Summary
finding accrual of post petition interest was not a necessary expense for special counsel of the debtor in a 506(c) surcharge context
Summary of this case from In re BaughOpinion
No. 285-02887-A-11
November 14, 1990
Charles M. Duffy, U.S. Department of Justice, Washington, D.C., attorney for the Internal Revenue Service.
Ron Sargis, Sacramento, California, attorney for the debtors.
Property of the Estate — Allowance of Claims — Surcharges — Secured Claims. — Inas-much as the expenses and fees of special counsel for debtors were reasonable, necessary, and beneficial to a secured creditor, a portion of the costs incurred were applied a surcharge against a secured creditor's claim. Through arbitration's, counsel was successful in recovering $1.6 million for the bankruptcy estate, which created the fund to be used to pay the entire claim. The surcharge amount is the proportion of the secured claim in relation to the total amount recovered.
See Sec. 506(c) at ¶ 9024 and cf. Sec. 506(b) at ¶ 9023.
Property of the Estate — Allowance of Claims — Surcharges — Claims — Postpetition — Interest. — Interest on secured claim that was surcharged is not itself subject to surcharge. The accrual of postpetition interest was not a necessary expense. For a claim to be surcharged, the expenses incurred must be reasonable, necessary, and beneficial to the creditor.
See Sec. 506(c) at ¶ 9024.
The above-entitled motion having been submitted for decision, and after consideration thereof, it is
ORDERED that the aforesaid motion be and the same is hereby granted in part.
It is undisputed that movant debtors, through their special counsel, successfully pursued three (3) arbitrations and recovered $1,682,678.74 for the estate. According to the debtors, the estate incurred attorney's fees and expenses related to the arbitrations in the amount of $411,480.78. The debtors continue that during the time that the arbitrations were pursued the claims of the Internal Revenue Service (I.R.S.) accrued an additional $121,939.62 in interest.
On May 9, 1988, respondent I.R.S. filed an amended proof of claim in this case in which it asserts that it has a secured claim, an unsecured priority claim, and an unsecured general claim for penalties. According to the brief of the I.R.S. filed on September 18, 1990 with this court, the balance owed to the I.R.S. on its secured claim as of February 9, 1990 was $233,414.53.
In the present motion the debtors seek to surcharge the I.R.S. under 11 U.S.C. § 506(c) for a portion of the expenses incurred by the debtors in creating the fund which, ultimately, will be used to pay the entire claim of the I.R.S.
11 U.S.C. § 506(c) states,
[t]he trustee may recover from property securing an allowed secured claim the reasonable, necessary costs and expenses of preserving, or disposing of, such property to the extent of any benefit to the holder of such claim.
As a preliminary argument, the I.R.S. argues that if a sec. 506(c) surcharge is proper, it will only reduce the collateral which secures the allowed secured claim of the I.R.S. The debtors vehemently disagree and argue that the surcharge is applied against the secured creditor's claim.
The court agrees with the debtors' interpretation of the interplay between 11 U.S.C. § 506(b) and 506(c). In the proper case, a secured creditor who is surcharged under sec. 506(c) can attempt to recoup those costs under sec. 506(b). The court agrees that the interpretation of sec. 506(c) set forth by the I.R.S. would render that section illusory.
The legislative history surrounding the enactment of 11 U.S.C. § 506 (c) is ambiguous as was the pre-Code law which considered the imposition of costs upon a secured creditor. See In re Central Foundry Co., 45 B.R. 395, 404 (Bankr. N.D. Ala. 1984). The court cannot apply the mechanical rule urged by the I.R.S. that a sec. 506(c) surcharge can never be applied against an oversecured creditor. Such a broad sweeping rule would completely ignore a fundamental rule of statutory interpretation that a statute should be interpreted to give full effect to the entire statute.
Turning to the elements which must be proven under sec. 506(c), the Ninth Circuit has held that a trustee or debtor in possession must show that the expenses incurred were reasonable, necessary, and beneficial to the secured creditor. In re Cascade Hydraulics and Utility Service, Inc., 815 F.2d 546, 548 (9th Cir. 1987); see also In re James E. O'Connell Co., Inc., 893 F.2d 1072 (9th Cir. 1990). To satisfy the benefit part of the test, the trustee must "establish in quantifiable terms that it expended funds directly to protect and preserve the collateral." Cascade Hydraulics, 815 F.2d at 548.
With these precepts in mind, the debtors in the present case successfully pursued three arbitrations which created a fund to pay creditors pursuant to the confirmed chapter 11 plan. The court agrees that the attorney's fees and expenses incurred to create the fund were reasonable and necessary. The court disagrees, however, with the debtors argument that the accrual of postpetition interest on the claim of the I.R.S. was a necessary expense for which the I.R.S. should be surcharged in part.
The court approved the contigent fee agreement entered into between the debtors and their special counsel on December 3, 1985 and since then has approved the payment of attorney's fees and expenses to special counsel. The request were approved based upon a finding, inter alia, that the fees and expenses were reasonable. That finding will not be disturbed at this time.
The court agrees with the debtors that the attorneys' fees and expenses incurred were necessary. It is obvious that if the arbitrations had not been pursued by special counsel the recovery of over $1.6 million dollars would not exist and the I.R.S. would not be able to look to the estate for payment. The court is not persuaded, however, that the accrual of postpetition interest was a necessary expense.
As to whether the expenses benefitted the I.R.S., the court finds that the district court opinion in Radtke Heating and Sheet Metal Co., Inc. v. State Bank of Cherry, 103 B.R. 932 (N.D. Ill. 1989) is instructive. In Radtke, the I.R.S. filed a notice of tax lien with a contractor as to amounts owed to Radtke, a subcontractor, two months before Radtke filed a chapter 11 petition. After the petition was filed, the bankruptcy court, upon the request of the debtor, ordered the contractor to turnover the amounts owed to the debtor. The debtor then claimed an interest in the fund which had been turned over. In addition, the I.R.S. pursuant to its tax lien and a bank which had a perfected security interest in the debtor's accounts receivable claimed an interest in the fund. Finally, the attorney for the debtor requested his fees and costs pursuant to 11 U.S.C. § 506 (c).
The bankruptcy court held that the debtor was not entitled to anything from the fund. The court then granted the attorney's request for fees and divided the remainder of the fund between the I.R.S. and the bank. Because the amount of the claims exceeded the amount of the fund, the bankruptcy court held that the bank's share and the portion of the fund due to the I.R.S. would be reduced proportionally to compensate the attorney for the debtor. 103 B.R. at 934
The creditors in Radtke were undersecured. The district court in Radtke did not discuss the propriety of using 11 U.S.C. § 506(c) against an undersecured creditor and this court does not make any finding as to that issue.
The district court affirmed the bankruptcy court which, in effect, had permitted the attorney a priority interest in the funds. Id. The district court rejected the argument of the United States that the activities of the attorney only identified the amounts due from the contractor but did not create a fund which benefitted the secured creditors. Id. The court found that the secured creditors had benefitted from the attorney's attempt to collect the fund because they each received a share of the fund. Id. at 935.
The district court also rejected the argument of the United States that the attorney's claim for fees cannot be paid prior to the federal tax lien. Id. at 936.
The activities of the special counsel for the debtors in the present case serve as an even more compelling reason why attorney's fees and expenses are proper under 11 U.S.C. § 506(c). Here, special counsel did not merely identify and collect various receivables which clearly belonged to the debtor. Instead, special counsel actually created the fund which will benefit the secured creditor, the I.R.S. Had the attorney in Radtke performed the feats that special counsel has in this case, the court doubts whether the United States could have opposed the fees upon the grounds set forth.
The debtors have met their burden of proving that the fees and expenses of special counsel were reasonable, necessary, and beneficial to the I.R.S. under 11 U.S.C. § 506(c). Another reason exists for the allowance of fees in this case.
Recently, the Supreme Court decided United States v. Ron Fair Enterprises, 103 L.Ed 2d 290 (1989). The Court held that 11 U.S.C. § 506 (b) entitles a creditor who holds a nonconsensual oversecured claim to receive postpetition interest. The creditor who held the nonconsensual lien in Ron Fair was the I.R.S.
The Supreme Court thus has found that the I.R.S., the holder of a priority claim which also happened to be secured, was entitled to the benefits of 11 U.S.C. § 506, that is, the accrual of postpetition interest. This court believes that since the I.R.S. is entitled to the benefits of sec. 506 it is only logical that the I.R.S., in the proper case, should also bear the burdens imposed by sec. 506.
Turning now to the amount which should be surcharged against the I.R.S., the court agrees with the formula set forth in Matter of Elmwood Farm, Inc., 19 B.R. 338, 342 (Bankr. S.D.N.Y. 1982). There the court found that the surcharge should be sixty-six (66) percent of the total expenses since the secured claims as of the filing of the chapter 11 petition constituted sixty-six percent of the total allowed secured claims.
In the present case, the surcharge will be based upon the percentage which the secured claim of the I.R.S. bears to the total amount recovered, which is $1,682,678.74. The court rejects the debtors argument that the total amount of the claims of the I.R.S. and not just the secured claim held by the I.R.S. should be the proper figure in the formula. The surcharge percentage then shall be applied only to the total amount of attorney's fees and expenses incurred by the special counsel for the debtors, which is $411,480.78.
IT IS SO ORDERED.