An Update on Payment of Unsecured Creditors’ Professional Fees and Expenses in Chapter 11 Cases

While the Bankruptcy Code provides for payment of the fees and expenses of an official creditors’ committee’s court-approved professionals[1] and for reimbursement of the expenses (although not the professional fees) incurred by a member of an official creditors’ committee incurred in performing committee duties,[2] it permits an unsecured creditor to seek reimbursement of “actual, necessary expenses,” plus “reasonable compensation for professional services” only where the creditor has made a “substantial contribution” in the chapter 11 case.[3] The Bankruptcy Code does not define “substantial contribution” or list the criteria to be used in determining whether a substantial contribution has been made. However, courts have interpreted “substantial contribution” narrowly, limiting reimbursement to instances of “extraordinary creditor actions which lead directly to tangible benefits to the creditors, debtors, or estate.”[4] Courts also will consider whether the creditor’s efforts were duplicative of other, estate-compensated professionals,[5] and whether the creditor’s actions were motivated by self-interest.[6]

It has been suggested by some commentators that the difficulty of demonstrating that a substantial contribution has been made has led to efforts to obtain reimbursement of creditors’ professional fees by other, more flexible methods. Whatever the cause, it is true that in a number of large chapter 11 reorganization cases, individual creditors and members of ad hoc and official creditors’ committees have sought to recover their professional fees through consensual chapter 11 plans. For example, in In re Adelphia Commnc’ns Corp.,[7] as part of a consensual chapter 11 plan, a number of ad hoc committees and individual creditors were authorized to recover their reasonable professional fees without making a substantial contribution showing. Overruling the U.S. Trustee’s objection, the bankruptcy court concluded that the plan provision permitting payment of creditors’ reasonable professional fees did not violate § 1123(b)(6) of the Bankruptcy Code because “section 503(b) does not provide, in words or substance, that it is the only way by which fees of this character may be absorbed by the estate,” and that it satisfied § 1129(a)(4) of the Bankruptcy Code because the fee requests were subject to court approval as reasonable.[8]

The Adelphia court’s reasoning was adopted by the bankruptcy courts in In re AMR Corp.[9] and In re Lehman Bros. Holdings Inc.[10] in approving provisions in consensual chapter 11 plans providing for payment of the reasonable professional fees of individual members of official creditors’ committees. However, on the U.S. Trustee’s appeal in the Lehman Bros. case, the district court held that committee members’ professional fees were administrative expenses that could only be allowed and paid pursuant to § 503(b) of the Bankruptcy Code, not “permissive non-administrative expense plan payments” that could be paid pursuant to §§ 1123(b)(6) and 1129(a)(4) of the Bankruptcy Code. For these reasons, the district court vacated the bankruptcy court’s decision and remanded the decision for a determination of whether the individual committee members’ requests for professional fees qualified under the substantial contribution test of § 503(b)(3)(D) of the Bankruptcy Code.[11] Thereafter, the district court denied the committee members’ motion to certify its opinion for immediate appeal.

As a consequence of the district court’s Lehman Bros. decision, it is more likely that an unsecured creditor’s attempt to recover its reasonable professional fees through a consensual chapter 11 plan provision will be challenged, and that the unsecured creditor will be required to demonstrate that it made a substantial contribution to the case in order to obtain a recovery. Nevertheless, not every court is certain to follow the Lehman Bros. decision, and not every plan containing a provision for payment of unsecured creditors’ or ad hoc committees’ reasonable professional fees will elicit an objection. For this reason, particularly in bankruptcy courts other than the Southern District of New York, unsecured creditors are unlikely to be dissuaded from attempting to recover their reasonable professional fees through a consensual chapter 11 plan.

Very recently, for example, in a large chapter 11 case in Delaware,[12] an ad hoc committee employed a “combination” approach in which it sought reimbursement of a portion of its professional fees and expenses pursuant to a consensual chapter 11 plan provision that provided that such fees and expenses would be paid as administrative expenses pursuant to § 503(b) of the Bankruptcy Code, combined with a separate motion for allowance and payment of its professional fees and expenses. Neither the relevant plan provision nor the subsequent motion were challenged by the bankruptcy court nor objected to by the U.S. Trustee, and the ad hoc committee was therefore not required to demonstrate that it had made a substantial contribution to the case.

While only further observation of creditor practice in large chapter 11 cases will tell, this recent example suggests that the reasoning of the bankruptcy courts in Adelphia and Lehman Bros. is not entirely discredited, and perhaps that the distinction between a creditor acting individually or as part of an ad hoc committee, on the one hand, and serving on an official committee, on the other hand, will prove to be an important one when a court considers an unsecured creditor’s request for payment of its professional fees from a bankruptcy estate.