In today's chapter 11 bankruptcies, it is common for cash-collateral orders to provide replacement liens to secured creditors as adequate protection for any diminution in the value of the secured creditors' interests in cash collateral used. It is also quite common for cash-collateral orders to provide "carve-outs" for professionals. Specifically, debtors often negotiate and/or include provisions in proposed cash-collateral orders that segregate, i.e., carve-out, from liens granted, an amount sufficient or a sum certain, for the payment of professional fees and expenses. A carve-out assures that unencumbered assets will exist for the payment of debtor's counsel's fees and expenses in the event of an insolvent estate. Additionally, a carve-out may provide for statutory fees and, sometimes, fees and expenses of other professionals.

Due to the emergency nature of interim cash-collateral orders, however, most are negotiated, signed and entered prior to the appointment of any official committee. Indeed, committee appointment may not occur until after a final cash-collateral hearing, thereby precluding a committee's ability to comment or object based on carve-out provisions that do not include committee counsel's fees and expenses.

While some may argue that cash-collateral orders should naturally include a carve-out for committee counsel, practitioners should be aware that a committee's standing to raise such issues is now questionable. In fact, due to the Supreme Court's recent Hen House opinion, and absent a debtor with a committee in mind, committees may lack the authority to object to the entry of interim and/or final cash-collateral orders based on the lack of a committee counsel carve-out from liens of a secured creditor.

Standing Under the Bankruptcy Code

When a secured creditor has a valid and perfected security interest in and lien on collateral, as well as the proceeds therefrom, those proceeds constitute cash collateral pursuant to 11 U.S.C. §§363(a) and 552(b)(2). Cash collateral may be used, however, pursuant to the provisions of §363(c), if a debtor-in-possession (DIP) provides adequate protection of the secured party's interests in the cash collateral.

Adequate protection may be provided in many forms under 11 U.S.C. §361, including, but not limited to, granting replacement liens to the extent that the use of the cash collateral actually diminishes the value of the secured party's interests therein. Noticeably absent from §§361 and 363(c) is any reference to a carve-out or other specific provisions to be included in a proposed cash collateral order, other than adequate protection provisions.

Recently, many courts have developed certain "guidelines" or have otherwise issued orders setting forth "appropriate items" for inclusion in proposed cash collateral orders. For example, some might argue that a recent unpublished opinion from the Southern District of Texas stands as authority for requiring a committee counsel carve-out, even over the objection of a secured creditor whose cash collateral is to be used. See In re ABN Sports Supply Inc., No. 00-35907-H2-11, "Written Reasons for Denial of Proposed Cash Collateral Order," p. 1 (Bankr. S.D. Tex. July 19, 2000) (where the court refused to issue an order unless the parties inserted certain language, but did not specify what language or principles the proposed order lacked).¹

Similarly, certain general orders have been issued in the District of Delaware regarding the appropriate provisions for inclusion in cash collateral/DIP financing orders. Among these "appropriate provisions" are provisions for professional fee carve-outs.

Despite these orders, there is simply no authority for a committee to object to a proposed cash-collateral order based on the lack of a committee counsel carve-out. See 11 U.S.C. §§361, 363(c) and 506(c). Specifically, one must examine the express language of §363(c), which provides that a DIP may move the Court to use cash collateral. Although §363(c)(2)(B) provides for the use of cash collateral over the objection of a secured creditor, assuming the secured creditor does not consent to a committee counsel carve-out, no part of §363(c) provides a committee with authority to move for such affirmative relief.

Thus, while a committee may have standing to object to a proposed cash-collateral order, in the best interests of its constituency, it does not have the independent authority that a DIP has under §363(c)(2)(B). Independent authority and standing was previously thought to exist under §506(c)'s surcharge provisions, but the recent opinion of the U.S. Supreme Court in Hartford Underwriter's Insurance Co. v. Union Planters Bank N.A. (In re Hen House Interstate Inc.), __ U.S. __, 120 S.Ct. 1942, __ L.Ed.2d __ (2000) changes this analysis.

Hen House's Effect on Committee Counsel Carve-outs

In Hen House, the Supreme Court clearly stated that §506(c)'s surcharge provisions are not available to any party other than a DIP or trustee. Hartford Underwriter's Insurance Co. v. Union Planters Bank N.A. (In re Hen House Interstate Inc.), __ U.S. __, 120 S.Ct. 1942, __ L.Ed.2d __ (2000). Specifically, the Supreme Court examined the plain language of §506(c) and determined that "had Congress intended the provision to be broadly available, it [w]ould simply have said so, as it did in describing the parties who could act under other sections of the Bankruptcy Code." See Hen House, 120 U.S. 1947-48.

In Hen House, therefore, the Supreme Court put the issue of standing under §506(c) to rest. Accordingly, a committee does not have standing under §506(c) to surcharge a secured creditor's collateral. Since a committee cannot use §506(c) to surcharge a secured creditor's collateral, and no other code provision authorizes a committee to obtain such an interest, no vehicle exists for forcing a committee counsel carve-out, either by motion or by objection to a proposed cash-collateral order.²

Theoretically, a committee could argue that a court has the power to require a committee carve-out in a proposed cash collateral order under 11 U.S.C. §105(a). Section 105(a), after all, states that "the court may issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of this title." This "equitable power" may give a committee the ammunition it needs to fight the carve-out battle.

On the other hand, the §105(a) requirement that the "order, process or judgment [be] necessary or appropriate to carry out the provisions of this title" can lead to the opposite conclusion. See, e.g., Hamilton v. Lumsden (In re Geothermal Resources International Inc.), 93 F.3d 648, 651 (9th Cir. 1996) (where the court held that a bankruptcy court cannot, in the name of its equitable powers, ignore specific statutory mandates); Omni Manufacturing Inc. v. Smith (In re Smith), 21 F.3d 660, 666 (5th Cir. 1994) (where the court held that bankruptcy courts cannot use their equitable powers under §105(a) to fashion substantive rights and remedies not contained in the Bankruptcy Code and/or Rules). Thus, when one considers the plain language of §§363(c) and 506(c), which do not give a committee the same authority as a DIP, granting similar relief under §105(a) may be construed as inappropriately creating substantive rights otherwise outside of the Bankruptcy Code.

Consequently, although a committee does have standing to object to a proposed cash-collateral order that is not in the best interests of its constituency, there otherwise appears to be no support, under either §363(c) or 506(c), for objecting to the lack of a committee counsel carve-out. It therefore appears that when no unencumbered assets exist, committee counsel's fees and expenses become dependent on a successful reorganization and/or the solvency of the bankrupt estate.

Conclusion

Although the Bankruptcy Code does not currently offer a method for committee counsel to receive compensation from estate assets that are fully encumbered, this article does not suggest that committee counsel should not receive or otherwise have a vehicle for obtaining compensation. Indeed, public policy dictates the need for committee counsel, just as the Bankruptcy Code authorizes and anticipates the representation of classes of creditors through official committees, as well as compensation for committee counsel from the bankrupt estate's assets.

A paradox exists in that committee counsel plays a vital role in chapter 11 proceedings, yet the current status of the law does not provide the same procedural avenue of relief available to debtor's counsel. Perhaps the answer lies in pending bankruptcy reform, or in subsequent Supreme Court opinions that create an exception to Hen House. Otherwise, committees may find themselves without counsel willing to represent their interests in cases where unencumbered assets are not available or are limited.

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Footnotes

¹ It should also be noted that the court specifically set forth in this order that its provisions applied to, and even underlined, "this case," thereby demonstrating its limited precedential value. Return to article

² Although a committee or other party-in-interest may challenge the validity and extent of a secured creditor's lien, this article is based on the assumption that no valid challenge exists. Return to article