Debtor-in-Possession Financing

Contrary to what many practitioners think, bankruptcy courts do not blindly accept all claims that the debtor cannot obtain financing on more favorable terms or approve any debtor-in-possession loan so long as it is unopposed. Lenders should be very careful about the terms they need to extend debtor-in-possession financing. If controversial terms are contained in the post-petition loan agreement or in the financing order, the debtor and creditor should be able to make a strong case that the market has been tested and that the proposed terms are the only available financing terms.

Certain controversial terms may in fact be very important points to the lender, but the lender should narrow its demands to those terms without which it would not be willing to make the loan.

A Cautionary Tale

A recent opinion out of the Western District of New York, In re The Colad Group, Inc., 2005 WL 1083201 (Bankr. W.D.N.Y. April 27, 2005), demonstrates that at least this court has not abdicated responsibility to the parties and is, perhaps, a cautionary tale for lenders about demanding too many over-reaching terms and losing credibility.

Colad involved a post-petition lender, Continental Plants Group, LLC, which proposed to make a post-petition advance to the debtor of $500,000 with a 90-day term. In addition to the $500,000 post-petition advance, Continental confirmed the pre-petition loan of approximately $2,750,000. The proposed interest rate was prime plus 4.5%, and the loan fees were $135,000. Other terms of the proposed financing included: 1) automatic relief from stay upon default; 2) limitations on the debtor's right to propose a plan of reorganization; 3) waivers of certain claims of the debtor against Continental and waiver of rights under the Bankruptcy Code, Federal Rules of Civil Procedures and Bankruptcy Rules; 4) a grant of administrative priority to the pre-petition debt; and 5) waiver of all rights to cause Continental to marshal its collateral.

Continental purchased the secured position of the pre-petition lender shortly before Colad's bankruptcy filing with the intent to use its position as secured lender to effect a purchase of the debtor's assets. The court found that Continental clearly had the power to dictate the terms of the post-petition lending but questioned whether the “proposed lending arrangement represented the best and only terms available to the debtor.” Id. at page 10.

The Interim Approval of the Financing

Judge Bucki began the opinion with a road map for considering first- day motions. Authority for granting first day orders is found in Section 105(a) of the Bankruptcy Code, which authorizes the issuance of orders that are “necessary or appropriate to carry out the provisions of this title.” 11 U.S.C. ' 105(a). The court articulated four guidelines for approval of first-day orders. First-day orders: 1) cannot make substantive rulings that irrevocably determine the rights of parties; 2) must be simple and clear to avoid unanticipated consequences; 3) should not change the procedural and substantive rights established by the Bankruptcy Code and Rules; and 4) should not “violate or disregard the substantive rights of parties, in ways not expressly authorized by the Bankruptcy Code.” Id. at 6.

Continental's proposed lending terms clearly offended the court on many levels. Perhaps the most egregious offense committed by Continen-tal was asking for the entire loan transaction to be approved as part of the first-day orders. The interim financing order submitted to the court was 26 pages long. The court's disapproval was aggravated by the lack of notice. Sufficient notice is next to impossible to provide for first day hearings and, for that reason, the court refused to grant rights to the lender or impair rights of other parties on the first day of the case except as was absolutely necessary.

Applying his four principles for considering first-day orders, Judge Bucki refused to approve the interim order. The court found that the interim order was not limited to credit terms “necessary to avoid immediate and irreparable harm to the estate” because it sought to approve the entire 93-page loan agreement between the debtor and Continental. The court refused to approve on an interim basis terms of the proposed financing order that altered substantive and procedural rights of creditors who had no “reasonable” opportunity to object. Furthermore, the proposed financing provided for proceeds of collateral to be applied first to the outstanding balance of the pre-petition debt. The court noted that it was not averse to approving rollover loan provisions but not at the expense of the procedural and substantive rights of other parties.

In response to Judge Bucki's refusal to approve the financing as originally proposed, the parties agreed to the entry of a simple interim order. The order permitted limited additional borrowing, super-priority administrative status for the post-petition debt and a lien on all of the debtor's assets to secure the interim borrowings. The court deferred consideration of the objectionable provisions while giving the parties some indication that the loan transaction may be approved after the final hearing.

Final Approval of the Financing

The debtor and Continental did not fare any better at the final hearing. The debtor and Continental proceeded to final hearing with modified loan terms meant to assuage the court's concerns but the terms fell far short of what the court was looking for. Judge Bucki was not satisfied with the modified terms even with the Official Committee of Unsecured Creditor's support for the post-petition loan. As a result, the court refused to approve the final financing order.

The court refused to approve the interest rate and loan fees for the post-petition loan. Continental unsuccessfully tried to characterize the post-petition loan as a $3,252,000 loan, but the court was not convinced that renewal of the pre-petition loan qualified as post-petition lending. The court found that the additional credit was only $500,000 and thus, the interest rate and fees violated New York usury laws limiting interest rates for loans under $2.5 million. The court refused to approve a loan transaction that violated New York law. Moreover, Judge Bucki would not approve the interest and fees demanded by the lender even without finding a violation of New York usury laws. As part of his refusal to approve the proposed financing on a final basis, the court found that the excessive interest rate and loan fees were a subterfuge meant only to advantage the lender in its desire to purchase all of the debtor's assets.

The court refused to make a finding for Bankruptcy Code Section 364(e) purposes that the post-petition financing was extended in good faith. Section 364(e) provides that the reversal or modification on appeal of an order authorizing post-petition lending will not affect the validity of the debt or the liens securing such debt “granted to an entity that extended such credit in good faith.” 11 U.S.C. ' 364(e). The court declined to find that sufficient evidence of good faith had been presented at the hearing and that the other terms of the financing order left the court unable to conclude that the lender had the requisite good faith.

It is difficult to determine the specific factor that drew the court's disdain. Was the court most offended by the parties attempt to obtain interim approval of a complicated transaction without any real opportunity for creditors to object? Clearly, the submission of a 26-page financing order at the first-day hearing seeking to approve a 93-page loan agreement offended the judge.

Lastly, the court was disturbed that the parties were disingenuous in their claim that there was no available lending on more favorable terms. One can infer that Continental's purchase of the pre-petition debt shortly before the debtor filed for bankruptcy and its interest in purchasing the debtor's assets led the court to become suspicious of Continental's motives. Many of the terms demanded by Continen-tal appeared to be designed to protect its interests as a buyer rather than as a post-petition lender. The fact that the lender retreated from its position for the interim financing order only further reinforced Judge Bucki's impression that the parties were not being forthright.

Most likely a combination of the above coupled with the excessive interest and fees and the lender's exertion its significant bargaining power backfired on the lender. These factors contributed to Judge Bucki's refusal to make a Section 364(e) good faith finding and his denial of authority to proceed with the proposed post-petition financing on terms routinely authorized by other courts at final hearings. The post-petition loan included both relatively non-controversial provisions such as relief from the automatic stay, waiver of marshalling rights, and waiver of the right to surcharge collateral under Section 506(c) of the Bankruptcy Code, and controversial provisions such as roll-over provisions, priming liens, and restrictions on debtor's right to propose a plan.

Rights Regarding Plans of Reorganization

An opinion from the United States District Court for the Western District of Pennsylvania, In re New World Pasta, 322 B.R. 560 (W.D. Pa. 2005) is an example of how far a court may be willing to go to approve post-petitioning financing even over the objection of the creditors committee if the debtor convinces the bankruptcy court that there is no other available financing. New World Pasta was an appeal by the Official Committee of Unsecured Creditors from an order by the bankruptcy court approving debtor in possession financing. The primary issue on appeal was whether Section 5.13 of the financing agreement, which conditioned the lenders' obligation to continue to provide financing on the debtor's proposal of a plan that was acceptable to the lenders, violated the Bankruptcy Code.

The committee argued that the provision was a “lockup” agreement that ceded control of the plan process to the post-petition lenders and, thereby, prevented the debtor from fulfilling its fiduciary duties. The District Court remanded some of the issues raised on appeal to the bankruptcy court for further ruling but upheld the bankruptcy court's approval of Section 5.13 of the financing agreement.

First, the court found that Section 5.13 was not an inappropriate lockup agreement. The court noted that lock-up agreements are agreements negotiated pre-petition to bind various constituencies to vote in favor of a plan if it contains certain agreed upon terms. The district court noted that lock-up agreements have been criticized and the votes required thereunder denied effectiveness in those cases where the lock-up agreements were entered into post-petition and prior to the approval of a disclosure statement. Section 5.13 was not a lock-up agreement, the court reasoned, because it was not signed pre-petition and it did not require any party to vote in favor of the plan.

Next, the court rejected the committee's argument that Section 5.13 violated the Bankruptcy Code by effectively forfeiting control of the bankruptcy process to the secured lenders. The court found that Section 1121(a) and (b), which allows the debtor to file a plan of reorganization and gives the debtor the exclusive right to do so during the first 120 days of the case were not violated because the exclusive period expired. Section 1129(a) that permits a cramdown of an impaired class was not violated because Section 5.13 did not prevent the debtor from confirming a plan over the objection of any lender.

Although a full analysis of the opinion is beyond the scope of this article, it is interesting to note that the court alluded to the fact that seemingly onerous provisions are judged in the context of the lending transaction as a whole.

Cross-Collateralization

Cross-collateralization is a controversial post-petition financing term that continues to persist notwithstanding Circuit Court opinions suggesting that cross-collateralization is not authorized under Section 364. The Eleventh Circuit in Shapiro v. Saybrook Manufacturing Company, Inc., 963 F.2d 1490 (11th Cir. 1992), held that Texlon-type cross-collateralization in post-petition financing is impermissible as it is directly contrary to the fundamental priority scheme of the Code. Texlon-type cross-collateralization, refers to a lending arrangement whereby the pre-petition loan is secured by both the pre-petition and post-petition assets of the debtor. The Second Circuit in Otte v. Manufacturers Hanover Commercial Corp. (In re Texlon Corp.), 595 F.2d 1092, 1094 (2d Cir. 1979) was the first circuit court to describe the practice; accordingly, it is sometimes called Texlon-type cross-collateralization. Non-Texlon-type cross-collateralization occurs when only the post-petition debt obtains the benefit of both pre-petition and post-petition collateral.

In Saybrook, the lender sought to secure $34 million of pre-petition debt with the collateral securing the $3 million post-petition loan – the pre-petition and post-petition assets of the Debtor. The pre-petition debt was under-secured by more than $20 million. The Eleventh Circuit held that Section 364 only applies to post-petition financing. The authority to grant liens provided in Sections 364(c) and (d) does not extend to pre-petition indebtedness. The court also reasoned that the general equitable powers of bankruptcy courts under Section 105 do not permit courts to approve cross-collateralization of pre-petition loans. To permit the granting of liens to under-secured pre-petition debt violates the priority scheme of the Bankruptcy Code by favoring one unsecured creditor over all other unsecured creditors. The Eleventh Circuit held that the equitable powers granted to bankruptcy courts under the Code cannot be invoked by the courts to change the priority of claims set forth in Section 507 of the Code.

Many lenders have shifted away from seeking cross-collateralization even in those jurisdictions which have not specifically adopted the Saybrook approach, in favor of rollover provisions.

Liens on Avoidance Actions

Liens granted on unencumbered assets are authorized by Section 364(c) of the Code and are generally not controversial if the creditor's committee is persuaded that the post-petition financing will enhance the debtor's prospects for reorganization or the recovery from a sale of assets. An exception is liens granted on bankruptcy-created causes of action. Recoveries from avoidance actions and fraudulent conveyance claims are often the last potential sources for payment of a dividend to unsecured creditors; accordingly, many courts refuse to permit the granting of liens on avoidance actions or their proceeds to secure post-petition debt. Other courts are willing to approve liens on proceeds of bankruptcy causes of action if post-petition financing would otherwise be unavailable. See In re WorldCom, Inc. Case No. 02-13533, Docket No. 1603 at 9.

Avoidance actions may be a legitimate source of collateral for post-petition lenders and obtaining a lien on avoidance actions may be the only incentive for certain lenders to accept the risk of lending post-petition. A lender will need to make a strong case as to why the lien on the only asset otherwise reserved for unsecured creditors should be granted.

Conclusion

Even in jurisdictions that have not adopted hard-line approaches to any of the above financing terms lenders should use caution in what terms they require in their post-petition loan transactions.

There has been much discussion among bankruptcy practitioners and scholars as to whether the courts have abdicated their responsibility to enforce the Bankruptcy Code and whether debtors and creditors committees are too easily pressured by lenders such that control of bankruptcy cases has been effectively ceded to secured creditors. One of the areas where many would say this is most prevalent is with post-petition lending.

Under Section 364(c) of the Bankruptcy Code, a post-petition lender may be entitled to a super-priority administrative claim, a lien on unencumbered assets or a junior lien on encumbered assets if the debtor is unable to obtain unsecured debt. Section 364 permits the granting of liens that are equal to or prime pre-petition liens if adequate protection can be provided to the existing lienholders and the debtor “is unable to obtain such credit otherwise.” 11 U.S.C. ' 364(d) “Unable to obtain unsecured debt” or “unable to obtain such credit otherwise” means that it is incumbent upon the debtor to show that it cannot obtain financing that is unsecured or secured by a junior lien.

The Code is silent as to what other terms may be included in a post-petition loan transaction. However, most debtor-in-possession financing includes terms beyond those contained in a typical loan transaction, and grant the lender rights or effectuate waivers which arguably are less related to the post-petition loan than to protecting the pre-petition debt. There is often simply no opposition by the creditor's committee or other parties in interest because they conclude that alternate financing on more favorable terms is unavailable. It is difficult for courts to deny motions to approve debtor-in-possession financing when all the parties are in favor of it. Even post-petition financing that violates bankruptcy principles has been justified as being consistent with the Code's purpose of encouraging business reorgani-zation if the debtor has no other source and needs the post-petition credit to operate.

Contrary to what many practitioners think, bankruptcy courts do not blindly accept all claims that the debtor cannot obtain financing on more favorable terms or approve any debtor-in-possession loan so long as it is unopposed. Lenders should be very careful about the terms they need to extend debtor-in-possession financing. If controversial terms are contained in the post-petition loan agreement or in the financing order, the debtor and creditor should be able to make a strong case that the market has been tested and that the proposed terms are the only available financing terms.

Certain controversial terms may in fact be very important points to the lender, but the lender should narrow its demands to those terms without which it would not be willing to make the loan.

A Cautionary Tale

A recent opinion out of the Western District of New York, In re The Colad Group, Inc., 2005 WL 1083201 (Bankr. W.D.N.Y. April 27, 2005), demonstrates that at least this court has not abdicated responsibility to the parties and is, perhaps, a cautionary tale for lenders about demanding too many over-reaching terms and losing credibility.

Colad involved a post-petition lender, Continental Plants Group, LLC, which proposed to make a post-petition advance to the debtor of $500,000 with a 90-day term. In addition to the $500,000 post-petition advance, Continental confirmed the pre-petition loan of approximately $2,750,000. The proposed interest rate was prime plus 4.5%, and the loan fees were $135,000. Other terms of the proposed financing included: 1) automatic relief from stay upon default; 2) limitations on the debtor's right to propose a plan of reorganization; 3) waivers of certain claims of the debtor against Continental and waiver of rights under the Bankruptcy Code, Federal Rules of Civil Procedures and Bankruptcy Rules; 4) a grant of administrative priority to the pre-petition debt; and 5) waiver of all rights to cause Continental to marshal its collateral.

Continental purchased the secured position of the pre-petition lender shortly before Colad's bankruptcy filing with the intent to use its position as secured lender to effect a purchase of the debtor's assets. The court found that Continental clearly had the power to dictate the terms of the post-petition lending but questioned whether the “proposed lending arrangement represented the best and only terms available to the debtor.” Id. at page 10.

The Interim Approval of the Financing

Judge Bucki began the opinion with a road map for considering first- day motions. Authority for granting first day orders is found in Section 105(a) of the Bankruptcy Code, which authorizes the issuance of orders that are “necessary or appropriate to carry out the provisions of this title.” 11 U.S.C. ' 105(a). The court articulated four guidelines for approval of first-day orders. First-day orders: 1) cannot make substantive rulings that irrevocably determine the rights of parties; 2) must be simple and clear to avoid unanticipated consequences; 3) should not change the procedural and substantive rights established by the Bankruptcy Code and Rules; and 4) should not “violate or disregard the substantive rights of parties, in ways not expressly authorized by the Bankruptcy Code.” Id. at 6.

Continental's proposed lending terms clearly offended the court on many levels. Perhaps the most egregious offense committed by Continen-tal was asking for the entire loan transaction to be approved as part of the first-day orders. The interim financing order submitted to the court was 26 pages long. The court's disapproval was aggravated by the lack of notice. Sufficient notice is next to impossible to provide for first day hearings and, for that reason, the court refused to grant rights to the lender or impair rights of other parties on the first day of the case except as was absolutely necessary.

Applying his four principles for considering first-day orders, Judge Bucki refused to approve the interim order. The court found that the interim order was not limited to credit terms “necessary to avoid immediate and irreparable harm to the estate” because it sought to approve the entire 93-page loan agreement between the debtor and Continental. The court refused to approve on an interim basis terms of the proposed financing order that altered substantive and procedural rights of creditors who had no “reasonable” opportunity to object. Furthermore, the proposed financing provided for proceeds of collateral to be applied first to the outstanding balance of the pre-petition debt. The court noted that it was not averse to approving rollover loan provisions but not at the expense of the procedural and substantive rights of other parties.

In response to Judge Bucki's refusal to approve the financing as originally proposed, the parties agreed to the entry of a simple interim order. The order permitted limited additional borrowing, super-priority administrative status for the post-petition debt and a lien on all of the debtor's assets to secure the interim borrowings. The court deferred consideration of the objectionable provisions while giving the parties some indication that the loan transaction may be approved after the final hearing.

Final Approval of the Financing

The debtor and Continental did not fare any better at the final hearing. The debtor and Continental proceeded to final hearing with modified loan terms meant to assuage the court's concerns but the terms fell far short of what the court was looking for. Judge Bucki was not satisfied with the modified terms even with the Official Committee of Unsecured Creditor's support for the post-petition loan. As a result, the court refused to approve the final financing order.

The court refused to approve the interest rate and loan fees for the post-petition loan. Continental unsuccessfully tried to characterize the post-petition loan as a $3,252,000 loan, but the court was not convinced that renewal of the pre-petition loan qualified as post-petition lending. The court found that the additional credit was only $500,000 and thus, the interest rate and fees violated New York usury laws limiting interest rates for loans under $2.5 million. The court refused to approve a loan transaction that violated New York law. Moreover, Judge Bucki would not approve the interest and fees demanded by the lender even without finding a violation of New York usury laws. As part of his refusal to approve the proposed financing on a final basis, the court found that the excessive interest rate and loan fees were a subterfuge meant only to advantage the lender in its desire to purchase all of the debtor's assets.

The court refused to make a finding for Bankruptcy Code Section 364(e) purposes that the post-petition financing was extended in good faith. Section 364(e) provides that the reversal or modification on appeal of an order authorizing post-petition lending will not affect the validity of the debt or the liens securing such debt “granted to an entity that extended such credit in good faith.” 11 U.S.C. ' 364(e). The court declined to find that sufficient evidence of good faith had been presented at the hearing and that the other terms of the financing order left the court unable to conclude that the lender had the requisite good faith.

It is difficult to determine the specific factor that drew the court's disdain. Was the court most offended by the parties attempt to obtain interim approval of a complicated transaction without any real opportunity for creditors to object? Clearly, the submission of a 26-page financing order at the first-day hearing seeking to approve a 93-page loan agreement offended the judge.

Lastly, the court was disturbed that the parties were disingenuous in their claim that there was no available lending on more favorable terms. One can infer that Continental's purchase of the pre-petition debt shortly before the debtor filed for bankruptcy and its interest in purchasing the debtor's assets led the court to become suspicious of Continental's motives. Many of the terms demanded by Continen-tal appeared to be designed to protect its interests as a buyer rather than as a post-petition lender. The fact that the lender retreated from its position for the interim financing order only further reinforced Judge Bucki's impression that the parties were not being forthright.

Most likely a combination of the above coupled with the excessive interest and fees and the lender's exertion its significant bargaining power backfired on the lender. These factors contributed to Judge Bucki's refusal to make a Section 364(e) good faith finding and his denial of authority to proceed with the proposed post-petition financing on terms routinely authorized by other courts at final hearings. The post-petition loan included both relatively non-controversial provisions such as relief from the automatic stay, waiver of marshalling rights, and waiver of the right to surcharge collateral under Section 506(c) of the Bankruptcy Code, and controversial provisions such as roll-over provisions, priming liens, and restrictions on debtor's right to propose a plan.

Rights Regarding Plans of Reorganization

An opinion from the United States District Court for the Western District of Pennsylvania, In re New World Pasta, 322 B.R. 560 (W.D. Pa. 2005) is an example of how far a court may be willing to go to approve post-petitioning financing even over the objection of the creditors committee if the debtor convinces the bankruptcy court that there is no other available financing. New World Pasta was an appeal by the Official Committee of Unsecured Creditors from an order by the bankruptcy court approving debtor in possession financing. The primary issue on appeal was whether Section 5.13 of the financing agreement, which conditioned the lenders' obligation to continue to provide financing on the debtor's proposal of a plan that was acceptable to the lenders, violated the Bankruptcy Code.

The committee argued that the provision was a “lockup” agreement that ceded control of the plan process to the post-petition lenders and, thereby, prevented the debtor from fulfilling its fiduciary duties. The District Court remanded some of the issues raised on appeal to the bankruptcy court for further ruling but upheld the bankruptcy court's approval of Section 5.13 of the financing agreement.

First, the court found that Section 5.13 was not an inappropriate lockup agreement. The court noted that lock-up agreements are agreements negotiated pre-petition to bind various constituencies to vote in favor of a plan if it contains certain agreed upon terms. The district court noted that lock-up agreements have been criticized and the votes required thereunder denied effectiveness in those cases where the lock-up agreements were entered into post-petition and prior to the approval of a disclosure statement. Section 5.13 was not a lock-up agreement, the court reasoned, because it was not signed pre-petition and it did not require any party to vote in favor of the plan.

Next, the court rejected the committee's argument that Section 5.13 violated the Bankruptcy Code by effectively forfeiting control of the bankruptcy process to the secured lenders. The court found that Section 1121(a) and (b), which allows the debtor to file a plan of reorganization and gives the debtor the exclusive right to do so during the first 120 days of the case were not violated because the exclusive period expired. Section 1129(a) that permits a cramdown of an impaired class was not violated because Section 5.13 did not prevent the debtor from confirming a plan over the objection of any lender.

Although a full analysis of the opinion is beyond the scope of this article, it is interesting to note that the court alluded to the fact that seemingly onerous provisions are judged in the context of the lending transaction as a whole.

Cross-Collateralization

Cross-collateralization is a controversial post-petition financing term that continues to persist notwithstanding Circuit Court opinions suggesting that cross-collateralization is not authorized under Section 364. The Eleventh Circuit in Shapiro v. Saybrook Manufacturing Company, Inc. , 963 F.2d 1490 (11th Cir. 1992), held that Texlon-type cross-collateralization in post-petition financing is impermissible as it is directly contrary to the fundamental priority scheme of the Code. Texlon-type cross-collateralization, refers to a lending arrangement whereby the pre-petition loan is secured by both the pre-petition and post-petition assets of the debtor. The Second Circuit in Otte v. Manufacturers Hanover Commercial Corp. (In re Texlon Corp.), 595 F.2d 1092, 1094 (2d Cir. 1979) was the first circuit court to describe the practice; accordingly, it is sometimes called Texlon-type cross-collateralization. Non-Texlon-type cross-collateralization occurs when only the post-petition debt obtains the benefit of both pre-petition and post-petition collateral.

In Saybrook, the lender sought to secure $34 million of pre-petition debt with the collateral securing the $3 million post-petition loan – the pre-petition and post-petition assets of the Debtor. The pre-petition debt was under-secured by more than $20 million. The Eleventh Circuit held that Section 364 only applies to post-petition financing. The authority to grant liens provided in Sections 364(c) and (d) does not extend to pre-petition indebtedness. The court also reasoned that the general equitable powers of bankruptcy courts under Section 105 do not permit courts to approve cross-collateralization of pre-petition loans. To permit the granting of liens to under-secured pre-petition debt violates the priority scheme of the Bankruptcy Code by favoring one unsecured creditor over all other unsecured creditors. The Eleventh Circuit held that the equitable powers granted to bankruptcy courts under the Code cannot be invoked by the courts to change the priority of claims set forth in Section 507 of the Code.

Many lenders have shifted away from seeking cross-collateralization even in those jurisdictions which have not specifically adopted the Saybrook approach, in favor of rollover provisions.

Liens on Avoidance Actions

Liens granted on unencumbered assets are authorized by Section 364(c) of the Code and are generally not controversial if the creditor's committee is persuaded that the post-petition financing will enhance the debtor's prospects for reorganization or the recovery from a sale of assets. An exception is liens granted on bankruptcy-created causes of action. Recoveries from avoidance actions and fraudulent conveyance claims are often the last potential sources for payment of a dividend to unsecured creditors; accordingly, many courts refuse to permit the granting of liens on avoidance actions or their proceeds to secure post-petition debt. Other courts are willing to approve liens on proceeds of bankruptcy causes of action if post-petition financing would otherwise be unavailable. See In re WorldCom, Inc. Case No. 02-13533, Docket No. 1603 at 9.

Avoidance actions may be a legitimate source of collateral for post-petition lenders and obtaining a lien on avoidance actions may be the only incentive for certain lenders to accept the risk of lending post-petition. A lender will need to make a strong case as to why the lien on the only asset otherwise reserved for unsecured creditors should be granted.

Conclusion

Even in jurisdictions that have not adopted hard-line approaches to any of the above financing terms lenders should use caution in what terms they require in their post-petition loan transactions.