Any business seeking to reorganize formally through Chapter 11 will require the assistance of specially trained professionals. Depending upon the size and complexity of the case, it would not be uncommon for a debtor to employ bankruptcy counsel, a financial adviser, an investment banker and a claims agent. In addition, the Bankruptcy Code permits the formation of official creditor committees that can be expected to hire their own army of professionals. All of these court-appointed professionals are entitled to recover their reasonable fees and expenses from the estate pursuant to Sections 327, 328 and 330 of the Bankruptcy Code.

But what about those professionals who are retained by an individual creditor, shareholder or indenture trustee? Should they be compensated by the bankruptcy estate as well? In a recent decision, In re S&Y Enterprises, Case No. 10-50623 (Bankr. E.D.N.Y., filed Sept. 28, 2012, Docket No. 160), the U.S. Bankruptcy Court for the Eastern District of New York addressed that question by narrowly construing Sections 503(b)(3)(D) and 503(b)(4) of the Bankruptcy Code as an avenue to recover such fees and expenses provided a “substantial contribution” is made in the case.

S&Y involved multiple single-asset real estate debtors that sought, through a Chapter 11 plan of reorganization, to sell substantially all of their assets for upscale retail development. Through an auction process, Bedford JV LLC lost to a competing bidder that ultimately paid in excess of $1 million more for the assets than Bedford had offered. Undaunted, Bedford sought to compel the debtor to pay its professional fees, alleging that it had made a “substantial contribution” to the bankruptcy case within the meaning of Sections 503(b)(3)(D) and (b)(4). Specifically, Bedford argued that it had caused the winning bidder to increase its offer (resulting in a higher sales price), that it had been involved in drafting and defending the debtors’ Chapter 11 plan, and participated in negotiations and motion practice, all of which resulted in a “substantial contribution” to the estate and its creditors.

The S&Y court noted that while the substantial contribution provision is intended to promote participation in the Chapter 11 process, the allowance of a § 503(b)(3) claim must be viewed as the exception and not the rule to avoid “mushrooming administrative expenses.” Thus, a court should “strictly limit compensation to extraordinary creditor actions which lead directly to tangible benefits to the creditors, debtor or estate” and these claims should be “kept to a minimum” and “narrowly construed.”

In further discussing what is inherently a fact-intensive and case-specific analysis, the court noted that actions taken in a creditor’s self-interest, which confer only an incidental benefit to the debtor’s estate or case, are not compensable. “At the same time,” the court recognized that “a measure of self-interest seems likely in nearly every situation, and the existence of a self-interest cannot in and of itself preclude reimbursement.” Thus, while a party seeking a substantial contribution claim need not possess an “altruistic motive” behind its actions, ordinary efforts taken by a creditor will not suffice. Rather, the creditor must undertake extraordinary actions in connection with a leadership role, of the type that would normally be performed by a “retained” professional such as the debtor’s or creditor’s committee’s advisers. Finally, the court held that the efforts for which the entity seeks compensation must yield “a direct and significant benefit to the bankruptcy estate or the parties as a whole.”

The court found that Bedford’s actions did not qualify for § 503(b) “substantial contribution” reimbursement. “Here, the record shows that Bedford JV’s activities … were principally in furtherance of its efforts to acquire the debtors’ properties … the primary objective of these activities was to advance Bedford JV’s own interests, not the interests of the bankruptcy estate or the parties as a whole.” The principal contribution cited by Bedford was its involvement with competitive bidding for the debtor’s assets. This, Bedford argued, benefited the debtors and case as a whole because it resulted in a $1 million-plus increase in the winning bidder’s offer, which redounded to the benefit of the debtors and all creditors in the case. In response, however, the court found that “if this were adequate, then a serious but unsuccessful bidder for a debtor’s assets, or a participant in a negotiation that provides additional leverage to a debtor in its negotiations with others, could shift its counsel fees and expenses to the debtor’s estate through a substantial contribution administrative expense. At most, Bedford JV has shown that its activities led to an indirect benefit to these bankruptcy cases, and plainly, that is not enough.”

Given that S&Y was a sale case, it is unclear why Bedford did not seek bid protections at the outset of the auction process as opposed to asserting a § 503 claim afterwards. Had it done so, it may well have received a “break-up fee” covering its counsel fees. Under the S&Y analysis, meeting the burden needed to justify a “substantial contribution” claim is difficult and achievable only in rare cases. Arguably, it creates a somewhat unfair bias in favor of professionals and the constituencies they represent who are formally court approved and thus have their fees paid by the debtor. In contrast, an individual creditor runs the risk that even though it incurs significant professional fees within a bankruptcy case, those fees will not be reimbursed absent a showing of truly extraordinary and unusual actions that resulted in a tangible benefit to the debtor, creditors or bankruptcy case as a whole. This opinion also imparts the lesson that, while a claimant’s self-interest is not necessarily fatal to a substantial contribution claim, those actions taken principally in the claimant’s interest with only an incidental or tangential benefit to the estate will not be rewarded. •

Francis J. Lawall is a partner in the Philadelphia office of Pepper Hamilton and concentrates his practice in national bankruptcy and reorganization matters. He routinely lectures to various creditor groups concerning general bankruptcy issues, including preferences, reclamation, the role of creditors committees and related issues.

 James C. Carignan is of counsel in the firm’s Wilmington, Del., office. He concentrates his practice primarily in the areas of bankruptcy, reorganization, creditors’ rights and out-of-court workouts.