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Carve-out for unsecured creditors

90 Second Lesson: Carve-Outs for Unsecured Creditors

How Does a Fee Carve-Out Relate to A Carve-Out for Unsecured Creditors?

[Editor’s Note: this is part of our irregular series in which we answer readers’ questions. If you have a question, submit it to [email protected] and we will try to answer it.]

In a separate 90 Second Lesson, we defined and explained the professional fee carve-out. That caused a few readers to email and ask: how does a fee carve-out relate to a carve-out for unsecured creditors?

Appeasing the Court in a Secured Creditor Bankruptcy

In addition to a professional fee-carve out, official committees of unsecured creditors are sometimes able to negotiate for a carve-out for its constituents. In this case, a secured creditor agrees to share a portion of its collateral with unsecured creditors, which is most often used to pay the unsecured creditors’ committee’s legal counsel fees.

There are not many published decisions that address this issue directly, but some courts consider a carve-out for unsecured creditors to be a price of admission to chapter 11, particularly where the pre-bankruptcy secured lender is the sole beneficiary of the bankruptcy process. This applies even if the only benefit to the secured creditor is a minimization of its losses.

Take the example of In re Encore Healthcare Associates, in which the court denied a motion to sell off the debtor’s assets because, in part, no sale proceeds were being made available to the general unsecured creditors.

As Charles Mooney Jr writes in “The (Il)Legitimacy of Bankruptcies for the Benefit of Secured Creditors”, “One common method of appeasing an agitated creditors’ committee under these circumstances is for the secured lender to carve out a portion of its recovery for the benefit of unsecured creditors. In addition to appeasing a creditors’ committee, such a [carve-out] also may appease a court that otherwise might not tolerate a secured creditor bankruptcy.”


[Editor’s Note: This 90 Second Lesson is based, in substantial part, in material reprinted from Commercial Bankruptcy Litigation 2d and Strategic Alternatives for and Against Distressed Businesses, with permission of Thomson Reuters. For more information about these publications, please visit www.legalsolutions.com.

To learn more about this and related topics, you may want to attend the following webinars: Negotiating and Drafting Cash Collateral/DIP Financing Orders and Cash Collateral and DIP Loan Contests. This is an updated version of an article originally published on April 26, 2016.]

©All Rights Reserved. October, 2020. DailyDACTM, LLC

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The editors and editorial board of DailyDAC include preeminent restructuring and insolvency professionals, journalists, and editors. They are devoted to providing reliable and plain English education and deal intelligence about assignments, corporate bankruptcy, receiverships, out-of-court workouts and similar topics.

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  • The proper relief in that situation is to grant stay relief to the secured creditor, not to force the senior secured creditor to pay off junior unsecured creditors! Violates the absolute priority rule and UCC sec. 9322(a)(2), as well as all state real property priority statutes.

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