Today’s dispute, in this most contentious of cases, is illustrative of the problems a debtor-in-possession faces when its relationship with a secured creditor sours and it has no other source of funds from which to compensate professionals. Here, the debtors seek authority to pay, at some point in the future, subject, of course, to applications for compensation, the professional fees of Proskauer Rose Goetz & Mendelsohn (“Proskauer”), counsel to the debtors, and Berlack, Israels and Liberman (“Berlack”), counsel to the Official Committee of Unsecured Creditors, out of rents and income from the debtors’ property. Mutual Benefit Life Insurance Co. (“Mutual”), the mortgagee, objects. With the consent of the debtors and the committee, Mutual is assumed for the purposes of this motion only to be the holder of a valid, perfected interest in these rents and income.
BACKGROUND
54th and Fifth Land Partners owns real property in Manhattan which it leases to 680 Fifth Avenue Associates, which in turn owns and operates a 27 story office building on the premises. On August 21, 1992, the debtors filed with this Court their respective voluntary petitions for relief under Chapter 11 of the Bankruptcy Code. Pursuant to Sections 1107 and 1108 of the Code, the debtors continue to operate their businesses and manage their properties as debtors-in-possession.
This case has been saddled since its inception with what seems like continuous disputes. Aside from the drawn-out Pros-kauer retention battle, the numerous discovery disputes and the battle fought over whether the state-court receiver ought be ousted, the debtors and Mutual have consistently bickered with respect to the debtors’ use of their rents and income constituting Mutual’s cash collateral. On August 21, 1992, Judge Garrity, in my absence, after what I understand to have been a highly-charged preliminary hearing, signed a narrowly-tailored preliminary order authorizing the debtors’ use of these post-petition rents and income. I thereafter signed several supplemental orders which granted the debtors limited use of their rents and accounts receivables pending this final hearing. Disputes over the use of rents have been raised with respect to amounts as low as approximately $100. At the last interim cash collateral hearing, the debtors sought authority to pay professional fees out of their rents and income. Mutual vigorously objected. The debtors argued, with the support of counsel for the Committee, that the “equities” of this case dictate that the rents and income the debtors receive should be exempted from attachment of Mutual’s security interest pursuant to the “equities” exception contained in section 552(b) of the Bankruptcy Code.
This exception is warranted, the debtors say, because they have no other source of funds with which to pay counsel, all of their assets being encumbered, and because Mutual has already benefited by receiving approximately $18 million on the sale of the property to the debtors and in prepayment of interest. See Debtor’s Memorandum of Law in Support of Application at 13.
Mutual disputes the applicability of section 552(b), asserting that what the debtors really are attempting to do is use Mutual’s cash collateral to compensate professionals, pursuant to Code section 506(c). Mutual then posits that the debtors cannot meet the section 506(c) burden of demonstrating that the fees sought are reasonable, necessary for the preservation of Mutual’s lien, and incurred primarily for Mutual’s benefit.
At the January 28, 1993 hearing on this matter, both sides made concessions. The Committee admitted that there are no reported cases in which a court has utilized section 552(b)’s equities exception to pay attorneys’ fees. Mutual conceded that the hypothetical list found in the
Collier
trea
DISCUSSION
As the Second Circuit recently noted in
In re Vienna Park Properties,
A bankruptcy judge construing an assignment of rent provision should take steps to ensure that the mortgagee is afforded in federal bankruptcy court the same protection he would have under state law if no bankruptcy had ensued.
Butner v. U.S.,
With certain exceptions, section 552(b) reflects those principles expressed in But-ner, providing in pertinent part that:
Except as provided in sections 363 [and] 506(c), ... 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 ... rents ... of such property, then such security interest extends to such ... rents ... acquired by the estate after the commencement of the case to the extent provided by such security agreement and by applicable non-bankruptcy 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).
Thus, the debtor in possession which seeks blanket authority to use rents subject to a perfected security interest must travel one of two roads; it may either (a) attempt to argue that those rents are exempted from the reach of the secured creditor’s cash collateral umbrella by virtue of the last phrase of section 552(b), commonly referred to as the equities exception, or (b) obtain the consent of the entity that has an interest in such cash collateral or, failing that consent, seek court authorization to use the cash collateral after notice and a hearing pursuant to section 363(c)(2) of the Code. Since these debtors are pursuing the former route, it is section 552(b)’s equity exception to which I now turn.
As Collier points out and the parties agree, there is no one scenario to which application of the equities doctrine is limited. Rather, the examples provided by the courts and treatises are but a few of what surely can be deemed a non-exhaustive list. The theme that rings true to all of the examples, however, is that the exception offers a bankruptcy court, essentially a court of equity, considerable latitude in balancing the rights of competing creditor entities with the overall rehabilitative scheme of bankruptcy law. 4 L. King, Collier on Bankruptcy ¶ 552.02 at 552-6-9 (15th ed. 1992). But the salutary aim of fostering reorganization is not alone enough to deprive the creditor of his collateral. To answer the question of whether the equities warrant invocation of section 552(b)’s exception, one must first ask for what purpose and under what factual predicate those equitable powers are sought to be applied.
Whether section 552(b)’s equity exception may cover the payment of professional fees appears a novel issue, and as the parties concede, one on which the courts have commented only tangentially.
Judge Sufana faced a similar issue in
In re Wabash Valley Power Ass’n, Inc.,
The third case that even relates to the issue is
In re Jefferson Business Center Associates,
I do not agree with Mutual’s initially expressed, but now abandoned, position that there is an absolute bar to allowing the use of rents to pay professional fees of the estate. Indeed, I can certainly envision circumstances where resort to section 552(b) could potentially allow a debtor to do what these debtors seek to do. For example, if a creditor were sufficiently ov-ersecured, the debtor could argue that the equities tipped in favor of allowing it to tap into rents that would otherwise be cash collateral because the creditor would be adequately protected and not harmed. Similarly, if there were any unencumbered assets, or maybe even contributed funds, which would be used to complete construction, thereby increasing the value of the secured creditor’s collateral, the equities well might tip in favor of cutting off all or some portion of the interest in rents because the creditor would be protected by the increased value of the building and would otherwise receive a windfall. But where a lender is undersecured, the debt- or’s use of that lender’s cash collateral, absent adequate protection, would clearly cause a decrease in the value of that creditor’s property in which the debtor had an interest,
In re Willowood East Apart-
Once the secured creditor has established that his interest in the rents is valid, the burden, as with every other situation in which the concept of adequate protection of an undersecured lender’s interest arises, is on the debtor in possession to prove that the secured creditor will receive the value for which he bargained.
In re Martin,
What the debtors seek, in essence, is authority to pay professional fees from rents and income without having to address section 506(c) of the Bankruptcy Code. Generally, unless the creditor is ov-erseeured, the administrative expenses of a debtor’s case are not to be charged against his collateral because a secured creditor’s interest in collateral is a property right which is not impaired in bankruptcy proceedings.
Matter of CD Elec. Co., Inc.,
Notwithstanding this broad prohibition, a trustee or debtor in possession may collect fees and expenses from encumbered assets if either (a) the party on whose behalf the rents and income are held as cash collateral consents impliedly or expressly, or (b) if the trustee or debtor in possession meets the exception set forth in 11 U.S.C. § 506(c).
CD Elec. Co., Inc.,
Pursuant to section 506(c), recovery can be had if three criteria are met: (1) the expenditure is reasonable; (2) the expenditure is necessary in preserving or disposing of the secured creditor’s collateral; and (3) the secured creditor benefits directly from the expenditure.
Flagstaff I,
Accordingly, on the facts presented, the debtors’ request must be denied.