Illinois Bankruptcy Court Weighs in on Chapter 7 Substantial Contribution Claims
June 9, 2021 – Herrick Restructuring ReviewThe Herrick Restructuring Review provides insights and information related to restructuring and finance litigation. The Herrick team regularly represents official and ad hoc creditor committees, hedge funds, distressed debt investors, bondholders, and other parties in interest, and often serve as conflicts or special counsel for large-scale complex litigation matters.
In re Concepts America, Inc., 625 B.R. 881 (Bankr. N.D. Ill. 2021), weighs in on a murky question: Can a creditor make an administrative expense priority claim because it made a substantial contribution in a case under chapter 7? The court answered no.
In Concepts America, creditor Galleria Mall Investors LP moved the bankruptcy court for allowance and payment of an administrative expense claim pursuant to sections 503(b)(3)(A), (b)(3)(D), and (b)(4) of the Bankruptcy Code.
Around May 2011, the Galleria entered into a lease with a restaurant affiliated with Concepts America, which guaranteed the lease. The restaurant eventually breached the lease, and a Texas state court entered judgment against the restaurant and Concepts America.
The Galleria tried to collect its judgment for nearly a year. Eventually, on September 19, 2014, it joined two other creditors in filing an involuntary chapter 7 petition against Concepts America. About two months later, Concepts America consented to the entry of an order for relief under chapter 7.
Early in September 2015, a chapter 7 trustee was authorized to employ special counsel to investigate and pursue claims relating to Concepts America’s pre-bankruptcy conduct. These claims included claims about transfers of assets and against related entities and individuals. The trustee eventually filed a seventeen-count adversary proceeding against more than twenty defendants, which is pending.
The Galleria argues it “did the important work of unearthing the facts and circumstances . . . that gave rise to and reason for the Trustee to retain special counsel and pursue the claims against the various insiders for the benefit of the entire estate.” Its motion seeks compensation for these services because they provided a “substantial contribution” to the bankruptcy estate.
Reimbursing creditors by allowing them an administrative expense claim for their “substantial contribution” is intended to encourage parties in a bankruptcy to take actions that benefit a bankruptcy estate. Under section 503(b), the court has authority to make such allowances, but the caselaw is clear that the exception is to be read narrowly because any allowance of a substantial contribution claim reduces the assets available for distribution to unsecured creditors.
In Concepts America, the bankruptcy court denied the Galleria’s motion because it held that section 503(b)(3)(D) does not allow an administrative expense priority claim in a chapter 7 case.
The bankruptcy court analyzed section 503(b) using canons of statutory construction and determined that substantial contribution claims are not available in chapter 7. Reading section 503(b)(3)(D)’s text, the court found that the section’s “plain and unambiguous language . . . is conclusive—substantial contribution claims are allowed as administrative expenses only in Chapters 9 and 11, not in Chapter 7.”
Turning to the canon against absurd results, the court similarly concluded that its analysis of section 503(b)(3)(D) was not absurd. The court highlighted precedent showing the purpose of section 503(b)(3)(D) was to recognize substantial contributions to reorganization efforts, and that there is no reorganization in a chapter 7 case. Thus, the court declared it was not absurd to read section 503(b)(3)(D) as applying to only chapters 9 and 11.
The court said its plain language analysis “comports with the American Rule that ‘[e]ach litigant pays his own attorney’s fees, win or lose, unless a statute or contract provides otherwise.” No statute or contract provided otherwise in Concepts America. The court further reasoned that applying section 503(b)(3)(D) to a chapter 7 case would render the words in that section “under chapter 9 or 11” superfluous. That other subsections under section 503(b)(3) are not expressly limited to cases under certain chapters is further evidence that Congress added those words to limit substantial contribution claims to cases “under chapter 9 or 11.”
The court next noted the canon that provides that “the specific governs the general.” Applying this canon, the court found that despite language making categories of administrative expense claims in section 503(b) non-exclusive (the section uses the term “including”), the specific limitations express in section 503(b)(3)(D) take precedence over that “general authorization.”
Courts disagree on whether creditors can base an administrative expense priority claim on their substantial contribution in a case under chapter 7. In In re Connolly North America, LLC, 802 F.3d 810 (6th Cir. 2015), creditors appealed a district court judgment denying their application for reimbursement of administrative expenses despite finding that they substantially contributed to achieving a settlement that benefited the estate. The Sixth Circuit reversed and held that section 503(b) allows administrative expenses in a chapter 7 case under certain circumstances that were present in Connolly.
In its statutory analysis, the Sixth Circuit decided that the term “including” in the introductory provision of section 503(b) gave bankruptcy courts the authority to allow reimbursement of administrative expenses incurred by a Chapter 7 creditor who makes a substantial contribution to the debtor’s estate. It reasoned that the term “including” evidenced Congress’s intent that the allowable expenses listed in 503(b) be non-exclusive. On Congress adding “under chapter 9 or 11” to section 503(b)(3)(D), the court noted that made “good sense” as an example because creditors as a matter of course will spend their own time and resources to benefit the estate under chapters 9 and 11. But in all but the most atypical chapter 7 case (such as the one in Connolly), the trustee fulfills that role. The court explained that denying creditors reimbursement in cases like Connolly would disincentivize participation in the bankruptcy process and “impugn the fundamental notion of bankruptcy as equitable relief.”
Had the court in Concepts America been persuaded by the Sixth Circuit’s decision, and applied similar “equitable considerations,” it might have allowed the Galleria reimbursement for all Galleria claimed it did to help the trustee retain special counsel and pursue claims for the benefit of the estate. After all, creditors who have been litigating with a debtor often know more facts than a trustee who gets appointed without any prior knowledge of the bankruptcy case. So, those creditors can point the trustee to facts or theories that might enable the trustee to bring a claim for the benefit of the estate that the trustee might not have been aware of.
But “agree[ing] with the majority view,” the court in Concepts America takes a firm stand that a creditor cannot make an administrative expense priority claim in a case under chapter 7.
For more information on this alert or other restructuring & finance litigation matters please contact:
Stephen B. Selbst at +1 212 592 1405 or [email protected]
Rodger T. Quigley at +1 212 592 1577 or [email protected]
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