A Chapter 11 debtor's post-bankruptcy workers' compensation premiums can be surcharged against a secured creditor's collateral despite the general rule prohibiting such surcharge. The Eighth Circuit Court of Appeals recently ruled that Section 506(c) allows a surcharge when there is express or implied consent to the expense by a secured creditor.
The Hartford Case
In Hartford Underwriters Ins. Co. v. Magna Bank, N.A. (July 27, 1998), the Eighth Circuit found the requisite consent in a post-bankruptcy financing agreement between the debtor and the secured creditor, which provided for the debtor's payment of ordinary and necessary operational expenses including insurance premiums. When the debtor's reorganization efforts failed, and the case was converted to Chapter 7, the workers' compensation insurer asserted an administrative expense for unpaid premiums under Section 503 of the Bankruptcy Code and a surcharge against the secured creditor's collateral under Section 506(c).
Under Section 506(c), a surcharge is allowable where:
- the expense was reasonable and necessary and rendered a benefit to the secured creditor; or
- the secured creditor agreed to the expense.
Citing to its earlier decision in Internal Revenue Service v. Boatmen's First National Bank of Kansas City (1993), the Eighth Circuit found the secured creditor's consent in the secured creditor's agreement to preserve and finance the ongoing operations of a Chapter 11 debtor, which barred the creditor from objecting to a surcharge for unpaid post-petition necessary expenses. In dicta, the Court also found that a benefit accrued to the secured creditor. After all, the secured creditor anticipated receiving a greater return on its claims through a successful reorganization, and provided the cash collateral for the debtor to continue operations.
Weak Spots
If the Magna Bank holding is disturbing to secured creditors, there may be some solace in knowing that not all courts would agree with the Eighth Circuit on two counts.
- First, in the Eighth Circuit, the Boatmen's case also holds that an administrative expense creditor has standing to surcharge a secured creditor's collateral, contrary to the plain language of Section 506(c). Under the Bankruptcy Code, the "trustee" can seek to surcharge a secured creditor's collateral to pay for reasonable and necessary expenses of preserving the collateral to the extent of any "benefit" to the secured creditor. In other circuits, the secured creditor's surcharge request is denied under the "plain meaning" of the Bankruptcy Code.
- Secondly, the Magna Bank Court found implied consent because of the existence of a post-petition financing agreement. But what happens in cases where the secured creditor is not providing post-bankruptcy financing or when cash collateral agreements are reached because continued use of cash poses no threat to the secured creditor's position? Magna Bank may leave secured creditors facing a difficult dilemma: either agree to post-petition financing and risk a surcharge if the debtor's reorganization goes badly; or deny such financing, actively oppose the debtor's reorganization efforts, and face a reduced recovery (potentially) in the debtor's subsequent liquidation.
For secured creditors who must walk the path between these two alternatives, consultation with bankruptcy counsel is a must.