In In re ID Liquidation One, Case No. 11-11046 (D. Del. Nov. 5, 2013), an insider of the debtors sought allowance of an administrative expense claim for services rendered pursuant to a prepetition management agreement signed by insiders on behalf of the debtors. Under the unique facts of the case, U.S. District Judge Brendan L. Shannon of the District of Delaware allowed the claim in an amount less than the contract rate, after rejecting the testimony of two expert witnesses and arriving at his own conclusion with regard to reasonableness. The case illustrates the hurdles insiders must overcome in seeking compensation for services rendered to the debtors' estates post-petition.
The debtors were owned and operated by entities created to manage the assets of the Oliver family. Ross J. Mangano managed many of these entities. Both pre- and post-petition, Mangano held the title of chairman of the board of managers and CEO of one of the debtors, Indianapolis Downs. Certain of the Oliver parties had entered into financing arrangements with the debtors post-petition. Under a 2010 written agreement, the debtors agreed to compensate the Oliver parties $2.2 million annually for credit and consulting services. Immediately before filing for Chapter 11, the Oliver parties and the debtors entered into a letter agreement, which provided that the Oliver parties would continue to provide services to the debtors, including Mangano's services, for an annual fee of $2.2 million. Mangano signed the compensation notice on behalf of both the Oliver parties and Indianapolis Downs. In the context of an adversary proceeding, payments under the compensation notice were stayed and the compensation notice was neither rejected nor assumed.
The debtors ultimately confirmed a plan under which their assets were sold to a third party, Centaur, for $500 million. Post-confirmation, the Oliver parties sought allowance of an administrative expense claim in the amount of $3.85 million for services Mangano rendered calculated at the rate set forth in the 2010 agreement. Several creditors objected.
Section 503(b)(1)(A) of 11 U.S.C. permits the allowance of an administrative expense claim for "the actual, necessary costs and expenses of preserving the estate." Shannon noted that Section 503(b) is "narrowly construed" and that the applicant faces a "heavy burden," citing In re Bernard Technologies, 342 B.R. 174, 177 (Bankr. D. Del. 2006). The 2010 agreement was an executory contract, and it is generally true that an administrative expense claim may be allowed "when the debtor enjoys the benefits of the contract pending assumption or rejection," according to In re Smurfit-Stone Container Shareholder Litigation, 425 B.R. 735, 731 (Bankr. D. Del. 2010).
There is a rebuttable presumption that the "contract terms and rate represent the reasonable value of the services or goods provided under the contract," according to the opinion in Smurfit-Stone. Shannon held that the objectors overcame the presumption for two reasons. First, the contract was negotiated by insiders and "signed by one individual for all sides." Second, evidence demonstrated that the annual fee "was not a valuation of the executive management services," but, instead, was based upon the interest rate of certain notes held by the Oliver parties.
Shannon rejected the objectors' argument that Mangano was not a "hands-on" executive and provided no meaningful services to the debtors. On the contrary, he provided valuable services in interacting with the Indiana Gaming Commission and with local taxing authorities, Shannon said. To Shannon, it was also significant that Mangano had presided over a business that was ultimately sold for $500 million.
Valuation of Mangano's services was a thornier issue. The Oliver parties and the objectors each produced expert witnesses. However, Shannon concluded that neither expert's testimony was conclusive. The Oliver parties' expert admitted that "this was his first time performing this type of compensation analysis." Further, he based his conclusions upon a review of other compensation packages that he conceded were not "presented as comparables." On the other hand, the objectors' expert based his analysis on the assumption that Mangano was a "non-executive chairman, and on rare occasion a chief executive officer." Since Shannon had concluded that Mangano did render valuable services, this expert's report was not conclusive.
Ultimately, Shannon noted that, post-confirmation, the parties had agreed to retain a chief restructuring officer at an annual compensation of $1.62 million. Acknowledging that a crisis manager might be paid more than a CEO, Shannon still found that this salary was "the best and most reliable measure of the appropriate value attributable to" Mangano's services.
The ID Liquidation case illustrates the significant hurdles an insider faces when seeking allowance of an administrative expense claim for services rendered to a debtor. The parties created an extensive record, including expert testimony. Ultimately, the court determined that the compensation of a post-petition chief restructuring officer was a valuable yardstick. In the absence of that evidence, it is unclear whether the movant would have met its burden.
Christopher M. Winter, a partner with the firm, is a Delaware business lawyer who focuses his practice on Chapter 11 bankruptcy law and proceedings, commercial and corporate finance and transactions, and Delaware corporate and alternative entity law.
Reprinted with permission from Delaware Business Court Insider, © ALM Media Properties LLC. All rights reserved.