Secured Credit and Effective Entity Priority

By Christopher W. Frost (University of Kentucky – College of Law)

The historical and doctrinal development of secured transactions and bankruptcy law has created a priority system that is asset based. Secured creditor priority is tied to the value of specific assets that constitute the secured creditor’s collateral and not to the value of the debtor itself. And yet, in corporate bankruptcy cases, lenders and their attorneys often assert broad claims to the entire enterprise value of the entity – that is to the present value of the cash flows that the entity will generate as a going concern. The doctrinal basis for such claims is often unstated, however, and several commentators have criticized the breadth of those claims under existing laws.

This article responds to those views  and argues that secured creditors can establish a broad enough security interest to create an “effective entity priority.”  The argument is premised on the notion that the broad secured claim creates a closed system in which all of the assets acquired relate, and can be traced, to pre-bankruptcy collateral. The secured creditor’s priority therefore may extend to the value of the entity, rather than the value of specific assets within the entity. Although the doctrinal claim is plausible, the article notes that it can be difficult to maintain under the facts of particular cases. Thus the article suggests that changes to the Bankruptcy Code and the Uniform Commercial Code that recognize true entity priority may provide clarity and efficiency to the bankruptcy process.

The full article is available here. The article is forthcoming in the Connecticut Law Review.

Junior Creditors Could Share In 363 Bankruptcy Sales

posted in: 363 Sale, Priority, Valuation | 0

By Charles Tabb and Tamar Dolcourt (Foley & Lardner LLP).

In July, the Seventh Circuit Court of Appeals issued a decision that appeared to upend the long-held understanding that an underwater secured creditor was entitled to all of the proceeds of a sale under Section 363 of the Bankruptcy Code. In our new article, we analyzed the decision in Illinois Department of Revenue v. Hanmi Bank in which the Seventh Circuit opened the door to a potential recovery for out-of-the-money junior creditors based on the theory that a free and clear sale under the Bankruptcy Code created a premium for the assets that the junior creditor may be entitled to share. Though Hanmi dealt explicitly with a state taxing authority and its particular rights under Illinois state law, there is nothing in the opinion which limits it to those facts or that type of creditor. Furthermore, even though the court ultimately valued the interest that the Illinois Department of Revenue was forced to give up through the free and clear sale at zero, that was simply a failure of proof in the particular case. We also consider the long-term ramifications of this opinion and its likely effect on future sales under Section 363, including the possibility of increased costs and delays of negotiating these sales with recalcitrant junior creditors.

The article may be found at Law 360:  the original publication.