Restructuring

Contributed by Elisa Lemmer
Of all the things that can be said about the Bankruptcy Code, one thing is true: the Bankruptcy Code has no shortage of terms and phrases whose definitions are left to the interpretation of bankruptcy courts.  This, of course, leads to litigation and, in some cases, to a lack of uniformity across the circuits. In recent memory, for example, we can recall the extensive litigation the term “indubitable equivalent” has caused, and today we add the term “substantial contribution” to the mix.
Last month, in In re Tropicana Entertainment LLC, the United States Court of Appeals for the Third Circuit entered an order affirming the denial of a motion for reimbursement of approximately $2.3 million in fees and expenses filed by a consortium of ad hoc noteholders, claiming their actions had resulted in a substantial contribution to the debtors’ estates under section 503(b)(3)(D) of the Bankruptcy Code.  Agreeing with the district court and bankruptcy court below, the Third Circuit found that the noteholders failed to overcome the presumption that they acted in their own best interests and failed to show that they would not have acted but for the prospect of reimbursement from the debtor’s estate.  The decision is consistent with prior Third Circuit jurisprudence on the issue, so it’s not groundbreaking in that regard.  It does, however, remind creditors that the term “substantial contribution” remains subject to interpretation across the circuits.
Background
The seeds for the substantial contribution fight that eventually made its way to the Third Circuit in Tropicana were planted almost five years ago, in December 2007, when the New Jersey Casino Control Commission revoked a New Jersey gaming license issued to Tropicana Entertainment LLC, a casino and resort operator, as a result of the “gross mismanagement of board member William J. Yung, III.”  The revocation of the New Jersey license had a domino effect across Tropicana’s operations, triggering events of default under Tropicana’s secured credit facility and indenture and resulting in threats of de-licensure for Tropicana’s other operations in Nevada and Indiana.  Against this backdrop, an ad hoc consortium of noteholders urged Yung to step down from the board.  He refused to step down, and in May of 2008, Tropicana sought bankruptcy protection in the United States Bankruptcy Court for the District of Delaware.
One day after Tropicana filed its voluntary petition, the consortium filed an emergency motion seeking the appointment of a chapter 11 trustee in the hopes of removing Yung from Tropicana’s management. The consortium’s motion was eventually settled, and the settlement provided that Yung would resign from his management position.  The settlement agreement also included an acknowledgement from Tropicana that the consortium’s expenses in prosecuting the trustee motion represented “a substantial contribution to the Debtors’ estate.”
Approximately one year later, in May 2009, Tropicana confirmed its plan of reorganization.  Shortly thereafter, the consortium filed an application for reimbursement of the expenses it had incurred in connection with the trustee motion.  The consortium argued that its legal fees represented a substantial contribution to Tropicana’s estate under sections 503(b)(3)(D) and 503(b)(4) of the Bankruptcy Code.
Section 503(b)(3)(D) allows as an administrative expense costs a creditor incurs in making “a substantial contribution in a case under chapter 9 or chapter 11” of the Bankruptcy Code.  Section 503(b)(4), in turn, allows reasonable compensation for professional services of an attorney or accountant of a creditor whose expense is allowable under section 503(b)(3)(D).  The bankruptcy court denied the consortium’s application for reimbursement holding that, although the trustee motion “turned out to have a beneficial effect on the estates,” the “action was taken largely in the self-interest of [the consortium] and would have been taken whether there would have been estate reimbursement or not.”  The United States District Court for the District of Delaware affirmed the bankruptcy court’s decision, and the consortium subsequently appealed the district court’s decision to the Third Circuit.
Analysis and Holding
The Third Circuit began its analysis by observing that, although it exercised plenary review over the district court’s decision and the legal determinations of the bankruptcy court, it reviewed the bankruptcy court’s factual findings only for clear error.  The court then stated that whether a creditor has made a substantial contribution to a debtor’s estate under section 503(b)(3)(D) is a question of fact and observed that the bankruptcy court “is in the best position to perform the necessary fact finding task.”  In other words, the consortium was facing an uphill battle on appeal.
In determining whether the services performed by the consortium constituted a “substantial contribution” to Tropicana’s estate, the Third Circuit employed the test it previously set forth in Lebron v. Mechem Fin. Inc., which examined “whether the efforts of the applicant resulted in an actual and demonstrable benefit to the debtor’s estate and creditors” and elaborated further that “the term ‘substantial’ is the concept that the benefit received by the estate must be more than an incidental one arising from activities the applicant has pursued in protecting his or her own  interests.”  The Lebron court also stated that a creditor would be presumed to act in its own interests until it showed that its efforts “transcended self-protection.”   Against this framework, as it did in Lebron, the Third Circuit concluded that a substantial contribution award should exclude reimbursement for activities of creditors that were aimed at furthering the creditors’ own interests and that would have been undertaken regardless of whether the creditors expected to be reimbursed from the debtor’s estate.
The consortium asserted that the bankruptcy court based denial of the consortium’s application on the finding that the consortium would have prosecuted the trustee motion without an expectation of reimbursement from the debtor’s estate.  The Third Circuit rejected this argument, observing that the bankruptcy court had properly applied Lebron to conclude that the consortium failed to present any evidence indicating that it would not have prosecuted the trustee motion without the promise of reimbursement from the estate.  In other words, the consortium’s self-interest in prosecuting the trustee motion was presumed – no finding of the bankruptcy court to that effect was necessary.  To overcome the presumption, the consortium was required to show that it would not have prosecuted the trustee motion but for the prospect of reimbursement from the debtor’s estate.  Finding little evidence presented by the consortium to that effect, the Third Circuit held that the bankruptcy court did not clearly err in rendering its decision and affirmed the judgment of the district court (which had affirmed the bankruptcy court’s judgment).
The Third Circuit’s standard for determining whether to award a creditor’s request under section 503(b)(3)(D) is not universal across the circuits.  Like the Third Circuit, the Tenth Circuit appears to consider a creditor’s motives when reviewing an application under section 503(b)(3)(D).  The Fifth and Eleventh circuits, however, have rejected the notion that a creditor’s motivation should factor in a court’s analysis of a creditor’s substantial contribution request.  They have observed that the degree of benefit conferred on an estate should not be diminished by the creditor’s “shrewd” motivations. And the Ninth Circuit has taken a middle of the road approach by noting that it need not decide between the competing approaches generally and limiting its substantial contribution analysis to the specific facts before it. Other circuit courts of appeals have not yet addressed the issue head on.
The lack of a definition for the term “substantial contribution” in the Bankruptcy Code coupled with conflicting jurisprudence makes the issue one to continue watching.  Perhaps the circuit split will help the issue eventually wind its way to the Supreme Court or perhaps Congress will take a stab at making its own “substantial contribution” to the Bankruptcy Code by defining what it means to have made a substantial contribution to a debtor’s estate (and whether a creditor’s motivation should play into that determination).  For now, creditors seeking reimbursement from a debtor’s estate under section 503(b)(3)(D) should be aware that what it means to make a “substantial contribution” to a debtor’s estate may differ depending on the judicial circuit in which the bankruptcy case is filed.