After an oversecured creditor obtained relief from the automatic stay and foreclosed on some property, the bankruptcy court asserted jurisdiction over disposition of the sale proceeds and denied in part the creditor’s claim for fees. The district court reversed and the case was appealed to the 5th Circuit.
The debtor owned an office building that was subject to a deed of trust. The lender (Wells Fargo) obtained relief from the automatic stay to permit it to proceed with a foreclosure sale in accordance with state law.
The trustee under the deed of trust conducted a non-judicial foreclosure sale that resulted in proceeds of ~$4.4 million. The proposed distribution of sale proceeds was as follows: (1) trustee commission of $217,750 (5% of the bid), (2) Wells Fargo indebtedness of ~ $3.3 million (including attorneys’ fees of more than $87,000), (3) junior lienholder indebtedness of ~$619,000, and (4) ~$222,000 to the debtor.
After the bankruptcy court concluded that disposition of the sale proceeds was subject to its jurisdiction, it reduced the amount payable to Wells Fargo on the basis that its claim included costs that were not reasonable. The district court reversed, holding that once the stay was lifted and the foreclosure sale occurred, the bankruptcy court no longer had jurisdiction over the property or the sale proceeds.
On appeal to the 5th Circuit, Wells Fargo contended that proceeds from the foreclosure sale should be applied in accordance with state law, including calculation of the amount owed under the deed of trust. In its view, the bankruptcy estate’s interest was limited to the surplus proceeds that were paid to the estate. The 5th Circuit disagreed, holding that the amount to be distributed to a secured creditor is still governed by the Bankruptcy Code notwithstanding relief from the automatic stay.
Under Section 506(b), an oversecured creditor is allowed a claim for interest and “any reasonable fees, costs, or charges provided for under the agreement.” This means that an oversecured creditor can make a claim for post-petition interest even though normally the claim would be disallowed (as a claim for interest that was unmatured as of the bankruptcy filing). In addition, it can make a claim for “reasonable” fees, costs and expense. (Note that the U.S. Supreme Court determined that “reasonable” qualifies fees, costs and expenses, but not interest in U.S. v Ron Pair Enterprises.)
On appeal the dispute was limited to the attorneys’ fees claimed by Wells Fargo and the commission of the deed of trust trustee. The court rejected an argument that if fees are valid under state law, they should be enforceable in bankruptcy.
Although the attorneys’ fees were largely post-petition, pre-petition fees were also included. A prior 5th Circuit case (Hudson Shipbuilders) already held that claims for pre-petition fees were subject to Section 506(b) notwithstanding contrary state law, and the court did not see any reason for treating post-petition fees differently. That left an argument that it should make a difference that the property had been sold at a non-judicial foreclosure sale following relief from the automatic stay. In the court’s view, this did not alter its conclusions.
The 5th Circuit noted that if state law governed once the stay was lifted and the foreclosure sale occurred, the deed of trust trustee would in effect have the power to determine the validity and amount of claims asserted by the foreclosing lender and the junior lien holder. The bankruptcy court order lifting the stay authorized Wells Fargo to foreclose using state law procedures. It did not grant any further authority and did not insulate the creditors from Section 506(b). The court emphasized that relief from the stay is not tantamount to an abandonment of the property (which would take the property out of the bankruptcy estate). Thus both the attorneys’ fees and the deed of trust trustee fees must be reasonable.
Although the trustee’s contractual fee of $217,750 (5% of the bid) was generally enforceable under state law, that did not mean that the fee was reasonable for purposes of the Bankruptcy Code. In effect Section 506(b) preempted state law. The court found that the bankruptcy court did not abuse its discretion in determining that a reasonable fee was $7,500 based on testimony that (1) the trustee spent between 10 and 20 hours carrying out the foreclosure and (2) her hourly rate was $375.
With respect to the attorneys’ fees, although the court acknowledged that Wells Fargo actually paid fees in the amount of $87,894, it concluded that the bankruptcy court was also within its discretion in denying the request for fees in its entirety because the claim was not supported by a proper application and supporting documentation that the fees were reasonable.
The court closed by ruminating on whether fees that were not reasonable could be submitted as an unsecured claim, or whether fees not allowed under Section 506(b) should be totally disallowed.
The court noted 9th Circuit (268 Limited) and 11th Circuit (Welzel) opinions holding that the claims should be bifurcated and fees that were not reasonable should be treated as an unsecured claim. It also noted dicta in a 1st Circuit case (Gencarelli) agreeing with this approach. The 5th Circuit questioned whether this approach was consistent with a Supreme Court decision (Timbers) holding that Section 506(b) had the “substantive effect of denying undersecured creditors postpetition interest on their claims.”
However, it acknowledged the reasoning of a 2d Circuit case that distinguished Timbers by noting that Timbers dealt with interest and also referenced Section 502(b)(2), which disallows a claim for unmatured interest. The court also noted that in yet another case (Travelers v PG&E) the Supreme Court declined to decide whether Section 506(b) disallows unsecured claims for attorneys’ fees.
Although this issue was raised to some extent in the lower courts, the 5th Circuit declined to decide given “the sparse briefing and sketchy actual record before us.” Consequently, it left it to the bankruptcy court to consider the issue in the first instance.
Two thoughts: (1) Courts clearly do not take a uniform approach on the extent to which a secured creditor should be able to receive contractual interest and expenses that are permitted under state law. (2) Obtaining relief from the stay does not necessarily mean that a secured creditor is no longer subject to the peculiar rules of bankruptcy.
Vicki R. Harding, Esq.