Despite a widespread assumption that all post-petition claims are entitled to administrative expense priority, judicial authority does not support such a view. While post-petition expenses often meet the requirements of the Bankruptcy Code and/or are not challenged, challenges to the entitlement to administrative expense priority of post-petition claims are becoming more common. This is particularly so with the increase in chapter 11 liquidations that seek to minimize any and all claims, particularly claims that would otherwise qualify as an administrative expense claim and thereby compete with professional fees and expenses.

These challenges are based on the express language of the Bankruptcy Code. Indeed, courts often strictly interpret the Bankruptcy Code's provisions concerning administrative expense claims, instead of determining such matters upon the mere date a claim accrues.

The date of accrual is important, as a pre-petition claim is not entitled to administrative expense priority. However, the Bankruptcy Code specifically sets forth a standard based on the actual, necessary costs of preserving the estate. See 11 U.S.C. §503(b). This standard works to exclude many post-petition claims, as well as create a large burden for a claimant seeking allowance over an objection by the debtor or other party-in-interest. Particularly difficult is the issue of fundamental fairness in denying administrative expense priority to post-petition claims that do not provide an actual, necessary cost of preserving the estate, yet were unavoidable by the claimant. Thus, courts have created an exception to the standard allegedly set forth in the Bankruptcy Code.

The Actual, Necessary Standard

Pursuant to the Bankruptcy Code, there shall be allowed administrative expenses, including "the actual, necessary costs and expenses of preserving the estate..." 11 U.S.C. §503(b)(1)(A) (emphasis added). Despite Congress's use of the word "including,"¹ courts have held that an entity asserting entitlement to an administrative expense claim has the burden to establish a prima facie case by evidence that (a) the claim arises from a transaction with the debtor-in-possession and (b) the goods or services supplied actually benefited the bankruptcy estate. See Toma Steel Supply Inc. v. TransAmerican Natural Gas Corp. (In the Matter of TransAmerican Natural Gas Corp.), 978 F.2d 1409, 1415 (5th Cir. 1992) (holding that entitlement to administrative expense priority was dependent upon the claim-enhancing the ability of the debtor-in-possession's business to function); see, also, In re White Motor Corp., 831 F.2d 106 (6th Cir. 1987) (holding that consideration must be given to the debtor's bankruptcy estate that directly and substantially benefits the estate).

---

[T]he concept of fundamental fairness does not require an affirmative post-petition act by the debtor to justify the allowance of an administrative expense claim.

---

Demonstrating that the claim at issue benefits the bankruptcy estate is typically easy to satisfy in the context of post-petition operating expense claims. Indeed, most such claims are not disputed, but are approved and allowed. More difficult are the claims that do not preserve the bankruptcy estate, but would act to diminish it. Indeed, a post-petition tort typically gives no benefit to a bankruptcy estate. Nor would post-petition interest on sales taxes preserve a bankruptcy estate. Yet, some may argue that it is unfair not to allow such claims. While it might be unfair to determine entitlement to administrative expense priority based on the date of accrual, pre-petition claims, no matter the benefit to the bankruptcy estate, are not entitled to such administrative expense priority.

Indeed, courts have recognized that such inequities occur, and have often generously found benefit and estate preservation. See In re Sharon Steel Corp., 161 B.R. 934 (Bankr. W.D. Pa. 1994). In Sharon Steel, the court found that the continuation of the debtor's right to receive benefits under a group insurance policy preserved the bankruptcy estate despite the lack of the receipt of any such benefits. Id., 161 B.R. at 937, citing In re Gamma Fishing Co. Inc., 70 B.R. 949 (Bankr. S.D. Cal. 1987). In fact, the court stated that the debtors were "under no time restrictions in which to reject or assume the [contracts] and could have received post-petition benefits until the [contracts] expired." Id.

While certain courts have attempted to expound upon the definition of what is actual and necessary to preserve an estate, other courts have expounded upon the exception created by the U.S. Supreme Court. See Reading Co. v. Brown, 391 U.S. 471 (1968).

The Exception

In Reading, a [trustee's] negligence led to a fire that damaged a non-debtor third party, who then asserted an administrative expense claim. The Supreme Court held that under the then-current Bankruptcy Act, damages caused by the actions of a [trustee] in a chapter 11 arrangement give rise to "actual and necessary costs." Reading, 391 U.S. at 479-83.

In fact, the Supreme Court disregarded the plain language of §64a of the Bankruptcy Act, which provided that debts having priority include the actual and necessary costs and expenses of preserving the estate subsequent to filing the petition. See Reading, 391 U.S. at 476. Instead, the court created an exception, which survived the passage of the Bankruptcy Code, based on the concept of "fairness to all persons having claims against an insolvent." Id. at 477.

Thus, the Reading exception provides a basis for entitlement to administrative expense priority upon the concept of fundamental fairness. While this "fundamental fairness" exception was created under the then applicable Bankruptcy Act, considering that §503(b) also reads actual and necessary, the Reading exception remains applicable. See Matter of Al Copeland Enterprises Inc., 991 F.2d 233 (5th Cir. 1993).

In Al Copeland, the Fifth Circuit recognized the Reading exception, and the numerous lower court's expansions thereon, and held that post-petition sales tax and interest was entitled to administrative expense priority because such resulted from the business operations of the debtors' bankruptcy estate. Al Copeland, 991 F.2d at 240.

Specifically, the Fifth Circuit acknowledged that Reading "survived Congress's revisions to the Bankruptcy Code" and has been expanded upon by lower courts, while further holding that "administrative expenses entitled to first-priority status are not necessarily confined to those enumerated at 11 U.S.C. §503(b)." Id. at 238-39, citing In re Flo-Lizer Inc., 107 B.R. 143, 145 (Bankr. S.D. Ohio 1989), aff'd., 916 F.2d 363 (6th Cir. 1990); see, also, Texas Comptroller of Public Accounts v. Megafoods Stores Inc. (In re Megafoods Stores Inc.), 163 F.3d 1063 (9th Cir. 1998) (finding that unpaid sales taxes constituted an administrative expense claim).

The Fifth Circuit further expounded upon its recognition of the Reading exception in In re Jack/Wade Drilling Inc., 258 F.3d 385 (5th Cir. 2001). In Jack/Wade, the Fifth Circuit again analyzed the application of the Reading exception to claims not traditionally associated with providing a "benefit" to a bankruptcy estate. Specifically, a non-debtor litigant sought attorney's fees as an administrative expense claim upon the successful defense of a breach-of-contract suit. While the Fifth Circuit declined to apply the Reading exception to the circumstances presented in Jack/Wade, the court did note that "[It] did not hold that a claimant must necessarily show a wrongful act committed in the course of a trustee's operation of a business in an attempt to improve the position of the existing creditors in order to obtain administrative expense priority under the Reading exception." See Jack/Wade, 258 F.3d at 390, n.4.

Thus, while courts are expanding on the Reading exception, the concept of fundamental fairness does not require an affirmative post-petition act by the debtor to justify the allowance of an administrative expense claim. In re MEI Diversified Inc., 106 F.3d 829, 832 (8th Cir. 1996). Indeed, courts are willing to apply the Reading exception where they deem it appropriate and/or fundamentally fair, such as for environmental clean-up costs. See In re Coal Stripping Inc., 222 B.R. 78 (Bankr. W.D. Pa. 1998) (holding that the state's post-petition reclamation following a debtor's abandonment of a mine was entitled to administrative expense priority, even though the debtor did not operate the property post-petition); but, see In re Mahoney-Troast Construction Co., 189 B.R. 57 (Bankr. E.D. Va. 1993) (declining to grant an administrative expense claim to the former real property lessor for post-petition environmental clean-up costs for pre-petition contamination); In re Hanna, 168 B.R. 386 (9th Cir. BAP 1994) (denying the allowance of an administrative expense claim to a claimant whose real property was experiencing the continuing effects of a pre-petition petroleum spill).

Similarly, the actual and necessary benefit to the estate standard has been found satisfied by testing the necessity of the expense, such as the cost of plugging an oil well, without regard to the benefit of the bankruptcy estate. See Texas v. Lowe (In re H.L.S. Energy Co.), 151 F.3d 434 (5th Cir. 1998). Yet, as noted above, not all such "necessary" expenses are entitled to administrative expense priority, even if fundamental fairness requires such an application.

However, the application of fundamental fairness should not be the only vehicle for subverting the standard allegedly set forth in §503(b). In fact, the express language of §503(b) is "including the actual, necessary costs and expenses of preserving the estate." The use of the word "including" means that post-petition claims entitled to administrative expense status are not limited to those that are "the actual, necessary costs and expenses of preserving the estate." Many courts simply overlook the use of the word "including" and search for other means to determine administrative expense priority. Regardless, the use of the word "including" means that there are other bases for allowance of an administrative expense claim.

Conclusion

Whether a claim is entitled to post-petition administrative expense priority is a fact-intensive issue that will continue to be litigated. Indeed, the applicability of Reading and the fundamental fairness exception hinges upon advocacy and the court hearing the issue.

The bankruptcy court is, after all, the finder of both fact and law. As such, and considering the express language of §503(b), the court has the discretion in determining the propriety of administrative expense priority for post-petition claims. More importantly, however, such a determination need not pivot on whether the expenses incurred were actual, necessary costs of preserving the bankruptcy estate.

Footnotes

¹ Pursuant to 11 U.S.C. ¶102(3), the use of the word "including" is not limiting. 4 King, Lawrence P., Collier on Bankruptcy ¶503.06[1] (15th Ed. 2001).