Daily Development for Friday, September 21,
2007
by:
Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC
School of
Law
Of Counsel: Blackwell Sanders Peper Martin
Kansas City,
Missouri
dirt@umkc.edu
BANKRUPTCY; CREDITORS CLAIMS;
LENDERS FEES;
REASONABLENESS: When the bankruptcy estate
has sufficient cash to
pay claims of all creditors, a lender may collect a prepayment premium
without
regard to whether such premium is reasonable within
the meaning of Bankruptcy
Code Section 506(b). The only relevant question is whether the fee
is
valid under state law, the test for creditors claims under
Bankruptcy Code
Section 502.
UPS Capital Business Credit v. Gencarelli (In re
Gencarelli), 2007 W.L. 2446833 (!st Cir. 8/30/07)
Debtor, a donut
maker, filed a voluntary bankruptcy petition. Apparently, at
that
time, there was intense competition regarding the donut business in
debtors
region, and when Debtors assets were sold at a bankruptcy
auction, a bidding
war ensued, they produced a three million dollar surplus after all
creditors
claims were paid (except those at issue here).
UPS claimed
that it
was entitled to a prepayment penalty as provided in the
instruments. The
penalty was a sliding scale percentage of principal, declining after the
first
five years. The trial court ruled that the prepayment fee claim
was
required to be a reasonable fee or charge within the
meaning of 506(b), and
conducted two hearings in an attempt to give UPS an opportunity to
demonstrate
the reasonableness of its fee. (In re Bess Eaton Donut Flour Co.,
2005
Westlaw 1367306 (1/19/05)).At least according to the trial court, UPS
failed
abysmally to do this:
When asked as to how the
questioned penalties were
calculated or established, [UPSs witness] stated, surprisingly,
that he "had no
knowledge," and instead concentrated on the process UPS follows in
selling notes
in the secondary market. [The witness] testimony turned out to
be completely
irrelevant to the issue about which the matter was
reopened.
The trial
court consequently denied the claim for the prepayment fee and the
District
Court upheld this ruling.
On appeal to the First Circuit Court of
Appeals, held: Reversed.
The court ruled that the applicable
statutory
test for the collectability of a prepayment fee is Section 502, which
requires
merely that the creditors claim be valid under state law.
The
reasonableness test of Section 506 (b) becomes
relevant only when the question
is whether the claim is secured - in other words whether it enjoys the
priority
of any security interest securing the note containing the fee
language.
Here, of course, there was no question of
priority.
Everyone else had been paid and there was still some pudding in the pot.
[Donuts
in the box??]
The court noted that this interpretation was a
matter of
first impression in the First Circuit, but that the question had already
been
resolved the same way in the Eleventh and Ninth Circuits, and, in dicta
in the
Second Circuit.
It is apodictic that unsecured
creditors may recover
their attorneys fees, costs and expenses from the estate of a
solvent debtor
where they are permitted to do so by the terms of their contract and
applicable
non-bankruptcy law . . . Thus, under the statutory scheme envisioned by
the
debtor . . . unsecured creditors would be permitted to reap the full
benefit of
their contractual bargains through the medium of Section 502, while
oversecured
creditors would be uniquely singled out for unfavorable treatment by the
operation of Section 506. There is no conceivable explanation as
to why
Congress might have wanted oversecured creditors to be treated in so
draconian a
fashion. . . .
Let us be perfectly clear. This is
a solvent debtor
case and, as such, the equities strongly favor holding the debtor to his
contractual obligations as long as those obligations are legally
enforceable
under applicable non-bankruptcy law.
[The editor larded
on this quote
largely to write out the word apodictic even though he
has no idea what it
means. Obviously the First Circuit panel did.]
Comment 1:
So the
lender collects the fee - right? Not so fast, cowboy!!! The
court
simply remands for a determination of whether state law would permit the
fee. An important question for state law is whether the fee ought
to be
construed as a possible penalty. The answer to that question
depends a
great deal upon whether the prepayment fee was triggered by default and
acceleration under the documents, and whether such default and
acceleration
actually occurred here. It may be that the note never went into
default
and was prepaid merely to facilitate the bankruptcy sale. Neither
of the
opinions the editor has read explains what happened on this
score.
If,
indeed, there was an acceleration and the fee is payable as a
consequence of
that, then the creditor in most jurisdictions would have to show that
the fee
met the test for liquidated damages. As the fee provided for a
sliding
scale percentage of the loan amount, the lender will have to work
relatively
hard to demonstrate that the fee approximated any damages to the lender
resulting from the prepayment. [Apparently the loan was intended to be
sold and
was sold on the secondary market, making the problem even
murkier.]
If
the prepayment could be characterized as voluntary,
then the only question is
whether the documents clearly provide for it. Most jurisdictions
view a
voluntary prepayment as an option for which the parties are entitled to
require
the borrower to pay an additional fee.
Comment 2: Of
course, this
is a relatively unusual case because of the surplus resulting from the
auction. More typically, secured creditors will have to deal with
Section
506(b). On this score, the court holds clearly that 506(b) is an
independent federal test. The fact that state law might have
authorized
the fee, even as a reasonable liquidated damages
provision, appears to be
irrelevant to the First Circuit.
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