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Legal Memorandum: Commercially Reasonable Financing Proposal

Issue: When is a debtor’s financing proposal commercially reasonable, pursuant to 11 U.S.C. 364(b)?

Area of Law: Bankruptcy & Creditors Rights
Keywords: Financing proposal; "Commercially reasonable" standard; Debtor
Jurisdiction: Federal
Cited Cases: None
Cited Statutes: 11 U.S.C. § 364(b); section 503(b)(1);11 U.S.C. § 364(d)(1)(B)
Date: 04/01/2006

Pursuant to 11 U.S.C. § 364(b), “[t]he court after notice and a hearing, may authorize the trustee to obtain unsecured credit or to incur unsecured debt other than under subsection (a) of this section, allowable under section 503(b)(1) of this title as an administrative expense.”   

Although the statute does not expressly incorporate a “commercially reasonable” standard, case authority and commentators agree that credit arrangements made pursuant to this provision must be reasonable under the circumstances:

As a general rule, terms will be left up to the debtor’s business judgment.  However, terms will not be approved that are [1] overly beneficial to the lender and [2] prejudice the rights of other parties in interest, or [3] which amount to a de facto  plan for reorganization,  or which give the lender control of the plan process.

Patrick A. Murphy, Creditors’ Rights In Bankruptcy § 8.07, p. 8-12 (1996) (emphasis added); see In re Defender Drugstores, 145 B.R. 312, 317 (B.A.P. 9th Cir. 1992) (“While certain favorable terms may be permitted as a reasonable exercise of the debtor’s business judgment, bankruptcy courts do not allow terms in financing arrangements that convert the bankruptcy process from one designed to benefit all creditors to one designed for the unwarranted benefit of the postpetition lender . . . [and] cannot, under the guise of section 364, approve financing arrangements that amount to a plan of reorganization . . .“) (emphasis added)); In re Farmland Indus., Inc., 294 B.R. 855, 879-80 (Bankr. W.D. Mo. 2003) […]

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