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Cash Collateral and DIP Loan ContestsBANKRUPTCY BATTLE ROYALE– COMMON LITIGATION SCENARIOS
Premiere Date: February 21,2017This webinar is sponsored by: EisnerAmper
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MODERATORLisa Vandesteeg Sugar Felsenthal Grais & Hammer,
ChicagoPANELISTS
Laura Davis Jones Pachulski Stang Ziehl & Jones, Wilmington DE
Gary Marsh Dentons US LLP, Atlanta Tomas J. Salerno Stinson Leonard Street, Phoenix
MEET THE FACULTY
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SERIES SPONSOR
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ABOUT THIS WEBINARShow me the money! Debtors in Chapter 11 proceedings cannot survive without money to continue operations, pay vendors and professionals, and work to restructure debt and/or sell assets.
Where do those necessary funds come from? There are really only two sources – existing or generated cash (generally the collateral of the secured lender) or new money coming into estate in the form of a post-petition debtor-in-possession (DIP) loan. At the very outset of the case, a debtor must get a court order allowing the use of either type of funds, and that order often contains terms that impact the entire course of the proceeding.
As a result, the battles over the terms of the use of cash collateral or DIP financing are some of the most hotly contested in the Chapter 11 process, involving numerous parties including the debtor, secured lender, unsecured creditors’ committee, and third party DIP lender. This webinar presents practical tips for each of these parties to protect their respective interests.
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ABOUT THIS SERIESNo matter how you are involved in a bankruptcy proceeding, there is a real chance you will wind up litigating some issue.
Litigating in bankruptcy court, however, is very different than litigating in any other federal or state court because the customs, rules and players are all different. Whether you are a general litigator or a business person who has never had to fight in bankruptcy court, this webinar series is for you if you want to understand some of the more commonly litigated issues in bankruptcy cases.
Each episode is delivered in Plain English understandable to business owners and executives without much background in these areas. Yet, each episode is proven to be valuable to seasoned professionals. As with all Financial Poise Webinars, each episode in the series brings you into engaging, sometimes humorous, conversations designed to entertain as it teaches. And, as with all Financial Poise Webinars, each episode in the series is designed to be viewed independently of the other episodes, so that participants will enhance their knowledge of this area whether they attend one, some, or all of the episodes.
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EPISODES IN THIS SERIES
EPISODE #1 Venue Fights1/17/2017
EPISODE #2 Cash Collateral and DIP Loan Contests2/21/2017
EPISODE #3 Lift-Stay Battles 4/4/2017
EPISODE #4 Contract and Lease Disputes 5/9/2017
EPISODE #5 Contesting Confirmation5/30/2017
EPISODE #6 Anatomy of a Preference Action6/13/2017
Dates shown are premiere dates; all webinars will be available on demand after premiere date
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OVERVIEW
• Debtor Financing and Use of Cash Collateral• Adequate Protection Issues for the Debtor’s Lenders• Motions for Authorization to Use Cash Collateral
and/or PostPetition Financing• Resolving Cash Collateral Disputes by Financing the
Debtor’s Business• Resolving Cash Collateral and PostPetition Financing
Disputes• Miscellaneous Considerations
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DEBTOR FINANCING AND
USE OF CASH COLLATERAL
INTRODUCTION• Debtor-In-Possession (DIP) Loan (from debtor’s existing or new
lenders) Necessary where there’s not enough cash flow to operate long
enough to achieve desired goal Problems with prepetition lenders:
o Typically try to protect prepetition position by cross-collateralizing the loan
o May use “drop dead” triggers to limit ability to challenge its liens
o May use the DIP financing order to lock up the sale/plan process to acquire the business or its assets
o Provisions could unduly favor lender because of leverage disparity with debtor
• Cash Collateral In rare cases where the company generates sufficient cash from
operations, this can be used to fund ongoing operations with court authorizatio
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APPLICABLE BANKRUPTCY CODE PROVISIONS• 11 U.S.C.A § 364(a)
Debtor is allowed to incur unsecured debt in the ordinary course of business
• 11 U.S.C.A § 364(b) Debtor may seek court approval for an unsecured loan other
than in the ordinary course of the debtor’s business Court can approve as an administrative priority
• 11 U.S.C.A § 364(c) Debtor may obtain a post-petition secured loan through liens
on unencumbered property or junior liens on encumbered property
• 11 U.S.C.A § 364(d) If credit cannot be obtained on the above terms, debtor may
seek approval with liens that prime pre-existing liens 14
APPLICABLE BANKRUPTCY CODE PROVISIONS CONT’DIf debtor only needs funds produced from its operation to finance reorganization:• 11 U.S.C.A § 363(a) defines cash collateral as:
Cash, negotiable instruments, documents of title, securities, deposit accounts, or other cash equivalents whenever acquired in which the estate and an entity other than the estate have an interest and includes the proceeds, products, offspring, rents, or profits of property and the fees, charges, accounts or other payments for the use or occupancy of rooms and other public facilities in hotels, motels, or other lodging properties subject to a security interest as provided in section 552(b) of this title, whether existing before or after the commencement of a case under this title.
• A particular state’s laws may determine whether court approval is required
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GENERAL CONSIDERATIONS• To protect its cash collateral, secured creditor should request
the debtor provide written assurances it will not use, will segregate, will reconcile and will account for all cash collateral.
If not provided immediately, request bankruptcy order prohibiting use of cash collateral
• Code does not provide specific sanctions for unauthorized use
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GENERAL CONSIDERATIONS CONT’D• If use of cash collateral is contested, debtor will be highly
motivated to settle related litigation because a loss would likely end an attempt of reorganization
This provides the secured creditor with a leg-up for negotiating settlement
• Settlement of cash collateral litigation can be structured in 2 ways:
An agreement whereby the secured creditor consents to the debtor’s use of cash collateral
An agreement whereby the secured creditor makes a new loan to the debtor 17
ADEQUATE PROTECTIONISSUES FOR THE
DEBTOR’S LENDERS
AP GENERALLY• To obtain court authorized use of cash collateral, debtor
must demonstrate the secured creditor is adequately protected Preserves the value of the secured creditor’s bargain by
placing restrictions upon rights that would otherwise be under the security agreement and state law
• Automatic Stay AP compensates creditor for any decrease in value of
interest in the collateral during the stay• Use of Collateral in Debtor’s Business
AP compensates for decrease in value of interest in the collateral caused by debtor’s use
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STANDARD FOR EVALUATING AP
In re Martin (8th Circuit) 3-part test:1. Establish the value of the creditor’s interest in the
collateral2. Identify the risks to that value resulting from the
debtor’s proposed use, sale, or lease of the collateral3. Determine whether the debtor’s proposed means of
AP protects value against those risks as nearly as possible in accordance with the concept of “indubitable equivalence”
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1. ESTABLISH THE VALUE OF THE CREDITOR’S INTEREST IN THE COLLATERAL
• Value is the lesser of the value of the collateral or the amount of its debt (Evidence of both required)
• Oversecured Creditor: Limited to the amount of its debt (including interest
and attorney’s fees)
• Undersecured Creditor: Equal to the value of the collateral
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2. IDENTIFY THE RISKS TO THAT VALUE RESULTING FROM THE DEBTOR’S PROPOSED USE, SALE, OR LEASE OF THE COLLATERAL
Debtor’s proposed use of the secured creditor’s collateral can affect its value, depending on the collateral type.
• Cash, inventory, and accounts will be used up or consumed in the business
• Equipment will depreciate• Real estate may depreciate or even appreciate
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3. DETERMINE WHETHER THE PROPOSED MEANS OF AP PROTECTS VALUE AGAINST THOSE RISKS
• Means of AP must be equivalent in value to the predicted amount of impairment
• Type of collateral: Soft
o Used up or consumed in the operation of the debtor’s business Hard
o Not used up or consumed, such as buildings and machineryo May depreciate, but will still be around at the end of the
bankruptcy
• If collateral doesn’t depreciate (real estate), may only need AP against waste
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METHODS OF PROVIDING AP• Replacement Liens
Upon bankruptcy filing, secured creditor’s rights in new accounts and inventory created after the petition date are cut off
Most common method for soft collateral Sufficient only if quality/quantity of postpetition inventory
and receivables are maintained at the same level as the outset of the case (Won’t happen if debtor continues to lose money in operation)
• Periodic Cash Payments Sufficient for soft collateral and hard collateral if
payments are enough to compensate creditor for diminution in value 24
METHODS OF PROVIDING AP CONT’D
• Proposed Use of Cash Collateral Ex. If the debtor proposes to spend the cash to harvest
crops or fees livestock subject to the creditor’s security interest
• Equity Cushion Excess value in collateral above the amount of the
creditor’s debt (Common with real estate) Rarely used with soft collateral but may suffice when
used with other methods of AP
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MOTIONS FOR AUTHORIZATIONTO USE CASH COLLATERAL
AND/OR FORPOSTPETITION FINANCING
GENERALLY• 11 U.S.C.A § 363(c)
Permits court to authorize use of cash collateral only after notice and hearingo Biggest issue is how far in advance to give notice
Hearing must be scheduled in accordance with needs of the debtor and court is instructed to act promptly
• Rule 4001: Request must be made by motion and served on any entity
with an interest, the creditors’ committee, and any other committees (or 20 largest creditors)
Final hearing must be 14 days later (Can have a preliminary hearing with notice)
• Secured creditor often not given enough notice to provide meaningful defense
• Court can authorize use on an interim basis if necessary• Most courts insist the creditors’ committee be given 30-60 days
at least to conduct an investigation before any waiver of claims will be effective against them
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CASH COLLATERAL HEARING• 3 Primary Issues
What is the extent of the secured creditor’s interest in cash collateral and other properties of the estate?
To what extend will the creditor’s interest be adversely affected by the debtor’s use of cash collateral?
Can the interest be adequately protected in connection with the used of its cash collateral?
• Creditor has burden of proving validity, priority, and extent of its interest in property. Must offer into evidence: security agreements,
financing statements, mortgages, and any other docs relevant
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VALUE OF COLLATERAL• 11 U.S.C.A § 506(a)
Valuation of collateral is to be conducted in light of the purpose of the valuation and the proposed disposition or use of the collateral
• Undervaluation can adversely affect: the amount a creditor received on account of the secured claim under the plan, priority under section 507(b), and right to interest and charges under section 506(b)
• Creditor should insist debtor provide periodic financial reports• Creditor has burden of proving validity, priority, and extent of
its interest in property.
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RESOLVING CASH COLLATERALDISPUTES BY FINANCINGTHE DEBTOR’S BUSINESS
TERMS OF AGREEMENT FOR USE OF CASH COLLATERAL
• Documented in a written agreement effective only upon court approval or in an order the parties stipulate to and submit to the court
• Principal issue in negotiation is what AP the creditor requires in exchange for its consent of the use of collateral
• Secured creditor should want: AP sufficient to protect against erosion during case and
insist on additional lien on hard collateral, periodic cash payments, or some other form of protection
Provision prohibiting debtor from granting superpriority claims/liens without consent
The debtor to develop a budget for reorganization and require reports
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TERMS OF AGREEMENT FOR USE OF CASH COLLATERAL CONT’D
• Secured creditor should want (CONT’D): Covenants dealing with debtor’s inventory levels, aging of
accounts receivable, working capital, and similar matters from commercial loan agreements
Release from potential liability from avoidance actions Provision requiring DIP to waive right under section 506(c) to
surcharge the collateral• Postpetition interest is a major issue and generally only
oversecured creditors are entitled to it (to the extent the value of its collateral exceeds the amount of the debt)
• If chapter 11 is converted to chapter 7, agreement should deal with: If AP later proves inadequate, the secured creditor may be
entitled to a section 507(b) superpriority claim to make up the deficiencyo Though 726(b) claims likely have priority over 507(b)
claims Should be enforceable in the absence of fraud or overreaching
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POSTPETITION EXTENSIONS OF CREDIT• Secured creditor typically bargains for the right to
apply its cash collateral to its prepetition loan and for a higher priority claim
• Section 364 governs and provides 4 routes: Obtain loan in the ordinary course of business Lender given first –priority administrative claim for
additional funds Security interest limited to a lien on encumbered
property or to a subordinate lien on already encumbered property
Priming lien on property that is already encumbered
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TERMS OF AGREEMENT FOR POSTPETITION EXTENSIONS OF CREDIT
• Priority, priming liens, and interest Superpriority claim Prime existing liens against debtor’s property (even
if prepetition loan docs with other creditors expressely prohibit such subordination)
Oversecured creditors entitled to postpetition interest
• Additional covenants to protect the secured lender Should include many same provisions as cash
collateral agreement• Lock-up agreements
Clauses addressing the secured lender’s approval or vote in favor of the debtor’s subsequent plan of reorganization (Must be drafted carefully to be enforceable)
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TERMS OF AGREEMENT FOR POSTPETITION EXTENSIONS OF CREDIT CONT’D
• Liens on the debtor’s Chapter 5 causes of action Significant doubt exists as to whether such liens are
permissible • Rolling up prepetition debt
Allows lenders to convert prepetition debt into postpetition debt
• Cross-collateralization clause (Not enforceable unless approved by a reluctant court) Provides either:
o That both the creditor’s pre and postpetition debts shall constitute a priority claim, or
o That both the creditor’s pre and postpetition debts are secured by the debtor’s pre and postpetition assets 35
RESOLVING CASH COLLATERALAND POSTPETITION DISPUTES
ADVANTAGES OF 364 FINANCING OVER AGREEMENTS FOR THE USE OF CASH COLLATERAL
• Two advantages already described: Creditor can obtain a claim that has a higher priority
than it would through AP Creditor’s right to postpetition interest is clear
• Additionally: Creditor is able to apply its cash collateral to the
prepetition loan, thereby converting its prepetition claim into a priority postpetition claimo Debtor must pay this priority claim in full at plan
confirmation, whereas a prepetition claim will be paid only in accordance with the terms of the plan
Creditor is protected even if the order authorizing extension of credit is appealed
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MISCELLANEOUSCONSIDERATIONS
• Second Lien Financing Financing via a second lien on the debtor’s assets provides the
bank with a most attractive position than if it extended an unsecured loan to the debtor
May also allow the debtor to obtain a better loan rate Hard to obtain during downturns in financial markets where
credit is less widely available
• Commingling Proceeds Common for creditor to permit debtor to deposit cash proceeds of
its collateral in the debtor’s general bank account Commingling of proceeds does not terminate the security
interest to the extent that the funds can be traced39
MISCELLANEOUS CONSIDERATIONS
• After-Acquired Property 552: A creditor’s prepetition lien does not extend to property the
estate acquires after the commencement of a bankruptcy case, with certain exceptions
• Proceeds of After-Acquired Property 552(b)(1): If a secured party’s security agreement covers
prepetition property, the security interest shall extend to any postpetition proceeds of that property to the extent provided for in the security agreements and by applicable nonbankruptcy law
• Rents and Hotel Revenues 552(b)(2): With certain exceptions, where a creditor has a
prepetition security interest that extends to property of the debtor acquired prepetition and to amounts paid as rents of the property or the fees, charges, accounts…, the creditor continues to have a security interest in such rents, etc., except to any extent the court (after notice and hearing) orders otherwise.
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MISCELLANEOUS CONSIDERATIONS CONT’D
QUESTIONS?
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ABOUT THE FACULTY
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LISA [email protected]
Lisa is a partner Sugar Felsenthal Grais & Hammer where she concentrates in the areas of bankruptcy and commercial litigation. Lisa’s experience has shown her that a “win” can take many forms. The issues facing her clients and their industries are diverse and require a situational approach, one that is driven by the goals her clients are ultimately looking to achieve. Communication is imperative in establishing those goals, so Lisa partners with her clients to first establish what their distinct “win” looks like in order to then determine a tailored plan of action. She also understands that time and cost considerations, though often overlooked, can sometimes be critical to formulating a successful plan.While each of Lisa’s cases demands a distinct posture, when possible, she works to establish a more collaborative and cooperative style rather than a strictly confrontational one.
Lisa concentrates her practices in the areas of bankruptcy and commercial litigation. She works extensively in the area of creditors’ rights, representing secured creditors, unsecured creditors, creditors’ committees, landlords, and shareholders in Chapter 11 and Chapter 7 cases in courts throughout the U.S. She has also worked on all aspects of civil litigation in federal and state courts, from initial pleadings through discovery, motion practice, trials and appeals.
ABOUT THE FACULTY
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LAURA DAVIS [email protected]
Laura Davis Jones is a name partner and managing committee member of the national bankruptcy law firm of Pachulski Stang Ziehl & Jones LLP, and is the managing partner of the firm's Delaware office. She gained national recognition as debtor's counsel in the Continental Airlines bankruptcy case, and has represented numerous debtors, creditors' committees, bank groups, acquirers, and other significant constituencies in chapter 11 cases and workout proceedings. She lectures at national bankruptcy and litigation seminars, and has authored numerous articles. Ms. Jones was named "Deal Maker of the Year" by The American Lawyer and has been profiled on additional occasions in The American Lawyer.
Ms. Jones has been named continuously by her peers as one of the "Best Lawyers in America" and as one of the "Best Lawyers in Delaware," and was selected as one of the top ten lawyers in Delaware by "Delaware Super Lawyers." She is included among Chambers USA America's "Leading Lawyers for Business," and ranked among the top-tier Bankruptcy/Restructuring lawyers in Delaware. She started her career as a judicial law clerk in the Bankruptcy Court for the District of Delaware. Ms. Jones is admitted to practice in Delaware and the District of Columbia.
ABOUT THE FACULTY
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GARY [email protected]
Gary Marsh is co-chair of Dentons US LLP’s Restructuring, Insolvency and Bankruptcy practice in Atlanta. He focuses on general commercial litigation and bankruptcy, workouts and debtor/creditor law. He represents creditors and debtors in Chapter 11 reorganization proceedings, out of court restructurings and debtor/creditor litigation. He also represents court appointed receivers, examiners and trustees. Mr. Marsh has extensive experience in representing creditors in and out of bankruptcy court in enforcing their rights and remedies. He also analyzes and defends against preference and fraudulent conveyance actions, represents buyers of assets out of bankruptcy and represents landlords and other parties who have leases or contracts with debtors.
Georgia Trend selected him as one of Georgia's "Legal Elite" and Atlanta Magazine named him one of Georgia's "Super Lawyers," and a "Top 100 Super Lawyer" in 2007 and 2012. Mr. Marsh is a fellow in the American College of Bankruptcy and has been included in The Best Lawyers in America and Chambers USA as one of America's Leading Business Lawyers in Bankruptcy law. And he was recognized in 2013 by the Georgia chapter of the Turnaround Management Association for his outstanding turnaround work. Mr. Marsh is Board Certified in Business Bankruptcy and Creditor's Rights by the American Board of Certification.
ABOUT THE FACULTY
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Thomas Salerno is a Partner in the Bankruptcy and Creditors’ Rights practice at Stinson Leonard Street resident in the Phoenix office. He represents distressed companies, acquirers and creditors in financial restructurings and bankruptcy proceedings, pre- and post-bankruptcy workouts, and corporate recapitalizations. Thomas works with clients from an array of industries: casinos, resort hotels, real estate, high-tech manufacturing, electricity generation, agribusiness, construction, health care, airlines and franchised fast-food operations. Managing a global roster of clients, Thomas has been involved in restructurings in the United States, the United Kingdom, Germany, France, Switzerland and the Czech and Slovak Republics.
Additionally, Thomas has represented parties in insolvency proceedings in 30 states and five countries. He headed the U.S. delegation advising the Czech government in the historic revamping of its bankruptcy law and advised the Dominican Republic and Costa Rica on updating their respective insolvency laws. He was a member of the UNCITRAL working group on its Insolvency Law Reform Project and has served as an expert witness on U.S. insolvency law in litigation in Germany. Thomas also teaches Comparative International Insolvency at the University of Salzburg.
Visit www.eisneramper.comEisnerAmper. Let's Get Down to Business®
EisnerAmper LLP is a leading full-service advisory and accounting firm, and is among the largest in the United States. We provide audit, accounting, and tax services, as well as corporate finance, internal audit and risk management, litigation services, consulting, private business services, employee
benefit plan audits, forensic accounting, and other professional advisory services to a broad range of clients across many industries. We work with high net worth individuals, family offices, closely held businesses, start-ups, middle market and Fortune 500 companies. EisnerAmper is PCAOB-registered and provides services to more than 200 public companies and to thousands of entities spanning the hedge, private equity, brokerage and insurance
space in the financial services marketplace. As companies grow we help them reach their goals every step of the way. With offices in New York (NY), New Jersey (NJ), Pennsylvania (PA), California (CA), and the Cayman Islands, and as an independent member of Allinial
Global, EisnerAmper serves clients worldwide.
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