Sixth Circuit “Contributes” to Section 503(b)(3)(D) Debate – Holds Substantial Contribution Claim is Available in a Chapter 7 Case

Contributed by Abigail Lerner
Congress made clear in its enactment of section 503(b)(3)(D) of the Bankruptcy Code that, to the extent a creditor makes a substantial contribution in a chapter 9 or chapter 11 bankruptcy case, that creditor should be rewarded.  Because the reward — reimbursement of fees and expenses as administrative expenses of the estate — is paid with funds that would otherwise be available to other creditors, oftentimes a request for a substantial contribution claim is met with resistance.  While substantial contribution claim litigation typically focuses on whether the creditor seeking reimbursement actually provided a contribution to the estate, a recent decision by the Sixth Circuit shows us that the debate surrounding section 503(b)(3)(D) does not stop there.  Rather, in In re Connolly North America, LLC, the court was asked to determine whether a creditor could assert a substantial contribution claim in a chapter 7 proceeding, notwithstanding  that the statute explicitly mentions the availability of these types of claims only in chapter 9 or chapter 11 cases.  Much to the relief of the petitioning creditors in Connolly, the Sixth Circuit answered yes (albeit in a 2-1 decision, demonstrating that the issue is a close call). 
In 2007, the bankruptcy court dismissed an adversary proceeding commenced by the chapter 7 trustee of Connolly North America, LLC, Mark H. Shapiro, after finding that Shapiro and his attorney had breached their discovery obligations due to gross negligence.  Subsequently, three of Connolly’s unsecured creditors filed a successful motion to remove Shapiro from the position of bankruptcy trustee.  Thereafter, Shapiro’s successor, Bruce Comly French, commenced an adversary proceeding against Shapiro, his law firm, and his professional liability insurer for damages.  The parties ultimately settled in 2012, which resulted in a significant increase in the amount of funds in the unsecured creditor pool.  In addition to approving the settlement, the bankruptcy court recognized that at least some of the work the unsecured creditors paid their attorneys to do in connection with removing Shapiro substantially benefitted the bankruptcy estate and Connolly’s unsecured creditors.
Notwithstanding the foregoing, the bankruptcy court denied the request made by two of the three unsecured creditors for reimbursement of $164,336.28 in attorney fees and costs for substantial contribution under section 503(b) of the Bankruptcy Code, which request was opposed by the U.S. trustee.  The bankruptcy court reasoned that section 503(b) does not authorize such reimbursement in a chapter 7 case.  The United States District Court for the Eastern District of Michigan affirmed, and the two creditors appealed to the Sixth Circuit, supported by the chapter 7 successor trustee as amicus curiae.
Majority Holding
The Sixth Circuit began its decision by setting forth two guiding principles.  First was “the overriding consideration that equitable principles govern the exercise of bankruptcy jurisdiction.”  Second, that statutory language is the keystone on which all other analysis relies.  With these principles in mind, the Sixth Circuit noted that it would only check the bankruptcy court’s exercise of its equitable powers where that exercise contradicts the plain, unambiguous meaning of the Bankruptcy Code.  After laying out these principles, the court turned to the issue at hand — whether the statutory construction of section 503(b)(3)(D) is a per se bar to reimbursement of administrative expenses under section 503 in a chapter 7 proceeding.
To answer this question, the court considered the text of the statute.  Section 503(b) states that administrative expenses may be awarded regarding nine categories of claims that it expressly deems reimbursable.  While recognizing one such category, set out in section 503(b)(3)(D), authorizes administrative expense reimbursement for creditors who have made “substantial contribution[s]” in cases under chapters 9 and 11 of the Bankruptcy Code, the court noted that there is no similar statutory provision for creditors in chapter 7 cases.  Specifically, that section provides:

(b) After notice and a hearing, there shall be allowed administrative expenses, other than claims allowed under section 502(f) of this title, including-

(3) the actual, necessary expenses, other than compensation and reimbursement specified in paragraph (4) of this subsection, incurred by-

(D) a creditor, an indenture trustee, an equity security holder, or a committee representing creditors or equity security holders other than a committee appointed under section 1102 of this title, in making a substantial contribution in a case under chapter 9 or 11 of this title.

11 U.S.C. §503(b)(3)(D) (emphasis added).
Although the lower courts were convinced that the above language precluded reimbursement in the present case, the Sixth Circuit was not persuaded that the statutory text compelled that conclusion.  Rather, the court focused on the “including” language leading into section 503(b)(3)(D), reasoning that section 102(3) of the Bankruptcy Code explains that the terms “includes” and “including” are not limiting and, accordingly, Congress’s failure to expressly designate a given expense allowable under section 503(b) did not mean that it was excluded.  Instead, reasoned the court, by using the term “including” in the opening lines of the subsection, Congress built a mechanism into section 503(b) for bankruptcy courts to reimburse expenses not specifically mentioned in section 503(b)’s subsections.
The court further explained that the examples in the subsections were not meaningless, but provided guidance to courts of the more common administrative expenses.  And, according to the court, it made good sense for Congress to expressly mention chapters 9 and 11 in the context of a creditor providing a substantial contribution where, in such cases, typically a creditor would use its own resources to benefit the estate.  In contrast, in a chapter 7 case, usually the U.S. trustee fills this role.  Here, the court noted, the U.S. trustee failed to fulfill its duty as “bankruptcy watch-dog.”
Finally, the court looked to the intent of the statute.  The court concluded that failing to award administrative expenses to the rare chapter 7 creditors who are forced to take action to benefit the estate when no other party will do so would disincentivize participation in the bankruptcy process, which would be inconsistent with the purposes of the Bankruptcy Code.  Therefore, holding that section 503(b)(3)(D) does not divest bankruptcy courts of authority to allow reimbursement in a chapter 7 case, the Sixth Circuit reversed the judgement of the district court and remanded for consideration of the merits of the unsecured creditors’ request.
Judge O’Malley, in dissenting from the majority opinion, characterized the majority as giving a “sweeping reach” to section 503(b).  Interpreting that section in the way the majority does, Judge O’Malley argued, would render section 503(b)(3)(D) superfluous because if substantial contribution claims in a chapter 7 case could be considered administrative expenses pursuant to the “including” proviso, Judge O’Malley explained, then so could substantial contribution claims under chapters 9 and 11, making section 503(b)(3)(D) unnecessary.  The dissent also relies on legislative history, noting that even the earliest drafts of section 503(b) fail to include a reference to chapter 7.  This is, according to Judge O’Malley, far more indicative of Congress’s intent than its use of the term “including.” ‎ While noting that the unsecured creditors’ actions here were commendable, the dissent concluded that the decision to expand section 503(b)(3)(D) to chapter 7 cases should be left to Congress.
As the adage goes, no good deed goes unpunished.  Except, maybe, in districts such as those in the Sixth Circuit.  There a creditor may be rewarded for its good deed of providing a substantial contribution in a chapter 7 case by having its fees and expenses reimbursed.  But, Connolly teaches us that creditors may not rest assured that this will uniformly be the case.  As the dissent points out, other courts, including at least one panel from the Sixth Circuit, agree that section 503(b)(3)(D) excludes chapter 7 cases.  Therefore, in advising their clients whether to take action in a chapter 7 case for the benefit of the debtor’s estate, attorneys should be sure to highlight the fact that any costs their clients incur will likely come out of their clients’ own pockets. Unless, of course, the case is in the Sixth Circuit.  In that circumstance, attorneys can tell their clients to rest a little easier – there is at least a chance that a substantial contribution claim will be approved even in a chapter 7 case.