Recently, the United States Bankruptcy Court for the District of Delaware held that a carve-out provision in a DIP financing order did not act as an absolute limit on the fees and expenses payable to the professionals retained by an unsecured creditors’ committee (the “Committee”).  Rather, in In re Molycorp, Inc., 562 B.R. 67 (Bankr. D. Del. 2017), Judge Christopher Sontchi held that $8,491,064 in fees and $226,170 in expenses incurred by the Committee’s law firm during the case were payable as administrative expenses of the estate.  The court overruled objections from the debtors’ DIP lender, who argued that a negotiated carve-out of $250,000 should serve as a cap on the Committee professionals’ compensation.

Importantly, the debtors in Molycorp case had successfully confirmed a plan of reorganization.  Because of this, the Court determined that section 1129(a)(9)(A) of the Bankruptcy Code applied, which requires that unless otherwise agreed, each administrative claimant must receive cash equal to the allowed amount of its claim on the effective date of the plan.  The Committee professionals and the DIP lender had agreed to a limited carve-out from the secured lender’s adequate protection to allow the Committee to investigate possible causes of action against the lender and the debtor’s officers and directors, which was memorialized in the final DIP order using the following provision:

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.

The Committee conducted an investigation over a four-month period, involving an extensive discovery process.  This culminated in the Committee filing a motion seeking standing to pursue certain causes of action.  The Court granted the motion, authorizing the Committee to bring claims on behalf of the debtors’ estates, and an adversary proceeding commenced.  The parties eventually settled, resulting in a consensual plan of reorganization that was confirmed by the Court.

Following plan confirmation, the Committee’s attorneys filed a fee application for the full amount of fees and costs incurred during the investigation, prosecution and settlement activities, which far exceeded the DIP carve-out amount.  The lender objected, arguing that the carve-out was intended to serve as an absolute cap for those actions and that the amounts were unreasonable.

The fees and costs had been reviewed and, other than a small recommended write off, had been approved by a Court-appointed fee examiner.  The Court sided with the Committee, finding that the carve-outs like the one agreed to in Molycorp provide some risk protection for committees to allow them to investigate a secured lender’s collateral, but do not act as an absolute cap on committee fees when a plan is confirmed.

In agreeing to a carve-out, a secured lender selectively subordinates some of its liens and superpriority claims to specific administrative expenses.  Due to the absolute priority rule, the Committee’s expenses would not have been paid, other than as a result of the carve-out, provided that the debtors had insufficient unencumbered assets to satisfy their administrative expenses: “[I]t should be noted that when there are insufficient unencumbered assets to pay professionals’ fees and no plan has been confirmed, professionals’ only recourse is the carve-out.”  562 B.R. at 13.

However, the priority of the secured creditors’ collateral becomes irrelevant once a plan is confirmed because of the section 1129(a)(9)(A) requirement that “if the secured parties desire confirmation, the administration claims must be paid in full in cash at confirmation even it if means invading their collateral.” Id. at 15; quoting In re Emons Industries, Inc., 76 B.R. 59, 60 (Bankr. S.D.N.Y. 1987).  Judge Sontchi decided that the DIP order unambiguously “lacks a language that can be interpreted as an automatic and absolute cap on the allowance of administrative claims.”  Id. at 19-20.

Some DIP lenders have avoided confronting this issue by seeking bankruptcy dismissals without a confirmed plan of reorganization or by including explicit fee cap language in their financing orders.  The Court in Molycorp noted that Committee counsel had provided a sample DIP order entered in another case that defined a “Creditor’s Committee Expense Cap” as “the aggregate fees and expenses of all professional persons retained pursuant to an Order of the Court by the Creditor’s Committee.”  Id. at 20, fn. 58.  Given the result in Molycorp, this language may become increasingly common and committee counsel should expect that DIP lenders may include other similar provisions in an effort to cap committee fees even when a plan is confirmed.