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January 20, 2023

First-Day Orders: You Snooze, You Lose

Any business can suddenly be confronted with a customer, client, or vendor seeking Chapter 11 bankruptcy relief. Oftentimes, when a Chapter 11 bankruptcy commences, “first-day motions” accompany the filing. These motions can be numerous—especially when the debtor is a large enterprise with multiple operating businesses that it needs to keep stable during the first few months of the bankruptcy and beyond—and provide generally for interim and final relief. They are often heard by the court before a committee of unsecured creditors (committee) is formed in the first few days of the case—hence, first-day orders. While first-day orders are subject to review by a committee (and that is why generally an interim and final order process is in place), all creditors need to understand these motions and the relief sought by the debtor so they can ensure that their rights are not adversely affected regardless of whether or not a committee is eventually appointed and weighs in. 

First-day orders become the rule of the case, as do second-day orders, seeking interim and final relief, respectively, and are binding on creditors and other parties in interest. Common first-day motions seek the following:

  • Permission to use cash collateral
  • Approval of a loan
  • Approval of insurance programs
  • Approval of employee programs, including pre-petition wages and benefits 
  • Honoring customer deposits and obligations
  • Permission to pay pre-petition debts to certain providers of goods and services (critical vendors)

Therefore, the initial three to four weeks of a Chapter 11 filing are crucial, as the debtor seeks permission to take certain action necessary to maintain its business operations through first-day and second-day orders. 

Cash Collateral 

Cash collateral is a liquid asset that is subject to a lien or security interest of a creditor. It may include cash on deposit, accounts receivable, rent payments from tenants, insurance policy proceeds, inventory, proceeds from the sale of assets if subject to a lien, or all of these. If granted by the court, the debtor is allowed to use cash collateral without obtaining prior consent from the creditor that holds a lien on the cash collateral. An order authorizing the use of cash collateral often contains provisions protecting the creditor’s position in connection with the use of cash collateral by providing “adequate protection” in the form of periodic cash payments, replacement liens, or some other “indubitable equivalent.” The creditor should pay close attention to the terms of this type of order.

Debtor-in-Possession (DIP) Financing and Loans   

The debtor may determine that, in order to operate as close to the ordinary course of business as possible, it will require new cash infusions (or it may be that cash collateral is not available). If the debtor decides that it will require a line of credit or other post-petition financing to keep operations at an even keel, it will seek permission to borrow funds and offer adequate protection and enhanced priorities to induce a lender to make a loan. These inducements could include giving the loan amount ordinary administrative or superpriority status, granting a lien on unencumbered assets, granting a senior lien on assets, or, again, some form of the “indubitable equivalent.” These new protections and priorities could affect other creditors’ rights. 

Insurance Programs

Businesses typically carry insurance coverage to protect themselves and their creditors against losses that occur during the course of their operations. They often pay their insurance premiums under the terms of a premium financing agreement. If on the Chapter 11 filing date the debtor has outstanding balances with respect to insurance policies, the debtor will seek permission to pay such expenses. If these amounts are not paid, insurance providers will not continue providing coverage to a debtor on a post-petition basis. Therefore, debtors often seek permission to pay outstanding pre-petition premiums, as well as authority to continue paying post-petition amounts in the ordinary course of business, to remain insured and to protect themselves, their bankruptcy estates, and creditors from losses that could occur after filing for Chapter 11. 

Pre-Petition Payroll and Employee Benefits 

A debtor may seek permission to pay pre-petition wages and employee benefits to ensure the it has a smooth transition into bankruptcy and a calm workforce. Funds subject to a security interest of a lender can be utilized for this purpose if court approval is received. Oftentimes, motions to pay pre-petition payroll include wages and vacation earned just prior to the filing. These claims have priority in a Chapter 11 case up to certain amounts, and debtors often will request authorization to pay these amounts to incentivize their employees to continue working.  Motions that include retention and stay bonuses and benefits are subject to heightened statutory oversight. 

Honoring Customer Deposits and Obligations in the Ordinary Course of Business

Filing for Chapter 11 may render customer deposits property of the estate, leaving the customers with unsecured claims. Absent relief from the court permitting the debtor to treat those deposits in the ordinary course of business as post-petition obligations, the debtor will be left in an untenable position with its customers. The relationship with customers may be critical to the ongoing success of a debtor’s operations. Courts often authorize the payment of pre-petition obligations where necessary to protect and preserve the bankruptcy estate, including the debtor’s good will, so long as the debtor can show sound business judgment. 

Pre-Petition Debtors or Critical Vendor Payments 

A debtor may seek authority to pay certain claims incurred prior to filing bankruptcy to suppliers of goods and services. Debtors often assert that their vendors will terminate deliveries, which will directly impact the debtor’s operations and, hence, their ability to reorganize. If the court is, in fact, convinced a debtor’s vendors are critical, it can issue an order authorizing the debtor to continue to do business with select “critical” vendors on specific business terms, including  continued provision of the goods and services and payment of pre-petition amounts. The debtor’s other creditors may raise issues with cash in advance, cash on delivery, or obtaining a standby letter of credit to secure future payments. 

While it may not be feasible for a business to fully investigate or comment on the details of first-day motions every time a customer, client, or vendor files a Chapter 11 case, the business should at least make that determination affirmatively. When a business has a significant claim against the Chapter 11 debtor, or if it has a material ongoing relationship with the debtor, making sure it fully understands the terms of the first-day motions and orders can at least minimize the chances of further economic damage.  

The Thought Leadership Committee of Barclay Damon’s Restructuring, Bankruptcy & Creditors’ Rights Practice Area issues alerts and blogs on an ongoing basis to keep clients, colleagues, and friends up to date on important developments in the insolvency space. If you have any questions regarding the content of this alert, please contact the author, Beth Ann Bivona, partner, at bbivona@barclaydamon.com; Robert Wonneberger, Thought Leadership Committee chair, at rwonneberger@barclaydamon.com; or Janice Grubin or Jeff Dove, co-chairs of the Restructuring, Bankruptcy & Creditors’ Rights Practices Area, at jgrubin@barclaydamon.com and jdove@barclaydamon.com.
 

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