Increasing instances of administrative insolvency, especially in the automotive sector, have caused many suppliers to question the value of 503(b)(9) claims.  Even when administrative expense claims are impaired, however, 503(b)(9) claims can be worth substantially more than their face amounts in settlements of bankruptcy preference claims.  Seldom do you see in one case, much less in one settlement order, the absolute worst and among the best examples of using this strategy.  A recent settlement order in the Cadence Innovation bankruptcy provides this rare opportunity.

In our original post on Cadence Innovation’s bankruptcy on December 12, 2008, we explained that the decision to liquidate Cadence Innovation meant that the preference claims would soon follow. Some suppliers did not have long to wait. By the end of January 2009, the initial waive of bankruptcy preference claim demand letters went out to the unsecured trade creditors. Now the first settlement order has been entered approving the initial batch of bankruptcy preference settlements.

The initial settlements are based on a trade off of 503(b)(9) claims plus pre-petition general unsecured claims against potential preference claims. (For a comprehensive summary of 503(b)(9) click here.)   Simply, Cadence and each supplier released each other of all claims in a cashless transaction.  The deal was offered to and accepted by 27 suppliers.

Conceptually, this is a good negotiating strategy for suppliers.  Often pre-petition general unsecured claims are worthless or will result in distributions of only pennies on the dollar.  The administrative expense claim under 503(b)(9) might be impaired to some degree.  The preference claims could mean real, out of pocket dollars.  The Cadence avoidance claim settlement order entered June 16, 2009 approved the absolute worst possible and some of the best possible example of using 503(b)(9) claims to settle preference claims.

First, the examples of the worst use of 503(b)(9) claims.  In 6 of the initial settlements, suppliers had less than the required dollar threshold for the bringing of a preference claim.  (We discuss this defense in an article on this website called “Dollar Threshold for a Bankruptcy Preference”, which can be reviewed by clicking here.)  Simply, there was no preference claim to be settled.  One supplier, who had $0 (that is zero) preference payments gave up a $7,320  expense priority under 503(b)(9) to settle… , well, nothing.  Another gave up a $9,647 claim under 503(b)(9) to settle a purported $736.40 preference payment.  The other settling suppliers with potential preference payments under the threshold are not quite as bad.  We provide the full listing below.

The remaining settlements, while not as outrageous, show a severe fluctuation in the percentage of 503(b)(9) claim to the payments made during the preference period.  The fluctuation is from 73 percent (i.e. the 503(b)(9) claim is 73 percent of the total potential preference payments to zero percent (i.e. there was not 503(b)(9) claim).  The average percentage was 23 percent.

As regards the best use of a 503(b)(9) claim the award goes to a supplier who settled a $688,986 preference claim in exchange for giving up a $99,893 administrative expense claim under 503(b)(9) and a $143,835 general unsecured claim.  In Cadence, the general unsecured claim is worthless and the 503(b)(9) claim is potentially impaired.  Giving those phantom dollars up to escape a near $700 thousand preference claim is a tribute to someone’s negotiating skills.

The lessons should be clear.  1. You can use 503(b)(9) claims effectively in the settlement of preference claims and at better than a dollar for dollar offset.  2. Some suppliers are going to do better than others in the bankruptcy preference settlement process.  3.  Suppliers who try and settle their own preference claims are leaving themselves at the mercy of lawyers who make a living at settling these claims.

The following is a table showing the settlement figures.  The names of the suppliers have been replaced by generic names.  The names are not important.

The column labeled “90 Day Transfers” represents the maximum possible preference payments.  The column labled “503(b)(9) Priority” is the maximum potential administrative priority claim the supplier could claim.  The column labeled “Pre-Petition” is the amount of the general unsecured claim of the supplier.