19: Administrative expenses
© Charles Tabb 2010
2nd priority (but in business case 1st)
 Administrative expenses are the 2nd priority,
under 507(a)(2)
 Really, though, in business cases, where admin.
expenses matter the most, they effectively are 1st,
b/c a business does not have DSO
Where find?
 507(a)(2) refers to 503(b) for the listing of admin
expenses
 There are 9 types of administrative expenses
listed in 503(b)
 No ordinal preference – all of equal rank
Not exclusive
 Not an exclusive list
 “including”
 So court can recognize an unlisted admin expense
but ONLY if it fulfills the statutory purposes
 As a practical matter almost everything ct might
consider falls within 503(b)(1) – “actual, necessary
costs and expenses of preserving the estate”
Narrow construction
 Cts narrowly construe admin expenses
 Why?
 They depart from the fundamental principle of
equality of distribution
Justification?
 So what is the justification for an admin expense,
given that allowing it puts one claimant ahead of
others – the residual unsecured crs?
 1) Is there a benefit to the residual claimants?
 2) if so, do we HAVE to give this particular
claimant priority in order to realize that benefit?
 i.e. if it makes sense to have a bankruptcy case in
the 1st place, do we have to afford admin priority
to fully capture the benefits of the bk case?
2 requisites
 1. Benefit to estate
 2. postpetition transaction with estate
2 main types
 1st – actual, necessary expenses either to operate the
dr’s business (e.g. in ch 11) or preserve & liquidate the
estate assets (eg in ch 7)
 Examples operating expenses:
 wages of ongoing employees
 current taxes
 rent
 Examples of liquidation expenses:
 Storage costs
 Costs of sale (advertising, auctioneer fees)
2nd type
 Pay people who work on the case
 E.g., their fees and expenses
 Examples:
 Bankruptcy trustee
 Attorneys for the estate
Jartran
 Illustrates the inducement principle behind
admin expenses
 Shows that even if have a benefit to the estate, no
admin priority unless also engage in a
postpetition transaction with the estate
Jartran
 Facts:
 Prior to bankruptcy, Dr (through agent) placed
orders for Yellow Page ads
 “closing date” for these ads passed
 Dr thus irrevocably committed before bankruptcy
 Jartran then filed ch 11
 Ads published during the ch 11 case
 Issue: is the cost of the ads published postpet (about
$1.3 mm) an admin expense?
Argument for allowing as admin
 Benefits the estate – a standard business expense
 Dr actually enjoyed the benefit of the published ads
during the pendency of the bankruptcy case
 Only fair – a cost of doing business while in
bankruptcy, Dr should have to pay
Why disallowed?
 7th circuit disallowed as admin expense
 Rationale was that there was no postpetition
transaction with the estate
 Deal was irrevocably committed prior to
bankruptcy
 Thus no need to afford admin priority in order to
induce Donnelly to do business with Dr
All prepetition?
 How decide if closing date for ad was pre-bk, and
ad published pre-bk?
 Then indisputably just a non-priority claim
 Neither a transaction with estate nor a benefit to
estate
All postpetition?
 Conversely, what if both closing date for ad and
publication of ad occurred post-bk, during
pendency of case?
 Now indisputably an admin expense
 Transaction with estate AND benefit to estate
 Fulfills the inducement rationale
q. 3 p. 263 –forced to perform K?
 A nondr party to a prepetition K with the dr, if
compelled to render performance to the estate on
that K during the case, is usually entitled to
admin expense payment as the quid pro quo for
such performance
 So - Why doesn’t that same rationale dictate
compensating Donnelly and Tinsley as an admin
expense here?
Reclamation admin claim
 Hypo:
 March 1: Ernie’s Elephants sold & delivered 5
elephants to DR (circus) on credit, $20K each
($100K total)
 March 15: Dr filed ch 11, had not paid Ernie
 What rights does Ernie have against the estate?
Reclamation claim
 Ernie is entitled to an administrative expense
under 503(b)(9)
 But what about fact that the K was made AND the
goods were delivered PRIOR to bankruptcy?
Jartran tells us that in such a case, no admin exp
 2005 special rule:
 Goods
 Dr received within 20 days of bankruptcy
 Ordinary course Dr’s business
Purpose reclamation admin rule
 Encourage sellers to keep doing business on
credit with a financially distressed DR
 Not have to worry that shortly after deliver goods,
Dr will file bk and Cr will be out of luck
 So a form of inducement here as well
 Effectively just moves the point of demarcation
back 20 days, from filing of petition to 20 days
before
Apply to Jartran?
 Would 503(b)(9) offer any solace to the
disappointed creditors on the facts in Jartran?
 NO – only applies to sales of goods, not services
In-kind reclamation
 Credit seller of goods on eve of bankruptcy also
might have a right to reclaim goods in kind from
the bk estate (or force estate to “buy” goods back,
i.e., pay in full!)
 546(c)(1):
Sale of goods to Dr in ordinary course
Dr insolvent when received (not required in 503)
Within 45 days before bk (longer period than 503)
Seller makes written demand within 45 days or 20
days after bk
 Implicit requirements that Dr (i) still HAS goods,
and (ii) are IDENTIFIABLE
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Goods only
 546(c) in-kind reclamation ALSO is limited to the
delivery of goods, not services
 So likewise would be of no help in a case such as
Jartran
Reading Co. v. Brown
 What do you mean by “benefit”??
 Facts:
 Receivership under Ch XI
 Dr’s workmen negligent, cause catastrophic fire
 tort damages exceed value of entire estate
 So if tort claimants paid admin expense, general unsecured
crs of Dr get nothing
Issue: are the tort claimants entitled to
admin expense?
Recall 2 prongs of admin expense
 1st – timing – POST-petition, during pendency of
the case
 NOT a problem here
 No question that the fire occurred during the bk
case, and was caused by the Dr’s employees
 2nd – benefit to estate
 This is the issue
Argue no benefit?
 What is the argument that the fire damages did
NOT “benefit” the estate?
Hold: grant admin expense
 Supreme Court held for the tort victims and
granted them admin expense status for their tort
damages
 Thus came ahead of prepetition general
unsecured crs
“fairness”
 One basis for Reading holding: fairness to the
tort victims
 J. Harlan for Ct said they “had an insolvent
business thrust upon them by operation of law”
Was this “unfair” to general Crs?
 NO – but why not?
 If reorg had succeeded, the general unsec. crs
would have enjoyed the upside
 View as residual owners since Dr likely insolvent
Broader principle of Reading
 Admin status for all costs of doing business:
“’actual and necessary’ costs should include costs
ordinarily incident to the operation of a business,
and not be limited to costs without which
rehabilitation would not be possible.”
Policy justification for Reading?
 As a matter of economic incentives, can we make
sense of the Supreme Court’s dictate in Reading
that must count as admin expenses ALL costs of
doing business?
 If rule were otherwise, what would the incentive
structure look like?
Midlantic National Bank
 May wonder why on earth we’re talking about
case that deals with abandonment of property in
connection with administrative expenses!
 Indeed, Supreme Court in Midlantic made clear
in a footnote that it was NOT a case about
payment priorities!
 But they were WRONG (as subsequent cases soon
figured out)
 Trivial note: it’s “Midlantic” and NOT “MidAtlantic”
Midlantic
 Facts:
 Dr (Quanta) stored illegal PCB at waste oil facilities
 Dr filed bankruptcy (ch 11, convert to 7)
 Bk trustee sought to abandon the two sites
 Met statutory test 554 – burdensome, inconsequential value
to the estate
 Cleanup Cost > Property value
 States of NJ and NY objected – threat to public
health and safety
 NY actually cleaned up and sought reimbursement
as admin expense (but issue not before SCOTUS)
Holding Midlantic
 SCOTUS held that bk trustee could “not abandon
property in contravention of a state statute or
regulation that is reasonably designed to protect
the public health or safety from identified
hazards.”
 Elaborated that threat to environment must be
“imminent and identifiable”
 Thus engrafted a judicial exception onto an
unambiguous statute (554)
Dissent – really about $
 The 4 dissenting Justices argued that the State’s
real interest was $: “barring abandonment and
forcing a cleanup would effectively place [the
states’] interest in protecting the public fisc ahead
of the claims of other creditors.”
 Can you see why??
Consequence of no abandonment
 Post-Midlantic, the lower courts have realized
that barring abandonment of polluted property as
a de facto matter affords the govt a priority
 Reason is that the estate is forced to remain in
possession of the site, and the environmental laws
dictate that anyone in possession of a polluted site
must clean up
 So estate must spend the estate assets to clean up
 Penn Terra déjà vu all over again
NP Mining
 Test what we’ve learned from Reading, Midlantic,
and the general principles driving the admin
expense issue in NP Mining
 Case nicely frames the question of what really
determines admin priority
NP Mining
 Facts:
 Dr NP Mining carried on strip mining in violation of Alabama
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state law
On land owned by others (i.e. site ≠ property estate)
Not a risk to public health and safety
Subject to noncompensatory (punitive) civil fines $750 day
Feb 1987: filed ch 11, operated as DIP: $399K fines
June 1988: trustee appointed, stopped operation: $1.9 M fines
April 1989: convert to ch 7
Total postpetition fines = $2,349,000 -> seek admin status
Total assets in estate = ~ $400-$500K
Issue: any of the punitive fines = admin expense?
Environmental rationale?
 1st – would the environmental cleanup obligation
rationale of Midlantic and its progeny compel
awarding the fines admin status?
Fairness rationale?
 Would the “fairness” rationale of Reading compel
awarding the fines admin status?
Reading, 28 USC 959(b)?
 Would the Reading “operations” rationale (“costs
ordinarily incident”) dictate admin status?
 See also 28 USC 959(b) – trustee or DIP must
comply with state law when manage and operate
estate property
Policy: civil fines as admin expense?
 As a policy matter, why does it make sense to
award even noncompensatory civil fines admin
status?
 And, what LIMITS does that policy suggest?
Which time periods?
 1. Prepetition operation, fines attribute to
prepetition “days”?
 2. Postpetition operation, fines attributable to
prepetition days?
 3. Postpetition operation, fines attributable to
postpetition days while operating?
 4. Postpetition NOT operating, fines attributable
to post-operating period?
Other priorities – problem 5.3
 1st: employee wages & benefits
 What policy?
Employees’ wages & benefits
 2nd priority: post-petition (503(b)(1)(A)(i))
 4th priority: 180 days pre-petition, up to max of
$10,950 per employee, for wages (507(a)(4))
 5th priority: benefits for the 180-day period, to
extent the $10,950/person amount not already
paid under 4th priority (507(a)(5))
 No priority: prepetition wages & benefits, either >
180 days old or in excess of $10,950 cap
 For purposes of applying timing rules, ask when
services performed, not when vested
5.3(a)
 Facts:
 Vacation pay claim = $2000, for one year’s service,
calendar year basis
 Employer files ch 11 at start 4th quarter (October 1)
 Vacation pay vests Jan 1 of following year
Employee argue entire $2k = admin
priority?
 How might the employee argue that the entire
$2,000 is entitled to administrative priority?
 Would say that entitled to nothing unless and
until kept working for the Dr during the pendency
of the ch 11 case, and became entitled to the entire
$2,000 only when it vested on Jan. 1, during the
pendency of the case
 But most courts say no
Accrual view
 Prevailing view in the cts is to ascribe an accrual
basis for things like vacation or severance pay
claims, even if the employee has no enforceable
entitlement until claim vests
 Here, on accrual basis (rounding off):
 ¼ 2nd priority (Oct 1-Jan1)= $500
 ½ 4th priority (180 days before filed Oct 1) = $1,000
 ¼ = no priority (1st quarter of last year) = $500
taxes
 Policy?
 Yeah, right, as if you have to ask
 Timing
 Post-petition – 2nd priority admin expense
(503(b)(1)(B)-(C))
 Pre-petition – 8th priority, IF meet requirements of
507(a)(8)
 Most important is income taxes for past 3 years
DSO – 1st priority
 2005 amended law to elevate “domestic support
obligations” to 1st priority
 Alimony, child support
 Talking about pre-petition claims
 Dr’s obligation to pay ongoing post-petition DSOs
is paramount – must pay in full in reorg cases to
confirm plan
 Indeed failure to pay currently can lead to dismissal
of case
5.3(b)
 Facts:
 Dr owes income taxes $14k for 1995 tax year
 Dr divorced 1996, state ct awarded Ex $20k support
 Dr files ch 7 on March 1, 1999
 Estate = $22k
Answer 5.3(b)
 Support claim = 1st priority DSO (507(a)(1)(A))
for entire $20K
 Tax claim = 8th priority (507(a)(8)(A)(i))
 For taxable year for which return last due within 3
years of bankruptcy
 For 1995 tax year, return last due April 15, 1996
 Petition filed March 1, 1999
Of course, since only $22K total in estate, there’s only
$2k left to pay the priority tax claim after pay the 1st
priority DSO
5.3(c)
 Facts:
 Creditor joined Debtor Health Club on Jan 1
 prepaid $2,000
 Entitled to one year of personal training sessions for
the $2k
 Dr closed Feb 1 – just 1 month into the year
Answer 5.3(c)
 7th priority for that portion of the $2k for which
the Cr did not receive the services paid for
 E.g., 11/12 of the $2k (got services in January, while
club still open, we assume)
 Purchase of services by an individual for personal
use
 Below cap of $2,425