1 19: Administrative expenses © Charles Tabb 2010

2 2 nd priority (but in business case 1 st ) Administrative expenses are the 2 nd priority, under 507(a)(2) Really, though, in business cases, where admin. expenses matter the most, they effectively are 1 st, b/c a business does not have DSO

3 Where find? 507(a)(2) refers to 503(b) for the listing of admin expenses There are 9 types of administrative expenses listed in 503(b) No ordinal preference – all of equal rank

4 Not exclusive Not an exclusive list “including” So court can recognize an unlisted admin expense but ONLY if it fulfills the statutory purposes As a practical matter almost everything ct might consider falls within 503(b)(1) – “actual, necessary costs and expenses of preserving the estate”

5 Narrow construction Cts narrowly construe admin expenses Why? They depart from the fundamental principle of equality of distribution

6 Justification? So what is the justification for an admin expense, given that allowing it puts one claimant ahead of others – the residual unsecured crs? 1) Is there a benefit to the residual claimants? 2) if so, do we HAVE to give this particular claimant priority in order to realize that benefit? i.e. if it makes sense to have a bankruptcy case in the 1 st place, do we have to afford admin priority to fully capture the benefits of the bk case?

7 2 requisites 1. Benefit to estate 2. postpetition transaction with estate

8 2 main types 1 st – actual, necessary expenses either to operate the dr’s business (e.g. in ch 11) or preserve & liquidate the estate assets (eg in ch 7) Examples operating expenses: wages of ongoing employees current taxes rent Examples of liquidation expenses: Storage costs Costs of sale (advertising, auctioneer fees)

9 2 nd type Pay people who work on the case E.g., their fees and expenses Examples: Bankruptcy trustee Attorneys for the estate

10 Jartran Illustrates the inducement principle behind admin expenses Shows that even if have a benefit to the estate, no admin priority unless also engage in a postpetition transaction with the estate

11 Jartran Facts: Prior to bankruptcy, Dr (through agent) placed orders for Yellow Page ads “closing date” for these ads passed Dr thus irrevocably committed before bankruptcy Jartran then filed ch 11 Ads published during the ch 11 case Issue: is the cost of the ads published postpet (about $1.3 mm) an admin expense?

12 Argument for allowing as admin Benefits the estate – a standard business expense Dr actually enjoyed the benefit of the published ads during the pendency of the bankruptcy case Only fair – a cost of doing business while in bankruptcy, Dr should have to pay

13 Why disallowed? 7 th circuit disallowed as admin expense Rationale was that there was no postpetition transaction with the estate Deal was irrevocably committed prior to bankruptcy Thus no need to afford admin priority in order to induce Donnelly to do business with Dr

14 All prepetition? How decide if closing date for ad was pre-bk, and ad published pre-bk? Then indisputably just a non-priority claim Neither a transaction with estate nor a benefit to estate

15 All postpetition? Conversely, what if both closing date for ad and publication of ad occurred post-bk, during pendency of case? Now indisputably an admin expense Transaction with estate AND benefit to estate Fulfills the inducement rationale

16 q. 3 p. 263 –forced to perform K? A nondr party to a prepetition K with the dr, if compelled to render performance to the estate on that K during the case, is usually entitled to admin expense payment as the quid pro quo for such performance So - Why doesn’t that same rationale dictate compensating Donnelly and Tinsley as an admin expense here?

17 Reclamation admin claim Hypo: March 1: Ernie’s Elephants sold & delivered 5 elephants to DR (circus) on credit, $20K each ($100K total) March 15: Dr filed ch 11, had not paid Ernie What rights does Ernie have against the estate?

18 Reclamation claim Ernie is entitled to an administrative expense under 503(b)(9) But what about fact that the K was made AND the goods were delivered PRIOR to bankruptcy? Jartran tells us that in such a case, no admin exp 2005 special rule: Goods Dr received within 20 days of bankruptcy Ordinary course Dr’s business

19 Purpose reclamation admin rule Encourage sellers to keep doing business on credit with a financially distressed DR Not have to worry that shortly after deliver goods, Dr will file bk and Cr will be out of luck So a form of inducement here as well Effectively just moves the point of demarcation back 20 days, from filing of petition to 20 days before

20 Apply to Jartran? Would 503(b)(9) offer any solace to the disappointed creditors on the facts in Jartran? NO – only applies to sales of goods, not services

21 In-kind reclamation Credit seller of goods on eve of bankruptcy also might have a right to reclaim goods in kind from the bk estate (or force estate to “buy” goods back, i.e., pay in full!) 546(c)(1): Sale of goods to Dr in ordinary course Dr insolvent when received (not required in 503) Within 45 days before bk (longer period than 503) Seller makes written demand within 45 days or 20 days after bk Implicit requirements that Dr (i) still HAS goods, and (ii) are IDENTIFIABLE

22 Goods only 546(c) in-kind reclamation ALSO is limited to the delivery of goods, not services So likewise would be of no help in a case such as Jartran

23 Reading Co. v. Brown What do you mean by “benefit”?? Facts: Receivership under Ch XI Dr’s workmen negligent, cause catastrophic fire tort damages exceed value of entire estate So if tort claimants paid admin expense, general unsecured crs of Dr get nothing Issue: are the tort claimants entitled to admin expense?

24 Recall 2 prongs of admin expense 1 st – timing – POST-petition, during pendency of the case NOT a problem here No question that the fire occurred during the bk case, and was caused by the Dr’s employees 2 nd – benefit to estate This is the issue

25 Argue no benefit? What is the argument that the fire damages did NOT “benefit” the estate?

26 Hold: grant admin expense Supreme Court held for the tort victims and granted them admin expense status for their tort damages Thus came ahead of prepetition general unsecured crs

27 “fairness” One basis for Reading holding: fairness to the tort victims J. Harlan for Ct said they “had an insolvent business thrust upon them by operation of law”

28 Was this “unfair” to general Crs? NO – but why not? If reorg had succeeded, the general unsec. crs would have enjoyed the upside View as residual owners since Dr likely insolvent

29 Broader principle of Reading Admin status for all costs of doing business: “’actual and necessary’ costs should include costs ordinarily incident to the operation of a business, and not be limited to costs without which rehabilitation would not be possible.”

30 Policy justification for Reading? As a matter of economic incentives, can we make sense of the Supreme Court’s dictate in Reading that must count as admin expenses ALL costs of doing business? If rule were otherwise, what would the incentive structure look like?

31 Midlantic National Bank May wonder why on earth we’re talking about case that deals with abandonment of property in connection with administrative expenses! Indeed, Supreme Court in Midlantic made clear in a footnote that it was NOT a case about payment priorities! But they were WRONG (as subsequent cases soon figured out) Trivial note: it’s “Midlantic” and NOT “MidAtlantic”

32 Midlantic Facts: Dr (Quanta) stored illegal PCB at waste oil facilities Dr filed bankruptcy (ch 11, convert to 7) Bk trustee sought to abandon the two sites Met statutory test 554 – burdensome, inconsequential value to the estate Cleanup Cost > Property value States of NJ and NY objected – threat to public health and safety NY actually cleaned up and sought reimbursement as admin expense (but issue not before SCOTUS)

33 Holding Midlantic SCOTUS held that bk trustee could “not abandon property in contravention of a state statute or regulation that is reasonably designed to protect the public health or safety from identified hazards.” Elaborated that threat to environment must be “imminent and identifiable” Thus engrafted a judicial exception onto an unambiguous statute (554)

34 Dissent – really about $ The 4 dissenting Justices argued that the State’s real interest was $: “barring abandonment and forcing a cleanup would effectively place [the states’] interest in protecting the public fisc ahead of the claims of other creditors.” Can you see why??

35 Consequence of no abandonment Post-Midlantic, the lower courts have realized that barring abandonment of polluted property as a de facto matter affords the govt a priority Reason is that the estate is forced to remain in possession of the site, and the environmental laws dictate that anyone in possession of a polluted site must clean up So estate must spend the estate assets to clean up Penn Terra déjà vu all over again

36 NP Mining Test what we’ve learned from Reading, Midlantic, and the general principles driving the admin expense issue in NP Mining Case nicely frames the question of what really determines admin priority

37 NP Mining Facts: Dr NP Mining carried on strip mining in violation of Alabama state law On land owned by others (i.e. site ≠ property estate ) Not a risk to public health and safety Subject to noncompensatory (punitive) civil fines $750 day Feb 1987: filed ch 11, operated as DIP: $399K fines June 1988: trustee appointed, stopped operation: $1.9 M fines April 1989: convert to ch 7 Total postpetition fines = $2,349,000 -> seek admin status Total assets in estate = ~ $400-$500K Issue: any of the punitive fines = admin expense?

38 Environmental rationale? 1 st – would the environmental cleanup obligation rationale of Midlantic and its progeny compel awarding the fines admin status?

39 Fairness rationale? Would the “fairness” rationale of Reading compel awarding the fines admin status?

40 Reading, 28 USC 959(b)? Would the Reading “operations” rationale (“costs ordinarily incident”) dictate admin status? See also 28 USC 959(b) – trustee or DIP must comply with state law when manage and operate estate property

41 Policy: civil fines as admin expense? As a policy matter, why does it make sense to award even noncompensatory civil fines admin status? And, what LIMITS does that policy suggest?

42 Which time periods? 1. Prepetition operation, fines attribute to prepetition “days”? 2. Postpetition operation, fines attributable to prepetition days? 3. Postpetition operation, fines attributable to postpetition days while operating? 4. Postpetition NOT operating, fines attributable to post-operating period?

43 Other priorities – problem 5.3 1 st : employee wages & benefits What policy?

44 Employees’ wages & benefits 2 nd priority: post-petition (503(b)(1)(A)(i)) 4 th priority: 180 days pre-petition, up to max of $10,950 per employee, for wages (507(a)(4)) 5 th priority: benefits for the 180-day period, to extent the $10,950/person amount not already paid under 4 th priority (507(a)(5)) No priority: prepetition wages & benefits, either > 180 days old or in excess of $10,950 cap For purposes of applying timing rules, ask when services performed, not when vested

45 5.3(a) Facts: Vacation pay claim = $2000, for one year’s service, calendar year basis Employer files ch 11 at start 4 th quarter (October 1) Vacation pay vests Jan 1 of following year

46 Employee argue entire $2k = admin priority? How might the employee argue that the entire $2,000 is entitled to administrative priority? Would say that entitled to nothing unless and until kept working for the Dr during the pendency of the ch 11 case, and became entitled to the entire $2,000 only when it vested on Jan. 1, during the pendency of the case But most courts say no

47 Accrual view Prevailing view in the cts is to ascribe an accrual basis for things like vacation or severance pay claims, even if the employee has no enforceable entitlement until claim vests Here, on accrual basis (rounding off): ¼ 2 nd priority (Oct 1-Jan1)= $500 ½ 4 th priority (180 days before filed Oct 1) = $1,000 ¼ = no priority (1 st quarter of last year) = $500

48 taxes Policy? Yeah, right, as if you have to ask Timing Post-petition – 2 nd priority admin expense (503(b)(1)(B)-(C)) Pre-petition – 8 th priority, IF meet requirements of 507(a)(8) Most important is income taxes for past 3 years

49 DSO – 1 st priority 2005 amended law to elevate “domestic support obligations” to 1 st priority Alimony, child support Talking about pre-petition claims Dr’s obligation to pay ongoing post-petition DSOs is paramount – must pay in full in reorg cases to confirm plan Indeed failure to pay currently can lead to dismissal of case

50 5.3(b) Facts: Dr owes income taxes $14k for 1995 tax year Dr divorced 1996, state ct awarded Ex $20k support Dr files ch 7 on March 1, 1999 Estate = $22k

51 Answer 5.3(b) Support claim = 1 st priority DSO (507(a)(1)(A)) for entire $20K Tax claim = 8 th priority (507(a)(8)(A)(i)) For taxable year for which return last due within 3 years of bankruptcy For 1995 tax year, return last due April 15, 1996 Petition filed March 1, 1999 Of course, since only $22K total in estate, there’s only $2k left to pay the priority tax claim after pay the 1 st priority DSO

52 5.3(c) Facts: Creditor joined Debtor Health Club on Jan 1 prepaid $2,000 Entitled to one year of personal training sessions for the $2k Dr closed Feb 1 – just 1 month into the year

53 Answer 5.3(c) 7 th priority for that portion of the $2k for which the Cr did not receive the services paid for E.g., 11/12 of the $2k (got services in January, while club still open, we assume) Purchase of services by an individual for personal use Below cap of $2,425