District Court Clarifies Distinction Between Burdens of Proof on Stay Relief and Adequate Protection in American Airlines Bankruptcy

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In AMR Corporation, et al., Debtors, Case No. 12-3967, 2013 WL 1339123 (S.D.N.Y. April 3, 2013), the United States District Court for the Southern District of New York acknowledged that to be granted relief from the automatic stay under 11 U.S.C. § 362(d), a secured creditor has the initial burden to show that there has been a decline—or at least a risk of decline—in the value of its collateral. Only then will the burden shift to the debtor to prove that the value of the collateral is not, in fact, declining. On the other hand, for purposes of adequate protection under 11 U.S.C. § 363(e), the secured creditor need only establish the validity, priority or extent of its interest in the collateral. At that point, the debtor bears the burden of proof under § 363(e). The distinction between the respective burdens of proof in §§ 362(d) and 363(e) can be a significant consideration for the formulation of a secured creditor's strategy at the outset of a chapter 11 case.

American Airlines, Inc. ("American") issued $1.0 billion of certain Senior Secured Notes that were guaranteed by, inter alia, AMR Corporation ("AMR"). The Senior Secured Notes were secured by a validly granted and properly perfected first-priority security interest in and lien on certain collateral. In February 2011, the collateral was appraised at a minimum of $2.37 billion. In November 2011, another appraisal was issued, and the same collateral was valued as low as $1.53 billion. 2013 WL 1339123, at *3–4.

Wilmington Trust Company, in its capacity as a co-trustee (the "Collateral Trustee"), together with U.S. Bank National Association, in its capacity as Indenture Trustee (the "Indenture Trustee" and, together with the Collateral Trustee, the "Trustees"), filed a motion for adequate protection under § 363(e) or, in the alternative, for relief from the automatic stay under § 362(d). In their motion, the Trustees alleged that the value of their interest in the collateral was at risk of diminution if "American fails to utilize the Collateral adequately or is not otherwise in compliance with the applicable regulations." The Trustees noted that the value of the collateral had declined by more than $840 million, or more than 35 percent, in a period of nine months. 2013 WL 1339123, at* 4.

The Trustees requested two forms of relief. Their primary request, made pursuant to § 363(e), was that the court impose "adequate protection" on the Debtors' continued use of the collateral as "adequate protection" of the Trustees' interest therein. Alternatively, they sought relief from the automatic stay, pursuant to § 362(d), to exercise their rights and remedies with respect to the collateral. Conceding that the value of the collateral was currently greater than the outstanding balance of the Notes, the Trustees still claimed an entitlement to their requested adequate protection package. 2013 WL 1339123, at *4.

The Bankruptcy Court noted that the Trustees bore the prima facie burden to demonstrate that the value of the collateral was decreasing or likely to decrease during the pendency of the bankruptcy case. The Court concluded the Trustees failed to meet this burden, relying in large part on the fact that the Debtors had submitted undisputed evidence that the Trustees enjoyed at least a 50-percent equity cushion in the collateral. Consequently, the Bankruptcy Court denied the motion without prejudice. 2013 WL 1339123, at *4.

The District Court ruled that the denial of the motion was a final order for purposes of appeal. It noted that a party seeking relief from the automatic stay has the burden of proof on the issue of a debtor's equity in the property and that the party opposing such relief has the burden of proof on all other issues. As such, the Trustees were required to show that there had been a decline (or at least that there was a real risk of decline) in the value of the collateral. Only upon such a showing would the burden shift to the debtors. 2013 WL 1339123,*7. The District Court held that the Bankruptcy Court's analysis as to the burden of proof for relief from the automatic stay was correct, and upheld the Bankruptcy Court's ruling on the issue.

However, the District Court disagreed with the Bankruptcy Court on the parties' respective burdens in connection with the Trustees' motion for adequate protection: As noted above, § 363 mandates that a debtor has the burden of proof on the issue of adequate protection and the party asserting an interest in property has the burden of proof on the issue of the validity, priority, or extent of such interest. 2013 WL 1339123,*7.

The District Court concluded that the Bankruptcy Court erred in its analysis of the Trustees' motion for adequate protection because it placed the burden upon the Trustees to make a prima facie showing that their interest in the collateral was not adequately protected. That notwithstanding, the District Court determined that the Bankruptcy Court's error was harmless. Because the debtors were able to establish the existence of an equity cushion of "at least 50%" of the value of the collateral, which is well "north of the twenty percent that is often relied upon by courts in making their determination," the ultimate rulings of the Bankruptcy Court went undisturbed. 2013 WL 1339123,*7.

As a matter of strategy, it can be vital to understand the differing burdens of proof under various provisions of the Bankruptcy Code and when those burdens shift.

For Further Information

If you have any questions about this Alert, please contact Walter J. Greenhalgh, any member of the Business Reorganization and Financial Restructuring Practice Group or the attorney in the firm with whom you are regularly in contact.

Topics:  Adequate Assurances, American Airlines, Burden of Proof, Chapter 11, Collateral, Trustees

Published In: Bankruptcy Updates, Business Organization Updates, Civil Procedure Updates, Finance & Banking Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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