The American Bankruptcy Institute’s Commission to study the Reform of Chapter 11 of the U.S. Bankruptcy Code recently made more than 200 recommended changes. Some of the recommendations would affect secured creditors’ rights, with most of these weakening, rather than strengthening, such rights. Below, I highlight a few of the more significant recommendations affecting secured creditors under the categories of the “Good, the Bad, and the Ugly.”

The Good

Under Section 363 of the Bankruptcy Code (1.), a debtor or trustee may sell estate assets outside of the ordinary course (i.e., sale of non-inventory items such as a creditors’ collateral equipment). 363 sales were originally intended to enable a debtor to swiftly sell unnecessary assets to help facilitate and finance the Chapter 11 reorganization process, but were not intended to enable a debtor do an end-run around the checks and balances of the Chapter 11 Plan of Reorganization process by enabling the debtor to sell substantially all its assets. In the wake of the 2015 amendments to the Bankruptcy Code, however, it has become more difficult for Chapter 11 debtors to successfully reorganize due to, inter alia, enhanced reclamation rights of vendors, reduced periods to assume or reject commercial real property leases, and reduced exclusivity periods to propose a Plan of Reorganization. As a result of this difficulty, 363 sales of substantially all the debtor’s assets have become far more popular as evidenced by the high visibility cases of Chrysler and General Motors (2.).  The bankruptcy Court in the Southern District of New York has even adopted guidelines for 363 sales (3.).  The process has, in this author’s opinion, become abusive, with debtors seeking 363 sales of substantially all assets within a couple of months of filing the petition in bankruptcy, thereby completely circumventing the Chapter 11 Plan of Reorganization process and the protections afforded creditors.

The good news is that under a recommended change, there will be a 60-day moratorium on 363 sales unless a party can demonstrate that the value of the debtor’s assets will significantly decrease during the 60-day period. Additionally, the Court must find that the proposed 363 sale is in the best interest of the estate and satisfies at least a few of the requirements of the Chapter 11 Plan of Reorganization process.

The Bad

During the period of time between the initial filing of a Chapter 11 bankruptcy petition and the confirmation of a Plan of Reorganization, a creditor may compel the debtor to provide the creditor with “adequate protection”. Absent such protection, a creditor is entitled to relief from the automatic stay to pursue its collateral. Adequate protection is a term of art in bankruptcy law which, despite many years of debate, has evaded precise definition. Adequate protection assures the creditor that any decrease in the value of its interest will be compensated by cash payments, additional or replacement liens, or relief that provides an “indubitable equivalent” to the creditors’ interest (4.).  The theory of adequate protection is not that the creditor should be protected to the full extent of its claim, but rather that the creditor should be protected to the extent of the value of the creditors’ collateral at the time of the filing of the bankruptcy petition.  In other words, if the creditor is owed $200,000 and its collateral is worth $75,000 at the time the debtor files the bankruptcy petition, under bankruptcy law, the creditor is, in fact, both a secured creditor and an unsecured creditor. The creditor is a secured creditor to the extent of $75,000, and an unsecured creditor for the balance of $125,000. The right to adequate protection applies only to the value of the secured creditors’ collateral, that is, $75,000 (5.).