Cross Baking Co., Inc., In re, 86-2038

• Decision Date: 03 March 1987
• Docket Number: No. 86-2038,86-2038
• Citation: 818 F.2d 1027
• Parties: , 17 Collier Bankr.Cas.2d 236, Bankr. L. Rep. P 71,825 In re CROSS BAKING CO., INC., Debtor. NEW HAMPSHIRE BUSINESS DEVELOPMENT CORPORATION, Plaintiff, Appellant, v. CROSS BAKING COMPANY, INC., Defendant, Appellee. . Heard
• Court: U.S. Court of Appeals — First Circuit

Page 1027

818 F.2d 1027

55 USLW 2658, 17 Collier Bankr.Cas.2d 236,

Bankr. L. Rep. P 71,825

In re CROSS BAKING CO., INC., Debtor NEW HAMPSHIRE BUSINESS DEVELOPMENT CORPORATION, Plaintiff, Appellant, v. CROSS BAKING COMPANY, INC., Defendant, Appellee.

No. 86-2038.

United States Court of Appeals First Circuit.

Heard March 3, 1987.

Decided May 18, 1987.

Russell F. Hilliard, Concord, N.H., for plaintiff, appellant.

Victor W. Dahar, Manchester, N.H., for defendant, appellee.

Before COFFIN and TORRUELLA, Circuit Judges, and PETTINE, ^* Senior District Judge.

COFFIN, Circuit Judge.

This case presents an issue of first impression in this circuit concerning the effect of section 552(b) of the Bankruptcy Code on the rights of a secured creditor holding a floating lien on a debtor's accounts receivable. Specifically, we must determine whether a secured lender, who permits a borrower to use cash collateral during reorganization without formally protecting its security interest, is entitled to any portion of the post-petition receivables collected upon liquidation. Both the bankruptcy court and the district court ruled that section 552(b) provides no assistance to a secured creditor in such circumstances. We agree and therefore affirm the judgment of the district court.

I. Factual Setting.

Cross Baking Company ("Cross"), a Claremont, New Hampshire bakery, experienced financial difficulties during early 1980 and filed a petition for relief under chapter 11 of the Bankruptcy Code on June 11, 1980. At the time of the filing, appellant New Hampshire Business Development Corporation ("NHBDC") ¹ held a security interest in the first $50,000 of Cross' accounts receivable. Another creditor, F.R. Lepage Baking Company ("Lepage"), also held a security interest in the accounts receivable, but its interest was subordinate to that of NHBDC pursuant to an agreement between the two creditors.

Soon after Cross filed for bankruptcy, NHBDC and Lepage agreed to permit Cross to use the cash generated by its pre-petition receivables during the reorganization. The record indicates that Lepage's counsel was to prepare a stipulation and secure a "cash collateral order" from the bankruptcy court which would have permitted Cross to use the cash collateral, see 11 U.S.C. Sec. 363(c)(2)(B) ², while simultaneously protecting the creditors' security interests, see 11 U.S.C. Sec. 363(e). ³ Such an order, for example, could have provided that the creditors' lien would extend to accounts receivable arising after the commencement of the bankruptcy case or to some other collateral. At no time, however, did either of the secured creditors ever seek or obtain such an order.

Cross operated as a chapter 11 debtor-in-possession for approximately seven months. During this period, payments by Cross' customers satisfied the outstanding balances on the vast majority of accounts receivable in existence prior to the bankruptcy filing. Cross used this cash in an attempt to reorganize its business. The reorganization effort failed, however, and a trustee was appointed to take over the business on January 9, 1981. Two weeks later, the trustee closed the business and filed a motion with the bankruptcy court to convert the proceedings to a chapter 7 liquidation. NHBDC immediately responded by filing both a complaint for relief from the automatic stay and a motion to prohibit further use of the proceeds of its cash collateral. On February 18, 1981, the bankruptcy court granted the trustee's chapter 7 conversion motion.

Subsequently, the trustee began to liquidate all of Cross' accounts receivable, most of which arose after the filing of the bankruptcy petition. NHBDC sought to recover up to $50,000 of these funds in accordance with its pre-petition security interest in Cross' receivables. The bankruptcy court issued its decision regarding NHBDC's claims on May 8, 1986, 62 B.R. 750, holding that Cross, by using the cash generated by the pre-petition receivables, had acted permissibly in light of NHBDC's actual consent to such use and that NHBDC had no right to any of the sums collected on the post-petition accounts. The district court affirmed the decision, opining that neither the Code nor the "equities of the case" entitled NHBDC to relief in this instance. This appeal ensued.

II. Section 552(b) and the Nature of NHBDC's Claim.

Section 552 of the Bankruptcy Code concerns the post-petition effect of security interests. 11 U.S.C. Sec. 552. Its purpose is to prevent a creditor's pre-petition security interest in "after-acquired property" (a "floating lien"), such as NHBDC's interest in Cross' receivables, from attaching to property acquired by the estate or debtor-in-possession after the filing of a bankruptcy petition. See H.R.Rep. No. 595, 95th Cong., 1st Sess. 376-77 (1977) reprinted in 1978 U.S.Code Cong. & Admin.News 5787, 5963, 6332-33 ("House Report"); S. Rep. No. 989, 95th Cong., 2d Sess. 91 (1978), reprinted in 1978 U.S.Code Cong. & Admin.News 5787, 5877 ("Senate Report"). Section 552(a) plainly states this general rule: "[P]roperty acquired by the estate or by the debtor after the commencement of the case is not subject to any lien resulting from a security agreement entered into by the debtor before the commencement of the case." 11 U.S.C. Sec. 552(a).

Section 552(b), however, states the lone exception to the general rule of subsection (a):

Except as provided in sections 363, 506(c), 522, 544, 545, 547, and 548 of this title, if the debtor and an entity entered into a security agreement before the commencement of the case and if the security agreement extends to property of the debtor acquired before the commencement of the case and to proceeds, product, offspring, rents, or profits of such property, then such security interest extends to such proceeds, product, offspring, rents, or profits acquired by the estate after the commencement of the case to the extent provided by such security agreement and by applicable nonbankruptcy 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. Sec. 552(b). It is this language regarding the post-petition treatment of "proceeds" on which NHBDC bases its claim in the instant case.

NHBDC, stressing the limited nature of its claim, seeks only to recover up to $50,000 of the money collected by the trustee upon liquidation which it contends must constitute the proceeds of the pre-petition receivables, its original collateral. It has repeatedly noted the ease with which the amount of proceeds collected by the trustee, and arguably owed to it, can be calculated. ⁴ The trustee disputes not the simplicity of the calculation, but rather the very existence of NHBDC's claim to a portion of the funds collected on post-petition receivables.

In its brief, NHBDC illustrates the scope of its claim by discussing three distinct categories of accounts receivable. Regardless of category, all of the accounts at issue share the common characteristic of having an outstanding balance on the date of Cross' bankruptcy filing. The first category comprises those accounts which experienced no additional post-petition charges and whose pre-petition balances were never fully paid during reorganization. The parties agree that NHBDC is entitled to any sums subsequently collected on these accounts and the trustee has apparently already paid to NHBDC the small amount of cash fitting this description.

The other two categories of accounts receivable described in NHBDC's brief, however, have sparked considerable controversy between the parties. Both disputed categories contain accounts which not only had an outstanding balance on the date of the bankruptcy filing, but which also experienced payments and additional charges during the course of the chapter 11 proceeding. The first disputed category involves those accounts for which the customer's payments during the chapter 11 proceeding exceeded its purchases. For example, an account would fall within this category if a customer owed Cross $2000 at the time of filing, and then made new purchases totalling $5000 and payments totalling $6000 during the reorganization. NHBDC contends that it should receive the entire amount collected on such accounts during liquidation (an amount that could reach $1000) because the trustee would already have been made whole (all charges incurred during the reorganization would have been paid) and the collection would necessarily represent the pre-petition receivable.

The second disputed category concerns those accounts for which the customer's post-petition payments on the account were less than the amount of additional charges incurred during the chapter 11 proceeding. For example, this category would include accounts with a $2000 balance at the time of filing, $5000 of subsequent new purchases, and only $4000 of payments during the reorganization. On these accounts, NHBDC claims not the entire amount collected by the trustee on liquidation, but only the amount by which the collected funds exceed the balance owed on new purchases during the chapter 11 proceeding. In other words, if the trustee liquidated the account described above and collected the entire $3000 balance, NHBDC claims only the $2000 that remains after the collected funds are applied against the $1000 balance owed for goods purchased during reorganization. To rule otherwise, claims NHBDC, would be to create a windfall gain in favor of the trustee and the unsecured creditors he represents.

The legal arguments identified in NHBDC's cursory brief are blended together in a fairly haphazard manner. Nevertheless, we believe it is possible to distill two distinct lines of argument, both of which are designed to support NHBDC's claim for recovery of a portion of the liquidated post-petition receivables. First, there is an argument that we should consider a portion of the money collected by the trustee to be the actual...