Pacific Gas and Electric Company's Chapter 11 filing earlier this year has highlighted an issue that is well settled but sometimes overlooked: Unsecured creditors generally have no right to receive immediate payment of their legal fees from a bankrupt borrower, regardless of any contractual rights they might otherwise have absent the bankruptcy. Further complicating this issue, courts are divided as to whether legal fees incurred post-petition are eligible to be allowed as valid unsecured claims (and therefore eligible to share in any estate property that will be available to satisfy unsecured claims). Administrative agents should keep these issues in mind in respect of distressed unsecured facilities, including considering how and when to protect and enforce their indemnification rights.
Creditors' Rights to Payment of Legal Expenses
Under most standard credit agreements,1 borrowers are required to pay the legal expenses of the lenders. The model credit agreement published by the Loan Sales and Trading Association ("LSTA") contains a typical formulation:
The Borrower shall pay (i) all reasonable out-of-pocket expenses incurred by the Administrative Agent and its Affiliates (including the reasonable fees, charges and disbursements of counsel for the Administrative Agent) . . . in connection with the syndication of the Facilities, the preparation, negotiation, execution, delivery and administration of this Agreement and the other Loan Documents, or any amendments, modifications or waivers of the provisions hereof or thereof (whether or not the transactions contemplated hereby or thereby shall be consummated), (ii) all reasonable out-of-pocket expenses incurred by any Issuing Bank in connection with the issuance, amendment, extension, reinstatement or renewal of any Letter of Credit or any demand for payment thereunder, and (iii) all out-of-pocket expenses incurred by the Administrative Agent, any Lender or any Issuing Bank (including the fees, charges and disbursements of any counsel for the Administrative Agent, any Lender or any Issuing Bank) . . . in connection with the enforcement or protection of its rights (A) in connection with this Agreement and the other Loan Documents, including its rights under this Section, or (B) in connection with the Loans made or Letters of Credit issued hereunder, including all such out-of-pocket expenses incurred during any workout, restructuring or negotiations in respect of such Loans or Letters of Credit [emphasis added].2
Particular language will vary across credit agreements, and in syndicated facilities legal fees are typically payable if incurred by the agent on behalf of the lenders, rather than the borrower paying the legal expenses of each separate lender. Lenders may of course retain their own counsel in relation to a syndicated facility, and might wish to do so if they require additional advice, if they are otherwise entitled to be reimbursed by the borrower, or if they believe that their interests might not align with those of the others in the lender group. However, lenders will commonly forgo retaining separate counsel and instead rely on the agent and the agent's counsel to advance the interests of the lender group. If legal expenses are incurred by the agent in connection with the administration of the facility, lenders would generally expect the borrower to pay directly such expenses. This expectation is important to bear in mind, because most credit agreements also contain a pari passu indemnification of agent expenses by the lenders. Again, a typical formulation can be found in the model credit agreement published by the LSTA as follows:
To the extent that the Borrower for any reason fails to indefeasibly pay any [amounts, including legal expenses, as required by the credit agreement], each Lender severally agrees to pay to the Administrative Agent . . . such Lender's pro rata share (determined as of the time that the applicable unreimbursed expense or indemnity payment is sought based on each Lender's Applicable Percentage at such time) of such unpaid amount (including any such unpaid amount in respect of a claim asserted by such Lender)...
In practice, this indemnification is seldom called upon because borrowers pay the agent's counsel's fees and expenses directly. Upon the filing of a bankruptcy petition, however, this process becomes prohibited.
Secured Creditors' Rights
Upon a filing of a bankruptcy petition,3 a wide variety of actions and claims are automatically stayed,4 and the debtor is generally barred from making post-petition payments on non-essential obligations such as lender fees and expenses. However, if secured lenders are over-secured, then such lenders may be able to receive direct periodic payment of post-petition legal fees as "adequate protection" for the debtor's use of lender collateral5 or as part of the lender's secured claim.6 Most commonly, debtors will request access to cash collateral in order to facilitate operations and/or effectuate their restructuring goals in exchange for a package of protections against the diminution in value of such collateral, and secured creditors will require the periodic payment of legal expenses.7 If approved by the court, the net effect to secured lenders is that the debtor remains obligated, post-petition, to pay the lenders' legal expenses, subject to the terms of the original contractual arrangement between the lenders and the debtor and the Bankruptcy Code's requirements as to the reasonableness of allowed expenses.
Additionally, outside of the adequate protection regime, it is also possible to have certain attorneys' fees paid by the debtor if such fees can be justified as qualified administrative expenses.8 These administrative expenses would be paid under the plan of reorganization on a preferential basis over general unsecured claims.9
1 Some structured credits, repurchase agreements and other forms of borrowing may not have such a requirement.
2 See www.lsta.org
3 11 U.S.C. § 101 et seq.
4 11 U.S.C. § 362(a).
5 11 U.S.C. § 361.
6 11 U.S.C. § 506(b).
7 11 U.S.C. § 361(1).
8 11 U.S.C § 503(b). Note that under § 361(3), compensation allowable under § 503(b)(1) is not permitted as a form of "other relief" granted as adequate protection.
9 11 U.S.C. § 507(a).
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