Laura B. Bartell, Straddle Obligations Under Prepetition Contractsprepetition Claims, Postpetition Claims, or Administrative Expenses?

• Publication year: 2011

STRADDLE OBLIGATIONS UNDER PREPETITION CONTRACTS: PREPETITION CLAIMS, POSTPETITION CLAIMS OR ADMINISTRATIVE EXPENSES?

Laura B. Bartell^*

The Bankruptcy Code¹("the Code") divides the universe of claims into two basic categories-those that arise at or before the order for relief concerning the debtor,²and those that do not-and treats each class very differently. Prepetition claims that are not granted priority treatment³receive their proportionate share of a liquidation of assets, or at least that amount through a plan of reorganization. The result for the creditor is often a minimal recovery. Postpetition obligations that constitute administrative expenses are entitled to priority treatment,⁴perhaps mandating payment in full.

Administrative expenses are addressed by Sec. 503 of the Code. Section

503(b) directs that certain administrative expenses be allowed, including those enumerated in nine listed categories.⁵The first of those categories is "the actual, necessary costs and expenses of preserving the estate," including certain wage and tax claims.⁶

When a debtor, whether an individual or entity, commences a case under the Code, invariably the debtor has prepetition contracts giving rise to a right to payment after the filing is made. Unfortunately, these "straddle" obligations do not fall neatly into one of the two categories of claims. The party asserting the claim invariably seeks to label it as an administrative expense under

Sec. 503(b), the contours of which are far from clear. Judges who conclude that these contractual claims are not administrative expenses often leap erroneously to the conclusion that they must, therefore, be prepetition claims even if they arose postpetition.

I will begin this article in Part I by reviewing the reasons it is important to classify obligations as prepetition or postpetition under the Code. In Part II, I will look at cases in which courts have attempted to develop tests for distinguishing between these categories, and conclude that certain obligations of the debtor under prepetition contracts constitute postpetition obligations. Part III looks at the concept of the administrative expense, which is limited to postpetition claims but does not embrace all of them. In particular, I will examine the Supreme Court's decision in Reading Co. v. Brown,⁷which expanded the concept of administrative expense to include certain postpetition obligations that do not benefit the debtor's estate. Finally, in Part IV I will suggest that an appropriate application of Reading requires that postpetition straddle obligations under prepetition contracts should be classified as an administrative expense when they are subject to discharge in the bankruptcy case, or if the holder will have no recourse to the debtor after the case is over because the debtor's entire estate is liquidated.

I. PREPETITION OR POSTPETITION: WHY DOES IT MATTER?

The starting point for establishing rights and duties of the debtor and its creditors under the Code is the definition of a claim in Sec. 101(5).⁸If an entity has a claim against the debtor arising or deemed to arise before the order for relief, that entity is defined as a creditor under Sec. 101(10)(A).⁹Only a creditor or an indenture trustee may file a proof of claim under Sec. 501(a).¹⁰Once filed, that claim is deemed allowed unless a party in interest objects to it.¹¹If objection to a claim is made, the court resolves the objection and allows it to the extent to that it is properly asserted.¹²

In a chapter 7 liquidation, property of the estate is distributed in payment of allowed claims in the order specified in Sec. 726.¹³In a chapter 11 reorganization, a plan of reorganization must designate classes of claims,¹⁴must specify any class of claims that is not impaired under the plan,¹⁵must specify the treatment of any impaired class of claims,¹⁶and generally must treat all claims within a particular class in the same way.¹⁷In addition, a plan of reorganization cannot be confirmed unless it satisfies the requirements of

Sec. 1129(a) and (b),¹⁸which include provisions protecting classes and holders of claims.¹⁹

The Code provides for the payment of one type of obligation that does not constitute a claim in a bankruptcy case. Section 507(a) grants priority to certain "expenses and claims."²⁰The "expenses" to which it refers must be those "administrative expenses allowed under section 503(b)."²¹The description of administrative expenses in Sec. 503(b) includes various obligations, whether incurred by the debtor or other parties, which Congress has allocated to the debtor on a priority basis.²²With only two exceptions,²³the expenses itemized in Sec. 503(b) arise after a bankruptcy petition is filed (i.e., they are postpetition expenses) and the entity to whom the debtor owes payment would not constitute a "creditor" with a "claim." Unlike Sec. 501, which provides for the filing of a proof of claim by a creditor, Sec. 503 allows any "entity" to file a request for payment of an administrative expense.²⁴Thus, the Code explicitly distinguishes between prepetition claims for which a proof of claim may be filed, and postpetition administrative expenses for which payment may be sought but no proof of claim filed.

This distinction is also critical when property of the estate is distributed in a chapter 7 liquidation, or when a plan of reorganization is prepared and confirmed. Under Sec. 726(a)(1), payment of priority claims under Sec. 507 precedes any distribution to general unsecured claims.²⁵In a reorganization under chapter 11, a plan of reorganization may not be confirmed unless priority claims, including administrative expenses, receive the treatment guaranteed them by Sec. 1129(a)(9).²⁶

Thus, the Code provides different procedural steps for seeking payment of prepetition "claims" and postpetition "administrative expenses," as well as different substantive rights upon a liquidation or reorganization of the debtor. Courts often resolve disputes over classification of claims when an entity seeks payment of an administrative expense that the debtor believes is properly characterized as a prepetition claim.²⁷

The distinction between prepetition claims and postpetition administrative expenses is important in other contexts as well. A filed bankruptcy petition operates as a stay of any action or proceeding against the debtor that "was or could have been commenced before the commencement of the case . . . or to recover a claim against the debtor that arose before the commencement of the case."²⁸If the claim against the debtor is not a prepetition claim, the automatic stay does not preclude its assertion against the debtor²⁹(although the holder of the claim may not seek to recover from property of the estate).³⁰When characterization of the claim is necessary to determine whether the automatic stay bars some action, the court may have to resolve the dispute.³¹

Filing the bankruptcy petition also creates an "estate" comprised of certain types of property, including "all legal or equitable interests of the debtor in property as of the commencement of the case."³²Courts may have to determine whether a claim held by the debtor was a prepetition claim (and thus part of the bankruptcy estate) or a postpetition claim (and therefore not subject to bankruptcy court administration).³³For example, although the automatic stay precludes creditors from offsetting debts they owe the debtor against other claims filed against the debtor,³⁴if a creditor obtains relief from the stay, Sec. 553 recognizes that creditor's right to offset a prepetition debt owed to the debtor "against a claim of such creditor against the debtor that arose before the commencement of the case."³⁵Courts often must determine whether the claim against which a setoff is proposed is prepetition (in which case the setoff is permissible) or postpetition (in which case no setoff may be made).³⁶

The prepetition versus postpetition distinction is relevant in still other contexts. Sometimes the court must determine whether litigation between the debtor and a creditor is a core proceeding³⁷or noncore. If a proceeding is noncore but is related to a bankruptcy case, the bankruptcy judge may only hear the proceeding, not hear and determine it.³⁸In addition, noncore proceedings involving personal injury tort or wrongful death claims against the estate are not subject to mandatory abstention.³⁹A proceeding based on a cause of action that arises postpetition is likely to be a core proceeding, whereas a cause of action arising prepetition is not. Therefore, identifying when a claim arises may be critical in this context as well.⁴⁰

If the debtor receives a discharge in the bankruptcy case,⁴¹that discharge operates as a permanent injunction against future acts to collect any discharged "debt"⁴²(defined as "liability on a claim").⁴³The "debts" that are discharged by the operative provisions of the Code are generally limited to prepetition debts.⁴⁴As a result, courts are often asked to determine whether a claim is prepetition or postpetition in order to define the scope of the discharge.⁴⁵

For these reasons (among others),⁴⁶it matters greatly whether the claim against the debtor constitutes a prepetition claim or a postpetition claim. In most cases, the proper category is easy to determine. But when disputes arise with respect to straddle obligations, courts have struggled to find an adequate test of when a claim "arose."

II. DISTINGUISHING PREPETITION CLAIMS FROM POSTPETITION CLAIMS

The definition of claim in the Code is extremely broad, and expressly includes obligations that are "contingent" and "unmatured."⁴⁷But the Code does not define what it means by a "contingent" or "unmatured" claim. Courts have often quoted the legislative history of the Code,⁴⁸which indicates that the concept of claim is to be given the "broadest possible definition," permitting "all legal obligations of the debtor, no matter how remote or contingent" to be dealt...