CHAPTER 9, B. Administrative Expense Priority of Post-Petition Lease Payments

• Jurisdiction: United States

B. Administrative Expense Priority of Post-Petition Lease Payments

ABI Journal

February 2019

Christopher J. Schreiber

von Briesen & Roper, sc

Milwaukee, Wisc.

David I. Cisar

von Briesen & Roper, sc

Milwaukee, Wisc.

Arecent decision, Kimzey v. Premium Casing Equipment LLC,¹ reveals growing tension over the appropriate post-petition treatment of a lessor's administrative expense claim if the debtor rejects the lease. Kimzey also highlights a circuit split over whether actual post-petition use of leased equipment is a condition precedent to the allowance of an administrative expense claim under § 503(b)(1)(A).

Kimzey and the TransAmerican Test

The specialized oilfield equipment leased by the debtor in Kimzey was not used post-petition, but the debtor's principals decided to retain the equipment due to potential future use, the higher cost of renting similar equipment and a desire to protect the value of the company pending a potential § 363 sale, among other factors.² The § 363 sale was held, but the leased equipment was not sold, so the debtor moved to reject the lease after the sale.³

The lessor, Premium Casing Equipment LLC, asserted an administrative expense claim for the amounts owed under the lease between the petition date and the rejection (approximately $58,000). The request was granted by the bankruptcy court for two primary reasons.⁴ First, the bankruptcy court ruled that the leased equipment did not have to be used by the debtor to be "necessary" in the context of § 503(b)(1)(A) "if the business derived some other benefit from its retention."⁵ Second, the bankruptcy court relied heavily on the exercise of the debtor's business judgment in deciding to retain the equipment (even though it was not used post-petition) and elected not to "second-guess that business judgment."⁶

The decision was upheld on appeal. The district court began by analyzing whether Premium had established a prima facie case for an administrative expense claim under § 503(b)(1)(A)⁷ using a two-pronged test established by In re TransAmerican Natural Gas Corp.⁸ The first prong examines whether "the claim arises from a transaction with the debtor-in-possession."⁹ Citing "[c]ase law throughout the country" and noting that an equipment lease represents "an ongoing exchange of benefits and obligations between the lessor and lessee," the district court concluded that pre-petition equipment leases are a form of post-petition transaction between the lessor/creditor and debtor.¹⁰

The second prong of the TransAmerican test is whether the leased equipment "enhanced the ability of the debtor in possession's business to function as a going concern."¹¹ The appellants in Kimzey (who were creditors) argued that it did not because no revenue was produced that enhanced the estate due to the lack of post-petition use of the equipment, and because the asset-purchaser did not purchase or assume the lease.¹² The appellants therefore asserted that there could be no benefit to the estate under the "plain meaning of the terms 'actual' and 'necessary'" in § 503(b)(1)(A).¹³ In response, Premium argued that the debtor's continued post-petition access to the leased equipment was a "real benefit" to the estate, provided the debtor with additional capacity to serve customers, and enhanced the value of the company prior to the sale because renting similar equipment would have been more expensive.¹⁴

While the district court had no problem concluding that the first TransAmerican prong was satisfied, the court was forced to confront "[t]wo divergent lines of cases" in addressing the second TransAmerican prong and the fundamental question of whether actual use of the leased equipment was a prerequisite for an administrative expense claim.¹⁵

Equitable Considerations Favor Lessor's Right to § 503(b)(1)(A) Claim

The first line of cases generally hold that a lessor is entitled to a post-petition administrative expense claim under § 503(b)(1)(A) for pre-rejection rent regardless of the debtor's actual use of the equipment.¹⁶ This avoids the lessor being compelled to protect its position under, for example, § 362(d) by moving for relief from stay or under § 365(d)(2) by moving to require the debtor, within a specified period of time, to assume or reject the lease.¹⁷ The court noted that a "creditor should have the right to assume that the debtor is utilizing the leased property for its intended purpose until the trustee rejects the lease."¹⁸

A foundational case in the first line of cases is In re Sturgis Iron & Metal Co. Inc.¹⁹ In that case, the debtor leased a shredder "large enough to accommodate a school bus" for use in its business of recycling metal from scrapped vehicles.²⁰ Despite rejecting the lease just two months into the bankruptcy case, two post-petition lease payments had accrued in the amount of $404,000, for which the lessor sought administrative expense treatment under § 503(b)(1)(A).²¹ The creditors' committee objected, claiming that only a nominal administrative claim amount might be appropriate due to the minimal, if any, post-petition use of the shredder.²² After a particularly thorough analysis, the bankruptcy court made the...