Chapter IV Negotiation of Financing with Lenders
| Jurisdiction | United States |
Chapter IV Negotiation of Financing with Lenders
A. Cash Collateral
The filing of a chapter 11 petition creates an estate consisting of all property owned by the debtor, wherever located, at the time of the filing.95 This includes the debtor's cash and cash equivalents, including the cash generated by the use or sale of collateral subject to a lien.96 For example, when inventory subject to a lien is sold, the secured lender's lien on the inventory is transferred from the inventory to the proceeds upon sale. The proceeds constitute cash collateral, regardless of whether it is generated pre-petition or post-petition.
While § 552(b) of the Bankruptcy Code generally provides that pre-petition liens remain in place post-petition, § 552(a) provides that property acquired by the estate after the case is commenced is free and clear of such liens.97 If the debtor in possession uses cash collateral to buy new raw material to generate new inventory, the new raw material would not be subject to the lender's existing lien. Accordingly, § 363(c) (2) of the Bankruptcy Code generally prevents a debtor from spending cash collateral without the consent of all parties that have an interest in the collateral or a court order.98
More specifically, the debtor in possession may only use cash collateral if either (a) the lender holding the lien consents, or (b) the court authorizes the use of cash collateral after determining that the lender is adequately protected.99 Much like the automatic stay, the prohibition against the use of cash collateral is automatically imposed. Unlike the automatic stay, the prohibition harms the debtor in possession in that the debtor is unable to utilize cash for anything, including the payment of ordinary business expenses, such as wages and insurance. As cash-collateral fights can be protracted and expensive, a debtor in possession typically reaches an agreement with the lender for the consensual use of cash collateral either before or shortly after the filing of the bankruptcy case and presents the agreement to the court for approval.
1. Debtor's Request for Authority to Use Cash Collateral
The request for the use of cash collateral, whether by agreement or otherwise, is presented to the court via motion, usually on the first day of the bankruptcy case.100 Most bankruptcy courts have adopted local procedural rules applicable to such motions, so it is important to consult such rules when dealing with a cash-collateral motion. A preliminary hearing on the motion is usually set within days of the petition date, and an interim order allowing the use of cash collateral (typically for no more than 30-60 days) is entered before an unsecured creditors' committee is appointed. This interim order will generally not be granted on a final basis until the committee is appointed so that the committee, and other parties in interest, will have an adequate opportunity to review and, if necessary, object to such order becoming final. A denial of the debtor in possession's request to use cash collateral usually results in a conversion of the case to a case under chapter 7. Likewise, the unauthorized usage of cash collateral by the debtor may result in a conversion of the case.101
As the contents of agreed orders have become nearly uniform, the Bankruptcy Rules require specific disclosures of key terms and a concise statement or summary of key terms. Specifically, Bankruptcy Rule 4001(d)(1)(B) contains a list of potentially objectionable terms that must be disclosed, including, but not limited to: (1) a grant of priority or a lien on property of the estate; (2) the provision of adequate protection; (3) a determination of the validity, enforceability, priority or amount of a pre-petition claim or of any lien securing such claim; (4) a waiver or modification of the automatic stay; (5) a waiver or modification of any entity's authority or right to file a plan, seek an extension of the exclusivity period or request authority to use cash collateral or obtain credit; (6) a waiver or modification of applicable nonbankruptcy law relating to the perfection of a lien on property of the estate; (7) a release or waiver of claims or causes of action belonging to the estate; (8) a waiver of the right to surcharge against a secured creditor's collateral; or (9) the granting of a lien on causes of action arising under chapter 5 of the Bankruptcy Code.102
2. Frequently Contested Issues
Cash-collateral orders only need to provide authorization for the debtor in possession's use of cash collateral, usually pursuant to a budget, and a description of the adequate protection, if any, being offered to the lender. Nevertheless, secured creditors often take advantage of the debtor in possession's need to immediately use its cash, and therefore require a bevy of additional favorable provisions in exchange for their consent to the use of cash collateral. In such circumstances, it is the role of the committee to object to such provisions.
B. Adequate Protection
Although adequate protection is not defined in the Bankruptcy Code, courts generally describe it as "a balancing of the debtor's and a creditor's respective harm,"103 and the legislative history of § 361 of the Bankruptcy Code reflects a congressional intent to give courts flexibility to fashion adequate protection in light of the facts of each case and general equitable principles.104 Additionally, § 361 of the Bankruptcy Code sets forth three nonexclusive methods of how an interest in property may be adequately protected, stating as follows:
When adequate protection is required under [§ 363] of this title of an interest of an entity in property, such adequate protection may be provided by:
(1) requiring the trustee to make a cash payment or periodic cash payments to such entity, to the extent that the stay under § 362 of this title, use, sale, or lease under § 363 of this title, or any grant of a lien under § 364 of this title, results in a decrease in the value of such entity's interest in such property;
(2) providing to such entity an additional or replacement lien to the extent that such stay, sale, lease or grant results in a decrease in the value of such entity's interest in such property; or
(3) granting such other relief, other than entitling such entity to compensation allowable under § 503(b)(1) of this title as an administrative expense, as will result in the realization by such entity of the indubitable equivalent of such entity's interest in such property.
The "interest" of a secured creditor that is entitled to be protected is the value of the secured creditor's allowed secured claim — that is, the amount of the secured creditor's claim up to the value of the collateral upon which the secured creditor has a lien as of the relevant valuation date.105 The secured creditor is only entitled to assurance that the value of its lien will not decrease as a result of the automatic stay and, if it does, that it will receive something as compensation for the decrease.106
Courts have flexibility to design an adequate protection scheme based on the facts and circumstances in each case.107 In determining what constitutes adequate protection, courts must consider not only the interests of the secured creditor whose cash collateral is impacted, but also the interests of all other creditors in light of the debtor's efforts to enhance the prospects of reorganization.108
As the form of interim adequate protection will often have been approved before the committee is formed, the committee is tasked with ensuring that the adequate protection to be approved on a final basis is not overreaching. "The Supreme Court has determined that 'adequate protection' is intended by the Bankruptcy Code only to assure that a secured creditor, during the pendency of a bankruptcy case, does not suffer a loss in the value of its interest in property of the bankruptcy estate..."109 As such, when replacement liens on new collateral are sufficient, the lender's request for payments could be considered overreaching and harmful to the debtor in possession's efforts to reorganize.
Moreover, the committee needs to ensure that the replacement liens themselves are not overreaching. It is common for lenders to request liens on all property acquired post-petition, including collateral that it may not have had a lien on pre-petition and on chapter 5 causes of action. However, the lender's "replacement lien" should be limited to the type of collateral included pre-petition. Regarding chapter 5 causes of action, most courts have held that a blanket pre-petition lien does not extend to such actions, because such actions only exist upon the commencement of a bankruptcy case.110 These courts base their decisions on the language of § 552(a) of the Bankruptcy Code, which provides that "property acquired by the estate after the commencement of the case is not subject to any lien resulting from any security agreement entered into by the debtor before the commencement of the case."111
Utilizing this analysis, courts generally prohibit a debtor from granting a replacement lien on chapter 5 causes of action as adequate protection in exchange for the continued use of cash collateral. Such courts also reason that chapter 5 causes of action are designed to facilitate equality of distribution among a debtor's general unsecured creditors and are not truly property of a debtor's estate. Rather, they are rights that the estate holds in trust for the benefit of creditors.112 Accordingly, bankruptcy courts customarily restrict the ability of debtors in possession to pledge chapter 5 causes of action as security.113
For the same reason, the committee should ensure that the lender does not attempt to obtain a super-priority administrative claim on chapter 5 causes of action. The granting of a super-priority claim is akin to a lien as it would precede...
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