Memorandum of Decision Re: Postconfirmation Matters

FOR THE NORTHERN DISTRICT OF CALIFORNIA In re COMMERCIAL ASSOCIATES I,                                       No. 587-06639-WCM      Debtor. ___________________________/
Memorandum of Decision
     Debtor Commercial Associates I is the former tenant of landlords Witt and Kennedy under a 65-year ground lease of commercial property. After a long legal battle with Witt and Kennedy, the debtor's Chapter 11 plan was confirmed a few months ago. The plan provided for the assumption and assignment of the lease to a new tenant.      Pursuant to the plan, a sum of money was held in escrow and the parties reserved the issue of whether Witt and Kennedy are entitled to reimbursement of their attorneys' fees as a condition of assumption. However, this simple issue has multiplied in the months since confirmation into a myriad of related issues, claims and counterclaims involving the debtor, Witt and Kennedy, and Mercury Savings & Loan, the construction lender. Since a provision of the plan left the door open for the raising of such issues, the doctrine of res judicata does not bar their postconfirmation litigation. The court accordingly will plunge into the sea of issues, in no particular order.
1. Past Due Rents
     Lessor Witt, not joined by lessors Kennedy, claims that more rents are due because rents for 1986 through 1988 were improperly calculated. Specifically, he argues that payments made by the debtor to Mercury were not proper deductions in determining the adjusted gross revenue of the debtor.      Despite a voluminous lease, it is clear that a circumstance occurred that was not specifically contemplated. Although Mercury loaned over $2 million, it did not insist on subordination of the lessors' interest and was accordingly not a "First Mortgagee" under the lease. The lease specifically allows as deductions only payments to the First Mortgagee. Witt argues that since Mercury was not a First Mortgagee, payments to it may not be deducted in computing the adjusted gross revenue upon which the rents are calculated.      The problem with Witt's argument is that the lease does not exclude payments to an entity which is not a First Mortgagee. The lease says that all cash expenditures for the benefit of or with respect to the property are proper deductions; the payments to Mercury clearly fall within this definition. The only expenditure excluded from the calculation of adjusted gross revenue is a rent payment to the landlords themselves. Thus, just because the payments to Mercury were not payments to a First Mortgagee, which are by the lease specifically included as proper deductions, does not mean that they were excluded from being proper deductions. The payments fall within the general definition of what is deductible, and the lease does not exclude from deductibility payments made to a secured creditor who is not a First Mortgagee.      As a fallback position, Witt argues that some of the funds borrowed from Mercury were used to reimburse the debtor for rents paid to the landlords. While the court agrees in principal that repayment of such funds is not deductible, a quick mental calculation shows that even if the unproved allegation were true the amount involved would be de minimus. The payments to Mercury were interest only, and the rents under the lease were only two percent of the adjusted gross income. Thus, any underpayment is only two percent of the interest on that small portion of the Mercury loan which was used to reimburse the debtor for rents. This comes out to roughly $400 per year, a sum too small to fuss with.       For the above reasons, Witt's application for an award of rents still owing will be denied.
2. Award of Attorneys' Fees to the Debtor
     The debtor alleges that because it obtained confirmation of its plan over the landlords' objection, it is entitled, as a "prevailing party," to recover its attorneys' fees from the landlords, and surcharge them for Mercury's fees as well. The court sees no merit in this claim for both factual and legal reasons.      Factually, the only reason that the plan was confirmed was that it was substantially modified during the confirmation hearing. To say that the debtor was the "prevailing party" because a plan was ultimately confirmed, and ignore months of trying to sell an unconfirmable version of the plan, is not something the court is prepared to do.      As a matter of law, a debtor is not entitled to attorneys' fees based on state law for obtaining confirmation of a plan over a party's objection. The plan confirmation process is unique to federal bankruptcy law, with no state law equivalent. Under such circumstances, attorneys' fees are recoverable only if federal law so provides. In re Johnson, 756 F.2d 738 (9th Cir.1985).
3. Fees of Witt and Kennedy
     Pursuant to resolution of state court litigation, lessors Witt and Kennedy recovered $50,000 in attorneys' fees from the debtor. The issue now before the court is whether they are entitled to additional reimbursement for attorneys' fees incurred in contesting the debtor's plan. Witt seeks and additional $80,000 in such fees and costs, and the Kennedys seek $28,000.      The court's first inquiry is whether section 506(b) of the Bankruptcy Code is applicable. That section allows an oversecured creditor to recover reasonable attorney's fees if there is a contractual provision which so provides. While in form Witt and Kennedy are lessors, the form of the financing vehicle should not alter the fact that they are in substance secured creditors. Such an approach is the "easy way" for the court to resolve the issue, as under section 506(b) a creditor may be awarded fees for any reasonable service, even if unsuccessful. In re Mills, 77 B.R. 413, 418 (Bkrtcy.S.D.N.Y.1987); In re Brunel, 54 B.R. 462, 465 (Bkrtcy.D.Colo.1985).      Unfortunately, the ground lease itself is not sufficient to afford the court an easy way of dealing with the problem. Deeds of trust usually contain a clause allowing the beneficiary to add to the amount of the obligation any attorney's fees incurred in protecting the beneficiary's interest, and such a clause clearly allows fees under section 506(b). However, the ground lease here contains no such provision. Witt points to Article 3.2, which does not mention attorneys fees and excludes from reimbursement expenses "incurred by or at the instance of Landlord." At the very least, it is far too vague to support an award of attorneys' fees. Witt also points to Article 23, which provides for attorney's fees to the prevailing party in litigation. In this regard Witt is no more a prevailing party than the debtor, in that he continued to fight the plan even after its amendment, and lost on the key issue as to whether the subordination provision in the lease was enforceable upon assumption.      Being prevented by the lease itself from looking to section 506(b), the court must base any award of attorneys' fees to the lessors on section 365(b)(1)(B) of the Code, which requires the bankruptcy estate to compensate the lessors for "actual pecuniary loss to such party resulting from such default." Such pecuniary losses include attorneys' fees. In re Bullock, 17 B.R. 438, 439 (9th Cir.BAP 1982). This is a more difficult application than 506(b) because under 506(b) the court could find reasonable any services, even if they were unsuccessful. Under section 365(b)(1)(B), only such fees which were incurred as the result of a default are recoverable. Therefore, fees for time spent litigating over an alleged default are not recoverable if the court ultimately found that there was no default.      Reviewing the fee applications with the above principles in mind, the court sees that the vast majority of the fees were directed toward defaults which the court found existed. However, some of the fees were associated with the landlord's argument that the lease could not be assumed because of the subordination provision. Since the lessors lost on this issue, the fees associated with its litigation cannot be said to be related to a default and section 365(b)(1)(B) does not require their reimbursement as a condition of assumption.      After a full review of the applications, the court finds that the sum of $25,000.00 is reasonable additional compensation to the Kennedys and $50,000.00 is reasonable additional compensation to Witt for attorney's fees related to defaults. The court has cut back Witt more than Kennedy because some of the fees sought by Witt's counsel were associated with the state court litigation for which he has already received full compensation. Also, some of Witt's application seems to be unnecessarily duplicative.
4. Fees of Mercury
     When the escrow for the assigment of the lease to the new buyer was ready to close, Mercury gave a demand for payoff to the escrow holder which included some $73,000.00 in attorneys' fees. The debtor now asks the court to review these fees for reasonableness, and Mercury has filed an application seeking another $30,000.00.      First, the court will have nothing to do with awarding more fees to Mercury. Its demand was satisfied, and the debtor's note paid. To the extent the court has some equitable power to award Mercury more fees it declines to do so. While the court may find the fees already taken by Mercury to be reasonable, they are only barely so. Adding anything further would be unconscionable.      As previously noted, Mercury is entitled to its reasonable attorneys' fees pursuant to section 506(b). Mercury was very actively involved in the confirmation process, at one point even taking the laboring oar in trying to sell the debtor's plan to the court. It would be very naive to think that Mercury would not seek reimbursement for its attorney's fees, and equally naive to think that the amount of the fees would be a bargain. The only way a trustor under a deed of trust can avoid having what many would see as exorbitant attorneys' fees added to its obligation is to keep the beneficiary from incurring any legal fees at all. Once it becomes necessary for the beneficiary to hire a lawyer, the trustor is not likely to be happy with the beneficiary's bottom line.      The fees paid to Mercury out of escrow are about thirty percent higher than the figure the court would have guessed, given the role it saw Mercury play in the confirmation process. However, they represent bills actually paid by Mercury and they are not out of line with the obligation owed to Mercury, which was well over $2 million. The court therefore reluctantly finds those fees reasonable, but not one penny more. Mercury and the debtor shall each bear their own attorneys' fees incurred in litigating this dispute over fees.
5. Priorities
     The funds held aside pursuant to the plan to compensate the lessors pursuant to section 365(b)(1)(B) are not property of the debtor's estate until after the landlord's claims have been satisfied. Accordingly, they are not to be prorated between the lessors and debtor's counsel. The latter may be compensated only from property of the estate, not property of the lessors.      No additional attorneys' fees will be awarded to any party as a result of litigating any of the issues addressed in this memorandum.      Counsel for the debtor shall submit an appropriate form of order which counsel for Witt, Kennedy, and Mercury have approved as conforming to the above decisions.
Dated: July 7, 1990                                                                              _______________________                                                                                                                      Alan Jaroslovsky                                                                                                                      U.S. Bankruptcy