• No Surcharge for Secured Party That Miscalculated Value of Its Lien Position
  • December 14, 2003 | Author: Constantine Karides
  • Law Firm: Reed Smith LLP - New York Office
  • In line with U.S. Supreme Court precedent that generally prevents parties other than the bankruptcy trustee from pursuing surcharge actions, a secured creditor recently was denied leave to bring an action to make up a shortfall in an inter-creditor agreement.

    The case involved two secured lenders, who disputed the relative priorities of their liens (In re Smith Bros. Motors, Inc., 286 B.R. 905 (Bankr. N.D. Cal. 2002).

    One secured lender made post-petition loans (in addition to pre-petition loans) at the request of the Chapter 11 trustee and received additional liens on the Debtor's collateral. The other secured lender requested bankruptcy court authority to commence a surcharge action under Bankruptcy Code § 506(c) against the first creditor to make up its shortfall under an inter-creditor agreement, based upon the additional liens granted to the first creditor.

    The second creditor conceded that, absent leave of court, it lacked standing to prosecute an 11 U.S.C. §506(c) surcharge action. In Hartford Underwriters, Ins. Co. v. Union Planters Bank, N.A., 530 U.S. 1 (2000), the US. Supreme Court held that because §506(c) vests the right to seek a surcharge of a secured party's collateral exclusively in the trustee, a party other than the trustee has no independent right to seek a surcharge under 11 U.S.C. §506(c).

    The second creditor argued that its expectation of having a security interest in certain assets of the debtor was diminished based upon the additional collateral provided by the first creditor. The court determined that because the trustee was not involved in the initial financing and the inter-creditor agreement between the creditors and the debtor, the trustee would lack standing to prosecute such an action.

    The Court found that the purpose of §506(c) is to compensate the estate when it expends funds to protect and preserve the collateral of a secured party. Thus, 506(c) is not intended to compensate a secured party who miscalculated the value of its lien position, as the second creditor argued.