Court Determines That DIP Lender’s Superpriority Administrative Claim Takes Priority Over Claims of a Chapter 7 Trustee

The Bankruptcy Court for the Southern District of Florida recently issued an important decision for administrative creditors in chapter 11 cases and chapter 7 cases alike.  In In re National Litho, LLC, 2013 WL 2303786 (Bankr. S.D. Fla. May 24, 2013), the court considered the effect, if any, of the conversion of a bankruptcy case from a chapter 11 case to a chapter 7 case on the primacy of the “superpriority” administrative expense claim granted to a chapter 11 debtor in possession (DIP) lender in connection with a postpetition financing facility.  In holding that these claims take priority over the administrative claims incurred by a chapter 7 trustee after the conversion of the case, the court handed an important victory to DIP lenders and underscored the continuing enforceability of orders approving DIP financing even after the debtor’s ability to borrow funds has terminated.

In National Litho, the bankruptcy court entered a final order (the “Final DIP Order”) in the chapter 11 case approving the financing agreement between the DIP lender and the debtor.  Pursuant to the Final DIP Order, the debtor granted the DIP lender a superpriority administrative expense claim pursuant to section 364(c)(1) “with priority over any or all administrative expenses of the kind” except for certain obligations owed under a factoring agreement and a carve-out for chapter 11 professionals and United States Trustee fees.  A mere two days after the Final DIP Order was entered, and at the debtor’s request, the bankruptcy court converted the debtor’s case to one arising under chapter 7 case of the Bankruptcy Code.  Approximately two months later, the DIP lender filed a motion for allowance and payment of its superpriority claim.  The chapter 7 trustee objected to the DIP lender’s motion, and contended that its post-conversion expenses should be paid before the superpriority claim is satisfied.

The trustee’s objection was premised on section 726(b) of the Bankruptcy Code, which provides that administrative claims arising in a chapter 7 case have priority over all claims arising in the pre-converted chapter 11 case.  The issue before the court was whether or not the grant of the superpriority claim to the DIP lender senior in priority to “any and all administrative expenses” included chapter 7 administrative expenses under section 726(b), or was instead limited to postpetition costs of the chapter 11 estate only.  Relying on the plain language of the Bankruptcy Code, the court denied the trustee’s motion, finding that (i) section 364(c)(1) of the Bankruptcy Code, which empowers courts to grant lender claims superpriority status, makes it clear that such claims have priority over every kind of administrative claim allowed in a case, regardless of whether the case has been converted to a chapter 7 case; and (ii) nothing in section 726(b) provides that a chapter 7 administrative claim has priority over a superpriority claim arising under section 364(c)(1).  The court determined that “the Bankruptcy Code, while convoluted, is unambiguous – the fact of conversion itself has no impact on the priority of the section 364(c)(1) claim over all other [administrative claims] whenever or however created.” The bankruptcy court also noted that, unlike in some cases, the carve-out in the Final DIP Order did not include a set aside for chapter 7 administrative expenses.  That fact, in combination with the fact that the superpriority claim was granted pursuant to section 364(c)(1), resulted in the favorable result for the DIP lender.

In support of its position the trustee had argued that policy objectives underlying section 726(b) outweigh those of section 364(c)(1), notwithstanding the plain language of the Bankruptcy Code. In support, the trustee cited In re Summit Ventures, Inc., 135 B.R. 478 (Bankr. D.Vt. 1991), a decision of the Vermont bankruptcy court holding that chapter 7 superpriority claims took precedence over chapter 11 superpriority claims on policy grounds.  The bankruptcy court rejected this argument and summarily dismissed the Vermont court’s prior ruling, noting that Summit was simply “wrong,” and concluding that a court may not rely on a policy argument to vary the Bankruptcy Code’s plain language.

The National Litho decision accentuates the often profound impact that pre-conversion orders and negotiations have on the administration of chapter 7 cases that began as chapter 11 proceedings.  Indeed, financing and cash collateral orders in chapter 11 cases are necessarily negotiated before a chapter 7 trustee enters the picture.  In those cases in which the DIP order does not include a carve-out for  a portion of a chapter 7 trustee’s expenses from the DIP lender’s superpriority claim, upon conversion a chapter 7 trustee may find himself working for the sole benefit of the DIP lender, with minimal ability to satisfy his own expenses or those incurred during the chapter 7 portion of the case.

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