The opinion
Opinions of the United
1994 Decisions States Court of Appeals
for the Third Circuit
7-20-1994
C.S. Associates v. Miller
Precedential or Non-Precedential:
Docket 93-1961
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UNITED STATES COURT OF APPEALS
FOR THE THIRD CIRCUIT
No. 93-1961
C.S. ASSOCIATES, d/b/a UNIVERSITY NURSING
AND REHABILITATION CENTER
UNITED JERSEY BANK,
Appellant,
v.
MITCHELL W. MILLER, ESQ.; THE CITY OF PHILADELPHIA;
THE UNITED STATES OF AMERICA; HEALTHCARE SERVICES
GROUP; PERLOFF BROTHERS, INC.; DIANE VENDETTI;
THE SCHOOL DISTRICT OF PHILADELPHIA; NICHOLAS CANUSO, DR.;
RAYMOND SILK, DR. and EUGENE SPITZ, DR.
MITCHELL W. MILLER, ESQ.,
Trustee
FREDERICK J. BAKER, ESQ.,
Trustee
On Appeal from the United States District Court
for the Eastern District of Pennsylvania
(D.C. Civ. No. 93-cv-03065)
Argued May 24, 1994
Before: COWEN and ROTH, Circuit Judges, and
ACKERMAN, District Judge.1
(Filed July 20, l994)
1
The Honorable Harold A. Ackerman, United States District Judge
for the District of New Jersey, sitting by designation.
1
John J. Francis, Jr. (argued)
Shanley & Fisher, P.C.
131 Madison Avenue
Morristown, NJ 07962-1979
Counsel for Appellant
United Jersey Bank
Joseph DiGiuseppe (argued)
Assistant City Solicitor
City of Philadelphia Law Department
1101 Market Street, 10th Floor
Philadelphia, PA 19107-2997
Counsel for Appellee
City of Philadelphia
Edward J. DiDonato
Ciardi & DiDonato, P.C.
1900 Spruce Street
Philadelphia, PA 19103
Counsel for Appellee
Mitchell W. Miller, Esq.,
Bankruptcy Trustee of the Estate
C.S. Associates
OPINION OF THE COURT
COWEN, Circuit Judge.
In this bankruptcy case, the bankruptcy court granted a
motion by the City of Philadelphia ("the City") to recover
unsecured post-petition real estate taxes and water/sewer rents
from the secured creditor, United Jersey Bank ("UJB"), pursuant
to 11 U.S.C. § 506(c). The district court affirmed the order of
the bankruptcy court. Because the City did not demonstrate that
2
the taxes conferred a direct benefit to the creditor whose claim
the property secures, we will reverse the order of the district
court.
I. BACKGROUND
C.S. Associates, d/b/a University Nursing and
Rehabilitation Center, the debtor in this case, owned and
operated a skilled care nursing home in Philadelphia. UJB is the
Indenture Trustee under a Trust Indenture agreement entered into
with the Philadelphia Authority for Industrial Development
("PAID") in order to finance the acquisition, construction and
equipping of the nursing home facility. C.S. Associates entered
into an installment sale agreement with PAID on February 16,
1983. To provide the necessary funds with which to finance the
acquisition, construction and completion of the facility, PAID
authorized and issued bonds ("1983 Bonds") in the aggregate
principal amount of $6,870,000. The 1983 Bonds were issued under
and are secured by the Indenture entered into by and between PAID
and UJB as Indenture Trustee on February 16, 1983. Pursuant to
the terms of the Indenture, PAID assigned all of its rights, its
title and its interest under the installment sale agreement and
all monies payable thereunder to UJB as Indenture Trustee for the
benefit of the holders of the 1983 Bonds.
To secure the repayment of the 1983 Bonds, C.S.
Associates granted to PAID a first priority mortgage on the
facility and real property constituting the site of the facility.
There is currently due and owing from C.S. Associates to UJB as
3
Indenture Trustee the principal amount of $3,367,037.47 plus
interest and fees, which amount is secured by the mortgage. Thus,
UJB is a secured creditor of C.S Associates.
On August 15, 1988, C.S. Associates filed a voluntary
petition for relief under Chapter 11 of the Bankruptcy Code.
Thereafter, C.S. Associates failed to provide adequate services
to its patients and on October 28, 1988, the facility was closed
by the Department of Health of the Commonwealth of Pennsylvania.
C.S. Associates' unsecured creditors' committee presented a plan
of reorganization which called for the sale of the facility;
however, this effort failed because, prior to the confirmation of
the plan, the facility was repeatedly and severely vandalized
from late September through December, 1989. On April 18, 1990,
pursuant to a motion filed by the United States Trustee, the
bankruptcy court ordered the debtor's case converted to a case
under Chapter 7 of the Bankruptcy Code. Thereafter, Mitchell W.
Miller was appointed Chapter 7 Trustee for the debtor.
During the pendency of C.S. Associates' Chapter 7
proceeding, the City of Philadelphia filed two proofs of claim
for post-petition administrative real estate taxes and
water/sewer rents, totalling $548,706.80, which had been assessed
against the facility. The City also filed a proof of claim for
pre-petition real estate taxes and water/sewer rents, totalling
$48,803.46, which under the applicable state law had properly
become liens against the facility.
By order dated November 10, 1992, the bankruptcy court
approved the sale of the facility for $2,416,000, free and clear
4
of all liens and encumbrances. UJB thereafter filed an action
with the bankruptcy court to predetermine the extent, validity,
and respective priority of any and all liens on the facility and,
accordingly, on the proceeds of the approved sale. The City
maintained that both its pre-petition and post-petition real
estate taxes and water/sewer rents had priority over UJB's
secured claim.
The bankruptcy court, in accordance with our holding in
Equibank, N.A. v. Wheeling-Pittsburgh Steel Corp., 884 F.2d 80,
84-85 (3d Cir. 1989), held that the City's pre-petition liens had
priority over UJB's secured claim as to the sale proceeds.
However, the bankruptcy court held that the City's post-petition
real estate taxes and water/sewer rents did not have priority
over UJB's secured claim as to the sale proceeds. The bankruptcy
court went on to suggest that the City might be able to recover
its post-petition real estate taxes and water/sewer rents from
the sale proceeds pursuant to either 11 U.S.C. § 503(b)(1)(B)(i)
or 11 U.S.C. § 506(c).
Accordingly, on March 12, 1993, the City moved the
bankruptcy court, pursuant to 11 U.S.C. § 506(c), to surcharge
the sale proceeds and allow the City to recover its post-petition
real estate tax claims and its water/sewer rent claims. In the
order of the bankruptcy court which is at issue in this appeal,
the bankruptcy court granted the City's motion under § 506(c) to
obtain compensation for post-petition real estate taxes and
water/sewer rents in the stipulated amount of $548,706.80.
5
UJB appealed the disputed bankruptcy court order to the
district court, arguing that the City had not met the
requirements of § 506(c) with respect to the post-petition real
estate taxes and water/sewer rents. The district court affirmed
the bankruptcy court's order. UJB took this appeal. We have
jurisdiction under 28 U.S.C. § 158(d).
II. DISCUSSION
UJB argues before us that the district court and
bankruptcy court erred in holding that the City had met the
requirements of 11 U.S.C. § 506(c) and could recover post-
petition real estate taxes and water/sewer rents under that
section. "Because the district court sits as an appellate court
in bankruptcy cases, our review of the district court's decision
is plenary. This [c]ourt'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). The issue in this
appeal is whether the bankruptcy court and district court
correctly interpreted and applied the legal standard contained in
§ 506(c), and we will therefore exercise plenary review. See
Maritime Elec. Co. v. United Jersey Bank, 959 F.2d 1194, 1203 (3d
Cir. 1992).
In Equibank, we held that the automatic stay provision
of the Bankruptcy Code, 11 U.S.C. § 362(a)(4), "prevents the
creation of a lien post-petition." 884 F.2d at 84. The only
amounts in question in this appeal are post-petition real estate
6
taxes and water/sewer rents, and therefore the City's taxes and
rents have not and cannot attain lien status for purposes of the
Bankruptcy Code. Id. at 84-85.
The code . . . provides two options for payment of
taxes that have not attained lien status as of the date
of the entry of the stay. First, they may be payable
by the trustee, either as first priority administrative
expenses, see 11 U.S.C. § 503(b)(1)(B)(i), or as
seventh priority expenses, 11 U.S.C. § 507(a)(1).
Second, they may be payable by the secured creditor as
payment for benefit received, see 11 U.S.C. § 506(c).
Equibank, 884 F.2d at 83.
The parties dispute whether the City could properly
receive payment for the real estate taxes and water/sewer rents
pursuant to the second option. Section 506(c) of the Bankruptcy
Code provides that: "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." 11 U.S.C.
§506(c). 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
7
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.").
In considering whether the post-petition real estate
taxes and water/sewer rents assessed by the City qualified for
treatment under § 506(c), the bankruptcy court stated:
The City's taxes and water and sewer rents are
costs which necessarily accrued against the Property
during the period that it was marketed for sale. As a
result of this marketing, the Property has been sold
for an amount which will result in payment of certain
net proceeds to UJB. These facts alone establish that
UJB was conferred with a benefit by the delays effected
by the sale process, which also caused the taxes to
accrue. Hence, UJB received a direct benefit from the
sale of the Property, which necessarily resulted in the
accrual of these taxes and water and sewer rents while
the Property was marketed, and is obliged to compensate
the City for same out of the net sale proceeds payable
to it.
In re C.S. Assocs., No. 88-12842S, slip op. at 2 (Bankr. E.D. Pa.
April 22, 1993); app. at 469.
On appeal from the order of the bankruptcy court, the
district court held:
[T]he fact of the accrual of the taxes over the period
during which the property was marketed is not open to
dispute, nor is the reasonableness of the amount of
taxes as assessed pursuant to Pennsylvania statute.
Further, the Bankruptcy Court's determination that the
fact of the accrual of taxes while the marketing of the
property took place was a benefit to the secured
creditor represents a permissible inference for the
court to have drawn and is supported by the record of
the proceedings.
United Jersey Bank v. Miller, No. 93-3065, slip op. at 5 (E.D.
Pa. Sept. 9, 1993); app. at 544.
8
As revealed by the language quoted above, the
bankruptcy court and the district court operated under the
assumption that the general and incidental benefits which an
entity receives from municipal services are the type of benefits
which § 506(c) contemplates. We find that the bankruptcy court
and the district court incorrectly interpreted and applied
§506(c) in allowing recovery of the assessed taxes and rents
without a demonstration by the City that such taxes and rents
caused a direct benefit to UJB, the secured creditor.
Both the bankruptcy court and the district court
mistakenly relied on our holding in Equibank, 884 F.2d 80, in
reaching their conclusion. In Equibank, we merely stated that
real property taxes "may . . . arguably be payable as the secured
creditor's liability pursuant to [§] 506(c)." Id. at 86
(emphasis added). Because it was not clear to us what benefit
the secured creditor derived from the payment of those taxes, we
remanded the case so that the bankruptcy court could make a
determination as to whether payment of the taxes provided a
direct benefit to the secured creditor. Id. at 86-87.
In this case, the City did not meet the requirement
that it demonstrate a direct benefit to the secured creditor.
Section 506(c) does not contemplate recovery for costs and/or
expenses associated with the incidental benefits an entity may
receive by virtue of existing within a municipality which
provides general services funded by taxes. This point has been
cogently made by a district court:
9
Section 506(c) was not intended to encompass ordinary
administrative expenses that are attributable to the
general operation and dissolution of an estate in
bankruptcy. Rather, it was designed to extract from a
particular asset the cost of preserving or disposing of
that asset. The trustee's payment of real property
taxes might benefit . . . the . . . secured creditors
to the extent that monies raised from the collection of
property taxes are used, in part, to fund the local
fire, police, and road maintenance departments, which
provide protection to the secured property against
vandalism and fire, and ensure that the adjoining road
is kept in good condition. This indirect benefit,
however, is insufficient to bring these post-petition
property taxes within the scope of § 506(c).
Courts have narrowly construed § 506(c) to
encompass only those expenses that are specifically
incurred for the express purpose of ensuring that the
property is preserved and disposed of in a manner that
provides the secured creditor with a maximum return on
the debt and also apportions those costs to the secured
creditor who, realistically, is assuming the asset.
Although in exchange for the payment of property taxes,
the estate would reap benefits that might aid in
preserving the asset in the advent of fire or from the
threat of vandalism, this incidental benefit is not
what was contemplated by § 506(c). Monies a government
entity derives from the collection of real property
taxes fund many governmental operations and services
which are not directly related to preservation and
disposal of the asset and in no way provide a benefit
to the secured creditor. Real estate tax revenues
support public parks, libraries, schools, and social
services, which do not constitute expenses peculiarly
connected with preserving or disposing of the parcel of
land.
Moreover, the Bankruptcy Code explicitly sets
forth the level of priority to be afforded unsecured
tax claims. Section 503 . . . indicates that tax
claims are generally afforded the status of ordinary
administrative expenses, thereby receiving first
priority after secured claims, unless they are the type
of taxes specified in § 507(a)(7), in which case they
will receive a seventh ranked priority after secured
claims.
10
In re Parr Meadows Racing Ass'n, 92 B.R. 30, 35-36 (E.D.N.Y.
1988) (citations omitted), aff'd in part, rev'd in part on other
grounds, 880 F.2d 1540 (2d Cir. 1989). This reasoning is
persuasive and we adopt it. Accord In re Glasply, 971 F.2d at
394 ("Even the small fraction of property taxes supplying fire
protection fails the benefits prong [of § 506(c)] because it does
not 'directly' protect and preserve the collateral. The
incidental benefits derived by [the secured creditor] from [the
payment of] property taxes do not trigger section 506(c)."
(citation omitted)). Accordingly, the incidental benefits which
the secured creditor received through general municipal services
to the property do not justify recovery by the City under §506(c)
for the post-petition real estate taxes and water/sewer rents
which accrued as to the subject property.
The City argues that since the debtor retained no
equity in the subject property, UJB as the secured creditor
received the full benefit from the sale of the property. The
City argues that having the property on the market benefitted UJB
because it was able to obtain the best available price for the
property, and therefore real estate taxes and water/sewer rents
which necessarily accrued during that time frame should be
recoverable under § 506(c). We reject this argument. Simply
because UJB benefitted from the sale of the property does not
automatically mean that payment of real estate taxes and
water/sewer rents which accrued pending the sale of the property
11
provided any direct benefit to the property in question.2 As
stated above, incidental benefits which an entity receives from
general municipal services are not the type of benefit
contemplated by § 506(c).
Had the City put forth evidence that the property had
received some direct or special governmental service which
benefitted the property, our conclusion might be different. For
instance, if the City had stationed a police officer at the
property to protect it, or if the fire department had provided
some direct service at the location, such services might have
been quantifiable and might have been recoverable under § 506(c).
But in this case, the City, the bankruptcy court and the district
court relied on the mere fact that government real estate taxes
and water/sewer rents accrued as to the property during the post-
petition time frame. This alone does not meet the requirement of
§ 506(c) that a direct benefit to the secured creditor be
demonstrated.
The City asserts that trash removal and road, water and
sewer service benefitted the property. However, the City
apparently never presented proof in the bankruptcy court that any
of these services actually were performed for the direct benefit
of the property. More importantly, even assuming that such
services were performed for the benefit of the property, the City
2
UJB contends vigorously that it will receive little benefit from
the sale of the property, even if it is completed as approved by
the bankruptcy court, since the net payment UJB will receive will
still leave it, as a secured creditor, with a shortfall of
$2,500,000.
12
did not quantify the value of services which were actually
performed. The City had the opportunity to present such proof in
the bankruptcy court, but failed to do so. The City therefore
did not meet its burden under § 506(c).
We will reverse the judgment of the district court. The
case will be remanded to the district court with a direction that
it remand the case to the bankruptcy court with instructions to
enter an order denying the motion of the City seeking payment
under § 506(c) of post-petition real estate taxes and water/sewer
rents from the proceeds of the sale of the subject property.
_________________________________________
13