I recently had occasion to review the changes to § 366 of the Code (click here for the redline version) regarding adequate assurance for utilities, and attend a hearing on the issue. Section 366(a), relatively unchanged, serves to enjoin utilities from altering, refusing or disconnecting service "solely on the basis of the commencement of a case." Subsection (b) then limits this injunction to 20 days unless the debtor or trustee furnishes "adequate assurance of payment, in the form of a deposit or other security, for service after such date."
Early in my career, I had the task of handling the §366 matters for a large utility. Typically, upon notice of the bankruptcy the utility would (and still does) request a deposit of two and a half month’s service. This would either be placed on a bill sent to the debtor, or in larger cases, in a letter from counsel. Conversely, in larger Chapter 11 cases, debtors typically file, as a first day motion, a request to either limit the deposit or a determination that the utility was "adequately protected" with the debtor’s "promise" to pay on time, or with a priority administrative expense claim.
The amendments to §366 in the BAPCPA change the landscape for Chapter 11 cases. Importantly, new subsection (c)(1) dictates what constitutes "adequate assurance" —
(c)(1) (A) For purposes of this subsection, the term `assurance of payment’ means — (i) a cash deposit; (ii) a letter of credit; (iii) a certificate of deposit; (iv) a surety bond; (v) a prepayment of utility consumption; or (vi) another form of security that is mutually agreed on between the utility and the debtor or the trustee.
(B) For purposes of this subsection an administrative expense priority shall not constitute an assurance of payment.
Additionally, and perhaps more importantly, new subsection (c)(2) allows the utility to "alter, refuse, or discontinue utility service, if during the 30-day period beginning on the date of the filing of the petition, the utility does not receive from the debtor or the trustee adequate assurance of payment for utility service that is satisfactory to the utility." Thus, the above sections clearly place the burden on the Chapter 11 debtor or trustee to come up with tangible adequate assurance "satisfactory to the utility" or risk the loss of service.
However, the debtor does have some limited recourse from new subsection (3) —
(3) (A) On request of a party in interest and after notice and a hearing, the court may order modification of the amount of an assurance of payment under paragraph (2).
(B) In making a determination under this paragraph whether an assurance of payment is adequate, the court may not consider–
(i) the absence of security before the date of the filing of the petition;
(ii) the payment by the debtor of charges for utility service in a timely manner before the date of the filing of the petition; or
(iii) the availability of an administrative expense priority.
Does this subsection mean that Chapter 11 debtors can continue the practice of filing a first day motion requesting some limitation on the adequate assurance requested by the utility?
The answer is no, according to at least one court.
Granted, subsection (c)(3) does give the trustee or debtor in possession the right to have the adequate assurance payment modified by the court. However, that right arises only after the adequate assurance payment has been agreed upon by the parties. In other words, the trustee or debtor in possession has no recourse to modify the adequate assurance payment the utility is demanding until the trustee or debtor in possession actually accepts what the utility proposes.
In re Lucre, Inc., 333 B.R. 151, 154, (Bkrtcy.W.D.Mich. 2005)(emphasis added). Therefore, the advantage is clearly given to the utility under the new amendments and the opinion of the Lucre court.
As noted by the plain language of the new statute, subsections (c)(2) and, by extension, (c)(3) only apply to Chapter 11 cases. In In re Astle, 338 B.R. 855 (Bankr. D. Id. March 14, 2006), the court analyzed both the statute and the legislative history and declined to extend the subsection to Chapter 12 cases —
This language rather clearly makes § 366(c)(2) applicable only in chapter 11 cases.
The initial clause found in § 366(c)(2) ( i.e., “Subject to paragraphs (3) and (4)”) does not contradict this conclusion. First, neither paragraph (c)(3) nor (c)(4) purports to expand § 366(c)(2)‘s scope beyond chapter 11; they merely qualify (c)(2)’s operation in chapter 11 cases. For example, § 366(c)(3)(A) provides a debtor with the ability to seek to modify the amount of an assurance of payment afforded a utility “under paragraph (2).” The provisions of paragraph (c)(4) address recovery or set off against a security deposit, but in no way indicate application beyond chapter 11 given (c)(4)’s limiting language “with respect to a case subject to this subsection.”
Second, there is a matter of nomenclature. Section 366(c)(2) refers to “ paragraphs (3) and (4)” while it refers to “ subsection (a)” later in the same sentence. This leads to the conclusion that when § 366(c)(1)(A)-the listing of the forms of adequate assurance debated here by the parties-says “For purposes of this subsection,” it is referring to subsection (c) alone. It does not state “for the purposes of this section.” Nor does it state “for the purposes of subsection (b).” So a dispute over whether a proffered form of adequate assurance falls within the list in § 366(c)(1)(A) would be misplaced unless the case is one that falls under subsection (c) in the first place. As § 366(c)(1)(A) and (c)(2) together indicate, these are only chapter 11 cases.
In re Astle, 338 B.R. at 859 ("Since this is a chapter 12 case, the Court concludes Debtors must provide adequate assurance of payment pursuant to § 366(b); they need not torture the language of subsection (c) to make their proposal fit"). The court there concluded that the adequate assurance offered by the Chapter 12 debtor, a first priority security interest in their cattle herd and receivables, was sufficient adequate assurance and qualified for the "other security" under §366(b).
One other nuance arises from the amendments. In Lucre, the debtor was in the business of providing telecommunications services to its customers. As part of its business, it purchased telecommunications services from utilities, then provided those services to its own customers. Thus, it was not the end user of some of the utilities requesting the adequate assurance under §366, raising the question of whether §366 was even applicable —
It is important to note that subsection (a) and (b) of Section 366 refer generally to the discontinuation of any “service” offered by the utility whereas subsection (c) refers specifically to only a “utility service” offered by the utility. Perhaps this difference is inconsequential. However, I consider that it is not. It is common now for utilities to offer services beyond simply those used by consumers. Indeed, this transformation is at least in part the result of legislation enacted by Congress to make utilities more competitive. Consequently, it is fair to assume that the Congress recognized the difference in services provided by utilities when it recently amended Section 366 and that Congress therefore purposely excluded services provided between utilities as in the case with IXC and Opex from the more stringent requirements of subsection (c). In other words, “utility service” in subsection (c) means only traditional services that the debtor in possession itself consumes in contrast to other services and rights provided by the utility, such as interconnection agreement services.
FN: On the other hand, if Congress did not intend to distinguish between the services subject to subsection (b) and the services subject to subsection (c), then it is appropriate to consider whether Section 366 generally excludes from its scope services provided by a utility that are used other than by the trustee or debtor as a consumer. However, as already explained, that issue is moot in this instance because it is Debtor itself who is seeking relief under Section 366.
Lucre, 333 B.R. at 154 -155 (emphasis added). This will likely be an important distinction in the many cases where the debtor is merely a "reseller" or middleman with respect to the utility services at issue.
Time will tell whether Judges continue to allow first day motions that may be contrary to the plain language of the Code and the authority above, especially where the discontinuation of utility service may very well spell the end of the debtor’s business. How did this week’s case end? Without much discussion on the new Code, the Judge allowed the utility to keep the two month deposit it had billed and collected post-petition.