Opinion
Bap Nos. MW 03-040, 03-094, (Consolidated), Bankruptcy Case Nos. 01-47214-JBR through 01-47217-JBR.
September 15, 2004
Daniel P. Gibson, Esq., Michael Mahoney, Esq., Kevin H. O'Neill, and Gibson Behman, P.C., on brief for the Appellant.
Paul J. Ricotta, Esq., Ruth M. Bayley, Esq. and Mintz, Levin, Cohn, Ferris, Glovsky and Popeo, P.C., on brief for the Appellees.
Before LAMOUTTE, HAINES, and KORNREICH,
Appeal from the United States Bankruptcy Court for the District of Massachusetts (Hon. Joel B. Rosenthal, U.S. Bankruptcy Judge).
This matter is before the Panel on two consolidated appeals from orders entered by the United States Bankruptcy Court for the District of Massachusetts (the "bankruptcy court") determining the appellant's proof of claim to be unsecured and denying the appellant's request for leave to file an amended proof of claim to change its status from "priority" to "secured".
We AFFIRM.
BACKGROUND
On December 11, 1995, Malden Mills Industries, Inc. ("Malden Mills") experienced a catastrophic fire which destroyed one million square feet of space and nearly all of its manufacturing capability in Lawrence, Massachusetts. At that time, General Reinsurance Company ("GenRe") was Malden Mills' excess workers' compensation carrier and provided reimbursement to Malden Mills following the workers' compensation injuries that arose from the fire. As a consequence of a dispute which arose with respect to the potential reimbursement of certain claims filed by some employees following the fire, on December 7, 2000, Malden Mills and GenRe entered into a settlement agreement (the "Settlement Agreement") resolving the parties' respective rights and obligations under their insurance policy. The Settlement Agreement contained an integration clause and a requirement that its terms were to be kept confidential by the parties, and stated that Malden Mills would make good faith efforts to subsequently provide security for the amounts owed under the Settlement Agreement.
Within six months following the execution of the Settlement Agreement, and in accordance therewith, GenRe advanced approximately $2.1 million for certain Malden Mills' employees, to be used in settling workers' compensation claims asserted against Malden Mills. The Settlement Agreement provided that Malden Mills was to reimburse GenRe for any payments made to, or on behalf of, Malden Mills under the Settlement Agreement in accordance with certain parameters directly related to the amount of recovery proceeds Malden Mills could receive from litigation against third parties (the "Recovery Litigation") for losses sustained as a result of the fire.
In June 1997, Malden Mills entered into an agreement with Commerce and Industry Insurance Co. ("C I"), pursuant to which Malden Mills and C I agreed to commence litigation against certain third parties that Malden Mills believed were responsible for the fire. In November 1998, in accordance with this agreement, Malden Mills, C I and another insurer commenced an action against numerous defendants, seeking damages in excess of $450 million for loss and damage sustained as a result of the fire. This litigation was subsequently removed to the bankruptcy court, which on September 3, 2002, approved a settlement among Malden Mills and the remaining third-party defendants.
On November 29, 2001, Malden Mills and its affiliated debtor entities filed voluntary petitions for reorganization pursuant to chapter 11 of the Bankruptcy Code. Appellant GenRe filed a proof of claim on January 23, 2002 (claim no. 64), asserting an unsecured "priority" claim in the amount of $5.1 million, based upon the terms and conditions of the Settlement Agreement. GenRe filed an amended proof of claim on July 26, 2002 (claim no. 642), asserting that its previously-filed claim is secured by "litigation proceeds" in an amount "to be determined". Through the amended proof of claim, GenRe sought to have the debtors' repayment obligations under the Settlement Agreement be treated as "secured" by the Recovery Litigation proceeds referenced therein, rather than be paid preferentially as a "priority" claim. The amended proof of claim was filed before a settlement was reached by Malden Mills in the Recovery Litigation on August 2, 2002, and before the debtors filed their disclosure statement or plan of reorganization.
Malden Mills Distributors Corp., ADS Properties Corp. and AES Properties Corp.
The debtors filed an objection "under seal" to GenRe's proof of claim on January 24, 2003. The debtors argued that claim no. 642 was not an amended claim related to claim no. 64, but instead was a new, late-filed claim. The debtors further object to claim nos. 64 and 642 because GenRe has neither a secured nor a priority claim, but rather a general, unsecured claim. Further, Malden Mills requested that the bankruptcy court limit GenRe to a single, contingent, unsecured claim in a maximum amount of $2.5 million, without interest, in accordance with the Settlement Agreement. GenRe filed a response "under seal" to the debtor's objection on February 24, 2003, accompanied by a motion to amend its proof of claim.
The bankruptcy court held a hearing on the matter on March 5, 2003. On March 17, 2003, the bankruptcy court entered an order denying GenRe's motion to amend its proof of claim, and entered another order sustaining the debtors' objections to the claim and determining that GenRe's claim is unsecured. The bankruptcy court concluded that "the Settlement Agreement dated December 7, 2000, which the parties acknowledge is the controlling agreement, does not contain language that can be construed as a grant of a security interest." App. at C. The bankruptcy court further concluded that "even if General Reinsurance had been granted a security interest, it failed to perfect it by filing." Id. GenRe filed a timely appeal of the orders on April 15, 2003.
The issues on appeal are: (1) whether the bankruptcy court erred in determining that the appellant's proof of claim constitutes an "unsecured" claim rather than a "secured" or "priority" claim; (2) whether the bankruptcy court erred in declining to impose an equitable lien upon certain settlement proceeds in favor of the appellant and against the debtor based upon the record; (3) whether the bankruptcy court erred in denying appellant's request for leave of court to amend its original proof of claim from a "priority" claim to a "secured" claim; (4) in the alternative, whether the appellant's proof of claim should be allowed as a "priority" claim as originally filed; and (5) whether the bankruptcy court erred in resolving the dispute between the parties concerning the validity, priority and extent of the appellant's claim, and the parties' rights pursuant to the settlement agreement, as a contested matter rather than as an adversary proceeding.
JURISDICTION
A bankruptcy appellate panel may hear appeals from "final judgments, orders and decrees pursuant to 28 U.S.C. § 158(a)(1), or with leave of the court, from interlocutory orders and decrees pursuant to 28 U.S.C. § 158(a)(3)." Fleet Data Processing Corp. v. Branch (In re Bank of New England Corp.), 218 B.R. 643, 645 (B.A.P. 1st Cir. 1998). "A decision is final if it `ends the litigation on the merits and leaves nothing for the court to do but execute the judgment.'" Id. at 646 (citations omitted).
The Panel finds that it has jurisdiction over this appeal pursuant to § 158(a)(1) as the bankruptcy court's orders determining the appellant's claim to be "unsecured" and denying the appellant's request to amend its proof of claim constitute final orders. In re Lambeth Corp., 227 B.R. 1, 6 (B.A.P. 1st Cir. 1999) (order resolving objection to claim is a final order for purposes of appeal); In re Saco Local Dev. Corp., 711 F.2d 441 (1st Cir. 1993) (order determining claim priority is final order for purposes of appeal).
STANDARD OF REVIEW
Appellate courts reviewing an appeal from the bankruptcy court generally apply the clearly erroneous standard to findings of fact and de novo review to conclusions of law. See T I Fed. Credit Union v. DelBonis, 72 F.3d 921, 928 (1st Cir. 1995); Western Auto Supply Co. v. Savage Arms, Inc. (In re Savage Indus., Inc.), 43 F.3d 714, 719-20, n. 8 (1st Cir. 1994). Where a matter on appellate review involves mixed questions of law and fact, the findings of fact are set aside if they are clearly erroneous, while conclusions of law are reviewed de novo and may be set aside if they are clearly erroneous or constitute an abuse of discretion. In re D.H. Assocs., 3 F.3d 512 (1st Cir. 1993).
The bankruptcy court's conclusion that the Settlement Agreement does not provide GenRe with a security interest in the Recovery Litigation proceeds is reviewed de novo because interpretation of a settlement agreement is a legal issue. Korman Co. v. Cumberland Farms, 140 F.3d 331, 333 (1st Cir. 1998); see also, In re Sergi, 233 B.R. 586 (B.A.P. 1st Cir. 1999) (interpretation of contract is question of law subject to plenary review).
The bankruptcy court's decision not to impose an equitable lien on the settlement proceeds involves both legal and factual determinations; the former are reviewed de novo, while the latter are reviewed for clear error. In re DH Assocs., 3 F.3d at 512; In re Fitzgerald, 117 F.3d 1428 (10th Cir. 1997). The Panel reviews the bankruptcy court's decision to determine the objection to claim by motion instead of through an adversary proceeding for abuse of discretion. In re Salem Suede, Inc., 221 B.R. 586 (D. Mass. 1998).
DISCUSSION
We will first consider whether GenRe can successfully assert a secured claim. Because, as explained below, we conclude it cannot, the bankruptcy court's denial of its motion to amend its proof of claim is of no moment.
Section 506 of the Bankruptcy Code concerns the determination of the secured status of a claim, and provides that a secured claim is "an allowed claim of a creditor secured by a lien on property in which the estate has an interest [. . .] to the extent of the value of such creditor's interest in the estate's interest in such property." 11 U.S.C. § 506(a). The threshold issue, then, is whether the claim is actually "secured"; that is, "whether it carries with it any special collection right with respect to specific items of property owned by the bankruptcy estate." 4 Lawrence P. King, et al., Collier on Bankruptcy ¶ 506.03 (15th ed rev'd 2004). "A claim cannot be a `secured claim' for purposes of section 506(a) unless it is secured by a `lien' on some specific item of property in which the estate has an interest." Id. at 506-10. Said lien may be created by agreement, statute, common law, equity or judicial process. Id.
The Massachusetts' Uniform Commercial Code provides that:
[A] security interest is enforceable against the debtor and third parties with respect to the collateral only if:
(1) value has been given;
(2) the debtor has rights in the collateral [. . .];
(3) one of the following conditions is met:
(A) the debtor has authenticated a security agreement that provides a description of the collateral [. . .]."
Mass. Gen L. ch. 106 § 9-203. In their treatise on the Uniform Commercial Code, White Summers note that pursuant to the "signed-writing rule" of UCC § 9-203(1)(a), a security interest is effective only if "the debtor has signed a security agreement which contains a description of the collateral", and state that such a writing must (1) contain sufficient language to embody a "security agreement", (2) include an adequate "description of the collateral", and (3) be "signed by the debtor". 4 White Summers, Uniform Commercial Code § 31-3 (4th ed. 2004). They further note that "security agreement" is defined in § 9-105 as "an agreement which creates or provides for a security interest", and that, in disputed cases, the conjunction of § 9-203 and § 9-105 may require the court to make two inquiries; to wit, whether, as a matter of law, the language of the writing objectively indicates that the parties actually intended a security interest; and whether, as a matter of fact, the parties actually intended a security interest. Id.
The Bankruptcy Court found that GenRe's claim is unsecured because the Settlement Agreement does not contain language which can be construed as granting a security interest. The Settlement Agreement provides in Paragraph 3.a:
[Malden Mills] will pay to Gen Re an amount equal to any amount in excess of ( [redacted] Dollars) received by [Malden Mills] from the Recovery Action, after giving effect to the division of the recovery proceeds pursuant to [Malden Mills'] Full and Final Settlement Agreement with Commerce and Industry Insurance Company (the "Coverage Agreement"), until ( [redacted] Dollars), plus simple interest at one percent below prime on the date of this Agreement, is paid in full. Except as otherwise provided herein, Gen Re shall have no recourse against [Malden Mills] for payment of this amount except from such excess proceeds, and [Malden Mills] shall have no obligation to pay Gen Re the amounts called for by this subparagraph except to the extent amounts in excess of ( [redacted] Dollars) are actually received by [Malden Mills] incident to the division of proceeds under the Coverage Agreement.
The Settlement Agreement further provides in Paragraph 4.b:
[Malden Mills] will make good faith efforts:
[. . .]
b. To obtain approval from its current lenders, on terms satisfactory to it in its sole and absolute discretion, to promise to pay the amount called for and in the manner provided under subparagraph 3.a and to provide security for such promise reasonably acceptable to Gen Re.
GenRe argues that the sums it advanced to the debtor were in exchange for Malden Mills' obligation to secure repayment of the debt with its proceeds from the Recovery Action; therefore, it was reasonable for GenRe to accept such repayment as "security" for its promise to pay. However, there is nothing in the language of the Settlement Agreement, quoted herein, which grants GenRe a security interest in the litigation proceeds. Paragraph 4 sets forth a formula for determining the amount of the claim and limits GenRe's recourse to the proceeds of the Recovery Action; it does not grant a lien or security interest to GenRe over those proceeds. Furthermore, the language of Paragraph 4.b implies that no security interest has been granted by providing that Malden Mills use its best efforts to obtain its lenders' approval and provide security acceptable to GenRe. That paragraph does not identify any collateral in which a lien has been granted; rather, it states that the collateral must be acceptable to GenRe. There is no indication that this statement refers to the proceeds of the Recovery Action. Accordingly, the Panel agrees with the bankruptcy court that the language of the Settlement Agreement does not grant GenRe a security interest in the settlement proceeds.
The appellant also argues that the bankruptcy court erred in not imposing an equitable lien upon the settlement proceeds based upon the record before the court. According to GenRe, it is entitled to an equitable lien because Malden Mills promised to reimburse GenRe from its share of the Recovery Litigation proceeds, and because the confidentiality agreement prohibited GenRe from perfecting its lien under Massachusetts law. In response, the debtor argues that equitable liens are only appropriate in situations where a party has engaged in fraudulent conduct, and there are no such allegations herein.
Under Massachusetts law, an equitable lien is defined as:
[A] charge upon specific property, entitling the holder of the lien to have the property applied in equity to the payment of his debt as against all other claimants of the property except purchasers for value without notice.
United States v. Friedman, 143 F.3d 18, 23 (1st Cir. 1998), citingBallentine v. Eaton, 297 Mass. 389, 8 N.E.2d 808, 809 (1937). "In Massachusetts, an equitable lien may arise from the express agreement of a debtor to pay a creditor out of a specific fund or property." Id., citing Check v. Kaplan, 280 Mass. 170, 182 N.E. 305, 306 (1932) ("[A]s between the parties a right in the nature of a lien on an identified and particular fund may be created [by express agreement] which will in appropriate circumstances be enforced in equity."); Delval v. Gagnon, 213 Mass. 203, 99 N.E. 1095 (1912); Pinch v. Anthony, 90 Mass. (8 Allen) 536, 539 (1864) ("The rule is perfectly well settled, that a party may by express agreement create a charge or claim in the nature of a lien on real as well as personal estate of which he is the owner or possessor, and that equity will establish and enforce such a claim [. . .]."). InFriedman, the court of appeals found that the district court was not clearly erroneous to conclude that the creditor held an equitable lien under Massachusetts law, given that the creditor has arranged a payment plan with the debtor that included a personal guarantee, and issued a forbearance from attaching the property at issue after receiving a written promise that its debt would be satisfied from the proceeds of the property's impending sale. 143 F.3d at 23.
In this case, the standard for finding an equitable lien to exist has not been met. First, the Settlement Agreement does not contain an express agreement to pay. Second, the Settlement Agreement does not identify a specific fund or property from which a payment is to be made; indeed, no such fund or property existed at the time of the agreement, only a contingent right to payment from potential proceeds of the Recovery Action.
In the alternative, GenRe argues that if the Panel agrees with the bankruptcy court's disallowance of its secured claim, its claim should still be allowed as a "priority" claim as originally filed. According to GenRe, its advance of funds to Malden Mills, although pre-petition, resulted in a beneficial post-petition recovery for the debtor's estate in the Recovery Litigation, and therefore was a "substantial contribution" to the bankruptcy case pursuant to 11 U.S.C. § 503(b)(3)(d). The debtor counters that the Settlement Agreement was pre-petition, the funds were obtained pre-petition and were not contributed during the pendency of the bankruptcy case, and therefore GenRe's claims arising out of the Settlement Agreement are pre-petition claims and are not entitled to administrative treatment. The bankruptcy court ruled that "the error in this argument is obvious" and that it "stands the Bankruptcy Code on its head. Under its theory virtually any prepetition creditor can claim it is entitled to a priority. Congress clearly did not intend this result." App. at C, 2. We agree.
In order for a claim to be entitled to administrative priority it must arise after the bankruptcy petition was filed. ARS Brook, LLC v. Jalbert (In re Servisense.com, Inc.), Case no. 03-2512 (1st Cir. September 8, 2004), citing Cramer v. Mammoth Mart, Inc. (In re Mammoth Mart, Inc.), 436 F.2d 950, 954 (1st Cir. 1976). If the claim is based upon a contract between the debtor and the claim holder, the creditor's right to payment has priority only to the extent that the consideration supporting the right to payment was both supplied to, and beneficial to, the debtor in the operation of the business. Id. A "substantial contribution" claim under § 503(b)(3)(D) is limited by the terms of the Bankruptcy Code to activities which occur after the petition filing date. In re Randall's Island Family Golf Centers, Inc., 300 B.R. 590 (S.D.N.Y. 2003); see also, La Electronica, Inc. v. Capo-Roman (In re La Electronica, Inc.), 995 F.2d 320 (1st Cir. 1993), wherein the court of appeals upheld the district court's reversal of the bankruptcy court's allowance of an administrative expense priority claim, concluding that any economic benefit to the debtor's estate had occurred pre-petition, not post-petition.
Finally, the appellant argues that the bankruptcy court erred in resolving the dispute between the parties as a contested matter rather than an adversary proceeding. According to the appellant, the essence of the debtors' objection to its claims was an attempt to have the bankruptcy court determine the validity, priority or extent of GenRe's equitable lien, or other interest, in the settlement proceeds, and to obtain declaratory relief as to the parties' obligations under the Settlement Agreement. However, the debtors counter that they are not objecting to the validity, priority or extent of GenRe's lien; rather, their position is that no such lien was ever in existence, and therefore Rule 7001 does not even apply.
Rule 7001 of the Federal Rules of Bankruptcy Procedure sets forth those proceedings which are adversary proceedings, including proceedings to determine the validity, priority or extent of a lien, and proceedings to obtain declaratory judgment. Objections to claims are contested matters, unless they include a demand for relief of the kind specified in Rule 7001, in which case they become adversary proceedings. Fed.R.Bankr.P. 3007. Objections to the allowance of a secured claim and the determination of a claim's secured status are contested matters; the issues they raise do not require an adversary proceeding. Matter of Beard, 112 B.R. 951, 955 (Bankr. N.D. Ind. 1990). However, "if a secured claim is challenged due to questions concerning the validity of a lien (the existence or legitimacy of the lien itself) [. . .] an adversary proceeding is required." Id.
Nevertheless, in cases where the parties have not been prejudiced, or have not objected, some courts allow such a matter to proceed as a contested matter rather than an adversary proceeding. 10 Lawrence P. King, et al., Collier on Bankruptcy ¶ 7001.01 (15th ed. rev'd 2004). InIn re Friendman, 184 B.R. 883 (Bankr. N.D.N.Y. 1994), the court noted that while a motion seeking to disallow a claim is usually brought before the court as a contested matter pursuant to Rule 9014, the debtor was actually seeking a declaratory judgment regarding the validity or extent of its creditors lien, which would more properly be brought as an adversary proceeding pursuant to Rule 7001(9). Id. at 887. "However, where the rights of the affected parties have been adequately protected and the parties have had an opportunity to be heard, form will not be elevated over substance, and the matter will be allowed to proceed on the merits as originally filed." Id., citing In re Command Servs. Corp., 102 B.R. 905, 908 (Bankr. N.D.N.Y. 1989). Similarly, in In re Braniff Int'l Airlines, Inc., the court noted that while a party seeking a determination as to the validity of a lien should do so by way of an adversary proceeding, "[w]here a party has proceeded by motion and the record has been adequately developed [. . .] courts have reached the merits of the dispute despite the procedural irregularity." 164 B.R. 820, 831 (E.D.N.Y. 1994).
In a recent opinion, the United States Court of Appeals for the First Circuit noted that, although the creditor's action should have been filed as an adversary proceeding rather than by motion as a contested matter, "the standard of proof in these two types of proceedings is the same, the procedural rules are similar, and the proceedings provided [the debtor] with more than adequate notice and an opportunity to be heard," concluding that the debtor was not prejudiced by the creditor's proceeding by motion. In re Valente, 360 F.3d 256, 265 (1st Cir. 2004)
The appellant has not established whether the bankruptcy court's resolution of the parties' dispute as a contested matter affected its opportunity to be heard, the adequacy of its notice of the proceedings, its opportunity to object, its opportunity to conduct discovery, etc. The Panel concludes that, although an adversary proceeding would have been the proper procedural vehicle for determining the objection to claim in this case, the appellant has not demonstrated that the bankruptcy court's decision to handle the issue as a contested matter affected its due process rights, and therefore it is not a ground for reversing the bankruptcy court on procedural grounds.
For the reasons set forth herein, the bankruptcy court's order determining the appellant's proof of claim to be unsecured, denying the appellant's request for leave to file an amended proof of claim to change its status from "priority" to "secured", and denying the appellant's request to allow its claim with "priority" status as originally filed, is AFFIRMED.