James M. Lawniczak on the Responsibility of Trade Creditors to Verify Debtor's Authority to Use Cash Collateral

James M. Lawniczak on the Responsibility of Trade Creditors to Verify Debtor's Authority to Use Cash Collateral

  By James M. Lawniczak

In this Emerging Issues Analysis, Lawniczak examines the 11th Circuit's holding in Marathon Petroleum Co., LLC v. Cohen (In re Delco Oil, Inc.), 599 F.3d 1255 (11th Cir. 2010), [enhanced version available to lexis.com subscribersunenhanced version available from lexisONE Free Case Law], in which the court addressed the ramifications for innocent trade vendors when a chapter 11 debtor in possession fails to comply with specific requirements of the Bankruptcy Code as to use of cash collateral.

The author writes: The Marathon decision puts nondebtor parties that conduct business with debtors in chapter 11 cases on notice that they will be required to make sure that the debtor is indeed authorized to pay them, under penalty of having to repay amounts to a subsequent trustee. In the initial filing of a chapter 11 case, a business debtor is generally occupied with creating and implementing a plan of action to facilitate a successful emergence from bankruptcy. Almost always the business debtor must include in any bankruptcy plan a financing component, because financing is necessary to ensure adequate funding to continue business operations through the bankruptcy process.

Generally there are two forms of postpetition financing used by chapter 11 business debtors: debtor-in-possession financing and cash collateral usage. Debtor-in-possession financing is governed by Bankruptcy Code section 364 and requires a lender, oftentimes the prepetition lender, to make a postpetition loan. It is always voluntary, as there is no authority in the Bankruptcy Code to compel a lender to loan money to a debtor. When cash collateral is used to fund operations in a chapter 11 case, the debtor must live on its current receipts. Cash collateral usage is usually voluntary, but can be involuntary if the bankruptcy court so orders, after finding that the interests of the secured creditor are adequately protected.

Almost every business debtor will have had prepetition financing. The prepetition revolving credit will usually be secured by current assets, such as inventory and accounts receivable, often pursuant to a borrowing base. Thus, when the bankruptcy proceeding is filed, all the debtor's accounts receivable and inventory, and their proceeds, will be pledged to the prepetition asset-based financer.

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James M. Lawniczak is a partner at Calfee, Halter and Griswold LLP in Cleveland, Ohio. He concentrates his practice on corporate bankruptcy and creditors' rights, as well as commercial business and finance matters. His experience includes bankruptcy plans and related disclosure statements, cash collateral and financing orders, asset sales, executory contracts and unexpired leases, and bankruptcy litigation and appeals. Mr. Lawniczak is a frequent author and lecturer in his field. He is a contributing author to the 16th edition of Collier on Bankruptcy, the leading national treatise on bankruptcy law. He is also the author of the bankruptcy chapters of the Matthew Bender treatises Asset Based Financing, Business Organizations (with Tax Planning), Debtor-Creditor Law and Franchising. He has been listed in multiple editions of Chambers USA as a Leading Lawyer for bankruptcy and restructuring and is recognized as one of the Best Lawyers in America.