Lending to a Debtor-in-possession
| Publication year | 1982 |
| Pages | 2382 |
| Citation | Vol. 11 No. 9 Pg. 2382 |
1982, September, Pg. 2382. Lending to a Debtor-in-Possession
"Who goeth a-borrowing
Goeth a-sorrowing."
Tusser, Five Hundred Points
of Good Husbandry
To few lawyers' surprise, the recession which has plagued the balance of the world has now officially come to Colorado.(fn1) With it will come the problem of continuing a lending relationship after filing a Chapter 11 petition which was structured in better days. Presumably, this structure has included a system of liens and security interests which encumbers most, if not all, the assets of a going business in favor of the lender. This article explores some of the considerations which motivate borrower and lender to continue their relationship under these circumstances and suggests techniques which will protect borrower and lender.
Business problems do not spring full blown from a void. There is a series of events which signal the decline and fall of any business which are familiar to all who have ever experienced the problems. Common milestones in the road to a Chapter 11 include slow payment of vendor's bills, failure to pay withholding contributions of employees and using that cash for other business needs, new collateral or guarantee requirements from lenders, C.O.D. terms from vendors, loan calls from banks and, of course, lawsuits for valid debts.
While Chapter 11 provides protection from creditor efforts to collect past due debts,(fn2) it does not require a vendor or a lender to continue to do business with a debtor. In fact, the Bankruptcy Code expressly prevents assumption by a trustee (or a debtor) of a pre-petition "contract to make a loan, or extend other debt financing or financial accommodations to or for the benefit of the debtor...."(fn3) Nevertheless, financing is available to a debtor on a voluntary basis. The form and structure of this credit depend upon what assets are available, what pre-petition credit arrangements have been made, how diligently the creditors which have security enforce it, and whether or not the debtor and his counsel realize the risks involved in improperly using cash collateral.
Prior to filing a petition, a borrower's assets are usually encumbered. Values in excess of loan amounts are minimal, particularly in a recession. Vendor credit is normally non-existent and debtors are on a C.O.D. basis for all goods and services.(fn4) Even where the encumbrance of borrower's assets is not complete, these assets may not be a source of cash. Sales may be slow of inventory whether real or personal property. Lenders may avoid a commitment for a number of reasons. There may be litigation or foreclosures pending. Management may be unrealistic, hostile or incompetent. Filing a petition for relief under Chapter 11 of the Bankruptcy Code can change all this. The Code provisions provide opportunities for creative action whereby lender and borrower can mutually benefit.(fn5)
Normally, a debtor has existing financing from a bank or other credit institution which is secured by most or all of its assets. This lender is usually the best place to get more credit. What could motivate any lender to continue to increase or begin a credit facility in bankruptcy when it was unwilling to do so before bankruptcy?
The existing creditor cannot enforce its security interest. The automatic stay prevents any enforcement of the security rights without action by the creditor.(fn6) Relief from this stay is available on a...
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