Admittedly, lawyers love gotchas. But in the Chapter 11 bankruptcy case of Molycorp, Inc., a lender’s attorney, who apparently sought to pull a gotcha, ended-up being got. Specifically, Judge Sontchi ruled last week against a secured lender in the Molycorp case after that lender objected to $8+ million in administrative expenses incurred by the creditor’s committee’s attorneys. In short, Judge Sontchi ruled that, despite a fee cap contained in a DIP financing order, that cap was ineffective to cap fees, and even subjected the lender’s collateral to payment of those fees, once the parties, including the secured lender, entered into a global settlement and agreed to incorporate that settlement into a consensual Chapter 11 plan. We’ll summarize that opinion in this post but, as usual, the always excellent Bill Rochelle beat us to it by a few minutes. I guess we’ll have to start getting up earlier!
Molycorp, Inc. and some of its subsidiaries, which we’ll collectively call Molycorp, filed their bankruptcy petitions in Delaware. Judge Sontchi has the case. While the case was pending, two events occurred that are relevant to this post. First, the debtors obtained approval of a DIP Financing Motion. Second, a creditor’s committee was appointed. The creditor’s committee sought standing to bring claims against Molycorp’s directors and officers and Oaktree Capital Management, L.P., Molycorp’s lender. Judge Sontchi granted the motion and the creditor’s committee filed the complaint. The case then proceeded to mediation at which the debtors, Oaktree Capital, and the creditor’s committee negotiated and executed a global settlement. The settlement formed the basis of a consensual Chapter 11 plan. The plan, which left Oaktree Capital owning most of the reorganized company, was confirmed in April 2016.
With the Chapter 11 plan confirmed, the case went into wind-up mode. As part of the wind-up, Paul Hastings, the attorneys for the creditor’s committee, filed a fee application seeking approval of fees of $8,491,064.75 and expenses of $226,170.96. Oaktree, however, objected to the compensation requested, arguing that the fees were incurred in direct violation of the DIP Financing Order, which contained a dollar-amount cap on the amounts of DIP financing that could be used to pay any creditor’s committee’s counsel.
Oaktree’s objection centered on the Section 4(b) of the DIP Financing Order:
“Notwithstanding the foregoing, up to $250,000.00 in the aggregate proceeds of the DIP Loans, the DIP Collateral, the Prepetition Collateral, and the Carve-Out may be used to pay fees and expenses of the professionals retained by the Committee that are incurred in connection with investigating (but not prosecuting any challenge to) the matters covered by the stipulations contained in Paragraphs I and J of this Final Order.”
Oaktree argued that that provision impacted Paul Hastings’ fees in 2 ways. First, Oaktree argued that Paul Hastings had not identified any funds beyond Oaktree’s collateral from which to receive payment, so Paul Hastings had no means of being paid. Second, Oaktree argued that Paul Hastings’ fee should be written down to the $250,000 cap and that any fees incurred beyond the Cap were presumptively unreasonable, especially the fees for litigation which were not provided for in the DIP Financing Order.
Administratively Insolvent Estate v. Chapter 11 Plan of Reorganization
Judge Sontchi ruled against Oaktree. His holding was based on the distinction between the distribution “waterfall” in an administratively insolvent estate and the treatment of claims under § 1129(a) under a confirmed plan of reorganization.
The Bankruptcy Code provides clear guidance for distributions in a case where no Chapter 11 plan has been confirmed and the estate is administratively insolvent. Under the Code, secured creditors get the value of their collateral. While administrative creditors such as Paul Hastings are next in line, they must be satisfied from estate property that is not collateral of a secured party. Thus, the administrative claimants bear a risk that the estate may be so administratively insolvent that they will not be paid or will only be partially paid.
Under a confirmed Chapter 11 plan, the “waterfall” is the same: the secured creditors get the value of their collateral and administrative creditors, such as attorneys, are paid next. There is, however, an additional requirement in the form of § 1129(a)(9), which requires that all administrative claims to be paid in full on the effective date of the plan, unless the administrative claimant agrees otherwise. Without a showing that the administrative claimant will be paid in full or has agreed to accept other treatment, the plan cannot be confirmed. Thus, the distinction between the two scenarios is not so much the order of payment, but a requirement that the “waterfall” of payments reach (and cover) the administrative claimants unless they agree to different treatment.
Judge Sontchi’s Holding
Judge Sontchi focused on this distinction in rebuffing Oaktree Capital’s objection. He explained that the DIP Financing Order impacted Oaktree Capital’s collateral, only. By agreeing to the DIP Financing Order, Oaktree Capital agreed that Paul Hastings could look for payment of up to $250,000 from Oaktree’s collateral. “In other words, the effect of a carve-out is to allow affected professionals to look to the secured creditor’s collateral where otherwise they would not be able to do so.” This made sense for both parties. Paul Hastings was assured that, even if the case ended up as administratively insolvent, Paul Hastings would be assured of up to $250,000. Oaktree stood to benefit if Paul Hastings was able to identify causes of action against other parties to Oaktree’s (as well as other creditors’) benefit.
Thus, if no Chapter 11 plan was negotiated and confirmed, Paul Hastings would be entitled to $250,000 from Oaktree Capital’s collateral and whatever it stood to receive from the debtors’ unencumbered property, if any. In contrast, when the febtors, Oaktree Capital, and the creditor’s committee agreed to a settlement and incorporated that settlement into the consensual plan of reorganization, they were required to show that the proposed plan met all of the requirements of Chapter 11. One of those requirements is § 1129(a)(9)’s mandate that all administrative fees be paid on the effective date unless the administrative claimant agrees otherwise.
“In the context of a plan confirmation, a cap on the amount to be paid towards administrative expenses may only be approved after obtaining the administrative claimant’s consent.” While the opinion indicates that consent may be obtained prior to plan confirmation (for example, in the context of a DIP Financing Motion), Paul Hastings had never agreed to such treatment. Thus, the statutory requirements of § 1129(a)(9) trumped the carve-out provisions of the DIP Financing Order and Paul Hastings was entitled to its fees.
Molycorp provides a helpful framework for thinking through treatment of administrative claims in the range of Chapter 11 cases. It also serves as a warning to lender’s counsel, as Oaktree’s counsel appears to have believed that any fee objection to Paul Hastings’ application would be upheld and Oaktree neglected to require a cap on the firm’s fees in either the settlement agreement or in the plan itself. By neglecting to obtain Paul Hastings’ express consent in the settlement or at plan confirmation, Oaktree’s lawyers doomed its objection.