In re Virginia Foundry Co., Inc., Bankruptcy No. 7-80-00470.

• Decision Date: 20 February 1981
• Docket Number: Bankruptcy No. 7-80-00470.
• Citation: 9 BR 493
• Court: U.S. District Court — Western District of Virginia
• Parties: In re VIRGINIA FOUNDRY COMPANY, INC., Debtor. UNITED VIRGINIA BANK, Appellant, v. VIRGINIA FOUNDRY COMPANY, INC., Appellee.

9 B.R. 493 (1981)

In re VIRGINIA FOUNDRY COMPANY, INC., Debtor.

UNITED VIRGINIA BANK, Appellant, v. VIRGINIA FOUNDRY COMPANY, INC., Appellee.

Bankruptcy No. 7-80-00470.

United States District Court, W.D. Virginia.

February 20, 1981.

John D. Copenhaver, Douglas W. Kielkopf, Roanoke, Va., for appellee.

G. Franklin Flippin, Roanoke, Va., for appellant.

Ross C. Hart, Roanoke, Va., for Collector's Committee.

MEMORANDUM OPINION

TURK, Chief District Judge.

This is an appeal arising out of a Chapter 11 proceeding in the bankruptcy court. Appellant, United Virginia Bank, a secured creditor, challenges a June 2, 1980, order and memorandum opinion of the bankruptcy court in which that court determined that appellant's attorney's fees were to be allowed in accordance with Title 11 U.S.C. § 503 and Rule of Bankruptcy Procedure 219 and that appellant is "adequately protected" under § 362.¹ The court finds both issues to have been wrongly considered by the bankruptcy court, and, accordingly, reverses that decision and remands for further consideration.

Appellant has advanced the debtor, Virginia Foundry Company, Inc., $400,000.00. That loan is evidenced by a promissory note dated October 9, 1978, payable on demand, with interest at 9½ per annum and is secured by a deed of trust on two parcels of land, a perfected security interest in Virginia Foundry's inventory and accounts receivable, an assignment of a $100,000.00 policy insuring the life of Virginia Foundry's president, and a pledge of all Virginia Foundry's outstanding corporate stock. According to the terms of the note, Virginia Foundry was liable for all expenses of collecting the debt "including an 18% attorney's fee."

Subsequent to the loan, the value of the Bank's collateral fell, Virginia Foundry's financial condition deteriorated, and it failed to pay real estate taxes on property covered by the deed of trust. In July of 1979, to protect its interest, appellant demanded payment of the note. Payment was not made and a default was declared. Payment was again demanded and default was again declared in December of 1979 and in April of 1980. On April 30, 1980, Virginia Foundry filed its Chapter 11 petition under the Bankruptcy Code. Appellant, in turn, sought relief from the automatic stay of Title 11 U.S.C. § 362(a) maintaining that it was not "adequately protected" under § 362(d)(1). In a proposed order appellant and Virginia Foundry set forth a plan which they agreed provided for adequate protection. However, because the plan, in part, called for an increase in interest to a current rate it was objected to by the creditor's committee.

As of June 2, 1980, the balance remaining on the promissory note was $260,000.00 plus interest and costs. On that date, the bankruptcy court set forth a plan which it found to provide "adequate protection" under § 362(d)(1) but which did not allow interest at a current or market rate because of undue prejudice to the general creditors. In that same order the bankruptcy court stated "that any costs, charges, and fees incurred or claimed by United Virginia Bank" would be paid upon "proper application . . . pursuant to Rule 219 of Federal Bankruptcy Rules and 11 U.S.C. 503."

I. COSTS, EXPENSES, AND ATTORNEY'S FEES

The bankruptcy court was clearly in error when it determined that costs, charges, and attorney's fees were to be paid in accordance with Title 11 U.S.C. § 503. That section applies to the allowance of costs, expenses, and fees for services rendered in the administration of a bankruptcy estate. The allowance of costs, expenses, and fees, including attorney's fees, to a secured creditor, with a provision for such in his secured agreement, on the other hand, is governed by Title 11 U.S.C. § 506(b) which reads as follows:

To the extent that an allowed secured claim is secured by property the value of which, after any recovery under subsection (c) of this section, is greater than the amount of such claim, there shall be allowed to the holder of such claim, interest on such claim, and any reasonable fees, costs, or charges provided under the agreement under which such claim arose.

If the reasonableness of the fees is to be determined in the bankruptcy judge's discretion in accordance with federal common law, the error is of little significance to the appellant in the present case. However, if determined in accordance with state law, the error may be of greater consequence.

Under the Bankruptcy Act of 1898, as amended, the allowance of attorney's fees provided for in a secured undertaking is determined in accordance with state law. In re Crafty Fox, Ltd., 475 F.Supp. 634 (W.D.Va.1979).² This results from the fact that under state law such fees are as much a part of the debt as the principal and interest. See University of Richmond v. Stone, 148 Va. 686, 139 S.E. 257 (1927); Schwab v. Norris, 217 Va. 582, 231 S.E.2d 222 (1977). In bankruptcy proceedings, the extent and nature of property rights are determined in accordance with state rather than federal common law. See Butner v. U.S., 440 U.S. 48, 99 S.Ct. 914, 59 L.Ed.2d 136 (1979). This point was emphasized by the Supreme Court in the recent case of Butner v. U.S., supra. That case, which arose out of a bankruptcy proceeding in North Carolina, involved the question of whether North Carolina law, which gives a mortgagee the right to rents and profits after default, must be applied by the bankruptcy court, or a federal rule of equity. In finding that state law controlled the court stated:

The constitutional authority of Congress to establish "uniform laws on the subject of bankruptcies throughout the United States" would clearly encompass a federal statute defining the mortgagee\'s interest in the rents and profits earned by property in a bankrupt estate. But Congress has not chosen to exercise its power to fashion any such rule. The Bankruptcy Act does include provisions invalidating certain security interests as fraudulent, or as improper preferences over general creditors. Apart from these provisions, however, Congress has generally left the determination of property rights in the assets of a bankrupt\'s estate to state law.

Property interests are created and defined by state law. Unless some federal interest requires a different result, there is no reason why such interest should be analyzed differently simply because an interested party is involved in a bankruptcy proceeding. Uniform treatment of property interests by both state and federal courts within a state serves to reduce uncertainty, to discourage forum shopping, and to prevent a party from receiving "a windfall merely by reason of the happenstance of bankruptcy." Citation omitted. The justifications for application of state law are not limited to ownership interest; they apply with equal force to security interests, including the interest of a mortgagee in rents earned by mortgaged property.

440 U.S. at 54-55, 99 S.Ct. at 918.

It could hardly be maintained that appellant's right to attorney's fees, costs, and expenses is less of a property right under Virginia law than the mortgagee's right to rents and profits is a property right under North Carolina law. Those expenses, costs, and fees would, therefore, be determined in accordance with state law if this case had arisen under the Bankruptcy Act of 1898, as amended. The present case arises under the Bankruptcy Reform Act of 1978, however, and the question presented is whether Title 11 U.S.C. § 506(b) of the new Bankruptcy Code permits a bankruptcy court to determine the reasonableness of such fees, costs, or charges provided under the secured agreement in accordance with federal and not state law. The court holds that it does not.

According to Senate Report No. 95-989, 95th Cong., 2d Sess., subsection (b) of § 506 was a codification of the law under the Bankruptcy Act of 1898, as amended:

Subsection (b) codifies current law by entitling a creditor with an oversecured claim to any reasonable fees (including attorney\'s fees), costs, or charges provided under the agreement under which the claim arose. These fees, costs, and charges are secured claims to the extent that the value of the collateral exceeds the amount of the underlying claim.

Id. at 68, U.S.Code Cong. & Admin.News 1978, pp. 5787, 5854. The House Report contains language to the same effect. H.R. Rep.No.95-595, 95th Cong., 1st Sess., at 356-357. House Bill 8200 provided that such fees, costs, and charges were to be allowed "to the extent collectible under applicable law." Senate Bill 2266 did not contain the "to the extent collectible under applicable law" language, however, and in compromise it was ultimately dropped by the House. In explaining the amendment to the House Bill, Rep. Don Edwards stated:

Section 506(b) of the House Amendment adopts language contained in the Senate Amendment and rejects language contained in H.R. 8200 as passed by the House. If the security agreement between the parties provides for attorney\'s fees, it will be enforceable under title 11 notwithstanding contrary law, and is recoverable from the collateral after any recovery under section 506(c).

124 Cong.Rec. 9-98 (1978). By deleting the language contained in the House Bill an anomalous situation arises. According to both House and Senate documents, Congress intended to codify the law in this area which existed under the Bankruptcy Act of 1898, as amended. As the Supreme Court explained in Butner v. U.S., supra, which, as previously stated, was decided under the 1898 Act, as amended, a "federal bankruptcy court should take whatever steps are necessary to insure that the mortgagee is afforded in federal bankruptcy court the same protection he would have under state law if no bankruptcy has ensued."³ 440 U.S. at 56, 99 S.Ct. at 918. Yet, in deleting the language of the House conditioning the entitlement to interest, costs, and reasonable fees upon collectibility under local law, the Congress missed the mark...