Contributed by Alana Katz.
Outside of section 506(b) of the Bankruptcy Code, which affords secured creditors a right to enforce their contractual entitlements to fees, the Bankruptcy Code does not expressly give creditors a right to seek reimbursement of fees incurred during a debtor’s bankruptcy. Section 503(b)(3)(D) of the Bankruptcy Code, however, permits a creditor to seek reimbursement of fees and expenses incurred by the creditor in making a “substantial contribution” to the case. In assessing a creditor’s “substantial contribution,” where does the bankruptcy court draw the line between the consequences of a creditor acting out of self-interest to capture the maximum value from the debtor’s estate as opposed to the effects of a creditor acting to uphold the integrity of the bankruptcy system? Does the motive even matter if the results benefit the estate? In a recent decision, the Bankruptcy Court for the Eastern District of Pennsylvania adopted a framework for answering these questions.
In Grasso, the debtor filed an individual chapter 11 case in which Madison Capital Company, LLC was one of the largest unsecured creditors. Madison Capital moved to convert the debtor’s case to a chapter 7 case based on the debtor’s failure to file monthly operating reports and required financial disclosures. Madison Capital’s motion also alleged the debtor improperly used estate assets to fund his postpetition living expenses. In the alternative, Madison Capital moved for the appointment of a chapter 11 trustee under section 1104(a) of the Bankruptcy Code.
The bankruptcy court ultimately appointed a chapter 11 trustee based on the grounds that the debtor was dishonest in his testimony to the court, diverted estate assets, and breached his fiduciary duty as a debtor in possession. Madison Capital then moved under section 503(b)(3)(D) for reimbursement of the fees and expenses it incurred in pursuing the conversion and trustee motions, as well as a related Bankruptcy Rule 2004 motion.
In determining where to draw the line between actions for which a party can seek reimbursement as a “substantial contribution” to the case and those for which the party is not entitled to reimbursement, the bankruptcy court first looked to the Third Circuit precedent in Lebron v. Mechem Financial Inc. In Lebron, the circuit court held that, although a creditor does not need to act purely from altruistic motives, the creditor’s actions must “transcend self-protection” in order to be reimbursed for fees and costs. No mantra is required, but the creditor must show that its actions are detached from purely selfish motives and have benefitted the entire bankruptcy process. The Bankruptcy Court for the District of Delaware recently clarified this threshold in In re Spansion Inc., identifying four factors courts can use when deciding whether a creditor should be reimbursed: (1) whether the services were provided to benefit the estate generally or the party specifically; (2) whether the services conferred a benefit upon the estate; (3) whether the services were duplicative of other parties’ efforts; and (4) whether the services would have been provided absent an expectation of reimbursement.
In connection with Madison Capital’s motions, the court found that Madison Capital uncovered inconsistencies in the debtor’s bankruptcy schedules and other disclosures. These inconsistencies were among the court’s primary reasons for appointing a chapter 11 trustee and would have led to a denial of plan confirmation, which the Third Circuit recognized in Lebron as a substantial contribution to the estate. Madison Capital’s efforts were therefore of primary significance to the court’s decision. As a result, the court held that Madison Capital satisfied all factors of the Spansion test for these motions and granted Madison Capital’s request for associated attorneys’ fees and costs as an administrative expense of the estate.
Madison Capital also requested reimbursement in connection with two other motions: a claim objection and a second motion to convert to chapter 7. In connection with these motions, the court found that Madison Capital’s actions did not meet all four factors. The court stated that Madison Capital’s self-interest in increasing the size of its distribution was the reason for filing the objection to a competing claim, therefore failing to satisfy the first factor. The court also explained that Madison Capital would have performed work related to the second conversion motion absent an expectation of reimbursement and that Madison Capital performed the services specifically to protect its claim, failing both the first and fourth factors. Therefore, the court denied Madison Capital’s request for reimbursement associated with these motions.
The Grasso decision demonstrates that creditors should be wary of relying on reimbursements simply for providing a benefit to the estate. Courts may analyze each action of the creditor separately to see whether self-interest motivated the party’s actions. Although a creditor’s actions are rarely altruistic, “transcending self-protection” and providing a substantial contribution to the estate can be recognized and rewarded by the court.