An unsuccessful reorganization allowed the Fifth Circuit to refine the standard for surcharging a secured lender for the costs of maintaining collateral under Section 506(c).
The opinion, issued on Dec. 29 by Circuit Judge Gregg Costa, included a low-key split with the Seventh Circuit on a sub-issue.
The lender argued that surcharge is permissible only if the trustee or debtor intended to benefit the secured creditor specifically and exclusively. Judge Costa rejected that formulation, holding that surcharge is proper if it primarily benefitted the collateral and was “direct and quantifiable.”
The case involved a company whose real property was appraised for $6 million and encumbered for less than $4 million. Everyone evidently believed at the outset of chapter 11 that the property could be sold, leaving a surplus for unsecured creditors. The liquidating chapter 11 plan put the property in trust for subsequent sale.
The trustee landed an offer for less than the secured debt. The lender refused to permit a sale because the trustee conditioned the sale on the recovery of costs to preserve and maintain the property. Eventually, the bankruptcy court authorized the trustee to abandon the property and surcharge the lender. The lender appealed the surcharge directly to the Fifth Circuit.
Judge Costa said that Section 506(c) only requires a showing that the expenses were reasonable, necessary, and of benefit to the creditor. He said courts added a requirement, that the expense “primarily” benefit the secured creditor, to prevent the section “from swallowing the principle that general administrative costs must be borne by the estate.”
Judge Costa declined to follow the Seventh Circuit’s Trim-X decision, which disallows surcharge “when the trustee is trying to realize value for the estate.” He also refused to disallow surcharge for expenses incurred before the trustee moves to abandon the collateral.
The lender is protected by a safety valve, because Judge Costa would bar discharge if the “trustee holds an asset longer than necessary to determine and realize its value, and the value turns out to be less than the creditor’s secured interest.”
The circuit upheld the bankruptcy court, because the findings of direct and primary benefit were not clearly erroneous.