In re Packaging Systems, LLC: Bankruptcy Court Allows Creditor's Postpetition Superpriority Claim Priority Over Trustee's Post-Conversion Administrative Expenses | Practical Law

In re Packaging Systems, LLC: Bankruptcy Court Allows Creditor's Postpetition Superpriority Claim Priority Over Trustee's Post-Conversion Administrative Expenses | Practical Law

In In re Packaging Systems, LLC, the US Bankruptcy Court for the District of New Jersey held a creditor's postpetition superpriority claim had priority over the Chapter 7 Trustee's post-conversion administrative expenses.

In re Packaging Systems, LLC: Bankruptcy Court Allows Creditor's Postpetition Superpriority Claim Priority Over Trustee's Post-Conversion Administrative Expenses

by Practical Law Bankruptcy & Restructuring
Published on 16 Nov 2016 • USA (National/Federal)
In In re Packaging Systems, LLC, the US Bankruptcy Court for the District of New Jersey held a creditor's postpetition superpriority claim had priority over the Chapter 7 Trustee's post-conversion administrative expenses.
On September 30, 2016, the US Bankruptcy Court for the District of New Jersey held in In re Packaging Systems, LLC, that a creditor's postpetition superpriority claim had priority over the Chapter 7 Trustee's post-conversion administrative expenses ( (Bankr. D.N.J. Sept. 30, 2016)).

Background

On December 9, 2010, Packaging Systems, LLC (Debtor) entered into a factoring agreement with Harborcove Financial, LLC, in which Packaging Systems sold accounts receivable to Harborcove, and subsequently issued liens on substantially all its assets, in exchange for advances or extensions of credit. Packaging Systems filed a voluntary Chapter 11 petition on April 3, 2012, and subsequently filed a motion to assume the prepetition factoring agreement, as postpetition DIP financing, and to grant Harborcove a Chapter 11 superpriority claim under section 364(c)(1) of the Bankruptcy Code. On May 17, 2012, the postpetition factoring agreement was approved by final order of the Bankruptcy Court.
On May 6, 2013, the Bankruptcy Court entered an order converting the case to Chapter 7 on motion by the US Trustee, without objection from Harborcove or the Debtor.
While the Chapter 7 proceeding was pending, the Chapter 7 trustee (Trustee) initiated six adversary proceedings to recover preferential and fraudulent transfers under Chapter 5 of the Bankruptcy Code.
Harborcove submitted a proof of claim in the amount of $182,826.83, which was secured against substantially all of Debtor's assets and accounts receivable, and claimed priority for the entire amount pursuant to 11 U.S.C. section 507(a)(2).
The Trustee successfully recovered $92,395.99 through the avoidance actions. On May 20, 2016, the Trustee filed a final report, which disclosed $89,341.53 remaining in the estate, and proposed a distribution that paid the entire amount remaining in the estate towards Chapter 7 administrative expenses, minus $2,500 for the Internal Revenue Service.
Harborcove objected to the Trustee's final report, arguing that under section 364(c)(1) of the Bankruptcy Code, its pre-conversion superpriority claim should take precedence over all post-conversion Chapter 7 administrative expenses. In addition, Harborcove moved for allowance and payment of its superpriority claim.
The Debtor's attorney, Norris, McLaughlin & Marcus, PA, (NMM), joined Harborcove's objection, requesting the firm's remaining carve-out of $15,000 be distributed to NMM before Harborcove or any other administrative claimant.

Outcome

The Bankruptcy Court sustained Harborcove's objection. In its decision, the Bankruptcy Court noted a split among courts on the issue of whether section 364(c)(1) or section 726(b) of the Bankruptcy Code controls the payment of a superpriority claim upon conversion from Chapter 11 to Chapter 7. Here, the Bankruptcy Court held section 364(c)(1) controls.
In its analysis, the Bankruptcy Court noted the tension between section 364(c)(1) and section 726(b) is caused by each giving out a type of superpriority status and neither statute directly addressing the other.
Each statute gives priority status in different situations:
The Bankruptcy Court analyzed these statutes and noted that section 726(b) is silent regarding the priority of a court approved claim under section 364(c)(1) in a Chapter 11 case that is converted to a Chapter 7 case. Section 726(b) only says that post-conversion section 503(b) administrative expense claims have priority over pre-conversion administrative expense claims. The Bankruptcy Court noted that section 364(c) specifically provides for priority over "any and all administrative expense claims" allowed under sections 503(b) or 507(b).

Plain Language of the Statute Rather Than Policy Concerns

The Bankruptcy Court agreed with In re National Litho, LLC and In re Mayco Plastics, Inc. finding that the plain language of the statute gives priority to claims under section 364(c). Specifically, each of these decisions gave priority to section 364(c) claims for different reasons, which were:
The Bankruptcy Court rejected interpretations by other courts that gave priority to administrative claims under section 726(b). Those courts relied on policy arguments after determining the statutory language was not clear. (See In re Sun Runner Marine, Inc., 134 B.R. 4 (B.A.P. 9th Cir. 1991); see also In re Visionaire Corp., 290 B.R. 348 (Bankr. E.D. Mo. March 21, 2003), aff'd in part and rev'd in part, 299 B.R. 530 (B.A.P. 8th Cir. 2003)). The Bankruptcy Court noted that in In re Summit Ventures, Inc., the Court ruled Chapter 7 administrative expenses should be given priority over section 364(c) superpriority claims because the "present need to administer a Chapter 7 case is always greater than the past, and also mooted, needs of the failed Chapter 11" (In re Summit Ventures, Inc., 135 B.R. 478, 483 (Bankr. Vt. July 9, 1991)).
The Bankruptcy Court rejected these policy concerns and agreed with the holdings of the courts in In re National Litho and In re Mayco because it found the statutory language to be clear and should be followed as written.

Equity Requires Trustee To Be Reimbursed

The Bankruptcy Court sustained Harborcove's objection but refused to grant them a windfall because, if not for the Trustee's actions, Harborcove would not have recovered any of its claim. Harborcove did not have standing to pursue Chapter 5 claims on its own. The Bankruptcy Court noted the following reasons that the Trustee should be reimbursed:
  • The recoveries from Chapter 5 claims belonged to the Trustee because only he could prosecute the claims. The failing of the Trustee was to consider the value of the Chapter 5 claims with regard to Harborcove's superpriority claim, in order to determine whether prosecuting the Chapter 5 claims was worth the Trustee's effort.
  • The final order approving Harborcove and the Debtor's factoring agreement excluded Chapter 5 recoveries from Harborcove's security interest, eliminating the Trustee's ability to claim a carve-out under section 506(c) of the Bankruptcy Code. The Bankruptcy Court noted that this exception made matters worse because the Trustee could have invoked section 506(c) and claimed a carve-out if Harborcove had held a secured position in the recoveries.
  • Harborcove was not without fault when it filed its proof of claim under section 507(a)(2), which as an administrative expense claim would have required a different form than the one Harborcove used.
  • The narrative Harborcove attached to its proof of claim added to the confusion by asking for payment from proceeds of its collateral, which did not extend to Chapter 5 claims, and requesting immediate payment of its claim at a time when the estate had no money.
For these reasons, the Bankruptcy Court used its equitable power to order the Trustee to submit an application for payment for its fees and expenses that were reasonably necessary for the recovery of the Chapter 5 claims. Additionally, the Bankruptcy Court upheld the NMM carve-out, leaving what remained to be distributed to Harborcove.

Practical Implications

This decision adds to the split among courts on the issue of whether section 364(c)(1) or section 726(b) controls the payment of a superpriority claim upon conversion from Chapter 11 to Chapter 7. It strengthens the argument that the statutory language of the provisions support granting priority to Chapter 11 superpriority claims over Chapter 7 administrative claims. As a result, Chapter 7 trustees must consider the value of pre-conversion superpriority claims when planning case administration and whether the expense of pursuing claims on behalf of the Chapter 7 estate exceeds them. The Chapter 7 trustee should consider reaching an arrangement with Chapter 11 superpriority claimants before incurring expenses for their benefit. At the same time, Chapter 11 superpriority claimants cannot assume that a Chapter 7 trustee will be required to forfeit payment of expenses incurred for the benefit of Chapter 11 superpriority claimants.