What Constitutes Adequate Assurance When a Customer Files Bankruptcy

Generally, one who transacts business with another, who later files for bankruptcy protection, has the right to refuse to continue providing goods or services to the bankrupt party, post-petition.  However, utility providers are subject to special rules that prevent them from discontinuing service solely due to the filing a bankruptcy by a customer. 
 
§ 366(a) of the Bankruptcy Code provides that “a utility may not alter, refuse, or discontinue service to, or discriminate against, the trustee or the debtor solely on the basis of the commencement of a case under this title or that a debt owed by the debtor to such utility for service rendered before the order for relief was not paid when due.”  11 USC § 366(a).  As such, a utility may not simply cut-off or refuse service due to the mere filing of a bankruptcy.
 
However, § 366(b) allows utility providers the ability to discontinue or refuse service under certain circumstances.  That Section states

Such utility may alter, refuse, or discontinue service if neither the trustee nor the debtor, within 20 days after the date of the order for relief, furnishes adequate assurance of payment, in the form of a deposit or other security, for service after such date. On request of a party in interest and after notice and a hearing, the court may order reasonable modification of the amount of the deposit or other security necessary to provide adequate assurance of payment.
11 USC § 366(b)

In 2005, § 366 was amended to clarify what constitutes “adequate assurance of payment” under subsection (b).  § 366(c)(1) defines “assurance of payment” as:

(i) a cash deposit;
(ii) a letter of credit;
(iii) a certificate of deposit;
(iv) a surety bond;
(v) a prepayment of utility consumption; or
(vi) another form of security that is mutually agreed on between       the utility and the debtor or the trustee.

11 USC § 366(c)(1).  The Code also explicitly states that an administrative expense priority is not an adequate assurance of payment. 

The Code modifies these special rules if the utility customer has filed a Chapter 11 Bankruptcy.  § 366(c)(2) states that when a customer files a Chapter 11 Bankruptcy, the utility “may alter, refuse, or discontinue utility service, if during the 30-day period beginning on the date of the filing of the petition, the utility does not receive from the debtor or the trustee adequate assurance of payment for utility service that is satisfactory to the utility.”  11 USC § 366(c)(2) (emphasis added).  Moreover, utilities are permitted to recover against a security deposit provided by the Chapter 11 debtor prior to the bankruptcy filing.

If the Chapter 11 debtor or trustee provides adequate assurance that is satisfactory to the utility, courts may order a modification of the amount of an assurance payment.  11 USC § 366(c)(3)(A).  In making this determination as to whether assurance of payment is adequate, the court may not consider

(i) the absence of security before the date of the filing of the petition;
(ii) the payment by the debtor of charges for utility service in a timely manner before the date of the filing of the petition; or
(iii) the availability of an administrative expense priority.

11 USC § 366(c)(3)(B).  It is important to note that the bankrupt party’s right to modify arises only have the adequate assurance has been agreed upon by both the utility and the bankrupt party/trustee.  In re Lucre, Inc., 333 B.R. 151 (Bkrtcy. W.D. Mich. 2005).

§ 366 of the Bankruptcy Code and its 2005 Amendment appears to be an attempt to balance the rights and interests of both the bankrupt customers and utilities.  § 366 protects a bankrupt customer from immediate termination or withholding of essential utility services while protecting the utilities right to adequate payment for services rendered.
 
With all of this in mind, understand it is extremely important that all utility providers have mechanisms in place to ensure compliance with § 366 of the Bankruptcy Code and its 2005 Amendment.  Terminating or refusing service solely based on the filing of a bankruptcy petition may lead to court intervention and sanctions.  However, if providers comply with the Code, their rights will be protected.