Chapter III TYPES OF BANKRUPTCY-RELATED DISPUTES

• Jurisdiction: United States

III. TYPES OF BANKRUPTCY-RELATED DISPUTES

Robert M. Fishman, et al.

Throughout the duration of a bankruptcy case, matters arise that may be appropriate for mediation. Certain typical disputes exist in many bankruptcy cases, such as automatic stay issues, plan-confirmation litigation, claims disputes and various adversary proceedings. Many of these typical situations may give rise to an opportunity for a mediated resolution. This chapter identifies some of these typical situations and discusses the potential benefits of utilizing mediation to attempt to resolve the parties' differences. In addition, this chapter provides a general overview of the types of issues that can arise in the early, middle and later stages of a case, as well as in an individual case concerning dischargeability issues.

At the commencement of a bankruptcy case, particularly a chapter 11 case, there are certain issues that often give rise to disputes between the debtor in possession/trustee and certain creditors (usually secured creditors). Among the most likely issues that might arise early in a case are disputes surrounding the debtor in possession's use of cash collateral,³ the continuation or modification of the automatic stay,⁴ and the necessity and nature of the provision of adequate protection⁵ (as it relates to either the use of cash collateral or the continuation of the automatic stay). These issues usually require prompt attention and can lead to extensive litigation and discovery. Valuation and financial performance evidence can be significant factual issues in such matters. To the extent that parties are comfortable in utilizing mediation to address these issues, mediation may be able to provide a more prompt and less expensive resolution, allowing the case to proceed toward its ultimate resolution.

Once a case makes it through the initial stages, the issues most likely to arise also change. It is at this stage of a case that adversary proceedings begin to be filed, disputes over the amount and nature of claims against the estate start to surface and be addressed, and the estate begins to consider and commence actions against third parties to collect claims of the estate and attempt to obtain turnover of assets in the hands of third parties that the debtor in possession believes rightfully belong to the estate.

The estate may commence adversary proceedings asserting causes of action for the avoidance of alleged preferential transfers,⁶ the recovery of alleged fraudulent transfers⁷ (actual or constructive fraud), the turnover of assets allegedly belonging to the estate⁸ or the recovery of monetary claims alledgedly owing to the estate (ranging from actions as complex as breach of fiduciary duty by officers and directors to simpler breach of contract claims). Also, this is often the stage of a case where the parties battle over the allowance, amount, nature and priority of an alleged creditor's claim against the estate. Many of these types of disputes are particularly appropriate for resolution through the mediation process.

Once a chapter 11 case is commenced, there are only three ways to bring it to conclusion: dismissal, conversion and confirmation of a plan. Plan mediations are a potentially powerful tool. They are currently underutilized by the bankruptcy community, but they present a wonderful opportunity to navigate the plan process, address objections, consider competing plans and deal with other plan obstacles. Plan-related litigation can be very expensive, time-consuming and complex. Even though plan mediation can be a bit unruly, due to the potential number of participants, the fact-intensive nature of many of the issues and the "bet the ranch" consequences of the resolution of the issues, it offers a less-expensive and more streamlined process. Sometimes, in the plan-confirmation context, an attempt at mediation can lead to constructive conversation, moderation of positions and eventual consensual resolution.

The dischargeability⁹ of a particular debt in the case of an individual debtor can be the most important issue of the entire case. The notion of the "fresh start" in bankruptcy is directly at odds with the claim that a particular debt is nondischargeable. Because these disputes are two-party disputes (the debtor and a particular creditor), the mediation of these disputes is really not particularly different than the mediation of any other type of adversary proceeding. As is so often the case, mediation may allow the creditor an outlet for its anger and frustration, without the need for the cost and expense of full-blown dischargeability litigation.

Each of the above issues is discussed further below.

A. Early-Case Issues

Scott K. Brown

Mediation has traditionally been used in the late stages of a case, such as when the parties have reached an impasse on cramdown issues and each side is determined to exercise all appellate rights ad infinitum, or when parties are fighting in an adversary proceeding that has no end in sight and drags out distribution to creditors indefinitely. But more often, parties are turning to experienced mediators early in bankruptcy cases. The first couple of months often set the tone of a bankruptcy case: war or peace, reorganization or liquidation, might or right. Mediators can change the toxic tone — soften it and absorb it — before it infects and destroys the reorganization process.¹⁰

1. Cash-Collateral Disputes

"Cash is king," and never is this more evident than in the early stages of a contested, "unpackaged"¹¹ bankruptcy case. A debtor needs ac-cess to cash to pay ongoing operations and fast-accruing professional fees, not to mention past-due debts. If one or more creditors has a secured interest in the debtor's assets — and, in particular, the proceeds of the debtor's operations (i.e., "cash collateral") — a debtor must either obtain that creditor's consent to use cash collateral, provide the creditor adequate protection to use the cash against the creditor's will (pursuant to a court order), or find alternative sources of cash (also, at times, against the creditor's will).

Consent is the first option.¹² But consent comes with a price: Generally, it requires a debtor to sign off on a lengthy order that gives the creditor tremendous control over the debtor's use of the cash collateral throughout the duration of the bankruptcy case. Such an order also typically insulates the creditor from attacks as to the scope and validity of its liens or other acts that may implicate liability. Often, this type of order skews leverage and prevents a debtor from addressing what may be the most significant issues in the case — indeed, the very reason a bankruptcy was filed in the first place. And the carrot to get a debtor to sign such an order (i.e., a "carve-out" for professional fees) may raise an ethical dilemma for an attorney who must consider whether provisions designed to ensure protection of professional fees come at an unacceptable cost of provisions harmful to the client.

Litigation is another option. The key issue is whether a creditor's interest in cash collateral is adequately protected.¹³ If so, the debtor may use cash collateral to pay its ongoing operations and other expenses, like professional fees, without the consent of the creditor.¹⁴

But the burden of litigation can be tremendous, often involving expensive and contentious discovery and valuation hearings, complete with experts, all within the first few weeks or months of a case (yes, months). That is because the value of most assets is fluid, enabling particularly litigious parties to reprise adequate-protection hearings over and over again like a bad Broadway production to the utter dismay of an exhausted bankruptcy judge.

This type of litigation rarely has any winners and presents many risks to both sides. The creditor, of course, risks losing control over an ev-er-increasingly expensive loan that has long since lost any hope of a profitable outcome (bad-debt buyers aside), not to mention spending unrecoverable money on professional fees (bad-debt buyers included). A debtor's only satisfaction may be that it is causing misery to the lender, but any solace on that point is usually short-lived, as the case typically melts into a sale or liquidation, even if adequate protection is somehow achieved, only to be attacked over and over again in a zombie-like fashion. And, of course, it only takes one defeat to sink the debtor and render it administratively insolvent and unable to pay the once-proud and aggressive legal team that stood by it only to now find out that each shovel of dirt it was heaving at the creditor was deepening its own grave. What's more, the carve-out option the debtor unceremoniously rejected once upon a time is usually a faint memory, one that is no longer on the proverbial "table" that has long since been auctioned off.

Then there is "DIP financing," whereby a debtor secures an alternative source of cash, sometimes secured and sometimes not. Attempts to obtain secured credit, particularly credit that promises a "priming" lien, can result in protracted litigation. As with cash collateral, the key issue is adequate protection, with all of its aforementioned glory.¹⁵

2. Advantages of Early-Case Mediation for Cash-Collateral Disputes

There is a fourth option that can resolve or soothe the forgoing options: mediation. "Early case" mediation makes sense for many reasons.

First, a mediator can act as an independent voice. Parties are often unwilling or unable to take an objective view of the prospects of a case at its commencement, and lawyers are usually not encouraged by their clients to think and act objectively. A creditors' committee may have the aura of "objectivity," but not all cases can afford a creditors' committee, and such a committee, even if it is in place, is not a neutral party that is only interested in furthering the interests of both secured creditors and a debtor. It has its own constituents that...