Filed: Aug. 28, 1998
Latest Update: Mar. 02, 2020
Summary: IN THE UNITED STATES COURT OF APPEALS FOR THE FIFTH CIRCUIT _ No. 97-50584 _ IN THE MATTER OF H.L.S. ENERGY CO., INC., Debtor. STATE OF TEXAS, Appellee, VERSUS JOHN PATRICK LOWE, Trustee, Appellant. _ Appeal from the United States District Court for the Western District of Texas _ August 28, 1998 Before JOLLY, SMITH, and BARKSDALE, Circuit Judges. JERRY E. SMITH, Circuit Judge: At issue is the priority to be afforded a state's claim on a bankrupt estate, for costs incurred by the state in satisf
Summary: IN THE UNITED STATES COURT OF APPEALS FOR THE FIFTH CIRCUIT _ No. 97-50584 _ IN THE MATTER OF H.L.S. ENERGY CO., INC., Debtor. STATE OF TEXAS, Appellee, VERSUS JOHN PATRICK LOWE, Trustee, Appellant. _ Appeal from the United States District Court for the Western District of Texas _ August 28, 1998 Before JOLLY, SMITH, and BARKSDALE, Circuit Judges. JERRY E. SMITH, Circuit Judge: At issue is the priority to be afforded a state's claim on a bankrupt estate, for costs incurred by the state in satisfa..
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IN THE UNITED STATES COURT OF APPEALS
FOR THE FIFTH CIRCUIT
_______________
No. 97-50584
_______________
IN THE MATTER OF
H.L.S. ENERGY CO., INC.,
Debtor.
STATE OF TEXAS,
Appellee,
VERSUS
JOHN PATRICK LOWE,
Trustee,
Appellant.
_________________________
Appeal from the United States District Court
for the Western District of Texas
_________________________
August 28, 1998
Before JOLLY, SMITH, and BARKSDALE, Circuit Judges.
JERRY E. SMITH, Circuit Judge:
At issue is the priority to be afforded a state's claim on a
bankrupt estate, for costs incurred by the state in satisfaction of
the estate's post-petition environmental obligations. Because we
conclude that such costs are “actual, necessary costs and expenses
of preserving the estate,” see 11 U.S.C. § 503(b)(1)(A), we affirm
the district court's order that they be given priority as
administrative expenses.
I.
In 1991, H.L.S. Energy Co., Inc. (“HLS”), filed for bankruptcy
reorganization under chapter 11. A large part of its assets
consisted of operating interests in oil and gas wells in Texas,
some of which were productive and some not. The chapter 11
trustee's basic plan of reorganization seems to have been to rid
HLS's viable assets of the burden posed by its unviable ventures.
This he achieved by selling off that which was profitable.
In 1994, once most or all of HLS's valuable assets had been
sold, the bankruptcy proceeding was converted from a chapter 11
reorganization to a chapter 7 liquidation. In this appeal, the
chapter 7 trustee, John Lowe, challenges the priority of a claim by
the State of Texas arising out of the chapter 11 proceeding.
During the pendency of the chapter 11 proceeding, the state
brought an informal enforcement action against the bankrupt estate
in order to secure its compliance with certain environmental
regulations. Specifically, the Texas Railroad CommissionSSwhich
oversees all oil and gas production in the stateSSsought to require
HLS to plug certain inactive oil wells in which HLS had the sole
operating interest. The action was brought pursuant to 16 TEX.
ADMIN. CODE § 3.9 (1998) (Tex. R.R. Comm'n, Plugging), which requires
that “[p]lugging operations on each dry or inactive well must be
2
commenced within a period of one year after drilling or operations
cease.”1
The wells had ceased production at various dates, some before
and some after initiation of the chapter 11 proceeding. None,
however, had been inactive for more than one year prior to the
bankruptcy.
At the time, the bankrupt estate had insufficient funds with
which to plug the wells. After some negotiation, the chapter 11
trustee reached an agreement with the state whereby the state would
plug the wells and charge the cost of plugging to the bankrupt
estate. The state also agreed to waive substantial penalties that
had accumulated while the wells remained unplugged. The cost to
the state of plugging the wells was $41,808, for which it claimed
reimbursement.
During the chapter 7 liquidation, the state asserted that its
claim should be entitled to priority over those of other unsecured
creditors under 11 U.S.C. § 503(b)(1)(A), as a necessary
administrative expense. The trustee disputed this
characterization. The bankruptcy court found, and the district
court agreed, that the state's claim should be entitled to
priority.
1
See also TEX NAT. RES. CODE ANN. § 89.011 (Vernon 1978) (“The operator of
a well shall properly plug the well when required and in accordance with the
commission's rules”); TEX NAT. RES. CODE. ANN § 89.121(a) (granting enforcement
authority to the Commission).
3
II.
A.
The state argues that in the proceedings below, the trustee
waived his argument that the state's claim should not be entitled
to priority. Having reviewed the record, we disagree.
Throughout the proceedings, the trustee consistently and
steadfastly maintained that the state's claims should be entitled
only to general unsecured status. The state makes much of the
trustee's statement to the bankruptcy court that “if the Court is
inclined to grant administrative expense status to this claim, it
should be granted status only as a Chapter 11 administrative
expense claim because that is consistent with the terms of the
agreed order.”
This statement is not a waiver. Rather, the initial caveat
demonstrates that it is an argument in the alternative: Even if
the claim were to receive chapter 11 priority, the trustee argued,
it should not receive chapter 7 priority as well.2 Consequently,
the trustee's objection to the chapter 11 administrative expense
status of the state's claim was not waived and is properly
presented on appeal.
B.
2
The question whether the claim should be entitled to chapter 7 priority
is no longer in dispute, for it appears that there is enough money to pay all the
chapter 11 administrative claims.
4
The state asserts that the terms of the Agreed Order conferred
administrative priority on the state's claim, regardless of whether
bankruptcy law would have so characterized its claim. This
averment encounters two obstacles: First, it is far from certain
that the Agreed Order purported to confer such priority status on
the state's claim. Second, the trustee argues that he was never
party to that orderSSafter all, he had not even been appointed
trusteeSSand cannot be bound thereby. The state responds that the
creditors' committee was a party to the order and that, inasmuch as
Lowe now challenges the state's priority on behalf of those
creditors, he is bound by the acquiescence of his principals.
Rather than engage these arguments, we address the merits of
whether this claim may be afforded administrative expense priority
under the bankruptcy law. Because the state prevails on the
merits, the terms and effect of the Agreed Order with regard to the
administrative priority are of no consequence.
III.
The Bankruptcy Code provides that “the actual, necessary costs
and expenses of preserving the estate” are characterized as
administrative expenses, 11 U.S.C. § 503(b)(1)(A) (1994), entitled
to priority over the claims of other unsecured creditors, id.
§ 507(a)(1) (1994). In Reading Co. v. Brown,
391 U.S. 471, 485
(1968), the Court provided an expansive interpretation of what is
5
an “actual, necessary cost” entitled to priority, holding that
damages in negligence to a third party arising out of the
receiver's administration of the estate give rise to an “actual and
necessary cost.” “It is theoretically sounder . . . to treat tort
claims arising during [a bankruptcy] arrangement as actual and
necessary expenses of the arrangement rather than debts of the
bankrupt.” Id. at 483.
Reading has survived subsequent revisions to the Code, as the
underlying statutory provision was left essentially unchanged. See
In re Al Copeland Enters., 991 F.2d 233, 239 (5th Cir. 1993). The
question is whether Reading and § 503(b)(1)(A) apply here to
characterize the state's claims as administrative expenses, imbued
with priority status.
An “actual and necessary cost” must have been of benefit to
the estate and its creditors. See, e.g., In re Transamerican
Natural Gas Corp., 978 F.2d 1409, 1416 (5th Cir. 1992). This
requirement is in keeping with the conceptual justification for
administrative expense priority: that creditors must pay for those
expenses necessary to produce the distribution to which they are
entitled. See 3 DANIEL R. COWAN, BANKRUPTCY LAW AND PRACTICE
§ 12.23(e)(1), at 83 (6th ed. 1994). “That is, the costs of
salvage are to be paid.”
Id. The “benefit” requirement has no
independent basis in the Code, however, but is merely a way of
testing whether a particular expense was truly “necessary” to the
6
estate: If it was of no “benefit,” it cannot have been
“necessary.” See LAWRENCE P. KING, ED., 4 COLLIER ON BANKRUPTCY
¶ 503.06[3][b] (15th rev. ed. 1998).
The trustee argues that the costs incurred by the state in
connection with plugging the unproductive wells did not “benefit”
the estate. Of course this is trueSSin the sense that the bankrupt
estate and its creditors would have been happy to abandon the
unproductive wells, leaving them unplugged in abdication of HLS's
obligations under Texas law. But bearing in mind that the
“benefit” requirement is simply a gloss on the underlying concept
of what is “necessary,” our notion of “benefit” cannot be limited
to the narrow sense that the trustee urges.
Under federal law, bankruptcy trustees must comply with state
law. See 28 U.S.C. § 959(b). Furthermore, a bankruptcy trustee
may not abandon property in contravention of a state law reasonably
designed to protect public health or safety. See Midlantic Nat'l
Bank v. New Jersey Dep't of Envtl. Protection, 474 U.S. 494, 507
(1986). And there is no question that under Texas law, the owner
of an operating interest is required to plug wells that have
remained unproductive for a year.3 See 16 TEX. ADMIN. CODE § 3.9
(1998) (Tex. R.R. Comm'n, Plugging). Furthermore, because the
3
The trustee asserts that the obligation to plug a well arises as soon as
it becomes unproductive. He is incorrect as a matter of law. Operators are
required to commence plugging within a year of the cessation of production. See
TEX. NAT. RES. CODE ANN. § 89.011; 16 TEX. ADMIN. CODE § 3.9. Thus, prior to the
passage of one year he may plug the wells, but after the passage of that year,
he is in violation if he does not.
7
wells became inactive post-petition or after a year prior to the
petition, the plugging obligations on these wells accrued post-
petition. See id. Thus, a combination of Texas and federal law
placed on the trustee an inescapable obligation to plug the
unproductive wells, an obligation that arose during the chapter 11
proceedings.
The fulfillment of this, the estate's obligation, can only be
seen as a benefit to the estate. In this sense, the state's action
resembles the sort of “salvage” work that lies at the heart of the
administrative expense priority. No one would challenge the
expense of shoring up the sagging roof on a bankrupt's warehouse,
for example, where carpentry was needed to prevent further damage
to the structure or liability from injury to passers-by. Cf.,
e.g., 4 King, supra, ¶ 503.06[1] (examples of “proper” expenditures
including repairs and upkeep). The laws of Texas compelled action
in this case just as surely as would the laws of physics in that
one. The unplugged unproductive wells operated as a legal
liability on the estate, a liability capable of generating losses
in the nature of substantial fines every day the wells remained
unplugged.
This case is not unlike our decision in Al Copeland, in which
the chapter 11 debtor had failed to remit sales tax revenues it had
collected and were due to the state under Texas law. Furthermore,
Texas law required the debtor to pay interest on revenues collected
8
that remained unpaid. Because the trustee was required to manage
the estate in accordance with state law, see 28 U.S.C. §§ 959(b)
and 960, it had been required ab initio to remit the tax revenues.
Therefore, the interest that accrued as a result of his post-
petition decision not to pay was an administrative expense: an
“actual and necessary cost” comparable to the “damages resulting
from the negligence of the receiver” in Reading. See Al Copeland,
991 F.2d at 238-240 (quoting
Reading, 391 U.S. at 485).
Just as the Al Copeland trustee was obligated under Texas law
to remit the sales tax revenues, the trustee here was obligated
plug the wells.4 The failure of the trustee in Al Copeland to
fulfill his state law obligations resulted in further liability
under state law, liability that was given priority as an
administrative expense. Similarly, the instant trustee's failure
to plug the wells resulted in the state's action in plugging them,
an action for which the bankrupt estate was obligated to pay.
This, too, must be given priority.
IV.
The trustee contends that the the chapter 11 trustee never
4
In fact, there is reason to believe that the decision to cease production
on the wells was an economic one: The wells had been depleted to the point at
which they cost more to operate than they produced revenue. Thus, the trustee
likely could have avoided the need to plug the wells by resuming production, but
made a rational economic calculation to cease production. Such a calculation,
however, must include the cost of plugging operations as a cost of ceasing
production.
9
“operated” the wells so as to render costs associated with the
wells of benefit to or necessary to his management of the estate.
Again, Texas law directly dictates otherwise.
Of course, the chapter 11 trustee never did anything with the
wells: The whole point of this case is that he neither produced
oil from nor plugged them. Still, the bankrupt estate possessed
the sole operating interest in the wells. Anyone possessing the
sole operating interest in an unproductive well surely would be
happy to abandon that interest, and the concomitant obligation to
plug that well. But he cannot, for Texas law requires well
operators to plug their wells when they are finished with
production. See TEX. NAT. RES. CODE ANN. § 89.011.
It therefore matters not whether the bankrupt estate produced
any oil or received any revenue from the wells. As the operator,
it was required to plug them.
V.
Because the plugging requirement here accrued post-petition,
we need not reach the question whether post-petition expenses for
the remediation of pre-petition environmental liabilities would
likewise constitute an administrative expense. But because we
conclude that the cost of plugging the wells in accordance with
Texas law was an “actual and necessary cost” of managing the
estate, we agree that such cost must be afforded priority as an
10
administrative expense. The order granting priority is AFFIRMED.
11
