Opinion
Case No. 02-13533 (AJG), (Confirmed Case)
November 10, 2003
MEMORANDUM DECISION AND ORDER DENYING ARC'S REQUEST FOR ADMINISTRATIVE EXPENSE PRIORITY
Commencing on July 21, 2002 and November 8, 2002, WorldCom Inc. and certain of its direct subsidiaries and indirect subsidiaries (collectively, the "Debtors") filed voluntary petitions for relief under Chapter 11 of Title 11 of the United States Code (the "Bankruptcy Code"). The Debtors Chapter 11 cases have been consolidated for procedural purposes only and are being jointly administered pursuant to orders dated, July 22, 2002 and November 8, 2002. Pursuant to §§ 1107(a) and 1108 of the Bankruptcy Code, the Debtors remained in possession of its property and were authorized to continue the operation and management as debtors-in-possession. On October 31, 2003 an order was entered confirming the Debtors' Modified Second Amended Joint Plan of Reorganization Under Chapter 11 of The Bankruptcy Code, Dated October 21, 2003.
Hereinafter, all references to sections are to the Bankruptcy Code, unless otherwise noted.
The Debtors provide a wide range of communication services. On August 28, 1998, American Business Communications Association ("ABC") and the Debtors entered into a contract where, inter alia, ABC would provide the Debtors with leads to obtain customers, and upon the commencement of the billing of customers (the "Customers") for the services provided, the Debtors would pay ABC a commission. The commissions paid to ABC were based upon a percentage of the amount billed to the Customers. The initial term of the Program Agreement (the "Contract") was three (3) years. At paragraph 5, the Contract provided that:
The term of the agreement shall be three (3) year's [sic] from the effective date stated below, and shall automatically renew for one year periods thereafter. As of the end of the initial term or as of the end of any subsequent one (1) year period, either party may terminate this Agreement without cause upon not less than sixty (60) days [sic] prior written notice.
According to ABC, the Contract could only be terminated on August 30 and then, only if written notice was provided sixty (60) days prior, or by June 30. On August 30, 2001 the Contract automatically renewed and ran until August 2002. In September 2001, ABC and the Debtors engaged in correspondence with respect to the Contract. On May 1, 2002, the Debtors sent a letter to ABC alleging that the Contract was terminable upon sixty (60) days' notice and that it was terminating the Contract effective July 31, 2002. Thereafter, ABC informed the Debtors that the May 1, 2002 letter was not an effective termination because the Debtors: position was incorrect. Rather, it was ABC's contention that either party could terminate the Contract at the end of the initial term or at the end of any subsequent one (1) year period, provided that not less than sixty (60) days' prior written notice is given, thus, the Contract could only be terminated at the end of its term (August 28), provided that there was a written notice sixty (60) days prior.
On June 14, 2002, the Debtors made its final payment under the Contract in the amount of $39,432.14, which represented payment commissions through April 2002. The Debtors have paid ABC for work from August 28, 1998 through April 2002. From August 28, 1998 through June 2002, ABC provided the Debtors with leads and the Debtors paid ABC from the Contracts inception up through June 2002, which payment represented commissions due through April 2002. ABC also maintains that upon information and belief, since May 2002 and up through the present, the Debtors have continued to obtain the benefits of the Contract, but have not paid ABC its commissions.
A November 4, 2002 e-mail sent by the Debtors' Marketing-Partner to ABC provided as follows:
Your contract ends in August 2002, so that means that you are in fact due commissions based upon revenue through 8/30/02. This final commission payment based on August revenue should have been paid to you in later October. Meanwhile, the commissions for revenue generated prior to 7/22 are considered pre-petition, as you already know. At some point you will receive a letter from the bankruptcy courts informing you how to petition a claim for this money.
ABC maintains that the Debtors have not paid ABC for services provided from May 2002 through the present. Historically, the commissions due are about $40,000 per month. This information is based upon invoices the Debtors submitted to ABC which set forth the amounts Customers were billed for services provided. ABC, however, cannot state with certainty the amount it is owed. It asserts the amount of the Claim is only ascertainable by a review of the Debtors: records. Based upon the compensation scale set forth in the Contract, in order to generate approximately $40,000.00 in payments, ABC's services must have generated in excess of $500,000.00 in revenue to the Debtors.
ABC asserts that according to § 503(b)(1)(A), creditors: claims for expenses which are comprised of the "actual costs and expenses of preserving the estate" are administrative expenses and may be allowed after the notice and hearing. ABC also contends that § 507(a)(1) provides that administrative expenses under § 503(b)(1)(A) are granted a first priority. ABC further maintains that subsequent to the Petition Date, ABC furnished services to the Debtors as the contract continued in effect, but ABC fails to reference what services they have provided the Debtors subsequent to the petition date.
On July 31, 2003, the Debtors stated, that "ABC ask[ed] the court to convert its pre-petition Commissions from May 2002 into an administrative expense simply because the Termination Letter was not an effective termination and the [Program Agreement] by its terms ran through August 28, 2002 and perhaps thereafter. Indeed, ABC admits that it provided the Debtors with leads only through June 2002." (Paragraph 5 of Debtors: Objection To American Business Communications Associations Application in Support of Motion Seeking Administrative Claim). Further, the Debtors argue that ABC is not entitled to payment of any Commissions as an administrative expense, because ABC cannot demonstrate that the Commissions were actual and necessary expenses of preserving the estate, or that ABC provided any benefit to the Debtors.
Discussion
The basic purpose of Chapter 11 is to rehabilitate the debtor's business. ACongress enacted it as an alternative to straight bankruptcy for businesses which might be successfully rehabilitated rather than being subjected to economically wasteful liquidation." In re Mammoth Mart, Inc., 536 F.2d 950, 953 (1st cir. 1976); Nicholas v. United States, 384 U.S. 678, 684-685 (1966). In order to rehabilitate a troubled business, the debtor-in-possession is free to take all steps necessary to solve the problems created by the debtor's operation of the business in the past See Section 1106(a). Mammoth Mart, 536 F.2d at 954.
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 (S.D.N.Y. 1991).
Pursuant to § 365(d)(2), until a Chapter 11 reorganization plan is confirmed, a debtor-in-possession is afforded substantial latitude in deciding whether to assume or reject an executory contract. In re Enron Corp., 279, B.R. 695, 702 (Bankr. S.D.N.Y. 2002). However, this substantial latitude to assume or reject an executory contract is not without limits. "Under § 365(d)(2), any party to an executory contract may request that the court fix a time within which the debtor must assume or reject an executory contract." In re Enron Corp., 279, B.R. at 702. "If a debtor-in-possession elects to continue to receive benefits from the other party to an executory contract pending a decision to reject or assume the contract, the debtor-in-possession is obligated to pay for the reasonable value of those services." NLBR v. Bildisco Bildisco, 465 U.S. 513, 531 (1984).
A debtor's election to receive benefits under a contract, post-petition, however, does not translate into an obligation to assume the contract because a debtor cannot assume a contract by implication. In re FBI Distribution Corp., 330 F.3d 36, 45 (1st Cir. 2003). The assumption of a contract cannot be implied because notice to the creditors and court approval is specifically required before contractual burdens can be imposed on the estate. In re Child World, 147 B.R. 847, 852 (Bankr.S.D.N.Y.). In the absence of assumption of a contract, a claim can only be based on quantum meiuit. In re Hooker Investments, Inc., 145 B.R. 138, 149-51 (Bankr. S.D.N.Y. 1960). However, if no services are performed post-petition under the contract, the fact that a debtor may receive the economic benefits from pre-petition contract services does not give rise to an administrative claim. Denton Anderson Co. v. Induction Heating Corp., 178 F.2d 841, 844 (2d Cir. 1949); In re Jartran, Inc., 732 F.2d 584 (7th Cir. 1984).
The Debtors did not assume this contract with ABC. As of July 9, 2003, according to the information submitted both by the Debtors and ABC, ABC's unpaid commissions are entirely based upon leads (new customers) furnished by ABC pre-petition. Also, neither ABC's application seeking an Administrative Claim nor its reply to the Debtors Objections, has identified any new customers supplied to the Debtors during the post-petition period. ABC has failed to demonstrate that it provided any services to the Debtors during this post-petition period.
As the Contract was not assumed and because assumption cannot be implied, the claims based on the post-petition breach of the pre-petition contract remain general unsecured claims, unless ABC can establish entitlement to a priority as an administrative expense under § 503(b)(1)(A).
In order for Chapter 11 to be carried out effectively, Congress enacted § 503(a) of the United States Bankruptcy Code, which allows the debtor-in-possession to incur expenses that maintain, preserve, or rehabilitate the bankrupt estate. Mammoth Mart, 536 F.2d at 954. Amalgamated Ins. Fund v. McFarlin's, Inc., 789 F.2d 98, 101 (2d Cir. 1986). These administrative expenses are the actual, necessary costs and expenses of preserving the estate, including wages, salaries and commissions, for services rendered after the commencement of the case. See Section 503(b)(1)(A). Pursuant to § 507(a)(1) of the Bankruptcy Code, these expenses for administering the estate are afforded first priority. Thus, expenses the debtor-in-possession incurs during the reorganization effort are afforded a first priority. Jartran., 732 F.2d 584, 586. This first 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." Mammoth Mart, 536 F.2d at 954. "Congress recognized that if a business is to be reorganized, third parties must be willing to provide the necessary goods and services" in order for that business to function. Mammoth Mart, 536 F.2d at 954. Section 503(a) allows for post-petition debts to be paid ahead of the pre-petition debts and liabilities of the debtor. Absent this incentive, third parties would refrain from dealing with the debtor-in-possession thereby inhibiting the reorganization effort and harming pre-petition creditors. Amalgamated Ins. Fund, 789 F.2d at 101, citing (in Mammoth Mart, 536 F.2d at 954.
These post-petition expenses are known as administrative expenses. Nonetheless, in light of the bankruptcy goal of providing equal distribution of a debtors assets to all creditors, priorities are narrowly construed. Amalgamated Ins. Fund, 789 F.2d at 100. Strictly construing the terms "actual" and "necessary" minimizes the 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 the debtor and a counter-party to the contract becomes a contest among the debtors creditors to share in the distribution of the debtors 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. Enron Corp., 279 B.R. at 705; In re Patient Education Media, Inc., 221 B.R. 97, 101 (Bankr. S.D.N.Y. 1998). The focus of allowance of a priority is to prevent unjust enrichment of the estate, not to compensate the creditor for its loss. In re Enron, 279 B.R. 79, 85 (Bankr. S.D.N.Y. 2002); In re R.H. Macy Co., Inc. 170 B.R. 69, 78 (Bankr. S.D.N.Y. 1994). Thus, a court looks to the actual benefit to the estate received from the post-petition services of the counter-party not the loss sustained by the creditor. In re CIS Corp., 142 B.R. 640, 642 (S.D.N.Y. 1992). The claimant has the burden of establishing entitlement to the priority. Enron Corp., 279 B.R. at 85; Drexel, 134 B.R. at 489.
In order for a claim to be considered an administrative expense, the debt must arise from a transaction with the debtor-in-possession and should also be founded on clear statutory purpose. Mammoth Mart., 536 F.2d at 954; Jartran, 732 F.2d at 586; Amalgamated Ins. Fund, 789 F.2d at 101. If the creditors claim does not comport to the underlying purposes of § 503, then the claim must be denied. Jartran, 732 F.2d at 586. The Court in Mammoth Mart devised a two part-test in determining whether a petitioner was entitled to an administrative expense priority. A claim will be afforded first priority if a debt
(1) arises from a transaction with the debtor in possession, and
(2) is beneficial to debtor in possession in the operation of the business.
Mammoth Mart, 536 F.2d at 954; Jartran, 732 F.2d at 587. Both prongs must be met. Id.
With respect to the benefit to the estate, the inclusion of the words "actual" and "necessary" in § 503(b)(1)(A) requires that the estate receive a "real benefit from the transaction." Drexel, 134 B.R. at 488. A potential benefit is not sufficient. Id. An option or a potential to benefit the estate, does not equal a benefit to the estate. R.H. Macy Co., 170 B.R. at 78. A claim based on a mere potential to benefit the estate premised on contingency is not entitled to priority, because it is not an actual value received to preserve, maintain or rehabilitate the estate. In re Kessler, 23 B.R. 722, 724 (Bankr. S.D.N.Y. 1982), aff'd, Amalgamated Ins. Fund v. Kessler, 55 B.R. 735 (D.C.N.Y. 1985).
With respect to the requirement that the claim arise from a transaction with the debtor in possession, the services at issue must have been "induced" by the debtor-in-possession, not the pre-petition debtor. Jartran, 732 F.2d at 587, citing, Mammoth Mart, 536 F.2d at 587. Requiring this inducement ensures that unnecessary services are not afforded this priority but that it is reserved only for services that preserve, maintain or rehabilitate the bankrupt estate. Mammoth Mart, 536 F.2d at 955; Jartran, 732 F.2d at 587. Pre-petition claims or contracts that may result in a benefit to the estate post-petition are not entitled to administrative priority, because consideration was supplied pre-petition. Mammoth Mart, 536 F.2d at 954; Jartran, 732 F.2d at 587; Denton Anderson Co. v Induction Heating Corporation, 178 F.2d 841, 844 (2d Cir. 1949). 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, 732 F.2d at 588, 590. Thus, benefit to the debtor-in-possession is not sufficient by itself to warrant entitlement to an administrative expense priority as it would be contrary to this policy reason for allowing the priority.
In this case, ABC contends that their claim should be allowed as an administrative expense because the Debtors accepted the benefits of ABC's pre-petition work during the post-petition period. Although the Debtors may have enjoyed the benefits of ABC's pre-petition "leads" during the post-petition period, "the transaction out of which these benefits arose was completed" during the pre-petition period. Jartran, 732 F.2d at 589. ABC fails to demonstrate it provided the Debtors with "leads," or any other services under the contract, subsequent to the Debtors: filing for bankruptcy. Therefore, this matter is outside of the scope of § 503(b)(1)(A) since, by definition, the absence of any post-petition performance of services would preclude a claimant from establishing the inducement prong of Mammoth Mart.
Based upon the foregoing ABC has failed to establish its entitlement to an administrative expense priority under §§ 503(b)(1)(A) and 507(a)(1).
Therefore, it is hereby
Ordered ABOs request for an administrative expense priority pursuant to §§ 503(a)(1)(A) and 507(a)(1) is denied in its entirety.