Some legal commentators have lamented the extent to which lenders have been able to use debtor in possession (“DIP”) financing arrangements to gain control over an entire Chapter 11 case. DIP lenders have usually been able to justify aggressive provisions, and courts have approved them, on the basis that they may provide the only realistic chance for debtors to reorganize or sell themselves as a going concern. However, recent events in Trico Marine Services show that there are limits on judges’ willingness to accept overreaching financing proposals and overly aggressive actions by DIP lenders to enforce their rights.
Liquidity is the life blood of Chapter 11 cases; even solvent companies can founder if their assets cannot be readily monetized. The Bankruptcy Code contains strong protections to encourage lenders to extend new financing to debtors and to consent to a debtor’s use of “cash collateral”, i.e., the cash proceeds of existing collateral.
Secured lenders have never been shy about using the leverage that they hold at the outset of a Chapter 11 case to extract significant concessions and benefits in exchange for offering new loans to DIPs and permitting the use of encumbered cash. Certain of the 2005 amendments to the Bankruptcy Code, such as the requirement of deposits for utilities, increased a debtor’s cash needs and exacerbated this trend. In many recent cases, lenders have used the debtor’s extreme need for post-petition cash to “roll-up” their existing loans into a new facility. In this situation, a portion of the money loaned to the debtor goes immediately to pay off the lender’s pre-petition loans, thus effectively providing the pre-petition loans with the enhanced benefits of post-petition loans, such as security interests that cannot be attacked (because they are granted pursuant to an order of the bankruptcy court), and a “super-priority” claim over all other creditors.
In Trico Marine Services, the debtors’ pre-petition lender sought to roll-up $25 million of pre-petition debt as a condition to providing $10 million of new financing and permitting the use of cash collateral. What made the lender’s position here particularly egregious was that it was plainly stated that the $10 million provided was not “expected to provide the liquidity necessary to accomplish a complete restructuring of the estates through confirmation of a Plan.” Judge Brendan Shannon of the U.S. Bankruptcy Court for the District of Delaware permitted Trico Marine Services to borrow the $10 million of new money at the outset of the case on an emergency basis, but ultimately declined to approve the roll-up.
This created an event of default under the DIP lending facility, and after further negotiations failed the lender gave the required five days notice of its intent to enforce its remedies. However, Trico Marine Services filed an emergency motion to prevent the lender’s enforcement, and requested permission to continue to use cash collateral. Judge Shannon granted the motion, noting that the lender would be protected because Trico Marine Services had sales of several of its ships pending that would generate proceeds sufficient to repay the lender in full.
The lender in Trico Marine Services was not willing to commit sufficient new money either to fund a reorganization, or at least to fund the Chapter 11 case for a commercially reasonable period of time. Judge Shannon’s rulings strongly suggest that judges are less willing to countenance overreaching by DIP lenders where, as here, the DIP lender is unwilling to pay the “full freight” necessary to get the case to a final resolution.