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Bankruptcy Court Permits Undersecured Creditor to Include Post-Petition Attorneys’ Fees as Part of its 1111(b) Secured Claim

In In re: Castillo, the Bankruptcy Court for Central District of California held that “after making an 1111(b) election, an undersecured creditor may include in its 1111(b) secured claim post-petition attorneys’ fees, but not post-petition interest.”

Factual Background and Procedural History

Chapter 11 debtor Idalia Roxana Castillo (Debtor) owned six pieces of real property. One was a rental property against which creditor Deutsche Bank National Trust Company (Deutsche) held a first deed of trust to secure repayment of a promissory note with a principal balance of $1,031,330.56. The property’s appraised value for plan purposes was $500,000.

After Debtor filed bankruptcy, Deutsche asserted a secured claim for $1,072,498.94. Debtor then filed a plan of reorganization. Deutsche thereafter timely elected to have its entire claim treated as fully-secured pursuant to Bankruptcy Code Section 1111(b). After Debtor filed an amended plan and disclosure statement, Deutsche filed an amended proof of claim, increasing the total amount of its claim to $1,207,652.57. The increase reflected Deutsche’s post-petition attorneys’ fees and post-petition interest. Debtor objected, arguing, inter alia, that Deutsche’s amended proof of claim included post-petition interest and attorneys’ fees even though, according to Debtor, Deutsche was not eligible to recover such charges under Bankruptcy Code Section 506(b).

After dispensing with Debtor’s other objections to Deutsche’s amended proof of claim, Judge Bluebond held that the issue of “whether an undersecured creditor who elects the application of Section 1111(b) is entitled to include post-petition interest and attorneys’ fees in the amount of its secured Claim” was worthy of further consideration. After reviewing the parties’ supplemental briefing and hearing oral argument on the issue, Judge Bluebond issued a memorandum explaining her analysis and conclusions, which she noted were “novel and surprising.”

Holding and Analysis

Relying heavily on Ninth Circuit Court of Appeals’ decision in Infonet Mgmt v. Centre Ins. Co. (In re SNTL Corp.), 571 F.3d 826 (9th Cir. 2009) (SNTL Corp.), Judge Bluebond overruled Debtor’s Claim Objection in part, holding that “after making an 1111(b) election, an undersecured creditor may include in its 1111(b) secured claim post-petition attorneys’ fees, but not post-petition interest.”

Judge Bluebond found that in SNTL Corp., the Ninth Circuit “faced squarely the question of whether Section 506(b) should be read for the proposition that post-petition attorneys’ fees may be recovered only if they are available under Section 506(b).” In SNTL Corp., the court held that the bankruptcy court should look to Section 502, not Section 506, to determine whether a claim should be allowed, holding that Section 506 governs the extent to which a claim is a secured claim, not the extent to which the claim should be allowed. Judge Bluebond therefore found that SNTL Corp. dictated that “unless one of the subsections of section 502 provides for disallowance of the claim, a claim that would otherwise be valid under applicable nonbankruptcy law should be allowed.”

Applying SNTL Corp. to the facts before her, Judge Bluebond held that Deutsche was permitted to include in the amount of its 1111(b) secured claim attorneys’ fees that it was entitled to recover under the terms of its prepetition contract with Debtor, including post-petition attorneys’ fees. Judge Bluebond reasoned that under Section 502(b) and SNTP Corp., Deutsche would be entitled to an allowed unsecured claim for post-petition attorneys’ fees. Therefore, since Deutsche was entitled to post-petition attorneys’ fees, having made an 1111(b) election, Deutsche could include the amount of its post-petition attorneys’ fees in its Section 1111(b) secured claim.

With respect to post-petition interest, Judge Bluebond held that because Section 502(b) contains a provision disallowing claims for interest unmatured as of the petition date, Deutsche’s Section 1111(b) secured claim could not include post-petition interest, finding “[a]s Deutsche holds an 1111(b) secured claim only to the extent that it has an allowed claim under Section 502(b), and Section 502(b) disallows Deutsche’s claim for post-petition interest, it follows necessarily that Deutsche’s Section 1111(b) secured claim may not include post-petition interest.”

Commentary

This case is noteworthy because it allows a creditor to include attorney’s fees incurred post-petition that are otherwise recoverable by the creditor as part of its Section 1111(b) secured claim. The case is also a reminder that Section 506 governs the extent to which a claim is secured, not whether the claim is allowed; to determine whether a claim is allowed, one must look to Section 502.