This is the next post in Plan Proponent’s series on the confirmation-related recommendations in the ABI Commission Report (and, in particular, its Exiting the Case piece). In this post, we’ll cover the Commission’s recommendations regarding Section 506(c) and charges against collateral.
Section 506(c) provides that 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.”
Generally, those expenses must be reasonable, necessary, and beneficial to the secured creditor against whose collateral the expenses are sought.
Section 506(c) protects collateral by giving the trustee an incentive to preserve collateral; it protects the trustee (including the debtor-in-possession) by having the secured creditor pay for the collateral protection.
Trustees and secured creditors tend to negotiate consensual carve-outs from collateral proceeds or stipulations waiving 506(c) claims altogether. Therefore, 506(c) issues are not heavily-litigated. Thus, even though the cases are pretty well-settled when the expenses at issue have a direct connection to the collateral, the Commission points out that the cases are less clear with respect to the scope of 506(c) and the standing of parties to make 506(c) claims.
With respect to scope, to what extent can 506(c) be used as a basis for paying less direct, more general administration costs–for example, the costs of readying a debtor for liquidation (i.e., “burial costs”) where the direct secured creditor benefit is less clear? Generally, courts strictly construe 506(c)’s scope and treat the scope issue as a fact-intensive, case-by-case inquiry.
With respect to standing, does an administrative claimant (e.g., an attorney) have direct standing to make a 506(c) claim? The Commission points out that in Hartford Underwriters (In re Hen House), the Supreme Court held that 506(c) does not provide an administrative claimant “an independent right to use [Section 506(c)] to seek payment of its claim.” If not, then can it make a derivative 506(c) claim through the trustee? The Supreme Court declined to rule on derivative standing. The Commission cites other cases that go both ways.
The Commission emphasizes that the above issues are particularly important today because recent Chapter 11 cases are characterized by relatively less unencumbered assets and free cash flow. Additionally, the resolution of 506(c) claims can impact recoveries, payment of administrative claims, and the debtor’s ability to rehabilitate, generally.
Ultimately, the Commission declined to recommend that Section 506(c) be expanded to permit a court to surcharge collateral for the “less direct, more administrative” category of costs.
The Commission determined that the “current scope of section 506(c) was appropriate, and that the required nexus between the estate’s expenditures and the secured creditor’s collateral was an appropriate gating feature” of Section 506(c). However, the Commission did recommend that Section 506(c) should be amended to prohibit a trustee from waivers or stipulations of its Section 506(c) rights, as such rights are for the benefit of the entire estate.
Although consensual 506(c) carve-outs should be permitted, they should not be “to the exclusion of section 506(c) claims.” That is because, the Commission concludes, the court should be able to “consider the appropriate allocation of expenses between the estate and the secured creditor.”
Stay tuned for our next ABI Commission post regarding Section 552(b) and the “Equities of the Case.”