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stating that “an unsecured creditor or an undersecured creditor is not entitled to recover postpetition fees and costs arising from his claim”
Summary of this case from In re MilbourneOpinion
Jointly Administered under, Case No. 03-19135.
March 15, 2005
MEMORANDUM
Healthcare Business Credit Corporation (referred to by the parties as "HBCC") has filed a motion seeking the allowance and payment of fees and costs pursuant to section 506(b) of the Bankruptcy Code and section 5.3(b) of the debtors' confirmed plan. These fees and costs were incurred by HBCC's counsel in representing this creditor during the pre-confirmation phase of the chapter 11 bankruptcy case. A "plan administrator," Mr. Sean P. Porrini, who has been appointed pursuant to the terms of the debtors' confirmed plan, has filed an objection to the payment of these fees costs under section 506(b). In essence, the plan administrator contends that HBCC is an undersecured creditor, and therefore is not entitled to the allowance requested.
In light of my forthcoming analysis of section 506(b), I shall assume, without deciding, that this objection was filed solely by the plan administrator, although the pleading itself creates some doubt on this point. The objection is titled as having been made by the debtors, but states in the body that it was filed by the "Plan Administrator . . . on behalf of the above debtors and their estates. . . ." The objection is signed by the "Attorneys for the Debtors and Debtors-in-Possession." The certificate of service for this objection is submitted by "counsel for the Debtors" and refers to the "Objection of the Debtors" to HBCC's motion. The memorandum of law, though, is styled: "The Plan Administrator's Reply Memorandum in Opposition to the Allowance of HBCC's Fees and Costs Under 506(b) of the Code." This memorandum is signed by counsel for the Plan Administator.
Due to the judicial estoppel issue asserted by HBCC, the identity of the objector could have been material. The concept of judicial estoppel "precludes a party from asserting a position in one legal proceeding which is contrary to a position it has already asserted in another." Patriot Cinemas, Inc. v. Central Cinema Corp., 834 F.2d 208, 212 (1st Cir. 1987). Thus, judicial estoppel only arises when inconsistent positions are taken by the same party, not different parties. See In re Allegheny Intern., Inc., 131 B.R. 24, 31 (W.D. Pa. 1991).
Under the terms of the debtors' confirmed plan, the plan administrator was chosen at confirmation "by the Debtors with the advice of the [Official Creditors'] Committee, HBCC and SouthTrust. . . ." Ex. HBCC-9, ¶¶ 1.55, 6.12. The plan administrator was authorized by the confirmed plan to "prosecute objections to Claims and Requests." Id., at ¶ 6.17(f). He was also empowered to object to administrative expenses, id., at ¶ 12.1, and to engage counsel. Id., at ¶ 6.17. The person chosen as plan administrator, however, was the former chief financial officer of the debtors, Ex. PA-1, who appears to have retained debtors' bankruptcy counsel. In addition, the debtors, as well as the plan administrator, were authorized in ¶ 5.3(b) of the plan to object to HBCC's fee request; although the extent of the permitted objection is now debated by these parties.
In some instances, a plan administrator may not be viewed as the same entity as the former chapter 11 debtor. See In re Submicron Systems Corp., 2004 WL 883391, at *3 (D. Del. 2004) (knowledge of the chapter 11 debtor was not attributed to the plan administrator); In re LaBrum Doak, LLP, 237 B.R. 275, 298-99 (Bankr. E.D. Pa. 1999) (plan administrator was a distinct entity from a prepetition debtor for purposes of claim preclusion). Given my conclusion, discussed below, that HBCC was an oversecured creditor entitled to an allowance under section 506(b), I need not determine in this contested matter whether the chapter 11 debtors and the plan administrator should be considered the same party for purposes of judicial estoppel, or whether the debtors are the actual objecting parties.
A hearing was held on the motion and the objection, and the facts are not at issue. Furthermore, each party has submitted a supporting legal memorandum. The undisputed facts may be summarized as follows.
I.
The debtors in this case are Plymouth House Health Center L.L.C. ("Plymouth"), Chateau Senior Care, L.L.C. ("Chateau"), Church Lane Senior Care, L.L.C. ("Church Lane"), Julia Ribaudo Senior Care, L.C.C. (" Julia Ribaudo"), Mill Hill Senior Care, L.L.C. ("Mill Hill") and Winthrop House Senior Care, L.L.C. ("Winthrop"). At the time of their separate bankruptcy filings in June 2003, these debtors operated various nursing home facilities, except for Mill Hill. Ultimately, these separate cases were jointly administrated and a consolidated chapter 11 plan was approved.
I take judicial notice, under Fed.R.Evid. 201 (incorporated into bankruptcy cases by Bankr. R. 9017), of the docket entries of this proceeding. See Maritime Electric Co., Inc. v. United Jersey Bank, 959 F.2d 1194, 1200 n. 3 (3d Cir. 1991); Levine v. Egidi, 1993 WL 69146, at *2 (N.D. Ill. 1993);In re Paolino, 1991 WL 284107, at *12 n. 19 (Bankr. E.D. Pa. 1991); see generally In re Indian Palms Associates, Ltd., 61 F.3d 197 (3d Cir. 1995).
SouthTrust Bank ("SouthTrust") loaned the debtors money during the course of their nursing home operations. As of the date of their bankruptcy filings, these debtors owed SouthTrust approximately $22.9 million. Ex. PA-1. SouthTrust filed UCC Financing Statements to perfect its security interests in the debtors' assets on August 20, 2001 for Chateau, Church Lane, Julia Ribaudo and Plymouth House. See Ex. HBCC-10. The UCC Financing Statements for Mill House and Winthrop were filed on September 23, 2002 and September 9, 2002 respectively. Id.
The financing statements are the same for each debtor, except for the identifying information. These financing statements disclose that SouthTrust has a security interest in:
all of Debtor's right, title and interest in and to all Improvements, Equipment, Rents, Accounts, Health Care Insurance Receivables, Instruments, General Intangibles, Inventory, Money and (to the fullest extent assignable) Permits and Reimbursement Contracts, whether now owned to or hereafter at any time acquired, and including all replacements, additions, accessions and substitutions thereto; provided however, that with respect to any items which are leased and not owned by Debtor, the term "Collateral" includes the leasehold interest only of Debtor together with any options to purchase any of said items and any additional or greater rights with respect to such items which Debtor may hereafter acquire, together with all Proceeds of any of the foregoing Collateral.
Id.
Subsequently, the debtors (along with IFIDA Health Care Group, Ltd.) entered into a loan and security agreement with HBCC on September 11, 2001. Ex. HBCC-1. Under the terms of this agreement, HBCC made available to the debtors $4 million in revolving loans, taking a security interest in their assets.Id. This agreement was later amended five times between March 6, 2002 and March 14, 2003. Id.
On September 14, 2001, HBCC filed UCC financing statements for all of the debtors. Ex. HBCC-3. These statements acknowledge that a security interest exists in the same collateral as the SouthTrust loan, and describe that collateral as:
The filing of the statements on this date would make HBCC "first-in-time" as to the assets of Mill House and Winthrop, but not as to the others. In his objection, the plan administrator contends that application of section 506(b) requires that the entire obligation owed to HBCC be applied to the value of only the Mill House and Winthrop collateral. Objection, at 6 n. 1. Although I do not find this position intuitive, see, e.g., In re Colonial Center, Inc., 156 B.R. 452, 461-62 (Bankr. E.D. Pa. 1993); In re Mihalko, 87 B.R. 357, 363 (Bankr. E.D. Pa. 1988); In re Panas, 68 B.R. 421 (Bankr. E.D. Pa. 1986), I need not now consider that position.
All accounts and health-care insurance receivables (including without limitation the accounts) of such Debtor, whether now existing or hereafter arising or acquired; (ii) All contract rights, instruments, chattel paper, remedies, guarantees, and collateral evidencing, securing or otherwise relating to such accounts, including, without limitation all rights of enforcement and collection, now existing or hereafter acquired; (iii) All Commercial Lockboxes, all Government Lockboxes, all Collection Accounts and other accounts into which any of the Collections are deposited . . . (iv) All books and records of such Debtor evidencing or relating to such accounts; (v) All information and data complied or derived by such Debtor with respect or such accounts . . . and (vi) All collections, receipts and other proceeds (cash and non-cash) derived from any of the foregoing.
Id.
In addition to its loan agreement with the debtors, HBCC entered into a subordination agreement with SouthTrust. SouthTrust agreed to subordinate its collateral interest to HBCC according to the following terms:
Priorities
HBCC and SouthTrust agree that, except as provided in Section 2.2 below, at all times, whether before, during or after the pendency of any bankruptcy, reorganization or other insolvency proceeding, and notwithstanding the priorities that ordinarily would result under the Uniform Commercial Code as enacted in each and every applicable jurisdiction, as amended from time to time ("UCC"), and other applicable law for the order of granting or perfecting of any security interests referred to herein, HBCC shall have a first and prior security interest in, upon and to the HBCC Collateral, and South Trust does hereby subordinate its security interest in to and to the HBCC Collateral to HBCC's security interest in and to the HBCC Collateral; provided, however, that if HBCC allows any UCC filing or other method of perfection to lapse such that an intervening creditor subordinate to SouthTrust shall have priority over HBCC, nothing herein is intended to or shall be construed as a subordination by SouthTrust to such other creditor.
Ex. HBCC-1, ¶ 2.1 (emphasis added).
Section 2.2 of the subordination agreement provided that, if there were a default by the debtors in repaying SouthTrust, SouthTrust could send notice to HBCC and SouthTrust would then have a first lien position on collateral that "accrues or arises from and after" forty-five days after notice was sent. The primacy of HBCC's lien, however, remained in all collateral that existed prior to that forty-five day period. Ex. HBCC-1, ¶ 2.2. There is no suggestion that any assets of the debtor involved collateral covered by this provision of the subordination agreement.
In addition, section 3.3 states "[e]ach financing statement of HBCC or SouthTrust that includes any HBCC Collateral will be amended to include, and each new financing statement hereafter filed by either of them with respect to the HBCC Collateral will include, a statement that it is subject to the terms of this Subordination Agreement." The objector notes that this was never done, but does not identify any effect caused by this omission upon the outcome of this dispute.
The subordination agreement also stated that the "substantive" laws of the State of New Jersey shall govern "without regard to principles of conflicts of laws of such State." See Ex. HBCC-1, ¶ 3.9. Moreover, the subordination agreement was acknowledged by all the debtors. Ex. HBCC-1.
At the time of the debtors' bankruptcy filing, it appears uncontested that HBCC was owed approximately $4.2 million dollars. See Ex. PA-1. Furthermore, for purposes the instant contested matter, it is also agreed that collateral securing both HBCC's loan and SouthTrust's loan — i.e., the accounts receivables — had a face value of $8,151,776.23 as of the petition date, with $6,456,776.23 currently collectible. See Ex. PA-1. Thus, both parties agree that the value of this collateral exceeds the amount owed to HBCC, but is far less than the $22.9 million owed to SouthTrust. See N.T. at 20-21, 25.
HBCC and the plan administrator also emphasize a particular provision of the debtors' joint confirmed plan. This plan stated in ¶ 5.3, when addressing HBCC's secured claim:
(b) Allowance. On the Effective Date, HBCC shall be conclusively deemed to hold an Allowed Secured Claim in the amount of (a) the principal and accrued non-default rate interest outstanding immediately prior to the Effective Date under its loan documents, and (b) the amount of HBCC's fees and costs incurred in connection with this case allowed by order of the Bankruptcy Court under the provisions of 506(b) of the Bankruptcy Code but not in excess of $150,000 (even if the fees and costs actually incurred by HBCC exceed such amount) or such other amount as agreed by the Plan Administrator, the Debtors, and HBCC. HBCC shall file a motion with the Bankruptyc [sic] Court requesting advance of fees and costs under Seciton [sic] 506(b) within thirty (30) days of the Effective Date. Any party including the Debtors, the Plan Administrator and/or the Liquidating Trustee may oppose the allowance of HBCC's fees under Section 506(b).
Ex. HBCC-9, ¶ 5.3(b). Indeed, the plan administrator acknowledges that "[u]nder the Debtors' Plan, $150,000 is being held in escrow and will be paid to HBCC if HBCC's 506(b) claim is allowed." Objection, ¶ 10.
The debtors' disclosure statement contained this provision involving section 506(b) and HBCC:
Under the Plan, HBCC's claim against the Debtors will be conclusively deemed to be an allowed claim in the amount of the outstanding principal and accrued non-default interest immediately prior to the Effective Date (together with costs and charges in the amount agreed to by the Debtors and HBCC or, in the absence of agreement, as determined by the Court under section 506(b) of the Bankruptcy Code).
See Ex. HBCC-8, at 37-38.
Thus, the debtors' confirmed plan authorized the payment of post-bankruptcy interest to HBCC, which the plan administrator did not contest. The plan also capped the fees HBCC could seek under section 506(b) at $150,000. Thus, even though HBCC's motion specifies $257,256.64 in costs and fees, Ex. HBCC-6, this creditor has limited its requested allowance to the aforementioned ceiling.
The plan administrator has now objected to the payment of these fees and costs, even at the capped amount, arguing that HBCC is not "oversecured" under section 506(b). HBCC argues to the contrary, and alternatively maintains that the plan administrator is estopped from so objecting, in light of the terms of the above-quoted confirmed plan, the disclosure statement and other documents, as well as the previous unchallenged payment of postpetition interest.
As a result, there are two questions issues by these parties in this contested matter: whether HBCC, in light of SouthTrust's subordination agreement, is an oversecured creditor entitled to reimbursement of costs and fees under section 506(b) of the Bankruptcy Code; and, if not, whether the plan administrator is now estopped from objecting to the instant 506(b) allowance. (As I construe the plan administrator's objection, however, he does not challenge the reasonableness of the $150,000 now demanded by HBCC.)
In its supporting memorandum, HBCC asserts that the application of judicial estoppel is appropriate, arguing that the debtors' bankruptcy schedules, prior pleadings, prior cash collateral orders, disclosure statement, confirmed plan and payment of postpetition interest "all provide and/or strongly infer that HBCC holds a first priority lien in the HBCC Collateral and that HBCC is oversecured. The Debtors' Objection puts them in direct conflict with prior conduct and is a bad faith attempt to deny HBCC the attorneys' fees it is warranted." HBCC Memorandum, at 13. This creditor also relies upon the same documents in contending that the objector is equitably estopped, or has waived his right to object. Id., at 14-19. In asserting these estoppel and waiver arguments, HBCC suggests that it may not have voted in favor of and consented to the debtors' proposed chapter 11 plan if it had understood that there could be a challenge to its entitlement to an allowance under section 506(b), except as to the reasonableness of the amount. Id., at 13, 16, 18.
Although I need not decide whether the plan administrator is now barred from challenging HBCC's status as an oversecured creditor, I note that HBCC assumes an identity of interest between the plan administrator and the debtors. I also observe that estoppel issues, particularly judicial estoppel issues, typically arise in bankruptcy cases from the failure of the chapter 11 debtor to disclose information, such as the existence of an asset or claim. See, e.g., Oneida Motor Freight, Inc. v. United Jersey Bank, 848 F.2d 414 (3d Cir.), cert. denied, 488 U.S. 967 (1988). Presumably, if the terms of the confirmed plan were sufficiently clear — that is, if the terms of the debtors' confirmed plan provided either for HBCC's section 506(b) allowance, or the plan administrator's right to object on the basis that the creditor was not oversecured — the binding nature of the confirmation process, see 11 U.S.C. § 1141(a), would supercede any prior understanding or agreement that HBCC and the debtors' might have made on this point. See also In re Allen, 300 F.3d 1055, 1060 (9th Cir. 2002) (judicial estoppel did not bar a debtor from proposing a plan that was inconsistent with a prior agreement); In re Envirodyne Industries, Inc., 183 B.R. 812, 825 (Bankr. N.D. Ill. 1995) (terms of plan placed creditor on notice of debtor's claim, so judicial estoppel was inapplicable).
Thus, the more precise question posed by HBCC may not be estoppel or waiver, but the proper interpretation of section 5.3(b) of the confirmed plan. Indeed, the plan administrator views the issue as such, and expressly contends that section 5.3(b) of confirmed plan authorized his present objection. Objector's Memorandum, at 1-3. I appreciate, though, that in construing a provision of a chapter 11 plan, if it were ambiguous, one may consider other documents, such as a disclosure statement, to aid in interpretation. See In re NVF Co., 309 B.R. 698, 703 (Bankr. D. Del. 2004) ("At the September 23, 2003 hearing I thought that NVF's interpretation of the Plan had some appeal. However, after a thorough review of the Plan and related documents, I now conclude that a different interpretation of the Plan is plausible and more consistent with the realities of the situation."). Therefore, HBCC's reference to provisions of cash collateral orders, the approved disclosure statement, and other documents might have been germane to this dispute; however, estoppel issues are probably inapplicable. Cf. In re Henthorn, 2005 WL 293646 (3d Cir. 2005) (non-precedential) (debtor's claim that fees were unreasonable under § 506(b) precluded by the confirmation process).
If either issue is resolved in favor of the movant, its motion should be granted and the escrowed funds paid to HBCC. Alternatively, if both questions are answered negatively, the plan administrator asserts that SouthTrust has been paid in full under the terms of the confirmed plan. If so, then the escrowed funds would be payable to general unsecured creditors and not to HBCC.
I first consider whether HBCC is an oversecured creditor entitled to an allowance under section 506(b).
II. A.
HBBC bases its request for allowance of counsel fees under 11 U.S.C. § 506(b). This subsection provides:
To the extent that an allowed secured claim is secured by property the value of which, after any recover under subsection (c) of this section, is greater than the amount of such claim, there shall be allowed to the holder of such claim, interest on such claim, and any reasonable fees, costs, or charges provided for under the agreement under which such claim arose.
Therefore, the statute provides that only an oversecured creditor is entitled to post-bankruptcy interest, attorney's fees and costs. See, e.g., United Savings Assn. of Texas v. Timbers of Inwood Forest Associates, Ltd., 484 U.S. 365, 372-73 (1988);In re F.B.F. Industries, Inc., 1995 WL 581935, at *1 (E.D. Pa. 1995). Moreover, such fees and costs can only be awarded if provided for in the loan or security agreements. See In re Auto Specialties Mfg. Co., 18 F.3d 358, 360 (6th Cir. 1994).
HBCC contends that its loan and security agreements, specifically, paragraph 9.5(a), provide that the debtors shall pay its counsel fees. See Ex. HBCC-1, ¶ 9.5(a), at 41. The objector does not argue to the contrary.
As noted by one treatise, section 506(b) was meant to codify "`current law by entitling a creditor with an oversecured claim to any reasonable fees, costs or charges provided under the agreement under which the claim arose. These fees, costs, and charges are secured claims to the extent that the value of the collateral exceeds the amount of the underlying claim.'" 4 Collier on Bankruptcy ¶ 506.LH[3] (15th ed. rev. 2004) (quoting H.R. Rep. No. 595, 95th Cong., 1st Sess. 356-357 (1977)); see also In re United Merchants and Manufacturers, Inc., 674 F.2d 134, 138 (2d Cir. 1982) ("Section 506(b), however, merely codifies pre-Code law that an oversecured creditor can assert, as part of its secured claim, its right to interest and costs arising under its credit agreement.").
A creditor is considered oversecured by section 506(b) only "to the extent that the value of [its] interest in the estate's interest in property is greater than the amount of the creditor's allowed prepetition claim." 4 Collier on Bankruptcy ¶ 506.04[1], at 506-102 (15th ed. rev. 2004). Therefore, "[u]nder this provision, an oversecured creditor is entitled to postpetition interest on its claim only `to the extent that such interest, when added to the principal amount of the claim,' does not `exceed the value of the collateral.'" Rake v. Wade, 508 U.S. 464, 468 n. 4 (1993) (quoting United Savings Assn. of Texas v. Timbers of Inwood Forest Associates, Ltd., 484 U.S. at 372).
The general rule in bankruptcy is that "interest on the debtors' obligations ceases to accrue at the beginning of proceedings." Vanston Bondholders Protective Committee v. Green, 329 U.S. 156, 163 (1946). Accordingly, no postpetition interest accrues upon unsecured claims or, in light of section 506(b), upon undersecured claims.See United Savings. Ass'n v. Timbers of Inwood Forest, 484 U.S. at 372-73 ("Since this provision [506(b)] permits postpetition interest to be paid only out of the `security cushion,' the undersecured creditor, who has no such cushion, falls within the general rule disallowing postpetition interest.").
11 U.S.C. 502(b)(2) states:
(b) Except as provided in subsections (e)(2), (f), (g), (h) and (I) of this section, if such objection to a claim is made, the court, after notice and a hearing, shall determine the amount of such claim as of the date of the filing of the petition, and shall allow such claim in lawful currency of the United States in such amount, except to the extent that —
(2) such claim is for unmatured interest . . .
Section 726(a)(5) creates an exception to this general rule when all creditors will be paid in full. See, e.g. In re Coram Healthcare Corp., 315 B.R. 321, 343-44 (Bankr. D. Del. 2004) (allowing the payment of postpetition interest to undersecured creditors before making a distribution to the equity holders).
Likewise, an unsecured creditor or an undersecured creditor is not entitled to recover postpetition fees and costs arising from his claim. See, e.g., In re Loewen Group International, Inc., 274 B.R. 427, 444 (Bankr. D. Del. 2002) ("[L]ike post-petition interest, post-petition fees and costs may only be recovered by creditors to the extent their claims are oversecured."); In re Woodmere Investors Ltd. Partnership, 178 B.R. 346, 356 (Bankr. S.D.N.Y. 1995) ("If no `security cushion' exists to allow for post-petition interest, none exists for the allowance of attorney fees and costs."); In re Saunders, 130 B.R. 208, 214 (Bankr. W.D. Va. 1991) ("An undersecured or unsecured creditor cannot recover contractual attorneys' fees for work performed postpetition.").
Accordingly, for HBCC to prevail upon its present request for an award of post-bankruptcy counsel fees, it must demonstrate that it is oversecured. See generally In re McCoy, 163 B.R. 206, 211-12 (Bankr. M.D. Fla. 1994). As previously noted, while the plan administrator has not challenged the payment of postpetition interest to HBCC as part of the debtors' confirmed plan, he now contests that HBCC is an oversecured creditor.
The plan administrator stated the payment of postpetition interest to HBCC "only proves that the Debtors compromised on potential claims and arguments in order to get the plan confirmed, just as HBCC agreed to cap its 506(b) claim at $150,000." Plan Administrator's Reply Memorandum at 9, n. 10.
As earlier mentioned, a creditor is oversecured only if its interest in the value of its collateral exceeds the amount of its debt. See, e.g., Farmers Home Admin. v. Farmers State Bank of Hosmer, 68 B.R. 282, 285 (D.S.D. 1986) ("An oversecured creditor is a holder of an allowed secured claim which is secured by collateral of greater value than the allowed secured claim.") A creditor's interest in collateral, and so its oversecured status, is affected by the existence of prior liens. See generally In re Indian Palms Associates, Ltd., 61 F.3d 197 (3d Cir. 1995).
Based upon the evidentiary record, HBBC contends that it holds a first lien position in the collateral, viz., the receivables, and that the value of this collateral exceeds its allowed claim. The plan administrator counters that SouthTrust holds the first lien position, and that the value of the collateral is less than the amount owed to SouthTrust. If so, then HBBC is not an oversecured creditor. See In re Morgan, 225 B.R. 309, 311-12 (Bankr. E.D. Pa. 1998).
As discussed above, there is no dispute regarding the value of the collateral, or the amounts owed to HBCC and SouthTrust. Therefore, this contested matter arises because the parties take opposing views regarding the effect of the subordination agreement upon HBCC's lien position. HBCC contends that the subordination agreement with SouthTrust resulted in the former replacing the latter as first lien holder of the debtors' assets. In contrast, the plan administrator maintains that the subordination agreement does not change the first lien position of SouthTrust for purpose of section 506(b). In the view of the objector, SouthTrust remained in the first lien position, but this creditor became contractually obligated under the subordination agreement to pay over any funds it would receive, up to the amount of HBCC's claim.
B.
In addressing their differing interpretations concerning the effect of the subordination agreement upon the application of section 506(b), both parties are aware of 11 U.S.C. § 510(a), which states: "A subordination agreement is enforceable in a case under this title to the same extent that such agreement is enforceable under applicable nonbankruptcy law." Thus, non-bankruptcy law, typically state law, would govern any dispute concerning the enforceability of a subordination agreement. See In re Southeast Banking Corp., 156 F.3d 1114, 1121 (11th Cir. 1998).
Prior to the enactment of section 510(a), the Third Circuit Court of Appeals held in In the Matter of Time Sales Finance Corp., 491 F.2d 841 (3d Cir. 1974) that in order for a senior creditor under a subordination agreement to receive post-petition interest out of the junior creditor's bankruptcy share, the subordination agreement must expressly so state. See also In re Kingsboro Mortgage Corp., 514 F.2d 400, 401 (2d Cir. 1975); In the Matter of King Resources Co., 385 F. Supp. 1269, 1281 (D. Colo. 1974). This federal common law doctrine was known as the "Rule of Explicitness." In re Bank of New England Corp., 364 F.3d 355, 362 (1st Cir. 2004). Some courts have concluded that the Rule of Explicitness did not survive the enactment of section 510. See, e.g., In re Bank of New England Corp., 364 F.3d at 359. In this instance, neither SouthTrust nor the plan administrator has challenged HBCC's entitlement to postpetition interest. Thus, I need not consider that issue.
As quoted earlier, the subordination agreement involving HBCC and SouthTrust made reference to the substantive law of New Jersey. New Jersey has adopted the revised version of Article 9 of the Uniform Commercial Code, which simply provides that "[t]his chapter does not preclude subordination by agreement by a person entitled to priority." N.J.S.A. 12A: 9-339 (effective July 1, 2001).
Current U.C.C. § 9-339 is derived from former U.C.C. § 9-316.
The plan administrator relies heavily upon In re Smith, 77 B.R. 624 (Bankr. N.D. Ohio 1987) for his contention concerning the effect of a subordination agreement. In Smith, Farmers Citizens Bank entered into a subordination agreement in favor of the FmHA. The loan made by the bank was secured, but the loan made by the FmHA was unsecured. Id., at 627 ("In the present case, the Bank is a secured creditor and FmHA is an unsecured creditor.")
The bank and the FmHA were each claiming entitlement to the proceeds of the bank's collateral. The Smith bankruptcy court applied the subordination agreement in the following manner:
Although there has not been a great deal of litigation in this area, it appears that a subordination agreement between a secured creditor and an unsecured creditor may be given effect in the following manner. Under nonbankruptcy law, a subordination agreement may not adversely affect the rights of a creditor who is not a party to the agreement. . . . Thus, under § 510(a) the subordination of a secured claim may not impair the rights of the other creditors. Essentially, this is accomplished by the exchange of priorities between the parties to the agreement. The amount to be paid to the party subordinating its claim (the Bank) is determined without reference to the subordination agreement. That amount is then paid to the beneficiary of the subordination agreement (FmHA) to the extent of its valid interest through the subordination agreement, with any remaining balance going to the subordinating creditor (the Bank). The subordinating creditor then receives a claim with the same priority enjoyed by the beneficiary of the agreement, to the extent of the amount paid to the beneficiary.
Id. at 627 (citations omitted).
Other courts, however, have described the effect of a subordination agreement in different terms. For example, in In re Lunan Family Restaurants, 194 B.R. 429, 444 (Bankr. N.D. Ill. 1996), the court quoted approvingly the following explanation:
"By executing a lien subordination agreement, the subordinating party agrees to demote the priority of its lien to that of another secured creditor, thereby delaying its recourse to the identified collateral until the other party's secured claim has been satisfied."
(quoting In re Lantana Motel, 124 B.R. 252, 256 (Bankr. S.D. Ohio 1990)); see also In re Bank of New England Corp., 364 F.3d at 361 ("[S]ubordination alters the normal priority of the junior creditor's claim so that it becomes eligible to receive a distribution only after the claims of the senior creditor have been satisfied."); In re Tri-Union Development Corp., 314 B.R. 611, 627 (Bankr. S.D. Tex. 2004) ("Subordination is the ordering of priority of debts between creditors."); In re Curtis Center L.P., 192 B.R. 648, 659 (Bankr. E.D. Pa. 1996) (the subordination agreement rendered the subordinating creditor's claim unsecured, because the value of the collateral was less than the amount due the new senior lienholder).
This difference in approach may be explained by observing that "subordination agreements may be generally classified as being one of two types: debt subordinations or property interest subordinations." In re Lantana Motel, 124 B.R. at 255.
In a debt subordination, the agreement provides that the subordinated creditor's right to payment and collection will be subordinate to the rights of another claimant. If the debt subordination is "complete," the subordinated creditor is barred from receiving payments until the superior debt is paid in full.
* * *
Debt subordination should be contrasted to property interest subordination. In a property interest subordination, the agreement affects only the relative rights of parties in particular real or personal property. Property interest subordination does not concern any rights the parties may have to receive payments.
The most common type of property interest subordination is lien subordination. By executing a lien subordination agreement, the subordinating party agrees to demote the priority of its lien to that of another secured creditor, thereby delaying its recourse to the identified collateral until the other party's secured claim has been satisfied.
Id., at 255-56; accord In re Environmental Aspecs, Inc., 235 B.R. 378, 396 n. 6 (E.D.N.C. 1999):
The Lantana court explained the difference between a debt subordination and a property interest subordination. In the former, the agreement "provides that the subordinated creditor's right to payment and collection will be subordinate to the rights of another claimant . . . [and] the subordinated creditor is barred from receiving payments until the superior debt is paid in full." Id. at 255-256. In a property interest subordination, "the subordinating party agrees to demote the priority of its lien to that of another secured creditor, thereby delaying its recourse to the identified collateral until the other party's secured claim has been satisfied." Id. at 256. A property interest subordination does not limit the subordinated party's right to receive payments. Id. Although EAI of NC's agreements with both AAL (1996) and SouthTrust (1997) in this case essentially constituted restructuring of prior obligations and thus required regular payments by the debtors to the creditors, the subordination agreement at issue in this case is in the nature of a property interest subordination.
With the distinction between the two types of subordination agreements in mind, the differing constructions of Smith andLunan become understandable. Smith was describing the effect of a "debt subordination"; Lunan was explaining the effect of a "property interest subordination."
Moreover, in Smith, since only one party to the subordination agreement held a security interest, the parties in that case could only have entered into a debt subordination. In the instant contested matter, however, the above-quoted language of the subordination agreement between HBCC and SouthTrust clearly describes a property interest subordination, whereby HBCC would hold the first lien position on collateral and SouthTrust a second position. This type of agreement is permitted under New Jersey law. See generally Metrobank for Sav., FSB v. National Community Bank of New Jersey, 262 N.J. Super. 133, 140 (1993). Indeed, the New Jersey Superior Court defined a subordination agreement in the following property interest terms:
Black's Law Dictionary, 1279 (5th ed. 1979) defines subordination agreement as an "agreement by which the subordinating party agrees that its interest in real property should have a lower priority than the interest to which it is being subordinated." Thus, a subordination agreement is an agreement to accept a lower priority for a lien than would otherwise be due. See 29 New Jersey Practice, Law of Mortgages, § 115, at 535-40 (Roger A. Cunningham Saul Tischler) (1975) (describing priority as affected by subordination agreements). Id., at 140; see also 29 New Jersey Practice' Law of Mortgages, § 3.29 (2d ed. 2004) (Subordination agreements "have the effect of altering the priority of interest in, or liens upon, realty.").
Therefore, I disagree with the plan administrator's contention that the subordination agreement did not effect a transposition of the respective lien positions of HBCC and SouthTrust for purposes of applying section 506(b). See generally In re Chance Industries, Inc., 2002 WL 32653679, at *3 (Bankr. D. Kan. 2002) ("all interested parties agreed that FFI [in whose favor there was a subordination agreement] was amply secured and likely oversecured."). Furthermore, this reordering of lien priority in estate property is consistent with decisions construing subordination agreements on issues of adequate protection under section 362(d)(1), see In re American Sweeteners, Inc., 1999 WL 1068446 (Bankr. E.D. Pa. 1999); In re Curtis Center Limited Partnership, 192 B.R. 648 (Bankr. E.D. Pa. 1996); In the Matter of Village Rathskeller, Inc., 147 B.R. 665, 672-73 (Bankr. S.D.N.Y. 1992); In re Nashua Trust Co., 73 B.R. 423, 426, 429-430 (Bankr. D.N.J. 1987), and lien avoidance under section 506(d). See In the Matter of Folendore, 862 F.2d 1537, 1538 (11th Cir. 1989) ("Due to Subordination Agreements and prior filings, the liens of the Federal Land Bank and Central Georgia Production Credit Association are superior to the lien of the United States Small Business Association."); In re Mihalko, 87 B.R. 357 (Bankr. E.D. Pa. 1988) (subordination agreement between the parties changes their relative lien positions; therefore a lien held by the creditor benefitted by the agreement can not be avoided under § 506(d)).
A creditor who is oversecured for purposes of section 362(d) or 506(d), due to a subordination agreement, should also be oversecured for purposes of section 506(b). See also United Steelworkers of America v. North Star Steel Co., Inc., 5 F.3d 39, 43 (3d Cir. 1993) ("[A] statute's provisions should be read to be consistent with one another, rather than the contrary.").
III.
Finally, the objector complains that if the effect of the subordination agreement were to allow HBCC to be treated as an oversecured creditor for purposes of section 506(b), unsecured creditors in this case will receive a smaller dividend. He observes that, absent the subordination agreement, SouthTrust would be in first lien position, and SouthTrust would be an undersecured creditor not be entitled to an allowance of fees under section 506(b). Since it is generally accepted that "the enforcement of subordination agreements between creditors of the same bankrupt affects only their rights and does not interfere with or change the rights of other creditors", In re Wyse, 340 F.2d 719, 723 (6th Cir. 1965), and since the $150,000 escrow fund would be payable to unsecured creditors if HBCC's motion were denied, the plan administrator reasons that the result sought by HBCC in this contested matter must be improper.
Of course, any potential distribution in this dispute to general unsecured creditors of the escrowed funds arises more from the terms of the consensual confirmed plan, as it dealt with SouthTrust's secured claim, than from construction of the Bankruptcy Code. Typically, an undersecured creditor, e.g., SouthTrust, would receive all of the proceeds of its collateral. Thus, the dispute in this instance is uncommon.
More fundamentally, however, the plan administrator ignores the benefit to creditors that generally follow from subordination agreements. Thus, the rights of unsecured creditors were not adversely affected by the HBCC/SouthTrust subordination agreement at issue in this contested matter.
A debtor may enter into pre-bankruptcy agreements with creditors that ultimately reduce the dividend to unsecured creditors in a subsequent bankruptcy case without impairing their rights. For example, a corporation can borrow funds from a lender and secure the loan using unencumbered corporate assets as collateral. Presumably, the loan proceeds will benefit the corporate borrower and its other creditors. The transaction would not be avoidable as a preference or fraudulent conveyance in a subsequent bankruptcy case commenced by the borrower (unless, perhaps, there was a marked disparity between the loan proceeds and the value of the security interest).
In other words, the debtor's estate received adequate consideration for the grant of the security interest. The rights of unsecured creditors were not diminished by this prepetition loan. That unsecured creditors may receive a smaller distribution in a subsequent bankruptcy case because these assets are now encumbered is no ground, by itself, to invalidate the security interest. Nor would it be a basis to deny the secured creditor an allowance under section 506(b), if the creditor so qualified.
Similarly, subordination agreements often arise because the corporate debtor needs additional funds and seeks to borrow them. The original lender either cannot or will not provide the needed cash; the second lender will only do so if its risk of non-payment is reduced. Thereupon, if the original lender agrees to subordinate its claim (for reasons involving its own self-interest), the debtor can obtain the additional funds it requires. See generally In re Lantana Motel, L.P., 124 B.R. at 255-56. Use of these loan proceeds are designed to benefit the debtor's operations and, indirectly, its general creditors. Again, absent concerns addressed by the preference and fraudulent conveyance provisions, the Bankruptcy Code will uphold a valid prepetition subordination agreement, see 11 U.S.C. § 510(a), and will accord the two creditor parties to the subordination agreement the relief to which they are entitled under the statute.
Indeed, within a bankruptcy case, a chapter 11 debtor may seek to borrow funds postpetition, and the post-bankruptcy lender may condition such a loan upon obtaining a first lien position upon some or all of the debtor's assets pursuant to 11 U.S.C. § 364(d). The effect of this priming lien would be to subordinate any prepetition liens. See generally In re Swedeland Development Group, Inc., 16 F.3d 552, 564 (3d Cir. 1994). If the chapter 11 reorganization is ultimately not successful, the effect of this postpetition borrowing may result in a smaller distribution to unsecured creditors. Such a result, albeit unfortunate, does not represent a diminishment of their rights as creditors. Cf. In re Adams Apple, Inc., 829 F.2d 1484, 1490 (9th Cir. 1987) ("section 364(d) . . . illustrates a Congressional willingness to subordinate the interests of pre-petition creditors to the goal of rehabilitation.").
In sum, HBCC's statutory entitlement to fees and interest as an oversecured creditor, pursuant to 11 U.S.C. § 506(b), is a component of the consideration it received for lending $4 million to the debtors in September 2001. It conditioned this loan upon priming SouthTrust's lien. Had it not lent these funds, unsecured creditors of these debtors could possibly have faired worse than they did under the terms of the confirmed plan. Thus, the enforcement of the subordination agreement made in September 2001, and which now permits the allowance of fees under section 506(b), does not impair the rights of unsecured creditors. It may, under these particular facts, diminish their dividend from the bankruptcy estate, but not their rights as creditors of these debtors.
Accordingly, an order shall be entered allowing HBCC's fees and costs under section 506(b) in the amount of $150,000, and authorizing the plan administrator to disburse the funds currently held in escrow for this purpose.
ORDER
AND NOW, this 15th day of March 2005, for the reasons stated in the accompanying memorandum, it is hereby ordered that the motion of Healthcare Business Credit Corporation for an allowance of costs and fees, pursuant to 11 U.S.C. § 506(b), in the amount of $150,000 is granted, and the objection of the plan administrator is overruled. The plan administrator is authorized to distribute the escrowed funds to HBCC forthwith.