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Counsel for many large businesses often file their Chapter 11 bankruptcy cases in Delaware because that court regularly enters far-reaching, legal-limit testing and debtor-friendly first-day orders. Bankruptcy courts around the United States are challenged to match such accommodating orders or be relegated to the large reorganization case backwater. In-house counsel should evaluate their bankruptcy counsel, in part, on the bankruptcy counsel’s ability to articulate a bankruptcy court’s approach to first-day orders. First-day orders generally include professional retention orders, post-petition financing orders and pre-petition claim payment orders. Sometimes they include extraordinary orders, such as the one issued on Jan. 4, 2002, by a Pittsburgh bankruptcy court restraining, on the first day of the bankruptcy case, 8,500 asbestos suits nationwide against related but nondebtor defendants. Courts often enter first-day orders with little or no notice to affected parties, usually with no opportunity for discovery or a hearing prior to entry. Due process generally consists of an opportunity to raise an objection at a subsequent hearing. The hearing is usually set on a “rocket” schedule. Often, these first-day orders are practically unappealable because of the doctrine of mootness and the statutory protections provided by the Bankruptcy Code that make it difficult to reverse these orders on appeal. Many times they set the direction of the entire case. In the vast majority of Chapter 11 cases, these orders are appropriate, reasonable and necessary. Further, once these orders are entered, many parties rely on their validity for the benefit of the reorganization and to the potential detriment of many if reversed. Expanding their use and scope to attract and accommodate business Chapter 11 cases, however, is dangerous business. U.S. Bankruptcy Judge D. Michael Lynn of Fort Worth, Texas, recently wrote a scholarly opinion signaling his approach to first-day orders in In re CoServ L.L.C. (2002) in the Bankruptcy Court of the Northern District of Texas. Although the opinion deals with the narrow issue of payment of pre-petition claims under the “doctrine of necessity,” bankruptcy courts around the nation would do well to take note of this approach. On Nov. 30, 2001, a Friday, CoServe and related debtors filed a Chapter 11 petition in Fort Worth. On that same day, the debtor’s counsel filed, among numerous first-day motions, a motion to pay $2,272,265 of unsecured claims to 27 different pre-petition creditors, citing, in part, published and unpublished Delaware bankruptcy court opinions and rulings, according to the opinion. On Tuesday, Dec. 4, 2001, one full business day after the case was filed, Lynn conducted a hearing to consider all the first-day pleadings, including the motion to pay more than $2 million in pre-petition claims, the opinion said. At the initial hearings, Lynn expressed concern with paying these claims and elevating them to the highest priority: immediate payment in full, according to the opinion. Given the court’s concerns, the proponent of the motion requested and was granted a 16-day continuance of the hearing relating to this motion. At the hearing on Dec. 20, 2001, the request for payment was reduced to $563,183.00 in pre-petition claims and involved only seven claimants. By the time of the Dec. 20 hearing, a creditors’ committee had been formed. The creditors’ committee supported the motion, and the only objecting party, a large secured creditor, withdrew its objection, according to the opinion. The opinion noted that the creditors’ committee informed the court that the committee anticipated requesting additional payment of unsecured pre-petition claims, including some claims held by members of the unsecured creditors’ committee. Despite the fact that the motion was unopposed (and even supported by the debtor and the creditors’ committee), Lynn was nonetheless unwilling to elevate more than half a million dollars of unsecured pre-petition claims to immediate payment without evidence of clear “necessity.” After considering the evidence and arguments of counsel (the written opinion addresses all authority cited by the proponents), Lynn rendered an opinion authorizing the payment of two pre-petition creditors in the total amount of $24,510 and denying payment of the remaining $500,000-plus in pre-petition claims. THREE-STEP APPROACH Lynn’s opinion took a three-step approach to granting and denying the motion. First, he determined, after complete review of the statutory authority, existing case law and history of the “doctrine of necessity,” that the Bankruptcy Code granted him authority to authorize payment of pre-petition debts but only under extraordinary circumstances, the opinion noted. Second, Lynn set up three tests for determining the existence of such extraordinary circumstances. Finally, he meticulously applied these tests to the seven claims before him. The opinion demonstrates at least four important approaches to first-day orders. First, Lynn indicated his complete willingness to consider quickly (within a day), in depth, the needs and reasons for all first-day orders — no matter how complicated — by inviting, requiring and giving the opportunity for a complete evidentiary hearing on short notice. Second, in the opinion Lynn provided a road map for practitioners to accomplish legally the ultimate ends of the motion. He cited as positive examples deposits and prepayments, payments on delivery and consignments as ways for a creditor to ensure against further loss. Three times the judge implicitly warned critical vendors not to attempt “economic blackmail” of the debtor by absolutely refusing to supply the debtor unless paid on a pre-petition claim. Third, Lynn taught the proper application of the “doctrine of necessity” in first-day orders by citing in the opinion numerous hypothetical situations for its use and carefully applying the “extraordinary circumstances” tests to the seven claims before him. Finally, Lynn followed the law by balancing needs of the reorganization with the protection of all parties and affected entities, notwithstanding the fact that all the parties appearing before the court had reached an agreement with respect to the relief sought in the motion. It is extremely expensive and difficult for every affected entity to appear and be heard in reorganization cases generally and particularly in first-day order situations. Thus, the need for bankruptcy courts to apply the law carefully in first-day situations is important to the well-being of the bankruptcy system. Although it is potentially more time-consuming and extremely taxing on the bankruptcy court, Lynn’s approach should be emulated. Arnie Cavazos is a partner in Cavazos, Hendricks, Poirot & Dewey in Dallas.

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