In re Coserv, L.L.C.

• Decision Date: 04 January 2002
• Docket Number: No. 01-48684.,01-48684.
• Citation: 273 B.R. 487
• Parties: In re COSERV, L.L.C. d/b/a CoServ Communications, et al., Debtors.
• Court: U.S. Bankruptcy Court — Northern District of Texas

Page 487

273 B.R. 487

In re COSERV, L.L.C. d/b/a CoServ Communications, et al., Debtors.

No. 01-48684.

United States Bankruptcy Court, N.D. Texas, Fort Worth Division.

January 4, 2002.

COPYRIGHT MATERIAL OMITTED

Holland Neff O'Neil, Richard M. Roberson, Merrill L. Kaliser, Gardere Wynne Sewell, LLP, Dallas, TX, for Debtors.

MEMORANDUM OPINION

DENNIS MICHAEL LYNN, Bankruptcy Judge.

Before the Court is Debtors' Emergency Motion for Order Authorizing Payment of Prepetition Claims of Critical Vendors (the "Motion"). The Court has jurisdiction over this matter pursuant to 28 U.S.C. § 1334(a). The Motion is a core proceeding under 28 U.S.C. § 157(b)(2),(A), (B) and (O). This Memorandum Opinion constitutes the Court's findings of fact and conclusions of law (Fed. R. Bankr.P. 7052, applicable to the Motion pursuant to Fed. R. Bankr.P. 9014).

I. Background

This case involves six related debtors: CoServ, L.L.C. d/b/a CoServ Communications, CoServ Telecom Holdings, L.P., CoServ Telecom GP, L.L.C., DWB GP, Inc., Multitechnology Services, L.P., d/b/a CoServ Broadband Services and Dallas Wireless Broadband, L.P., d/b/a CoServ Broadband¹ (collectively "Debtors" or "CoServ"). Debtors each filed a petition for relief under Chapter 11 of the Bankruptcy Code on November 30, 2001. By order entered the same day, Debtors' cases were consolidated for administrative purposes.

Debtors' principal businesses consist of providing telecommunications services, cable television, website development and hosting in parts of North Texas. In some areas, Debtors are the only providers of these services.

On March 15, 2001 CoServ, together with non-debtor affiliates, entered into a restructuring agreement with their Lender, National Rural Utilities Cooperative Finance Corporation ("Lender" or "CFC"). Thereafter, CoServ agreed with CFC to sell the six companies' assets by September 30, 2001. No purchaser was found by the target date, but subsequently CoServ entered into a non-binding term sheet with Stellar Holdings, L.L.C. ("Stellar") for a sale of the assets (in a going-concern configuration) for $90,000,000. CoServ then commenced these cases to effectuate the sale. Debtors anticipate early consummation of the sale and so do not expect to operate in Chapter 11 for a long period of time.

Debtors claim that they owe Lender approximately $26,000,000 prepetition and that the sale of their assets (in a going-concern configuration) to Stellar² will provide a substantial return to all creditors. CFC disputes the amount owed to it and has suggested in pleadings and statements to the Court that Debtors' obligations to it substantially exceed $90,000,000. In any case, it appears that Debtors' businesses will continue in the future. Thus it is in the interests of unsecured creditors, so far as it is consistent with prudent business practices, to facilitate Debtors' maintenance of their businesses. Not only will this make payment of unsecured claims more likely; it will in many cases preserve an ongoing customer.

Debtors have negotiated an agreement with Lender for the use of cash collateral and $5,400,000 in additional financing. This agreement has been preliminarily approved by the Court. Between use of cash collateral and the substantial additional funds CFC will make available to Debtors, Debtors should not have a problem meeting post-petition obligations.

Debtors filed the Motion contemporaneously with their petition with other "first-day pleadings." The Court held hearings on "first day pleadings" on December 4, 2001. At that time Debtors requested that the Court defer consideration of the Motion until December 14, 2001. Hearing of the Motion was continued again at Debtors' request to December 20, 2001.

At the time of the initial hearing, Debtors sought authority to expend $2,272,265.93 in payment of prepetition claims of 27 creditors. The Court expressed concern with the nature and extent of the Motion, and, by December 20, Debtors had narrowed the list of "critical vendors" to seven creditors to whom Debtors wished to pay $563,183.00 of prepetition indebtedness. However, at the hearing counsel for the Official Unsecured Creditors Committee (the "Committee") suggested the list should be expanded to include additional "critical vendors" (some of whom are members of the Committee).

The Lender initially opposed the Motion. Once pared down, however, on December 20 the Lender announced that it neither opposed nor supported the Motion.³ Only one other party (Temple, Inc., designated by Debtors as one of the critical vendors), participated in the December 20 hearing.⁴ In support of the Motion Debtors presented the testimony of Steven Chisholm, Debtors' president, Ron Clinton, Debtors' chief financial officer, and Terry R. Falls, Debtors' engineering and planning vice president. The specific testimony of these witnesses will be discussed later in this memorandum opinion.

II. The Issues Presented by the Motion

Though the Motion was not opposed, the Court is not prepared to grant it solely on that basis. In the first place, the Court has an independent obligation to ensure that the Bankruptcy Code is complied with. In the second place, the United States trustee was not present on December 20. In other cases before this Court, the United States trustee has opposed payment of employee expenses (as opposed to wages, salaries or commissions) because their payment would discriminate improperly among unsecured creditors. Third, the remarks of counsel for the Committee suggest that there are additional "critical vendors" awaiting the Court's granting of the Motion whose pleas for special treatment are likely to follow a favorable ruling. Thus the Court believes it is necessary to treat the Motion as a contested matter and decide it based on the law and the record made on December 20.

The Motion presents the Court with three questions:

1. May a bankruptcy court ever authorize, pre-plan, a Chapter 11 debtor to pay prepetition general unsecured claims?

2. If so, what test should the bankruptcy court apply in deciding whether a claim should be paid?

3. Which, if any, of the claims Debtors seek to pay should the Court authorize Debtors to pay?

III. Discussion

Debtors assert that, on the basis of the "Doctrine of Necessity" (or the "Necessity of Payment Rule"), this Court has ample equitable powers to authorize pre-plan payment of selected prepetition claims. The Court does not disagree that it can allow the Debtors to pay prepetition debt other than pursuant to a plan — but holds it may do so only under extraordinary circumstances. Thousands of debtors have successfully navigated through Chapter 11 in the past without paying the prepetition claims of "critical" vendors. Despite the increasing willingness of courts in a few jurisdictions to allow payment of prepetition claims long prior to consummation of a plan, this Court does not believe there has been a sea change in the law that would warrant such a drastic expansion of the "Doctrine of Necessity," a device to be used only in rare cases.

A. The Debtors' Position

In the Motion and an accompanying Memorandum of Law⁵ (the "Memorandum") the Debtors cite extensive authority for the proposition that the Code permits payment of prepetition claims even in exchange for assurances by the creditor of post-petition credit (Motion at 5, citing In re Just for Feet, Inc., 242 B.R. 821 (D.Del.1999) and other, unreported Delaware decisions).

The principal statutory basis for the Court's power to permit payment of prepetition claims is found by Debtors in 11 U.S.C. § 105(a).⁶ Debtors, however, also cite cases which have relied on the court's authority under 11 U.S.C. § 363(b)(1) to utilize property of the estate other than in the ordinary course of business (See In re Ionosphere Clubs, Inc., 98 B.R. 174, 176 (Bankr.S.D.N.Y.1989)); the powers of the debtor in possession pursuant to 11 U.S.C. § 1107(a) (See id.); and even the Court's power under 11 U.S.C. § 549 to reverse a post petition transfer (In In re Isis Foods, Inc., 37 B.R. 334, 336 n. 3 (W.D.Mo.1984) the court implied Section 549 might permit a bankruptcy court to authorize such transfers).

As justification for the Court's exercise of its authority, Debtors rely on the Doctrine of Necessity and the Necessity of Payment Rule. Both the Doctrine of Necessity and the Necessity of Payment Rule are rooted in pre-Code decisions.⁷ See Russell A. Eisenberg & Frances F. Gecker, The Doctrine of Necessity and Its Parameters, 73 Marq L.Rev. 1 (1989) [hereinafter "Eisenberg & Gecker"]. These authorities lead Debtors to the conclusion that this Court may authorize payment of prepetition claims to ensure continuation of the Debtors' operations (Motion at 5, Memorandum at 4); if the payment is critical to Debtors' reorganization (Motion at 5, Memorandum at 4); to "facilitate the continued operation and rehabilitation" of the Debtors (Motion at 5, citing In re Ionosphere Clubs, Inc., 98 B.R. at 176); to preserve the going concern value of the Debtors (Memorandum at 4); "to realize the paramount purpose of a Chapter 11 reorganization — preventing liquidation of the debtor in possession and preserving its potential for rehabilitation" (Memorandum at 5); to induce creditors to supply services or material essential to conduct of the business (Memorandum at 6 and 7); to avert a threat to the Chapter 11 process (Memorandum at 8); and to obtain customary trade terms from creditors (Motion at 5, Memorandum at 8). The Debtors suggest (Memorandum at 6) that there is a flexibility inherent in the Bankruptcy Code such that "it is well established that, particularly in the early stages of the case, a court may authorize payment of prepetition debts in order to preserve [the] potential for rehabilitation." (Memorandum at 6, quoting Robert Ordin, Finality of Order of Bankruptcy Court, 54 Am. Bankr.L.J. 173, 177 (1980)).

The Court's Analysis

1. The Bankruptcy Code:

The Court...