An indenture trustee has no independent claim against the debtor for attorneys’ fees incurred in efforts to recover on bonds unless the indenture trustee has paid or is obligated to pay counsel, according to Delaware Bankruptcy Judge Brendan L. Shannon.
The opinion means that trust indentures need to be rewritten if the holders and the issuer intend to cover circumstances where counsel are representing bondholders on a contingency and the lawyers drill a dry hole.
In a major chapter 11 reorganization, a bank served as indenture trustee for an issue of about $1.25 billion in unsecured bonds that were subordinated to almost all claims. The bondholders ended up receiving nothing in the confirmed chapter 11 plan.
Typical Indenture Provisions
When bonds go into default or bankruptcy, indentures typically provide that the indenture trustee is not required to incur expenses absent indemnification by the holders. In the case before Judge Shannon, a pair of bondholders agreed to indemnify the indenture trustee for $3 million.
The indenture trustee retained counsel. The engagement agreement gave the lawyers the right to recover the greater of their hourly rates or 10% of the bondholders’ recovery. However, the engagement agreement went on to say that the indenture trustee’s liability to pay counsel would be limited to the $3 million indemnification. The agreement also said that the indenture trustee would not be obligated to use its own funds to pay counsel.
Although not relevant to the case at hand, indentures usually also include a so-called trustee’s lien. Based on the concept of a possessory lien, the provision means that the indenture trustee can recover its expenses from the distribution earmarked for noteholders before paying the remainder to noteholders. The indenture trustee’s lien was inapplicable to the case before Judge Shannon because there was no distribution for bondholders in the plan.
The bondholders’ lawyers went on to spend almost $30 million more than the $3 million indemnification. So, the indenture trustee filed an unsecured proof of claim for the $30 million. Had the claim been allowed, the plan would have paid almost one-third, meaning that the lawyers would have been paid about $10 million for their trouble.
The $30 Million Unsecured Claim
The debtor objected to the $30 million claim, even though the confirmed plan specifically provided that the indenture trustee could file an unsecured claim for its fees and expenses. The lawyers still ended up with nothing under Judge Shannon’s June 25 opinion.
The debtor did not base the objection on anything in the Bankruptcy Code or the plan. Rather, the debtor relied on the indenture to disallow the $30 million unsecured claim.
The indenture provided that the debtor must “reimburse the Trustee . . . for all reasonable expenses, disbursements and advances incurred or made by the Trustee . . . .” Naturally, the indenture trustee argued that it had “incurred” $30 million in unpaid counsel fees.
Judge Shannon framed the question as “whether professional fees are ‘incurred’ when the client has no obligation to pay them.” He cited Black’s Law Dictionary and caselaw for the notion that an expense is “incurred” only when there is liability for the expense. Of course, the indenture trustee had no liability for the $30 million in the case at hand as a consequence of the disclaimer in the engagement agreement.
Judge Shannon therefore held that the indenture did “not require [the debtor] to reimburse [the indenture trustee] for amounts that [the indenture trustee] is not obligated to pay, that is, amounts that were not incurred.”
Having failed by relying on the words “incurred” and “reimburse,” the indenture trustee proffered another provision in the indenture that did not include those words. Following default by the debtor, that section said that the debtor will “pay . . . such further amount as shall be necessary to cover the costs and expenses of collection.”
The provision didn’t underpin a valid claim for two reasons, Judge Shannon said.
First, if the indenture trustee “has not incurred any liability to pay the costs or expenses of collection, then there is no amount to pay to [the indenture trustee].”
Second, Judge Shannon said there were no “costs and expenses of collection” because the noteholders collected nothing.
Judge Shannon held that the other sections did “not create a right to payment for fees and costs that [the indenture trustee] is not obligated to pay.” [Emphasis in original.]
Judge Shannon allowed the claim for $3 million, the amount of the indemnification, but disallowed the remainder.
An indenture trustee has no independent claim against the debtor for attorneys’ fees incurred in efforts to recover on bonds unless the indenture trustee has paid or is obligated to pay counsel, according to Delaware Bankruptcy Judge Brendan L. Shannon.
The opinion means that trust indentures need to be rewritten if the holders and the issuer intend to cover circumstances where counsel are representing bondholders on a contingency and the lawyers drill a dry hole.
In a major chapter 11 reorganization, a bank served as indenture trustee for an issue of about $1.25 billion in unsecured bonds that were subordinated to almost all claims. The bondholders ended up receiving nothing in the confirmed chapter 11 plan.