S.D.N.Y. Endorses Commonly Used Procedures for Providing Adequate Assurance to Utility Providers

Utility providers are considered to be different from other vendors and entitled to different treatment because, at least historically, they were often government-approved monopolies, and the debtor did not have meaningful alternative suppliers. In addition, utilities are often forced credit-providers, in the sense that, for example, a debtor receives credit every time it turns on a light switch, so long as the power is on, and is not billed for such usage of electricity until a later date. Prior to 2005, ' 366 of the Bankruptcy Code operated, in substance, to prevent utility providers from altering, refusing, or discontinuing service to, or discriminating against, a debtor because of pre-petition non-payment, unless the debtor fails to provide some form of adequate assurance of payment, such as a deposit or other security, for post-petition service. Even though the language of ' 366 seemed to imply that some sort of security could be required of a debtor, such requirement was not explicit, and debtors were able fairly routinely to obtain first-day orders enjoining utility providers from discontinuing service for not providing more than administrative claim status that utility providers would have in bankruptcy (often including language requiring timely payment and a finding that the debtor had sufficient projected liquidity), unless utility providers requested another form of adequate assurance by a certain date.

As a result of what was viewed by some to be unfair treatment of utility providers (and presumably with the help of some lobbying efforts), the 2005 BAPCPA amendments modified ' 366 in certain ways, including making it explicit that any proposed adequate assurance would have to be in the form of a cash deposit, letter of credit, certificate of deposit, surety bond, prepayment, or similar security acceptable to the utility provider. Post-BAPCPA, ' 366 also established different deadlines by which a debtor had to propose adequate assurance and explicitly excluded prior payment history and the availability of an administrative claim (i.e., typical pre-BAPCPA procedures) from constituting adequate assurance by themselves.

In adapting to the post-BAPCPA world, debtors experimented with different alternatives designed to minimize adverse liquidity effects. Relatively common practice has developed, at least in Delaware and New York, where debtors propose two-week deposits (sometimes held by the utility providers and sometimes held by the debtors in segregated or escrow accounts) and procedures early in the case for objection to such proposed adequate assurance, including requiring utility providers to ask for anything beyond the proposed deposit (and for the parties to agree on appropriate adequate assurance or for the court to adjudicate any continuing disputes).

A&P Procedures, Disputes, and Bankruptcy Court
Ruling

In a first-day motion, the A&P debtors proposed to provide two-week deposits as adequate assurance, which, along with related procedures, was approved by the United States Bankruptcy Court for the Southern District of New York (Drain, J.) over the objection of certain utility providers. These objecting utilities argued, among other things, that two-week deposits were insufficient to provide adequate assurance because state tariffs exposed them to greater than two weeks of “credit” risk (generally, two months) at any given time.

The bankruptcy court found that the proposed two-week deposits appropriately balanced the protections afforded debtors under Chapter 11 with the interests of, and risks borne by, utility providers under ' 366. The bankruptcy court also found that, to require a debtor to provide the adequate assurance demanded by a utility provider prior to a ruling on appropriate procedures, as the objecting utilities argued ' 366 requires, would be “unworkable.”

District Court Appeal and Decision

The district court agreed with Judge Drain's determination of the appropriate balance between the interests of the A&P debtors and the objecting utilities, and affirmed the bankruptcy court's decision.

Specifically, the district court found that a bankruptcy court can weigh many factors, such as the existence of liquidity under DIP financing, to find that deposits proposed as adequate assurance need not equal the utility providers' maximum exposure. Similarly favorable to debtors, the district court affirmed the bankruptcy court's ruling that a segregated utility account, even though not
specifically enumerated in ' 366(c) as a potential form of adequate assurance, complied with ' 366 and that the power lay with the debtor, and not the utility company, to set forth the proposed form of adequate assurance. Finally, the district court again agreed with the bankruptcy court that it was appropriate for the debtor to seek adequate assurance procedures by motion ' rather than by adversary proceeding, even though such procedures appear tantamount to an injunction, in some instances ' and that interim orders establishing related procedures placing certain burdens on utility providers entered near the first day of a case were acceptable, even though the burden ultimately was on a debtor to formulate acceptable adequate assurance.

Conclusion

At least one United States District Court has approved of specific procedures to adequately assure utility providers of payment following a bankruptcy filing that have been the standard in many bankruptcy cases, providing meaningful authority for potential debtors on the adequate assurance issue. As a result, debtors can now, with even more confidence, propose adequate assurance procedures for utility providers and better forecast post-petition financing needs, as well as transition into Chapter 11 with more certainty and with less risk of sustainable litigation from utility providers during the early stages of a Chapter 11 case.

Joel H. Levitin, a member of this newsletter's Board of Editors, and Richard A. Stieglitz Jr. are partners at Cahill Gordon & Reindel LLP in New York. The authors can be contacted at [email protected] and [email protected] respectively.

When Congress passed the BAPCPA amendments in 2005, it became clear that a debtor's satisfactory prior payment history and the provision of an administrative claim to utility providers for post-petition utility services would no longer be sufficient to satisfy the debtor's requirement to provide “adequate assurance of payment” under Bankruptcy Code ' 366, so as to preclude termination of such services in bankruptcy. What would be sufficient was much less clear.

The general practice since BAPCPA, at least in Delaware and New York, has been to provide two-week deposits based upon annualized averages for utilities held in a segregated utility account and procedures for utilities to object to such adequate assurance and/or to request additional or different adequate assurance. The United States District Court for the Southern District of New York, in In re The Great Atlantic & Pacific Tea Company, Inc., et al., 11-CB-1338 (CS) (S.D.N.Y. Nov. 14, 2011), recently endorsed the use of such procedures, over the objection of multiple utilities.

History of ' 366

Utility providers are considered to be different from other vendors and entitled to different treatment because, at least historically, they were often government-approved monopolies, and the debtor did not have meaningful alternative suppliers. In addition, utilities are often forced credit-providers, in the sense that, for example, a debtor receives credit every time it turns on a light switch, so long as the power is on, and is not billed for such usage of electricity until a later date. Prior to 2005, ' 366 of the Bankruptcy Code operated, in substance, to prevent utility providers from altering, refusing, or discontinuing service to, or discriminating against, a debtor because of pre-petition non-payment, unless the debtor fails to provide some form of adequate assurance of payment, such as a deposit or other security, for post-petition service. Even though the language of ' 366 seemed to imply that some sort of security could be required of a debtor, such requirement was not explicit, and debtors were able fairly routinely to obtain first-day orders enjoining utility providers from discontinuing service for not providing more than administrative claim status that utility providers would have in bankruptcy (often including language requiring timely payment and a finding that the debtor had sufficient projected liquidity), unless utility providers requested another form of adequate assurance by a certain date.

As a result of what was viewed by some to be unfair treatment of utility providers (and presumably with the help of some lobbying efforts), the 2005 BAPCPA amendments modified ' 366 in certain ways, including making it explicit that any proposed adequate assurance would have to be in the form of a cash deposit, letter of credit, certificate of deposit, surety bond, prepayment, or similar security acceptable to the utility provider. Post-BAPCPA, ' 366 also established different deadlines by which a debtor had to propose adequate assurance and explicitly excluded prior payment history and the availability of an administrative claim (i.e., typical pre-BAPCPA procedures) from constituting adequate assurance by themselves.

In adapting to the post-BAPCPA world, debtors experimented with different alternatives designed to minimize adverse liquidity effects. Relatively common practice has developed, at least in Delaware and New York, where debtors propose two-week deposits (sometimes held by the utility providers and sometimes held by the debtors in segregated or escrow accounts) and procedures early in the case for objection to such proposed adequate assurance, including requiring utility providers to ask for anything beyond the proposed deposit (and for the parties to agree on appropriate adequate assurance or for the court to adjudicate any continuing disputes).

A&P Procedures, Disputes, and Bankruptcy Court
Ruling

In a first-day motion, the A&P debtors proposed to provide two-week deposits as adequate assurance, which, along with related procedures, was approved by the United States Bankruptcy Court for the Southern District of New York (Drain, J.) over the objection of certain utility providers. These objecting utilities argued, among other things, that two-week deposits were insufficient to provide adequate assurance because state tariffs exposed them to greater than two weeks of “credit” risk (generally, two months) at any given time.

The bankruptcy court found that the proposed two-week deposits appropriately balanced the protections afforded debtors under Chapter 11 with the interests of, and risks borne by, utility providers under ' 366. The bankruptcy court also found that, to require a debtor to provide the adequate assurance demanded by a utility provider prior to a ruling on appropriate procedures, as the objecting utilities argued ' 366 requires, would be “unworkable.”

District Court Appeal and Decision

The district court agreed with Judge Drain's determination of the appropriate balance between the interests of the A&P debtors and the objecting utilities, and affirmed the bankruptcy court's decision.

Specifically, the district court found that a bankruptcy court can weigh many factors, such as the existence of liquidity under DIP financing, to find that deposits proposed as adequate assurance need not equal the utility providers' maximum exposure. Similarly favorable to debtors, the district court affirmed the bankruptcy court's ruling that a segregated utility account, even though not
specifically enumerated in ' 366(c) as a potential form of adequate assurance, complied with ' 366 and that the power lay with the debtor, and not the utility company, to set forth the proposed form of adequate assurance. Finally, the district court again agreed with the bankruptcy court that it was appropriate for the debtor to seek adequate assurance procedures by motion ' rather than by adversary proceeding, even though such procedures appear tantamount to an injunction, in some instances ' and that interim orders establishing related procedures placing certain burdens on utility providers entered near the first day of a case were acceptable, even though the burden ultimately was on a debtor to formulate acceptable adequate assurance.

Conclusion

At least one United States District Court has approved of specific procedures to adequately assure utility providers of payment following a bankruptcy filing that have been the standard in many bankruptcy cases, providing meaningful authority for potential debtors on the adequate assurance issue. As a result, debtors can now, with even more confidence, propose adequate assurance procedures for utility providers and better forecast post-petition financing needs, as well as transition into Chapter 11 with more certainty and with less risk of sustainable litigation from utility providers during the early stages of a Chapter 11 case.

Joel H. Levitin, a member of this newsletter's Board of Editors, and Richard A. Stieglitz Jr. are partners at Cahill Gordon & Reindel LLP in New York. The authors can be contacted at [email protected] and [email protected] respectively.