United States: District Court Vacates Decision In Lehman Brothers Bankruptcy Case

Last Updated: May 12 2014
Article by Ronni N. Arnold, Leah M. Eisenberg and Andrew I. Silfen

Often times indenture trustees seek to sit on creditors committees in furtherance of their fiduciary duties to holders. Obviously, the professional fees and expenses can be paid as a first priority pursuant to a charging lien as provided for under the indenture documents. The payment of such fees and expenses becomes an issue, however, when there are no plan distributions to holders or the plan distributions are illiquid or non-cash.

On March 31, 2014, the United States District Court for the Southern District of New York issued a decision in In re Lehman Brothers Holdings Inc., et al., vacating the Bankruptcy Court's decision allowing the payment of individual committee members' professional fee expenses, and remanding to the Bankruptcy Court to determine whether such expenses qualify for an administrative expense payment as a "substantial contribution" under sections 503(b)(3)(D) and 503(b)(4) of the Bankruptcy Code.

The holding of the Lehman decision may now impede the inclusion of provisions in plans of reorganization that provide for the payment of professional fees and expenses of individual members of an official committee of unsecured creditors absent a showing of "substantial contribution." As a result of this decision, indenture trustees who sit and serve as members of a creditors committee may find it more difficult, or a real challenge, to have their professional fees and expenses paid under a plan of reorganization. Fortunately, there may be alternative avenues for payment available, which will be discussed below.

Case Summary

By way of background, Lehman's plan of reorganization (the Plan) included a provision, section 6.7, which provided that the reasonable professional fee expenses of the individual members of the official committee of unsecured creditors (the Individual Members) would be allowed as "Administrative Expense Claims" and, therefore, would be paid in full. Once the Plan was confirmed, the Individual Members filed a joint application with the Bankruptcy Court for payment pursuant to section 6.7 of the Plan, or, in the alternative, pursuant to sections 503(b)(3)(D) and 503(b)(4) of the Bankruptcy Code. The United States Trustee objected to the joint application, arguing that not only did the Bankruptcy Code not provide for the payment of the Individual Members' professional fee expenses, but that it actually prohibited such payment and as a result, section 6.7 of the Plan was invalid.

In a decision dated February 15, 2013, the Bankruptcy Court held that section 6.7 of the Plan was permissible, and therefore it declined to decide whether the expenses could be paid under sections 503(b)(3)(D) and 503(b)(4). Although the Bankruptcy Court acknowledged that the Bankruptcy Code did not expressly provide for the payment of committee members' professional fees, even characterizing section 6.7 of the Plan as an attempt to "circumvent the apparent restrictions on administrative expense treatment for professional compensation claims of this sort," it nonetheless held that the Bankruptcy Code did not forbid such payment. Therefore, the Bankruptcy Court held that the payments provided for pursuant to section 6.7 of the Plan were not inconsistent with any Bankruptcy Code provision and were thus permissible pursuant to section 1123(b)(6) of the Bankruptcy Code. The United States Trustee thereafter appealed this ruling.

In its discussion, the District Court first addressed section 1123(b)(6) of the Bankruptcy Code, a catch all provision, which provides that a plan provision is permissible if it is both appropriate and not inconsistent with any applicable provision of the Bankruptcy Code. The District Court stated that therefore, at a minimum, section 1123(b)(6) does not authorize plan provisions that override, undermine or rewrite relevant provisions of the Bankruptcy Code. Next, the District Court went on to discuss section 503(b) of the Bankruptcy Code, which (a) is the exclusive avenue for payment of administrative expenses, and (b) does not provide for payment of the professional fee expenses of individual members of an official committee. Indeed, the District Court stated that official committee members' professional fee expenses are glaringly excluded as a result of the structure of sections 503(b)(3) and (4) of the Bankruptcy Code. Section 503(b)(3) allows for the payment of actual, necessary expenses incurred in certain situations, one of which includes the payment of the expenses incurred by official committee members in performing committee work. See  Bankruptcy Code section 503(b)(3)(F). However, professional fee expenses are not dealt with in section 503(b)(3) but instead are covered by section 503(b)(4), which authorizes professional fee expenses for any entity that qualifies for expenses under sections 503(b)(3)(A) through (E). The District Court noted that entities eligible for expenses under section 503(b)(3)(F) – members of an official committee – are not covered by 503(b)(4). Therefore, sections 503(b)(3) and 503(b)(4) guarantee payment in full for any professional fee expense incurred in a situation covered by 503(b)(3)(A) through (E), but not F.

The District Court was further persuaded by the fact that the provision for reimbursement of professional fees of committee members as an administrative expense was removed from the Bankruptcy Code. Until 2005, the Bankruptcy Code allowed professional fees incurred by individual committee members to be paid as an administrative expense in chapter 11. The enactment of what is referred to as BAPCPA amended the Bankruptcy Code to remove the allowance of these types of payments as administrative expenses by no longer including (F) in 503(b)(3). Therefore, the District Court held that because section 503(b) of the Bankruptcy Code excludes the payment of professional fee expenses on the basis of committee membership, the Individual Members could not have their professional fee expenses paid as administrative expenses solely on the basis of committee membership.

The District Court determined that section 6.7 of the Plan did in fact call for the payment of administrative expenses on the basis of committee membership, a result which was impermissible. The Individual Members received payment in full only because the Plan provided for payment in full of all "Administrative Expense Claims," which included the Individual Members' professional fee expenses. Functionally, the District Court said the Plan attempted to give the Individual Members' professional fee expenses special priority payment treatment. As a result, according to the District Court, "there is no practical difference between an administrative expense under [section] 503(b) and an 'Administrative Expense Claim' under section 6.7." Appellees, the Individual Members, argued that paying expenses, such as those included in section 6.7 of the Plan, in full, incentivizes committee members to take on the work necessary for a productive bankruptcy process, thereby benefiting all claimants. According to the District Court, however, section 6.7 effectively rewrote section 503(b) by seeking to pay an administrative expense on a basis that section 503(b) omits. As a result, the District Court found section 6.7 was inconsistent with section 503(b), and therefore impermissible under section 1123(b)(6).

Judge Sullivan refused to extend administrative expense priority beyond those specifically set out in the Bankruptcy Code. Judge Sullivan also disregarded a distinction or difference between plan payments and payment of administrative expense claims. That is, plan payments that are negotiated, consensual and agreed upon under a confirmed plan of reorganization are permitted under section 1123(b)(6) of the Bankruptcy Code, subject to court review in the case of fees and expenses as provided under section 1129(a)(4) of the Bankruptcy Code. Thus, it can be argued that plan payments are not inconsistent or specifically precluded under the Bankruptcy Code (even though this argument was not accepted by Judge Sullivan).

Appellees relied on In re Adelphia Commcn's Corp., 441 B.R. 6 (Bankr. S.D.N.Y. 2010) in support of their position that payments pursuant to section 6.7 of the Plan were distinct from administrative expense payments pursuant to section 503(b) of the Bankruptcy Code. There, the Bankruptcy Court reasoned that the Bankruptcy Code does not state that administrative expense payments are the only kinds of permissible plan payments; section 1129(a)(4) "permits the possibility" of making plan payments for professional fees beyond the payments authorized by section 503(b); and 1123(b)(6)'s "broad grant of authority" allows debtors and bankruptcy courts to include plan provisions to meet the needs of a particular case. The District Court, however, was not persuaded for several reasons. First, allowing payments under the Plan beyond claims and expenses "could lead to mischief"; for example, a junior claimant could be paid ahead of a senior claimant in violation of the absolute priority rule by virtue of a plan provision specifically authorizing such payment. Moreover, none of the reasons raised by the Adelphia  court nor Appellees could justify a plan provision that is "merely a backdoor to administrative expenses that [section] 503 has clearly excluded." The District Court noted that with the 2005 BAPCPA Amendments, Congress and the President clearly determined that individual committee members are already motivated to advance the bankruptcy process, and do not have to be incentivized with payment of their professional fees by the estate. Therefore, the District Court concluded that section 6.7 of the Plan called for the payment of administrative expenses, and that Appellees could not circumvent the requirements of section 503(b) of the Bankruptcy Code by using the label of "permissive plan payments."

The District Court did disagree with the United States Trustee's argument that the Individual Members cannot be paid under sections 503(b)(3)(D) and 503(b)(4) of the Bankruptcy Code on the ground that they made a "substantial contribution" to the case. The United States Trustee argued that such payment is impossible, because section 503(b) forbids reimbursement of official committee members' professional fee expenses, even if the committee members independently satisfy some other category listed in that section. The District Court disagreed, noting that there is no reason to think the Bankruptcy Code would punish an entity that has made a substantial contribution solely because it also served on the official committee. Therefore, the District Court remanded the case to the Bankruptcy Court to determine whether the Individual Members made a substantial contribution and, as a result, their professional fee expenses could be satisfied as an administrative expense claim.

Unfortunately, absent consensus, it has been historically difficult for a creditor or an indenture trustee to have its fees and expenses qualify as an administrative expense under the "substantial contribution" standard. The standard generally requires a showing that a creditor's actions led to a tangible benefit to the creditors, debtor or estate. Judge Sullivan appears to have recasted or tweaked the standard by stating that a committee member needs to show extraordinary work which benefits the estate, and that such work is beyond normal committee duties. It is uncertain as to whether Judge Sullivan's formulation of the standard to be applied to committee members will be adopted by other courts. What is clear is that either standard is not easily satisfied, and in any event requires a difficult and detailed evidentiary showing.

Current Procedural Status

The Individual Member Appellees filed a motion to certify the case for interlocutory appeal pursuant to 28 U.S.C. section 1292(b) to the Second Circuit Court of Appeals, along with a memorandum of law in support of the motion. The District Court ordered that Appellant must submit any opposition to Appellee's motion by May 16, 2014. Oral argument will take place on May 30, 2014 at 11:45 a.m.

Thoughts and Solutions

Although this decision is not binding in other jurisdictions, including Delaware, and may not be controlling precedent on the Bankruptcy Courts in the Southern District, it still may be considered persuasive authority.

Depending on the circumstances of the proceeding, indenture trustees may now want to consider alternative ways to recover their professional fees and expenses. Possible alternatives to recover professional fees and expenses include (a) having the debtor and other supporting parties agree or stipulate that the indenture trustee has made a substantial contribution, (b) having the debtor incorporate a substantial contribution finding in favor of the indenture trustee in the confirmation order, (c) prior to plan confirmation, resolving the payment of indenture trustee fees and expenses as a settlement under Section 363 of the Bankruptcy Code and Bankruptcy Rule 9019, (d) seeking payment as an administrative claim through the payment or indemnity provisions of the applicable indenture or (e) including in a plan a topping provision which would provide that the plan distribution to holders include the amount of professional fees and expenses owed to the indenture trustee and having those payments remitted directly to the indenture trustee.

For now, indenture trustees serving on creditors committees should not assume that their professional fees will be paid under a confirmed plan of reorganization or that approval of such professional fee and expense payments will be easy to obtain. Thought should be given to obtaining approval of such payments outside of a plan, or through other negotiated transaction or plan structure alternatives to obtain payment. 

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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