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    Delaware Bankruptcy Courts Strictly Construe Challenge Periods Benefitting Lenders

    S&K Analysis
    April 19, 2022

    Debtors often agree to stipulate to the extent and validity of a prepetition lenders’ (“Lenders”) liens and to release claims against them as part of post-petition financing arrangements. These concessions, included within the language of the relevant order approving the financing arrangement, preclude a debtor from challenging the Lenders’ claims in any way, including the validity of their liens, the amount of their claims, and whether their claims are subject to avoidance. Language in the relevant order, however, usually provides a creditors’ committee (“Committee”), or other parties in interest, with a limited period of time to investigate and challenge the Lenders’ claims (the “Challenge Period”). If an action challenging the Lenders’ claims is not commenced prior to the expiration of the Challenge Period, parties in interest are bound by the debtors’ stipulations. This makes the interpretation of and compliance with the applicable challenge provisions critical for Committees and other stakeholders. There have been some recent bankruptcy court rulings in Delaware that have limited the ability of Committees to challenge, and ultimately recover upon, claims against Lenders, highlighting the importance of scrutinizing these provisions.

    Background

    Bankruptcy courts in certain jurisdictions, including Delaware and the Southern District of New York, have adopted local rules that set fixed Challenge Periods. For example, in Delaware, a Committee is typically given at least 60 days from the date of its formation to challenge secured creditors’ liens or waiver of claims. See Del. Bankr. L.R. 4001-2(a)(i)(B). In the Southern District of New York, a Committee is typically provided with 60 days from the date of entry of the final order to investigate and seek authority to commence litigation as a representative of the estate. See S.D.N.Y. Bankr. L.R. 4001-2(g)(4). In addition to the Challenge Period, the relevant orders generally include limits on the amount of estate funds a Committee can spend investigating the claims (the “Investigation Budget”). The length of the Challenge Period and Investigation Budget are often sharply contested: unsecured creditors benefit from more time and a larger budget, and Lenders want the protection of a shorter time period, lower expenses, and finality. Recent attempts to construe the Challenge Period more favorably for the Committee have come out decidedly in the Lender’s favor.

    Jevic

    In Jevic,1 Judge Shannon of the Delaware Bankruptcy Court held that a chapter 7 trustee (the “Trustee”), appointed after the conversion of the cases from chapter 11 did not have standing to continue claims originally brought by the Committee against Lenders. There, the post-petition financing order set a Challenge Period for the Committee of 75 days after formation, while the Challenge Period for all other parties in interest was 75 days from the petition date. The Committee timely filed an adversary proceeding against the Lenders within the Challenge Period, but was eventually disbanded upon conversion of the case to chapter 7. The Trustee then sought to substitute itself as plaintiff in the Committee’s adversary proceeding. The court, however, found that the Trustee only succeeded to the interests of the debtor, not the interests of the Committee. Accordingly, the Trustee was bound by the debtor’s stipulations and the Committee’s timely challenge to the Lender’s claims became ineffective. The Trustee appealed the decision. On March 25, 2022, however, the Trustee sought court approval of a settlement in which the Trustee would dismiss the appeal in exchange for over $400,000 being paid to the estates from the Lenders and the equity owner. The court approved the settlement on April 13, 2022.

    Alto Maipo

    In Alto Maipo,2 Judge Owens of the Delaware Bankruptcy Court recently denied the Committee’s request for an additional 60 days to challenge claims of Lenders. There, the Challenge Period under the interim cash collateral order was originally February 3, 2022. Pursuant to the express language of the final cash collateral order, however, the Challenge Period was modified to expire on January 31, 2022. The Committee was appointed on January 31, 2022, selected counsel that night, and promptly filed an emergency motion to extend the Challenge Period on February 3, 2022. A challenge to the Lenders’ claims was likely the only plausible path to recovery for unsecured creditors. Judge Owens, however, found that late formation of a Committee does not provide grounds to revive an expired Challenge Period. The court emphasized that the finality of the Challenge Period, as set without objection by entry of the final cash collateral order, weighed decidedly against granting the relief requested by the Committee. On March 2, 2022, the Committee filed a notice of appeal of Judge Owen’s ruling.

    Takeaway

    These decisions certainly favor Lenders, who benefit from the strict interpretation of the relevant Challenge Periods. They should send a message to unsecured creditors that they must be wary of the terms proposed, which may deviate from expectations. Committees are often put under extraordinary time pressure at the beginning of their existence. Debtors and Lenders have often struck a deal which they want to consummate at breakneck speed and leave the Committee little margin for error. It appears that this recent jurisprudence only raises the stakes even further.


    1 Official Comm. of Unsecured Creditors v. CIT Grp./Business Credit, Inc. (In re Jevic Holding Corp.), Case Nos. 08-11006, 08-51903, 2021 Bankr. LEXIS 1203 (Bankr. D. Del. May 5, 2021).

    2 Alto Maipo Delaware, LLC, Case No. 21-11507, Dkt. No. 299 (Bankr. D. Del. Feb. 23, 2022).

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