptcy court lacked the constitutional authority to enter a final judgment on the claim.
B. The Court ruled that the tortuous interference counterclaim was a core proceeding and that the
bankruptcy court had the constitutional authority to enter a final judgment on the claim.
C. The Court ruled that the tortuous interference counterclaim was not a core proceeding and that
the bankruptcy court lacked the constitutional authority to enter a final judgment on the claim.
D. The Court ruled that the tortuous interference counterclaim was a core proceeding in part and
that the bankruptcy court had the constitutional authority to enter a final judgment on portions of the
claim.
28. Under a guaranty of ________, the guarantor’s obligation to pay the lender is triggered
automatically when the debtor fails to make a payment when due.
A. security
B. collection
C. payment
D. performance
29. Which of the following expresses the effect of the D’Oench, Duhme doctrine in relation to federally
insured banks?
A. It makes it harder for federal agencies to bring criminal charges against bank officials who
negligently, but not intentionally, made bad loans.
B. It makes it easier for federal agencies to bring criminal charges against bank officials who
negligently, but not intentionally, made bad loans.
C. It makes it harder for federal agencies to collect on outstanding loans by specifically providing
that an oral loan commitment is enforceable so long as at least two bank officials confirm the
existence of the oral agreement and there is no indication that the debtor involved acted in an illegal
manner.
D. It makes it easier for federal agencies to collect on outstanding loans by barring enforcement of
any agreements unless the agreements are in writing and approved contemporaneously by the bank’s
board or loan committee and recorded in the bank’s written records.
30. In a ________ bankruptcy under Chapter 11, the debtor solicits votes on its plan of reorganization
and only files for Chapter 11 protection after it has obtained the required votes in favor of the plan.
A. preapproved
B. preplanned
C. prepackaged
D. prenegotiated
Fact Pattern 23-1 (Questions 31-32 apply)
Bailey has been making large credit card purchases for months. He has also borrowed money from Jack and
Susan, friends of his, so that he can continue his rather lavish lifestyle involving foreign travel. He borrowed
$1,000 from Jack and $2,000 from Susan. He also borrowed $500 from his mother. Bailey finally decides that
he can no longer continue to make even the minimum payments on his credit cards and considers filing for
bankruptcy. He does, however, want to pay some of his debts. Bailey, therefore, puts off the credit card
companies and saves his cash. He starts the New Year off by paying on January 1 all funds owed to his mother.
He was particularly concerned about repaying his mother because he still lived at home and had some concerns
that she would kick him out of the house if he did not repay her. Then, on June 1 he pays Jack; and on July 4,
he pays Susan. Bailey proceeds to file bankruptcy on August 2 because he has repaid anyone he really cares
about. He plans to complete the bankruptcy and move to the Caribbean.
31. Refer to fact pattern 23-1. Which of the following is true regarding the repayment of the loan to Bailey’s
mother?
A. It will be considered a preference because Bailey’s mother would be considered an insider, and it was made
within one year of the filing for bankruptcy.
B. Although Bailey’s mother would not be considered an insider, the payment would be considered a
preference because it was made within one year of the filing for bankruptcy.
C. The filing will be considered a preference only if Bailey and his mother had an agreement that she would
advance the amounts to him again once the bankruptcy was completed.
CHAPTER 23 DEBTOR-CREDITOR RELATIONS AND BANKRUPTCY 373
D. The payment would not be considered a preference because it was not made within 30 days of the filing for
bankruptcy.
32. Refer to fact pattern 23-1. Which of the following is true regarding the repayment of the loans from Jack and
Susan?
A. The payment to Susan would be considered a preference because it was made within 30 days of the filing
for bankruptcy, but the payment to Jack would not be considered a preference because it was made more than
30 days prior to the bankruptcy filing.
B. Payments to both Jack and Susan would be considered preferences because they were made within 90 days
of the filing for bankruptcy.
C. Payments to both Jack and Susan would be considered preferences because Jack and Susan are insiders, and
the payments were made within one year of the bankruptcy filing.
D. The payments would not be considered preferences.
33. Bank president Spencer had approved significant loan amounts to Bob for the purpose of developing
a shopping center. Spencer was satisfied that the land collateralizing the shopping center loan was
sufficient, and Spencer was not particularly concerned about that loan. Bob, however, requested an
additional loan for the purpose of starting a temporary employee agency. Bob offered to
collateralize that loan with his office equipment, but Spencer was uneasy that such collateral was
insufficient. If Spencer decides to go forward with the loan involving the temporary employee
agency, which of the following is true regarding his options?
A. Spencer should request a cross-default provision and also a cross–collateralization provision.
B. Spencer should only request a cross-default provision because Article 9 makes cross–
collateralization provisions unenforceable.
C. Spencer should only request a cross-collateralization provision because Article 9 makes cross–
default provisions unenforceable.
D. Spencer should request a guarantee from a solvent person or entity because Article 9 makes both
cross-default and cross-collateralization provisions illegal.
34. Matthew has filed for Chapter 7 bankruptcy relief. He had borrowed money from his best friend,
Rick, for the purchase of a car. Matthew really wants to repay Rick, but does not want to jeopardize
his bankruptcy relief and the discharge of a number of other debts. What option, if any, is open to
Matthew?
A. No options are open to Matthew because any payment to Rick would be considered a voidable
preference.
B. Matthew can reaffirm the debt to Rick, and the bankruptcy judge has no authority to interfere in
that decision.
C. Matthew can reaffirm the debt to Rick, but the bankruptcy judge has the authority to disapprove
of the agreement if the court finds that it is not in Matthew’s best interest.
374 MANAGERS AND THE LEGAL ENVIRONMENT
D. Matthew can reaffirm the debt to Rick but only up to 50% of the maximum amount owed, and
the bankruptcy judge has the authority to disapprove of the agreement if the court finds that it is not
in Matthew’s best interest.
35. Bob goes bankrupt. He has several creditors and a small amount in savings. He owes XYZ Bank
$200,000 for which he used his home as collateral. XYZ Bank properly perfected its interest in the
home. Bob additionally owes $3,000 in alimony to an ex-wife, Sue; $50,000 in unsecured credit
card bills; and $5,000 in unsecured debt to his friend Tina. After all exemptions are satisfied,
$205,000 from the sale of the home and $5,000 in a small bank account remain for distribution to
creditors. Which of the following is true regarding priority?
A. All funds are added together and disbursed to the claimants based upon the percentage of each
creditor’s claim.
B. Tina has first priority, the credit card companies are then paid, and XYZ Bank is entitled to any
remainder.
C. XYZ Bank receives $200,000 from the sale of the home, Sue receives $3,000, and the remainder
is divided between the credit card companies and Tina.
D. Tina has first priority, XYZ Bank is then paid, and the credit card companies divide the
remainder.
36. Alice, the president of ABC Bank, had a meeting with Fred to discuss the fact that he was having
difficulty making the payments on his loan that was guaranteed by Sylvia. Fred requested that Alice
provide a grace period to Fred and allow him to miss a few payments without penalty in order to
catch up his finances. Alice had no objection. Assuming the guaranty agreement did not address
such situations, is Alice acting prudently and why or why not?
A. Yes, because Sylvia, as a guarantor, has no rights to oppose any action of the bank.
B. Yes, because while Sylvia has certain rights in regard to actions taken by the bank, she had no
right to oppose the provision of a grace period since it is unlikely that allowing such a grace period
would impair Sylvia’s interests.
C. No, because Alice should have obtained the written consent of Sylvia in the form of an
affirmation of the guaranty in view of the grace period.
D. No, because as a matter of equitable business practice, Alice should have put Sylvia on notice
although Alice did not increase the bank’s exposure by failing to do so.
ESSAY QUESTIONS
1. What is required in a filing for a voluntary petition in bankruptcy? An involuntary petition?
2. What is a preference under the bankruptcy code? What time period is reviewed to determine if a
preference has occurred? When does a long-term debt payment to a bank qualify under the ordinary
course of business exception?
3. Set forth the five events referenced in the text that usually constitute events of default.
4. Define the terms security interest, dragnet clause, and perfection. What are the methods of perfecting
a security interest?
5. Discuss the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (“BAPCPA”) in
regards to whether Chapter 7 or Chapter 13 relief is appropriate.
6. Several commentators have criticized the Bankruptcy Code as too easily excusing individuals and
businesses from honoring their lawful obligations. From a societal standpoint, do you believe that
the Bankruptcy Code plays a positive role in social and economic relationships? What changes, if
any, would you recommend?