Opinion
Case No. 01 B 16034 (AJG) Jointly Administered
March 17, 2003
MEMORANDUM DECISION CONCERNING REQUEST FOR ADMINISTRATIVE CLAIM
The issue presented is whether a claim based on a post-petition conversion of a commodity that arises out of a pre-petition contract for storage of that commodity is entitled to administrative expense priority. The Court finds that where a commodity was delivered to a debtor pursuant to a contractual agreement for storage of that product, constituting a bailment, if the bailor makes a demand for return of the bailed commodity and the bailee fails to return it, under Texas state law, the bailor may maintain an action for conversion against the bailee and a claim based upon a post-petition conversion of the commodity is entitled to administrative expense priority, at least where the commodity was delivered post-petition. The Court further finds that under the facts of this case, the presumption under Texas state law that there was a post-petition conversion of the natural gasoline and ethane in issue has not been rebutted, entitling Shell to administrative priority for its claims.
FACTS
Commencing on December 2, 2001, and periodically thereafter, Enron Gas Liquids, Inc. ("EGLI") and its affiliated debtor entities (collectively, the "Debtors") filed voluntary petitions for relief under chapter 11 of title 11 of the United States Code (the "Bankruptcy Code"). Pre-petition, on January 1, 1995, EGLI and Shell Oil Company, an affiliate of Shell Chemical, L.P. ("Shell"), entered into a Storage and Transportation Agreement, which was most recently amended on June 20, 2001 (as amended, the "Storage Agreement") pursuant to which EGLI was to provide storage capacity at a facility located in Mont Belvieu, Texas (the "Facility") for petroleum products owned by Shell. EGLI was to store the petroleum products until Shell directed it to transport or otherwise dispose of the product. Pursuant to the Storage Agreement, Shell was to pay a fee for EGLI's receipt, storage and re-delivery of the petroleum products stored at the Facility. Storage Agreement, ¶ 4.1. The Storage Agreement provided that Shell was to retain title to its petroleum products delivered to the Facility. Storage Agreement, ¶ 6.1. The Storage Agreement further provided that Shell would bear the risk of loss or damage to its petroleum products while they were in EGLI's custody "unless the loss or damage is the result of EGLI's negligence." Storage Agreement, ¶ 6.2.
Although Shell's products "stayed titled" at Mont Belvieu, [Deposition Transcript, Ina Norman, January 30, 2003 (Norman Dep. Tr.), page 19, line 3 through page 25, line 11], in addition to being stored at that location, certain product was stored at a location in Morgan's Point, as well as in the bi-directional pipelines connecting the two facilities. As it does not impact the Court's decision, hereinafter references to the Facility is to all locations where Shell's petroleum products may have been stored.
Metering systems were used to measure the volume of natural gasoline pumped into or removed from the Facility, from which measurements, a calculation could be made as to the volume remaining there. The Facility's operator maintained all documents and records concerning the volumes of natural gasoline held in the Facility. Shell also maintained records of the volume of natural gasoline and ethane it had stored at the Facility. The ethane was treated in a similar manner. Pre-petition, on June 29, 2001, EGLI sold the Facility to EOTT Energy Liquids, L.P. ("EOTT") and simultaneously entered into the Mont Belvieu Storage Capacity Purchase Agreement with EOTT (the "EOTT Agreement") pursuant to which EOTT "sold" or agreed to provide storage capacity at the Facility to EGLI to enable EGLI to store either its own petroleum products or those petroleum products "with respect to which [EGLI] has legal custody under agreements with third parties." EOTT Agreement, ¶ 2.1. On April 2, 2002, an order was entered approving EGLI's rejection effective April 12, 2002 of the EOTT Agreement as burdensome to the estate. The order approving rejection of the EOTT Agreement also provided that "EOTT may approach parties who may have had agreements with EGLI for storage in the [Facility] covered by the [EOTT Agreement] and attempt to secure new contracts from such parties for their storage requirements from and after [April 12, 2002]. See Stipulation and Order Regarding Rejection of Certain Contracts between EOTT and EGLI, dated April 2, 2002, ¶ C. The Debtors had previously filed a notice, dated March 15, 2002, to reject the Storage Agreement. Shell initially opposed the rejection. In an affidavit in response to Shell's objection to the rejection, which affidavit was filed after the rejection of the EOTT Agreement, W. Wade Hicks, the director of trading of EGLI asserted that rejection of the agreements with Shell was appropriate because EGLI was unable to perform under the agreements with Shell. This was because once EGLI had rejected the agreements with EOTT, "EGLI no longer had any control over any of the product, storage and toll conversion facilities at the [Facility]." See, Debtors' Affidavit in Response to Rejection Objection by Shell Regarding Transportation Contract, ¶ 5 (dated June 6, 2002). Mr. Hicks also asserted that once the agreements with EOTT were rejected "EGLI no longer had control of any of the storage and conversion operations or the related transpiration grid systems and facilities at the [Facility]." Id., at ¶ 23. Thereafter, Mr. Hick also testified that EOTT assumed operations of the facility on April 12th. [Deposition Transcript, Wade Hicks, January 30, 2003 (Hicks Dep. Tr.), p. 9, lines 6-10]. In response to Shell's objection to rejection of the Storage Agreement, a hearing was scheduled. Subsequently, by stipulation, Shell withdrew its objection to the rejection and agreed upon March 15, 2002 as the effective date of the rejection of the Storage Agreement. On June 20, 2002, the Court entered an order approving the rejection of the Storage Agreement effective March 15, 2002. In addition, upon the Debtors' rejection of the EOTT Agreement, Shell entered into an interim storage agreement with EOTT effective April 12, 2002.
At issue in this matter are certain quantities of natural gasoline and ethane which Shell stored in the Facility pursuant to the Storage Agreement but were not available for re-delivery to Shell when it requested such.
Natural gasoline
Shell delivered to, and withdrew from, the Facility various quantities of natural gasoline between January 31, 2002 and February 28, 2002, resulting in a net balance of 70,000 barrels as of February 28, 2002. Stipulation of Facts, ¶ (1). EGLI's books indicate that as of March 12, 2002, Shell had a balance of 70,000 barrels of natural gasoline at the Facility as a result of deliveries made between January 31, 2002 through February 28, 2002. Stipulation of Facts, ¶ (2). Thus, post-petition EGLI accepted and stored a net balance of 70,000 barrels of natural gasoline at the Facility. Movants Ex. 2, Inventory Transfer Letters.
At some time in early March, 2002, on or prior to March 12, 2002, Shell sought to schedule a withdrawal of natural gasoline from the Facility and was informed that no natural gasoline remained in the Facility. The price of natural gasoline on March 12, 2002 was $22.89 per barrel. Stipulation of Facts, ¶ (8).
Ethane
Shell delivered and withdrew ethane from the Facility from December 2, 2001 through April 12, 2002. Stipulation of Facts, ¶ (3). Shell had also delivered and withdrawn ethane from the Facility pre-petition. As of April 12, 2002, Shell's ethane book balance at the Facility was 169,355.09 barrels. Stipulation of Facts, ¶ (4). As of April 12, 2002, the physical inventory of ethane located in the Facility totaled 113,005 barrels. Stipulation of Facts, ¶ (5). The difference between Shell's ethane book balance and the physical inventory of ethane at the Facility as of April 12, 2002 was 56,350.09 barrels. Stipulation of Facts, ¶ (6). The price of ethane as of April 12, 2002 was $10.4738 per barrel. Stipulation of Facts, ¶ (7). As of April 12, 2002, when EGLI relinquished control of the Facility to EOTT, the physical inventory of ethane turned over to EOTT was 113,005 barrels, 56,350.09 barrels less than Shell claims to have delivered to the Facility.
On October 11, 2003 Shell filed an amended motion (the "Motion") seeking the allowance and payment of administrative claims for conversion of natural gasoline and ethane. On February 6, 2003, the Debtors filed an objection (the "Debtors' Objection") to the relief requested in the Motion. On February 10, 2003, the Official Committee of Unsecured Creditors appointed to serve in the Debtors' cases, filed a joinder to the Debtors' Objection. On February 12, 2003, Shell filed a reply to the Debtors' Objection.
Shell had previously filed a motion seeking the same relief on October 10, 2002, which was superceded by the filing of the amended motion. It also filed a proof of claim which sought that relief and, alternatively, sought allowance as an unsecured claim for any portion of its claim not accorded administrative status.
An evidentiary hearing on this matter was conducted on February 13, 2003 (the "Hearing"), at which time EGLI and Shell presented Stipulations of Facts Relevant to the Motion (the "Stipulation of Facts"). At the conclusion of the Hearing, it was agreed that the parties would submit additional briefing. Thereafter, on February 19, 2003, Shell filed a brief on the issue of whether there is a presumption of negligence in a bailment and a brief on the issue of whether breach of a bailment contract gives rise to an action for conversion. On February 20, 2002, Shell filed a designation of testimony from the depositions of Ina Norman and W. Wade Hicks to be considered by the Court. On February 25, 2003, EGLI filed a supplemental brief in support of their objection to the Motion, as well as a cross-designation of deposition and affidavit testimony for the Court to consider in deciding the Motion. On March 4, 2003, Shell filed its reply to EGLI's supplemental brief.
In its Motion, Shell argues that it made certain post-petition deliveries of natural gasoline and ethane to EGLI pursuant to the Storage Agreement. Shell further contends that as EGLI held the natural gasoline and ethane in bailment, when EGLI was subsequently unable to deliver the natural gasoline and ethane to Shell upon its post-petition demand, EGLI was liable for conversion. Shell argues that because its claim against EGLI is based on EGLI's post-petition tort of conversion, its claim against the estate is entitled to administrative expense priority.
The Debtors argue that because Shell's claim stems from a pre-petition contract, it is an unsecured claim. The Debtors further argue that because the allowance of an administrative expense priority is narrowly construed and Shell has not shown that the loss of the natural gasoline or ethane conferred any benefit on the estate, it is not entitled to administrative expense priority.
Administrative Expense Priority
Section 503(b)(1)(A) of the Bankruptcy Code provides a priority for "the actual, necessary costs and expenses of preserving the estate . . . for services rendered after the commencement of the case." Pursuant to section 507(a)(1) of the Bankruptcy Code, these expenses for administering the estate are afforded a first priority. Thus, expenses the debtor-in possession incurs during the reorganization effort are afforded a first priority. In re Jartran, Inc., 732 F.2d 584 (7th Cir. 1984).
This priority is based on the premise that the operation of the business by a debtor-in possession benefits pre-petition creditors; therefore, any claims that result from that operation are entitled to payment prior to payment to "creditors for whose benefit the continued operation of the business was allowed." Cramer v. Mammoth Mart, Inc. (In re Mammoth Mart, Inc.), 536 F.2d 950, 954 (1st Cir. 1976). While Mammoth Mart was decided under the former Bankruptcy Act, its analysis is applicable under the Bankruptcy Code. In re Drexel Burnham Lambert Group Inc., 134 B.R. 482, 489 (Bankr.S.D.N.Y. 1991).
Administrative expenses are afforded this priority to facilitate the reorganization effort by encouraging third-parties, who might be reluctant to deal with a debtor-in-possession, to transact such business. Amalgamated Ins. Fund v. McFarlin's, Inc., 789 F.2d 98, 101 (2d Cir. 1986) citing, Mammoth Mart, 536 F.2d at 954. Otherwise, absent this incentive, the third-parties would refrain from dealing with the debtor-in-possession, thereby inhibiting the reorganization effort and harming pre-petition creditors. Id.
Nevertheless, in light of the bankruptcy goal of providing equal distribution of a debtor's assets to all creditors, priorities are narrowly construed. Amalgamated Ins. Fund, 789 F.2d at 100. Strictly construing the terms "actual" and "necessary" minimizes administrative expense claims thereby preserving the estate to benefit all creditors. Drexel, 134 B.R. at 488. If claims not intended to have priority are afforded such, the value of the priority for those creditors Congress intended to prefer would be diluted. Mammoth Mart, 536 F.2d at 953. It is important to note that once a debtor is in bankruptcy, an ordinary contract action between a provider of goods or services and the solvent recipient of such goods or services becomes a contest among the debtor's creditors to share in the distribution of the debtor's assets. General American Transportation Corp. v. Martin (In re Mid Region Petroleum, Inc.), 1 F.3d 1130, 1133 (10th Cir. 1993). Any priority given to one creditor is done to the detriment of other creditors. In re Patient Education Media, Inc., 221 B.R. 97, 101 (Bankr.S.D.N.Y. 1998).
Ordinarily, an expense will be accorded administrative status
1) if it arises out of a transaction between the creditor and the bankrupt's trustee or debtor-in-possession; and
2) only to the extent that the consideration supporting the claimant's right to payment was both supplied to and beneficial to the debtor-in-possession in the operation of the business.
Amalgamated Ins. Fund, 789 F.2d at 101; Mammoth Mart, 536 F.2d at 954.
The services performed by the claimant must have been "induced" by the debtor-in-possession, not the pre-petition debtor. Jartran, Inc., 732 F.2d at 587, citing, Mammoth Mart, 536 F.2d at 587. Considering inducement by the debtor-in-possession to be a crucial element comports with the policy reason for allowing the priority, which is to encourage third-parties to supply the debtor-in-possession with goods and services with the goal of achieving a reorganization to benefit all creditors. Jartran Inc., 732 F.2d at 588, 590. Thus, benefit to the debtor-in-possession alone is not sufficient to warrant entitlement to an administrative claim priority as it would be contrary to this policy reason for allowing the priority. Jartran, Inc., 732 F.2d at 590.
Where a "debtor-in-possession elects to continue to receive benefits from the other party to an executory contract pending a decision to assume or reject the contract, the debtor-in-possession is obligated to pay for the reasonable value of those services." Patient Education Media, 221 B.R. at 101, quoting, NLRB v. Bildisco Bildisco, 465 U.S. 513, 531, 104 S.Ct. 1188, 1199, 79 L.Ed.2d 482 (1984); see also In re Continental Airlines, Inc., 146 B.R. 520, 526 (Bankr.D.Del. 1992). Therefore, the claims of third-parties who are induced to supply goods or services to a debtor-in-possession pursuant to a contract that has not been rejected are afforded administrative priority to the extent that the consideration supporting the claim was supplied during the reorganization. Jartran, Inc., 732 F.2d at 588. The claimant has the burden of establishing entitlement to the priority. Drexel, 134 B.R. at 489.
An exception to the requirement that there be an actual benefit to the estate before a claim can be accorded administrative priority has developed in the context of torts committed by the trustee or debtor-in-possession during the course of a chapter 11 proceeding. In re Puerto Rican Food Corp., 41 B.R. 565, 572-73 (Bankr.E.D.N.Y. 1984), citing, Reading Co. v. Brown, 391 U.S. 471, 482, 88 S.Ct. 1759, 1765, 20 L.Ed.2d 751 (1968) (other citations omitted).
In Reading, which concerned an arrangement under Chapter XI of the Bankruptcy Act, the Supreme Court reasoned that if a party were injured by negligence in the operation of an "insolvent business thrust upon it by operation of law," it was "fairer" to compensate the injured party upon whom the arrangement had been imposed before compensating those for whose benefit the arrangement was being effected. Reading, 391 U.S. at 478-79, 88 S.Ct. at 1763-64. Thus, the Supreme Court held that a tort arising during the arrangement is treated as "actual and necessary expenses" of the estate. Reading, 391 U.S. at 482, 88 S.Ct. at 1765. The concept has since been applied in chapter 11 reorganization cases under the Bankruptcy Code. See, Puerto Rico Food Corp, 41 B.R. at 572-73 (citing cases). The justification is that it is "more natural and just" to compensate those who were injured by the operation of the business during the reorganization effort ahead of those for whose benefit the business was allowed to continue to operate. See Reading, 391 U.S. at 482, 88 S.Ct. at 1765. As conversion is a tort, a claim based on a post-petition conversion by the debtor-in-possession would be accorded administrative priority as an actual and necessary expense for the privilege of continuing to operate the business. See Puerto Rico Food Corp., 41 B.R. at 572.
Shell contends that EGLI continued to operate its storage business post-petition by virtue of continuing to accept natural gasoline and ethane pursuant to the Storage Agreement. Shell further argues that the Storage Agreement, which provided that it would be construed pursuant to the laws of the state of Texas, was a commercial bailment. Shell maintains that, pursuant to Texas state law, it may pursue either a breach of contract action or a tort action against EGLI. Thus, Shell maintains that when EGLI failed to return the natural gasoline and ethane upon Shell's post-petition demand, a claim for conversion arose in connection with EGLI's post-petition business for which Shell is entitled to administrative priority.
EGLI argues that Shell has not met its burden to establish entitlement to an administrative priority for its claim. EGLI contends that because the loss of the petroleum products stems from the Storage Agreement, it is a breach of contract claim requiring a showing of benefit to the estate which EGLI maintains has not been shown. In addition, EGLI contends that even if a conversion action may be maintained, Shell has not established the elements of a conversion. EGLI further argues that even if there were a conversion, Shell has not established that the conversion occurred post-petition.
Conversion
The Storage Agreement provided that it was governed by Texas state law and the loss of the petroleum products occurred in Texas. To establish conversion, a plaintiff must establish that:
1) it owned or had legal possession of the property or entitlement to possession;
2) the defendant unlawfully and without authorization assumed an exercised; dominion and control over the property to the exclusion of, or inconsistent with; the plaintiff's rights as an owner;
3) the plaintiff demanded return of the property; and
4) the defendant refused to return the property.
Apple Imports, Inc. v. Koole, 945 S.W.2d 895, 899 (Ct.App. Tex Austin 1997). A party's innocence or good faith is not a defense to a conversion action and wrongful intent is not required. White-Sellers Jewelry Co. v. Goodyear Tire Rubber Co., 477 S.W.2d 658, 662 (Ct. Civ. App. Texas Houston (14th Dist.) 1972). The requisite intent is only an intent to assert a right in property. Id.
The Debtors argue that Shell has not proven that EGLI assumed or exercised dominion and control over the products or that EGLI had an intent to assert a right in the products because it has not shown what happened to the products. Shell counters that as the products were in EGLI's control during the period of storage, Shell should not be required to show what happened to the petroleum products. Rather, Shell maintains that because the Storage Agreement was a commercial bailment, there is a presumption of conversion when a bailee fails to return property placed in storage upon the demand of the bailor.
Bailment
The basic elements to establish a bailment are as follows:
1) the delivery of personal property by one person to another is made in trust for a specific purpose;
2) acceptance of such delivery;
3) an express or implied contract that the trust will be carried out; and
4) an understanding under the terms of the contract that the property will be returned to the transferor or dealt with as the transferor directs.
Soto v. Sea Road Int'l, Inc., 942 S.W.2d 67 (Ct.App. Corpus Christi 1997).
If the bailee fails to return the bailed property at the end of the bailment period, it is considered a conversion of the property and the bailor is entitled to recover the property's value. Soto v. Sea Road Int'l, Inc., 942 S.W.2d at 72. This is because in breaching its duty as a bailee, it has exercised dominion and control over the bailed property inconsistent with the right of the bailor to the property. Int'l Freight Forwarding, Inc. v. American Flange, 993 S.W.2d 262, 269 (Ct.App.Tex. San Antonio 1999). To establish its claim the bailor must prove that at the time of the conversion it was the owner of the property or had legal entitlement to possession. Soto v. Sea Road Int'l, Inc., 942 S.W.2d at 72. Thus, a bailor has several options regarding relief for breach of a bailment contract, including an action for conversion. Int'l Freight Forwarding, Inc. v. American Flange, 993 S.W.2d 262, 269 (Ct.App.Tex. San Antonio 1999). The damages recoverable are the value of the property at the time of conversion, plus interest. Soto v. Sea Road Int'l, Inc., 942 S.W.2d at 74.
In a bailment for mutual benefit, when it is proven that bailed property was not returned to a bailor, "there is a rebuttable presumption of negligence and a prima facie case of liability is established by a bailor against a bailee." Buchanan v. Byrd, 519 S.W.2d 841, 843 (Supreme Court Tex 1975). "Where there is a succession of bailees, there is a presumption that damage to the bailed goods occurred while the goods were in the possession of the last bailee, in the absence of evidence to the contrary." Houston Aviation Products Co. v. Gulf Ports Crating Co., 422 S.W.2d 844, 845-46 (Tex Civ App. Houston (1st Dist 1967)) writ ref n.r.e. (Apr 24, 1968). As the presumption of negligence is rebuttable, the bailee then has a duty to produce evidence of some other cause for the loss. Buchanan v. Byrd, 519 S.W.2d at 843. This is because the party with custody or control over the property is more likely to know the cause or circumstances of its disappearance. Id. To rebut the presumption of negligence, the bailee must come forward with an "exculpatory explanation" and a mere showing of lack of knowledge as to how the loss occurred is not sufficient. Id. at 844. Rather, the bailee must show the cause of the loss was something other than its own negligence or that however it occurred, its negligence could not have been the cause of the loss. Id. The justification for the presumption of negligence is twofold:
1) to avoid the "insurmountable burden" that would be imposed on a bailor if required to prove the bailee's negligence; and
2) the desire to promote caution in the handling of property entrusted to it.
Id. Allowing a bailor to rebut the presumption of negligence by merely asserting that it did not know what happened to the bailed property would defeat these purposes. Id.
Shell argues that EGLI continued to accept and store the natural gasoline and ethane post-petition and therefore continued to operate its storage business. Shell further maintains that as EGLI continued to conduct the business post-petition, it exposed itself to the risk of being negligent and thereby committing the tort of conversion. Thus, Shell argues that a claim based on a party's injuries that stem from a debtor's tortious conduct during the post-petition period during which the debtor continued to conduct business activity is entitled to administrative claim priority.
The Debtors argue that Shell has not established the elements of conversion. The Debtors further argue that even if there was a conversion, the presumption of negligence is rebuttable and they maintain that they have successfully rebutted it by setting forth other ways in which the petroleum product may have been lost and because they claim not to know what happened to the products.
EGLI continued to accept and store Shell's petroleum products post-petition. Subsequently, when EGLI, as bailee, was unable to account for the bailor — Shell's petroleum products, EGLI breached its duty as bailee and exercised dominion and control over the bailed property, inconsistent with Shell's rights. As such, Shell is entitled to the benefit of a rebuttable presumption of negligence against EGLI.
The Debtors also argue that even if there is a presumption of the conversion, the Facility was sold to EOTT on June 29, 2001, and EOTT, not EGLI, operated the Facility at the time of the conversion. Thus, the Debtors argue that Shell may not avail itself of the presumption to hold EGLI liable for the tort of conversion.
The evidence, however, establishes that EGLI had control of operations at the Facility during the relevant period up until April 12, 2002 when EOTT took control of the Facility. Shell's affiliate entered into the Storage Agreement with EGLI. Although the Storage Agreement had been amended only nine days prior to the sale of the Facility to EOTT to reflect the revised fees due EGLI pursuant to the terms of the Storage Agreement, Shell was not informed of the sale of the Facility. When the Facility was sold on June 29, 2001, EGLI made arrangements to buy-back the storage capacity to store its own or its customers' petroleum products. The meter ticket receipts used to establish the volume of stored products at the Facility had EGLI's name printed on them. [Trial transcript, February 13, 2002 (Tr. transcript), testimony of Bruce Vandewalker, p. 32, line 15 through p. 33, line 1]. EGLI's director of trading testified that EOTT assumed operations of the Facility on April 12, 2002 when the EOTT Agreement was rejected. [Hicks Dep. Tr. at p. 9, lines 6-10; see also, Norman Dep. Tr. at p. 14, line 15 through p. 15 line 6]. Mr. Hicks also testified that once the EOTT agreement was rejected, EGLI could no longer perform under the agreements with Shell as EGLI no longer had any control over any storage operations at the Facility. Further, it was only after the EOTT Agreement was rejected that EOTT was given authority, pursuant to the order approving rejection of the EOTT Agreement, to negotiate with third-parties that previously had arrangements with EGLI to store their petroleum products. Indeed, EOTT entered into an interim storage agreement with Shell effective April 12, 2002. The evidence establishes that EGLI had control and operated the Facility with respect to the storage of Shell's petroleum products until April 12, 2002. Inasmuch as EGLI had control over the Facility when Shell made demand for return of the petroleum products, Shell is entitled to the presumption of negligence.
Moreover, because the Storate Agreement was between EGLI and Shell's affiliate, even if EOTT employees had read the meters, EOTT would have been acting as EGLI's agent.
The Court finds that the Debtors have not successfully rebutted the presumption of negligence. The Debtors' claim not to know what happened to the products in their custody is not an exculpatory explanation. Rather it is "an `explanation which does not explain'" Buchanan, 519 S.W.2d at 844 (citation omitted). Moreover, the other "possible" reasons for the loss of the natural gasoline which the Debtors proffer either do not have substance or the Debtors themselves refute that the supposed "possibility" is possible. The first concerns shrinkage which all parties agree may explain the loss of a small amount of petroleum products but which could not possibly explain the loss of the volume of petroleum products unaccountable for in this case. Indeed, the Debtors acknowledge that the amount attributable to shrinkage is usually minimal. The Debtors also suggested that there may have been blending of Shell's products with other petroleum products and asserted that Equistar, another company for which EGLI moved barrels of natural gasoline, had a shortage of 40,000 barrels in their trading account of natural gasoline. The Debtors, however, did not elaborate on how these events explain the shortage of Shell's account or how they would negate EGLI's negligence. Finally, the Debtors contend that it could have been traded by one of the Debtors' traders who sometimes used Shell product to cover its trades, quickly replacing it with repurchased product. Yet the Debtors contradict this possibility by steadfastly maintaining that there was no trading post-petition. Thus, none of the Debtors explanations establish that something other than the EGLI's own negligence caused the loss or that EGLI's negligence could not have been the cause of the loss.
While allowing the use of its product to cover the Debtors' trades in the ordinary course of business until it was replaced would indicate a debtor-creditor relationship between the parties and make Shell's claim an unsecured breach of contract claim, there is no indication that Shell was aware that its petroleum product was used by the Debtors' trader to cover these sales. Rather, pursuant to the Storage Agreement, Shell retained title to its petroleum products.
The Debtors also argue that even if Shell is entitled to a presumption of negligence, because administrative priority claims are narrowly construed to allow for equitable distribution of the estate assets, Shell's claim based on a presumption is not sufficient to support allowance of an administrative priority. The Debtors argument, however, neglects the other purpose served in affording claims administrative priority which is to encourage third-parties to transact business with a debtor-in-possession. Post-petition, if a debtor-in-possession could induce third-parties to transact business with it and remain immune from liability for torts committed against them during the period the debtor continued to operate, it would discourage those parties from transacting business with the debtor and hinder the reorganization effort. Moreover, by frustrating the reorganization effort, pre-petition creditors would be harmed. Thus, claims based on tort resulting from the post-petition operation of a debtor's business are entitled to payment prior to payment to those creditors who were meant to benefit from the business's continued operation.
The Debtors contend that even though the debtor's post-petition acts caused Shell's damage, because the source of the estate's obligation to pay the tort damages was the pre-petition Storage Agreement, the Reading exception concerning tort actions does not apply. The Debtors cite to Abercrombie v. Hayden Corp. (In re Abercrombie), 139 F.3d 755, 756 (9th Cir. 1998) where the claimant was seeking administrative priority for attorneys' fees that arose out of litigation over a pre-petition contract, which contract provided for payment of such fees to the prevailing party in any litigation. The Abercrombie court found that because the claim for attorneys' fees did not arise out of an effort to preserve the estate but, rather, stemmed from the pre-petition fee provision in the contract, the claim was not entitled to administrative priority. Id. at 756, 759. As the attorneys' fees were awarded pursuant to a pre-petition contract, "the fees arose out of a transaction with the individual debtor rather than the debtor-in-possession." Id. at 758. The right to the attorneys' fees stemmed from the pre-petition contract, not from a post-petition transaction. Id. at 759.
Here, as previously discussed, the tort claim arose out of EGLI's effort to preserve the estate by continuing to operate its business post-petition. Moreover, Shell has an independent right to pursue a tort action under Texas state law. In addition, this is not a case where one party contracts to sell products to another and title to the product passes from seller to buyer upon consummation of the sale. Rather, here Shell had title to the petroleum products at all times and EGLI merely had custody of the products owned by Shell. As such, EGLI held the property in trust for Shell and had a fiduciary duty to account for the property.
Most of the contract cases requiring benefit to the estate for administrative priority have addressed situations where the non-debtor party to the contract provides a service and seeks administrative priority for the payment due from the debtor for that service. Here, the debtor, EGLI, contracted to provide the service of receiving, storing and re-delivering the non-debtor's, Shell's, products. In return, Shell was to pay a monthly fee for these services subject to certain contractual yearly minimum amounts due. See Storage Agreement, ¶ 4.1. Indeed, had the debtor completed its contractual obligation, including re-delivery of the products, Shell presumably would have paid the monthly fee owed. However, due to the loss of the products, EGLI, did not complete performance. While that constitutes a breach of contract, Shell is also afforded the opportunity to pursue a tort action, pursuant to Texas state law.
On or about March 12, 2002, Shell made demand for the net balance of 70,000 barrels of natural gasoline that it had delivered to the Facility from January 31, 2002 to February 28, 2002. EGLI had no natural gasoline to deliver and has not adequately accounted for the loss of the natural gasoline. Shell is entitled to a presumption that there was a conversion of the natural gasoline and the Debtors have not adequately rebutted that presumption. Shell's claim based upon the post-petition conversion of its natural gasoline is entitled to administrative expense priority. The damages recoverable are the value of the property at the time of conversion, plus interest. The price of natural gasoline on March 12, 2002 was $22.89 per barrel. Therefore, Shell is entitled to the value of 70,000 barrels of gasoline at $22.89 per barrel, plus interest calculated from March 12, 2002. That amount should be reduced by any amounts due EGLI in accordance with the terms of the Storage Agreement.
With respect to the ethane, as of April 12, 2002, the physical inventory at the Facility totaled 113,005 barrels and Shell's book balance was 169,355.09 resulting in a shortage of 56,350.09 barrels. When EOTT took control of the Facility on April 12, 2002, it informed Shell that, as of that date, the physical inventory of ethane was not the same as the book inventory volume provided to EOTT by EGLI.
EGLI argues that Shell has not met its burden to establish entitlement to an administrative priority because Shell delivered and withdrew ethane both pre and post-petition and cannot prove that the shortage happened post-petition. The Debtors argue that Shell does not have actual knowledge of the amount of ethane that was at the Facility on the petition date and only relies on the amounts listed on the November statement issued by EGLI with regard to how much there was at that time at the Facility. Thus, the Debtors suggest that the shortage of ethane may actually have occurred pre-petition.
Shell argues that the ethane was delivered post-petition and, therefore, the loss could only have occurred post-petition. Shell contends that because EGLI was the custodian of the ethane and responsible for providing the calculation of the volume of ethane in storage, Shell was justified in relying on EGLI's calculation as reflected in the November statement, especially in light of the fact that those figures coincided with Shell's calculation of the volume of ethane in storage.
EGLI was the custodian of the ethane and sent Shell monthly statements reflecting the balance of Shell's products at the Facility. In its November statement, EGLI provided Shell with verification that the volume of ethane that Shell considered as having been stored was actually in storage. The records maintained by both EGLI and Shell concur that there was no pre-petition deficiency. As EGLI had custody of the ethane, when Shell received the November statement, it was justified in relying on EGLI's calculation of the volume of natural gasoline in the Facility and not requiring further substantiation that the amount reflected in EGLI's November statement was correct. Other than speculation by EGLI that its November statement may have been incorrect, there is nothing in the record to refute the accuracy of that calculation. Thus, based on the record of this case, the Court finds that the ethane in issue was delivered post-petition and, therefore, the loss of the ethane must have occurred post-petition. Shell has met its burden to establish its entitlement to an administrative priority for its claim based on the post-petition loss of the ethane. As the delivery of the ethane occurred post-petition, the Court does not reach the issue of whether a post-petition loss of a product delivered pre-petition would qualify for administrative priority. Shell is entitled to the value of the ethane on April 12, 2002, which is the date that EOTT took over the operations of the Facility and informed Shell of the discrepancy concerning the 56,350.09 barrels. Thus, Shell is entitled to the value of the 56,350.09 barrels at $10.4738 per barrel, plus interest calculated from April 12, 2002. That amount should be reduced by any amounts due EGLI in accordance with the Storage Agreement.
Nor does the Court reach the issue raised, alternatively, by Shell, and contested by the Debtors, that the tort of conversion arises, for these purposes, when a post-petition demand is made for the return of the ethane.
Shell had originally requested payment of its claims calculated at the date on which the value of the products was highest between the conversion and the filing of its motion for administrative claim priority. This request was based on Shell's contention that EGLI's action in converting the property constituted fraud, willful wrongdoing, or gross negligence. Shell has not established such conduct and, in any event, in the Storage Agreement, Shell waived any entitlement under any of the provisions of the Storage Agreement to "consequential, incidental, punitive, exemplary or indirect damages in tort, contract . . . or otherwise." See Storage Agreement, ¶ 6.4.
Shell has requested immediate payment of its administrative priority claims. The Debtor argues that this payment should be made upon confirmation of a plan of reorganization. The Court has discretion in determining the timing of payment of an administrative claim. In re Photo Promotion Associates, Inc., 881 F.2d 6, 8-9 (2d Cir. 1989). The Court determines that payment of this claim should await confirmation of EGLI's plan of reorganization, at which time the Court can better assess the amount of allowed administrative claims against the EGLI estate and the funds available to satisfy those claims.
CONCLUSION
Pre-petition, EGLI and Shell entered into the Storage Agreement which was a bailment agreement. Post-petition, EGLI continued to operate its storage business pursuant to the Storage Agreement when it continued to accept and store Shell's petroleum products. As such, when EGLI, as bailee, failed to account for the loss of the post-petition delivered products upon a demand for return of the products made by Shell, as bailor, there was a rebuttable presumption of negligence by EGLI under Texas state law, which controlled the transaction and which allowed Shell to maintain an independent action for the tort of conversion. EGLI has not adequately rebutted that presumption and is therefore liable to Shell for the tort of conversion. Shell's claims based upon such loss of its products are entitled to administrative expense priority. The payment of these claims, however, should await confirmation of EGLI's plan of reorganization.
Counsel for Shell is to settle an order, consistent with this Memorandum Decision, on three (3) days' notice.