Fifth Circuit Clarifies ‘Admin’ Status for a Drilling Contractor’s Post-Rejection Claims

In a significant opinion for the oil and gas industry, the Fifth Circuit clarified the circumstances when an offshore drilling contractor is entitled to an administrative expense claim after the rejection of a drilling contract. More generally, the appeals courts says that a specific request from the debtor in possession for services is not required for the allowance of an administrative claim.

After remand to make additional findings of fact, the drilling contractor may end up with a larger administrative claim than the bankruptcy court originally allowed.

The Drilling Contract

The debtor was the owner of an offshore drilling and production platform. Before bankruptcy, the debtor hired the drilling contractor to install a drilling rig and associated equipment on the platform and provide workers to drill a new well from the platform. 

Before bankruptcy, a worker was killed in an accident on the platform. Federal regulators then shut down the drilling project. Two weeks later, creditors filed an involuntary petition against the owner of the platform.

In chapter 11, the debtor in possession paid the creditor to abandon the well. When abandonment was completed, the debtor filed a motion to reject the contract with the creditor. 

The bankruptcy court granted the rejection motion, effective as of the day when abandonment had been completed. 

Four months after rejection of the contract, regulators approved a demobilization plan for the drilling contractor to remove the drilling rig and its other equipment from the platform. Six months after rejection, the drilling contractor had removed its equipment from the platform.

The drilling contractor filed an administrative claim for about $7 million, covering the period from the effective date of rejection until it had removed its equipment from the platform.

The bankruptcy judge allowed an administrative claim for some $900,000, holding that the contractor was entitled to a priority claim only for services specifically requested by the debtor after the effective date of rejection. The district court affirmed in July 2018. To read ABI’s report on the district court affirmance, click here.

The drilling contractor appealed and won a remand in a July 26 opinion by Circuit Judge Stephen A. Higginson. Having clerked on the Supreme Court and served as an assistant United States Attorney, Judge Higginson was unanimously confirmed by the Senate in 2011.

The Law on ‘Admin’ Claims

Judge Higginson synthesized Fifth Circuit law on the allowance of administrative claims under Section 503(b)(1)(A). To qualify as “actual, necessary costs and expenses of preserving the estate,” he said the claim must have arisen post-petition and as a result of actions taken by the debtor in possession that benefitted the estate.

More to the point, Judge Higginson said that the claim must have arisen from a transaction with the debtor in possession, as opposed to the pre-bankruptcy debtor. The creditor, he said, “must show some inducement by the debtor in possession.” However, he said there need be no “explicit request by the debtor in possession for specific services.”

In line with sister circuits, Judge Higginson said that an administrative claim can be based on a direct request by the debtor or by “the knowing and voluntary post-petition acceptance [by the debtor] of desired goods or services.” In addition, the claimed expenses must benefit the estate.

Significantly, Judge Higginson said that a debtor in possession cannot rent equipment and then disclaim liability as an expense of administration “by asserting that it did not end up needing the equipment.”

Judge Higginson said that the bankruptcy court drew a “sharp distinction” between being available to provide services and actually providing services. Nonetheless, he said, “conducting business as usual often requires that certain goods or services be available, even if ultimately not used.”

Pre- and Post-Demobilization Claims

Applying the facts to the law, Judge Higginson broke down the claim into two segments: (1) Predemobilization, meaning the four months after rejection up until the contractor was authorized by regulators to begin removing its equipment from the platform, and (2) demobilization, or the two months it took to remove the equipment from the platform after the receipt of regulatory approval.

With regard to the predemobilization, Judge Higginson said that the denial of most of the claim for administrative status “appears to have been influenced by [the bankruptcy court’s] stated view that [the drilling contractor’s] mere availability on the platform did not warrant administrative priority.” To the contrary, he said, waiting for regulatory approval “can benefit the debtor in possession,” because the debtor asked the contractor to prepare a demobilization plan and wanted the contractor to await regulatory approval before removing its equipment.

Applying the concepts to the facts, Judge Higginson said that the contractor would have a priority claim “for the actual and necessary cost of its presence on the platform for the period of time required to satisfy [the debtor’s] logistical and regulatory requirements.” On the other hand, he said the contract would not qualify for a priority claim “for the costs of its presence on the platform for any time attributable to its own unnecessary delay.”

Judge Higginson remanded the case for the bankruptcy court to determine: (1) whether the debtor induced the contractor to remain on the platform; (2) the length of time the contractor was on the platform “because of [the debtor’s] post-petition needs,” and (3) “the actual and necessary costs of staying on the platform during this time period.” He said that “actual and necessary” includes the costs of “remaining on the platform” and “the full and ordinary costs of providing a service, including overhead costs and other indirect expenses.” In a footnote, he said the contractor is not entitled to a double recovery.

On the demobilization costs, the contractor did not fare so well, because Judge Higginson upheld the bankruptcy court by denying administrative status for everything. He said that demobilization “was simply the consequence of [the debtor’s] rejection of the contract and did not benefit the estate.”