In a recent decision arising out of the Lehman case, which has been characterized as the largest and most complex bankruptcy in history and saw professional fees and expenses exceed $1.8 billion, the U.S. District Court for the Southern District of New York overturned the bankruptcy court’s approval of payment by the bankruptcy estate of professional fees of individual members of the unsecured creditors’ committee.[1] The plan of reorganization, which was accepted by an “overwhelming percentage of creditors” and confirmed by the bankruptcy court, provided for the payment of approximately $26 million in fees as administrative expenses of the estate subject to a finding that the fees in question were “reasonable.”[2]
While no economic stakeholder objected, the Office of the U.S. Trustee objected to the payments as being violative of § 503(b), which, according to the U.S. Trustee, is the “exclusive pathway” that all creditors must follow in order to receive compensation for their individual counsel fees and requires a showing of “substantial contribution.”[3] The U.S. Trustee argued that the omission of any reference to § 503(b)(3)(F) from § 503(b)(4) precludes any possibility that professional fees of official committee members can be reimbursed under any circumstances.[4]
Recognizing that the existence of authority for payment of such fees under § 503(b) is “doubtful” and noting the scant legislative history available, the bankruptcy court looked elsewhere for authority for what it characterized as a “contractual patch” designed to cover the hole in § 503(b)(4).[5] The bankruptcy court found its answer in the “catch-all” provision of § 1123(b)(6): “[A] plan may include any other appropriate provision not inconsistent with the applicable provisions of this title.” According to the bankruptcy court, “section 1123(b)(6) is a broadly worded, open-ended invitation to the creativity of those who are engaged in drafting plan language.”[6]
Coupled with the court’s equitable powers granted by § 105(a), § 1123(a) gives courts “a great deal of flexibility” to confirm a plan of reorganization as long as it does not otherwise violate the Bankruptcy Code.[7] The bankruptcy court then looked to a decision in In re Adelphia Commnc’ns Corp. where, faced with a similar plan provision, the court engaged in a textual analysis of §§ 503 and 1123(b)(6) and concluded that such payments do not violate the Bankruptcy Code because (1) § 503(b) is not “the only way by which individual creditors’ fees may be absorbed by an estate” and (2) “while [such payments] may or may not be authorized, they are not forbidden.” [8] Viewing the plan payments in question with a recognition of the “creativity and flexibility” that the plan necessarily required, the Lehman court found that § 1123(b)(6) provides “an alternate method” to payment of such fees and that “confirmation of the Plan substitutes all of the protections that are needed….”[9]
On appeal, the district court took dead aim at the language of § 503(b) and the omission of subparagraph (F) from § 503(b)(4), stating that “[t]he problem is … that the structure of § 503(b)(3) and (4) glaringly exclude professional fees of official committee members.”[10] The court further noted that committee members’ professional fees were expressly omitted from § 503(b) as a result of the enactment of the Bankruptcy Abuse Prevention and Consumer Protection Act in 2005. Thus, because committee members’ fees are administrative expenses that Congress intentionally omitted from § 503(b), the court concluded that § 503(b) precluded payment of committee members’ professional fees “solely on the basis of their committee membership.”[11] Having reached that decision, it was not difficult for the court to find that § 1123(b)(6) does not provide an independent basis for payment.[12] The Court also rejected the members’ attempts to draw a distinction between administrative expenses subject to § 503(b), which they characterized as non-consensual claims, and “permissive plan payments,” which they argued are consensual in nature and permitted under § 1123(b)(6), because, due to the priority treatment afforded the professional fees under the plan, “there is no practical difference between an administrative expense under § 503(b) and an ‘Administrative Expense Claim’ under section 6.7 [of the Plan].”
While the district court precluded payment solely on account of committee membership, the court left open the possibility that official committee members – those who are able to demonstrate that they made a “substantial contribution” under § 503(b)(3) – may have their professional fees paid under § 503(b)(4). In doing so, the court rejected a per se prohibition against such payments, pointing to the language of § 503(c), which precludes certain payments even if they satisfy other provisions of § 503(b), demonstrating Congress’s ability to expressly limit the statutory path for approval of payments if it so desires.[13] Thus, to the extent members of official committees can establish that they made a substantial contribution to the estate unrelated to their status as a committee member (whatever that may mean), they may have their professional fees paid by the estate. The district court remanded the matter to the bankruptcy court to make that determination.
Although the story is not over, the Lehman decision stands as a limitation on the tools available to plan architects to forge consensus and may provide a disincentive to those creditors most likely to participate in plan negotiations from seeking (or maintaining) a seat on an official committee. After all, it is not uncommon for creditors to organize and participate in plan negotiations on an ad hoc basis and thereafter obtain payment of their professional fees and expenses from the estate, as was indeed the case in Lehman.[14] After Lehman, however, those very same creditors, were they to participate as an official committee member, might have to clear an additional (perhaps insurmountable) hurdle of demonstrating that their “substantial contributions” to the estate had nothing to do with their role as official committee members.
[1] In re Lehman Bros. Hold. Inc., 508 B.R. 283 (S.D.N.Y. 2014).
[2] In re Lehman Bros. Hold. Inc., 487 B.R. 181, 184 n.3, 187 (Bankr. S.D.N.Y. 2013). Section 6.7 of the Plan provided:
Subject to entry of the Confirmation Order, the reasonable fees and expenses (including attorneys fees) of … the individual members of the Creditors’ Committee, in each case, incurred in their capacities as … members of the Creditors’ Committee, respectively, shall, (i) to the extent incurred and unpaid by the Debtors in accordance with the Debtor Allocation Agreement upon application to and subject to approval of the Bankruptcy Court, and (ii) to the extent incurred after the Effective Date, be Allowed as Administrative Expense Claims and paid by the Debtors on a monthly basis upon the submission of fee statements without further order of the Bankruptcy Court.
[3] Id. at 184, 185-86.
[4] Id. at 185-86.
[5] Id. at 184; 11 U.S.C. § 503(b)(4) (omitting members of official committees referenced in § 503(b)(3)(F)).
[6] Id. at 189 (also characterizing § 1123(b)(6) as a “green light’ for those engaged in plan negotiations.”)
[7] To become unenforceable, a plan must be “clearly in conflict” with the Bankruptcy Code, and any “’tie should go to the ‘runner’” as to whether the plan is appropriate. Id. at 192.
[8] In re Adelphia Commnc’ns Corp., 441 B.R. 6, 15 (Bankr. S.D.N.Y. 2010).
[9] Lehman, 487 B.R. at 191.
[10] 508 B.R at 290.
[11] Id.
[12] The court also raised a concern that finding otherwise could lead to “serious mischief” along the lines of a junior creditor receiving a plan payment not on account of its claim, but only on account of a similar plan provision and otherwise in violation of the absolute priority rule. While the court failed to identify what such a payment would be on account of if it was not on account of the creditor’s claim, such a concern seems to overstate the likelihood that creditors will tolerate a debtor’s obvious gifting of the estate.
[13] Curiously, § 503(c) was also cited by the court in Adelphia as evidence that Congress did not intend § 503(b) to be the exclusive means by which a creditor’s professional fees may be paid by the estate. See Adelphia, 441 B.R. at 12-13.
[14] Lehman, 487 B.R. at 183 n.1 (listing several applications for reimbursement of fees and expenses of ad hoc creditor groups approved by the bankruptcy court).