Administrative Claimants Do Not Have Standing To Surcharge Secured Creditor's Collateral
 
June 1, 2000
 
Richard E. Lear- Washington

On May 30, 2000, the United States Supreme Court resolved a split in the circuits regarding whether Section 506(c) of the Bankruptcy Code provides a holder of an administrative claim with an independent right to seek payment of its claim from the collateral of a secured creditor.  In a unanimous decision written by Justice Scalia, the Court concluded in Hartford Underwriters Ins. Co. v. Union Planters Bank, N.A., 2000 WL 684180, - S.Ct. – (May 30, 2000), that Section 506(c) does not provide an administrative claimant with an independent right to use the section to seek payment of its claim.  The Hartford Underwriters decision resolved a statutory construction issue which had divided courts for several years.  The majority of circuit courts which had considered Section 506(c) had interpreted the statute broadly, allowing administrative claimants to invoke the statute, in part, to avoid windfalls in bankruptcy.(1)  Two other circuits had determined that, as a result of the plain language of the statute, only the trustee was empowered to invoke Section 506(c).(2)

Factual Background

The Hartford Underwriters decision arises out of the bankruptcy case of Hen House Interstate, Inc., which owned or operated several retail establishments, including restaurants and service stations.  On September 5, 1991, Hen House filed its Chapter 11 case in the Eastern District of Missouri.  Union Planters Bank, N.A. (Union Planters) was Hen House’s prepetition lender and held a perfected security interest in essentially all of Hen House’s assets.  Union Planters also loaned money to Hen House post-petition pursuant to a loan agreement approved by the Bankruptcy Court.  The order approving the loan agreement also approved the debtor’s use of the loan proceeds and Union Planters’ cash collateral to pay expenses, including workers’ compensation expenses.

During its Chapter 11 case, Hen House obtained workers’ compensation insurance from Hartford Underwriters Ins. Co. (Hartford).  Hen House failed to make the monthly insurance payments to Hartford, but Hartford continued to provide workers’ compensation insurance coverage.  When the Chapter 11 case was converted to a Chapter 7 liquidation proceeding in January 1993, Hen House owed Hartford more than $50,000.00 in unpaid post-petition premiums.  Hartford learned for the first time that Hen House had filed a petition in bankruptcy in March 1993, after the conversion of the bankruptcy case.

Due to the lack of unencumbered funds in the bankruptcy, Hartford filed an application seeking allowance of the unpaid insurance premiums as an administrative expense and requesting that the Bankruptcy Court charge the unpaid premiums against Union Planters’ collateral pursuant to Section 506(c) of the Bankruptcy Code.  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.  11 U.S.C. § 506(c).

Hartford argued that Section 506(c) authorized charging the unpaid insurance premiums against Union Planters’ collateral because providing the workers’ compensation insurance allowed Hen House to continue operating which, in turn, benefited Union Planters by preserving the secured creditor’s collateral.  Alternatively, Hartford argued that benefit could be implied as a result of Union Planters’ consent to the post-petition financing order.

The Bankruptcy Court ruled in favor of Hartford and the District Court and the Eighth Circuit panel affirmed.  Subsequently, the Eighth Circuit granted an en banc review and reversed the decision, concluding that Section 506(c) could not be used by an administrative claimant.

Petitioner’s Arguments

Hartford’s argument was based in large part on pre-Code practice.  Although authority for charging secured creditors’ liens with certain administrative expenses could not be found in the text of the Bankruptcy Act of 1898, the pre-cursor to the Bankruptcy Code, the practice had existed prior to the enactment of the 1898 Act under cases establishing an equitable principle that, when a court had custody of property, the costs of administering and preserving the property were given a priority over existing liens and encumbrances.  Although the trustee would normally be the party seeking to surcharge the collateral, a number of lower court decisions exist in which parties other than the trustee were permitted to pursue such charges under the 1898 Act.  Citing recent Supreme Court precedent that, absent a clear indication that Congress intended to change pre-Code practice in enacting the Bankruptcy Code, the practice should be deemed to continue under the Code; Hartford argued that it should be allowed to invoke Section 506(c) and attempt to obtain recovery of the unpaid premiums from the secured creditor’s collateral.3

Supreme Court’s Analysis

In addressing the issue, the Supreme Court turned first to the language of Section 506(c).  The Court noted, as it has in the past, that when the language of a statute is plain, the sole function of the courts is to enforce the statute.  Following that approach, the Court concluded that the statute was quite plain on its face in specifying who may use section 506(c) – the trustee.  Furthermore, the Court had little trouble concluding that it is proper to infer that the trustee was the only party empowered to invoke the statute, notwithstanding the failure of Congress to specifically include restrictive language.

In this regard, the Court supported its conclusion by a review of the context of the statute.  Initially, the Court stated that it would be inappropriate to presume nonexclusivity when a statute authorizes specific action and designates a particular party to take the designated action.  Second, due to the unique role of the trustee in bankruptcy, the Court expressed the belief that it was entirely plausible that Congress would provide a power to the trustee and not to other parties in interest.  Additionally, the Court determined that the point of the statute was not only to establish that certain costs could be obtained from collateral, but also to establish the party empowered to seek to obtain recovery of the costs.

Turning to Hartford’s argument that, unless explicitly rejected by Congress, pre-Code practice was to continue under the Bankruptcy Code, the Court questioned whether the precedents cited by Hartford established a bankruptcy practice sufficiently widespread  to support the conclusion that the practice was implicitly adopted by Congress in enacting the Code.  Moreover, the Court stated that, while pre-Code practice may assist in understanding the Bankruptcy Code, it is merely a tool of construction and may not be used when the language of the Bankruptcy Code is plain.  With respect to the issue of who had standing to proceed under Section 506(c), the Court was of the opinion that the language of the Code left no room for clarification by pre-Code practice, rejecting the policy concerns which had influenced the majority of the circuit courts that had previously considered the issue.

Conclusion

It is appropriate to consider the Hartford Underwriters decision on two levels.  On its most basic level, the decision establishes the Court’s rejection of the reading of Section 506(c) by the majority of the circuit courts, establishing that only the bankruptcy trustee has the standing to seek to obtain payment of administrative claims from the collateral of a secured creditor.  Accordingly, administrative creditors must look to different avenues for payment, including insisting on cash payments, or obtaining a super-priority or a security interest under Section 364(c) of the Bankruptcy Code.  On a more general level, one might argue that the Hartford Underwriters decision signals that the Court has turned away from its practice of supplementing the language of the Bankruptcy Code with pre-Code equitable practices which have not been rejected specifically by Congress.

In that regard, two different approaches have been followed by the Supreme Court in reviewing the Bankruptcy Code in several of the Court’s most recent bankruptcy decisions: enforcing the plain language of the Bankruptcy Code and reading into the Bankruptcy Code a broader pre-Code practice, which had not been specifically rejected by Congress in enacting the Code.  In Hartford Underwriters, these two themes met head-to-head and the approach of enforcing the plain language of the Code prevailed.  Although this decision might be interpreted as the Court generally rejecting the notion that pre-Code equitable practices ought to be considered in interpreting the Bankruptcy Code, this conclusion is not really supported by a reading of the decision.  In fact, the Court appears to go out of its way to harmonize its decision in Hartford Underwriters with those of Dewsnup v. Timm, 502 U.S. 410, 418, 112 S.Ct. 773 (1992)(relying on “clearly established” pre-Code practice) and Kelly v. Robinson, 479 U.S. 36, 46, 107 S.Ct. 353 (1986)(giving weight to pre-Code practice that was “widely accepted” and “established”) in which the Court considered  “clearly established” pre-Code practice.

By emphasizing that it is questionable that the pre-Code practice relied upon by Hartford was “sufficiently widespread and well recognized to justify the conclusion of implicit adoption by the Code...,” the Court does not appear to reject out-of-hand the notion that pre-Code practice should be considered in interpreting the Bankruptcy Code.  Instead, the Court emphasizes in Hartford Underwriters that, while pre-Code practice may assist in understanding the Bankruptcy Code, “it cannot overcome that language.  It is a tool of construction, not an extratextual supplement.”

The challenge that is left to the lower courts after Hartford Underwriters is determining when the language of the Bankruptcy Code is sufficiently plain and unambiguous so that it must be enforced as written.

1.  See Precision Shearing, Inc. v. Fremont Fin. Corp. (In re Visual Indus., Inc., 57 F.3d 321, 325 (3d Cir. 1995);  North Country Jeep & Renault, Inc. v. General Elec. Capital Corp. (In re Palomar Truck Corp.), 951 F.2d 229, 232 (9th Cir. 1991), cert. denied, 506 U.S. 821 (1992):  In re Parque Forestal, Inc., 949 F.2d 504, 511-12 (1st Cir. 1991);  New Orleans Pub. Serv., Inc. v. First Fed. Sav. & Loan Ass’n (In re Delta Towers Ltd.), 924 F.2d 74, 77 (5th Cir. 1991).  

2.  See Hartford Underwriters Ins. Co. v. Magna Bank N.A. (In re Hen House Interstate, Inc.), 177 F.3d 719, 721 (8th Cir. 1999);  Ford Motor Credit Co. v. Reynolds Co. (In re JKJ Chevrolet, Inc.), 26 F.3d 481, 484 (4th Cir. 1994).  The debtor-in-possession also may invoke Section 506(c).  See 11 U.S.C. § 1107(a)(with certain limitations, a debtor-in-possession has all the rights, powers and duties of a bankruptcy trustee).

3.  Hartford also argued, inter alia, that because Section 506(c) did not limit specifically the use of the statute “only” to the trustee, restricted use of the section was not intended.