First DaysCrazy Days Or Theres Mischief in Them Thar Motions

First DaysCrazy Days Or Theres Mischief in Them Thar Motions

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The first days of any sizeable chapter 11 case bring a flurry of activity. A host of issues must be addressed and resolved immediately or the case can grind itself to a halt before it even gets underway. To their credit, most courts have become much more sensitive to these "first-day" issues and setting hearings shortly after the case is filed.

Critical first-day issues include cash collateral, debtor-in-possession (DIP) financing and professional employment. These "operational" issues can determine whether a debtor remains in possession of an operating business or becomes merely the jetsam of a business that was closed unexpectedly and prematurely. Horror stories of companies filing for relief and then immediately shutting down for lack of a cash-collateral order are becoming much fewer and further apart.

As courts became more accommodating to critical first-day issues, the list of "critical" issues began to expand as more professionals got involved. (Some would argue that there was exponential growth with each layer of professionals—both for the debtor and certain creditors—since each had a distinctive bit of turf to protect.) For example, first-day matters now include many issues that are not always life-or-death issues for the company.

Unsecured creditors (and particularly unsecured creditors' committees) must watch and challenge overreaching actions when they see them, so that new "plateaus" of egregious orders do not become the "norm" in their jurisdictions. (Stated another way, closing the door might not get this horse back into the barn, but you might keep the next one from getting loose.)

First-day issues now include "interim" rulings that can effectively become final and determinative of key parts of the case. How egregious the "first-day goodie grab" becomes can be the difference between a company's life and death. Knowing this, the parties with first-day issues sometimes reach for too much at the outset, either hastening the demise of a reorganizable business or loading on so much administrative expense that no company could emerge from chapter 11.

DIP "financing orders" under 11 U.S.C. §364 enjoy specific Bankruptcy Code protections for creditors if the orders are appealed. Provided that the creditor acted in good faith, the bankruptcy court's decisions cannot be undone even if the order is later reversed on appeal. With the proper findings (regarding the creditor's good faith), a bankruptcy court can effectively become the supreme court on those issues.

When it comes to protecting secured creditors, cash collateral and DIP financing orders cannot be beaten. It is not uncommon to see provisions that purport to bind all creditors and even subsequently appointed trustees to waive claims against the lender, prevent surcharges under §506(c) and even allow pre-petition lenders to convert pre-petition claims to post-petition claims through a variety of devices.

For example, DIP financing can be arranged through the pre-petition lender's affiliate (or friend). The court then approves the loan payoff and release of claims so the pre-petition lender will release its liens. This places the collateral in a position to secure first-lien DIP financing without the heightened burden lien-priming requires. Sometimes, this occurs and is effective well before the final hearing to approve the arrangement.

Even if an objection is sustained at the final hearing, the agreement provides that it is nevertheless effective as to the amounts advanced before the final hearing. By that time, claims have been released and "new" lenders have acquired veto power over any plan of reorganization, since their new administrative claims must either be paid at confirmation or a previous repayment arrangement because debtors cannot invoke cramdown on administrative claims.

Realizing this power, some attorneys and courts have first-day motions that also serve as pre-emptive strikes against certain types of creditors to neutralize them before they can even get organized. Procedures are established to process reclamation claims through a somewhat byzantine procedure of exchanging demands, documents and offers. The process creates new "hoops" for the claimants to navigate if they want to assert reclamation claims. Of course, when the creditor misses a step, the claim is disallowed. But, when the debtor misses a deadline, the claim is not automatically allowed. All the while, the debtor merrily uses the reclamation claimant's products without fear of being required to actually return those items in the foreseeable future.

Other common first-day issues include ruling on utilities motions without strictly complying with §366 and paying employee claims in full as the case is only beginning. Requesting authority to pay "essential" vendors can also provide the opportunity for substantial mischief in favor of some favored vendors.

Some courts have even established intricate procedures for selling significant assets. Not surprisingly, these procedural orders can stack the deck in favor of a favored purchaser with substantial break-up fees and overbid requirements.

That these occur without other parties being involved is somewhat surprising. However, some attorneys and courts view the bankruptcy jurisdiction rather expansively and deem requirements as something that can be avoided.

While it is hard to predict what new twists are in store in the future, unsecured creditors can rest assured that those twists are limited only by the imagination of the attorneys involved and the willingness of courts to tolerate such conduct. It is rather easy to see why so many unsecured creditors believe that the deck is stacked against them and that debtors' attorneys are dealing the cards.

Journal Date: 
Thursday, June 1, 2000