Filed: Jun. 09, 1995
Latest Update: Mar. 02, 2020
Summary: Opinions of the United 1995 Decisions States Court of Appeals for the Third Circuit 6-9-1995 InRe:Visual Industries,Inc Precedential or Non-Precedential: Docket 94-5676 Follow this and additional works at: http://digitalcommons.law.villanova.edu/thirdcircuit_1995 Recommended Citation "InRe:Visual Industries,Inc" (1995). 1995 Decisions. Paper 162. http://digitalcommons.law.villanova.edu/thirdcircuit_1995/162 This decision is brought to you for free and open access by the Opinions of the United St
Summary: Opinions of the United 1995 Decisions States Court of Appeals for the Third Circuit 6-9-1995 InRe:Visual Industries,Inc Precedential or Non-Precedential: Docket 94-5676 Follow this and additional works at: http://digitalcommons.law.villanova.edu/thirdcircuit_1995 Recommended Citation "InRe:Visual Industries,Inc" (1995). 1995 Decisions. Paper 162. http://digitalcommons.law.villanova.edu/thirdcircuit_1995/162 This decision is brought to you for free and open access by the Opinions of the United Sta..
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Opinions of the United
1995 Decisions States Court of Appeals
for the Third Circuit
6-9-1995
InRe:Visual Industries,Inc
Precedential or Non-Precedential:
Docket 94-5676
Follow this and additional works at: http://digitalcommons.law.villanova.edu/thirdcircuit_1995
Recommended Citation
"InRe:Visual Industries,Inc" (1995). 1995 Decisions. Paper 162.
http://digitalcommons.law.villanova.edu/thirdcircuit_1995/162
This decision is brought to you for free and open access by the Opinions of the United States Court of Appeals for the Third Circuit at Villanova
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UNITED STATES COURT OF APPEALS
FOR THE THIRD CIRCUIT
----------
No. 94-5676
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IN RE: VISUAL INDUSTRIES, INC., a Delaware Corporation
STACOR CORPORATION, a New Jersey Corporation,
Debtors
PRECISION STEEL SHEARING, INC.
Appellant
v.
FREMONT FINANCIAL CORPORATION
Appellee
----------
On Appeal from the United States District Court
for the District of New Jersey
(D.C. Civil No. 94-03414)
----------
Argued Tuesday, May 16, 1995
BEFORE: COWEN, LEWIS and GARTH, Circuit Judges
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(Opinion filed June 9, 1995)
----------
Michael B. Kaplan (Argued)
Stern, Lavinthal, Norgaard & Daly
184 Grand Avenue
Englewood, New Jersey 07631
Attorney for Appellant
Joel R. Glucksman (Argued)
Tod S. Chasin
Friedman Siegelbaum
7 Becker Farm Road
Roseland, New Jersey 07068
Attorneys for Appellee
----------
OPINION OF THE COURT
----------
GARTH, Circuit Judge:
The Bankruptcy Code in § 506(c) provides that a secured
creditor may be charged for expenses incurred by another in
preserving or disposing of the secured property. 11 U.S.C.
§ 506(c). The question that is presented on this appeal and
which we must answer is: "Does 11 U.S.C. § 506(c) authorize
payment to trade creditors who furnish raw materials to a Chapter
11 debtor thereby maintaining the debtor's operation, where the
materials supplied did not directly benefit the secured
creditor's property?" Our answer to that question is "no" --
§ 506(c) does not extend to such a circumstance.
I.
Visual Industries Inc. and Stacor Corporation
(collectively, "Visual") were manufacturers of office furniture.
In the course of its operation, Visual purchased cut steel from
plaintiff-appellant Precision Steel Shearing, Inc.
On August 14, 1992, (the "petition date"), Visual filed
a voluntary petition with the bankruptcy court in the District of
New Jersey pursuant to Chapter 11 of the Bankruptcy Code.1
Defendant-appellee Fremont Financial Corporation was
Visual's primary pre-petition secured creditor and held extensive
security interests in Visual's assets, including liens on, inter
alia, inventory, raw materials, machinery, equipment, furniture,
fixtures, instruments, chattel paper, general intangibles, other
personalty, and the products and proceeds of all of the
foregoing. App. 241. As of the petition date, Visual was
indebted to Fremont in the amount of $1,946,605.90 plus costs,
expenses and attorneys' fees.
In addition to Fremont's pre-petition security
interest, on August 31, 1992, the bankruptcy court entered an
"Amended Consent Order Authorizing the Temporary Use of Cash
Collateral and Approving Post-Petition Financing" (the "Financing
Order") granting Fremont "cash collateral" in, and liens on,
essentially all of Visual's personalty and proceeds.2 The Order
also permitted Visual to make continued use of Fremont's pre-
1
. On August 20, 1992 the Bankruptcy Court entered an order
authorizing the joint administration of these cases pursuant to
Fed. R. Bankr. 1015.
2
. The Bankruptcy Code, as amended in 1994, defines cash
collateral in relevant part as "cash, negotiable instruments,
documents of title, securities, deposit accounts, or other cash
equivalents whenever acquired in which the estate and an entity
other than the estate have an interest and includes the proceeds,
products, offspring, rents, or profits of property subject to a
security interest . . . whether existing before or after the
commencement of a case under this title." 11 U.S.C. § 363(a).
petition cash collateral and provided for additional post-
petition financing of Visual's operations by Fremont. App. 247.3
Fremont's post-petition financing enabled Visual to
continue in operation for almost a year, during which time it
produced sufficient revenues to reduce its obligations to Fremont
by roughly $900,000 to $1,004,740.
During this time Precision continued to supply cut
steel to Visual. Precision and Visual arranged a payment system
whereby Precision would ship the steel to Visual upon receipt of
a telefax copy of a check to be sent by overnight mail. The
checks were post-dated and made payable forty-five to sixty days
after the shipment had been made. No order of the bankruptcy
court either authorized or directed such an arrangement.
3
. In addition to the other protections afforded Fremont's
interests, the Financing Order specified that Fremont's secured
claim would be treated as an allowed administrative expense claim
with priority over, inter alia, "administrative expenses of the
kind specified in or ordered pursuant to Section[]. . . 506(c)
. . . of the Code," App. 179, and further provided that:
Anything to the contrary notwithstanding, any
and all costs and expenses of the
preservation and/or disposition of assets of
the Debtors against which [Fremont] holds
liens or mortgage, or which are otherwise
chargeable to Fremont pursuant to Section
506(c) of the Code, shall not be chargeable
to and/or against Fremont by any person or
governmental unit.
App. 180-181. Fremont in part relies on these references to
§ 506(c) to support its argument that no claim under § 506(c) can
be made. Precision points out that it was not a party to the
Order and hence is not precluded from making the present § 506(c)
claim.
We do not rely on this provision of the Order in our
disposition of this appeal.
Visual's checks began to be returned for insufficient
funds in June of 1993, and shortly thereafter Visual ceased
business, owing Precision $94,414.90 for post-petition steel
deliveries. On September 7, 1993, Visual's Chapter 11
reorganization was converted into a Chapter 7 liquidation
proceeding.
On May 10, 1994, Precision filed a motion with the
bankruptcy court pursuant to § 506(c) of the Code seeking to
compel payment of unpaid post-petition cut steel invoices by
surcharging Fremont's collateral. The bankruptcy court denied
Precision's motion on June 20, 1994, on the ground that under
§ 506(c) Precision's furnishing of cut steel to Visual did not
directly benefit the property securing Fremont's loan to Visual.
Precision appealed to the United States District Court
for the District of New Jersey, which affirmed the decision of
the bankruptcy court on September 26, 1994. The District Court
recognized that a direct or express benefit to the secured
creditor had to be shown, and agreed with the bankruptcy court
that the sales of raw material to Visual did not operate to
directly preserve or dispose of Fremont's collateral. Hence, the
District Court affirmed the bankruptcy court's decision. This
appeal followed. Our jurisdiction rests on 28 U.S.C. § 158(d).
We affirm.
II.
This Court's standard of review is clearly erroneous as
to findings of fact by the bankruptcy court, and plenary as to
conclusions of law. In re Stendardo,
991 F.2d 1089, 1094 (3d
Cir. 1993) (citation omitted). Because the district court sits
as an appellate court in bankruptcy cases, our review of the
district court's decision is plenary.
Id. The issue in the
present appeal is whether the district court correctly
interpreted and applied the legal standard of § 506(c) to the
undisputed facts. We therefore exercise plenary review. In re
C.S. Associates,
29 F.3d 903, 905 (3d Cir. 1994).
III.
To answer the question we posited at the outset of this
opinion, our analysis starts with the common law that led to the
present bankruptcy statute, 11 U.S.C. § 506(c). We then examine
In re McKeesport Steel Castings Co.,
799 F.2d 91 (3d Cir. 1986)
and In re C.S. Associates,
29 F.3d 903 (3d Cir. 1994), the most
recent opinions of this Court addressing § 506(c) in any detail.
The general rule is that post-petition administrative
expenses4 and the general costs of reorganization ordinarily may
not be charged to or against secured collateral. General
4
. Administrative expenses include: "the actual, necessary
costs and expenses of preserving the estate"; certain taxes,
fines and penalties; and compensation and reimbursement for a
limited range of services. See 11 U.S.C.A. § 503(b) (West 1993).
Electric Credit Corporation v. Levin & Weintraub (In re Flagstaff
Foodservice Corp.),
739 F.2d 73, 76 (2d Cir. 1984). Rather, such
expenses are normally chargeable only against the unburdened
assets of the estate, 11 U.S.C. § 503, thus preserving for
secured creditors the collateral securing the debtor's
obligations.
However, at common law the general rule was disregarded
when a debtor, debtor in possession or trustee had expended funds
to preserve or dispose of the very property (collateral) securing
the debt. See generally 3 Collier on Bankruptcy ¶ 506.06
(Lawrence P. King, et al. eds., 15th ed. 1994) (tracing
historical evolution of the rule) (hereinafter "Collier on
Bankruptcy"). Classic examples of compensable expenditures under
this exception include storage costs when the secured creditor's
collateral was warehoused, or auction costs incurred on the sale
of the creditor's collateral. In re Myers,
24 F.2d 349, 351 (2d
Cir. 1928) (preservation of the estate's property); Miners
Savings Bank v. Joyce,
97 F.2d 973, 977 (3d Cir. 1938) (costs of
sale).
Collier on Bankruptcy contains a detailed list of the
types of costs and expenses that would generally be found to
relate to the preservation or disposition of the subject property
and benefit the holder of the security interest. This list
includes: appraisal fees, auctioneer fees, advertising costs,
moving expenses, storage charges, payroll of employees directly
and solely involved with the disposition of the subject property,
maintenance and repair costs, and marketing costs.
Id. at
506.56-57. All of these expenditures share a common
characteristic: they are expenses directly related to disposing
of or preserving the creditor's collateral.
Thus, when such expenditures inured to the direct
benefit of the secured creditor by preserving or disposing of the
subject property, the common law permitted recovery by the
claimant on the theory that the creditor whose collateral had
been preserved or disposed of for the benefit of the secured
creditor, would be unjustly enriched at the expense of the
claimant. Collier on Bankruptcy at 506.06.
In 1978, this exception was codified at section 506(c)
of Chapter 11 of the Bankruptcy Code, which provides as follows:
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.
Congress' intent in enacting § 506(c) was to assure that when a
claimant "expends money to provide for the reasonable and
necessary costs and expenses of preserving or disposing of a
secured creditor's collateral, the . . . debtor in possession is
entitled to recover such expenses from the secured party or from
the property securing an allowed secured claim held by such
party." 124 Cong. Rec. 32,398 (cum. ed. Sept. 28, 1978)
(statement of Rep. Edwards), reprinted in 1978 U.S. Code Cong. &
Admin. News 6451. Thus, like the equitable common law rule which
preceded it, § 506(c) is designed to prevent a windfall to the
secured creditor at the expense of the claimant. IRS v.
Boatmen's First Nat'l Bank of Kan. City,
5 F.3d 1157, 1159 (8th
Cir. 1993). The rule understandably shifts to the secured party,
who has benefitted from the claimant's expenditure, the costs of
preserving or disposing of the secured party's collateral, which
costs might otherwise be paid from the unencumbered assets of the
bankruptcy estate, providing that such unencumbered assets exist.
Failing that, the costs of preserving the security for the
secured party's benefit would otherwise fall on the warehouseman,
auctioneer, appraiser, etc.
Although § 506(c) in terms refers only to recovery by
the trustee, we, like many other courts, have held that
administrative claimants other than trustees have standing to
recover under § 506(c), particularly when no other party has an
economic incentive to seek recovery on the claimant's behalf. In
re McKeesport Steel Castings Co.,
799 F.2d 91, 93-94 (3d Cir.
1986); accord Collier on
Bankruptcy, supra, at 506-58 n.7a (while
authorities are contradictory, the better position is to allow an
administrative claimant to assert its claim under § 506(c)).
The circumstances under which a claimant may rely on
§ 506(c) are, as we have pointed out, sharply limited. In C.S.
Associates we said:
Our decisions have clarified that to recover
expenses under § 506(c), a claimant must
demonstrate that (1) the expenditures are
reasonable and necessary to the preservation
or disposal of the property and (2) the
expenditures provide a direct benefit to the
secured creditors.
Equibank, 884 F.2d at 84,
86-87; In re McKeesport Steel Castings Co.,
799 F.2d 91, 94-95 (3d Cir. 1986); see also
In re Glasply Marine Indus.,
971 F.2d 391,
394 (9th Cir. 1992) ("[T]o satisfy the
benefits prong [of § 506(c) the claimant]
must establish in quantifiable terms that it
expended funds directly to protect and
preserve the collateral." (internal
quotation marks omitted)); In re Flagstaff
Foodservice Corp.,
762 F.2d 10, 12 (2d Cir.
1985) ("[T]o warrant [§] 506(c) recovery
. . . [the claimant] must show that . . .
funds were expended primarily for the benefit
of the creditor and that the creditor
directly benefitted from the expenditure.").
C.S.
Associates, 29 F.3d at 906 (emphasis in the original). The
bankruptcy court and the district court concluded that
Precision's sales of raw material to Visual did not operate
directly to preserve or dispose of Fremont's collateral and hence
Precision had not demonstrated a direct benefit to Fremont, as it
is required to do under C.S. Associates. Dist. Ct. Op. 10-11.
Precision nevertheless contends that as a supplier of
raw materials it helped "preserve" Visual as a going concern, and
that by continuing in operation Visual was enabled to pay back a
substantial portion of its debts to Fremont. Therefore, claims
Precision, Fremont benefitted from Precision's post-petition
dealings with Visual. As a result, Precision argues, Fremont's
collateral is chargeable by Precision under § 506(c). We cannot
agree. We do not interpret § 506(c) or understand our precedents
interpreting § 506(c) to protect ordinary trade creditors such as
Precision.
Nor is our analysis altered by Precision's argument
that it helped maintain Visual as a "going concern." Precision
voluntarily continued to deal with Visual, presumably with the
hope of turning a profit. There is no reason to believe that
Congress intended to afford the same special protection for trade
creditors who furnish materials to a Chapter 11 debtor as it did
for claimants who preserve or dispose of secured assets. The
benefit provided by Precision's supply of raw materials was not
directed towards preserving or disposing of Fremont's cash
collateral. Accordingly, Precision's reliance on § 506(c) is
misplaced.
IV.
Precision, in petitioning for payment from Fremont's
cash collateral, relies on In Re McKeesport Steel Castings Co.,
799 F.2d 91 (3d Cir. 1986). McKeesport upheld a claim by a
utility, Equitable Gas, which had supplied natural gas to the
debtor manufacturer, McKeesport, while McKeesport was undergoing
Chapter 11 reorganization. McKeesport's largest creditor,
Equibank, whose loans were secured by liens on McKeesport's
inventory, accounts receivable, real property, fixtures and
equipment, challenged the payment to Equitable Gas for its post-
petition gas service.
Relying on three different theories, one of which
contended that Equitable Gas had preserved the lienholder's
collateral under § 506(c), the utility sought to charge the
collateral securing Equibank's interest for unpaid post-petition
utility bills. Equitable Gas also relied on its superpriority
status granted by a consent order entered by the bankruptcy
court,5 and on 11 U.S.C. § 366(b), which provides that a utility
may discontinue services if it is not furnished "adequate
assurance" of payment.6
The bankruptcy court had authorized, by order,
payment out of Equibank's cash collateral for Equitable Gas's
post-petition gas services. However, despite a payment time
table set by the bankruptcy court, McKeesport regularly failed to
meet its obligations to Equitable Gas.
On two different occasions, Equitable Gas had attempted
to discontinue its gas services after McKeesport failed to make
timely payments. Each time, the bankruptcy court entered orders
denying Equitable Gas the right to discontinue service, stating
that by ordering the continued supply of gas it was seeking to
protect the lienholders. On Equitable Gas's third application,
however, the bankruptcy court granted its petition for relief and
ordered the secured creditors to pay $57,261.16 for post-petition
gas service. The district court denied recovery to Equitable
Gas, but we reversed the district court's order and affirmed the
order of the bankruptcy court.
5
. The Bankruptcy Court by order had permitted McKeesport to
use its cash collateral to pay for raw materials, supplies, gas,
etc. It had also granted a superpriority to those who provided
raw materials, utilities and supplies used in McKeesport's
manufacturing process.
6
. 11 U.S.C. § 366 forbids a utility to discontinue service
solely on the basis of the commencement of Chapter 11
proceedings, provided it is furnished with adequate assurance of
payment in the form of a deposit or other security.
We acknowledge that in ordering payment to Equitable
Gas for providing post-petition gas service, the McKeesport court
stated that it was doing so "to preserve the going concern value
of the debtor's
estate." 799 F.2d at 95. This would appear to
lend support to Precision's argument. However, the difference
between the circumstances of McKeesport and the circumstance
which we face is dramatic. This difference was recognized as
well by the bankruptcy court and by the district court.
As we have just recounted, in McKeesport, the
bankruptcy court had entered two orders denying Equitable Gas the
right to discontinue service. As a result, Equitable Gas, unlike
Precision, had no choice as to whether to supply its product to
the debtor in possession. Equitable Gas had been directed by the
bankruptcy court to continue to provide post-petition gas
service.
Moreover, Equitable Gas had still another string to its
bow, which Precision does not. While the McKeesport court had no
need to rule or rely on Equitable Gas's claim under § 366(b), we
cannot ignore the obvious fact that under § 366(b), Equitable Gas
was, as a utility, entitled to "adequate assurance" of payment,
an assurance not given to Precision.
We do not question that the court's discussion in
McKeesport may have inadvertently encouraged trade creditors such
as Precision to believe that any materials furnished to a debtor
which assisted a debtor's operations -- materials such as raw
materials, typewriters, paper clips, pencils, and the like --
constituted a benefit to the debtor and thus could be charged
against a secured lender's collateral. However, we do not read
McKeesport as generously as Precision does. We believe that the
bankruptcy court order obtained by Equitable Gas, the cash
collateral order providing for payment to utilities and the
presence of § 366 issues all distinguish McKeesport from the
situation in which Precision has found itself.
Merely providing some benefit to the debtor, as
Precision has provided by supplying Visual with steel, does not
satisfy § 506(c)'s requirement that the claimant in order to
prevail must provide a direct benefit inuring to the secured
lender for the preservation or disposition of the secured
property. Were it otherwise, no secured lender would assist in
financing the debtor, because then every trade creditor would in
effect have priority over the secured lender. As the bankruptcy
court emphasized, the availability of Chapter 11 financing would
be jeopardized if we were to allow any claimant who furnishes any
benefit to a secured creditor to claim under § 506(c). The Court
of Appeals for the Fifth Circuit has also recognized that
§ 506(c) cannot readily be looked to by trade creditors who
supply materials to a debtor in Chapter 11, observing that:
In a reorganization, it is essential that the
debtor keep his post-bankruptcy accounts
paid, so that tradesmen will have an
incentive to deal with the company in Chapter
11. If this goal is not reached, in many
cases Chapter 11 debtors will find it
increasingly difficult to maintain operations
and to reorganize as going concerns, and the
purpose of Chapter 11 would be seriously
undermined. It is equally clear, however,
that § 506(c) was not intended as a panacea
for this problem.
Matter of P.C., Ltd.,
929 F.2d 203, 206 (5th Cir. 1991).
We conclude that McKeesport neither governs nor
conflicts with the disposition of this case.
V.
Our most recent instruction respecting § 506(c) appears
in C.S.
Associates, supra, a decision which followed McKeesport
by some eight years and to which we have referred earlier in this
opinion. See supra, pp. 9-10. In that case we rejected a claim
by a municipality seeking post-petition real estate taxes and
water and sewage rents to charge the proceeds of sale of a
building under § 506(c). Although the claimant municipality
argued that it had "benefitted" the secured party through general
municipal services, we held that this "benefit" could not support
a claim under § 506(c). Section 506(c) was "designed to extract
from a particular asset the cost of preserving or disposing of
that
asset." 29 F.3d at 907 (quoting In re Parr Meadows Racing
Ass'n,
92 B.R. 30, 35 (E.D.N.Y.1988), aff'd in part, rev'd in
part on other grounds,
880 F.2d 1540 (2d Cir. 1989)).
Because the city had not demonstrated that the services
"actually were performed for the direct benefit of the [secured]
property,"
id. at 908, we denied relief, making clear that
expenses incurred by another can be charged against the property
securing a secured lender's loan only where, and only to the
extent that, the lender has been directly benefitted by the
preservation or disposition of property serving as collateral.
VI.
Because Precision had not been specifically ordered by
the bankruptcy court to provide steel to Visual, and because
Precision has not met the test of § 506(c) mandated by C.S.
Associates, we will affirm the district court's order of
September 26, 1994, which had denied relief to Precision for the
same reasons as had the bankruptcy court.