Article

Note: Texas Commercial Energy (Debtor) an electricity provider, purchased electricity from Electric Reliability Council of Texas (Creditor) the electric grid operator for the state of Texas.

When Debtor filed for bankruptcy, it had over US$31,000,000 in outstanding debt with Creditor. To enable Debtor to continue operations in an attempt to maximize Creditor's value and avoid liquidation of Debtor, the Bankruptcy Court issued an order limiting the actions that Creditor could take to collect the prebankruptcy debt. That order included the following: "[Creditor] is prohibited from directly or indirectly...(ii) drawing down any Letter of Credit ("LC") securing the obligation represented by those Invoices...."

The court order was incorporated into Debtor's plan of reorganization (Chapter 11), which was confirmed by the court. The plan also set out a schedule for repayment of the pre-bankruptcy debt owed to Creditor. Debtor/Applicant then obtained a US$900,000 LC as collateral for its post-bankruptcy obligations to Creditor/Beneficiary.

Debtor/Applicant made timely payments on its post-bankruptcy obligations but failed to make timely payments on its pre-bankruptcy debt. As a result, Creditor/Beneficiary drew on the LC even though Debtor/Applicant had not defaulted on any postbankruptcy obligations. The Trustee for Debtor/ Applicant then sued Creditor/Beneficiary in an adverse proceeding for improperly drawing on the LC.

The Bankruptcy Court gave judgment for Debtor/ Applicant and ruled that Creditor/Beneficiary was not permitted to draw on the LC. On appeal, the United States District Court for the Southern District of Texas, Jack, J., affirmed.

The appellate court rejected Creditor/ Beneficiary's claims that, after the confirmation of the reorganization plan, all of Debtor/Applicant's debt became post-bankruptcy debt not covered by the language of the injunction. The court ruled that although the invoices covered by the injunction were "technically" discharged, they were contemporaneously incorporated into the plan of reorganization and subject to the injunction. The court also rejected Creditor/Beneficiary's claim that it had the authority to draw on the LC under its own membership "protocols" that bound Debtor/Applicant. The court stated that the confirmed plan of reorganization had binding effect on both Creditor/ Beneficiary and Debtor/Applicant as a final judgment. Therefore, Creditor/Beneficiary could not avoid the terms of the order by relying on power granted by its protocols. Noting that the order provided that the LC could not be drawn upon to collect any prebankruptcy debt, the appellate court concluded that the Creditor/Beneficiary had improperly drawn on the LC. It awarded damages to the Trustee for Debtor/Applicant for payments made under a promissory note to cover the obligations under the LC as well as prejudgment interest.

[JEB/mdg]

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