Two recent judicial decisions, Sanchez Energy and Tribune Media, highlight the challenges faced by indenture trustees and their professionals in chapter 11 cases where there are no recoveries to noteholders. Federal law requires that public debt be issued under a trust indenture and that a qualified financial institution serve as trustee to protect noteholders’ interests. The payment of fees and expenses incurred under these indentures when the issuing company goes into bankruptcy, particularly the fees and expenses of attorneys and other professionals retained by trustees to assist them in their duties to noteholders, often becomes a contentious issue.
If there are sufficient funds in the bankruptcy estate to provide at least a partial recovery to noteholders, the indenture trustee may assert a right of priority payment for its fees and expenses under the indenture against such recovery, commonly referred to as the “charging lien.” However, in cases where there are no distributions to noteholders, indenture trustees must establish a legal basis for payment from the debtor, either as a contractual right under the terms of the indenture or as a statutory right under the Bankruptcy Code. The judges in Sanchez Energy and Tribune Media adopted narrow interpretations of these respective rights and denied the requested payments.
In Sanchez Energy Corporation, Case No. 19-34508 (Southern District of Texas), Judge Marvin Isgur took a limited view of an indenture trustee’s statutory right to payment. The indenture trustee (the “IT”) sought payment of its fees and expenses in the amount of approximately $930,000 as an administrative priority claim under section 503(b)(1)(A) of the Bankruptcy Code, arguing that such fees and expenses were part of the “actual, necessary costs and expenses of preserving the [bankruptcy] estate[.]” Claims allowed under section 503(b)(1)(A) are entitled to payment ahead of all other unsecured claims and must be paid in full in order for a chapter 11 plan to be confirmed.
Under section 503(b)(1)(A), a claim may be considered a “necessary” expense of administration if it confers a benefit to the debtor and its bankruptcy estate. The IT pointed to a number of services that it undertook during the course of the chapter 11 case which purportedly benefitted the debtor. Among other things, the IT highlighted the notices of key case developments which it provided to noteholders, its service as a member of the official committee of unsecured creditors, and its role in negotiating an overall settlement and certain important documents in connection with the debtor’s reorganization. The IT further contended that its continued service as indenture trustee in and of itself was a benefit to the debtor, allowing it to comply with its obligations under federal securities law.
Judge Isgur disagreed. Although he acknowledged the tasks undertaken by the IT and that the debtor and its estate may have benefitted from its efforts, he ruled that a higher standard applied. Judge Isgur noted that sections 503(b)(3)(D), 503(b)(4), and 503(b)(5) of the Bankruptcy Code specifically refer to “an indenture trustee” as a party which can assert an administrative priority claim based on “making a substantial contribution in a case under [chapter 11].” Specifically, Judge Isgur held that those provisions require that an indenture trustee must show more than merely a “benefit” to the debtor from its services, and that it actually made a “substantial contribution” to the chapter 11 case. Allowing an administrative claim for an indenture trustee under the lower “benefit” standard section 503(b)(A)(1) would, in Judge Isgur’s view, make sections 503(b)(3)-(5) “mere surplusage.”
Utilizing the higher requirements for establishing a “substantial contribution,” Judge Isgur rejected administrative priority status for all but a fraction of the IT’s asserted claims. Judge Isgur held that the trustee’s actions needed to have actually “foster[ed] and enhance[ed] . . . the progress of reorganization.” The only actions of the IT that satisfied this higher standard, Judge Isgur determined, were certain of its notifications to noteholders, to the extent that such notices effectively relieved the debtor of that responsibility. However, such work only accounted for a small fraction – less than 1% – of the IT’s requested fees and expenses.
Tribune Media Company, Case No. 08-13141 (District of Delaware), is among the largest and most contentious chapter 11 cases in recent memory. Judge Brendan Shannon noted that the dispute alone over the fees of the IT for a series of subordinated notes “has been negotiated, mediated, and litigated up to the Third Circuit and back” over several years. The dispute that recently wound up back in front of Judge Shannon turned on whether, under the contractual terms of the indenture, the IT could establish a claim for attorneys’ fees for services rendered by its counsel but for which the IT had no direct liability to pay.
In Tribune Media, the IT had retained counsel that undertook, among other services, a detailed investigation of a pre-bankruptcy leveraged buyout, and litigated extensively on behalf of the noteholders throughout the lengthy chapter 11 case. Although there were no recoveries under the chapter 11 plan on account of the subordinated notes, the plan provided that the IT could seek payment of fees and expenses allowable under the terms of the indenture as a general unsecured claim and receive a recovery of approximately 33%. The total fees sought exceeded $30 million.
The IT pointed to standard language in the indenture that required the debtor “to reimburse the Trustee . . . for all reasonable expenses, disbursements and advances incurred or made by the Trustee . . . including the reasonable compensation and the expenses and disbursements of its agents and counsel[.]” Other sections of the indenture entitled the IT to be paid, upon the occurrence of a default, “the reasonable compensation, expenses, disbursements and advances of the Trustee, its agents and counsel[,]” and “[i]n the pendency of any … bankruptcy” to be paid “any amount due it for the reasonable compensation, expenses, disbursements and advances of the Trustee, its agents and counsel[.]”
The debtor countered that these provisions should be read narrowly, and that the IT had not actually “incurred” most of the fees being sought. Under the terms of the engagement letter, the IT and the law firm providing the services at issue had agreed that the IT would have no liability for payment of professional fees other than $3 million that two large noteholders provided to the IT for that express purpose. Beyond that, the law firm was effectively working on a contingent fee basis, based on any recoveries on the subordinated notes.
Judge Shannon agreed with the debtor that an expense could only be “incurred” for purposes of “reimbursement” under the indenture if the IT were actually liable for payment, and held that the IT’s fees should be limited to $3 million. He dismissed the IT’s arguments regarding customary market practice, under which indenture trustees rarely pay fees out of pocket prior to seeking reimbursement:
The Court is not requiring an indenture trustee to advance payment of fees and costs, but it is requiring that an indenture trustee be liable to pay those costs either out of its pocket or from distributions received. Asking Tribune to pay more than the amount that [the IT] is obligated to pay – – that is, the amount of fees that [the IT] incurred – – is tantamount to giving [the IT’s] professionals a blank check.
Judge Isgur and Judge Shannon, influential and respected judges in two of the country’s busiest districts for large chapter 11 cases, have taken limited views of an indenture trustee’s statutory and contractual rights in their respective decisions in Sanchez Energy and Tribune Media. It is possible that the impact of Tribune Media may be mitigated to some extent by careful drafting of engagement letters, to establish that an indenture trustee has “incurred” professional fees without disrupting customary market practice. Sanchez Energy, however, with its narrow reading of an indenture trustee’s ability to establish an administrative priority claim under section 503(b) of the Bankruptcy Code, will unquestionably make it more difficult for indenture trustees and their professionals to recover fees and expenses in cases where there are no recoveries for noteholders.