Bertrand Pan & Jennifer Taylor, Sustaining Power: Applying 11 U.s.c. Sec. 366 in Chapter 11 Post-bapcpa

• Publication year: 2011

ARTICLES

SUSTAINING POWER:

APPLYING 11 U.S.C. Sec. 366 IN CHAPTER 11 POST-BAPCPA

Bertrand Pan & Jennifer Taylor*

INTRODUCTION

The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 ("BAPCPA")¹appears on its face to have struck a significant blow to chapter

11 debtors. Although BAPCPA has created quite a controversy over its consumer debtor provisions, the possibility of business debtors achieving successful rehabilitation could also be in jeopardy. Specifically, certain amendments to the U.S. Bankruptcy Code ("Bankruptcy Code")²cut at the most fundamental of business needs-utility services.

Section 366 of the Bankruptcy Code was originally intended to protect the chapter 11 debtor's access to utility services and thereby provide the debtor with a realistic chance at rehabilitation.³In exchange, the utility service provider was entitled to adequate assurance of payment to protect its legitimate business interest in receiving payment for the services it provided.⁴To further the underlying purpose of Sec. 366, bankruptcy courts considered the particular facts of each case when determining the amount or type of assurance that was adequate and applied Sec. 366 with a focus on balancing the interests of the debtor and utility service provider.⁵

372 EMORY BANKRUPTCY DEVELOPMENTS JOURNAL [Vol. 22

On the surface, BAPCPA shifted that balance. The new Sec. 366(c) provides the chapter 11 debtor must produce assurance of payment "satisfactory to the utility."⁶This provision appears to vest the utility provider with total discretion, effectively permitting the utility to terminate the debtor's service- and rehabilitation effort-at its will. Such a result is entirely at odds with the original purpose of Sec. 366.

In this Article we discuss how bankruptcy courts are likely to maintain the balance Sec. 366 was intended to create. We believe the courts, as they did pre- BAPCPA, will continue to approach debtor-utility issues with the intent of balancing the debtor's interest in successful rehabilitation and the utility's interest in minimizing risk. Courts can do so while remaining consistent with Congress' apparent intent to give utilities better protection by reading a good faith requirement into the utility satisfaction language.⁷Not only is this approach consistent with pre-BAPCPA Sec. 366 analyses, it is also consistent with other federal and state law provisions.⁸

In Part I of this Article, we discuss the origins of Sec. 366, including the purpose behind the original enactment of Sec. 366 and the procedure that developed pre-BAPCPA. The case law demonstrates courts were willing to exercise broad discretion to achieve the appropriate balance of interests dictated by the circumstances of the particular case.⁹In Part II, we discuss the sweeping changes made to Sec. 366 by BAPCPA, which seem to have the effect of shifting the previous balance in favor of utilities. In Part III, we begin to look at the application of Sec. 366 post-BAPCPA. The first step, as discussed in this Part, is determining when Sec. 366, and subsection (c) in particular, applies. We also illustrate how courts may use the applicability rules as yet another method of avoiding the harsh result of Sec. 366's plain language. In Part IV, we examine the wisdom of imposing a good faith requirement on utilities as well as discuss possible tests bankruptcy courts may use in determining whether a utility has acted in good faith. We conclude bankruptcy courts will likely read an implied good faith requirement into Sec. 366(c) to better achieve the balance between chapter 11 debtor and utility interests that Sec. 366 was intended to create.

2006] APPLYING 11 U.S.C. Sec. 366 IN CHAPTER 11 POST-BAPCPA 373

I. THE ORIGINS OF Sec. 366

Utility services such as electricity and telephone services are essential to the continued operation of the chapter 11 business debtor. Without such services, the debtor may be unable to manufacture its product or communicate with customers and would have no possibility of successful reorganization.¹⁰

As a result, courts have come to view utility services as a necessary minimum for rehabilitation.¹¹

Problems arise in bankruptcy, however, because utilities generally enjoy monopoly power in a given region and the debtor is unable to obtain, or at least easily obtain, a new source of supply.¹²The utility may attempt to use its position to coerce the debtor into paying prepetition debts or granting other security with threats of terminating future service.¹³If it acquiesces, the debtor may be forced into an even more precarious financial position.¹⁴Moreover, granting preferential treatment to the utility prejudices the debtor's remaining creditors by disrupting the bankruptcy distribution scheme.¹⁵On the other hand, the utility has a legitimate business concern if forced to provide service to the debtor while prevented from obtaining overdue payments or future security from the debtor.¹⁶

374 EMORY BANKRUPTCY DEVELOPMENTS JOURNAL [Vol. 22

Although utility services were not singled out in the original Bankruptcy Act of 1898,¹⁷courts applying the Bankruptcy Act took note of the special relationship that existed between debtors and utility companies and the special concerns that resulted.¹⁸Consequently, when the Bankruptcy Code was enacted in 1978,¹⁹Congress specifically intended Sec. 366 to address the particular issues arising out of the debtor-utility relationship.²⁰The first version of Sec. 366, which took effect on October 1, 1979,²¹read as follows:

(a) Except as provided in subsection (b) of this section, a utility may not alter, refuse, or discontinue service to, or discriminate against, the trustee or the debtor solely on the basis that a debt owed by the debtor to such utility for service rendered before the order for relief was not paid when due.

(b) Such utility may alter, refuse, or discontinue service if neither the trustee nor the debtor, within 20 days after date of the order for relief, furnishes adequate assurance of payment, in the form of a deposit or other security, for service after such date. On request of a party in interest and after notice and a hearing, the court may order reasonable modification of the amount of the deposit or other security necessary to provide adequate assurance of payment.²²

2006] APPLYING 11 U.S.C. Sec. 366 IN CHAPTER 11 POST-BAPCPA 375

Subsection (a) was subsequently amended to include commencement of a bankruptcy case as an additional basis upon which utility service could not be altered, refused, or discontinued.²³

The legislative history indicates Congress intended Sec. 366 to give "debtors protection from a cut-off of service" by the prohibition set forth in subsection (a).²⁴At the same time, the concept of adequate assurance of payment set forth in subsection (b) was intended to protect utility companies.²⁵The dual purpose of Sec. 366 reflects the dual purpose of the Bankruptcy Code itself. The first goal of bankruptcy is to provide a debtor with relief from creditors so he or she is able to rehabilitate and accumulate new wealth in the future.²⁶The second goal is to provide an orderly distribution of the debtor's assets to its creditors.²⁷

Section 366 furthers these goals by providing the debtor an automatic twenty- day breathing period under subsection (a) and by permitting the utility to obtain adequate assurance of payment or terminate service after the twenty-day period has lapsed under subsection (b).²⁸When interpreting and applying

Sec. 366 in the past, courts have focused on this dual purpose and emphasized the balance between interests that Sec. 366 and the Code in general seek to achieve.²⁹

376 EMORY BANKRUPTCY DEVELOPMENTS JOURNAL [Vol. 22

To begin, Sec. 366 is intended to be "self-executing."³⁰Subsection (a) automatically comes into effect upon entry of the order for relief, preventing the utility from altering, refusing, or discontinuing service without, for example, a motion by the debtor for an injunction.³¹In theory, within the next twenty days, the debtor and utility will negotiate the type or amount of adequate assurance payment the debtor is to provide. The utility may make a demand or may leave the burden on the debtor to come forward with a proposal.³²If no adequate assurance is provided within twenty days, the utility is expressly allowed to terminate service.³³For this reason, it may be in the best interest of the debtor to initiate communication to avoid service disruption.³⁴This can all be done without judicial determination.³⁵

Nevertheless, a party in interest, which includes the debtor, trustee, utility, or other creditor,³⁶may initiate a proceeding for a hearing and determination by the court; in practice, it is usually the subject of a first day motion.³⁷

Section 366 issues that have been the subjects of litigation include: (1) the definition of the term "utility," (2) whether a utility may terminate service for some reason other than prepetition indebtedness or filing of a bankruptcy petition, (3) whether prepetition indebtedness is a prerequisite for adequate assurance of payment, and (4) what constitutes adequate assurance of payment.³⁸

Determination of what constitutes adequate assurance of payment appears to be the most heavily litigated issue. In part, this is because under Sec. 366 as enacted in 1978, "adequate assurance of payment" was not defined.³⁹In approaching this issue, courts have emphasized four important concepts.

2006] APPLYING 11 U.S.C. Sec. 366 IN CHAPTER 11 POST-BAPCPA 377

First, bankruptcy courts have broad power when applying Sec. 366.⁴⁰The equitable power created by Sec. 366 is supplemented by the power under Sec. 105 to "issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of [title 11]."⁴¹This permits the court to fashion an appropriate remedy in its sound discretion.⁴²Second, bankruptcy courts act with significant flexibility and discretion under Sec. 366.⁴³In this context, courts...