When Renewed Pre-Petition Contracts Can and Can’t Have Administrative Status
Claims under pre-petition contracts extended after bankruptcy can have administrative status if there was benefit to the estate, district judge says, reversing the bankruptcy court.
A district judge in New York reversed the bankruptcy court for a ruling that could have been interpreted to mean that the post-petition extension of a contract on identical terms can never give rise to an administrative claim, even if the breach occurred after filing.
In brief summary, the creditor filed a $14 million administrative claim. The bankruptcy court relegated the claim to the status of a pre-petition unsecured claim, on the theory that the post-petition breaches were within the fair contemplation of the parties when they signed the contract before bankruptcy.
In an opinion on September 23, District Judge Lewis A. Kaplan reversed, holding that the creditor might be entitled to an administrative claim. The reversal is not earthshaking, because Judge Kaplan only remanded for the bankruptcy judge to decide whether the post-petition breaches were costs of preserving the estate and thus entitled to administrative status.
Relegation to Pre-Petition Status
The creditor was a lender that made reverse mortgage loans. The debtor was a servicer of the reverse mortgages. They entered into a servicing agreement years before the servicer’s bankruptcy. They extended the servicing agreement many times before bankruptcy and several times after the servicer filed a chapter 11 petition.
The debtor-servicer did not assume the executory servicing contracts. The last extension expired on the effective date of the debtor-servicer’s chapter 11 plan. To the extent any servicing contracts might have extended beyond confirmation, they were automatically rejected. The purchaser of the debtor’s business did not assume any of the agreements with the servicer.
The lender filed $14 million in administrative claims, based on alleged post-petition breaches of the servicing agreement. After the debtor objected to allowance of the claims, the bankruptcy court upheld the objection to the extent of relegating the claims to the status of pre-petition unsecured claims.
The lender appealed.
The Basis for the Bankruptcy Court’s Ruling
As characterized by Judge Kaplan, the bankruptcy judge decided that the claims were deemed to arise before filing because the post-petition mistakes in servicing were within the “fair contemplation of the parties” when they entered into the agreements before bankruptcy.
Judge Kaplan framed the issue on appeal as a single question of law: When will a post-petition breach give rise to an administrative claim under Section 503(b)? The lack of a clear answer, he said, stems from “the psychedelic confusion [that] arises at the intersection of two parts of the Bankruptcy Code: Section 365, which governs the classification of breach claims under rejected executory contracts, and Section 503, which governs administrative priority.”
Judge Kaplan cited Section 365(g)(1) to say that the claim resulting from rejection of an executory contract before assumption is a pre-petition claim, generally speaking. Section 503(b) gives administrative status for “the actual, necessary costs and expenses of preserving the estate.”
Parsing the issues, Judge Kaplan said that the outcome does not turn on the state law concept that the renewal of a contract on the same terms is not a new contract. Instead, he said that the Bankruptcy Code determines when a claim arises and does not incorporate principles of New York contract law.
Judge Kaplan characterized the bankruptcy court’s analysis as viewing the post-petition contract extensions as pre-petition contracts and that the errors and other post-petition breaches were “within the fair contemplation of the parties” when the contracts were originally executed.
“To hold as a matter of law that a post-petition contract extension on identical substantive terms never can result in an administrative-priority breach of contract would flip the Bankruptcy Code on its head,” Judge Kaplan said. Also, it “would invite unjust enrichment of the bankruptcy estate.”
Instead, Judge Kaplan said that the outcome about the administrative status of the claims turned on whether the claims represented the “actual, necessary costs and expenses” of preserving the estate under Section 503(b).
Judge Kaplan cited the Second Circuit for saying that claims under a pre-petition executory contract can have administrative status if the debtor did not reject the contract but elected to receive benefits from the creditor’s performance. He went on to say that “inducement -- more than simply receipt of benefits -- is required under the statute.”
Having found that the bankruptcy court applied the wrong standard, Judge Kaplan reversed and remanded. He said it was “appropriate for the Bankruptcy Court to determine in the first instance whether [the lender] has any administrative expense claims on a ‘demonstrable benefits’ theory.”
Finance of America LLC v. Mortgage Winddown LLC (In re Ditech Holding Corp.), 21-10038 (S.D.N.Y. Sept. 23, 2022)
Finance of America LLC v. Mortgage Winddown LLC (In re Ditech Holding Corp.)