In Hartford Underwriters Insurance Company v. Magna Bank (In re Hen House Interstate, Inc.), a 6-5 majority of the United States Court of Appeals for the Eighth Circuit recently ruled that a nontrustee claimant lacks statutory standing to seek recovery of its administrative claim by surcharging a secured creditor's collateral. The Eighth Circuit's en banc decision in Hartford Underwriters overrules six years of Eighth Circuit law established by a three-judge panel in I.R.S. v. Boatmen's First National Bank, which held that nontrustees have standing under section 506(c) to surcharge a secured creditor's collateral.
Administrative expenses in bankruptcy are the actual and necessary expenses of preserving the estate. The general rule is that administrative expenses cannot be charged against the collateral of a secured creditor but are chargeable only against the estate's unsecured assets. An exception to the general rule is carved out by section 506(c) of the Bankruptcy Code, which provides that the trustee (or the debtor in possession) may surcharge the collateral of a creditor holding an allowed secured claim to pay the reasonable, necessary costs and expenses of preserving or disposing of the creditor's collateral to the extent of any benefit received by the creditor. Because the statute specifically grants this right to the trustee, however, some courts have ruled it inapplicable to nontrustee claimants.
The question presented for review in Hartford Underwriters was whether Hartford Underwriters Insurance Company, a nontrustee claimant, had standing under section 506(c) to surcharge the collateral of Magna Bank, N.A. The Eighth Circuit ruled that only a trustee can surcharge collateral under section 506(c).
The Hen House Case
Magna had made various loans to the debtor, Hen House Interstate, Inc., which owned and operated a number of restaurants, service stations, gift stores, and an outdoor advertising firm. The loans were secured by virtually all of the debtor's real and personal property. The debtor subsequently filed a petition for relief under chapter 11 of the Bankruptcy Code. When the debtor filed its petition, it was indebted to Magna in the approximate amount of $4.1 million.
Magna agreed to lend the debtor an additional $300,000 to help finance the debtor's postpetition reorganization efforts. The bankruptcy court approved the loan agreement and authorized the debtor to use the proceeds of the postpetition loan and the cash collateral that was subject to Magna's security interest to pay certain expenses, including workers' compensation premium payments of up to $8,600 per month.
During the debtor's attempted chapter 11 reorganization, Hartford provided workers' compensation insurance coverage to the debtor. The terms of the insurance policy required the debtor to pay a monthly premium to Hartford. The debtor made the initial payment but failed to make the remaining payments, which totaled $51,871.40.
The debtor's chapter 11 effort ultimately failed, and the bankruptcy court converted the case to a chapter 7 liquidation proceeding and appointed a chapter 7 trustee. After the case was converted to chapter 7, Hartford brought an action in the bankruptcy court seeking allowance of its claim for unpaid premiums as an administrative expense and seeking to recover the claim by surcharging Magna's collateral.
The Lower Court Decisions
The bankruptcy court followed the holding of a three-judge panel of the Eighth Circuit in I.R.S. v. Boatmen's, that nontrustees have standing under section 506(c) to surcharge a secured creditor's collateral. Accordingly, the bankruptcy court determined that Hartford had standing to seek recovery of its administrative claim against Magna's collateral and ordered the surcharge of Magna's collateral. Magna appealed to the district court, claiming that Hartford lacked standing to assert its claim, but the district court, also relying on I.R.S. v. Boatmen's, affirmed the judgment in favor of Hartford.
Magna next appealed to a three-judge panel of the Eighth Circuit, which affirmed the judgment in favor of Hartford, holding, among other things, that I.R.S. v. Boatmen's was controlling. Notably, two members of the panel expressed their belief that I.R.S. v. Boatmen's had been wrongfully decided and should be considered by a full panel of the Eighth Circuit. Magna sought and was granted a rehearing by a full panel of the Eighth Circuit.
The Majority Opinion
By a majority of 6-5, the full court of the Eighth Circuit reversed the judgment in favor of Hartford and expressly overruled I.R.S. v. Boatmen's. The majority focused on the plain language of the statute and found that the natural reading of section 506(c) entitles only the trustee to seek to surcharge property securing the claim of an allowed secured creditor. In the majority's view, if Congress had intended for claimants other than the trustee to be able to surcharge a creditor's collateral, it would have stated so expressly.
The majority noted that its conclusion was not the consensus of the circuits that have considered the issue, but opined that the circuits arriving at a contrary conclusion had done so by circumventing the plain language of the statute and resting their determination on policy considerations and equitable concerns. Instead, the majority found persuasive the determination of the Court of Appeals for the Fourth Circuit that the clear and unambiguous language of section 506(c) leaves no doubt that only trustees are granted the authority to seek recovery of postpetition costs and expenses from a secured creditor's collateral.
The majority reasoned that its interpretation of section 506(c) was entirely consistent with the carefully crafted equality-of-distribution scheme that is the central policy of the Bankruptcy Code, and that Hartford's position was incompatible with this goal. In support, the majority stated that when a trustee recovers administrative expenses from the property securing the claim of an allowed secured creditor, the proceeds become part of the bankruptcy estate and are distributed pro rata among creditors according to their relative priorities. In contrast, the majority explained that a nontrustee claimant's recovery of administrative expenses out of the secured creditor's collateral would not be incorporated into the bankruptcy estate or contribute to the appropriate distribution of the debtor's property among its creditors. Thus, it would frustrate the fundamental equal distribution goals of the Bankruptcy Code. Additionally, the majority expressed concern that allowing nontrustee claimants to bring surcharge claims under section 506(c) would encourage "a flood of satellite litigation by those seeking to avoid a pro rata division of the estate."
The dissent stated that the majority improperly overruled six years of Eighth Circuit law, rejected the views of four other circuits whose holdings are consistent with the Eighth Circuit's prior decision in Boatmen's, ignored the teachings of a leading bankruptcy treatise, and departed from the well-established view that administrative claimants have section 506(c) standing to enforce administrative claims against secured creditors who have benefited from the goods or services provided by an administrative claimant. In the dissent's view, the prudential standing doctrine required the court to confer section 506(c) standing on Hartford.
The dissent stated that any determination of standing involves both the limitations on federal court jurisdiction under Article III of the Constitution and the prudential limitations on its exercise. To satisfy Article III standing, a plaintiff must allege that:
- he or she suffered or imminently will suffer an injury;
- the injury is fairly traceable to the defendant's conduct; and
- a favorable court decision is likely to redress the injury.
The dissent observed that in the present case, Hartford had suffered an injury because Hartford had provided statutorily required workers' compensation insurance but was not paid. The injury was traceable to Magna's conduct because Magna had consented to the expenditures and had benefited in two ways.
- First, workers' compensation insurance enabled the debtor to continue to operate, thereby increasing the possibility that Magna would recover the full value of its security interest.
- Second, Magna benefited in the debtor's ultimate liquidation because its recovery was increased as a result of the debtor's liquidation as a going concern.
Finally, the dissent noted, a decision favorable to Hartford would redress its injury.
The dissent stated that since Hartford had satisfied the general requirements for Article III standing, the applicable prudential standing requirement is whether the interest sought to be protected by the plaintiff is arguably within the zone of interests to be protected or regulated by the statute. The dissent noted that "[w]here Congress has neither expressly allowed nor denied administrative claimants ' 506(c) standing, the Supreme Court has held that 'Congress legislates against the background of our prudential standing doctrine, which applies unless it is expressly negated.'" In the dissent's view, Hartford's continued provision of workers' compensation insurance to the debtor helped to preserve its assets that secured Magna's claim, thereby benefiting Magna. Thus, Hartford's administrative expense claim is the type contemplated by section 506(c) because the claim was for reasonable and necessary expenses that benefited Magna. Accordingly, the dissent concluded that Hartford satisfied the prudential standing requirement and was entitled to seek to surcharge Magna's collateral pursuant to section 506(c).
The dissent rejected the majority's contention that allowing nontrustees to pursue section 506(c) claims alters the fundamental distribution scheme of the Bankruptcy Code. Instead, the dissent stated that section 506(c) clearly alters the general rule against requiring secured creditors to pay administrative expenses when, among other things, the expenditures benefit the secured creditor. Thus, in the dissent's view, it is the obligation created by Congress in section 506(c), rather than the identity of the party enforcing the obligation, that alters the distribution scheme.
The Eighth Circuit's decision that only trustees have standing to surcharge a secured creditor's collateral was good news for postpetition lenders like Magna, while trade creditors such as Hartford view the decision as a windfall for the secured creditor at their expense. Although the plain language of the statute seems to support the majority's position, the majority's interpretation does not appear to effectuate the purpose of section 506(c)-to charge the secured creditor with the reasonable and necessary costs and expenses of preserving or disposing of its collateral. Since the decision in Hen House has created a 4-2 split among the circuits on whether administrative claimants have standing under section 506(c), this important issue affecting chapter 11 financing is ripe for a Supreme Court decision. This certainly is an issue that both secured lenders and trade creditors will wish to follow, and we will keep you informed of future developments.
Hartford Underwriters Insurance Company v. Magna Bank (In re Hen House Interstate, Inc.), 177 F.3d 719 (8th Cir. 1999).
I.R.S. v. Boatmen's First National Bank, 5 F.3d 1157 (8th Cir. 1993).