Volume 1, Number 1
Adequate
Assurance Under Section 366 of the Bankruptcy Code:
Deposit Not Required
Written by Sherri Morissette
Greenberg
Traurig, LLP
77 W. Wacker Drive, Suite 2500
Chicago, IL 60601
morissettes@gtlaw.com
Every business is dependent upon some type of utility service — whether it be electricity for running freezers, gas for running cooking appliances or telephones for taking orders. Upon commencement of the bankruptcy case, the debtor wants to ensure ongoing utility service and the utility provider wants to ensure payment for the continuation of services, many times in the form of a deposit. In enacting Section 366 of the Bankruptcy Code, Congress attempted to strike a balance between the concerns of a debtor and its utility companies. Section 366 provides a debtor with protection from the discontinuation of utility services within the first 20 days of filing a bankruptcy case, and the utility provider with a means to ensure that it is provided adequate assurance of payment after the filing of a bankruptcy case
Section 366 of the Bankruptcy Code provides that a utility may not alter, refuse, or discontinue service or discriminate against a debtor solely on the basis of filing bankruptcy. However, Section 366 (b) also states:
[s]uch utility may alter, refuse, or discontinue service if neither the trustee nor the debtor, within 20 days after the date of the order for relief, furnishes adequate assurance of payment, in the form of a deposit or other security, for service after such date. On request of a party in interest and after notice and a hearing, the court may order reasonable modification of the amount of the deposit or other security necessary to provide adequate assurance of payment.
At first glance it may seem as if a debtor’s requirement to pay a security deposit to its utility provider upon filing bankruptcy is set in stone. However, there has been much debate on what constitutes “adequate assurance” under Section 366 of the Bankruptcy Code and one recent decision found a security deposit was unnecessary under the Section 366 analysis. The Second Circuit in In re Adelphia Business Solutions Inc., 280 B.R. 63 (Bankr. S.D.N.Y. 2002) specifically found that the requirement of “adequate assurance” in certain cases, does not require payment of a security deposit by a debtor.
In the Adelphia case, certain telecom providers requested over $14 million in additional deposits as “adequate assurance” under Section 366 of the Bankruptcy Code. Id. at 66. The debtors argued that the combination of their record of pre-petition payment and allowance to the utilities of an administrative expense for post-petition service was sufficient assurance of future performance. Id. In addition, the debtors argued that because of the ongoing relationships between the telecom providers and the debtors, the debtors were also creditors of the telecom providers and those telecom providers may have owed the debtors substantial amounts. Id.
The Adelphia court held that while the debtors’ position was insufficient to provide adequate assurance to the utilities, adequate assurance did not require the deposits requested by the utilities that would drain the debtors of all their cash and be highly prejudicial to the interests of all other creditors in the case. Id. The court looked to the totality of the circumstances to determine if the utilities would be subject to an unreasonable risk of nonpayment, including the fact that obligations ran in each direction and that, based on those obligations, the telecom providers may in fact owe the debtors substantial amounts. Id. at 67. Specifically, the court stated
under the same totality of circumstances analysis, the court can and should try to gauge the bona fides and materiality of debtor contentions that a utility has debts running back to the debtors, but that it is inappropriate for the court, on a Section 366 motion, to either determine the complex disputes between a debtors and its counterparties with respect to the amounts each owes to the other, or to accept either sides ipse dixit assertions with respect to the merits of the parties disputes.
Id.
The Adelphia court also considered factors in its decision such as available financial resources, including liquid assets, other assets and borrowing capability, measures to provide early warning in the event of negative operating results and quick access to the court to help the utilities minimize their risk. Id. at 83. The Aldephia court indicated that merely historical factors — such as pre-petition payment history and whether the utilities demanded deposits in the past — have lesser relevance.
Therefore, based on the totality of the circumstances as of the hearing date, the court concluded that no deposits were required.
Until Aldephia,
the past practices of debtors had a significant impact in determining
the necessity of adequate assurance and the requirement of a deposit.
Adelphia changed the analysis in the Second Circuit to one of
total circumstances rather than past practice. Under Adelphia,
a telecom provider is not assured of receiving a security deposit upon
a customer filing bankruptcy. If a bankruptcy court initially concludes
the utilities risk of non-payment for post-petition services is small,
and the prejudice to a debtor is substantial, a court may not require
that any additional security or deposit be issued by a debtor under Section
366 of the Bankruptcy Code.
OTHER
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IN THIS ISSUE:
Article:
Telecom headed for bankruptcy reruns?
The Almanac - Telecom-
munication Bankruptcies