Charging Secured Interests In Bankruptcy – Timing Is Everything, Or Is It?

In bankruptcy cases, distributions are made according to priorities established in section 507 of the Bankruptcy Code. Generally, administrative expenses (e.g., expenses incurred by a trustee in fulfilling their duty in the case) have priority over most other claims in bankruptcy.

However, it is equally accepted that administrative claims cannot be satisfied from collateral pledged to secure a debt owing to a lender. The administrative claimant must look to unencumbered assets of the bankruptcy estate for satisfaction of such claims. There is, however, a narrow exception to this rule, found in section 506(c) of the Bankruptcy Code which provides that a “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 taxes with respect to the property.” In viewing whether section 506(c) is limited to expenses which were incurred by a trustee with a specific and exclusive intent to benefit the secured creditor, the Fifth Circuit has held that an expense that was not incurred primarily preserve or dispose of encumbered property is not capable meeting the requirement of being incurred primarily for the benefit of the secured creditor. This principal was recently re-affirmed by the Fifth Circuit in Southwest Securities, FSB v. Segner, No. 14-41463; however, the court went further and adopted the inverse position, i.e., an expense incurred primarily to preserve or dispose of encumbered property does not meet the requirement. The key is whether the expense was necessary to the preservation and disposal of the secured creditors’ encumbered property. If, as in Southwest Securities, a trustee holds an asset longer than is necessary to determine and realize its value, and the value turns out to be less than the creditors’ secured interest, the creditor can challenge the necessity of the costs incurred by the trustee in disposing of the collateral. The key is temporal reasonableness of the trustee’s action; however, whether the secured creditor received a direct and quantifiable benefit from the trustee’s actions will, as noted in Southwest Securities, be of equal import.