Clear as Mud

08 Nov Clear as Mud

Late last month, the 9th Circuit Bankrpuptcy Appellate Panel clarified earlier precedent and held that adequate protection determinations are entirely within a bankruptcy court’s discretion – and not, as suggested by a number of recent decisions, subject to a “bright line” test of the time when adequate protection was requested.

The facts in People’s Cpaital and Leasing Corp. v. Big3D, Inc (In re Big3D) weren’t in dispute:  Big3D, which operated a commercial printing business and leased specialized equipment from People’s Capital (PCLC), encountered difficulties in making its equipment lease payments to PCLC.  A series of lease amendments failed to rectify Big3D’s ongoing missed payments.  PCLC sued Big3D for breach of contract in Fresno and obtained a prejudgment writ of possession regarding its equipment.  Two days later, Big3D was in Chapter 11 protection in California’s Eastern District.  Big3D’s bankruptcy schedules assigned PCLC’s equipment a value of $400,000 – about $50,000 more than the amount of Big3D’s debt to PCLC – and acknowledged that PCLC held a secured claim for this amount.

About 6 months passed.  Then, in March 2009, PCLC sought relief from the automatic stay – or, alternatively, adequate protection – in Big3D’s bankruptcy case.  PCLC claimed the value of its equipment had remained constant at $380,000 from the time of its lawsuit through the date of Big3D’s Chapter 11 case, and thereafter had declined $45,000 in the first 6 months of Big3D’s case “because of adverse economic conditions” – but as of the time of PCLC’s request, was depreciating at an estimated rate of approximately $3,350 monthly.

Though the facts weren’t in dispute, PCLC’s entitlement to adequate protection was.  Big3D and PCLC agreed that, moving forward, PCLC should receive adequate protection payments of $3,500 monthly.  But the parties were at odds over PCLC’s entitlement to adequate protection for the first 6 months of Big3D’s case, in which PCLC sat by and did nothing to protect its rights.

PCLC cited Paccom Leasing Corp. v. Deico Elect’s., Inc. (In re Deico Elect’s., Inc.), 139 B.R. 945 (9th Cir. BAP 1992), for the proposition that adequate protection should be provided to a creditor as of the time from which the creditor could have obtained its state court remedies if bankruptcy had not intervened.  According to PCLC, this was immediately prior to Big3D’s case, since PCLC had already been awarded a writ of possession and was about to foreclose.  Therefore, PCLC argued, its $3,500 month was perhaps a good start, but not enough – it should also receive adequate protection payments for the entire first 6 months of Big3D’s case.

The Bankruptcy Court for the Eastern District of California disagreed, instead reading Deico as granting it “discretion to fix any initial lump sum [of adequate protection], the amount payable periodically, the frequency of payments, and the beginning date [of adequate protection], all as dictated by the circumstances of the case and the sound exercise of that discretion.”  The Bankruptcy Court focused on PCLC’s acknowledgment that depreciation of its equipment was related to economic conditions – and not to Big3D’s continued use during its Chapter 11 case.  It also expressed concern over PCLC’s apparent delay in getting around to seeking adequate protection.  In the end, the Bankruptcy Court declined to award PCLC any adequate protection for the first 6 months of Big3D’s case.  PCLC appealed, claiming the Bankruptcy Court had abused its discretion.

An en banc Appellate Panel first determined that the Bankruptcy Court had not, in fact, abused its discretion.  Specifically, the Panel reckoned that to exercise its remedies, PCLC would have had to take possession of the equipment and sell it for cash.  It took issue with PCLC’s claim that a mere writ of possession was sufficient to entitle it to adequate protection all the way through Big3D’s case: “To be entitled to adequate protection, Deico requires that [the creditor] establish both a temporal point at which it would have ‘exercised’ its state law remedies outside of bankruptcy, and the amount the equipment declined in value after that time.”  It also accorded weight to the Bankruptcy Court’s observation that PCLC hadn’t been prompt in seeking relief – but had waited for 6 months before seeking adequate protection.

The Panel further determined that, despite a gradual shift in the case law from an early focus on the petition date to a more recent emphasis on the date of the adequate protection request as the time from which adequate protection payments should apply, Deico provides bankruptcy courts with needed flexibility in determining adequate protection for specific creditors in specific cases:

“When a creditor can or could exercise its statutory or contractual remedies to realize upon collateral is an inherently factual determination, but the fact that such a determination can be complicated does not make it unworkable.  The discretionary standard adopted by Deico gives bankrupcy courts the needed flexibility to make appropriate adequate protection determinations as provided for in the Bankruptcy Code, based upon the evidence presented by the parties.”

As a result, Deico remains good law in the 9th Circuit.  Courts continue to have wide discretion to fashion adequate protection remedies according to the particulars of the case before them.  Debtors are without a “bright line” from which to gauge the need to come up with adequate protection payments.  And creditors are on notice: It is critical that any request for adequate protection be (i) supported by a thorough brief explaining when – but for the intervention of bankruptcy – state law remedies could have been exercised; (ii) backed by solid evidence detailing the loss of value in the creditor’s collateral; and (iii) on time.