Proposals for Change in Chapter 11 Affecting Secured Lenders

Chapter 11The American Bankruptcy Institute (ABI) formed a Commission to Study the Reform of Chapter 11 which has submitted a report containing a number of proposals for changes in Chapter 11 bankruptcies. The Commission’s aim was to reduce barriers to the entry of a Chapter 11 filing, facilitate more certainty of resolutions and timeliness of disputes, enhance exit strategies for debtors and resolve uncertainty between court circuits.

A number of the proposed changes will directly affect secured creditors. The Report is very extensive and consists of approximately 400 pages. Some of the highlights are:

Changes in Debtor in Possession (DIP) Financing

For many years the only real source of DIP financing was the existing lender. In exchange for granting the debtor new funds, the existing lender made demands on the debtor pertaining to its pre-petition financing. These included provisions for the “roll-up” of the existing debt into the post-petition facility and granting priorities to the lender. The Report recommends severe limitations on roll-ups. The Report recommends only allowing roll-ups to the extent that financings are provided by new lenders, where the new financing repays the pre-petition facility in cash while providing substantial new credit to the debtor or provides for financing on better terms.

Changes to Adequate Protection

Currently, a debtor may only use cash and other collateral by providing the secured creditor protection from diminution in value of the collateral. Such adequate protection can take the form of periodic cash payments or replacement liens. The debtor’s failure to provide adequate protection is grounds for the secured creditor to obtain relief from the automatic stay. The Report proposes significant changes to these concepts. Currently, courts can consider between liquidation, going concern or market value methods in assessing the adequacy of adequate protection. The Report recommends replacing these methods with “foreclosure value,” which happens to be the least common method of valuation currently in use. Foreclosure value is the net value that a secured creditor could realize upon a hypothetical, commercially reasonable foreclosure sale of its collateral under non-bankruptcy law as of the date of the request for adequate protection.

Changes to Absolute Priority Rule

Under the proposal equity holders will be allowed to participate in Chapter 11 plans even if creditors are not being paid in full. While the changes are too extensive for discussion in this article, they contain, in part, new concepts of “reorganization value” and “redemption option value.” The proposed changes would affect most Chapter 11 cases but most directly single asset realty cases.

60 Day Breathing Space Prior to Going Concern Sales

A change is also proposed in so called “363 sales” or a sale of all or substantially all of the assets of the debtor. These are a common proposal under current practice. The report includes a prohibition of such sales during the first 60 days after the filing of the petition.

There are many other changes to practices and laws contained in the Report. Creditors should become familiar with the proposals as some are certainly likely to be adopted. The full report can be found here.

This document is intended for informational purposes only and is not legal advice or a substitute for consultation with a licensed legal professional in a particular case or circumstance.

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