In Re: Debbie Reynolds Hotel & Casino, Inc. Debtor. In Re: Debbie Reynolds Management Company, Inc. Debtor. In Re: Debbie Reynolds Resorts, Inc. Debtor. Debbie Reynolds Hotel & Casino, Inc., a Nevada Corporation Debbie Reynolds Management Company, Inc., a Nevada Corporation Debbie Reynolds Resorts, Inc., a Nevada Corporation v. Calstar Corporation, Inc., Resort Funding, Inc. v. Calstar Corporation, Inc.
Docket: 99-17240
Court: Court of Appeals for the Ninth Circuit; July 6, 2001; Federal Appellate Court
Debbie Reynolds Hotel, Casino, Inc., along with its affiliated companies, appealed a decision from the Bankruptcy Appellate Panel (BAP) which reversed a bankruptcy court's approval of a settlement agreement between the debtor and secured creditor Resort Funding, Inc. (RFI). The settlement involved RFI making a $50,000 payment to the debtor's counsel under 11 U.S.C. § 506(c). The BAP identified two main reasons for its reversal: first, that the settlement agreement improperly infringed on Calstar Corporation's right to surcharge RFI's secured collateral; and second, that allowing the payment directly to the debtor's counsel instead of the debtor's estate contravened the priority distribution rules under 11 U.S.C. § 507.
The Ninth Circuit Court reversed the BAP's decision, affirming the validity and enforceability of the settlement agreement. Citing the Supreme Court ruling in Hartford Underwriters Ins. Co. v. Union Planters Bank, the court determined that Calstar lacked standing to contest the settlement's terms. Furthermore, it concluded that surcharges under § 506(c) should be paid directly to the debtor's counsel, reflecting the services rendered to the estate that justified the surcharge request.
The background includes a failed sale of the Debbie Reynolds Hotel and Casino, originally negotiated with Central Florida Investments (CFI) for $14 million, which was later increased to $15.6 million but fell through when CFI withdrew. Subsequently, Calstar agreed to purchase the property for $15.5 million and provided a $150,000 loan to keep the hotel operational during due diligence, which was approved by the bankruptcy court with superpriority status. Calstar later opted not to proceed with the purchase.
The bankruptcy court approved the sale of the Debtor's hotel and related assets through public auction, resulting in a sale price of $10,650,000. Following the sale, Debtor's counsel sought a $50,000 surcharge from RFI's secured collateral under 11 U.S.C. § 506(c), which allows a trustee to recover necessary costs from property securing an allowed secured claim. RFI, while not acknowledging any benefit from Debtor's actions, agreed to the surcharge in exchange for a provision that no party could further challenge RFI's claims. Calstar objected to the settlement, asserting that it had its own right to surcharge RFI's collateral due to a prior loan it provided to the Debtor and that the settlement improperly protected RFI's collateral at Calstar's expense. The bankruptcy court upheld the surcharge; however, the Bankruptcy Appellate Panel (BAP) reversed this decision, stating that the lower court abused its discretion by not assessing whether RFI benefited from the actions of other claimants and by allowing the surcharge to be paid directly to Debtor's counsel instead of the estate, thus infringing on Calstar's superpriority claim. Both RFI and the Debtor appealed the BAP's decision. The standard of review for the bankruptcy court’s approval of the settlement is for abuse of discretion, while legal interpretations of the Bankruptcy Code are reviewed de novo. The BAP's ruling centered on the bankruptcy court's interpretation of § 506(c) regarding the surcharging of RFI, which is a legal question that warrants de novo review.
Two key issues arise under Section 506(c) of the Bankruptcy Code in this case. First, Calstar lacks standing to object to a settlement agreement between the secured creditor and the debtor-in-possession, which precludes Calstar from seeking to surcharge the secured collateral of RFI. Following the precedent set in *Hartford Underwriters*, it is established that only the trustee or debtor-in-possession has the right to seek a surcharge under § 506(c), thus rendering Calstar's objection invalid. The decision of the Bankruptcy Appellate Panel (BAP) is reversed.
Second, the distribution of $50,000 in proceeds from the § 506(c) surcharge is addressed. It is determined that the party providing a benefit to a secured creditor is entitled to reimbursement from the secured collateral. The BAP's decision is reversed, affirming that the debtor's counsel is entitled to the $50,000 surcharge according to the settlement agreement's terms.
The immunizing language in the settlement agreement is scrutinized, and it is concluded that it does not affect Calstar's rights since they lack standing to seek a surcharge. The *Hartford Underwriters* ruling clarifies that only the trustee or debtor-in-possession may utilize § 506(c), and since Calstar does not meet this criterion, it cannot pursue a surcharge. Additionally, Calstar fails to demonstrate that the bankruptcy court's approval of the settlement agreement's immunizing language caused them direct and adverse financial harm, further solidifying their lack of standing to appeal. Consequently, the BAP’s ruling is reversed based on these findings.
The Supreme Court in Harper v. Virginia Department of Taxation established that once a federal law rule is announced, it must be applied retroactively to all parties in similar cases on direct review, with limited exceptions. In Hartford Underwriters, the Court affirmed a ruling that an administrative claimant lacked standing, which is applicable to Calstar's appeal as well. The core issue is whether a surcharge under 11 U.S.C. § 506(c) fits within the priority schedule of 11 U.S.C. § 507. Calstar argues that the surcharge should be treated as part of the estate's general assets, while the appellants contend that it allows a benefit provider to directly seek reimbursement from the secured collateral, irrespective of priority. The analysis concludes that a § 506(c) surcharge is not an administrative claim but an obligation against the collateral, thus not subject to the priority scheme of the Bankruptcy Code. The expenses incurred under § 506(c) are to be paid from sale proceeds before any payments to secured creditors. Furthermore, the precedent established in In re Palomar Truck Corp. regarding the direct distribution of § 506(c) proceeds to the claimant remains valid despite the Supreme Court's overruling of other aspects of that case in Hartford Underwriters.
The $50,000 surcharge secured by the debtor-in-possession through a settlement agreement is to be paid directly to Debtor's counsel, as the surcharge originates from the attorneys' work. If the trustee had paid its counsel's fees prior to seeking the surcharge, the outcome would be similar to a direct distribution to Debtor's counsel. The trustee can be reimbursed from secured collateral for reasonable and necessary expenses that benefit the secured creditor, as established in *In re Compton Impressions Ltd.*. Counsel's entitlement to the surcharge proceeds should not hinge on whether the debtor incurred debt or spent money before the surcharge request.
The Bankruptcy Appellate Panel's view that direct distribution would disrupt the Bankruptcy Code's priority schedule is rejected. It is asserted that Congress would have explicitly stated any fundamental alterations to bankruptcy principles. Only the trustee or debtor-in-possession can request a surcharge under *Hartford Underwriters*, and third parties must persuade the trustee or seek court permission to request a § 506(c) surcharge. This requirement can deter unpaid administrative claimants from utilizing § 506.
To obtain a surcharge, parties must demonstrate that their expenses were reasonable, necessary, and provided a quantifiable benefit to the secured creditor, which is a challenging standard. The party seeking the surcharge bears the burden of showing a concrete benefit, and the recovery is capped at the proven benefit amount. In the current case, Debtor's counsel secured the agreement of the secured creditor to pay the surcharge, which included assurances that no other parties would seek payment from the secured collateral. However, after *Hartford Underwriters*, it is deemed unlikely for secured creditors to enter similar agreements again, as they received no tangible benefit in return for the $50,000 payment, diminishing the likelihood of similar future controversies and collusion risks between unsecured and secured creditors.
Hartford Underwriters is applicable retroactively to this appeal, establishing that Calstar lacks the standing to seek a surcharge from RFI. The settlement agreement’s immunizing language did not modify Calstar’s legal rights and was appropriately sanctioned by the bankruptcy court. The BAP's prior decision that disapproved the settlement is overturned. Furthermore, 11 U.S.C. § 506(c) permits the allocation of surcharge proceeds directly to the party that provided a quantifiable benefit to the secured collateral, thus reversing the BAP's directive to distribute these proceeds according to the priority outlined in 11 U.S.C. § 507. The court's decision is REVERSED and REMANDED. Additionally, under 11 U.S.C. § 364, if a trustee cannot secure unsecured credit as an administrative expense, the court may authorize incurring debt with priority over specified administrative expenses. Compensation for professionals is categorized as an administrative expense under 11 U.S.C. § 503(b)(2), and Calstar's loan has priority over such expenses. RFI's consent to a surcharge benefiting the Debtor's counsel further substantiates the appropriate distribution of the surcharge.
