What are First Day Motion Filings in Chapter 11 Bankruptcies?
The First Day Motion Filings is one of the first steps of a Chapter 11 bankruptcy proceeding and is when the debtor appears before the Court to file urgent requests pertinent to continue operating.
In a reorganization, the value of the debtor must be retained to have a chance at emerging from bankruptcy as a “going concern”. Thus, the Court provides measures such as the “automatic stay” provision to protect the debtor from collection attempts by pre-petition creditors and can approve certain motions deemed necessary for the debtor to sustain its operations.
- Once enacted by the Court, what becomes prohibited by the “automatic stay” provision?
- How does the classification of a claim as either 1) pre-petition or 2) post-petition impact recoveries?
- What is the common objective shared by all first day motion filings?
- Which circumstances might cause a debtor to be more likely to file a motion to pay critical vendors, access DIP financing, use cash collateral, and compensate employees?
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On a compressed time frame, the Court must approve or deny the requests of the debtor, but the decisions made here can have significant ramifications on the reorganization later on.
If the value of the debtor were to drop during its time under Chapter 11, that would contradict the purpose of the reorganization (i.e., maximizing creditor recoveries). As a result, the Court is biased towards approving most First Day Motion requests. A recurring theme is that the first day motions function as immediate relief to help the debtor “keep the lights on” and limit any reductions in its value.
“Automatic Stay” Provision
The “automatic stay” provision and classification of claims as being either pre-petition or post-petition make the petition filing date an important marker.
Chapter 11 bankruptcies are commenced by the filing of a petition for relief, with the vast majority being initiated as a “voluntary” petition filed by the debtor. There are also rare instances when a group of creditors could force the filing in what is known as an “involuntary” petition.
Once filed, the “automatic stay” provision immediately goes into effect to protect the company (i.e., now referred to as the “debtor”) from collection attempts from Pre-petition Creditors.
The automatic stay provision is designed to give the debtor relief and temporary protection to formulate a plan without constant distractions from pre-petition lenders.
The goal of Chapter 11 is to create a beneficial environment for the debtor to get back on track and return to operating on a sustainable basis. Creditors pursuing litigation and attempting to force the debtor to repay its due obligations would clearly conflict with that particular intent.
Based on Court orders, creditors are legally prohibited from trying to obtain recovery by means of foreclosure and threats of litigation – and refusal to follow the Court’s instructions and performing certain acts with the proven intent to harm the debtor (and the value of the estate) could lead to Equitable Subordination.
For a conceptual review of Chapter 11, take a look at our linked post below:
Pre-petition vs. Post-Petition Claims
During the temporary stay period, management can work on stabilizing its operations and making progress on the Plan of Reorganization (“POR”) without distractions from pre-petition lenders.
To achieve this goal, the debtor is likely to face significant hurdles when attempting to raise capital (e.g., Debt Financing), work with past Suppliers/Vendors, and use cash it holds on its balance sheet.
To address these obstacles, since the bankruptcy is conducted In-Court, incentives and protective measures are offered to those that cooperate with the post-petition debtor. That said, post-petition claims receive higher recoveries than pre-petition claims for this reason, as our article on the Priority of Claims explained.
Another reason for the importance of the date of filing is that many Legal Disputes contain language referencing the petition filing date.
For example, the petition filing date determines whether litigation can be pursued or not based on the lookback period.
Another important distinction is that oversecured creditors, in which the collateral value is greater than the claim amount, are entitled to receive post-petition interest.
Conversely, creditors holding unsecured debt obligations are not entitled to post-petition interest, nor does the interest on the debt accrue to the ending balance.
First Day Motion Filings & Cause of Financial Distress
Generally, most of the motions filed are related to the operations of the debtor – more specifically, ensuring that day-to-day operations can run normally.
Based on the Catalyst for Distress and reasons for financial underperformance, the first day motions filed by the debtor (and Court approval) will differ in each case.
For example, a debtor suffering from a liquidity shortfall and experiencing severe deterioration in its Credit Metrics is more likely to file liquidy-related requests, especially since Debt Financing was not an available option.
Motion for “Critical Vendor” Payments
Chapter 11 is designed to enable the debtor to continue operating and sustain its value – in which suppliers and vendors have a crucial role.
The Critical Vendor Motion helps the debtor operate “business as usual” during the Chapter 11 proceeding, and is one of the most common examples of a first day motion filing.
A frequent obstacle, however, is the reluctance of pre-petition suppliers/vendors to work with the debtor.
If the products/services were delivered 20 days before the petition date, the claims can receive treatment as administrative claims. For other pre-petition claims, they get classified as general unsecured claims (or “GUCs”), which are very unlikely to receive full recovery.
To address this impediment, the critical vendor motion can authorize vendors deemed “critical” for operations of the debtor to continue to be granted pre-petition payments. In return, the vendor(s) are required to continue supplying the debtor on contractual terms.
The motion is granted based on the notion that unless the motion is approved, then pre-petition suppliers/vendors would cease working with them and jeopardize the reorganization efforts. Additionally, there must be no substitutes available that could fill the “void” left by the pre-petition supplier/vendor.
Motion for Debtor in Possession (DIP) Financing
Being able to access DIP financing can be sufficient of a reason to file for Chapter 11.
Another important provision granted by the Court is called Debtor in Possession Financing (“DIP”).
DIP financing represents short-term debt capital that funds the working capital needs of the debtor and operational expenses while under Chapter 11.
A debtor filing for Chapter 11 is considered an untrustworthy borrower by Lending Standards, but can still access DIP capital because the Court offers various levels of protection and incentives to the DIP lender.
Types of protection include a priming lien on the DIP loan that enables the holder to be near the top of the priority of claims waterfall (and above Senior Secured Bank Debt, if granted “super-priority” status). Such protective measures are one of the primary benefits of In-Court Restructurings, especially for cash-constrained debtors.
Motion to Use Cash Collateral
Under the Bankruptcy Code, Cash Collateral is defined as cash & cash equivalents and the proceeds from highly liquid assets such as accounts receivable (“A/R”) and inventory that are subject to a lien or interest of a creditor. In short, due to being subject to the lien of a creditor, prior approval is required for the cash to be used – which is often necessary by the debtor.
Seldom would the creditor approve the request without much objection, while in other cases, a contested meeting will be required to take place in front of the Court.
To receive the desired Court ruling, the debtor is required to show that the creditor has “adequate protection” to receive Court approval to use any cash collateral.
Otherwise, the debtor remains legally restricted from using the cash, and the Legal Ramifications could be detrimental to the reorganization and relationships if a breach were to occur.
If the motion is accepted, the Court order authorizing the usage of the cash collateral typically contains language containing provisions protecting the interests of the creditor to protect their recoveries and maintain the fairness of the case.
Motion to Pay Pre-petition Payroll
Before compensation related to employee payroll can be issued, it is necessary for the debtor to file a motion with the Court to obtain approval. The use of existing funds for payroll purposes is in part closely associated with the aforementioned topic of cash collateral.
For operations to continue, employees are clearly very important Internal Stakeholders even if they do not hold a claim in the way that lenders do, although certain employees may own partial equity (e.g., stock-based compensation).
Retaining employees during Chapter 11 is especially important for companies where employees are not easily replaceable (e.g., software developers).