Until recently, one of the enduring tenants of chapter 11 bankruptcy cases was that administrative claims had to be paid in full for the plan of reorganization to go into effect. Recently, however, debtors in several high-profile cases have exploited a loophole to this rule by offering “administrative claim consent programs,” where administrative creditors voluntarily accept reduced payments on their claims and debtors are still allowed to pursue a chapter 11 plan of reorganization or liquidation.
Most claims against a bankrupt debtor arise before the debtor files its Chapter 11 case. Administrative claims, by contrast, arise after the filing and accrue while the case is pending. For unions, administrative claims against the debtor may include claims for wages, paid time off, and severance pay accruing to employees who continue working while the employer is in bankruptcy. For benefit funds, administrative claims may include fund contributions that come due during the bankruptcy and potentially some portion of withdrawal liability.
The Bankruptcy Code states that, in most cases, a chapter 11 plan cannot take effect until administrative claims are paid in full. 11 U.S.C. § 1129(a)(9). In bankruptcy parlance, debtors without sufficient cash to pay off administrative creditors at the end of the case are “administratively insolvent.” The historical response to an administratively insolvent debtor was to have the case converted to a chapter 7 liquidation or to dismiss the case entirely.
Administrative claim consent programs exploit an exception to Section 1129(a)(9) that allows chapter 11 plans to take effect without administrative creditors being paid in full, so long as the administrative creditors consent to a lesser payout on their claims. How do debtors convince administrative creditors to accept a lesser payout than the full recovery they are entitled to under the Bankruptcy Code?
Administrative claim consent programs typically involve the looming threat of administrative insolvency for debtors that do not plan to emerge from bankruptcy as going concerns. In recent cases, debtors have proposed such programs after they have sold off their primary operations and assets through the bankruptcy case and are winding down the business. At that stage, the debtor hints that it is likely administratively insolvent, i.e. that it does not have enough cash on hand to pay administrative creditors in full, and that the case may need to convert to chapter 7 or be dismissed, in which case administrative creditors would likely get paid nothing. To avoid a chapter 7 conversion or dismissal, a third party, usually the debtor-in-possession lender, will put up enough cash to pay administrative creditors some fraction of their claims, but only if the creditors waive their right to collect the full value of their claims at the end of the case. If administrative creditors don’t take the offer, the debtor and the lender may pull the plug and convert the case to chapter 7 or dismiss.
Administrative claim consent programs give administrative creditors a choice of sorts: accept a significantly smaller payment now to allow the debtor to pursue a chapter 11 plan, or hold on to the claim and run the risk of collecting nothing if the case converts to chapter 7 or gets dismissed. Either way, administrative creditors stand to receive far less than the full recovery promised by the Bankruptcy Code.
As administrative claim consent programs become more common, unions and benefit funds can take some precautions early in the bankruptcy case to protect their administrative claims and those of their members. For example, unions and benefit funds can suggest language for first day wages orders to ensure that wages, other compensation, and fund contributions are paid in the ordinary course of business during the bankruptcy and do not accumulate as administrative claims that may eventually be impaired through an administrative claim consent program. In addition, if a bankruptcy unfortunately involves plant closures and layoffs, unions and benefit funds can seek to negotiate shutdown agreements that provide for severance payouts as early as possible, again to limit the risk that such payments eventually get impaired through such a consent program.