September 12, 2018
Author: Dale Baringer
Organization: THE BARINGER LAW FIRM, L.L.C.
It behooves both debtors and lenders to consider alternative means of resolving problem commercial loans. In order to properly evaluate the advisability and feasibility of the various alternatives, it is necessary to gain a clear understanding of the reasons why the loan has turned bad. Some of the more common reasons include the following:
• A downturn in the economy, in general;
• A downturn in the debtor’s particular industry or line of business;
• Entry of new and stronger competition in the debtor’s industry or line of business;
• Mismanagement by the debtor which might consist of:
° Lack of proper accounting procedures that are essential to managing costs, pricing of the debtor’s products, use of labor, dividend payments to and/or withdrawals by the owner(s) of the business, tax obligations for both payroll taxes and income taxes, and general cash flow management;
° Poor safety policies and procedures resulting in excessive workmen’s compensation and third party liability claims;
° Lack of or inadequate insurance coverage resulting in uninsured losses to the debtor;
° Excessive and extravagant personal lifestyle and personal expenditures by the owner(s) of the business resulting in the owner(s) withdrawing excessive funds from the business leaving it unable to meet creditor claims;
° Outright fraudulent business practices which can leave management facing criminal prosecution;
° Inability to keep up with innovations in technology which leave the debtor unable to compete in its market;
° Technology developments that leave the debtor’s product or service in their wake as outdated;
° Disputes between and among owners of the business;
° Inability to maintain compliance with regulations applicable to the debtor’s business; and
° Any others one might imagine;
• Natural disasters;
• Extraordinary losses such as catastrophic injury claims exceeding available insurance coverage;
• Changes in the regulatory environment that impose excessive costs on the business;
• Changes in the law that negatively impact the business; and
• Major litigation claims.
This list is certainly not exhaustive; but these types of circumstances may dictate the appropriate course of action for both debtor and lender. For instance, the debtor’s condition may be due to conditions beyond the debtor’s control such that the debtor’s business may simply need, and be well suited to survive, if it receives a brief respite in the form of an informal forbearance from the lender’s acting upon a default, be it a technical default of a loan agreement provision or a monetary default in failing to meet a payment obligation. On the other hand, they may indicate that the business is doomed to failure in the long run, such that foreclosure is the only logical course for the lender.
A. NEGOTIATIONS TOWARD A CONSENSUAL PLAN
1. Forbearance Agreements.
Forbearance agreements may come in many forms. As suggested above, they may be in the form of a mere informal forbearance by the lender in deciding not to act immediately upon a particular default by the debtor. The forbearance agreement is an agreement between the creditor and the debtor whereby the creditor agrees to forbear from suing, foreclosing or taking other action against the debtor and/or a guarantor so long as the debtor meets a pre-agreed set of conditions. These conditions may vary from maintenance of financial covenants, to time limitations upon liquidation of assets, to the granting of deeds in lieu of foreclosure, arrangements for refinancing, etc. The forbearance agreement often serves as a substitute for restructuring of the loan transaction on a short-term basis.
In any case, upon a default, the lender should be making contact with the debtor in regard to the default to investigate the reasons for it and evaluate the debtor’s prospects for curing the default. Once it becomes clear that a default is not simply an isolated aberration in an otherwise prudent manager’s business experience, the lender should dig deeper into the root causes and possible solutions to the problem with the debtor. The lender must not stand by and allow the debtor to stick its head in the sand and hope things turn around. The prudent lender and debtor, both, should take a proactive approach to the situation. From this process, it might be determined that particular action is likely to bring about a cure of the default, and that if both parties agree to a particular plan, then it should be reduced to writing in the form of a forbearance agreement. A forbearance agreement is simply a written memorialization of a consensual workout between the debtor and the lender creditor.
Frequently, all that is required to salvage a difficult situation is to provide some form of interim relief while the debtor works out a temporary cash flow crisis created by abnormal and nonrecurring business developments. Where the problems are more severe, or longer lasting, the steps to be taken are more complex. It may be appropriate, for instance, for a creditor to agree to extend the maturity of the indebtedness, to rework the existing interest rates and even to advance additional funds in order to alleviate acute problems. The kinds of assistance a creditor may offer to the troubled debtor are very much dependent upon the nature of the particular problems involved; hence, proper identification of the source of the problems is critical. A creditor should be cautious in relying upon the debtor's explanation of the source of the problem, since the debtor may be overlooking or ignoring the real roots of its difficulty, particularly if they lie in its own management, business practices or product line. On the other hand, the focus of the debtor and counsel in this context should be on building credibility of the debtor with the lender. This requires that the debtor be forthright in its statutory obligation to be truthful in the representations to the lender. The best approach is simply to be objective an realistic in evaluating the debtor’s alternatives.
Often the debtor's problem is with one party - - its bank, its principal supplier, its landlord or the like. In such a case, the debtor may be able to solve its problem through a forbearance agreement with the particular creditor without seriously affecting its relationship with other creditors. On the other hand, if the debtor's problems are so pervasive that its cash flow is generally insufficient to satisfy the claims of most of its creditors, every creditor will be affected. In such cases, all of the debtor’s creditors should be called upon to bear their proportionate share of the loss, and a general work out agreement with all creditors may be more appropriate. The prudent lender being asked to grant concessions to its borrower in a forbearance agreement will want to know that it is not being asked to bear a larger portion of loss from the debtor’s insolvency than the debtor’s general creditors may bear.
Before entering into discussions with troubled debtor, the creditor may be well advised to have the debtor execute a pre-workout agreement to prevent misunderstandings and potential lender liability claims against the creditor. The pre-workout agreement should acknowledge that the lender and borrower are about to commence negotiations concerning the credit and that without liability for failing to do so, each plans to discuss various courses of action that might be in their mutual interest. It should provide that either the lender or the borrower may terminate the discussions at any time and for any reason, and that upon such termination of discussions, the respective obligations of the lender and borrower to one another shall be only as set forth in executed written loan documents which should be generally described therein. It should provide further that no negotiations or other actions undertaken pursuant to the agreement will constitute a waiver of any party's rights under any of the loan documents, except to the extent specifically stated in a written agreement.
In the context of a forbearance agreement, the lender should seek to strengthen its position in regard to being prepared to foreclose, should that become necessary, and to prepare for a possible Chapter 11 or Chapter 13 bankruptcy case.1 As has been noted by the previous speaker, if the lender has done its job when signs of trouble with a loan first materialize, it will have evaluated its loan documents and collateral and determined whether there are any defects or issues that might give rise to problems with the formal foreclosure or bankruptcy process. For instance, if the lender has determined that there was a failure to record or reinscribe a mortgage, or file or renew a UCC-1, in order to validly perfect a lien or mortgage, the lender may be motivated to agree to a forbearance agreement with the debtor to allow the lender time to correct the failure by recording its mortgage or UCC-1, and assuring that the 90 day preference period of §547 of the Bankruptcy Code runs before the debtor is forced to file bankruptcy. 2
1 §109(e) of the Bankruptcy Code provides that:
Only an individual with regular income that owes, on the date of the filing of
the petition, noncontingent, liquidated, unsecured debts of less than $360,475
and noncontingent, liquidated, secured debts of less than $1,081,400, or an
individual with regular income and such individual's spouse, except a
stockbroker or a commodity broker, that owe, on the date of the filing of the
petition, noncontingent, liquidated, unsecured debts that aggregate less than
$360,475 and noncontingent, liquidated, secured debts of less than $1,081,400
may be a debtor under chapter 13 of this title.
While most debtors with problem commercial loans or real estate loans would be looking to Chapter 11 reorganization as the primary source of bankruptcy relief in the work out context, those individuals who operate as a sole proprietor or who own investment properties with secured loans in their own name who fall below the debt limitations for Chapter 13 are eligible for relief under Chapter 13.
2 Section 547(b) of the Bankruptcy Code provides as follows:
(b) Except as provided in subsections (c) and (i) of this section, the trustee may avoid any transfer of an interest of the debtor in property--
(1) to or for the benefit of a creditor;
(2) for or on account of an antecedent debt owed by the debtor before such transfer was made;
(3) made while the debtor was insolvent;
(4) made--
(A) on or within 90 days before the date of the filing of the petition; or
(B) between ninety days and one year before the date of the filing of the petition,
if such creditor at the time of such transfer was an insider; and
(5) that enables such creditor to receive more than such creditor would receive if--
(A) the case were a case under chapter 7 of this title;
(B) the transfer had not been made; and
(C) such creditor received payment of such debt to the extent provided by the
The lender may also be well advised, at the first sign of trouble, to obtain a conveyance and mortgage certificate, and a UCC-1 lien search from the Clerk of Court in order to determine whether the debtor has begun to transfer or otherwise encumber unencumbered properties to place them beyond the reach of creditors. If these things have been done by a debtor who is, or is thereby made to be, insolvent, then they may be rescinded through an action in state court under the Louisiana revocatory action, or in bankruptcy, as a fraudulent conveyance; but only if acted upon in a timely manner.3 The debtor may be seeking a forbearance agreement solely for the purpose of aging prior fraudulent transfers of property or to make new fraudulent transfers of property and put them beyond the periods within which they may be revoked under either state law or federal bankruptcy law.
Therefore, an important objective of the lender in a forbearance agreement, in addition to provisions of this title.
3 Section 548(a)(1) of the Bankruptcy Code provides:
(a)(1) The trustee may avoid any transfer (including any transfer to or for the
benefit of an insider under an employment contract) of an interest of the debtor
in property, or any obligation (including any obligation to or for the benefit of
an insider under an employment contract) incurred by the debtor, that was made
or incurred on or within 2 years before the date of the filing of the petition, if the
debtor voluntarily or involuntarily--
(A) made such transfer or incurred such obligation with actual intent to hinder, delay, or defraud any entity to which the debtor was or became, on or after the date that such transfer was made or such obligation was incurred, indebted; or
(B)(i) received less than a reasonably equivalent value in exchange for such transfer or obligation; and
(ii)(I) was insolvent on the date that such transfer was made or such obligation was incurred, or became insolvent as a result of such transfer or obligation;
(II) was engaged in business or a transaction, or was about to engage in business or a transaction, for which any property remaining with the debtor was an unreasonably small capital;
(III) intended to incur, or believed that the debtor would incur, debts that would be beyond the debtor's ability to pay as such debts matured; or
(IV) made such transfer to or for the benefit of an insider, or incurred such obligation to or for the benefit of an insider, under an employment contract and not in the ordinary course of business. La. Civ. Code Art. 2036 provides: “An obligee has a right to annul an act of the obligor, or the result of a failure to act of the obligor, made or effected after the right of the obligee arose, that causes or increases the obligor's insolvency.
La. Civ. Code Art. 2041provides: “The action of the obligee must be brought within one year from the time he learned or should have learned of the act, or the result of the failure to act, of the obligor that the obligee seeks to annul, but never after three years from the date of that act or result.” affording the debtor an opportunity to cure defaults and place its business on solid ground, is to eliminate areas of dispute, so that collection efforts proceed as efficiently as possible should the debtor be unsuccessful in turning its financial affairs around under the forbearance agreement. Moreover, the lender should use the opportunity to determine whether there are other assets of the debtor that might be available as additional collateral to the lender in return for the concessions of the lender in the forbearance agreement.
On the other hand, the debtor should, likewise, take the opportunity to consult with counsel at this juncture, have the loan documents reviewed by counsel, and determine whether there may be issues such as unrecorded mortgages or UCC-1s, or other possible defenses to enforcement of the loan documents. The debtor should expect that the lender will discover these things in the context of considering a forbearance agreement and will be seeking to correct them.
Should the debtor discover that such a circumstance exists, it may be a good reason to move immediately on filing a Chapter 11 or Chapter 13 bankruptcy case because the collateral will end up being unencumbered in the bankruptcy case. This presents the debtor with a major advantage over the lender in bankruptcy. In either a Chapter 11 case or a Chapter 13 case, the debtor will not be able to keep the collateral subject to a duly perfected security interest without paying the lender under the plan at least the fair market value of the property over time. In Chapter 11 cases, this is made so by the provisions of §§1129(a)(7) and 1129(b)(1) & (2) of the Bankruptcy Code.4 In Chapter 13 cases, this is made so by the provisions of §1325(a)(5) of the 4 In Chapter 11, this is so by virtue of §1129(a)(7) and §1129(b)(1)&(2) which provide: (a)(7) With respect to each impaired class of claims or interests--
(A) each holder of a claim or interest of such class--
(i) has accepted the plan; or
(ii) will receive or retain under the plan on account of such claim or interest property of a value, as of the effective date of the plan, that is not less than the amount that such holder would so receive or retain if the debtor were liquidated under chapter 7 of this title on such date . . .
(b)(1) Notwithstanding section 510(a) of this title, if all of the applicable requirements of subsection (a) of this section other than paragraph (8) are met with respect to a plan, the court, on request of the proponent of the plan, shall confirm the plan notwithstanding the requirements of such paragraph if the plan does not discriminate unfairly, and is fair and equitable, with respect to each class of claims or interests that is impaired under, and has not accepted, the plan.
(2) For the purpose of this subsection, the condition that a plan be fair and equitable with respect to a class includes the following requirements:
(A) With respect to a class of secured claims, the plan provides--
(i)(I) that the holders of such claims retain the liens securing such claims, whether the property subject to such liens is retained by the debtor or transferred to another entity, to the extent of the allowed amount of such claims; and
(II) that each holder of a claim of such class receive on account of such claim deferred cash payments totaling at least the allowed amount of Bankruptcy Code.5
The investigation by both debtor and lender of the root causes of the condition of default under the loan documents should lead to the development of what should be the primary focus of the forbearance agreement, affording the debtor the opportunity to do what is necessary to cure the default.
The principal goal of a creditor faced with a distressed debtor is payment of its outstanding debt. Sometimes, particularly where the distressed loan is an operating line of such claim, of a value, as of the effective date of the plan, of at least the value of such holder's interest in the estate's interest in such property; (ii) for the sale, subject to section 363(k) of this title, of any property that is subject to the liens securing such claims, free and clear of such liens, with such liens to attach to the proceeds of such sale, and the treatment of such liens on proceeds under clause (i) or (iii) of this subparagraph; or (iii) for the realization by such holders of the indubitable equivalent of such claims.
5 §1325(a)(5) provides as follows:
(a) Except as provided in subsection (b), the court shall confirm a plan if--
(5) with respect to each allowed secured claim provided for by the plan-
(A) the holder of such claim has accepted the plan;
(B)(i) the plan provides that--
(I) the holder of such claim retain the lien securing such claim until the earlier of--
(aa) the payment of the underlying debt determined under nonbankruptcy law; or
(bb) discharge under section 1328; and
(II) if the case under this chapter is dismissed or converted without completion of the plan, such lien shall also be retained by such holder to the extent recognized by applicable nonbankruptcy law;
(ii) the value, as of the effective date of the plan, of property to be distributed under the plan on account of such claim is not less than the allowed amount of such claim; and
(iii) if--
(I) property to be distributed pursuant to this subsection is in the form of periodic payments, such payments shall be in equal monthly amounts; and
(II) the holder of the claim is secured by personal property, the amount of such payments shall not be less than an amount sufficient to provide to the holder of such claim adequate protection during the period of the plan; or
(C) the debtor surrenders the property securing such claim to such holder; . . . credit, the forbearance agreement may include a commitment by the lender to extend additional credit. If the creditor elects to extend additional credit to the debtor, it also must take steps to protect its future dealings with the debtor to avoid any risk of loss beyond that existing at the time of identification of the problem. Any payment or security interest granted in property of the debtor that follows new value given to the debtor is encouraged by the Bankruptcy Code by virtue of the “new value” exception to the preference provisions.6 Thus, good credit management can limit preference exposure while you continue to do business with a financially troubled customer. To stay within the exception, good credit managers should never allow the “new value” to precede payments from the customers or to exceed the amount of the prior payment.
The parties to the forbearance agreement must evaluate the dynamics that will determine whether a Chapter 11 or a Chapter 13 bankruptcy plan may be confirmed and what might be accomplished in such plan by either the debtor or the lender. This requires an understanding of the requirements of the Bankruptcy Code for the contents, both permissive and mandatory, of a plan under either chapter, and an understanding of the dynamics that go into what it takes to get a plan approved in bankruptcy.7 These are discussed in detail in other portions of this program.
6 See §547(c)(4) provides as follows:
(c) The trustee may not avoid under this section a transfer . . .
(4) to or for the benefit of a creditor, to the extent that, after such transfer, such creditor gave new value to or for the benefit of the debtor--
(A) not secured by an otherwise unavoidable security interest; and
(B) on account of which new value the debtor did not make an otherwise unavoidable transfer to or for the benefit of such creditor . . .
7 Generally, in order to confirm a Chapter 11 plan of reorganization in the face of an objecting class of creditors, the court must find that all of the requirements of §1129(a) of the Bankruptcy Code, other than
§1129(a)(8) [each class of impaired claims has approved the plan], are satisfied [including §1129(a)(10), requiring acceptance of the plan by at least one class of claims that is impaired under the plan], and that the plan does not discriminate unfairly, and is fair and equitable, with respect to each class of claims or interests that is impaired under, and has not accepted, the plan. With respect to a class of secured claims, generally, the plan is fair and equitable as long as the holders of such claims retain the liens securing such claims, whether the property subject to such liens is retained by the debtor or transferred to another entity, to the extent of the allowed amount of such claims; and each holder of a claim of such class receives on account of such claim deferred cash payments totaling at least the allowed amount of such claim, of a value, as of the effective date of the plan, of at least the value of such holder's interest in the estate's interest in such property. Where the collateral is to be sold pursuant to §363(k) of the
Code, the plan must provide that such liens attach to the proceeds of such sale. Otherwise, the plan must provide for “the realization by such holders of the indubitable equivalent of such claims.” See §1129(b) of the Bankruptcy Code.
With respect to a class of unsecured claims, generally, the plan is fair and equitable if (i) the plan provides that each holder of a claim of such class receive or retain on account of such claim property of a value, as of the effective date of the plan, equal to the allowed amount of such claim; or (ii) the holder of any claim or interest that is junior to the claims of such class will not receive or retain under the plan on account of such junior claim or interest any property, except that in a case in which the debtor is an individual, the debtor may retain property included in the estate under section 1115, subject to the requirements of subsection (a)(14) of this section. Id.
The forbearance agreement does not necessarily waive existing defaults; rather, the creditor agrees to forbear from accelerating obligations or exercising rights it might otherwise have as a result of the existing defaults. The creditor must specifically identify which events or which new defaults might trigger the rights of the creditor. Further, the forbearance agreement also provides for the debtor and the guarantors to reaffirm all obligations without defense, setoff, or counterclaim. Finally, the forbearance agreement should include releases of any claims of lender liability on behalf of the debtor. Typical provisions of the forbearance agreement might include:
? Borrower's acknowledgment of the obligation and default
? Borrower waivers or releases of claims against the lender
? Lender's reservation of rights against third parties
? Ratification of the debt and the obligations under the loan documents
? Lender not waiving rights and remedies
? Provisions addressing the provisions of the loan documents may be modified, amended or waived by the lender, whether they will be permanent or temporary modifications
? Whether additional credit is to be extended
? Whether additional collateral is to be provided by the debtor
Finally, the forbearance agreement must be considered by the institutional lender in light of all applicable state and federal laws, such as laws and regulations that limit the powers of banks, insurance companies and other regulated entities, together with applicable tax, corporate and securities laws.
2. Out-of-Court- restructuring plans.
Out-of-Court debt restructuring plans or workout plans typically are agreements between the debtor and his creditors, collectively. In this writer’s experience, more often than not, these types of workout agreements involve requests that each of the general creditors of the debtor reduce their claims to an amount that represents the creditor’s share of the debtor’s liquidation value, when taking into account all secured and unsecured claims together with the priorities afforded certain claims under the law. The key to success is in the ability of the debtor to convince the creditors that they are better off with the treatment under the workout plan than they would be if the debtor were to pursue bankruptcy relief. Such savings can come in the form of (1) commitments by the debtor to sell assets on the open market at reasonable fair market values compared to the fire sale or auction values that are likely to be realized if the same thing is done through the bankruptcy court; (2) elimination of the cost of a bankruptcy trustee’s fees; (3) minimization of the legal expenses to be incurred through the workout as compared to an expensive litigated chapter 11 reorganization process; and (4) elimination of the delay likely to be experienced if the debtor is forced to seek bankruptcy relief.
Just as it is with the lender facing a troubled loan, the most important question facing a creditor group considering an out-of-court workout is whether there is any reasonable chance that it will solve the debtor's problems and maximize recovery on the creditors’ claims. If the economic reality of the situation is such that an out-of-court workout will not function as planned, at least some creditors, and usually the debtor, will be adversely affected by the attempt.
If the debtor's cash flow is negative and likely to remain negative, a proposal for an out-of-court workout that requires gradual repayment of existing indebtedness obviously will not work. The debtor’s effort in such cases should be to reduce the creditor claims to a point where the payments to creditors can be managed with the debtor’s existing cash flow.
An out-of-court workout requiring positive cash flow in excess of that which the debtor has historically produced will be a waste of time. In such cases, bankruptcy may be a better alternative. Any creditor participating in the negotiation of an out-of-court workout should keep in mind that economic reality must prevail, unless that creditor has an ulterior motive (for example, aging payments to it against the bankruptcy preference period).
There are generally two types of out-of-court workouts. One type involves a moratorium pending resolution of the debtor's difficulties through refinancing, a major sale, or infusion of investment capital. The other involves adjustment of indebtedness between the debtor and its creditors similar to reorganization under bankruptcy.
Chapter 11 of the Bankruptcy Code, and Chapter 13, where applicable, provide an orderly, court-supervised framework for the restructuring of indebtedness and the rehabilitation of a debtor's business. Bankruptcy reorganization may be impractical or not feasible based upon the financial affairs of the debtor. In such cases, Chapter 7 provides for the orderly court supervised liquidation of the debtor’s assets. The principal issue in determining whether to attempt an out-of-court workout is whether the advantages and disadvantages of an out-of-court workout versus those of a Chapter 11 reorganization weigh in favor of the workout.
There are two significant advantages to the reorganization of a debtor under Chapter 11 of the Bankruptcy Code which are not available in an out of court workout. These are the ability to bind dissenting creditors and the automatic stay of §362 of the Bankruptcy Code. The plan of reorganization in a Chapter 11 case will ordinarily be confirmed by a bankruptcy court if each class of creditors accepts the plan by a two-thirds majority in amount and a majority in number of those voting and if the other statutory requirements for confirmation are met. As previously noted, the court may even confirm a plan of reorganization if one or more classes have failed to accept the plan of reorganization as long as the “cram down” standards are satisfied. This means that creditors and other parties in interest in the Chapter 11 case are all bound by the terms of the plan of reorganization whether or not they favored it.
On the other hand, in an out of court workout, the dissenting creditor or other party in interest must be dealt with separately. Thus, for example, if a debtor has $100,000 with which to deal with a group of creditors having claims totaling $200,000, and the debtor's plan to pay a pro rata payment from that fund is accepted by 70% in amount, under Chapter 11, each creditor will receive 50% of its claim whereas, in the out-of-court workout, the 30% of dissenting creditors would represent $60,000 in claims that would have to be dealt with by the debtor separately, requiring reservation of $60,000 from the $100,000 fund to cover the claims of dissenters. In this writer’s experience, the latter circumstance dooms the out of court work out to failure. Thus, the key to success is in the debtor imposing a condition that the out of court workout will only be agreed to if all creditors agree to participate and accept the same treatment they would get if the plan were implemented through the bankruptcy process, which is to accept their pro rata share of any assets available for distribution to the general unsecured class of creditors.
The automatic stay provided by Bankruptcy Code §362 provides an automatic, nonconsensual moratorium, permitting a debtor and its creditors time to work out the debtor's problems. In an out-of-court workout, no such tool exists to deter one or more of the debtor's creditors from pursuing its remedies. Thus in an out-of-court workout situation, participating creditors must constantly be wary lest others either enforce their remedies to the disadvantage of the general creditor group or extort particular advantage in exchange for their agreement to defer pursuit of their remedies.
In bankruptcy, the court has the power to force persons to take actions and execute papers as necessary to carry out the terms of the confirmed plan of reorganization. Thus, should a plan be arrived at, and a release of lien be required from a dissenting creditor, such release may be forced by the court. No such leverage exists in an out-of-court situation.
Reorganization under the bankruptcy court allows the court to impose necessary controls on the management of the debtor. Creditors, without fear of being sued under causes of action based upon improper control of a debtor's business by a creditor may seek those controls without recourse. In addition, if the circumstances warrant, the Bankruptcy Code provides for the appointment of a trustee or examiner to oversee operation of the debtor's business or take control of the assets of the debtor.
Other advantages of Chapter 11 over the out of court workout include the ability of the debtor in Chapter 11 to reject or terminate contracts such as real property leases and other executory contracts. Thus, in a Chapter 11 case, the debtor may free itself of burdensome contracts of supply, leaseholds and the like. The claims arising from rejection of contracts in bankruptcy are unsecured claims, and the other parties to the contract with the debtor are foreclosed from pursuing equitable remedies, which might be available to them but for the pending bankruptcy case. Although a debtor is certainly free to include parties to such executory contracts in the negotiation of an out of court workout, this adds complexity to the workout that may not, as a practical matter, be easily overcome.
Another critical factor in the consideration of out of court workouts versus Chapter 11 reorganization is that where debt is forgiven as the result of an out-of-court workout, that forgiveness of debt gives rise to income for the debtor under §108 of the Internal Revenue Code (the “IRC”). In a Chapter 11 reorganization, on the other hand, debt forgiveness does not give rise to taxable income. An exception to the income from discharge of indebtedness rule under IRC §108 allows the debtor to exclude such debt forgiveness from income to the extent of the debtor’s insolvency. Essentially, if the debtor is insolvent at the time the debt is forgiven, it does not result in taxable income as long as the forgiven debt does not reduce the debtor’s debts to below the value of its non-exempt assets. Nevertheless, under some circumstances, this limitation on potential tax liability may give rise to an ability to treat creditors better under Chapter 11 than in an out-of-court workout.
There are many advantages to the out of court workout. First, a bankruptcy case is formal, complex, and consequently very costly. The very law that ensures that creditors' rights are observed necessitates formal action to accomplish many things that out of court would be done without a second thought. A Chapter 11 case requires significant and long term involvement by numerous attorneys. The cost may be substantial.
The out of court workout recognizes that if the debtor is already insolvent, heaping significant additional debts in the form of attorney fees makes it that much more difficult to overcome. Moreover, one of the major selling points for the out of court workout should be that if the debtor is forced to seek bankruptcy relief, be it reorganization through Chapter 11 or 13, or liquidation through Chapter 7, the debtor’s attorney fees in the Chapter 11 and 13, and the trustee’s fees and attorney fees in the Chapter 7, are treated as administrative expenses entitled to payment from the debtor’s assets in priority to the general unsecured creditors.
Thus, there are numerous advantages of the out of court workout:
• lower costs
• avoidance of lengthy delays involved in the Chapter 11 process
• perhaps a better chance of the debtor retaining some equity
• needed capital is preserved to fund the workout (selling point to creditors)
• debtor has more freedom to conduct his business
• avoids risk of appointment of trustee in Chapter 11 & loss of control
• avoidance of negative publicity
• less damage to the credible debtor’s reputation and integrity
• potential for higher recoveries to creditors
• creditors avoid risk of exposure to trustee avoidance powers (§§544-549)
Chapter 11 reorganization is usually a long drawn-out process and may leave secured creditors without the ability to force monthly payments by the debtor until a plan is confirmed. A creditor whose debtor has filed for relief under Chapter 11 of the Bankruptcy Code may expect delays of anywhere from six months to many years before recovery on its claim. There are also mixed blessings in being before the bankruptcy court. Depending on the position of any given creditor, or even a creditor group entering into a workout arrangement, the applicability of causes of action arising by virtue of a bankruptcy case may or may not be a good thing. Creditors entering into an out-of-court workout or a moratorium pending an out-of-court workout who receive consideration in return for their forbearance may find that such consideration is ordered returned by a bankruptcy court.
Some of the controls existing on the debtor for the protection of creditors may also cause severe problems for the creditor group. The Bankruptcy Code provides under §362 that the secured creditor must be accorded adequate protection if its collateral is to be used. The adequate protection accorded a secured creditor by negotiation or by order of the court may serve to strip a debtor's estate of property that would otherwise be available for satisfaction of unsecured creditors.
Finally, some debtors will suffer irreparable harm to the business by reason of a bankruptcy filing. Often the fear of this occurring is unwarranted, but on occasion the publicity associated with a bankruptcy may have a severe impact on a debtor. This would be especially true, for example, of a debtor whose customers relied on the debtor's continued existence to solve warranty problems or to complete custom fabrication. There are also certain types of business that have greater difficulty staying alive in bankruptcy. Businesses dependent on consumer confidence in their continuance (as, for example, with warranties) suffer in Chapter 11. Businesses that depend on the willingness of others to extend their credit (as with bonding companies that bond contractors) often have difficulty with Chapter 11 operations. While problems of this sort may be overcome, they certainly militate against a bankruptcy filing. The basic provisions of an out-of-court workout plan should not be substantially different from those of a plan of reorganization. An out-of-court workout plan does not need to conform to some of the requirements of a Chapter 11 reorganization plan. However, the law permits a debtor to submit an out-of-court workout plan to the bankruptcy court and use acceptances of that plan to obtain its confirmation. Thus if a debtor and its creditors anticipate utilizing the Bankruptcy Code to confirm an out-of-court workout plan, it is appropriate to conform the plan to the requirements of the Bankruptcy Code. Because the out-of-court plan and the Chapter 11 plan will have some differences, the better practice is to provide creditors with a copy of the plan to be filed in an ensuing Chapter 11 as an exhibit to the workout plan when votes on the Chapter 11 plan are sought.
Often a debtor may be capable of getting the requisite majorities for confirmation of a Chapter 11 plan, but dissenters are too great in aggregate amount to permit implementation of the plan outside of Chapter 11. By utilizing the ability to present the out-of-court plan to the bankruptcy court for confirmation, the debtor substantially shortens the time required for reorganization and avoids the difficulties of dealing with dissenters.
The plan may provide that if more than a certain proportion of the creditors accept the plan, the debtor will be obligated to perform the plan even though dissenters remain who must be dealt with. The plan may also provide that if creditors holding less than the required amount of indebtedness agree to accept the plan the debtor may, at its option, perform. Under certain circumstances, creditors will wish the debtor to be prohibited from performing under the plan if the acceptance rate is too low; for example, in certain circumstances where creditors look to the debtor's cash flow to satisfy them, a substantial group of dissenting creditors may create a sufficient impediment to the realization of that cash flow to make it impossible to carry out the terms of the plan. Accepting creditors will be concerned that non-participating creditors will gain preferential treatment.
An out-of-court plan should provide for satisfaction of small creditors. It may be that the debtor will be accorded the right to deal with small creditors even prior to dissemination of the plan to affected creditors. Creditors negotiating an out-of-court workout should keep in mind that the likelihood of its success is increased by a reduction in the number of people who will be affected by it. Furthermore, it may be that disbursement to creditors under the plan will be a complex process and the degree of complexity may make satisfaction of relatively small claims under the plan uneconomical. Moreover, because the bankruptcy law allows for differing treatment of small claims without violation of the absolute priority rule in the plan confirmation context, creditors are less likely to be concerned that small creditors are receiving a greater return per dollar than those participating in the plan.
To the extent that the plan provides for a waiver of rights by creditors, the debtor should agree to an extension of any time limits on pursuit of those rights until the plan is performed. A creditor, for example, who is owed $200,000 and accepts a payout of $100,000 under a plan ought to be able to assert its full claim in the event that the debtor fails fully to perform. If the plan does not provide for a waiver of the statute of limitations, limitations may run concerning the $100,000 debt, leaving the creditor with a claim limited to its contractual rights under the workout plan.
A plan may provide options. Especially if the plan provides for an exchange of notes or equity in the debtor for claims, it is wise to allow smaller creditors to opt out for a cash payment of a part of their claims.
Just as with Chapter 11 plans, adequate provision should be made for carrying out the terms of the plan after it is agreed to by all creditors. It may be important to provide for a creditor representative to act for creditors, since the creditors themselves may lose interest in policing the activities of the debtor as soon as the terms of the plan are agreed to. Out of court workout arrangements may include many of the features that are available in Chapter 11 reorganizations. These might include exchange features, where a new debt instrument is exchanged for existing debt instruments, conversions of debt to equity, moratoriums, new financing, modifications of interest rates, collateralization of previously unsecured debts, management changes, and forgiveness/discharge of debt.
In pursuing an out of court workout arrangement, consideration should be given to the following:
• prepare financial disclosure (financial statements, narrative outlining condition and objectives of out of court workout effort, prepare bankruptcy Schedules & Statement of Financial Affairs, means test analysis)
• confidentiality agreement to protect dissemination of non-public information
• request a moratorium from prosecution of litigation
• furnish periodic progress reports
• be mindful of applicable federal and state laws such as securities laws
• call meeting of creditors whose claims are expected to be impaired
• adhere to pro-rata participation in debtor’s assets and cash flow
• establish committees of like situation creditors - negotiate through representatives of committees
• conversion of debt to equity
• factor in tax consequences
• offer of collateralization (preferably in return for new value)
• management changes?
• hire workout specialist executive?
• work hard to preserve or restore debtor credibility & integrity
• consider possible role for a mediator
3. Orderly Liquidation: Sales and Friendly Foreclosures.
As has been alluded to above, for the debtor who is willing to face the reality that his business or investment property has failed with nothing available to be salvaged for the debtor save his credibility, integrity and a semblance of his or her good name, there are advantages to such debtor if he or she can avoid a bankruptcy filing by implementing an orderly out of court liquidation of the business or a friendly foreclosure proceeding. Generally, an out of court liquidation has the potential to leave some equity to the debtor not otherwise available in a Chapter 7 bankruptcy case if the debtor is able to sell assets on the open market rather than through trustee sales, while at the same time, avoiding the added expenses of the Chapter 7 case. Sometimes, the tax implications to the debtor may stand in the way of out of court liquidations. For tax purposes, the filing of Chapter 7 or Chapter 11 bankruptcy petition by an individual gives rise to a separate taxable entity which succeeds to the assets, liabilities, and certain tax attributes of the debtor, i.e., the bankruptcy estate, which is wholly distinct from the individual for income tax purposes. No Separate entity is created upon the commencement by an individual of case under Chapter 13, or in the case of any other entity under title 11 (e.g. corporations, partnerships and LLC's). IRC 1398.
Tax is computed in the same matter as for an individual using rates applicable to married persons filing separate returns. The estate receives a personal exemption and, if it does not itemize deductions, uses the basic standard deduction for married filing separate. IRC 1398(c).
The estate includes in gross income: (i) any gross income item of the individual debtor which, under substantive bankruptcy law (11 U.S.C. 541) constitutes property of the bankruptcy estate; and (ii) the gross income of the estate beginning on and continuing after the date the case is commenced. The gross income of the debtor does not include any item to the extent that such item is included in the gross income of the estate. IRC 1398(e). The estate takes deductions for the normal trade or business expenses which the individual debtor would normally be entitled to, and in addition, the estate is entitled to deduct the administrative expenses of the bankruptcy case. IRC 1398(h).
Thus, any element of gain on a sale by trustee of the debtor's property is taxed to the trustee/estate which does not get a deduction or exclusion for payment to the debtor of portion of proceeds attributable to any exemption available to the debtor. The individual debtor is considered to hold a lien on the property to the extent of his/her homestead exemption. See PLR 91-22042 in which the IRS reversed its position in PLR 90-17075.
The transfer of assets from the individual debtor in a Chapter 7 or Chapter 11 case, to the bankruptcy estate (other than by sale or exchange) is not considered a disposition of the assets for tax purposes, and thus, does not trigger recognition of gain or loss. IRC §1398(f)(1).
Likewise, \"in the case of a termination of the estate, a transfer (other than by sale or exchange) of an asset from the estate to the debtor shall not be treated as a disposition for purposes of assigning tax consequences to the disposition, and the debtor shall be treated as the estate would be treated with respect to such asset. IRC §1398(f)(2).
In the sale or exchange of property, a taxpayer is chargeable with income on the excess of the amount realized over the adjusted basis. 26 U.S.C. §1001(a). Foreclosure of a mortgage with recourse is treated as a sale by the property owner notwithstanding the involuntary nature of the transaction. Helvering v. Hammel, 311 U.S. 504, 510, 61 S.Ct. 368, 371, 85 L.Ed. 303 (1941). The same is true with respect to foreclosure of a mortgage or other lien where the holder of the lien has no recourse against the owner for a deficiency. Helvering v. Nebraska Bridge Supply & Lumber Co., 312 U.S. 666, 61 S.Ct. 827, 85 L.Ed. 1111 (1941). The amount realized for income tax purposes in the sale of property subject to a nonrecourse mortgage equals the balance of the debt, whether the sales price is more or less than the debt or the property's value, and whether it is a sale to a third party or a deed in lieu of foreclosure. Commissioner v. Tufts, 461 U.S. 300, 103 S.Ct. 1826, 75 L.Ed. 2d 863 (1983) (assumed nonrecourse mortgage exceeded value of property); Crane v. Commissioner, 331 U.S. 1, 67 S.Ct. 1047, 91 L.Ed. 1301 (1947) (property sold for more than nonrecourse debt); Laport v. Commissioner, 671 F.2d 1028 (7th Cir. 1982) (deed in lieu of foreclosure). If the mortgage is with recourse, and the transaction involves satisfaction of the entire debt, the amount realized is also the full amount of the debt. Chilingirian v. Commissioner, 918 F.2d 1251 (6th Cir. 1990).
Thus, if property is foreclosed upon while it remains property of the bankruptcy estate in a Chapter 7 or Chapter 11 case, the bankruptcy estate is liable for any taxes on any gain recognized on the transaction. The IRS takes the position that a tax liability of the estate is not triggered upon an abandonment of property to the debtor. It takes the position that if such an abandonment occurs, a subsequent foreclosure or datien of the property will trigger a post petition tax liability of the debtor. Therefore, trustees typically abandon such property unless there is equity to the bankruptcy estate which can be realized upon sale of the property, and in such cases, the trustee must evaluate the impact of any tax liability on such a sale in determining whether it is in the best interest fo the estate to sell the property abandon it. If the secured debt on property substantially exceeds its tax basis, the tax attributable to the gain on a foreclosure or datien may exceed the amount of equity over and above the secured debt. Therefore, as a practical matter, a debtor should not forego an opportunity to allow a friendly foreclosure on the hope that he or she can avoid the tax liability inherent in the transaction by filing Chapter 7 and expecting that the tax liability will fall to the Chapter 7 bankruptcy estate unless there is sufficient equity in the property that the trustee will find realize net proceeds which materially exceed the tax liability created by the transaction.
While the debtor may find it impossible to pay the resulting tax liability, he or she may, nevertheless, be better off suffering the tax liability in an out of court liquidation or foreclosure and relying upon his or her ability to discharge that liability in a Chapter 7 case filed more than three years after the due date of a timely filed tax return for the year of the foreclosure or liquidation sale.8 The alternative might be the debtor is left to suffer the tax liability after filing a Chapter 7 case when the trustee abandons the property to avoid the tax liability and due to lack of sufficient equity, and the property is foreclosed upon by the lender after the abandonment to the debtor. Then the debtor is ineligible to file another Chapter 7 case for another eight years.9
4. Prenegotiated Bankruptcy Cases.
Prenegotiated bankruptcy cases may take any number of forms. There may be aspects of the lender/borrower relationship that can be agreed upon in contemplation that the debtor will file a Chapter 7, Chapter 13 or Chapter 11 bankruptcy case.
Just like a successful out-of-court workout, a pre-negotiated Chapter 11 plan requires substantially all of the company’s major creditors to negotiate, and ultimately agree upon, an agreement resolving the economic and legal issues confronting the debtor. Such a plan is more likely to succeed where the debtor’s financial structure is fairly simple, or where only a portion of the debt structure must be impaired to facilitate a successful restructuring.
Bankruptcy Code contemplates pre-packaged Chapter 11 plans. §1102(b)(1) allows a committee of creditors established prior to a bankruptcy filing to act as the official committee of creditors in the bankruptcy case “if such committee was fairly chosen and is representative of the different kinds of claims to be represented,” although a party in interest may request that the composition of any statutory committee be changed. §1121(a) specifically allows a debtor to file a plan with its petition. §1126(b) provides for the prepetition solicitation of acceptances of a plan. §1125(g) provides:
Notwithstanding subsection (b) [no solicitation in absence of acceptance or rejection in absence of plan and disclosure statement], an acceptance or rejection of the plan may be solicited from a holder of a claim or interest if such solicitation complies 8 §523(a)(1)(A), by way of the Bankruptcy Code excepts from the debtor’s discharge any tax on or measured by income for a taxable year ending on or before the date of the filing of the bankruptcy petition for which a return, if required, is last due, including extensions, after three years before the date of the filing of the petition. 9 See §727(a)(8). with applicable nonbankruptcy law and if such holder was solicited before the commencement of the case in a manner complying with applicable nonbankruptcy law.
The Chapter 11 plan, including the prepackaged plan, carries these benefits:
• ability to modify payment terms of debt owed by a class of creditors by counting only those creditors voting
• ability to define, liquidate and disallow claims
• procedural complexities that often cause creditors to abstain from participation in the process, which allows the debtor to control the process
• ability to accept or reject contracts
• favorable tax treatment for discharge of debt
• exemption from securities laws
• ability to bind all creditors, including those opposing or objecting to the plan
• ability to resolve contingent, unliquidated, and unmatured claims through the estimation procedures or trust arrangements
• ability to complete quick sales of encumbered assets free and clear of liens and encumbrances
• reject executory leases while limiting breach damages
• ability to reject collective bargaining agreements subject to the provisions of §1113
• stop litigation and other creditor actions through the automatic stay under §362
• potential to eliminate balance sheet debt at less than full payment while maintaining control for existing management or owners
In the historic classic example of the pre-packaged Chapter 11 filing, In re General Motors Corp., 407 B.R. 463 (2009), part of the plan for General Motors was a §363 sale, which allows the purchaser of the assets of a company in bankruptcy proceedings to obtain approval for the purchase from the court prior to the submission of a reorganization plan, free of liens and other claims (i.e. successor liability). The Bankruptcy Court in the General Motors case approved the sale holding that:
1. \"good business reason\" existed for allowing debtor to sell its assets immediately to purchaser sponsored by government, rather than having to wait for confirmation of plan;
2. Government-sponsored purchaser had to be deemed as acting in \"good faith\"'
3. Proposed sale was not an impermissible \"sub rosa plan\";
4. \"debt\" that debtor owed to government, for financing that government had made available in order to keep manufacturer afloat until it could enter bankruptcy and to assist it with its reorganization, could not be restructured as \"equity,\" so as to prevent government from credit-bidding amount of debt;
5. Government's claim could not be equitably subordinated;
6. Debtor's assets could be sold free and clear of successor liability claims;
7. Chapter 11 plan confirmation requirement, which prevented court from confirming proposed plan unless it provided for \"continuation after its effective date of payment of all retiree benefits,\" was not implicated in connection with sale outside the ordinary course;
8. Debtor did not have to choose between either assuming its dealer agreements and assigning them to purchaser or rejecting them outright but could seek to ameliorate effects of immediate rejection and to provide dealers with softer landing by negotiating deferred termination agreements;
9. Court could not utilize its equitable power to enter \"necessary or appropriate\" orders, in order to force purchaser to assume certain liabilities of the old debtormanufacturer based on court's notions of equity;
10. Any objection to use of Troubled Asset Relief Program (TARP) funds in connection with financing that government had provided to debtor was moot; and
11. Debtor's shareholders were not parties aggrieved, with ability to challenge proposed sale.
The pre-packaged or pre-arranged Chapter 11 plan can include any Chapter 11 case in which the debtor has discussed with some constituency prior to the commencement of the bankruptcy some form of reorganization or restructuring to be accomplished through the Chapter 11 process and has received some form of commitment (which may or may not be contractual or binding by its terms) form the constituency to support (in some form) a Chapter 11 plan that accomplishes a reorganization or restructuring that, prior to the bankruptcy case has been:
• negotiated with representatives of the most significant contituencies that are expected to be impaired under the plan and whose acceptance is sought or needed for confirmation (e.g. the senior bank lenders (often known as the 800 pound gorilla), bondholders and principal equity security holders).
• agreed to by those representatives (even if those representatives, by themselves, constitute a significant portion of the creditor class but are not sufficient in number or amount to assure acceptance of the particular classes of claims they represent.
• memorialized in written agreements containing all or most of the definitive terms of a plan of reorganization (sometimes referred to as “lockup agreements”). The term “prearranged plan” is often used to refer to the context in which official solicitation of ballots is neither begun nor completed until the bankruptcy case commences; while the term “prepackaged plan” is often used to refer to the context in which the solicitation occurs prior to the bankruptcy filing and is governed by nonbankruptcy law, including applicable securities laws. Typical steps in the prearranged plan might include:
• negotiation of the terms of an agreement with the senior lender and representatives of bondholders or major general unsecured creditors by management
• approval of a term sheet and lockup agreement by the debtor
• filing the bankruptcy petition, plan of reorganization and disclosure statement on the first day, or soon thereafter, in accordance with the lockup agreement
• hearing on approval of the disclosure statement
• solicitation of ballots
• hearing on confirmation
• plan effectiveness
B. UNILATERAL COLLECTION EFFORTS.
1. Self-Help UCC Remedies.
Louisiana law permits financial institutions and regulated lenders to use self-help only in the repossession of motor vehicles where repossession can be achieved without a breach of the peace and is accomplished through a licensed “repo-man”. R.S. 6:966.
These procedures may be used to obtain possession and dispose of collateral following default by a debtor without previous citation and judgment to enforce a security interest evidenced by a security agreement or a lease. Prior to the use of these procedures, a secured party must send notice to all debtors in writing at the last known address of the debtors, of the right of the secured party to take possession of the collateral without further notice upon default as defined in R.S. 6:965(C). Such notice must include the debtor's name, last known address, and description of the collateral and the following in at least twelve-point type:
“Louisiana law permits repossession of motor vehicles upon default without further notice or judicial process.” After obtaining possession of the collateral, the secured party may dispose of it in any manner permitted by Chapter 9 of the Louisiana Commercial Law, R.S. 10:9-101 et seq. or by resort to available judicial procedures, and may cause the collateral to be retitled. Unless the secured party causes the collateral to be sold at judicial sale under ordinary or executory process, all receipts from the secured party's disposition of the collateral shall be applied as set forth in R.S. 10:9-601, and the secured party shall be obligated to account to the debtor for any surplus.
These provisions may be utilized only by:
(1) Financial institutions chartered under the laws of the state of Louisiana, another state, or the United States.
(2) Persons licensed or regulated as lenders by the commissioner of financial institutions pursuant to the Louisiana Consumer Credit Law, R.S. 9:3510 et seq.
(3) Persons licensed or regulated as lenders by the Louisiana Motor Vehicle Commission pursuant to the Louisiana Motor Vehicle Sales Finance Act, R.S. 6:969.1 et seq.
Any individual who physically obtains possession of the collateral pursuant to these provisions must obtain a repossession agent license from the Office of Financial Institutions. In the event a tow truck, as defined in R.S. 32:1713, is required to be used in the repossession, the provisions of Chapter 16 of Title 32 of the Louisiana Revised Statutes of 1950 pertaining to tow trucks shall apply. The tow truck owner or operator, as defined in R.S. 32:1713, is required to possess a common carrier certificate issued by the Louisiana Public Service Commission pursuant to R.S. 45:164.
The secured party retains all of the possessory and enforcement rights provided under Chapter 9 of the Louisiana Commercial Laws, R.S. 10:9-101 et seq., including the right to recover a deficiency or any other costs associated with the seizure proceeding.
If the debtor has personal property of his own or of another inside the repossessed collateral, the owner of the personal property has ten days in which to contact the repossessing creditor and demand the return of his property. The secured party must immediately return the personal effects upon request of the debtor. At the end of thirty days following the repossession of the collateral, the personal effects located inside of the repossessed collateral shall be deemed abandoned and the secured party is no longer be responsible for them.
2. Prejudgment Sequestration & Attachment.
La.C.Civ.Pr. Article 3501 of the La. Code of Civil Procedure authorizes issuance of a writ of attachment or sequestration only when the nature of the claim and the amount thereof, if any, and the grounds relied upon for issuance of the writ clearly appear from specific facts shown by a verified petition, or by a separate affidavit of the petitioner or his counsel or agent. The petitioner is required to furnish security for the payment of damages the defendant may sustain if the writ is determined to have been obtained wrongfully.
Attachment or sequestration may issue before the petition is filed, upon obtaining leave of court and filing of security. Garnishment is available under a writ of sequestration if the plaintiff claims ownership or possession of the property held by a third party or a privilege thereon. La.C.Civ.Pr. Art. 3503.
A final judgment must be obtained by the plaintiff before the property subject to a writ of attachment or sequestration may be sold to satisfy the claim of the plaintiff. La.C.Civ.Pr. Art. 3510. Attachment or sequestration effects a privilege upon the property subject to the writ. La.C.Civ.Pr. Art. 3511. This may be important if the debtor ultimately files for bankruptcy relief because the 90 day preference period commences upon attachment or sequestration. If the debtor waits until the outcome of the case to decide whether to file bankruptcy, the petitioner may escape exposure to the preference action in the bankruptcy case if he has obtained attachment or sequestration prior to entry of the judgment on the merits.
Pursuant to La.C.Civ.Pr. Art. 3541 attachment is available when:
(1) the debtor has concealed himself to avoid service of citation;
(2) the debtor has granted a security under Chapter 9 of Title 10, or has mortgaged, assigned or disposed of his property or is about to do any of these acts with intent to defraud his creditors or give some unfair preference to one or more of them;
(3) the debtor has converted or is about to convert his property into money or evidence of debt, with intent to place it beyond the reach of his creditors;
(4) the debtor has left the state permanently or is about to do so before a judgment can be obtained and executed against him; or
(5) is a nonresident who has no duly appointed agent for service of process in the state.
Pursuant to La.C.Civ.Pr. Art. 3571 sequestration is available when the plaintiff claims the ownership or a right to possession of property, or a mortgage, security interest, lien or privilege thereon if it is within the power of the defendant to conceal, dispose of, or waste the property or the revenues therefrom, or remove the property from the parish, during the pendency of the action.
Sequestration based on a lessor’s privilege may be obtained before the rent is due, if the lessor has good reason to believe that the lessee will remove the property subject to the lessor’s privilege. If the rent is paid when it comes due, the costs must be paid by the plaintiff. La.C.Civ.Pr. Art. 3572. Under Article 3575, a writ of sequestration to enforce a lessor’s privilege does not require the furnishing of security.
Since the lessor’s privilege is not sustainable against a trustee in bankruptcy as a statutory lien (Bankruptcy Code §545, In re WRT Energy Corp., 169 F.3d 306 (5th Cir. (La.) 1999)), the lessor may benefit from the sequestration of property subject to the privilege if the debtor allows the 90 day preference period to run after the seizure, because the privilege afforded the petitioner from the pre-judgment seizure of the property should qualify as a judicial lien. In re Skinner, Bkrtcy.W.D.Tenn.1997, 213 B.R. 335.
The court may, on its own motion, order the sequestration of property the ownership of which is in dispute without requiring security when one of the parties does not appear to have a better right to possession than the other.
3. Collection lawsuits/Garnishment.
In execution of a judgment obtained in a collection action, the plaintiff may employ the use of garnishment proceedings. These rules are found in the La. Code of Civil Procedure at Articles 2411 set seq.
4. Receiverships.
Under La.R.S. 12:151, a court may, after trial, appoint a receiver to take charge of a corporation's property when it is made to appear, in a proceeding instituted against the corporation:
(1) By any shareholder or creditor, that the directors or officers of the corporation are jeopardizing the rights of its shareholders or creditors by grossly mismanaging the business, or by committing gross and persistent ultra vires acts, or by wasting, misusing or misapplying the assets of the corporation; or
(2) By any shareholder or creditor, that the corporation's property has been abandoned, or that, by failure of the shareholders to elect directors, or the failure of the directors or officers to serve, there is no one authorized to take charge of or conduct its affairs; or
(3) By any creditor, that the corporation is insolvent, or such creditor's claim has been reduced to judgment, on which execution has been issued and returned “nulla bona”; or
(4) By any creditor, that property of the corporation has been seized under judicial process by fraud or collusion between the corporation, its directors, officers or shareholders, and any creditor; or
(5) By any shareholder, that a majority of the shareholders are violating the rights of minority shareholders and endangering their interests; or
(6) By a shareholder or shareholders, severally or jointly, who have been registered owners for a period of not less than six months of not less than twenty per cent of the entire outstanding shares of the corporation, that either of the grounds for involuntary dissolution set forth in R.S. 12:143(A)(4) and (5) exists. The court may, ex parte, pending trial, (1) appoint a temporary receiver whose authority shall cease upon appointment of a receiver after trial or upon dismissal of the proceeding, (2) on the applicant furnishing security in the amount fixed by the court, enjoin the corporation and its directors, officers, agents and shareholders from disposing of its property or changing the status of its affairs to the injury of the applicant, and (3) stay proceedings by other persons against the corporation's property.
If a receiver is appointed, after trial, on application by a shareholder or shareholders, the court shall make a reasonable allowance for the fees of the applicants' counsel, which, together with their other costs, shall be taxed as costs and paid out of the corporate assets. The corporation or the receiver shall have the right to recover the amount of such costs from any directors, officers or shareholders whose conduct was the cause of the proceeding under subsection A(1) or (5) of this section. If an application by a shareholder or shareholders is dismissed, and the court determines that the application was made in bad faith, the applicants shall be condemned to pay reasonable counsel fees and other expenses incurred by the corporation, or by the directors, officers or shareholders on whose conduct the application was based under subsection A(1) or (5) of this section. In case of an application under subsection A(1) or (5) of this section, the court may require the applicant or applicants to post reasonable bond to cover their liability, if any, under this subsection.
Courts are slow to interfere with management of the affairs of a corporation, in absence of a clear showing of fraud or breach of trust, and will order appointment of a receiver only when it is manifest that such appointment should be made, being influenced by consideration of whether such action will serve a useful purpose. Peiser v. Grand Isle, Inc., 221 La. 585, 60 So.2d 1 (La. 1952).
A receiver will not be appointed for a solvent corporation at instance of a minority shareholder in absence of clear showing of fraud or breach of trust, and then only when it is manifest that action would serve useful purpose. Farwell v. Milliken & Farwell, Inc., 145 So.2d 644 (La. App. 4 Cir.1962).
Courts may, in exercise of their inherent equitable power, appoint receiver for voluntary association that is classed as neither corporation nor partnership where exigencies of case require it. Levy v. Bonfouca Hunting Club, 223 La. 832, 67 So.2d 96 (La. 1953).
Under La.C.C. Art. 2834, in the absence of a contrary agreement, a partnership is liquidated in the same manner and according to the same rules that govern the liquidation of corporations. Querie whether this includes La.R.S. 12:151 to permit appointment of a receiver pursuant thereto for a partnership. Former R.S. 12:751 et seq. authorizing and regulating the appointing of receivers of corporations was not applicable to the appointment of liquidators or receivers of a partnership. Sklar v. Kahle, 196 La. 137, 198 So. 883 (La. 1940). The Supreme Court in Sklar recognized that there were several decisions in the lower courts that had approved appointment of receivers for partnerships. The court recognized that one of the prior decisions referred to the so-called receiver, indiscriminately, as a receiver or liquidator, thus: ‘Thereupon a receiver or liquidator was appointed to the partnership.’ It was said that the authority to appoint a receiver or liquidator of a partnership was found in the equity power conferred upon the courts by article 21 of the Revised Civil Code—as it was with regard to appointing receivers for corporations before the adoption of the act of 1898. In dictum, the court noted:
The jurisprudence on the subject, therefore, has left no doubt that
the practice of appointing liquidators for partnerships—even
though they may be called receivers instead of liquidators—is not
governed by Act No. 159 of 1898, the object of which is declared
in its title to be merely to authorize and regulate the practice of
appointing receivers of corporations. Under that title we doubt that
the statute could be construed as authorizing and regulating the
appointment of receivers for partnerships, without doing violence
to the constitutional requirement that the title of a statute must be
indicative of its object. The provisions in the statute itself, for the
most part, show that it was not intended to authorize or regulate the
appointment of receivers of partnerships. For example, the causes
for which a receiver may be appointed, first, at the instance of any
stockholder, second, at the instance of any stockholder or creditor,
third, at the instance of any mortgage or privilege creditor, and,
fourth, at the instance of any creditor, are not applicable to a
partnership, as they are to a corporation.
There appear to be no cases subsequent to Sklar which have addressed whether receivership is available with respect to partnerships. Article 2834 appears to have been added to the Civil Code by the 1980 session of the legislature, with no similar predecessor in the law. It refers only to liquidation of a corporation. It is noteworthy that La.R.S. 12:151 appears under Part XV of Title 12, entitled “Receivers”, while Liquidation appears in Part XIV, entitled “Dissolution.”
It is equally unclear whether receivership applies to limited liability companies. The Louisiana Limited Liability Company law contains no provision expressly addressing the issue of receivership. The statute has its own Part VII on Dissolution, beginning at La.R.S. 12:1334, et seq. Note that while the business corporation statute provides for involuntary dissolution proceedings (§143) instituted at the behest of a judgment creditor whose execution on the corporation has been issued and returned “nulla bona”, or at the behest of a receiver appointed under R.S. 12:151, the LLC statute has no such provisions. It provides in §1335 for Judicial dissolution, which provides: “On application by or for a member, any court of competent jurisdiction may decree dissolution of a limited liability company whenever it is not reasonably practicable to carry on the business in conformity with the articles of organization or operating agreement.”
Article 1303 of the LLC statute provides that “All limited liability companies . . . shall have the powers, rights, and privileges provided for a corporation organized under the Business Corporation Law (R.S. 12:et seq), and provided for a partnership under Title XI of Book III of the Louisiana Civil Code.” While one might argue this somehow incorporates by reference the provisions of R.S. 12:151, it would seem doubtful a court would find that this was intended when the legislature specifically provided for liquidation in the LLC statute and left out any provision for receivership, and even omitted to allow for involuntary dissolution proceedings upon the petition of a judgment creditor.
5. Real Estate foreclosures and Receiverships.
(a) Petition, Seizure, and Sale (La. Code of Civ. Proc. Art. 2631)
Under the rules of executory process, there can e rapid foreclosure and certain property may be sold without obtaining a personal judgment against the debtor. Venue is the parish where the property is located or where venue is proper under La. Code of Civ.Proc. art. 42 only.
i. Requirements
A mortgage or privilege executed by authentic act (i.e., in the presence of a notary and two witnesses), or a security agreement under Chapter 9 of the Louisiana commercial laws (which need not be executed before a notary) containing a confession of judgment clause. If movable property, may be by private signature duly acknowledged or by authentic act.
ii. Procedure
a. Petition
File a petition praying for seizure and sale and include all authentic evidence. Note that “every link in the chain” of evidence must be in authentic form except facts as to the identity of the proper defendant, taxes due, insurance, etc., or evidence the law expressly treats as authentic evidence of the note, bond, or other debt instrument secured by the mortgage, security agreement or privilege; the authentic act of mortgage or privilege on immovable property importing a confession of judgment; or the act of mortgage or privilege on movable property importing a confession of judgment, whether by authentic act of private signature duly acknowledged. If authentic evidence is missing, must proceed by ordinary process.
Note: An executory proceeding may be brought against the surviving spouse (without naming the heirs), the heirs or legatees (if the mortgagor is dead), or the attorney appointed to represent an absentee or a succession (where no succession representative has been appointed), or a corporation or partnership (upon whom service cannot be made).
b. Execution of a Writ of Seizure and Sale
The sheriff seizes the property and the defendant must be given written notice of the seizure. This cannot be waived.
c. Mennonite Notice
The sheriff provides Mennonite notices as with seizures under a writ of fifa.
d. Debtor’s Options
At this point the debtor’s only recourse is to seek to enjoin the seizure, or a suspensive appeal
1) Injunction
An injunction can be granted upon a showing that:
a) Debt Extinguished
The debt has been extinguished; or
b) Debt Unenforceable
Is unenforceable; or
c) Proper Procedure not Followed
That property executory process procedure (e.g., lack of “authentic evidence”) has not been followed.
2) Appeal
A suspensive appeal (requiring bond to be posted) may be taken by the debtor within 15 days of the signing of the order directing issuance of the writ seizure (La. Code of Civ. Proc. art. 2642).
3) Stipulated Attorneys’ Fees
A claim that attorneys’ fees stipulated in the mortgage or privilege are unreasonable is not grounds for injunction but must be raised by rule to show cause filed at least 10 days before sale, and heard before sale, or as defense to deficiency judgment proceeding after sale. A second mortgage may contest fees by intervention in the foreclosure.
e. Auction
An auction is then conducted according to the rules provided for foreclosure sales under execution of a judgment (writ of fieri facias), except that the property need not be appraised if appraisal is waived in the mortgage. Note: Seized property subject to LCC need not be appraised prior to sale. La. Code of Civ. Proc. art. 2723. Note that there is no requirement that seized property subject to a security interest under Chapter 9 of the Louisiana Commercial Laws (La.R.S. 10:9-101, et seq), be appraised prior to judicial sale.
f. Notice to Junior Lienholders
Prior to sale the seizing creditor should give notice to all junior lienholders (and property owner if difference from mortgagor) of the seizure and sale.
g. If Mortgagor Sells Property Seized
If the mortgagor has sold the property seized to a third party, that party’s rights are to pay the debt, enjoin the sale on any ground set forth in (e) above or that mortgage not recorded, or intervene to claim proceeds equal to his improvements to property. La. Code of Civ. Proc. art. 2703.
(b) Deficiency Judgments
i. Definition
A deficiency judgment is obtained by suit to collect the balance due if the proceeds from the sale of the debtor’s property in an executory proceeding are insufficient to satisfy the debt. The Deficiency Judgment Act does not apply to sales in connection with Chapter 9 of the UCC.
ii. Requirements
Generally, an appraisal must have been made or the creditor’s right to a deficiency judgment is waived, unless the non-appraisal sale was made through a major stock exchange, foreclosure was pursuant to a mortgage in a commercial transaction, or some other exceptions created by the Louisiana Deficiency Judgment Act (La. Rev. Stat. 13:4106) is satisfied. La. Code of Civ. Proc. art. 2771.
iii. Procedure
Convert executory proceeding into an ordinary proceeding or file a separate suit. In either case, ordinary process applies. La. Code of Civ. Proc. art. 2772.
iv. Use of Affirmative Defenses by Debtors
(Like set off) to action for deficiency, debtors may raise affirmative defenses, but they may not raise defects in executory process as a defense.
6. Remedies Against Guarantors.
Actions against guarantors are brought by filing suit in an ordinary proceeding. In ordinary proceedings, petition is served upon the defendant who is cited to appear and respond within 15 days of service. The defendant may file any one of a number of exceptions and these are often employed either to obtain a quick dismissal of the petition, for instance, where the claim has prescribed, is barred by the doctrine of res judicata, etc. Parties are allowed to engage in discovery of facts through various discovery procedures.
Either party may move for a summary judgment if there are no disputed issues of material fact under the law such that judgment may be granted as a matter of law. If the case cannot be resolved by summary judgment, then a trial on the merits is required. If a judgment is obtained, the plaintiff them may execute on the judgment by seizing property of the debtor.
7. Involuntary Bankruptcy Proceedings.
§ 303 of the Bankruptcy Code provides that an involuntary bankruptcy case may be commenced only under chapter 7 or 11, and only against a person, except a farmer, family farmer, or a corporation that is not a moneyed, business, or commercial corporation, that may be a debtor under the chapter under which such case is commenced.
The involuntary case against a person is commenced by the filing with the bankruptcy court of a petition under chapter 7 or 11 by three or more entities, each of which is either a holder of a claim against such person that is not contingent as to liability or the subject of a bona fide dispute as to liability or amount, or an indenture trustee representing such a holder, if such noncontingent, undisputed claims aggregate at least $14,425 more than the value of any lien on property of the debtor securing such claims held by the holders of such claims.
If there are fewer than 12 such creditors, excluding any employee or insider of the debtor and any transferee of a transfer that is voidable under §§544, 545, 547, 548, 549, or 724(a), then the petition may be filed by one or more of such creditors that hold in the aggregate at least $14,425 of such claims.
If the debtor is a partnership, then the petition may be filed by fewer than all of the general partners in such partnership; or if bankruptcy relief has been ordered under with respect to all of the general partners the partnership, by a general partner in the partnership, the trustee of the general partner, or a holder of a claim against the partnership.
An involuntary petition may also be filed by a foreign representative of the debtor’s estate in a foreign bankruptcy proceeding involving the debtor.
After the petition is filed, but before the case is dismissed or relief is ordered, a creditor holding an unsecured claim that is not contingent, other than an existing petitioning creditor may join in the petition with the same effect as if such joining creditor were an original petitioning creditor. Therefore, if the original petitioning creditors do not satisfy the requirements of §303 for an effective involuntary case, additional creditors may join in the petition after it is filed. The debtor, or a general partner in a partnership debtor that did not join in the petition, may file an answer to a petition under this section. After notice and a hearing, and for cause, the court may require the petitioners to file a bond to indemnify the debtor for any amounts the court may later allow as damages under §303(i).
Except to the extent that the court orders otherwise, and until an order for relief in the case, any business of the debtor may continue to operate, and the debtor may continue to use, acquire, or dispose of property as if an involuntary case concerning the debtor had not been commenced. This period between the filing of the petition and the date an order for relief is entered is referred to as the “gap period.”
Any time after the commencement of an involuntary case under chapter 7 but before the order for relief is entered, the court, on request of a party in interest, after notice to the debtor and a hearing, and if necessary to preserve the property of the estate or to prevent loss to the estate, may order the United States trustee to appoint an interim trustee under section 701 of this title to take possession of the property of the estate and to operate any business of the debtor. Before an order for relief is entered, the debtor may regain possession of property in the possession of a trustee ordered appointed under this subsection if the debtor files such bond as the court requires, conditioned on the debtor's accounting for and delivering to the trustee, if there is an order for relief in the case, such property, or the value, as of the date the debtor regains possession, of such property.
If the petition is not timely controverted by the debtor, the court enters an order for relief against the debtor by default. Otherwise, after trial, the court is required to order relief against the debtor only if--
(1) the debtor is generally not paying such debtor's debts as such debts become due unless such debts are the subject of a bona fide dispute as to liability or amount; or
(2) within 120 days before the date of the filing of the petition, a custodian, other than a trustee, receiver, or agent appointed or authorized to take charge of less than substantially all of the property of the debtor for the purpose of enforcing a lien against such property, was appointed or took possession.
If the court dismisses a petition under §303 other than on consent of all petitioners and the debtor, and if the debtor does not waive the right to such a judgment, the court may grant judgment--
(1) against the petitioners and in favor of the debtor for--
(A) costs; or
(B) a reasonable attorney's fee;10 or
(2) against any petitioner that filed the petition in bad faith, for--
(A) any damages proximately caused by such filing; or
(B) punitive damages.
The court can dismiss an involuntary petition only after notice to all creditors and a hearing
(1) upon the motion of a petitioner;
(2) upon the consent of all the petitioners and the debtor; or
(3) for lack of prosecution.
If an involuntary petition is false or contains any materially false, fictitious, or fraudulent statement, the debtor is an individual; and the court dismisses the petition, the court, upon the motion of the debtor, is required to seal all the records of the court relating to the petition, and all references to the petition.
If the debtor is an individual and the court dismisses a petition under §303, the court may enter an order prohibiting all consumer reporting agencies (as defined in section 603(f) of the Fair Credit Reporting Act (15 U.S.C. 1681a(f))) from making any consumer report (as defined in section 603(d) of that Act) that contains any information relating to such petition or to the case commenced by the filing of the petition.
In light of §303(i), exposing petitioning creditors to liability for damages for a bad faith filing of an involuntary petition , petitioning creditors should carefully examine the risks undertaken in the filing of an involuntary petition. Weintraub and Resnick, Bankruptcy Law Manual, § 2.17 (1992); 2 Collier on Bankruptcy, ¶ 303.39 (15th ed. 1995). The court in In re McDonald Trucking Co., Inc., 76 B.R. 513, 516 (Bankr.W.D.Pa.1987) stated:
The filing of an involuntary petition by a creditor must be carefully scrutinized by the Court because such action is extreme in nature and carries with it serious consequences to the alleged debtor, examples of which include loss of credit standing, interference 10 Note the distinction between (1) and (2). Court can aware costs or reasonable attorney fees to the debtor if the petition is dismissed without the consent of all of the petitioning creditor(s) and the debtor. If there is bad faith, the court may award damages, including punitive damages. Contested involuntary cases can quickly generate substantial legal costs to the debtor, and thus substantial liability to the petitioning creditor(s), which liability is absolute if the cases is dismissed by the court after a contested trial of the involuntary petition. with general business affairs and public embarrassment.
The court in In re Advance Press & Litho, Inc., 46 B.R. 700, 702 (D.Colo.1984) warned that the filing of an involuntary petition is not something which should be lightly undertaken. The court noted that even the good-faith filing of such a petition creates onerous circumstances for a debtor. Moreover, in In re R.N. Salem Corporation, 29 B.R. 424 (S.D.Ohio 1983), the court admonished that the Bankruptcy Code was created by Congress to act as a shield for debtors, rather than as a sword for creditors.
The statute is clear in providing that whether or not an involuntary petition is filed in bad faith, the court may grant judgment against unsuccessful petitioners for costs and attorneys fees. In re K.P. Enterprise, 135 B.R. 174, 176 (Bankr.D.Me.1992). As has been recognized by the bankruptcy court within this circuit, clearly the granting of such an award is discretionary. In re David J. Ross, 135 B.R. 230, 234 (Bankr.E.D.Pa.1991). With respect to an award of costs and fees, there is a split of authority. Some courts have held that one who successfully defends against an involuntary petition should generally be granted the costs and fees associated with its defense. This line of authority begins with In re Howard, Neilsen & Rush, Inc., 2 B.R. 451, 453– 54 (Bankr.M.D.Tenn.1979) where the court provides insight into the development of the current law under § 303(i). There the court discussed the fact that the old equitable standard for an award of costs and fees, limiting the award to situations involving bad faith or oppressive and vexatious conduct on the part of petitioning creditors, has been drastically altered by the Bankruptcy Code which now contemplates a routine award of costs and counsel fees under § 303(i) upon dismissal of an involuntary petition. No bad faith need be shown. Under this line of cases, In re Camelot, 25 B.R. 861, 865 (Bankr.E.D.Tenn.1982) holds, in pertinent part, that bad faith on the part of a creditor filing an involuntary petition is not a condition precedent to an award of costs and attorneys fees on dismissal of the petition.
In re Ross, 135 B.R. at 235, indicates that the statute itself provides no framework or list of factors Congress expected courts to consider in the exercise of their discretion. In re Anderson, 95 B.R. 703, 704 (Bankr.W.D.Mo.1989), recognizes that two somewhat disparate lines of reasoning have been developed by the courts as to the award of costs or attorneys fees. In re Advance Press and Litho, Inc., 46 B.R. at 703, holds that it is not necessary that the involuntary bankruptcy petition be frivolous or meritless to award costs and attorney fees upon dismissal of the petition, nor is there a need to make a finding of bad faith on the part of one or more of the petitioners under section 303(i); See also, In re Leach, 102 B.R. 805, 808 (Bankr.D.Kan.1989); In re Anderson, 95 B.R. 703, 705 (Bankr.W.D.Mo.1989); and In re K.P. Enterprise, 135 B.R. at 177.FN15 Other courts have found that fees and costs should not be awarded unless there is a finding of bad faith. In re Allen Rogers and Company, 34 B.R. 631, 633 (Bankr.S.D.N.Y.1983) (sufficient cause must be shown to award the debtor costs and fees under § 303(i)); In re Nordbrock, 772 F.2d 397 (8th Cir.1985) (holding that district court did not abuse its discretion declining to award debtor attorney's fees on creditor's appeal from dismissal of involuntary petition in bankruptcy court); see also, In re Fox Island Square Partnership, 106 B.R. 962, 967 (Bankr.N.D.Ill.1989) (holding that although § 303(i) does not require a bad faith filing, few courts have assessed cost and attorneys fees absent a bad faith finding); In re West Side Community Hospital, Inc., 112 B.R. 243, 257 (Bankr.N.D.Ill.1990) (employing the court's discretion to deny an award of costs and fees where there was no bad faith finding).
The reasoning behind the latter line of cases was articulated by the court in In re Ross, 135 B.R. at 236, which stated that if the attorneys' fees were limited to bad faith filings, then the fee provision would be found not in subsection 303(i)(1), but in subsection 303(i)(2) (citing In re Reid, 854 F.2d 156, 160 (7th Cir.1988)).
With respect to the award of attorneys fees and costs the court notes the decision of In re Ross, 135 B.R. at 238 which held that on dismissal of a petition:
[T]he burden shifts to the petitioning creditors to present evidence
to disallow an award of fees. In that sense, the award of fees is
“routine” insofar as the award should be made unless the
petitioners demonstrate otherwise based upon the totality of the
circumstances.... Moreover, once one eliminates the issue of the
petitioner's bad faith as a relevant factor in deciding whether to
award fees, it becomes difficult to articulate that which a
prevailing debtor need demonstrate, beyond dismissal itself, to
justify an award under section 303(i)(1).
C. THE CHAPTER 11 RESPONSE.
1. DIP Loans and Use of Cash Collateral.
Bankruptcy Code § 364 authorizes the debtor in possession to obtain credit. Lenders that advance money after the petition date are given priority if:
1. If the DIP borrows in the ordinary course of business, then the lender's claim is a first-priority administrative expense under §364(a).
2. If not in the ordinary course of business, the lender may still receive administrative priority if the advance is approved by a court order (infrequent) under § 364(b).
3. Under § 364(c), a lender may obtain either a super-priority administrative expense or a lien in unencumbered property, but not both.
4. If the DIP cannot get credit otherwise, the court may authorize a security interest that is \"senior or equal\" to an existing security interest under § 364(d).
A debtor in possession may not use cash collateral without the consent of the creditor or authorization by the court. 11 U.S.C. § 363. The debtor must file a motion requesting an order from the court authorizing the use of the cash collateral. Pending consent of the creditor or court authorization, the debtor must segregate and account for all cash collateral in its possession. 11 U.S.C. § 363(c)(4). A creditor with an interest in the property being used by the debtor may request that the court prohibit or condition this use to the extent necessary to provide adequate protection to the creditor. When cash collateral is spent, the creditors are entitled to receive additional protection under section 363 of the Bankruptcy Code.
Per Bankruptcy Rule 4001, the court may authorize DIP financing and/or cash collateral use only to the extent necessary to avoid irreparable damage pending the final hearing.
2. Relief from the Automatic Stay.
The automatic stay provides a period of time which all judgments, collection activities, foreclosures, and repossessions of property are suspended and may not be pursued by the creditors on any debt or claim that arose before the filing of the bankruptcy petition. This automatically takes effect when the chapter 11 debtor files the bankruptcy petition, 11 U.S.C. § 362(a), excluding the listed action in 11 U.S.C. § 362(b). The automatic stay gives the debtor time to negotiate.
Under specific circumstances, a creditor can obtain an order from the court granting relief from the automatic stay. Creditors may seek court orders, lifting the stay, when the debtor has no equity in the property and the property is not necessary for an effective reorganization. 11 U.S.C. § 362(d).
4. Transfers of Assets.
The debtor in possession may use, sell, or lease property of the estate in the ordinary course of its business, without prior approval, unless the court orders otherwise. 11 U.S.C. § 363(c). If the intended sale or use is outside the ordinary course of business, the debtor must obtain permission from the court.