Saybrook Mfg. Co., Inc., Matter of

• Decision Date: 25 June 1992
• Docket Number: No. 91-8542,91-8542
• Citation: 963 F.2d 1490
• Parties: , 27 Collier Bankr.Cas.2d 277, 23 Bankr.Ct.Dec. 355, Bankr. L. Rep. P 74,692 In the Matter of SAYBROOK MANUFACTURING CO., INC., Clinton Marine Products, Inc., Sero Holdings, Inc., the Sero Company, a/k/a Sero of New Haven, a/k/a Ms. Sero, a/k/a Par-Ex, a/k/a Wrecked, a/k/a Scoundrel, a/k/a Jennifer Kirk, a/k/a C.J. Taft, Debtors. Jeffrey SHAPIRO and Seymour SHAPIRO, Plaintiffs-Appellants, v. SAYBROOK MANUFACTURING COMPANY, INC., Clinton Marine Products, Inc., Sero Holdings, Inc., the Sero Company, Mfg. Hanover Trust, Manufacturer's Hanover Trust Company, Manufacturer's Hanover Bank (Delaware), Union Trust Company, an Irving Commercial Corporation, Defendants-Appellees.
• Court: U.S. Court of Appeals — Eleventh Circuit

Page 1490

963 F.2d 1490

61 USLW 2019, 27 Collier Bankr.Cas.2d 277,

23 Bankr.Ct.Dec. 355,

Bankr. L. Rep. P 74,692

In the Matter of SAYBROOK MANUFACTURING CO., INC., Clinton Marine Products, Inc., Sero Holdings, Inc., the Sero Company, a/k/a Sero of New Haven, a/k/a Ms. Sero, a/k/a Par-Ex, a/k/a Wrecked, a/k/a Scoundrel, a/k/a Jennifer Kirk a/k/a C.J. Taft, Debtors Jeffrey SHAPIRO and Seymour SHAPIRO, Plaintiffs-Appellants, v. SAYBROOK MANUFACTURING COMPANY, INC., Clinton Marine Products, Inc., Sero Holdings, Inc., the Sero Company, Mfg Hanover Trust, Manufacturer's Hanover Trust Company Manufacturer's Hanover Bank (Delaware), Union Trust Company, an Irving Commercial Corporation, Defendants-Appellees.

No. 91-8542.

United States Court of Appeals, Eleventh Circuit.

June 25, 1992.

Ward Stone, Jr., Adams & Hemingway, Macon, Ga., for plaintiffs-appellants.

C. David Butler, Lee Brooks Rivera, Alston & Bird, Atlanta, Ga., for defendants-appellees.

Appeal from the United States District Court for the Middle District of Georgia.

Before COX, Circuit Judge, JOHNSON ^* and REAVLEY ^**, Senior Circuit Judges.

COX, Circuit Judge:

Seymour and Jeffrey Shapiro, unsecured creditors, objected to the bankruptcy court's authorization for the Chapter 11 debtors to "cross-collateralize" their pre-petition debt with unencumbered property from the bankruptcy estate. The bankruptcy court overruled the objection and also refused to grant a stay of its order pending appeal. The Shapiros appealed to the district court, which dismissed the case as moot under section 364(e) of the Bankruptcy Code because the Shapiros had failed to obtain a stay. We conclude that this appeal is not moot and that cross-collateralization is not authorized under the Bankruptcy Code. Accordingly, we reverse and remand.

I. Facts and Procedural History

Saybrook Manufacturing Co., Inc., and related companies (the "debtors"), initiated proceedings seeking relief under Chapter 11 of the Bankruptcy Code on December 22, 1988. On December 23, 1988, the debtors filed a motion for the use of cash collateral and for authorization to incur secured debt. The bankruptcy court entered an emergency financing order that same day. At the time the bankruptcy petition was filed, the debtors owed Manufacturers Hanover approximately $34 million. The value of the collateral for this debt, however, was less than $10 million. Pursuant to the order, Manufacturers Hanover agreed to lend the debtors an additional $3 million to facilitate their reorganization. In exchange, Manufacturers Hanover received a security interest in all of the debtors' property--both property owned prior to filing the bankruptcy petition and that which was acquired subsequently. This security interest not only protected the $3 million of post-petition credit but also secured Manufacturers Hanover's $34 million pre-petition debt.

This arrangement enhanced Manufacturers Hanover's position vis-a-vis other unsecured creditors, such as the Shapiros, in the event of liquidation. Because Manufacturers Hanover's pre-petition debt was undersecured by approximately $24 million, it originally would have shared in a pro rata distribution of the debtors' unencumbered assets along with the other unsecured creditors. Under the financing order, however, Manufacturers Hanover's pre-petition debt became fully secured by all of the debtors' assets. If the bankruptcy estate were liquidated, Manufacturers Hanover's entire debt--$34 million pre-petition and $3 million post-petition--would have to be paid in full before any funds could be distributed to the remaining unsecured creditors.

Securing pre-petition debt with pre- and post-petition collateral as part of a post-petition financing arrangement is known as cross-collateralization. The Second Circuit aptly defined cross-collateralization as follows:

[I]n return for making new loans to a debtor in possession under Chapter XI, a financing institution obtains a security interest on all assets of the debtor, both those existing at the date of the order and those created in the course of the Chapter XI proceeding, not only for the new loans, the propriety of which is not contested, but [also] for existing indebtedness to it.

Otte v. Manufacturers Hanover Commercial Corp. (In re Texlon Corp.), 596 F.2d 1092, 1094 (2d Cir.1979).

Because the Second Circuit was the first appellate court to describe this practice in In re Texlon, it is sometimes referred to as Texlon -type cross-collateralization. Another form of cross-collateralization involves securing post-petition debt with pre-petition collateral. See, e.g., In re Antico Manufacturing Co., 31 B.R. 103, 105 (Bankr.E.D.N.Y.1983). This form of non-Texlon-type cross-collateralization is not at issue in this appeal. See Appellant's Brief at 8-9. The Shapiros challenge only the cross-collateralization of the lenders' pre-petition debt, not the propriety of collateralizing the post-petition debt. Id. at 10.

The Shapiros filed a number of objections to the bankruptcy court's order on January 13, 1989. After a hearing, the bankruptcy court overruled the objections. The Shapiros then filed a notice of appeal and a request for the bankruptcy court to stay its financing order pending appeal. The bankruptcy court denied the request for a stay on February 23, 1989.

The Shapiros subsequently moved the district court to stay the bankruptcy court's financing order pending appeal; the court denied the motion on March 7, 1989. On May 20, 1989, the district court dismissed the Shapiros' appeal as moot under 11 U.S.C. § 364(e) because the Shapiros had failed to obtain a stay of the financing order pending appeal, rejecting the argument that cross-collateralization is contrary to the Code. Shapiro v. Saybrook Mfg. Co. (In re Saybrook Mfg. Co.), 127 B.R. 494 (M.D.Ga.1991). The Shapiros then appealed to this court.

II. Issues on Appeal

1. Whether the appeal to the district court and the appeal to this court are moot under section 364(e) of the Bankruptcy Code because the Shapiros failed to obtain a stay of the bankruptcy court's financing order.

2. Whether cross-collateralization is authorized under the Bankruptcy Code.

III. Contentions of the Parties

The lenders argue that this appeal is moot under section 364(e) of the Bankruptcy Code. That section provides that a lien or priority granted under section 364 may not be overturned unless it is stayed pending appeal. Even if this appeal were not moot, the Shapiros are not entitled to relief. Cross-collateralization is a legitimate means for debtors to obtain necessary financing and is not prohibited by the Bankruptcy Code.

The Shapiros contend that their appeal is not moot. Because cross-collateralization is not authorized under bankruptcy law, section 364(e) is inapplicable. Permitting cross-collateralization would undermine the entire structure of the Bankruptcy Code by allowing one unsecured creditor to gain priority over all other unsecured creditors simply by extending additional credit to a debtor.

IV. Standard of Review

Conclusions of law by the bankruptcy and district courts are reviewed de novo. Equitable Life Assurance Society v. Sublett (In re Sublett), 895 F.2d 1381, 1383 (11th Cir.1990).

V. Discussion

A. Mootness

We begin by addressing the lenders' claim that this appeal is moot under section 364(e) of the Bankruptcy Code. Section 364(e) provides that:

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.

11 U.S.C. § 364(e). The purpose of this provision is to encourage the extension of credit to debtors in bankruptcy by eliminating the risk that any lien securing the loan will be modified on appeal.

The lenders suggest that we assume cross-collateralization is authorized under section 364 and then conclude the Shapiros' appeal is moot under section 364(e). This is similar to the approach adopted by the Ninth Circuit in Burchinal v. Central Washington Bank (In re Adams Apple, Inc.), 829 F.2d 1484 (9th Cir.1987). That court held that cross-collateralization was "authorized" under section 364 for the purposes of section 364(e) mootness but declined to decide whether cross-collateralization was illegal per se under the Bankruptcy Code. Id. at 1488 n. 6. See also Unsecured Creditors' Committee v. First National Bank & Trust Co. (In re Ellingsen MacLean Oil Co.), 834 F.2d 599 (6th Cir.1987), cert. denied, 488 U.S. 817, 109 S.Ct. 55, 102 L.Ed.2d 33 (1988).

We reject the reasoning of In re Adams Apple and In re Ellingsen because they "put the cart before the horse." By its own terms, section 364(e) is only applicable if the challenged lien or priority was authorized under section 364. See Charles J. Tabb, Lender Preference Clauses and the Destruction of Appealability and Finality: Resolving a Chapter 11 Dilemma, 50 Ohio St.L.J. 109, 116-35 (1989) (criticizing In re Adams Apple, In re Ellingsen, and the practice of shielding cross-collateralization from appellate review via mootness under section 364(e)); see also In re Ellingsen, 834 F.2d at 607 (Merritt, dissenting) (arguing that section 364(e) was not designed to prohibit creditors from challenging pre-petition matters and that "[l]enders should not be permitted to use their leverage in making emergency loans in order to insulate their prepetition claims from attack"). We cannot determine if this appeal is moot under section 364(e) until we decide the central issue in this appeal--whether cross-collateralization is authorized under section 364. Accordingly, we now turn to that...