Obtaining Attorney Fee Carve-outs in Cash-collateral Orders

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Oct 2000

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In today's chapter 11 bankruptcies, it is common for cash-collateral orders to provide replacement liens to
secured creditors as adequate protection for any diminution in the value of the secured creditors' interests
in cash collateral used. It is also quite common for cash-collateral orders to provide "carve-outs" for
professionals. Specifically, debtors often negotiate and/or include provisions in proposed cash-collateral
orders that segregate, i.e., carve-out, from liens granted, an amount sufficient or a sum certain, for the
payment of professional fees and expenses. A carve-out assures that unencumbered assets will exist for the
payment of debtor's counsel's fees and expenses in the event of an insolvent estate. Additionally, a
carve-out may provide for statutory fees and, sometimes, fees and expenses of other professionals.

Due to the emergency nature of interim cash-collateral orders, however, most are negotiated, signed and
entered prior to the appointment of any official committee. Indeed, committee appointment may not occur
until after a final cash-collateral hearing, thereby precluding a committee's ability to comment or object
based on carve-out provisions that do not include committee counsel's fees and expenses.

While some may argue that cash-collateral orders should naturally include a carve-out for committee
counsel, practitioners should be aware that a committee's standing to raise such issues is now questionable.
In fact, due to the Supreme Court's recent Hen House opinion, and absent a debtor with a committee in
mind, committees may lack the authority to object to the entry of interim and/or final cash-collateral orders
based on the lack of a committee counsel carve-out from liens of a secured creditor.

<h3>Standing Under the Bankruptcy Code</h3>

When a secured creditor has a valid and perfected security interest in and lien on collateral, as well as
the proceeds therefrom, those proceeds constitute cash collateral pursuant to <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… U.S.C. §§363(a)</a> and
552(b)(2). Cash collateral may be used, however, pursuant to the provisions of §363(c), if a
debtor-in-possession (DIP) provides adequate protection of the secured party's interests in the cash
collateral.

Adequate protection may be provided in many forms under <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… U.S.C. §361</a>, including, but not limited
to, granting replacement liens to the extent that the use of the cash collateral actually diminishes the value
of the secured party's interests therein. Noticeably absent from §§361 and 363(c) is any reference to a
carve-out or other specific provisions to be included in a proposed cash collateral order, other than adequate
protection provisions.

Recently, many courts have developed certain "guidelines" or have otherwise issued orders setting forth
"appropriate items" for inclusion in proposed cash collateral orders. For example, some might argue that
a recent unpublished opinion from the Southern District of Texas stands as authority for requiring a
committee counsel carve-out, even over the objection of a secured creditor whose cash collateral is to be
used. See In re ABN Sports Supply Inc., No. 00-35907-H2-11, "Written Reasons for Denial of Proposed
Cash Collateral Order," p. 1 (Bankr. S.D. Tex. July 19, 2000) (where the court refused to issue an order
unless the parties inserted certain language, but did not specify what language or principles the proposed
order lacked).<a href="#1" name="1a">1</a>

Similarly, certain general orders have been issued in the District of Delaware regarding the appropriate
provisions for inclusion in cash collateral/DIP financing orders. Among these "appropriate provisions" are
provisions for professional fee carve-outs.

Despite these orders, there is simply no authority for a committee to object to a proposed cash-collateral
order based on the lack of a committee counsel carve-out. See <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… U.S.C. §§361, 363(c)</a> and 506(c).
Specifically, one must examine the express language of §363(c), which provides that a DIP may move the
Court to use cash collateral. Although §363(c)(2)(B) provides for the use of cash collateral over the
objection of a secured creditor, assuming the secured creditor does not consent to a committee counsel
carve-out, no part of §363(c) provides a committee with authority to move for such affirmative relief.

Thus, while a committee may have standing to object to a proposed cash-collateral order, in the best
interests of its constituency, it does not have the independent authority that a DIP has under §363(c)(2)(B).
Independent authority and standing was previously thought to exist under §506(c)'s surcharge provisions,
but the recent opinion of the U.S. Supreme Court in <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… Underwriter's Insurance Co. v. Union
Planters Bank N.A. (In re Hen House Interstate Inc.), __ U.S. __, 120 S.Ct. 1942</a>, __ L.Ed.2d __ (2000)
changes this analysis.

<h3>Hen House's Effect on Committee Counsel Carve-outs</h3>

In Hen House, the Supreme Court clearly stated that §506(c)'s surcharge provisions are not available to
any party other than a DIP or trustee. <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… Underwriter's Insurance Co. v. Union Planters Bank N.A. (In
re Hen House Interstate Inc.), __ U.S. __, 120 S.Ct. 1942</a>, __ L.Ed.2d __ (2000). Specifically, the Supreme
Court examined the plain language of §506(c) and determined that "had Congress intended the provision to
be broadly available, it [w]ould simply have said so, as it did in describing the parties who could act under
other sections of the <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… Code." See Hen House, 120 U.S. 1947-48</a>.

In Hen House, therefore, the Supreme Court put the issue of standing under §506(c) to rest. Accordingly,
a committee does not have standing under §506(c) to surcharge a secured creditor's collateral. Since a
committee cannot use §506(c) to surcharge a secured creditor's collateral, and no other code provision
authorizes a committee to obtain such an interest, no vehicle exists for forcing a committee counsel carve-out,
either by motion or by objection to a proposed cash-collateral order.<a href="#2" name="2a">2</a>

Theoretically, a committee could argue that a court has the power to require a committee carve-out in a
proposed cash collateral order under <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… U.S.C. §105(a)</a>. Section 105(a), after all, states that "the court may
issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of this title."
This "equitable power" may give a committee the ammunition it needs to fight the carve-out battle.

On the other hand, the §105(a) requirement that the "order, process or judgment [be] necessary or
appropriate to carry out the provisions of this title" can lead to the opposite conclusion. See, e.g., <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…
v. Lumsden (In re Geothermal Resources International Inc.), 93 F.3d 648, 651 (9th Cir. 1996)</a> (where the
court held that a bankruptcy court cannot, in the name of its equitable powers, ignore specific statutory
mandates); <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… Manufacturing Inc. v. Smith (In re Smith), 21 F.3d 660, 666 (5th Cir. 1994)</a> (where the
court held that bankruptcy courts cannot use their equitable powers under §105(a) to fashion substantive
rights and remedies not contained in the Bankruptcy Code and/or Rules). Thus, when one considers the
plain language of §§363(c) and 506(c), which do not give a committee the same authority as a DIP,
granting similar relief under §105(a) may be construed as inappropriately creating substantive rights
otherwise outside of the Bankruptcy Code.

Consequently, although a committee does have standing to object to a proposed cash-collateral order
that is not in the best interests of its constituency, there otherwise appears to be no support, under either
§363(c) or 506(c), for objecting to the lack of a committee counsel carve-out. It therefore appears that when
no unencumbered assets exist, committee counsel's fees and expenses become dependent on a successful
reorganization and/or the solvency of the bankrupt estate.

<h3>Conclusion</h3>

Although the Bankruptcy Code does not currently offer a method for committee counsel to receive
compensation from estate assets that are fully encumbered, this article does not suggest that committee
counsel should not receive or otherwise have a vehicle for obtaining compensation. Indeed, public policy
dictates the need for committee counsel, just as the Bankruptcy Code authorizes and anticipates the
representation of classes of creditors through official committees, as well as compensation for committee
counsel from the bankrupt estate's assets.

A paradox exists in that committee counsel plays a vital role in chapter 11 proceedings, yet the current
status of the law does not provide the same procedural avenue of relief available to debtor's counsel.
Perhaps the answer lies in pending bankruptcy reform, or in subsequent Supreme Court opinions that create
an exception to Hen House. Otherwise, committees may find themselves without counsel willing to
represent their interests in cases where unencumbered assets are not available or are limited.

<hr>
<h3>Footnotes</h3>

<a name="1">1</a> It should also be noted that the court specifically set forth in this order that its provisions applied to, and even underlined, "this case," thereby demonstrating its limited precedential value. <a href="#1a">Return to article</a>

<a name="2">2</a> Although a committee or other party-in-interest may challenge the validity and extent of a secured creditor's lien, this article is based
on the assumption that no valid challenge exists. <a href="#2a">Return to article</a>

Journal Authors

Bruce H. White

William L. Medford

Journal Date

Sunday, October 1, 2000 - 12:00