Bob Dremluk Published in The Bankruptcy Strategist
"First and Second Liens - Don't Lien on Me (Too Much)"

The May 2006 issue of The Bankruptcy Strategist includes an article entitled "First and Second Liens - Don't Lien on Me (Too Much)" authored by Bob. The article discusses the recent decision in Contrarian Funds, LLC v. Westpoint Stevens, Inc. concerning the tension between first and second lienholders in bankruptcy cases in the context of an asset sale---this case highlights an important issue facing bankruptcy attorneys today.

In Westpoint the first and second lienholders held perfected liens in company's assets. An auction sale of these assets was authorized by the bankruptcy court. Upon conclusion of the auction, an order approving the sale was entered that provided (i) that the assets were to be sold free and clear of all liens and (ii) that first and second lienholders were to receive cash and a distribution of equity interests in the purchaser in exchange for their secured claims. The cash and securities to be distributed to the lienholders were intended to fully satisfy their claims, thus terminating their liens. The first lienholders challenged the claim satisfaction and lien termination provisions on the grounds that their secured claims were effectively converted into an illiquid minority interest in the purchaser without their consent. On appeal, the district court agreed and held (i) that the in-kind distribution to first lienholders impaired their contractual right to receive cash consideration and (ii) that such a distribution was not sanctioned by various provisions of the Bankruptcy Code relating to asset sales by debtors.

Westpoint augurs well for a secured creditor to have its claim satisfied in the manner contemplated by its credit agreement. The holding assures a secured creditor that any alteration or modification of its contractual rights may be sought only through a much more rigorous process under the Chapter 11 plan confirmation provisions of the Bankruptcy Code. Lastly, Westpoint confirms that Sections 105(a) and 363(b) of the Bankruptcy Code, which relate to the exercise of equitable powers by the bankruptcy court and authorization of debtors to conduct asset sales, do not give bankruptcy courts carte blanche to fashion relief that impairs the contractual rights of secured parties---- even when such relief could arguably be economically or equitably justified.