In re LTAP US, LLLP, Case No. 10-14125 (KG) (Bankr. D. Del. Feb. 18, 2011)
The debtor sought to use cash collateral to enable it to pay insurance premiums on policies essential to the continuation of its business. The debtor also moved for approval of DIP financing provided by a new lender that would, among other things, prime the interests of the debtor’s pre-petition secured lender. The secured lender opposed the debtor’s motions, and moved for relief from the automatic stay. The Bankruptcy Court denied the debtor’s motions, finding that the debtor was unable to provide adequate protection to the secured lender. The court granted the lift stay motion.
LTAP was in the life settlement business, purchasing unmatured life insurance policies at a discount from face value, receiving revenue (and profiting) only when the insured died. Cash flow of LTAP, as well as the ability to pay premiums and purchase policies on an ongoing basis, depended on a steady rate of maturity of the policies. Unfortunately for LTAP, policies did not mature at the projected rates. In 2010, LTAP experienced significant cash flow issues that rendered it unable either to pay the policy premiums coming due or purchase new policies. Indeed, although the aggregate death benefits of the policies in LTAP’s portfolio were $1.36 billion, LTAP faced imminent policy premiums of $9 million that needed to be paid in order to maintain the policies. At the same time, LTAP had only $9,000 in cash.
A U.S. bank was LTAP’s pre-petition secured lender under a Loan and Security Agreement, with an outstanding balance in excess of $230 million as of the petition date. As and for security of the amounts due under the Agreement, LTAP granted the bank a security interest in substantially all of LTAP’s assets.
Prior to the petition date, the bank terminated the Agreement, and LTAP filed a petition for chapter 11 protection. On the petition date, LTAP filed a motion seeking approval to use the bank’s cash collateral to pay the upcoming policy premiums, alleging that if it could not pay the imminent premiums of $9 million, policies with face value of $297 million would lapse and become valueless. In addition, LTAP sought court approval of a DIP financing facility with Monarch Alternative Capital LP that would alleviate its impending premium crisis. The DIP financing facility was conditioned upon the DIP loan priming the bank’s liens.
At issue before the court were LTAP’s motion for use of the bank’s cash collateral, LTAP’s motion seeking approval of the DIP financing facility that would prime the bank’s liens, and the bank’s motion for relief from stay. The outcome of each of these motions was predicated on the value of the life insurance policies, and whether that value exceeded the obligations to the bank.
The Debtor’s Motions
LTAP’s request to use cash collateral was governed by section 363 of the Bankruptcy Code. In order to prevail, LTAP was required to prove that there was sufficient value in its assets to protect the secured lender’s position. Both the bank and LTAP presented expert testimony on the value of LTAP’s portfolio. The bank’s expert valued the portfolio by examining the fair market value of the portfolio in the life settlement market. In contrast, LTAP’s expert valued the portfolio by examining LTAP’s future premiums, life expectancy of the insureds, administrative expenses, and projected monthly cash flows, and then applied appropriate discount rates. After evaluating the testimony of both experts, the court found that the bank’s evidence was strongly persuasive. The court determined that LTAP’s expert made several key assumptions, including the use of inaccurate policy maturity projections, which led to a flawed ultimate conclusion as to value. Moreover, the court found that LTAP’s expert failed to take into consideration the fact that the life settlement industry as a whole was suffering, and that willing buyers for LTAP’s assets were difficult to locate without offering steep discounts.
The court concluded that the prognosis for LTAP’s continued viability was negative, and that its ability to reorganize was also unlikely. In addition, the court found that the value of LTAP’s assets did not provide adequate protection of the bank’s loan, thereby necessitating the denial of LTAP’s motion to use the cash collateral. Similarly, since the bank’s security interests were not adequately protected, the court declined to approve the DIP financing facility and granted the bank’s motion for relief from stay. In doing so, the court held that “[p]roviding [the bank] with a replacement lien on assets against which it already has a lien is illusory. Debtor must provide the bank with additional collateral, and there is none.”
Court approval of the use of cash collateral requires a showing that the secured lender’s interests are adequately protected. Clearly, courts are looking hard at valuation evidence, to ensure that protection is truly adequate. Replacement liens in collateral must provide actual security to the lender. Lenders and debtors alike must be prepared to present credible, thorough and persuasive evidence as to the value of collateral.