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90 Second Lesson: What is a “Professional Fee Carve-Out” in a Chapter 11 case?

Editors’ Note: this is part of our irregular series in which we answer readers’ questions. If you have a question, submit it to info@dailydac.com and we will try to answer it.

90 Second Lesson: Professional Fee Carve-Out

QUESTION:

A commercial banker emailed saying, “We’ve recently had a large asset-based loan default and the company filed Chapter 11.  Our attorney has advised us that we should agree to pay the borrower’s attorneys by letting them get paid from the proceeds of the sale of our collateral.  Can this possibly be right?”

ANSWER:

In a word, yes.  Your attorney, to use the term of art, is suggesting that you agree to a “carve-out.” It is typical for a secured lender in a chapter 11 case to set aside an agreed-upon portion of the proceeds of its collateral for the purpose of paying professional fees incurred during a chapter 11 case. This type of “carve-out” is designed to compensate counsel to the debtor and the official committee of unsecured creditors (“Committee” or “Creditors’ Committee”) appointed in the case—and possibly other professionals. Though the provisions of such professional fee carve-outs vary, they typically provide for how much money is to be set aside, with attendant restrictions on how and when it is to be applied, and they also usually provide for the effect of the occurrence or non-occurrence of certain events on the continuing availability of the carve-out. In fact, many courts insist that any proposed order authorizing the use of cash collateral and debtor-in-possession (“DIP”) financing include a reasonable professional fee carve-out.  Alan Lepene, Andrew Turscak, Jr., and James Henderson write more about this here.

Note: This 90 Second Lesson is based, in substantial part, in material reprinted from Commercial Bankruptcy Litigation 2d and Strategic Alternatives for and Against Distressed Businesses, with permission of Thomson Reuters. For more information about these publications, please visit www.legalsolutions.com.

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The editors and editorial board of DailyDAC include preeminent restructuring and insolvency professionals, journalists, and editors. They are devoted to providing reliable and plain English education and deal intelligence about assignments, corporate bankruptcy, receiverships, out-of-court workouts and similar topics.

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