Specific Expenses, Specific Collateral, Specific Benefit: Ninth Circuit BAP Addresses Surcharge Standards

In order for a trustee to surcharge expenses under § 506(c), he “must prove that [his] expenses were reasonable, necessary, and provided a quantifiable benefit” to the secured creditors property.[1] The trustee must show some benefit sufficient for surcharge under this objective test, identify the specific expenses, tie them to specific collateral, and provide evidence of a benefit that considers the use of the U.S. Department of Agriculture’s (USDA) cash collateral.[2] The Ninth Circuit Bankruptcy Appellate Panel (BAP) recently held that the trustee had not met this burden in USDA v. Hopper (In re Colusa Regional Medical Center).[3] In vacating and remanding the U.S. Bankruptcy Court for the Eastern District of California’s ruling, the BAP held that the lower court applied the wrong legal standard by analyzing the benefit to the USDA at a global level instead of looking at requested expenses and how they were reasonable, necessary and provided quantifiable benefits.[4]

The lower court looked that the benefit the trustee provided by calculating the USDA’s final payout, deducting the cash collateral they had already paid and then comparing it to the amount of cash the debtor had on the petition date.[5] This global analysis was inconsistent with the test that the Ninth Circuit has established,[6] which requires that each expense must be “tied to a corresponding, quantifiable benefit” and has to be “more than just incidental from the perspective of collateral preservation.”[7]

The BAP also took issue with the surcharge request “double dipping” from the USDA.[8] The lower court found that collection efforts for accounts receivable for the debtor constituted a benefit to the USDA that could justify surcharge,[9] but the trustee acknowledged that he had used the UDSA’s cash collateral to pay former hospital employees to do the highly specialized work of collecting hospital receivables.[10] Thus, the USDA had paid for the collection efforts in the first place with its cash collateral, and having them pay for it again through surcharge would charge them for their efforts twice.[11]

The trustee also sought surcharge for its expenses associated with the sale of the debtor’s assets. The BAP found that the sale benefited the estate generally, not the USDA specifically.[12] The BAP also found that the sale benefitted multiple parties, and that because of that benefit, the sale expenses could not be surcharged “globally and entirely” from the USDA’s collateral.[13] Any benefits from the sale that the USDA received would be categorized as permissible “incidental” benefits.[14] For benefits to rise to the level needed to warrant surcharge under § 506(c), the trustee would need to establish that “it expended funds directly to protect and preserve the collateral.”[15]

The BAP held that, on remand, the trustee will have to show some benefit sufficient for surcharge under the objective test, identify the specific expenses, tie them to specific collateral, and provide evidence of a benefit that considers the use of the USDA’s cash collateral.

The trustee also argued, and the lower court found, that the USDA impliedly consented to the surcharge. A trustee may surcharge collateral if the secured creditor “caused or consented to” the surcharge expense.[16] In finding that there was no implied consent, the BAP held that “creditor cooperation and case participation does not inevitably lead to surcharge....”[17] The BAP, finding that the Ninth Circuit did not have a “firm test or standard for implied consent,”[18] detailed a “workable implied consent test.”[19]

To establish implied consent, the BAP stated that the trustee is required to identify:

specific expenses and evidence that would cause a reasonable person to assume that a secured creditor should be charged with that expense because it directly benefitted its collateral and because otherwise other creditors would be unjustly depressive of an opportunity for payment. Implied consent also requires either some direct creditor action to cause the expense or some inaction that suggests an understanding that it is otherwise receiving a windfall.[20]

The BAP held that they saw none of these factors and “nothing that would suggest as a legal and factual matter that surcharge is appropriate.”[21] The BAP stated that if the trustee wanted to argue implied consent on remand, he must apply the implied consent.

Trustees should take note of the objective test standards and evidence when seeking to surcharge collateral, identify specific expenses tied to specific collateral, and show evidence of the benefit provided to the collateral. If attempting to justify surcharge through implied consent, trustees — in the Ninth Circuit, at least — will need to follow the implied consent test that the BAP has established in this case.