Summary of a Recent
Judicial Development in
Bankruptcy

Existing Lender's Interests Must Be Adequately Protected
When Subordinating that Lender's Lien

Walt McCarter
National AgLaw Center Research Associate

Summary of Decision

In In re Campbell Sod, Inc., 378 B.R. 647 (Bankr. D. Kan. 2007), the United States Bankruptcy Court for the District of Kansas held that the debtors' Chapter 12 plan was confirmable, and allowed further borrowing from a new lender because their existing lender's rights would be adequately protected.

Background

Arthur Campbell owned most of the capital stock of Campbell Sod, Inc. (CSI), a company which grew and sold sod to golf courses and residential developments. Id. at 650. The Debtors, Campbell and CSI, owed the First National Bank of Wamego $1.595 million dollars. Id. The Debtors' plan proposed that the debt be paid off over seven years at 7% interest. Id. at 651. The Debtors also sought to obtain a $200,000 loan from Irish, L.L.C., to help them pay off their obligation to the Bank. Id. at 649. The Bank objected to confirmation of the plan and to the borrowing of money from Irish. Id.

Arguments

The Debtors argued that their plan was proper and the borrowing should be allowed, because the cash infusion would provide adequate protection to the Bank's interests. Id. at 654.

The Bank argued that the plan was not feasible, and that its interests would not be adequately protected if the loan were allowed. Id. at 651.

Analysis and Holdings

The court found it clear that the Debtors' plan would not be feasible without the $200,000 loan from Irish, L.L.C. Id. at 651-52. The court considered § 364(d), which allows an existing lender's lien to be subordinated only if:

(A) the trustee is unable to obtain such credit otherwise; and
(B) there is adequate protection of the interest of the holder of the lien on the property of the estate on which such senior or equal lien is proposed to be granted.
Id. at 652.

It was clear that the Debtors would be unable to obtain such a loan other than from Irish (which satisfied subsection A), so the issue before the court was whether the proposed loan and subordination of the Bank's lien could be made while adequately protecting the Bank's interests (subsection B). Id. at 652.

Section 361 defines adequate protection as one, or a combination of the following elements: "(1) cash payments to compensate a creditor for a decrease in his collateral value; (2) an additional or replacement lien; or (3) some other provision to assure the secured creditor the indubitable equivalent of his interest." Id. at 653. The court concluded that the working capital infusion would result in increased asset value that would adequately protect the Bank, and that the effect of the borrowing would not be to pass an unacceptable portion of risk from the new lender to the old one. Id. at 655. Thus the court granted the Debtors' motion for borrowing. Id.

The case was decided on October 18, 2007.