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Class 19_ Administrative expenses - OU Law

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19: Administrativeexpenses© Charles Tabb 2010
Administrative expenses are the 2ndpriority, under 507(a)(2)Really, though, in business cases, where admin. expenses matter the most, they effectively are 1st, b/c a business does not have DSO
507(a)(2) refers to 503(b) for the listing of admin expensesThere are 9 types of administrative expenses listed in 503(b)No ordinal preference – all of equal rank
Not an exclusive list“including”So court can recognize an unlisted admin expense but ONLY if it fulfills the statutory purposesAs a practical matter almost everything ct might consider falls within 503(b)(1) – “actual, necessary costs and expenses of preserving the estate”
Ctsnarrowly construe admin expensesWhy?They depart from the fundamental principle of equality of distribution
So what is the justification for an admin expense, given that allowing it puts one claimant ahead of others – the residual unsecuredcrs?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 1stplace, do we have to afford admin priority to fully capture the benefits of thebkcase?
1. Benefit to estate2. postpetition transaction with estate
1st– actual, necessary expenses either to operate thedr’sbusiness (e.g. inch11) or preserve & liquidate the estate assets (eginch7)Examples operating expenses:wages of ongoing employeescurrent taxesrentExamples of liquidation expenses:Storage costsCosts of sale (advertising, auctioneer fees)
Pay people who work on the caseE.g., their fees and expensesExamples:Bankruptcy trusteeAttorneys for the estate
Illustrates theinducementprinciple behind admin expensesShows that even if have a benefit to the estate, no admin priority unless also engage in a postpetition transaction with the estate
Facts:Prior to bankruptcy, Dr (through agent) placed orders for Yellow Page ads“closing date” for these ads passedDr thus irrevocably committed before bankruptcyJartran then filedch11Ads published during thech11 caseIssue: is the cost of the ads publishedpostpet(about $1.3 mm) an admin expense?
Benefits the estate – a standard business expenseDr actually enjoyed the benefit of the published ads during the pendency of the bankruptcy caseOnly fair – a cost of doing business while in bankruptcy, Dr should have to pay
7thcircuit disallowed as admin expenseRationale was that there was no postpetition transaction with the estateDeal was irrevocably committed prior to bankruptcyThus no need to afford admin priority in order to induce Donnelly to do business with Dr
How decide if closing date for ad was pre-bk, and ad published pre-bk?Then indisputably just a non-priority claimNeither a transaction with estate nor a benefit to estate
Conversely, what if both closing date for ad and publication of ad occurred post-bk, during pendency of case?Now indisputably an admin expenseTransaction with estate AND benefit to estateFulfills the inducement rationale
Anondrparty to a prepetition K with thedr, ifcompelledto 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 performanceSo - Why doesn’t that same rationale dictate compensating Donnelly and Tinsley as an admin expense here?
Hypo:March 1: Ernie’s Elephants sold & delivered 5 elephants to DR (circus) on credit, $20K each ($100K total)March 15: Dr filedch11, had not paid ErnieWhat rights does Ernie have against the estate?
Ernie is entitled to anadministrative expenseunder 503(b)(9)But what about fact that the K was made AND the goods were delivered PRIOR to bankruptcy?Jartrantells us that in such a case, no admin exp2005 special rule:GoodsDr received within 20 days of bankruptcyOrdinary course Dr’s business
Encourage sellers to keep doing business on credit with a financially distressed DRNot have to worry that shortly after deliver goods, Dr will filebkand Cr will be out of luckSo a form ofinducementhere as wellEffectively just moves the point of demarcation back 20 days, from filing of petition to 20 days before
Would 503(b)(9) offer any solace to the disappointed creditors on the facts inJartran?NO – only applies to sales of goods, not services
Credit seller of goods on eve of bankruptcy also might have a right to reclaim goodsin kindfrom thebkestate (or force estate to “buy” goods back, i.e., pay in full!)546(c)(1):Sale of goods to Dr in ordinary courseDrinsolventwhen received (not required in 503)Within45 daysbeforebk(longer period than 503)Seller makes written demand within 45 days or 20 days afterbkImplicit requirements that Dr (i) still HAS goods, and (ii) are IDENTIFIABLE
546(c) in-kind reclamation ALSO is limited to the delivery of goods, not servicesSo likewise would be of no help in a case such asJartran
What do you mean by “benefit”??Facts:Receivership under Ch XIDr’s workmen negligent, cause catastrophic firetort damages exceed value of entire estateSo if tort claimants paid admin expense, general unsecuredcrsof Dr get nothingIssue: are the tort claimants entitled to admin expense?
1st– timing – POST-petition, during pendency of the caseNOT a problem hereNo question that the fire occurred during thebkcase, and was caused by the Dr’s employees2nd– benefit to estateThis is the issue
What is the argument that the fire damages did NOT “benefit” the estate?
Supreme Court held for the tort victims and granted them admin expense status for their tort damagesThus came ahead of prepetition general unsecuredcrs
One basis forReadingholding:fairnessto the tort victimsJ. Harlan for Ct said they “had an insolvent business thrust upon them by operation of law”
NO – but why not?Ifreorghad succeeded, the generalunsec.crswould have enjoyed the upsideView asresidual ownerssince Dr likely insolvent
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.”
As a matter of economic incentives, can we make sense of the Supreme Court’s dictate inReadingthat must count as admin expenses ALL costs of doing business?If rule were otherwise, what would the incentive structure look like?
May wonder why on earth we’re talking about case that deals withabandonmentof property in connection withadministrative expenses!Indeed, Supreme Court inMidlanticmade clear in a footnote that it was NOT a case about payment priorities!But they wereWRONG(as subsequent cases soon figured out)Trivial note: it’s “Midlantic” and NOT “MidAtlantic”
Facts:Dr (Quanta) stored illegal PCB at waste oil facilitiesDr filed bankruptcy (ch11, convert to 7)Bktrustee sought to abandon the two sitesMet statutory test 554 – burdensome, inconsequential value to the estateCleanup Cost > Property valueStates of NJ and NY objected – threat to public health and safetyNY actually cleaned up and sought reimbursement as admin expense (but issue not before SCOTUS)
SCOTUS held thatbktrustee 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)
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 publicfiscahead of the claims of other creditors.”Can you see why??
Post-Midlantic, the lower courts have realized that barring abandonment of polluted property as a de facto matter affords thegovta priorityReason is that the estate is forced to remain in possession of the site, andthe environmentallaws dictate that anyone in possession of a polluted site must clean upSo estate must spend the estate assets to clean upPenn Terradéjà vu all over again
Test what we’ve learned fromReading, Midlantic,and the general principles driving the admin expense issue inNP MiningCase nicely frames the question of what really determines admin priority
Facts:Dr NP Mining carried on strip mining in violation of Alabama state lawOn land owned by others (i.e. site≠property estate)Not a risk to public health and safetySubject tononcompensatory(punitive) civil fines$750 dayFeb 1987: filedch11, operated as DIP: $399K finesJune 1988: trustee appointed, stopped operation: $1.9 M finesApril 1989: convert toch7Total postpetition fines = $2,349,000 -> seek admin statusTotal assets in estate = ~ $400-$500KIssue: any of the punitive fines = admin expense?
1st– would the environmental cleanup obligation rationale ofMidlanticand its progeny compel awarding the fines admin status?
Would the “fairness” rationale ofReadingcompel awarding the fines admin status?
Would theReading“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
As a policy matter, why does it make sense to award evennoncompensatorycivil fines admin status?And, what LIMITS does that policy suggest?
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?
1st: employee wages & benefitsWhat policy?
2ndpriority:post-petition (503(b)(1)(A)(i))4thpriority:180 days pre-petition, up to max of $10,950 per employee, forwages(507(a)(4))5thpriority:benefitsfor the 180-day period, to extent the $10,950/person amount not already paid under 4thpriority (507(a)(5))No priority: prepetition wages & benefits, either > 180 days old or in excess of $10,950 capFor purposes of applying timing rules, ask when servicesperformed, not when vested
Facts:Vacation pay claim = $2000, for one year’s service, calendar year basisEmployer filesch11 at start 4thquarter (October 1)Vacation pay vests Jan 1 of following year
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 thech11 case, and became entitled to the entire $2,000 only when it vested on Jan. 1, during the pendency of the caseBut most courts say no
Prevailing view in thectsis to ascribe anaccrualbasis for things like vacation or severance pay claims, even if the employee has no enforceable entitlement until claim vestsHere, on accrual basis (rounding off):¼ 2ndpriority (Oct 1-Jan1)= $500½ 4thpriority (180 days before filed Oct 1) = $1,000¼ = no priority (1stquarter of last year) = $500
Policy?Yeah, right, as if you have to askTimingPost-petition – 2ndpriority admin expense (503(b)(1)(B)-(C))Pre-petition – 8thpriority, IF meet requirements of 507(a)(8)Most important is income taxes for past 3 years
2005 amended law to elevate “domestic support obligations” to 1stpriorityAlimony, child supportTalking aboutpre-petition claimsDr’s obligation to pay ongoingpost-petition DSOs is paramount – must pay in full inreorgcases to confirm planIndeed failure to pay currently can lead to dismissal of case
Facts:Dr owes income taxes $14k for 1995 tax yearDr divorced 1996, state ct awarded Ex $20k supportDr filesch7 on March 1, 1999Estate = $22k
Support claim = 1stpriority DSO (507(a)(1)(A)) for entire $20KTax claim = 8thpriority (507(a)(8)(A)(i))For taxable year for which return last due within 3 years of bankruptcyFor 1995 tax year, return last due April 15, 1996Petition filed March 1, 1999Of course, since only $22K total in estate, there’s only $2k left to pay the priority tax claim after pay the 1stpriority DSO
Facts:Creditor joined Debtor Health Club on Jan 1prepaid $2,000Entitled to one year of personal training sessions for the $2kDr closed Feb 1 – just 1 month into the year
7thpriority for that portion of the $2k for which the Cr did not receive the services paid forE.g., 11/12 of the $2k (got services in January, while club still open,we assume)Purchase of services by an individual for personal useBelow cap of $2,425

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Class 19_ Administrative expenses - OU Law