IDL Development, Inc.

UNITED STATES BANKRUPTCY COURT

DISTRICT OF MASSACHUSETTS

)

In re: ) Chapter 11

) Case No. 18-14808-CJP

IDL DEVELOPMENT, INC., )

)

Debtor )

)

ORDER SUSTAINING THE DEBTOR’S OBJECTION TO CLAIM #6-1

Upon consideration of the Objection to Priority Claim of Continuum Energy

Technologies, LLC [Claim No. 6-1] [Doc. No. 364] (the “Claim Objection”) of IDL

Development, Inc. (“IDL” or the “Debtor”) to the portion of Claim No. 6-1 filed by Continuum

Energy Technologies, LLC (“CET”) asserting an administrative priority claim in the amount of

$2,141,682.71 pursuant to 11 U.S.C. § 507(a)(2)1 (the “Priority Claim”), Continuum Energy

Technologies, LLC’s Response to Debtor’s Objection to Priority Claim [Doc. No. 388] as

supplemented by the Supplemental Declaration of Todd A. Sullivan, Esq. [Doc. No. 405]

(collectively, the “Response”), the arguments of counsel at a hearing on October 16, 2019

regarding the Claim Objection (the “Hearing”), evidence introduced at prior hearings in this

case, and the docket of this case, the Court sustains the Claim Objection and rules that CET’s

Priority Claim is disallowed for the reasons set forth below.

Facts and Applicable Law

In Claim No. 6-1, CET asserts a total claim in the amount of $38,500,000 for “future

running royalties” pursuant to a license agreement dated March 15, 2018 (the “License

1 While not specifically cited in the Priority Claim, based on the arguments made by CET in subsequent pleadings

and at a hearing on the Claim Objection, the Court understands that CET claims an administrative expense under §

503(b)(1)(A).

Agreement”) by which CET licensed to the Debtor certain patents and other intellectual property

(the “Licensed IP”) relating to electromagnetic chemistry applications using engineered carbon.

CET contends that the Priority Claim should be allowed on account of asserted diminution in

value of the Licensed IP after commencement of the Debtor’s bankruptcy case, consisting of a

daily diminution of $18,786.69 for 114 days that “will continue to accrue until the [License]

Agreement is rejected.” Claim 6-1, Ex. B.

The Bankruptcy Code provides that administrative expenses include “the actual,

necessary costs and expenses of preserving the estate.” 11 U.S.C. § 503(b)(1)(A). Claims for

administrative expenses have priority over, inter alia, general unsecured claims against the

estate. See 11 U.S.C. § 507(a)(2). A party seeking priority treatment has the burden of proving

entitlement to statutory priority. Mason v. Official Comm. of Unsecured Creditors (In re FBI

Distribution Corp.), 330 F.3d 36, 42 (1st Cir. 2003). “In general, for a claim to qualify as an

administrative expense under subsection 503(b)(1), (1) it must have arisen from a transaction

with the trustee or debtor in possession, rather than from a prepetition transaction with the

debtor, and (2) the consideration supporting the claim must have benefitted the estate in some

demonstrable way.” Id. (citing Woburn Assocs. v. Kahn (In re Hemingway Transp., Inc., 954

F.2d 1, 5 (1st Cir. 1992)). These requirements are set forth in the conjunctive and both must be

met for an administrative claimant to be entitled to priority. See, e.g., In re Hopkinton Indep.

Sch., Inc., 499 B.R. 158, 162 (Bankr. D.N.H. 2013) (holding that “if a transaction is determined

not to have benefitted the estate of the debtor, a court need not also determine whether the

transaction took place with the debtor estate”). Additionally, section 503 priorities are to be

construed narrowly “because of the presumption that the debtor has limited resources to equally

distribute among creditors.” In re Kmart Corp., 290 B.R. 614, 621 (Bankr. N.D. Ill. 2003) (citing

Isaac v. Texmex Energy, Inc. (In re Amarex), 853 F.2d 1526, 1530 (10th Cir. 1988) and Cramer

v. Mammoth Mart, Inc. (In re Mammoth Mart, Inc.), 536 F.2d 950, 953 (1st Cir. 1976) (“To give

priority to a claimant not clearly entitled thereto is inconsistent with the policy of equality of

distribution; it dilutes the value of the priority for those creditors Congress intended to prefer.”)).

In a Chapter 11 case, a debtor may determine whether to assume or reject an executory

contract, such as the License Agreement, at any time prior to confirmation. See 11 U.S.C. § 365;

Moody v. Amoco Oil Co., 734 F.2d 1200, 1215 (7th Cir. 1984). In this case, CET appropriately

pursued its available remedies to seek to mitigate the alleged decrease in value of the Licensed IP

by moving to compel the Debtor to assume or reject the License Agreement and by seeking relief

from the automatic stay to terminate the License Agreement. Each of those motions was denied.

In connection with the stay relief motion, the Court (Feeney, J.) held that “CET did not introduce

any evidence from which this Court could find that the Debtor’s interest in the License

Agreement with CET was a ‘wasting asset.’” See Stay Order, [Doc. No. 105] at 2–3. CET sought

leave to appeal the Stay Order to the extent it was deemed to be interlocutory, but the

Bankruptcy Appellate Panel for the First Circuit denied CET’s motion for leave to appeal.

Decision dated May 23, 2019 [Doc. No. 214].

The Debtor ultimately moved to reject the License Agreement on August 30, 2019, after

the Court approved a sale of its assets that did not include the assumption and assignment of the

License Agreement. The Court granted that motion on September 13, 2019. The Debtor asserts

that it did not use the Licensed IP after the petition date, and, therefore, there was no postpetition

“transaction” between the Debtor and CET and no demonstrable benefit to the estate. CET

contends that any intellectual property owned by the Debtor was derivative of the Licensed IP

and that the Debtor benefited its sale process by maintaining the License Agreement during the

period that it marketed its assets.

The terms of the License Agreement are not in dispute. The License Agreement provides

for royalty payments only if the Debtor commercialized the Licensed IP or products using the

Licensed IP. Claim 6-1, Ex. A (Article 2 “Grant of Right” and Article 3 “Royalties and Payment

Terms”). In relevant part, the License Agreement provides that the Debtor shall pay royalties up

to $48,000,000 to CET based upon specified percentages of (i) the Debtor’s net sales of products

developed by the Debtor with the Licensed IP and (ii) income received by the Debtor from

sublicensing the Licensed IP (collectively, the “CET Royalties”). It is uncontested that the

Debtor did not commercialize technology using the Licensed IP by selling any products or

sublicensing the Licensed IP prior to or during its bankruptcy.2 CET acknowledged on the

record at the Hearing that the Debtor did not engage in any postpetition activity that would have

given rise to a payment obligation under the License Agreement.

Analysis

CET is not entitled to administrative priority for a claim arising from the License

Agreement where no postpetition payments became due under the terms of that agreement. See

In re Death Row Records, Inc., No. 2:06-bk-11205, 2014 WL 2526963, at *6 (Bankr. C.D. Cal.

May 9, 2014) (finding no priority claim because the claimant failed to allege any postpetition

sales by the debtor that would arise to entitlement of royalties based on the terms of the contract).

An “actual, necessary cost[] and expense[] of preserving [an] estate” constituting an

administrative expense under § 503(b)(1)(A) entitled to priority under § 507(a)(2) should be

2 The Debtor has acknowledged that it failed to make a $9,500,000 “License Fee Payment” due under the License

Agreement prior to the petition date. The License Fee Payment is the subject of Claim No. 5-1 filed by CET.

narrowly construed to ensure fair distribution of the assets of a bankruptcy estate in accordance

with the distribution priorities established by the Bankruptcy Code. See In re FBI Distribution

Corp., 330 F.3d at 49 n.16 (recognizing that Congress balanced the equities in Chapter 11 “in

favor of reorganization and equality of distribution of the limited assets to all unsecured

creditors” and against counterparties to an executory contract); In re Kmart Corp., 290 B.R. at

621. CET has not met its burden to demonstrate that the Debtor engaged in activity after the

petition date that triggered royalty payment obligations under the License Agreement or

otherwise resulted in a payment obligation under that executory contract. CET received all

consideration to which it was entitled under the License Agreement during the postpetition

period prior to rejection of that contract. The extra-contractual “damage” claim for alleged

diminution in the value of the Licensed IP and “purported” value conferred on the Debtor in its

sale process asserted by CET is speculative and does not meet the requirements of

§ 503(b)(1)(A). Cf. Broad. Corp. of Ga. v. Broadfoot, II (In re Subscription Television of Greater

Atlanta), 789 F.2d 1530, 1532 (11th Cir. 1986) (reducing the allowed amount of an

administrative expense claim to contract payments for services actually used and denying an

administrative expense claim for contract payments for period when services were not used

during a pre-rejection sale process and observing: “That which is thought to have some potential

benefit, in that it makes a business more likely salable, may be a benefit but is too speculative to

be allowed as an ‘actual, necessary cost and expense of preserving the estate.’”).

Generally, a claimant is not entitled to an administrative claim because a debtor does not

immediately reject an executory contract. See, e.g., Kmart Corp., 290 B.R. at 621. CET pursued

its available remedies to protect against the damages that it alleges by seeking to compel

rejection and obtain relief from the automatic stay.3 CET was unsuccessful in persuading the

Court that the alleged diminution in value of the Licensed IP constituted cause to grant either of

those motions; the Court will not now approve an administrative priority claim where the

License Agreement does not provide a basis to claim any amounts due from the Debtor arising

from the Debtor’s postpetition activities. The First Circuit Court of Appeals has noted that

Chapter 11 may be a “harsh reality” for counterparties to executory contracts with a debtor. In re

FBI Distribution Corp., 330 F.3d at 46 n.16, 47. In connection with its claim for administrative

priority, CET asserts a per diem measure of damages based on royalties that may have become

due under the License Agreement if the Debtor had commercialized the Licensed IP. When an

executory contract is ultimately rejected, damages for loss of future potential value of that

contract are properly considered as unsecured, non-priority rejection damage claims. 11 U.S.C.

§§ 365(g)(1), 502(g); see also In re FBI Distribution Corp., 330 F.3d at 42 (citations omitted); In

re Old Carco LLC, 424 B.R. 633, 639–40 (Bankr. S.D.N.Y. 2010) (the Bankruptcy Code

specifically treats rejection damage claims as prepetition claims with general unsecured status

under § 365(g), which allows the non-debtor party to still have a claim against the debtor, and

“that affording rejection claims administrative priority would effectively eliminate the purpose

behind providing a debtor with the power to reject a contract”).

CET has cited no authority supporting the proposition that a claim for administrative

expense priority may be allowed where the underlying contract that has later been rejected does

not provide for any payment obligation on account of a debtor’s postpetition activity.4 Further,

3 See In re FBI Distribution Corp., 330 F.3d at 49 n.16 (recognizing the balance struck by Congress to narrowly

construe administrative expense claims and the remedy of a party to an executory contract to seek to compel

rejection of an executory contract pursuant to 365(d)(2)).

4 The case cited by CET in support of its position falls short because in that case the court approved an

administrative expense claim in the amount of unpaid lease payments provided for under the applicable executory

contract. See Kimzey v. Premium Casing Equip., LLC, No. 16-CV-01490, 2018 WL 1321971, at *6 (W.D. La. Mar.

CET has not cited any case, and the Court has found none, where a court has allowed an

administrative expense claim under § 503(b)(1)(A) for value conferred on an estate that exceeds

amounts that would have been due pursuant to the underlying executory contract.

In cases where an executory contract that is later rejected provides for postpetition

payments, courts will sometimes apply a presumption in favor of the contract “rate” as reflective

of the value of the benefit conferred in the absence of rebuttal evidence that the value conferred

to the estate was less than the contract rate in considering allowance of an administrative expense

claim. See In re Highway Techs., No. 13-11326, 2015 Bankr. LEXIS 308, at *18—19 (Bankr. D.

Del. Jan. 30, 2015) (allowing an administrative expense for number of terminals where software

was actually used, instead of the bargained for use at up to 100 terminals); see also In re

Sportsman’s Warehouse, Inc., 436 B.R. 308, 315 (Bankr. D. Del. 2009) (in the rent context,

explaining that the amount of benefit to the estate is presumed to be the contract rate, but that

may be reduced if the debtor can prove the benefit to the estate is lower); In re Bridgeport

Plumbing Prods., Inc., 178 B.R. 563, 569-70 (Bankr. M.D. Ga. 1994) (in equipment lease

context, the debtor rejected lease more than three months after filing date, but only used

equipment for a total of ten hours, and the court calculated hourly lease amount by hours

equipment actually used for total amount entitled to an administrative claim). It is in this context

14, 2018) (affirming bankruptcy court’s finding due to the absence of a bright line rule in the Fifth Circuit, and

explaining that although there was no direct profit from leased equipment, the leased equipment provided intangible

benefit to the estate). The focus of the court in Kimzey was whether the debtor’s estate benefitted through the

“increased capacity to respond to potential customer demand” and availability of on-site equipment in the event of a

mechanical problem and whether the value of that benefit was the lease payment amount or a lesser amount. See id.

at *1—2; see also In re Kimzey Casing Serv., LLC, No.15-51337, Doc. No 42: Motion for Allowance and Payment of

Administrative Expense Pursuant to 11 U.S.C. § 503(b)(1)(A), at 2 (Bankr. D. La. May 16, 2016) (claimant seeking

an administrative expense for unpaid monthly rental invoices for the equipment pursuant to leases, for a total of

$57,752.93 representing a $11,225.81 11/20/2015 invoice and a $46,527.12 12/23/2015 invoice); accord Kimzey,

2018 WL 1321971 at *1 (“The Bankruptcy Court allowed an administrative expense claim in the amount of

$57,752.93”).

that courts often use broad language regarding a debtor’s obligation to pay the “reasonable

value” of postpetition services or other consideration provided by the counterparty to an

executory contract. For example, the First Circuit Court of Appeals has noted: “If the 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, which, depending on the circumstances of a particular

contract, may be what is specified in the contract.” In re FBI Distribution Corp., 330 F.3d at 45

(emphasis in original) (denying administrative priority claim for severance payments that

became due postpetition). The Court does not read the language of FBI Distribution or the

similar language in other cases to contemplate that an administrative expense claim under

§ 503(b)(1)(A) may be allowed in an amount that exceeds the amount of payment obligations

provided for in the executory contract.

Conclusion

For the reasons above, the Court sustains IDL’s Claim Objection and disallows CET’s

Priority Claim. CET may only assert a general unsecured claim against the estate for rejection

damages. See 11 U.S.C. § 365(g)(1).

Dated: November 1, 2019 By the Court,

KZ A a

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<nristopher J. Panos

United States Bankruptcy Judge