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Vol 12, Num 4 l October 2015

Secured Credit - an ABI Newsletter

Contract Illegality Cannot Be Used as a Defense to Adequate Protection


Jeffrey E. Altshul
Carlson Dash LLC

Can a debtor use its lack of following corporate and statutory formalities as a defense to a request for adequate protection? The U.S. Bankruptcy Court for the District of Maine ruled on this question as well as some others in In re Parkview Adventist Medical Center.[1]

The question arose in the context of a cash-collateral motion. The debtor, which operated a medical center, experienced financial difficulties, and its board authorized its president to take steps to become a subsidiary of the Central Maine Healthcare Corporation (CMHC). The debtor and CMHC entered into discussions to accomplish this. Later, the debtor’s president reported to the board that the affiliation would take more time and that without a loan from CMHC, the debtor could not continue to operate. The debtor’s board of directors adopted resolutions authorizing the loan and granted a security interest for the loan, but never authorized the execution of the loan documents. The proceeds of the CMHC loan were used to pay the pre-existing obligations of the debtor, and the remainder was deposited into the debtor’s operating account. The debtor subsequently filed for chapter 11.

The debtor filed a motion for authority to use cash collateral, which was opposed by CMHC. The debtor presented four arguments in support of its motion: first, that CMHC did not possess valid security interests as the debtor’s board of directors had not specifically authorized the execution of the loan documents; second, that CMHC’s security interest did not attach to Medicare or Medicaid receivables; third, that any proceeds of accounts were commingled and that CMHC’s security interest did not follow; and fourth, that CMHC was adequately protected because it was better off in the chapter 11 proceedings than in state court receivership.

The court rejected all four arguments. The court first rejected the ultra vires argument, holding that the debtor could not use its own actions as a “sword against CMHC to invalidate its mortgages or security interests” and that the debtor would not be relieved from the consequences of its own actions. Next, the court held that while CMHC did not possess a valid security interest in the Medicare and Medicaid receivables, CMHC did have a perfected security interest after these receivables “flowed through the provider” and were deposited into the debtor’s bank account, and the court rejected without much discussion the debtor’s arguments regarding the tracing of funds. Finally, the court denied the debtor’s argument that CMHC was adequately protected by the bankruptcy filing itself regarding a receivership, stating that it was without proof, and added that the debtor had not demonstrated the existence of a sufficient equity cushion to protect CMHC.

1. No. 15-20442, ECF No. 233 (Bankr. D. Maine).

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