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The limited ability of a bankruptcy trustee to surcharge a secured creditor's collateral

In In re Colusa Regional Medical Center, 2019 WL 4398419, the Ninth Circuit Bankruptcy Appellate Panel (the "BAP") emphasized the limited ability of a bankruptcy trustee to surcharge a secured creditor's collateral for the stated purpose of estate preservation. The Colusa case involved a California county's only hospital and four associated clinics (the "Debtor"), which initiated a chapter 7 case shortly after ceasing operations. The chapter 7 trustee found a buyer to reopen the hospital within a month of his appointment, but then tried to surcharge his commission and attorney's fees, totaling about $200,000, against the USDA-which held liens over much of the hospital's property.

The general rule is that "bankruptcy administrative expenses may not be charged to or against secured collateral." In re Choo, 273 B.R. 608, 610-11 (9th Cir. BAP 2002). The exception to this rule is found in Section 506(c) of the Bankruptcy Code, which states, "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." However, in order to surcharge against a secured creditor's collateral, a bankruptcy trustee's office "must prove that its expenses were reasonable, necessary[,] and provided a quantifiable benefit" to that secured creditor. In re Debbie Reynolds Hotel & Casino, Inc., 255 F.3d 1061, 1068 (9th Cir. 2001).

In the underlying case, the bankruptcy court approved of the trustee's surcharge because it reasoned that the USDA was receiving $2 million from the sale of the hospital as a going concern-greatly in excess of what the USDA would receive if the hospital's assets had been sold at liquidation value. The trial court also adopted the trustee's arguments that the USDA had "impliedly consented to the surcharge" by offering to reduce its lien amounts to facilitate the sale.

The BAP took issue with the bankruptcy court's methodology for approving the surcharges. In vacating the trial court's ruling, the BAP's decision cited the line of cases requiring a direct benefit to a secured creditor from any expense sought to be surcharged against the creditor's collateral. See In re Choo, 273 B.R. at 611 ("the focus is on whether the expenditure in question was directed specifically toward the collateral, as opposed to property of the estate generally."). The appellate court emphasized that any benefit to the secured creditor must be "more than incidental" and not just part of a "generalized benefit to the estate." For example, the BAP disapproved of the trustee's surcharging the costs of the hospital sale to the USDA because the Debtor owned multiple buildings, only some of which were subject to the USDA's liens. Interestingly, the appellate panel also reasoned that surcharging the trustee's commission and fees against the USDA amounted to double-dipping-the trustee had previously used the USDA's cash collateral to pay the Debtor's former employees to collect receivables, so surcharging would essentially require the creditor to pay these expenses again.

With regard to the trustee's implied consent argument, the BAP's decision found that the USDA had not impliedly consented to the attempted surcharges because the Debtor was not administratively insolvent, the USDA had not requested the sale, and the USDA had previously paid estate expenses from its cash collateral. The BAP stopped short of crafting a new rule for implied consent, but its decision stated that a finding of implied consent in the surcharge context required a direct benefit to the creditor, as well as "some direct creditor action to cause the expense or some inaction that suggests an understanding that it is otherwise receiving a windfall."

The BAP instructed that on remand, the trustee would have to identify specific expenses, tie them to specific collateral, and identify the benefit to the relevant creditor in order to surcharge against its cash collateral. The trustee would also be required to show implied consent to justify the surcharge. Otherwise, the estate's general creditors would bear the cost of estate administration. Thus, the Colusa case renews the strict line of authority in the Ninth Circuit that limits the Bankruptcy Code's surcharge remedy.

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