Business Law

Fin. of Am. LLC v Mrtg, Windown LLC (In re Ditech Holdings Corp.) (S.D.N.Y. 2022)

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The following is a case update written by Adam A. Lewis, Senior Counsel, Morrison & Foerster LLP, analyzing a recent decision of interest:


In Fin. of Am. LLC v Mrtg, Windown LLC (In re Ditech Holdings Corp.), ___ F.4th ___, 2022 U.S. Dist. LEXIS 172793, 2022 WL 4448867 (S.D.N.Y. 2022) (“Ditech”), the United States District Court for the Southern District of New York (the “District Court”) overruled the decision of the Bankruptcy Court for the Southern District of New York (the “Bankruptcy Court”) that a creditor’s claim for postpetition performance on a later-rejected prepetition executory contract generates only a general unsecured claim rather than an administrative expense claim.  The District Court rejected the Bankruptcy Court’s theory that because a contingent obligation arose when the contract was signed, whenever the duty might later be performed, it necessarily was a prepetition claim. In its ruling, the District Court advanced two rationales:  (1) that the question is not per se when the obligation arose, but whether the parties reasonably contemplated that it might be performed at a later date that turned out to be postpetition in a bankruptcy; and (2) that equitable considerations disfavor conferring a windfall on a debtor in possession and because the benefits to the debtor’s bankruptcy estate created by the creditor’s performance outweigh the imposition on the estate.

To view the opinion, click here


The creditor lender (the “Lender”) and the subservicer/eventual debtor (the “Servicer”) entered into subservicing contracts beginning in 2011 under which the Servicer collected and remitted mortgage payments to the Lender for a fee.  The Servicer filed its voluntary Chapter 11 petition on February 11, 2019 (the “Petition Date”). 

The 2011 contract’s term, including automatic renewals, expired in March of 2018, but the parties entered into a series of extension agreements that ran through March of 2019, a month and a half after the Petition Date.  The second and third agreements, signed in December 2017 and October 2018 were for a month each, but each allowed the parties jointly to extend it on a monthly basis.  The parties exercised the monthly extensions of the second agreement through February of 2019, that is, until the end of the month of the Petition Date.  And they executed monthly extensions of the third agreement through September 2019, right after which the debtor’s confirmed plan became effective (the “Effective Date”), seven months after the Petition Date.  Notably, all the extended agreements expired postpetition, and the 2011 and 2018 agreements were extended at least once (and in the case of the 2018 agreement, multiple times) postpetition.  Thus, when the bankruptcy case was filed all three agreements were executory contracts, one for just a half month through February 2019, one a little longer through March 2019 and one for some months through September 2019 until the Effective Date. 

In November 2019, shortly after the Effective Date, the Lender filed an administrative proof of claim for $375,000+, which it later amended to at least $14 million (the “Administrative Claim”), seeking compensation under Bankruptcy Code (the “Code”) section 503(b)(1) for “actual, necessary costs and expenses of preserving the estate.”  The opinion does not describe the facts giving rise to the alleged breaches underlying the Administrative Claim.  Thus, who did or did not do what is unclear to the reader. 

In April 2020 the plan administrator filed an objection to the Administrative Claim that the Bankruptcy Court sustained.  The Bankruptcy Court based its decision on case law tied whether a claim for postpetition breach of an executory contract is a general unsecured claim or a priority administrative claim to when the parties entered the underlying contract giving rise to the rights and duties at issue, not when the duties themselves matured or were violated.  It added that because the extensions were of prepetition agreements, under New York law all three of the contracts were considered to be prepetition rather than new, postpetition agreements even though the extensions occurred postpetition.  The Lender appealed to the District Court, which reversed. 


The District Court rejected the Bankruptcy Court’s reliance on New York law rather than on the Code to characterize the contracts, particularly sections 503(b)(1) and 365 (which governs executory contracts), along with bankruptcy law generally. 

The correct test, the District Court wrote, begins with whether “‘the risk of . . . . [postpetition breaches] . . .was within the fair contemplation of the parties”s upon entering the contract.  [Citation omitted.]  Put differently, the question is whether when agreeing to the contract the parties thought they might still have obligations to perform after February 11, 2019 (which turned out to be the petition date).  Note that is a different question than whether the parties thought they might have obligations to fulfill after a bankruptcy petition was filed.  This is a calendar test, not an intervening(bankruptcy) event test.  If the answer is “yes,” then a postpetition breach cannot generate an administrative claim.  But if the answer is “no” because any actual postpetition transaction otherwise in accordance with its terms was not prescribed by the contract to occur but instead voluntarily initiated postpetition, then it can give rise to an administrative expense.  The District Court never explains why this matters; the apparent reason is that a debtor that asks for performance not otherwise due but provided for in the contract if requested is in a sense engaging in a totally postpetition transaction. 

The District Court endorses this conclusion by reverting to the rationale for administrative expenses:  it is to induce parties to do business with a postpetition debtor to help improve (or at least stabilize) its financial condition for the benefit of its creditors generally.  A genetically-related rationale is to avoid unjust enrichment of the debtor and its other creditors at the expense of a party whose postpetition performance benefitted them.

The District Court treated one more issue.  Even if the Lender’s claims did not otherwise qualify for administrative expense claims, there is precedent for sustaining such claims when the debtor received “demonstrable benefit” under the contract postpetition.  The court identifies this as a species of quasi-contract recovery.


Unfortunately, because the opinion does not recite what exactly transpired between the parties postpetition, it is hard to tell just what conduct does and does not qualify under the criteria the District Court formulates, thus limiting its instructive value.  But whatever may be the particulars, it seems incontestable (or it should be incontestable) that if a debtor induces or demands postpetition performance under a prepetition executory contract, it (that is, its bankruptcy estate) should pay for it.  Bankruptcy is not a ticket to operate for free.  Another fact missing from the opinion is whether the postpetition extensions were approved by the Bankruptcy Court.  Any party doing business with a debtor is wise to ask itself whether postpetition contract modifications need no approval because they are ordinary course (see Code section 363(b)(1)); if the answer to that is not clear, it is wise to require of the debtor to seek such approval.

This review was written by Adam A. Lewis, Senior Counsel, Morrison & Foerster LLP, a member of the ad hoc group, with editorial assistance by the Hon. Meredith Jury (U.S. Bankruptcy Judge, C.D. CA., Ret.), a member of the ad hoc group. Thomson Reuters holds the copyright to these materials and has permitted the Insolvency Law Committee to reprint them. This material may not be further transmitted without the consent of Thomson Reuters.

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