In re ALVIN D. COLPITTS and CORABELLE COLPITTS, Debtor(s)

Case No. A88-00614-HAR Chapter 7 MEMORANDUM REGARDING DEBTORS' OBJECTION TO SBPCA'S PROOF OF CLAIM

Index		Page
1.  PROCEDURE AND RULING		196
2.  SBPCA'S CALCULATIONS OF ITS UNSECURED CLAIM		197
3.  DEBTORS' CALCULATION OF SBPCA'S UNSECURED CLAIM		197
4.  DISCUSSION		198
	4.1.  Introduction	198
	4.2.  SBPCA's Total Claim on the Petition Date	198
	4.3.  What is SBPCA's Secured Claim?	199
	4.4.  What is SBPCA's Unsecured Claim?	203
	4.5.  What Interest is Allowable if This is a Solvent Estate?	203

»»»»»»»»»»»»»»»»»»»»»»»»»»»»»»»»»»»»»»»»»»»»»»»»»»»»»»»»

     1.  PROCEDURE AND RULING - The debtors in this chapter 7 case objected to Proof of Claim No. 2 filed by Sierra Bay Production Credit Association (SBPCA) in the amount of $174,076.72.

The claim was based upon two promissory notes signed by debtors. One was secured by California real property and the other by debtors' SBPCA stock and the fishing vessel F/V Coral.

At the hearing on debtors' objection, SBPCA stated that it is now only making a claim on the one promissory note which was secured by a preferred ship's mortgage on the F/V Coral and the SBPCA stock which was foreclosed upon after SBPCA got relief from stay. The other promissory note secured by the California real property has been fully satisfied by a foreclosure, and no deficiency is being claimed by SBPCA on the real property promissory note.

If the debtors reduce SBPCA's unsecured claim, they may have money       3 ABR 197  coming back to them from the trustee under § 726(a)(6) of the Bankruptcy Code. Thus, they have standing to make the objection.

For the reasons stated, I tentatively find that SBPCA's unsecured claim is $75,574.89 (see, § 4.4 of this memorandum). Its tentative allowed secured claim of $58,571.88 has been satisfied (see, § 4.3 of this memorandum).

If this is a solvent estate, an adjustment will have to be made for interest under § 726(a)(5) of the Bankruptcy Code (see, § 4.5 below). Debtors will be given some time to further investigate the amount of the secured claim.

     2.  SBPCA'S CALCULATIONS OF ITS UNSECURED CLAIM - SBPCA calculates its unsecured claim as follows (Docket Entry 151):

Reduced Principal	$33,075.00
Accrued Int. (6/30/86-2/22/91) @ 12.4%	62,144.14
Accrued Int. (2/22/91-6/1/93) @ 12.4%	9,306.72
Attorney Fees (for admiralty action)	4,704.00
U.S. Marshall	11,289.76
Other costs	139.36
TOTAL	$120,658.98

The $33,075 "reduced principal" is derived from deducting from the $107,780 principal balance (i.e., without counting costs and fees) of SBPCA's claim, by the amount it bid as the upset price on the F/V Coral ($60,000)and a further offset for the value of SBPCA stock it recovered from debtors ($14,705). The interest is calculated from the petition date, June 23, 1988 to the present at 12.4%, the amount called for in the promissory note.

     3. DEBTORS' CALCULATION OF SBPCA'S UNSECURED CLAIM -

SBPCA obtained relief from stay and prosecuted a post-petition admiralty action to foreclose on its preferred ship mortgage in the F/V Coral. Debtors argue that SBPCA thereby merged its promissory note (having a principal balance at the time of foreclosure of $107,780) and rights to attorney fees and costs in the admiralty judgment by the U.S. District Court for the District of Alaska, Sierra Bay Production Credit       3 ABR 198  Association, a California Corp. v F/V Coral, Official No. 642,633, in rem, Case No A89-312 Civil, citing In re Schlecht, 36 BR 235 (Bankr D Alaska 1983).

The debtors also argued that this matter involves federal law and no attorney fees are allowable for Mr. Offret's endeavors. They cite § 506(b) of the Bankruptcy Code and In re Fobian, 951 F2d 1149 (9th Cir 1991).

     4. DISCUSSION -

I disagree with debtors that SBPCA's foreclosure costs should be ignored or disregarded; they must be considered in a liquidation case in determining the allowed secured claim.

I also disagree with both debtors and SBPCA's calculation of interest.

By following the blueprint in the Bankruptcy Code, the amount (or at least the formula) should be relatively easy to determine.

     4.2. SBPCA's Total Claim on the Petition Date -

Principal balance	$107,780.00
Accrued Int. (6/30/86-6/23/88) @ 12.4%	26,509.75
TOTAL ALLOWED CLAIM on 6/23/88	$134,289.75

     4.3. What is SBPCA's Secured Claim? -

The debtors on the other hand adopt a waiver, merger, and/or estoppel argument to say that SBPCA irrevocably fixed its total claim at $107,076 in the admiralty action, and must therefore offset the upset bid of $60,000 and the value of the stock of $14,705 to leave a balance of $33,075. The debtors likewise never focus on what the appropriate secured claim should be.

The analysis of SBPCA's secured claim begins with the cumbersome language of § 506(a) of the Bankruptcy Code:

(a) An allowed claim of a creditor secured by a lien on property in which the estate has an interest, or that is subject to setoff under section 553 of this title, is a secured claim to the extent of the value of such creditor's interest in the estate's interest in such property, or to the extent of the amount subject to setoff, as the case may be, and is an unsecured claim to the extent that the value of such creditor's interest or the amount so subject to set off is less than the amount of such allowed claim. Such value shall be determined in light of the purpose of the valuation and of the proposed disposition or use of such property, and in conjunction with any hearing on such disposition or use or on a plan affecting such creditor's interest.

The collateral securing SBPCA consists of two types. One is the value of the debtors' stock in SBPCA itself which both parties value at $14,705.

The other collateral is the F/V Coral. Its value for the purposes of our inquiry involving a chapter 7 liquidation would be quite different than its value in a chapter 11 reorganization case. In a chapter 7 liquidation case, the valuation of such collateral is usually less. See,       3 ABR 200  generally, 3 Collier on Bankruptcy ¶ 506.04 (15th ed 1993).

One of the reasons that collateral values are often higher in reorganization cases is that a debtor frequently retains the collateral. Estate property that does not have to be sold retains more value. Sometimes it is called "going concern " versus "liquidation" value. 3 Collier on Bankruptcy ¶ 9.04 at page 506-28 (15th ed 1993). Because of this, most courts hold that the "transaction costs" (often "hypothetical" transaction costs because a court must estimate them) are not deducted in arriving at the value of the secured claim when the debtor or the estate retains the property. Lomas Mortgage USA v Wiese, 1279, 1285-86, (9th Cir 1993), cert granted and remanded on other grounds, 1993 WL 123045 (June 7, 1993); In re Case, 115 BR 666, 670 (9th Cir BAP 1990); and, In re Cobb, 122 BR 22, 26 (Bankr MD Ga 1989). But, see, In re Mitchell, 954 F2d 557 (9th Cir 1992), in which another 9th Circuit panel valued a car which chapter 13 debtors intended to keep at wholesale as opposed to retail.

The panel in Lomas Mortgage did not discuss the implications of Mitchell (or, even cite it), but the cases are somewhat in conflict, with Lomas Mortgage using a "high" value (based on continued use by the debtor, the value in the hands of the debtor was deemed the appropriate test) and Mitchell using a "low" value (notwithstanding the continued use by debtor, valuing the collateral on what it would hypothetically be worth to the secured creditor).

In a liquidation situation, on the other hand, transaction costs are commonly deducted to determine the value of the secured claim. In re Smith, 92 BR 287 (Bankr SD Ohio 1988). These should include the costs of foreclosure. Compare, La Jolla Mortgage Fund v Rancho El Cajon Associates, 18 BR 283, 289 (Bankr SD Cal 1982) (relief from stay motion indicating foreclosure costs must be deducted in arriving at determination of value); In re Kertennis, 40 BR 895, 899 fn2 (Bankr DRI 1984); In re Craig, 50 BR 289, 291 (Bankr ED Pa 1985); and, In re Figueroa Ruiz, 121 BR 419, 422 (Bankr DPR 1990). Thus, the $60,000 upset price (if that is the reasonable minimum value which should be obtained at an auction by the Marshall) should be reduced by the transaction costs, which should include the costs of foreclosure.

The transaction costs of the admiralty action, which the parties       3 ABR 201  seem to acknowledge was a necessary step in recovering title to the F/V Coral, should include the SBPCA's attorney fees, incidental court costs and Marshall fees. These total:

Attorney Fees (for admiralty action)	$4,704.00
U.S. Marshall costs	11,289.76
Other costs	139.36
TOTAL	$16,133.12

While the court must often estimate the "hypothetical costs," where the real costs, provided they are reasonable, are far superior in arriving at a realistic value for a secured claim. See, 3 Collier on Bankruptcy, ¶ 506.04[2] at page 506-27 (15th ed 1993). Simplistically, the value of the secured claim at the time of the Marshall's sale (February 22, 1991) might be determined as follows:

Value of F/V Coral before costs	$60,000.00
Value of debtors' SBPCA stock	14,705.00
Less foreclosure cost	-16,133.12
TOTAL SECURED CLAIM (Tentative)	$58,571.88

However, I have not been advised how the $60,000.00 upset price was arrived at, nor whether it is reasonable to allow other transaction costs (e.g., the holding costs of storage and a carrying charge for lost interest if it would reasonably take 6 months after acquisition to resell the vessel, or, perhaps most importantly, what costs were actually incurred by SBPCA).

What if it turns out that SBPCA resold the F/V Coral "as is" in February, 1991 for $100,000.00? Such a scenario would probably establish a higher secured claim than SBPCA admits to. Neither the debtor nor SBPCA has submitted evidence about transaction costs other than the fees in the admiralty action.

SBPCA seems satisfied with $58,571.88 calculation of its secured claim (see § 2 of this memorandum in which SBPCA arrived at this result in essence). Therefore, I will tentatively allow a secured claim of $58,571.88, but permit the debtors to seek reconsideration under § 502(j) of the Bankruptcy Code if they establish that a higher secured claim should be found which would in turn reduce the unsecured claim and possibly leave debtors with some cash at the end of the case.

This analysis rejects debtors' argument about the merger of SBPCA's claim in the $107,780 amount mentioned in the admiralty judgment. A       3 ABR 202  January 15, 1991 judgment by the U.S. District Court in the admiralty case stated: "Plaintiff [SBPCA] may enter a credit bid of $60,000 which shall be an offset against the principal balance of Plaintiff's perfected ship's mortgage of $107,780   " The order confirming the marshall's sale filed March 19, 1991 stated that SBPCA was "the highest bidder with an offset credit bid of $60,000 against its perfected ship's mortgage   ."

SBPCA did not ask the U.S. District Court to calculate allowable attorney fees, but it argues that its note and preferred ship's mortgage allow for such recovery.

Debtors' argument is basically that SBPCA has waived its interest and attorney fees by not claiming them in the admiralty action. I believe this is too constricted an interpretation, given the dynamics of this case. The debtors filed chapter 7. During the case, SBPCA, as an undersecured creditor, obtained an order from this court to lift the stay so it could foreclose against the F/V Coral. It went to admiralty court to foreclose on a vessel which was worth less than the amount of its claim. The U.S. District Court never determined the total amount which SBPCA would have been entitled to, including accrued interest, attorney fees, and costs. The district court referred to the $107,780 preferred ship's mortgage as a matter of identification, not as a "judgment" liquidating that amount as the total claim. The amount was just the principal balance of a note which was about 2 years overdue. It is

implausible to believe that the U.S. District Court ruled that this was the total obligation. Thus, the amount of SBPCA's secured and unsecured claims were not merged in the judgment.

I also reject debtors' analysis regarding the attorney fees for foreclosing. The general rule is that attorney fees are not allowed in federal actions. See, In re Sparkman, 703 F2d 1097 (9th Cir. 1983) ("American rule" denies attorney fees in federal court litigation in the absence of contract, applicable statute, or other exceptional circumstances). Nonetheless, reasonable attorney fees should be considered as a "transaction cost" to arrive at the value of a secured claim if they are a legitimate cost of recovering collateral in a liquidating bankruptcy. In re Smith, 92 BR 287 (Bankr SD Ohio 1988). They are theoretically similar to other types of transaction costs.

If debtors claim the transaction costs are too high in this case, this is in part due to the fact that debtors hotly contested certain of the foreclosure issues in the admiralty proceedings.

Parenthetically, I should state that I recognized the potential conflict in allowing SBPCA's attorney to act as attorney for the trustee. Nonetheless, I authorized the representation of the trustee by SBPCA's attorney because I perceived the matter would largely be a two-sided dispute between SBPCA and the debtors with little likelihood that a conflict would develop because SBPCA's interests might conflict with those of other creditors. As it turns out, SBPCA is the only allowed claim. As such, there is no conflict sufficient to debar the representation.

     4.4. What is SBPCA's Unsecured Claim? -

Total Allowed Claim (§ 4.2 of memo)	$134,146.77
Tentative Secured Claim (§ 4.3)	-58,571.88
TENTATIVE UNSECURED CLAIM	$75,574.89

This allowed unsecured claim is "tentative" because I will allow debtor to pursue an inquiry as to whether the "secured claim" is greater then $58,571.88 under § 4.3 of this memorandum. Also, if this is a solvent estate, the figures will have to be recalculated as discussed in the § 4.5 of this memorandum.

     4.5.  What Interest is Allowable if This is a Solvent Estate? -

Debtors argue that the rate of interest is 3.45%. This was the legal rate under 28 USC § 1961 on February 22, 1993 when I entered a judgment against the debtors and in favor of the trustee in Adv. Proc. A88-00614-001-HAR, Battley v Colpitts.

The federal judgment rate under 28 USC § 1961 on June 23, 1988 (the petition date) was 7.59%. This is the appropriate rate if this is a solvent estate. In re Melenyzer, 143 BR 829, 832 (Bankr WD Tex 1992) and In re Godsey, 134 BR 865 (Bankr MD Tenn 1991). As Melenyzer points out, some courts opt for a legal rate based on state law. In the present case it would be easy to apply the state rate (Alaska or California) or the       3 ABR 204  contract rate since there are no other unsecured creditors to make the math complicated. However, the rational in Melenyzer for using the federal judgment rate is convincing.

If the estate is solvent, interest should be calculated at the 7.59% per year rate on the total $134,146.77 allowed secured and unsecured claims from June 23, 1988 through the February 22, 1991 date of the Marshall's sale (974 days at $27.8951 per diem, or $27,169.90). On February 22, 1991 there was an offset of $58,571.88 against the principal and accrued interest as a result of the Marshall's sale of the F/V Coral in the admiralty case and the value of the SBPCA stock. A new balance for the allowed unsecured claim on February 22, 1991 would be $102,744.79 and would bear interest at 7.59% from February 23, 1991 until today, June 30, 1993 (858 days), and thereafter at $21.3653 per diem until paid). This explanation is easier to visualize if scheduled as follows:

Allowed Claim (6/23/88)	$134,146.77
Accrued Int. (6/23/88-2/22/91) @ 7.59%	27,169.90
Claim on 2/22/91 (before payment)	161,316.67
Received by SBPCA from vessel/stock	-58,571.88
Allowed claim 2/22/91 (after payment)	102,744.79
Accrued Int. (2/23/91-6/30/91) @ 7.59%	18,331.42
TOTAL unsecured claim of 6/30/93	$121,076.21

If the estate turns out to be completely solvent, this is the formula for paying SBPCA before refunding anything to debtors. The payment of interest on the $134,146.77 allowed total claim is not an impermissible payment of interest on interest. See, U.S. v Hannon, 728 F2d 142 (2nd Cir 1984).

Whether this is a solvent estate depends on whether the trustee or Mr. Colpitts prevails with respect to entitlement to an Alaska Limited Entry Permit for the Bristol Bay salmon fishery.

DATED: June 30, 1993

HERBERT A. ROSS
U.S. Bankruptcy Judge