Matter of Senior-G & A Operating Co., Inc.

In the Matter of SENIOR–G & A OPERATING CO., INC., Debtor.

PSI, INC. OF MISSOURI, Appellant,

v.

H. Kent AGUILLARD, et al., Appellees.

No. 91–4026.

United States Court of Appeals,

Fifth Circuit.

April 13, 1992.

Appeal from the United States District Court for the Western
District of Louisiana.

Before WISDOM, JOLLY, and SMITH, Circuit Judges.

E. GRADY JOLLY, Circuit Judge:

PSI appeals from an order of the bankruptcy court, affirmed by

the district court, holding it liable, as a secured creditor

receiving a benefit, for a portion of the cost of reworking an oil

well in which Senior, the bankrupt debtor, held a working interest.

For the reasons set out below, the judgment of the district court

is AFFIRMED in part, REVERSED in part, and REMANDED for further

proceedings in accordance with this opinion.

I

A

Senior owned a number of oil and gas producing properties,

among which was the U. Richard No. 2, 2–D Well. In July of 1988,

Senior needed cash. In return for the sum of $5,100,000 from PSI,

Senior entered into what was called by the parties a "Production

Payment Loan Agreement" (the Agreement). Under the terms of the

Agreement, Senior conveyed PSI the right to production payments
totalling $12,750,000 from a number of wells owned by Senior,

including the U. Richard No. 2, 2–D Well (the well). The Agreement

specified that the arrangement was to be treated as a loan for tax

purposes. The Agreement also specifically stated that "[t]he

Production Payment granted hereby shall constitute a lien upon the

Subject Minerals covered hereby."

At the time of the Agreement, the well was subject to a 30%

royalty burden; Senior owned a 70% working interest. The

Agreement gave PSI the right to production payments amounting to

85% of the 70% working interest revenues or a net revenue interest

of 59.5%. Sometime after entering the Agreement, Senior conveyed

most of its working interest in the well to Baxter Drilling and

Exploration and its affiliates (Baxter) and retained only 10% of

the 70% working interest. At this point, ownership under the well

was as follows:

Royalty burden 30 %

Baxter 80% × 70% Working Interest 56

Senior 10% × 70% O O 7

Others 10% × 70% O O 7

___

100 %

The working interest owned by Senior and "others" was a

"carried" interest, i.e., free of expenses of drilling, production,

maintenance, etc. However, the working interest, including that

conveyed to Baxter, was still subject to Senior's agreement with
PSI, so that 85% of production revenues attributable to each

interest went first to PSI. Thus, for example, Senior received

only 15% of 7% or 1.05% of any production from the well.

Significantly, Baxter, the owner of that portion of the working

interest responsible for all costs associated with the well,

received only 8.4% (15% of 56%) of the revenue produced by the

well.

Sadly, some months later, production from the well diminished.

Senior advised PSI that a workover of the well was needed in order

to restore production. Senior did not have the funds to pay for

the workover and Baxter was unwilling to do so in view of its

slender cut of any revenue. After negotiation, PSI agreed that it

would loan Senior and Baxter the needed funds for this workover and

some work to be done on another well subject to the Agreement. In

November 1988, the parties entered into a separate loan agreement

and PSI deposited $250,000 in escrow to cover these workover costs.

The workover commenced and hopes for further production were

renewed. Indeed, by February 1989 production was restored, at

least to some extent.

Things were not improving on all fronts, however. In December

1988, Senior filed a Chapter 11 bankruptcy petition. Furthermore,

because of a dispute with Baxter, PSI refused to release from

escrow the funds needed to pay for the workover. There is some

indication in the record that the total workover cost was over

$335,000. Timco Well Service (Timco), one of the contractors that
had performed services during the workover of the well, sought

payment of its total charges of $96,868.19 from Senior (who had

contracted for the services) and from Baxter. Timco was not paid.

B

Timco then moved for an order from the bankruptcy court

ordering payment of its charges as an "administrative expense." On

May 16, 1989, following a hearing, the bankruptcy court entered its

order allowing Timco's charges as an administrative expense. At

that time, it also ordered PSI, who had not been a party to the

hearing, to appear and show cause why it should not be required to

pay a portion of those charges from revenue attributable to the

well.

Thus, following a hearing on June 23, 1989, at which PSI

appeared, the bankruptcy court entered the following order upon its

minutes: "Order to show cause dismissed. Court holds that PSI

cannot be surcharged under § 506(c) at this time." (Emphasis

ours.) On July 5, the court followed with its order vacating its

June 23 order without prejudice to any of the parties. PSI

emphatically contends it never received a copy of this order, even

though it is listed as having been sent one. PSI, with even

greater vigor, contends that the bankruptcy court's ruling

following the June 23 hearing finally disposed of Timco's claim and

that, under the principles of res judicata, its liability for

Timco's claim is a dead issue.
 On July 10, 1989, the trustee filed a motion with the

bankruptcy court asking the court to reconsider its allowance of

Timco's charges as an administrative expense. The bankruptcy judge

denied this order on July 17, but gave the trustee an additional

forty days to seek reconsideration of the court's allowance of

Timco's claim. The trustee then filed a "Motion to Assess Section

506(c) Expenses and for Reconsideration of Allowance of

Administrative Expense Claim." The trustee essentially argued that

Timco's charges should not be allowed as an administrative expense.

If they were so allowed, however, then PSI, rather than the estate,

should pay its share because PSI would receive the lion's share of

the revenue. The Trustee also argued that as a secured creditor

PSI should properly be assessed its share under 11 U.S.C. §

506(c).1 PSI countered that it was a royalty owner, not a secured

creditor. PSI insisted that the Agreement clearly established that

it received production payments, a form of royalty, and that the

Agreement made clear that its arrangement with Senior was a "loan"

only for tax purposes. This motion was heard at an "evidentiary

rehearing" on October 20.

On July 30, 1990, the court rendered its memorandum opinion.

118 B.R. 444. In that opinion, the bankruptcy court held that PSI

was a secured creditor under the terms of its Agreement with

Senior, that the Agreement gave PSI only an in rem interest in the

well and no right to proceed against Senior, that PSI had received

1
Section 506(c) does not normally apply to prepetition
expenses. This issue, however, was not presented on appeal and
has been waived by the parties.
a benefit from the rework of the well, that the reworking charges

of Timco Well Services were properly allowable as administrative

expenses, that those charges were both "necessary" and

"reasonable," and that 11 U.S.C. § 506(c) authorized charging PSI

with its proportionate share of Timco's charges. On August 15,

1990, the court entered its judgment and ordered PSI to pay 59.5%

of Timco's $96,868.19 bill, or a net amount of $56,636.57.

PSI appealed this judgment to the district court. On November

27, 1990, the district court affirmed the judgment of the

bankruptcy court. This appeal followed.

II

A

Findings of fact made by a bankruptcy court will not be set
aside unless clearly erroneous. In other words, this Court
will reverse only "when[,] although there is evidence to
support it, the reviewing court on the entire evidence is left
with a firm and definite conviction that a mistake has been
committed." [citation omitted]. Conclusions of law,
conversely are subject to plenary review on appeal.

In re Delta Towers, Ltd., 924 F.2d 74, 76 (5th Cir.), reh'g denied

1991 WL 8493, 1991 U.S.App. Lexis 4829 (5th Cir.1991). With this

standard before us, we examine the issues raised by PSI in its

appeal.

B

PSI's status pursuant to the terms of the Agreement is the

key issue in this appeal. All parties seem to agree that if PSI

owns a royalty interest, it cannot be held responsible under any
theory for any portion of the costs of reworking the well. The

bankruptcy court held that PSI was a secured creditor within the

meaning of 11 U.S.C. § 506(c). The district court affirmed that

holding. We review de novo as a question of law the issue of PSI's

status under the Agreement.

PSI argues that the transaction between it and Senior was

actually a mineral sale and its interest is a royalty. It says

that a production payment is by definition a royalty interest—a

share of actual product at the wellhead free of costs of

extraction, but limited by amount, value or time and expiring when

the limit is reached. The only difference, according to PSI,

between a royalty interest and a production payment is that a

royalty interest continues indefinitely while a production payment

terminates when the predetermined limiting factor is met. Thus,

PSI argues, the interest granted it by the Agreement is a share of

production, free of costs of extraction, which share expires when

the monetary limit set out in the agreement is reached; it is

therefore a royalty.

PSI does admit that its interest is a "hybrid," as the

Agreement gives PSI a lien on Senior's mineral interest under the

well. Addressing this point, however, PSI contends that while its

production interest in the well is a royalty, the lien created by

the Agreement attached to Senior's mineral interest, thus allowing

PSI to seize and operate the well if Senior failed to do so in

breach of the Agreement. According to PSI's view, the fact that it
had a lien securing its "royalty" does not convert that "royalty"

to repayment of a loan secured by the minerals producing the

"royalty." In further support of its position that it is a royalty

owner, not a creditor, PSI points out that it never filed a claim

with the bankruptcy court against Senior; it was denominated a

creditor only because the trustee listed it as such. It further

argues that it has never voluntarily participated in the bankruptcy

proceedings.

There are a number of reasons to reject PSI's argument that

it is the owner of a royalty interest. We take as our launching

point Tidelands Royalty "B" Corp. v. Gulf Oil Corp., 804 F.2d 1344

(5th Cir.1986), cited at oral argument by both parties as

supporting their respective positions. Tidelands instructs us to

look exclusively to Louisiana law rather than hornbook law, or case

law from other states, in interpreting mineral agreements in

Louisiana. Tidelands, 804 F.2d at 1349, 1349 n. 15, n. 16. Under

Louisiana law,

[t]he royalty owner holds a nonexecutive interest—an interest
that does not include the right to grant leases. The
distinguishing characteristic of a non-executive royalty
interest is its "passive" nature. The royalty owner has no
right to explore, develop, or lease the subject tract.
Moreover, the landowner has no obligation to develop or lease
the premises for the benefit of the royalty owner. (Emphasis
ours.)

Tidelands, 804 F.2d at 1350; see also LA.REV.STAT.ANN. 31:81 (West

1989) (The statute states: "The owner of a mineral royalty has no

... right to conduct operations ... to produce minerals." Comment

characterizes the statute as verging on superfluous, but desirable
to "further elaborate the nature of the royalty and clearly state

that it does not carry with it any operating rights."). Certainly,

PSI's interest has none of these characteristics. Senior was

obligated to produce the well and to make payments from that

production. If it failed to do so, PSI could foreclose on the

well, then operate it and make production. It, therefore, appears

clear that PSI does not own a pure royalty interest in the well.

C

If not a royalty owner, what, then, is PSI's status? PSI's

interest arises under the terms of an instrument called "Production

Payment Loan Agreement." This instrument does not purport to be a

mineral transfer; indeed, it is denominated by the parties as a

loan agreement. However, "[i]n determining the nature of a

transaction the court will look to its substance, not merely to the

descriptive title." Grace–Cajun Oil Co. v. FDIC, 882 F.2d 1008,

1011 (5th Cir.), reh'g denied 1989 WL 98881, 1989 U.S.App. Lexis

16,118 (5th Cir.1989) (citing American Bank & Trust Co. v.

Louisiana Savings Ass'n, 386 So.2d 96 (La.App.1980)).

We will therefore look to the substance of the Agreement,

enlightened by Louisiana law. The Agreement provides that "[t]he

Production Payment granted hereby shall constitute a lien upon the

subject minerals covered hereby." Louisiana law in effect at the

time of the agreement provided that "a mineral right is susceptible

of mortgage to the same extent and with the same effect ... as ...

immovables." LA.REV.STAT.ANN. 31:203 (West 1989) (current version
at West Supp.1991). It also provided that "a mortgage of mineral

rights may also provide for the pledge of minerals subsequently

produced." LA.REV.STAT.ANN. 31:204 (West 1989) (current version at

West Supp.1991). Under Louisiana law, the landowner has the right

to explore and develop mineral resources under his land.

LA.REV.STAT.ANN. 31:15. This right may be transferred by lease and

the mineral lease is a "basic mineral right." LA.REV.STAT.ANN.

31:16. This interest of the mineral lessee is usually referred to

as "the working interest." LA.REV.STAT.ANN. 31:126, Comment.

Louisiana law defines a mortgage as "a right granted to the

creditor over the property of the debtor for the security of his

debt and [which] gives him the power of having the property seized

and sold in default of payment." LA.CIV.CODE ANN. 3278 (West

1972). This description reflects exactly the power given to PSI by

its "loan agreement" with Senior. Further, the Agreement gave PSI

the right to take production in kind if it so elected. This right

accords with the pledge provisions of Louisiana law noted above.

See Grace–Cajun Oil Co. v. FDIC, 882 F.2d 1008, 1011 (5th Cir.1989)

(operation of Louisiana law in regard to pledge of hydrocarbon

production). It is, therefore, clear that Senior mortgaged—it did

not transfer—its mineral interest in the well to PSI (and also

pledged its production), and under Louisiana law, PSI must be

classified as a secured creditor as opposed to a royalty owner.

The rulings of the courts below so holding are thus affirmed.

Additionally, once it is determined that PSI is not a royalty

owner under Louisiana law, the next question to arise is, not
whether PSI is a secured creditor under Louisiana law, but whether

PSI has an "allowed secured claim" under federal law. 11 U.S.C. §

506(c). We can arrive at this conclusion by a few inductive steps.

First, PSI has a "claim" against the property of the estate. 11

U.S.C. § 101(5)(A) ("claim" defined as "right to payment"). As

noted above, PSI has a right to payment from the minerals owned and

produced by the debtor. Consequently, PSI has a claim against the

debtor, Senior, within the meaning of the bankruptcy act. 11

U.S.C. §§ 101(10)(A), 102(2) (" "claim against the debtor' includes

claim against property of the debtor"). It is clear from the

Agreement that PSI's claim is secured by virtue of the lien the

Agreement imposes on the minerals. 11 U.S.C. §§ 101(51), (37).

Finally, the bankruptcy court recognized PSI's security interest

and allowed monies to be paid to it pursuant to that security

interest (although PSI was required to retain these monies for the

trustee). We, therefore, hold that PSI has an "allowed secured

claim."

D

(1)

We now come to the question whether PSI, by claiming an

interest in the assets of a debtor in bankruptcy, was within the

jurisdiction of the bankruptcy court. This question of law, if

answered in the affirmative, is followed by a number of procedural

questions. As to this initial question of law, we quickly conclude

that once PSI asserted rights against Senior's interest in the well

pursuant to the Agreement, it became part of the " "process of
allowance and disallowance of claims' [or] the restructuring of

debtor-creditor relations." At that point, both PSI and its

secured interest were within the court's jurisdiction. 28 U.S.C.

§ 1334; Granfinanciera v. Nordberg, 492 U.S. 33, 58, 59 n. 14, 109

S.Ct. 2782, 2799, 2799 n. 14, 106 L.Ed.2d 26 (1989); see also In

re Majestic Energy Corp., 835 F.2d 87, 91 (5th Cir.1988)

(bankruptcy jurisdiction exists if the matter is "related to"

bankruptcy, i.e., if the bankruptcy estate could conceivably be

affected by outcome of matter).

(2)

We now turn to the arguments raised by PSI in opposition to

the bankruptcy court's order that it pay a proportional share of

the expenses for reworking the well. PSI first argues that Timco

had no standing to assert its claim as administrative expense under

11 U.S.C. § 506(c) because, in PSI's view, these claims could here

be asserted only by the trustee. In the first place, this argument

is immaterial because, in fact, the 506(c) claim is being pressed

by the trustee. We note in passing, however, that we resolved this

question in In re Delta Towers, 924 F.2d 74, 76–77 (5th Cir.1991).

In that case, we concluded "that the advantages of § 506(c) are not

limited to trustees" and held that a vendor of services to the

debtor had standing to bring its claim under that section. Delta

Towers, 924 F.2d at 76. Based on Delta Towers, Timco has standing

to bring a 506(c) claim before the bankruptcy court.

(3)
 PSI next argues that it was never served a summons and

complaint requiring it to appear before the bankruptcy court and

defend a demand. PSI further contends that "no motion for

surcharge was ever properly brought before the Bankruptcy Court."

Therefore, according to PSI, it was denied due process and the

surcharge cannot stand. We disagree. We think that the bankruptcy

court's order, directing PSI to show cause why it should not be

surcharged for its share of Timco's expenses, fairly brought PSI

before that court. PSI was afforded notice and an opportunity to

be heard. Indeed, after that hearing, the bankruptcy court

dismissed the show cause order and held that PSI would not be

ordered to pay any of Timco's expenses "at [that] time."

Furthermore, the motion filed by the trustee asking that the court

reconsider its award to Timco of its charges as administrative

expenses or, in the alternative, to surcharge PSI with its share of

those expenses was properly entertained by the bankruptcy court.

On that occasion, PSI was, again, given notice and an opportunity

to be heard. See In re Sam, 894 F.2d 778, 781 (5th Cir.1990)

(citing Mullane v. Central Hanover Bank & Trust Co., 339 U.S. 306,

314–15, 70 S.Ct. 652, 657–58, 94 L.Ed. 865 (1950)) (due process

requirement met by "notice reasonably calculated, under all the

circumstances to apprise [creditor] of the pendency of the action

and afford [creditor] an opportunity to present his objections.").

In this case, PSI knew of the pendency of the action seeking

surcharge of PSI for a portion of the workover expenses and it had

an opportunity to present its objections. We find no denial of due

process to PSI.
 (4)

Finally, PSI argues that the bankruptcy court's minute entry

of June 23, 1989, which confirmed its oral order dismissing Timco's

claim against PSI is res judicata to that claim. We conclude that

the proper reading of the minute entry is that the bankruptcy court

simply held that it would not order PSI to pay any costs at that

time; that holding, however, was without prejudice to Timco or the

trustee to present the matter again to the court. This reading is

supported by the court's July 5 order so stating. We thus find

PSI's argument in this respect to be without merit. We now turn to

what we consider to be the more difficult issues of this appeal.

E

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). Usually, administrative expenses are satisfied

out of the bankruptcy estate. Section 506(c), however, provides an

exception. Delta Towers, 924 F.2d at 76 (citing In re Trim–X,

Inc., 695 F.2d 296, 301 (7th Cir.1982)).

Section 506(c) was intended by Congress as a codification of
... the equitable principle that a lienholder may be charged
with the reasonable costs and expenses incurred by the ...
trustee which are required to preserve or dispose of the
property subject to lien to the extent the lien-holder derives
a benefit therefrom.

3 Collier's on Bankruptcy, ¶ 506.06. "The underlying rationale for
charging a lienholder with the costs and expenses of preserving or

disposing of the secured collateral is that the general estate and

unsecured creditors should not be required to bear the cost of

protecting what is not theirs." In re Codesco, Inc., 6 C.B.C.2d

395, 18 B.R. 225 (S.D.N.Y.1982). In this case, the bankruptcy

court correctly determined that "the general estate and unsecured

creditors should not be required to bear the cost of protecting"

PSI's 85% share of the production from the working interest.

Generally, the courts have allowed such expenses where there

was a "clear and direct benefit" to the lienholder. Id. This

court has held that in order to charge a secured creditor with

expenses on the basis of § 506(c), three elements must be

established: "1) the expenditure was necessary, 2) the amounts

expended were reasonable, and 3) the creditor benefitted from the

expenses." Id. (citing In re Trim–X, Inc., 695 F.2d at 299.)

Furthermore, the expenses must have been incurred 1) "primarily for

the benefit of the secured creditor" and must have resulted in a 2)

"quantifiable direct benefit" to the secured creditor. See Delta

Towers, 924 F.2d at 77 (citing with approval cases so holding and

discussing the lack of showing of a "quantifiable direct benefit"

to secured creditor.). The burden of establishing these elements

is on the claimant. Id. at 76 (citing In re Flagstaff Foodservice

Corp., 739 F.2d 73, 77 (2d Cir.1984) ("Flagstaff I"); Brookfield

Production Credit Ass'n v. Borron, 738 F.2d 951, 952 (8th

Cir.1984)).
 (1)

The bankruptcy court held that these expenditures were

necessary for the preservation of PSI's collateral, the well and

its production. Before the workover, production had declined and

after the workover, production was restored. The bankruptcy court

found that Senior, Baxter and PSI had agreed, before the work was

done, that it was necessary. We certainly cannot hold that the

court was clearly erroneous in finding this workover to be

necessary.

(2)

A recovery under § 506(c) also requires that the expenditure

be "reasonable." Apparently, all concerned, including PSI, agreed

beforehand that the expenditure of at least $250,000 was reasonable

under the circumstances. Furthermore, the bankruptcy judge found

that PSI had a representative present on site during the workover

operations and that this representative took an active part in

decisions made by Baxter and Senior concerning the methods to be

pursued in completing the workover. He also found that, by its

conduct, PSI had impliedly or directly consented to expenditure of

the funds necessary to rework the well. We cannot say that the

bankruptcy court was clearly erroneous in these findings, up to the

expenditure of the $250,000 which PSI had agreed to fund.

The bankruptcy court also found that this expenditure was

reasonable because PSI received approximately $97,000 in revenue

for a pro-rata portion of expenses amounting to $56,636.57. This
finding, however, seems to ignore that Timco's claim was only part

of the cost of the workover. The total expenditure for the

workover was apparently in excess of $335,000. If this is true,

PSI's pro-rata share of the expenditures would have been

approximately $200,000 (using the pro-rata share assessed by the

bankruptcy court), not $56,000. The bankruptcy court thus erred to

the extent that its finding of reasonableness was based on the

workover charges of Timco and a comparison of only those charges to

PSI's share of revenue from the well to determine that the

expenditures were "reasonable."

Before the bankruptcy court can say that the expenditure of

any amount in excess of $250,000 is reasonable, it will have to

consider the totality of the circumstances, including any prior

agreement between the parties as to the workover, cost overruns and

responsibility for them, and projected revenue and actual earnings

from the well as a result of the workover.

In the alternative, PSI, by its conduct, may have agreed in

advance that expenditures in excess of $250,000 were reasonable.

Although the bankruptcy court's opinion may be read to imply that

PSI, by its conduct, did agree to these excess expenses, that court

did not specifically so find.

In any event, for the reasons we have stated, we hold that

the bankruptcy court erred in finding that the expenses over

$250,000 were "reasonable". We affirm, however, the courts below
in holding that expenditures up to $250,000 were "reasonable." If

the bankruptcy court should find that PSI, implicitly or

explicitly, consented to expenditures above $250,000, then such

expenditures would be "reasonable," by virtue of that consent, for

purposes of assessing 506(c) charges against PSI. Cf. 3 COLLIER ON

BANKRUPTCY ¶ 506.06 (consent by secured creditor may be treated as

advance acknowledgement that such expenses will confer a benefit on

creditor.)

(3)

In order to support a surcharge under Section 506(c), not

only must the expenditures be "necessary" and "reasonable" but the

expenditures must have resulted in a quantifiable direct benefit to

the creditor and must have been made primarily for the creditor's

benefit. Delta Towers, 924 F.2d at 77. PSI makes the dubious and

unsupported argument that it cannot be charged expenses under

Section 506(c) unless it receives a benefit not received by anyone

else as a result of that expenditure, i.e., "higher than the

proportionate benefit received by ... any other interest in the

well." To the extent that its argument might rest upon our holding

that the expense must be primarily for the benefit of the creditor,

Delta Towers, 924 F.2d at 77, PSI misreads the test to determine

chargeability under 506(c). "Primarily for the creditor's benefit"

as a determinative factor in a section 506(c) analysis is

particularly case specific. In this case, for example, the very

fact that PSI received 59.5% of the production rendered the

workover expense "primarily" for its benefit. This conclusion is
not to say, however, that in an appropriate case, a 506(c) charge

cannot be made against a minority secured interest holder. We

would further point out that Delta Towers states that "expenses

which benefit the debtor or other creditors rather than the secured

creditor himself are immaterial, [citation omitted]." (Emphasis

ours). Delta Towers, 924 F.2d at 77. This observation suggests

that neither proportionality nor non-proportionality is a factor in

the "benefit" analysis; the focus is on the benefit to the secured

creditor. Consequently, we find PSI's argument without merit. The

courts below correctly found that the workover was "primarily" for

PSI's benefit.

More relevant under the facts of this case, however, is that

when "the holder of the secured claim has consented to ...

preservation by the debtor ..., the court may treat such consent as

an advance acknowledgement that certain of the costs and expenses

incurred would benefit such holder.... Consent may also be found

to have been impliedly given." 3 COLLIER ON BANKRUPTCY ¶ 506.06.

PSI, by its conduct to which we have earlier alluded, acknowledged

in advance that the expenditure of up to $250,000 to rework the

well would be to its benefit.

Finally, with respect to the requirement that the benefit be

direct and quantifiable, the telling fact is that PSI, before the

workover, was receiving no revenue as a result of production from

the Champagne sand; after the workover, it was receiving revenue

from restored production. The revenue it received, and will
receive in the future, is, absent the operation of section 506(c),

free and clear and is unquestionably a "direct and quantifiable

benefit" to PSI.

(4)

We must now determine whether the bankruptcy and district

courts erred in assessing PSI a 59.5% share of expenses. The

bankruptcy court correctly stated that "[o]wing to the Production

Payment Loan Agreement, PSI essentially had an 85% interest in the

70% interest in the well." The court then stated that "PSI

received 59.5% of the[ ] revenues after royalty burdens and so

should be taxed or surcharged for only 59.5% of the workover costs"

and on this basis assessed PSI 59.5% of Timco's charges. The

district court affirmed "the Bankruptcy Court's assessment against

PSI." The court erred in so holding because it failed to take into

account that Section 506(c) allows recovery only "from property

securing an allowed secured claim.... [emphasis ours]." 11 U.S.C.

§ 506(c). In order to correctly apply this section, we must first

determine what "property secur[es]" that claim and then determine

the quantum of the "allowed secured claim."

First, it must be determined whether the estate actually has
an interest in the collateral. If, for example, the
collateral was transferred by the debtor prior to the
commencement of its bankruptcy case, the debtor retained no
interest therein, and the transfer has not been set aside, the
estate has no interest therein and secured claim status cannot
be based on a lien against the transferred collateral.

3 COLLIER ON BANKRUPTCY ¶ 506.04. Furthermore, we have stated, in

a case construing the predecessor to section 506(a), that a
creditor is not a "secured creditor" where "the security interest

is in property not belonging to the bankrupt, even if the security

interest originally encumbered property of the bankrupt that the

bankrupt parted with prior to bankruptcy." R.I.D.C. Indus. Dev.

Fund v. Snyder, 539 F.2d 487, 491 (5th Cir.1976). We held that

"R.I.D.C. ... held a security interest in property in possession of

the bankrupt, but prior to bankruptcy the property was conveyed to

a third person. Thus ... R.I.D.C. was not a secured creditor."

Id. at 492. In the present case, Senior transferred its working

interest to Baxter prior to bankruptcy, that transfer has not been

set aside, and Senior retains only a 7% carried interest.

Therefore, PSI is a "secured creditor" of the bankruptcy estate

only as to Senior's 7% interest in the well; or, stated in the

context of our analysis here, the "property securing the allowed

secured claim" is only Senior's 7% interest in the well.

We next turn to 11 U.S.C. § 506(a) to identify the "allowed

secured claim." This section provides that "an allowed claim of a

creditor secured by a lien on property in which the estate has an

interest ... is a secured claim to the extent of the value of such

creditor's interest in the estate's interest in such property....

[emphasis ours]." Id. We transpose that language to the facts at

hand: the "allowed claim of a creditor [PSI] secured by a lien

[the right to production given by the Agreement] on property in

which the estate has an interest [the well] ... is a secured claim

to the extent of the value of such creditor's [PSI's] interest

[85%] in the estate's interest [Senior's 7% interest] in such
property [the well]." Therefore, PSI has a secured claim to the

extent of 85% of Senior's 7% interest in the well, or 5.95%. As we

have already held, this is an "allowed secured claim." The

"property securing [that] allowed secured claim" is Senior's

interest in the well, not the entire 70% working interest, and,

accordingly, the trustee may recover administrative expenses

allowed under section 506(c) in an amount not exceeding 5.95% of

the well's total production.

The courts below, therefore, were in error in assessing PSI's

share of administrative expenses as 59.5% without considering the

fact that the entirety of that share must come from revenues

attributable to 5.95% of the well's production because that is the

"property securing an allowed secured claim." Section 506(c) also

limits surcharges to "the extent of any benefit to the holder of

such claim." 11 U.S.C. § 506(c). In the peculiar circumstances of

this case, the "extent of the benefit" to PSI is 59.5% of the

revenues attributable to restored production and is always more

than the amount recoverable from "property securing an allowed

secured claim"—PSI's 85% interest in Senior's 7% interest, or

5.95%. On remand, PSI's proper share of the workover expenses

should be determined only after consideration of the benefit "cap"

as well as PSI's 5.95% share of production as the sole source of

payment for § 506(c) surcharges against PSI.

F

We sum up and conclude as follows: The courts below did not
err in finding the expenditures in question "necessary" and that

they were made "primarily for the benefit" of PSI. Nor did they

err in finding that the expenditures conferred a benefit on PSI to

the extent of the revenues it received as a result of the restored

production of the well. PSI can be surcharged for workover

expenditures no amount greater than 5.95% of the total revenues

resulting from restored production. Under section 506(c), this is

its share of "property securing an allowed claim." 11 U.S.C.

506(c). This holding, however, does not preclude the bankruptcy

court from equitably charging PSI more than 5.95% of the total

workover costs so long as such charges do not exceed 5.95% of the

revenues from the restored production.2

Remand is, therefore, necessary to determine what percentage

of the workover expenses will be assessed against PSI. Remand is

further necessary for a determination by the court below whether

the expenditures in excess of $250,000 were "reasonable." Only to

the extent that these expenses are found reasonable, whether by

PSI's consent or otherwise, may the court below order surcharge of

PSI under the provisions of section 506(c) for a share of those

expenditures in excess of $250,000.

2
We also note that, absent the operation of § 506(c), PSI,
as a carried interest, would have no obligation to pay any of the
rework expenses. PSI's only commitment (as the case was
presented to us) was to lend money to Senior and Baxter in order
to fund the workover. We do not address what rights, if any, in
or out of bankruptcy court, PSI has to recover the charges, or
any part thereof, assessed against it under § 506(c) from other
parties, including an unsecured claim against the estate which we
understand is still in the process of being administered.
 We, therefore, REVERSE the holding below that surcharges PSI

with 59.5% of Timco's charges based on section 506(c) and REMAND

for further proceedings not inconsistent with this opinion.

AFFIRMED in part, REVERSED in part, and REMANDED.