A Committee Member’s Guide to Financing and Cash-collateral Stipulations
by Bernard D. Bollinger Jr.
One of the first issues addressed in most chapter 11 bankruptcy cases is the negotiation of an interim financing or cash-collateral stipulation. Often, the terms of the interim stipulation are “negotiated” between the debtor and its secured creditor before a committee is officially formed. Due to the typically weak negotiating position of an often cash-starved debtor that may not wish to “bite the hand that feeds,” interim stipulations typically fail to include a number of provisions that are necessary to insure that a committee can play a meaningful role in protecting the interests of unsecured creditors during the course of a debtor’s reorganization.
As a result, a newly-formed committee can be saddled with the daunting task of reviewing an often lengthy and sometimes deliberately obtuse interim stipulation, identifying its most objectionable terms and providing the committee’s attorney with a sufficient factual background to do battle with the secured creditor over those objectionable terms. This situation is exacerbated by the shortened notice requirement of Bankruptcy Rule 4002(d), which permits the entry of a final order approving a financing or cash-collateral stipulation as early as 15 days after notice of the motion for approval of the stipulation.1
This article is dedicated to demystifying the process of negotiating financing and cash-collateral stipulations. Although each case is factually different and can therefore raise a panoply of atypical issues, this article should drastically shorten the learning curve of a committee member faced with the need to decipher a multiple-page, jargon-laced cash-collateral or financing stipulation in order to protect the interests of unsecured creditors. Just as important, even if the negotiating position of the parties is such that few concessions can be obtained from the secured creditor, a committee member that understands those concessions will be better equipped to make strategic decisions later in the bankruptcy case.
Issue 1: What is the difference between financing and cash collateral use?
Is it just a priority issue?
The Bankruptcy Code is all about priorities—the ordered distribution scheme that dictates the manner in which a debtor’s assets are distributed to its creditors. This distribution scheme is important both in the context of a reorganization plan and a liquidation. For a reorganization plan to be confirmed, creditors with similar priorities are grouped into classes and must be treated in accordance with the mandates of §1129 in order for that plan to be confirmed. In a liquidation, a debtor’s assets are liquidated and distributed to creditors in accordance with the priorities listed in §726.
The distinction between cash-collateral use and financing is significant because a party that provides financing receives a right to repayment that has a higher priority than that afforded a party that permits cash-collateral use.2 The task of deciphering the priority afforded each is not a simple one because it involves references to several different Bankruptcy Code sections,3 but the end result is that the priority afforded a party for use of its cash collateral is a §507(b) administrative priority, while a party providing financing is afforded priority over any and all administrative expenses, including those under §507(b).
Doesn’t the need for cash flow trump the priority issues?
The Code describes financing as “the obtaining of credit or the incurring of debt.”4 “Cash collateral” is defined less succinctly by the Code as “cash, negotiable instruments, documents of title, securities, deposit accounts or other cash equivalents whenever acquired in which the estate and an entity of the estate have an interest and includes the proceeds, products, offspring, rents or profits of property…”5 Put in their most simple context, financing can be thought of as the post-petition lending of new money to the debtor and cash-collateral use as the debtor’s post-petition use of collateral that it would otherwise be required to use to pay down a pre-petition obligation to a secured creditor, but the distinction isn’t that simple and is often quite fact-specific.
Yet the vagaries of cash flow often make the distinction between financing and cash collateral use little more than an intellectual exercise. If a debtor does not have adequate cash flow to fund operations without the infusion of new money, it must obtain financing and provide the lender the priorities provided by the Code. That decision is typically made by a debtor’s financial team and often involves facts to which committee members are not privy.
In many instances, trade creditors are far more comfortable extending post-petition credit to a debtor that receives financing rather than one that has to survive on cash-collateral use. The willingness of a lender to finance often lends credibility to a debtor and legitimizes its chance to successfully reorganize. Nevertheless, a ready and willing secured lender should not lull the committee into the belief that the terms of a financing stipulation are of little consequence. A diligent committee can obtain a number of benefits from negotiating a stipulation’s terms; an analysis of those benefits will be included in this series of articles.
Issue 2: Why so many defined terms and how can they impact creditor’s rights?
Both “cash collateral” and “financing” stipulations contain numerous defined terms. As in any contract, the meaning ascribed to defined terms plays an essential role in interpreting the agreement reached between the parties. Deciphering the meaning of defined terms in a cash-collateral or financing stipulation is made more difficult by the fact that some of those terms are loaded with meaning from sources other than the stipulation itself. Terms like “avoidance actions,” “surcharge,” “priming lien,” “adequate protection,” “relief from stay,” “carve-out,” and “perfection act” all carry meaning that has been developed by provisions in the Code or the Uniform Commercial Code and case law interpreting those provisions. The way that many of those defined terms are treated in a cash-collateral or financing stipulation can significantly impact the rights of creditors throughout the course of a bankruptcy case. As a result, each of those terms will be discussed separately during the course of this series of articles.6
As a preliminary matter, however, there are many seemingly innocuous definitions that can also impact the interpretation of a cash-collateral or financing stipulation. The definition of the date of the filing of the bankruptcy petition as the “petition date” is significant only to the extent that there are numerous time periods and deadlines that are measured from the petition date.7
Other definitions, like the definition of “pre-petition obligations” and “pre-petition liens” are fact-specific, but are significant because these provisions, if combined with a prohibition on the committee’s ability to investigate and attack the amount of the obligation or the validity of pre-petition liens, can bind the estate. Since the committee’s ability to preserve the right to attack the validity, extent and priority of pre-petition liens is one of the most important objectives of the negotiation of cash-collateral and financing stipulations, a discussion of the preservation of that right will also be the subject of a subsequent article.
Conclusion
This article lays the groundwork for a series of articles that address issues posed by cash-collateral and financing stipulations. The series will help enhance committee members’ ability to understand cash-collateral and financing stipulations so that they will be better equipped to make strategic decisions that will help protect the interests of unsecured creditors.
Footnotes
- Federal Rule of Bankruptcy Procedure 4001(d) provides, in pertinent part: “Unless the court fixes a different time, objections may be filed within 15 days of the mailing of the notice… [I]f no objection is filed, the court may enter an order approving or disapproving the agreement without conducting a hearing.” As a matter of practice, however, bankruptcy courts almost always set a final hearing on approval of financing or cash-collateral stipulations and often liberally construe the deadline for filing objections. Return to article.
- Typically the first source of recovery for a party that extends financing is a lien on the post-petition assets of a debtor; the administrative claim priority discussed in this section comes into play only if the collateral securing that lien is insufficient to repay the credit extended by the financing party. Similarly, cash-collateral use is typically secured by a replacement lien(s) on post-petition assets; the administrative-claim priority comes into play only if the collateral securing the replacement lien(s) is insufficient to repay the amount of cash collateral used by the debtor. Return to article.
- The priority afforded a party for use of its cash collateral is determined by reference to the following Bankruptcy Code sections in the following order: 363(c)(2)(B), 363(e), 361(3), 503(b)(1) and 507(b). The priority afforded a party that provides financing is determined by reference to §364(c)(1), which provides “a priority over all administrative expenses of the kind specified in…§507(b).” Return to article.
- Section 364(c). Return to article.
- Section 363(a). Return to article.
- Even though terms like “cross collateralization,” and “roll-up” are often not defined in a cash-collateral or financing stipulation, it is also important for committee members to have a working knowledge of these terms and their implications. As a result, they will be the subject of a subsequent article in this series. Return to article.
- The time periods and deadlines include the “reach-back” provisions for preferences in §547 (90 days) and fraudulent conveyances in §548 (one year, but three years for insiders), as well the deadlines by which a debtor or trustee must bring certain actions under §546(a). The petition date and the order for relief are the same date except in the context of an involuntary bankruptcy petition, where there is time period between the date of the involuntary petition and the order for relief that is referred to as the “gap period” described in §502(f). Return to article.