Creditors' Expenses Can Be Reimbursed in Ch. 7 Case

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By Diane Davis

Sept. 22 — The reasonable administrative expenses of creditors whose efforts substantially benefit the bankruptcy estate and its creditors are allowed in a Chapter 7 bankruptcy case, the Sixth Circuit held Sept. 21.

Judge Bernice Bouie Donald of the U.S. Court of Appeals for the Sixth Circuit reversed the district court's judgment and remanded the case for consideration of the appellant/creditors' request.

Three unsecured creditors, including Mediofactoring and Coface Argentina, successfully removed a bankruptcy trustee for misfeasance in their Chapter 7 case. The successor trustee commenced an adversary proceeding against his predecessor and reached a settlement that significantly increased the amount of funds available for the bankruptcy estate and its creditors.

The bankruptcy court, however, denied the two creditors' request for reimbursement of administrative expenses under Bankruptcy Code Section 503(b), and the district court affirmed.

“Denying creditors reimbursement of administrative expenses in such circumstances not only would disincentivize participation in the bankruptcy process, it also would impugn the fundamental notion of bankruptcy as equitable relief,” the Sixth Circuit said.

Most Courts Disagree, Dissent Says 

Judge Kathleen M. O'Malley of the U.S. Court of Appeals for the Federal Circuit, sitting by designation, dissented, concluding that the case law upon which the majority relies does not actually support an interpretation of Section 503(b).

Congress expressly limited Section 503(b)(3)(D) to only Chapters 9 and 11, she said. Other circuits and bankruptcy appellate panels, including 25 bankruptcy or district courts, have also expressly held that substantial contributions in a Chapter 7 proceeding aren't administrative expenses under Section 503(b), she said.

Sixth Circuit ‘Got It Wrong,' Expert Says 

“The Sixth Circuit got it wrong,” Prof. Charles Tabb, Mildred Van Voorhis Jones Chair in Law, University of Illinois, told Bloomberg BNA Sept. 22.

“The result is sympathetic and understandable but does violence to the statute,” Tabb said. “Why bother to go to the trouble to say substantial contributions can be compensated in Chapters 9 and 11 if such contributions in Chapter 7 also are fair game? If that were the statutory construct Congress intended, it simply could have said that a creditor can be compensated if it makes a substantial contribution ‘in a case under this title,'” he said.

“The reference to Chapters 9 and 11 is surplusage. While it is true that the opening clause of 503(b) says ‘including,' which is not limiting, the decision here renders meaningless and unnecessary the specific reference to Chapters 9 and 11 in 503(b)(3)(D),” Tabb said. “The canon of interpretation that the specific controls the general dictates that the ‘including' clause in the introductory part of 503(b) is trumped by the narrow limitation to Chapters 9 and 11 in 503(b)(3)(D),” he said.

Broad Reading of Statute 

Bankruptcy Code Section 503(b), which provides that administrative expenses may be awarded in nine categories of claims that it expressly deems reimbursable, also authorizes reimbursement for creditors who have made “substantial contribution[s]” in cases under Chapters 9 and 11 of the Bankruptcy Code. There is no similar express statutory provision for creditors in Chapter 7 cases in the Code, the Sixth Circuit said.

Starting with the concept that bankruptcy courts are “specialized court[s] of equity,” the Sixth Circuit concluded that a broad reading of the statute would allow for administrative expenses in Chapter 7 cases.

According to the court, it makes good sense that Congress would expressly mention Chapters 9 and 11 in the context of creditor activity making a “substantial contribution” but not Chapter 7. In both Chapters 9 and 11, a creditor will spend its own time and resources to benefit the estate, but in the most atypical Chapter 7 case, the U.S. Trustee fulfills this role, the court said.

Role of U.S. Trustee 

The U.S. Trustee is tasked with the role of “monitoring the progress of cases under [the Bankruptcy Code] and taking such actions as the United States trustee deems to be appropriate to prevent undue delay in such progress,” the court said. The U.S. Trustee is not a “fail-proof” safeguard, the court noted, and in certain circumstances, a Chapter 7 creditor may be compelled to use its own resources to protect the estate as a whole, as happened in this case.

According to the appeals court, “there is no question that the estate would have paid the expenses associated with removing the former trustee and prosecuting the malpractice action.” Thus, the construction favored by the bankruptcy court, the U.S. Trustee, and the dissent results in the “disallowance of an administrative expense that would have been allowed had the bankruptcy proceeded as intended by the Bankruptcy Code,” the court said.

Judge Helene N. White joined the opinion.

William M. Hannay, Schiff Hardin, Chicago, represented amicus curiae; Marc N. Swanson, Miller, Canfield, Paddock & Stone, PLC, Detroit, represented plaintiffs/appellants; Cameron M. Gulden, United States Department of Justice, Chicago, represented defendant/appellee.

To contact the reporter on this story: Diane Davis in Washington at

To contact the editor responsible for this story: Jay Horowitz at

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