Adequate Assurances for Utility Services Under Revised §366 of the Bankruptcy Code and the Lessons from In re Supra Telecommunications & Systems Inc.
by Michael S. Budwick, Meland Russin Hellinger & Budwick PA, Miami
Section 366 Requires a Debtor to Provide a Utility Adequate Assurances of Payment for Post-petition Services
Section 366(a) of the Bankruptcy Code prevents a utility from altering, refusing or discontinuing service to, or discriminating against, a debtor during the first 20 days after the filing of a bankruptcy case solely on the basis that the debtor (1) filed a bankruptcy petition or (2) is indebted to the utility for service rendered pre-petition. Section 366(b) in turn authorizes the utility to alter, refuse or discontinue service unless within 20 days of the petition date the debtor provides the utility “adequate assurance of payment” for post-petition services. Section 366(b) provides that the “adequate assurance of payment” may take “the form of a deposit or other security,” although “assurance of payment” is not specifically defined and has been the subject of litigation in telecommunication chapter 11 cases. Recently, some reported decisions have held that affording the utility an administrative expense priority may constitute a satisfactory form of adequate assurance based on the “totality of the circumstances.” See, e.g., In re Adelphia Business Solutions Inc., 280 B.R. 63 (Bankr. S.D.N.Y. 2002).
Amended §366 Affords Significantly Greater Assurance of Payment Protections to a Utility
Section 366 has been significantly amended by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 and includes an entirely new subsection (c). Section 366(c)(1)(A) explicitly defines “assurance of payment” as a cash deposit, letter of credit, certificate of deposit, surety bond, prepayment of utility consumption or other form of security that is mutually acceptable among the parties. As a corollary, §366(c)(1)(B) provides that “an administrative expense priority shall not constitute an assurance of payment.” Therefore, although §366(b) has always required an assurance of payment, that term had previously been relegated to judicial interpretation. Section 366(c) represents a departure by expressly defining what may or may not constitute an assurance of payment.
Furthermore, §366(c)(2) now provides that a utility may “alter, refuse or discontinue utility service” if, during the 30-day period following the petition date, the utility does not consent to the form of adequate assurance provided by the debtor. This will likely eliminate the present practice among debtors of requesting a court to impose uniform measures of adequate assurance for a series of utilities and then requiring each utility to object and assert at a future evidentiary hearing that an alternative form of assurance is appropriate.
Debtors will be required to seek relief from §366(c)(2) pursuant to §366(c)(3)(A), which provides that on request of a party and after notice and a hearing, the court may order modification of the form of adequate assurance under §366(c)(2). Therefore, §366(c)(2) and (3) together will require a debtor to be proactive to seek a judicial determination imposing the debtor’s preferred form of adequate assurance, as well as litigate very early in a case the appropriate amount of any deposit, bond, pre-payment or letter of credit. However, in considering a §366(c)(3) request, a court will now be precluded from considering:
- the absence of a pre-petition security deposit;
- the debtor’s timely pre-petition payment history; or
- the availability of administrative expense priority.
See §366(c)(3)(B).
Finally, new §366(c)(4) authorizes a utility to set off a pre-petition deposit without notice or order of a court and without regard to non-bankruptcy law.
Certainly, newly enacted §366(c) as a whole markedly empowers utilities and imposes a greater financial burden on debtors that provide and consume telecommunications services. However, the pre-payment approach employed by Judge Robert A. Mark in the Southern District of Florida in In re Supra Telecommunications Inc., discussed below, appears to meet the requirements of the revised statute while avoiding the onerous impact that a security deposit, letter of credit, certificate of deposit or surety bond tend to impose on a telecommunication debtor’s cash position at the beginning of its reorganization effort.
The “Pay as It Goes” Assurances Provided in In re Supra Telecommunications & Systems Inc. Are Consistent with Amended §366 of the Bankruptcy Code
In October 2002, Supra Telecommunications & Systems Inc. (Supra) filed a chapter 11 case in the Southern District of Florida. At the time, Supra was the largest competitive local exchange carrier (CLEC) in Florida and the largest competitor to BellSouth Telecommunications Inc. (BellSouth), the incumbent local exchange carrier (ILEC) in BellSouth’s nine-state region.
As is common in telecommunication cases, in the Supra case, BellSouth demanded a two-month cash deposit in the amount of $26 million, citing among other factors Supra’s poor pre-petition payment history. Because Supra lacked the cash to fund any type of significant deposit, it faced discontinuation of service with a resulting shutdown of its business if a material deposit requirement were to be imposed. In response, as in Adelphia, Supra asserted that under the “totality of the circumstances,” an administrative expense priority would suffice as an assurance of payment, particularly because Supra asserted significant claims against BellSouth and Supra’s financial models reflected post-petition viability and administrative solvency.
In an unpublished decision, the court ordered a different type of assurance of payment. After conducting an evidentiary hearing to estimate post-petition monthly invoices, the court directed Supra to pay at the conclusion of each week a pro-rated portion of the estimated monthly bill for the following week. The failure to timely pay would entitle BellSouth to discontinue service. In effect, Supra was required to “pay as it goes,” regardless of the due date for payment of monthly invoices set forth in the parties’ pre-petition interconnection agreement. Periodically, the court conducted true-up hearings to resolve billing disputes and reconcile the post-petition payments. During its 27 months in chapter 11, Supra timely paid over $200 million in weekly adequate assurance payments to BellSouth while avoiding a disruption in service.
Ultimately, in January 2005, after resolving various pre-petition litigation with BellSouth and restructuring much of its business operations, Supra confirmed a plan of reorganization and exited chapter 11 as a stronger competitor to BellSouth than when it had filed. Among the reasons for Supra’s success was the court’s ability to craft a means by which Supra could provide adequate assurance of post-petition payment in a manner that protected the legitimate interest of BellSouth to be paid for post-petition services while avoiding the potentially financially crippling effect of a large cash deposit. The court’s approach appears consistent with the new assurance requirements of revised §366(c)(1)(A), which explicitly include as a form of “assurance of payment” a “prepayment of utility consumption.”
Conclusion
Certainly revised §366 empowers utilities and imposes a greater financial burden on debtors that provide and consume telecommunications services. Absent a utility consenting to a debtor’s proposed assurances, a debtor must seek a judicial determination of appropriate assurances or face a disruption in service. Administrative expense priority is an insufficient assurance of payment under the new statute. Both the lack of a security deposit under the parties’ pre-petition interconnection agreement and the fact that a CLEC paid its pre-petition bills timely are rendered irrelevant as a matter of law. However, the pre-payment approach employed in the Supra case appears to meet the requirements of the revised statute while avoiding the onerous impact that a security deposit imposes on a debtor’s cash position at the commencement of a case. To avoid the negative impact on cash associated with the imposition of a cash deposit, letter of credit, certificate deposit or surety bond, a debtor may wish to consider weekly pre-payment, as in Supra. Although pre-payment also has a negative impact on cash, the result is less draconian than the other forms of “assurance,” as that term has now been expressly defined.