Opinion
No. 11-02-15145 MS
November 7, 2003
James A. Askew, Albuquerque, NM, for Spencer Fair, Ph.D
Robert H. Jacobvitz, Albuquerque, NM, for Debtor
ORDER CLASSIFYING REMAINDER OF SPENCER FARR'S CLAIM AND DENYING SPENCER FARR'S MOTION FOR ALLOWANCE OF ADMINISTRATIVE CLAIM
THIS MATTER is before the Court on Spencer Fair's Motion for Allowance of Administrative Claim ("Motion for Administrative Claim"), filed by his attorneys of record, Rodey, Dickason, Sloan, Akin Robb, P. A. (James A. Askew) and the Debtor's Objection to Spencer Farr's Proof of Claim Filed January 27, 2003 ("Objection to Claim"), filed by Phase-1 Molecular Toxicology, Inc. (Debtor), by and through its attorneys of record, Jacobvitz, Thuma Walker, P.C. (Robert H. Jacobvitz). The Court held a final hearing on the Motion for Administrative Claim and Objection to Claim on October 8, 2003, at which time the Court took the matters under advisement. After reviewing the relevant documents in the case file, considering arguments of counsel, and being otherwise sufficiently informed, the Court finds: 1) that Spencer Fair does not have an administrative claim against the bankruptcy estate based on his performance of the non-compete provision of the Settlement and Release Agreement ("Settlement Agreement"); 2) that Dr. Farr's claim for pre-petition attorneys' fees in the amount of $1,846.39 will be treated as a general unsecured claim against the bankruptcy estate; and 3) that Dr. Fair is not entitled to the return of a certain patent he previously transferred under the Settlement Agreement.
BACKGROUND AND DISCUSSION
Both the Motion for Administrative Claim and Dr. Farr's proof of claim relate to the Settlement Agreement that was the subject of Adversary Proceeding Number 02-1212 M. The Court previously ruled in Adversary Proceeding Number 02-1212 that the claim of Dr. Farr in the amount of $260,000.00 was specifically and exclusively tied to the transfer of stock by Dr. Farr to the Debtor in accordance with paragraphs 4. and 5. of the Settlement Agreement, and was, therefore, subordinated to the priority of common stock pursuant to 11 U.S.C. § 510(b). See Memorandum Opinion Regarding Plaintiff's Motion for Summary Judgment, p. 6 (Adv. Proceeding No. 02-1212M; Docket No. 26).
The Settlement Agreement contains many other provisions, including the following: 1) a non-compete provision that prohibited Dr. Farr from competing with the Debtor for a period of two years after June 25, 2001 ( See Settlement Agreement, Farr Exhibit 5, ¶¶ 12 and 35); 2) the cancellation by the Debtor of a promissory note executed by Dr. Farr ( See Settlement Agreement ¶ 8); 3) the assignment of all rights, title and interest by Dr. Farr to Debtor in all patents and patent applications ( See Settlement Agreement ¶ 2); 4) mutual releases for the claims raised in state court litigation between the parties ( See Settlement Agreement ¶ 15); and 5) the recovery by the prevailing party for attorneys' fees incurred in any action to enforce the Settlement Agreement ( See Settlement Agreement ¶ 23). In addition, there are other parties to the Settlement Agreement besides Dr. Farr and the Debtor.
On September 9, 2002, Dr. Farr filed a Motion to Compel Debtor to Assume or Reject Executory Contract ("Motion to Compel") seeking to compel the Debtor to immediately assume or reject the Settlement Agreement. ( See Docket # 68). Ultimately, the Debtor rejected the Settlement Agreement as of December 27, 2002, the effective date of the confirmed plan. ( See Order Confirming Second Plan of Reorganization and Second Plan of Reorganization, ¶ 5.1.1). At the final hearing on the Motion for Administrative Claim, the Court ruled that the Settlement Agreement is an executory contract.
A. Administrative Expense Claim
Dr. Fair bases his claim for administrative expense on the non-compete provision of the Settlement Agreement. Dr. Fair contends that because he did not compete against the Debtor in accordance with the provisions of the Settlement Agreement, he conferred a benefit to the estate that entities him to an administrative claim in the amount of his pro-rated salary from the date of the bankruptcy petition through the date the Debtor rejected the Settlement Agreement. Dr. Fair reasons further that the Court's prior ruling in Adversary Proceeding No. 02-1212 M determined that the money due under the Settlement Agreement was solely in exchange for the transfer of stock, precluding the conclusion that the money due under the Settlement Agreement also served as consideration for the non-compete provision.
The Debtor counters that all consideration for the mutual promises and releases is encompassed by the Settlement Agreement, and that there are no additional damages flowing from Dr. Farr's continued performance of the non-competition provision in the Settlement Agreement from the petition date through the date Debtor rejected the Settlement Agreement. Debtor reasons further that the only damage stemming from the Settlement Agreement is Dr. Farr's claim for $260,000.00 which the Court has already ruled is subordinated pursuant to 11 U.S.C. § 510(b).
The starting point for analysis of Dr. Farr's claim is 11 U.S.C. § 365(g), which provides that "the rejection of an executory contract . . . constitutes a breach of such contract" as of the date of the petition. 11 U.S.C. § 365(g). Rejection "permit[s] the creditor to seek allowance of its claim under section 502" which will generally result in an unsecured pre-petition claim for damages. 3 Collier on Bankruptcy ¶ 365.09[1] (Alan N. Resnick and Henry J. Sommer, eds., 15th ed. rev. 2003).
As stated above, the Settlement Agreement contains mutual promises and releases, and both Dr. Farr and the Debtor provided consideration to each other pursuant to the terms of the Settlement Agreement. The only unpaid monetary consideration contained in the Settlement Agreement was the $260,000.00 that the Court previously ruled was exclusively tied to the transfer of stock, and subordinated pursuant to 11 U.S.C. § 510(b). Dr. Farr made no allegation nor offered any evidence at trial that Debtor failed to meet any other obligation under the Settlement Agreement. Dr. Farr merely asserts that the Debtor's rejection of the Settlement Agreement constitutes a breach of contract, and that Dr. Farr did not receive consideration for his performance of the non-compete provision.
This Court disagrees. "The significance of rejection of an executory contract is that it not only relieves the estate of burdensome future obligations but it also gives rise to a prepetition general unsecured claim for damages rather than an administrative expense priority." In re Spectrum Info. Tech., Inc., 193 B.R. 400, 403-404 (Bankr.E.D.N.Y. 1996). The date immediately preceding the petition date is considered that date of the breach for determining damages arising from rejected executory contract. 11 U.S.C. § 365(g)(1); see also In re Asian, 909 F.2d 367, 371 (9th Cir. 1990) (holding that "when the debtor secures a rejection of a non-assumed executory contract under 365(g)(1), the date of breach is the day `immediately before the date of the filing of the petition.'") (quoting the district court opinion). Only if the claim relates to a post-petition actual and necessary expense of administration can a claim based on rejection of an executory contract give rise to an administrative expense under 11 U.S.C. § 503(b). Spectrum, 193 B.R. at 404 ("[A]an exception to the prepetition status of a claim arises if the claim relates to a post-petition actual and necessary expense of administration"). Moreover,
[A]n expense is administrative only if it arises out of a transaction between the creditor and the bankrupt's trustee or debtor in possession and only to the extent that the consideration supporting the claimant's right to payment was both supplied to and beneficial to the estate in the operation of the business.
In re Commercial Fin. Services, Inc., 246 F.3d 1291, 1294 (10th Cir. 2001) (quoting Isaac v. Temex Energy, Inc. (In re Amarex, Inc.), 853 F.2d 1526, 1530 (10th Cir. 1988) (quotations and internal citations omitted)).
Here, all consideration for the non-compete provision in the Settlement Agreement was exchanged pre-petition. Dr. Farr has, therefore, suffered no damages related to the non-compete provision of the Settlement Agreement as of the date immediately preceding the date of the petition. Therefore, under the general analysis for breach of executory contract resulting from debtor's rejection, Dr. Farr has no claim related to the non-compete provisions of the Settlement Agreement.
It likewise follows that because all consideration for the non-compete provision of the contract was exchanged pre-petition, Dr. Farr's post-petition continued performance of the non-compete was not a transaction with the debtor-in-possession, nor was it an actual and necessary expense of administration that was beneficial to the estate in the operation of its business. Dr. Farr is, therefore, not entitled to a claim for administrative expense based on his post-petition performance of the non-compete provision of the Settlement Agreement.
This conclusion is not inconsistent with the Court's prior ruling. The Court previously ruled that the unpaid monetary consideration in the Settlement Agreement was strictly related to the transfer of stock. The Settlement Agreement also provided for consideration from the Debtor in the form of forgiveness of a promissory note and release of the state court claims against Dr. Farr, in exchange for, among other things, the non-compete agreement from Dr. Farr.
B. Claim for Pre-petition Attorneys' Fees
Dr. Farr also claims attorneys' fees in the amount of $1,846.39 incurred pre-petition in his attempt to enforce the Settlement Agreement as a general unsecured claim against the Debtor's bankruptcy estate. Under paragraph 23 of the Settlement Agreement, the substantially prevailing party in an action "to enforce or remedy a breach of a provision" of the Settlement Agreement is entitled to recover its attorneys's fees from the other party. Dr. Farr incurred $1,846.39 in attorneys' fees in pursuit of his pre-petition state court action against the Debtor to enforce the Settlement Agreement. Debtor does not contest the amount of these fees nor that Dr. Farr has a claim against the Debtor for these fees, but, rather, contends that because the Court subordinated Dr. Farr's claim for payment of $260,000.00 under the Settlement Agreement to the priority of common stock pursuant to 11 U.S.C. § 510(b), the attorneys' fees requested should likewise be subordinated to other claims.
This Court disagrees. The attorneys' fees were incurred pre-petition in connection with Dr. Farr's state court action to enforce the Settlement Agreement against the Debtor. They were not incurred in connection with the adversary proceeding which resulted in the subordination of Dr. Farr's claim. The Court, therefore, finds it appropriate to classify Dr. Farr's claim for attorneys' fees in the amount of $1,846.39 as a general unsecured claim against the bankruptcy estate.
The Court has not been able to locate any case law on this issue directly on point. Nor did counsel for either party cite any case law in support of their respective positions regarding this issue.
C. Request for Return of Patent to Dr. Farr
Dr. Farr also requests that a certain patent transferred by the terms of the Settlement Agreement be returned to him. Dr. Fair's proof of claim asserts a claim for "damages for Debtor's failure to perfect assigned intellectual property and damages for the value of previously assigned intellectual property or the return thereof." The proof of claim does not specify the amount of damages, nor was any evidence of damages presented at the final hearing. Return of the patent to Dr. Farr is not a remedy available to him under the circumstances present here. There are other parties to the Settlement Agreement besides Dr. Farr and the Debtor. As stated previously, both parties have already performed many of the promises and releases contemplated by the Settlement Agreement. Having been awarded a claim against the bankruptcy estate (albeit a subordinated claim) based on the Settlement Agreement, Dr. Farr cannot now also recover a patent he already transferred to the Debtor under the terms of the Settlement Agreement. In short, Dr. Farr's prior election of remedies precludes recovery of the transferred patent. See Restatement (First) of Contracts § 381 (1932) ("The bringing of an action for one of these remedies [damages or restitution] is a bar to the alternative one unless the plaintiff shows reasonable ground for making the change of remedy.")
WHEREFORE, IT IS HEREBY ORDERED, that Spencer Farr's Motion for Allowance of Administrative Claim is DENIED.
ORDERED FURTHER, that Spencer Farr's claim for pre-petition attorneys' fees in the amount of $1846.39 is allowed as a general unsecured claim.
I hereby certify that a true and correct copy of the foregoing was either electronically transmitted, faxed, delivered, or mailed to the listed counsel and parties, on the date file-stamped above.