David R. Duncan, Chief US Bankruptcy Judge
This matter is before the Court on a motion to use cash collateral filed by the debtor, Stacy's Inc. ("Debtor"), on November 15, 2013. Bank of the West ("BOTW") objected to the motion. Debtor filed a supplement to its motion on December 19, 2013, which, although labeled as a supplement, includes other grounds for relief, more specifically requesting that BOTW's collateral be surcharged under 11 U.S.C. § 506(c). The Official Committee of Unsecured Creditors ("Committee") filed a response in support of Debtor's motion and supplement. After several continuances, due to inclement weather and other reasons, the Court held a hearing on March 12, 2014. Two days before the hearing, BOTW filed a supplement to its objection addressing the arguments raised in Debtor's supplement and filed a reply to the Committee's response in support of Debtor's motion.
Debtor filed a voluntary petition under chapter 11 of the Bankruptcy Code on June 21, 2013. Debtor's primary operation consisted of cultivating large quantities of plants and selling them wholesale to large retailers such as Wal-Mart, Home Depot, and Lowe's. The same day it filed its petition it also filed a motion seeking an order authorizing a sale of substantially all of its assets free and clear of liens, claims, encumbrances, and other interests pursuant to 11 U.S.C. § 363(f) ("Sale Motion"). In the Sale Motion, Debtor also sought authorization to sell free and clear of liens assets owned by entities related to Debtor, including the real property on which Debtor conducted most of its operations. The related entities did not file bankruptcy petitions. Debtor had an asset purchase agreement with a stalking horse bidder in place and planned to hold an auction on August 23, 2013, with the closing occurring on or before August 30, 2013.
BOTW is Debtor's largest secured creditor by far. Its security interest encumbers Debtor's accounts, chattel paper, inventory, equipment, fixtures, farm products, water rights, instruments, investment
BOTW objected to the Sale Motion, and the Court held an evidentiary hearing on August 12, 2013. One of the major disputes between the parties was regarding a carve-out from the sale proceeds for payment of allowed general unsecured claims and allowed 11 U.S.C. § 503(b) administrative expense claims. Until the day before the hearing, Debtor listed BOTW's claim as undisputed on its schedules. On August 11, 2013, Debtor amended its schedules to list BOTW's claim as disputed and filed an adversary proceeding against BOTW in an effort to obtain Court approval of the sale over BOTW's objection pursuant to 11 U.S.C. § 363(f)(4). Debtor included in the complaint initiating the adversary proceeding a cause of action for surcharge of BOTW's collateral under 11 U.S.C. § 506(c). Coincidentally, the Committee, on August 11, 2013, filed a motion seeking authorization to proceed with litigation on behalf of Debtor against BOTW and others.
At the conclusion of the August 12th hearing, the Court took the matter under advisement. While prepared to issue its ruling two days after the hearing, the Court delayed ruling at the request of Debtor, the Committee, and BOTW to allow the parties more time to negotiate a consensual sale, which the parties did. On August 21, 2013, the Court entered a consent order authorizing the sale of Debtor's assets, which was signed by Debtor, BOTW, and the Committee. Among the terms in the consent order was a carve-out from the sale proceeds of $950,000 for allowed administrative expense claims, a $450,000 carve-out for allowed general unsecured claims, an agreement by Debtor to promptly dismiss with prejudice its adversary proceeding against BOTW, and an agreement by the Committee to amend its August 11, 2013 motion to reflect it was no longer seeking authorization to pursue litigation against BOTW. The consent order also contained a release of BOTW by Debtor and the Committee:
Finally, the consent order provided that BOTW would have an allowed secured claim in the "maximum amount" of $22,580,896.87. There were no competing bidders at the auction scheduled for August 23, 2013, and on August 26, 2013, the Court entered an order approving the sale of assets to the stalking horse bidder, MG Acquisition, Inc ("MG").
In its motion for use of cash collateral filed November 15, 2013, Debtor seeks to use BOTW's cash collateral to pay the following expenses:
In the supplement to its motion filed December 19, 2013, Debtor seeks, in addition to the above expenses, to use BOTW's cash collateral to pay approximately $10,000 in fees for termination of its 401k plan and $5,000 for a computer consultant. The computer consultant was involved with storing the data on the computers and related equipment formerly owned by Debtor but now owned by MG. At the hearing on March 12, 2014, Debtor indicated, in addition to the above, it was seeking to use cash collateral to pay $6,055.96 in federal unemployment taxes. Debtor's ex. A. Tim Brindley, who was Debtor's president until the sale of substantially all of Debtor's assets to MG, testified the unemployment taxes have been paid with unencumbered assets. The primary focus of the parties in their briefing and at the hearing was on the $525,000 estimated income tax liability. The tax liability is the result of more money being collected post-petition than anticipated, lower expenses than expected, and a higher working capital adjustment defined below.
The asset purchase agreement ("APA") under which Debtor sold its assets contained a requirement that Debtor have at least $11.5 million in working capital at closing. Working capital consisted of inventory and accounts receivable. The APA referred to the amount by which the working capital exceeds $11.5 million as the "working capital adjustment." The purchase price under the APA was adjusted upward based on the working capital adjustment. Brindley and Debtor's counsel indicated at the August 12, 2013 hearing that the working capital adjustment might be as much as $2 million. Transcript of August 12, 2013 hearing, docket entry 178, pp. 17, 21, 110, 148. Debtor's accountant and financial advisor, Marty Ouzts, testified at the March 12, 2014 hearing that shortly before the closing on August 30, 2013, there was concern expressed by BOTW's representatives involved with the inventorying of Debtor's working capital during the week preceding the closing that Debtor would not have the $11.5 million working capital minimum required under the APA. At the time of closing, the working capital adjustment was calculated to be $300,000. Following the closing, the working capital adjustment was amended upward to $585,006. Brindley, in his capacity as Debtor's president, signed a letter, dated September 27, 2013, directing the $585,006 constituting the working capital adjustment be transferred to BOTW by MG. Debtor's ex. J.
In order to fund its operations during this bankruptcy until the sale of its assets,
Ouzts prepared a tax analysis for Debtor at the start of this bankruptcy, projecting there would no income tax liability. Debtor's ex. B-1. He prepared another tax analysis on July 18, 2013, again projecting no income taxes would be owed based on there being accounts receivable and inventory of $11.5 million on August 30, 2013. Debtor's ex. B-2. Debtor's financial consultant did not conduct another tax analysis until September of 2013. Debtor did not consult with him in connection with the negotiations with BOTW regarding the administrative carve-out and he did not know the carve-out was $950,000 until after the Court entered the August 21, 2013 consent order. Ouzts indicated he would not have projected income tax liability even if he had done a tax analysis contemporaneously with the August 21, 2013 consent order.
On July 22, 2013, Ouzts sent an email to BOTW's financial advisor projecting accounts receivable of $1.7 million and inventory of $11.5 million as of August 30th. BOTW's ex. 4. If these numbers in the July 22, 2013 email are used in the July 18, 2013 tax analysis, potential taxable income is $65,251. If the $13.5 million working capital figure suggested at the August 12, 2013 hearing is plugged into the July 18th tax analysis, potential taxable income is $365,251. BOTW's financial consultant, Thomas Plumb, testified with respect to what a tax analysis done on August 15, 2013 might have shown. See BOTW's ex. 8-D. This analysis used the $5,513,534 cash collateral projection for August 30th contained in the August 15th cash collateral budget and the inventory and accounts receivable numbers contained in the July 22, 2013 email. Id. Plumb intended for the "Gain/Loss Fixed Assets" and "NOL Carry-Over" numbers to be the same as those appearing in Ouzts' July 18th tax analysis. However, when Ouzts emailed his July 18th tax analysis to BOTW's counsel in December of 2013, he had to recreate his July 18th tax analysis because he did not save a copy of it when it was originally created. In recreating the tax analysis, he mistakenly used different "Gain/Loss Fixed Assets" and "NOL Carry-Over" figures than the projections for these figures that appear in his actual July 18th tax analysis. Compare BOTW's ex. 5, with Debtor's ex. B-2. If the correct figures are used in Plumb's hypothetical August
At the March 12, 2014 hearing, Ouzts attempted to quantify how BOTW benefited from Debtor's assets being sold through this bankruptcy while it still operated as opposed to if Debtor's assets had been liquidated through a state court proceeding. He did so through a spreadsheet that constitutes Debtor's exhibit O. He testified his opinion was BOTW benefited from this bankruptcy. Brindley also testified he believed BOTW benefited from Debtor's continuing operations during this bankruptcy as opposed to closure of the business.
As of March 7, 2014, BOTW had received $19,289,461 during this bankruptcy toward its allowed secured claim. Although in its motion and supplement Debtor questioned whether the funds it is seeking authorization to use are BOTW's cash collateral, Debtor did not pursue this argument at the hearing. Therefore, it is undisputed the funds Debtor is seeking to use are BOTW's cash collateral.
Under 11 U.S.C. § 363(c)(2), Debtor "may not use, sell, or lease cash collateral... unless (A) each entity that has an interest in such cash collateral consents; or (B) the court, after notice and a hearing, authorizes such use, sale, or lease in accordance with the provisions of this section." Pursuant to section 363(e), "at any time, on request of an entity that has an interest in property used, sold, or leased, or proposed to be used, sold, or leased, by the trustee, the court, with or without a hearing, shall prohibit or condition such use, sale, or lease as is necessary to provide adequate protection of such interest." Debtor has the burden of proof on the issue of adequate protection. See 11 U.S.C. § 363(p)(1).
In asserting the Court should authorize the use of cash collateral over BOTW's objection, Debtor relies almost exclusively on the analysis of the United States Bankruptcy Court for the Eastern District of Virginia in In re JKJ Chevrolet, Inc., 190 B.R. 542 (Bankr.E.D.Va.1995). This case involved an order by the bankruptcy court that the creditor pay commissions, salaries, and other benefits to former employees of the debtor for work they performed during the debtor's bankruptcy. The Fourth Circuit in an unpublished opinion held it was not necessary to address the bankruptcy court's conclusions regarding adequate protection because the objecting creditor in that case consented to the use of its cash collateral to pay post-petition wages of the debtor's employees. Ford Motor Credit Co. v. JKJ Chevrolet, Inc. (In re JKJ Chevrolet, Inc.), 117 F.3d 1413, 1997 WL 407827, at *2-3 (4th Cir. 1997) (per curiam). With respect to the adequate protection issue, the Fourth Circuit noted that the creditor would have received "nothing in return" if compelled to pay the wages. Id. at *2. This Court declines to apply the analysis of adequate protection set forth by the bankruptcy
In its supplement, Debtor argues BOTW's collateral should be surcharged for the expenses described in its motion, supplement, and at the hearing. Again, the primary focus of the parties is the income tax liability. The general rule is that "administrative expenses are paid from the unencumbered assets of a bankruptcy estate rather than from secured collateral." Ford Motor Credit Co. v. Reynolds & Reynolds Co. (In re JKJ Chevrolet, Inc.), 26 F.3d 481, 483 (4th Cir. 1994). Administrative expenses include "the actual, necessary costs and expenses of preserving the estate" and "any tax ... incurred by the estate" with one exception not applicable here. 11 U.S.C. § 503(b). Section 506(c) of the Bankruptcy Code "provides an exception to this general rule." Ford Motor Credit Co. v. Reynolds & Reynolds Co. (In re JKJ Chevrolet, Inc.), 26 F.3d 481, 483 (4th Cir.1994). Pursuant to section 506(c), "[t]he 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 purpose of [section 506(c)] is to prevent a windfall to a secured creditor at the expense of the estate." Ford Motor Credit Co. v. Reynolds & Reynolds Co. (In re JKJ Chevrolet, Inc.), 26 F.3d 481, 483 (4th Cir.1994).
BOTW asserts Debtor's surcharge claim is precluded by res judicata based on Debtor's inclusion of a surcharge cause of action in the adversary proceeding filed with this Court the day before the August 12, 2013 evidentiary hearing on the Sale Motion. In connection with its surcharge claim in the adversary proceeding, Debtor alleged its "expenditures in connection with the bankruptcy cash flow and anticipated sale have provided a direct and substantial benefit to [BOTW]" and that it was "entitled to surcharge [BOTW]'s collateral or the proceeds resulting from the sale of [BOTW]'s collateral for the reasonable, necessary costs and expenses of preserving, or disposing of, such collateral." Adv. Pro. No. 13-80135-dd, docket entry 1, p. 11. As part of the August 21, 2013 consent order in which BOTW consented to the sale to MG of substantially all of Debtor's assets, BOTW agreed to a $950,000 carve-out for section 503(b) administrative expenses and Debtor agreed to dismiss the adversary proceeding with prejudice. Debtor filed a notice of dismissal with prejudice in the adversary proceeding on August 27, 2013, four days before the sale to MG closed.
Because the adversary proceeding against BOTW was filed and finally decided in a federal forum, this Court applies federal common law in assessing the preclusive effect of the dismissal of that adversary proceeding with prejudice. Taylor v. Sturgell, 553 U.S. 880, 891, 128 S.Ct. 2161, 171 L.Ed.2d 155 (2008). Under federal common law, generally "a judgment is res judicata not only as to all matters litigated and decided by it, but as to all relevant issues which could have been but were not raised and litigated in the suit." Heiser v. Woodruff, 327 U.S. 726, 735, 66 S.Ct. 853, 90 L.Ed. 970 (1946). Res judicata, also known as claim preclusion, occurs when three conditions are satisfied:
Debtor sought to surcharge BOTW's collateral for the costs and expenses of preserving or disposing of its collateral as part of the adversary proceeding it filed and dismissed with prejudice. In consenting to a sale of its collateral to MG, BOTW agreed to a $950,000 carve-out for section 503(b) administrative expenses, and income taxes incurred during a bankruptcy are ordinarily treated as a section 503(b) administrative expense. Part of what BOTW received in exchange for the $950,000 administrative carve-out was a dismissal of the adversary proceeding against it with prejudice. Debtor is now again seeking to surcharge BOTW's collateral, essentially attempting to renegotiate the administrative carve-out because the $950,000 is not enough. While Debtor asserts it did not know about the expenses it seeks to surcharge at the time the adversary proceeding was filed and dismissed, actual knowledge of a potential claim is not a requirement for applying res judicata. Harnett, 800 F.2d 1308 at 1313. Nonetheless and first with respect to the expenses Debtor seeks to surcharge other than the income tax liability, Debtor knew or should
Even if res judicata did not apply, section 506(c) only allows a trustee to recover the reasonable, necessary costs and expenses of preserving, or disposing of, a secured party's collateral. 11 U.S.C. § 506(c). One treatise has listed the types of expenses that may qualify for surcharge under section 506(c) as including "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."
Finally, while the Eighth Circuit has held that the benefit for purposes of section 506(c) can be general in nature, see United States v. Boatmen's First Nat'l Bank of Kansas City, 5 F.3d 1157, 1160
Pursuant to 11 U.S.C. § 552(b)(1), with certain exceptions, "if the debtor and an entity entered into a security agreement before the commencement of the case and if the security interest created by such security agreement extends to property of the debtor acquired before the commencement of the case and to proceeds, products, offspring, or profits of such property, then such security interest extends to such proceeds, products, offspring, or profits acquired by the estate after the commencement of the case to the extent provided by such security agreement and by applicable nonbankruptcy law, except to any extent that the court, after notice and a hearing and based on the equities of the case, orders otherwise." Emphasis added. While Debtor did not reference the equities of the case exception in its motion or supplement, the Committee asserts the exception in its response in support of Debtor's motion. Therefore, the Court addresses it here.
In applying the equities of the case exception, courts place significant weight "on whether a debtor expended unencumbered funds of the estate, at the expense of the unsecured creditors, to enhance the value of the collateral." All Points Capital Corp. v. Laurel Hill Paper Co. (In re Laurel Hill Paper Co.), 393 B.R. 89, 93 (Bankr.M.D.N.C.2008); see also Stanzale v. Finova Capital Corp. (In re Tower Air, Inc.), 397 F.3d 191, 205 (3d Cir.2005); Marine Midland Bank v. Breeden (In re the Bennett Funding Group, Inc.), 255 B.R. 616, 634 (N.D.N.Y.2000); In re Muma Serv., 322 B.R. 541, 558-59 (Bankr.D.Del.2005). No evidence has been presented establishing that Debtor used unencumbered assets post-petition to increase the value of BOTW's collateral. Rather, it "was only through the use of [BOTW]'s cash collateral ... that the estate was able to continue to operate." Muma Serv., 322 B.R. at 559. BOTW already has agreed to carve-outs from the proceeds of its collateral totaling $1,400,000 for administrative expenses and unsecured creditors. After careful consideration,
For the reasons set forth herein, Debtor's motion to use cash collateral is denied.
AND IT IS SO ORDERED.
