Reimbursement of Committee Member Expenses Also May Include Members Professional Fees

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Apr 2000

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Editor's Note:

See <a href="/journal/00aprletter.html">"Letter to the Editor"</a> of this issue and <a href="/abidata/online/journaltext/00marlast.html">"Third Circuit Creates the 'Hidden
Administrative Claim' in Chapter 11 Cases,"</a> by Thomas J. Salerno, March 2000 ABI Journal.
</blockquote>

Prior to 1994, substantial disagreement existed over whether the Bankruptcy Code authorized members
of an official committee of unsecured creditors to be reimbursed for their actual and necessary expenses.
See 2 Queenan, J., Hendel, P. and Hillinger, I., Chapter 11 Theory and Practice: A Guide to
Reorganization, §10.09, pp. 10:24-10:27 (LRP Publications, 1994). While the Code specifically
authorized the reimbursement of expenses of a "committee...other than a committee appointed under
§1102..." (§503(b)(3)(D), emphasis added), making a substantial contribution to the case, the Code was
silent on the reimbursement of expenses for members of official committees appointed under §1102.

With the passage of the Bankruptcy Reform Act of 1994, however, this issue was finally put to rest.
Section 503 of the Code was amended to add §503(b)(3)(F), which provides for the reimbursement of the
"actual, necessary expenses...incurred by a member of a committee appointed under §1102 of this title, if
such expenses are incurred in the performance of the duties of such committee." <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… U.S.C. §503(b)(3)(F)</a>.
As a majority of the pre-amendment decisions recognized, reimbursement of actual and necessary expenses
is only fair. Committee members, after all, typically hold the largest unsecured claims against a debtor.
They donate their time to serve as fiduciaries without compensation by the estate. It would be unreasonable
to require them to go out-of-pocket for their actual and necessary expenses as well. And so, with the
passage of the 1994 amendments, the issue was thought to be settled.

But was it? Section 503(b)(4) provides, as an administrative expense, "reasonable compensation for
professional services rendered by an attorney or an accountant of an entity whose expense is allowable
under paragraph (3) of this subsection..." With the addition of paragraph 3(F) in 1994, committee
members are now referenced in paragraph (3). Are legal and accounting fees incurred by a committee
member the kind of actual, necessary expense that is reimbursable by the estate under §503(b)(4)? If they
were incurred by a committee member in the performance of committee duties, they are in the Third
Circuit, the only circuit court to decide this issue thus far. <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re First Merchants Acceptance Corp., __
F.3d __, 1999 WL 1140769 (3rd Cir. 1999)</a>.

The debtor, First Merchants Acceptance Corp. (FMAC), was in the business of purchasing used car loans
from various auto dealers. J.C. Bradford & Co. held a number of FMAC's unsecured promissory notes.
As one of the debtor's largest unsecured creditors, Bradford was appointed to the official committee by the
U.S. Trustee and selected as its chairman. The committee retained professionals, including attorneys, whose
retention applications were approved by the court. Bradford also retained counsel during the course of the
bankruptcy, using the firm that had represented it in connection with the pre-petition promissory notes
(Bass). As narrated by the court,

<blockquote>
According to Bradford, Bass was retained by Bradford to assist it both in its capacity as a creditor and
as a member and chair of the committee. Bradford also contends that some services Bass performed
were with the knowledge of, and at the request of, the committee's counsel and members of the
committee.
</blockquote>

<a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… WL at *1</a>.

A plan was confirmed in March 1998, and shortly thereafter, Bradford applied for reimbursement
under §503(b)(4) of some of the attorney fees it paid to Bass during the case. The district court, sitting
as the bankruptcy court, denied Bradford's application, holding that §§503(b)(3)(F) and (4) "were
ambiguous with respect to whether an individual committee member may obtain reimbursement for
professional fees and that the legislative history and policies of the Bankruptcy Code suggest that
Congress intended to prohibit recovery of such fees as administrative expenses.'" Id., quoting slip
opinion.

Section 503(b)(4) provides for "reasonable compensation for professional services rendered by an
attorney or an accountant of an entity whose expense is allowable under paragraph (3)." (emphasis
added). Confronted with this language, the Third Circuit properly rejected the alleged ambiguity:

<blockquote>
It seems inescapable from the statutory language that when Congress enacted the 1994 Bankruptcy
Reform Act and added members of creditors' committees to the list in §503(b)(3) of those who can
claim "actual" and "necessary expenses," it simultaneously expanded the list of entities who are
entitled to reimbursement for professional fees under §503(b)(4).
</blockquote>

Id. at *3.

Given the plain language of the statute, the Third Circuit was compelled to reject the arguments of
the debtor and the U.S. Trustee that allowing a committee member to recover its professional fees would
be in "sharp conflict" with the statutory process by which the committee as a whole may employ
professionals. Section 1103(a) of the Code requires that a majority of the committee select professionals
subject to court approval following the requisite disclosures. According to the debtor and the U.S.
Trustee, allowing an individual committee member to retain private counsel would vitiate the
requirement of prior approval by the court and the committee as a whole, and would conflict with the
legislative history surrounding the 1994 amendments. In the absence of statutory ambiguity, the Third
Circuit was required to respect the innumerable decisions of the Supreme Court, declaring that "only
absurd results and 'the most extraordinary showing of contrary intentions' justify a limitation on the
'plain meaning' of the statutory language." Id. at *9, quoting <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… States v. Gonzales, 520 U.S. 1</a>; <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…
S.Ct. 1032</a>; <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… L.Ed.2d 132 (1997)</a>. According to the court, no such extraordinary showing was made.
"Responsible fulfillment of these [committee] duties may entail a substantial amount of work by
committee members, which is of value to the committee as a whole and may require services by a
creditor's counsel." <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; at *9</a>.

Rejecting the prediction that the allowance of professional fees to committee members would be
"an invitation to chaos," the court noted that the "bankruptcy court retains the power to ensure that only
those fees that are demonstrably incurred in the performance of the duties of the committee, the
statutory standard, are reimbursed." <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; at 9</a>. Moreover, any such fees must be reasonable and
necessary, a "review committed to the sound discretion of the bankruptcy courts." <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; Thus, the court
concluded that many of the concerns raised "can be accommodated within the plain language
interpretation of the statute, and the ruling of the bankruptcy court on remand will set the tone for
future applications, even if Congress fails to amend the statute once more to make clear its intent..."
<a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…;

At least since the Supreme Court's decision in <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…. v. Ron Pair Enterprises Inc., 109 S.Ct. 1026
(1989)</a>, the Third Circuit had little choice in its reliance on the "plain language" of the statute.
Nevertheless, the court may have been too sanguine in assuming that the impact of its holding would
be limited. It has become increasingly common for attorneys to sit on committees as their client's
representative. In one recent case, for example, several large Korean companies retained bankruptcy
counsel to serve on the unsecured creditors' committee as their designated representatives. Designating
experienced bankruptcy counsel is equally common in cases involving large unsecured institutional debt
or bond issues. The fees generated by these attorneys/committee representatives would almost certainly
be "incurred in the performance of the duties of such committee," the statutory standard under
§503(b)(3)(F). Due to issues of geography or legal complexity, among others, such fees may also be
"actual and necessary" to the functioning of the committee, the only other requirement under §503(b).
In these circumstances, it may be more difficult for the bankruptcy court on remand "to set the tone for
future applications," as instructed by the Third Circuit, than was originally thought.

Journal Authors

Joel D. Applebaum

Journal Date

Saturday, April 1, 2000 - 12:00