19: Administrative expenses © Charles Tabb 2010

2 nd priority (but in business case 1 st ) Administrative expenses are the 2 nd priority, under 507(a)(2) Really, though, in business cases, where admin. expenses matter the most, they effectively are 1 st, 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 1 st 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 1 st – 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)

2 nd type Pay people who work on the case E.g., their fees and expenses Examples: Bankruptcy trustee Attorneys for the estate

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 1 st – 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 2 nd – 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: Tom Jackson’s Transfer of Ownership metaphor.

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?

Other priorities – problem st : employee wages & benefits What policy?

Employees’ wages & benefits 2 nd priority: post-petition (503(b)(1)(A)(i)) 4 th priority: 180 days pre-petition, up to max of $10,950 per employee, for wages (507(a)(4)) 5 th priority: benefits for the 180-day period, to extent the $10,950/person amount not already paid under 4 th 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 4 th 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. What would be an alternative treatment?

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 2 nd priority (Oct 1-Jan1)= $500 ½ 4 th priority (180 days before filed Oct 1) = $1,000 ¼ = no priority (1 st quarter of last year) = $500

taxes Policy? Yeah, right, as if you have to ask Timing Post-petition – 2 nd priority admin expense (503(b)(1)(B)-(C)) Pre-petition – 8 th priority, IF meet requirements of 507(a)(8) Most important is income taxes for past 3 years

DSO – 1 st priority 2005 amended law to elevate “domestic support obligations” to 1 st priority Alimony, child support Talking about pre-petition claims, see 1322(a)(2) Dr’s obligation to pay ongoing post-petition DSOs is paramount – must pay in full in reorg cases to confirm plan—, see 1325(a)(8) Indeed failure to pay currently can lead to dismissal of case

5.3(b) Facts: Dr owes income taxes $14k for 2005 tax year Dr divorced 2006, state ct awarded Ex $20k support Dr files ch 7 on March 1, 2009 Estate = $22k

Answer 5.3(b) Support claim = 1 st priority DSO (507(a)(1)(A)) for entire $20K Tax claim = 8 th priority (507(a)(8)(A)(i)) For taxable year for which return last due within 3 years of bankruptcy: 3 year pre-petition would be March 1, 2006 For 2005 tax year, return last due April 15, 2006 Petition filed March 1, 2009 Of course, since only $22K total in estate, there’s only $2k left to pay the priority tax claim after pay the 1 st 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) 7 th 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