By Benjamin D. Feder and Lauren M. McEvoy
Disputes over a debtor’s cash are common in Chapter 11 cases. Usually this entails the desire of the debtor to use cash that is subject to a senior secured creditor’s lien, and the secured creditor’s efforts to prevent this. The Chapter 11 bankruptcy case of Monitor Oil and its affiliates has featured a struggle over cash, but one with a decidedly man-bites-dog twist: the dispute in this case has arisen from the junior creditors’ efforts to compel a senior secured creditor to take the cash, and the secured creditor’s refusal to do so.
As one would suspect, this seemingly counterintuitive move did not stem from altruistic motives. Recent filings in the Monitor Oil bankruptcy proceeding in the Bankruptcy Court for the Southern District of New York reveal a novel approach by the undersecured bondholders to try to wrest control of the case from Monitor Oil’s senior secured lender.
The undertext of the Bondholders’ rather unusual maneuvering lay in their attempt to have the Chapter 11 case here in the United States dismissed, and to have an insolvency proceeding commenced in England. In addition to dispensing with the need for “adequate protection,” the Bondholders believed that payment of the cash collateral would substantially reduce the treatment of a guaranty claim that the Senior Lender would have under English law.
Accordingly, shortly after Monitor Oil filed for Chapter 11 relief, the Bondholders filed a motion to compel it to pay the Senior Lender virtually all of its cash. The approximately $46.5 million in cash was held by Monitor Oil subject to the Senior Lender’s security interest. The Bondholders’ request was part of their objection to Monitor Oil's proposed debtor-in-possession (DIP) financing with the Senior Lender. In exchange for offering the debtors $5 million in DIP financing, the Senior Lender negotiated adequate protection of the Cash Collateral in the form of payment of its pre-petition attorney’s fees and expenses, and a priming lien on Monitor Oil’s assets.
The Bondholders demanded that the Senior Lender take the Cash Collateral so that Monitor Oil would not have to protect it. They argued that Monitor Oil’s further retention of the Cash Collateral was “causing waste of precious estate assets,” that the “real effect” of the proposed DIP financing was to give the Senior Lender control over other unencumbered assets and to allow it to recover attorney’s fees, and, ultimately, that “the little that remain[ed] of the pie [would] be carved between [Monitor Oil] and management, to the harm of everyone else.” Compelling the Senior Lender to take back its cash, the Bondholders argued, would save the estate “hundreds of thousands of dollars.” In court papers, the Bondholders stated:
An undersecured creditor refuses its collateral, and demands compensation for not having it. It has already created a set of arrangements under which no one else may have it. Restoration of that collateral would obviate any pretext to hang massive “adequate protection” payments from its nominal status.
The Senior Lender was unreceptive to the Bondholders’ generosity and objected to the Bondholders’ motion. The Bondholders’ argument relied almost exclusively on the Court’s equitable authority, under section 105(a) of the Bankruptcy Code, to “issue any order, process, or judgment that is necessary or appropriate to carry out the provisions” of the Code. The Senior Lender first pointed to the lack of specific Bankruptcy Code authority supporting the motion, then stated:
[T]he Bondholders’ true motives in filing the instant motion are apparent. Without any care as to what their actions are doing to the Debtors’ value and prospects for reorganization, the Bondholders’ singular, narrow focus is on the size of [the Senior Lender’s] claim…. And they are using every tactic, no matter how unseemly, to attempt to alter that claim – from seeking to have the case transferred to their preferred jurisdiction, to attempting to hold up [Monitor Oil] and its case in order to force [the Senior Lender] into paying a ransom in the form of a compromise to their concededly valid guarantee claim. It is clear that the Bondholders are sabotaging the Debtors’ chapter 11 cases on the basis of a pure intercreditor dispute.
Although the motion has not yet been decided, and it is not likely that the Court will compel Monitor Oil to drain its bank account to pay off the Senior Lender, subsequent developments in the case indicate that the Bondholders’ creative demands may have succeed in whittling away somewhat at the Senior Lender’s control of the case. The Senior Lender has since abandoned its DIP financing proposal and agreed to permit Monitor Oil the use of $5 million of the Cash Collateral. Also, the Senior Lender has made concessions from its initial position on adequate protection through continued negotiations with the Bondholders.
However, the Court denied the Bondholders’ motion to dismiss the Chapter 11 case.
Benjamin D. Feder is a partner in the Business Restructuring, Creditors’ Rights & Bankruptcy; Commercial & Public Finance; and Corporate Transactions & Securities practice groups in the New York office of Thompson Hine LLP. You can visit his blog at www.overhedged.blogspot.com.
Lauren M. McEvoy is an associate in the Business Restructuring, Creditors’ Rights & Bankruptcy and Business Litigation practice groups in the New York office of Thompson Hine LLP.