Memorandum Decision re:: Permitting Recovery Under §506(c) in part and Denying Recovery under §506(c) in part

Original Filed September 3, 1999


In re: Case No. 92-57143-ASW Chapter 7 Los Gatos Lodge, Inc. Debtor __________________________________/ Case No. 92-57303-ASW Chapter 7 Norman and Jean McFate, Debtors __________________________________/ MEMORANDUM DECISION PERMITTING RECOVERY UNDER §506(c) IN PART AND DENYING RECOVERY UNDER §506(c) IN PART

Before the Court is a motion in each of the above-numbered Chapter 7 cases, filed by Mohammed Poonja ("Poonja"), trustee in the case of Los Gatos Lodge, Inc. ("Corporation"). By such motions, Poonja seeks to surcharge collateral of Sacramento Savings Bank ("Bank"), predecessor of Alleghany Properties, Inc. ("Alleghany"), pursuant to 11 U.S.C.1§506(c).

Poonja is represented by Seymour J. Abrahams, Esq. and Alleghany is represented by Jeffrey B. Gardner, Esq. of Saxon, Barry, Gardner & Kincannon. The matter has been briefed and argued, and this Memorandum Decision constitutes the Court's findings of fact and conclusions of law pursuant to Rule 7052 of the Federal Rules of Bankruptcy Procedure ("FRBP").


The facts of this matter are largely undisputed.

Corporation is the Debtor in Chapter 7 Case No. 92-57143, and Norman and Jean McFate ("McFates") are the Debtors in Chapter 7 Case No. 92-57303. McFates (or their family trust) owned the shares of Corporation; McFates (or their family trust) also owned the real property upon which Corporation's business was located, and leased the real property to Corporation. Corporation owned a building on the real property, where Corporation operated a business consisting of a motel, a restaurant, and a cocktail lounge.

Corporation filed a Chapter 11 petition on October 13, 1992 and McFates filed one on October 20, 1992. Each bankruptcy debtor operated as a debtor-in-possession until June 9, 1993, when a Chapter 11 trustee was appointed in each case: Poonja was appointed in Corporation's case and John Richardson ("Richardson") was appointed in McFates' case. Corporation's case was converted to Chapter 7 on November 26, 1993 and Poonja was appointed Chapter 7 trustee; McFates' case was converted to Chapter 7 on December 17, 1993 and Richardson was appointed Chapter 7 trustee.

Bank was owed over $6.5 million by McFates, which debt was secured by a first deed of trust on the real property that was owned by McFates (or their family trust) and leased to Corporation. Bank claimed that such debt of McFates was also secured by a security interest in personal property of the motel business that Corporation operated upon the real property, and in the rents generated by the motel; the rents were subject to a senior security interest held by Comerica Bank and the Court ruled during the Chapter 11 phase of the cases that Bank held no security interest in rents.

While the cases were in Chapter 11, Bank sought stay relief to foreclose and such relief was granted in June 1993 with a stay until September 2, 1993. Bank foreclosed on the real property October 7, 1993 and bid $6,570,903.47, which was $200,000 less than Bank was owed. Bank then foreclosed under its claimed personal property security interest and bid $200,000 for that property.

At the request of another creditor, Poonja was appointed Chapter 11 trustee in Corporation's case at approximately the same time that stay relief was granted to Bank. At the hearing on appointment of a trustee, Bank asked that a single trustee be appointed to handle both Corporation's estate and McFates' estate, but the office of the United States Trustee appointed separate trustees. As trustee, Poonja operated Corporation's business for approximately four months, until the foreclosures and (by agreement with Bank) for six days after the foreclosure, until Bank took possession. Bank never expressly consented to Poonja surcharging Bank's collateral under §506(c), nor did Bank tell Poonja during his operation of the business that Bank would oppose such a surcharge.

Poonja took the position that Bank's personal property security interest did not extend to property owned by Corporation and applied only to property owned by McFates, who were Bank's debtors and who had granted the security interest. That controversy was compromised in May 1994 by a Court-approved settlement ("Settlement"), under which: 1) Bank paid Poonja $138,054.39 (allocated by Allegheny as: $3,100 for a van; $9,000 for the business' liquor license; $17,454.39 for inventory and cash on hand; $28,500 for the business' name and goodwill; and $80,000 for furnishings, fixtures, and equipment); 2) Poonja agreed to assert no further interest in the subject personal property; 3) the secured claim that Bank had filed in Corporation's case was disallowed; and 4) Poonja turned over $21,000 of the amount paid by Bank to Comerica, which had asserted a senior security interest in some of the same property that Bank claimed as collateral. The Settlement expressly provides that the parties' respective rights under §506(c) are not affected by the Settlement and are reserved.

Poonja claims to have devoted $80,861.37 worth of time and money to operating Corporation's business, and has requested allowance of a Chapter 11 administrative expense claim in McFates' case for that amount. Poonja has received in response a letter from counsel for Richardson, refusing to pay such claim and saying that Poonja should pursue Bank under §506(c) because it was Bank that benefitted from Poonja's efforts rather than McFates' estate, and Richardson is not going to pursue Bank under §506(c) on behalf of McFates' estate.


Poonja seeks to recover from Bank's successor Alleghany the sum of $80,861.37, alleged to be the value of Poonja's services and expenditures devoted to preserve Bank's collateral, which preservation is alleged to have benefitted Bank to an extent exceeding such amount; he also seeks attorney's fees (in an amount to be determined) incurred to pursue such recovery. Poonja is proceeding under §506(c), which provides:

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. Alleghany opposes, on the following bases:

A/ Relief under §506(c) must be sought by means of an adversary proceeding. B/ Poonja lacks standing as trustee of Corporation's estate, since Bank is not a secured creditor of that estate and §506(c) permits recovery only from "property securing an allowed secured claim". C/ Poonja lacks standing as an administrative creditor of McFates' estate because he does not hold an allowed administrative claim in that case. D/ Poonja's services did not benefit Bank and §506(c) permits recovery only "to the extent of any benefit to the holder of" an allowed claim secured by the property sought to be surcharged. E/ Poonja's charges are not reasonable and/or necessary.

A. Requirement of Adversary Proceeding

Alleghany correctly points out that FRBP 7001(1) requires an adversary proceeding "to recover money or property", with certain exceptions not relevant here.

Poonja argues that everything is before the Court now and no purpose would be served by requiring him to commence an adversary proceeding and file the same pleadings in that matter that have already been filed in these two bankruptcy cases. Poonja notes that In re Palomar Truck Corp., 951 F.2d 229 (9th Cir. 1991), cert. denied sub nom General Electric Capital Corp. v. North County Jeep & Renault, Inc., 506 U.S. 821, 113 S.Ct. 71 (1992) ("Palomar") and "many" other cases concerning §506(c) have been handled as contested matters rather than as adversary proceedings. That is true (at least as to Palomar), but Palomar is distinguishable, since there is no indication in that case of any objection to the motion procedure, whereas Alleghany does object here.

Poonja correctly points out that Alleghany has shown no prejudice thus far from the use of motion procedure rather than of an adversary proceeding, and cites In re Orfa, 170 B.R. 257 (E.D.Pa. 1994) ("Orfa") (a case also cited by Alleghany), in which a district court declined to "elevate form over substance" by requiring an adversary proceeding where no prejudice was shown to have resulted from treating the dispute as a contested matter. Orfa cites with approval In re Command Services Corp., 102 B.R. 905, 908-909 (Bkrtcy. N.D.N.Y. 1989), which in turn cites extensive authority supporting Poonja's position:

... courts have concluded that where the rights of the affected parties have been adequately presented so that no prejudice has arisen, form will not be elevated over substance and the matter will be allowed to proceed on the merits as originally filed. See, e.g., In re Szostek, 93 B.R. 399, 403 n. 6 (Bankr.E.D.Pa.1988) (Bankr.R. 7001(5): revocation of confirmation order); In re Morysville Body Works, Inc., 89 B.R. 440, 441_442 (Bankr.E.D. Pa.1988) (Bankr.R. 7001(7): debtor's petition to stay IRS in collecting responsible penalty tax from its principal); In re Roberts Hardware, Co., No. 87_01800, slip op. at 4 n. 3, ___ B.R. ____, ____, n. 3 (Bankr.N.D.N.Y. Apr. 11, 1988) (Bankr. R. 7001(1): action to recover property); In re Data Entry Serv. Corp., 81 B.R. 467, 468 n. 1 (Bankr.N.D.Ill.1988) (Bankr.R. 7001(2): lien determination and distribution order); In re McClain Airlines, Inc., 80 B.R. 175 (Bankr.D. Ariz.1987) (defense under Code § 541 to debtor's motion to assume lease does not require opponent to file adversary complaint); In re Stern, 70 B.R. 472, 473 n. 1 (Bankr.E.D.Pa.1987) (Bankr.R. 7001(4): revocation of discharge); In re Wallman, 71 B.R. 125, 126 n. 1 (Bankr.D.S.D. 1987) (Bankr.R. 7001(2): debtor's motion for contempt and sanctions due to nonexistence of lien); Doran v. Treiling (In re Treiling), 21 B.R. 940, 941 n. 1 (Bankr.E.D.N.Y.1982) (Bankr.R. 7001(1): pro- ceeding to recover money); cf. Smith v. New York State Higher Education Serv. Corp. (In re Smith), No. 83_01317, slip op. at 8_9, 11, ___ B.R. ____, ____ _ ____, ____ (Bankr.N.D.N.Y. Mar. 21, 1988) (noting operative verb in Bankr.R. 7001 is "may", in contrast to "shall" in Bankr.R. 9014). Accord In re Banks, 94 B.R. 772 (Bankr. M.D.Fla.1989) (motion of Chapter 11 debtor's counsel for recog- nition and approval of charging lien). ... Indeed, the notice pleading of the Federal Rules and the mandate of Rule 8(f) of the Federal Rules of Civil Procedure ("Fed.R.Civ.P."), incorporated by Bank. R. 7008(a), that "[a]ll pleadings shall be so construed as to do substantial justice" support this liberal interpretation by a court of equity. ... Bankr.R. 9005 is also germane, applying as it does Fed.R.Civ.P. 61 which provides, in part, that "[t]he court at every stage of the proceeding must disregard any error or defect in the proceeding which does not affect the substantial rights of the parties." See In re Ross & Hurney Paving, Inc., supra,51 B.R. at 375.

Alleghany has not cited, nor has this Court located, any binding precedent that prohibits use of motion procedure for claims under §506(c). FRBP 9014 provides that the Court "may at any stage in a particular matter" direct that any of the rules governing adversary proceedings are to apply to contested matters such as motions. Under the circumstances of this case, Alleghany's rights will be fully protected if Part VII of the FRBP governing adversary proceedings is applied to these motions with respect to any future proceedings.

Poonja may proceed under §506(c) by means of motion, with the rules governing adversary proceedings made applicable prospectively.

B. Poonja's Standing in Corporation's Case

Alleghany argues that Poonja lacks standing to assert §506(c) against Alleghany in Corporation's case because Alleghany's predecessor Bank did not hold an allowed secured claim in Corporation's case and §506(c) only applies to recovery from "property securing an allowed secured claim". Alleghany notes that Poonja objected to the secured claim filed by Bank in Corporation's case, which secured claim was disallowed pursuant to the Settlement.

Poonja points out that Rule 408 of the Federal Rules of Evidence ("FRE") prohibits evidence of a settlement to prove the validity or amount of a claim so, to any extent that the Settlement may have determined whether Bank was a secured creditor in Corporation's case, the Settlement should not be admitted as evidence to establish that fact now. Poonja is correct since, unlike a judicial decision, a settlement does not determine the truth of any disputed fact, it merely acts prospectively to give effect to a bargain; these parties' agreement to treat each other in certain ways does not mean that Bank's claim was not (or was) actually secured. Poonja also notes that the Settlement expressly reserves issues concerning the parties' respective rights under §506(c), so that such rights cannot now be affected by the fact that the Settlement exists, nor by the provisions or operation of the Settlement. The Court agrees with Poonja's position on that point since, to do otherwise would be contrary to the parties' agreement that their §506(c) rights would remain intact despite the Settlement.

Poonja argues that Bank was a secured creditor of Corporation's estate at the time Poonja performed the subject services (June through October 1993) and lost that status only by virtue of the Settlement (May 1994), which occurred after Poonja had provided Bank with the benefit of his work in operating the business until Bank foreclosed and took possession. Under the Settlement, Bank acquired from Corporation's estate title to personal property that Bank had not attempted to foreclose upon (items such as the van and the liquor license, which were indisputably not encompassed within Bank's security interest), and also was relieved of a cloud on title to such personal property as Bank had purported to foreclose upon under a security interest that Poonja claimed was defective. Once the Settlement was completed, Bank ceased to be a secured creditor of Corporation's estate but, prior to that time, Bank was a secured creditor of Corporation's estate because there had been no judicial determination that the security interest asserted by Bank was not valid. Further (although Poonja does not make this point), §502 provides that a claim is deemed allowed until objected to and the secured claim filed by Bank was only disallowed as part of the Settlement, after Poonja's services had been provided. Alleghany cites no facts or law under which Bank's loss of secured status at the time of the Settlement in May 1994 should be given retroactive effect 2, such that Bank should be considered to have been an unsecured creditor at the time Poonja was rendering services during the latter half of 1993. Poonja is correct that Bank was the holder of an allowed secured claim in Corporation's case at the time Poonja rendered the services for which he now seeks to charge Alleghany.

Poonja argues that the requirement of secured creditor status contained in §506(c) should apply to the creditor's status at the time the creditor's collateral is benefitted, not to the creditor's status at some later time after the benefit has already been conferred -- Alleghany appears to argue the opposite position, although that is not entirely clear. Poonja cites no authority for his proposition, nor has this Court located anything on point, but the opposite approach would render the statute useless in many (perhaps most) situations. Adopting a position contrary to that taken by Poonja would mean that §506(c) could never be used after a secured creditor forecloses because a secured creditor that has foreclosed upon its collateral is necessarily left with only an unsecured deficiency claim against the estate; it would be nonsensical to say that one who preserves collateral pre-foreclosure cannot use §506(c) post-foreclosure, merely because the creditor who was secured by the collateral pre-foreclosure (during the period of preservation) is no longer secured post-foreclosure. Similarly, whenever a trustee or debtor-in-possession sells a secured creditor's collateral and pays the creditor in full from proceeds, the creditor thereupon ceases to be a creditor of the estate; if the relevant time for secured status was something other than the time at which the collateral was benefitted, the seller could not, post-payoff, look to the former creditor to recover expenses of sale and/or of preserving the collateral pending sale because the former creditor would then no longer be a secured creditor, having been paid in full.

Alleghany also argues that Bank was unsecured because Bank's claimed collateral was subject to a senior lien held by Comerica for $553,000, which was far more than the value of Bank's claimed collateral, so that Bank was undersecured to the point of being completely unsecured. Poonja responds that this is not a case with a "massive" senior lien that absorbs all value and leaves a junior lienholder such as Bank effectively unsecured, because only part of Bank's claimed collateral was subject to a senior lien; Poonja correctly points out that Comerica's documents show its security interest to be limited to pre-petition accounts receivable and some inventory (such as food and beverage supplies, linens, and janitorial supplies), the value of which Poonja contends was not great and was consistent with the $21,000 that Comerica accepted under the Settlement. Alleghany does not argue that Comerica's security interest served to encumber all of the collateral claimed by Bank and the amount of the debt claimed by Comerica is irrelevant with respect to the extent of Comerica's security interest.

Poonja has standing to proceed under §506(c) in Corporation's case.

C. Standing in McFates' Case

Poonja contends that, if he were found to lack standing to assert §506(c) in Corporation's case, he would nevertheless have such standing in McFates' case. Alleghany argues that Poonja lacks standing to assert §506(c) in McFates' case because §506(c) is only available to the trustee of that estate or, perhaps, to the holders of allowed administrative claims against that estate, and Poonja is neither.

Poonja relies upon Palomar, a case that Alleghany contends takes an unduly "expansive" view of §506(c) and was wrongly decided. In Palomar, the holder of an allowed administrative claim proceeded under §506(c) when the Chapter 11 trustee did not make use of the statute himself and did not object to the creditor making use of it. The Ninth Circuit noted a three-way split in authority as to whether §506(c) was available for use by anyone other than a trustee or Chapter 11 debtor-in-possession, and found (at 232) that "no compelling policies are served by a restrictive reading of §506(c) in the circumstances of this case"; the Court also noted (id.) that, if somebody did not make use of §506(c), the result would be a "windfall" to the secured creditor whose collateral was enhanced by the administrative creditor. Alleghany argues that United States v. Ron Pair Enterprises, 489 U.S. 235, 109 S.Ct. 1026 (1989) ("Ron Pair") calls for statutory interpretation based on "plain meaning" and §506(c) expressly provides for recovery by a "trustee", so the Ninth Circuit should not have permitted anyone other than a trustee to use it. Poonja points out that Palomar was decided in 1991, two years after Ron Pair, so the Ninth Circuit must have been aware of Ron Pair in making the decision that it did. In any event, however much Alleghany may disagree with Palomar, the fact remains (as Poonja notes) that the case has not been overturned and remains binding upon this Court.

Alleghany argues that, even if Palomar is applied here, it does not assist Poonja, since the non-trustee party permitted to make use of §506(c) in that case was an administrative creditor and Poonja does not hold an allowed administrative claim in McFates' case. Poonja points out that Alleghany cites no authority for the proposition that a non-trustee using §506(c) must be an administrative creditor, simply because that is what the non-trustee party in Palomar happened to be; Poonja argues that the rationale of Palomar was to avoid a "windfall" to a secured creditor who benefitted from a non-trustee's efforts, and such rationale would be defeated by denying relief to Poonja solely because he may not hold an allowed administrative claim against McFates' estate. This Court agrees with Poonja that the rationale of Palomar does not depend upon whether the non-trustee party seeking to use §506(c) holds an allowed administrative claim -- the stated goal of Palomar was to avoid windfalls to secured creditors who are benefitted by the services of others (whether those others be trustees, administrative creditors, or some different type of party in interest) and there is no apparent reason for limiting the holding of that case to administrative creditors as opposed to some other kind of non-trustee party. One of the three schools of thought discussed by Palomar holds that a non-trustee party can make use of §506(c) only when the trustee has refused to do so, and that is the case here, where counsel for McFates' trustee Richardson has stated that Richardson will not make use of §506(c).

Pursuant to Palomar, Poonja has standing to proceed under §506(c) in McFates' case.

D. Benefit

The Ninth Circuit has held that

[T]o satisfy the benefit test of section 506(c), [the movant] must establish in quantifiable terms that it expended funds directly to protect and preserve the collateral. [Citations omitted]. [The movant's] recovery, however, is limited to the extent that the secured creditor benefited from the services. [Citation omitted].

In re Cascade Hydraulics and Utility Service, Inc., 815 F.2d 546, 548 (9th Cir. 1987).

Alleghany argues that Poonja's services in operating Corporation's business did not benefit Bank, or at least not to the extent of more than the $138,054.39 that Bank paid Poonja under the Settlement, and that Poonja's operation of the business was for the purpose of benefitting Corporation's estate and did benefit that estate.

Poonja contends that, when he was appointed Chapter 11 trustee, Corporation had no prospect of reorganization, because: Bank had received relief to foreclose in three months; the lease to the real property upon which Corporation's business was located had been deemed rejected when not assumed within sixty days post-petition as required by §365, and Corporation owed "many months" of unpaid rent; tangible assets were of "limited value"; gross revenues for that year were $2,340,000 with anticipated net earnings of $112,313, without accounting for monthly rent of $72,000 ($864,000 per year); Corporation had "serious" problems with its management company and faced charges of unfair labor practices and illegal activity in the lounge; "very substantial" deferred maintenance required attention (including termite fumigation) and one wing of the motel could not be rented due to its poor condition. Poonja claims that the only reason he undertook operation of the business was to preserve its going-concern value pending Bank's upcoming foreclosure, in case the trustee in McFates' case were able to prevent foreclosure by sale or refinance. However, foreclosure did occur and Bank bid $200,000 for the personal property of Corporation in which Bank asserted a security interest. Poonja points out that, had he not kept the business operating until Bank foreclosed, Bank would have taken over only a vacant building furnished and equipped as a motel/restaurant/lounge that had been closed for four months, which interruption would have created such problems as: a need to hire and train new employees; a loss of advance reservations; a "very substantial" loss of business from travel agents and corporate travel managers, whose patronage would be transferred elsewhere after the closing and would have to be solicited again, if it could be recaptured at all; a loss of established customers for the restaurant and lounge, who would find other facilities during the hiatus and might not return; risks of theft and vandalism, and the expense of preventive attempts such as fencing and security services; the possible necessity of conforming to local building codes as a prerequisite of reopening; and a "great reduction" in resale value compared to the value of a functioning business operation. Alleghany notes that Poonja's point about the possibility of Bank having to comply with current building codes is "speculative", but does not seriously contradict the rest of Poonja's allegations. Poonja has been on this Court's panel of Chapter 7 trustees for many years, is an experienced Chapter 11 trustee and examiner, and has served as a receiver in State Court matters; he is well qualified to state reliable opinions as to the difference between taking over a business such as that here in the form of a going concern, and taking over such a business after it has been closed for four months. Poonja has demonstrated that the value of Bank's collateral was preserved by his operation of the business pending foreclosure.

Poonja does not attempt to compare in dollar amounts the value that Bank's collateral would have had if the business had not been operated with the value that Bank's collateral did ultimately have, other than to contend that the collateral's value would have been depressed had the business closed, and that Bank bid $200,000 at foreclosure for the personal property in which Bank asserted a security interest. Alleghany does not attempt to show that the value of its collateral declined during Poonja's operation. Poonja has established that Bank's collateral was worth at least the amount that Bank bid for it at foreclosure (i.e., $200,000).

Alleghany argues that Bank paid $138,054.39 under the Settlement to buy the subject personal property from Corporation's estate, and that the price set by the Settlement should be considered to represent any value attributable to Poonja's services (which amount has already been paid in full). Poonja argues that evidence of the Settlement cannot be used to show the value of the personal property because FRE 408 forbids use of settlements to prove the amount of a claim, and also points out that the Settlement expressly provides for §506(c) rights to be unaffected by the Settlement. As discussed below, the price paid by Bank under the Settlement appears to have been based on many factors other than the value of the personal property but, whatever that price may have represented, the plain language of the Settlement makes clear that the price was not compensation as con- templated by §506(c). The Settlement's provision that the parties' rights under §506(c) are to remain unaffected is completely in- consistent with Alleghany's position that the amount called for by the Settlement should determine an issue raised by §506(c), i.e., the value of Bank's collateral.

Poonja contends that, if the price in the Settlement is to be considered, the "controlling factors" in arriving at that price must also be taken into account, and are as follows: that Bank had "a very strong claim" that Bank already owned most of the personal property by virtue of having bid $200,000 for it in foreclosure, whereas Poonja had a "technical" argument against the validity of Bank's security interest; that it would be expensive for Poonja to remove from the premises such things as air conditioners, stoves, beds, dressers, etc. and their market value once removed would be "negligible", whereas it would be expensive for Bank to install replacement items for whatever Poonja removed; and that Bank wanted to avoid delay in using the business' liquor license. Poonja points out that Bank was the party allocating the amount paid under the Settlement, and Poonja considers the allocations to be "low" under normal circumstances (e.g., $30,000 for good will and signs of a motel/restaurant/lounge is low, even for a business being sold in bankruptcy). This Court concludes that the facts surrounding creation of the Settlement show that it was intended by the parties to be just that, a settlement, designed to compromise a controversy as to whether Bank held a valid security interest in personal property that Bank wished to own. Bank had just bid $200,000 to acquire the property by foreclosure, only to face Poonja's "technical" challenge that Bank had no security interest to foreclose; even though it might not be cost effective for Poonja to remove the property from the building, it would be time-consuming and costly for Bank to replace the property if Poonja did remove it -- further, Corporation's estate held title to a van and a liquor license that Bank wanted soon and those were indisputably not subject to Bank's claimed security interest, so Poonja's control of those items gave him some leverage with respect to the other items. The position of each party had strong points and weak points, and litigation would have entailed risk, delay, and expense for both -- those are factors typically found in compromises, and compromise is what occurred in this case. Bank agreed to pay $1,300 to buy the van and $9,000 to buy the liquor license, plus $125,954.39 to settle the dispute over the validity of the security interest that Bank claimed in the other items. The gravamen of the Settlement is not a purchase of Bank's claimed collateral, it is a compromise that can be presumed to have taken into account not only the subject property's value to each party, but also such factors as litigation costs avoided, expenses associated with delay, and the degree of risk posed by litigation. To any extent that the Settlement may be indicative of the collateral's value, it is certainly not dispositive of that issue and Alleghany has not established that Bank's payment of the amount called for by the Settlement constituted payment for the full value of the collateral, as opposed to payment in order to effect compromise of a controversy. As for whether Corporation's estate benefitted from Poonja's operation of the business, Alleghany argues that the business was operating at a monthly net loss of $29,000 when Poonja took over but was operating at a monthly net gain of $1,000 when Bank foreclosed, so the estate benefitted from Poonja's efforts to the extent of at least $90,000, which enabled Poonja to sell estate assets such as inventory and goodwill to Bank. Poonja replies that Alleghany's figures are drawn from the monthly operating reports filed by Corporation's estate and those were prepared on a "modified accrual" basis so as to be consistent with the method used by Corporation prior to Poonja's appointment as trustee; such basis did not account for monthly rent of $72,000 that was being accrued but not paid, and rent payments of even $6,000 per month would have absorbed any apparent profit. Poonja also points out that his operation of the business could not have assisted the estate because there was no hope of reorganization, for the reasons set forth above. Poonja's operation of the business has not been shown to have been for the benefit of the estate, nor to have actually benefitted the estate rather than having benefitted Bank.

E. Reasonable and Necessary Charges

Expenses recoverable under §506(c) are limited to "the reasonable, necessary costs and expenses of preserving, or disposing of" the collateral sought to be surcharged. Alleghany argues that Poonja claims amounts that were not reasonable and necessary, for various reasons discussed below.

Poonja likens the services provided by him to those of receivers in State Court matters. Poonja contends that, if a Chapter 11 trustee had not been appointed, Bank's remedy would have been to seek appointment of a receiver in the State Court to run the business pending foreclosure, in order to preserve the going-concern value of the collateral -- however, Bank's receiver could not have taken charge of assets that were not Bank's collateral, such as receipts of the restaurant and lounge, or the liquor license needed to operate the lounge, or the accounts receivable and rents that were subject to the security interest of Comerica -- thanks to the appointment of a Chapter 11 trustee, Bank was not limited to the imperfect remedy of receivership and was instead able to avail itself of Poonja's services in operating the entire three-part business with the liquor license intact. Poonja provides a declaration by Randy Sugarman and one by Jerome Robertson, both of whom state that they are experienced receivers in State Court matters: the Sugarman declaration states that he charges $300 per hour for his services, $220 to $250 per hour for the services of partners and principals in his firm, $100 per hour for the services of financial analysts, and $40 per hour for clerical services; the Robertson declaration states that he charges $200 per hour for his services, $125 per hour for the services of his associates, and $85 per hour for clerical and accounting services; each declarant opines that a receivership of the type described by Poonja would be time-consuming and expensive, though neither has reviewed Poonja's itemized charges. Poonja also provides a declaration of himself, in which he states that he has served as a receiver in State Court matters and it is his opinion that operation of Corporation's business by a receiver would have cost at least as much as Poonja now seeks; he also points out that, in order to have a receiver appointed, Bank would have had to pay: 1) an attorney to file a complaint and move for appointment; 2) the cost of posting a receivership bond; 3) an attorney to represent the receiver; and 4) the receiver's fees and expenses. Poonja's itemized charges include $250 per hour for his services and $80 per hour for the services of an associate; they also include $14,000 in rent payments attributable to the period during which Poonja operated the business prior to Bank's foreclosure, based on a Court-approved compromise with trustee Richardson for rent owed by Corporation's estate to McFates' estate.

Alleghany complains that Poonja charges for overhead, including preparation of reports filed with the Court. Poonja points out that receivers in State Court matters charge, and are paid, for all services in connection with the receivership, including preparation of reports required by the State Court. Poonja's charges do not include specific items of overhead, such as his office rent or the like.

Alleghany notes that the recovery sought by Poonja exceeds that permitted by §326 governing compensation of bankruptcy trustees. Poonja correctly points out that §326 limits what bankruptcy trustees are permitted to charge estates, not what they are permitted to recover from others for estates, and it is the latter that Poonja seeks to do here. Poonja confirms that the recovery sought by these motions is for the benefit of Corporation's estate and not for Poonja's own personal benefit, noting that his trustee commission based on such recovery will be only the 3% rate provided by §326.

Alleghany takes issue with Poonja's charges of $80 per hour for services provided by an associate, without explaining why such amount is too much. Poonja responds by stating the associate's qualifications and duties (most of which appear to have been clerical), and also points out that the Robertson declaration states an hourly rate of $85 for "clerical" staff of a receiver.

This Court agrees with Poonja's analogy of his role in operating this business to that occupied by a State Court receiver, since it does appear that receivership would have been Bank's remedy in the absence of a trustee; Alleghany does not contend otherwise, or show that the analogy is inapposite. The declarations of Sugarman, Robertson, and Poonja are useful in determining the type and amount of reasonable and necessary charges incurred by receivers; Alleghany provides no evidence to the contrary. This Court has reviewed Poonja's charges and finds them both reasonable and necessary within the meaning of §506(c) under the facts of these cases.

Poonja also seeks to recover his attorney's fees and costs incurred to prosecute these motions (in an amount to be determined), citing In re Soucek, 50 B.R. 753 (N.D.Ill. 1985). That case does not address the issue, nor does this Court find any authority on point. Since §506(c) permits recovery only of expenses incurred to preserve or dispose of collateral, and only to the extent that such preservation or disposition benefits the holder of a lien upon such collateral, it is not readily apparent how the expense of seeking relief under §506(c) could be recoverable under that statute. Poonja has not demonstrated that he is entitled by §506(c) to recover from Alleghany his attorney's fees incurred to prosecute these motions.


For the reasons hereinabove set forth:

Poonja's motions are granted in part and he is entitled to recover from Alleghany the sum of $80,861.37 ($65,520.80 for services plus $15,340.57 for costs) pursuant to §506(c), as reasonable and necessary expenses incurred to preserve the collateral of Alleghany's predecessor; and

Poonja's motions are denied in part and he is not entitled to recover from Alleghany his attorney's fees and costs incurred to prosecute such motions; such denial is without prejudice to Poonja demonstrating entitlement to such recovery under §506(c).

Counsel for Poonja shall submit an order consistent with this Memorandum Decision, after review as to form by counsel for Alleghany.

Dated: September 3, 1999 ______________________________ ARTHUR S. WEISSBRODT United States Bankruptcy Judge

1These cases were filed prior to October 22, 1994, the effective date of the amendments to Title 11, United States Code ("Bankruptcy Code") that were enacted in 1994; unless otherwise noted, all statutory references are to Title 11 as it provided prior to such amendments. §506(c).

2This is not a situation where a court found in a contested proceeding that no security interest ever existed, and this Court does not reach the issue of what the result would be under such facts.

CANB DocumentsNorthern District of California