Use, Sale, or Lease of Chapter 11 Estate Property in the Ordinary Course of Business

Unless the court order otherwise, a Debtor in Possession ("DIP") in a Chapter 11 case may use, sell, or lease property of the bankruptcy estate in the "ordinary course of business" without court approval.  The DIP has automatic statutory authority to run the business in Chapter 11 unless the court orders otherwise.

The Ordinary Course of Business

The question is, "what is the ordinary course of business?"

Courts often apply a two-part test.  The first part, call the "horizonal" dimension, looks at whether the proposed DIP transaction is typical industry-wide  in other similar businesses.  The second part, called the "vertical dimension," considers whether transaction subjects creditors to risks different from those undertaken by the business at the time the creditor extended credit.  One might ask, "is this a new activity for this particular business?"

There are, of course, limitations on the DIP use of estate property.  When the property that is going to be used is subject to liens or co-ownership, "adequate protection" might be necessary.  Further, the use of cash collateral, defined as cash or cash equivalents in which a third party has a security interest, always requires creditor consent or authorization after notice and hearing.

But what if the proposed sale or use is not in the ordinary course of business?  Then, the DIP must first give notice to creditors and parties in interest of the intended use, sale or lease outside the ordinary course of business.  The DIP must show reasonable business judgment to obtain court approval.  Selling property of the estate, apart from sales of inventory, is ordinarily not in the usual course of business.

Adequate Protection

When property of the estate subject to a security interest is used or sold, upon request of the creditor, adequate protection must be paid by the DIP.  Adequate protection may include cash payments, additional or replacement liens,  or other relief that provides "indubitable equivalent" of the creditor's interest in the property.  Cash payments can be made periodically to equal the decrease in value from the use or the passage of time.  An equity cushion in property may also provide adequate protection to a secured creditor.

Always consult an attorney if you face a Chapter 11 case as a creditor.  Mansfield Cheney, PC is available to assist in complex Chapter 11 matters.  Call us at 805-642-6406 or visit us on the web at http://www.hcmlawfirm.com.