Thawing the Freeze: Cutting Costs and Increasing Efficiency by Granting Administrative Expense Priority to Nonquantifiable Benefits

• Publication year: 2020

Thawing the Freeze: Cutting Costs and Increasing Efficiency by Granting Administrative Expense Priority to Nonquantifiable Benefits

Alan M. Hinderleider

THAWING THE FREEZE: CUTTING COSTS AND INCREASING EFFICIENCY BY GRANTING ADMINISTRATIVE EXPENSE PRIORITY TO NONQUANTIFIABLE BENEFITS

ABSTRACT

Disputes over priority claims in bankruptcy proceedings are common because they are often the only way to recover assets from the limited pool available to claimants. Claims for professional fees for those who facilitate bankruptcy proceedings after the petition has been filed are given high priority to ensure that they have incentive to complete their work. However, those who come into bankruptcy with claims against the debtor have a much harder time recovering their costs if they do any work to assist with the proceedings. Currently, the administrative expense analysis requires these applicants to demonstrate that they made a substantial contribution to the estate before receiving priority on their claims for reimbursement. Courts overwhelmingly deny requests for administrative expenses under § 503 of the Bankruptcy Code because the applicant did not make a quantifiable benefit to the estate.

This Comment calls upon the Federal Judiciary and Congress to allow administrative expense priority for reasonable expenses to applicants who benefit the estate without being duplicative, self-interested, or meritless, but are unable to directly quantify how they did so. For applicants and their attorneys, this Comment serves as a guide on requesting administrative expense priority for costs incurred when a direct benefit cannot be shown.

The current substantial contribution analysis will be discussed to show why it should not require a benefit to be quantifiable. First, the types of potential applicants for this priority claim will be analyzed to demonstrate how each can benefit the estate in ways that are not quantifiable under the current interpretation of § 503(b)(3)(D). The language that courts commonly use to convey the rationale of a substantial contribution analysis will be discussed to show that precedent does not preclude the proposed interpretation. An interpretation is provided for the existing text of § 503(b)(3)(D) that would allow courts to make this change on a case by case basis. Finally, a change to the text of § 503(b)(3)(D) that would allow Congress to implement this change directly is provided as a model.

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INTRODUCTION

Bankruptcy estates, by definition, do not have enough assets to cover all debts and expenses.¹ As a result, costs are prioritized by § 507 of the Bankruptcy Code (Code) to ensure that the assets of the estate are distributed in order of importance.² First priority is given to the repayment of professionals that facilitate proceedings because their work is essential for the debtor to make it through bankruptcy quickly and efficiently.³ These highly prioritized repayments are classified as "administrative expenses" and they ensure that those who keep the estate running smoothly are not discouraged from participating due to a fear of not receiving payment.⁴

Other administrative expenses, however, are given second priority by § 507.⁵ These include the costs incurred by a variety of interested parties: creditors,⁶ indenture trustees,⁷ equity security holders,⁸ and committees representing creditors or equity security holders.⁹ This group will be collectively referred to as "applicants" below. Those who qualify as applicants under § 503(b)(3)(D) only receive repayment if they show that their expenses were

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"actual and necessary" and incurred while making a "substantial contribution" to the estate.¹⁰

This approach, although reasonable on the surface, has caused an unnecessary problem within bankruptcy litigation: the "substantial contribution" analysis has been interpreted to only allow administrative expense priority for claimants who can show that they made a benefit to a bankruptcy estate that is "quantifiable," meaning that the benefit must be measurable and have directly contributed assets to the bankruptcy estate.¹¹ However, significant benefits can be conferred that are difficult or impossible to quantify under this standard.

The substantial contribution analysis in Matter of D'Lites provides a good illustration of what is not considered a quantifiable benefit under the current standard.¹² In Matter of D'Lites, the applicant, Walton Investments, Inc., ran the debtor's business using Walton employees in an attempt to keep the company afloat.¹³ Although this provided the estate with the benefit of a workforce that operated the business as it wound down, the court held that it did not constitute a substantial benefit to the estate in part because it could not be quantified.¹⁴

The court then compared the facts with those of a case heard by the Seventh Circuit Court of Appeals.¹⁵ In Park Terrace Townhouses v. Wilds, the applicant "instituted a marketing program which significantly increased occupancy rates and monthly income" at the debtor's property.¹⁶ While the applicants in both cases made an effort to benefit the estate, only the applicant in Park Terrace was awarded administrative expenses because he was able to quantify the benefit he conferred.¹⁷ This Comment proposes that an applicant who is unable to directly quantify a benefit to the estate should be granted administrative expense priority for reasonable expenses spent on good faith efforts to increase the value of the estate.

The proposed increase in the number of applicants who qualify for administrative expenses must be reconciled with the purpose of limiting priority in the first place. There are many reasons for having limits imposed on the range

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of possible claims against the bankruptcy estate: § 503 is intended to balance competing interests in this context—on the one hand, promoting meaningful creditor participation—on the other hand, minimizing costs to the estate.¹⁸ Therefore, courts have an interest in preventing administrative costs from "mushrooming,"¹⁹ and excluding claims that are "duplicative,"²⁰ solely motivated by self-interest,²¹ or create meritless legal actions.²²

It is possible to recognize and endorse the restrictions above and still permit non-quantifiable benefits to a bankruptcy estate to be honored and repaid. When creditor participation can be encouraged while lowering costs to the estate, both aims of § 503 can be met simultaneously. Creditors who benefit the estate in ways that smooth the bankruptcy process, lower costs, foster collaboration, etc. should have the opportunity to recover reasonable costs for their efforts.

The current requirement that a benefit be quantifiable before priority is granted is problematic because it does not give applicants an incentive to assist in the administrative process. Instead, applicants face a "chilling effect"²³ because they are afraid to "throw good money after bad."²⁴ With a small and manageable change in this area of the law, however, this problem can be eliminated without significant additional burdens being imposed on the bankruptcy process.

This Comment proposes a solution that requires only a small adjustment in the language or interpretation of § 503(b)(3)(D) but will result in increased judicial efficiency, shortened cases, and the more efficient use of resources. Allowing applicants to show that they benefited the estate in new ways will keep the competing interests of § 503 balanced²⁵ because not only will more

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applicants have an incentive to participate in proceedings, but costs of administering the estate will decrease as well.

This Comment calls upon the Federal Judiciary and Congress to allow administrative expense priority for reasonable expenses to applicants who benefit the estate without being duplicative, self-interested, or meritless but are unable to directly quantify how they did so. For applicants and their attorneys, the following serves as a guide on requesting administrative expense priority for costs incurred when a direct benefit cannot be shown.

The current substantial contribution analysis will be discussed to show why it should not require a benefit to be quantifiable. First, the types of potential applicants for this priority claim will be analyzed to demonstrate how each can benefit the estate in ways that are not quantifiable under the current interpretation of § 503(b)(3)(D). The language that courts commonly use to convey the rationale of a substantial contribution analysis will be discussed to show that precedent does not preclude the proposed interpretation. An interpretation is provided for the existing text of § 503(b)(3)(D) that would allow courts to make this change on a case-by-case basis. Finally, a change to the text of § 503(b)(3)(D) that would allow Congress to implement this change directly is provided as a model.

A. Participation is Worth Promoting

This Comment does not suggest that courts should allow administrative expenses to all applicants, as this would almost certainly lead to estates being bombarded with frivolous claims. Instead, it proposes that judges read § 503(b)(3)(D) to allow for reasonable compensation for applicants who benefit the estate in a manner that cannot be quantified to an exact figure. The small amount of time spent working out how much an applicant has benefited the estate will be offset by the benefits of having more efficient parties take on administrative tasks. Creating new avenues for applicants to receive administrative expense priority will also incentivize behavior that adds value to the estate indirectly.

Providing applicants an incentive to benefit the estate will result in faster cases, larger recoveries, and more debtors exiting bankruptcy without being liquidated.²⁶ When applicants are in a better position to facilitate bankruptcy

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proceedings, they should not be encouraged to do so in exchange for nothing. Applicants should be...