The Eighth Circuit Court of Appeals has ruled in Official Committee of Unsecured Creditors v. Farmland Industries Inc. (In re Farmland Industries)² that although qualifying as an administrative claim, the contingent aspect of a financial advisor's fee need not be paid out of the "general fund" of the estate.

When Farmland Industries filed for chapter 11 relief, the U.S. Trustee exercised its discretion under 11 U.S.C. §1102(a) to appoint not only an unsecured creditors' committee but also a separate bondholders committee.³ Both committees hired financial advisors who were to be paid flat fees on a monthly basis for their services, along with a contingent "success fee" based on the amounts recovered for the employing committee's constituency. The significant difference between the employment agreements of the two committees related to how the success fees were to be paid. The bondholders' committee agreed to pay such a fee out of the recovery achieved for bondholders, while the unsecured creditors' committee agreement called for payment of the success fee as an administrative claim, effectively paid by the estate prior to distribution to junior priority creditors and general unsecured creditors.

Each committee sought court approval of their respective employment contracts pursuant to §§328(a) and 1103(a). While the bankruptcy court approved the terms of the bondholders' committee employment contract, the court refused to approve the success fee terms sought by the unsecured creditors' committee. Instead, the bankruptcy court ruled that the success fee for the unsecured creditors' committee must be paid in the same manner as that approved for the bondholders committee—i.e., from the proceeds recovered on behalf of unsecured creditors. Upon appeal by the unsecured creditors' committee, the Bankruptcy Appellate Panel for the Eighth Circuit upheld the bankruptcy court's ruling. The unsecured creditors' committee appealed this ruling as well.

At the Eighth Circuit, the unsecured creditors' committee argued that the bankruptcy court's ruling was based on clearly erroneous findings of fact because there was insufficient evidence that the financial advisor for the unsecured creditors' committee was working solely for the benefit of trade creditors. The committee also contended that the bankruptcy court's finding that the fee agreement adopted by the bondholders' committee was fair and more equitable to all creditors was clearly erroneous.

The appellate court first examined the issue of the retention order's "finality" and whether there was the proper appellate jurisdiction. For purposes of this article, suffice it to say that the court found appropriate grounds for jurisdiction to consider the appeal. The court then delved into the issue of the means by which professionals approved for employment by the estate may be paid.

The court first noted that the matter of the payment of the unsecured creditors' committee's financial advisors' success fee had been previously reserved by the bankruptcy court in conjunction with the interim order approving retention. Without reference to any specific statutory or case authority, the court reasoned that payment in the manner approved by the bankruptcy court satisfied standards of basic fairness and further noted that such fees were "customarily paid by those who contract for them."⁴

In addition, the court found no statutory impediment to upholding the ruling of the bankruptcy court. In doing so, the court considered the language of §328(a):

The trustee, or a committee appointed under §1102 of this title, with the court's approval, may employ or authorize the employment of a professional person under §327 or §1103 of this title, as the case may be, on any reasonable terms and conditions of employment, including on a retainer, on an hourly basis or on a contingent-fee basis. Notwithstanding such terms and conditions, the court may allow compensation different from the compensation provided under such terms and conditions after the conclusion of such employment, if such terms and conditions prove to have been improvident in light of developments not capable of being anticipated at the time of the fixing of such terms and conditions.

The court then properly considered the standards prescribed by §330 for compensating professionals, and in particular §330(a)(4)(A)(ii), which provides:

Except as provided in subparagraph (B), the court shall not allow compensation for—

(ii) services that were not—

(I) reasonably likely to benefit the debtor's estate; or
(II) necessary to the administration of the case.

The court acknowledged that payments approved in accordance with §330(a) shall be allowed as administrative expenses as allowed by §503(b)(2).

Notwithstanding the proper characterization of the success fee as an administrative claim under §503, the court rejected the argument that, as an administrative expense, the financial advisor success fee was required to be made from the estate's general funds. Instead, the court specifically found that nothing in either §330 or 503(b) mandated that payments to professionals that qualify as administrative expenses must be paid from any specific funds of the debtor.⁵ Section 328(a) was cited as support for the court's conclusion that the bankruptcy court could exercise broad discretion in reviewing terms of professional employment, as §328(a) authorizes the court to approve any reasonable terms and conditions of employment.

Finally, the court was not deterred by the unsecured creditors' committee's argument that payment of an administrative expense out of the dividend to unsecured creditors violated the priority rule of §507. In response to this argument, the court stated:

Claim priority means that administrative claims must be paid in their entirety before lower priority claims may be paid. It does not mean that the amounts to be paid to lower priority claimants may not be calculated before the administrative expense claims are paid.⁶

While this case appears to place in question the source of payment of administrative expenses from other than the "general fund" or general revenue of the debtor, serious consideration should be given to the type of administrative expense addressed in this case. Unlike attorneys' fees and the standard monthly fee paid to financial advisors, the contingent nature of the fee at issue no doubt played a significant part in the court's decision. Nonetheless, committee members and their counsel, not to mention financial advisors, should take serious note of this decision and recognize that the qualification of an expense or fee as an administrative expense will not necessarily insure that the source of payment for same will be paid by the estate.

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Footnotes

¹ David B. Wheeler, a member in the Charleston, S.C., office of Moore & Van Allen PLLC, is a contributing editor of the ABI Journal, the editor of ABI's Unsecured Trade Creditors Committee E-newsletter and co-chair of ABI's Mass Torts Committee. Return to article

² 397 F.3d 647 (2005). Return to article

³ Further references to the Bankruptcy Code shall be by section number only. Return to article

⁴ Id. at 651. Return to article

⁵ Id. at 652. Return to article

⁶ Id. at 653. Return to article