In the context of a Chapter 11 bankruptcy proceeding, generally speaking, administrative expenses are the post-petition obligations of the debtor. The Bankruptcy Code defines administrative expenses as the actual, necessary costs and expenses of preserving the estate, including wages, salaries or commissions for services rendered after the commencement of the case. 11 U.S.C. 503(b). These post-filing claims include ordinary course business expenses, such as those relating to inventory received after the filing, as well as fees of a professional retained by the debtor. In the case of professional fees, while 11 U.S.C.503(b)(4) includes within the scope of allowed administrative expenses reasonable compensation for services, retention and payment are dependent upon orders of the Court.
Administrative Expense Priority in Bankruptcy
With the exception of the claim of a secured creditor to the extent of the value of its collateral, administrative expenses have the highest priority in a bankruptcy proceeding. 11 U.S.C. 507(a)(1). Thus, while the lay person is often heard to comment that only professionals get paid from the bankruptcy estate, in point of fact, the Bankruptcy Code places the claims of professionals in parity with all other post-petition obligations of the debtor. Despite this theoretical equality among administrative claimants, practical realities, and a growing body of case law, dictate that not all administrative claims share the same priority in fact. From the standpoint of the Chapter 11 professional, this conclusion is particularly troublesome since it is claims for professional fees which occupy the most subordinate position.
Unequal treatment of administrative claims typically arises in a case of "administrative insolvency," that is, when the bankruptcy estate has insufficient funds to pay administrative claims in full. As described by the Court in In re Vernon Sand & Gravel, Inc., 109 B.R. 255 (Bankr. N.D. Oh. 1989), "when a Chapter 11 business converts to Chapter 7, all Sec. 503(b) claimants are not on equal footing. Some ordinary course administrative claimants have been paid in full; others were paid throughout the period of the business's operation, but have claims remaining. Some professional administrative claimants have received interim compensation under Sec. 330, which has paid their claims in full; some have been paid in part and have claims remaining. Other administrative claimants have received nothing. Theoretically, all of these entities are to share equally on the same pro-rata basis." Vernon at 258.
Vernon involved a Chapter 11 fee application by debtor's counsel, considered by the Court at a time after the case was converted to a Chapter 7 proceeding, and when the estate had insufficient funds to pay Chapter 11 administrative claims in full. The Vernon case is interesting not so much for its holding in denying further compensation to the Chapter 11 professional, but for its emphatic declaration in dicta that administrative expenses incurred in the ordinary course of business, which must be paid by a debtor immediately, are not subject to pro-rata reduction after the fact in a circumstance of administrative insolvency. In issuing this statement, the Vernon Court focused upon the prejudicial effect the possibility of disgorgement from an ordinary course business claimant would have upon the ability of a bankrupt entity to operate its business, let alone upon the reorganization effort.
Rent is an Administrative Expense
Rent accrued by a tenant debtor after the filing date is also an administrative expense. The Bankruptcy Code specifically requires a debtor to timely perform all post-petition lease obligations until assumption or rejection of the lease, including the obligation to pay rent when due. 11 U.S.C. 365(d)(3). The failure to make timely rental payments frequently triggers a motion to compel payment by the non-debtor landlord. Anticipating that insufficient funds would be available to pay administrative expenses in full, the debtor in In re Telesphere Communications, Inc., 148 B.R. 525, 1992 WL 379048 (Bankr. N.D. Ill. 1992) objected to such a motion arguing that by requiring payment immediately, the landlord would receive more than its pro-rata share based upon available funds allocated among all administrative claims.
In a well-reasoned opinion that flies in the face of in the majority view, the Telesphere Court determined that the express language of 11 U.S.C. 365(d)(3) provides post-petition rent claimants with a superpriority administrative status. The Court concluded that any alternative holding would require a landlord of a Chapter 11 debtor who received post-petition rent to disgorge if the estate proved to be administratively insolvent, something the Court viewed as contrary to the express provisions of 11 U.S.C. 365(d)(3).
In contrast to the Vernon commentary, which was premised upon the practical realities of the business world, the Telesphere Court based its holding upon express language of the Bankruptcy Code.
Professional Fees
Unlike post-petition rent or other ordinary course business obligations, professional fees cannot be paid by a debtor immediately. 11 U.S.C. 331 allows interim compensation to professionals not more than once every 120 days, thereby requiring Chapter 11 professionals to endure at least a three-month wait for payment. Given the time lag between the filing of a fee application and a hearing upon such application, typically the wait is substantially longer. In situations where the debtor's financial condition deteriorates over time, this delay may effectively preclude payment.
A second factor tending to subordinate the priority of professional fees is the possibility of disgorgement. Since the Bankruptcy Court must pass upon the propriety of a fee application, the Court is more willing, albeit, still reluctantly, to consider disgorgement from a professional than another administrative claimant. The May 1991 American Bankruptcy Institute National Report On Professional Compensation In Bankruptcy Cases indicates that on average, disgorgement of professional compensation was ordered once yearly per judge.
Although the Vernon and Telesphere opinions are supported by differing rationale, their natural consequence is to promote a race for payment among administrative claimants, a contest in which the professional will always finish last. For the practitioner representing non-professional post-petition creditors, the best advice may be that despite the theoretical equality among administrative claimants expressed in the Bankruptcy Code, the first in time is the first in right.