Protecting Administrative Claims of Creditors in Chapter 11 Bankruptcy Cases

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December 6, 2021 – Most vendors who do business with debtors know that administrative expense claims must be paid in full. In recent significant Chapter 11 cases, however, debtors have taken advantage of the risk of administrative insolvency to evade their obligation to pay the holders of trade and administrative debts in full in the ordinary course of business, as required by Articles 503 (b), 507 (a) (2), and 1129 (a) (9) of the Bankruptcy Code. Some debtors have continued to pay some holders of administrative claims (usually professionals) in full, while commercial and ordinary administrative creditors receive only a small percentage.

In many recent Chapter 11 cases, debtors have been able to avoid paying administrative claimants in full.

Truth — Administrative claims reduced after plan reserve underestimates claim amounts. Recently, during the bankruptcy of Verity Health System of California, Inc. in the Central District of California, debtors obtained post-plan confirmation approval from Judge Ernest Robles to pay some administrative claimants between 15% and 23%. Professionals and holders of administrative debts who had already been paid were not subject to this reduction.

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The plan has established a reserve of $ 52,749,000 to settle non-professional administrative claims that have been accepted and unpaid on the effective date of the plan. The amount of the reserve was based on the debtors’ projections of the administrative claims to be filed. In support of the confirmation of the plan, the debtors submitted a statement from their financial advisor attesting to the sufficiency of the administrative reserve for receivables.

However, the plan was confirmed before the deadline for administrative claims, and debtors grossly underestimated the amount of administrative claims – by a factor of eight. In fact, according to debtors, at one point they only had $ 5.3 million to settle over $ 25 million in administrative claims. This shortfall led the liquidator trustee to seek and obtain court approval – despite vehement opposition from creditors – to pay administrative claimants between 15% and 23%.

Southern Foods – Reduced administrative claim by protocol allowing expedited payment of reduced claims. In Southern Foods’ bankruptcy before Judge David Jones in the Southern District of Texas, debtors, seeking to avoid administrative insolvency, obtained approval to allow them to reduce the amount of administrative claims.

Under the protocols, administrative claimants who opted in to the affirmative received an “accelerated” cash distribution in exchange for reducing their claim to 80% of the amount of the “reconciled” claim. These administrative claimants received an initial cash distribution equal to 30% of the reduced administrative claim within 10 working days of membership, with the remaining amount to be paid at a later date to be determined by the debtors with the agreement of the committee. official of unsecured creditors. Conversely, applicants who refused to reduce their administrative request were subordinated to administrative applicants who opted.

In this case, the debtors succeeded in exploiting the risk of administrative insolvency to reduce the amount of administrative claims.

Platform 1 – Administrative claims are jeopardized after the court has ordered the late payment until the effective date of the plan. Finally, in the bankruptcy of Pier 1 in the District Court of Eastern Virginia, Judge Kevin Huennekens approved the debtors’ motion to delay payment of all “critical expenses” except some included in a provisional budget. .

Many landlords, among other creditors, opposed the petition because the rent owed under their respective leases would be deferred. As an alternative, the owners demanded immediate payment of the rent. The court granted the landlords a request for an administrative fee reimbursement for the deferred rent, but denied their request for immediate payment.

After the debtors remained in possession of their rented premises and delayed paying rent for two months, the debtors became administratively insolvent, resulting in the write-down of the landlord’s administrative claims.

Debtors subsequently filed a plan that called for administrative claimants to receive a reduced payment. In order to gain the approval of the creditor agency, the plan provided for a discharge from Chapter 5 causes of action for holders of administrative claims who voted in favor of the plan. (Chapter 5 of the Bankruptcy Code contains the debtor’s avoidance powers, including preferences and fraudulent transfers under 11 USC §§ 547 and 548.) The creditor agency voted in favor of the plan and the Administrative claimants were paid well under 100 cents of dollars. .

While creditors are required to continue to provide services to debtors after petition and the Bankruptcy Code requires full payment of administrative claims, Verity, Southern Foods, Pier 1 and other cases, such as Sears (Bankr. SDNY 2018) and Toys “R” We (Bankr. ED Va. 2017), show that holders of administrative claims must be vigilant in protecting their claims; otherwise, they may end up with significantly reduced claims.

Here are some tips that can help creditors collect 100% of their administrative debts. Of course, their effectiveness depends on the circumstances of the case and the leverage effect of the creditor:

•Be proactive. Do not assume that administrative complaints will be paid in full. Monitor debtor transactions and ensure, to the extent possible, that debtors make payment in advance or on delivery.

• Participate in the creditors committee. Committee members will receive periodic and timely reports on cash flow (and administrative solvency).

• Try to work with debtors to obtain immediate payment on an informal basis, rather than seeking court intervention. As Pier 1 demonstrates, asking for a court to intervene can backfire on administrative claimants. As in Pier 1, the court may allow debtors to defer payment of the administrative debt until the effective date of the plan, creating the risk that debtors will become administratively insolvent in the meantime.

• If the administrative complaint is based on an enforceable contract, move on to compel acceptance or rejection of the enforceable contract. The assumption of the enforceable contract will guarantee the payment of the post-claim repair amounts. Rejection would cap the amount of the administrative claim that would potentially be at risk.

• If the plan provides for the settlement of administrative claims from a reserve, ensure that the date of the administrative prohibition request is before the plan is confirmed, in order to ensure the sufficiency of the administrative reserve for claims. . Also, look for the discovery of receivables to confirm the sufficiency of the plan’s reserves.

• Ensure that the plan provides for identical treatment for all administrative claims and does not allow some claims (ie professional fees) to be paid before others.

• Negotiate a provision of the plan providing for (i) cash distributions to comply with the top priority rule in order to avoid any distribution to any lower priority creditor before all administrative claims are settled; (ii) any excess amount reserved for professionals to be paid to administrative claimants who have remained unpaid; and (iii) recovery of administrative claims paid previously in the event of insufficient distribution to administrative claimants.

• Negotiate release and exoneration clauses so that they do not take effect until full payment of administrative complaints.

• Negotiate caps on professional fees that could otherwise deplete debtors’ assets.

• Negotiate to exchange a reduction in the administrative claim in exchange for a release of Chapter 5 claims.

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The opinions expressed are those of the author. They do not reflect the views of Reuters News, which, under the principles of trust, is committed to respecting integrity, independence and freedom from bias. Westlaw Today is owned by Thomson Reuters and operates independently of Reuters News.

Janet E. Fishburn