Buttermilk Towne Center: Increased Lender Leverage in Single Asset Chapter 11

The Bankruptcy Appellate Panel of the Sixth Circuit (the "BAP") recently issued an opinion in In re Buttermilk Towne Center, LLC, No. 10-8036, 2010 Bankr. LEXIS 4563 (B.A.P. 6th Cir. Dec. 23, 2010), which will likely dramatically increase the degree of leverage that a lender may exert early in a single asset Chapter 11 case where the debtor lacks equity in the collateral.

At issue was whether the debtor is entitled to use post-petition rents, constituting lender's cash collateral, over the objection of the lender in order to pay debtor's counsel. The Debtor argued that it was permitted to do so, provided that it offered adequate protection to the lender for the use of such cash under 11 U.S.C. § 363(e). As adequate protection for the proposed use of cash, the Debtor offered a replacement lien on all post-petition rents and periodic payments pursuant to 11 U.S.C. § 361.

The Lender argued that the replacement lien and periodic payments were insufficient to protect its interest in the cash collateral in which it had a security interest pursuant to a recorded Assignment of Lease and Rents (the "ALR"). The Lender argued that it already possessed a lien in rents by virtue of its ALR, which continues in effectiveness post-petition pursuant to 11 U.S.C. § 552(b)(2). See In re Stearns Building, 165 F.3d 28 (6th Cir. 1998). Thus, the Lender argued, offering a replacement lien on and/or a payments from a stream of revenue that already constitutes the Lender's collateral does nothing to compensate it for or offset the Debtor's use of that cash collateral for expenses that do not enhance the value of the underlying real property collateral.

The Bankruptcy Court agreed with the Debtor, finding that the replacement lien and periodic payments sufficiently protected the Lender's interest. The Bankruptcy Court noted that "if the Debtor is not allowed to use rents to pay its professionals, the bankruptcy case will effectively end and the going concern value of the business will be eviscerated to the detriment of all parties, including [the Lender]." The BAP reversed, holding that where the Lender has a continuing post-petition security interest in all post-petition rent, offering a replacement lien on and/or periodic payments from that rent does not constitute adequate protection.

The BAP's decision gives an immense amount of leverage to Lenders in single asset cases (or other cases where Section 552(b)(2) is likely to apply) where there is no equity in the underlying real estate. In such cases, debtors likely have little or nothing else to offer that could constitute adequate protection (i.e., replacement liens on other property not subject to the lender's lien), and without successfully obtaining some kind of voluntary professional fee carveout from the lender, will likely be unable to pay their professionals. This decision may severely diminish the utility of "eve of foreclosure" bankruptcy filings to borrowers, because lenders are unlikely to agree to a professional fee carveout without significant concessions, including, perhaps, conditioning the debtor's cash collateral use on a timeline for an agreed asset sale under Section 363.