Armstrong World Industries, Inc. v. James A. Phillips, Inc. (In Re James A. Phillips, Inc.)Armstrong World Industries, Inc. v. James A. Phillips, Inc. (In Re James A. Phillips, Inc.)
OPINION AND ORDER
Armstrong World Industries, Inc. (“Armstrong”) appeals from orders entered by former Bankruptcy Judge Roy Babitt authorizing certain payments by the debtor in possession James A. Phillips, Inc. (“Phillips”). For the reasons that follow, Armstrong’s appeal is denied and the Bankruptcy Judge’s orders are affirmed.
Phillips is an accoustical ceilings and walls contractor, and Armstrong is a supplier of construction materials. On December 14, 1981 Armstrong obtained a $74,101.91 judgment against Phillips for goods sold and delivered. On June 11, 1982, having suffered major losses on a large construction project and in anticipation of an execution to satisfy Armstrong’s judgment, Phillips filed a petition under chapter 11 of the Bankruptcy Code, 11 U.S.C. § 101, et seq. Armstrong has not moved for conversion or dismissal of that filing, see 11 U.S.C. § 1112(b), or for relief from the stay of execution of its judgment, see 11 U.S.C. § 362(d)(1). On June 16, 1982 Phillips applied to the Bankruptcy Court for authority to pay a number of construction suppliers other than Armstrong. That same day Judge Babitt signed orders authorizing the payments without a hearing and without notice to Armstrong or to any of Phillips’ other creditors. Armstrong’s counsel learned of these orders a few days after June 16, during a check of Phillips’ file in the Bankruptcy Court. On June 25, 1982 Judge Babitt heard argument on and denied Armstrong’s application to vacate his orders.
Phillips maintains that the payments authorized by the Bankruptcy Court were essential to its hopes for survival. The suppliers to whom the payments were authorized had provided materials to Phillips at three construction sites. Phillips had substantially completed its work at two of those sites, but in response to one supplier’s threat to file a mechanics’ lien on the buildings involved, the contractors at the sites, Regal Construction Corp. and O & Y Construction Corp., stopped payment on checks delivered to Phillips and indicated that further payments due Phillips would not be forthcoming until all suppliers with potential liens were paid. The amounts due Phillips from Regal and O & Y (respectively $27,279 and $104,206) were substantially greater than the amounts authorized by the Bankruptcy Court to be paid the suppliers on each site ($10,065 and $36,665). At the third site Phillips had not substantially completed its work, and had not been contacted by the contractor, George A. Fuller Co., or by any of the suppliers who had the right to file liens on the real property involved. Moreover, the amount then due Phillips from Fuller ($42,261) was substantially less than the amount authorized to be
Armstrong objects to the payment of over $117,000 to other suppliers of Phillips, while Armstrong’s judgment against Phillips for over $74,000 remains unsatisfied, with execution frozen by Phillips’ chapter 11 petition. As a result of the payments authorized by Judge Babitt, Armstrong’s share of the monies owed Phillips’ top fourteen creditors jumped from 35% to 61%. Relying upon various provisions of the Bankruptcy Code as well as the decisions in
In re Texlon Corp.,
At the root of the many difficulties posed by this appeal is the nature of the potential liens available to the “preferred” supplier-creditors. The suppliers’ right to assert liens under state law is not stayed by the debtor’s chapter 11 petition. Rather, § 362(b)(3) and § 546(b) of the Bankruptcy Code, 11 U.S.C. § 362(b)(3), § 546(b), permit such liens to “relate back” to the time of the underlying debt’s creation as provided by New York Lien Law § 13(5) (McKinney’s 1982).
See In re C.H. Stuart, Inc.,
The Code provides no clear answer to the question whether Armstrong was entitled to notice of the applications to pay the suppliers. Indeed, one cannot fault the Bankruptcy Court’s equivocal conclusion at the June 25, 1982 hearing that “maybe it [the application for payments] should have been on notice and hearing because it’s out of the ordinary, although I am not even sure it’s so.” Transcript of 'June 25, 1982, Bankruptcy Court Hearing (hereinafter “Transcript”) at 12. On this appeal Armstrong initially relied on § 1109(b) of the Code, 11 U.S.C. § 1109(b), which provides that a party in interest “may raise and appear and be heard on any issue in a case under [chapter 11].” The notice requirement in this section is implicit at best. As the leading treatise has observed, the question of notice under § 1109(b) “undoubtedly will be a source of litigation,” but any rule requiring “a right to notice of all steps taken in the reorganization ... would result in much unwarranted difficulty and expense.” King, et al., 5 Collier On Bankruptcy ¶ 1109.02[3] (1979).
Unlike the implicit notice requirement of § 1109(b), provisions elsewhere in the Code explicitly deal with the issue of notice. Section 363(b) and § 363(c)(1), 11 U.S.C. § 363, provide that a trustee may use, sell or lease the bankrupt’s property without notice and a hearing only so long as the transactions are conducted “in the ordinary course of business.” These provisions apply to a debtor in possession under 11 U.S.C. § 1107(a). Thus, if the payments in this case were transactions “in the ordinary
The legislative history of § 363 provides no test or guideline concerning the scope of the “ordinary course of business” standard. Hughes, “Wavering Between the Profit and the Loss”: Operating a Business During Reorganization Under Chapter 11 of the New Bankruptcy Code, 54 Am.Bankr. L.J. 45, 74 n. 207 (1980); see H.R.Rep. No. 595, 95th Cong., 1st Sess. 182, 345 (1977), U.S.Code Cong. & Admin.News 1978, p. 5787, reprinted in, King, et al., 2 App. Collier On Bankruptcy (1979). Nonetheless, the apparent purpose of requiring notice only where the use of property is extraordinary is to assure interested persons of an opportunity to be heard concerning transactions different from those that might be expected to take place so long as the debtor in possession is allowed to continue normal business operations under 11 U.S.C. § 1107(a) & § 1108. The touchstone of “ordinariness” is thus the interested parties’ reasonable expectations of what transactions the debtor in possession is likely to enter in the course of its business. So long as the transactions conducted are consistent with these expectations, creditors have no right to notice and hearing, because their objections to such transactions are likely to relate to the bankrupt’s chapter 11 status, not the particular transactions themselves. Where the debtor in possession is merely exercising the privileges of its chapter 11 status, which include the right to operate the bankrupt business, there is no general right to notice and hearing concerning particular transactions. To preclude such transactions, interested parties must apply to the Bankruptcy Court for relief from the stay, 11 U.S.C. § 362(d)(1), or for conversion or dismissal of the chapter 11 petition, 11 U.S.C. § 1112(b).
Under this analysis, payments of the sort involved here might well have been “in the ordinary course of business.” Given the special status of suppliers whose unstayed lien rights have not expired under state law, payment to such suppliers following a contractor’s chapter 11 filing would appear a reasonable response to business exigencies. But for the accelerated nature of the payments precipitated by Phillips’ chapter 11 filing, the payment of suppliers with potential lien rights seems within the ordinary course of Phillips’ business activities.
Cf. In re Listle/Shreeves Corp.,
In its post-argument brief, however, Phillips acknowledges that the payments in this case were made under exigent circum
The notice required, however, should not be permitted to undermine the capacity of the debtor in possession to accomplish the legitimate ends sought by the transactions at issue. In this case, the only notice required was a telephone call informing Armstrong that Phillips intended to seek the relief involved, and a brief opportunity (measured in hours rather than days) to examine and verify the fundamental facts alleged. The form and extent of notice required under the Code depends on the particular situation before the Bánkruptcy Court, and the action proposed by Phillips required only a brief opportunity to confirm the underlying facts and to argue its propriety. See 11 U.S.C. § 102; King, et al., 2 Collier On Bankruptcy ¶ 102.02 (1979).
Lack of proper notice under the Bankruptcy Code ordinarily is a serious deficiency, usually requiring some form of corrective action on appeal. Several considerations make reversal an inappropriate response in this case, however. The circumstance that made the payments in this case extraordinary was their timing, not their nature. Short of objecting to the overall legitimacy of Phillips’ chapter 11 status, Armstrong could not have objected in principle to the prior payment of suppliers with potential lien rights; the interplay of state and federal law is such that the suppliers were a special class of creditors whose bills could reasonably be paid ahead of Armstrong to prevent Phillips’ operations from coming to a standstill because of mechanics’ liens on its construction sites. As Judge Babitt put it at the June 25 hearing, “the fact that these people have been ‘preferred’ is unfortunately a fact of life.... These people [the suppliers] stand in a unique position — they can be pulled off the job, put liens on the property and, therefore, nobody gets anything.” Transcript at 13. Armstrong has suggested no way, moreover, in which the accelerated nature of the payments prejudiced its interests, except to the extent that nonpayment might have driven
A second consideration favoring affirmance of the Bankruptcy Court orders, despite the lack of notice, is that a hearing was in fact held on June 25, at which Armstrong failed to challenge the critical facts alleged in Phillips’ June 19 applications for accelerated payments. Armstrong on this appeal characterizes the facts alleged by Phillips as mere “self-serving representations.” Appellant’s Brief 17. But the June 25 transcript demonstrates that Armstrong did not question the critical facts- — such as amounts owed and amounts owing — -that supported Phillips’ June 19 applications. Armstrong’s counsel focused at the hearing on lack of notice, and on the uncertainty involved in the payments made to suppliers at the site where Phillips had not substantially completed its work for the George A. Fuller Co. Transcript at 8-14. Armstrong’s present objections to the Bankruptcy Court’s reliance on the allegations in Phillips’ applications are now too late, and are in any event unsubstantiated by allegations that would place in doubt any of Phillips’ factual claims not challenged at the hearing. Furthermore, insofar as Armstrong did challenge the facts, or rather predictions of successful performance, underlying the application to pay suppliers at the Fuller site, Armstrong failed to demand a full hearing, or to offer evidence that controverted Phillips’ allegations. Moreover, as Judge Babitt suggested by pointing out that Phillips’ reorganization plan was unlikely to proceed without Armstrong’s cooperation, Transcript at 15-16, the underlying objection to payments to the Fuller suppliers was not their “preferential” nature, but rather the uncertainties involved in any effort at reorganizing Phillips and bringing it out of bankruptcy. See Transcript at 14. This objection belongs in a § 362(d)(1) or § 1112(b) motion, not on an appeal from the authorization of payments made in the context of a presumably valid chapter 11 reorganization effort.
A final consideration weighing against reversal of the Bankruptcy Court’s order is § 363(m)’s specific provision that “reversal or modification on appeal of an authorization under subsection (b) or (c) of this section of a sale or lease of property does not affect the validity of a sale or lease under such authorization to an entity that purchased or leased such property in good faith .... ” If this provision were applicable to the Bankruptcy Court orders in this case, then a reversal of those orders would have no practical significance, since the relief Armstrong seeks in this case is reversal of the order permitting the payments. Armstrong argues that § 363(m) is inapplicable because payments to suppliers are not sales or leases of property. The definition sections of the Code do not define “sale” or “lease”, and an analysis of § 363’s use of the terms provides no clear answer to their scope in § 363(m).
3
A reasonable argument
Appellant’s reliance on
In re Texlon Corp.,
Indeed,
Texlon
distinguished an earlier case,
In re Applied Logic Corp.,
Appellant’s reliance on
In re Sullivan Ford Sales,
In conclusion, despite the improper lack of any notice, the Bankruptcy Court’s orders in this case must be affirmed. The error in not affording notice was harmless, and Armstrong has failed to question the essential facts supporting the ex parte orders. Invalidating the payments made would also unfairly prejudice the suppliers who acted in apparent good faith. The orders of the Bankruptcy Court are affirmed.
SO ORDERED.
Notes
. In a post-argument brief, Armstrong also makes reference to the notice requirements of § 362(c)(2). This provision is inapposite. It deals with transactions involving cash collateral, not cash. See King, et al., 2 Collier On Bankruptcy ¶ 363.04 (1979). Notwithstanding its judgment against Phillips, Armstrong had no property interest in any of Phillips’ cash that would entitle Armstrong to notice under § 362(c)(2).
. Perhaps a Bankruptcy Court should never authorize payments without notice and hearing under § 363. Insofar as transactions are actually in the ordinary course, they are authorized automatically by § 363(c)(1) and § 1107(a), and do not require Bankruptcy Court approval.
See supra
at 393-94. Since the only occasions definitely requiring Bankruptcy Court authorization involve nonordinary transactions to which interested persons object following notice, Bankruptcy Courts should routinely require notice and hearing whenever a debtor or trustee requests authorization for any transaction, if the Court decides to give its sanction to the transactions involved.
See In re Hanline,
. Section 363(c)(1) provides that “the trustee may enter into transactions, including the sale or lease of property of the estate, in the ordinary course of business, without notice or a hearing, and may use property of the estate in the ordinary course of business without notice of a hearing.” Inasmuch as this subsection specifies sales or leases as a particular category of “transactions”, the later reference in § 363(m) to “a sale or lease of property” should perhaps be narrowly construed to exclude transactions, such as payments for supplies, that do not readily fit everyday definitions of “a sale or lease of property.”
On the other hand, § 363(b) simply states that “[t]he trustee, after notice and a hearing, may use, sell, or lease, other than in the ordinary course of business, property of the estate.” Here, despite the absence of any reference to “transactions”, the words “use, sell, or lease” seem intended to include the entire range of transactions the trustee or debtor might enter; were it otherwise, the statute would not authorize transactions, other than “use”, “sale”, or “lease”, which were not in the ordinary course despite the fact that notice was given. Similarly, § 363(c)(2) provides that the “trustee may not use, sell or lease cash collat
. Although “use” appears to be the broadest among the three terms, its inclusion may have been intended to cover events involving the debtor’s property, but not involving third parties, such as the operation of machinery in the debtor’s business. Thus, the purchase of supplies with cash may be regarded as much a “sale or lease” of property as it is a “use” of property. On the other hand, the use of cash may pose special dangers that warrant exclusion of such transactions from the automatic protection of § 363(m).