A Secured Creditor’s Guide To Navigating Chapter 11
By: Stephanie Lieb
Michael G. Williamson, Chief Bankruptcy Judge for the Middle District of Florida, explained in an interview with the Tampa Bay Times on March 21, 2019, that despite a robust economy, climbing home prices, and job growth, Florida is experiencing an increase in bankruptcy filings on both the consumer and commercial fronts. Here is what creditors need to know to protect themselves in the event of a Chapter 11 filing.
To a secured creditor, a borrower filing for Chapter 11 protection can present a daunting proposition — from digesting the schedules and first-day motions and tracking the many deadlines to developing and implementing a strategy to maximize potential recovery. This article is meant to be a map to help creditors traverse the Chapter 11 process and emerge as unscathed as possible.
1. Understand the Loan and Collateral Position Quickly
When you don’t know where to start, try the beginning. When a borrower files a Chapter 11 case, the first order of business is to gather and organize all of the documents. This includes loan documents, title policies, Uniform Commercial Code (UCC) searches, forbearance agreements, appraisals, payment history, prepetition collection activities, and any other relevant communications with the obligors on the loan. Bankruptcy counsel should be engaged immediately and provided access to this information. Counsel should work with relevant parties to identify issues with the documents or prepetition course of dealing, asking key questions like:
- At what point in the loan relationship did the borrower default?
- Does the creditor’s UCC-1 financing statement match the collateral description in the security agreement?
- Has a lender liability claim been filed, or threatened in prepetition communications with the borrower?
At the outset of an engagement, counsel should prepare a “loan map” analyzing the loan documents and detailing key dates, terms and issues. Walking through a chronology leading up to the filing will also help give context to the documents.
Next, run a title search on the collateral and a UCC search on the borrower. If there is a surprise title problem, turn to the document package and evaluate whether there is a viable title claim. Once the loan position is determined and any title issues are identified, turn the key to recovery: the loan-to-value. The company’s position as partially or fully secured makes all the difference to its treatment and options in Chapter 11 cases. When was the collateral last appraised, and did it include all of the collateral pool? Are the assumptions made in the appraisal appropriate for the current use of the collateral?
Although the debtor is in the driver’s seat in timing the filing of its case, a secured creditor can regain control by simply being prepared.
2. Be Vigilant as to the Case Deadlines and Filings
If you snooze, you lose in bankruptcy court. Noting deadlines and monitoring the docket and electronic notices is critical. On a basic level, counsel must review the docket regularly and note initial deadlines, such as the proof of claim deadline, hearing dates for first-day motions, the Section 341 meeting of creditors and the plan filing deadline. These cases have many moving parts, requiring an accelerated reaction time.
Probing deeper, Chapter 11 cases often have many different creditors and pieces of collateral, and each stakeholder has his/her/its own agenda. However, because all estate assets and liabilities impact the pie in some way, it is vital to be vigilant in considering how a particular action toward one asset/liability affects the whole. For example, a successful stay relief motion by one creditor with a lien on inventory will necessarily affect the debtor’s ability to service debt of the other creditors.
3. Evaluate the Schedules Carefully
The schedules and statement of financial affairs contain a wealth of information about the debtor. Review these documents carefully, and compare the items listed on the schedules to the information in the document file. Focus on the way the debtor scheduled the collateral, as well as the collateral’s value. Compare the list of equipment or inventory from the most recent appraisal to the list on the schedules. Look for missing assets or dramatic value changes. Also, determine whether the debtor has listed any lender liability claims against the creditor.
Many Chapter 11 trustees observe that determining the validity and priority of the secured creditor’s lien immediately is critical, including if the creditor is fully secured or has a deficiency. The creditor may choose to bifurcate its claim between secured and unsecured status.
4. Prepare and File the Proof of Claim Early
In calculating the claim, do so as of the petition date, and include out-of-pocket costs and expenses (i.e. legal fees, foreclosure fees, appraisal fees, advances for insurance or property taxes). With respect to interest, break down prepetition contract interest and default interest. Be sure to double-check the math and compare the claim to the foreclosure affidavit of amounts due. Be as detailed as possible in explaining how the claim amount was calculated, and attach adequate supporting documentation. This will avoid unnecessary objections to the claim, and thus conserve resources.
Some jurisdictions require the proof of claim to be filed prior to seeking relief from the automatic stay. However, even if this is not a requirement, filing the claim early is advisable. It not only preserves the creditor’s rights as to the amount of the claim and the collateral securing its debt, but also functions to alert the other players in the case to the creditor’s position.
In filing a secured claim, be sure to file an unsecured claim as well for protection in the event the debt is undersecured. Counsel and the company should decide whether they are prepared to commit to a specific collateral value in their claim, and reserve their rights to amend and reallocate between secured and unsecured amounts.
5. Understand the Parties in Your Case
Unlike regular litigation cases with generally only two parties, Chapter 11 bankruptcy cases contain many, varied stakeholders. The typical parties in a Chapter 11 include the debtor, United States trustee, other secured lenders, creditors committee, unsecured creditors, landlords and equity holders. They all have a role to play in the case and may have varying degrees of influence over the case direction. With so many different parties in a case, all vying for a larger slice of the pie, an appreciation of the dynamics will work to the creditor’s advantage. For example, have the equity holders personally guaranteed certain loans? If so, they may be more motivated to have the debtor satisfy those creditors over others. How willing are the debtor’s trade creditors to assist the debtor’s efforts to reorganize (e.g., will they provide product on terms or only cash on delivery?). Understanding these undercurrents will help counsel navigate the case effectively.
6. Utilize the Rule 2004 Examination Process as Needed
Rule 2004 allows any party in interest to use this tool for broad discovery with respect to the “acts, conduct, or property or to the liabilities and financial condition of the debtor ….” It may be useful to request documents from and/or depose a representative of the debtor, its accountant or other key individuals. Often the Rule 2004 process is used as a tool to investigate prepetition conduct by the debtor’s management, uncover causes of action the debtor omitted from its schedules, and delve into the underpinnings of the debtor’s financials. The facts uncovered may then serve as the basis for a motion to appoint an examiner or trustee, or for dismissal, or could cause the debtor to pursue causes of action it would not have otherwise.
Keep in mind that Rule 2004 discovery should be completed prior to initiating an adversary proceeding.
7. Choose Your Initial Response Strategy Wisely
A creditor’s initial response to the filing of a Chapter 11 case will shape the way they are viewed by the judge, as well as their relationship with the debtor in the case. Daniel J. Stermer, an attorney and managing director of Development Specialists Inc. in Fort Lauderdale, often serves as a Chapter 11 fiduciary. He notes that “[h]istory can play a significant role in how a secured creditor acts, whether in a conciliatory position … or more aggressive fashion, and what the desired end result the Chapter 11 may bring. Understanding the ‘exit strategy’ and how to best achieve that result may dictate what steps are taken at the beginning of a matter.”
Some options include seeking stay relief, adequate protection, conversion, dismissal or the appointment of a trustee or examiner. Creditors should consider their goals carefully. Taking an overly aggressive stance early in the case, even if successful, could result in a short-term gain but a long-term loss.
Going through this process will best position the creditor to craft a solid response to the filing of the bankruptcy case and to set the tone for the case, be it an aggressive response or a tempered, cooperative one.
8. Study and Use the Disclosure Statement and Monthly Operating Reports to Your Advantage
The monthly operating reports and disclosure statement — mandatory filings in every Chapter 11 case — contain significant and critical information that can help the creditor bolster its position, and can also illuminate the true viability of the debtor’s plan. Review the monthly operating reports in detail. Compare the current month to the previous ones. Are there discrepancies? When the disclosure statement is filed, review the projections in comparison to the trends established by the monthly operating reports. Ascertain the assumptions the debtor makes in its projections.
9. Approach Confirmation Thoughtfully
Has the initial strategy worked? What are the best- and worst-case scenarios? Consider what can realistically be recovered within the Chapter 11 context versus outside of the bankruptcy. Bear in mind, the debtor may be able to confirm a plan over the creditor’s objection in three scenarios: (1) if the plan provides for the creditor to retain its lien and accept deferred payments; (2) if the plan provides for the sale of the collateral (allowing the creditor to credit bid); or (3) if the plan provides the creditor with the “indubitable equivalent” of its claim, an ill-defined term that often results in litigation. Creditors should think through how each of these scenarios would affect their rights. If they agree to modify the loan in connection with confirmation, they should specifically address the applicability and enforceability of their existing or modified loan documents in the confirmation order.
10. Create a Post-Confirmation Default Plan Early
The harsh reality is that many confirmed plans fail. Consider this in confirmation negotiations. Outlining default consequences and action steps in connection with confirmation will ensure an efficient and expeditious resolution of a post-confirmation default.
In the end, if a borrower does file for Chapter 11, secured creditors have several tools available to safeguard collateral, minimize potential losses and maximize their opportunity for recovery. The onus is on secured creditors to protect their claims by planning, paying attention to deadlines and details, and staying vigilant in terms of their recovery.
