Debtor-In-Possession and Exit Financing
Below is an excerpt from Chapter 11 of Debtor-In-Possession and Exit Financing: Leading Lawyers on Securing Funding and Analyzing Recent Trends in Bankruptcy Financing, written by Elizabeth L. Thompson, a Member in the firm's Lexington office. Liz's practice focuses on the representation of substantial claimants, purchasers of assets, creditors' committees and debtors in Chapter 11 bankruptcies, commercial litigation and representation of lenders in loan restructurings and work-outs. She joined the firm in 1995, recently served on its Management Committee, is head of its Creditors' Rights & Bankruptcy Service Group and developed and facilitates its associate mentoring program.
Increased Conditions Demanded for Cash Collateral Use or DIP Financing
Even when cash collateral use and DIP financing are extended, they are often subject to an ever-increasing list of conditions, as discussed below, designed to provide extra protection for secured creditors. These forces, some commentators speculate, have resulted in an uptick in Chapter 11 liquidations. For example, some blame the liquidation of Circuit City and the attendant loss of 34,000 jobs on secured creditors who curtailed lending during the bankruptcy, advancing only $50 million in post-petition financing, which included $30 million in loan fees and was coupled with a short timeline for sale of the company and the ability to declare default at almost any time.2 Experts note a growing trend toward liquidation in large Chapter 11 cases.3 Professor Lynn LoPucki, who studied the trend in increasing Chapter 11 liquidations prior to the enactment of the Bankruptcy Abuse Prevention and Consumer Protection Act, found that "41 firms that filed bankruptcy as public companies each with assets exceeding approximately $218 million liquidated in 2002, although no more than 8 such firms did so in any year prior to 1999."4
DIP financing or cash collateral use are frequently conditioned on some or all of the following terms demanded by secured creditors in order to limit their risk in extending post-petition lending.
Rollover of Pre-Petition Secured Debt
Pre-petition secured debt is frequently rolled up into DIP financing in one of two ways. First, agreements may require post-petition payments to be applied initially to pre-petition secured debt. Second, the DIP loan may consist of a single advance, a portion of which satisfied pre-petition secured indebtedness. If the pre-petition secured creditor is over-secured, such treatment may be allowed by the court, but where the opposite is true, the pre-petition secured creditor should not be allowed to improve its position at the cost of the unsecured claimants.
Releases of Pre-Petition Secured Lenders
Pre-petition secured lenders generally seek releases of claims by the debtor. Such releases may include a stipulation of the validity, priority, and amount of the pre-petition secured claims as well as a release of defenses, claims, and claims for preferences, fraudulent conveyance, and other avoidance actions. Though frequently allowing the waivers described above by the debtor, most courts reserve the rights of the unsecured creditors committee to object to claims and expressly provide that these waivers are not binding on the unsecured creditors committee. Even where the unsecured creditors committee's rights are preserved, however, it has been increasingly common to include terms limiting the amount of time that the committee is allowed to investigate and assert claims against the pre-petition secured creditor.
Since cash collateral use and DIP financing orders frequently encumber all free assets of the debtor and grant the lender a super-priority administrative claim a carve-out of this lien position must be granted by the lender to allow for payment of professional fees, including those of the debtor and the unsecured creditors committee. Lenders may therefore seek to limit fees tightly for professional's and thereby exert control over the duration of any Chapter 11, as well as limit the ability of the professionals to investigate claims against the pre-petition secured creditor. Amounts allocated for such investigation are often specifically limited.5
Liens on Avoidance Actions
Recoveries for preferences, fraudulent conveyance, and other avoidance actions under Chapter 5 of the Bankruptcy Code have historically been preserved for the benefit of the unsecured claimants in most Chapter 11 cases. Increasingly, however, lenders are seeking a lien on the avoidance action recoveries to secure cash collateral use and DIP financing or, alternatively, seeking orders providing that these avoidance action recoveries are subject to payment of the DIP lender's super-priority administrative expense claim under 11 U.S.C. § 364(c)(1).
Section 506(c) Waivers
11 U.S.C. § 506(c) (West 2009) allows reasonable and necessary administrative expenses that are incurred to preserve or liquidate a secured creditor's collateral to be surcharged to the proceeds of this collateral under certain circumstances. Because DIP lenders do not wish to have their liens found later to be subject to Section 506(c) surcharges, many DIP lenders require Section 506(c) surcharge waivers.
Financial Conditions and Deadlines
DIP financing and cash collateral use are generally conditioned upon the debtor providing extensive financial information and compliance with projected budgets, including meeting specified income and expense targets. Moreover, trigger dates (such as dates by which sale of the debtor's assets or the date by which a Chapter 11 plan containing terms acceptable to the DIP lender must be filed) are often required.6
Relief from the Automatic Stay
Finally, some DIP lenders require inclusion of terms granting relief from the automatic stay without further order or hearing upon breach of the cash collateral or DIP financing order.
Many courts discourage inclusion of the above conditions. For example, some courts, including the U.S. Bankruptcy Court for the District of Delaware, have adopted local rules requiring conspicuous disclosure of provisions that: (1) give cross-collateralization protection to pre-petition secured creditors; (ii) bind the estate with respect to the validity, perfection, or amount of the secured creditors pre-petition lien or debt, or waiver of claims against the secured creditor, without giving certain specified periods to investigate; (iii) waive, without notice, the estate's Section 506(c) rights; (iv) deem pre-petition secured creditor to pay all or part of the secured creditor's pre-petition debt ("roll-ups"); (v) provide disparate treatment for the committee's professionals from that provided for the debtor's professionals with respect to a professional fee carve-out; and (vi) prime any secured lien without consent of the lien holder.7 Such conditions are being approved, however, after disclosure and consideration by the courts.
2American Bankruptcy Institute, Circuit City Unplugged: Why Did Chapter 11 Fail to Save 34,000 Jobs?: Four ABI Members Testify before House Subcommittee on Commercial and Administrative Law, 28-3 ABIJ 10 (Apr. 2009)
4Lynn LoPucki, The Nature of the Bankrupt Firms: A Response to Baird and Rasmussen's The End of Bankruptcy, 56 STAN. L. REV. 645 (2003)
5See Appendix J, Page 8, Paragraph 14, Order (1) Authorizing the Debtors to Obtain Post-Petition Financing and Use Cash Collateral, And (II) Granting Adequate Protection to Prepetition Secured Parties, In Re: Black Diamond Mining Company, LLC, et al., United States Bankruptcy Court for the Eastern District of Kentucky, Pikeville Division, Case No. 08-70066 through 08-70067 and 08-70069 through 08-70073.
6For a survey of DIP financing orders entered in the U.S. Bankruptcy Court for the District of Delaware, including the percentage of such orders that included some of the terms discussed in this chapter, See American Bankruptcy Institute, A Year in Review: Delaware DEBTOR-IN-POSSESSION Orders in 2008, 28-2 ABIJ 32 (Apr. 2009) (contributing ed., David B. Stratton). For examples of cash collateral or DIP financing orders negotiated by the author or entered in the U.S. Bankruptcy Court for the Eastern District of Kentucky, see Appendices I, J., and K.