Indenture Trustees Must Provide Substantial Contribution to Qualify for Administrative Expense

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The United States Bankruptcy Court for the Southern District of Texas recently clarified the administrative expense standard applicable to indenture trustees by holding that they can recover fees and expenses as administrative expenses only when they make a “substantial contribution.” This standard requires a greater showing than “benefit to the estate,” which is the general administrative expense standard. In re Sanchez Energy Corp., No. 19-34508 (Bankr. S.D. Tex. May 3, 2021).

Background

Prior to filing for chapter 11, Sanchez Energy Corporation (“Sanchez”) issued two indentures for certain senior notes for which Delaware Trust Company (“DTC”) acted as the successor Indenture Trustee. The confirmed chapter 11 plan called for payment in full in cash for holders of allowed administrative claims. The terms of the indentures indicated that DTC would be entitled to payment for fees and expenses, and that these fees and expenses may be classified as an administrative expense in a bankruptcy case.

DTC filed its proof of claim seeking $928,345, consisting of about $743,000 for fees and expenses incurred by counsel and $185,974.27 for fees and expenses incurred directly by DTC. DTC contended that it was entitled to an administrative expense claim for these fees and expenses under Section 503(b)(1)(A) because Sanchez “knowingly and voluntarily accepted” DTC’s services that benefited its estate. Mesquite Energy, Inc. (“Mesquite”), the renamed reorganized debtor, argued that DTC’s actions failed to raise to the level of “substantial contribution” required under the applicable standard.

Discussion

In discussing the applicable standard for administrative expenses, the Court began with highlighting the general standard of Section 503(b)(1)(A), which states that administrative expenses include “the actual, necessary costs and expenses of preserving the estate.” The section goes on to state that to qualify as an administrative expense, the expense “must have been of benefit to the estate and its creditors.” The Court then noted that Section 503(b)(3)-(5) sets a higher standard for expenses to qualify as administrative expenses when indenture trustees and related professionals are involved. Under Section 503(b)(3)(D), indenture trustees and related professionals are allowed to recover “actual, necessary expenses,” when they make “a substantial contribution in a case under chapter 9 or 11.” Additionally, Section 503(b)(5) grants administrative priority for “reasonable compensation for services rendered by an indenture trustee in making a substantial contribution … based on the time, the nature, the extent, and the value of such services.” Finding that Congress created a standard specifically for indenture trustee compensation, the Court ultimately held that the applicable standard for determining whether DTC could be paid on an administrative expense basis was the substantial contribution standard.

In applying the standard to the case at hand, the Court noted that the substantial contribution standard is a high bar, requiring that the contribution be “considerable in amount, value, or worth,” and causally related to the services. This heightened standard, the Court held, gave effect Section 503(b) in its entirety and ensured that the provisions directed specifically at indenture trustees were not rendered superfluous.

Examining the various categories of services provided by DTC, the Court rejected DTC’s arguments that it substantially contributed to Sanchez’s estate by performing the necessary role of indenture trustee, updating the noteholders as to the status of the reorganization, filing proofs of claim on behalf of noteholders, choosing not to object to the plan of reorganization, and assuming a role as a member of the Committee. The Court did find, however, that DTC, as the noticing agent for the noteholders, was entitled to administrative priority to the extent that it fulfilled Sanchez’s notice obligations. The Court noted that if DTC had not taken the role as noticing agent, Sanchez itself would have been tasked with those obligations. As a result, DTC’s actions substantially contributed to Sanchez’s reorganization by directly saving Sanchez a substantial expenditure of estate funds related to providing notice.

Takeaways

Although the decision has no precedential value and does not cite to any other authority on this issue, indenture trustees and noteholders should take note of the Sanchez Energy Corp. ruling and carefully structure and document the indenture trustee’s actions, so they are well positioned to establish that the actions meet the substantial contribution standard.

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