First Services Group, Inc. v. O'Connell et al

UNITED STATES BANKRUPTCY COURT
EASTERN DISTRICT OF NEW YORK
------------------------------------------------------------x
In re: 	Chapter 7
CARL CERON, 	Case No. 04-25876-ess
Debtor.
------------------------------------------------------------x
FIRST SERVICES GROUP, INC.,
Plaintiff, 	Adv. Pro. No. 08-1277-ess
- against -
RICHARD E. O’CONNELL,
as Chapter 7 Trustee of the Estate of Carl Ceron,
Defendant.
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MEMORANDUM DECISION ON PLAINTIFF’S MOTION AND DEFENDANT’S
CROSS-MOTION FOR SUMMARY JUDGMENT
Appearances:
C. Nathan Dee 	Samuel E. Kramer
Cullen & Dykman LLP 	225 Broadway
100 Quentin Roosevelt Boulevard 	Suite 3300
Garden City, NY 11530 	New York, NY 10007
Attorneys for First Services Group, Inc. 	Attorneys for Richard E. O’Connell
as Chapter 7 Trustee
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HONORABLE ELIZABETH S. STONG
UNITED STATES BANKRUPTCY JUDGE
This adversary proceeding was commenced by the filing of a complaint (the
“Complaint”) by First Services Group, Inc. (“FSG”), a creditor of Carl Ceron, against Richard E.
O’Connell, the Chapter 7 Trustee (the “Trustee”) of the estate of Carl Ceron (the “Debtor”), to
recover the surplus proceeds (the “Funds”) that remain from the foreclosure sale of real property
located at 676 Georgia Avenue, Brooklyn, New York (the “Property”), on which FSG had a
junior lien.
Before the Court is FSG’s motion for summary judgment on all of its claims for relief,
which seek a determination that FSG holds a valid secured lien on the Funds, an award of that
amount plus interest, penalties, and attorneys fees, an accounting of the Funds held by the
Trustee, and the turnover of the Funds to FSG. Also before the Court is the Trustee’s cross-
motion for summary judgment, in which the Trustee opposes FSG’s summary judgment motion
and seeks the dismissal of the Complaint for failure to state a cause of action, and also seeks to
recover the reasonable and necessary costs and expenses of preserving or disposing of FSG’s
property pursuant to 11 U.S.C. § 506(c).
Jurisdiction
This Court has jurisdiction over this proceeding pursuant to 28 U.S.C. §§ 1334(b) and
157(b)(2)(F). This is a core proceeding pursuant to 28 U.S.C. § 157(b)(2)(H). The following
constitutes the Court’s findings of fact and conclusions of law pursuant to Rule 52 of the Federal
Rules of Civil Procedure, as made applicable herein by Federal Rule of Bankruptcy Procedure
7052.
Procedural History
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On November 11, 2008, FSG filed the Complaint against the Trustee. Docket No. 1. On
December 12, 2008, the Trustee filed an Answer and Counterclaim, in which he admits many of
FSG’s factual allegations and asserts certain affirmative defenses and counterclaims. Docket
No. 4.
On March 2, 2009, FSG filed a motion for summary judgment against the Trustee under
Federal Rule of Civil Procedure 56 (the “Summary Judgment Motion”) together with a
Memorandum of Law in Support of Summary Judgment Motion (the “FSG Mem.”). Docket
Nos. 9, 10. The Summary Judgment Motion is supported by the affidavit of FSG’s president,
Jon Krigsman. Docket No. 12. FSG also filed a Statement of Material Facts Pursuant to Rule
7056-1 of the Local Bankruptcy Rules for the Eastern District of New York (the “FSG Statement
of Material Facts”), in which it states that there are no issues of material fact to be tried. Docket
No. 11.
On April 27, 2009, the Trustee filed a cross-motion under Rule 56 for summary judgment
against FSG (the “Cross-Motion”). Docket No. 17. The Cross-Motion is supported by the
declarations of Samuel Kramer, the attorney for the Trustee, and Mr. O’Connell, the Trustee (the
“O’Connell Decl.”). Id. On April 30, 2009, the Trustee filed a Memorandum of Law in Support
of the Trustee’s Cross-Motion (the “Trustee Mem.”). Docket No. 19. The Trustee also filed a
response to the FSG Statement of Material Facts admitting many of FSG’s allegations and its
own Statement of Material Facts pursuant to Local Rule 7056-1 (the “Trustee Statement of
Material Facts”), in which he, like FSG, states that there are no issues of material fact to be tried.
Docket No. 17.
On June 2, 2009, FSG filed a Reply in Connection with its Summary Judgment Motion
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and Response to the Trustee’s Cross-Motion (the “FSG Reply”). Docket No. 22. FSG also filed
a response to the Trustee Statement of Material Facts admitting many of the Trustee’s
allegations. Docket No. 21.
On June 15, 2009, the Trustee filed a Reply Memorandum of Law in Support of the
Trustee’s Cross-Motion (the “Trustee Reply”). Docket No. 23. On July 30, 2009, FSG filed the
declarations of Ruth O’Connor (the “O’Connor Decl.”) of Cullen and Dykman LLP, attorneys
for FSG, and Mr. Krigsman (the “Krigsman Decl.”). Docket No. 29. And on August 8, 2009,
the Trustee filed a Supplemental Memorandum of Law in support of the Cross-Motion (the
“Trustee Supp. Mem.”). Docket No. 29. On August 24, 2009, the Trustee filed a further
declaration of Mr. Kramer (the “Kramer Reply Decl.”) and FSG filed the declaration of C.
Nathan Dee, also of Cullen and Dykman LLP (the “Dee Decl.”). Docket Nos. 31, 32.
Hearings on the Summary Judgment Motion and Cross-Motion were held on June 29,
2009, and August 6, 2009, at which counsel for FSG and counsel for the Trustee appeared and
were heard. The matters were submitted for decision on August 26, 2009. After consideration
of the submissions, the arguments of counsel, and the record before the Court, for the reasons set
forth below, the Summary Judgment Motion is granted in part and denied in part and the Cross-
Motion is granted in part and denied in part.
Background
On October 22, 2004, Mortgage Electronic Registration Systems, Inc. (“MERS”), as
nominee for Olympia Mortgage Corporation (“Olympia”), commenced a foreclosure action
against the Debtor and other defendants in the New York Supreme Court, Kings County, Index
No. 34829/04 (the “State Court Action”). FSG Statement of Material Facts ¶ 4. Olympia is
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named as both plaintiff and defendant in the State Court Action because it holds both first and
second liens in the Property. FSG Statement of Material Facts ¶ 5.
On November 10, 2004, the Debtor filed a petition for relief under Chapter 7 of the
Bankruptcy Code. Case No. 04-28576 (In re Carl Ceron), Docket No. 1. On November 20,
2004, MERS, as nominee for Olympia, filed a motion to lift the stay with respect to the Property.
Case No. 04-28576, Docket No. 5. On January 26, 2005, the Trustee filed a response stating that
he did not oppose the motion to lift the stay. Case No. 04-28576, Docket No. 6. On February 2,
2005, the Court entered an order granting the motion to lift the stay which provided, among other
things, that the Trustee retained his interest in any surplus monies produced by a sale of the
Property. Case No. 04-28576, Docket No. 12.
On October 20, 2005, a Judgment of Foreclosure and Sale was entered in the State Court
Action allowing the Property to be sold and the first mortgage to be paid from the sale proceeds.
Trustee Statement of Material Facts ¶ 8; O’Connell Decl. Exh. D (State Court Judgment of
Foreclosure and Sale). On December 1, 2005, a state court referee conducted the sale of the
Property in the State Court Action. FSG Statement of Material Facts ¶ 13.
On January 24, 2006, the referee issued a report of sale and surplus money affidavit
stating that the Property had been sold to a third party and after satisfaction of MERS’s senior
lien on the property, there remained $84,912.90 in surplus proceeds. FSG Statement of Material
Facts ¶¶ 14, 15. The referee did not file a motion to confirm the sale of the Property. FSG
Statement of Material Facts ¶ 16.
On February 23, 2006, the Debtor entered into an agreement with Wilfly Capital
Management LP (“Wilfly”) transferring to Wilfly his interest in the Funds. O’Connell Decl.
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¶ 25. On April 18, 2006, Wilfly filed a notice of claim to the Funds in the State Court Action.
O’Connell Decl. ¶ 26. On April 25, 2006, the Trustee also filed a notice of claim to the Funds in
the State Court Action. FSG Statement of Material Facts ¶ 17. On July 2, 2007, the Trustee
filed a motion seeking, among other things, the turnover of the Funds to the Trustee. FSG
Statement of Material Facts ¶ 18. In his motion, the Trustee did not seek to confirm the sale of
the Property. FSG Statement of Material Facts ¶ 20. On July 23, 2007, Olympia assigned to
FSG all of its rights to the Funds under the mortgage documents. FSG Statement of Material
Facts ¶ 21. On October 24, 2007, FSG filed a notice of claim to the Funds in the State Court
Action. FSG Statement of Material Facts ¶ 23.
On October 30, 2007, the state court entered an order directing that the Funds be
distributed to the Trustee. FSG Statement of Material Facts ¶ 25. On April 25, 2008, the Trustee
received $92,234.71 from the New York City Department of Finance. Trustee Statement of
Material Facts ¶ 16. On July 16, 2008, FSG filed a secured proof of claim in the Debtor’s
bankruptcy case in the amount of $62,833.72, plus interest, penalties, and attorneys fees. Case
No. 04-28576, Claim No. 2. On September 25, 2008, FSG amended the amount of its proof of
claim to $86,497.88, plus interest at a rate of 12.5 percent, attorneys fees, costs, and expenses.
Case No. 04-28576, Claim No. 4. FSG states that as of March 2, 2009, the amount owed on its
proof of claim is approximately $96,074.99, plus legal fees and related costs. FSG Statement of
Material Facts ¶ 29.
On July 15, 2009, the Court entered a stipulation and order authorizing the Trustee to
make an interim distribution of $69,035.01, to FSG. Docket No. 27. Accordingly, the parties
dispute the proper distribution of the remaining balance of some $23,199.70 of the Funds.
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The Trustee does not dispute that FSG holds a valid secured claim on the Funds. Trustee
Reply at 2. Instead, the Trustee argues that it would be inequitable for FSG’s claim for interest
at a rate of 12.5 percent to consume the balance of the Funds merely because Olympia did not
exercise its right to be paid on its claim directly by the referee under Section 1351.3 of the New
York Real Property Actions and Proceedings Law (“RPAPL”). Id. The Trustee also calls on
this Court to exercise its general equitable powers and to consider the equities of the case under
Bankruptcy Code Sections 105(a) and 552(b). Trustee Mem. at 9, 13. Finally, the Trustee
argues that he may recover his reasonable and necessary costs and expenses, including attorneys
fees, from the Funds under Bankruptcy Code Section 506(c) because FSG benefitted from his
efforts to recover the Funds in the State Court Action. Trustee Reply at 7-10.
Discussion
The Standard for Summary Judgment
Federal Rule of Civil Procedure 56, made applicable to this adversary proceeding by
Bankruptcy Rule 7056, provides that summary judgment is appropriate when “‘the pleadings,
depositions, answers to interrogatories, and admissions on file, together with the affidavits . . .
show that there is no genuine issue as to any material fact and that the moving party is entitled to
judgment as a matter of law.’” Celotex Corp. v. Catrett, 477 U.S. 317, 322 (1986) (quoting FED .
R. CIV . P. 56(c)); Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 247-48 (1986); Matsushita
Elec. Indus. Co. v. Zenith Radio Corp., 475 U.S. 574, 586-87 (1986). A fact is “material” if it
“might affect the outcome of the suit under the governing law.” Anderson, 477 U.S. at 248. And
an issue of fact is genuine “if the evidence is such that a reasonable jury could return a verdict
for the nonmoving party.” Id.
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“When summary judgment is sought, the moving party bears an initial burden of
demonstrating that there is no genuine dispute of material fact to be decided with respect to any
essential element of the claim in issue; the failure to meet this burden warrants denial of the
motion.” Smith v. Goord, 2008 WL 902184, at *4 (S.D.N.Y. Mar. 31, 2008) (citing Anderson,
477 U.S. at 250 n.4). If this burden is met, the nonmoving party “must do more than simply
show that there is some metaphysical doubt as to the material facts.” Matsushita, 475 U.S. at
586. Rather, it must present “significant probative evidence” that a genuine issue of fact exists.
Anderson, 477 U.S. at 249 (quotation omitted). “There is no issue for trial unless there exists
sufficient evidence in the record favoring the party opposing summary judgment to support a
jury verdict in that party’s favor.” Cadle Co. v. Newhouse, 2002 WL 1888716, at *4 (S.D.N.Y.
Aug. 16, 2002) (citing Anderson, 477 U.S. at 249). See Anderson, 477 U.S. at 250 (finding that
summary judgment is appropriate only when “there can be but one reasonable conclusion as to
the verdict”).
In reviewing a motion for summary judgment, a court must “construe the evidence in the
light most favorable to the [nonmoving party], drawing all inferences and resolving all
ambiguities in [that party’s] favor.” Mathirampuzha v. Potter, 548 F.3d 70, 72-73 (2d Cir. 2008)
(citations and quotations omitted).
RPAPL Section 1351.3
RPAPL Section 1351.3 provides:
If it appears to the satisfaction of the court that there exists no more than one
other mortgage on the premis[e]s which is then due and which is subordinate only
to the plaintiff's mortgage but is entitled to priority over all other liens and
encumbrances . . . , upon motion of the holder of such mortgage made without
valid objection of any other party, the final judgment may direct payment of the
subordinate mortgage debt from the proceeds in accordance with subdivision 3 of
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section 1354.
RPAPL § 1351.3.
In Liberty View Limited Partnership v. 90 West Associates, 150 Misc. 2d 913, 571
N.Y.S.2d 376 (Sup. Ct. N.Y. Co. 1991), the court referenced the legislative history of RPAPL
Section 1351.3 as follows:
The Bill Jacket (L 1982, ch 364) contains a letter dated June 9, 1982, from the
Assembly cosponsor of the legislation. The letter to the Governor’s counsel
states that the bill:
“authorizes the payment of surplus monies from a mortgage
foreclosure action, directly to a subordinate mortgagee who is
entitled to priority over other liens and encumbrances, without the
necessity of a surplus monies proceeding.
This simplified procedure would only require the holder of the
subordinate mortgage and priority lien to make a motion to the
Court for payment. The final judgment may then provide for direct
payment of the subordinate mortgage indebtedness, if no valid
objection is made by any party. The Referee in the foreclosure
action may then pay the monies due the subordinate mortgagee
directly from the proceeds of the public sale, pursuant to the Court
judgment. This procedure would streamline the otherwise
cumbersome surplus monies proceedings which must now be
conducted postforeclosure, in those cases where the subordinate
mortgagee is the priority lien holder.”
Liberty View, 150 Misc. 2d at 914-15, 571 N.Y.S.2d at 377-78. The court concluded that “this
history makes clear that the [New York] Legislature intended that the second mortgage could be
paid without the delay and expense involved in surplus money proceedings.” Liberty View, 150
Misc. 2d at 915, 571 N.Y.S.2d at 378.
Bankruptcy Code Section 506(c)
Bankruptcy Code Section 506(c) provides:
The trustee may recover from property securing an allowed secured claim the
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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 property taxes with respect to the property.
11 U.S.C. § 506(c).
“[T]he underlying purpose of 11 U.S.C. § 506(c) is that the secured creditor should pay
for the benefit it received.” Marc Stuart Goldberg, P.C. v. City of New York (In re Navis Realty,
Inc.), 193 B.R. 998, 1006 (Bankr. E.D.N.Y. 1996).
To have a valid claim under Section 506(c) and absent implied or express consent by the
secured creditor, a trustee must demonstrate that the expenses were necessary, the amounts
expended were reasonable, and the expenses directly benefitted the secured creditor. In re
McLean Indus., Inc., 84 B.R. 340, 350 (Bankr. S.D.N.Y. 1988); PSI, Inc. of Mo. v. Aguillard (In
re Senior-G & A Operating Co.), 957 F.2d 1290, 1299-1300 (5th Cir. 1992); In re Guterl Special
Steel Corp., 316 B.R. 843, 854 (Bankr. W.D. Pa. 2004). The trustee bears the burden of showing
that Section 506(c) applies. Gen. Elec. Credit Corp. v. Levin & Weintraub (In re Flagstaff
Foodservice Corp.), 739 F.2d 73, 77 (2d Cir. 1984) (“Flagstaff I”).
Generally, expenses are “necessary” under Section 506(c) only if there is equity in the
collateral for the benefit of the estate, and unnecessary if there is no equity. See, e.g., In re
Crutcher Concrete Const., 218 B.R. 376, 380 (Bankr. W.D. Ky. 1998) (expenses associated with
trustee’s disposition of automobiles were “necessary” where trustee reasonably anticipated at
time of sale that vehicles had potential equity for the estate); Noland v. Williamson (In re
Williamson), 94 B.R. 958, 963 (Bankr. S.D. Ohio 1988) (trustee’s sale of estate property was
“unnecessary” where it was evident before the sale that there was no equity for the estate).
To support a surcharge against a secured creditor, the trustee must also show that the
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expenditures were made “primarily for the benefit of the creditor and that the creditor directly
[benefitted] from the expenditure.” Gen. Elec. Credit Corp. v. Peltz (In re Flagstaff Foodservice
Corp.) (“Flagstaff II”), 762 F.2d 10, 12 (2d Cir. 1985) (denying Section 506(c) claim because
payroll taxes incurred during debtor’s attempted reorganization were not for the primary benefit
of secured creditor). See In re Sports Info. Data Base, Inc., 64 B.R. 824, 827 (Bankr. S.D.N.Y.
1986) (payment of rent did not give rise to a Section 506(c) claim where primary benefit was to
estate, not to secured creditor); In re Senior-G & A Operating Co., 957 F.2d at 1300 (expenses to
rework oil well benefitted secured creditor that received percentage of production from the well).
A trustee “does not meet this burden of proof by suggesting possible or hypothetical benefits.”
Flagstaff II, 762 F.2d at 12. See In re Mall at One Assocs., L.P., 185 B.R. 981, 991 (Bankr. E.D.
Pa. 1995) (denying debtor in possession recovery of fees for proposed sale of collateral that
never occurred).
Bankruptcy Code Section 552(b)
Section 552(b)(1) provides:
Except as provided in sections 363, 506(c), 522, 544, 545, 547, and 548 of this
title, if the debtor and an entity entered into a security agreement before the
commencement of the case and if the security interest created by such security
agreement extends to property of the debtor acquired before the commencement
of the case and to proceeds, products, offspring, or profits of such property, then
such security interest extends to such proceeds, products, offspring, or profits
acquired by the estate after the commencement of the case to the extent provided
by such security agreement and by applicable nonbankruptcy law, except to any
extent that the court, after notice and a hearing and based on the equities of the
case, orders otherwise.
11 U.S.C. § 552(b)(1).
Under Section 552(b)(1), a secured creditor with a valid lien in the proceeds of a
collateral is entitled to have that interest enforced, “except to any extent that the court, after
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notice and a hearing and based on the equities of the case, orders otherwise.” 11 U.S.C.
§ 552(b)(1). “Under this standard, a Bankruptcy Court is required to ‘strike the proper balance
between the rights of the secured creditor and the rehabilitative goals of the Code.’” In re
Bennett Funding Group, Inc., 255 B.R. 616, 634 (N.D.N.Y. 2000) (quoting In re Island
Helicopter Corp., 63 B.R. 515, 522 (Bankr. E.D.N.Y. 1986)). “The primary purpose of the
equity exception is to prevent a secured creditor from reaping benefits from collateral that has
appreciated in value as a result of the trustee’s/debtor-in possession’s use of other assets of the
estate.” In re Bennett Funding Group, 255 B.R. at 634 (citation and quotation marks omitted)
(denying relief under Section 552(b)(1), where the trustee had done nothing to cause the
proceeds of chattel papers to appreciate in value).
The Motion and Cross-Motion for Summary Judgment
In the Summary Judgment Motion, FSG seeks a determination that it holds a valid
secured lien on the Funds, and an award of that amount plus interest, penalties, and attorneys
fees. FSG Mem. ¶¶ 1, 18-19. FSG also seeks an accounting by the Trustee with respect to the
Funds and the turnover of the Funds to FSG. Id. In the Cross-Motion, the Trustee opposes the
Summary Judgment Motion and seeks the dismissal of the Complaint for failure to state a claim,
and also seeks an award of his reasonable and necessary costs and expenses of preserving or
disposing of FSG’s property under 11 U.S.C. § 506(c). Trustee Mem. at 1-2.
The parties do not dispute that FSG has a valid secured lien on the Funds and indeed, the
Trustee has already turned over $69,035.01 to FSG. Trustee Reply at 2. See Docket No. 27
(July 15, 2009, Order). But the parties dispute how the balance of the Funds should be
disbursed.
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FSG argues that the balance of its claim, for interest, penalties, and attorneys fees, should
be paid under Bankruptcy Code Section 506(b). FSG Mem. ¶ 18-19. The Trustee does not
dispute that this is the starting point for the analysis. But the Trustee looks to Bankruptcy Code
Sections 105(a) and 552(b), including its equity exception, and argues that this Court should use
its equitable power to prevent FSG’s interest claim from consuming the balance of the Funds.
Trustee Mem. at 8-12; Trustee Reply at 3-6. And the Trustee argues that he is entitled to recover
reasonable and necessary costs and expenses from the Funds pursuant to Section 506(c), because
FSG benefitted from his efforts to recover the Funds in the State Court Action. Trustee Mem. at
12-15; Trustee Reply at 7-10.
Olympia’s Failure To Proceed Under RPAPL Section 1351.3 and the Trustee’s Equitable Claims
RPAPL Section 1351.3 provides that “upon motion of the holder of [a second] mortgage
made without valid objection of any other party, the final [foreclosure] judgment may direct
payment of the subordinate mortgage debt from the proceeds” of the foreclosure sale. RPAPL
§ 1351.3. As explained in Liberty View, this Section authorizes the payment of surplus funds
from a mortgage foreclosure action directly to the holder of a valid second mortgage. Liberty
View, 150 Misc. 2d at 914-15, 571 N.Y.S.2d at 377-78. This serves the purpose of allowing “the
second mortgage [to] be paid without the delay and expense involved in surplus money
proceedings.” Liberty View, 150 Misc. 2d at 915, 571 N.Y.S.2d at 378.
Section 552(b)(1) allows a secured creditor with a valid lien on the proceeds of collateral
to have that interest enforced, “except to any extent that the court, after notice and a hearing and
based on the equities of the case, orders otherwise.” 11 U.S.C. § 552(b)(1) (emphasis added).
As noted above, this Section requires the court to “strike the proper balance between the rights of
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the secured creditor and the rehabilitative goals of the Code.” In re Bennett Funding Group, 255
B.R. at 634 (citations and quotation marks omitted).
The Trustee argues:
[T]he failures of Olympia . . . to either appear in the foreclosure action or . . .
exercise its rights under RPAPL § 1351.3 must preclude FSG from seeking and
obtaining payment of any portion of the Surplus beyond that which Olympia
could have recovered between December 1, 2005, when the Referee sold the
property and January 24, 2006, when he issued his Report of Sale.
Trustee Mem. at 10. The Trustee seeks to call upon this Court’s general equitable powers under
Sections 105(a) and 552(b) to reduce FSG’s claim and allocate a portion of the Funds to his
administrative costs, including attorneys fees. Trustee Mem. at 9, 13; Trustee Reply at 4-5.
FSG responds that Olympia had no legal obligation to proceed under RPAPL Section
1351.3, because the statute, by its plain terms, is permissive, not mandatory, and leaves open to
the mortgagee the option of pursuing a surplus money proceeding. FSG Reply ¶ 4. FSG also
argues that equity does not favor the Trustee, because he did not make his motion for turnover of
the Funds in the State Court Action until July 2, 2007, more than seventeen months after the
January 25, 2006, referee’s report of sale. FSG Reply ¶ 5. Finally, FSG argues that the Trustee
could have filed a motion to confirm the sale in the State Court Action pursuant to RPAPL
Section 1361.2 to halt the accrual of interest on FSG’s secured claim at any time after April 25,
2006, when he filed his notice of claim to the Funds, but elected not to do so. FSG Mem. at 14-
15.
The Trustee replies that the voluntary nature of RPAPL Section 1351.3 does not
circumscribe this Court’s equitable powers, and that Olympia’s failure to make a motion under
this Section remains the principal cause of the competing claims to the Funds. Trustee Reply at
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3-6.
Section 552(b)(1) allows a secured creditor with a valid lien on the “proceeds, products,
offspring, or profits” of collateral to have that interest enforced, unless the court, after notice and
a hearing and based on the equities of the case, orders otherwise. 11 U.S.C. § 552(b)(1). The
equity exception to the payment of a secured creditor under Section 552 is not often invoked by
courts in this Circuit. And neither the Trustee nor this Court’s research has uncovered a situation
where a court applied the equity exception of Section 552 to the distribution of surplus funds
after a foreclosure sale. Instead, courts have applied the exception to situations where the value
of the collateral or its proceeds was substantially enhanced through post-petition efforts of a
party other than the secured creditor, such as the debtor or the trustee. See In re Photo
Promotion Assocs., Inc., 61 B.R. 936, 939-40 (Bankr. S.D.N.Y. 1986) (applying equity
exception where creditor had lien on pre-petition cash receivables for photographic work that
was substantially performed post-petition).
In J. Catton Farms, Inc. v. First National Bank of Chicago, 779 F.2d 1242 (7th Cir.
1985), the Seventh Circuit explained the equity exception as follows:
Suppose a creditor had a security interest in raw materials worth $1 million, and
the debtor invested $100,000 to turn those raw materials into a finished product
which he then sold for $1.5 million. The proceeds of this sale (after deducting
wages and other administrative expenses) would be added to the secured
creditor's collateral unless the court decided that it would be inequitable to do so -
as well it might be, since the general creditors were in effect responsible for much
or all of the increase in the value of the proceeds over the original collateral.
J. Catton Farms, 779 F.2d at 1247. As one court observed, “[t]he primary purpose of the equity
exception is to prevent a secured creditor from reaping benefits from collateral that has
appreciated in value as a result of the trustee’s/debtor-in possession’s use of other assets of the
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estate.” In re Bennett Funding Group, 255 B.R. at 634. See In re Photo Promotion, 61 B.R. at
939-40. Neither that purpose, nor any other purpose that might logically be associated with this
exception, such as not rewarding bad faith or other inequitable conduct, is implicated here. For
these reasons, and based on the entire record, the Trustee may not recover under Section
552(b)’s equity exception.
The Trustee also argues that this Court should use its equitable powers under Section
105(a) to find that Olympia’s failure to obtain payment on its claim directly from the referee
after the foreclosure sale pursuant to RPAPL Section 1351.3 blocks FSG’s claim for interest. It
is undisputed that, pursuant to Bankruptcy Code Section 506(b), FSG may collect interest on its
secured claim for so long as its claim remains fully secured. 11 U.S.C. § 506(b) (allowing
interest and any reasonable fees, costs, or charges provided for under the agreement under which
the claim arose).
It is undisputed that Olympia had the option to move under RPAPL Section 1351.3 to
receive payment directly from the proceeds of the foreclosure sale without further surplus money
proceedings. See RPAPL § 1352.3; Liberty View, 571 N.Y.S.2d at 377-78. But Olympia also
had the option not to move for that relief, and instead, it elected to receive payment on its junior
lien at a later date through a surplus money proceeding. The Trustee does not argue, and the
record does not show, that Olympia acted in bad faith or inequitably in electing to receive
payment at a later date. In the absence of bad faith or other inequitable conduct, the ordinary
operation of Section 506(a) should not be disturbed. For these reasons, and based on the entire
record, the Court will not use its equitable powers under Section 105 to alter the payment
priorities established by the Bankruptcy Code.
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The Trustee’s Section 506(c) Claim
To recover his expenses under Section 506(c), the Trustee must show that the expenses
were necessary, the amounts that he expended were reasonable, and the expenses directly
benefitted the secured creditor. In re McLean Indus., 84 B.R. at 350. The Trustee has the
burden of proof to show that Section 506(c) applies. Flagstaff I, 739 F.2d at 77. Generally,
expenses are not “necessary” under Section 506(c) unless there is equity in the collateral that the
estate may recover. In re Crutcher Concrete, 218 B.R. at 380. And the Trustee must show that
the expenses were incurred “primarily for the benefit of the creditor and that the creditor directly
[benefitted] from the expenditure.” Flagstaff II, 762 F.2d at 12. A trustee “does not meet this
burden of proof by suggesting possible or hypothetical benefits.” Id.
Here, when the Trustee made his motion seeking the turnover of the Funds in the State
Court Action on July 2, 2007, there was some equity for the estate to recover. Case No.
04-28576, Claim No. 4 (claim as of July 14, 2008, was $86,497.88); Trustee Statement of
Material Facts ¶ 16 (total amount of funds as of April 25, 2008, was $92,234.71). This supports
the Trustee’s argument that the expenses were necessary. See In re Crutcher Concrete, 218 B.R.
at 380.
Whether the expenses incurred were reasonable requires a more detailed assessment. In
order to satisfy this element, the expense incurred should be in some sensible proportion to the
value of the benefit to be received. The record does not indicate the amount of equity available
for the estate at the time that the Trustee’s motion for turnover of the Funds was made. And
similarly, while FSG states that “upon information and belief, the fees and commission sought
by the Trustee and his counsel in this matter are approximately $30,000,” the record does not
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show the amount of the Trustee’s Section 506(c) claim against the Funds. FSG Mem. at 22.
This record falls short of demonstrating that the entire amount sought by the Trustee is
reasonable, but does not rule out that some lesser amount may be reasonable under the
circumstances.
Finally, the expenses must provide a direct benefit to the secured creditor. The Trustee
argues that the expenses benefitted FSG because he protected FSG’s rights against a competing
creditor, Wilfly, and because his application in the State Court Action permitted FSG to avoid
incurring the costs associated with a surplus money proceeding. Trustee Reply at 7-8. FSG
responds that its rights were already fully protected against Wilfly because Wilfly’s unsecured
interest in the Funds is junior to FSG’s secured claim. FSG Reply ¶¶ 8-9. FSG also argues that
the attorneys fees associated with a surplus money proceeding in Kings County are
approximately $1,200. O’Connor Decl. ¶ 4; Krigsman Decl. ¶ 7. The Trustee replies that FSG’s
estimate does not take into account the additional complexity attributable to a bankruptcy case.
Trustee Supp. Mem. 1-5; Kramer Reply Decl. ¶¶ 1-8.
Here, the Debtor assigned his contingent unsecured interest in the Funds to Wilfly, who
later filed a notice of claim in the State Court Proceeding. O’Connell Decl. ¶¶ 25-26. It is
undisputed that Wilfly’s unsecured interest is junior to FSG’s secured interest in the Funds. The
Trustee has not shown that Wilfly’s junior position placed FSG’s interest in the Funds in
jeopardy in any way. In a surplus money proceeding, FSG’s claim would have been satisfied
prior to Wilfly’s. RPAPL § 1355.2. As a result, FSG did not receive a direct benefit from the
Trustee’s actions in respect of Wilfly’s claim to the Funds.
But the situation is different with respect to the costs associated with a surplus money
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proceeding. The record shows that but for the Trustee’s application in the State Court Action,
FSG would likely have incurred the costs of pursuing a surplus money proceeding. FSG
estimates these costs at some $1,700, comprised of $1,200 in attorneys fees and $500 in referee
fees. See O’Connor Decl. ¶ 4; Krigsman Decl. ¶ 7; Dee Decl. ¶ 7. That is, the Trustee’s actions
provided a direct benefit to FSG, which may be measured by the costs that it avoided.
For these reasons, and based on the entire record, the Trustee may recover $1,700 of his
expenses associated with the turnover of the Funds in the State Court Action under Bankruptcy
Code Section 506(c) because these expenses were necessary, reasonable, and directly benefitted
FSG.
Conclusion
For the reasons stated herein, FSG’s Summary Judgment Motion is granted in part to the
extent that FSG may recover its secured claim and interest, penalties, and attorneys fees from the
Funds. The Trustee’s Cross-Motion is granted in part to the extent that he may recover $1,700
from the Funds, representing the amount of his expenses that were necessary, reasonable, and
directly benefitted FSG.
An order and judgment in accordance with this Memorandum Decision shall be entered
simultaneously herewith.
Dated: Brooklyn, New York
September 1, 2009
s/Elizabeth S. Stong
ELIZABETH S. STONG
UNITED STATES BANKRUPTCY JUDGE
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