                                                                                                                           Opinions of the United
1995 Decisions                                                                                                             States Court of Appeals
                                                                                                                              for the Third Circuit


6-9-1995

InRe:Visual Industries,Inc
Precedential or Non-Precedential:

Docket 94-5676




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                    UNITED STATES COURT OF APPEALS
                        FOR THE THIRD CIRCUIT

                              ----------

                             No. 94-5676

                              ----------

IN RE:   VISUAL INDUSTRIES, INC., a Delaware Corporation
         STACOR CORPORATION, a New Jersey Corporation,

                                           Debtors



                    PRECISION STEEL SHEARING, INC.

                                           Appellant

                                  v.

                    FREMONT FINANCIAL CORPORATION

                                           Appellee
                              ----------

          On Appeal from the United States District Court
                  for the District of New Jersey
                     (D.C. Civil No. 94-03414)

                              ----------

                    Argued Tuesday, May 16, 1995

          BEFORE:   COWEN, LEWIS and GARTH, Circuit Judges

                              ----------

                    (Opinion filed June 9, 1995)

                              ----------



                              Michael B. Kaplan (Argued)
                              Stern, Lavinthal, Norgaard & Daly
                              184 Grand Avenue
                              Englewood, New Jersey 07631
Attorney for Appellant
                              Joel R. Glucksman (Argued)
                              Tod S. Chasin
                              Friedman Siegelbaum
                              7 Becker Farm Road
                              Roseland, New Jersey 07068

                              Attorneys for Appellee

                              ----------

                         OPINION OF THE COURT

                              ----------

GARTH, Circuit Judge:


            The Bankruptcy Code in § 506(c) provides that a secured

creditor may be charged for expenses incurred by another in

preserving or disposing of the secured property.       11 U.S.C.

§ 506(c).   The question that is presented on this appeal and

which we must answer is: "Does 11 U.S.C. § 506(c) authorize

payment to trade creditors who furnish raw materials to a Chapter

11 debtor thereby maintaining the debtor's operation, where the

materials supplied did not directly benefit the secured

creditor's property?"    Our answer to that question is "no" --

§ 506(c) does not extend to such a circumstance.



                                 I.

            Visual Industries Inc. and Stacor Corporation

(collectively, "Visual") were manufacturers of office furniture.

In the course of its operation, Visual purchased cut steel from

plaintiff-appellant Precision Steel Shearing, Inc.
          On August 14, 1992, (the "petition date"), Visual filed

a voluntary petition with the bankruptcy court in the District of

New Jersey pursuant to Chapter 11 of the Bankruptcy Code.1

          Defendant-appellee Fremont Financial Corporation was

Visual's primary pre-petition secured creditor and held extensive

security interests in Visual's assets, including liens on, inter

alia, inventory, raw materials, machinery, equipment, furniture,

fixtures, instruments, chattel paper, general intangibles, other

personalty, and the products and proceeds of all of the

foregoing.   App. 241.   As of the petition date, Visual was

indebted to Fremont in the amount of $1,946,605.90 plus costs,

expenses and attorneys' fees.

          In addition to Fremont's pre-petition security

interest, on August 31, 1992, the bankruptcy court entered an

"Amended Consent Order Authorizing the Temporary Use of Cash

Collateral and Approving Post-Petition Financing" (the "Financing

Order") granting Fremont "cash collateral" in, and liens on,

essentially all of Visual's personalty and proceeds.2   The Order

also permitted Visual to make continued use of Fremont's pre-

1
 .   On August 20, 1992 the Bankruptcy Court entered an order
authorizing the joint administration of these cases pursuant to
Fed. R. Bankr. 1015.
2
 .   The Bankruptcy Code, as amended in 1994, defines cash
collateral in relevant part as "cash, negotiable instruments,
documents of title, securities, deposit accounts, or other cash
equivalents whenever acquired in which the estate and an entity
other than the estate have an interest and includes the proceeds,
products, offspring, rents, or profits of property subject to a
security interest . . . whether existing before or after the
commencement of a case under this title." 11 U.S.C. § 363(a).
petition cash collateral and provided for additional post-

petition financing of Visual's operations by Fremont.     App. 247.3

          Fremont's post-petition financing enabled Visual to

continue in operation for almost a year, during which time it

produced sufficient revenues to reduce its obligations to Fremont

by roughly $900,000 to $1,004,740.

          During this time Precision continued to supply cut

steel to Visual.   Precision and Visual arranged a payment system

whereby Precision would ship the steel to Visual upon receipt of

a telefax copy of a check to be sent by overnight mail.     The

checks were post-dated and made payable forty-five to sixty days

after the shipment had been made.    No order of the bankruptcy

court either authorized or directed such an arrangement.



3
 .   In addition to the other protections afforded Fremont's
interests, the Financing Order specified that Fremont's secured
claim would be treated as an allowed administrative expense claim
with priority over, inter alia, "administrative expenses of the
kind specified in or ordered pursuant to Section[]. . . 506(c)
. . . of the Code," App. 179, and further provided that:
          Anything to the contrary notwithstanding, any
          and all costs and expenses of the
          preservation and/or disposition of assets of
          the Debtors against which [Fremont] holds
          liens or mortgage, or which are otherwise
          chargeable to Fremont pursuant to Section
          506(c) of the Code, shall not be chargeable
          to and/or against Fremont by any person or
          governmental unit.
App. 180-181. Fremont in part relies on these references to
§ 506(c) to support its argument that no claim under § 506(c) can
be made. Precision points out that it was not a party to the
Order and hence is not precluded from making the present § 506(c)
claim.
          We do not rely on this provision of the Order in our
disposition of this appeal.
          Visual's checks began to be returned for insufficient

funds in June of 1993, and shortly thereafter Visual ceased

business, owing Precision $94,414.90 for post-petition steel

deliveries.   On September 7, 1993, Visual's Chapter 11

reorganization was converted into a Chapter 7 liquidation

proceeding.

          On May 10, 1994, Precision filed a motion with the

bankruptcy court pursuant to § 506(c) of the Code seeking to

compel payment of unpaid post-petition cut steel invoices by

surcharging Fremont's collateral.   The bankruptcy court denied

Precision's motion on June 20, 1994, on the ground that under

§ 506(c) Precision's furnishing of cut steel to Visual did not

directly benefit the property securing Fremont's loan to Visual.

          Precision appealed to the United States District Court

for the District of New Jersey, which affirmed the decision of

the bankruptcy court on September 26, 1994.   The District Court

recognized that a direct or express benefit to the secured

creditor had to be shown, and agreed with the bankruptcy court

that the sales of raw material to Visual did not operate to

directly preserve or dispose of Fremont's collateral.     Hence, the

District Court affirmed the bankruptcy court's decision.     This

appeal followed.   Our jurisdiction rests on 28 U.S.C. § 158(d).

We affirm.
                                 II.

          This Court's standard of review is clearly erroneous as

to findings of fact by the bankruptcy court, and plenary as to

conclusions of law.    In re Stendardo, 991 F.2d 1089, 1094 (3d

Cir. 1993) (citation omitted).     Because the district court sits

as an appellate court in bankruptcy cases, our review of the

district court's decision is plenary. Id.    The issue in the

present appeal is whether the district court correctly

interpreted and applied the legal standard of § 506(c) to the

undisputed facts.     We therefore exercise plenary review.    In re

C.S. Associates, 29 F.3d 903, 905 (3d Cir. 1994).



                                 III.

          To answer the question we posited at the outset of this

opinion, our analysis starts with the common law that led to the

present bankruptcy statute, 11 U.S.C. § 506(c).    We then examine

In re McKeesport Steel Castings Co., 799 F.2d 91 (3d Cir. 1986)

and In re C.S. Associates, 29 F.3d 903 (3d Cir. 1994), the most

recent opinions of this Court addressing § 506(c) in any detail.

          The general rule is that post-petition administrative

expenses4 and the general costs of reorganization ordinarily may

not be charged to or against secured collateral.     General


4
 .   Administrative expenses include: "the actual, necessary
costs and expenses of preserving the estate"; certain taxes,
fines and penalties; and compensation and reimbursement for a
limited range of services. See 11 U.S.C.A. § 503(b) (West 1993).
Electric Credit Corporation v. Levin & Weintraub (In re Flagstaff

Foodservice Corp.), 739 F.2d 73, 76 (2d Cir. 1984).    Rather, such

expenses are normally chargeable only against the unburdened

assets of the estate, 11 U.S.C. § 503, thus preserving for

secured creditors the collateral securing the debtor's

obligations.

            However, at common law the general rule was disregarded

when a debtor, debtor in possession or trustee had expended funds

to preserve or dispose of the very property (collateral) securing

the debt.   See generally 3 Collier on Bankruptcy ¶ 506.06

(Lawrence P. King, et al. eds., 15th ed. 1994) (tracing

historical evolution of the rule) (hereinafter "Collier on

Bankruptcy").    Classic examples of compensable expenditures under

this exception include storage costs when the secured creditor's

collateral was warehoused, or auction costs incurred on the sale

of the creditor's collateral.   In re Myers, 24 F.2d 349, 351 (2d

Cir. 1928) (preservation of the estate's property); Miners

Savings Bank v. Joyce, 97 F.2d 973, 977 (3d Cir. 1938) (costs of

sale).

            Collier on Bankruptcy contains a detailed list of the
types of costs and expenses that would generally be found to

relate to the preservation or disposition of the subject property

and benefit the holder of the security interest.   This list

includes: appraisal fees, auctioneer fees, advertising costs,

moving expenses, storage charges, payroll of employees directly

and solely involved with the disposition of the subject property,

maintenance and repair costs, and marketing costs.    Id. at
506.56-57.     All of these expenditures share a common

characteristic: they are expenses directly related to disposing

of or preserving the creditor's collateral.

             Thus, when such expenditures inured to the direct

benefit of the secured creditor by preserving or disposing of the

subject property, the common law permitted recovery by the

claimant on the theory that the creditor whose collateral had

been preserved or disposed of for the benefit of the secured

creditor, would be unjustly enriched at the expense of the

claimant.    Collier on Bankruptcy at 506.06.

             In 1978, this exception was codified at section 506(c)

of Chapter 11 of the Bankruptcy Code, which provides as follows:
          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.


Congress' intent in enacting § 506(c) was to assure that when a

claimant "expends money to provide for the reasonable and

necessary costs and expenses of preserving or disposing of a

secured creditor's collateral, the . . . debtor in possession is

entitled to recover such expenses from the secured party or from

the property securing an allowed secured claim held by such

party."   124 Cong. Rec. 32,398 (cum. ed. Sept. 28, 1978)

(statement of Rep. Edwards), reprinted in 1978 U.S. Code Cong. &

Admin. News 6451.     Thus, like the equitable common law rule which

preceded it, § 506(c) is designed to prevent a windfall to the

secured creditor at the expense of the claimant.     IRS v.
Boatmen's First Nat'l Bank of Kan. City, 5 F.3d 1157, 1159 (8th

Cir. 1993).   The rule understandably shifts to the secured party,

who has benefitted from the claimant's expenditure, the costs of

preserving or disposing of the secured party's collateral, which

costs might otherwise be paid from the unencumbered assets of the

bankruptcy estate, providing that such unencumbered assets exist.

Failing that, the costs of preserving the security for the

secured party's benefit would otherwise fall on the warehouseman,

auctioneer, appraiser, etc.

          Although § 506(c) in terms refers only to recovery by

the trustee, we, like many other courts, have held that

administrative claimants other than trustees have standing to

recover under § 506(c), particularly when no other party has an

economic incentive to seek recovery on the claimant's behalf.       In

re McKeesport Steel Castings Co., 799 F.2d 91, 93-94 (3d Cir.

1986); accord Collier on Bankruptcy, supra, at 506-58 n.7a (while

authorities are contradictory, the better position is to allow an

administrative claimant to assert its claim under § 506(c)).

          The circumstances under which a claimant may rely on

§ 506(c) are, as we have pointed out, sharply limited.    In C.S.
Associates we said:
          Our decisions have clarified that to recover
          expenses under § 506(c), a claimant must
          demonstrate that (1) the expenditures are
          reasonable and necessary to the preservation
          or disposal of the property and (2) the
          expenditures provide a direct benefit to the
          secured creditors. Equibank, 884 F.2d at 84,
          86-87; In re McKeesport Steel Castings Co.,
          799 F.2d 91, 94-95 (3d Cir. 1986); see also
          In re Glasply Marine Indus., 971 F.2d 391,
          394 (9th Cir. 1992) ("[T]o satisfy the
           benefits prong [of § 506(c) the claimant]
           must establish in quantifiable terms that it
           expended funds directly to protect and
           preserve the collateral." (internal
           quotation marks omitted)); In re Flagstaff
           Foodservice Corp., 762 F.2d 10, 12 (2d Cir.
           1985) ("[T]o warrant [§] 506(c) recovery
           . . . [the claimant] must show that . . .
           funds were expended primarily for the benefit
           of the creditor and that the creditor
           directly benefitted from the expenditure.").


C.S. Associates, 29 F.3d at 906 (emphasis in the original).    The

bankruptcy court and the district court concluded that

Precision's sales of raw material to Visual did not operate

directly to preserve or dispose of Fremont's collateral and hence

Precision had not demonstrated a direct benefit to Fremont, as it

is required to do under C.S. Associates.   Dist. Ct. Op. 10-11.

           Precision nevertheless contends that as a supplier of

raw materials it helped "preserve" Visual as a going concern, and

that by continuing in operation Visual was enabled to pay back a

substantial portion of its debts to Fremont.   Therefore, claims

Precision, Fremont benefitted from Precision's post-petition

dealings with Visual.   As a result, Precision argues, Fremont's
collateral is chargeable by Precision under § 506(c).    We cannot

agree.   We do not interpret § 506(c) or understand our precedents

interpreting § 506(c) to protect ordinary trade creditors such as

Precision.

           Nor is our analysis altered by Precision's argument

that it helped maintain Visual as a "going concern."    Precision

voluntarily continued to deal with Visual, presumably with the

hope of turning a profit.   There is no reason to believe that
Congress intended to afford the same special protection for trade

creditors who furnish materials to a Chapter 11 debtor as it did

for claimants who preserve or dispose of secured assets.    The

benefit provided by Precision's supply of raw materials was not

directed towards preserving or disposing of Fremont's cash

collateral.   Accordingly, Precision's reliance on § 506(c) is

misplaced.



                                IV.

          Precision, in petitioning for payment from Fremont's

cash collateral, relies on In Re McKeesport Steel Castings Co.,

799 F.2d 91 (3d Cir. 1986).    McKeesport upheld a claim by a

utility, Equitable Gas, which had supplied natural gas to the

debtor manufacturer, McKeesport, while McKeesport was undergoing

Chapter 11 reorganization.    McKeesport's largest creditor,

Equibank, whose loans were secured by liens on McKeesport's

inventory, accounts receivable, real property, fixtures and

equipment, challenged the payment to Equitable Gas for its post-

petition gas service.

          Relying on three different theories, one of which

contended that Equitable Gas had preserved the lienholder's

collateral under § 506(c), the utility sought to charge the

collateral securing Equibank's interest for unpaid post-petition

utility bills.   Equitable Gas also relied on its superpriority

status granted by a consent order entered by the bankruptcy
court,5 and on 11 U.S.C. § 366(b), which provides that a utility

may discontinue services if it is not furnished "adequate

assurance" of payment.6

            The bankruptcy court had authorized, by order,

payment out of Equibank's cash collateral for Equitable Gas's

post-petition gas services.   However, despite a payment time

table set by the bankruptcy court, McKeesport regularly failed to

meet its obligations to Equitable Gas.

          On two different occasions, Equitable Gas had attempted

to discontinue its gas services after McKeesport failed to make

timely payments.   Each time, the bankruptcy court entered orders

denying Equitable Gas the right to discontinue service, stating

that by ordering the continued supply of gas it was seeking to

protect the lienholders.   On Equitable Gas's third application,

however, the bankruptcy court granted its petition for relief and

ordered the secured creditors to pay $57,261.16 for post-petition

gas service.   The district court denied recovery to Equitable

Gas, but we reversed the district court's order and affirmed the

order of the bankruptcy court.




5
 .   The Bankruptcy Court by order had permitted McKeesport to
use its cash collateral to pay for raw materials, supplies, gas,
etc. It had also granted a superpriority to those who provided
raw materials, utilities and supplies used in McKeesport's
manufacturing process.
6
 .   11 U.S.C. § 366 forbids a utility to discontinue service
solely on the basis of the commencement of Chapter 11
proceedings, provided it is furnished with adequate assurance of
payment in the form of a deposit or other security.
           We acknowledge that in ordering payment to Equitable

Gas for providing post-petition gas service, the McKeesport court

stated that it was doing so "to preserve the going concern value

of the debtor's estate."    799 F.2d at 95.   This would appear to

lend support to Precision's argument.   However, the difference

between the circumstances of McKeesport and the circumstance

which we face is dramatic.    This difference was recognized as

well by the bankruptcy court and by the district court.

           As we have just recounted, in McKeesport, the

bankruptcy court had entered two orders denying Equitable Gas the

right to discontinue service.    As a result, Equitable Gas, unlike

Precision, had no choice as to whether to supply its product to

the debtor in possession.    Equitable Gas had been directed by the

bankruptcy court to continue to provide post-petition gas

service.

           Moreover, Equitable Gas had still another string to its

bow, which Precision does not.    While the McKeesport court had no

need to rule or rely on Equitable Gas's claim under § 366(b), we

cannot ignore the obvious fact that under § 366(b), Equitable Gas

was, as a utility, entitled to "adequate assurance" of payment,

an assurance not given to Precision.

           We do not question that the court's discussion in

McKeesport may have inadvertently encouraged trade creditors such
as Precision to believe that any materials furnished to a debtor

which assisted a debtor's operations -- materials such as raw

materials, typewriters, paper clips, pencils, and the like --

constituted a benefit to the debtor and thus could be charged
against a secured lender's collateral.    However, we do not read

McKeesport as generously as Precision does.    We believe that the

bankruptcy court order obtained by Equitable Gas, the cash

collateral order providing for payment to utilities and the

presence of § 366 issues all distinguish McKeesport from the

situation in which Precision has found itself.

            Merely providing some benefit to the debtor, as

Precision has provided by supplying Visual with steel, does not

satisfy § 506(c)'s requirement that the claimant in order to

prevail must provide a direct benefit inuring to the secured

lender for the preservation or disposition of the secured

property.    Were it otherwise, no secured lender would assist in

financing the debtor, because then every trade creditor would in

effect have priority over the secured lender.    As the bankruptcy

court emphasized, the availability of Chapter 11 financing would

be jeopardized if we were to allow any claimant who furnishes any

benefit to a secured creditor to claim under § 506(c).   The Court

of Appeals for the Fifth Circuit has also recognized that

§ 506(c) cannot readily be looked to by trade creditors who

supply materials to a debtor in Chapter 11, observing that:
          In a reorganization, it is essential that the
          debtor keep his post-bankruptcy accounts
          paid, so that tradesmen will have an
          incentive to deal with the company in Chapter
          11. If this goal is not reached, in many
          cases Chapter 11 debtors will find it
          increasingly difficult to maintain operations
          and to reorganize as going concerns, and the
          purpose of Chapter 11 would be seriously
          undermined. It is equally clear, however,
          that § 506(c) was not intended as a panacea
          for this problem.
Matter of P.C., Ltd., 929 F.2d 203, 206 (5th Cir. 1991).

           We conclude that McKeesport neither governs nor

conflicts with the disposition of this case.



                                  V.

           Our most recent instruction respecting § 506(c) appears

in C.S. Associates, supra, a decision which followed McKeesport

by some eight years and to which we have referred earlier in this

opinion.   See supra, pp. 9-10.   In that case we rejected a claim

by a municipality seeking post-petition real estate taxes and

water and sewage rents to charge the proceeds of sale of a

building under § 506(c).    Although the claimant municipality

argued that it had "benefitted" the secured party through general

municipal services, we held that this "benefit" could not support

a claim under § 506(c).    Section 506(c) was "designed to extract

from a particular asset the cost of preserving or disposing of

that asset."   29 F.3d at 907 (quoting In re Parr Meadows Racing

Ass'n, 92 B.R. 30, 35 (E.D.N.Y.1988), aff'd in part, rev'd in

part on other grounds, 880 F.2d 1540 (2d Cir. 1989)).

           Because the city had not demonstrated that the services

"actually were performed for the direct benefit of the [secured]

property," id. at 908, we denied relief, making clear that
expenses incurred by another can be charged against the property

securing a secured lender's loan only where, and only to the

extent that, the lender has been directly benefitted by the

preservation or disposition of property serving as collateral.
                              VI.

          Because Precision had not been specifically ordered by

the bankruptcy court to provide steel to Visual, and because

Precision has not met the test of § 506(c) mandated by C.S.

Associates, we will affirm the district court's order of

September 26, 1994, which had denied relief to Precision for the

same reasons as had the bankruptcy court.
