In the case of Domistyle, Inc., 14-41463 (5th Cir. Dec. 29, 2015), the United States Court of Appeal for the Fifth Circuit affirmed an order of the bankruptcy court requiring a secured creditor to reimburse the trustee for expenses paid to preserve real property subject to the creditor’s lien until the debtor’s eventual surrender of the property to the creditor. The surcharge was based on Section 506(c) of the Bankruptcy Code which provides a “narrow” and “extraordinary” exception to the general rule that the administrative expenses of the bankruptcy estate are to be satisfied by the unencumbered assets of the estate. In creating an exception to this rule, Section 506(c) provides:

“The 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, including the payment of all ad valorem property taxes with respect to the property.”

The Fifth Circuit recognized that 506(c) is designed to remedy the inequity of having all the creditors bear the costs of maintaining property which is the collateral of some secured creditor, i.e. the inequity of forcing “the general estate and unsecured creditors . . . to bear the cost of protecting what is not theirs.”

To recover expenses under this provision, the trustee bore the burden of proving the following: “(1) the expenditure was necessary, (2) the amounts expended were reasonable, and (3) the creditor benefitted from the expenses.”

The secured creditor argued that the trustee’s request for a surcharge failed on the last of these elements, alleging it did not benefit from the expenses paid by the trustee to preserve the property. In rebuttal, the trustee argued at least two benefits were conferred upon the creditor by these expenditures (principally maintenance expenses like lawn mowing, roof repairs, and security): (1) receiving the Property with its value preserved and (2) avoiding preservation costs during the nearly 14 months that the property was part of the estate.

In resolving the critical question of whether or not the creditor benefited from the trustee’s payment of the expenses, the Fifth Circuit agreed with the trustee that the expenses identified were “primarily for the benefit” of the creditor to whom they were ultimately charged.  The Fifth Circuit held that the creditor received a “direct and quantifiable benefit” from the expenses paid by the trustee since it received the property in a more valuable condition owing to the trustee’s stewardship.

As the Fifth Circuit and bankruptcy court observed, the result of the case was unfortunate. Everyone (including the secured creditor) believed the property in question could be sold for more than the secured creditor’s claim if kept in good condition. As it turned out, the property could not be sold at all. That being said, the bankruptcy court’s ruling that the trustee’s expenditures ultimately conferred a direct and quantifiable benefit to the creditor was supported by the record. If anything, the best argument was that the benefit, while it may have been direct, was not exactly “quantifiable” on the evidence presented. Indeed the creditor argued that the bankruptcy court had confused the math on the issue.  However, the standard of review on that particular issue, which was a finding of fact based on the evidence presented to the bankruptcy court, simply did not permit the Fifth Circuit (who reviewed that finding for clear error) to disturb that portion of the ruling. As a result, the order of the bankruptcy judge was affirmed.

A copy of the Fifth Circuit’s ruling can be found here.

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