Matter of Saybrook Mfg. Co., Inc.
963 F.2d 1490, 1992 U.S. App. LEXIS 14489, 27 Collier Bankr.Cas.2d 277 (1992)
Premium Feature
Subscribe to Lexplug to listen to the Case Podcast.
Rule of Law:
The practice of cross-collateralization, which secures a creditor's pre-petition, unsecured debt with the debtor's post-petition assets as part of a post-petition financing agreement, is not authorized by Section 364 of the Bankruptcy Code and is impermissible because it violates the Code's fundamental priority scheme.
Facts:
- Saybrook Manufacturing Co., Inc. and related companies ('debtors') owed Manufacturers Hanover approximately $34 million prior to filing for bankruptcy.
- This pre-petition debt was significantly undersecured, as the collateral securing it was valued at less than $10 million, leaving about $24 million of the debt unsecured.
- After filing for Chapter 11 bankruptcy, the debtors needed additional financing to continue their operations.
- Manufacturers Hanover agreed to lend the debtors an additional $3 million post-petition.
- In exchange for the new loan, the debtors granted Manufacturers Hanover a security interest in all of their assets, both pre-petition and post-petition.
- This security interest collateralized not only the new $3 million loan but also the pre-existing, undersecured $34 million debt.
- This arrangement effectively elevated Manufacturers Hanover's large, unsecured pre-petition claim to a fully secured status, giving it priority over other unsecured creditors, including Jeffrey and Seymour Shapiro.
Procedural Posture:
- Saybrook Manufacturing Co. initiated Chapter 11 proceedings in the U.S. Bankruptcy Court.
- The debtors filed a motion for an emergency financing order, which the bankruptcy court granted, authorizing the cross-collateralization arrangement.
- Jeffrey and Seymour Shapiro, unsecured creditors, filed objections to the financing order, which the bankruptcy court overruled after a hearing.
- The Shapiros filed a notice of appeal and requested a stay of the financing order from the bankruptcy court, which was denied.
- The Shapiros appealed to the U.S. District Court for the Middle District of Georgia and also moved for a stay from that court, which was also denied.
- The district court dismissed the Shapiros' appeal as moot under 11 U.S.C. § 364(e).
- The Shapiros (appellants) appealed the district court's dismissal to the U.S. Court of Appeals for the Eleventh Circuit, with the debtors and lenders as appellees.
Premium Content
Subscribe to Lexplug to view the complete brief
You're viewing a preview with Rule of Law, Facts, and Procedural Posture
Issue:
Is the practice of cross-collateralization, which secures a creditor's pre-petition unsecured debt with post-petition assets, authorized as a form of post-petition financing under the Bankruptcy Code?
Opinions:
Majority - Judge Cox
No. The practice of cross-collateralization is not authorized under the Bankruptcy Code. First, the court rejected the argument that the appeal was moot under § 364(e), reasoning that § 364(e)'s protection only applies to financing that was validly authorized under § 364 in the first place. The court reasoned that it must first determine the legality of cross-collateralization before it could decide the mootness issue. Second, the court held that the plain text of § 364(c) and (d) only authorizes the granting of liens to secure future, post-petition extensions of credit, not to secure pre-petition debts. Third, the court rejected the argument that bankruptcy courts' equitable powers under § 105(a) could justify the practice. It held that these powers cannot be used to contravene the fundamental priority scheme explicitly laid out in § 507 of the Code, which mandates equal treatment for creditors within the same class. Cross-collateralization impermissibly creates a superpriority for one unsecured creditor over all others.
Analysis:
This decision established a significant precedent by creating a per se rule in the Eleventh Circuit that Texlon-type cross-collateralization is illegal. It rejected the approach of other circuits that had avoided ruling on the merits by using the mootness provision of § 364(e). The ruling reinforces the Bankruptcy Code's strict priority scheme, prioritizing the principle of equitable treatment of creditors over the practical, but potentially unfair, financing needs of a debtor in reorganization. This case provides a clear, bright-line rule that limits the tools available for debtor-in-possession financing and curtails the leverage of pre-petition lenders.
