The U.S. Court of Appeals for the Fifth Circuit has issued a case useful for credit bidders that successfully bid on their own collateral at a bankruptcy sale, which goes forward without a specific agreement "carving out" expenses. Borrego Springs Bank N.A. v. Skuna River Lumber L.L.C., (In re Skuna River Lumber, LLC), 564 F.3d 353 (5th Cir. 2009).

In Borrego Springs, the debtor Skuna filed bankruptcy and decided to sell substantially all of its assets at auction. Skuna hired a business broker to locate buyers. The bankruptcy court approved the auction procedure and granted the business broker the right to seek payment of its expenses and commission. Although the business broker did find some bidders, the successful bid at the bankruptcy sale under section 363 of the Bankruptcy Code was a credit bid by the senior secured party, Borrego Springs Bank.

After the bankruptcy sale closed, Skuna filed an adversary case against the bank to recover the expenses of sale, consisting of the business broker's commission and marketing costs, under section 506(c) of the Bankruptcy Code. Section 506(c) provides:

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 ....

The bankruptcy and district courts held in favor of Skuna.

The Fifth Circuit reversed, holding that, while section 506(c) impressed the bank's collateral with the possibility of a "surcharge" claim, no such claim could be asserted after the collateral was sold and was no longer within the jurisdiction of the bankruptcy court. The bank, having acquired its collateral by credit bid "free and clear of interests," could not, therefore, be compelled to pay expenses of sale pursuant to section 506(c).

To the extent that section 363 provides that liens and interests continue in the proceeds of sale, the Fifth Circuit pointed out to the misfortune of the unpaid business broker that the only proceeds were a reduction in debt.

Going Forward

The holding of this case is useful in bankruptcy cases in which a lender becomes a successful credit bidder for its own collateral at a bankruptcy sale that goes forward without a specific agreement "carving out" expenses. The decision reinforces the notion that section 506(c) is to be narrowly construed and cannot be used to affix liability on the creditor, but only the collateral and only while that collateral remains within the bankruptcy court's jurisdiction.