A recent decision from the Bankruptcy Court for the District of New Jersey (In re Packaging Systems LLC, 2016 WL 57877239, 09/30/2016) is a good wake up call for factors, lenders and practitioners representing them. The lesson learned is to assure that your rights under a Chapter 11 Super Priority Claim are properly asserted during a subsequent Chapter 7 proceeding.
The case involved a debtor-in-possession factoring facility. The Final Order approving the post-petition factoring facility provided the Factor with a typical super-priority administrative claim, senior to all other administrative claim as follows:
[Factor] is hereby granted a super-priority administrative claim under Section 364(c)(1) of the Bankruptcy Code over any and all administrative expenses incurred and priority claims arising in this case for the obligations of the Debtor to [Factor] under the Pre-Petition Factoring Agreement, as amended by the Amendment, and Post-Petition Factoring Agreement, including all pre-petition and post-petition debt existing at the time of the Debtor’s assumption of the Pre-Petition Factoring Agreement, subject and subordinate only to the following: (a) the quarterly fees required to be paid to the U.S. Trustee; and (b) the fees and expenses incurred by counsel for the Debtor as approved by the Court, up to the sum of $25,000.
The order also granted the Factor a broad lien on all assets other than Chapter 5 recoveries:
[Factor] is hereby granted, and all loans, advances, obligations and amounts due or hereafter becoming due and owing by the Debtor to [Factor] are hereby secured by, valid and perfected first and senior security interests and liens in favor of [Factor] in and on all existing and after acquired assets of the Debtor and the Debtor’s estate, and the proceeds thereof, wherever located, excluding recoveries from actions brought pursuant to the provisions of Chapter 5 of the Bankruptcy Code.
The Chapter 7 Trustee pursued six adversary proceedings to recover for preferential and fraudulent transfers under Chapter 5 and ultimately recovered about ninety thousand dollars.
Factor did not take any action to assert its Super Priority Administrative Claim other than to file a request for payment of administrative claim annexed to the approximately $183,000 Proof of Claim it filed, despite a note contained in the Official Form with a caveat against using the Proof of Claim for such purpose. Instead, Factor raised its Super Priority Administrative Claim as part of its objection to the Trustee’s Final Report, which reported that substantially all of the recovered funds would be used to pay the Trustee’s administrative expenses incurred
The dilemma that faced the Court was whether the Trustee could be paid his administrative expenses in light of Factor’s Super Priority. Ultimately the Court focused on Factor having failed to properly submit a request for payment of its administrative claim as well as its failure to bring its Super Priority to the Trustee’s attention, and “invoked its equitable powers to conclude that the Trustee [was] entitled” to be paid from its recoveries.
The drafting of the DIP orders were somewhat less than they should have been. Typical provisions addressing these issues are as follows:
Pursuant to §§ 364(c) and 364 (d) of the Code, any and all obligations and liabilities of the Debtor owing to BANK and arising after the date of this Order, together with accrued interest and charges incidental thereto, shall have priority in payment over any other obligations or liabilities now in existence or incurred hereafter by the Debtor and of all expenses of the kind specified in Sections 503(b), 506(c), 507(b) and 552(b) of the Code.
No expenses of administration of the Debtor’s Chapter 11 case or any future proceeding which may result from such case, including liquidation in bankruptcy or other proceedings under the Code, shall be charged against the BANK Collateral pursuant to § 506(c) of the Code, or otherwise, without the prior written consent of BANK and no such consent shall ever be implied from any other action, inaction or acquiescence by BANK.
The Court had the correct conclusion (even if its reasoning was less than perfect). Except in rare circumstances, the Chapter 5 claims are preserved for the Debtor’s estate and are neither part of the secured creditor’s collateral nor Super Priority Administrative Claim. It would have been unfair to the Trustee [am I really saying this?] had he expended considerable effort in effecting Chapter 5 recoveries only for the benefit of the secured creditor. Had the Factor intended to assert the claim it ultimately pursued, it would have been wise to first approach the Trustee and work out an arrangement.
Now for what was not an issue in the case but became apparent during my review of the orders.
The Factoring and Security Agreement appears to be a true sale non-recourse factoring agreement. However, the orders approving the post-petition factoring arrangement (both an interim order authorizing a post-petition factoring agreement and a final order authorizing the Debtor to assume the pre-petition factoring agreement) fail to address the nature of the factoring arrangement and merely authorize the Debtor to borrow money from and grant post-petition security interests to Factor. The simple solution would have been to have the order also authorize the Debtor to sell its accounts to Factor pursuant to Section 363 of the Bankruptcy Code in addition to the traditional Section 364 (c) and (d) provisions that were included in the order.