Circuits Split on Secured Lenders’ Responsibility for Paying Excess Surcharges Sought by Bankruptcy TrusteeA recent decision by the U.S. Court of Appeals for the Fifth Circuit has caused a split with a prior Seventh Circuit decision on when a bankruptcy trustee may surcharge expenses for maintaining a property prior to abandonment.

Section 506(c) of the Bankruptcy Code allows the bankruptcy trustee to recover from a lender’s collateral any necessary expenses for preserving and disposing of that collateral “to the extent of any benefit” to the lender or if the lender consents to the expenses. In this case — Southwest Securities FSB v. Segner (In re Domistyle, Inc.) — the debtor was the owner of a Laredo, Texas, factory. The bankruptcy trustee believed that the property was worth more than what was owed to the lender, and attempted to sell it for approximately 14 months.

During that time, the trustee incurred expenses for utilities, roof repairs, security and other maintenance. Unfortunately, the property was overvalued and a buyer could not be found at a price that would result in any recovery to the estate. After 14 months, the trustee abandoned the sale of the property and turned it over to the lender. The trustee then sought to recover the expenses of maintaining the property from the lender during the time he tried to sell it.

A 1982 decision by the Seventh Circuit in In re Trim-X Inc. held that a lender can be charged expenses for a short period of time between when the trustee seeks and a court approves the abandonment. The Fifth Circuit ruled otherwise in Domistyle, concluding that “The necessary direct relationship between the expenses and the collateral is obvious here; all of the surcharged expenses related only to preserving the value of the Property and preparing it for sale.”

Even though the lender received no benefit from the 14-month delay while the trustee sought to sell the property, the court held that  “there is no indication [the lender] could have sold the Property earlier and avoided these expenses,” in effect shifting the burden of proof as to whether the lender received a benefit from the trustee to the lender.

Following this decision, lenders should make every effort in similar situations to establish with the bankruptcy court that they are seeking and will conduct an immediate foreclosure sale in order to avoid excess surcharges from a protracted sale process.

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