Opinion
No. 7-02-10188 MA.
November 30, 2005
Daniel J. Behles, Chapter 7 Trustee, Albuquerque, NM.
Louis Puccini, Jr., Albuquerque, NM, Attorney for Funds Administration Services.
William F. Davis, Albuquerque, NM, Attorney for Debtors.
ORDER GRANTING FUNDS ADMINISTRATION SERVICES' APPLICATION FOR ALLOWANCE AND PAYMENT OF ADMINISTRATIVE PRIORITY EXPENSE CLAIM
THIS MATTER is before the Court on Funds Administration Services' Application for Allowance and Payment of Administrative Priority Expense Claim ("Application"). Creditor Lovelace Health Systems, Inc. filed an objection to the Application which was later withdrawn. (See Docket # 944 and #985). Daniel J. Behles, the Chapter 7 Trustee, also filed an objection to the Application, and the Court held a final hearing on the Application after which the Court took the matter under advisement. Funds Administration Services ("FAS") seeks payment from the bankruptcy estate as an administrative priority expense its claim in the amount of $78,562.14 representing certain funds that should have been paid to Chubb Group of Insurance Companies/Vigilant Insurance Company ("Vigilant") pursuant to the terms of a Funds Administration Agreement between FAS and the Debtors, but which were instead received by the Debtors and used to fund the Debtors' payroll expenses.
The Chapter 7 Trustee raises the following objections: 1) that because FAS sent the funds at issue to the Debtors in error, its own mistake should not entitle it to payment of its claim as an administrative expense, though it may have a claim against the Debtors for misappropriation of funds; 2) that the liability resulting from a default in a pre-petition bond is not an expense of administration; and 3) that there is no evidence the funds were used for or provided any benefit to the bankruptcy estate. Upon consideration of the evidence and testimony offered at the final hearing in light of applicable statutes and case law, the Court finds that the claim of FAS qualifies as an administrative expense of the Chapter 11 estate. In reaching this determination the Court FINDS:
1. Salvador and Patricia Guzman (together, the Guzmans, or "Debtors") filed a voluntary petition under Chapter 11 of the Bankruptcy Code on January 10, 2002.
2. The Debtors owned and operated an unincorporated business known as Chava Trucking Company.
3. The purpose of FAS's business is to ensure that contract proceeds from construction projects are applied to contract obligations. It performs this service at the request of surety companies. (Testimony of David Strauss).
4. Pre-petition, the Guzmans, d/b/a Chava Trucking Company, entered into a surety bond arrangement with FAS in connection with work Chava Trucking Company was performing on the New Mexico Highway Department Broadway Intersection Project. The surety bond arrangement is reflected in a Funds Administration Agreement ("Agreement") dated October 4, 2001. See Exhibit A.
5. The Agreement provided that in the event Chava Trucking Company was in default under the surety bonds, or any other agreement with the surety, the surety could demand that all contract funds held by FAS be released only to the surety. See Exhibit A, ¶ 6.8.0.
6. Vigilant was the surety identified in the Agreement. See Exhibit A, ¶ 2.1.0.
7. In November of 2001, Vigilant notified FAS and the Guzmans that the Guzmans were in default under their indemnity agreement with Vigilant. See Exhibits D and E. Vigilant also notified the New Mexico State Highway and Transportation Department that all payments due to the Guzmans in connection with the New Mexico Highway Department Broadway Intersection Project were to be made through the FAS account. See Exhibit F.
8. The following year, in November of 2002, Vigilant sent a letter to FAS requesting that all remaining funds relating to the New Mexico Highway Department Broadway Intersection Project that FAS had in its possession should be forwarded to Vigilant in accordance with the terms of the Agreement. See Exhibit G.
9. On December 3, 2002, FAS issued a check for the remaining funds in the amount of $78,562.14 and mailed the check to Chava Trucking Company. This check should have been sent to Vigilant.
10. The payee identified on the check was Chava Trucking Company. See Exhibit H. It is the regular practice of FAS to put the contractor's name in the upper left corner of the check and to make the check payable to the contractor even when the funds are to be sent to the surety as a means of tracking its contracts because FAS does not maintain segregated accounts for each contractor. (Testimony of David Strauss of FAS). The surety held a power of attorney that allowed it to cash checks payable to Chava Trucking Company. (Testimony of Davis Strauss of FAS).
11. The Guzmans took the check from FAS to the bank and exchanged it for a cashier's check.
12. The funds were used to meet the payroll expenses of Chava Trucking Company. See Exhibit I — Monthly Operating Report for December 2002 with copy of bank statement for Chava Trucking Payroll Acct reflecting a deposit on December 6, 2002 in the amount of $78,562.14.
13. FAS did not recover the funds from the Guzmans or from any other source and paid Vigilant $78,562.14 from FAS's corporate funds. Testimony of David Strauss.
14. The Guzmans' bankruptcy proceeding was converted to Chapter 7 on June 3, 2003, and Daniel J. Behles was appointed the permanent Chapter 7 Trustee.
15. FAS filed a proof of claim in the Debtors' bankruptcy proceeding (Claim No. 64) in the amount of $78,562.14 as an administrative expense on July 22, 2003.
16. On September 5, 2003, FAS filed an adversary proceeding against the Guzmans, d/b/a Chava Trucking, as Case No. 03-1324 M objecting to the Debtors' discharge pursuant to 11 U.S.C. § 727(a) and objecting to the dischargeability of the debt represented by the $78,562.14 based on claims of embezzlement, fraud, conversion, and/or willful and malicious injury pursuant to 11 U.S.C. § 523(a)(4), § 523(a)(6) and § 523(a)(2)(A). This adversary proceeding has been stayed by stipulation among the parties. See Adv. No. 03-1324 M; Docket # 6.
DISCUSSION
Administrative expenses include the "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). The party seeking allowance of an administrative expense bears the burden of proving that treatment of its claim as an administrative expense is warranted. In re Mid Region Petroleum, Inc., 1 F.3d 1130, 1132 (10th Cir. 1993); In re Eleva, Inc., 226 B.R. 123, 125 (Bankr.D.Utah 1998) (citing In re Fullmer, 962 F.2d 1463, 1467 (10th Cir. 1992)). To qualify as an administrative expense, "the expense must: (1) arise out of a transaction between the creditor and the bankrupt's trustee or debtor-in-possession; and (2) benefit the debtor-in-possession in the operation of the business." Id. at 1133 (quoting In re Amarex, Inc., 853 F.2d 1526, 1530 (10th Cir. 1988)). Phrased slightly differently, the creditor requesting an administrative expense must prove that "(1) it has a claim against the estate and (2) the claim arose as a cost of administration." In re Athens/Alpha Gas Corp., 332 B.R. 578, 580 (8th Cir. BAP 2005) (quoting AgriProcessors, Inc., v. Iowa Quality Beef Supply Network, L.L.C. (In re Tama Beef Packing, Inc.), 290 B.R. 90, 95 (8th Cir. BAP 2003)). Benefit to the estate is established when the use of the creditor's property provides some tangible benefit to the estate; potential benefit to the estate is insufficient to satisfy the "actual and necessary" requirement for an allowed administrative expense. Mid Region Petroleum, Inc., 1 F.3d at 1133 (citing Broadcast Corp v. Broadfoot, 54 B.R. 606, 611 (N.D.Ga. 1985), aff'd in part, rev'd in part sub nom., In re Subscription Television of Greater Atlanta, 789 F.2d 1530 (11th Cir. 1986)). See also, In re Magnolia Gas Co., L.L.C., 255 B.R. 900, 916-17 (Bankr.W.D.Okla. 2000) (discussing Mid Region Petroleum, Inc., and determining that within the Tenth Circuit, benefit is determined by actual use of the creditor's property, not by mere opportunity for use). The Court will address the benefit requirement first.
It is not disputed that the funds at issue were deposited into the debtor-in-possession bank account for payroll. The monthly operating report from December 2002 includes a bank statement from the Debtors' payroll account that reflects a deposit in the same amount as the check issued by FAS. As the statement reflects total deposits of $322,747.95, including the $78,562.14 deposit representing the funds from the check issued by FAS, and an ending balance of $3,185.65, the funds represented by the check issued by FAS must have been used in the operation of Debtors' business, and in all likelihood were used to fund the Debtors' payroll expenses. No evidence was presented at the final hearing that would indicate that the funds were not used for payroll expenses during the period that the debtor-in-possession operated its business. The Court, therefore, finds that FAS has met its burden of establishing that the funds at issue were used to meet the actual and necessary costs and expenses of the estate. Payroll expenses served to preserve the estate for the benefit of all creditors because it enabled the debtor-in-possession to continue its business operations during the Chapter 11 proceeding and complete pending contracting jobs, generating additional estate funds. The funds thus supplied the requisite benefit necessary to sustain a claim for administrative expense.
Although the withdrawals representing payroll expenses, described as "Chava Trucking Exp/Pay . . . Chava Trucking" on the copy of the bank statement attached to the December 2002 monthly operating report cannot be read clearly, a close scrutiny of the entries shows that payroll expenses of over $138,000.00 were incurred.
Turning to the first requirement, the claimant must show that the claim arose out of a transaction between the creditor and the debtor-in-possession. Mid Region Petroleum, Inc., 1 F.3d at 1133. The Chapter 7 trustee contends that because the source of FAS's claim is the initial pre-petition default by the Guzmans in 2001 under their indemnity agreement, that the liability arising therefrom is a pre-petition debt that is not an administrative expense of the bankruptcy estate. This argument fails to acknowledge the fact that the funds were received by the Guzmans during their chapter 11 bankruptcy proceeding and used in payment of the Debtors' payroll expenses incurred as a result of operating their business. The transaction between FAS and the Guzmans that gives rise to FAS's claim is the disbursement of the 78,562.14 held in FAS's account that was mailed to the Guzmans, exchanged by the Guzmans for a cashier's check, and deposited in the Guzmans' payroll account to be used for payroll expenses incurred during the operation of the Guzmans' business. As discussed by the Eighth Circuit Bankruptcy Appellate Panel in Athens/Alpha Gas Corp.,
The term "transaction" is broadly defined. Distilled to its essence, it is an act between the parties which alters their legal relationship, as is stated in the legal definition adopted previously by this court:. . . . "Something which has taken place, whereby a cause of action has arisen . . . and by which the legal relations of such persons between themselves are altered. It is a broader term than `contract.'"
332 B.R. at 580-81 (quoting Trustees of the Trism Liquidating Trust v. IRS (In re Trism, Inc.), 311 B.R. 509, 516-17 (8th Cir. BAP 2004) (quoting Black's Law Dictionary 1496 (6th ed. rev. 1990)), aff'd, 126 Fed.Appx. 339 (8th Cir. 2005)).
Here, the disbursement of funds that should have been paid to the surety instead to the Guzmans and the use of those funds by the Guzmans, altered the legal relationship between the Guzmans and FAS and gave rise to a cause of action.
In Athens/Alpha Gas Corp., the claimants owned certain interests in an oil and gas well operated by the debtor. 332 B.R. at 579. Post-petition, instead of distributing to the claimants their share of the profits in accordance with the parties' pre-petition agreement for sharing revenue, the debtor used the proceeds to pay operating expenses and debts unrelated to the well. Id. In determining that the claimants were entitled to a claim for administrative expenses, the Eighth Circuit Bankruptcy Appellate Panel reasoned that the "transaction" between the claimants and the debtor was the debtor's exercise of control over all the profits which were used to pay the debtor's operating expenses, resulting in an "involuntary infusion of cash . . . which permitted the debtor to maintain operations and therefore indirectly benefitted all creditors." Id. at 581. The existence of a pre-petition agreement between the parties concerning revenue distribution did not negate the fact that the claim arose post-petition against post-petition assets derived from post-petition production. Id. at 580. Similarly, in this case, the claim of FAS consists of the post-petition action of the Guzmans in using the funds in the operation of the business.
Finally, the Trustee asserts that because it was FAS's mistake in sending the funds to the Guzmans instead of the surety, it should remain responsible for its own loss and should not benefit from its mistake by receiving a payment from estate funds. Imposing an additional administrative expense on the estate, the Trustee argues, will unfairly dilute the distribution to unsecured creditors. The Court disagrees. Payroll expenses incurred during a debtor's operation of its business in Chapter 11 are quintessential administrative expenses. 11 U.S.C. § 503(b)(1)(A) (administrative expenses include "wages . . . for services rendered after the commencement of the case."). The use by the Debtors of the funds at issue to meet payroll expenses allowed the Debtors to continue their operations, thus benefitting the estate, and rendered the funds at issue a de facto administrative expense.
WHEREFORE, IT IS HEREBY ORDERED that Funds Administration Services' Application for Allowance and Payment of Administrative Priority Expense Claim is GRANTED. Funds Administration Services' claim in the amount of $78,562.14 is allowed as an administrative Chapter 11 expense.
Pursuant to 11 U.S.C. § 726(b), when a case has been converted from Chapter 11 to Chapter 7, the administrative expenses of the Chapter 7 estate have priority over allowed administrative expenses of the Chapter 11 estate. 11 U.S.C. § 726(b) (". . . a claim allowed under section 503(b) of this title incurred under this chapter after such conversion has priority over a claim allowed under section 503(b) of this title incurred under any other chapter of this title before such conversion . . .").