The Debtor in Possession

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1 Adequate Protection/Cash Collateral in Chapter 11 The Automatic Stay in Bankruptcy Patricia M. Gibeault David M. Pelletier Kevin D. Trost Axley Brynelson, LLP WISCONSIN BANKING LAW UPDATE Community Bankers of Wisconsin The Debtor in Possession Chapter 11 bankruptcies are (typically) reorganizations. The debtor in possession ( DIP ) remains in control of its assets. The DIP can operate its business in the ordinary course (until the court orders otherwise). So, for example, even though you have a mortgage on the DIP s factory, the DIP can continue to operate.

2 Use of Cash Collateral Different rule for cash collateral. What is cash collateral? Cash, negotiable instruments, documents of title, securities, deposit accounts. If you have a lien on the DIP s cash collateral, the DIP must obtain your permission to continue using it or obtain a court order permitting its use. Unauthorized use of cash collateral is grounds for dismissal, conversion, or appointment of trustee. DIP s Burden The DIP has the burden to obtain consent or court order. Typically (especially if debtor s counsel is on the ball) attempts will be made before the filing of the bankruptcy to obtain permission to use cash collateral. If no agreement then DIP usually files an emergency motion for permission to use cash collateral on an interim basis. Note that an agreement between the lender and the DIP for use of cash collateral (at least initially) is also usually an interim agreement.

3 What should be included in a cash collateral order? Budget DIP must maintain insurance DIP provide lender with monthly operating reports. Replacement lien on post-petition assets Acknowledgement of lender debt/security Termination date Maintain DIP account at your bank Adequate protection payments Adequate Protection Under the code, a secured creditor is entitled to adequate protection. Creditor lacks adequate protection if the value of its collateral is declining as a result of the bankruptcy/passage of time. 11 U.S.C. 361 Adequate protection may be provided by: Requiring payment of cash payments Granting a replacement lien

4 Is there an equity cushion? The level of adequate protection that a secured creditor is entitled to will depend, in large part, on whether there is equity in the collateral. What cash payments may be available? Principal payments? Interest payments? If so, what interest rate? Past due taxes? What about penalty and interest? Accruing taxes? Attorneys fees?

5 The Automatic Stay The filing of the bankruptcy petition acts as an automatic stay of most actions (1) against the debtor, and (2) to obtain property of the debtor or against property of the estate. In other words, by filing the petition, all creditors are prevented from attempting to collect from the debtor except through the bankruptcy court process unless there is an applicable exception. Violations of the stay can result in a finding of contempt by the bankruptcy court and award of sanctions, including the payment of a penalty. Return of Collateral If collateral has been replevied pre-bankruptcy but not sold then the creditor has a duty to return the collateral to the debtor, then seek relief from stay and/or adequate protection. See In re Herbst, (W.D. Wis. Bk. Ct. 4/11/12)

6 Co-Debtor Stay The automatic stay is extended to co-debtors (for example, cosigners, guarantors, or others principally obligated on a note) in certain situations in Chapters 12 and 13 EVEN IF THEY DON T FILE BANKRUPTCY. Co-debtors are not protected in Chapter 7 or Chapter 11 unless they file their own bankruptcy petition or unless the court enters a specific order. The co-debtor stay, when applicable, prevents creditors from attempting to collect on a debt against the co-debtor. Relief from Stay Secured creditor may request relief from the automatic stay, which may be granted: For cause Lack of adequate protection -OR- If: Debtor does not have equity in such property; and, The property is not necessary for an effective reorganization.

7 Relief from Stay Must file motion and pay filing fee Should you file in a Chapter 7? Should you also seek abandonment? If contested, could be costly Questions? Attorney David M. Pelletier Axley Brynelson, LLP dpelletier@axley.com