In re Flagstaff Foodservice Corp.
1984 U.S. App. LEXIS 20654, 739 F.2d 73, 10 Collier Bankr. Cas. 2d 1309 (1984)
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Rule of Law:
A super-priority lien on a debtor's assets, granted to a creditor under 11 U.S.C. § 364(c)(1), takes precedence over claims for administrative expenses, including professional fees, unless those expenses were incurred for the direct benefit of the secured creditor in preserving or disposing of their collateral as provided under 11 U.S.C. § 506(c).
Facts:
- General Electric Credit Corporation (GECC) provided financing to Flagstaff Foodservice Corporation, secured by Flagstaff's assets.
- Flagstaff filed for Chapter 11 bankruptcy protection, at which time it owed GECC approximately $22 million, secured by collateral valued at $42 million.
- To obtain post-petition financing from GECC to continue operations, Flagstaff sought and received a court-approved 'Financing Order'.
- This order granted GECC a super-priority lien on all present and future property of Flagstaff, which was explicitly given priority over all administrative expenses.
- Pursuant to this order, GECC advanced an additional $9 million to Flagstaff.
- The reorganization effort failed, and Flagstaff's business operations were ultimately terminated.
- At the end of the proceedings, the remaining value of GECC's collateral was insufficient to satisfy the outstanding debt owed to it.
- Attorneys and accountants for the debtor and the unsecured creditors' committee sought payment of their interim professional fees from GECC's encumbered collateral.
Procedural Posture:
- Flagstaff Foodservice Corporation filed petitions for Chapter 11 reorganization in the U.S. Bankruptcy Court.
- The Applicants-Appellees (attorneys and accountants) filed applications with the bankruptcy court for interim compensation to be paid from GECC's collateral.
- The bankruptcy court granted the applications, awarding the fees and ordering payment from the collateral in which GECC held a security interest.
- GECC, the Objector-Appellant, appealed the bankruptcy court's order to the U.S. District Court for the Southern District of New York.
- The district court affirmed the bankruptcy court's order.
- GECC appealed the district court's decision to the U.S. Court of Appeals for the Second Circuit.
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Issue:
Does a bankruptcy court have the authority to order payment of interim professional fees from a secured creditor's collateral when that creditor holds a super-priority lien under 11 U.S.C. § 364(c)(1) that is explicitly senior to administrative expenses?
Opinions:
Majority - Van Graafeiland, Circuit Judge
No. A court cannot order payment of administrative fees from assets encumbered by a super-priority lien granted under § 364(c)(1), except under the narrow conditions of § 506(c). The plain language of § 364(c)(1) explicitly authorizes a court to grant a security interest that has priority over all other administrative expenses, including professional fees compensable under § 330. The only statutory exception is § 506(c), which permits recovery from a secured creditor's collateral for 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.' Here, the professionals failed to meet their burden of proving their services directly benefited GECC. The services were aimed at reorganizing the debtor for the benefit of the estate as a whole, and any benefit to GECC was merely incidental. In fact, GECC's financial position worsened during the proceedings, as it went from being over-secured to under-secured. Furthermore, a secured creditor's cooperation with a Chapter 11 proceeding does not constitute implied consent to have its collateral charged with administrative expenses; such consent cannot be lightly inferred and was expressly contradicted by the terms of the Financing Order.
Analysis:
This decision significantly strengthens the position of post-petition lenders in Chapter 11 cases by affirming the sanctity of super-priority liens granted under § 364(c)(1). It provides assurance to lenders that their priority status will not be subordinated to administrative expenses, thereby encouraging the provision of critical financing to struggling debtors. The ruling clarifies that the exception under § 506(c) is narrow and requires proof of a direct, quantifiable benefit to the secured creditor, not just an indirect or incidental benefit from general reorganization efforts. This places the risk of a failed reorganization on the estate and its professionals, who cannot look to a super-priority creditor's collateral for payment unless the strict requirements of § 506(c) are met.
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