Filed: Sep. 10, 2019
Latest Update: Mar. 11, 2020
Summary: FILED SEP 10 2019 SUSAN M. SPRAUL, CLERK U.S. BKCY. APP. PANEL OF THE NINTH CIRCUIT ORDERED PUBLISHED UNITED STATES BANKRUPTCY APPELLATE PANEL OF THE NINTH CIRCUIT In re: BAP No. EC-18-1266-TaBS COLUSA REGIONAL MEDICAL CENTER, Bk. No. 2:16-bk-23655 Debtor. UNITED STATES DEPARTMENT OF AGRICULTURE, Appellant, v. OPINION J. MICHAEL HOPPER, Chapter 7 Trustee, Appellee. Argued and Submitted on June 20, 2019 at Sacramento, California Filed – September 10, 2019 Appeal from the United States Bankruptcy
Summary: FILED SEP 10 2019 SUSAN M. SPRAUL, CLERK U.S. BKCY. APP. PANEL OF THE NINTH CIRCUIT ORDERED PUBLISHED UNITED STATES BANKRUPTCY APPELLATE PANEL OF THE NINTH CIRCUIT In re: BAP No. EC-18-1266-TaBS COLUSA REGIONAL MEDICAL CENTER, Bk. No. 2:16-bk-23655 Debtor. UNITED STATES DEPARTMENT OF AGRICULTURE, Appellant, v. OPINION J. MICHAEL HOPPER, Chapter 7 Trustee, Appellee. Argued and Submitted on June 20, 2019 at Sacramento, California Filed – September 10, 2019 Appeal from the United States Bankruptcy C..
More
FILED
SEP 10 2019
SUSAN M. SPRAUL, CLERK
U.S. BKCY. APP. PANEL
OF THE NINTH CIRCUIT
ORDERED PUBLISHED
UNITED STATES BANKRUPTCY APPELLATE PANEL
OF THE NINTH CIRCUIT
In re: BAP No. EC-18-1266-TaBS
COLUSA REGIONAL MEDICAL CENTER, Bk. No. 2:16-bk-23655
Debtor.
UNITED STATES DEPARTMENT OF
AGRICULTURE,
Appellant,
v. OPINION
J. MICHAEL HOPPER, Chapter 7 Trustee,
Appellee.
Argued and Submitted on June 20, 2019
at Sacramento, California
Filed – September 10, 2019
Appeal from the United States Bankruptcy Court
for the Eastern District of California
Honorable Christopher D. Jaime, Bankruptcy Judge, Presiding
Appearances: Jeffrey James Lodge, Assistant United States Attorney,
argued for appellant; Kristen Renfro of Desmond, Nolan,
Livaich & Cunningham argued for appellee.
Before: TAYLOR, BRAND, and SPRAKER, Bankruptcy Judges.
TAYLOR, Bankruptcy Judge:
INTRODUCTION
The Colusa Regional Medical Center provides the only hospital and
emergency medical services to thinly-populated Colusa County, California.
Facing financial problems, it ceased operations in 2016 and initiated a
chapter 7 case.1 The majority of its assets were over encumbered by liens,
including those held by the United States Department of Agriculture (the
“USDA”).
J. Michael Hopper was appointed trustee. He successfully
orchestrated a sale of a substantial portion of Debtor’s assets, and the
record supports that the hospital thereafter reopened and hospital medical
1
Unless specified otherwise, all chapter and section references are to the
Bankruptcy Code, 11 U.S.C. §§ 101–1532, all “Rule” references are to the Federal Rules
of Bankruptcy Procedure, and all “Civil Rule” references are to the Federal Rules of
Civil Procedure.
2
services resumed. The Trustee achieved excellent results in the case that
benefitted both creditors and the citizens of Colusa County.
The present appeal concerns the question of who should pay a
substantial portion of the Trustee’s attorney’s fees and his entire interim
statutory commission. By way of a surcharge motion, the Trustee argued
that many of his fees and costs were devoted to preserving and protecting
the USDA’s collateral, that the USDA saw considerable benefit (including
achievement of its expressed desire that Colusa County not be without
hospital services), and, thus, that the USDA should shoulder these
significant expenses. The USDA disagrees; it suggests that the estate (and,
derivatively, other creditors) should cover these administrative costs. The
bankruptcy court agreed with the Trustee.
We determine that the bankruptcy court clearly erred in finding
surcharge objectively appropriate; it did not employ the test required by
Ninth Circuit precedent and, thus, it failed to make factual findings that
support surcharge. It also erred when it considered evidence introduced
only on reply and found that the USDA impliedly consented to surcharge
or caused the administrative expenses that form the basis for the Trustee’s
surcharge request.
Accordingly, we VACATE and REMAND for further proceedings.
3
FACTS2
Debtor was a nonprofit public benefit corporation that opened in
2001. It was the principal health care facility in Colusa County, California,
and consisted of its only hospital, three family medical clinics, and a
women’s health center. Facing a financial crisis, it halted operations in
April 2016 and filed a chapter 7 petition two months later.
No one disputes that Colusa County had a critical need for reopening
of the hospital. The County argued that as of the petition date Colusa
County residents faced a 30 to 45 minute ambulance ride to reach an
emergency room, sometimes in situations where time was a factor in
survival. Thus, the public interest overwhelmingly favored a chapter 7
liquidation that allowed the hospital to resume operations.
Fortunately for all concerned, the Trustee received an offer to
purchase the assets necessary to reopen the hospital almost immediately.
The billing statements in the case evidence that the Trustee and his
attorney met with the eventual purchaser approximately three weeks after
the Trustee’s appointment and filed an initial motion to approve a sale to
American Specialty Healthcare, Inc. (“American Specialty”) a little more
2
We exercise our discretion to take judicial notice of documents electronically
filed in the underlying bankruptcy case. See Atwood v. Chase Manhattan Mortg. Co. (In re
Atwood), 293 B.R. 227, 233 n.9 (9th Cir. BAP 2003).
4
than a week later.3 There were hurdles, but the American Specialty sale
closed, and the hospital reopened to the benefit of many.
Debtor’s assets and liabilities. Debtor’s assets included real and
personal property leases and commercial real property. The estate also held
other personal property, including licenses relating to its operations;
various non-leasehold furniture, fixtures, and equipment; $565,000 in cash
or cash equivalents; approximately $11,000,000 in accounts receivable4; and
a claim for recovery of a preference in the approximate amount of $160,000.
The USDA’s lien encumbered many of these assets and secured an
approximately $3,000,000 debt. In particular, the USDA held a first priority
lien on accounts receivable and their proceeds, the real property lease
between Colusa County and the Debtor,5 as well as the equipment and
other tangible and intangible personal property related to operation of the
hospital.
The USDA, however, did not hold a lien against Debtor’s fee simple
interest in the “Williams Family Health Center”, a real property asset
3
The petition date was June 3, 2016. The Trustee’s time records record a one hour
entry for: “Meeting . . . with [American Specialty] re: sale of CRMC campus and leases”
on June 27, 2016. His lawyers, similarly, recorded an entry for “prepare for and meet
with buyers” on that same date. On July 6, 2016, the Trustee filed a motion to sell assets
to American Specialty.
4
The schedules estimate that only approximately $1.5 million of this amount was
collectible.
5
The hospital is located on this leasehold.
5
valued in Debtor’s schedules at $861,164 (the “Williams Property”).
Another creditor held a lien on this asset that secured a debt in the
approximate amount of $320,000.6
The schedules, thus, evidence that in any reasonable scenario there
would be funds in the estate to pay administrative expenses. But the
apparent availability of funds to pay administrative expenses meant that
the Trustee was unable to avoid the estate’s patient records obligations
under applicable law. See 11 U.S.C. § 351. These responsibilities increased
the costs of administration; for example, early in the case, the Trustee had
to seek bankruptcy court permission to destroy stale patient records.
And not surprisingly, there were numerous junior secured creditors,
unsecured creditors, and priority creditors.
Cash collateral. While the hospital was not operational and the
Trustee never filed a § 721 motion authorizing him to operate a business,
the Trustee had a critical need for cash collateral in the early stages of the
case. First, he needed security guards to protect the hospital physical plant.
6
There is also no evidence in the record or available on the case or claims docket
evidencing that the USDA held a lien on the 2016 leases and subleases between Debtor
and Adventist Health in relation to the Williams Property and a clinic location in
Arbuckle, California. Prepetition the Debtor leased or sub-leased its Arbuckle, Williams
Property, and hospital site clinic locations to Adventist Health. Adventist Health
describes itself in documents filed on the case docket as a nonprofit organization which
provides health services to rural communities. It also stated that it operated the clinics
under its own license and without operational or other support from the Trustee or
Debtor’s estate.
6
Second, absent immediate turnover of assets to the USDA, he needed
personnel knowledgeable in the collection of medical receivables and
accounting records software. Third, he needed software to manage
electronic patient records. Fourth, he needed to pay for insurance,
including a tail policy that would provide the estate with a defense to
malpractice claims filed postpetition. Fifth, he needed to pay utilities. And
finally, he needed limited office space.
The USDA was the focus of cash collateral negotiation, although the
Trustee acknowledged that Debtor’s cash and accounts receivable assets
were subject to other junior competing lien interests held by Amerisource-
Bergen Drug Corporation, River Valley Community Bank, Cardinal Health,
and FlexCare LLC.
In the initial cash collateral motion, the Trustee acknowledged partial
USDA consent and noted that the Debtor had about $565,000 in cash on the
petition date, that he anticipated that this amount would soon exceed
$1,000,000, and that he could increase collection recoveries by using USDA
cash collateral to finance collection efforts. And before the cash collateral
hearing, he advised that the USDA now supported all proposed cash
collateral uses except for the payment for malpractice tail insurance. The
bankruptcy court later overruled the USDA’s objection and allowed all
cash collateral use as proposed by the Trustee.
To adequately protect the USDA, the cash collateral order provided it
7
with replacement liens on all postpetition causes of action, including
avoidance actions, but the order clarified that the replacement liens would
not encumber the Williams Property or its income and proceeds. The order
also allowed the USDA to receive payments from its cash collateral of
$20,000 a month.
The USDA directly benefitted from some of the requested cash
collateral use. The security guards protected its tangible collateral. The
personnel collecting receivables did so for its benefit. And the accounting
software, as well as the patient records software, assisted in these
collections.
But the USDA was not the only party who benefitted. The patient
records software, paid for with USDA cash collateral, preserved patient
records, even if not necessary for collection, and, thus, eliminated or
limited the use of unencumbered estate assets to maintain patient records.
Also, USDA cash collateral use was requested in relation to utility
payments for the Williams Property and Arbuckle clinic locations to the
extent the rental income was insufficient to pay debt service on the
Williams Property and all building operational costs as to all three clinic
locations. And the requested use for insurance directly protected others as
well. In particular, tail insurance provided no obvious benefit to the USDA;
to the extent late-filed malpractice claims could not be defended, this
would increase unsecured claims, but it would not result in senior claims
8
against the USDA’s collateral.
The Trustee later obtained two additional cash collateral orders. The
second order largely duplicated the first except that the Trustee did not
request use for office rent and insurance premiums. The third motion
largely duplicated the second but also requested use to pay renewal fees
for licenses critical to both hospital operations and completion of the
American Specialty sale. In this motion, the Trustee noted: “The services of
the Debtor’s former employees have provided substantial assistance to the
Trustee in navigating the complexities involved with the Debtor’s billing
and collection operations and the management of the Debtor’s records, and
maintaining access to and security for the records is necessary to facilitate
further collections and satisfy requests for records.”
The USDA objected to use of cash collateral after September 27, 2016.
In short, it asserted that the estate should cover expenses from other
sources if the American Specialty sale had not then closed by that date. The
bankruptcy court overruled its objections and allowed use as requested by
the Trustee. The USDA also sought stay relief as to the accounts receivable
collateral. The bankruptcy court granted its motion.
Sale of assets. As noted, the Trustee very rapidly identified a buyer
for the hospital and clinic operations, including the Williams Property, for
$1,000,000. The proposed sale to American Specialty would be free and
clear of liens except as to the Williams Property, which was sold subject to
9
the existing lien.
In support of his sale motion, the Trustee argued, in part, that
creditors would benefit from both the sale proceeds and a reduction of
administrative expenses as a result of the buyer’s assumption of
responsibility for medical records. In other words, the Williams Property’s
proceeds—available for payment of administrative expenses and
unsecured claims—would not be diminished by any ongoing patient-
record obligations. Thus, the allocation of sale proceeds to the Williams
Property provided a benefit to the estate even beyond the allocated
proceeds of sale. In sum, the Trustee contended: “the proposed sale to the
Buyer is a good faith effort by the Trustee to maximize the net return to the
estate on account of the Sale Assets.”
Thereafter, there were several objections from secured lenders and
parties with executory contracts. And a supplemental motion to approve a
sale agreement followed. The revised sale included additional assets (the
non-leasehold furniture, fixtures, and equipment) and an increased
purchase price of $1,100,000. In describing how lienholders would be
treated, the Trustee represented that the USDA consented to the sale on the
condition that it receive $550,000 from the sale proceeds. The Trustee, thus,
allocated the remainder of the sale proceeds ($550,000) to the Williams
10
Property.7 This amount was available to pay administrative creditors and
to make payment to priority creditors and possibly unsecured creditors.
The Trustee also allocated $31,000 of this amount to pay three lienholders
other than the USDA to obtain their consent.
In November 2016, the bankruptcy court entered its order granting
the supplemental sale motion (the “Sale Order”).
Subsequent Administration and the Trustee’s surcharge request.
The Trustee thereafter sought interim approval of $154,878.58 in attorney’s
fees and expenses. In the motion, the Trustee noted that he might file a
§ 506(c) surcharge motion.
Over a year later, the USDA filed a motion to compel the Trustee to
abandon its remaining $300,000 in cash collateral. The Trustee then filed a
first interim application to approve $66,092.18 in Trustee’s compensation
based on $1,428,072.80 in disbursements. He concurrently filed a motion
seeking to recover an amount equal to his commission and $133,167.50 of
his counsel’s fees from USDA collateral. He explained: “Working in
7
We acknowledge that the schedules evidence that the equity available to the
estate from the Williams Property (before reduction for costs of sale), was slightly less
than this amount and that the Debtor had admittedly limited additional assets such as
the Arbuckle lease and Adventist Health subleases. But the bankruptcy court and the
Trustee clearly viewed this case through a lens that broadly assumed that the Trustee’s
obvious options were the sale he chose or a stand alone sale of the Williams Property
coupled with abandonment. In effect, the trial court discounted the availability of
realizable equity from other assets. We see no error in this determination and make the
same assumption.
11
conjunction with various interested parties trying to preserve both the
economic value of the hospital and associated assets, and the public
interest in preserving the hospital and health services in Colusa County,
the Trustee undertook” the task of attempting a sale of the hospital and its
related assets.
The Trustee initially supported the surcharge motion with his own
declaration. It consisted of an outline of case progress, an overview of the
asserted secured claims, and a broad overview of disbursements in the
case. The Trustee also provided time records for himself and his attorneys
and a schedule of the disbursements that justified his statutory
commission. But the Trustee discussed the USDA’s involvement in the case
only in brief.8 Nowhere in the declaration did the Trustee discuss any
specific interactions with the USDA that allegedly influenced his actions in
the case. He similarly failed to discuss the alleged motivations and analysis
that led him to accept the offer from American Specialty as opposed to
pursuing sale of the Williams Property and abandoning other assets. And
8
In his declaration, he stated: the undisputed fact of the USDA’s possession of
liens, 2:18–19 & 3:7; the fact that he sold free and clear of these liens and paid the USDA
$550,000 from sale proceeds, 4:19–22; the adequate protection payments and
replacement liens received by the USDA, 5:26–28; the fact that the USDA obtained stay
relief to undertake collections in November of 2016 but, to the best of his knowledge,
did not engage in such collections, 6:22–25; the fact that he engaged in settlements and
litigation that freed up $92,500 for the USDA, 7:21–8:11; the fact that he returned an
overpayment with the remainder ($187,986) subject to the USDA’s lien at 8:12–19; and
the quantum of payments to the USDA from all sources at 8:20–9:2.
12
he made no effort to tie particular fees to a benefit to the USDA and its
collateral.
The Trustee sought surcharge for fees broadly related to sale of the
hospital and the vast majority of other case activity from the petition date
through closing of the sale. The Trustee conceded that the USDA did not
expressly consent to surcharge but argued that it impliedly consented.
Not surprisingly, the USDA opposed. It broadly disputed the
appropriateness of surcharge and specifically disputed that the Trustee
adequately established a benefit to the USDA or consent by the USDA for
the purposes of surcharge.
In connection with his reply, the Trustee submitted his own brief
supplemental declaration. In it, he recounted two conversations for the first
time:
• “On June 10, 2016, I spoke with Jeffrey A Streiffer, counsel for the
[USDA], about the USDA’s claim and the USDA’s desire for me to
preserve its collateral. Mr. Streiffer told me that the USDA was open
to reducing its loans to secure a buyer for the Debtor’s hospital and
related assets and that the USDA did not want to leave the Colusa
community without the health services provided by the hospital.”
• “I also spoke numerous times with Anita Lopez, the community
facilities director with the USDA that was handling this case, who
told me at the outset of this case that the USDA wanted to preserve
13
health services in Colusa and later indicated to me that it was not
prepared to pursue its own collection activities.”
At the hearing on the surcharge motion, the USDA argued as
outlined in its opposition. It also objected to the supplemental declaration
on multiple theories including that it exceeded the scope of what was
appropriate for a reply and, thus, that the USDA could not provide a
meaningful response.
The bankruptcy court then provided an oral ruling. It overruled the
USDA’s objection to the second declaration, reasoning that unspecified
civil rules and local rules required pre-hearing written objections.9 Noting
that surcharge is evaluated under two tests, an objective test and a
subjective test, it concluded that the Trustee satisfied both.
In its evaluation of both tests, it found that the USDA obtained a
benefit and that the USDA could not have duplicated the benefit provided
by the American Specialty sale and the collection of receivables by the
estate. It concluded that, without the Trustee’s efforts, the USDA would not
have received significantly more than the $565,000 in cash available on the
petition date. Indeed, it added that it was “not persuaded that USDA could
9
The bankruptcy judge also noted that the USDA failed to file any written
objections to the evidentiary assertions contained in the first declaration as required by
the Local Bankruptcy Rules. We do not find this surprising given the content of the
Trustee’s initial declaration; it is an outline of the timeline of the case at a high level.
Having reviewed the docket and the record, we see nothing inconsistent with a faithful
overview of case history.
14
or would have collected any receivables.” Hr’g Tr. (Sept. 11, 2018) 18:3–4.
And it continued: “In fact, according to its community facilities director,
USDA was not prepared to do that at the inception of the case, and it also
made no effort to do that after the automatic stay was terminated in
November of 2016 for the express purpose of allowing USDA to collect
accounts receivable.” Id. at 18:4–9.
It also reasoned that the USDA would have realized nothing on
account of its lease, license, and intangible collateral.
Finally, it faulted the USDA for failing to submit evidence about the
value of the furniture, fixtures, and equipment, and concluded that it
would not have received more than the $100,000 the Trustee received
through the American Specialty sale.
Having determined that the USDA would have effectively
abandoned its receivable collateral (and using math that ignores even the
$100,000 previously allocated to the USDA’s tangible personal property
collateral), the bankruptcy court found that the USDA received $2,000,000
from the estate and that “$649,000 of [USDA’s] collateral was expended to
produce that $2 million that USDA received. Crediting for that use of cash
collateral, that is a net benefit to the USDA of $1,351,000.” Id. at 18:21–24.
This net benefit, the bankruptcy court found, “exceeds by at least $702,000
what . . . USDA would have received at the inception of this case . . . and
that is the $565,000 in cashier’s checks.”
Id. at 19:1–6.
15
In further support of its conclusion, the bankruptcy court noted: “Just
so there is no doubt that USDA benefitted by the preservation and
disposition of its collateral and that it understood that it benefitted by that
sale, preservation and sale, again, I refer to USDA’s prior counsel’s
statement during the hearing on September 27, 2016, where there’s
statement of benefit.” Id. at 19:7–12.
The bankruptcy court also considered necessity and emphasized the
statement by the USDA’s counsel that it was willing to reduce its loans in
order to keep medical services in Colusa County. Id. at 18:10–15. Thus, it
noted: “in light of USDA’s desire for the trustee to preserve and sell its
collateral so that Colusa County would not be left without medical services
and the importance of that objective to USDA given its willingness to
reduce its loans to make that happen, the expenses that the trustee and his
professionals incurred were necessary.”
Id. at 20:2–7.
Finally, as relevant to the objective test, the bankruptcy court
concluded that the surcharge amount was reasonable. It emphasized that
the sale of the hospital and the associated leases and licenses was not easy,
involved numerous moving parts, aggressive and somewhat contentious
hearings, and medical and patient records issues. Id at 20:8–15.
The bankruptcy court next found that the USDA impliedly consented
to the surcharge. Although acknowledging that consent could not be
inferred from limited cooperation, the bankruptcy court found that the
16
USDA “caused the expenses the trustee and his professionals incurred
when its counsel told the trustee that its overriding objective was not to
eliminate medical services from Colusa County.” Id. at 21:9–15. That this
goal was important to the USDA, the bankruptcy court found, was clear,
because it “offered to reduce its loans to see that objective achieved.”
Id. at
21:16–19. As a result, the bankruptcy court reasoned, the “USDA’s
involvement was not so much mere cooperation with the trustee, but
rather, and actually, was the impetus for the trustee to act and the reason
the trustee acted as he did.”
Id. at 21:19–22. “In that respect,” the
bankruptcy court continued, the “USDA caused the expenses that the
trustee and his professionals incurred and now seeks [to] surcharge.”
Id. at
21:19–24.
The bankruptcy court also noted: “The only evidence of why the
trustee pursued preservation of a going concern sale of the hospital and
related assets rather than a simple liquidation of the property of the estate
is found in the trustee’s supplemental declaration that’s filed with the
reply.” Id. at 12:19–23. The bankruptcy court continued: “According to that
declaration, the trustee’s efforts and the direction that this Chapter 7 case
took resulted from the USDA’s twin desires” to sell the assets so that
Colusa County would not be without medical services and to collect
receivables “that USDA was not prepared to collect on its own behalf at
that time.”
Id. at 12:24–13:7. Based on these requests, the bankruptcy court
17
found, the Trustee worked to sell the hospital as a going concern.
The bankruptcy court noted that other factors supported its implicit
consent finding. First, it observed that the “USDA was aware early in the
case that the asset liquidation without a sale as a going concern would not
net sufficient funds to pay administrative expenses and its secured claim in
full.” Id. at 22:1–4. Second, it found that the USDA, to a significant extent,
controlled and directed the Trustee’s actions by limiting the use of its cash
collateral—this had the effect of focusing the Trustee on selling the hospital
as a going concern.
Id. at 22:14–25.
The bankruptcy court entered its order granting the Trustee’s motion
and authorizing the Trustee to surcharge $199,259.68 from the USDA’s
collateral. The USDA timely appealed.
JURISDICTION
The bankruptcy court had jurisdiction under 28 U.S.C. §§ 1334,
157(b)(2)(B), and 157(b)(2)(M). We have jurisdiction under 28 U.S.C. § 158.
ISSUES
Did the bankruptcy court err by overruling the USDA’s evidentiary
objections to the Trustee’s declaration?
Did the bankruptcy court err when it surcharged the USDA’s
collateral?
STANDARDS OF REVIEW
We review evidentiary rulings made in the context of a summary
18
judgment motion for an abuse of discretion. Wong v. Regents of Univ. of Cal.,
410 F.3d 1052, 1060 (9th Cir. 2005). We review the bankruptcy court’s
interpretation and application of the local rules for an abuse of discretion.
Shalaby v. Mansdorf (In re Nakhuda),
544 B.R. 886, 898 (9th Cir. BAP 2016),
aff’d, 703 F. App’x 621 (9th Cir. 2017).
We review entitlement to surcharge, a question of law, de novo.
Debbie Reynolds Hotel & Casino, Inc. v. Calstar Corp., Inc. (In re Debbie
Reynolds Hotel & Casino, Inc.), 255 F.3d 1061, 1065 (9th Cir. 2001). But “[t]he
issue of whether expenses were reasonable, necessary, and benefitted the
secured creditor is a question of fact which we review for clear error.”
Golden v. Chicago Title Ins. Co. (In re Choo),
273 B.R. 608, 610-11 (9th Cir. BAP
2002).
A factual finding is clearly erroneous, if, after examining the
evidence, the reviewing court “is left with the definite and firm conviction
that a mistake has been committed.” Anderson v. City of Bessemer City,
470 U.S. 564, 573 (1985). More concretely, a factual finding is clearly
erroneous if it is illogical, implausible, or without support in inferences that
may be drawn from the facts in the record. See TrafficSchool.com, Inc. v.
Edriver Inc.,
653 F.3d 820, 832 (9th Cir. 2011).
DISCUSSION
A. The Trustee’s motion was timely.
The USDA initially argues that the surcharge motion was untimely,
19
because a surcharge must be paid from collateral proceeds and the USDA
had already received the proceeds from the American Specialty sale. It also
argued that laches barred the motion. We disagree.
Surcharge payments do not come from the debtor’s estate; rather,
they come “directly from the secured party’s recovery.” In re Debbie
Reynolds Hotel & Casino, Inc., 255 F.3d at 1067. But, where multiple items of
collateral secure a single debt, a trustee in bankruptcy may recover
expenditures made in connection with the preservation or disposition of
one item of collateral from the other collateral. Lines v. N. Coast Prod. Credit
Ass’n, (In re James E. O’Connell Co., Inc.),
893 F.2d 1072, 1074 (9th Cir. 1990).
Here, the USDA filed a single proof of claim secured by multiple
items of collateral; so the Trustee could surcharge costs related to one item
of collateral from other collateral. Id. The bankruptcy court thus correctly
concluded that the motion was neither untimely nor barred by laches.
B. The bankruptcy court abused its discretion when it overruled
the USDA’s objection to consideration of the declaratory
evidence filed on reply and relied on it as substantial support
for its decision.
The bankruptcy court disregarded the USDA’s oral evidentiary
objection to consideration of the Trustee’s supplemental declaration on
reply. We agree with the USDA that this was an abuse of discretion.
Typically, a party must have an adequate opportunity to address the
evidence against it and an opposing party should have both the ability to
20
do so in writing and to produce counterevidence. Provenz v. Miller, 102 F.3d
1478, 1483 (9th Cir. 1996) (“We agree with the Seventh Circuit, which held
that ‘[w]here new evidence is presented in a reply to a motion for summary
judgment, the district court should not consider the new evidence without
giving the [non-]movant an opportunity to respond.’” (alterations in
original) (citing Black v. TIC Inv. Corp.,
900 F.2d 112, 116 (7th Cir. 1990))).
Here, the bankruptcy court considered this evidence and heavily
relied on it notwithstanding the USDA’s oral objection. It did so based on
the stated conclusion that civil rules and the local rules require that all
evidentiary objections to testimony must be submitted in writing before the
hearing. The bankruptcy court, however, did not cite to any specific rule
that so states; we cannot identify one that supports this conclusion.
Neither the Federal Rules of Bankruptcy Procedure nor the Federal
Rules of Civil Procedure contain such a rule. Nor do the Local Rules for the
United States Bankruptcy Court for the Eastern District of California
(“Local Rules” or “LBR”). They expressly state that supportive evidence
should be filed with a motion and opposition. LBR 9014-1(d)(3)(D) &
(f)(1)(B). But, while they allow for a reply, they make no mention of
submission of evidence on reply. LBR 9014-1(f)(1)(C). And, while they
allow parties to file a document giving citation to newly issued authority at
any time before the hearing, they expressly bar the filing of any other
memorandum, declaration, or document, other than those otherwise
21
specified, without court approval. LBR 9014-1(f)(1)(D).10 If there is a
violation of a rule here, it appears to be a violation of Local Rule 9014-
(f)(1)(D) at the hands of the Trustee. The Local Rules barred the USDA
from filing a written evidentiary objection.11
Thus, the bankruptcy court abused its discretion in considering the
late-filed evidence without providing the USDA with an opportunity to
provide written response and counterevidence. And this was not harmless
error because the bankruptcy judge relied heavily on this evidence; indeed
he described it as the only evidence of the Trustee’s reasons for pursuing
the American Specialty sale.
But, even if the declaration is considered, we conclude that we must
vacate and remand for further proceedings. Thus, we provide more
analysis.
10
The bankruptcy court may have been thinking of Local Rule 7056-1(f), which
governs evidentiary objections in connection with motions for summary judgment. The
non-movant (here, the USDA) is required to “file and serve written objections to
movant’s evidence not later than the date specified in subdivision (b) of this rule.” LBR
7056-1(f). Subdivision (b), however, concerns the initial opposition to the motion for
summary judgment. As a result, this local rule does not contemplate objecting to
declaratory evidence submitted in a reply. It, thus, is inapposite and did not require the
USDA to file a written evidentiary objection.
11
The Local Rules incorporate only limited and specific rules of the United States
District Court for the Eastern District of California (“District Court Rules”). See
LBR 1001-1(c). None of the incorporated District Court Rules are relevant to this issue,
and nowhere else in the District Court Rules is there a requirement of pre-hearing
written opposition to evidence introduced on reply.
22
C. The Trustee failed to show he was entitled to surcharge under
the objective test.
“Generally, bankruptcy administrative expenses may not be charged
to or against secured collateral.” In re Choo, 273 B.R. at 611. But § 506(c)
codifies a common law exception to this rule.
Id. It 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.
11 U.S.C. § 506(c). The party seeking surcharge under § 506(c) bears the
burden of proof. Fed. Deposit Ins. Corp. v. Jenson (In re Jenson), 980 F.2d 1254,
1260 (9th Cir. 1992).
Section 506 continued a practice that existed under the Bankruptcy
Act of 1898. Hartford Underwriters Ins. Co. v. Union Planters Bank, N.A., 530
U.S. 1, 9 (2000). That practice “was not to be found in the text of the Act,
but traced its origin to early cases establishing an equitable principle that
where a court has custody of property, costs of administering and
preserving the property are a dominant charge.”
Id.
But striking the right balance when evaluating surcharge is
important. In explaining why mere cooperation with the debtor does not
make the secured creditor liable for all expenses of administration, the
Ninth Circuit cautioned that shifting liability to the secured creditor would
make it difficult, if not impossible, to induce new lenders to finance a
23
chapter 11 operation. Cent. Bank of Montana v. Cascade Hydraulics & Util.
Serv., Inc. (In re Cascade Hydraulics & Util. Serv., Inc.), 815 F.2d 546, 548-49
(9th Cir. 1987). And, as it further acknowledged, “[i]t would discourage the
trustee or debtor in possession from taking reasonable steps to expedite the
reorganization and encourage negligence.”
Id. Cf. Hartford Underwriters Ins.
Co., 530 U.S. at 13 (“The possibility of being targeted for such claims by
various administrative claimants could make secured creditors less willing
to provide postpetition financing.”).
And consistent with the importance of encouraging reasonable
secured creditor cooperation as a general matter, this case has an additional
public policy overlay: the provision of critical medical services to Colusa
County. In evaluating surcharge, we conclude that a creditor’s altruism,
here a willingness to consider reduction of a secured claim to assist in
retention of medical services to a rural area, is not, in insolation, a sufficient
basis for surcharge. Deterrence of creditor cooperation through fear of
surcharge is particularly to be avoided where critical public benefits are at
issue.
Thus, to surcharge expenses under § 506(c), the Trustee “must prove
that its expenses were reasonable, necessary[,] and provided a quantifiable
benefit to” the USDA. In re Debbie Reynolds Hotel & Casino, Inc., 255 F.3d at
1068. And this benefit must be more than incidental or arising in the
context of generalized benefit to the estate. In re Cascade Hydraulics & Util.
24
Serv., Inc., 815 F.2d at 548. The objective test is “not an easy standard to
meet.” In re Debbie Reynolds Hotel & Casino,
Inc., 255 F.3d at 1068. The
burden is onerous.
Id. At a simplistic level, the Trustee must show that the
specific administrative expenses at issue were reasonable in amount and
necessary to a result beneficial to a secured creditor. In re Cascade Hydraulics
& Util. Serv.,
Inc., 815 F.2d at 548. So, the benefit cannot be hypothetical.
Compton Impressions, Ltd. v. Queen City Bank, N.A. (In re Compton
Impressions, Ltd.),
217 F.3d 1256, 1261 (9th Cir. 2000). And the
administrative expenses must be incurred primarily for the secured
creditor’s benefit. In re Cascade Hydraulics & Util. Serv.,
Inc., 815 F.2d at 548.
When considering the threshold inquiry of necessity to the secured
creditor, a court should consider whether the secured creditor “could have
internalized many of the post-petition costs incurred by the Debtor and its
professionals simply by using in-house resources.” In re Compton
Impressions, Ltd., 217 F.3d at 1261. Thus, the necessity and reasonableness of
the Trustee’s incurred expenses must be balanced against the benefits
obtained for the secured creditor and the amount that the secured creditor
would have necessarily incurred through foreclosure and disposal of the
property.
Id. at 1260.
1. The bankruptcy court applied the wrong legal standard
when it analyzed benefit at a global level for purposes
of the objective test for § 506(c) surcharge.
Section 506(c) and caselaw make clear that surcharge is permissible
25
when the requested expenses were necessary, reasonable, and of specifically
identifiable and tangible benefit to the secured creditor. The expenses need
to be tied to a corresponding, quantifiable benefit—which, itself, needs to
be more than just incidental from the perspective of collateral preservation.
The bankruptcy court did not undertake this analysis (nor did the
Trustee). Instead, the bankruptcy court found that the USDA’s benefit was
$786,000, calculated by taking the USDA’s receipt of $2,000,000, deducting
the use of $649,000 in cash collateral, and comparing it to the $565,000 in
cash in Debtor’s accounts on the petition. The bankruptcy court’s approach,
thus, involves looking at the USDA’s payout in the entire case and finding a
benefit justifying surcharge because the payout to the USDA, net of cash
collateral use, was greater than the cash on hand when the case was filed
and greater than an assumed recovery if the USDA did not get the benefits
of the American Specialty sale.
This global analysis is inconsistent with the test mandated by the
Ninth Circuit. And its faults become clear when one focuses on the
components of the USDA’s alleged benefit.
Turnover of accounts receivable collections obtained through
fortuity or use of USDA cash collateral did not create a benefit for
surcharge purposes. The bankruptcy court found a benefit justifying
surcharge based in part on the estate collecting receivables and turning
them over to the USDA. It mathematically acknowledged that the USDA
26
financed these efforts by deducting from its calculation of benefit an
amount equal to USDA cash collateral expended by the Trustee. But this
calculation is legally flawed because neither the Trustee nor the bankruptcy
court identified any associated administrative expense paid from non-
USDA collateral to produce this benefit.
At oral argument, the Trustee’s counsel conceded that neither the
Trustee nor his counsel was involved in the highly specialized effort to
collect hospital receivables. Instead, the Trustee used USDA cash collateral
to pay former hospital employees to do so. Thus, the surcharge request
relating to collection of receivables amounts to the Trustee double dipping:
he first used the USDA’s cash collateral to pay Debtor’s former employees
to collect receivables and to maintain the records required for collections;
having done that, the Trustee then claims this “benefitted” the USDA in
paying out the resulting proceeds and asks for surcharge. Where the USDA
already paid the specific administrative expenses related to receivable
collections from its cash collateral, requiring it to pay these expenses again
through surcharge is error. And that is exactly what the bankruptcy court’s
high level analysis requires in material part.
The bankruptcy court attempted to bolster its reliance on accounts
receivable collections and turnover by finding that the USDA would have
done nothing except gather the cashier’s checks already in Debtor’s
accounts; it based this finding on the Trustee’s recollection, in the
27
declaration on reply, that the USDA’s community facilities director
handling the case said that the USDA was not prepared to pursue its own
collection activities. Thus, the bankruptcy court concluded, the Trustee’s
paying accounts receivable proceeds over to the USDA produced a
quantifiable benefit to the USDA. This finding is directly contradicted by
the record and documents on the bankruptcy court’s docket.
In the Trustee’s supplemental declaration related to his initial cash
collateral motion, the Trustee explained that the estate had $565,000 in cash
on the petition date and, ten days later, the estate had received $260,000 by
direct deposit and $58,000 by mailed checks. The Trustee stated that he
understood that about $1,400,000 of the $11,000,000 accounts receivable
were collectible but noted that maximizing the collections would require
monetary expenditures. The USDA consented to use of its cash collateral to
allow this maximization, and the Trustee so used this money.12 Indeed,
even in the Trustee’s surcharge motion, the Trustee represented that he
maintained a deposit account in Debtor’s name that continued to receive
periodic direct deposits on account of receivables.13 The record makes clear
12
This included cash collateral use to maintain the records necessary for such
collections and fulfillment of the Trustee’s record-keeping obligations.
13
This is related to the USDA’s broader “necessity” argument that, although
highly persuasive, we need not rely on for our decision: the USDA argues that it would
not have incurred any legal fees to dispose of its collateral because it administers its
own loans, agency attorneys provide legal services, and the United States Attorney’s
(continued...)
28
that the USDA would have received more than cash on hand on the
petition date if the Trustee did nothing but open the mail and transfer
collections after direct deposit.
We, thus, conclude that broadly including the proceeds from
accounts receivable collections in the calculation of monetary benefit was
erroneous. The Trustee identifies no administrative expense related to
these collections that was not paid for using USDA cash collateral.
The American Specialty sale provided only incidental benefit to
the USDA as it otherwise benefitted the estate generally; it was not
appropriate to surcharge USDA collateral for all related administrative
expenses. The Trustee also seeks to surcharge USDA collateral for all costs
of the American Specialty sale. But because the USDA was not the only or
even primary recipient of sale proceeds, the conclusion that its receipt of
half the monetary proceeds equated to a benefit for § 506(c) purposes
(...continued)
Office provides litigation services. The USDA also argues that it, too, could have used
its cash collateral to pay Debtor’s former employees to collect the USDA’s receivables.
This is not inconsistent with the statement by the USDA’s community facilities
director that the USDA was not prepared to pursue its own collection efforts. Setting
aside the obvious questions of how the director could know this and whether the
Trustee’s supposed reliance on the director’s statement was reasonable, the director
simply said the USDA could not pursue “its own” collection efforts; it does not state that
the USDA was unable to hire Debtor’s former employees or request the United States
Attorney’s Office for assistance in collection activities. As such, we are not persuaded
on the present record that the USDA (i.e., the federal government) was incapable of
collecting its collateral receivables.
29
sufficient to surcharge 100% of the costs related to the sale was erroneous.
As a preliminary matter, the USDA argues that the sale of the
hospital did not produce a quantifiable benefit but rather a net loss of
$483,211.12. We need not, however, unwind the parties’ accounting to
determine who is correct as a factual matter because, as a broader legal
matter, the sale benefitted multiple parties and, as a result, the expenses of
the sale cannot be surcharged globally and entirely from the USDA’s
collateral. To the extent the USDA benefitted monetarily (which the USDA
disputes) and keeps this benefit, this falls in the category of benefits that
are permissible as incidental benefits. Cf. In re Choo, 273 B.R. at 613.
This is not a new proposition of law. In re Cascade Hydraulics & Util.
Serv., Inc., 815 F.2d at 548 (“To satisfy the benefit test of section 506(c),
Cascade must establish in quantifiable terms that it expended funds directly
to protect and preserve the collateral.” (emphasis added) (citing Brookfield
Prod. Credit Assoc. v. Borron,
738 F.2d 951, 952 (8th Cir. 1984) and Sells v.
Sonoma V (In re Sonoma V),
24 B.R. 600, 603 (9th Cir. BAP 1982))). See also In
re Proto-Specialties, Inc.,
43 B.R. 81, 84 (Bankr. D. Ariz. 1984) (“Action by the
Trustee to benefit the estate, although also of benefit to secured creditors, is
insufficient to justify a § 506(c) award. The effort and funds must be
expended primarily and directly for the lienholders.” (citation omitted)).
As we have said, when analyzing benefit “the focus is on whether the
expenditure in question was directed specifically toward the collateral, as
30
opposed to property of the estate generally.” In re Choo, 273 B.R. at 611. In
the latter case any benefit to the secured creditor would be incidental and
surcharge would be inappropriate.
Id. at 611–12.
Here, the asset sale included assets not subject to the USDA’s lien
including primarily the Williams Property. Based on the sale of non-USDA
collateral, the Trustee and the estate received $550,000 (half) of the
proceeds. As a result of the sale, the Trustee also reduced ongoing
administrative expenses by transferring ongoing responsibility for medical
records. And the sale was particularly beneficial in relation to the Williams
Property because proceeds were not reduced by the costs of sale
universally seen where real property is sold in isolation.14
So the Trustee correctly argued in his sale motion that he had a valid
business justification for the sale and that the sale was in the best interests
of the estate generally. As a result, the Trustee’s and his counsel’s efforts
were not directed specifically and exclusively toward the USDA’s
14
The Trustee argued that the USDA benefitted because it avoided all costs of
sale related to the American Specialty sale; it calculated this amount at $66,000 utilizing
6% as the estimated cost of sale. Putting aside the question of why the USDA should be
held responsible for 100% of costs of sale where it received only 50% of the proceeds,
we note that the real beneficiary under the bankruptcy court and Trustee’s view of the
case was the estate. Using 6% as the appropriate estimate of sale costs, in a standalone
sale of the Williams Property at full value, sale proceeds would be reduced by $32,460 if
the lienholder allowed sale subject to its lien and costs of sale were calculated only on
the equity. In the more likely scenario where the Williams Property lienholder required
payment from sale proceeds, the proceeds of a full value sale would be reduced by
$51,669, assuming 6% costs of sale.
31
collateral. Other creditors were paid. The Colusa County community also
reaped the societal benefit of the resumption of emergency medical
services. Thus, many parties benefitted from the sale and it was erroneous
to surcharge all related expenses against the USDA’s collateral.
The USDA did not receive a benefit that justifies a surcharge equal
to 100% of the Trustee’s statutory commission. When one reviews the
request for 100% surcharge of the trustee’s statutory commission, the lack
of a benefit is also obvious.
Section 326(a) limits the trustee’s compensation to a specific
percentage of amounts disbursed or turned over to parties in interest. So
the relevant document for review is the Form 2 attached to the Trustee’s
First Interim Application to Approve Trustee’s Compensation. We cannot
do the fact-finding necessary to compare cash collateral use to exact Form 2
disbursements. But we know that it was significant because the cash
collateral motion detailed types of expenses reflected in Form 2, the cash
collateral motions identify payees listed in Form 2, and the bankruptcy
court found that cash collateral use equaled $649,000. There was no benefit
to the USDA within the meaning of § 506(c) justifying the Trustee in
surcharging USDA collateral on account of a statutory commission based
on payments made from other USDA collateral. Such a surcharge amounts
to double payment from USDA collateral.
Similarly, we question the surcharge based on adequate protection
32
payments. First, they come from USDA collateral or replacement collateral.
Mere turnover of a secured creditor’s collateral does not create a benefit
within the meaning of § 506(c).
Also, the Trustee requested surcharge of USDA collateral even in
relation to payments to other creditors or in relation to distributions not
obviously or even arguably related to USDA collateral. There is no benefit
that supports a § 506(c) surcharge in this regard.
And finally, why should the USDA be surcharged for attorneys’ fees
twice? The Trustee directly requests surcharge for specific fees and then
also requests surcharge on account of his commission and the
disbursement on account of the same fees among others. Why is that
appropriate? And while we do not understand the reasoning that brings
his time sheets into the debate—the commission is not based on them in
any respect—to the extent they have any relevance they underscore the
logical flaw here: why is the USDA unilaterally benefitted by things such as
the Trustee’s initial site visit and case analysis or tasks with no logical
relationship to preservation of USDA collateral? The Trustee’s time
records, to the extent relevant, do not support the bankruptcy court’s
theory of surcharge.
2. The USDA did not concede that it received a benefit for
§ 506(c) surcharge purposes.
This brings us to the bankruptcy court’s conclusion that the USDA’s
counsel admitted to receiving a benefit for purposes of surcharge. To start,
33
because Ninth Circuit caselaw requires that the relevant benefit be concrete
and quantifiable, we agree with the USDA that it was improper to consider
this statement an admission of a benefit for § 506(c) purposes.
Further, the specific quote in context and in full does not support the
bankruptcy court’s characterization. The USDA’s attorney noted that the
USDA had cooperated with the Trustee because it wanted the American
Specialty sale to occur but stated a concern about the length of the sale
process. He then objected to the continued magnitude of cash collateral use
and asked that it be scaled back to the bare minimum. The request to limit
use of USDA cash collateral was based on the assertion that other parties
also stood to benefit from the sale, and, thus, the USDA also requested
sharing of operational costs by those other parties pending completion of
the sale.
So the USDA’s counsel’s statement does not amount to an admission
that the USDA was benefitting in isolation and thus welcomed the
continued use of its cash collateral. Far from it. The USDA objected to the
continued use of its cash collateral and—even as its counsel recognized the
pragmatic reality that the bankruptcy court clearly indicated that it would
approve the Trustee’s continued use of cash collateral—suggested that
other benefitting parties should share the cost. This is not an admission that
a benefit for purposes of § 506(c) exists or that surcharge is appropriate.
34
3. On remand, the Trustee may attempt to show some
benefit sufficient for surcharge under the objective test,
but he must identify specific expenses, tie them to
specific collateral, and provide evidence of a benefit
that takes into account his use of USDA cash collateral
and situations where the benefit is merely incidental.
While we conclude that the USDA saw some benefit from the
American Specialty sale and collection of receivable collateral by the estate,
any benefit was financed through cash collateral use or arising in the
context of generalized benefit to the estate and does not support surcharge.
But we acknowledge that, although we cannot discern it on this record,
there may be a specific sale related expense justifying surcharge.
We also acknowledge that the Trustee also sought to recover fees for
other activities; all of them, he argued, benefitted the USDA because at a
global level the USDA saw a benefit. But, again, the bankruptcy court did
not separately analyze these fees as required for § 506(c) surcharge. In a
contested matter, the “bankruptcy court must render findings of fact and
conclusions of law as required by Civil Rule 52(a) (incorporated by Rules
7052 and 9014(c)).” Rediger Inv. Corp. v. H Granados Commc’ns, Inc. (In re H
Granados Commc’ns, Inc.), 503 B.R. 726, 732 (9th Cir. BAP 2013). In the
absence of complete findings, “we may vacate a judgment and remand the
case to the bankruptcy court to make the required findings.” First Yorkshire
Holdings, Inc. v. Pacifica L 22, LLC (In re First Yorkshire Holdings, Inc.),
470
B.R. 864, 870 (9th Cir. BAP 2012). That said, we need not reverse, even if the
35
bankruptcy court rules without articulating its findings, if the record
provides us “with a full, complete, and clear view of the issues on appeal.”
In re H Granados Commc’ns, Inc., 503 B.R. at 732. Here the record does not
allow us to affirm in any respect.
On remand, the Trustee must identify specific services, demonstrate
that they benefitted the USDA in a quantifiable fashion, demonstrate that
the benefit was predominately to the USDA and not incidental to the
general benefit to creditors, and take into full consideration the extent to
which the services were already paid for from USDA cash collateral.
D. The Trustee did not show that the USDA implicitly consented
to or caused the surcharged expenses.
Alternatively, the Trustee may surcharge collateral if the USDA
“caused or consented to” the surcharged expenses. In re Compton
Impressions, Ltd., 217 F.3d at 1260. See Weinstein, Eisen & Weiss v. Gill (In re
Cooper Commons LLC),
512 F.3d 533, 536 (9th Cir. 2008). This is known as the
subjective test. We determine that the bankruptcy court also erred in its
finding that the USDA implicitly consented15 to payment of the Trustee’s
15
We do not consider express consent; the Trustee conceded in his papers that
the USDA did not expressly consent to surcharge, and the bankruptcy court did not rule
to the contrary. As such, the parties’ discussion about the United States Trustee’s
Handbook for Chapter 7 Trustees is not particularly apposite. They agree that the
handbook suggests, but does not require, that trustees negotiate explicit consent for a
surcharge; they disagree on what that means for this case. We are not bound by the
handbook, although we note that negotiation on this point likely would have positively
impacted the administrative expense bottom line as the surcharge issue would not be
(continued...)
36
entire commission and the vast majority of the administrative attorneys’
fees in this case. Nor does the record show that the USDA caused the
American Specialty sale. The bankruptcy court’s analysis is legally
erroneous, and its factual conclusions are not supported by the record even
if the late-filed declaration is considered.
1. The bankruptcy court erred in finding implied consent
for the purpose of § 506(c) surcharge.
Secured creditor cooperation and case participation does not
inevitably lead to surcharge and liability for all administrative expenses. In
re Cascade Hydraulics & Util. Serv., Inc., 815 F.2d at 548 (“Mere cooperation
with the [trustee] does not make the secured creditor liable for all expenses
of administration.”). Thus a “secured creditor’s consent to the payment of
designated expenses, limited in amount, is not a blanket consent to be
charged with additional expenses not included in the consent agreement.”
Id. at 549. As the Ninth Circuit explained in a slightly different context:
Here, all the Banks did by joining in the cash-collateral
stipulations was authorize restricted payments for specified
items in the form of carve-outs from the sales of units in the
development. Neither the Banks’ joinder in the cash-collateral
stipulations, nor its willingness to defer foreclosure
proceedings, caused the Debtor to incur the expenses sought by
the surcharge motion. The Banks did nothing more than
cooperate with the Debtor in its attempt to salvage some equity
15
(...continued)
subject to dispute. And given the trustee’s heavy burden of proof, it certainly makes
good sense.
37
from the development. The bankruptcy court did not clearly err
in finding that the Banks did not cause or consent to the
expenses the Debtor sought to recover by its surcharge motion.
In re Compton Impressions, Ltd., 217 F.3d at 1261–62. So one question on
appeal is whether the level of cooperation by the USDA rises to the level of
implied consent.
Initially, we note that the Ninth Circuit has not articulated a firm test
or standard for implied consent. And as it is not mentioned as a basis for
surcharge in the statute, we must proceed with caution given the Supreme
Court’s decision in Hartford Underwriters, where it determined that
surcharge was only available to trustees and debtors-in-possession and
emphasized the plain and unambiguous language of § 506(c). 530 U.S. at 6.
See Comerica Bank-California v. GTI Capital Holdings, LLC (In re GTI Capital
Holdings, LLC), BAP No. AZ-06-1096-PaDS,
2007 WL 7532277, at *14 (9th
Cir. BAP Mar. 29, 2007). We also conclude that where the objective test is
not met, implied consent will not easily fill the void. Against this
background, we determine that the as-developed facts of this case cannot
meet any reasonably articulated standard or test for § 506(c) surcharge.
In an unpublished decision, we noted factors that might support an
implied consent finding:
[W]hen it appears that a secured creditor in a reorganization
case holding a lien on nearly all of the debtor’s assets secures
and promotes the services of an examiner, not only to
investigate the debtor’s financial affairs, but also to sell the
debtor’s business as a going concern and to settle outstanding
38
claims, while all the time appreciating that the debtor may be
administratively insolvent, the bankruptcy court may properly
conclude that the secured creditor impliedly consented that the
costs of administering that bankruptcy estate be paid from its
cash collateral.
In re GTI Capital Holdings, LLC, 2007 WL 7532277, at *15. None of these
factors are present here.
First, in this case, the USDA did not hold a lien on substantially all
assets. The schedules evidence that from case initiation it was clear that the
estate included the Williams Property with equity available to the estate of
approximately $540,000 before consideration of costs of sale. And in the
first weeks of the case, the Trustee identified a substantial and easily
recoverable preference of $160,000.16 As we have already discussed, many
benefitted from this bankruptcy. So this is not a case where the only
beneficiary was the secured lender. It is implausible that the USDA
implicitly consented to pay a statutory commission and substantial
administrative attorneys’ fees for distributions that it did not receive and a
benefit that it did not enjoy.
Second, there is no evidence in the record or even in the docket that
the USDA expressly suggested or sought the American Specialty sale.
When a secured creditor expressly requests specific case activity by motion
and where this activity abounds to its benefit, implied consent may be
16
The Trustee’s time records show that he made demand in relation to this
preference two days after the petition date.
39
found. Implied consent should not be found where a secured creditor
merely acquiesces in case activity that is of benefit to many.
And while we acknowledge that the USDA did seek cooperation in
collection of its receivables, the USDA also paid the underlying estate
administrative expenses from its cash collateral. Implicit consent to the
payment of a broad range of administrative expenses cannot be found
where the secured creditor funds requested administrative costs from its
own collateral.
Finally, there is no evidence that there was ever a realistic concern
that this case would be administratively insolvent. The Williams Property
equity was available to pay general administrative expenses, and USDA
cash collateral paid administrative expenses that directly related to its
collateral and other expenses that benefitted the estate and not the USDA.
A workable implied consent test, thus, requires identification of
specific expenses and evidence that would cause a reasonable person to
assume that a secured creditor should be charged with that expense
because it directly benefitted its collateral and because otherwise other
creditors would be unjustly deprived of an opportunity for payment.
Implied consent also requires either some direct creditor action to cause the
expense or some inaction that suggests an understanding that it is
otherwise receiving a windfall. Here, we see no such factors and nothing
that would suggest as a legal and factual matter that surcharge is
appropriate. The imprecise global benefit analysis that the Trustee and
40
bankruptcy court relied upon is not a basis for a finding of implied consent
to the broad surcharge at issue here.
2. On this record, the bankruptcy court erred in finding
that the USDA caused administrative expenses such that
surcharge is appropriate.
We acknowledge that the USDA caused some administrative
expenses. For example, it apparently requested cooperation in accounts
receivable collection. But as to these expenses, it has already paid the
related costs from cash collateral, and this causation of specific expenses is
not a basis for broader surcharge. Further, the analytical flaws we noted in
the bankruptcy court’s application of the objective test also render its
application of the cause component of the § 506(c) subjective test
erroneous. The record fails to support that the USDA caused the broad
range of administrative expenses that form the basis for the Trustee’s
surcharge request.
There is no evidence that the USDA’s desire that Colusa County
maintain a hospital and its willingness to cooperate in this regard were
the only reasons and, thus, the cause for the Trustee’s pursuit of the
American Specialty sale. The bankruptcy court found that the USDA
caused the American Specialty sale because the “only” reason the Trustee
41
pursued what it described as a going-concern sale17 was the USDA’s
request that the hospital remain capable of re-opening and its agreement to
cooperate in this regard; there is no support for this factual determination
in the record.
First, the Trustee provided no declaration so stating. Had the Trustee
provided a state of mind declaration, the USDA could have defended and
requested an opportunity for cross examination. But the Trustee never
provided evidence that he sold assets to American Specialty solely or even
primarily because the USDA wanted Colusa County to retain access to
hospital services. Nor did he provide evidence that the USDA’s willingness
to cooperate was the only reason he accepted the American Specialty offer.
Further, such a conclusion is illogical. The time records for the
Trustee and his attorney evidence that they were speaking to American
Specialty as “the purchaser” during the first month of the case. And these
same time records evidence only 54 minutes of conversation with the
USDA’s representatives (42 minutes with Mr. Streiffer and a 12 minute
conversation with Ms. Lopez) before both this meeting and the submission
17
We do not understand the bankruptcy court to use this term in the usual sense
of a business that remained fully operational. At the time of the sale, the Debtor had
subleased its clinic locations to Adventist Health; it was not running them. And, as best
we can glean from the record and the docket, other than passive collections of
receivables through employees paid with USDA cash collateral and possible passive
collection of rent from the clinic sites, the Debtor was not a going concern. The sale,
thus, was a “going concern” sale only in that it included assets that would allow the
purchaser to resume full hospital operations.
42
of the sale motion. The conclusion that the Trustee made the most
significant business decision in the case based “only,” and at most, on these
two communications, especially, when he never so declares, is illogical and
unsupported by the record.
The statement from Mr. Streiffer is an especially weak basis for final
decision. According to the Trustee, Mr. Streiffer merely said that the USDA
wanted Colusa County to have a hospital and “would consider” a claim
compromise to achieve this result. It is implausible that the experienced
Trustee agreed to the American Specialty sale based only on the USDA’s
desire that Colusa County have a hospital and the mere possibility the
USDA might compromise its claim to achieve this result.
And that this conclusion is erroneous is underscored by the Trustee’s
statements in support of the sale motion itself, where he discusses
generalized benefit to the estate from the sale, the fact that the sale
included assets that were not USDA collateral, and the fact that the sale
yielded significant proceeds on account of non-USDA collateral. In fact, in
his sale motion, the Trustee emphasized two benefits specific to parties
other than the USDA: first, he would recover proceeds from sale of the
Williams Property (half the sale proceeds); and second, he would reduce
administrative expenses related to medical records.
The record does not support that the USDA controlled the case and,
thus, caused the American Specialty sale. Next, we consider the notion
43
that the USDA “controlled” the Trustee’s actions, by limiting use of cash
collateral or otherwise. The record does not support this either.
Again, the Trustee never said as much in either declaration. Second,
to the extent it sought to control the Trustee, the USDA abjectly failed to do
so. The USDA repeatedly objected to specific uses of its cash collateral; the
bankruptcy court repeatedly overruled those objections. The Trustee
prevailed. This does not amount to control. To the extent there was control,
the bankruptcy court controlled the process, not the USDA.
In addition, the Trustee protected a significant asset unencumbered
by the USDA’s lien—the Williams Property. The USDA never obtained a
replacement lien on this property. The Trustee then leveraged the inclusion
of the Williams Property in the sale to claim half of the sale proceeds for the
estate.
We acknowledge that the USDA surely benefitted from the American
Specialty sale and clearly desired the sale. But the record does not support
that the USDA caused or compelled the Trustee to pursue this sale. Again,
the record evidences that the Trustee was motivated by other factors—to
wit, the Williams Property and its scheduled equity and relief from the
estate’s medical record obligations. And the record is crystal clear that the
other secured creditors and the estate benefitted from the sale. And we
assume, as is only logical, that the Trustee was not indifferent to Colusa
County’s need for hospital services.
44
In short, the record does not support a finding that the subjective test
is met in this case. The bankruptcy court clearly erred when it found
otherwise. As with the objective test, however, we are not in a position,
given the state of the record, to determine that there is no element of cause
or implied consent that would justify some specific instance of surcharge in
this case. If the Trustee attempts to justify surcharge under the subjective
test on remand, he must apply an implied consent test as outlined above,
and he must prove cause as to specific administrative expenses through
specific evidence that takes into account the use of USDA cash collateral.
CONCLUSION
Based on the foregoing, we VACATE and REMAND for further
proceedings.
45
