When a Lessee Files for Bankruptcy

The Bankruptcy Code defines “cash collateral” in Section 363 regarding the Use, Sale or Lease of Property as “cash, negotiable instruments, documents of title, securities, deposit accounts, or other cash equivalents … ” A Chapter 11 DIP may have encumbered its cash and other cash equivalents and it must obtain the secured creditors' and the court's approval to use its own cash. A DIP will file a Motion to Approve the Use of Cash Collateral (which will attach a budget that is usually an excel spreadsheet listing the payments the Debtor may make to payors) with the bankruptcy court. Generally, the court will approve the use on an interim basis before it enters a final order on the use of Cash Collateral.

What Is DIP Financing?

This is a type of financing used by Chapter 11 DIPs that generally provides the lender with a first lien on all assets, and requires that a DIP attach a budget for all payments to payors. In fact, the proposed order will generally state that unless a payor is on the attached budget, the Debtor shall not pay that entity. A DIP will present a Motion to have the DIP Financing approved by the bankruptcy court, and generally, lenders make the financing available on an interim basis, and the court will approve the use on an interim basis before it enters a final order on DIP Financing.

A Common Scenario

XYZ Corp. (XYZ) hauls oil and gas, and recently filed a Voluntary Petition under Chapter 11. A few days later, XYZ, as DIP, files an Emergency Motion to Approve Debtor in Possession Financing. You are in-house counsel at ABC, an equipment lessor, and XYZ signed a Security Agreement and Retail Contract for a Tanker Truck with you prior to when it filed bankruptcy. It had been paying regularly, though lately it's needed to use its grace periods, and this month ABC received no payment at all. You hear about the bankruptcy before ABC actually receives notice, and have ABC's legal department look at the bankruptcy case. ABC's in-house lawyer sees that the docket shows an emergency hearing tomorrow morning on the XYZ's Emergency Motion to Approve DIP Financing. A review of the Motion does not make it clear if ABC will receive its monthly payments going forward.

Typical Provisions in a Proposed Order

Priming of Pre-petition Liens

The financing bank will likely include a provision to have its lien come first, before all others, in order to agree to provide the financing.

Budgets and Forecasts

This is the document attached to the (proposed) Cash Collateral or Financing Order. You will want to make sure that there is a provision for payment of your client's lease. Usually, budgets have general categories, such as “equipment lease” and a dollar amount, and you will have to confirm with Debtor's counsel that in fact it is your equipment lease.

If you are a lessor, and the DIP needs your equipment to operate, you will have a good argument to get paid. If you are a secured creditor (i.e., your lease is a financing arrangement), you may not be able to obtain adequate protection payments unless you file a motion and prove that you are not being adequately protected.

Responding to Cash Collateral or Financing Orders

Early Participation

Nothing can substitute for early participation in the case. In this scenario, ABC should have counsel attend the “first-day” motion hearings (which generally include the Emergency Motion for DIP Financing). ABC will want to object to the Debtor's Motion unless ABC is listed in the budget to receive its regular monthly payment. ABC should seek counsel who can negotiate with XYZ's counsel regarding ABC's treatment and file an Objection to XYZ's Emergency Motion to be sure the Debtor includes payment to ABC.

Protection

In addition, where DIP Financing is involved, ABC will want to make sure that the lender does not obtain priority over ABC's properly perfected prepetition lien. ABC should protect its pre-petition liens from being primed by XYZ's lender. A lender to a DIP will seek the security of a priming lien for itself, and if the proposed Financing Order does not indicate that the properly perfected pre-petition liens of your company are not primed by the lender, you should object to the DIP's Emergency Motion. ABC will want to seek counsel to file an Objection to XYZ's Emergency Motion.

Ensure You Are in the Debtor's Budget

XYZ has not attached a budget, but has indicated it will do so prior to the hearing. ABC must make sure it is in the budget or it may desire to consider filing for Relief from the Automatic Stay. A lessor should make sure lease payments are in the DIP or cash collateral budget. Some debtors posture the budget as “projections.” It should make no difference — being included is better than not being included.

Read Every Paragraph of the Proposed Cash Collateral or DIP Financing Order

You always need to review the proposed Cash Collateral Order or proposed DIP Financing Order with a fine tooth comb to be sure that your company is not being harmed by the Debtor's proposed Order. As a suggestion, pay particular attention to paragraphs regarding Pre-petition First Liens and Collateral and the Budget as well as the lender's Adequate Protection lien. You may see that these paragraphs do not take your client's rights into account or provide the lender with priming over your valid pre-petition lien.

Obtain a Carve-out of the Priming Lien

If you represent a lender, try to have your Purchase Money Security Interest (PMSI) carved out of the priming lien granted to a lender — or at least have it given equal status or leave the issue open for future determination and “adequate protection.”

Insist on a Default Provision to Quickly Obtain Collateral

If you are treated in the financing orders, insist on default provisions that can allow your client to quickly obtain possession of its collateral or leased property. Limited default notices or “drop-dead” provisions can be of great help. Try to negotiate a clause that if the DIP fails to make a payment to your client, your client's lease is rejected and has Relief from the Automatic Stay to obtain the collateral. The DIP may not agree, but at least it will understand that your client is serious.

Consider Filing a Motion for Relief from the Automatic Stay

If you do not think that the Debtor realizes that you mean business but still wants to keep your equipment, you may want to file such a motion to get the debtor to face the fact that you are not kidding — it's payment now (not at a later time when a Plan may be confirmed) or no equipment.

Keep Track of the Docket and Events in the Debtor's Case

You will want to monitor the Debtor's bankruptcy case especially for subsequent interim and final financing and cash collateral hearings and objection deadlines. You can do this by either going on to the government Pacer website and obtaining the docket, or depending on the state in which you reside, your company's in-house counsel may file a notice of appearance.

Conclusion

A Debtor's Emergency Motion for Use of Cash Collateral or for DIP Financing shouldn't be taken lightly. It could be the most important route to your company's payment and can prove a wonderful opportunity for an equipment lessor. If ignored, the Chapter 11 case could proceed without you and you do not want to be in that position.

*****
Deirdre M. Richards is a partner at Fineman Krekstein & Harris PC in Philadelphia. She can be reached at [email protected].

A Chapter 11 debtor's motion for an order approving use of Cash Collateral or for Debtor-in-Possession (DIP) Financing usually happens as part of the so-called first-day hearings held within a few days after commencement of the case, or in districts that do not have first-day hearings, as an emergency motion.

The problem for creditors and equipment lessors is that while the debtor may have sent your client a notice of the bankruptcy case, the notice sometimes goes to the payment lock box or to someone who doesn't even know what bankruptcy is, much less that the order being sought is key to your client's future payment. While this may impede your ability to protect your client's interest on “day one,” you should know that the initial orders at least with respect to Cash Collateral or DIP Financing will be “interim” and should provide you with some ability to object or negotiate before, as they say, “the die is cast.”

What Is Cash Collateral?

The Bankruptcy Code defines “cash collateral” in Section 363 regarding the Use, Sale or Lease of Property as “cash, negotiable instruments, documents of title, securities, deposit accounts, or other cash equivalents … ” A Chapter 11 DIP may have encumbered its cash and other cash equivalents and it must obtain the secured creditors' and the court's approval to use its own cash. A DIP will file a Motion to Approve the Use of Cash Collateral (which will attach a budget that is usually an excel spreadsheet listing the payments the Debtor may make to payors) with the bankruptcy court. Generally, the court will approve the use on an interim basis before it enters a final order on the use of Cash Collateral.

What Is DIP Financing?

This is a type of financing used by Chapter 11 DIPs that generally provides the lender with a first lien on all assets, and requires that a DIP attach a budget for all payments to payors. In fact, the proposed order will generally state that unless a payor is on the attached budget, the Debtor shall not pay that entity. A DIP will present a Motion to have the DIP Financing approved by the bankruptcy court, and generally, lenders make the financing available on an interim basis, and the court will approve the use on an interim basis before it enters a final order on DIP Financing.

A Common Scenario

XYZ Corp. (XYZ) hauls oil and gas, and recently filed a Voluntary Petition under Chapter 11. A few days later, XYZ, as DIP, files an Emergency Motion to Approve Debtor in Possession Financing. You are in-house counsel at ABC, an equipment lessor, and XYZ signed a Security Agreement and Retail Contract for a Tanker Truck with you prior to when it filed bankruptcy. It had been paying regularly, though lately it's needed to use its grace periods, and this month ABC received no payment at all. You hear about the bankruptcy before ABC actually receives notice, and have ABC's legal department look at the bankruptcy case. ABC's in-house lawyer sees that the docket shows an emergency hearing tomorrow morning on the XYZ's Emergency Motion to Approve DIP Financing. A review of the Motion does not make it clear if ABC will receive its monthly payments going forward.

Typical Provisions in a Proposed Order

Priming of Pre-petition Liens

The financing bank will likely include a provision to have its lien come first, before all others, in order to agree to provide the financing.

Budgets and Forecasts

This is the document attached to the (proposed) Cash Collateral or Financing Order. You will want to make sure that there is a provision for payment of your client's lease. Usually, budgets have general categories, such as “equipment lease” and a dollar amount, and you will have to confirm with Debtor's counsel that in fact it is your equipment lease.

If you are a lessor, and the DIP needs your equipment to operate, you will have a good argument to get paid. If you are a secured creditor (i.e., your lease is a financing arrangement), you may not be able to obtain adequate protection payments unless you file a motion and prove that you are not being adequately protected.

Responding to Cash Collateral or Financing Orders

Early Participation

Nothing can substitute for early participation in the case. In this scenario, ABC should have counsel attend the “first-day” motion hearings (which generally include the Emergency Motion for DIP Financing). ABC will want to object to the Debtor's Motion unless ABC is listed in the budget to receive its regular monthly payment. ABC should seek counsel who can negotiate with XYZ's counsel regarding ABC's treatment and file an Objection to XYZ's Emergency Motion to be sure the Debtor includes payment to ABC.

Protection

In addition, where DIP Financing is involved, ABC will want to make sure that the lender does not obtain priority over ABC's properly perfected prepetition lien. ABC should protect its pre-petition liens from being primed by XYZ's lender. A lender to a DIP will seek the security of a priming lien for itself, and if the proposed Financing Order does not indicate that the properly perfected pre-petition liens of your company are not primed by the lender, you should object to the DIP's Emergency Motion. ABC will want to seek counsel to file an Objection to XYZ's Emergency Motion.

Ensure You Are in the Debtor's Budget

XYZ has not attached a budget, but has indicated it will do so prior to the hearing. ABC must make sure it is in the budget or it may desire to consider filing for Relief from the Automatic Stay. A lessor should make sure lease payments are in the DIP or cash collateral budget. Some debtors posture the budget as “projections.” It should make no difference — being included is better than not being included.

Read Every Paragraph of the Proposed Cash Collateral or DIP Financing Order

You always need to review the proposed Cash Collateral Order or proposed DIP Financing Order with a fine tooth comb to be sure that your company is not being harmed by the Debtor's proposed Order. As a suggestion, pay particular attention to paragraphs regarding Pre-petition First Liens and Collateral and the Budget as well as the lender's Adequate Protection lien. You may see that these paragraphs do not take your client's rights into account or provide the lender with priming over your valid pre-petition lien.

Obtain a Carve-out of the Priming Lien

If you represent a lender, try to have your Purchase Money Security Interest (PMSI) carved out of the priming lien granted to a lender — or at least have it given equal status or leave the issue open for future determination and “adequate protection.”

Insist on a Default Provision to Quickly Obtain Collateral

If you are treated in the financing orders, insist on default provisions that can allow your client to quickly obtain possession of its collateral or leased property. Limited default notices or “drop-dead” provisions can be of great help. Try to negotiate a clause that if the DIP fails to make a payment to your client, your client's lease is rejected and has Relief from the Automatic Stay to obtain the collateral. The DIP may not agree, but at least it will understand that your client is serious.

Consider Filing a Motion for Relief from the Automatic Stay

If you do not think that the Debtor realizes that you mean business but still wants to keep your equipment, you may want to file such a motion to get the debtor to face the fact that you are not kidding — it's payment now (not at a later time when a Plan may be confirmed) or no equipment.

Keep Track of the Docket and Events in the Debtor's Case

You will want to monitor the Debtor's bankruptcy case especially for subsequent interim and final financing and cash collateral hearings and objection deadlines. You can do this by either going on to the government Pacer website and obtaining the docket, or depending on the state in which you reside, your company's in-house counsel may file a notice of appearance.

Conclusion

A Debtor's Emergency Motion for Use of Cash Collateral or for DIP Financing shouldn't be taken lightly. It could be the most important route to your company's payment and can prove a wonderful opportunity for an equipment lessor. If ignored, the Chapter 11 case could proceed without you and you do not want to be in that position.

*****
Deirdre M. Richards is a partner at Fineman Krekstein & Harris PC in Philadelphia. She can be reached at [email protected].