Does Section 506(b) Permit 'Reasonable' Prepetition Fees and Charges? S.D.N.Y. Bankruptcy Court Deepens the Splits with the Fifth and Eleventh Circuits.

In In re 1300 Desert Willow Road, LLC, the U.S. Bankruptcy Court for the Southern District of New York addressed an unsettled question under the Bankruptcy Code: Does section 506(b)’s requirement that fees, costs and charges allowed to oversecured creditors be “reasonable” apply to prepetition charges or only to postpetition charges?

Judge Philip Bentley held that section 506(b)’s reasonableness standard applies only to postpetition amounts and that prepetition fees and charges are governed by applicable nonbankruptcy law. In so holding, the court disagreed with the Fifth and Eleventh circuits and aligned with what it described as the majority rule among lower courts outside those circuits, deepening a split on an issue that the Second Circuit has not yet addressed.

Background on Sections 502(b) and 506(b)

The Bankruptcy Code treats prepetition and postpetition claims differently. Section 502(b) provides that a claim is determined “as of the date of the filing of the petition.” As a result, postpetition interest and other postpetition charges are generally excluded from the claim and not allowed.

Section 506(b) is a limited exception to the rule that claims are fixed as of the petition date and permits an oversecured creditor to recover “interest on such claim” as well as “any reasonable fees, costs, or charges provided for under the agreement or State statute under which such claim arose.”  

The issue before the court was whether section 506(b) had any effect on the prepetition portions of an oversecured creditor's claim—or both the pre and postpetition portions of the claim. 

Facts of the Dispute

The debtor had taken out a $20 million loan secured by a first mortgage on an industrial property in New Mexico. After the debtor defaulted, the debtor and the lender entered into a series of forbearance agreements spanning more than two years. 

The debtor eventually filed for Chapter 11 in June 2025. The lender filed a secured claim of approximately $26 million, consisting of about $20 million of principal and $6 million in interest and other charges. The debtor objected to the lender’s claim, challenging the inclusion of default interest, late fees and forbearance fees on grounds of reasonableness. 

The Court’s Holding

The threshold question was whether section 506(b)’s reasonableness standard applied to the prepetition portion of those fees and charges or just to the postpetition fees and charges.

The court ultimately concluded that section 506(b)’s reasonableness standard applies only to postpetition amounts for two reasons.

First, the reading harmonized sections 506(b) and 502(b). Section 502(b) unambiguously allows prepetition claims to the full extent provided by nonbankruptcy law, while section 506(b) can plausibly be read to apply only to the postpetition sums it adds to the creditor’s claim. 

Second, reading Section 506(b) to apply to both pre and postpetition claims would produce what the court called an “absurd” and “topsy-turvy” result where oversecured creditors would be treated less favorably than undersecured creditors with identical prepetition claims, because only the oversecured creditor’s prepetition fees and charges would be subject to a reasonableness review.

In so holding, the court observed that there was no decision in the Second Circuit that squarely addressed the issue, “the case law is divided” in other jurisdictions and its ruling disagreed with the Fifth and Eleventh circuits, which have held that section 506(b)’s reasonableness standard applies to both prepetition and postpetition fees and interest. However, the court acknowledged that its ruling aligned with lower courts, which have held that section 506(b)’s reasonableness standard only applies to postpetition fees and charges with any prepetition fees and charges being governed by nonbankruptcy law without any reasonableness overlay.

Turning to the specific fees and charges, the court applied New York law to prepetition fees, disallowing late fees as duplicative of default interest but allowing forbearance fees as compensation for delayed enforcement. For postpetition fees and charges under section 506(b), the court allowed default interest at the contractual rate but disallowed late fees as per se unreasonable when the creditor is already receiving default interest.

Conclusion

The court’s decision adds to the ongoing debate over section 506(b)’s scope. By ruling that the reasonableness standard applies only to postpetition fees and charges, the court diverged from decisions issued by the Fifth and Eleventh circuits. For secured creditors and borrowers negotiating loan documents in the Southern District of New York, the decision reinforces that prepetition contractual fees and charges will be evaluated under state law as opposed to a federal reasonableness standard as long as the creditor is oversecured.