Restructuring

Contributed by Victoria Vron
It is a common misconception that services or goods provided postpetition to a debtor will always be paid as an administrative expense claim.  While generally true, In re Universal Building Prods., Case No. 10-12453 (Bank. D. Del. Mar. 7, 2011), reminds us of the risks a person undertakes in providing services or goods to a debtor postpetition – especially when those services or goods are provided voluntarily.

In Universal Building Prods., the debtors entered into an asset purchase agreement with their prepetition lender, UBPAC, to sell substantially all of their assets to UBPAC.  UBPAC agreed to provide the debtors DIP financing pending completion of the sale.  The DIP budget included a line item for the debtors’ costs for cleaning up leased facilities upon rejection of the leases in the amount of $635,000.  The debtors rejected all of their real estate leases shortly after approval of the sale.
Notwithstanding the line item in the DIP budget for the debtors’ clean-up costs and before the debtors could commence any clean-up of their own, UBPAC (through its affiliate) paid certain vendors and service providers directly for clean-up and exit costs related to the debtors’ vacating the leased facilities.  UBPAC then filed an application with the bankruptcy court seeking payment of an administrative expense claim for such costs in the amount of $674,964.00.  The debtors objected to the motion and the bankruptcy court sustained the objection for the reasons that follow.
As a refresher, the Bankruptcy Code provides that administrative expenses shall be allowed after a notice and a hearing, including “the actual, necessary costs and expenses of preserving the estate.”  11 U.S.C. § 503(b)(1)(A).  According to the bankruptcy court, to fall into this category, an expense must satisfy the following two-prong test:
(1)   the expense must have arisen from a postpetition transaction between the creditor and the debtor; and
(2)   the transaction must have been “actual and necessary” to preserve the estate.
The bankruptcy court found that UBPAC’s claim satisfied the first prong of the test because the asset purchase agreement evidenced a postpetition transaction between the parties.
The bankruptcy court found, however, that UBPAC’s claim failed the second prong of the test.  UBPAC claimed that its efforts to leave the leased facilities in a broom-clean condition benefited the estate by preventing the Debtors from having to pay clean-up costs as required under the leases.  The bankruptcy court disagreed for two reasons.  First, the bankruptcy court pointed to the fact that UBPAC cleaned up the leased facilities voluntarily, as neither the asset purchase agreement nor the debtors required UBPAC to do so.  In fact, UBPAC took such actions knowing that the DIP budget reflected that it was the debtors’ obligation to do such clean up.
Second, the bankruptcy court found that UBPAC’s actions actually would harm the estate if administrative expense status were awarded because it would transform a prepetition claim for clean-up costs into a postpetition administrative expense claim.  The bankruptcy court observed that the debtors consciously determined not to clean up the leased facilities because the leases were being rejected.  As a result, the landlords’ claims for the clean-up costs would have been part of their rejection damages, which are treated as prepetition claims.  Thus, the court noted that it was, in fact, the landlords, and not the debtors, that received a benefit from UBPAC’s voluntary actions.
It is not clear what prompted UBPAC to voluntarily clean up the leased premises (based on the pleadings filed by both parties, the debtors appear to contend that it was allegedly to derail the debtors’ chapter 11 plan by making the estate administratively insolvent, while UBPAC claims it was to ensure that landlords do not assert amounts for holdover rent or seek damages for clean-up, which may require additional DIP advances), but the end result for UBPAC was disastrous.  Not only is it unclear whether UBPAC will be able to successfully assert even a general unsecured claim for the clean-up costs (the court’s decision was silent on this point), but UBPAC arguably ended up paying twice for the clean-up costs because, as part of a last minute settlement with the official committee of unsecured creditors regarding the sale process, UBPAC had agreed to lend the money in the DIP budget, regardless of whether it was actually used.  From this, the court noted that UBPAC should have been aware that the debtors could elect to use any unused DIP funds (such as the $635,000 that was allocated for clean-up costs) to fund the plan’s distributions to unsecured creditors.
Universal Building Prods. is thus a cautionary tale to all parties to make sure that proper documentation exists to support an argument that services or goods are being provided to benefit the estate and are not just being provided voluntarily.