In re Heatron, Inc., Bankruptcy No. 80-02656-2-11.

• Decision Date: 22 September 1980
• Docket Number: Bankruptcy No. 80-02656-2-11.
• Citation: 6 BR 493
• Parties: In re HEATRON, INC., Debtor.
• Court: U.S. Bankruptcy Court — Western District of Missouri

6 B.R. 493 (1980)

In re HEATRON, INC., Debtor.

Bankruptcy No. 80-02656-2-11.

United States Bankruptcy Court, W.D. Missouri.

September 22, 1980.

Charles A. Darby, Kansas City, Mo., for debtor.

Frank W. Koger, Shockley, Reid & Koger, Kansas City, Mo., for Commerce Bank and Capital for Business.

ORDER AUTHORIZING USE OF CASH COLLATERAL

JOEL PELOFSKY, Bankruptcy Judge.

This is a proceeding under Chapter 11 of the Code. Debtor has filed a Motion, pursuant to the provisions of Section 363, Title 11, U.S.C., to use cash collateral in the continuation of its business. The debt is secured by equipment, fixtures and tools and all accounts receivable and inventory, now owned or hereafter acquired. Debtor alleges that the creditor is adequately protected; the fair value of assets exceeds the debt and will generate replacement accounts. Evidentiary hearings were held on three occasions, at which debtor appeared by counsel and officers and employees and the creditors, Commerce Bank and Capital for Business, appeared by attorney and various officers. Evidence was taken on each occasion. There is no question that debtor must use the cash collateral to continue its business. The issue is that of adequate protection for the creditor.

Section 361, Title 11, U.S.C., provides, in part, that

"When adequate protection is required under section . . . 363 . . . of this title of an interest of an entity in property, such adequate protection may be provided by-

(1) requiring the trustee to make periodic cash payments to such entity . . .

(2) providing to such entity an additional or replacement lien

(3) granting such other relief . . . as will result in the realization by such entity of the indubitable equivalent of such entity\'s interest in such property."

The concept of adequate protection is based upon two contradictory realities. One is that the use of cash collateral is essential to the success of the reorganization. The other is that the use necessarily diminishes the value of the security bargained for by the creditor and the secured position ought not to be allowed to deteriorate. Section 363(e) of Title 11, U.S.C. requires the Court, upon "request of an entity that has an interest in property used" to condition such use so as to provide adequate protection of such interest. Providing adequate protection is mandatory, 2 Collier on Bankruptcy, Paragraph 363.06 (15th Ed.), but the precise form and sufficiency of such protection must be developed by the trustee (here the debtor in possession) and addressed to the sound discretion of the Court. 2 Collier on Bankruptcy, Paragraph 361.01 (15th Ed.).

The concept of adequate protection rests upon constitutional principles of due process. "The bankruptcy power, like the other great substantive powers of Congress, is subject to the Fifth Amendment. Under the bankruptcy power Congress may discharge the debtor's personal obligations, because, unlike the states, it is not prohibited from impairing the obligations of contracts." Louisville Joint Stock Land Bank v. Radford, 295 U.S. 555, 589, 55 S.Ct. 854, 863, 79 L.Ed. 1593 (1935). The question in Radford, however, was whether the Congress could, by statute, take "substantive rights in specific property." 295 U.S. at 590, 55 S.Ct. at 863.

"Legislation by Congress may supersede that of a state . . . but Congress cannot repeal a state law; nor can it exert control over individual property rights except in the proper exercise of its constitutional powers . . .

"Of course, under the bankruptcy power Congress may provide for the fair and equitable distribution of a debtor\'s property among his creditors; may discharge the debtor from liability for pre-existing debts; may impair or destroy the obligation of private contracts; and may effect changes in the lienholder\'s remedy or delay its enforcement . . . the exercise of these powers does not permit the total or partial destruction of vested property rights . . . Congress, in the exercise of the bankruptcy power . . . may not take a property right from one creditor and transfer it without compensation to another without violating the Fifth Amendment." Ginsberg v. Lindel, 107 F.2d 721, 725-726 (8th Cir. 1939).

While the issue of the Court's power to authorize the use of collateral during reorganization, once the subject of much argument, cf. In re Waltham Watch Co., 185 F.2d 791 (1st Cir. 1950), is well settled by statute (Sections 361, 362 and 363, Title 11, U.S.C.), the authority is hedged about with restrictions to insure that the use does not result in the impairment of the value of the security.

In the case at bar, debtor owes two entities, Commerce Bank and Capital for Business. They are related in some fashion, not significant here. Initially, Capital for Business lent the debtor $200,000.00 to enable it to buy out the principal shareholder. This transaction was secured by an assignment of stock and occurred in November of 1979. Subsequently, the Bank loaned debtor $90,000.00, a substantial portion of which was paid to the principal shareholder as interest. The Bank took a security position in equipment, inventory and accounts receivable. Thereafter the Bank made two additional loans, totalling $21,000.00 to pay for accounting services provided to the debtor by Ernst & Whinney and to pay taxes due the Internal Revenue Service. Capital for Business also made an additional loan. The aggregate amount of the debt owed to the two entities exceeds $325,000.00.

The debt instruments and the precise amount of the debt are not in evidence. The testimony indicates that the debt is in the form of demand instruments and payments are interest only for the immediate future. The payments were made regularly through July of 1980. In April of 1980, however, the debtor failed to furnish the Bank with its monthly financial statement. The last statement was that of March. Commerce Bank insisted that the debtor hire an outside accounting firm to revitalize its financial reporting. Ernst & Whinney was hired; its representatives designed a system but made no audit. The June financial statements were prepared by the debtor's comptroller with assistance of Ernst & Whinney. It showed a significant loss in shareholder equity.

This report alarmed the Bank which attempted to audit the accounts receivable. The audit was not successful. The Bank also participated in a physical audit in early August. This was completed but not with any precision. The Bank representative testified that he had little confidence in the accuracy of the inventory, although he participated in the taking of it and expressed no reservation at the time. The evidence does persuade that the inventory taken in early August was nonchalant at least.

On August 14, 1980, the Bank declared its notes due, seized the money in the collateral control account and directed the debtor to shut down its business. On August 19, 1980, the debtor filed its petition for reorganization under Chapter 11 and motions for use of cash collateral and the appointment of an attorney.

The issue of adequate protection rests, of course, upon an analysis of the security which the creditor had. Initially, the question to be answered is the method of valuation. In bankruptcy generally, the valuation is the amount to be received at a forced sale. In a reorganization, however, where the business is on going, there is merit in considering values resulting from sales at market resulting from a bona fide negotiation. Certainly, the thrust of the Uniform Commercial Code, Sections 400.9-504 ff. V.A.M.S., requiring security to be sold in a reasonably commercial manner, supports such a position.

"The commercial reasonableness requirement currently imposed on virtually all collateral dispositions by the Uniform Commercial Code involving personal property is no less appropriate for Chapter 11 collateral impairment valuation purposes . . .

"It is of little more than the articulation of an unexceptional business judgment to hold that, whenever practicable, conversion in the ordinary course of business should be considered the most commercially reasonable collateral disposition simply because and to the extent that it is more productive."

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