Bankruptcy Law

Administrative Claim Arising From Rejected Contract

By Michael Enright

Although rejection of a prepetition executory contract gives rise to a breach of contract claim that qualifies as a general prepetition claim, the contract counterparty sometimes may recover on an administrative claim basis from the bankruptcy estate if it can show that the debtor benefited from its postpetition performance in some way. The case law on this issue typically focuses on whether the debtor induced the other party to some further performance during the chapter 11 case.  Such was the case in the Fifth Circuit’s recent decision in Matter of Whistler Energy II, LLC, Case No. 18-30940 (5th Cir. July 26, 2019).  The debtor owned an oil and gas production platform in the Gulf of Mexico, and entered into a prepetition contract with Nabors Offshore to provide drilling equipment on the platform.  The debtor rejected the contract with Nabors in its chapter 11 case, but removal of the drilling equipment was complicated, not just by the remoteness of its location, but also due to regulatory issues. Ultimately, Nabors sought allowance of an administrative expense of about $6 million, to recover its expenses related to work done in connection with demobilization of the equipment.  The bankruptcy court denied the claim, concluding that the expenses were simply the consequences of rejection and did not benefit the estate.  On appeal, the Fifth Circuit reversed and remanded, holding that a creditor can establish that its expenses are attributable to the actions of the bankruptcy estate through evidence of either a direct request from the debtor or other inducement via the knowing and voluntary post-petition acceptance of desired goods or services.  Although the debtor may not have used Nabor’s equipment on the platform, having the equipment available to it could yield a benefit to the estate.  When the debtor induces availability and the estate derives a benefit from it, the ordinary cost of ensuring such availability qualifies as an administrative expense.  The court remanded so that the bankruptcy court could determine whether the debtor induced Nabors to keep its equipment on the platform, and to consider the costs incurred by Nabors in keeping it there. Parties to rejected executory contracts that are involved in postpetition complexities with a chapter 11 debtor may benefit from a careful review of the decision in Whistler Energy II.    



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