Increase in Regulatory Expense for Debtor-In-Possession Revolving Credit Facilities
The United States Court of Appeals for the Seventh Circuit held that payments made by a debtor’s customers to its lender converting a pre-petition loan to a post-petition loan constituted disbursements for the purposes of calculating the statutory fees payable pursuant to 28 U.S.C. 1930(a)(6). In re Cranberry Growers Coop., 2019 U.S. App. LEXIS 21121 (7th Cir. July 17, 2019). This decision, coupled with the increase in the quarterly fees for the U.S. Trustee Program, is likely to increase the cost of certain DIP loans, and lenders may wish to utilize alternative structures when lending to debtors in bankruptcy.
The debtor, which operated a farming business, owed debt to its secured lender under a line of credit. Following the debtor’s bankruptcy filing, the bankruptcy court approved the debtor’s proposed debtor-in-possession financing with its lender (the “DIP Loan”). The DIP Loan consisted of a “roll-up” revolving line of credit, whereby the proceeds of the debtor’s accounts receivable would be paid directly to the lender to reduce the prepetition revolving line, the prepetition debt would then be “rolled up” (or converted) into post-petition debt to the extent of such reduction, and the lender would thereafter re-advance to the debtor the amount of such proceeds (less interest and fees). The debtor would use the advanced funds for normal operating expenses in accordance with a budget approved by the lender. The arrangement benefited the lender in that it elevated the priority of its pre-petition claim to administrative priority, thereby giving it preferable treatment over all pre-bankruptcy claims, and gave the lender control over the use of its cash collateral through the delivery to the lender of the proceeds of the debtor’s accounts receivable and their disbursement through a budget that the lender approved. From the debtor’s perspective, it provided it with a much-need post-petition credit and the flexibility to pursue its restructuring options.
The bankruptcy court held that the customers’ payments to the lender were not disbursements for purposes of Section 1930(a)(6). Viewing “disbursements” as payments that paid off a debt, the court found it critical that the payments did not reduce the debt owed the lender. The court found the arrangement in the nature of a “cash management arrangement” and the funds “merely ‘recycled’ through” the lender and were “immediately readvanced and deposited into Debtor’s account.”
Disagreeing with the court below, the Court of Appeals found the payments to constitute disbursements. The Court found support for such conclusion in the dictionary definition of “disbursement” and case law espousing a broad interpretation of the term. In short, the Court found the payments constituted disbursements as they were “funds that belonged to the debtor (customer receivables) [and] paid to a creditor and, therefore, constituted disbursements.”
The decision has significant implications for lenders and their borrowers alike in that it highlights a hidden increased cost of borrowing in a roll up debtor-in-possession financing. Following the amendment to the quarterly fees paid to the U.S. Trustee Program (which became effective in 2018), this cost could no longer be ignored as the fees increased drastically. Now debtors disbursing as little as $1 million or more per quarter must pay one percent of quarterly disbursement or $250,000, whichever is less. For example, a debtor that makes $4.5 million of monthly disbursements previously paid $13,000 but now pays $135,000 in quarterly fees, a 938% increase. As a result, lenders extending a DIP financing and their cash-strapped borrowers would be wise to consider structuring the transaction in a manner that can minimize the burden of the increased cost. Please contact us if you would like to discuss such options.