United States Court of Appeals
For the First Circuit
No. 06-2700
IN RE LOUIS A. GENCARELLI, SR.,
Debtor.
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UPS CAPITAL BUSINESS CREDIT,
Plaintiff, Appellant,
v.
LOUIS A. GENCARELLI, SR.,
Defendant, Appellee.
APPEAL FROM THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF RHODE ISLAND
[Hon. Ernest C. Torres, U.S. District Judge]
[Hon. Arthur N. Votolato, U.S. Bankruptcy Judge]
Before
Boudin, Chief Judge,
Selya, Senior Circuit Judge,
and Howard, Circuit Judge.
Edward J. Pontacoloni, with whom Barbara A. Frederick, Updike,
Kelly & Spellacy, P.C., Thomas J. Cronin, and Gunning & LaFazia,
Inc. were on brief, for appellant.
Christopher M. Mulhearn, with whom Ferrucci Russo P.C. was on
brief, for appellee.
August 30, 2007
SELYA, Senior Circuit Judge. This bankruptcy dispute
presents a question of first impression in this circuit concerning
a commercial lender's right to receive a bargained-for prepayment
penalty from a solvent debtor. The lender's best argument was not
presented very clearly in the lower courts, but the parties have
vigorously contested the point in this court. Because the issue
was at least arguably preserved and because its resolution has
significant ramifications for the due administration of the
Bankruptcy Code (the Code), we decide it. That decision leads us
to reverse the lower courts' rulings, vacate their orders, and
remand for further proceedings consistent with this opinion.
The facts are not seriously disputed. On February 14,
2002, Bess Eaton Donut Flour Co. and its sole shareholder, Louis A.
Gencarelli, Sr., entered into a pair of commercial loan agreements
with UPS Capital Business Credit. One loan, involving roughly
$5,000,000, was for a thirty-year term; the other, involving nearly
$2,000,000, was for a twenty-year term. Each was governed by Rhode
Island law, secured by interests in real property and other
business assets owned by Bess Eaton, and bore interest at a
floating rate pegged to 1.25% over prime.
Pertinently, each loan agreement allowed the borrowers to
repay at any time, subject, however, to a prepayment penalty
provision. That provision, common to each loan agreement, stated
in substance that, should repayment occur within the first five
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years of the loan term, the borrowers would pay a fee equal to a
percentage of the amount prepaid. That percentage would vary
depending upon the date of prepayment (generally speaking, the
earlier the prepayment, the higher the percentage).
On March 1, 2004, Bess Eaton filed a voluntary petition
for bankruptcy under Chapter 11. See 11 U.S.C. §§ 301, 1101-1174.
Gencarelli followed suit within the next few days. The bankruptcy
court consolidated the cases.
In due course, the bankruptcy court arranged for, and
oversaw, the sale of Bess Eaton's operating assets. See id. §
363(b). The auction, skillfully managed by the bankruptcy judge,
inspired unbridled enthusiasm, which translated into hard cash. As
a result, the sale fetched a far higher price than had been
anticipated — so much higher that the bankruptcy estates wound up
with funds sufficient to pay all creditors in full (including
interest). Even so, a multimillion dollar surplus remained for
Gencarelli.
Along the way, UPS submitted timely proofs of claim to
the bankruptcy court in which it asserted a right to the unpaid
principal balances of the two loans, plus accrued interest, plus
the prepayment penalties. Because full repayment was to be made in
the third year of the loans, the loan agreements called for
penalties equal to 3% of the outstanding principal balances. This
amounted to aggregate prepayment penalties of some $200,000.
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The debtors conceded liability for the loan balances
(including accrued interest); those balances have been paid in full
and are not at issue in this appeal. Withal, the debtors balked at
paying the prepayment penalties.
As a practical matter, the dispute over the prepayment
penalties narrowed to one between Gencarelli and UPS. Gencarelli
filed an objection to those portions of the claims that sought
prepayment penalties. He averred that, under the Code, an
oversecured creditor is entitled to recover such costs only to the
extent that they are "reasonable." Id. § 506(b). He posited that
the prepayment penalties demanded by UPS were unreasonable because
they bore no rational relationship to the added expense that
prepayment might inflict on the lender. Accordingly, the claims
should be disallowed.
UPS countered, albeit without citation to any specific
Code provision, that the prepayment penalties were valid under
controlling state law and, therefore, were enforceable in
bankruptcy. In the alternative, it asserted that the penalties
were reasonable.
Following a hearing, the bankruptcy court held that
section 506(b) of the Code governed, displacing state law and
creating a uniform federal standard of reasonableness that served
as a substantive limitation on the fees, costs, and other charges
that a secured creditor could recoup. In re Bess Eaton Donut Flour
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Co., Nos. 04-10630, 04-10682 (Bankr. D.R.I. Oct. 8, 2004). Ergo,
the prepayment penalties coveted by UPS were enforceable only to
the extent that they were reasonable, regardless of their status
under Rhode Island law. Id. at 1.
The bankruptcy court subsequently took evidence to
determine the reasonableness of the prepayment penalties.
Thereafter, the court found the penalties unreasonable in amount
and disallowed UPS's claims for them in their entirety. In re Bess
Eaton Donut Flour Co., Nos. 04-10630, 04-10682, 2005 WL 1367306, at
*3 (Bankr. D.R.I. Jan. 19, 2005).
UPS appealed this ruling to the United States District
Court for the District of Rhode Island. In the proceedings that
followed, most of the briefing was devoted to the question of
whether the prepayment penalties were reasonable. But UPS also
argued that "a finding that fees, costs, or charges are
unreasonable under § 506(b) means only that they cannot be allowed
as a secured claim, and instead must be treated as an unsecured
claim." While UPS again neglected to cite the relevant Code
provisions, it did offer pertinent case citations in support of
this argument.
Although its analysis diverged somewhat from that of the
bankruptcy court, the district court agreed that section 506(b)
governed and that an oversecured creditor can recover charges, such
as prepayment penalties, only if they are reasonable. See UPS
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Capital Bus. Credit v. Gencarelli, No. 1:05-cv-00039, 2006 WL
3198944, at *3 (D.R.I. Nov. 3, 2006). In affirming the bankruptcy
court's order, the district court did not address the possibility
that unreasonable prepayment penalties might qualify as unsecured
claims.
This timely appeal ensued. In it, UPS argues that
section 506(b)'s reasonableness standard is not relevant to the
question of whether an oversecured creditor is entitled to collect
a contractually-based prepayment penalty from a solvent debtor. It
directs us to section 502 of the Code and to a wealth of case law
holding that if fees, costs, or other charges are deemed
unreasonable, an oversecured creditor nonetheless may collect them
as unsecured debt (subject to the provisions of section 502). In
the alternative, it argues that the lower courts' models of
reasonableness are unsuited to the realities of modern commercial
lending.
Gencarelli counters on several levels. First, he asserts
that UPS has forfeited the statutory argument. Second, even if
this argument is properly before us, he dismisses it as incorrect.
Third, he indiscriminately defends the reasonableness analyses
conducted by the lower courts (glossing over the fact that the
district court and the bankruptcy court did not see eye to eye as
to how reasonableness should be measured in this context).
We begin our inquiry by examining the merits of UPS's
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statutory interpretation argument. This argument turns on the
interrelationship between sections 502 and 506(b) of the Code.
Section 502 is entitled "[a]llowance of claims or
interests." Subject to other provisions not relevant here, it
instructs that a bankruptcy court "shall allow" claims made against
the debtor, valued "as of the date of the filing of the petition,"
with nine categorical exceptions. See 11 U.S.C. § 502(b). Only
one of these is arguably implicated here. That category calls for
the disallowance of claims that are unenforceable under "applicable
law." Id. § 502(b)(1). UPS maintains that Rhode Island law
governs the loan agreements at issue here and that the prepayment
penalty provisions contained in these agreements are enforceable
under that "applicable" state law.
The bankruptcy court disallowed UPS's claims for
prepayment penalties not because they were unenforceable under
Rhode Island law but, rather, because it deemed a different Code
provision controlling. That provision states:
To the extent that an allowed secured claim is
secured by property the value of which . . .
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
for under the agreement or State statute under
which such claim arose.
Id. § 506(b) (emphasis supplied). The bankruptcy court found that
UPS was an oversecured creditor that had failed to show the
prepayment penalties were reasonable.
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UPS disputes the bankruptcy court's interpretation of
section 506(b). It submits that section 506(b) speaks only to
whether an oversecured creditor may enjoy special priority over
other creditors with respect to ancillary claims for various kinds
of fees, costs, and other charges. The statute accomplishes this
objective by classifying certain claims as secured and charging
them against the creditor's security cushion (that is, the margin
by which the value of the security held exceeds the value of the
base claim). This priority-driven triage, it says, has no bearing
on whether those fees, costs, or other charges, reasonable or not,
comprise allowable claims.
Normally, priority is of tremendous importance in
bankruptcy cases. It is irrelevant, however, where the debtor is
solvent and can afford to pay all claims (secured and unsecured) in
full. This is such a "solvent debtor" case. Accordingly, UPS
argues that even if the prepayment penalties are unreasonable (and,
therefore, not entitled to priority as secured claims), they are
nonetheless allowable as unsecured claims under section 502.
We are persuaded that UPS's view of the interrelationship
between sections 502 and 506(b) is correct. As a matter of
bankruptcy law, the lower courts should not have disallowed the
claims for prepayment penalties in toto based solely upon a finding
that they were not entitled to priority under section 506(b).
Section 502, not section 506(b), affords the ultimate test for
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allowability, and any claim satisfying that test is, at the very
worst, collectible as an unsecured claim. Leading commentators,
case law from other circuits, and common sense all conduce to this
result.
There is universal agreement that whereas section 506
furnishes a series of useful rules for determining whether and to
what extent a claim is secured (and, therefore, entitled to
priority), it does not answer the materially different question of
whether the claim itself should be allowed or disallowed. See 4
Lawrence P. King et al., Collier on Bankruptcy § 506.01, at 506-6
(15th ed. 2007). Rather, the general rules that govern the
allowance or disallowance of claims are set out in section 502.
See id. It follows that:
If a creditor is generally entitled to add
postpetition . . . fees to its secured claim
because of the existence of an oversecurity,
and the claim for . . . fees is valid under
the agreement and applicable state law, but is
disallowed by the bankruptcy court for want of
reasonableness, the amount so disallowed
should be treated as an unsecured claim
against the estate.
Id. § 506.04[3][a], at 506-120 to 506-121; see Daniel R. Cowans,
Bankruptcy Law & Practice § 17.22, at 305 (7th ed. 1999) (noting
that the "limits of § 506(b) are applicable to the secured nature
of the claim and any excess under the contract may be filed as an
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unsecured claim").1
The opinions of other courts comport with this
understanding. The Eleventh Circuit has held that section 502
controls the overall question of whether an oversecured creditor's
bargained-for right to fees will be allowed or disallowed. Welzel
v. Advocate Realty Inv., LLC (In re Welzel), 275 F.3d 1308, 1318
(11th Cir. 2001) (en banc). The court added that once a claim for
fees is found to be allowable under section 502, it then must be
assessed for reasonableness under section 506 in order to determine
its priority. Id. To the extent that the contract between the
parties calls for unreasonable fees, the fees should be bifurcated
and the unreasonable portion should be treated as an unsecured
claim. Id.
Welzel is squarely in the mainstream of the case law.2
The Ninth Circuit has reached much the same conclusion. See Jospeh
F. Sanson Inv. Co. v. 268 Ltd. (In re 268 Ltd.), 789 F.2d 674, 678
1
While these passages discuss claims for attorneys' fees,
there is no principled basis for treating attorneys' fees
differently from prepayment penalties in this context. See, e.g.,
4 Collier on Bankruptcy, supra § 506.04[3], at 506-113 (implying
that the discussion applies to "[f]ees, [c]osts, and [c]harges").
2
Although both parties discuss at length the Supreme Court's
decision in United Sav. Ass'n of Texas v. Timbers of Inwood Forest
Assocs., Ltd., 484 U.S. 365 (1988), we regard that decision as
inapposite. The case dealt with claims for post-petition interest,
which — unlike the prepayment penalties at issue here — are made
unavailable as unsecured claims by an explicit statutory provision.
Id. at 372-73; see 11 U.S.C. § 502(b)(2).
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(9th Cir. 1986). The Second Circuit, albeit by implication,
marches to the same beat. See United Merchs. & Mfrs., Inc. v.
Equitable Life Assurance Soc'y (In re United Merchs. & Mfrs.,
Inc.), 674 F.2d 134, 138 (2d Cir. 1982) (emphasizing, in dictum,
that section 506 speaks only to whether costs can be treated as
secured claims).
We add that disallowing claims in their entirety based on
section 506(b) defies common sense. It is apodictic that
"unsecured creditors may recover their attorneys' fees, costs and
expenses from the estate of a solvent debtor where they are
permitted to do so by the terms of their contract and applicable
non-bankruptcy law." Official Comm. of Unsecured Creditors v. Dow
Corning Corp. (In re Dow Corning Corp.), 456 F.3d 668, 683 (6th
Cir. 2006). Thus, under the statutory scheme envisioned by the
debtor (and adopted by the lower courts), unsecured creditors would
be permitted to reap the full benefit of their contractual bargains
through the medium of section 502, while oversecured creditors
would be uniquely singled out for unfavorable treatment by the
operation of section 506(b). There is no conceivable explanation
as to why Congress might have wanted oversecured creditors to be
treated in so draconian a fashion. Creating that sort of uneven
playing field would be antithetic to the general policy of the
Code, which strongly favors oversecured creditors. See Welzel, 275
F.3d at 1319. It seems equally improbable that Congress would have
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intended to allow debtors "to avoid otherwise valid contractual
obligations under state law," including "prepayment penalties," by
"filing voluntary bankruptcy petitions" and invoking section
506(b)'s reasonableness requirement. Id.
By way of contrast, UPS's reading of the interaction
between sections 502 and 506(b) makes good policy sense. Section
506(b) is designed to protect general creditors from the inequities
that would occur if secured creditors were able to cloak
unreasonable fees and charges with first-priority status. See In
re A.J. Lane & Co., 113 B.R. 821, 824 (Bankr. D. Mass. 1990)
(explaining that section 506(b) promotes a "policy favoring a fair
distribution to creditors"). Seen in this light, it makes sense
that oversecured creditors should not be allowed to prioritize
unreasonable fees, costs, and charges; it does not make sense that
oversecured creditors should be penalized by disallowing those
fees, costs, and charges altogether — especially when unsecured
creditors can collect them.
Let us be perfectly clear. This is a solvent debtor case
and, as such, the equities strongly favor holding the debtor to his
contractual obligations as long as those obligations are legally
enforceable under applicable non-bankruptcy law.3 When the debtor
3
We recognize that bankruptcy courts are courts of equity, see
Thinking Machs. Corp. v. Mellon Finan. Servs. Corp. (In re Thinking
Machs. Corp.), 67 F.3d 1021, 1028 (1st Cir. 1995), and that the
balance of the equities may be different if unsecured creditors are
at risk of collateral damage. For that reason, this opinion should
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is solvent, "the bankruptcy rule is that where there is a
contractual provision, valid under state law, . . . the bankruptcy
court will enforce the contractual provision." Debentureholders
Protective Comm. of Cont'l Inv. Corp. v. Cont'l Inv. Corp., 679
F.2d 264, 269 (1st Cir. 1982); see Dow Corning, 456 F.3d at 679
(noting that in solvent debtor cases, "courts have generally
confined themselves to determining and enforcing whatever pre-
petition rights a given creditor has against the debtor"); In re
Chi., Milw., St. Paul & Pac. R.R. Co., 791 F.2d 524, 528 (7th Cir.
1986) (observing that "if the bankrupt is solvent the task for the
bankruptcy court is simply to enforce creditors' rights according
to the tenor of the contracts that created those rights").
The short of the matter is that both precedent and policy
militate in favor of allowing UPS's claims for prepayment penalties
as unsecured claims, even if the penalties are deemed unreasonable,
so long as they are valid under section 502. But there is a rub:
it is unclear whether UPS adequately presented this statutory
interpretation issue to the bankruptcy court. This is not a mere
technicality; it is a general rule — and a salutary one — that
appellate courts ordinarily ought not to consider issues that were
not adequately presented below. See, e.g., Evergreen Credit Union
not be construed as speaking to the different question of whether
an unsecured creditor can enforce a contractual right to post-
petition fees against the estate of an insolvent debtor under
section 502. See Travelers Cas. & Sur. Co. v. Pac. Gas & Elec.
Co., 127 S. Ct. 1199, 1207 (2007) (reserving this question).
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v. Woodman (In re Woodman), 379 F.3d 1, 2-3 (1st Cir. 2004);
Higgins v. New Balance Athletic Shoe, Inc., 194 F.3d 252, 259-60
(1st Cir. 1999).
UPS insists that it sufficiently preserved the statutory
interpretation issue for appellate review. It emphasizes that it
argued to the bankruptcy court that it should be allowed to recoup
the prepayment penalties because those penalties were valid and
enforceable under Rhode Island law. Even though this issue was
raised without any explicit reference to section 502, the very act
of asserting a claim under state law, UPS says, necessarily
implicated section 502. It adds that the proof of the pudding is
that Gencarelli's counsel referred to section 502 during oral
argument before the bankruptcy court.
We have held that it is the making of an argument, not
the mechanical citation to a particular authority, that preserves
the argument for further appellate review. See Air Line Pilots
Ass'n, Int'l v. Gilford Trans. Indus., Inc., 399 F.3d 89, 100 n.7
(1st Cir. 2005). Even on this understanding, however, UPS's
references to state law make out a borderline case for preservation
of the issue. These references lacked the directness and
sophistication that characterize the issue as UPS has framed it
here. To that extent, we can hardly fault the bankruptcy court for
not focusing on the precise contours of the problem.
In the end, we need not definitively resolve the close
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question of whether UPS adequately preserved this issue for appeal.
It is clear that we retain the discretionary authority, to be used
sparingly and in exceptional cases, to relieve a party of a
forfeiture. See, e.g., Chestnut v. City of Lowell, 305 F.3d 18, 21
(1st Cir. 2002) (en banc) (per curiam); United States v. La
Guardia, 902 F.2d 1010, 1012-13 (1st Cir. 1990). Although the
instances in which we have shown a willingness to relax our
preservation rules have been "few and far between," Nat'l Ass'n of
Soc. Workers v. Harwood, 69 F.3d 622, 627 (1st Cir. 1995), the
claim of error here fits within these narrow confines. The
statutory interpretation issue was at least arguably preserved; no
possible strategic advantage could have inured to UPS from
obscuring it; additional factual development would shed no light on
its resolution; and the issue is an important one.
Moreover, were we to deem the issue procedurally
defaulted, we would be forced to address, without any real
necessity for doing so, the preserved question of how section
506(b)'s reasonableness requirement applies to prepayment penalty
provisions in commercial loans. This is a difficult question that
has significant ramifications for the commercial lending industry.
It has no clear-cut answer, and we think that it would be imprudent
to venture needlessly into that arena. We therefore deem the
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statutory interpretation issue preserved4 and find it dispositive
here.
We summarize succinctly. We entertain UPS's argument
about the interrelationship between sections 502 and 506(b). That
argument boils down to the proposition that, regardless of
reasonableness, an oversecured creditor may be entitled to collect
bargained-for prepayment penalties as the functional equivalent of
unsecured debt. We accept that proposition.
As applied in this case, that proposition is decisive.
Because Gencarelli is solvent and the bankruptcy estate possesses
funds sufficient to pay all claims (secured and unsecured) in full,
no useful purpose would be served by inquiring into whether the
prepayment penalties are reasonable (and, thus, deserving of
priority) within the contemplation of section 506(b). What matters
is that the Code does not relieve Gencarelli, as a solvent debtor,
of this obligation unless one of the section 502 exceptions
applies. Consequently, we must reverse the decisions of the lower
courts.
There is one loose end: the tagalong question of whether
4
In addition to contending that UPS failed to preserve the
statutory interpretation issue in the bankruptcy court, Gencarelli
contends that UPS failed to preserve that issue in the district
court. There, however, UPS explicitly argued that it should be
allowed to recover as an unsecured creditor if its claim was
disallowed in whole or in part under section 506(b). Although it
did not cite section 502, it did cite Welzel, a case directly on
point. No more was exigible to preserve the issue for further
appellate review.
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the prepayment penalties are enforceable under section 502. To
resolve that aspect of the matter, we remand the case to the
district court with instructions to remand it, in turn, to the
bankruptcy court. That court should determine whether the
prepayment penalties are enforceable under Rhode Island law. For
our part, we need go no further.
Reversed and remanded. Costs shall be taxed in favor of the
appellant.
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