ABI Bankruptcy Reform

This rule fit well with the asset-based lending practices in 1978. For example, a prepetition lender's lien on a book publisher's inventory prepetition would continue post-petition with respect to accounts generated from the sale of such inventory and the eventual cash payment when received by the debtor. If that cash was then used to purchase all of the raw materials for the production of new books, the lender's lien would attach to those new books and all of the resulting accounts and cash. However, if that cash was used to purchase only half of the raw materials and the other half was purchased with post-petition trade credit, the proceeds of the finished goods would be allocated based on the “equities” of the case. Thus, because asset-based lending was the predominant form of secured lending in 1978, the Bankruptcy Code requirement for an equitable sharing of proceeds between secured and unsecured components was relatively uncontroversial.

But after 1978, borrowers began to obtain a fundamentally different type of secured loan based upon the aggregate value of the assets as a going concern ' cash flow lending. Companies would be bought and sold as going concerns for purchase prices tied to multiples of EBITDA. Lenders would provide financing based on a fraction of the purchase price secured by liens on substantially all of the purchased assets. Some lenders would offer cheaper financing in exchange for first lien priority and other lenders, sometimes in multiple tranches, would charge incrementally higher interest for second or third lien priority to account for the additional risk that the collateral would be insufficient to satisfy their loans after paying the lenders with higher priority. All of these lenders assumed, of course, that the blanket lien on substantially all of the assets would be protected during bankruptcy, such that the proceeds from the sale of a company as a going concern would first be applied to reduce the secured debt in the order of priority and any residual proceeds would be applied towards the unsecured claims (e.g., trade creditor claims).