IBI Security Service, Inc. v. National Westminster Bank USA (In re IBI Security Service, Inc.)

Citations: 206 B.R. 23; 1997 U.S. Dist. LEXIS 7110Docket: No. CV 94-4667(ADS); Bankruptcy No. 91-71235-21; Adversary No. 092-7042-21

Court: District Court, E.D. New York; March 2, 1997; Federal District Court

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BII, Inc., a secured creditor in a bankruptcy case, appeals two final orders from the bankruptcy court: one approving a settlement in an adversary proceeding and the other authorizing the distribution of settlement proceeds to the Chapter 7 Trustee. BII argues that these actions violate a prior settlement agreement between itself and the Trustee, previously approved by the court. 

The bankruptcy case originated when IBI Security Service, Inc. filed for Chapter 11 bankruptcy, which was later converted to Chapter 7, with Andrew M. Thaler appointed as Trustee. At conversion, IBI was involved in litigation against multiple banks regarding a $2.9 million alleged shortage of funds. In the adversary proceeding, IBI's claims included demands for costs and indemnification from Lloyd’s of London, contesting set-offs made by Natwest as preferences, and alleging unfair competition and tortious interference against Natwest and Revere.

The Trustee retained the law firm Mangone, Sehnapp to continue the litigation. Meanwhile, BII entered into an agreement with Glenfed Financial Corp., which assigned all rights in IBI’s assets to BII for $200,000, making BII a secured creditor with claims in the Natwest Litigation. BII asserts a security interest of $720,000 in IBI’s assets, and its president, Michael Shields, is related to IBI’s president. Following the assignment, BII communicated to IBI's customers about its acquisition of IBI’s assets.

BII took control of IBI's assets, including armored cars, money processing equipment, and accounts receivable. The Trustee challenged BII's actions, claiming they violated the automatic stay provisions of the Bankruptcy Code upon the conversion of the case to Chapter 7, leading to potential causes of action for subordination of BII's claims and monetary damages. BII contended it acted within its rights under the Glenfed Assignment. The dispute was settled on July 23, 1993, under the BII Settlement, which upheld the validity of the Glenfed Assignment while establishing that BII had an allowed secured claim of $720,000, later reduced to $480,000 after accounting for previously received assets and a $40,000 payment to the estate. The settlement allowed BII to collect prepetition accounts receivable, while the Trustee pursued post-petition accounts and funds from the Natwest Litigation. The payment scheme outlined that initial recoveries would reduce BII’s secured claim, with BII receiving 25% of net proceeds from the Natwest Litigation after expenses. The bankruptcy court approved this settlement on September 16, 1993.

On June 29, 1994, the Trustee and others reached a partial settlement in the Natwest Litigation, which included mutual releases and specific payments: $375,000 to the Trustee, $1.1 million to Natwest, and $150,000 to First Fidelity. The only unresolved claim involved IBI's allegation against Natwest and Revere for unjust competition and tortious interference. The Natwest Settlement's terms were binding on IBI and BII, ensuring that BII's rights from the earlier settlement would be attached to the $375,000 payment to the Trustee.

The Natwest Settlement received approval from the bankruptcy court, despite objections from BII regarding the distribution method of the settlement proceeds, specifically the $375,000 payment to the Trustee. BII acknowledged the settlement's substance but contested that under the BII Settlement terms, it was entitled to $275,000 of the payment, with the first $150,000 and the remaining $125,000 payable to BII, while the estate would receive $100,000. BII argued that the Trustee's plan to use part of the settlement for administrative expenses infringed on the BII Settlement terms.

After a hearing, the bankruptcy court found that the Natwest Settlement benefitted BII and ruled that the Trustee could deduct certain administrative expenses from the settlement payment under section 506(c) of the Bankruptcy Code. The court approved $191,757.13 in professional fees, attributing 50% to BII as the primary beneficiary. Consequently, it ordered $95,878.56 to be set aside for these fees, with $279,121.44 from the settlement to be distributed according to the BII Settlement: $150,000 to BII, $100,000 to the estate, and $29,121.44 to BII.

BII is appealing the bankruptcy court's approval of the Natwest Settlement and the distribution order, arguing that its secured claim should not be subject to administrative expenses and that it was entitled to a total of $275,000 from the settlement. Additionally, BII contends the imposition of half of the professional fees was unreasonable. The court's findings of fact will be reviewed for clear error, while legal conclusions will be assessed de novo. The Trustee claims entitlement to recover professional fees under 11 U.S.C. 506(c), which allows recovery of reasonable costs that benefit a secured claim holder.

Bankruptcy estate administrative expenses are typically not recoverable from secured claimholders, as the trustee represents the estate and unsecured creditors. However, section 506(c) allows recovery of such expenses if they primarily benefit the secured creditor or if the creditor caused or consented to the expenses. The trustee must demonstrate that the expenses are necessary, reasonable, and primarily for the creditor's benefit, with the creditor directly benefiting from the expenditure.

In the current case, BII contends that section 506(c) does not apply due to terms in the BII Settlement, which allocates a $140,000 payment to the trustee for expenses related to the Natwest Litigation. BII claims this amount is a 'carve out' from cash collateral for its secured claim, meaning the remaining payments under the settlement are exempt from administrative expenses. BII supports its argument with three points: 

1. The language in paragraph 8 of the BII Settlement specifies a payment hierarchy that does not mention administrative expenses.
2. Past practices under the settlement show payments to BII were not subject to administrative expenses, as evidenced by a direct payment from the TBTA.
3. The trustee's characterization of the $140,000 payment as a 'carve out' suggests it is intended for administrative expenses, a term supported by precedents like Flagstaff I, where secured creditors had explicit exemptions from certain administrative expenses under their financing agreements.

Section 503(b) allows for the payment of interim professional fees, but a bankruptcy court ordered that such fees be paid from encumbered collateral, which was affirmed by the district court. However, the Second Circuit reversed this decision, stating that the financing agreement granted the creditor a super-priority lien under section 364(e)(1) of the Bankruptcy Code, exempting it from the payment of professionals' fees outlined in section 503(b). The court specified that fees could only be recovered under section 506(c) if they primarily benefited the secured creditor or if the creditor consented to cover the costs.

BII argued that its settlement created a super-priority status similar to that in a previous case (Flagstaff I) but the bankruptcy court disagreed, stating that the fees incurred were primarily for pursuing litigation and settlement that directly benefited BII. The court noted that the BII Settlement did not explicitly exempt BII's claim from administrative expense payments and that the Trustee did not relinquish rights under section 506(c). 

Additionally, the court rejected BII's claims about past practices of exempting certain settlement proceeds from professional fees, highlighting that BII had engaged legal counsel under a retainer agreement, suggesting that if its claim were indeed super-prioritized, it would not have needed to pay those fees upfront. The court also dismissed BII’s characterization of a $140,000 payment as a 'carve out' for litigation expenses, stating that it was primarily for the benefit of the estate. The court concluded that most expenses were incurred in relation to the Trustee’s efforts in the Natwest Litigation, which directly benefited BII, thus allowing the Trustee to recover administrative expenses before distributing settlement proceeds to BII. BII's arguments regarding the settlement language were deemed ineffective.

The settlement agreement lacked explicit provisions indicating that the $140,000 payment to the Trustee was designated for professional fees related to the Natwest Litigation or that BII’s secured claim was exempt from administrative expenses. This absence suggests that the parties did not intend such terms. The bankruptcy court correctly differentiated this case from Flagstaff I, where an agreement prioritized creditors’ claims over professionals’ fees. In Croton River Club, it was established that fees could be recoverable under section 506(c) even without a super-priority interest. Consequently, the bankruptcy court's determination that the Trustee could recover professionals’ fees before satisfying BII’s claim was legally sound and factually accurate. 

The bankruptcy court found the professionals' fees reasonable, based on interim fee applications and time records, with most fees related to the Natwest Litigation. The breakdown included $40,373 and $1,231.67 for the Trustee’s general counsel, $11,862.50 and $62.56 for accountants, and $135,024.60 and $3,202.80 for special counsel, totaling $191,757.13 in fees and expenses. The decision to have BII and the Trustee share these costs was justified, as both benefited from the litigation outcome. The bankruptcy court's orders from August 18, 1994, regarding the settlement agreement and the distribution of proceeds to the Chapter 7 Trustee are affirmed, concluding the case. The settlement involved the TBTA paying the debtor’s estate $40,000 and BII receiving $84,165.50, with the $40,000 credited towards BII's claim reduction.