09.03.2020 | Articles

Why Do We Care About Bankruptcy Waivers ?

By Dorothy J. Heebner, David C. Phalen, Brian F. Plunkett

One of the primary reasons that companies declare bankruptcy is to be protected from creditors filing lawsuits against them and foreclosing and liquidating the company’s assets.

Every company that files bankruptcy is granted that protection and it’s called the automatic stay. The automatic stay, true to its name, is an automatic order that immediately stops all creditor enforcement actions against the company and its assets even if those assets have been pledged as collateral for a loan. If the lender has no confidence in the ability of the company to successfully reorganize in bankruptcy then the lender may request the bankruptcy judge to “lift the stay” to permit the lender to foreclose and sell its collateral. In many workout agreements (such as settlement agreements or forbearance agreements) entered into between a troubled borrower and a secured lender prior to an actual bankruptcy filing, the secured lender will require that the company agree prior to bankruptcy to waive the automatic stay.  Will the company’s pre-bankruptcy waiver of the automatic stay be enforced by the bankruptcy judge?

The short answer is that in many cases pre-bankruptcy waivers will not be enforced.  This stems in part from the rejection by the courts of waivers of a company’s right to file bankruptcy at all. Such waivers of the right to file bankruptcy have universally been deemed unenforceable as against public policy. Those rulings are based on the explicit authorization in the United States Constitution (Article 1, Section 8, Clause 4) for Congress to enact “uniform laws on the subject of Bankruptcies throughout the United States.”  Congress has done just that by adopting a comprehensive federal statute referred to as the Bankruptcy Code.  There is no specific prohibition of bankruptcy waivers contained in the Bankruptcy Code. However, waivers of the right to file bankruptcy have been rejected based on the practical argument that if such waivers were enforced then every commercial lender would include those waivers in every loan agreement and no commercial borrower would ever be permitted to file bankruptcy again completely defeating the purpose of the Bankruptcy Code. While a waiver of the automatic stay is not a waiver of a company’s right to file bankruptcy, courts have ruled that the stay is so vital to a company’s ability to reorganize that a waiver of the automatic stay is tantamount to a waiver of the right to file bankruptcy.

If the waiver of the stay may not be enforced should it still be included in loan agreements? Yes, because there are still certain situations when the bankruptcy court may enforce pre-bankruptcy waivers of the automatic stay. Those situations usually involve commercial borrowers that have defaulted under their existing loans and have entered into forbearance or modification agreements with the lender and in exchange for the pre-bankruptcy waiver the lender has agreed to grant certain accommodations to the borrower. In these “workout” situations, particularly when the borrower was represented by an attorney and the borrower has obtained something of value from the lender in exchange for giving the pre-bankruptcy waiver of the automatic stay, the court may consider the waiver as a factor in deciding whether to grant the lender’s motion to lift the stay.  The likelihood that the pre-bankruptcy waiver will be enforced is even stronger if the waiver is contained in a settlement agreement entered into by the borrower to resolve an existing bankruptcy case and then that borrower later refiles another bankruptcy case. Keep in mind that no waiver of the automatic stay is self-executing. The lender must always first file a motion with and obtain approval from the bankruptcy court to lift the stay before the lender can foreclose and sell its collateral.

In summary, not all waivers of the automatic stay have an equal chance of being enforced.  Waivers of the stay contained in the original transaction documents are almost never enforced. Waivers of the stay contained in workout agreements entered into after the borrower has defaulted may be a factor considered by a bankruptcy judge.  The waivers of the stay most likely to be enforced are those included as part of settlement agreements that have been approved by the bankruptcy court in a prior bankruptcy case.

In addition to a waiver of the stay, lenders should review whether to include in a forbearance agreement a set of agreed facts that will support the lender’s claim to lift the stay. If the judge is unwilling to enforce the waiver of the stay, the judge may still find that the factual admissions are binding. Those admissions may help establish certain facts that the lender must prove to win its lift stay motion and gain the right to foreclose and sell its collateral.

This communication is for informational purposes only and should not be construed as legal advice on any specific facts or circumstances.

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