This is the next post in Plan Proponent’s series on the confirmation-related recommendations in the ABI Commission Report (and, in particular, its Exiting the Case piece). In this post, we’ll cover the Commission’s recommendations regarding Section 552(b) and the “Equities of the Case” exception.
Section 552(b) addresses the effect of pre-petition liens on post-petition property. Section 552(a) states the general rule: post-petition property is not subject to a pre-petition lien. Section 552(b) states two exceptions: a pre-petition lien continues as to post-petition proceeds and post-petition rents from pre-petition collateral. In turn, the two exceptions are subject to an exception: the court, after notice and a hearing, can treat the pre-petition lien differently based on the “equities of the case.”
Basically, courts will analyze the facts of a particular case to determine whether a secured creditor’s pre-petition lien should be limited, altered, or terminated on account of estate expenditures that enhance such creditor’s position (e.g. the use of otherwise unencumbered estate resources to improve a creditor’s position). One goal is avoiding windfalls for secured creditors.
Section 552(b) is similar to Section 506(c) (which we discussed here) in at least 2 respects: (1) it represents a compromise between the rights of secured creditors and the Code’s rehabilitative purpose and (2) due to common waivers or stipulations by trustees, there is not very much case law addressing the scope of “equities of the case,” and, thus, determining where to draw the line for that compromise.
The Commission concerned itself with 2 matters: (1) the scope of the term “proceeds” and (2) whether Section 552(b) strikes an appropriate balance between the estate and secured creditors.
With respect to scope, the Commission reviewed the recent Residential Capital decision–an enormous, 117 page opinion by Judge Glenn which reads like a treatise on cash collateral and valuation issues, among other issues. In pertinent part, Judge Glenn rejected a secured creditor’s claim that its pre-petition lien extended to the debtor’s enhanced, post-petition goodwill. The Court reasoned that even if the creditor’s collateral had been used, in part, to enhance the debtor’s post-petition goodwill, the debtor had also used its other resources to enhance goodwill. Therefore, the enhanced goodwill did not constitute “proceeds” under Section 552(b) to which the creditor’s lien would attach. Although the Commissioners considered a bright line rule whereby all post-petition goodwill is excluded from proceeds, they determined that a case-by-case determination is more appropriate.
Additionally, the Commissioners considered the ever-expanding definition of proceeds under state law, particularly via amendments to Article 9 of the UCC, and even considered recommending a more limited, federal definition of proceeds. However, they rejected that consideration as well, concluding that creating a conflict between state and federal law would not be appropriate or warranted.
With respect to whether Section 552(b) strikes an appropriate balance, the Commission agreed that a creditor’s lien should continue, post-petitition, in proceeds, subject to the equities of the case exception. However, some Commissioners expressed concern about the trustee’s required evidentiary showing under the exception.
Ultimately, the Commissioners concluded that the exception should be clarified to make it clear that as long as the trustee establishes, as an evidentiary matter, that it created value for the estate through some means (whether via time, effort, money, property, savings, etc.), the estate should be entitled to that value under Section 552(b)’s “equities of the case” exception.
Finally, just as the Commission recommended that a trustee should not be able to waive its Section 506(c) rights, it recommended that a trustee should not be able to waive the equities of the case exception.
In our next post, we’ll turn to a more confirmation-relevant topic: the Commission’s recommendations regarding cramdown interest rates. In fact, from here on out, the Exiting the Case piece focuses primarily on pure confirmation topics.