Ellingsen MacLean Oil Co., Inc., In re, 86-1452

• Decision Date: 15 January 1988
• Docket Number: No. 86-1452,86-1452
• Citation: 834 F.2d 599
• Parties: 17 Collier Bankr.Cas.2d 1402, Bankr. L. Rep. P 72,127 In re ELLINGSEN MacLEAN OIL CO., INC., and related cases, Debtor. UNSECURED CREDITORS' COMMITTEE; Mobil Oil Corporation, Plaintiffs-Appellants, v. FIRST NATIONAL BANK & TRUST COMPANY OF ESCANABA, and the Northern Trust Company, Defendants-Appellees.
• Court: U.S. Court of Appeals — Sixth Circuit

Page 599

834 F.2d 599

17 Collier Bankr.Cas.2d 1402, Bankr. L. Rep. P 72,127

In re ELLINGSEN MacLEAN OIL CO., INC., and related cases, Debtor.

UNSECURED CREDITORS' COMMITTEE; Mobil Oil Corporation, Plaintiffs-Appellants, v. FIRST NATIONAL BANK & TRUST COMPANY OF ESCANABA, and the

Northern Trust Company, Defendants-Appellees.

No. 86-1452.

United States Court of Appeals, Sixth Circuit.

Argued April 24, 1987.

Decided Nov. 30, 1987.

Rehearing and Rehearing En Banc Denied Jan. 15, 1988.

Jonathan F. Thoits (argued) Day, Sawdey, Flaggert & Porter, Timothy J. Curtin, Varnum, Riddering, Schmidt, and Howlett, Grand Rapids, Mich., for plaintiffs-appellants.

Thomas L. Butch, Escanaba, Mich., David F. Heroy (argued), Barbara A. Zahs, Gardner, Carton & Douglas, Chicago, Ill., for defendants-appellees.

Before MERRITT, WELLFORD and NELSON, Circuit Judges.

WELLFORD, Circuit Judge.

This case presents interesting and difficult questions about the application of section 364 of the Bankruptcy Code. The case arises from a consolidated bankruptcy proceeding involving thirteen related debtors, among which Ellingsen MacLean Oil Company is the largest. The debtors are oil companies who provide, among other things, home heating oil to homes in the Marquette, Michigan area. These debtors were all operating under a Chapter 11 bankruptcy reorganization at the time the order at issue was entered.

On March 31, 1984, the bankruptcy court entered an Agreed Order authorizing the various debtors to use their assets, including cash collateral, which were subject to prepetition security interests held by appellees First National Bank and Trust Company of Escanaba and the Northern Trust Company (the Banks), the debtors' principal secured creditors. The Order also allowed the debtors to borrow an additional $500,000 from the Banks. As an incentive to the Banks to extend added credit, the debtors granted the Banks first and senior replacement liens on all of the debtors' assets pursuant to Bankruptcy Code section 364, ¹ and the debtors agreed to make periodic payments to the Banks as permitted under other sections of the Code.

The debtors failed to make the agreed periodic payments, and the Banks filed a motion for relief from the automatic bankruptcy stay then in effect. In response, the debtors filed a petition for authority to settle the stay litigation, to amend the Agreed Order of March 31, 1984, and to obtain new credit. The immediate need for new credit was to purchase needed home heating oil for delivery to approximately 1200 to 1500 customers during Christmas week.

The bankruptcy court held an emergency telephonic hearing. The debtors, the Banks, and the appellants, the Unsecured Creditors Committee and Mobil Oil Corporation, a major unsecured creditor, were all represented. After the hearing the bankruptcy court entered an order (the amended order), which is the source of dispute on this appeal. The amended order authorized the extension of new credit, including an immediate advance of $60,000 in cash and $175,000 made available in the form of letters of credit, with authority for the debtors to use the cash collateral pursuant to section 363. ² As an incentive for the Banks to extend this further credit, they were granted first and senior replacement liens in all of the debtors' assets pursuant to section 364. The debtors also agreed to "settle all controversies regarding the validity of the Banks' security interests ... by waiving any objections they may have with respect thereto...." ³ The order further specifically stated that the validity of the liens granted "shall not be affected on appeal by reversal or modification of the authorization contained herein unless this Order is stayed pending appeal."

Appellants immediately appealed the bankruptcy court amended order to the district court. Appellants did not, however, obtain a stay of the order pending this appeal. Because no stay was in effect, the Banks filed a motion for dismissal pursuant to Bankruptcy Code section 364(e). The district court granted the Banks' motion and ordered dismissal. 65 BR. 358. Appellants now appeal for relief to this court.

Section 364(e) provides:

The reversal or modification on appeal of an authorization under this section to obtain credit or incur debt, or of a grant under this section of a priority or a lien, does not affect the validity of any debt so incurred, or any priority or lien so granted, to an entity that extended such credit in good faith, whether or not such entity knew of the pendency of the appeal, unless such authorization and the incurring of such debt, or the granting of such priority or lien, were stayed pending appeal.

Appellants argue that dismissal pursuant to section 364(e) was in error because that section does not apply to the amended order. They argue further that even if section 364(e) does apply, the Banks did not extend money in good faith and thereby lost section 364(e)'s protection.

I. Does section 364(e) apply?

The contention that section 364(e) should not apply stems from the phrase "under this section," which limits the protection under subsection (e) to authorizations made under section 364(c). The amended order was purportedly made pursuant to section 364(c), but appellants argue that it exceeded the bounds allowed by section 364(c) and therefore is not entitled to 364(e) protection.

11 U.S.C. Sec. 364(c) provides:

If the trustee is unable to obtain unsecured credit allowable under section 503(b)(1) of this title as an administrative expense, the court, after notice and a hearing, may authorize the obtaining of credit or the incurring of debt--

(1) with priority over any or all administrative expenses of the kind specified in section 503(b) or 507(b) of this title;

(2) secured by a lien on property of the estate that is not otherwise subject to a lien; or

(3) secured by a junior lien on property of the estate that is subject to a lien.

11 U.S.C. Sec. 364(c).

The express language of this subsection suggests that the priority or lien granted thereunder is limited to securing the newly incurred debt authorized by that provision. Appellant urges this interpretation and finds support in two bankruptcy cases. See In re FCX, Inc., 54 B.R. 833, 841 (Bankr.E.D.N.C.1985) (Section 364(c)(1) authorizes super priority for postpetition loans, not prepetition loans); In re Monarch Circuit Industries, 41 B.R. 859, 862 (Bankr.E.D.Pa.1984) ("the terms of Sec. 364(c) appear to limit the extent of the priority or lien to the amount of the credit obtained or debt incurred after court approval") (emphasis in original).

We read the amended order at issue as expressly granting section 364(c) priority only to postpetition debt. The bankruptcy court stated that "[a]ll Liabilities other than Pre-petition Liabilities, shall, to the extent not paid from collateral granted herein, be accorded priority pursuant to Section 364(c)(1)...." It also asserted that "the interest granted herein to the Banks in such Free Asset [previously unencumbered assets] shall be limited to security for only those Liabilities which are not Pre-petition Liabilities;...." This portion of the order, therefore, complied with appellants' interpretation of section 364(c).

The more troublesome aspect of the amended order is the portion in which the debtors agreed to "settle all controversies regarding the validity of the Banks' security interests...." Appellants contend that this aspect of the order, in essence, gave the Banks valid, perfected security interests securing prepetition loans. This, according to appellants, is beyond the scope of section 364(c) and therefore not protected by section 364(e).

This aspect of the order does not fit neatly into any of the aforesaid categories of section 364(c). It did not precisely create a new lien or priority; instead, it prohibited any challenges to the validity of already existing liens. This aspect of the order, however, was part of the whole "package" authorized under section 364(c). The question is whether section 364(c) allows such a transaction. In re FCX and In re Monarch both hold that section 364(c) authorizes priority or liens only for postpetition debt, not prepetition debt. This order in controversy bolstered liens securing prepetition debt, and thus may exceed the scope of section 364(c).

Even if the order were interpreted to exceed the scope of section 364(c), however, we are aware of no case authority holding that section 364(e) protection is unavailable to orders purportedly granted under section 364(c) but determined to have exceeded section 364(c)'s scope. In re Monach expressly declined to address this section 364(e) question. See 41 B.R. at 862. In re FCX never mentioned section 364(e) after ruling that section 364(c) does not authorize "super priority" for prepetition loans. See 54 B.R. at 841. If an order exceeded the scope of section 364(c), is it not entitled to section 364(e) protection, if purportedly granted under section 364(c) and relied on by the debtor and lending party concerned in good faith?

Appellants assert several policy reasons for their position that section 364(e) does not protect this amended order. First, appellants assert that "cross-collateralization" is generally disfavored as a financing mechanism. See, e.g., In re FCX, Inc., 54 B.R. at 840; In re Roblin Industries, 52 B.R. 241, 244 (Bankr.W.D.N.Y.1985); In re Antico Mfg. Co., 31 B.R. 103, 105 (Bankr.E.D.N.Y.1983); In re Vanguard Diversified, Inc., 31 B.R. 364, 366 (Bankr.E.D.N.Y.1983). In re Vanguard set out a four part test to determine whether to allow cross-collateralization, which other courts have followed. See In re Roblin, 52 B.R. at 244; In re Antico, 31 B.R. at 105. Appellant argues that approving the cross-collateralization order and thus protecting it from review by applying the section 364(e) language, "unless ... stayed pending appeal," thwarts the policy disfavoring...