District Court Holds that Attorneys Retained by Members of Creditors’ Committee in Lehman Cannot be Paid by the Estate in a Chapter 11 Plan

May 13, 2014

In a decision that could significantly affect the ability of indenture trustees’ professionals to be paid their fees and expenses under a chapter 11 plan, the United States District Court for the Southern District of New York (the “District Court”) recently overturned the Lehman Bankruptcy Court’s decision that had approved a provision in the Lehman Chapter 11 Plan (the “Lehman Plan”) providing for the payment of the fees of the attorneys for the individual members of the Lehman Statutory Creditors’ Committee.1 The District Court’s holding that the Bankruptcy Code prohibits professionals retained by individual committee members from recovering their fees and expenses solely on the basis of committee membership affects not only committee members’ professionals, including the professionals of indenture trustees that sit on committees, but also may impact the ability of indenture trustees and their professionals to recover their fees and expenses as administrative expenses under a confirmed chapter 11 plan.

The Lehman Bankruptcy Court Decision

The Lehman Plan provided that fees and expenses, including attorneys’ fees, of, among others, the individual members of the committee, would be allowed as administrative expense claims, subject to review and approval by the Bankruptcy Court. In overruling an objection to this provision by the United States Trustee (“UST”), Bankruptcy Judge Peck held that even though the payment of such fees is not specifically provided for under section 503(b) of the Bankruptcy Code, payment of the fees is not inconsistent with that section (the “Bankruptcy Court Decision”).2 Judge Peck found that section 1123(b)(6) of the Bankruptcy Code, which provides that a plan may include any provision not inconsistent with the Bankruptcy Code, gives plan proponents “enormous leeway” in determining what to include in a chapter 11 plan.3 Moreover, because section 1129(a)(4) of the Bankruptcy Code allows fees and expenses to be paid for services in connection with the case or the plan so long as they are reasonable, and section 503(b) is not inconsistent with section 1129(a)(4), Judge Peck held that the Lehman Plan’s provision for payment of professional fees of committee members was permissible.4 The UST appealed the Bankruptcy Court Decision to the District Court.

The District Court Overrules Judge Peck

On appeal, the District Court vacated the Bankruptcy Court Decision. The District Court rejected the Bankruptcy Court’s analysis, and held instead that the payment of individual committee members’ professional fees solely on the basis of committee membership is in fact inconsistent with section 503(b) of the Bankruptcy Code and therefore not permissible under a chapter 11 plan. Whereas the Bankruptcy Court was not bothered by section 503(b)’s failure to specifically provide for the payment of committee members’ professional fees, the District Court found such failure to be determinative. The District Court pointed to Bankruptcy Code section 503(b)(3)(F), which provides for payment of the expenses incurred by official committee members (but not payment of their professionals’ fees), and Bankruptcy Code section 503(b)(4), which provides for the payment of certain creditor’s professionals’ fees and expenses, but which “glaringly exclude[s]” members of creditors’ committees.5 The District Court concluded that because the legislative history reveals this omission to be intentional, committee members’ professionals could not be reimbursed for their fees and expenses solely on the basis of the committee member’s position on a committee.

The District Court also rejected the argument that the Lehman Plan provision permitting the payment of committee members’ professionals’ fees and expenses did not pay administrative expenses but rather made “permissible plan payments.” Noting that only claims and postpetition expenses are paid under plans, because the professionals’ fees and expenses were incurred postpetition, the District Court found they were in fact administrative expenses that could not be paid under sections 503(b)(3)(F) and 503(b)(4).6

The District Court did leave open one avenue for the payment of committee member professional fees and expenses – payment under the “substantial contribution” standard of Bankruptcy Code section 503(b)(3)(D). If an individual committee member qualifies under section 503(b)(3)(D) by virtue of having made a “substantial contribution” to the bankruptcy case, then that member’s professional fee expenses can be paid under section 503(b)(4). Accordingly, the case was remanded to the Bankruptcy Court to address whether the substantial contribution standard had been met by the individual committee members.7

No party has appealed the District Court decision, although an appeal is still possible after the Bankruptcy Court enters it decision on remand.

The District Court Decision’s Effect on Indenture Trustees in Chapter 11 Cases

Although the District Court decision stated that indenture trustee committee members should not be treated differently from other committee members, the District Court did not specifically address the fees and expenses of indenture trustees and their professionals, which are often paid as administrative expenses under a plan. Even when indenture trustees do not sit on creditors’ committees, the payment of their professionals’ fees and expenses stands in a very similar position under the Bankruptcy Code to the payment of committee members’ professionals’ fees and expenses. In fact, there is no Bankruptcy Code provision that specifically provides for the payment of indenture trustee fees, or their professionals’ fees, except where indenture trustees have been found to have substantially contributed to the case.

As a result of the District Court’s decision, if indenture trustee fees and expenses, including the fees and expenses of their counsel, are to be paid by the estate under a plan, then those fees and expenses might be limited to being paid only if the court determines that the indenture trustee made a substantial contribution to the case. Requiring indenture trustees to satisfy the substantial contribution standard, as it is typically applied by the courts (benefit must be to whole estate, not just noteholders), will impose substantial risks of nonpayment. Moreover, although indenture trustees typically have their charging lien rights on distributions to their holders, there is no certainty that the form and/or value of consideration distributed under a plan would be sufficient to make the indenture trustee and its professionals whole.

Such risk of non-payment of indenture trustees’ and their professionals’ fees and expenses could affect an indenture trustee’s decision to serve on official committees and their use of their own professionals to assist them in such roles that, in turn, could affect the entire chapter 11 case. This is unfortunate as, unlike most other creditors, an indenture trustee is itself not a true economic stakeholder in a debtor’s case, yet indenture trustees and their professionals often play a valuable and critical role in chapter 11 cases-they (i) are the conduit through which communications and distributions to hundreds or thousands of holders generally flow, (ii) provide support to, and respond to questions from, their holders throughout the course of a bankruptcy case, and (iii) typically serve on official creditors committees and (A) do not resign, (B) do not have an individual agenda or other, potentially conflicting interests, and (C) have vast experience in chapter 11 cases and on committees, providing a steady hand where often the other members have no similar experience.

In light of the District Court decision, it is reasonable to expect further challenges to the payment of fees and expenses of indenture trustees, including the fees and expenses of their professionals, under chapter 11 plans.

Alternatives for Payment of Indenture Trustees

Even if courts do follow the District Court decision, there are potentially a number of other ways for indenture trustees’ fees and expenses, including their professionals’ fees, to continue to be paid as administrative claims:

  1. Since section 503(b) does not specifically address whether indenture trustees’ fees can be paid outside the context of membership on a creditors’ committee and the District Court decision only dealt with indenture trustees as committee members, indenture trustees can make the argument that indenture trustee fees can be paid under section 503(b) as actual necessary expenses of administration of the estate, although it may be difficult to successfully make this argument because a benefit to the estate would need to be shown; under the “Reading Exception,” which provides that actual and necessary costs of preserving the estate include costs ordinarily incidental to the operation of the debtors’ businesses8, indenture trustees could argue that their fees and expenses should be payable as administrative expenses because, as described above, indenture trustees provide valuable services to the estate in dealing with the numerous noteholders that hold claims against the debtors;
  2. If the distribution to holders is in cash, indenture trustees with charging liens can assert such liens for the payments of fees and expenses;
  3. Where distributions to holders do not involve cash, the treatment under the plan can provide for cash in the amount of the indenture trustees’ fees and expenses to be paid as part of the distribution to satisfy the indenture trustee’s charging lien;
  4. Settlements outside of a plan under Rule 9019 of the Federal Rules of Bankruptcy Procedure can provide for indenture trustees’ fees and expenses to be paid as part of the settlement; since approvals of Rule 9019 settlements are subject to the “business judgment standard,” the payment of fees under the settlement should not be subject to the “substantial contribution” standard;
  5. If the notes are secured, indenture trustee fees and expenses can be paid as adequate protection payments where the debtor seeks to prime the indenture trustee’s liens under debtor-in-possession financing or to use the indenture trustee’s cash collateral; and

The plan can provide that the indenture trustee has made a substantial contribution to the case; assuming that there are no objections to such provision, the fees and expenses should be paid.


1 Davis v. Elliott Mgmt. Corp. (In re Lehman Brothers Holdings Inc.), 59 Bankr. Ct. Dec. 80; 2014 U.S. Dist. LEXIS 48102 (S.D.N.Y. March 31, 2014).

2 In re Lehman Brothers Holdings Inc., 487 B.R. 181 (Bankr. S.D.N.Y. 2013)

3 Id. at 186.

4 Id. at 193.

5 Lehman, U.S. Dist. LEXIS 48102 at *11.

6 Id. at *25.

7 Id. at *30-31.

8 See Reading Co. v. Brown, 391 U.S. 471 (1968).