In re Vanguard Diversified, Inc., Bankruptcy No. 883-31219-18.

• Decision Date: 28 June 1983
• Docket Number: Bankruptcy No. 883-31219-18.
• Citation: 31 BR 364
• Parties: In re VANGUARD DIVERSIFIED, INC., a/k/a Vanguard Business Furniture, Debtor.
• Court: U.S. Bankruptcy Court — Eastern District of New York

31 B.R. 364 (1983)

In re VANGUARD DIVERSIFIED, INC., a/k/a Vanguard Business Furniture, Debtor.

Bankruptcy No. 883-31219-18.

United States Bankruptcy Court, E.D. New York.

June 28, 1983.

Louis P. Rosenberg, Brooklyn, N.Y., Friend, Dorfman & Marks, New York City, for debtor.

Judge Joel Lewittes, Parker, Chapin, Flattau & Klimpl, Marcy Sharon Cohen, New York City, for Bank Leumi.

DECISION

C. ALBERT PARENTE, Bankruptcy Judge.

Debtor-in-possession, Vanguard Diversified, Inc., (hereinafter "Vanguard") seeks the court's approval of a certain proposed financing order, which provides inter alia for the cross-collateralization of its present and future indebtedness to Bank Leumi Trust Company of New York (hereinafter "Bank Leumi"). After a hearing on notice to Vanguard's twenty largest creditors, the court reserved decision.

FACTUAL CONTEXT

On June 21, 1983, Vanguard filed a petition for reorganization under Chapter 11 of the Bankruptcy Code, and has been continued in the management and possession of its property as debtor-in-possession pursuant to section 1108 of the Bankruptcy Code. Vanguard is engaged in the business of manufacturing steel office furniture.

Since July 1982, Vanguard has financed its operations with Bank Leumi. At present, Vanguard has outstanding indebtedness to Bank Leumi in the approximate sum of $5,000,000. This indebtedness is secured by a first lien held by Bank Leumi on all of Vanguard's personal property including without limitation all accounts, general intangibles, goods, instruments, documents and chattel paper, and a lien on certain motor vehicles owned by Vanguard. Bank Leumi also holds certain fourth-level subordinate mortgages in the aggregate amount of $2,299,500, covering Vanguard's premises located at 10 Java Street, Brooklyn, New York.

At the time Vanguard filed its Chapter 11 petition, it had no funds with which to purchase inventory or to pay salaries. In order to prevent a disruption of Vanguard's business operations, counsel for Vanguard and Bank Leumi presented a proposed interim financing order (hereinafter "Interim Order") to the court on June 21, 1983. Upon the supporting affidavits and representations of counsel, the Interim Order was duly signed and entered on June 21, 1983. The order provided that pending a hearing to be held on June 24, 1983, Bank Leumi was authorized to advance sums not exceeding $225,000 at any one time outstanding, with the advances to be secured by a lien on certain described assets of the debtor and debtor-in-possession, and by a superpriority status pursuant to 11 U.S.C. § 364(c). Contrary to the intimations of counsel, the order contained, in rather innocuous terms, a cross-collateralization provision granting Bank Leumi certain security interests and a superpriority status in the pre-petition claims of Bank Leumi against the debtor.

On June 24, 1983, a hearing was held to consider the approval and implementation of the proposed financing order (hereinafter "Financing Order"). The Financing Order provides that Bank Leumi will extend to Vanguard a $5,000,000 revolving line of credit at interest of 1.5% over prime in exchange for the following security: (1) A first lien on all pre- and post-petition Security (as defined in Schedule A of the Security Agreement) to secure payment of all pre- and post-petition debts of Vanguard to Bank Leumi; (2) Subordinate mortgages on Vanguard's real property previously granted to Bank Leumi in the approximate amount of $2,299,500, to secure payment of all pre- and post-petition debts of Vanguard to Bank Leumi; (3) A super-priority pursuant to 11 U.S.C. § 364(c) for all pre- and post-petition debts of Vanguard to Bank Leumi; and (4) A certificate of indebtedness which shall: (i) be a first lien, subject to existing nonavoidable liens, on all real and personal property of the debtor and debtor-in-possession together with all after-acquired property and proceeds, and (ii) have a superpriority over any administrative expenses and subsequent liens.

DISCUSSION

Under the doctrine of In re Texlon Corp., 596 F.2d 1092 (2d Cir.1979), cross-collateralization is a disfavored means of financing which may only be authorized after its necessity has been established at a hearing held on notice to creditors. In re General Oil Distributors, Inc., 20 B.R. 873 (Bkrtcy.E. D.N.Y.1982); see In re Borne Chemical Company, 9 B.R. 263 (Bkrtcy.D.N.J.1981); In re Flagstaff Food-Service Corp., 14 B.R. 462 (Bkrtcy.S.D.N.Y.1981). Since cross-collateralization accords preferential treatment to the claims of the financing party, In re Texlon Corp., supra at 1097, it is a device that "may be utilized as a last resort only when the debtor is otherwise unable to obtain needed financing on acceptable terms." Weintraub & Resnick, Cross-Collateralization of Prepetition Indebtedness as an Inducement for Postpetition Financing: A Euphemism Comes of Age, 14 U.C.C.L.J. 86, 90 (1981) (hereinafter "Weintraub & Resnick").

In seeking to grant cross-collateralization, the debtor-in-possession must demonstrate that: (1) Absent the proposed financing, its business operations will not survive, see Weintraub & Resnick, supra at 90-91; (2) It is unable to obtain alternative financing on acceptable terms, Weintraub & Resnick, supra at 90, see In re Texlon, supra at 1098; (3) The proposed lender will not accede to less preferential terms; and (4) The proposed financing is in the best interests of the general creditor body, see In re Texlon Corp., supra at 1098-99.

In support of its first element of proof, Vanguard's co-counsel, Louis Rosenberg and Solomon Friend, testified under oath that the debtor-in-possession is out of funds, and will cease to operate immediately if no financing is forthcoming. Tr. 6/24/83, at 17-18. Without financing, Vanguard will be unable to...