A corporate restructuring and bankruptcy BLOG

    Bankruptcy Courts Continue to Disagree on Whether Avoidance Actions Should be Collateral

    S&K Analysis
    October 24, 2022

    Most bankruptcy filings include a request by debtors for new financing (“DIP Motion”) and/or to use an existing lender’s cash collateral (“Cash Collateral Motion”) and in consideration therefor to grant the DIP lender or prepetition lender liens on proceeds of preference and other “chapter 5” causes of action (“Avoidance Proceeds”). This request often draws an objection from the unsecured creditors’ committee. Such friction is unsurprising, particularly when unencumbered assets are sparse—lenders want to ensure that they are protected against downside risk, while unsecured creditors seek any kind of recovery (or at least the ability to control potential litigation in which they might be the defendant). When the propriety of liens on Avoidance Proceeds is litigated, the results are a mixed bag. Given the importance of Avoidance Proceeds to both lenders and unsecured creditors’ committees, we took a look at a few recent cases where this familiar give-and-take was at issue.


    Chapter 5 of the Bankruptcy Code contains several avoidance powers—the most commonly invoked relate to transfers that are avoidable under state law (Section 544), preferences (Section 547), and fraudulent transfers (Section 548). Section 541(a)(3) of the Bankruptcy Code provides that proceeds of avoidance actions are property of the estate. That is where Congressional guidance ends, however. Historically, bankruptcy courts have viewed avoidance actions as a power specifically designed to generate recoveries for the benefit of unsecured creditors.1 Indeed, some bankruptcy courts have taken the position that “[a]voidance actions . . . never belonged to the [d]ebtor, but rather were creditor claims that could only be brought by a trustee or debtor in possession.”2 Others found it “well-settled” that “neither a trustee . . . nor a debtor-in-possession, can assign, sell or otherwise transfer the right to maintain a suit to avoid a preference.”3 Nonetheless, as highlighted below, disagreement remains over whether it is proper for liens granted to a DIP lender or prepetition lender to extend to Avoidance Proceeds.4

    Recent Case Survey

    On August 1, 2022, in the Revlon, Inc. cases pending in the U.S. Bankruptcy Court for the Southern District of New York, Judge David S. Jones rejected the official committee of unsecured creditors’ objection to a DIP Motion which challenged the propriety of granting DIP liens on Avoidance Proceeds. In doing so, Judge Jones concluded there is “no serious legal basis” for arguing that Avoidance Proceeds are legally required to be preserved for unsecured creditors and cannot be pledged to a DIP lender. In reaching his decision, he acknowledged the absence of other substantial unencumbered assets in the cases.

    A different result was reached in another court a few days later. On August 10, 2022, during Gissing North America’s first day hearing in the U.S. Bankruptcy Court for the Eastern District of Michigan, Judge Lisa S. Gretchko recommended that the debtors remove language from their proposed interim order that would have granted a lien on Avoidance Proceeds. Although the debtors obliged and indicated they would reserve the issue for the final order, Judge Gretchko emphasized that the court historically does not grant liens on avoidance actions.

    Parties often opt for compromise on the issue without the need for a final court ruling on the matter. These solutions can be creative rather than binary. For example, in the SAS AB cases, pending in the U.S. Bankruptcy Court for the Southern District of New York before Judge Michael E. Wiles, the debtors sought to secure approval of a $700M DIP facility, which contained language that granted liens on Avoidance Proceeds. After initially drawing an objection from the official committee of unsecured creditors, on September 2, 2022, the parties negotiated a consensual resolution after agreeing to several modifications to the terms of the DIP facility implementing a marshaling concept, including that “[p]rior to seeking payment of any . . . DIP Facility obligations from the proceeds of any avoidance actions, [the DIP lender] will first seek to satisfy such obligations from all other DIP Collateral.” In the First Guaranty Mortgage Corp. cases, pending before Judge Craig T. Goldblatt in the U.S. Bankruptcy Court for the District of Delaware, the parties negotiated a settlement of the official committee of unsecured creditors’ objection to the DIP Motion that provided that Avoidance Proceeds would be split 50% to the debtors’ estates and 50% to the DIP lender. Additionally, the estates’ share of Avoidance Proceeds would not be considered part of the collateral for the DIP facility or be available to satisfy any claims of released parties under the DIP facility. Most recently, in the Endo International Plc cases pending in the U.S. Bankruptcy Court for the Southern District of New York before Judge James L. Garrity, Jr., after the filing of a limited objection to the Cash Collateral Motion from the official committee of unsecured creditors, the parties negotiated a consensual final order whereby the lenders agreed to marshal away from any adequate protection liens on Avoidance Proceeds.


    Avoidance Proceeds are often a crucial (and sometimes the only) means of recovery for unsecured creditors in cases where there are no unencumbered assets. On the other hand, debtors lacking unencumbered assets may need to use Avoidance Proceeds as collateral to finance the bankruptcy. As seen in the cases above, there is no hard and fast rule. The propriety of a secured party’s liens over the Avoidance Proceeds will likely be a product of jurisdiction, judge, and the facts and circumstances of the particular case. Periodic disputes on the issue are inevitable, although compromises, such as those summarized above, may prevent a bitter battle at the outset of a case that risks further depleting estate resources to the detriment of all creditors.

    1 See Official Comm. of Unsecured Creditors of Cybergenetics Corp. v. Chinery (In re Cybergenetics Corp.), 226 F.3d 237, 244 (3d Cir. 2000); In re Tribune Co., 464 B.R. 126, 171 (Bankr. D. Del. 2011).

    2 Bethlehem Steel Corp. v. Moran Towing Corp. (In re Bethlehem Steel Corp.), 390 B.R. 784, 786-87 (Bankr. S.D.N.Y. 2008).

    3 In re Sapolin Paints, Inc., 11 B.R. 930, 937 (Bankr. E.D.N.Y. 1981).

    4 Although not the subject of this article, another notable issue arises even if lenders are not expressly granted a lien on Avoidance Proceeds. In such a situation, proceeds would first go to satisfy superpriority administrative claims that lenders receive—unless Avoidance Proceeds are expressly carved out from the lenders’ superpriority administrative claims.

    The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm or its clients, or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.


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