Addressing Section 503(b)(9) Claims Issues at the Outset

It is a common fact pattern among cases filed in the U.S. Bankruptcy Court for the District of Delaware over the past decade: an over-leveraged debtor is in default under its prepetition credit facility, and the prepetition secured lender is looking to liquidate its collateral and get out as quickly and inexpensively as possible. It is this fact pattern, along with an increased awareness of the costs and uncertainty associated with “free fall” Chapter 11 bankruptcies, that has helped maintain the popularity of sale cases under Section 363 of the Bankruptcy Code. Assuming an appropriate marketing process has been conducted, Section 363 generally enables a debtor to complete a sale of substantially all of its assets within 60 to 90 days of the petition date. There are, however, still significant costs involved in funding a sale process of this length, including, among other things, funding the post-petition costs and expenses of operating the business through the sale process. More likely than not, these costs will need to be funded by the prepetition secured lender in the form of a DIP (debtor-in-possession) credit facility or through the consensual use of the prepetition lender’s cash collateral. This article discusses the impact that Section 503(b)(9) of the Bankruptcy Code may have on the funding needs of a case and explores the manner in which the Delaware bankruptcy court has addressed the issue.

In seeking bankruptcy court approval of DIP financing or the consensual use of cash collateral, the general requirement is that the debtor be able to demonstrate that the case will be “administratively solvent” through the conclusion of the sale process. Generally speaking, this requires a showing from the debtor that the DIP financing and/or use of cash collateral will provide for the payment of all post-petition administrative claims incurred by the debtor in operating its business through the sale process. These expenses include, among other things, post-petition amounts owed to trade vendors, employees, utility providers and certain professionals incurred in the ordinary course of operating the debtor’s business. Section 503(b)(9) of the Bankruptcy Code, however, complicates a debtor’s ability to demonstrate administrative solvency early in a Chapter 11 case. Section 503(b)(9) essentially elevates prepetition claims for “goods received by the debtor within 20 days before the” petition date to administrative claims against the debtor’s estate. While this has an obvious effect on how such claims will be treated under any Chapter 11 plan, it also presents a potential financing issue early on in a Section 363 sale case. Specifically, the issue is whether a debtor can demonstrate administrative solvency where the proposed financing budget does not provide assurance of payment for all Section 503(b)(9) claims. This issue typically arises as a dispute between the proposed DIP lender, who wants to limit the funding necessary to get through the sale process, and an objecting creditors’ committee or individual claimant.