The following is a case update prepared by Dan Schechter, Professor Emeritus, Loyola Law School, Los Angeles, analyzing a recent decision of interest:
A bankruptcy court in Washington has held that after a creditor assisted a bankruptcy trustee’s prosecution of a fraudulent transfer claim against a bank, the creditor was entitled to seek an award of administrative expenses for its “substantial contributions” to the Chapter 7 estate. [In re Maust Transport, Inc., 2018 Westlaw 4488712 (Bankr. W.D. Wash.).]
FACTS: Following the filing of an involuntary Chapter 7 petition, one of the petitioning creditors suspected that the debtor’s secured lender had received a fraudulent transfer. The Chapter 7 trustee had no funds to pursue the case and could not locate contingent fee counsel to handle the matter. The petitioning creditor then assembled some evidence and obtained a firm willing to handle the prosecution on a contingency basis.
Ultimately, that firm settled the fraudulent transfer claim against the bank, resulting in a substantial influx of cash to an otherwise-administratively insolvent estate. The settlement also extinguished the bank’s $3 million deficiency claim.
The petitioning creditor eventually sought to recover its fees and costs incurred in assisting the trustee’s pursuit of the fraudulent transfer settlement, claiming that it had made a “substantial contribution” under 11 U.S.C.A. §503(b)(3)(D). That provision permits the court to award administrative expenses incurred by “a creditor . . . in making a substantial contribution in a case under chapter 9 or 11 of this title.”
While acknowledging the creditor’s assistance, the trustee objected to the creditor’s application for administrative expenses, arguing that the statute permitted an award to a creditor who had made “a substantial contribution in a case under chapter 9 or 11 of this title.” Since the debtor’s bankruptcy was an involuntary Chapter 7 case, the language of the statute was not broad enough.
REASONING: The court disagreed, first noting that the introductory paragraph of §503(b) included the word “including,” which is an expansive term, rather than a limitation on the court’s powers. The court acknowledged noted that there was no controlling Ninth Circuit authority on the precise issue at bar and that the cases throughout the country were in conflict. The court held that the language of the statute did not prohibit an award of expenses:
[T]here is nothing in the Code specifically excluding such administrative claims in a Chapter 7. The use of the term “including” indicates an intent that the categories listed in the statute not be exhaustive and that the terms be flexible and adaptable to the unique circumstances of each case. In addition, the legislative history of this section indicates that Congress’s intent in enacting subsection (b)(3)(D) was to resolve a problem that was occurring in Chapters 9 and 11, not to exclude the allowance of such fees in the rare Chapter 7 case to which it would be applicable. Further, Congress could have specifically stated that such claims are never allowed in Chapter 7, 12 or 13, but it did not.
The court then invoked public policy in support of its reading of the statute:
The purpose of § 503(b)(3)(D) is to encourage creditors in whatever chapter a bankruptcy case is filed to “substantially contribute” to the estate by pursuing funds that will be available for distribution to claimants. If the particular facts of a case warrant reimbursement, the court should have the ability to fashion a remedy that will foster rather than hinder such actions for the benefit of the estate. While it is true, that in cases where there is a trustee, the allowance of such claims will be rare and such allowed substantial contribution claims should be limited to avoid overlap and duplication of efforts with those of the trustee, there are cases where for any number of reasons a creditor may still provide a “substantial contribution.”
The court finally held that the creditor’s efforts merited an award, although not in the full amount claimed by the creditor:
[The creditor’s] actions significantly benefitted the Chapter 7 estate. [The creditor] expended significant resources in obtaining documents, locating and interviewing counsel, and convincing such counsel to pursue the claims on a contingency basis. The fraudulent transfer action resulted in a compromise with [the bank] and other defendants and recovery for the estate in the amount of $200,000. After payment of fees and costs, the net recovery to the estate was $130,830.57. Although these are not the only funds recovered, they do constitute the bulk of funds received, and it is undisputed that such funds would not have been available for distribution to creditors but for [the creditor’s] actions.
AUTHOR’S COMMENT: It appears that this decision will not be appealed, which is unfortunate; it would be nice to have some guidance on this issue from either the BAP or the Ninth Circuit. If this case had gone up, I would have predicted affirmance. There is no sound policy reason that “substantial contributions” in Chapter 7 cases should be treated differently than in Chapter 9 or Chapter 11 cases. Why not reward creditors for helping the estate, whenever possible, as long as the bankruptcy courts carefully supervise the creditors’ fee applications?
For discussions of cases involving related issues, see:
- 2012 Comm. Fin. News. 50, Despite Lenders’ Key Role in Successful Reorganization, Court Declines to Award Administrative Status to Lenders’ Expenses.
- 2006 Comm. Fin. News. 83, Even Though Estate Benefited from Creditor’s Prepetition Pursuit of Fraudulent Transfers, Creditor May Not Receive Administrative Expense Reimbursement.
- 2006 Comm. Fin. News. 38, Creditor of Chapter 11 Debtor Is Entitled to Expense Reimbursement Where Creditor’s Negotiations with Other Creditors Resulted in “Substantial Contribution” to the Case.
These materials were written by Dan Schechter, Professor Emeritus, Loyola Law School, Los Angeles, for his Commercial Finance Newsletter, published weekly on Westlaw. Westlaw holds the copyright on these materials and has permitted the Insolvency Law Committee to reprint them.