The Toolbox: Section 503(b) Administrative Expenses

Last month I addressed Section 502(b) and claim objections. This month I want to talk about Section 503(b) and administrative expenses. Section 503(b) states:

(b) After notice and a hearing, there shall be allowed administrative expenses, other than claims allowed under section 502 (f) of this title, including—

(1)(A) the actual, necessary costs and expenses of preserving the estate including—

(i) wages, salaries, and commissions for services rendered after the commencement of the case; and

(ii) wages and benefits awarded pursuant to a judicial proceeding or a proceeding of the National Labor Relations Board as back pay attributable to any period of time occurring after commencement of the case under this title, as a result of a violation of Federal or State law by the debtor, without regard to the time of the occurrence of unlawful conduct on which such award is based or to whether any services were rendered, if the court determines that payment of wages and benefits by reason of the operation of this clause will not substantially increase the probability of layoff or termination of current employees, or of nonpayment of domestic support obligations, during the case under this title;

(B) any tax—

(i) incurred by the estate, whether secured or unsecured, including property taxes for which liability is in rem, in personam, or both, except a tax of a kind specified in section 507 (a)(8) of this title; or

(ii) attributable to an excessive allowance of a tentative carryback adjustment that the estate received, whether the taxable year to which such adjustment relates ended before or after the commencement of the case;

(C) any fine, penalty, or reduction in credit relating to a tax of a kind specified in subparagraph (B) of this paragraph; and

(D) notwithstanding the requirements of subsection (a), a governmental unit shall not be required to file a request for the payment of an expense described in subparagraph (B) or (C), as a condition of its being an allowed administrative expense;

(2) compensation and reimbursement awarded under section 330 (a) of this title;

(3) the actual, necessary expenses, other than compensation and reimbursement specified in paragraph (4) of this subsection, incurred by—

(A) a creditor that files a petition under section 303 of this title;

(B) a creditor that recovers, after the court’s approval, for the benefit of the estate any property transferred or concealed by the debtor;

(C) a creditor in connection with the prosecution of a criminal offense relating to the case or to the business or property of the debtor;

(D) a creditor, an indenture trustee, an equity security holder, or a committee representing creditors or equity security holders other than a committee appointed under section 1102 of this title, in making a substantial contribution in a case under chapter 9 or 11 of this title;

(E) a custodian superseded under section 543 of this title, and compensation for the services of such custodian; or

(F) a member of a committee appointed under section 1102 of this title, if such expenses are incurred in the performance of the duties of such committee;

(4) reasonable compensation for professional services rendered by an attorney or an accountant of an entity whose expense is allowable under subparagraph (A), (B), (C), (D), or (E) of paragraph (3) of this subsection, based on the time, the nature, the extent, and the value of such services, and the cost of comparable services other than in a case under this title, and reimbursement for actual, necessary expenses incurred by such attorney or accountant;

(5) reasonable compensation for services rendered by an indenture trustee in making a substantial contribution in a case under chapter 9 or 11 of this title, based on the time, the nature, the extent, and the value of such services, and the cost of comparable services other than in a case under this title;

(6) the fees and mileage payable under chapter 119 of title 28;

(7) with respect to a nonresidential real property lease previously assumed under section 365, and subsequently rejected, a sum equal to all monetary obligations due, excluding those arising from or relating to a failure to operate or a penalty provision, for the period of 2 years following the later of the rejection date or the date of actual turnover of the premises, without reduction or setoff for any reason whatsoever except for sums actually received or to be received from an entity other than the debtor, and the claim for remaining sums due for the balance of the term of the lease shall be a claim under section 502 (b)(6);

(8) the actual, necessary costs and expenses of closing a health care business incurred by a trustee or by a Federal agency (as defined in section 551 (1) of title 5) or a department or agency of a State or political subdivision thereof, including any cost or expense incurred—

(A) in disposing of patient records in accordance with section 351; or

(B) in connection with transferring patients from the health care business that is in the process of being closed to another health care business; and

(9) the value of any goods received by the debtor within 20 days before the date of commencement of a case under this title in which the goods have been sold to the debtor in the ordinary course of such debtor’s business. ¹11 U.S.C. § 503(b).

Section 503(b)(1)(A) provides that the costs and expenses of preserving the estate are entitled to administrative expense status. Though the only expenses specifically included in Section 503(b)(1)(A) are post-petition wages, the section is much broader. By way of example, a trustee’s (or debtor in possession’s) post-petition torts give rise to administrative expense claims. ²Reading Co. v. Brown, 391 U.S. 471, 485 (1968) (holding that the negligence of a receiver administering an estate under Chapter XI of the Bankruptcy Act gives rise to an “actual and necessary” cost of doing business); see also 28 U.S.C. § 959(a) (authorizing receivers, trustees, and other managers of property to be sued for their post-petition conduct without leave of the supervising court). But see Pa. Dep’t of Envtl. Res. v. Tri-State Clinical Labs., Inc., 178 F.3d 685, 693 (3d Cir. 1999) (denying administrative expense status for a fine imposed on a debtor in possession, reasoning that the purpose of such a fine was for deterrence, retribution, and punishment not an “actual and necessary” cost of doing business). Subsection (1)(B)–(D) accords like status to post-petition taxes.

Subsection (b)(2) provides that fees and expenses awarded under Section 330 of the Bankruptcy Code (the “Code”) ³11 U.S.C. §§ 101 et seq. (2006). are entitled to administrative expense status. Notably, while this means fees awarded on an application are an administrative expense, the cost of defending an application against attack may not be. ⁴Compare Burgess v. Klenske (In re Manoa Fin. Co.), 853 F.2d 687, 690 (9th Cir. 1988) (holding that costs and expenses of defending a fee application are compensable if defended successfully; majority rule), and Boyd v. Engman, 404 B.R. 467, 483 (W.D. Mich. 2009) (same), with ASARCO, L.L.C. v. Jordan Hyden Womble Culbreth & Holzer, P.C. (In re ASARCO, L.L.C.), —- F.3d ——, No. 12–40997, 2014 WL 1698072, at *9–10 (5th Cir. Apr. 30, 2014) (disallowing defense costs under the American Rule, reasoning that the defense benefits only the law firm and not the estate; minority rule). See also Timothy S. Springer, Damned If You Do, Damned If You Don’t: Current Issues for Professionals Seeking Compensation Under 11 U.S.C. § 330, 87 Am. Bankr. L.J. 525, 536–43 (2013) (discussing the split of authority and arguing in favor of compensating defense costs).

Section 503(b)(3) provides for certain parties to receive their expenses if they meet certain criteria. Subsection (A) grants administrative expense status to expenses of a petitioning creditor in an involuntary case. Subsection (B) allows an administrative expense of a creditor that gets court permission to pursue, and that successfully pursues, recovery of property of the estate—in other words, property preferentially or fraudulently transferred. Subsection (C) does the same for a creditor that plays a role in the prosecution of a criminal offense, such as those specified in Chapter 9 of Title 18. I will deal with subsection (D) below. Subsection (E) provides for compensation of a displaced custodian. ⁵Custodian is defined in section 101(11) as(A) receiver or trustee of any of the property of the debtor, appointed in a case or proceeding not under this title;(B) assignee under a general assignment for the benefit of the debtor’s creditors; or(C) trustee, receiver, or agent under applicable law, or under a contract, that is appointed or authorized to take charge of property of the debtor for the purpose of enforcing a lien against such property, or for the purpose of general administration of such property for the benefit of the debtor’s creditors.11 U.S.C. § 101(11). Subsection (F), which was added to the Code in 1994, ⁶Bankruptcy Reform Act of 1994, Pub. L. No. 103–394, § 110, 108 Stat. 4119, 4124. clarified that members of official committees appointed pursuant to Section 1102 were entitled to have their expenses from committee service reimbursed.

In order to qualify for an administrative expense under Section 503(b)(3), the requesting party must have paid the expense and be seeking reimbursement. ⁷Smith v. Mirant Corp. (In re Mirant Corp.), 308 F. App’x 824, 827 (5th Cir. 2009). The Code does not provide for advances against anticipated expenses.

That brings us to Section 503(b)(3)(D), which authorizes administrative expense status for expenses incurred by a creditor, an indenture trustee, an equity owner, or an unofficial committee (but not other parties in interest) in making a substantial contribution in a Chapter 9 or 11 case. Courts have cited five factors in assessing whether there has been a substantial contribution.

First, there must be a benefit. ⁸In re Mirant Corp., 354 B.R. 113, 132 (Bankr. N.D. Tex. 2006), aff’d, 308 F. App’x 824 (5th Cir. 2009). Despite the plain language of the provision, which requires that the contribution be “to the case,” some courts have held there must be a benefit to the estate. ⁹E.g., Lebron v. Mechem Fin. Inc., 27 F.3d 937, 944 (3d Cir. 1994) (“Inherent in the term ‘substantial’ is the concept that the benefit received by the estate must be more than an incidental one arising from activities the applicant has pursued in protecting his or her own interests.”) (emphasis added). But see Speights & Runyan v. Celotex Corp. (In re Celotex Corp.), 227 F.3d 1336, 1338 (11th Cir. 2000) (holding that a “substantial contribution” is one that “‘foster[s] and enhance[s], rather than retard[s] or interrupt[s] the progress of reorganization’”) (emphasis added) (quoting Pierson & Gaylen v. Creel & Atwood (In re Consolidated Bancshares, Inc.), 785 F.2d 1249, 1253 (5th Cir. 1986)); In re Mirant, 354 B.R. at 132 (rejecting “benefit to the estate” analysis in favor of “substantially contributed to the proper allocation of Debtor’s value among stakeholders”). Second, the “benefit” must run to more than just the contributor or a small class of creditors or equity holders. ¹⁰In re Mirant Corp., No. 03–46590, 2014 WL 172272, at *4 (holding that the benefit the applicants conferred ran only to the applicants, thus weighed against finding a substantial contribution). Arguably the benefit (as would be true with an accretion to the estate) should be for all creditors (and equity owners). ¹¹Hall Fin. Grp., Inc. v. DP Partners, Ltd. P’ship (In re DP Partners, Ltd. P’ship), 106 F.3d 667, 673 (5th Cir. 1997); In re Mirant Corp., 2014 WL 172272, at*4.

The third factor pertains to the applicant’s expectation that the services rendered would give rise to estate reimbursement. I don’t put much store by this factor. It seems that no one other than a statutory fiduciary should act in expectation of funding from the estate.

A fourth factor is whether the benefit of the applicant’s contribution exceeds its cost. ¹²Hall Fin. Grp., 106 F.3d at 673 (“At a minimum, however, the court should weigh the cost of the claimed fees and expenses against the benefits conferred upon the estate which flow directly from those actions.”). Obviously, the estate should not pay more than its gain from the applicant’s efforts.

Fifth, the court will consider whether the efforts for which reimbursement is sought under Section 503(b)(3) duplicated what was done by other parties. ¹³Id. at 673–74; In re Mirant, 354 B.R. 133–34. To the extent, for example, that a creditor merely echoes a creditors’ committee, reimbursement is inappropriate.

To these five factors I have suggested adding two more. ¹⁴In re Mirant, 354 B.R. at 132. First, how the creditor or interest owner became involved with the debtor is relevant. If it was through post-petition purchase of a claim or stock the situation is different than if the relationship was prepetition because dealing with the bankrupt in the latter scenario was voluntary and for profit. Second, if the applicant engaged in conduct detrimental to the case as well as making a substantial contribution that should be taken into account. ¹⁵See id. (noting when awarding a small fraction of the amount sought under Section 503(b)(4) that the shareholder applicant’s contribution to the case had “not been entirely positive” but rather included “conduct that should not be encouraged in [C]hapter 11 cases”).

Section 503(b)(4) provides that an attorney or accountant for a party entitled to its expenses under Section 503(b)(3)(A)–(E) may apply for compensation and reimbursement. Though relatively straight-forward, there is a question whether administrative expense status can be given to fees if the entity qualifying under Section 503(b)(3) has not paid the fees. ¹⁶Compare Olsen v. Robinson Brog Leinwand Greene Genovese & Gluck P.C. (In re Olsen), 334 B.R. 104, 107 (S.D.N.Y. 2005) (holding “incurred by” means the creditor/client must pay the fees and expenses of its attorney or account and then seek reimbursement from the estate under Section 503(b)(4)); with Smith, 308 F. App’x at 827 (holding that Section 503(b)(4) does not require that an attorney’s or an accountant’s fees and expenses be paid by the client before those fees and expenses may be recovered by the estate); and In re W. Asbestos Co., 318 B.R. 527, 530 (Bankr. N.D. Cal. 2004) (same). There is also doubt whether a professional other than an attorney or accountant can be compensated pursuant to Section 503(b)(4). ¹⁷In re Mirant, 354 B.R. at 138–39 (holding that the statutory language dictated an application under Section 503(b)(4) had to be reduced by the amount requested in fees incurred by professionals other than attorneys and accountants).

Subsection (b)(5) deals with sums due to indentured trustees. While the subsection requires that the indenture trustee make a “substantial contribution” in a case under Chapter 9 or 11, which would suggest an analysis similar to that applied under Section 503(b)(3)(D), the standard is often relaxed for indenture trustees. This is because, under most indentures, the trustee will be entitled to assess its fees against its constituents’ future distributions. Thus the effect of not paying an indenture trustee from the estate is to dun creditor recoveries.

Section 503(b)(6) pertains to witnesses. It provides administrative expense status for fees and mileage expenses of witnesses allowable an attorney or his or her client pursuant to 28 U.S.C. § 1821. Such fees and expense will often also be allowed through Section 503(b)(2), (3), or (4).

Section 503(b)(3), (8), and (9) were added to the Code in 2005. ¹⁸Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, Pub. L. No. 109–8, §§ 1103, 1208, 1227(b), 119 Stat. 23. Section 503(b)(7) serves to limit a realty landlord’s damages in the event a lease previously assumed is thereafter rejected. ¹⁹A related situation is where the debtor stays in possession of the real property post-petition and fails to pay rent before subsequently rejecting the lease. In such a situation, the landlord may be able to claim administrative expense status under section 503(b)(1)(A) for the actual and necessary costs of preserving estate property—that is, the rent accrued in exchange for the landlord essentially storing estate property. Essentially, the damages are limited to the next two years’ rental costs, including all monetary obligations of the debtor-tenant other than from a failure to operate or a penalty. Counsel should keep in mind that an assumed lease, even at an above-market rate, may be assignable at smaller cost than the damages fixed by the subsection.

Section 503(b)(8) was one of a number of provisions added to the Code to address problems peculiar to health care businesses. ²⁰See H.R. 109–31(I), at 21 (2005), reprinted in 2005 U.S.C.C.A.N. 88, 106. The term “health care business” is defined in section 101(27A), which states:(27A) The term “health care business”—(A) means any public or private entity (without regard to whether that entity is organized for profit or not for profit) that is primarily engaged in offering to the general public facilities and services for—(i) the diagnosis or treatment of injury, deformity, or disease; and (ii) surgical, drug treatment, psychiatric, or obstetric care; and(B) includes—(i) any—(I) general or specialized hospital; (II) ancillary ambulatory, emergency, or surgical treatment facility; (III) hospice; (IV) home health agency; and (V) other health care institution that is similar to an entity referred to in subclause (I), (II), (III), or (IV); and(ii) any long-term care facility, including any—(I) skilled nursing facility; (II) intermediate care facility; (III) assisted living facility; (IV) home for the aged; (V) domiciliary care facility; and (VI) health care institution that is related to a facility referred to in subclause (I), (II), (III), (IV), or (V), if that institution is primarily engaged in offering room, board, laundry, or personal assistance with activities of daily living and incidentals to activities of daily living.11 U.S.C. § 101(27A). Section 503(b)(8) accords administrative expense status to expenses of closing a health care business. The benefits of the section accrue to government agencies as well as the trustee but do not extend to others—for example, a lender—that assist in closing a health care business.

Section 503(b)(9) is a bit more interesting, especially when one considers the reclamation rights granted by Section 546(c) of the Code. What are “goods”? Probably, the definition comes from the Uniform Commercial Code (the “UCC”). ²¹See In re Pilgrim’s Pride Corp., 421 B.R. 231, 236 (Bankr. N.D. Tex. 2009) (relying on Article II of the UCC to define “goods” for the purposes of Section 503(b)(9)) (citing In re Goody’s Family Clothing Inc., 401 B.R. 131, 133–34 (Bankr. D. Del. 2009)). What does “received by” mean? What about FOB delivery? What is the “value” of goods? Is it wholesale or retail or something else? Does this section mean (as it seems to) that debts for goods delivered prepetition are entitled to a higher priority that those delivered during the gap period in an involuntary case?

Congress has granted special status to all these administrative claims. Because they are paid off the top—see Code sections 726(a)(1), 1129(a)(9)(A), 1222(a)(2), 1322(a)(2)—the amount of these claims typically affect the amount received by unsecured creditors and so the success of the case. For this reason a trustee or debtor in possession must keep close watch on administrative expenses and minimize their incurrence.