Haynes and Boone's Newsroom

Weathering the Storm: Bankruptcy - Pay Attention from the Start Because Things Happen Fast
04/01/2009
Lenard M. Parkins, Sue P. Murphy, Stephen M. Pezanosky, Kenric D. Kattner

When a company files bankruptcy, it is crucial to closely monitor the bankruptcy proceedings from the beginning. After filing its petition, the debtor will likely file numerous “first day motions” intended to stabilize the Debtor’s business and facilitate an efficient case administration. These motions can severely affect the rights of unwary creditors who may find their interests primed by the actions of the debtor in the first few days of the case.

Actively monitoring a Debtor’s first day motions and participating in the initial stages of the bankruptcy can protect your interests and may present opportunities for early payment of your claim. Among the more common first day motions to be aware of are:

  • Motion for use of cash collateral/motion to obtain DIP financing. In most cases, a Chapter 11 Debtor will fund its operations through the use of a secured lender’s cash collateral or by borrowing new funds from a “DIP lender” or group of lenders. The Debtor’s ability to fund its operations is of paramount importance as to whether your company will continue to do business with the Debtor; however, the participating lenders generally require a certain level of protection in exchange for such funding. The lenders are usually granted a super-priority administrative claim and senior liens on the Debtor’s assets through which they may attempt to prime your interests. You should take care that any lien rights you own are recognized in the cash collateral and financing orders. In addition, both the Debtor and the lending institutions involved could argue that actions taken pursuant to the cash collateral order or financing order bar creditors from later asserting their interests in the bankruptcy case.

  • Motion to pay critical vendors. The Debtor may seek authority to pay certain pre-petition vendors which it deems critical and non-replaceable in order to get uninterrupted post-petition supply or work. The Debtor has a high burden of showing that these “critical vendors” are entitled to be paid their pre-petition debt outside the normal Chapter 11 process. Normally only the most vital suppliers and vendors should be paid, in particular where no substitute or alternatives are available to the Debtor. Nevertheless, if your company is selected (or later added) as a critical vendor, the critical vendor program may be the quickest way for your pre-petition claim to be paid in full. Once a critical vendor program is approved, coordination with the Debtor is crucial.

  • Motion to pay possessory lien holders. A possessory lien enables certain creditors in possession of products of the Debtor (e.g., shippers, haulers, warehouseman, etc.) to retain such possession until the creditor receives payment or is otherwise satisfied. The Debtor often seeks permission to pay the pre-petition claims of these possessory lien holders in order to preserve the value of the estate as a going concern and to avoid disruptions in the delivery of goods. Not unlike a critical vendor payment, coordination with the Debtor and understanding the procedures approved are essential to the Debtor recognizing your lien as one relating to a claim that needs to be paid.

  • Motion to establish reclamation/Section 503(b)(9) procedures. Vendors that ship goods to the Debtor on credit may have the right under state law to reclaim such goods and may additionally have the same rights in the bankruptcy or, at the very least, a right to assert a claim for the value of the goods as an administrative expense. To avoid the administrative nightmare of separately litigating these vendor demands, a prudent Debtor will often seek to provide uniform procedures for asserting such reclamation and 503(b)(9) claims, which will govern the timing and substance of such demands.

  • Motion to sell assets or approve “pre-packaged” plan of reorganization. The Debtor may set forth in its first day motions a plan to sell all of its assets or seek court approval of a plan of reorganization, either of which could significantly affect your claim(s) and relationship with the Debtor moving forward. With the Debtor taking such drastic action in the first few days of the case, inattentive creditors miss their opportunity to take part in negotiations and/or object to the sale or plan. For the fast moving bankruptcies, the cases may for all practical purposes be “over” before a slow moving creditor makes its appearance.

  • Motion to assume or reject certain executory contracts and leases. The Trustee or the Debtor may seek court approval to assume or reject executory contracts or unexpired leases of the Debtor. Rejected leases and executory contracts are treated as if they were breached immediately prior to filing the bankruptcy case, giving the counterparty a general unsecured claim for breach of contract damages. Before the Debtor can assume a contract or lease, it must cure (for the most part) any and all defaults under the contract or lease. Through these motions, the Debtor will attempt to bind your company as to the “cure” amount and thereby limit an unwary creditor’s damages under the contract.

  • Motion for permission to pay pre-petition employees' wages. The Debtor will normally seek relief to pay outstanding payroll and benefits in order to preserve the value of the business as a going concern, but which also may represent a significant obligation that affects the Debtor’s creditworthiness going forward.

  • Motion to deal with utilities. In order for the Debtor to ensure access to needed utilities during the reorganization, it may file a motion to provide adequate assurance of payment to its utilities.

Remember to always notify your legal department and bankruptcy counsel at the first sign of a bankruptcy. The sooner you act, the more you may be able to recover in the end.

For more information on the Restructuring, Workouts and Recapitalizations group and its members, go to Restructuring, Workouts, and Recapitalizations.