In re HEMINGWAY TRANSPORT, INC., et al., Debtors.
WOBURN ASSOCIATES, Appellant,
v.
Herbert C. KAHN, Trustee for Hemingway Transport, Inc. and
Bristol Terminals, Inc., Appellees.
In re HEMINGWAY TRANSPORT, INC., et al., Debtors.
WOBURN ASSOCIATES, Appellee,
v.
Herbert C. KAHN, Trustee for Hemingway Transport, Inc. and
Bristol Terminals, Inc., Appellants.
Nos. 91-1389, 91-1437.
United States Court of Appeals,
First Circuit.
Heard Sept. 3, 1991.
Decided Jan. 16, 1992.
Thomas V. Urmy, Jr., with whom Michelle H. Blauner and Shapiro, Grace & Haber, Boston, Mass., were on brief, for Woburn Associates.
Martin P. Desmery with whom William F. Macauley, Peter J. Roberts and Craig and Macauley P.C., Boston, Mass., were on brief, for Herbert C. Kahn, Trustee.
Before CAMPBELL, Circuit Judge, BOWNES, Senior Circuit Judge, and CYR, Circuit Judge.
CYR, Circuit Judge.
In the competition for what little is left for distribution in the consolidated chapter 7 estate of Bristol Terminals, Inc. and Hemingway Transport, Inc., Woburn Associates appeals from a district court judgment affirming a bankruptcy court order denying Woburn's request for administrative priority status for attorney fees incurred in defending against a postpetition action brought by the trustee in bankruptcy. The trustee in bankruptcy cross-appeals, challenging the affirmance of a bankruptcy court order allowing Woburn's claim for attorney fees as an unsecured prepetition claim.
BACKGROUND
Hemingway, a Massachusetts corporation, leased a parcel of real estate ("Property") from Woburn in 1974. The lease contained an indemnification clause whereby Hemingway agreed to hold Woburn harmless for all attorney fees incurred by Woburn as a consequence of Hemingway's occupation and possession of the Property.1 In 1980, Woburn sold the Property to Bristol, the wholly-owned subsidiary of Hemingway, receiving in return, inter alia, Bristol's $100,000 purchase money note secured by a second mortgage on the Property.
In 1982, Hemingway and Bristol simultaneously filed voluntary chapter 11 petitions pursuant to Bankruptcy Code §§ 109(d) and 301, 11 U.S.C. §§ 109(d) & 301 (1987). An application for an order authorizing joint administration of the Bristol and Hemingway chapter 11 estates was immediately granted by the bankruptcy court. See Fed.R.Bankr.P. 1015(b). Woburn promptly filed its proof of claim based on the Bristol note and second mortgage.2 Woburn did not file a separate proof of claim based on its indemnification agreement with Hemingway, Bristol's parent corporation.
Bristol, in its capacity as a chapter 11 debtor in possession, sold the Property to Juniper Development Group ("Juniper") in May 1983. Seven months later, the Hemingway-Bristol chapter 11 proceedings were voluntarily converted to chapter 7 liquidation proceedings and cross-appellant Kahn was appointed trustee in bankruptcy of both chapter 7 estates. See Fed.R.Bankr.P. 2009(c)(1). In April 1987, the bankruptcy court, after notice and hearing, granted the trustee's application for substantive consolidation of the chapter 7 estates. See 11 U.S.C. § 105(a). Woburn filed no further proof of its indemnification claim against the consolidated Bristol-Hemingway chapter 7 estate.
Meanwhile, in February 1986, the Environmental Protection Agency had issued an administrative order, pursuant to the Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA), 42 U.S.C. §§ 9601-9657 (1981 & Supp.1990), which required Juniper, as the owner, to clean up hazardous substances which had been discovered on the Property. After expending more than $60,000 to comply with the CERCLA order, Juniper initiated an adversary proceeding against the consolidated Bristol-Hemingway chapter 7 estate for indemnification and contribution on its CERCLA response costs, which are made recoverable from "any person who at the time of disposal of any hazardous substance owned or operated any facility at which such hazardous substances were disposed...." 42 U.S.C. § 9607(a)(2) (emphasis added).3
The trustee in bankruptcy filed a third party complaint alleging that Woburn became a "potentially responsible party" under CERCLA section 9607(a) by virtue of its ownership of the Property between 1974 and 1980. Woburn counterclaimed against the trustee, asserting that its indemnification agreement with Hemingway shifted the risk of Woburn's potential CERCLA liability to Hemingway. The Woburn counterclaim also asserted for the first time that the indemnity clause in the Hemingway lease obligated the trustee in bankruptcy to hold Woburn harmless for the attorney fees incurred in defending against the trustee's third party action under CERCLA.
The bankruptcy court granted summary judgment for Woburn on the trustee's third party complaint, on the ground that the indemnification clause in Woburn's lease with Hemingway "evidence[d] a clear and unequivocal intent to redistribute risks [to Hemingway] for purposes of section 107(e)(1) of CERCLA that does not violate public policy." The bankruptcy court further ruled that the lease indemnification clause entitled Woburn to recover $51,395.84 in attorney fees from the chapter 7 estate.
Relying on Reading Co. v. Brown,
Woburn appealed to the district court. The trustee cross-appealed, asserting that Woburn's failure to file a timely proof of claim under its lease indemnification agreement with Hemingway barred any distribution to Woburn, even as the holder of an unsecured claim. The district court affirmed the bankruptcy court order disallowing administrative priority status, but dismissed the trustee's cross-appeal on the ground that Woburn was not the holder of a "claim" for attorney fees against Hemingway at the commencement of the case, see 11 U.S.C. § 101(4), and that "[i]t would be unjust to punish Woburn for its failure to predict this lawsuit several years before its filing."
II
DISCUSSION
A. The Woburn Appeal: Administrative Expense Priority
Woburn contends on appeal that the bankruptcy court committed reversible error by disallowing its request for priority payment of its attorney fees as an administrative expense. See 11 U.S.C. §§ 503(a), (b)(1)(A) & 507(a)(1). Woburn argues that administrative priority status is appropriate in these circumstances as a deterrent against the frivolous and ill-advised decision of the trustee to activate Woburn's right to indemnification under the Hemingway lease by commencing the third party action against Woburn. See, e.g., In re E.A. Nord Co.,
The traditional presumption favoring ratable distribution among all holders of unsecured claims counsels strict construction of the Bankruptcy Code provisions governing requests for priority payment of administrative expenses. See Southern Ry. Co. v. Johnson Bronze Co.,
The Bankruptcy Code permits top priority payment of "actual, necessary costs and expenses of preserving the estate, including wages, salaries, or commissions for services rendered after the commencement of the case," 11 U.S.C. § 503(b)(1)(A), as a means of enabling the debtor estate to acquire the requisite postpetition credit with which to preserve itself after the filing of the petition. Preservation of the estate includes protection of the assets of the estate, as well as postpetition operation of the business of the debtor. See, e.g., In re Mammoth Mart, Inc.,
As a general rule, a request for priority payment of an administrative expense pursuant to Bankruptcy Code § 503(a) may qualify if (1) the right to payment arose from a postpetition transaction with the debtor estate, rather than from a prepetition transaction with the debtor, and (2) the consideration supporting the right to payment was beneficial to the estate of the debtor. See In re Mammoth Mart, Inc.,
We have recognized a special category of expense entitled to administrative priority status, based on considerations of fundamental fairness, see Reading Co.,
In Reading, a receiver appointed to operate the debtor's business in a Chapter XI arrangement proceeding negligently caused fire losses to several neighboring business establishments. The debtor was adjudicated bankrupt. The injured parties filed requests for priority payment of their losses as administrative expenses incurred after the commencement of the Chapter XI proceeding. The trustee in bankruptcy objected on the ground that the fire losses sustained as a result of the receiver's negligence conferred no benefit on the Chapter XI estate, either by preserving its assets or by facilitating its postpetition business operations. Reading,
The Supreme Court disagreed with the lower courts and concluded that the requests for priority payment of the fire losses should take precedence over the claims of unsecured creditors for whose ultimate benefit the business of the debtor had been operated during the Chapter XI arrangement proceeding. The Court first acknowledged the "decisive, statutory objective [of] fairness to all persons having claims against the insolvent." Id. at 477,
At the moment when an arrangement is sought, the debtor is insolvent. Its existing creditors hope that by partial or complete postponement of their claims they will, through successful rehabilitation, eventually recover from the debtor either in full or in larger proportion than they would in immediate bankruptcy. Hence the present petitioner did not merely suffer injury at the hands of an insolvent business: it had an insolvent business thrust upon it by operation of law.
Id. at 478,
Unlike losses sustained by creditors who enter into voluntary prepetition transactions with the debtor, the fire losses in Reading resulted from unilateral postpetition conduct on the part of the operating receiver, "ordinarily incident to the operation of a business." Id. at 483,
The debtor in this case deliberately continued a violation of law month after month presumably because it was more lucrative for the business to operate outside the zoning ordinance than within it. If fairness dictates that a tort claim based on negligence [Reading ] should be paid ahead of pre-reorganization claims, then, a fortiori, an intentional act which violates the law and damages others should be so treated.
In re Charlesbank Laundry, Inc.,
Woburn's request for allowance of an administrative expense priority is not within the ambit of either Reading or Charlesbank, for the simple reason that its attorney fees were incurred in resisting the efforts of the chapter 7 trustee to liquidate the CERCLA claim against Woburn. The postpetition operation of the Bristol-Hemingway business under chapter 11 in no manner caused or contributed to the attorney fees incurred by Woburn in resisting the chapter 7 trustee's third party action under CERCLA. Rather, the third party action against Woburn was brought by the trustee in bankruptcy in the ordinary course of the liquidation of the assets of the consolidated chapter 7 estate for distribution among Bristol-Hemingway creditors. While we do not decide that a Reading- Charlesbank administrative expense priority may never be appropriate in the context of a chapter 7 liquidation proceeding, we are nevertheless satisfied that neither fundamental fairness nor economic necessity would warrant its allowance in the present circumstances.
Woburn's request for allowance of an administrative expense priority cannot be distinguished on any principled basis from any other prevailing party's request for priority payment of attorney fees incurred in defending against a lawsuit brought by a chapter 7 trustee engaged in the routine liquidation of the assets of the chapter 7 estate. A chapter 7 trustee's lawsuit may indeed impose burdensome litigation expense upon successful and unsuccessful defendants alike, yet its prepetition genesis ultimately distinguishes it from the postpetition losses accorded priority in Reading and Charlesbank. Woburn's prepetition ownership of the Property and its prepetition lease with Hemingway, respectively, provided the grounds for the trustee's third party complaint and Woburn's counterclaim. Thus, Woburn's request for administrative expense priority cannot qualify under the Reading- Charlesbank exception, since its attorney fees were incurred in resisting the trustee's third party action for CERCLA contribution based on Woburn's prepetition ownership of the Property, which had nothing whatever to do with any postpetition operation of the Bristol-Hemingway business.6 We are aware of no authority that the Reading- Charlesbank exception encompasses a right to payment originating in a prepetition contract with the debtor.7
B. The Trustee's Cross-Appeal:
1. Lease Indemnification Agreement as "Contingent Claim"
The trustee in bankruptcy cross-appeals on the ground that Woburn's failure to file timely proof of its contingent prepetition indemnification claim under the Hemingway lease precludes Woburn from any distribution from the chapter 7 estate, even as the holder of an unsecured claim. Woburn responds that it possessed no "right to payment" under the indemnification agreement until the trustee instituted the third party action which caused Woburn to incur the attorney fees at issue on appeal. Woburn argues that any prepetition "right to payment" would not have been susceptible to reasonable valuation at the time of the filing of the Bristol and Hemingway chapter 11 petitions in 1982.
Woburn's argument disregards the remodeled claim allowance process set in place by the Bankruptcy Reform Act of 1978. Under the Bankruptcy Act of 1898, allowance of a timely proof of claim, and hence the right to participate in distribution, depended on the "provability" of the claim. See Bankruptcy Act § 63(a), 11 U.S.C. § 103(a). Consequently, a contingent or unliquidated claim incapable of either reasonable or expeditious valuation was disallowed entirely, as unprovable. See Bankruptcy Act § 57(d), 11 U.S.C. § 93(d); see also In re Esgro, Inc.,
The inequitable results occasioned by the "provability" requirement under the Bankruptcy Act--precluding the would-be creditor from participating in distribution and the debtor from obtaining a discharge of the debt--ill served the two principal legislative policies federal bankruptcy law was meant to foster. See In re Johns-Manville Corp.,
The difficulty or impossibility of estimation no longer constitutes a legitimate basis for disallowing any prepetition right to payment as a "claim" against the estate. See In re Baldwin-United Corp.,
Given the great breadth of the term "claim" as defined under the Bankruptcy Code, we conclude that Woburn held a prepetition claim against Hemingway at the time of the chapter 11 petition in 1982, albeit a right to payment contingent on a future occurrence reasonably within the contemplation of the parties as evidenced by the terms of the indemnification agreement. See supra note 1. That the claim remained contingent, unliquidated and unmatured at the time of the filing of the chapter 11 petition is immaterial to Woburn's obligation to file a timely proof of claim under the Bankruptcy Code. Although valuation of Woburn's contingent right to indemnification by Hemingway would have been difficult, if not impossible, to estimate with reasonable precision in 1982 or 1983, these considerations are no longer determinative of either the characterization or the allowability of a "claim" under the Code. We hold, nonetheless, on other grounds, see Max Sugarman Funeral Home, Inc. v. A.D.B. Investors,
2. Woburn's Proof of Claim
The timely proof of claim Woburn filed against the Bristol chapter 11 estate in 1982 asserted a right to payment based on (and included a copy of) the second mortgage, which explicitly provides that the sale and second mortgage of the Property were "subject to" the 1974 Hemingway lease, containing the indemnification clause. For instance, in one of the more significant mortgage provisions, Bristol categorically warranted that it would not "modify, amend, cancel or permit the surrender of the lease with Hemingway Transport" without Woburn's consent. As surely as a trustee in bankruptcy would be found to have been on notice of Woburn's second mortgage on the Property, and of the Hemingway lease, by reason of the recordation of the second mortgage, Woburn's 1982 proof of claim placed the Bristol chapter 11 estate on reasonable notice of Woburn's contingent indemnification claim under the 1974 lease with Hemingway.10 See, e.g., In re Simms,
Although the original proof of claim ascribed no several value to Woburn's contingent right to indemnification, in no event would there have been any reasonably reliable means of doing so until the occurrence of the postpetition contingency covered by the Hemingway indemnification agreement. Similarly, for purposes of its allowance in 1982 any separate proof of claim under Woburn's indemnification agreement could have been assigned no more than nominal value, subject to amendment under Bankruptcy Rule 3008 at such time as the right to indemnification matured. See Fed.R.Bankr.P. 3008. Moreover, as a general rule, amendments intended merely to increase the amount of a claim grounded in the same right to payment are not considered "new" claims under the Code. See In re Hanscom Retail Foods, Inc.,
The counterclaim Woburn filed in the third party CERCLA contribution action brought by the trustee in bankruptcy constituted an allowable amendment to Woburn's 1982 proof of claim.11 Amendments to proofs of claim timely filed are to be freely allowed, whether for purposes of particularizing the amount due under a previously-asserted right to payment, or simply to cure technical defects in the original proof of claim. See, e.g., In re Sambo's Restaurants, Inc.,
The equitable determination to allow or disallow an amendment to a proof of claim timely filed is entrusted to the sound discretion of the bankruptcy court. In re AM Int'l, Inc.,
First, as previously discussed, the genesis of Woburn's indemnification counterclaim for attorney fees lay in the same prepetition lease-sale-mortgage transaction which was the subject of Woburn's original proof of claim. Thus, the Woburn counterclaim to the third party complaint for CERCLA contribution relating to the Property can in no sense be considered an entirely new "claim," see supra notes 2 & 10, as defined under the Bankruptcy Code, see supra Section B.1.
Second, other holders of unsecured claims against the consolidated Bristol-Hemingway chapter 7 estate were caused no unfair prejudice even though the 1982 proof of claim was filed directly against Bristol, rather than Hemingway. Cf. Liakas v. Creditors' Comm. of Deja Vu, Inc.,
Hemingway and Bristol filed simultaneous chapter 11 petitions in July 1982, along with an immediate application for joint administration of their estates.12 Joint administration is a procedural device for "combining [certain related] estates by using a single docket for the matters occurring in the administration, including the listing of filed claims, the combining of notices to creditors of the different estates, and the joint handling of other purely administrative matters that may aid in expediting the cases and rendering the process less costly." Fed.R.Bankr.P. 1015 advisory committee's note (1983). The Bristol-Hemingway application for joint administration was immediately granted by the bankruptcy court, and the Hemingway and Bristol chapter 11 estates were thereupon jointly administered from the outset, utilizing a joint claims docket, as well as a single proceedings docket to record both debtors' statements of financial affairs, executory contracts, unexpired leases and schedules of assets.13 This continuous unitary administration afforded both debtors in possession, as well as the cross-appellant trustee, no less opportunity to acquire actual notice of Woburn's 1982 proof of claim against Bristol than if a separate proof of claim had been filed against each estate. One simply could not have examined the 1982 proof of claim, filed against Bristol and docketed on the joint Bristol-Hemingway claims docket, without being alerted to Woburn's indemnification agreement with Hemingway.
Moreover, after notice and hearing in April 1987, the bankruptcy court granted cross-appellant's motion for substantive consolidation of the Bristol and Hemingway chapter 7 estates.14 Whereas joint administration is designed in large part to promote procedural convenience and cost efficiencies which do not affect the substantive rights of claimants or the respective debtor estates, see Unsecured Creditors Committee v. Leavitt Structural Tubing Co.,
Finally, there is no evidence whatever from which to infer that Woburn intentionally refrained, out of any improper or dilatory purpose, from asserting a more particularized indemnification claim under the 1974 lease in its original proof of claim. Rather, Woburn counterclaimed against the consolidated chapter 7 estate immediately after the trustee in bankruptcy brought the third party complaint for contribution to the cost of the CERCLA clean-up of the Property covered by the Hemingway lease and Bristol's second mortgage. In these circumstances, as the district court supportably concluded, "[i]t would be unjust to punish Woburn for its failure to predict [the trustee's third party action] several years before its filing." On the basis of the record in these proceedings, therefore, we hold that there was no abuse of discretion in the allowance of Woburn's counterclaim for indemnification for attorney fees as an amended unsecured claim, see 11 U.S.C. § 726(a)(2)(A), against the consolidated Bristol-Hemingway chapter 7 estate.
Affirmed; no costs to either party.
Notes
The indemnity clause in the Property lease provided, in pertinent part, that Hemingway, as lessee, would hold Woburn harmless
against all liabilities, obligations, damages, penalties, claims, costs, charges and expenses, reasonable attorneys fees which might be imposed upon, incurred by or asserted against the lessor by reason of any work or thing done in, on or about the Property, any use, nonuse, condition, maintenance or management of the Property, any negligence on its part or on the part of its agents, any accident, injury or damage to any person or property occurring in, on, or about the property, and any failure on its part to perform or comply with any of the covenants, agreements or conditions contained in the lease to be performed or complied with.
(Emphasis added).
The Woburn proof of claim included a copy of Bristol's second mortgage, with its numerous explicit references to the Hemingway lease. The mortgage unmistakably provides that the sale and mortgage of the Property were "subject to" the Hemingway lease and indemnity clause. See also infra note 10 & accompanying text
In January 1990, the bankruptcy court granted summary judgment in the amount of $38,763.60 against the trustee in bankruptcy on Juniper's claim for past response costs and accorded it administrative priority status against the consolidated chapter 7 estate. Earlier, the bankruptcy court had granted partial summary judgment in favor of the trustee on Juniper's claim for future response costs, on the ground that Bankruptcy Code § 502(e)(1)(B) required disallowance. Section 502(e)(1)(B) states that "the court shall disallow any claim for reimbursement or contribution of an entity that is liable with the debtor ... to the extent that ... such claim for reimbursement or contribution is contingent as of the time of allowance or disallowance...." 11 U.S.C. § 502(e)(1)(B) (emphasis added)
A right to payment predicated on an executed prepetition contract is not entitled to priority payment as an administrative expense. In re Mammoth Mart,
Most decisions employing the Reading rationale have arisen in the context of reorganization proceedings. See, e.g., In re Microfab, Inc.,
The only arguable basis for asserting that Woburn's attorney fee expense did not derive, in its entirety, from Woburn's prepetition ownership of the Property would be that the third party action was so groundless that its commencement constituted a distinct postpetition injury to Woburn such as would warrant an award of counsel fees to the prevailing party. See, e.g., Fed.R.Civ.P. 11. The difficulties with such an assumption in the present case are twofold. First, the bankruptcy court supportably found that the trustee's action, though unsuccessful, was neither frivolous nor ill-advised. Moreover, the district court upheld the bankruptcy court determination that the trustee's action was not "frivolous," since earlier decisions had not been in agreement as to whether any pre-CERCLA indemnification agreement could shift the risk of CERCLA liability to the indemnitor. Second, it is by no means clear, nor do we suggest, that the commencement of a groundless lawsuit by the trustee in bankruptcy would warrant allowance of an administrative expense priority to the detriment of holders of unsecured claims. It might be that the more appropriate recourse for the prevailing defendant in such circumstances would be against the trustee in bankruptcy, or the trustee's attorney, or by way of an action to surcharge the trustee's bond. See, e.g., In re San Juan Hotel Corp.,
The source of the claimant's right to payment in all of the decisions cited by Woburn invariably originated during the postpetition period. For example, in Reading,
Under Bankruptcy Code § 502(j), the holder of a contingent claim incorrectly estimated at the time of allowance may request reconsideration and the court "may increase or decrease the amount of [the] prior allowance ... or enter any other appropriate order." Fed.R.Bankr.P. 3008 advisory committee's note (1983)
Woburn relies on In re M. Frenville Co.,
Woburn's reliance on Frenville is unavailing for at least two reasons. First, more recent decisions consistently have declined to accept the Frenville reasoning and its failure to accord full breadth to the term "claim," see, e.g., In re Yanks,
Second, and more importantly for present purposes, Frenville explicitly noted that "[t]he present case is different from one involving an indemnity or surety contract. When parties agree in advance that one party will indemnify the other party in the event of a certain occurrence, there exists a right to payment, albeit contingent, upon the signing of the agreement." Frenville,
The second mortgage provided that insurance policies on the Property held by Hemingway, as tenant under "the existing lease ... dated June 26, 1974," must include Woburn as a party insured, that Woburn would collect future condemnation awards on the Property to reduce Bristol's indebtedness on the second mortgage note, "[s]ubject ... to the provisions of the lease with Hemingway Transport " (emphasis added), and that Bristol's unilateral modification, amendment, cancellation, or acceptance of the surrender of the Hemingway lease without Woburn's prior written consent would constitute a mortgage default
It would be formalistic to deny amendatory consideration to Woburn's counterclaim merely for failure to style it as an "amendment" to the 1982 proof of claim. See, e.g., In re Pyramid Bldg. Co.,
Bankruptcy Rule 1015(b)(4) provides that "[i]f ... two or more petitions are pending in the same court by or against ... a debtor and an affiliate, the court may order a joint administration of the estates." Fed.R.Bankr.P. 1015(b)(4). The Bankruptcy Code defines "affiliate" as a "corporation 20 percent or more of whose outstanding voting securities are directly or indirectly owned, controlled, or held with power to vote, by the debtor." 11 U.S.C. § 101(2)(B). Bristol was Hemingway's wholly-owned corporate subsidiary
After cross-appellant was appointed chapter 7 trustee, the bankruptcy court authorized joint administration of the chapter 7 estates
Substantive consolidation is not dealt with in specific terms by the Bankruptcy Code. Rather, the power to order substantive consolidation is premised on the broad language of Bankruptcy Code § 105(a), which provides that "[t]he court may issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of this Title." See, e.g., In re Auto-Train Corp.,
Consolidation is permitted only if it is first established that the related debtors' assets and liabilities are so intertwined that it would be impossible, or financially prohibitive, to disentangle their affairs. See In re Augie/Restivo Baking Co.,
The court otherwise might conclude that consolidation should not be permitted--especially if holders of unsecured claims reasonably relied on the fact that the related debtors were distinct entities at the time credit was extended. See, e.g., In re Amereco Envtl. Services, Inc.,