In re: AA 10000 Corp.

• Court: United States Bankruptcy Court, D. Puerto Rico
• Decided: December 11, 2007
• Docket: 07-06601
• Status: Unknown

Opinion

1 IN THE UNITED STATES BANKRUPTCY COURT > FOR THE DISTRICT OF PUERTO RICO 4 | IN RE: AA 10000 Corp., : 3 CASE NO. 07-06601 (ESL) 6 : Chapter 11 Debtor : 7 : 3 OPINION AND ORDER 10 This case came before the court on December 6, 2007, for an evidentiary hearing on the

12 || Emergency Motion Requesting Order to Use Cash Collateral filed by AA 10000 Corp. 13 || (“Debtor”) on November 13, 2007 (Dkt. 9),' pursuant to 11 U.S.C. § 363 (the “Cash Collateral 14 Motion”), and the opposition by Debtor’s senior secured creditor, Western Bank Puerto Rico I (“Westernbank”). (Dkt. 24). For the reasons set forth below, the court DENIES Debtor’s Cash 16 Collateral Motion. 17 18 Background and Procedure: 19 30 Debtor filed a voluntary petition for reorganization under chapter 11 of the Bankruptcy 21 || Code on November 7, 2007. The schedules filed with Debtor’s petition identify Westernbank as 22 the sole senior secured creditor in the amount of $ 10.1 million dollars (Dkt. 1, Sched. D). The 23 stated value of Debtor’s entire collateral base in this schedule is $ 10.1 million dollars. 24 95 Westernbank is also listed as having unsecured claims worth approximately $ 8.2 million dollars 26 || (kt. 1, Sched. F). It has been stipulated by the parties that Westernbank is undersecured. The 27 | Debtor is not challenging that Westernbank has a valid and continuing lien over the cash 28 IP eferences to items in the docket of thic case willhe ia “Dkt

1 | collateral according to the Commercial Transactions Act of the Commonwealth of Puerto Rico for the purpose of considering the Cash Collateral Motion. 4 The court held a preliminary hearing on Debtor’s Cash Collateral Motion on November > || 20, 2007 (Dkt. 30, transcript at Dkt. 31), wherein the parties reached a short-term, one week 6 interim agreement pending a final hearing on the use of cash collateral. The court authorized Debtor to use $47,300 to pay for critical operating expenses, as agreed to by the parties, and

9 scheduled a final hearing for November 29, 2007. The November 29, 2007 hearing was 10 || continued as per Debtor’s counsel’s request due to the illness and his impending surgery. The 11 | court held an in-chamber’s conference instead. (Dkt. 38). The short-term interim order for the use 12 of cash collateral was renewed until the new hearing date, that is December 6, 2007. On December 6, 2007, the court held a final hearing on Debtor’s Cash Collateral Motion.

15 Debtor’s Cash Collateral Motion (Dkt. 9): 16 The basic facts underlying Debtor’s Cash Collateral Motion can be summarized as 17 || follows: a) Debtor and Westernbank have a secured debtor/creditor relationship pursuant to 18 | various credit facilities extended to Debtor under the terms of a master Loan and Security 1? Agreement (the “Loan”); b) Debtor owes Westernbank approximately $18 million dollars in secured credit lines under the Loan; c) $ 3 million of Westernbank’s claim is secured by the cash 2 collateral comprising inventory and accounts receivable with a “net” value of $1.79 million, the 23 || use of which is presently before the court, (Dkt. 9 at 2), and d) Debtor needs to use the cash 24 || collateral to maintain the day to day operations, maintain the Debtor’s value as a going concern 2s and protect the assets of the estate for the benefit of creditors. 26 27 28 Lo.

1 In order to be authorized the use of cash collateral, Debtor’s “proffer of adequate 2 protection” consists of, 1) a replacement lien on inventory and accounts receivable generated post-petition from the use of cash collateral, and 2) monthly cash interest payments. (Dkt. 9 at 5)

5 Westernbank’s opposition: 6 Westernbank opposes Debtor’s use of cash collateral alleging that “Debtor has: (a) no 7 || right to use pre-petition cash collateral of Westernbank, as the same has been transferred to and i: 8 I the property of Westernbank pursuant to a pre-petition foreclosure (Dkt. 12); (b) a continuously ° deteriorating operation and financial condition that generates insufficient funds for the Debtor to fully satisfy its recurring obligations to Westernbank or its suppliers; (c) no equity in any assets, 12 || as all are encumbered to Westernbank (Dkt. 1); and (d) no purchasers or refinancing alternatives 13 || that could even remotely provide a viable exit strategy pursuant to which creditors, such as 14 || Westernbank, will be paid.” (Dkt. 24 at 1-2). Westernbank asserts it has a perfected security 15 interest in the Debtor’s assets that extends to all post-petition proceeds generated from the collateral, and is undersecured. Westernbank argues that it foreclosed Debtor’s accounts

18 receivable prior to Debtor’s bankruptcy petition pursuant to the terms of the loan and to 19 || unrevised UCC 9-502, Collection rights of secured party, as adopted in September 1996 by the 20 || Puerto Rican legislature and codified in 19 L.P.R.A. § 2202 (Laws of Puerto Rico Annotated, 21 LexisNexis of P.R. 2005) (the “P.R.-UCC”). In support of its contention, Westernbank filed a Motion to Inform of Pre-petition Foreclosure on the Debtor’s Accounts, Dkt. 12, dated November 13, 2007. This motion includes exhibits of notices of default and foreclosure sent to 35 || Debtor and Debtor’s customers dated October 12, 2007. (Dkt. 12, Exh. A-B; Dkt.14). 26 || Westernbank also started a pre-petition foreclosure action on November 6, 2007 before the 27 Superior Court of Puerto Rico, Bayamon Part. (12/6/07 Hearing, Joint Exhibit 1). 28 Westernbank’s basic legal argument is that the Debtor no longer has any proprietary _3-

1 | interest in the disputed cash collateral, especially in the accounts receivable. Westernbank argues 2 that by the terms of the loan agreement with Debtor and the authority of the P.R.-UCC, the pre- petition notice of default to Debtor and the notices to Debtor’s customers constitute extra-judicia

5 foreclosure over the accounts receivable. (See, e.g., Dkt. 14 at 3; Dkt. 24 at 4; Dkt. 32). 6 After reviewing the pleadings and the evidence presented by the parties; Westernbank’s 7 || notices of default and foreclosure sent to Debtor and to Debtor’s customers on October 12, 2007 8 (Dkt. 12, Exh. A-B; Dkt. 14); and the provisions of the 19 L.P.R.A. § 2202 (UCC 9-502) and ° related case law, we agree that Westernbank effectively made a pre-petition foreclosure over the accounts receivable. We also find that Westernbank’s pre-petition foreclosure over the accounts 12 || receivable effectively extinguished Debtor’s (and the estate’s) “interest” in said collateral. 13 || Debtor no longer has an interest in the disputed collateral, and therefore this court will not 14 | authorize the Debtor to continue using it. I Discussion 16 A motion to use cash collateral is governed by 11 U.S.C. § 363. Section 363(c)(2) forbids

18 the trustee from using the cash collateral unless cach entity with an interest in the cash collateral 19 || consents, or the court, after notice and a hearing, authorizes such use of cash collateral. Section 20 || 363(e) expressly authorizes the court to forbid or condition the use of cash collateral in order to 71 provide adequate protection to the interested entity. Adequate protection must be afforded to secured creditors who have an interest in property. 11 U.S.C. § 361. Adequate protection is not

24 defined, and the provisions in section 361 are illustrative and not exclusive of the remedies that 35 || can be fashioned by the court to secure the “indubitable equivalent” of the entity’s interest in 26 || such property. Section 552(b)(i) recognizes that a secured party’s interest attaches to the post- 27 petition proceeds generated from property of the estate that was encumbered pre-petition, to the 28 extent provided by the security agreement and applicable non-bankruptcy law. Except that the

1 | court, after notice and a hearing and based on the equities of the case, may order otherwise 2 regarding the ownership, use or apportionment of such post-petition proceeds. Use of Cash Collateral and Adequate Protection:

5 The determination of a section 363 motion for the use of cash collateral is not governed 6 | by any set of neatly articulated legal standards. On the contrary, given the nature of bankruptcy 7 | and the distinct characteristics of every debtor, the decision requires a case-by-case analysis of 8 the facts and circumstances of each case, prior to authorizing or denying the request to use cash ° collateral. See, In re Dynaco Corp, 162 B.R. 389, 394-95 (Bankr. D.N.H. 2002) (granting a cash collateral motion after finding adequate protection in the form of a viable business plan that

12 || would create sufficient value in replacement liens to protect creditor’s interest); accord, First 13 || Bank of Miller v. Wieseler, 45 B.R. 871, 875 (D. South Dakota 1985) (denying cash collateral 14 || motion after rejecting adequate protection in future lien over non-existent property and stating 15 that determining the value of creditor’s interest is essential prior to deciding the issue of adequate protection}. In order to decide Debtor’s Cash Collateral Motion, this court must strike a balance

ig between two irreconcilable interests, First, Westernbank, as secured creditor, must not be left 19 || unprotected by Debtor’s unrestricted use of its cash collateral. However, achieving chapter 11’s 20 |] paramount goal of debtor rehabilitation will generally require granting debtor access to the cash 21 collateral covered by the secured creditor’s claim. Dynaco, 162 B.R. at 393; Wieseler, 45 B.R. at 22 876. 23 Prior to deciding the motion, the court must first determine if the disputed property is 95 || “cash equivalent whenever acquired in which the estate and an entity other than the estate have 26 || an interest [including proceeds].” 11 U.S.C. § 363(a). If the Debtor’s estate no longer has an 27 | “interest” in the disputed property, the motion lacks legal foundation because we are no longer 28 dealing with “cash collatera]”. On the other hand, ifthe property falls within the statutory □□

1 || definition of “cash collateral”, we must determine whether Debtor’s proffer of adequate 2 protection under section 361 will sufficiently protect the secured creditor’s interest in the value of the cash collateral. Dynaco, supra, at 394-397. If such a finding is not made, the motion must

5 be denied. Because we find that Debtor’s estate no longer has an interest in the disputed 6 || collateral and may not continue using it for any purpose, the court cannot authorize or condition 7 || its use. 8 || Unrevised UCC 9-502 and Notice Foreclosure (19 L.P.R.A. § 2202): Westernbank argues that the unrevised UCC section 9-502 allows the creditor to foreclose on accounts receivable without the need for judicial action or otherwise resort to

12 remedies at law to recover its collateral. UCC 9-502(1) as codified in 19 L.P.R.A. § 2202 13 || subsection 1 provides: 14 (1) When so agreed and in any event on default the secured party is entitled to 15 notify an account debtor or the obligor on an instrument to make payment to him whether or not the assignor was theretofore making collections on the 16 collateral, and also to take control of any proceeds to which he is entitled 7 under section 2106 of this title.

18 In support of its argument, Westernbank cites to specific provisions of the loan agreement 19 || with Debtor, which grant Westernbank the property rights in collections made “whether on 20 || Accounts or as proceeds of Inventory or other Collateral.” (Dkt. 32 at 2-3). Furthermore, 71 Westernbank correctly argues that UCC 9-502 grants authority to lenders to execute extra- jadicial notice foreclosure on intangible collateral such as accounts receivable, without the need

to proceed in a court of law. (Dkt. 32 at 3-5). In support of its proposition of notice foreclosure 25 || under UCC 9-502, Westernbank cites to several cases interpreting and commenting on the legal 26 | effects of UCC 9-502. According to Westernbank, UCC 9-502 expressly authorizes notice 27 | foreclosure upon accounts receivable. (Dkt. 32 at 4-5 (Westernbank’s opposition) citing, inter 28 alia, In re Prichard Plaza Assocs. Lid. Patnership, 84 B.R. 289, 297 (D. Mass 1988); Allied -6-

1 | Building Products Corp. v. Federal Insurance Co., 729 F.Supp. 477, 479 (D. Md. 1990); Bank oj 2 Kansas v. Hutchinson Health Services, Inc., 773 P.2d 660 (Kansas App. 1989); Manufacturers & Traders Trust Co. v. Pro-Mation, Inc., 497 N.Y.S.2d 541 (N.Y. App. 1985); and Jn re

5 Contractors Equipment Supply Co., 861 F.2d 241 (9" Cir. 1988)). 6 The court finds Westernbank’s arguments and supporting authorities to be persuasive 7 | and in accord with the policies of the UCC to keep commercial transactions flowing with 8 | minimal interruption to businesses and, hopefully, with little involvement or waste of limited judicial resources. When the Debtor received the notice of default on or about October 12, 2007 (Dkt. 12, Exh. A), it is unquestionable that Westernbank was immediately authorized to exercise

12 | it nights under the loan agreement, including the right to foreclose and exercise control over the 13 {| collateral. Under these circumstances, UCC 9-502 creates and alternative method for foreclosing 14 || on accounts receivable and similar security interests such as chattel paper and instruments of I indebtedness. See, Interchange State Bank v. Rinaldi, 696 A.2d 744, 750 (N.J. Super. 1997); accord, Law & Practice of Secured Transactions: Working with Article 9, Chapter 5. Default §

18 5.06 Secured Party’s Collection Rights (2007). The commercial purpose for the wording of 19 || UCC 9-502(1) is to create an alternative system of non-judicial foreclosure, “for a secured party 20 || to foreclose a security interest in accounts receivable.” Western Decor & Furnishings Industries, ine. v. Bank of America National Trust & Savings Assoc., 91 Cal. App.3d 293, 302 (Cal. App. 1979). “There is a problem of realizing on collateral for accounts receivable, as opposed to

24 tangible collateral, thus section 9-502 subdivision 1 allows a creditor to collect directly from the 35 || account debtor without causing an interruption in business.” Jd. Consequently, UCC 9-502 26 || “allows the assignee [creditor] to liquidate in the regular course of business by collecting 27 | whatever may become due on the collateral, whether or not the method of collection 28 _J-

1 | contemplated by the security arrangement before default was direct (... ‘notification financing’) 2 or indirect (... ‘non-notification financing’).” See, 10 Anderson U.C.C. §9-502:1 (3d. ed. 2007). We find that “[tj]he range of non-judicial enforcement actions under Article 9 depends on

5 the type of collateral covered by the security interest. If the secured party holds intangible 6 || collateral on which payments are being made, additional action to take control of such collateral 7 || and enforce collections following default is authorized by § 9-502.” See 1 Sec. Intersts in Pers. 8 Prop. §18:5 (2007) (depicting the difference of possession between intangible and tangible collateral and how the latter requires possession pursuant to § 9-503). Accordingly, we find that the default and collection notices sent to Debtor and its customers places Westernbank in control

12 || of the accounts receivable. Pursuant to the loan agreement, the collateral is now the property of 13 || Westernbank, and no further action need be taken to enforce its interest in the collateral and 14 || divest the estate’s interest in the same. 1S Because we find that the Debtor does not have an interest in the accounts receivable foreclosed prior to the petition date, there is no need to pass upon Debtor’s alternative basis for

18 relief, pursuant to 11 U.S.C. § 552(b) “equities of the case”. Simply put, Westernbank stripped 19 || Debtor of its interest in and control over the disputed collateral nearly a month before the filing 20 1 of Debtor’s chapter 11 bankruptcy petition. The accounts receivable and any proceeds thereof are 71 now and have been the property of Westernbank for as long as the bankruptcy has been in place. Equity will not come to the aid of Debtor under these circumstances.

Conclusion: 25 In summary, cash collateral is property in which both the estate and entities such as 26 |; Westernbank have an interest in. Debtor’s may be given access to cash collateral with or without 27 || the consent of the interested entity if the court finds there is sufficient adequate protection for the 28 entity’s mterest in the value of the cash collateral. However, in this case, Debtor no longer has an

1 || interest in the disputed property deemed to be cash collateral for purposes of this motion. Debtor 2 has been using the collateral on a limited basis pursuant to court order. Westernbank effectuated a valid pre-petition foreclosure on the property and is not willing to allow Debtor to continue

5 using the collateral. Debtor has no equity in the collateral and since the assets constituting the 6 || cash collateral are insufficient to secure Westernbank’s claim over the same, there are no 7 || equitable grounds to continue blocking Westerbank’s use and unfettered access to the collateral 8 consisting of accounts receivable. For the reasons stated herein, Debtor’s Emergency Motion ° Requesting An Order To Use Cash Collateral is hereby DENIED. SO ORDERED.

12 rh 13 San Juan, Puerto Rico, this if ‘day of, Peteentev 2007. 14

16 ENRIQUE S. LAMOUTTE U.S. Bankruptcy Judge 18 19 20 21 22 23 24 25 26 27 28