Is the Tide Turning Against Secured Creditors?


A GIVEN for bankruptcy lawyers is that secured creditors typically control the bankruptcy process. Although bankruptcy courts are a haven for debtors seeking relief, at least temporarily, from secured and unsecured creditors alike, a debtor with substantially all of its assets encumbered by liens has little wiggle room.

A debtor is limited in its use of encumbered cash (i.e., cash collateral) in bankruptcy to manage its business and pay its professionals absent approval of its secured creditors. A debtor is also limited in obtaining additional credit, particularly new credit that seeks to prime existing secured claims, without a trial to determine a host of issues, including whether the lender is adequately protected (i.e., there is a cushion to ensure that the lender’s collateral will not diminish in value as a result of the extension of new credit). See, e.g., §§363 and 364 of title 11, Chapter 11 of the U.S. Code (Code).

However, bankruptcy judges wield tremendous power in interpreting Code provisions in the context of a court of equity where principles of fairness are as important as principles of law. This power was most evident in Official Comm. of Unsecured Creditors of Tousa Inc. v. Citicorp N. Am. Inc. (In re Tousa), 422 B.R. 783 (Bankr. S.D. Fla. 2009), where a bankruptcy judge set aside as fraudulent conveyances “transfers” of cash and liens on property ostensibly made by certain subsidiaries of Tousa Inc.

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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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