In In re River Center Holdings, LLC,1 the United States Bankruptcy Court for the Southern District of New York refused to permit lenders to enforce an oral commitment of the debtors’ principal to fund certain litigation. In River Center, the debtors’ principal had stated at a hearing that he would fund a condemnation action relating to property that served as collateral for the lenders’ financing. The Bankruptcy Court found that the lenders did not have standing to enforce the principal’s alleged promises, which, in any event, were not clear and unequivocal enough to be enforced. The Bankruptcy Court also denied requests by the debtors and their principal to surcharge the lenders’ collateral and grant the principal a charge against the litigation award as subrogee to the rights of the debtors’ attorneys. The Bankruptcy Court, however, enforced the debtors’ attorneys’ charging lien against the lenders’ collateral.

Background

Prior to their bankruptcy filings on February 28, 2001, River Center Holdings, LLC and its affiliated entities (collectively, “River Center”) owned real property in Manhattan, secured by a mortgage held by Blackacre Bridge Capital LLC and SWH Funding Corp. (together, the “Lenders”), and personally guaranteed by River Center’s principal, Joseph Korff. In April 2001, the Dormitory Authority of the State of New York (“DASNY”) took the property by eminent domain. DASNY offered to pay approximately $82 million to River Center for the property, but River Center contended that the property was worth approximately $227 million. This dispute was the basis of an action (the “Condemnation Action”) initiated in 2001 in New York state court.

On October 23, 2001, the Lenders filed a motion seeking conversion of River Center’s chapter 11 case to chapter 7, arguing that River Center was incurring continuing losses as a result of its inability to pay its professional fees in both the bankruptcy case and the Condemnation Action. At the November 5, 2002, hearing on the motion (the “Conversion Motion”), Mr. Korff made several statements (the “Alleged Korff Promises”) regarding his willingness and/or commitment to fund expenses of the Condemnation Action, including:

To the extent that the professionals that I’ve engaged do not agree to continue to work without being self-funded, I will fund them. Now, this is based on a projection of what these expenses may be. I have no difficulty in making that statement without qualification at this point in time unless of course you drastically accelerate what’s going to happen in the rest of the case.2

[B]y the end of next year [2003] hopefully, our plan will be confirmed, the trial will have been concluded and the state will have determined whether or not to take an appeal, and in that context I expect to continue to fund whatever administrative expenses are incurred. . . .3

At the hearing, counsel for River Center termed Mr. Korff’s testimony as “loose,” and the Bankruptcy Court also noted the “softness of some of Mr. Korff’s testimony.”4 Nevertheless, the Bankruptcy Court denied the Conversion Motion, “satisfied” that Mr. Korff had agreed to continue to fund the administrative costs of the estates through the end of the trial.5

Thereafter, in 2005, River Center and the Lenders entered into a settlement agreement (the “Settlement Agreement”), approved by the Bankruptcy Court, to allow River Center to emerge from chapter 11. Under the Settlement Agreement, (i) the Lenders’ allowed secured claim was fixed at $46.5 million plus interest; (ii) the Lenders consented to River Center’s use of their cash collateral to pay its counsels’ costs and expenses in the Condemnation Action; (iii) recovery from DASNY in the Condemnation Action would go directly to the Lenders; and (iv) River Center released the Lenders from all claims.

After a lengthy trial, the state court in the Condemnation Action ruled that the value of the property was $97 million (the “Condemnation Award”),6 an amount insufficient to pay the Lenders in full. Further, neither River Center nor Mr. Korff had paid their attorneys all fees and expenses to which each was entitled. Accordingly, on May 8, 2008, the Lenders filed a motion pursuant to section 105 of the Bankruptcy Code (i) seeking enforcement of the Settlement Agreement; (ii) seeking enforcement of the Alleged Korff Promises; and (iii) requesting that the Court deny the charging liens asserted under New York Judiciary Law § 475 by River Center’s professionals against the proceeds of the Condemnation Award. River Center and Mr. Korff opposed the motion and cross-moved for an order (i) pursuant to section 506(c) of the Bankruptcy Code, permitting River Center to recover from the property securing the Lenders’ allowed claim for its litigation expenses; and (ii) pursuant to section 509 of the Bankruptcy Code, granting Mr. Korff a charge against the Condemnation Award as subrogee to the rights of counsel to the extent that such counsel had already been paid.

Enforcement of Settlement Agreement and Korff’s Promise to Fund Condemnation Action

The Lenders sought enforcement of the Settlement Agreement and the Alleged Korff Promises under section 105 of the Bankruptcy Code. Section 105 is a catch-all section of the Bankruptcy Code that allows a court to “issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of this title.” Among other things, section 105 can be used by a party-in-interest to enforce and implement earlier orders of a court. The Bankruptcy Court first noted that it was “debatable” whether a court could use section 105 to enforce an alleged oral promise made in court, rather than in a contract, and that no party had found any case where a court did so. Putting aside this debate, the Bankruptcy Court reasoned that such enforcement could ever result only if (i) the party seeking enforcement of the promise had standing to enforce it as the party to whom performance of the promise was due; and (ii) the promise was “sufficiently clear and unequivocal.”7 In River Center, the Bankruptcy Court found both elements lacking.

First, the Bankruptcy Court considered the standing issue, finding that the beneficiary of the Alleged Korff Promises was the estate, and the Lenders were indirect beneficiaries of only a promise to make payments on behalf of the estate. Although bankruptcy courts have authority in some circumstances to grant rights to creditors to bring actions on behalf of the estate, in the Second Circuit this requires an “STN order,” which the Lenders did not seek.8 The remedies available to the Lenders during the pendency of the cases to address a failure of Mr. Korff to honor the Alleged Korff Promises (including to move for appointment of a trustee, dismiss the case, terminate exclusivity, or move again to convert the case) did not, the Bankruptcy Court held, confer ownership to the Lenders of causes of action belonging to the estate. Accordingly, the Bankruptcy Court held that the Lenders lacked standing to seek specific performance or damages for Mr. Korff’s failure to honor the Alleged Korff Promises.

Next, the Bankruptcy Court considered whether, if the Lenders were assumed to have standing, the Alleged Korff Promises were of a sufficiently clear nature so as to be capable of enforcement. The Bankruptcy Court determined that Mr. Korff preceded his remarks with assumptions, and spoke “in terms of anticipation, not promise.”9 Though admitting that it had earlier found these statements sufficient to deny the Conversion Motion, the Bankruptcy Court argued that the factual findings at that time were made in a different context, as a matter of determining how the case should proceed, rather than enforcing mere “predictions or statements of present intention.”10 Accordingly, the Bankruptcy Court held that the language of the Alleged Korff Promises was not sufficiently concrete to warrant a finding of breach of promise.

Charging Lenders’ Collateral

River Center and Mr. Korff sought authority to charge the Lenders’ collateral for the costs of prosecuting the Condemnation Action under sections 506(c) and 509 of the Bankruptcy Code. Section 506(c) of the Bankruptcy Code provides that a debtor 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.” Section 509 provides for co-debtor liability, stating that co-debtors that pay a claim of the debtor are “subrogated to the rights of such creditor to the extent of such payment.”

The Bankruptcy Court held that, under the Settlement Agreement, River Center and Mr. Korff released any claims that either might have otherwise been able to assert. River Center argued that the Settlement Agreement waived claims only up to the effective date of the release, but the Court found that the release unambiguously released the Lenders from all claims, including contingent claims and claims subsequent to the release. The Bankruptcy Court also found that only a debtor may assert a section 506(c) claim. As River Center’s plan was effective, River Center was no longer a debtor in possession and did not have standing to bring an action under section 506(c). Similarly, the Bankruptcy Court found that Mr. Korff’s claims were released under the Settlement Agreement, and, additionally, that Mr. Korff had offered no evidence, as required by section 509 to be able to seek to collect, that he was liable with River Center on the duty to pay the counsel’s fees (and, to the contrary, had argued in opposition to the Lenders’ motion that he was not liable because the Alleged Korff Promises were merely equivocal statements of intention).

Charging Liens

Finally, counsel for River Center in the Condemnation Action sought enforcement of their charging liens pursuant to New York Judiciary Law 475 which provides that, if a charging lien is valid, the client’s property right in a cause of action is what remains after transfer to the attorney of the agreed upon share. In determining whether to give an attorney’s charging lien priority over another party’s right to the proceeds of a judgment, a court can take into account equitable considerations. Here, the Bankruptcy Court found that counsel’s efforts resulted in increases in the value of the property, and allowing the Lenders to receive the entire Condemnation Award, without offset for compensation to the counsel, would be unfair. The Court found no counterbalancing equitable considerations. Accordingly, the Bankruptcy Court ruled that it would permit counsel to assert their charging liens against the Condemnation Award.

Conclusion

In River Center, the Southern District declined to enforce the debtors’ principal’s verbal promises to fund the Condemnation Action. This is especially notable because the statements were made on the record of a contested hearing and were the basis of the Bankruptcy Court’s decision not to convert the debtor’s case to chapter 7. The holding of River Center thus begs the question of whether a party-in-interest can ever rely on statements made in court in the multiparty setting of a bankruptcy proceeding.

In River Center, the Bankruptcy Court noted that the Settlement Agreement entered into among the parties did not include any representations by Mr. Korff of his promise to continue funding the Condemnation Action. Had the Lenders required that Mr. Korff affirm these representations in the Settlement Agreement, the issues resolved in this decision might have never arisen. After River Center, lenders hoping to hold parties-in-interest to statements made in open court should require that any such statements be memorialized in a written agreement that is signed by the appropriate parties and approved by the court.