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

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. 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.

[Editor’s Note: This 90 Second Lesson is part of our irregular series in which we answer readers’ questions. If you have a question, submit it to [email protected] and we will try to answer it. The 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.

To learn more about this and related topics, you may want to attend the following webinars: A Distressed Company and Its Secured Lender and Bad Debtor Owes Me Money!]