And the Last Shall Be FirstBut Do They Have the Right to Ask for It

And the Last Shall Be FirstBut Do They Have the Right to Ask for It

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In cases where a secured creditor has all of the assets of the estate tied up with liens, the ability of an administrative creditor to surcharge that collateral under Bankruptcy Code §506(c) is obviously a critical component. From a general unsecured creditor's perspective, that ability is also important for at least two reasons—first, because it will ensure that estate professionals will be involved in the case to preserve the value of the estate (which value, hopefully, will rebound to the benefit of the general unsecured creditors in the case); and second, it protects creditors that continue to do business with a debtor post-petition on credit terms (again, preserving the going concern value of a debtor enterprise). Post-petition services (both professional and otherwise) are more likely to be rendered in the case in the period prior to a plan where the ability to surcharge secured creditors' collateral is allowed, particularly in those cases where a debtor's operations are precarious.

While the issue of whether to surcharge a secured creditor's collateral is of interest, an even more fundamental and preliminary issue is which parties, specifically, have the ability to seek a surcharge. The issue had been definitively decided in the Eighth Circuit in 1993 resulting from the chapter 11 case of Missouri OHM Inc., which operated dry cleaning stores in three states. The debtor owed approximately $770,000 in unpaid federal withholding taxes. The secured lender had agreed to extend post-petition financing to the debtor to cover its operating costs so that it could continue as a going concern (as its stores were being sold off). As part of the debtor-in-possession facility, the lender (not surprisingly) requested and received superpriority administrative expense claims and liens, but agreed to subordinate them to "legitimate administrative expenses of the bankruptcy estate." The debtor continued to operate and sold off a group of its stores, but ultimately a trustee was appointed. The proceeds resulting from the store sales prior to the appointment of a trustee were paid towards the pre-petition indebtedness owing to the secured lender.

The trustee continued to sell the stores as going concerns until the case was ultimately converted to a chapter 7 liquidation. Subsequent to the conversion to chapter 7, the Internal Revenue Service (IRS) filed an administrative claim for unpaid withholding and FICA taxes incurred between the filing of the bankruptcy petition and the appointment of a trustee. The bankruptcy court allowed the IRS's administrative claim, and also allowed the claim to be surcharged against the secured creditors' collateral under Bankruptcy Code §506(c) because they, in essence, benefited from the lender's collateral by keeping operations as a going concern. However, the bankruptcy court did not allow as a surchargeable expense the interest and penalties that the IRS was attempting to assess with respect to the unpaid post-petition withholding and FICA taxes. The bankruptcy court's reasoning was that, with respect to these penalty and interest claims, they did not preserve or benefit the lender's collateral, and there was no actual implied consent to the incurrence of those sorts of expenses. The district court affirmed, and the Eighth Circuit Court of Appeals affirmed in part, reversed in part and remanded. See IRS v. Boatmen's First National Bank of Kansas City, 5 F.3d 1157 (8th Cir. 1993). The Eighth Circuit affirmed that post-petition withholding taxes were properly surchargeable under §506(c), but reversed the district court with respect to the issue of the surcharge of interest and penalties. The Eighth Circuit held that once an expense is found to be surchargeable, the interest and penalties that may accrue with respect to that expense would also be properly surchargeable. See Boatmen's at 1159-1160.

With respect to the issue of whether or not the IRS had standing in that case to seek a surcharge, the Eighth Circuit affirmed the district court, which found that an administrative claimant does have standing to seek a surcharge of a secured creditor's collateral. Circuit Judge Bowman dissented based on the actual language of §506(c), which "unambiguously provides that '[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.'" Boatmen's at 1161. The dissent found that the court should not expand upon the clear language of the statute because to do otherwise would be "to infringe upon Congress' role as makers of lawsŠ" Id. Accordingly, it would have seemed that, notwithstanding Judge Bowman's dissent, the law was established in the Eighth Circuit that an administrative claimant indeed had standing to seek a surcharge under §506(c)...

Bowman's Revenge

...but not for long! The issue raised its ugly head again. The failed chapter 11 case of Hen House Interstate Inc. pending in the Eastern District of Missouri provided Judge Bowman with an opportunity to attempt to persuade the Eighth Circuit of the wisdom of his dissenting opinion in Boatmen's. In Hen House Interstate, a restaurant operation ran into financial difficulties, filed chapter 11, was involved in sales of its operations, and was ultimately converted to a chapter 7 (which appears to be the standard operating procedure for business operations in the District of Missouri). In any event, at issue in Hen House was unpaid workers' compensation insurance premiums. In that case, there was a cash collateral operating budget agreed upon by the secured lender that included amounts for workers' compensation expenses. Notwithstanding that, the debtor became delinquent in the payment of those premiums (although the insurance company continued to provide the coverage.) After the case converted to a chapter 7, the insurance company brought a surcharge motion under §506(c) to recover the premiums, as well as interest. The bankruptcy court allowed the surcharge, and the district court affirmed. The lender appealed.

The Eighth Circuit affirmed in In re Hen House Interstate Inc., 150 F.3d 868 (8th Cir. 1998). Judge Bowman apparently never forgot his experience in the Boatmen's case, and specifically made reference to the fact that he was the sole dissent in the Boatmen's decision on the issue of who has standing to seek a surcharge, and reiterated his view that the plain language of the Code only gives standing to the trustee. Notwithstanding that, Judge Bowman (who authored the opinion) stated, "I remain of that view today but recognize Boatmen's as a controlling precedent in this circuit." The decision then went on to affirm the district court, and allow the insurance company to surcharge the secured creditors' collateral for the unpaid workers compensation premiums. Apparently, Judge Bowman was becoming more persuasive in his arguments regarding the standing issue because he persuaded Circuit Judge Hansen to issue a one-paragraph concurrence in which Judge Hansen agreed with Judge Bowman's dissent in Boatmen's and added (perhaps wistfully): "But that is not the current law of this circuit, and only an en banc court can, and in my view, should change it."

And change it they might! The secured creditor requested that this matter be reheard en banc by the Eighth Circuit to reconsider the standing issue, since only the circuit sitting en banc can reconsider and overturn a prior circuit court panel decision. On September 22, 1998, the Eighth Circuit's decision in Hen House Interstate was vacated, and set to be heard on October 22, 1998 for oral argument en banc. See 1998 U.S. App. LEXIS 23922. Accordingly, Judge Bowman might yet have his way and have the Eighth Circuit adopt his view, which the Boatmen's panel apparently found unpersuasive.

From an unsecured creditor's standpoint, it would seem that having the Eighth Circuit reconsider its Boatmen's opinion, and finding that only a trustee has standing to seek surcharge, could become problematic. It may chill the provision of post-petition goods or services in those cases where the assets are encumbered. Only time will tell if Judge Bowman has his judicial revenge, and whether the Eighth Circuit will limit the standing on surcharge rights.

Journal Date: 
Sunday, November 1, 1998