Posted on March 20, 2009 by Jason Cornell, Esq.

Issues Relevant To The Fairchild Corporation Bankruptcy: What are the Standards for DIP Financing Priming Liens and Granting Relief from the Automatic Stay?

Introduction

The Fairchild Corporation ("Fairchild" or the "Debtor"), filed for bankruptcy in Delaware on March 18, 2009.  Fairchild's bankruptcy proceeding is before the Honorable Christopher S. Sontchi of the United States Bankruptcy Court for the District of Delaware.  According to its press release, Fairchild operates in three markets:  aerospace, real estate and motor cycle apparel.  In the aerospace industry, Fairchild distributes parts and equipment to companies servicing aircraft.  Fairchild's business also includes managing and developing commercial real estate.  Finally,  with its apparel business, Fairchild designs and produces motorcycle apparel for companies such as Harley Davidson and PoloExpress.  (Read Fairchild's Affidavit in Support of Bankruptcy Motions here.)

The DIP Financing Motion and Relief From the Automatic Stay

One of Fairchild's "first day" motions seeks debtor-in-possession ("DIP") financing, refinancing of prepetition debt and modification of  the automatic stay (the "DIP Motion").  As stated in the DIP Motion,  Fairchild's prepetition debt totals $19 million and Fairchild seeks to refinance its debt with a postpetition revolving credit facility up to $23 million (the "DIP Facility").  Under the DIP Facility, PNC, as postpetition lender, would receive a "priming lien" that is senior or equal to previously encumbered property.  Fairchild seeks the priming lien for the DIP Facility pursuant to 11 U.S.C. 364(d)(1)(authorizing a bankruptcy court to approve DIP financing secured by an equal or superior lien on property of the estate already subject to a lien, provided the holder of the primed lien receives adequate protection). 

Pursuant to paragraph 65 of the DIP Motion, Fairchild proposes that the automatic stay under 11 U.S.C. 362 be vacated to permit the DIP lenders to perform "any acts necessary to implement" the DIP Facility.  In addition, Fairchild seeks to lift the automatic stay for the lenders "to the extent necessary to exercise, upon the occurrence and during the continuation of any event of default ... and to take various actions without further order of or application to the Court."  Although the DIP Motion does not contain citations for granting relief from the automatic stay, it notes that "[s]tay modification provisions of this sort are ordinary and usual features of debtor in possession financing."  This blog post will look at the standard often applied in Delaware for parties seeking relief from the automatic stay.

Scope of the Automatic Stay

Section 362(a)(3) of the Bankruptcy Code defines the scope of the automatic stay.  Under this section, the automatic stay bars any "act to obtain possession of property of the estate or of property from the estate or to exercise control over property of the estate."  In order to have the stay "lifted,"  section 362(d) authorizes a bankruptcy court to "grant relief from the stay provided
under subsection (a) of this section, such as by terminating, annulling, modifying or conditioning such stay …(1.) for cause, including the lack of adequate protection of an interest in property of such party in interest."

In order to trigger the automatic stay, there must be an act against either the debtor or against property of the debtor or of the estate. The automatic stay does not stay actions taken against non-debtor third parties. The Third Circuit has recognized that although the automatic stay has a broad scope,  the clear language under 362(a) applies only against a debtor.  See McCartney v. Integra Nat’l Bank North, 106 F.3d 506, 509 (3d Cir. 1997).  As a consequence “it is universally acknowledged that an automatic stay of proceedings accorded by § 362 may not be invoked by entities such as sureties, guarantors, co-obligors, or others with a similar legal or factual nexus to the … debtor."  Id.

Relief from Stay

Under section 362(d)(1) of the Bankruptcy Code, the bankruptcy court “shall” lift the automatic stay for “cause.”  If a creditor seeking relief from the automatic stay makes a prima facie case of “cause” for lifting the stay, the burden going forward shifts to the debtor pursuant to Bankruptcy Code § 362(g). See In re 234-6 West 22nd St. Corp., 214 B.R. 751, 756 (Bankr.S.D.N.Y. 1997).  

The Bankruptcy Code does not define “cause.” Instead, whether cause exists to lift the automatic stay should be determined on a case by case basis. See Izzarelli v. Rexene Prod. Co. (In re Rexene Prod. Co.), 141 B.R. 574, 576 (Bankr.D.Del. 1992). See also, In re Texas State Optical, Inc., 188 B.R. 552, 556 (Bankr. E.D.Tex. 1995) (finding that “cause” for modification of the automatic stay is “an intentionally broad and flexible concept that permits … [a] [b]ankruptcy [c]ourt, as a court of equity, to respond to inherently fact-sensitive situations.”) Courts determine what constitutes “cause” based on the totality of the circumstances in each particular case. Baldino v. Wilson (In re Wilson), 116 F.3d 87, 90 (3d Cir. 1997).

In re Rexene provides the “balancing test” to determine whether cause exists to lift the automatic stay. 141 B.R. at 576. Under Rexene, the balancing test looks at three factors to decide whether to lift the automatic stay, including: (a.) whether prejudice will be caused to the estate or the debtor;
(b.) whether hardship to the movant from continuing the stay outweighs any hardship to the debtor; and (c.) whether the movant has a reasonable probability of prevailing on the merits of the suit. Id.

Conclusion

The relief from stay sought for the DIP lenders in the Fairchild DIP Motion serves as one example of the importance of the automatic stay.  Through the DIP Motion, Fairchild seeks to preemptively lift the automatic stay so its lenders can exercise their rights in the event of a default.  Without receiving such blanket protection, lenders may be unwilling to lend to a debtor in possession.  Regardless, the automatic stay is a fundamental protection provided to debtors.  It is always helpful to understand the scope of the stay, as well as the parameters applied when a party seeks relief from the automatic stay.

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If you have any questions regarding this, or any other bankruptcy proceeding discussed on the Delaware Bankruptcy Litigation Blog, please contact Jason Cornell, Esquire at (302) 427-5512 or jcornell@foxrothschild.com.
 
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Posted on October 1, 2008 by Jason Cornell, Esq.

American Home Mortgage Sheds Light on the Meaning of "Repurchase Agreement"

Earlier this year, the United States Bankruptcy Court for the District of Delaware issued an important decision in American Home Mortgage, Inc. regarding the scope of the recently amended definition of a “repurchase agreement”.  Under the Bankruptcy Abuse Prevention Consumer Protection Act of 2005,  Congress broadened the Bankruptcy Code's definition of  "repurchase agreement" to include the transfer of "mortgage related securities, mortgage loans [and] interests in mortgage related securities or mortgage loans."  A review of the opinion in Calyon New York Branch v. American Home Mortgage Corp., 379 B.R. 503 (Bankr.D.Del. 2008) provides guidance regarding how courts apply the revised definition going forward.  Furthermore, given the increase in mortgage related bankruptcies, Judge Christopher S. Sontchi's decison In American Home Mortgage, Inc. addresses an important issue which is likely to arise again in future bankruptcy proceedings.

American Home Mortgage originated, sold and serviced subprime loans. Prior to filing for bankruptcy, Calyon New York Branch issued a notice of default to American Home, demanding that it repurchase the loans in Calyon’s possession. Soon after American Home filed for bankruptcy, Calyon sought a declaratory judgment finding that the agreement between the parties was a “repurchase agreement” as defined under the Bankruptcy Code.  Calyon also asked the court to find that the entire contract was a repurchase agreement, including the portion of the agreement governing loan servicing.

The court agreed with Calyon that the terms of the agreement rendered it a “repurchase agreement,” however, the court rejected Calyon’s argument that the loan servicing portion was a repurchase agreement. The court based its decision on the plain meaning of the contract. Applying the definition of “repurchase agreement” to the terms of the contract, the court found that American Home Mortgage agreed to transfer the originated loans to Calyon in exchange for funds, Calyon agreed to transfer the loans back to American Home Mortgage, also for funds, and the second transfer by Calyon was made within 180 days of the first.

By finding that the parties entered into a repurchase agreement, Calyon could proceed with its rights under the contract despite the automatic stay’s injunction against actions arising from a pre-bankruptcy default. However, Calyon did not receive such “safe harbor” protection for the loan servicing portion of the contract. Instead, the court found that the servicing component was an asset of American Home Mortgage that could be severed from the repurchase portion of the agreement.

In order to find that loan servicing could be severed from the repurchase agreement, the court considered several factors, most important of which was the language of the agreement. The loans were sold on a “servicing retained” basis, instead of “servicing released.” Had the parties intended to transfer the servicing rights to Calyon, the loan would have been structured as a servicing released agreement, resulting in Calyon paying a higher premium for the loans.

American Home Mortgage sheds light on how parties to a loan repurchase agreement can receive the protections provided under the Bankruptcy Code by satisfying the Code’s definition of “repurchase agreement.” It is the language of the agreement, not the economics of the transaction, that determine whether a contract is a repurchase agreement. Additionally, whether the servicing portion of the contract remains with the loan originator, versus the loan purchaser, also depends on the terms of the contract. By clarifying what constitutes a repurchase agreement under the Bankruptcy Code, American Home Mortgage provides guidance and certainty to parties drafting repurchase agreements, or those seeking to enforce their rights under an agreement with a lender in bankruptcy.

 

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