Section 506(c) of the Bankruptcy Code offers a debtor an opportunity to “surcharge,” or to recover from, a secured lender the “reasonable and necessary costs” of preserving collateral to the extent those costs benefited the secured creditor. This provision can be used to ensure that a bankruptcy case does not utilize assets that might benefit all case constituents solely for the benefit of the secured creditor. Section 506(c) rights are typically waived, however, as a concession to a lender providing postpetition financing or allowing the use of cash collateral. As a result, litigation involving section 506(c) is uncommon, and thus notable when it arises. Section 506(c) was front and center in the Bouchard bankruptcy cases, and that litigation is recapped below.
Background
On September 28, 2020, Bouchard Transportation Co., Inc. and its affiliates (the “Debtors”), independently-owned ocean-going petroleum barge companies, filed for chapter 11 relief in the U.S. Bankruptcy Court for the Southern District of Texas.1 The Debtors entered bankruptcy after failing to generate revenue from fleet operations and, consequently, falling behind on necessary maintenance and payment obligations to crew members and creditors, some of which resorted to self-help maritime remedies.2 One of those creditors, the Debtors’ prepetition secured lender (the “Secured Lender”), held approximately $164 million in claims, which were secured by preferred ship mortgages on many of the Debtors’ vessels, liens on related equipment and machinery, and proceeds thereof (the “Collateral”).3 By the Debtors’ account, the collateral vessels were “under-manned, in disrepair, and, in some instances, precariously positioned—with some . . . anchored at sea away from a safe berth and others under arrest and subject to pending judicial sales.”4
After the Debtors filed for bankruptcy, they acquired over $100 million in new debtor-in-possession (“DIP”) financing.5 Notably, the DIP financing was not provided by the Secured Lender and the Collateral was not considered cash collateral, thus the Debtors did not agree to waive the estate’s right to seek a 506(c) surcharge regarding the Collateral.6 During the pendency of the cases, the Debtors “regained certain certifications required to service customers, repaired relationships with key counterparties, completed critical and necessary maintenance and repairs on vessels as part of the Debtors’ return-to-service plan, and implemented prudent cost-savings measures.”7 On July 19, 2021, the Debtors’ efforts culminated in an auction, resulting in a winning bid of $130 million for the Collateral.8
The Surcharge Litigation
The Debtors, joined by the official committee of unsecured creditors (the “Committee”),9 sought to surcharge the Secured Lender, arguing that their efforts during the bankruptcy proceedings (and the use of funds provided by a party other than the Secured Lender) significantly enhanced the value of the Collateral. Specifically, the Debtors sought to surcharge the proceeds of the Collateral, and asserted that necessary expenses (totaling at least $30 million) included things such as: “(a) employee compensation and benefits; (b) executive compensation; (c) repairs, maintenance, utilities, and other operational expenses; (d) maritime lien settlements; (e) insurance costs; (f) bankruptcy professional fees; (g) ordinary course professional fees; (h) sales and marketing costs; (i) interest and fees for postpetition financing; and (j) ad valorem taxes[.]”10 Alternatively, the Debtors sought to limit the Secured Lender’s liens on proceeds of the Collateral pursuant to the equities of the case exception “because the Debtors’ efforts to sell [the] [C]ollateral, including the steps taken to maintain [the] . . . [C]ollateral and prepare it for sale, enhanced its value.”11 The Secured Lender objected to the surcharge motion, asserting that “nearly everything that the Debtors have done . . . has been for the primary benefit of parties other than [the Secured Lender]” and “the Debtors’ operations worked to devalue the vessels below what [the Secured Lender] could have achieved through its own prepetition self-help.”12
The parties eventually negotiated a consensual resolution of the issue without the need for further litigation. The Secured Lender agreed to (i) vote in favor of the Debtors’ amended plan of reorganization, (ii) contribute $15 million for distribution to creditors, and (iii) subordinate recovery on its deficiency claims to general unsecured claims via a carve-out of the first $20 million in recoveries in exchange for a release of all claims against the Secured Lender.13 on August 26, 2021, Judge David R. Jones entered an order confirming the Debtors’ amended plan of reorganization, which incorporated the settlement terms.14
Takeaway
The ability to seek a section 506(c) surcharge is an important tool in a debtor’s toolbox that—even where it does not result in a bankruptcy court granting surcharge rights—can provide leverage for cost-saving concessions that benefit the estate and, in turn, unsecured creditors. It is particularly relevant in the case of maritime bankruptcies where, as demonstrated above, debtors may incur significant costs in repairing and/or maintaining collateralized vessels. If you have questions related to surcharge rights of maritime companies please don’t hesitate to reach out to your primary contact at S&K.
1 In re Bouchard Transportation Co., Inc., Case No. 20-34682 (DRJ) (Bankr. S.D. Tex.).
2 Dkt. No. 1110 at 2.
3 Id. at 3.
4 Id. at 7.
5 Id. at 2-3.
6 See Dkt. No. 334.
7 Dkt. No. 1110 at 3.
8 Id. at 9.
9 Dkt. No. 1139.
10 Dkt. No. 1100 at 4.
11 Id.
12 Dkt. No. 1160 at 2.
13 See Dkt. No. 1293, Attach. 1.
14 Dkt. No. 1319.
